9/1/19: Banca Carige & the Promise of Euro Banks Insolvency Resolution Regime

Italy has been the testing ground for the European regulatory framework for resolution of insolvent banks for several years, running. In all past sagas, the framework has been shown to fall short of protecting the taxpayers from the risk contagion loops that dominated the banking sector insolvency resolution regimes during the Global Financial Crisis. And the latest problem bank, Carige, is no exception.

Per latest reports (https://www.ft.com/content/b9fe3384-1427-11e9-a581-4ff78404524e) the Italian Government is pushing toward nationalization of the troubled lender in need of at least EUR400 million in fresh capital - capital it can't raise in the markets. The Government is also set to guarantee new bonds sold by Carige.

Carige assets of ca EUR25 billion are set against current capitalization of just EUR84 million. Per V-Lab data, Banca Carige is suffering from a massive spike in liquidity risk, with illiquidity index (a measure of liquidity risk) spiking to its highest levels in more than 21 years:

In late December, the ECB has taken the unprecedented step of placing Banca Carige in temporary administration, with administrators given three-month mandate to reduce balance sheet risks and arrange sale/merger/takeover of the bank. As a part of this work, the administrators are trying to review the Italian Government guarantee (issued in December) that led to the Italian deposits guarantee fund (FITD) purchasing EUR320 million of Carige's bonds.  In a notable development, the purchased bonds are potentially convertible into equity in an event of Carige's capital levels falling below regulatory threshold. In other words, these are CoCo-type bonds, implying the state fund is carrying the entire risk of Carige's future capital breaches. Beyond this, there are on-going talks with the Government on the possible SGA SpA (state-owned bad assets fund) purchase of some of the Banca Carige's non-performing assets. As an important aside, the existent bondholders in Carige are not subject to the bail-in rules the EU has put forward as the core measure for reforming banking sector insolvency regime.

These guarantees, buy-ins into Carige's bonds, lack of bondholders bail-in, and potential purchases of the bank's troubled loans constitute a de facto bailout of the bank using sovereign (taxpayers) funds. In other words, the European banking insolvency regime core promise - of shielding taxpayers from the costs of banks bailouts - is simply an empty one.

8/6/2013: Shortages of Safe Assets & Banks Recaps - troubled waters of Basel III

Here's an interesting view on European banks: http://www.voxeu.org/article/urgent-need-recapitalise-europe-s-banks . The core point is here:

Chart: Market-to-book value of European banks:

Quote: " On average, the market-to-book value of European banks now is about 0.50 (see Figure 1). This indicates that accountants’ estimates of bank capital are far too rosy, and that banks have substantial hidden losses on their books."

But there's more. "Until now, Europe’s banking sector has been kept afloat by implicit state guarantees of virtually all liabilities. …in 2012 these guarantees provided banks in Europe with an annual average funding advantage amounting to 0.3% of total assets. …An annual funding advantage of 0.3% of assets can be capitalised to be equivalent to 2% of total assets, on the assumption of a discount rate of 15% commensurate with banks’ uncertain earnings prospects. Given total banking assets of €33 trillion in the Eurozone, we are talking about an implicit guarantee of about €650 billion."

In short, through the crisis, European banking system was pumped with implicit supports to the tune of EUR2.6 trillion.

More than that. EBA is delaying stress tests into 2014, so we won't even in theory be able to know what is going on in the banks. Except, one has to doubt that the theory is a good instrument for the reality, as EBA has managed to bungle all stress tests it carried out to-date. In other words, EBA is acting de facto to increase implied supports as it delays and evades recognition of losses.


Look at the following paper: http://www.cpb.nl/en/publication/private-value-too-big-fail-guarantees (alternative link via ssrn: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2271326) which concluded that: "over the period 1-1-2008 until 15-6-2012" for only 151 European banks, "the size of the funding advantage' granted by various state supports "is large and fluctuates substantially over time. For most countries it rises from 0.1% of GDP in the first half of 2008 to more than 1% of GDP mid 2011. Our results are comparable to findings in previous studies. We find that larger banks enjoy on average higher rating uplifts, but the effect of size does not increase anymore for banks with total assets above 1,000 billion Euro compared to banks with assets between 250 and 1,000 billion Euro. In addition, a higher sovereign rating of a bank‟s home country leads on average to a higher rating uplift for that bank."

In other words, remove the protectionist supports and the system will crumble.

Note, the paper also cites the case of Ireland. "When we take a closer look at the funding advantages of banks from Spain, Italy, and Portugal in Figure 7, we see that the advantages enjoyed by banks are relatively small in these countries. This can be explained by the smaller rating uplifts that the banks from these countries enjoy. The fact that rating uplifts are relatively small in these countries is likely to be related to lower sovereign creditworthiness. The banking sector in, for example, Spain is not necessarily smaller when compared to GDP than the banking sector in France and Germany. So this is unlikely to explain the results we find. In Ireland, funding advantages are relatively large compared to the other three countries. The funding advantage enjoyed by Irish banks is somewhat higher than the advantage enjoyed by French and German banks."

