Creating "bad banks"

mike65 · 17-01-2009 03:42PM #1

yay or nay.

Its been much discussed, the UK gov appear to be taking the creation of one seriously, it been mentioned here with regard to Anglo Irish.

Good idea or not?

Économiste Monétaire · 17-01-2009 03:48PM

A bad bank isn't actually a bank as such. It would effectively be an institution created to manage distressed assets. Look to Sweden's "bad banks," Retriva and Securum, for examples of this. Anglo is a commercial bank so it's not really suitable, against what people are saying. It can be nice because it gives your regular banks piece of mind so they can lend again, and they actively work to restructure loans to minimise losses.

silverharp · 17-01-2009 04:28PM

I googled the term and came across the piece below, being reasonable I would say that there is nothing to be gained by throwing people out on the street now. there maybe an opportunity to create some kind of Housing Associations that would buy up bad home loans, where debt defaulters could come under the wings of the said association maybe with an option to buy in the future.
It sounds like a nighmare if there was any incentive for people to stop paying their mortgages so that they can have their debt "restructured" and it may be dangerous to compare these schemes to other countries as any previous crises was country specific and the country was able to trade its way out of the hole. The last thing the gov should be trying to do is prop up land prices, or locking in the "unaffordability" in existing house or land prices.

"Could It Work In Ireland?
So this “bad bank” scheme is being tried in the current banking crisis too. I think that it could be successfully applied to Ireland.

What would need to happen? Firstly all non-performing assets of the banks would need to be substantially written down; no more of the piecemeal writes-downs we have been seeing. This would reduce the government’s liability.

Once this is done, all the bad commercial and residential loans could be consolidated under the management of the Irish State. They can then appoint restructuring experts to do what is needed for the greater good of the economy. If the cost was 4% of GDP, that’d work out at around €6 billion. But this expenditure could certainly be justified in an once-in-a-lifetime crisis. Plus the government will also have their substantial stake in the banks, which they would sell-off (hopefully at a profit) in a few years time.

Effectively the banks would be passing on their worst loans to a debt collector. But this debt collector, the government, could afford to take more of a long term view to the loans. For example the government could restructure property developer’s debts in a way that gives more benefit to the economy as a whole. Their efforts could ensure a minimum amount of bankruptcies in 2009 and 2010. The mortgages of struggling families could be restructured so that a situation of mass repossessions (such as the one occurring in the US) doesn’t happen here. Essentially the government could do what is needed to ensure a recession doesn’t turn into a depression."

BenjAii · 17-01-2009 05:11PM

If the banks are, understandably, hoarding cash as they feel they have huge future provisions to make for bad debts, that is obviously going to cause huge extra unnecessary pain in the economy.

I haven't come across any figures yet that detail how much banks normal day today financing of SME's have contracted, but if it's about to lead to widespread layoffs and closures of otherwise viable businesses then it's a no-brainer to want to prevent this.

I don't see any other way of doing it, short of fully nationalising bank lending and having a government body take on that function, which sounds even more undesirable.

Who decides which businesses will survive ? Some will have no future and will have to go to the wall anyway, whereas others with the lifeline of their normal financing restored can make a good claim for survival through to profit in the better times.

mike65 · 18-01-2009 09:46PM

Looks like Biffo/Brian L have knocked the idea on the head.

nesf · 18-01-2009 09:53PM

mike65 wrote: »

Looks like Biffo/Brian L have knocked the idea on the head.

How so?

mike65 · 18-01-2009 09:55PM

Thought I heard that on the news (will admit to being distracted by 5 year old neice at the time!)

ntlbell · 18-01-2009 09:55PM

mike65 wrote: »

Looks like Biffo/Brian L have knocked the idea on the head.

Didn't they knock the idea of buying anglo on the head 4 or 5 days before buying it?

nesf · 19-01-2009 12:19AM

mike65 wrote: »

Thought I heard that on the news (will admit to being distracted by 5 year old neice at the time!)

He played it down, didn't dismiss it. Add in some standard banks can't be given a free lunch rhetoric and honestly, I don't think they've ruled it out but are playing it safe.

thebman · 19-01-2009 12:31AM

nesf wrote: »

He played it down, didn't dismiss it. Add in some standard banks can't be given a free lunch rhetoric and honestly, I don't think they've ruled it out but are playing it safe.

They seem fine with letting the heads of the banks off so I imagine that is a sign they don't like the idea rather than they don't think the banks should get a free lunch.

BenjAii wrote: »

If the banks are, understandably, hoarding cash as they feel they have huge future provisions to make for bad debts, that is obviously going to cause huge extra unnecessary pain in the economy.

