Tuesday, March 29, 2011

Irish bank's fifth bailout suggests its time to implement FDR Framework (updated)

Ireland is approaching the conclusion of its bank stress tests and preparing for its fifth round of bank bailouts.  In preparation for the bailout, the Irish government hired BlackRock to value the loans at several of the banks.  As a result of this evaluation and the stress tests, the mainstream media is reporting that additional capital injections of 25 billion euros will be identified.

This is the fifth time that the Irish government, either by itself or using high priced third parties, has examined the balance sheets of the banks, claimed to identify and value the troubled assets, and injected capital into the banking system.

Beyond hoping, why should anyone believe that this time they got it right?  More importantly, why should the Irish government keep pursuing this strategy when one of the fundamentals of the financial markets is to Trust, but Verify?

Before the results are officially released, there are several market participants who are already on record as saying that twice this amount of capital is needed (see this post and this Independent article).  In addition, because of financial constraints under the IMF-EU Bailout, it looks like the need for 25 billion euros of capital reflects the constraint of available capital under the bailout and not the true condition of the financial institutions.

Arguing that there were experts involved does not improve the believability that this time the Irish government got it right.  To date, the Irish government has hired and paid for high priced experts and what there is to show for it is an ongoing run on both the Irish banking system and its sovereign debt.  

This ongoing run is occurring despite an unaffordable guarantee of the unsecured and senior bank debt holders, two rounds of bad loan purchases by NAMA, one round of stress tests and now compromised loan valuations combined with stress tests.

This blog has long maintained that the simple, low cost solution for restoring confidence in the Irish financial sector and stopping the bank run is for the Irish government to adopt and implement the FDR Framework.  With the current asset and liability level data disclosed under the FDR Framework, market participants will be able to analyze the data and prove to themselves the adequacy of the 25 billion euro capital injection.

If the Irish government believes that 25 billion euros is really the last capital injection necessary, they will also announce adoption of the FDR Framework.  Adopting the FDR Framework would be the equivalent of saying we are confident in our analysis and here is the underlying loan level data to prove it.


According to a Bloomberg article, the Irish government is going to adopt the Spanish government's strategy for recapitalizing the banks:  tell the banks to raise the money from private investors and leave open whether the government is going to recapitalize or unwind the bank.

As this blog has pointed out, the only way that investors are going to invest in these banks is if they can see and analyze the current loan-level data so they can determine for themselves the riskiness of the investment.

There are two ways to provide this data:  the opaque way favored by Wall Street where only a few select investors get to see the data or the transparent way favored by the FDR Framework where all market participants get to see the data.

This blog has repeatedly pointed out that the opaque way favored by Wall Street is designed to favor Wall Street.  By contrast, the transparent way favored by the FDR Framework is designed to favor all market participants including, in this case, the banks that would like to issue capital.

Update II

According to a Wall Street Journal article,
"So far, every time we thought that we had reached the bottom a new piece of bad news has come along and demoralized people," Richard Bruton, Ireland's economy minister, said in an interview Wednesday with German newspaper Handelsblatt. "We need an honest assessment at last, and one that is based on international best practice."
Perhaps, as this posting suggests, the problem with international best practice is that it relies on "Trust Us" and fails to recognize that market participants also want to be able to "Verify" for themselves.
... If the stress tests manage to squelch doubts about the viability of the country's banking sector, that could translate into lower borrowing costs for both the banks and the Irish government. That, in turn, would help ease the burden of Ireland's huge debt load, a major drag on the country's battered economy. 
In an effort to promote the stress tests' credibility, Irish officials have been touting the fact that the tests have been conducted in part by outside advisers from BlackRock Inc. They also have been lobbying the European Union, International Monetary Fund and European Central Bank to issue statements Thursday validating the tests' outcome, according to people familiar with the matter. 
A sure way to discredit the stress tests is to hold up these visibly conflicted third parties as saying that the outcome of the stress tests are valid.
Ireland's crisis arose from of an epic property-lending binge that propelled Ireland's economy for years. When real-estate prices started tumbling, it wrecked the banking sector.
Repeated banking bailouts have pushed Ireland to the brink of insolvency. 
Last December, unable to borrow money on the public markets, the debt-laden country accepted a €67.5 billion international rescue package.the banks. But the existence of those funds failed to dispel investor fears about the sector's health. 
Actually, raising these funds confirmed that the Irish government did not have its arms around the situation despite four previous efforts at restoring confidence.
Investors are worried that the banks are sitting on potentially major losses on residential mortgages. Those portfolios will be a focal point of the stress tests, according to officials at the central bank. 
So far, losses on home loans have been modest compared with the industry's more than €70 billion in write-downs on commercial real estate. 
But more borrowers have been falling behind on their home loans. As of Dec. 31, about 5.7% of residential mortgages were at least 90 days past due, up from 3.6% a year earlier, according to Ireland's central bank.
Ultimately, the Irish government will adopt the FDR Framework solution and provide the banks' current asset level data to the markets.  Without doing this, it will continue to struggle with restoring confidence in the banking sector and its sovereign debt.

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