Figure 7: funding advantage per country (Spain, Ireland*, Italy, and Portugal) (*note that the figure for Ireland is drawn on a different scale)

Now, when you just thought that the resolution path (as suggested by the article linked above) is well-known: assess, expose, recap, things are getting slightly out of hand. BIS has warned that simply pumping more capital into banks might be a wrong thing to do. Here's the BIS paper: http://www.bis.org/publ/cgfs49.pdf.

In the nutshell, BIS is saying that core tools for dealing with banks insolvency so far are… possibly… making these banks less safe, not more. The problem is that under Basel III, safety of bank capital is determined by safety of underlying assets held as capital (so far - fine). These 'safe' assets are… err… Government bonds and Government-guaranteed commercial paper (e.g. MBS). The idea is that 1) these assets are more secure, thus provide better cushion in the case of distress, and 2) these assets can be sold (are liquid) easily to cover any losses.

Problem is: there is a shortage of 'safe' assets as defined by Basel. The shortages are riven by 1) higher demand for these assets, 2) smaller number of 'safe' (highly-rated) sovereigns, 3) reduced issuance by highly-rated sovereigns ('austerity') and 4) central banks and non-banking financial institutions (e.g pensions funds) hoovering up these assets. BIS is not worried about the shortages of safe assets, but here are some links on this:

• from the Economist: http://www.economist.com/blogs/freeexchange/2013/02/safe-asset-shortage
• and from BIS own researchers: http://www.bis.org/events/conf120621/gourinchas_paper.pdf
• from Bruegel: http://www.bruegel.org/nc/blog/detail/article/1023-blogs-review-the-safe-asset-shortage/
• from FT Alphaville: http://ftalphaville.ft.com/tag/shortage-of-safe-assets/ with a chart:

In turn, shortages of safe assets, even if nascent, can drive ups emend for riskier assets and thus increase riskier assets allocations by the financial intermediaries (think insurance and pensions funds on drugs).

Here's a very interesting discussion of what can happen next from @simonefoxman: http://qz.com/88585/new-fears-of-financial-interconnectedness-highlight-the-delusion-of-bank-capital/?oref=dbamerica

"And therein lies the risk. The assets don’t change hands permanently: It’s just one institution lending junk bonds to another and borrowing higher-quality ones in return. So a default on one side could translate into problems for the other. In such cases, the “high-quality capital” is only as reliable as the low-quality capital it was exchanged for. Moreover, if assets on either end of such a deal are mispriced, it could have knock-on effects across the financial system.

As a result, warns the BIS, the financial system is becoming more interconnected—and thus more susceptible to system-wide problems of the kind we saw in the financial crisis a few years ago."

Once again, Basel III might be off the target by a mile when it comes to improving quality of risk buffers in the banks… Just as with liquidity buffers: http://trueeconomics.blogspot.ie/2013/05/352013-basel-25-can-lead-to-increased.html

Economics 27/8/10: The path & cost of banks bailouts

On the foot of today's comment in the Financial Times, here are few quick estimates as to the extent to which current policy on banks recapitalization is bleeding the economy dry.

As estimated by myself (comfortably within the S&P projections), Ireland will stand to lose net:

• Nama - net loss of (mid-range) €12-19bn;
• Banks - net losses are €50-55.6bn.

These are mid-range estimates.

My estimates translate into:

• Anglo Irish Bank expected supports are likely to exceed the overall decline in our GDP by a factor of more than 1.5 times (constant prices GDP fell €20.26bn between 2007-2009). Thus Anglo alone will cost Irish economy more than the entire Great Recession;
  
• The bailout will cost us €23,422-34,880 per each person in our labour force as of Q1 2010. Mid range estimate loss is €27,121. Note, labour force includes both employed and unemployed.
• The entire bailout of the banking system can end up costing Ireland in excess of x3 times the total economic loss incurred during this Great Recession.
• Anglo alone will cost us the equivalent of providing unemployment benefits for 2 years to over 1.25 million Irish workers.
• Anglo bailout would cover current Live Register costs for more than 6 years
• The banking bailout would have covered over one half of all outstanding mortgages in the nation once we adjust for interest accruals (a note to our FR: that's one hell of a real moral hazard, Mr Elderfield, much more real than any aid to mortgage holders you can ever fathom)
• The cost of bailout risks running at over €69,000 per family of 2 able-bodied adults either employed or unemployed
• 'Repairing' the banks Government-way can cost 35% of constant prices 2010 GDP or 43.2% of 2010 Gross Disposable National Income, using mid-range estimates for the expected bailout
  

Lastly, let me note that the alternatives to this 'blank cheque' recapitalization approach always existed and were known to the Government: see links here & here. Members of the cabinet were briefed as to the above-linked proposal and were provided with full cost estimates of these proposal. In at least one case, one cabinet member sought analysis/appraisal of the above proposal from official advisers, with evaluation returning 'no objections to the numbers cited' according to my source. In other words - they couldn't find anything wrong with it at least on the basis of quick evaluation.