I haven't come across any figures yet that detail how much banks normal day today financing of SME's have contracted, but if it's about to lead to widespread layoffs and closures of otherwise viable businesses then it's a no-brainer to want to prevent this.

I think that's exactly what the banks are doing and it is rightly screwing Irish businesses. Government need to act now. This nonsense of hoping it sorts itself out is leaving many people unemployed.

I don't see any other way of doing it, short of fully nationalising bank lending and having a government body take on that function, which sounds even more undesirable.

Who decides which businesses will survive ? Some will have no future and will have to go to the wall anyway, whereas others with the lifeline of their normal financing restored can make a good claim for survival through to profit in the better times.

I don't really see what be so terrible about nationalising bank lending. The private sector has already shown it can't do it responsibly so I don't see the problem with having a semi-state body doing it or something like that. It seems too important to leave in the hands of the private sector TBH since it is essential to the economy of the country.

Anything that essential should be in the hands of the country and not private interests IMO.

blast05 · 19-01-2009 12:33AM

I take it if this were to go ahead then the state would take a share of all banks who moves their bad loans over to Anglo ?
Also, would it apply only to the 6 banks who are covered under the states guarantee. If so, then would this not motivate all other banks in the Irish market to decide to cut their losses and get out of the Irish market as they would be put into an unfavourable market position ?

nesf · 19-01-2009 12:51AM

brim4brim wrote: »

I don't really see what be so terrible about nationalising bank lending.

Bad things:

1) The lending cycle might start looking like the budget cycle. i.e. first year after an election? Not a chance of a loan. Year before an election? Here have two..

2) Regional lending distributions might start looking like the Sports Capital Grant distributions (i.e. plenty of credit for the constituencies and counties of sitting Ministers).

3) Lack of innovation/stagnation. If our banking sector is nationalised, it doesn't have to compete with anyone, ergo no pressure to improve business practices, merely do enough to get by.

4) Any trading or loans done by this bank would implicitly be viewed as State guaranteed. This was part of what caused the whole sub-prime mess with Fanny May and Freddie Mac.

5) Unprofitable practices might be continued purely because of political concerns, i.e. banks staying in tiny towns because it'll cost votes when in reality it's just a huge waste of taxpayer's money for the bank to be there because it does so little business.

6) Trouble getting a mortgage? Talk to your local TD about it.

That's off the top of my head, I'm sure there are plenty more reasons not to have a nationalised banking sector but I can't think of them right now.

mike65 · 19-01-2009 12:58AM

We could do with rather less "innovation" in banking right now.

nesf · 19-01-2009 01:06AM

mike65 wrote: »

We could do with rather less "innovation" in banking right now.

Heh, I'm thinking of retail banking innovation here rather than financial market innovations in this context. I don't even want to think of how bad nationalised investment banking would be...

thebman · 19-01-2009 01:43AM

nesf wrote: »

Bad things:

1) The lending cycle might start looking like the budget cycle. i.e. first year after an election? Not a chance of a loan. Year before an election? Here have two..

2) Regional lending distributions might start looking like the Sports Capital Grant distributions (i.e. plenty of credit for the constituencies and counties of sitting Ministers).

3) Lack of innovation/stagnation. If our banking sector is nationalised, it doesn't have to compete with anyone, ergo no pressure to improve business practices, merely do enough to get by.

4) Any trading or loans done by this bank would implicitly be viewed as State guaranteed. This was part of what caused the whole sub-prime mess with Fanny May and Freddie Mac.

5) Unprofitable practices might be continued purely because of political concerns, i.e. banks staying in tiny towns because it'll cost votes when in reality it's just a huge waste of taxpayer's money for the bank to be there because it does so little business.

6) Trouble getting a mortgage? Talk to your local TD about it.

That's off the top of my head, I'm sure there are plenty more reasons not to have a nationalised banking sector but I can't think of them right now.

Most of those disadvantaged are erradicated if you stop the government directly controlling the state bank.

They don't decide ESB prices should come down in a recession, the minister can't force that or line rental to decrease because they act seperate to government. Such as sytem would remove most of the above problems.

nesf · 19-01-2009 02:21AM

brim4brim wrote: »

Most of those disadvantaged are erradicated if you stop the government directly controlling the state bank.

They don't decide ESB prices should come down in a recession, the minister can't force that or line rental to decrease because they act seperate to government. Such as sytem would remove most of the above problems.

