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Bank Lending and the Bad Bank (Addendum: The U.S. $1tn (+) trust/bad bank)
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10-02-2009 05:05PM#1
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I'm tired/sick and been dealing with a sick 2 year old all day so this mightn't make much sense.
Économiste Monétaire wrote: »What do other people think of the bad bank-good bank concept? Or, what about this "new good bank" idea? Maybe someone can enlighten me as to why it's not an analogous, yet unnecessarily more complicated, approach to BB-GB. The only benefit I can see is that you side-step the problem of pricing the "toxic assets" to market before selling them.
The "new good bank" idea just looks extremely messy and I think is based on an overly simplistic model of the whole financial sector. It also invites a political nightmare (i.e. just to start who staffs this new bank...). Since I first saw it it struck me as a lovely idea in principle that'd be unworkable in practice. Setting up a new institution in reality isn't going to be easy, clean or quick and could cause a lot of havok and confusion.
The bad bank idea is a good one in some respects I think. Take something like development land which at the moment is screwing over the Irish banks. That is something that a custom built entity could buy (punitively but not cripplingly) cheap and make a profit on over the long term. It does force the bank to write down the loss but at the moment the issue is that these assets will be undervalued due to illiquidity in the market. Though arguably it's going to be politically messy in reality.
I think any deal like creating a "toxic bank" will have to be combined with new regulation to force banks to essentially play it safer by keeping larger assets in reserve etc to avoid moral hazard but this is a separate and more complicated issue I think. Our hand might be forced if the rest of the EU goes ahead with this also.0 -
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I agree. The "new good bank" approach is far more complicated than bad banks -> AMCs being used; and keeping the current institutions. From what I’ve read, it’s essentially the reverse application of a bad bank/trust purchasing distressed assets—i.e. the taxpayer will be paying for good assets. OK, again, what is a good asset? What is the likelihood that we can accurately define a performing loan in the current climate? It will take several months for arrears to accumulate after a series of lay-offs, and purchasing these from the "legacy" banks will be based on a snapshot in time. I’d hazard that the situation will be far more complicated in 6 months with rising defaults, and collapsing commercial property.I'm tired/sick and been dealing with a sick 2 year old all day so this mightn't make much sense.
The "new good bank" idea just looks extremely messy and I think is based on an overly simplistic model of the whole financial sector. It also invites a political nightmare (i.e. just to start who staffs this new bank...). Since I first saw it it struck me as a lovely idea in principle that'd be unworkable in practice. Setting up a new institution in reality isn't going to be easy, clean or quick and could cause a lot of havok and confusion.
The bad bank idea is a good one in some respects I think. Take something like development land which at the moment is screwing over the Irish banks. That is something that a custom built entity could buy (punitively but not cripplingly) cheap and make a profit on over the long term. It does force the bank to write down the loss but at the moment the issue is that these assets will be undervalued due to illiquidity in the market. Though arguably it's going to be politically messy in reality.
I think any deal like creating a "toxic bank" will have to be combined with new regulation to force banks to essentially play it safer by keeping larger assets in reserve etc to avoid moral hazard but this is a separate and more complicated issue I think. Our hand might be forced if the rest of the EU goes ahead with this also.
The solution we’re looking for is to have a banking system reasonably safe in the knowledge that there are no major skeletons in the balance sheet, and so they stop hoarding cash (right now, they have unlimited liquidity from the ECB). This idea, from my perspective, appears to be an attempt to minimise the propensity that the tax payer can/will lose out. Purchasing every prime loan from Irish MFIs will be more costly than I believe has been considered. The guarantee issued by the state would, I assume, come into effect if AIB and BoI, in name, were forced into bankruptcy (which would be required to facilitate this?). I'd wonder what we would need to pay to purchase both the deposit wing and loan books of BoI and AIB, if they were still privately held.
