…No less a financial publication than the Wall Street Journal has come to the conclusion that “in a perfect world, S&P wouldn’t exist. And neither would its rivals Moody’s Investors Service and Fitch Ratings Ltd. At least not in their current roles as global judges and juries of corporate and government bonds.”[4] As its financial editor Francesco Guerrera wrote quite eloquently in the aftermath of S&P’s bold threat to downgrade the U.S. Treasury’s credit rating: “The historic decision taken by S&P on Aug. 5 is the culmination of 75 years of policy mistakes that ended up delegating a key regulatory function to three for-profit entities.”

The behavior of leading banks and ratings agencies Cleveland and other similar cases – of promising to give good ratings to states, counties and cities that agree to pay off short-term bank debt by selling off their crown jewels – is not ostensibly criminal under the law (except when their hit men actually succeed in assassination). But the ratings agencies have made an compact with crooks to endorse only public borrowers that agree to pursue such policies and not to prosecute financial fraud.

To acquiescence in such economically destructive financial behavior is the opposite of fiscal responsibility. Cutting federal taxes and Social Security payments to obtain a more positive S&P “opinion” would give banks an ability to “pull the plug” and force privatization and anti-labor austerity plans by refraining from rolling over the U.S. debt – and cutting taxes Tea-Party style rather than funding spending by taxation on a pay-as-you-go-basis.

The present meltdown of the euro provides an object lesson for why policy-making never should be left to central bankers, because their mentality is pro-creditor. Otherwise they would not have the political reliability demanded by the financial sector that has captured the central bank, Treasury and regulatory agencies to gain veto power over who is appointed. Given their preference for debt deflation of the “real” economy – while trying to inflate asset prices by promoting the banks’ product (debt creation) – central bank and Treasury solutions tend to aggravate economic downturns. This is self-destructive because today’s major problem blocking recovery is over-indebtedness.

Obama’s Problem Simply Defined: It Was the Banks

Friday, 11/5/2010 – 4:09 pm by James K. Galbraith | 18 Comments

Obama must break his devil’s pact with the banks in order to succeed.

Bruce Bartlett says it was a failure to focus. Paul Krugman says it was a failure of nerve. Nancy Pelosi says it was the economy’s failure. Barack Obama says it was his own failure — to explain that he was, in fact, focused on the economy.

As Krugman rightly stipulates, Monday-morning quarterbacks should say exactly what different play they would have called. Paul’s answer is that the stimulus package should have been bigger. No disagreement: I was one voice calling for a much larger program back when. Yet this answer is not sufficient.

The original sin of Obama’s presidency was to assign economic policy to a closed circle of bank-friendly economists and Bush carryovers. Larry Summers. Timothy Geithner. Ben Bernanke. These men had no personal commitment to the goal of an early recovery, no stake in the Democratic Party, no interest in the larger success of Barack Obama. Their primary goal, instead, was and remains to protect their own past decisions and their own professional futures.

(link to full article)

Nama was painted as a socially responsible undertaking that will be reporting to the Government ministers on the issues of ‘social dividend’. It will provide housing for the poor and will take off the market vast surpluses of unwanted properties. Nama will also deliver a healthy dividend by charging local authorities for this ‘service’. But the local authorities will still somehow come on top by saving money.

Perhaps mindful of having produced too much gibberish of the above variety, our public representatives have started talking up the discounts that Nama will apply on loans it buys from the banks. Just 6 months or so ago Nama enthusiasts were saying that a 12-20 percent average discount will reflect the ‘true long term economic value’ of the loans? Now we are into 30-35 percent haircuts and rising.

The iron logic of finance tells us that the greater the discount Nama imposes the greater proportion of the original loan will have to be written down by the banks as a loss. This will require fresh capital, of which the taxpayers are the only source for no investor will be willing to buy new shares in Irish banks voluntarily.

By my estimates from some 9 months ago, the Irish banks will require Euro 10-13 billion of fresh capital the minute Nama goes through their books. After months of ignoring this prediction, the Government now admits as much.  ….

This arithmetic is not escaping the ECB. Since December, we are painfully aware of Frankfurt’s intentions to close the discount window through which Irish banks have already pumped some Euro 98 billion worth of junk-rated assets in exchange for cash. By all Euro area standards, Ireland – a minnow accounting for roughly 1.8 percent of the entire common currency economy – has swallowed about 19% of all cash released by the ECB since the beginning of the crisis. More than any other country in absolute terms. Add to that the prospect of Euro 59 billion worth of Nama bonds, plus another Euro 10-12 billion for banks recapitalization, Irish banking system bailout can cost ECB up to Euro 170 billion in loans secured against, you’ve guessed it – unfinished estates in the middle of nowhere.