What's the difference between what you are describing and a regulated private bank in practice? Also, how do you insulate it from the Government? Who appoints the people in control of the bank and so on? It's really not easy to have a truly independent nationalised company and where are the advantages to doing this versus leaving it to the private sector and regulating them?

P. Breathnach · 19-01-2009 02:35AM

nesf wrote: »

Bad things:
...
3) Lack of innovation/stagnation. If our banking sector is nationalised, it doesn't have to compete with anyone, ergo no pressure to improve business practices, merely do enough to get by.
...

I'm not sure that's entirely a bad thing. Many recent and current problems are the result of innovation, things like the intensification of risk in instruments like derivatives. And we still don't know how much damage was made possible by securitisation.

nesf · 19-01-2009 03:05AM

P. Breathnach wrote: »

I'm not sure that's entirely a bad thing. Many recent and current problems are the result of innovation, things like the intensification of risk in instruments like derivatives. And we still don't know how much damage was made possible by securitisation.

As above I was speaking of retail banking innovation rather than financial instrument innovation. However, it is a gross oversimplification by the media/left that things like securitization are in general a bad idea. The problem with CDOs etc in the Sub Prime crisis was due to the problems with ratings companies misclassifying securities with poor quality debt with AAA ratings etc. Which was mainly down to a very poorly thought out system where the ratings companies were paid the banks whose products they rated.

Securities allow large corporate loans to be split off into smaller chunks and sold to investors who could not (or do not want to) fund the large corporate loan themselves. These forms of securities are both useful and work very well simply because rating an individual publicly listed corporation's ability to repay is relatively straightforward and for the most part the information is public knowledge to begin with.

P. Breathnach · 19-01-2009 03:38AM

nesf wrote: »

As above I was speaking of retail banking innovation rather than financial instrument innovation. However, it is a gross oversimplification by the media/left that things like securitization are in general a bad idea.

Agreed. That is why I referred to the damage made possible by securitisation.

The problem with CDOs etc in the Sub Prime crisis was due to the problems with ratings companies misclassifying securities with poor quality debt with AAA ratings etc.

Also agreed.

Which was mainly down to a very poorly thought out system where the ratings companies were paid the banks whose products they rated.

I find it difficult to envisage a manageable and reliable rating system for a bond issue based on several hundred individual home mortgages: either the amount of work involved would be enormous and expensive, or the purchaser of the bond chooses to accept a level of risk. If the purchasers choose to accept risk, then there is temptation for the seller to put ever-increasing numbers of risky loans into the bundle. Which is pretty well what happened. If a retail bank can eliminate the risk, then it will do so; if it can make very bad investments and eliminate the risk, then wow!

Securities allow large corporate loans to be split off into smaller chunks and sold to investors who could not (or do not want to) fund the large corporate loan themselves. These forms of securities are both useful and work very well simply because rating an individual publicly listed corporation's ability to repay is relatively straightforward and for the most part the information is public knowledge to begin with.

Agreed. That is the good foundation on which those flimsy houses were built.

nesf · 19-01-2009 03:47AM

P. Breathnach wrote: »

I find it difficult to envisage a manageable and reliable rating system for a bond issue based on several hundred individual home mortgages: either the amount of work involved would be enormous and expensive, or the purchaser of the bond chooses to accept a level of risk. If the purchasers choose to accept risk, then there is temptation for the seller to put ever-increasing numbers of risky loans into the bundle. Which is pretty well what happened. If a retail bank can eliminate the risk, then it will do so; if it can make very bad investments and eliminate the risk, then wow!

Honestly, I've never agreed with the idea of bundling mortgages into securities. Keeping mortgages on the issuing bank's books gives them a decent incentive to lend responsibly, or at least more so than if they can turn a quick profit by selling on any mortgage instantly to the market.

P. Breathnach · 19-01-2009 04:00AM

nesf wrote: »

Honestly, I've never agreed with the idea of bundling mortgages into securities. Keeping mortgages on the issuing bank's books gives them a decent incentive to lend responsibly, or at least more so than if they can turn a quick profit by selling on any mortgage instantly to the market.

Okay, we can agree on that one.

But that brings us to another question: what criteria should apply to bundling any types of loan into securities? Can you package 1,000 car loans and sell them on? [And why might anybody buy them, rather than simply lend money at interest to the motor finance company?]

Is there some general principle that can be enunciated that should apply to what can be securitised? Or do we stand back and allow investors take risks, even though we can see how poorly they judged their exposure on sub-primes?

silverharp · 19-01-2009 08:55AM

P. Breathnach wrote: »

Or do we stand back and allow investors take risks, even though we can see how poorly they judged their exposure on sub-primes?

