Saturday, March 8, 2014

8/3/2014: Morgan Kelly on the Next Incoming Train...

Superb as he always is, Professor Morgan Kelly gives a public lecture on the state of Irish economy (poor), the evolution of the crisis (currently at a temporary stabilisation), recovery (superficial) and what is coming up (ugly)...

Morgan delivers in his usual - engaging - manner.

I must say that I do not necessarily agree with all of this, but that is not the point for this post...


Brian O' Hanlon said...

Why did Irish companies, want to buy property anyhow?

What does it say about our skills of portfolio management here in Ireland, and what does it say about the over-influence that banks in Ireland, had on the economy over the period of the Celtic Tiger?

It makes me laugh, at how we went about approaching the problem of providing private pensions here in Ireland, compared to how they went about it in the United States for example (where 'property' instead of publicly traded shares were included in the portfolio).

Where they decided to diversify pension fund investment portfolios, with a 'property' element in them, they established things called real estate investment trusts, . . . where they sold the equity or preferred stock in these REIT entities on to major investors such as pension funds.

The whole notion of the REIT by the way, often, and even when these north American REIT's operate here in Europe building all kinds of factories, hospitals, hotels and office buildings, is they provide the long term financing of loans on these developments, after the shorter term 'construction only' loan to the local 'bank' has been repaid by the builder of the project.

In other words, what you see in the north American model in regards to 'property' more and more, is the local bank institution being required to provide a short term, high interest rate/fees construction only loan, and the REIT afterwards takes care of long term financing of many projects, . . . and also allows the pension fund to offer its capital into the REIT, in the form of equity or (rated) hybrid securities at higher yields.

What did we do here in Ireland?

Well, for a kick off, we didn't treat the construction lending as short term, high interest rate financing. Instead the Irish banks tried to play the part of both bank lending provider and long term financing provider. It was no surprise then, that our Irish banks just became as fat as fools in terms of their balance sheets.

And then, as if that wasn't even bad enough, . . . the Irish banks, grew that same swollen balance sheet another third or more, by giving loans to viable companies to buy property (using finance from the bank ! ! ! ), . . . so that the small company could supply its members with a pension of some sort ? ? ? ?

In other words, in America the banks are able to score on one out of three counts, where REITs and other structure geared for the longer term, and management of large portfolios of property, take the other two components of financing and investment AWAY from the banks.

Here in Ireland, it was very different unfortunately. It became three-nil to the banks, and REIT's or anything of that nature did not appear on the scene until now ? ? ?

Irish banks in the Celtic Tiger era were trying to earn the vig, in three different ways (short term financing, long term financing and financing of pension pot speculation too), . . . because they were allowed to do so, while swelling their size up to monster-like proportions.

I understand how NAMA is planning to do the whole 'joint venture' thing, . . but it does make me wonder though, in terms of NAMA, how it is going score on this 'how many of three' metric, which I established above. Is it possible that NAMA will in fact, end up looking more like the Irish bank of the boom times, and less like the more pragmatic system that the Americans have figured out for themselves.

(Bearing in mind, that in America, the real blow-up, happened in residential mortgage securitization, . . . rather than in commercial property investment and management, like happened here in Ireland)

From time to time, I look at NAMA, and I wonder if it is able to learn anything from our past here in Ireland?

Brian O' Hanlon said...

And the other that is worth mentioning about small company pension pots and property investments such as REIT's, is that the stock in the REIT is liquid. If you don't like what the REIT is doing, you can sell it and buy something different. When a small company decides to buy property to underpin its pension pot, . . then if you enter into a property downturn, you have to wait years in order to work your way out of that debt servicing arrangement, . . . because what you have purchases is illiquid (especially, if it is commercial property of zoned land here in Ireland).

So now, we are talking about this thirty billion euros of SME debt that will have to be segregated, and the property stuff 'parked' so that the SME will be able to come back later and work it out.

So who gets the fee to manage this SME property debt in the mean time? You've guessed it, the Irish banks, just like they are given the job by NAMA of managing portfolios of commercial property that created in the first place.

This is like a fourth string to the bow, for the Irish banks, and just another way, in which it appears they have got a stranglehold on the entire thing (from every conceivable angle you can imagine).

Brian O' Hanlon said...


In reference to court cases going on in Ireland today, in regards to Irish banks who providing (long term) lending to their own clients to purchase equity in the bank. And in reference to the upcoming Irish banking inquiry. I think that to get this story figured out properly, one has to look at the longer term trends in Ireland, and compare those trends to ones happening in other locations abroad, that have well developed financial markets.

In the couple of comments above, I tried to describe the different capital structure, backing ‘real estate’ investments in north America compared to here in Ireland.

What I would like to suggest, is that very few of the financial/business minded of our Irish politicians are likely to ask the right kinds of questions in any banking inquiry. For instance, I could foresee a situation where a lot of time in the Irish banking inquiry gets used up on telephone calls between the Taoiseach and the leader of the coalition Green party. But what the focus of a banking inquiry should be, is on figuring out what the longer term trends were, that led to the behaviour and actions witnessed. And also, how those trends have been interrupted or not, as the case may be, in the aftermath to the financial crash in Ireland.

I would like to suggest, based upon my comments above about REIT’s and short term/long term financing of real estate in Ireland, that proving long term finance to Irish bank borrowers to buy equity in Irish banks, was not a weird step to take (giving the entire trend and behaviour of Irish banks in the Irish economy). But in fact, we were always going to end up at that logical conclusion, where eventually, an Irish bank would force their customers to buy equity in the bank itself.

Brian O' Hanlon said...

The reason is, is that the trend in the Irish economy, was always that Irish banks would ‘take a piece’ of any and all ‘action’ that was happening in the financial sector. There were no real independent entities such as REIT’s or pension funds, or anything else, who handled different parts of the process. There were only these large Irish banks, that had their tentacles in everything. The focus of an Irish banking inquiry should be to establish the extent of that trend in general, and to see how we have learned in the aftermath of that ‘system’ going radically wrong within the Irish economy.

But the truth of the matter is, I don’t really see how our Irish politicians have the insight into the financial industry either in Ireland or anywhere else, to pursue this useful line of inquiry.

Remember for example, at the time of the conversation about ‘burning the bondholders’ of Irish banks, and we found out that that wasn’t okay. Why? We were told that Irish pension funds and credit unions would become insolvent.

In summary, we can surmise that Irish banks really did own a piece of everything, and made themselves the focal point of the entire Irish economy. No ‘report’ or no inquiry to date in Ireland, has even explored that avenue. No ‘report’ or inquiry in Ireland, in my understanding will ever bother to pursue this line of investigation and fact finding. No Irish politician, it is my opinion, will even know enough about the capital structures within economies in the modern world, in order to ask these kinds of questions.

Irish banks were providing short term and long term finance to cover real estate ventures. Irish banks were lending money to small business to support investment in property. Pension funds in Ireland held Irish bank debt. Irish bank borrowers held equity stock in Irish banks. It seems as though in the decade of the 2000s in Ireland, about the only financial instrument that Irish borrowers or investors were allowed to handle, were those created by Irish banks, for Irish banks. And nothing else.

The unfortunate thing, is I don’t know of anyone in Ireland with any real level of expertise, who has ever asked any significant or serious questions about that.

All we really have now in Ireland, is a sort of legacy mission statement from former minister for finance, Brian Lenehan, who told us that there were these entities known as Irish banks, . . . and that we had to ‘save’ them for some reason, . . . or it would all be bad. And that initial Brian Lenehan 'mission statement', has informed most of the debate I have heard, ever since.