Aehso’s Output

@paddyb just tweeted an absolutely superb piece written by Michael Lewis about The End (of Wall Street’s Boom) that anyone with even the mildest curiosity about why the investment banking sector is imploding will enjoy, though maybe ‘enjoy’ isn’t the right word to use in this context given the consequences for us all.

Of course the investment bankers are primarily to blame but the rating agencies didn’t exactly cover themselves in glory in recent years. One particular paragraph from the article really sticks in my head:

But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.

(That Steve Eisman guy seems like a legend, his career history in the article is class)

Michael Lewis is the author of Liars Poker, a book I first read many moons ago when I was working for Iona Technologies. The book is superb if even for only for bringing terms like Big Swinging Dick into the common vernacular. Funnily enough, I bought the book in Dublin airport back in ‘97 while on my way to Wall Street to train up a bunch of IT guys in a large investment bank (right across the road from the US Stock Exchange) on using Orbix and OrbixWeb as the middleware for some of some new internal systems. I had the book finished long before the week was out and it turned into a pretty lively topic of conversation when the guys on the course saw it on my desk one morning.

Ah, they were the good days, unfortunately the investment bank bull appears to be about to be slaughtered.

Anyway, what was the point of this post? Oh yeah, Irish default rates – does anyone truly believe that they will stay as low as the 1-1.5 point levels that the Irish bank management teams are publicly quoting?

I wish there was a ‘zero probability’ smiley I could tack onto the end of this post.

aehso banks banks, liars poker, michael lewis, wall street

I believe the national government is obliged to intervene to stabilize key sectors of the economy. However, I think we’ve gone about this the wrong way.

The Irish economy is only a small part of the larger European economy (we contribute a minuscule 1.2% of EU GDP) which has no restrictions on flow of capital. Our cute hoor politicians have burned a bridges with Europe in passing this legislation. If the EU/ECB do produce rescue packages to preserve the larger EU economy in the near future how high do we think the Irish state will be in the receiving order?

Rushing this legislation may end up destroying trust in the credit rating of the Irish state. May is not a satisfactory qualifier given the amount of money involved and the potential long term damage this would do to future moves to pull this country out of the recession that it is already in. The state would possibly have to borrow for capital expenditure (to kick start the economy) at much higher interest rates while also servicing a much larger existing national debt.

I don’t buy the ‘it’s only a guarantee’ party line. Equivalent guarantees are implicitly provided by the governments of most western economies and in recent weeks we have seen a slew of nationalizations and forced mergers. Making the guarantee explicit via national law draws clear lines in the market that can be manipulated by vested interests (bankers, & investors).

I don’t buy the ‘this won’t cost the taxpayers’ party line. The banks that being protected are constantly revising their bad debt provisions upward and independent analysts believe they are currently understating their positions.

The legislation was drafted with the participation of the chief executives of AIB & BOI. Shouldn’t the Central Bank be advising the government on these matters rather than having PLCs directly bend the ear of the government in private meetings?

At least two of these banks (AIB & BOI) are still planning on paying out dividends to their shareholders this year. AIB raised their interim dividend last summer in a bid to bluff the market. Firstly, does it make any sense to be paying out cash to investors at a time when a liquidity crisis is threatening your ability to survive as a going concern? Secondly, given bluffs like the above, what other ‘risks’ are the senior management of the banks taking in their negotiations with our government?

Incidentally, this legislation effectively allows practically insolvent property developers to continue to negotiate with their existing banks rather than face the music with a bank liquidator. Given the economy is in recession and house/property prices will continue to fall for the foreseeable future, I wonder did the threat of having a sharp implosion of our over-bloated construction sector weigh heavily on the governments thinking?

Is it really worth exposing the Irish state to this risk in order to drag out the inevitable equalization of the Irish construction sector?

aehso banks, economy, ireland, irish

[Also see follow-up Part II post]

I was tweeting about this last night and this morning but I realized that really isn’t the right medium for such a complex topic and I needed to read a little more about what exactly the Irish Government are proposing to pass into law today.

Of course it still all seems to be up in the air but I still wanted to write down some observations:

• I can understand the need to guarantee deposits, but guaranteeing debts? As well as owing record amounts to banks are the Irish population now to act as guarantors to these same institutions for these same loans?
• Where did they get this magical €400 billion figure from? This figure, an order of magnitude greater than our national debt, seems recklessly high for a nation of just over 4 million people in the context of the free movement of capital within the EU, even more so at a time when EU markets are so unstable.
• These are ISEQ listed public limited companies. Some are also listed on foreign stock markets and no doubt they all have foreign investors. So, in the age of multinational businesses and free trade (and free movement of capital) within the EU, how Irish are they, really?
• Will the Irish State have any oversight/control of bank operations during this two year window? Do we continue to entrust this responsibility to the Central Bank or other financial regulatory authorities who have allowed these banks to generate record profits while overextending themselves?
• Statements from banks like the following ring hollow when words like ‘normal’ is used as a qualifier. These are not normal times
  

  We will pay the Irish taxpayer for the privilege of using Ireland’s balance sheet to allow us to borrow internationally and the capital which is in banks, the equity capital, will absorb any losses which arise in our normal course of business lending

  (emphasis mine).

• Did anyone in our government stop to think what position this places other European states, our primary trading partners, in? It would seem not.
• Last but not least – how is it that the Irish government were the first to introduce such a guarantee? I always get worried when Irish politicians think they’ve found a different way to tackle a problem that the whole world is struggling with. The usual ‘Ireland is different’ (as we are used to hearing during our recent property bubble) won’t work here. Also of concern was the the implicit assurances to investors that this legislation will be passed, and in a rushed manner.

Hopefully more information will be revealed about this legislation and the thinking behind it but from where I’m sitting it does doesn’t seem to have been thought through – and the risks to the Irish State are too great for that.

aehso banks, economy, ireland

“Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist”

Kenneth Boulding

If you want to understand how the global economy got into the mess that it is in, you could do worse than spend 45 minutes of your life re-learning more about how money is created. At the very least, it will remind you of some of the fundamentals you may have learned in Economics classes of old. Be warned, you’ll probably get a distinctly queasy feeling @ about 22 minutes in.

(see Money As Debt site for references)

New word of the day for me: Usury

aehso banks, economy, global, money