I'd have to say yes. Other groups of investors made huge mistakes for instance pension funds "investing" in commodities..... I'd focus on freeing up the state sponsered rating system. Had junk not been rated as A, whole groups of investors would not have been allowed to invest in them in the first place.

thebman · 19-01-2009 10:37AM

nesf wrote: »

What's the difference between what you are describing and a regulated private bank in practice? Also, how do you insulate it from the Government? Who appoints the people in control of the bank and so on? It's really not easy to have a truly independent nationalised company and where are the advantages to doing this versus leaving it to the private sector and regulating them?

I think the main difference would be that the reason they'd exist to grow the economy and not entirely to make a profit.

It wouldn't be in their interest to leave us in the current crisis as they'd be accountable and would have to face the nation themselves instead of just the financial regulator while the person that helped cause the mess hides away and refuses to talk to the public.

The only real alternative is an actual regulator instead of a worm which we appear to have had up to now an stricter regulations. In fact, regulators have failed Ireland in almost every sector from Broadband to Energy to Finance so I think simply having a regulator isn't good enough as they don't actually do anything. Better to have a state body entirely responsible for it that can be held accountable to the public.

Either way, it can't continue working the way it is as the lax regulation has lead to the banks over exposing themselves to a financial crisis.

nesf · 19-01-2009 01:40PM

brim4brim wrote: »

I think the main difference would be that the reason they'd exist to grow the economy and not entirely to make a profit.

It wouldn't be in their interest to leave us in the current crisis as they'd be accountable and would have to face the nation themselves instead of just the financial regulator while the person that helped cause the mess hides away and refuses to talk to the public.

The only real alternative is an actual regulator instead of a worm which we appear to have had up to now an stricter regulations. In fact, regulators have failed Ireland in almost every sector from Broadband to Energy to Finance so I think simply having a regulator isn't good enough as they don't actually do anything. Better to have a state body entirely responsible for it that can be held accountable to the public.

Either way, it can't continue working the way it is as the lax regulation has lead to the banks over exposing themselves to a financial crisis.

How do you prevent political interference though? That's the million dollar question.

thebman · 19-01-2009 04:41PM

nesf wrote: »

How do you prevent political interference though? That's the million dollar question.

The same way we did with communications. The regulator does the work. The government don't get involved.

I imagine the present government would just be happy to have an organisation to point the finger at so they have one less responsibility and continue earning the massive wage.

nesf · 19-01-2009 06:16PM

P. Breathnach wrote: »

But that brings us to another question: what criteria should apply to bundling any types of loan into securities? Can you package 1,000 car loans and sell them on? [And why might anybody buy them, rather than simply lend money at interest to the motor finance company?]

Well, for one the security would give you a direct claim on the repayments from those loans rather than being a corporate loan and also, you could structure the security differently to produce a different risk/reward rate than loaning directly to the motor finance company (i.e. take 10,000 car loans to people with absolutely spotless credit ratings and solid incomes and you have a very different entity to loaning to a motor finance company that a) loans to many different customer types and b) you've no say over how the money will be used). Securities allow loans to be packaged and broken up into little pieces, this kind of granuality allows risk to be pooled and spread around which improves the ability of entities to access credit (i.e. a corporation can take out one loan, with all the paperwork/time/money savings that that brings instead of taking out fifty or a hundred very small loans with all the excess cost that that brings).

P. Breathnach wrote: »

Is there some general principle that can be enunciated that should apply to what can be securitised? Or do we stand back and allow investors take risks, even though we can see how poorly they judged their exposure on sub-primes?

In principle mortgage backed securities can work if you the rating agencies are doing their job correctly and the banks loan responsibly. The question to what should be securitized comes down to how much of the above is manageable/doable. I think with the American approach to mortgages makes this harder, i.e. no recourse loans, you don't owe the lender anything if your home sells for less than the mortgage amount. This makes defaulting a relatively cheap an option for mortgage holders and makes default risk much more problematic than our system here. Combine no-recourse mortgages with people who've bad credit records all ready (i.e. little to lose by defaulting) and you've a nightmare scenario.

Any derivative or financial product is only as good as the the accuracy with which the underlying assets have been valued/analysed for risk. We need to strengthen this side of the system, allowing investors to take risks only works when they can accurately estimate the risk involved.

Tricity Bendix · 19-01-2009 06:43PM

brim4brim wrote: »

Anything that essential should be in the hands of the country and not private interests IMO.

By such logic we should nationalise farms.

