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Letting Anglo go would trigger Lehman-like panic
DAN O'BRIEN
ANALYSIS: Options for containing the costs of Anglo Irish Bank’s huge losses are tragically limited
ACCORDING TO the Banker magazine, Anglo Irish Bank booked the biggest losses of any financial institution in the whole world last year. With yesterday’s news of more massive multibillion-euro losses for the first half of 2010, it is likely to collect that dubious accolade for the second consecutive year.
If a behemoth bank in the world’s largest economy – a Citibank or a Bank of America– had topped this list, it would be one thing. That a small bank in a small economy will top it for two successive years is almost beyond belief. The losses in the first six months amount to nearly €2,000 for every woman, man and child in the State. More pertinently, they amount to well over €4,000 for every person in gainful employment.
It is hard to know what to be more outraged about: that such a thing should have come to pass, or that the people responsible have not suffered the commonplace fate that usually befalls those whose businesses fail, often through no fault of their own.
Some consideration of how this situation has been arrived at is necessary, not least because many people (understandably) still believe that no taxpayers’ money should be wasted on propping up the infernal institution. Consider four points.
Point 1: Banking is inherently a riskier business than most others. Banks take deposits, which must be repaid on demand, and make loans that cannot be called in at will. This mismatch means that banks can blow up easily.
Point 2: We know that economies do not function well with impaired banking systems, and that governments everywhere step in to minimise the costs of banking crises even if it means bailing out financial institutions.
Point 3: Given point 2, bankers understand that they enjoy an implicit guarantee from taxpayers. Faced with a “heads I win, tails you lose” proposition, they take even bigger risks than they might otherwise take, making inherently fragile banking systems more fragile still.
Point 4: Given points 2 and 3, banking is subject to much more regulation than most other businesses. This regulation has failed, and the largest bailout ever has taken place.
One central banker has described the evolution of finance in recent decades as a “doom loop”– ever larger crises, leading to ever larger bailouts, leading to ever larger crises, and so on. Breaking that loop is perhaps the biggest public policy question facing rich countries today because the world will not be able to afford another banking crisis for decades to come.
It is not clear that the Irish State can afford the current crisis.
So what would happen if the State were to withdraw its support for Anglo Irish Bank and let it collapse?
The answer is that nobody knows for sure. In September 2008, the US authorities allowed Lehman Brothers to collapse because it was relatively small and thought not to be systemically important. US regulators wanted to send a signal to Wall Street that risk-taking meant just that. Letting Lehman collapse was done for the right reasons, but it proved very wrong.
Letting Anglo go is unquestionably the “right” thing to do. But a collapse would cause collateral damage. Faith in the other banks would be undermined, perhaps gravely. The contagion effect is powerful in financial affairs.
The solvency of the Irish State could also be questioned even more than it has been hitherto. Those who lend money to the Government – so that it can continue to run massive budget deficits – already seek a very high premium to compensate for the elevated risk that they will not be repaid.
Some people argue that if the State were to lessen its exposure to Anglo, it would
reassure lenders, and thus bring down the cost of financing ongoing budget deficits.
This view is not illogical, but I believe it is wrong.
In my judgment – and this is very much a matter of judgment – letting Anglo go would very probably trigger a Lehman-like panic.
It is worth noting that no European Union government has risked letting an institution with liabilities as large as Anglo’s default since Lehman. European governments collectively have not risked letting Greece go, and have clubbed together to put a massive bailout package in place in order to rescue other countries, if that becomes necessary.
Governments have done all this because they understand that the international financial system as it has existed in recent decades has failed.
It is akin to a structurally unsound building which remains standing only because it is buttressed on all sides.
A large-scale default – by a bank or a country – would be tantamount to triggering an earthquake. The entire edifice could come down.
Just as a default on Greece’s government debt would have consequences far beyond that country’s borders, default on Anglo’s debts would ripple out across the world. They would have most effect in the rest of our currency union.
The decision on the future of Anglo Irish Bank is thus not one taken exclusively in Dublin. The European Commission, the European Central Bank and other euro-zone governments all have a say.
The consensus is that it should be kept standing. This is in keeping with this take-no-risks, pay-any-price approach to containing the financial crisis in Europe in the post-Lehman era.
The options now available to the Government to minimise the costs to taxpayers of Anglo Irish Bank are limited. The damage has been done. Everyone in this State – one way or another – will pay the price for years to come.
