Brian O'Doherty's Blog  

We moved our server from one data center and replaced it with a new one in a second location. Then the second one crashed and all data was temporarily lost. Now we seem to have everything going again, except music to your right. But keep the faith !

I regret to advise that this site may not be always accessible during the period up to January 31, 2011. This is due to the need to move to a new server in a new data center, and transfer all operating system, software and files. We regret any inconvenience to our members.

This is a post I sent to the IrishEconomy.ie blog today. The discussion followed a recent speech by CB Governor Paddy Honohan
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When the Governor raised the matter of accounting practices, I thought he was going to tell us some good news. He said:

" I have already railed elsewhere against the backward-looking loan-loss provisioning practices encouraged by International Financial Reporting Standards (IFRS) and still all too pervasive in the reporting by most of the Irish banks. ..."

But he should know that IFRS is to be changed !!.

Firstly, though, it seems to me that the losses being incurred by our main banks are related NOT to already crystallised losses, but to estimates--including overestimated NAMA figures- related to "marking to market" of tens of billions of euros worth of loans still with many years to run. (Many of the properties, we can be sure, will over time be inflated out of their current loss status). It is for this - estimates of future losses which must be debited to P&L account now - that we must shove out the shareholders and let the State take over the banks. (Uniquely in the world, of course !)

But, IFRS is to be changed. The Governor should have reminded us that the G20 two years ago asked the International Accounting Standards Board to develop a more realistic and less catastrophic accounting treatment for banks' impaired banking assets (i.e.loan book losses as opposed to equity trading losses). They did, and proposed their solution to governments a year ago. Their solution basically would permit many banks to re-estimate their loan losses every year and write them off gradually over the remaining maturity periods of the loans (in certain circumstances). This will be enormously helpful to Irish banks and to the capital requirements/ Basle ratios situation. But the EU has refused to agree the new proposals as yet--they probably will agree a version in early 2011- because it doesn't suit the French/German banks, who derive much of their profit from trading activities, as opposed to banking.

Why didn't the Governor talk about this, since he raised the topic of accounting treatment of impaired assets?? What's he trying to hide??
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I also dealt with this prospect previously ..http://brianodoherty.ie/wp/featured/2010/11/stop-committing-economic-suicide..-as-follows/

- or scroll down a few posts to see it.

Why don't they let us see the report published last week by Goldman Sachs, which says, in essence, that we have been far to negative in estimating our financial losses, at bank and national level. As a result, we are forcing the banks to raise unnecessary capital (and the shareholders to consequently take unnecessary losses). Some new capital may be required, but not on the scale indicated by the regulator.

In particular Goldman blames NAMA, as being far too pessimistic in estimating the value of banks assets being transferred to it. Even in a worst case scenario, the organisation is "unrealistically" pessimistic, they say. Our banks, which are forced by our government (-who then takes them over !!-) to face their full losses- and more - up front--uniquely in the world - have not in fact, lost that much more, as a percentage of their total loans, than banks in other countries, whose losses are covered up by government rescue schemes. (This applies in the EU also, where bank losses in every country are effectively cloaked by hidden bail outs). Goldman says:

"...Aggregating over the entire loan book, the assumptions
would give us gross credit losses for domestic banks of
€35bn over the 5-year cycle, which amounts to 8.4% of
total loans, and 22% of GDP (Table 1). This compares
with our colleagues’ estimates of total credit losses
worth 7% of GDP for domestic banks in the US, and
6.5% of GDP in the UK..."

They also say:

"...But if our estimates suggest anything, it is that the
ultimate losses, and the ultimate burden on the Irish
government, will be quite a bit lower than estimated by
NAMA, which is likely to make money on its
investments. Correspondingly, the government will
significantly have over-capitalised the banks, perhaps
by tens of billions of Euros...."

Its extraordinary that our media have not reported this to our people !.

This is a post I sent to IrishEconomy.ie blog today:

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To all, and especially those who recently insisted that we could keep on issuing NAMA bonds....The situation is very clear:
It’s the ECB that wants a bail out!!
THEY, themselves, want to be "bailed out", of the alleged obligation on them to keep on cashing NAMA bonds (which they most probably never agreed to, but the Irish government has managed to impose on them)
So, ECB wants the Irish government to find some other way to handle the bank liquidity problem..OK?...Even if it means that the EU must extend loans to Dublin.