So understandably, the ECB folks are worried. By May they will start reversing junk securities they loaned against out of their vaults and back into the banks. Should they succeed, Irish taxpayers will be stuck for more cash to plug the new hole in banks balancesheets.

Which in turn will drive the quality of our collateral even lower. Mortgage rates will climb by 100-150 basis points for those of us who are still paying them down. Cost of credit for businesses will rise well into double-digit figures. Credit cards, car loans, consumer loans – all will become as rare in Ireland as polar bears in Sahara. Taxes and charges will increase – by 15-20 percent on average over 2011-2013. Instead of banks stimulating demand for credit, as Alan Ahearne suggests, Ireland Inc will be back on the slippery slope toward deeper recession.

Ultimately, it is the prospect of Ireland sliding back to rival Greece as the drag on the Euro that has been bothering my friends, as well as the ECB and the EU Commission. Sadly, their concerns are our last line of defense against Nama. (link to article)

Having heard the ‘debate’ afterward and having obtained a letter from one of the Green Party parliamentary party members to a senior ranking disillusioned member of the party in which a venerable Green legislator claims, as Alan did today, that academics commenting on Nama with a critical perspective are not fully appreciative of complexities of Nama and are not offering any solutions to the porblems Nama is supposed to tackle, I can say the following:

I stand by my original estimates of losses expected from Nama. Alan Ahearne’s quoted figures are based on thin air, as Dr Ahearne has failed to produce any evidence to support his assumptions or estimations, while my (and Brian Lucey’s) balancesheet for Nama has been in public domain and under public scrutiny for over two months now,

Points raised by myself, Brian Lucey and Karl Whelan (and some others as well) about the lack of safe guards, stop0loss rules, transparency, accountability and ownership of Nama and its assets are not academic, they are as real as Dr Ahearne’s salary in the employment of the Minister. Nay, they are actually more real, because families who will be paying for Nama deserve to be the rightful owners of Nama assets and deserve to have full access to Nama operations,

As far as I know, neither Dr Ahearne, nor his masters have offered any, I repeat, any clarifications as to the amendments they plan to propose for Nama legislation. In contrast, everyone can read my proposal for Nama3.0, Karl Whelan’s proposals for changing Nama legislation, Patrick Honohan’s ideas on how Nama can be fixed and altered, and so on. None of us have been paid for doing so, unlike Dr Ahearne who, having not failed to accuse us all of being ‘academic’ has (a) called us ‘colleagues’ (surely this makes his musings on the subject also ‘academic’, and (b) has managed to produce no new ideas on Nama beyond what his masters produced in the proposed legislation.

I am having a very hard time understanding how myself and other independent observers of Nama can be labelled ‘academic’ when the questions we raised about Nama are both immediately relevant to the issue of Nama operations and are countered from the opposing side by the nonsense of unsubstantiated numbers quoting and references to us ‘not appreciating the complexities’?

Here are couple of questions sent to me by one senior policy person in Ireland with my quick replies to them:

Q: Apparently, in one of the debates, a pro-Nama person suggested that Banks nationalisation cannot occur before Nama is paid for because, while the ECB will do the swap for Irish government bonds as a reasonable discount, they will not give the same deal for a nationalised bank. Or if they do help us, they will insist on their pound of flesh i.e.they will do an IMF on us and we will lose all economic sovereignty. My questions about that are… a) is that really true…

A: It is true in so far as the ECB lending window is for private banks that are solvent. However, it is a technicality, since the ECB will have to offer lending facility to the governments as well. It simply has not been confronted with such a prospect before, but hey, there is always a first one.

b) if Irish government put their shares in Trust for taxpayers as per Nama3.0 – hey presto no link to government – does that get over ECBproblem?

A: Yes, it does, further, recall that I have argued that (steps 3 and 4) the Government can provide for private ownership diluting its own share holding in the banks, so the banks will be owned by a trust (Nama), plus two large groups of private investors, with the Government nowhere to be seen. We can even go further and include as shareholders in Nama some developers/investors by offering them shares in Nama in return for equity in their development projects written against the loans.

Note to Opinion Columnists: It DOES Matter How We Deal With the Banks

This post was written by Karl Whelan

There’s been a flood of recent commentary on NAMA from opinion columnists, editorial writers and broadcast journalists. Unfortunately, much of this discussion has been premised on an incorrect but apparently appealing idea.

