ANALYSIS:The objective of the €10bn fund for the banks is not clear: is it to massage share values or to encourage more lending,? asks Michael Casey
THE GOVERNMENT'S decision to set up a fund of €10 billion for the purpose of recapitalising the banks is a curious one because there is not a shred of hard evidence to indicate that the banks are short of capital.
The Central Bank and Financial Regulator and the banks themselves have repeatedly denied that capital adequacy is a problem. The 20 PwC accountants who were sent into the banks to go over the books came to exactly the same benign conclusion.
The "establishment" view is that the banks are not short of capital and that they have adequate , indeed "robust", capacity to absorb impaired debts now and in the future.
We know, however, that speculators are continuing to adopt the opposite view. And this is what is driving down the share values of the banks. The speculators, and some academic economists, seem to be basing their view on the experience of some other countries where banks were exposed to the property market. They clearly do not believe one word of the establishment line. Which side is right? We don't know yet, but we will early in the new year.
This extraordinary difference of opinion is reminiscent of the currency crisis of 1992. Many economists believed that the Irish pound was not overvalued at the time but the speculators were not interested in looking at any data or analyses.
They had made up their minds about the currency and about the minister in charge at the time. Huge bets against the currency were placed by speculators in London. And because the Irish markets were, and still are, very small by international standards, the weight of money won the day. The currency was devalued.
The rights or wrongs sometimes don't matter. If big players get a bee in their bonnets about the assets of a small country, then it is often extremely difficult to defend the value of those assets. (The seriousness of the currency crisis was lightened by the fact that the church accused speculators of committing sin, and the trade union movement drew up a blacklist of Irish banks that were deemed to be speculating against the Irish pound!)
The point is that many speculators don't care about fundamentals or empirics; if they can develop a momentum and if they have enough money to gamble, then they can often achieve a self-fulfilling result.
If this is what is happening now there may be no option but to bow to the inevitable. Whether the Minister for Finance believes the establishment line or the speculators' hunch, probably doesn't matter all that much. The speculators have clearly won the first round by forcing him to set up the recapitalisation fund whether it is needed or not. The speculators have rewarded the Minister already by pushing up the share values a little bit though the gains didn't last long.
What is not clear, however, is the strategic objective of the Government action. Is it to massage share values or to encourage the banks to lend more to Irish companies?
It is true that low share values make it difficult for institutions to raise more capital in the future. But the banks themselves have said that they have adequate capital and have no intention of tapping existing shareholders. Another issue may relate to the possibility of Irish banks being snapped up on the cheap by the institutions of other countries. So what? We live in a globalised world. New Zealand doesn't have one New Zealand-owned bank. There are no UK-owned car manufacturers left. Nationality of ownership should not be a strategic concern.
In fact foreign ownership of "Irish" banks would even reduce the need for financial regulation in this country. Is that, by any chance, the hidden agenda?
The Department of Finance, the Central Bank and the Financial Regulator would certainly be most unhappy if Irish banks were taken over by foreign institutions and the need for domestic regulation were substantially diminished.
Banks will probably not lend much more to Irish companies even if they do acquire additional capital. They now realise belatedly that they took risks lending for property; it is unlikely that they will now take on more risks by lending to companies in the grip of a recession.
Traditionally, Irish banks have been very conservative with regard to venture capital. It almost seems as if the Government wants to use the banks to administer a soft lending programme for industries in difficulty. If that is the aim then complete nationalisation of one or two entities might be the way to go.
It really is difficult to interpret what exactly the Government is hoping to achieve. There is some vague talk about strengthening the banks so as to grow the economy. This is fantasy.
Suppose a firm does get a loan from a bank and starts to produce more goods. It won't be able to sell them because demand has slumped in the recession. The goods pile up as unsold stock on the shelves. The firm is now in worse trouble. Does it then get another loan merely to pile up more debt and unsold stock?
One hopes that there is more to the Government scheme than this. Supply does not create its own demand.
Of course nothing has really happened yet. The Government has merely set up a facility totalling €10 billion. Because it involves the pension reserve fund the impression is given that it won't cost the taxpayer anything. This is wrong and, in the interests of transparency, this impression should be corrected as soon as the scheme is finalised.
The scheme is something of a double-edged sword. If and when the chief executive of a bank arrives at Government Buildings looking for a share of the fund, he or she will, by definition, be admitting to three serious errors. One, that the capital was inadequate all along. Two, that earlier protestations to the contrary were misleading.
And three, that the bank concerned had been badly mismanaged for several years. The chief executive will also be telling the nation that the establishment view was incorrect and misleading all along. The cat will be out of the bag.
The individual bank concerned will get some capital (on terms to be announced) and the chief executive will, presumably, have to stand down. By setting up the fund in this way the Minister may have posed a moral dilemma for the chief executives. If they come forward to save their banks it may well be at the cost of their jobs and reputations. It would also raise questions about the authorities in terms of the regulatory job they did and their analysis of the situation.
Consolidation is the other way forward and this has merit. But are the banks going to sort this out among themselves without a hard push from Government?
This option, too, will have adverse implications for senior positions in banks. In some respects the recapitalisation fund lets the banks off the consolidation hook.
In any case, it will be interesting to see which bank executives, if any, come forward with their hands up and their letters of resignation in their back pockets. If even a short queue forms at Government Buildings in January we will finally know that the speculators' hunch was correct and that the establishment view was wrong.
If no queue forms we will still be in the dark.
Michael Casey is a former chief economist with the Central Bank and a former member of the board of the International Monetary Fund.