Economics 1/08/2009: NAMA – alternatives Part IV

“This note …evaluates various restructuring options for systemically important banks. The note assumes that the government aims to reduce the probability of a bank’s default and keep the burden on taxpayers at a minimum [a tall assumption for own Government, but hey…].

…If debt contracts can be renegotiated easily, the probability of default can be reduced without any government involvement by a debt-for-equity swap. Such a swap, if appropriately designed, would not make equity holders or debt holders worse off. However, such restructurings are hard to pull off in practice because of the difficulty of coordinating among many stakeholders, the need for speed, and the concerns of the potential systemic impact of rewriting debt contracts.

When debt contracts cannot be changed, transfers from the taxpayer are necessary. Debt holders benefit from a lower default probability. Absent government transfers, their gains imply a decrease in equity value. Shareholders will therefore oppose the restructuring unless they receive transfers from taxpayers.

The required transfer amounts vary across restructuring plans. Asset sales are more costly for taxpayers than asset guarantees or recapitalizations. [We know thi – NAMA will ask us to pony up €60bn in bonds, plus another €10bn+ in recapitalization funds on top of already awarded €7bn+ – all for bailing out a system that in its entirety is worth no more than €10bn]. This is because sales are not specifically targeted to reduce the probability of default. Guarantees or recapitalizations affect default risk more directly. Transfers can also be reduced if the proceeds of new issues are used to buy back debt.

Depending on the options chosen, restructuring may generate economic gains. These gains should be maximized. Separating out bad assets can help managers focus on typical bank management issues and thereby increases productivity. Because government often lacks the necessary expertise to run a bank or manage assets, it should utilize private sector expertise [Now, if you read NAMA legislation, the system will rely on NAMA-own employees to run risk and credit committees – what ‘private sector expertise’?]. Low up-front transfers can help prevent misuse of taxpayer money [Well, NAMA will have up-front transfers of some €60bn!In contrast, my proposal for the banks to take market-driven writedowns before NAMA transfers would minimise this.]. Moreover, the design of bank managers’ compensation should provide incentives to maximize future profits.

If participation is voluntary, a restructuring plan needs to appeal to banks. Bank managers often know the quality of their assets better than the market does. This means banks looking for new financing will be perceived by the market to have more toxic assets and, as a result, face higher financing costs. Banks will therefore be reluctant to participate in a restructuring plan and demand more taxpayer transfers. A restructuring that uses hybrid instruments – such as convertible bonds or preferred shares – mitigates this problem because it does not signal that the bank is in a dire situation. [Of course, NAMA is all about one instrument – taxpayers’ cash] In addition, asset guarantees that are well designed can be more advantageous to taxpayers than equity recapitalizations. [Well, of course we had no ‘well-designed’ guarantees – we have a blanket guarantee. And thus we also have subsequent recapitalizations. And now NAMA. And after NAMA – more recapitalizations… I mean this Government and its advisers wouldn’t last long in a junior policy research job at the IMF…] A compulsory program, if feasible, would obviously eliminate any signaling concerns. Information problems can also be mitigated if the government gathers and publicizes accurate information on banks’ assets. [NAMA is a compulsory programme. And yet, despite the IMF advice, it is reliant on a sweet-heart deal for the banks with total disregard for the taxpayers’ interests. Reckless? Venal? You decide.]

In summary, systemic bank restructuring should combine several elements to address multiple concerns and trade-offs on a case-by-case basis. In any plan, the costs to taxpayers and the final beneficiaries of the subsidies should be transparent. [NAMA legislation makes its operations fully concealed from any public scrutiny and fully indemnified against any charges of reckless waste of taxpayers’ resources. It even makes it impenetrable to the courts.] To forestall future financial crises, managers and shareholders should be held accountable and face punitive consequences. [This is explicitly prevented in the NAMA legislation] In the long run, various frictions should be reduced to make systemic bank restructuring quicker, less complex, and less costly.

I rest my case. In a nutshell, even by IMF standards, NAMA is a monster that will willingly or recklessly defraud the Irish taxpayers.