This is the idea that it doesn’t really matter which approach we take to resolving the banking crisis because the costs to the taxpayer are going to be about the same no matter what happens. We’ve guaranteed the liabilities, these people will argue, so basically we’re on the hook no matter what. And since all the plans are going to expose us to lots of risk, let’s just get on with the plan the government has.  link to full article

In answer to our own question we remember our usual repsonse to conspiracy theorists everywhere;- never underestimate the sheer incompetence of authorities.

I was bemused to learn that a number of my economics colleagues are apparently starting to ‘discover’ the idea of resolving the banking crisis through the use of a voucher-styled equity acquisition in Irish banks and disbursement of these to the taxpayers. Oh, it makes me glad that potentially some of them – possibly including even those who would not give me a fulltime job in their august departments – are now coming around to accepting some of my original ideas.

So to clearly draw a line in the sand, I espoused the idea of voucher-styled recapitalization of Irish banks on the pages of Business & Finance, with Prof Brian Lucey (the only person who saw, amongst academics, any merit in this idea from the start) in the pages of the Irish Times, in the Sunday Times and in the Irish Independent, as well as, of course, on this blog. But my entire view on how the banking crisis should be handled is summarized here:

Step 1: Require banks to take full mark-to-market writedown on their loan book;
Step 2: Travel down the capital ranks to draw down shareholder equity, deplete perpetual bond holders and so on to cover the writedowns;
Step 3: Force the bond holders into debt for equity swap;
Step 4: Open enrollment for a share-participation in Irish banks recapitalization to SVFs, vulture funds and any other form of private capital;
Step 5: Cover all remaining shortfalls in capital base with Government bonds swapped for equity after Steps 1-4 are completed and after an independent assessment of the value of the remaining loans is carried out to determine the true extent of banks under-capitalization;

Step 6: Hold equity in an escrow account (NAMA3.0) on behalf of the taxpayers, appointing a Supervisory Board to every bank recapitalized by the taxpayers money. The SB should consist of one appointee by the Minister for Finance, 3 direct independent representatives of the taxpayers, who are charged with explicitly guarding the taxpayers’ interests, 1 representative of the bank board, 1 representative of NAMA3.0 and 1 independent director. Each member (other than those from NAMA3.0 and the bank) will hold a veto power. A requirement that risk and credit committees of NAMA3.0 include at least 51% majority of independent experts who cannot be employees of the state, NAMA3.0 or any other parties to this undertaking;

Step 7: NAMA3.0 accountability: no indemnity for negligence and incompetence for any employee or director of the escrow organization; no cross borrowing by the Exchequer from NAMA3.0 is allowed, so Brian Lenihan and his successors cannot raid the nest egg; ownership of shares in the account accrues to the taxpayers, not to the state or the public sector; NAMA3.0 cannot lend money to continue any of the banks’ projects;

Step 8: NAMA3.0 transparency: full disclosure of all recapitalization acts and shares held in NAMA3.0 – on the web, updated live; full disclosure of all employment contracts, wages, bonuses etc, CVs of all managers and directors and disclosure of all potential conflicts of interest; full disclosure and updating of the comprehensive NAMA3.0 balance sheet, cost/benefit analysis of the undertaking and live weekly mark-to-market report on the value of shares held;

Step 9: NAMA3.0 operational efficiencies: NAMA3.0 can, with consent of the Minister for Finance and in orderly (market-respecting) fashion disburse all or a part of its shareholdings so as to maximize the return to the taxpayers. This disbursal should be fully notified to the public immediately post execution, with price achieved fully disclosed. NAMA3.0 will then have 30 days to issue every resident of this country – registered at the date of creation of NAMA3.0 – his or her share of the sale proceeds net of NAMA3.0 operating costs and a special withholding tax of 25% on CGT, in a form of the cheque;

Step 10: NAMA3.0 legal remit over assets: NAMA3.0 in recapitalizing the banks will have a mandate to help the banks collect on outstanding loans by aiding them in seizing requisite collateral. In doing so, NAMA3.0 will have to agree a procedure to address problems of cross-collateralization of specific assets. NAMA3.0 will have a right to impose seize borrower’s property (applicable only to developers) when such property has been legally shielded from authorities or banks at any time after July 2008.

