Banks would be overcome by losses without the state’s help
The root cause of the global recession is the crisis in the world's banking and financial system.
The world economy will not recover until the broken system is fixed and a smaller, more cautious, more regulated financial industry can resume lending to worthy customers and businesses.
Yet, almost two years after it began, and despite frantic, hugely expensive efforts by the US and other governments, the situation is getting worse, not better.
There is growing alarm that the huge cost of policy measures so far — especially those of the US and Britain — threaten the solvency of their governments, since the money has to be borrowed.
In the current climate, pension funds, banks and insurance companies which lend money to governments — on the basis that this is the safest place to put it — may not be willing to provide the amounts that governments will need over the next few years.
All of these problems confront Ireland as well — but doubly so. The budgetary threat in America and Britain stems mainly from the cost of saving their economies and banking systems.
Ireland has a serious budgetary problem even before it starts thinking about such things — the result of paying for so much public spending from now-vanished property sale taxes.
That is why the Republic’s international standing is so perilous. The €17bn in cuts and new taxes which the Department of Finance sees over the next five years is just to fill the yawning gap in the public finances.
It includes no figure for the restoration of the Irish banking system. Yet the system has been fully guaranteed by the Government.
The worry is whether the State can afford any more billions to bring the banks back to health. The Government has provided up to €10bn in new capital (and probably all of it will be needed), and then nationalised Anglo Irish Bank.
But the guarantees and nationalisation were panic responses to crises in the banks, while the capital leaves the banks only in the minimum state of financial health. Much more will have to be done.
There are reports this week that the Irish banks have begun reassessing their loans to see what they may really be worth, prior to isolating the worst of them. Bank shares have risen on talk of similar moves in the US, but it is not as simple as it sounds.
The value of a new shopping centre or apartment block depends entirely on whether one thinks it will have tenants or buyers, and what they will pay. No one can know for sure and the range of possibilities is very wide. But it is clear that we have to make a start.
Markets and taxpayers want to know the realistic range of possible losses. In theory, the banks themselves could then begin writing off those losses, paid for by profits elsewhere and the raising of new capital.
In practice, much of the Irish banking system would probably be overwhelmed by the losses, which is why the State will have to get involved.
The Irish Independent believes that the best policy is some kind of ‘bad bank' which would take over the worst loans and spend some years getting what it could from the borrowers and from the sale of the properties and other assets involved.
The real problem is how much the Government should pay for these bad loans — and could it afford to add that amount to the national debt? They must be worth something, although it will be hard to say what.
The more pessimistic the assessment, the less cost to the taxpayer, but the bigger the hit to bank shareholders, who have been almost wiped out already.
There is little comfort for shareholders in any scheme. If there is serious value left in the banks in which they invested their money, then the rescue scheme is not really necessary and shareholders can expect to get quite a bit from the proceeds of the ‘bad bank' in the end.
That may be why banks seem to prefer government insurance to cover the eventual losses, if required. The trouble with that is it could leave doubts hanging over the banks' true position for years to come, and restrain their lending in the meantime. The priority must be to remove this millstone from the necks of the banks so that they can raise new capital from existing or fresh shareholders and return to normal, post-boom business. Normally, the banks would also benefit from the money the State paid for the bad loans.
The Government, though, may not be in a position to hand over whatever billions of value is put on the loans. If this is the case, an even more drastic solution may be needed — simply taking them over without immediate payment.
It would be the ultimate shock therapy, but it is already being discussed seriously in Britain and the US.
There, too, governments may simply not have the necessary resources. In the end, the banks would receive a share of any value left in the ‘bad bank'. In the meantime, they would urgently need fresh capital, to which the Government could contribute a share.
It will be said, not unreasonably, that none of this will impinge on the well-paid senior executives who presided over the disaster. No doubt anything legal which can impinge upon them should be impinged.
But the banks are ours, not theirs — shareholders, workers in pension schemes, customers and taxpayers. It will be long, messy, complicated and expensive, but we have got to get them back.
Brendan Keenan writes for the Irish Independent