March 2010 Archives

The following is an update of our previous estimate of the direct cost of the Irish banking crisis following the announcements on Bail-Out Tuesday (30th March 2010) by the Minister for Finance, Central Bank and Financial Regulator.

Our previous estimate was that the ultimate direct cost could be between €12.2 billion (best case) and €34.2 billion (worst case) with the most likely cost being €23.2 billion.

Our updated estimate is €22.8 billion (best case), €46.5 billion (worst case) and €34.7 billion (most likely). The central finding is that the most likely cost has increased by about 50% and our previous worst case estimate has effectively become the most likely.

The updated most likely cost amounts to three years' income tax receipts - equivalent to about €17,000 per taxpayer, or six months' average earnings.

This table presents the basis of our estimates. They exclude the cost of borrowings, dividend/coupons payments and any profits from share stakes, and they ignore the massive social and economic costs of the crisis.

Ignoring timing differences, crisis-related borrowings could theoretically hit €83 billion comprising cash provided to covered institutions (€38 billion) plus the Nama bonds (€45 billion). This takes account of the fact that any share investments made by the National Pension Reserve Fund are effectively funded by borrowings via the NTMA. Again ignoring timing issues, the annual interest cost could peak at about €3.8 billion before allowing for possible interest, dividend and coupon receipts.This is equivalent to about one-third of annual income tax receipts. At a guess, the net annual interest cost to the taxpayer could exceed €1 billion per annum. 

Rough calculations suggest that, in the "worst" case, the banking crisis could ultimately cost taxpayers about €35 billion based on €10.8 billion expended to date, €14 billion for further bail outs and partial nationalisations, and a provision of €10 billion to cover Nama losses.

This is equivalent to about three years' income tax receipts, or €17,000 - or six months' average earnings - per taxpayer. Related borrowings would peak at about €79 billion with annual interest of about €3.5 billion either borrowed or paid by taxpayers. It takes no account of broader economic and social consequences.

Given the magnitude of the likely losses, it is truly extraordinary that a full public enquiry is not already well underway. Maybe, this because most of those who created, or failed to prevent, the crisis are still in charge.

Lead letter published in the Sunday Business Post on 22nd March 2010.

Some additional comments:

1. In a "best" case scenario, triggered by a miraculous resumption of growth, the foregoing cost (€35 billion) might be reduced by two-thirds thanks to Nama achieving better than break even, repayments by some banks and proceeds of bank share sales.
   
   
2. Based on the average of "best" and "worst" cases, the "most likely" direct cost of the banking crisis could be about €24 billion.

For the record, the key assumptions were as follows:

• €10.8 billion already expended: €3.5 billion to Bank of Ireland and AIB; €3.8 billion to Anglo Irish Bank.
• €13.4 billion for further bale outs etc.: €6 billion for Anglo; €2 billion for Irish Nationwide and €0.4 billion for EBS; €5 billion in new equity to be shared between Bank of Ireland and AIB.
• Provision for Nama losses: €10 billion based on 20% of the €54 billion to be paid for loans from the covered institutions.
• "Best" case provision assumed that all funds (€12.2 billion) to Anglo, Irish Nationwide and EBS are written off; that Nama breaks-even; and that preference and ordinary share investments in AIB and Bank of Ireland are recovered at cost,
• Peak borrowings comprise cash provided to the covered institutions (€24.2 billion) plus the Nama bonds (€54 billion). This takes account of the fact that any share investments made by the National Pension Reserve Fund are effectively funded by borrowings via the NTMA.
• Assumed interest rate on these borrowings is 4.5% (current yield on 10-year Government bonds).

The foregoing estimates exclude any possible losses linked to €10 billion provided by the Central Bank to Anglo Irish Bank under Master Loan Repurchase Agreements last March. This is secured against collateral of €14.5 billion provided by Anglo. For more information, see Outsiders Pay for Insiders Greed by David McWilliams in the Sunday Business Post and Anglo's latest fun in the sun by Dr. Constantin Gurdgiev.

Following publication of the Report of the Innovation Task Force in March 2010, I thought it would be interesting to dust off a report entitled Stimulating Indigenous High Tech Manufacturing Industry (SIHTMI) which I wrote back in 1983 for an Education, Innovation and Entrepeneurship Research Programme.

Here is the Full SIHTMI Report  (140 pages) and a Summary.

To place 1983 in context, it was the year that:

• The domain name system for the Internet was created.
• Compaq launched the first portable PC.
• 64k 8-bit memory devices were the norm.
• Lotus 1-2-3 and the IBM PC XT were launched.
• World market for NMR imaging machines was only 80 units.
• UK introduced the Business Expansion Scheme to bridge the "equity-gap".
• EEC was formulating plans for technology support programmes.
• The US market for cellular radio services was worth less than US$200 million .

The SIHTMI Report estimated that, at that time, there were about 20-40 indigenous high tech manufacturing firms in Ireland employing between 400 and 800 people. High tech was defined as covering microelectronics, biotech, materials and speciality chemicals, specialised mechanical products and software.

The SIHTMI Report concluded that (despite hype at the time) a high tech sector didn't exist and would not develop without major changes. It indicated a need to create a national policy on high tech; to streamline state support to high tech firms; to pursue strategies based in identified niches; to establish centres of excellence and better HE/industry interaction; to encourage proven entrepreneurs and senior managers to locate to Ireland using tax breaks; to introduce tax incentives to encourage investment; and to improve the general infrastructure, environment and competitveness.

These recommendations, when compared with the Innovation Task Force's, shows just how much (or how little) progress has been made over almost three decades. Chris Horn, a well-known "tech champion" and member of the Innovation Taskforce, identified the following similarities between recommendations in the 1983 and 2010 reports:

• need for risk capital
• need to augment domestic entrepreneurs with attracting overseas ones
• shortage of international commercial skills
• need for more progressive procurement policies by the State
• need for oversight committee for the enterprise economy with public and private sector and Ministerial engagement
• co-ordinated focus around a single enterprise agency for delivery of support and aid
• grant aid for early stage ventures
• put "wood behind the arrow" in a few carefully selected market niches
• tax incentives to foster private risk capital
• aid, coaching, administrative support from large established companies to younger smaller ones.

This list begs the question as to why it takes so long (27+ years) to fully implement substantial but basic changes in industrial policy in Ireland.

Over the past few months, the Minister for Finance and NTMA have announced the membership of Nama's board and its senior management team.

Given that Nama is going to become one of the largest property managers in the world, it is very surprising that so many of these appointments have been drawn from the NTMA which has no prior experience or expertise in managing and running down a vast property portfolio. By way of confirmation, the former CE of NTMA told the Oireachtas Public Accounts Committee in May 2009 that "we have no experience of bank restructuring or the whole new area which is coming our way, and we will be on a very steep learning curve."

For the record, two of the eight members are from the NTMA and two of the four senior management appointments are from the NTMA. This means that one-third of the team leading Nama are NTMA insiders. Of the remainder, only one has extensive property experience, one works for a major multinational, two are former bankers, two are former public servants and two are accountants. Although an additional person with international financial and banking expertise will join the board in May 2010, this will not radically alter the team's range of expertise or experience.

Having previously commented on the need for Nama to have world-class management,  I would have expected to see more property, legal, banking and international expertise on a team managing a €80 billion loan/property portfolio. I would also have expected a somewhat larger board and executive team. This gives rise to a concern that Nama, by accident or design, may be under-resources at top levels and overly dependent on very expensive and footloose external advisers.