Step 11: Conditions for banks’ participation in NAMA3.0 banks wishing to participate in this undertaking will be required to adhere to the following rules, including, but not limited to, the caps on executive compensation at the banks and the requirement to set up fully independent, veto-wielding risk assessment committee at each bank with a mandatory requirement for a position of a taxpayers’ representative on the board that cannot be occupied by a civil servant or anyone who has worked in the Irish banking or development industry in the last 10 years;

Step 12: Re-legitimising the public system of regulation in Financial Services: as a part of NAMA3.0, the Government must address the ever-widening crisis of markets, investors’ and taxpayers’ trust in the Irish system of Financial Services regulation. Many steps must be taken to address this problem, and these can be worked out over time – suggest away. But in my view, there must be a stipulation that all and any regulatory authorities (and their senior level employees) that were involved in regulating the banking and housing sector in this country until now must be forced to take a mandatory pension cut of 50%, a salary cut to put them at -10% relative to their UK counterparts wages, and return any and all lump sum funds they collected upon their retirement. The Government must impose measures to prevent banks from beefing up their profit margins through squeezing their preforming customers. The measures to force the banks to reduce their cost bases by laying off surplus workers must be enforced. From now on, every regulatory office should be required to publish all minutes of its meetings, disclose all its voting, decisions and rulings to the public, create a public oversight board that must include members of the Dail from non-Governing Parties, a taxpayer representative and independent directors.

This is a sketch of NAMA3.0. Please feel free to build a bigger picture with me

“On the face of it, the announcement looks like good news. AIB get to replace €2.4 billion of one type of debt with €1.3 billion of a different kind of debt. (Full gory details here.) This reduces AIB’s liabilities by €1.1 billion and boosts the core (shareholder) equity capital of the banks. To the extent that this gives the shareholders a greater cushion it’s good news for them. From the point of view of radical nationalisation advocates like me and, um, the IMF, it also means more equity capital can be used to absorb losses before the call on making up the rest of the capital shortfall moves onto the State.

However, when you dig a bit deeper, there is less to be enthusiastic about:

1.
The new bonds are “10 year bullet dated subordinated Lower Tier 2” – the key is that they are dated, so now they count under the guarantee (See page 5). So while technically, the loss-sharing burden on the state is reduced by the €1.1 billion profit that AIB booked, the contingent liability for the state is increased by the €1.3 billion that gets added to the list of guaranteed debt. And if you believe that the losses are such that they should wipe out the equity of the banks, then the extra €1.1 billion will still get wiped out and the state will have lost any opportunity to clean out non-guaranteed subdebt holders. So this could cost the state more in the long run, provided we extend the guarantee in its present form, as it appears the government wants to do.  Link to full article

Speaking today, Fine Gael’s Richard Burton said that ordinary shareholders in the banks have lost nearly all of their investments, Fine Gael deputy leader:

“Under the NAMA approach there is no sharing of losses by the providers of other capital – subordinated debt and risky funding such as unsecured bonds who made good profits in the good years but who will walk away scot-free under this proposal.”

The NAMA plan will not work because the public will not trust that fair prices are paid for failed property loans, while NAMA will take years longer to deal with them after they have been bought.

Burton also rejected the nationalisation plan strongly pushed by Labour leader, Eamon Gilmore on the basis it “makes it almost certain” that the taxpayer will have to honour every one of the Irish banks’ debts, including bonds”.

“There is a moral hazard in capitalism. They can’t expect to be baled out. That is not healthy. Nor can we get into this notion that a bank is too big to fail,”.

But is this simply rhetoric as Burton acknowledges that if NAMA is up and running before the general election it will be here to stay as, speaking to the Irish Times, he said “Governments are legally liable for the decisions made by past governments. It would be too late to change anything then.”

To work we have to believe that the civil and public servants we all know and sometimes love, have the creative and energetic capacity to help rebuild our shattered economy.   In my experience a public sector company, the ESB has been the single greatest obstacle to developing a viable renewable energy sector in Ireland – how are they to work in partnership in the new dispensation with those they seeked to destroy?.

We also have to hope that other problems facing us- resource constraints and system limits, for which this particular set of socio-economic spectacles has a complete blind spot, are indeed of little consequence because they do not feature at all in this scenario.  Publicly owned Coillte and Bord na Mona have proved to be poor stewards of the resources in their care by any set of economic or environmental  criteria – are they our great hope for the future?

The time of great achievement of the public sector company may be in the past, and there were indeed, great achievements – Ardnacrusha was a feat of global significance.

Might it be the Left is still fighting the last war with the ‘old enemy’ of  ‘the free interplay of market forces’ when in fact the enemy is within corrupting both sides, unrecognised – the money system.