So, we must unwind the NAMA scheme--at least for not yet nationalised banks- because it is that scheme that has seriously damaged our credibility. (What do you think bond investors think of us when we put our sovereign guarantee on joke bonds..bonds that "mature" in six months when the issuer has no chance of redeeming them for many years, bonds that the issuer pays 1.5% on, when his real risk rate is a large multiple of that, bonds with no firm redemption (for cash) commitment, for any date ?? This is what's damaged our credibility).

And this is what is extremely difficult to recover from politically. Just look at the damage we have done to our better banks...forcing them, uniquely in the world, to mark €80 bn. to market when loans still have years to run, etc. The European bond investors like schemes wherein governments support banks, not ruin them and keep them private, not nationalise them, and show some sophistication in handling liquidity problems, in discussion with partners, not landing partners with bag loads of joker bonds worth less than Monopoly money. They must think the people in charge of our banking sector and economic policy are idiots.

So, unwind all that, apologise, fall on swords, etc. In just handing property back to BOI-AIB alone we save perhaps €20bn. of future NAMA (=State perceived) obligations...or c. 15% of the National debt v. GNP ratio... in a few strokes of the pen. Here's more detail : http://brianodoherty.ie/wp/featured/2010/11/stop-committing-economic-suicide..-as-follows/

After that,. Investors will see that a deficit reduction of €6 bn. is in fact a very big step towards resolving the structural fiscal problem and should enable us to get back into the bond market at a fair price. If not, then we can go to the EFSF.

So, then, what to do about the banks liquidity problem? Maintain the guarantee for a while---it already duplicates the NAMA guarantee anyway...and discuss sensibly with the ECB and partners some resolution of the (short term) problem. The solution is out there and some of the brilliant minds who contribute to this blog will find it, if they start thinking positively and even if MK can't see it.

And one more very important thing we must do for national credibility in this matter...Someone must advise the Governor that his job is to defend the national banking sector, not go around offering it for sale abroad!

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It seems that Chancellor Merkel has clarified her previous suggestions that bond holders must not rely on an EU bailout for Irish and other sovereign debt by saying her proposal only commences from 2013. All existing debt will therefore be free of all but EU sovereign risk to debt holders

That's what it seems to me. There is no way to avoid the conclusion that all of our existing debt, guaranteed by the State, will rest on an implicit--and almost explicit- EU backstop guarantee. Brilliant ! The risk spread over German Bunds should therefore disppear, or almost so, in relation to presently outstanding debt and debt to be issued in the near future

Most of the currently issued Irish debt-- that is "promises to pay" guaranteed by the Irish State - relates to NAMA. This year, something like €30-40 bn. of NAMA bonds are being issued. Up to now, the money market chaps didn't really expect that our State could redeem these bonds fully.. and neither did I. (Especially as their Term Sheets do not contain a firm redemption commitment, other than to offer more bonds in exchange). But now, Angela Merkel has added her promise to them...Is that right?

This seems marvellous !..It means that the Irish government is borrowing up to €40 bn. of encashable property from the banks, at an incredible interest rate of c. 1.5%, to be used when it needs to use it - i.e. sell for cash when ready- and without a firm repayment date to the banks. Meanwhile, the banks get their funds to be going on with--in the form of borrowings- from the European Central Bank. What a deal! for the State....(And Shane Ross wanted us to join the sterling area, not the Euro !) (Of course, expect the ECB to say something about that..They may pressure the goverment here to pay the banks- i.e. redeem the bonds- immediately upon selling the property, and meantime to pay a proper interest rate on the bonds)

This can only be good for bank shares, too, to the (considerable) extent that the government guarantee which was (recently unsuccessfully) backstopping the banks normal market funding operations, a guarantee of diminishing credibility, had a major depressing influence on bank share values and should now become a real positive for the banks.

I don't know that Angela really realises what she has done. A year ago there was no EU guarantee backstopping Irish obligations, short of an expensive and humiliating EU-IMF bailout. Then she suggested that it was unfair to German taxpayers that investors in Irish bonds should get away scott free in the event of a collapse. That really depressed the bond prices, and bank shares. But now, in saying that her ideas about loss-sharing won't come into force for 3 more years, she has effectively stated that there will be an EU guarantee for Irish bonds before then.

