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.

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  1. mannfm11

    I don’t recall anything being sold around here for 85 cents on the dollar. Donald Carter, who owned the Mavericks bought sizable amounts of late model office properties for around 35 cents on the dollar. The DFW property was in better shape than most of it. The entire deposit base was less than $50 billion for the S&L’s I can recall going down. Now, I don’t know what they had loaned on this stuff, but I can recall some stuff being offered for a dime on the dollar for what I understood the loan was.

  2. Ignim Brites

    “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.” Possibly this. Also, depressing Irish real estate values will have a bewildering, stunning and subduing effect on the Irish elite.

  3. SA

    FIRREA required the RTC to use outside loan workout and collections firms wherever possible. This was both a gift to certain constituents and a refusal to increase Federal staffing. Early on, assets were worked rather than packaged into securities or JVs with investors. The bulk-sale approach made sense given a) the unwillingness of Congress to fund a long-term agency and b) the increasing difficulties of monitoring the outside workout firms.

    Banks that purchased the deposits of failed S&Ls were unwilling to take, on average, more than 20% of the assets. So in retrospect putting these assets into the hands of distressed investors was the only path, short of creating an agency that would last for decades.

  4. attempter

    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.

    The moment I hear of the alleged need for speed in any context my automatic default is that it’s the Shock Doctrine and disaster capitalism. By now Occam’s Razor demands that, after we’ve seen so much of how these criminals operate. Anything they say or do has to be considered guilty until proven innocent.

    As Michael Hudson keeps pointing out, the intent is to exploit deflation to finally buy up all the real assets with the soon-to-be-worthless funny money.

    So here my first idea is that

    1. They know this garbage will never be worth anything.

    2. So you might as well go ahead and depress it, which will depress the underlying, the land itself, which is the real target.

    3. And if the Bailout can by some chance temporarily reflate these “assets”, then the speculators who bought them at that fire sale price will reap a windfall.

    4. So it’s win-win, especially since the speculation is undertaken with 100% taxpayer provided or guaranteed money.

    History’s worst crime is also history’s perfect crime. Nothing short of the complete destruction of the banksters will end it and bring justice for it.

    1. traderjoe

      It’s the perfect set-up – inflate assets, get everyone to take out huge loans, earn banker fees and bonuses. Then deflate assets and use the bonuses and banker fees to acquire assets on the cheap. Then default on the currency and start over again. Rinse and repeat.

      Austerity and IMF/ECB bailouts are the final steps in the scam of the century.

  5. drfrank

    The RTC was a like junk yard having an auction. You bought by the lot, figuring some stuff was going to be total trash, some OK and somewhere in there you would find a pony. People literally bought boxes of unexamined files hoping to find enough good paper to make a tidy profit, and many did. If the recovery rate was as high as 85%, it was 85% of a previously written down figure. It went on for years and years and there were years and years of inept solutions before the junk yard was set up.

    Before the RTC, failed S&L’s were managed in quasi receiverships because the FSLIC, the S&L counterpart of the FDIC, didn’t have enough to cash to cover the insured depositors. Before that, private capital solutions were sought and unside down S&L’s were sold to speculators, generally real estate developers, who were happy to be able to raise money under an FDIC type guaranty.

    In the years before the RTC, Congress didn’t want to appropriate additional money to the FSLIC, which meant that people with friends in Washington got their loans restructured and the sores festered. The then Speaker of the House, Jim Wright of Texas, where there was a concentration of multifamily properties underwater, was in the center of the payola.

    One of the interesting things about this time was that the market failed to clear for an extended period. There were no buyers at any price for empty apartment houses in North Dallas for example and what looked a lot like arson was in some cases the best way out for a borrower with a personal guaranty in the deal.

    Another interesting thing was that when you dug down into the insured liabilities it turned out that most of the holders of high rate insured CD’s were other regulated (that is to say, insured) institutions.

    The idea that a fire sale is anything other than a restructure is nonsense anyway when you consider that the buyer in a firesale has got to be getting credit from someplace or at any rate recording a credit someplace. Restructure or firesale, the key point is that both processes involve the recognition of the loss. The bad bank strategy involves a radical mark to market. And the institution that goes this route has to have enough capital to absorb the writeoffs. Note that write offs (real losses) are different from writedowns (recognition of “loss content”) and in the current mess we haven’t even gotten to the writedowns yet. Oh My God!

    It would be so much worse if the Irish people were to be saddled with the unending liability for bad loans and not have the benefit of banks restored to some kind of semblance of normalcy, not that I am advocating in any way the awful deal they have been forced into.

    Finally, if you really think that taking time to work out of a loan mess is better than a quick disposition of bad deals (the old adage, “your first loss is your best loss”) , then I suppose you would advocate exactly the kind of programs put forth by Treasury and the Fed, whose sole purpose it seems to me is to temporize in the hope that things will somehow cure themselves, without causing the TBTF banks ( and their linked creditors) to recognize their losses.