(Irish Times)
DAN O'BRIEN
ANALYSIS: Options for containing the costs of Anglo Irish Bank’s huge losses are tragically limited
ACCORDING TO the Banker magazine, Anglo Irish Bank booked the biggest losses of any financial institution in the whole world last year. With yesterday’s news of more massive multibillion-euro losses for the first half of 2010, it is likely to collect that dubious accolade for the second consecutive year.
If a behemoth bank in the world’s largest economy – a Citibank or a Bank of America– had topped this list, it would be one thing. That a small bank in a small economy will top it for two successive years is almost beyond belief. The losses in the first six months amount to nearly €2,000 for every woman, man and child in the State. More pertinently, they amount to well over €4,000 for every person in gainful employment.
It is hard to know what to be more outraged about: that such a thing should have come to pass, or that the people responsible have not suffered the commonplace fate that usually befalls those whose businesses fail, often through no fault of their own.
Some consideration of how this situation has been arrived at is necessary, not least because many people (understandably) still believe that no taxpayers’ money should be wasted on propping up the infernal institution. Consider four points.
Point 1: Banking is inherently a riskier business than most others. Banks take deposits, which must be repaid on demand, and make loans that cannot be called in at will. This mismatch means that banks can blow up easily.
Point 2: We know that economies do not function well with impaired banking systems, and that governments everywhere step in to minimise the costs of banking crises even if it means bailing out financial institutions.
Point 3: Given point 2, bankers understand that they enjoy an implicit guarantee from taxpayers. Faced with a “heads I win, tails you lose” proposition, they take even bigger risks than they might otherwise take, making inherently fragile banking systems more fragile still.
Point 4: Given points 2 and 3, banking is subject to much more regulation than most other businesses. This regulation has failed, and the largest bailout ever has taken place.
One central banker has described the evolution of finance in recent decades as a “doom loop”– ever larger crises, leading to ever larger bailouts, leading to ever larger crises, and so on. Breaking that loop is perhaps the biggest public policy question facing rich countries today because the world will not be able to afford another banking crisis for decades to come.
It is not clear that the Irish State can afford the current crisis.
So what would happen if the State were to withdraw its support for Anglo Irish Bank and let it collapse?
The answer is that nobody knows for sure. In September 2008, the US authorities allowed Lehman Brothers to collapse because it was relatively small and thought not to be systemically important. US regulators wanted to send a signal to Wall Street that risk-taking meant just that. Letting Lehman collapse was done for the right reasons, but it proved very wrong.
Letting Anglo go is unquestionably the “right” thing to do. But a collapse would cause collateral damage. Faith in the other banks would be undermined, perhaps gravely. The contagion effect is powerful in financial affairs.
The solvency of the Irish State could also be questioned even more than it has been hitherto. Those who lend money to the Government – so that it can continue to run massive budget deficits – already seek a very high premium to compensate for the elevated risk that they will not be repaid.
Some people argue that if the State were to lessen its exposure to Anglo, it would
reassure lenders, and thus bring down the cost of financing ongoing budget deficits.
This view is not illogical, but I believe it is wrong.
In my judgment – and this is very much a matter of judgment – letting Anglo go would very probably trigger a Lehman-like panic.
It is worth noting that no European Union government has risked letting an institution with liabilities as large as Anglo’s default since Lehman. European governments collectively have not risked letting Greece go, and have clubbed together to put a massive bailout package in place in order to rescue other countries, if that becomes necessary.
Governments have done all this because they understand that the international financial system as it has existed in recent decades has failed.
It is akin to a structurally unsound building which remains standing only because it is buttressed on all sides.
A large-scale default – by a bank or a country – would be tantamount to triggering an earthquake. The entire edifice could come down.
Just as a default on Greece’s government debt would have consequences far beyond that country’s borders, default on Anglo’s debts would ripple out across the world. They would have most effect in the rest of our currency union.
The decision on the future of Anglo Irish Bank is thus not one taken exclusively in Dublin. The European Commission, the European Central Bank and other euro-zone governments all have a say.
The consensus is that it should be kept standing. This is in keeping with this take-no-risks, pay-any-price approach to containing the financial crisis in Europe in the post-Lehman era.
The options now available to the Government to minimise the costs to taxpayers of Anglo Irish Bank are limited. The damage has been done. Everyone in this State – one way or another – will pay the price for years to come.
(Irish Times)