March 16th Afternoon: The Recession Diaries

Public Ownership of Banks

Back in November, while the bank guarantee had alerted us to the fragile state of the Irish banking system, no one could imagine what was laying in wait for us: collapse, fraud, and irresponsibility on a frightening scale. The issue is now not whether the banks should be taken into public ownership; that’s a given. The debate is now what we do with the banks.

I would suggest a radical refiguring of the banking landscape following a flushing out of the bad assets (either through a ‘bad’ bank or ‘good’ bank process) with the creation of:

• An infrastructural and long-term bank
• A venture / seed development capital bank
• Banks dedicated to ofering new credit lines for small and medium enterprises
• A public enterprise retail bank

Money is utility, banks are instruments: they are (or should be) servants of the real economy. Nationalise them immediately and start making that service happen.

Borrowing

Quaintly, I had thought that increasing borrowing to 55 percent of the GDP would provide considerable resources for a stimulus programme. Our public finances, however, have deteriorated to such a point that 55 percent of GDP would now imply massive cutbacks. So let’s no get hung up on percentages, etc. (even now, we are still well below the Euorzone average).

Since November, we have now discovered that the National Treasury Management Agency has accumulated a cash balance of €20 billion. Let’s not hoard it – use it: start getting people back to work, increasing economic activity, investing and lending and spending.  This is the seed-capital, if you will, for a medium-term stimulus programme.

Fiscal Deficit and Unemployment

Again, such has been the deterioration of our public finances that the orthodoxy has been able to confine the national debate to fiscal measures. They never ask the more fundamental question: why is tax revenue collapsing, why is government expenditure (i.e. social welfare costs) rising? Unemployment is the answer they never come up with. To solve the fiscal crisis is to first solve the unemployment crisis. And to do that requires a stimulus – an expansion of government expenditure, both current and capital.

Save Jobs – Subsidise Businesses

The rate of job losses was not as pronounced in November. Now it’s an avalanche. We should subsidise businesses to stay in business – especially in critical traded sectors. Germany has recently launched a €100 billion enterprise aid package; pro-rata, that would be equivalent to €7 billion here. This aid package would include a range of measures: underwriting loans/overdrafts, temporary sterling stabilisation scheme, avoidance redundancy schemes (e.g. topping up short-timed workers’ pay to avoid redundancies), etc. Of course, this must come with strings attached –enterprises must become high-road companies, granting their workforce the right to collectively bargain being just one of many labour-inclusive strategies at the local level. But, yes, subsidise firms to stay in business. At the end of the day, it will cost less than letting firms go to the wall.

Save Businesses – ‘Nationalise’ Them

Public enterprise – something I will be exploring in later posts – is one of the great weapons in our enterprise arsenal. The last thing we should let happen is to watch firms with key skill-sets and global brands in key economic sectors go down the tubes. In the last instance, they should be brought into public enterprise. This could mean public sector equity, public-private partnerships; public enterprise companies are only one aspect of bringing key companies into the public realm. The modern Irish economy owes much to public enterprise – energy, transport, banking, insurance and finance, natural resources; it is now time to employ this strategy to current economic and social needs.  Better than to let ‘the free interplay of market forces’ destroy our economic base.

Bring Back Telesis

In the early 1980s Telesis caused a storm with its proposal that the state should actively ‘select’ 75 to 100 indigenous companies to become national champions – giving them every aid and support to break into export markets. It was attacked for being ‘statist’ and ‘anti-market’ (even though Telesis was a US consultancy firm). But it was correct.

So use Enterprise Ireland as the vehicle for creating economic champions in our traded sectors. If we don’t have potential champions in key sectors – create them through public enterprise. Whatever, get business up and moving. Export markets may be difficult now but we need to urgently start building the foundations for new state-sponsored and state-driven high-road enterprises whether in the formal private or public sector; to be in a position to take advantage of any recovery in international demand.

* * *

As I look out at the wreckage that the Irish economy has become since last November when I penned that essay, I only see one solution: more and more social democracy, more public realm, more inter-penetration of the private and public spheres to the point that the distinction between the two becomes ever more blurred. To understand that all our economic assets are, first and foremost, social assets is to prepare the ideological ground for creative strategies of growth and expansion. And democracy.

For there is no going back to normal. Normal is dead and gone. This recession must give way to a new order – a progressive order; one that reconciles abilities and needs, economy and society, where profit is instrumental and prosperity for all is no longer an aspiration but an economic and political necessity.

And, if in a few months, if I have to rewrite this again, so be it. But better still, let’s get ahead of the curve rather than trying to catch up.