Ireland About to Give Another Sop to the Banks, a Bad Assets Fire Sale?

Reader Swedish Lex, who was involved in the famed and generally well regarded Swedish banking industry cleanup of the early 1990s, read an innocuous-sounding Financial Times story the same way I did. Not only are the banks who lent recklessly to Ireland’s overheated property sector being shielded from most of the consequences of their stupidity and greed, but other financiers are likely to make out like bandits on what looks certain to be an unduly rapid sale of bad bank assets.

For readers new to how banks get euthanized, an approach generally regarded as sound when dealing with banks that are seriously insolvent (as in their assets are worth less than their debts) is the “good bank-bad bank” approach. The bank is taken over, the board and senior management is fired. The good parts of the bank are usually spun back out as quickly as possible with new management in place. The bad parts, typically the bad loans, are put in a separate entity and disposed of.

Now there are a lot of variants on that theme. For instance, a bank might be taken over, given a government guarantee, and have its bad assets spun out gradually (as opposed to setting up a separate bad bank entity). Some Texas banks that went bust in the late 1980s had their own bad bank entities. By contrast, the S&L crisis featured one big bad bank entity, the Resolution Trust Corporation, whose mission it was to sell the asset of failed thifts. Most of these banks had gotten into trouble with speculative real estate lending (sound familiar?) and as a result, a lot of the assets that had to be sold were real property.

The problem is that the US RTC example has been treated, in revisionist history fashion, as an unadulterated success, when its record was seen as more mixed at the time. That isn’t a reflection of the performance of the RTC staff, as much as how its charter was defined. First, the RTC was authorized only to liquidate assets. That meant it could not restructure loans. By contrast, the Swedish treated their bad bank company as a asset manager and gave it more latitude. It could restructure bad loans (which would make them more appetizing to buyers). It was even allowed to extend more credit to borrowers (Sweden was going through a bad recession, due to the impact of the end of the Soviet Union on its economy, and some companies with otherwise sound businesses were experiencing cash crunches that looked to be short term in nature. It often made good business sense to cut a borrower like that some slack).

Second, the liquidate bad assets mandate meant the RTC was in the auction business. One of the key tricks of that trade is never, never put too much product on the market if it can at all be avoided; all you do is depress prices. But Congress, which was decidedly not happy to have to make special budget authorizations to clean up the savings and loan crisis mess, wanted the RTC wound up relatively quickly. Even though the RTC did better than anticipated, recovering 85 cents on the dollar, even the staff of the RTC thought that extending the process another year or so would have yielded even better returns.

By contrast, the article tonight at the Financial Times has all the indicators that the time pressure will be considerable. And that not only means greater odds of low prices, which equates to a steal for buyers, but even worse, the potential for collusion. As Swedish Lex noted, “It increases the risk for corruption since it is impossible to say that assets were disposed of too cheaply when the market is a 100% buyers’ market.”

From the Financial Times:

Ireland will accelerate the pace of shrinking the country’s banks, as a quid pro quo for continued access to emergency European funding.

The banks will have to sell tens of billions of euros worth of legacy loans in a matter of months, say people briefed on the details of Ireland’s €85bn ($114bn) bail-out by the European Union and the International Monetary Fund.

“The deleveraging has to go fast. That was part of the deal to keep European Central Bank funding,” said a person involved in the discussions.

It’s one thing for the assets to be removed from the banks quickly, quite another for them to be sold quickly. But it looks like the ECB is taking an even more short-sighted view than Congress did in the early 1990s, which is just peculiar. Congress resented funding the working capital of the RTC; the ECB similarly appears not too happy to fund the crappy bank assets. But the ECB is a central bank, comparatively insulated from short term budgetary pressures. The only reason for haste might be that it envisions a great deal more bank asset liquidations in the pipeline, and assumes prices will be low no matter what process in put in place.


Originally published at Naked Capitalism and reproduced here with the author’s permission.