Friday, July 22, 2011

ECB set to select advisor to restore confidence in Irish banking system

A Reuters' article discussed how the ECB is in the process of selecting advisors to help it deal with both a restructuring of the Irish banking system and the management of its own exposure.

Ultimately, the solution to both of these issues goes under the broader heading of restoring confidence in the Irish banking system.  For example, with the restoration of confidence, private investors and depositors will provide the funds the Irish banks need to repay the ECB funding.

The question is what does it take to restore confidence in the Irish banking system?

Regular readers know that restoring confidence requires adoption and implementation of the FDR Framework.

The key to restoring confidence is making available to market participants all the useful, relevant information on the Irish banks in an appropriate, timely manner.  This information consists of the banks' current asset and liability-level data.

Market participants, knowing that they are responsible for any gains or losses on investments in these banks, will analyze this data to understand the risk/reward of an investment.  Confident in their analysis, market participants can then make a decision to invest.

Absent current asset and liability-level disclosure, any solution that the select advisor(s) propose will not work and is not worth the money spent for the advice.

This is not the first time your humble blogger has made this observation with respect to Ireland.  It is a matter of record that before Ireland spent a significant amount of money on a BlackRock Solution led stress test and bank restructuring your humble blogger said it would not restore confidence.  It is a matter of record that the exercise failed to restore confidence.
The European Central Bank is in the closing stages of appointing advisers to help it deal with Ireland's battered banking system and manage its own exposure to the heavily indebted country. 
The ECB asked potential advisers at the end of April to make proposals on how best to restructure Ireland's banking system, reduce banks' dependency on ECB funding and sell off their assets or alternatively transfer them to resolution funds....   
Only a handful of financial advisers were invited to pitch to the ECB, in part because institutions such as Barclays Capital, BlackRock Solutions and Boston Consulting Group might face a conflict after advising the Central Bank of Ireland in the run up to its stress tests. 
The conflict these firms face is their recommended solution failed to restore confidence.
The ECB could pick from the biggest debt restructuring houses like Rothschild -- which was the main adviser for the previous Irish government -- and Lazard. 
In November investment banks including Bank of America Merrill Lynch, JP Morgan, Goldman Sachs and UBS headed to Dublin to counsel the government and banks.
Aside from bank advisers, fixed income independent advisory firms like AGFE and Stormharbour have built specialist teams, as have alternative asset managers, such as BlackRock Solutions and PIMCO.
Other than adopting disclosure as recommended by your humble blogger, what these firms have to offer are variations of solutions that Barclays, BlackRock Solutions and Boston Consulting previously rejected as inferior to the failed stress test and bank restructuring they led.  The problems identified with these variations that made them inferior to the failed stress test and bank restructuring still exist.

More importantly, there is no reason to believe that the variations of the solutions that Barclays, BlackRock Solutions and Boston Consulting previously rejected will restore confidence.
The dependency of Irish and other periphery banks on the ECB is complicating the process of raising interest rates, and runs the risk of tarnishing the image of its lending operations.
Actually, what tarnishes the ECB's image is the activities it undertakes that are outside of its staff's highly regarded expertise in the conduct of monetary policy.  Examples of these activities outside the expertise of the ECB's staff include the ECB's attempts to restore confidence in the Irish national banking system or to bring transparency to the market for structured finance securities.

In attempting to restore confidence in the Irish banking system, the ECB is tarnishing its image.  It does this by appearing to practice Albert Einstein's definition of insanity:  doing the same thing over and over again and expecting different results.  The Irish have already tried investment banking, asset management and global management consulting firms and this has not worked to restore confidence.  Why would trying other firms from these industries as advisors produce a different result?

In attempting to bring transparency to the structured finance securities market, the ECB is permanently staining its image.  This blog has documented three significant problems with the ECB's solution.  Its proposed ABS data warehouse violates fair disclosure regulations.  It provides updated data on a frequency not satisfactory for timely rating changes or knowing what you own under Article 122a of the Capital Requirements Directive.  It features exactly the types of conflicts of interest in control of a data vendor that the European Union's Competition Committee does not want.  Each of these problems by itself should have caused the ECB to announce that it was withdrawing its proposal and going to rethink how it pursued this initiative.  Instead, the ECB has carried on as if these problems do not exist.
The decision to go to the private sector is evidence of the problems the ECB has encountered over the past two years in trying to come up with an in-house plan to wean weak banks off its liquidity support.     
It came close to launching a medium-term funding facility for Irish banks, which it hoped could have been a template for others, back in March, but eventually shelved the plans after hitting resistance from some of its own policymakers. 
The ECB is estimated to have bought around 15-20 billion euros of Irish government debt under its controversial bond buy programme. 
Irish banks are also borrowing almost a quarter of all the money it lends, leaving the ECB with over 100 billion euros worth of Irish collateral on its balance sheet. 
The Irish banking system has encountered the modern equivalent of a bank run.  Market participants do not know which banks are solvent and which are not. Because solvency is the issue, it is not surprising to see investors and depositors reducing their exposure to these banks.  As this occurs, the ECB is required to step up and cover the shortfall in funding at the banks.

It is not surprising that any in-house plan that did not involve disclosing all the current asset and liability-level data to market participants has failed.  Disclosing this data to a limited group of market participants in the Irish stress tests also failed. 
The proposal that the ECB's market operations and financial stability departments sent to potential advisers specified that the bank was looking for an independent assessment and a set of recommendations guided by the ECB's policy objective.
My firm could take on the assignment.
The winner of the main 3 million euro contract, which lasts until the end of 2011 but could be extended, will have to provide updates to the ECB before each EU/ECB/IMF mission to Dublin, meaning the first recommendations are likely to come around mid-October. 
Unlike the firms that assisted in running the latest Irish stress test and reorganization that failed to restore investor confidence, my firm would be willing to put some of its fee at risk that its solution will restore investor confidence.
Staff teams from this "troika" published the outcome of their latest quarterly review this week. 
The ECB's requirements include an assessment of how much capital Irish banks require for markets to perceive them as safe.
Why guess how much capital is needed for markets to perceive the Irish banks as safe when providing disclosure results in the markets telling everyone how much capital is required for the markets to think the Irish banks are safe?
It also wants opinions on liquidation prices and investor demand for various types of banks' assets, including potential proposals for the consultant to partner with private equity or distressed debt specialists to sell assets, and an assessment of the potential for selling securities backed by banks' assets.
Again, why guess when by providing disclosure to the markets the answer can be known?  Without the answer from the market, all the solutions the ECB is looking at are designed to maximize the looting of the Irish.

I look forward to advising the ECB and restoring confidence in the Irish banking system.

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