D.S. · 19-01-2009 07:00PM

nesf wrote: »

Well, for one the security would give you a direct claim on the repayments from those loans rather than being a corporate loan and also, you could structure the security differently to produce a different risk/reward rate than loaning directly to the motor finance company (i.e. take 10,000 car loans to people with absolutely spotless credit ratings and solid incomes and you have a very different entity to loaning to a motor finance company that a) loans to many different customer types and b) you've no say over how the money will be used). Securities allow loans to be packaged and broken up into little pieces, this kind of granuality allows risk to be pooled and spread around which improves the ability of entities to access credit (i.e. a corporation can take out one loan, with all the paperwork/time/money savings that that brings instead of taking out fifty or a hundred very small loans with all the excess cost that that brings).

In principle mortgage backed securities can work if you the rating agencies are doing their job correctly and the banks loan responsibly. The question to what should be securitized comes down to how much of the above is manageable/doable. I think with the American approach to mortgages makes this harder, i.e. no recourse loans, you don't owe the lender anything if your home sells for less than the mortgage amount. This makes defaulting a relatively cheap an option for mortgage holders and makes default risk much more problematic than our system here. Combine no-recourse mortgages with people who've bad credit records all ready (i.e. little to lose by defaulting) and you've a nightmare scenario.

Any derivative or financial product is only as good as the the accuracy with which the underlying assets have been valued/analysed for risk. We need to strengthen this side of the system, allowing investors to take risks only works when they can accurately estimate the risk involved.

I would largely agree that the appropriateness of securitised products as you say are based upon:

- The appropriateness of the collateral in relation to the securitised product
- The accuracy of Credit Rating Agencies in their rating methodologies
- Valuation of underlying asset

I would also add two items that have a huge role to play in the treatment of securities:

1) The accounting standards: the current Mark-to-market accounting standards had a big part to play in the liquidity crisis. Mark-to-market accounting means that firms set aside capital for off-balance sheet transactions based upon their mark-to-market values. When prices start to crash in a bear period, companies have to write off the depreciated value of the portfolio whether or not they intend to sell the asset in the current financial period. The run on CDO's combined with the M2M system caused panic in the financial system and led to the liquidity crisis we are currently experiencing.

Also, the ability to move securitised products completely off balance sheet incentivises banks to focus on the sale of the credit product rather than on the credit worthiness of the consumer. Not addressing this point would mean that poor securitised products would continue to enter the market.

2) Regulatory Standards: Regulatory standards potentially need to severely increase the amount of capital that should be set aside for off-balance sheet products to allow for the inherent risk. It's quite clear that these products were mis-priced but additionally, Basel II incentivised banks to set away less cash than they should have by going with the more advanced methodologies. This is counter intuitive as banks should of been setting aside more capital in the boom time to prepare for the recession.

I'd argue the additional two points above would provide for a safer environment with which to trade securitised products.

nesf · 19-01-2009 07:00PM

brim4brim wrote: »

The same way we did with communications. The regulator does the work. The government don't get involved.

The Government doesn't get involved in communications because it's not really worth their while, having sway over the financial regulator or those running a nationalised bank on the other hand is a very different proposition. What's to stop them appointing a regulation/chairman who's amenable to doing political favours?

Flamed Diving · 19-01-2009 08:22PM

nesf wrote: »

How do you prevent political interference though? That's the million dollar question.

You can't. That's why it is a terrible idea.

youcrazyjesus! · 20-01-2009 05:03AM

nesf wrote: »

Bad things:

1) The lending cycle might start looking like the budget cycle. i.e. first year after an election? Not a chance of a loan. Year before an election? Here have two..

2) Regional lending distributions might start looking like the Sports Capital Grant distributions (i.e. plenty of credit for the constituencies and counties of sitting Ministers).

3) Lack of innovation/stagnation. If our banking sector is nationalised, it doesn't have to compete with anyone, ergo no pressure to improve business practices, merely do enough to get by.

4) Any trading or loans done by this bank would implicitly be viewed as State guaranteed. This was part of what caused the whole sub-prime mess with Fanny May and Freddie Mac.

5) Unprofitable practices might be continued purely because of political concerns, i.e. banks staying in tiny towns because it'll cost votes when in reality it's just a huge waste of taxpayer's money for the bank to be there because it does so little business.

6) Trouble getting a mortgage? Talk to your local TD about it.

That's off the top of my head, I'm sure there are plenty more reasons not to have a nationalised banking sector but I can't think of them right now.

This all sounds like hogwash to me and quite spurious given any system would obviously be run independent of political influence and concerns. State run does not mean Government run.

Creating "bad banks"

Comments