If you purchase assets which you know to be distressed, you discount the credit risk by paying less. So if we fail to accurately price these, the tax payer loses out as the proprietors of the “bad banks.” Now reverse that. The tax payer purchases, what it believes to be, “good assets.” If the current banks have an incentive to understate the amount of un-performing loans, as it may have to write down others, in the situation where these are sold to the bad bank, then you have an analogous problem in purchasing good assets. I believe the propensity for losses is greater under the “new good bank” scheme. Good bank -> purchase “good assets” for X -> “good assets” turn bad -> Bad bank purchases good assets at a discounted price -> Tax payer loses anyway. Maybe my train of thought is messed up there
I guess more to my last point about the money supply, we’re in a deflationary period due to falling effective demand. The long-term extent to which this can occur is dependent on monetary policy. The extent to which monetary policy is effective, even though we’re subject to the will of Frankfurt, is based upon our main financial institutions; I can’t see the ECB allowing national NCBs to become specific credit allocators by purchasing corporate debt. What kind of lag is involved in setting up new banks by which you have a lending multiplier? I would wonder... It would be great if we could package these up and exchange them for existing government debt, Fed style, and the ECB were to purchase ~€15bn of our debt (considering their balance sheet is over €2tn already).
Has this “new good bank” approach ever been tried before? And, as you already said, what will the costs of disruption to the general public?
If you were to nationalise both main banks, you could move the assets off to another vehicle without the need to price them. You still have to capitalise the bad bank and recapitalise your MFIs; you have the ability to move more assets off balance sheet when/if the need arises. That’s what Nordbanken tried to do originally, with a private AMC, and what SEB ended up doing. The argument I’ve seen, which looks good in theory, is of leaving the garbage in the legacy banks, and letting the tax payer buy good assets, while the creditors of the bank burn (Dr. Doom proposed this recently). Of course, we can’t do that, because of the guarantee.
I guess nothing is a perfect solution. Securum, made an overall loss of something like 40% from the original amount put in by the Swedish government. However, we should follow what has worked, and the Swedish tax payer, from what I recall, made a net profit overall. The insurance idea, vis-a-vis the British approach, seems to be in favour as you don't need any up-front cash, unlike the bad bank.
Good points.silverharp wrote: »It seems to be more of an administrative issue. what I would like to see is visibilty of the various loan books that are going to be bought up and the underlying assumptions about writedowns now and in the future. At least then you could make a judgment of how realistic their cost assumptions are.
My worry here is that they have not factored in higher long term interest rates in the future, it would give a different slant on future bad debt assumptions and the ultimate cost of the bailout0 -
SkepticOne wrote: »At least with recapitalisation there is something that has to be paid back and the government gets an equity stake, but where is the compensation here. If these loans default then the country is left with a load of worthless land that may never recover in value.
Seriously, be thankful it's land that the banks have on their books and not CDOs. We've got it easy compared other countries with our bad debt problems.
That said. Land can be valued and the purpose of doing this is to remove this debt from the system to leave it function again and wind down the assets away from the scenes. The land can be repackaged and sold on and there is no reason to sell it immediately, it could be put aside and sold on in a decade when land prices have recovered, which they most likely will.
Does it feel "just"? No. Might it be necessary? Unfortunately.
Économiste Monétaire, I'll respond to your post tomorrow hopefully, am too sick to do it justice right now.
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Any one know what a billion is? we just paid 7 of them to bail out two banks.
Is it
7,000,000,000 ( 7 thousand million )
or
7,000,000,000,000 ( 7 million million )
Maybe the papers should stop using the word billion and put it in words people can really understand...
might bring it home what a blooming mess we are in.
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thanks for the explanation on what a billion is.... does that mean we just saved some money
at least our banks arent in as bad a shape as those in Japan...