Tausend Dank, Frau Merkel !

Prof. Morgan Kelly writes an hysterical piece in the Irish Times today saying we are all doomed. And, he offers no solution...he sees none. His main shocking prediction is that AIB will cost us as much as Anglo, mainly because it will lose a fortune on its residential mortgages, over the next few years. So, I had to respond a little and I reproduce my contibution here, for you Sheila, and your sister..

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What we don't need at this time is hysterical commentary, dumping on our banks and economy and unable to propose solutions to perceived problems. Also, its improper of the Irish Times not to lend part of its OpEd page to a more positive and optimistic evaluation of our circumstances. It seems they only wish to publicise the negative and depress the nation, and bond markets, further than what the real situation merits.
At an AIB meeting last year, the Chairman stated categorically that the bank had not repossessed a house in over eight years. Its last detailed financial report, earlier this year, stated that it never pursued a policy of providing more than 92% mortages and those only to first timers, although at the time foreign banks were offering 100%+ interest only deals. (I don't think Morgan Kelly complained about that practice by foreigners, although he did call the property market correctly, as did tens of thousands of ordinary Irish residents who decided Not to buy in those years.)
In alleging that AIB will cost the taxpayer c. €34 bn., Mr. Kelly seems to be plucking from some fruity tree of knowledge superior to that of our Regulator, the EU stress testers and the banks own management and directors, including new directors, not to mention the NAMA evaluators. Kelly attributes the bulk of his forecast loss to likely losses on residential mortgages. But AIB is not the largest provider of residential mortgages and seems to be in the best position in terms of impairment ratios. In any case, Mr. Kelly should know that mortgages are long term loans and, under the new rules for accounting treatment of impaired financial assets, proposed by the International Accounting Standards Board, and which are very likely to be adopted by EU nations in the near future, predicted losses on mortgages can be estimated annually and then amortised over the remaining period of the loan. The period is long enough for losses to be replaced by profits as inflation increases house prices and, if not, the annual debit to P/L will be easily covered by the bank's operating profits, even if losses are to be estimated at catastrophic levels.
"

OK, Part 1 of the Four Year National Revival plan (FYNRP) is to stop doing the things that are getting us into a deeper and deeper hole and start earning some respect from our creditors.
Take NAMA. A good idea in principle when first launched, it has become a monster !. Instead of "saving" the banks and helping them with their liquidity problems, it has probably contributed greatly to loss of our national financial credibility and, therefore, to serious deterioration in the banks' funding position (and decimated shareholder values). I mean, what foreign investor will purchase the guarantee of the Irish government (when our banks come looking for funds with that guarantee)...a government which guarantees (NAMA) bonds which carry an interest rate of 1.5% (when the reality is that our interest rate should be four or five times that)- who are we trying to fool?..Then, when they look at the Term Sheets for the bonds they see that there is no real redemption date- commitment to repay the bonds for cash, and of course they realise that there is no capacity to repay them; so they figure that the bonds aren't really for adult serious people at all, but just artifically constructed to enable the banks liquidity problem to be thrown onto the ECB, with no ultimate payment date. With this sort of carry on, how can we expect the markets not to downgrade our credibility?
So, lets rewind NAMA and give the banks back their property (AIB/BOI) and their lost profits (temporarily at least). That will reduce our long term National Debt- meaning our bank property repayment obligation- by €20 bn. or so (- the nationalised banks may not benefit, so don't include them yet) and our financial market rating should improve
Then, we must help the banks out of the position where their property has been devalued by public officials by around €18 bn or so (- I'm guessing the figures for now-) and work with them to rebuild their position and especially their funding. The State guarantee can be maintained for a while. Also they can use their exisitng holdings of (non-NAMA) government bonds as collateral for short term ECB borrowings. Then they can consider other options, including separation of truly toxic debt into bad banks, the possibility of finding friendly foreign takeover parents, merger of the two Irish banks, the setting up of assets value insurance schemes- which we should have done, it seems in hindsight- and, especially one real opportunity...the upcoming change in accounting rules.