    They are temporizing because they don’t know what else to do, given the magnitude of the problem. They are confusing their success in temporizing with a real solution. And the cost of temporizing is apt to be but a fraction of what the ultimate resolution will actually cost. Except we will never be able to quantify that cost as it will take 10 or 20 years for many of the injured to recover, and in those kinds of time frames, it is just one’s life.

    If I were an Irish voter, I would vote for default as the better of the bad choices.

    1. Ignim Brites

      “If I were an Irish voter, I would vote for default as the better of the bad choices.” Indications are that this is what will happen.

  6. Random Blowhard

    A full default by Ireland is in fact the BEST choice as it may well bring down the TBFT banks in Europe and Wall Street. Global financial meltdown will not only eliminate the debt but also end the “Era of Securitisation” and all the bad incentives it creates. Default, Nuke it all and let the recovery begin.

    1. Siggy

      If a full default is, indeed, the best choice for Ireland, could not the same be said for the US?

      Well, it might not have been the US specifically but it could have been those of the TBTF community who needed to go poof.

      The missed opportunity in the US was the failure to implement something that closely followed the Swedish model.

      As to the RTC, if you look closely at the detail of what it did, it was a failure. Billions of dollars were left on the table in the name of a quick resolution. In the DFW area, the sale of 13 see-thru office buildings to Don Carter at roughly 35 cents on the depreciated replacement cost dollar was far from stellar performance in that Mr Carter was able to within three years time sell the 13 properties to Richard Rainwater, former advisor to the Bass brothers of Ft. Worth, for approximately 65 cents on the depreciated replacement cost dollar.

      Curiously, all of the 13 properties are now performing respectably, albeit not outstandly. Moral, the RTC left the better part of 40 cents per depreciated replacement cost dollar on the table.

      In the current mania, property acquisitions made during the period from roughly 2000 thru 2006 were done at trailing twelve cap rates of 6% or less. That’s an incredibly strong statement as to what the expectations for future NOI happen to be. The developing reality is that the projected increases in NOI are not occurring and where the LTV exceeded 70%, loan default is either in progress or imminent. On the other hand that compressed 6% cap rate may be more of a statement as to the present and expected future loss of purchasing power in the dollar. That is an aspect of the problem that bears examination.

      There is an emminent and likable local personnage who styles himself as a recovering developer who as an aside opines that he is grateful to be at the denouement of his career. His view is that restructuring the loan is best for all parties. Lenders absorb the loss, borrowers relinquish the property and management is replaced.

      The current practice is to pretend and extend which is often faciltated with a cash infusion that builds a bit of equity in the borrowers position. Just where the additional equity is coming from is, however, unclear. And the reason for that is that the lender is undercapitalized and incapable of absorbing the loss which would otherwise put it in the bankruptcy court. Thus, pretend and extend is an entity survival response mutually shared by borrower and lender. The same phenomenon is what presents in the case of Ireland.

      Ultimately, we will probably see the banks come to the recognition that the foregone restructuring was a very bad choice in that their balance sheet has not improved and the assets that the economy might have fairly paid to use have gone underutilized and more costly to operate than might otherwise have been the case.

      Now, where the assets are of the derivative, CDO/CDS nature, lenders would be wise to consider accounting for them as Goodwill and amortizing them over say 5 to 10 years.

      The case of the Euro and the EMU is quite curious. Here we have a fiat currency that is difficult to inflate. Is there a lesson in that contrary condition and who should we listen to when resolutions to the balance of payments and financing problems are considered? Lastly, is there a unifying political will to rebalance the EMU and at what price and to whom?

  7. yoganmahew

    “1. They know this garbage will never be worth anything.”
    I think you are close – they know that the assets will never be worth bubble prices. Holding out for an improvement in the market is pointless when you are causing paralysis in it. There is no lending going on in Ireland, so who is going to have funding to buy?

    For those advocating default, try and do the sums. You can’t just magic up money to give back to depositors, you can’t just refund depositors and not refund bondholders, or rather you can, but you have to have an external cash agency.

    In the event of default, what do you think happens to the assets of the banks? That’s right, they get sold in a firesale…

    The Irish government has had two years since the original guarantee to do something about the banks. So far, nothing has been done. No deleveraging has taken place. The banks are not cleaned up. NAMA is a disaster.

    This is liquidation without the liquidiser…

    1. traderjoe

      If they defaulted, they could issue a currency without debt and without interest (like a Lincoln Greenback), which negates the need for debts, interest payments, etc. The currency could be issued at a 1:1 value for the now-worthless Euro. They would not have to liquidate anything.

      Over-simplifying, but it would benefit everyone but the bankers.

      1. yoganmahew

        Mmmm, okay. I don’t really fancy going back to eating spuds, living in a clay and wattle hut, and driving an ass. Do you suppose the internet revolution would stay still so my 2008 hardware would always be able to keep up with it?

        It’ll be quite a blow for the rest of Europe to realise that 1% of their economy can cause the euro to become worthless. Perhaps that’s the strength of Sarah Palin! Alaska holds the other 49 states to ransom…

        Thanks for your input, though. Good luck with the trading.

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