I've just heard from the Far East that the Origami Bank has just folded while the Bonsai bank is planning to cut some branches in the spring and the Sumo bank has gone belly up :eek:0 -
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unemployed_dub wrote: »Thats what i was getting at !!! it does make a difference what scale (system) is being used .... It wouldnt be the first time a measurement scales was mixed up.... just ask NASA
Occasionally use the word milliard if you want to confuse people. You'd be amazed by how long you can use it before they stop you and ask whether you've made up that word or not..0 -
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Right less sick so I'll try and reply to this. This is going far outside my area of training though so I'll try and keep it "bullet pointed" rather than a long interlinked stream of thought.Économiste Monétaire wrote: »I agree. The "new good bank" approach is far more complicated than bad banks -> AMCs being used; and keeping the current institutions. From what I’ve read, it’s essentially the reverse application of a bad bank/trust purchasing distressed assets—i.e. the taxpayer will be paying for good assets. OK, again, what is a good asset? What is the likelihood that we can accurately define a performing loan in the current climate? It will take several months for arrears to accumulate after a series of lay-offs, and purchasing these from the "legacy" banks will be based on a snapshot in time. I’d hazard that the situation will be far more complicated in 6 months with rising defaults, and collapsing commercial property.
The solution we’re looking for is to have a banking system reasonably safe in the knowledge that there are no major skeletons in the balance sheet, and so they stop hoarding cash (right now, they have unlimited liquidity from the ECB). This idea, from my perspective, appears to be an attempt to minimise the propensity that the tax payer can/will lose out. Purchasing every prime loan from Irish MFIs will be more costly than I believe has been considered. The guarantee issued by the state would, I assume, come into effect if AIB and BoI, in name, were forced into bankruptcy (which would be required to facilitate this?). I'd wonder what we would need to pay to purchase both the deposit wing and loan books of BoI and AIB, if they were still privately held.
If you purchase assets which you know to be distressed, you discount the credit risk by paying less. So if we fail to accurately price these, the tax payer loses out as the proprietors of the “bad banks.” Now reverse that. The tax payer purchases, what it believes to be, “good assets.” If the current banks have an incentive to understate the amount of un-performing loans, as it may have to write down others, in the situation where these are sold to the bad bank, then you have an analogous problem in purchasing good assets. I believe the propensity for losses is greater under the “new good bank” scheme. Good bank -> purchase “good assets” for X -> “good assets” turn bad -> Bad bank purchases good assets at a discounted price -> Tax payer loses anyway. Maybe my train of thought is messed up there
I guess more to my last point about the money supply, we’re in a deflationary period due to falling effective demand. The long-term extent to which this can occur is dependent on monetary policy. The extent to which monetary policy is effective, even though we’re subject to the will of Frankfurt, is based upon our main financial institutions; I can’t see the ECB allowing national NCBs to become specific credit allocators by purchasing corporate debt. What kind of lag is involved in setting up new banks by which you have a lending multiplier? I would wonder... It would be great if we could package these up and exchange them for existing government debt, Fed style, and the ECB were to purchase ~€15bn of our debt (considering their balance sheet is over €2tn already).
Has this “new good bank” approach ever been tried before? And, as you already said, what will the costs of disruption to the general public?
If you were to nationalise both main banks, you could move the assets off to another vehicle without the need to price them. You still have to capitalise the bad bank and recapitalise your MFIs; you have the ability to move more assets off balance sheet when/if the need arises. That’s what Nordbanken tried to do originally, with a private AMC, and what SEB ended up doing. The argument I’ve seen, which looks good in theory, is of leaving the garbage in the legacy banks, and letting the tax payer buy good assets, while the creditors of the bank burn (Dr. Doom proposed this recently). Of course, we can’t do that, because of the guarantee.
I guess nothing is a perfect solution. Securum, made an overall loss of something like 40% from the original amount put in by the Swedish government. However, we should follow what has worked, and the Swedish tax payer, from what I recall, made a net profit overall. The insurance idea, vis-a-vis the British approach, seems to be in favour as you don't need any up-front cash, unlike the bad bank.
First point: The problem is that it is more palatable politically to say we'll buy good assets than to say we'll buy the bad ones. So rhetorically it works better to phrase it in this way. It really makes little difference because what we're trying to do is separate bad debt from good debt so the institution(s) with the good debt can go back to functioning normally and the one(s) with the bad debt can be wound down slowly over time.
Second point: I agree with you, it would a lot more to buy out AIB and BoI of the good debt than to buy their bad debt and I think this makes it a practical non-runner from the start. We're not in a fiscal position to do such a thing without crippling the rest of the economy.
