- Irish banks lend to all comers on increasingly lax terms for 10 years plus, funding their balance sheet from bond and interbank money markets.
- Debt financed demand for Irish real assets (property) leads them to become over-valued to a mind boggling extent.
- Policy tightening from the ECB and subsequent crisis in credit markets (i.e. the global financial crisis) squeeze demand and then supply of credit (mortgages, commercial development loans)
- The spiral reverses its course and demand for real assets crashes and prices deflate.
- Large amounts of liabilities on bank balance sheets (borrowing from other banks, institutions)
- A large chunk of certain assets (lending, to developers mainly) that will never be repaid in full and hence needs to be marked down in price.
2-1 < 0 =" insolvent
It really is that simply.
Now for the complicated bit. What to do about it?
Firstly, make an observation on the potential answers to the question posed. At the highest level there is in fact two potential answers:
- Do something
- Do nothing
So, here is the story so far on "what has been done":
- Offer enhanced government guarantee on deposits (total guarantee)
- Guarantee most of the liabilities of the bank (i.e. just about most people in addition to depositors who have lent money to these banks)
- Form a government Special Purpose Vehicle (SPV) to buy large amounts of the assets that have created the insolvency problem.
It is important at this point to understand a little about 3. Earlier I stated that large chunks of bank assets (loans to developers) needed to be marked down, hence making assets less than liabilities and hence making the banks insolvent. However, I left out an important extra fact. The banks have not written down those assets sufficiently to reflect their true worth (what you might expect to get back from the people who borrowed the money) because the size of the deficit would be so large that the government would have had to recapitalise them by nationalising (taking ownership and injecting tax payers' money, or cough up money under the liability guarantee to people who have lent to the banks. So, everyone has been pretending that the banks are technically solvent by only writing down those bad assets a little bit at a time.
You may say this sounds like a pretty puerile fudge that wouldn't fool a 5 year old.
You would be correct.
So we find ourselves now with NAMA. This is the SPV that, when tanked up with bucket loads of money borrowed on bond markets (i.e. deferred tax), will buy the bad loans that the banks are gradually trying to write down to their true worth in order to restore solvency. With the banks free of these loans that everyone knows are worth far less than reported in the banks' financial accounts, the banks can get back to banking instead of playing a three cup game with their balance sheets. That's the theory.
So NAMA buys these assets, but the question is how much to pay? Remember, we they aren't worth what the banks claim they are. So NAMA (i.e. the tax payer) is facing two options.
Pay the true market value that reflects the fact that these loans will never be repaid in full (because the people who borrowed the money effectively just wasted it) and are extremely uncertain. This will mean the banks crystallise their losses in one big hit and declare insolvency - back to nationalisation (taxpayers pouring money into the banks to own them) or deliver on the liability guarantee (effectively pay off a load of the banks creditors).
Pay a more generous price, justifying it on the premise that the loan money wasn't wasted, the developers are just having a few short-term difficulties. Over time these loans will pay back a big proportion of their initial amount (yeah, right). D0 that of course and NAMA is going to be a loss making venture (Ireland has too many houses, built for too much money, on land that was bought by developers for too much money).
So that is it. All government policy has been set up so that which ever way things go, taxpayers are on the hook for the losses.
A lose/lose for tax payers.