The International Accounting Standards Board has proposed new rules for banks' accounting treatment of impaired assets/ loans. Bottom line is that these estimated future losses of banks should be spread over the remaining periods of the loans in question--that is "amortized" - instead of being fully recognised up front (as by NAMA). Our banks are crippled because thay have had to accept a value for their loans/ assets which reflects a completely illiquid non-market- which we have at present- although the loans do not mature for many years into the future and in fact circumstances could change in the future and foreseen losses could in some cases become profits. For many reasons this is not a realistic way to estimate real losses, so many foreign governments are ready to adopt new rules which would greatly improve the banks current protfit positions. The Irish government should press very hard to get these new rules immediately adopted by the EU, or perhaps go ahead itself. It could also change the law here, if necessary, so that stated accounting losses can be re-calculated for two years backwards.

I submitted this to the IrishEcomony.ie blog today and reproduce it here for the other two readers:

About these widening spreads....I suspect they are related to NAMA, which is the source of the great majority of new Irish debt.
Last February I worked out approximately that, based on the preliminary NAMA Business plan, the interest rate that NAMA, a government agency offering sovereign-guaranteed debt- was offering--c. 1.5%- at a time when the real price of Irish sovereign debt was 4.5% (God be with the days !..), amounted to c. a €10 bn. euro extra hidden hit on Irish banks over the period of the proposed NAMA redemptions.
That figure has now changed a little, but can only be worse as the spread between our NAMA discount rate and our secondary market sovereign rate rises towards 7%. The market-rated yield on sovereign debt is based on an amalgam of the individual yields on all pieces of our sovereign debt. NAMA bonds can/must be seen as official debt and they are worth something in the region of face value less 33% I would guess (- I might try to run calculations later-) and so are pulling the average down substantially
Its only my theorem, but , if true, it suggests that the best thing we can now do to protect our sovereign rating is to re-wind NAMA and find another solution to the bank liquidity problem.

It seems to me to be improper for the State to guarantee the bonds being issued by NAMA-SCAMA, when the said organisation does not have the readies to redeem them at maturity and the State also is blatantly obviously unable to pony up tens of billions of euros for the same purpose if its guarantee is called. Such imprudence on the State's part is likely to be eventually twigged by investors (and the ECB) and will result (or has resulted) in the State's loss of credibility and the NAMA scheme's collapse along with the banks it should have been trying to support. In reality, the Good NAMA has become the BAD NAMA and brought down the banks with it, ruining shareholder value (and, according to some stories floating around at the recent AIB EGM) even causing some suicides among very distressed elderly shareholders.

NAMA was meant to operate like an old-style Fianna Fail "good stroke", in which the government would pretend to negotiate a rescue for banks with the ECB via a special ERB-funded "liquidity scheme". In effect the government would use a pre-existing ECB liquidity scheme for Eurozone banks (which operated between the ECB and the banks and had nothing to do with governments) by giving the Irish banks NAMA bonds which they could use as collateral for borrowings from the ECB. In exchange the government takes tens of billions of property from the banks, at distressed market values, which it can hold or sell at its own leisure, with the banks paying overhead costs. So, it actually pays the banks nothing in real terms but leaves them hoping that the ECB will lend them money. And, the government gets credit, and the banks get abuse, for this scam, which is branded as a "bail out" . Yes, a good stroke and lets bash the banks!

The problem is that this was not agreed with the ECB...Instead, the liquidity problem (version: Irish solution) was dumped onto the ECB, which in any case only lends short term (6 months or maximum a year). There is no guarantee that after 6-12 months the banks loans from ECB will be rolled over, for the many years it will take for NAMA to eventually redeem the bonds and thereby pay for the property it has taken. Meanwhile, the banks have been forced, uniquely in the world of banking, to recognise enormous losses up front, without the benefit of a future rise in values. (Other banks around the world have lost more, you know, but don't have to recognise the losses all in one go, upfront !) So, international investors see Irish banks being in a position where they must sell off their profitable businesses to raise immediate capital and also have no certain route to medium term funding, other than the guarantee of an almost bankrupt Irish exchequer. The last straw is when the government values the shares of the biggest bank at 50 cents, six times lower than even last years peak, and therefore effectively wipes out 90,000 elderly shareholders across the land.

It wasn't the banks that brought down the State: it was vice versa.