Daily Economics 18/04/09: Nationwide fall(bail)out

Nationwide - systemic importance?
In today's Irish Times (here), Mr Cowen makes a ludicrous assertion that Irish Nationwide - or as we can call it - Irish Nationvile. How, Mr Cowen? Care to explain?

Irish Nationvile is not a systemically important organization. It is a mutually-owned closed shop (officially) or Fingleton's fiefdom (unofficially) that has done much good to this economy in the past as a safe-house for dodgy directors loans from the Anglo, a default bank for the most speculative developers, and an exemplary case study for corporate mis-governance. By its size, it is roughly equivalent to 10% of the property loans held by the two laregst banks, or just 6.4% of the property-related loans of our 6-banks system. It has virtually no productive net assets outside property sector so should the society go under, the economy of Ireland will hardly notice if, say, €8-10bn in performing loans were to be bought at a discount by the likes of HSBC or Barclays or Ulster Bank or NIB or whoever steps to the plate. Even BofI and AIB might want to step in and pick up depositors and good lending assets from the ruin.

But letting Nationvile sink - publicly and swiftly - will send two important signals to the international markets and to domestic voters. The first one will be to tell the world that Irish Exchequer is starting to manage its downside risk - throwing Nationwide out of the umbrella of state bailouts will make the case for judging Irish Government banks policies as being informed by economic efficiency rationale, not political expediency that Mr Cowen is so skilled in. The second one will be to tell the voters that there is at least some bound to the recklessness with which the Government is willing to use taxpayers hard earned cash to help its own cronies.

So, in my view, let it sink. Now!


ESB - another systemically important waster?
The Royal Bank of Scotland is toning down its flash headquarters to bring the building down to the early realities of the crisis. Many banks and large companies (including some Irish) are turning away from the posh offices they were planning to move to, but not ESB. The state monopoly that has milked its customers for years (and still does) with the second highest cost of electricity in Europe is planning to 'renovate' its (admittedly ugly) headquarters in Dublin as a package of 'stimulus' economics. To create jobs, so to speak. This amazing fact did not trace across Irish official media (Irish Times and RTE) reporting on the arrogant, in-your-face monopoly's last week's announcement.

The price of uncertainty

Here is something that we have been discussing in my Investment Theory course in Trinity’s MSc in Finance: the role of LTCM bailout in creating a self-perpetuating culture of “We are too big to fail” amongst the US, UK and even Irish institutions.

“Today, … that ad hoc intervention by the government no longer looks so wise. With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed,” says Tyler Cowen.

How true this rings in the context of AIB and Bank of Ireland today! Indeed, their bizarre wobbling between “We don’t need capital injections” and “We’ll take some public money, please” speaks louder than Anglo’s surrender to the Exchequer. The message to the Government is clear – “Rescue us, but hold passing the costs – we are too big for you to let us fail”.

Tyler Cowen, however, puts this type of bluffing into perspective when he concludes that:
“John Maynard Keynes famously proclaimed that ‘in the long run we are all dead.’ …We’re not quite dead, but we are seriously ailing. ...we may be tempted again to put off the hard choices. But perhaps the next ‘long run,’ too, is no more than 10 years away. If we take the Keynesian maxim too seriously, and focus only on the short run, our prospects will be grim indeed.”

How? Well, those of you who were in my class last Fall would remember its core message: “Uncertainty and risk are all that matters in the financial markets”. In Tyler Cowen’s words:
“It has become increasingly apparent that the market doesn’t know what to expect and that many financial institutions are sitting on the sidelines, waiting to see what regulators will do next. Regulatory uncertainty is stifling the ability of financial markets to engineer at least a partial recovery.”

If there is a need for any proof of this – watch Anglo’s ADRs melting away in the US while the Irish market and the Government remain shut for the holidays: $0.12 on December 26.

Or here is the evidence in two charts and on a slightly more macro scale, plotting ISE Financials index performance against main policy shift dates and ISE Financials relative to S&P Banks index (both normalized to 100 at June 3, 2008). The trend is clear – every new round of Irish Government policy announcements has been greeted by the markets as a sign of a rising risk premium on Irish shares. This macro-trend has been about as clear as the fact that a long put on Irish banks on any date just prior to a new Government policy announcement would be in the money.

And this poor record has far less to do with the Anglo's or AIB's or BofI's fundamentals than with the short-termist and unconvincing policy performance by the Government. For all would-be-Keynesians out there, the gap between December 20th price (Anglo’s de facto nationalization announcement) and current price – a loss of 76% or $-0.38 per ADR – is, in effect, the latest revealed price of regulatory & policy uncertainty in Ireland. Steep!