Tuesday, March 30, 2010

Amhran na bhFiann

Yes, the PIIGS (Portugal, Italy, Ireland, Greece, & Spain) have made headlines once again. With the Greek tragedy continuing, for the hero has still not encountered misfortune, Ireland has thrust itself into the spotlight. Today, the government announced its plans to create a ‘bad bank’ to purchase bad debt from Irish banks and lending institutions. Additionally, they implemented rules that could result in more banks being nationalized. This plan is very similar to plans enacted by the United States in 1989 with the creation of the Resolution Trust Corporation and Sweden in 1992 with S&R. However, this solution has not been utilized in the developed world during the current financial crisis, as governments have chosen to use capital injections to repair the banks instead.

Looking at some of the details, the Irish government will spend 8.5 billion Euros to purchase 1,200 loans valued at 16 billion Euros. The price paid is an astonishing average discount, or price below par value, of 47%. First, the price paid should be a little concerning to U.S. financial sector investors, since many loans here are still marked close to par. Second, and as equally important, it shows how badly the European financial sector has been hit by the financial crisis and housing bubbles. And there is still much work to be done to repair the damage.

John Mauldin recently wrote a piece titled “What Does Greece Mean to You?” In it, he comes to the not so simple conclusion that “…Greece is important? Because so much of their debt is on the books of European banks. Hundreds of billions of dollars worth.” Financial institutions in the developed world are on a precipitous cliff, since a default of similar magnitude would be very bad. Now, the Greek situation has improved recently but we still need the European Central Bank and International Monetary Fund to develop a long term solution. We need to restore confidence in the market, or we will quickly see how many nations follow this tragic path.