Third point: Politically you have this problem with a "new bank". In almost "every" town in this country there are two banks AIB and BoI. When we create this new one, which one do you close and which staff do you now fire? Again, a non-starter because of this.
Fourth point: Pricing bad debt for us is a lot easier than it is for the other European countries because our bad debt is Real Estate debt and theirs is CDO debt for the most part. I know which I'd prefer to put a value on if given the choice! This makes the toxic bank a better option for us, essentially we're talking about land and buildings and while both are in freefall in terms of value now, we can be reasonably confident that over the median term we could realise real gains from the prices that we should be able to negotiate with the banks. There are political problems with this in that there might be political pressure down the road to sell off the land quickly to fund some pet project or to release it into the market to "prop" it up or some such. But this could be gotten around if they formed a small and independent group to manage the bank.
Fifth point: On the money supply, I don't think the ECB is going to buy Real Estate debt, we don't have a corporate debt issue per se. If we can remove the bad Real Estate debt the markets markets "should" improve their outlook on our big two banks which would improve things here. It won't solve the underlying problem of excess demand I think, or at least not quickly. The lag could also be substantial which is the problem politically, people will want/expect quick results and monetary policy most likely won't give them.0 -
Sorry, I totally missed your reply.
True, the end goal remains the same: free up credit. It's just which intermediate path we take is the problem.Right less sick so I'll try and reply to this. This is going far outside my area of training though so I'll try and keep it "bullet pointed" rather than a long interlinked stream of thought.
First point: The problem is that it is more palatable politically to say we'll buy good assets than to say we'll buy the bad ones. So rhetorically it works better to phrase it in this way. It really makes little difference because what we're trying to do is separate bad debt from good debt so the institution(s) with the good debt can go back to functioning normally and the one(s) with the bad debt can be wound down slowly over time.
This point is something I have yet to observe any commentator elaborate on. If you read Patrick Honohan's piece in the SPB, he conveniently avoids this; whether that is intentional, or not, I don't know. He does raise a good point about clarifying what exactly a bad bank is, although he doesn't seem aware that a bad bank constitutes having numerous AMCs—at least from historical precedent.Second point: I agree with you, it would a lot more to buy out AIB and BoI of the good debt than to buy their bad debt and I think this makes it a practical non-runner from the start. We're not in a fiscal position to do such a thing without crippling the rest of the economy.
Yup. The whole "new" approach is being watered down, from what I can see, with the intention of buying all branch networks from the legacy banks. That, again, raises the issue of costs versus the vanilla bad bank approach.Third point: Politically you have this problem with a "new bank". In almost "every" town in this country there are two banks AIB and BoI. When we create this new one, which one do you close and which staff do you now fire? Again, a non-starter because of this.
That's a good point on the level of sophistication, or one might say obfuscation, of financial assets in Ireland. I wonder what the handbook of fixed income securities would look like for usFourth point: Pricing bad debt for us is a lot easier than it is for the other European countries because our bad debt is Real Estate debt and theirs is CDO debt for the most part. I know which I'd prefer to put a value on if given the choice! This makes the toxic bank a better option for us, essentially we're talking about land and buildings and while both are in freefall in terms of value now, we can be reasonably confident that over the median term we could realise real gains from the prices that we should be able to negotiate with the banks. There are political problems with this in that there might be political pressure down the road to sell off the land quickly to fund some pet project or to release it into the market to "prop" it up or some such. But this could be gotten around if they formed a small and independent group to manage the bank.
We may have a Euroarea problem of collapsing commercial paper demand for corporate borrowers—mirroring the U.S.—if things get a lot bleaker on the bankruptcy side. Good point on lags. J.C. Trichet: Mortgage Broker :pac:Fifth point: On the money supply, I don't think the ECB is going to buy Real Estate debt, we don't have a corporate debt issue per se. If we can remove the bad Real Estate debt the markets markets "should" improve their outlook on our big two banks which would improve things here. It won't solve the underlying problem of excess demand I think, or at least not quickly. The lag could also be substantial which is the problem politically, people will want/expect quick results and monetary policy most likely won't give them.
Goodbody released a piece on the possible losses of the banks today. ~30bn, or something like that.0 -
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