National debt to soar as price of Bacon"s 'bad bank" solution

Michael Somers still runs the National Treasury Management Agency (NTMA), the semi-autonomous agency which successfully managed the huge government debts built up during the economic hard times of the 1980s. Such crisis days across the island were believed to be long over. Then, with little regulatory scrutiny, the banks loaned outrageous amounts of money to a small group of property developers. The property sites are now worth a lot less than the developers paid for them but these overvalued assets or loans remain on the banks" accounts, threatening to destabilise the economy and public finances for a generation to come. So step forward silver-haired Peter Bacon, who, all going well, may - like Somers - become known as the man who came up with a plan to save the economy from another debt crisis. Bacon is a self-confident independent consultant who has been in and around government circles for the past decade. Long before the property bubble, he urged various finance ministers to turn down the heat on the residential property market by stopping tax breaks for investors. Bacon is the most able of advisers but it would be going too far to believe claims that Ireland would have avoided the depths of the property and banking crash if his advice had been followed. However, it is to Bacon"s audacious plan to solve the banking crisis that Taoiseach Brian Cowen, Minister for Finance Brian Cowen and their cabinet colleagues have turned. Bacon proposes to seize all the land and property development sites the Dublin-based banks hold as security for their now devalued loans to developers, including greenfield land banks, residential and office blocks and shopping centres in the Republic, the North, Britain and elsewhere. The whole lot would then be transferred out of the banks for the next 10-15 years into a new NTMA-like Irish government agency, called NAMA, or the National Asset Management Agency. NAMA, Bacon hopes, will prove to be the 'bad bank" tool the Swedes used to solve a property and banking implosion that threatened their economy in the early 1990s. Bacon"s abridged report, which was released to journalists last week, is probably one of the clearest, jargon-free and concise economic studies of its type. NAMA, he says, will be no free lunch for a generation of Irish taxpayers, who will have to take on huge extra debts as the unpalatable but necessary price of saving reckless banks. The report recommends NAMA to be set up as a transparent agency to restore confidence in the Irish economy abroad. All the more unfortunate then that Bacon agreed to excise from his report an estimate of the tens of billions of euro in debt the Irish taxpayer will have to carry after buying the devalued property sites from the banks. Government and NTMA officials unconvincingly claimed last week that disclosing the figure at this time would compromise their negotiations with the banks. Paraphrasing Bacon"s own words, this is how he believes NAMA will work. The agency buys, at a discount, all the property-related loans clogging up the six Irish banks. It becomes the new owner of the greenfield site, shopping centre or empty office block in Dublin, Wicklow, Belfast and elsewhere. Bacon wants to take the whole haul of property loans, be they fair, fairly bad or unspeakable, out of the six Dublin-based banks. Those loans have a face value of €80-90bn, a remarkable figure which stands for the huge recklessness of a bunch of senior bank executives in the last five years. Shrinking It represents over half the annual output of a shrinking economy, and about three times more than the Government will raise in taxes this year. Paraphrasing the report, Bacon says that 'at the heart of' the Irish banking crisis lie the fears of international markets that the banks here will fail to raise enough money to fill in the black holes when they write down the value of those €89-90bn property loans to realistic prices. 'Several well publicised regulatory failures and dubious practises at a number of institutions' have also heightened international concern, he says. The total €80-90bn loans the six Irish banks gave to property developers to buy land and develop sites are now worth only €xbn, with the new value excised from the report. The so-called impaired loans are so huge that initiatives taken so far have failed to convince private investors to put money into the Irish banks. If this continues to be the case, the banks will become zombie banks and economic recovery will be impaired. But it gets worse. The longer this goes on, the greater the risk that speculators will push up sovereign Irish interest rates to crisis levels. We therefore need a plan, and quickly, to place the banking system on a sound footing, he says. Meantime, international investors who lend to the Irish Government are uncertain how to value the €440bn liability the Government took on last September when it guaranteed the deposits and the bond debt in the banks. Unfortunately, the guarantee hasn"t stopped people withdrawing their savings and accounts from Irish banks. All this has helped push up the cost of sovereign Ireland borrowing abroad. Restoring stability, he says, involves removing all doubts that the banks have adequate reserves to meet their big loan losses. Recapitalisation, asset guarantee schemes (as proposed by the British) and asset management schemes, like NAMA, are three ways of dealing with banking crises of this type, he says. Bacon notes that there have been many recapitalisation schemes put in place in the US and the EU, including Ireland, where the Government has pledged to inject €3.5bn each into AIB and Bank of Ireland. Under asset guarantee schemes, the State insures the loans which stay with the banks and they are not written down, immediately, to reflect the current reality of much lower land prices. ING, Citigroup, Bank of America and RBS have participated in such schemes, the report says. But under NAMA-like asset management schemes, the State forces banks to sell it their troubled loans at an agreed discount. The banks take the hit on the property loan losses immediately but, in future years, should more easily raise money for the now cleansed banks. But buying out the loans means that Government debt soars because, even at a discounted price, the State is paying a huge amount of money. Sweden used the asset management scheme to aid UBS and Securum/Nordbanken in the 1990s. Of the three schemes, the guarantee scheme looks appealing because there are no upfront costs to taxpayers. But Bacon believes that it would not work here because we already have a €440bn scheme that, since last September, guarantees all the deposits and the bond debt in the banks. The guarantee has not worked smoothly because 'the resulting confusion' has caused a big jump in borrowing costs for the Irish State. No free lunch There can be no free lunch. 'Capital markets have not grappled well with the contingent liability of €440bn created by the guarantee deposit scheme' so they are unlikely to give Ireland the benefit of the doubt for a second insurance scheme. He says the creditworthiness of Ireland has become 'inextricably bound up' with fears that the banks do not have enough money. A second guarantee, where the State underwrites the bad property loans, will more than likely only make matters worse, Bacon suggests. A NAMA-like scheme where a government agency takes on the property loans has a few advantages for the Irish crisis, the report says. The bad loans are taken as far away from the bankers who created the problems in the first place, helping to break the 'crony capitalism' between bankers and developers who created the mess in the first place. The NAMA scheme also holds out hope that, over 10 or 15 years, the property sites can be sold at higher prices. Developers here are privately incorporated and, unlike in Britain and the US, cannot tap stock market private funds with heavily discounted rights issues to pay back the banks. Bacon believes there is little choice for the taxpayer here but to pick up the bill. 'The disadvantage, obviously, is that it adds substantially to the national debt,' he says. But the pain may not stop there. The banks may be cleansed but they may still require more capital after the sale of property assets. It appears the Government will likely have to inject more money in return for majority stakes in the banks. Bacon favours retaining some form of stock market listing for the banks as a way of ensuring the State can, in time, get its money back if property values fall more than it bargained for. He says there can be no half measures, such as the Government promising to pay a sort of balloon-payment in 10 years" time. The taxpayer will have to take the pain immediately and for many years to come. It shows the severity of the crisis that the Government is backing Bacon"s politically unpopular prescription.