Busch: Why Ireland Scares Goldman

With the US government set to release the results of the FDIC bank stress tests, there's great concern over who will be the winners and losers. What will the government force the losers to do if they don't meet capital requirements? What will the government force the winners to do to make sure the losers aren't ostracized in the repo markets? There are several reasons why a bank like Goldman who will pass the test want to give their TARP money back as fast as possible.

Ireland has been a leader in ground breaking strategies for dealing with the current financial crisis. In September, they surprised the European Union by announcing that they would guarantee all of the deposits of the Irish-owned banksand all money borrowed by the banks from other financial institutions. This came after the six major banks in Ireland saw steep losses in their share prices and stabilized temporarily the situation. The guarantee essentially put the Irish taxpayer on the hook for 400 billion euro.

Now, the Irish government is unveiling it's proposals for a bad bank. The concept is similar to the PPIP for legacy securities and loans in the Untied States: an attempt to help cleanse bank's balance sheets of toxic assets. The major difference is that the Irish plan is going to force banks to show the true extent of their bad debts by taking these loans and selling them to the National Asset Management Agency. The Irish government estimates that up to 90 billion euros of bad loans will be purchased by the NAMA from the banks.

So far, so good. The problem is pricing. According to Independent, a 50% write-down of these loans would wipe out the equity of all the Irish banks twice over. Clearly, the banks don't want to do this and want to write down the loans by only 15-20%. The Department of Finance made a statement, "The level of discount and the terms and conditions of the transfer of assets will ensure that the banks do not 'get of lightly.' Is this starting to sound familiar?

The other angle to the story is that as NAMA takes over loans that are personally guaranteed by big developers, they will seize assets such as homes and possessions as collateral. Dr Peter Bacon, who proposed the new agency, insists that it will have full powers to maximize the financial take for the taxpayers. "Dr Bacon said that while the agency would be a "disinterested third party", it would help to break up what he termed "the crony capitalist connections" that would impede the transfer of assets from powerful developers," according to the Independent.

The driving concept behind the bad bank for toxic assets is to dislodge the non-performing assets of the banks and thereby get them start aggressively lending again. This speeds up the process by which the operating profits at banks are used to assist writing down the assets and taking losses. In Japan, the process took ten years. This is what Ireland and the United States are trying to avoid.

In the United States, the current programs by the US Treasury are not likely to force the banks to utilize the PPIF. However, this could dramatically change with the results of the "stress tests" being run by the FDIC. If they find that a bank is undercapitalized to handle the stress, the FDIC may inform the bank that they have to take TARP funding or increase their current allocation of TARP funding. At the same time, they may inform the bank that they must utilize the PPIF to unload some assets that are not deemed satisfactory. Then the US Treasury becomes an owner of the loans and can attempt to recover their value any way they see fit.

Whether it's Ireland or the United States, the banks have not written down their assets to the extent that they can begin lending to the extent that the governments want. Debt re-structuring is a key component to ending the current deleveraging process and a key to ending the recession. A forced restructuring would speed the process, but would have massive negative short term implications for financial companies share prices. Even banks that are in good financial shape could be forced to participate in this debt restructuring process.

Either way, the banks of both countries will face continued uncertainty over whether they will survive in their current form or share price.

And that's one big reason why Goldman wants out.


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Andrew Busch
Andrew Busch


Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.