Willem Buiter once again provides an entertaining analysis of the crisis, with a blog post titled Save banking, not the bankers or the banks; the case of ING. The source of his ire is a Dutch bail-out of ING, which he terms a “guarantee”:
The assistance takes the form of a back-up guarantee facility for a portfolio of $39bn (face value) worth of securitised US Alt-A mortgages. Under the deal, the state shares with ING any gains and losses on this portfolio relative to a benchmark value for the portfolio of $35.1 bn. The shares of the state and ING in any gains/losses are 80% and 20% respectively.
The bank pays a guarantee fee to the state. The state document I saw did not specify the magnitude of the guarantee fee, or how it was arrived at.
The state pays ING a management and funding fee. Again, I don’t know the amount or how it was arrived at (it would be cute, however, if the guarantee fee and the management and funding fee just happened to cancel each other out!).
The other relevant conditionality is that ING is to provide 25 bn euro of additional credit to businesses and households and that there will be no bonuses for 2009 and until a new remuneration policy is adopted. The CEO was told to fall on his sword.
I strongly disagree with the characterization of the facility as a guarantee. According to me, a guarantee will have an asymmetrical reward profile, whereas this has a payoff diagram that looks a whole lot more like 80% ownership. This isn’t a guarantee: this is a futures contract.
Buiter has complaints about the strike price of the contract:
The guarantee is a good deal for ING and a bad deal for the tax payer because the market valuation of the Alt-A portfolio did not imply the 10% discount (from $39 bn to $ 35.1 bn) that was used to define the reference value for the guarantee, but a 35% discount (from $39 bn to $25.4bn). It is possible that the hold-to-maturity value of the portfolio (the present discounted value of its current and future cash flows, discounted at an interest rate that is not distorted by illiquidity premia, is $35.1 bn or more. Possible, but not likely.
It is possible that the guarantee fee appropriately prices the risk assumed by the state. Until I see the numbers and can verify the assumptions on which they are based, I consider it possible but not likely.
Dr. Buiter prefers a good bank / bad bank solution, blithely skipping over the question of asset value determination:
The good bank would take the deposits of ING and purchase any of the good assets of ING it is interested in.
The valuation of these good assets would not represent a problem, because part of the definition of ‘good asset’ is that there either is a liquid market price for it or, in the case of non-traded assets, that the buyer can determine their value in a straightforward and transparent manner. It is possible that none of the existing assets of ING would be bought by New ING. In that case, the assumption of ING’s deposit liabilities by New ING would be effected by a loan from the state to ING, and the asset-side counterpart on New ING’s balance sheet to the deposits acquired from ING could be a matching amount of government debt.
This, to me, misses the point. As I see it, the problem is not so much that certain assets have gone bad, but that banks are over-levered and – more importantly – confidence has been lost. It is the problem of overleverage that the contract addresses, in an attempt to restore confidence.
I agree with him wholeheartedly, however, on the dangers of social engineering and political grandstanding:
Often government financial assistance to banks imposes conditionality, costs and constraints on the bank’s management and existing shareholders without taking full ownership and control of the bank. Examples are; onerous financial terms; constraints on bonuses and other aspects of executive and board remuneration; constraints on dividend pay-outs and share repurchases; constraints on new acquisitions and on foreign activities; guidance and direction on how much to lend and to whom. All these encumbrances last until the state has had its stake repaid.
This creates terrible incentives encouraging banks that are already in hock to the government to hoard liquidity and hold back on new lending activities to get rid of the government’s interference.