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by John Walsh

Should Anglo Irish Bank be wound down? The answer to this question has huge implications for the country. In fact, according to some commentators it has the potential to sink the economy if the wrong course of action is taken.

The bank is projected to soak up €25bn of the dwindling tax take - money that will never be recovered. Of more concern is the potential for an overshoot. The ratings agency Standard & Poor’s claims that the final bill for Anglo could come in at a whopping €35bn. The backdrop could not be less propitious. International investors have concerns about Ireland’s solvency. And if there is one thing markets hate, that is uncertainty. Until the final cost of bailing out the banks becomes clear, then uncertainty is set to continue. In other words, it has the potential to become a vicious circle.

Ireland experienced the worst bubble in the global economic history. Anglo Irish Bank played a central role in fanning the flames of this credit bubble. The new Chief Executive Mike Aynsley (pictured) and Chief Financial Officer Maarten van Eden have been taken on to clear up the mess. They are two of the most vocal advocates of keeping Anglo as a going concern. Not all of it. There is roughly €12bn of the post-Nama loanbook that could form the “stub of a good bank” according to Aynsley. The only possible payback for the taxpayer is if some form of a good bank is salvaged from this corporate wreck, which can be sold down the line when the markets stabilise.

But as long as Anglo exists as an entity, then there will be uncertainty. As long as there is uncertainty the Government will have to pay extra in borrowing costs. The doomsday scenario is if by the end of this year AIB is unable to reach the €7.4bn capital target laid down by the Financial Regulator Matthew Elderfield, through the disposal of assets and a rights issue. In that event the Government will have to step in with some banking analysts claiming that the State will have to take an 80% stake in the bank.

Would this drive the country to insolvency? “It is possible to have two banks in state ownership,” says Aynsley. “But it is not consistent with where the financial sector should be. It is a generally held belief that banks should be privately held and stable.”

The Australian born chief executive says that there are short-and-long term systemic issues arising from having banks in the state fold. “There is the European Commission and the ECB. From a systemic perspective they will have the motivation to avert a crisis. If the funding dries up in a country then the ECB has to step in. It will be a systemic crisis from that perspective, but you will still get funded and get through it.

“But in the long term how do you go from that situation where a large proportion of your banks are funded by the ECB to one where you get confidence and stability back in the banking system. In political circles it might be better to say let’s wipe Anglo off the face of the earth, but there are funding implications.”

A number of Opposition and possibly Green politicians have rowed in behind S&P’s estimate cost to the exchequer of €35bn from Anglo. That is €10bn at least more than the Government’s position of losses between €23bn-to-€25bn.

Marteen van Eden says the numbers do not stack up in favour of a wind down. And certainly not in the short term. “I am using rough figures here, but the post-Nama loan book is €40bn on which we have taken €8bn of impairments. In a short-term liquidation scenario, you will get 30c in the euro. That means another €20bn in losses.”

“Then we are back to winding down Anglo over a longer period of time, because to wind down Anglo over the short term is unacceptable from a cost point of view. Then you get back to the other side of the balance sheet. Much of the funding would walk out the door because you are in a wind down. What is the difference between taking a loss today and funding for the next ten years? A loss needs to be funded. Only at the end of the ten year period will you know if the funding will lead to a loss or if it will create a profit from these assets.”

Moreover, Aynsley and van Eden argue that if the decision is made to close down Anglo then it would not create the certainty.

“People pretend that the decision to close down Anglo whether it is in five or ten years will create certainty. It isn’t. There is no certainty going to be created by closing down Anglo over the long term, because we have no certainty about where we can dispose the assets in the longer term. The markets could stay at these levels for ever and ever. There is certainly enough overhang,” says Aynsley.

But then again, the Government’s view of €25bn losses is predicated on the market being close to the bottom. The National Asset Management Agency (Nama) has applied a haircut of close to 60-65% on Anglo’s loanbook. Every 5% beyond this level means another €1bn in losses.

But how close is the economy to the bottom of this cycle? One London-based bond trader that B&F spoke to last week argued that the longer Anglo stays in existence, then the further the economy is from reaching the bottom.

The European Commission is set to hand down its verdict over the next few days on whether the Government can proceed with its plans for a good/bad bank split for Anglo. Aynsley says that the Commission may not come to a decision using a rationale based on the economic merits of the case.

“With any of these things you never know as much as you do on the ground. Last week you had The Labour Party coming out with a plan that would cost €4bn-to-€5bn less by closing down Anglo over the next five years. We have been looking at the numbers over the past 12 months and we wonder how they [Labour] can come up with this figure.”

Moreover, van Eden says there are other considerations that have to be thrown into the mix. “Anglo had €27bn in Government assets at the end of June. By the end of the year this could be €50bn. The Government is trying to support the banking system through Nama and through recapitalisation in the form of promissory notes. It is not providing cash, it is providing assets. That means those assets have to be financed by the bank either through a funding franchise or through the European Central Bank. So the question then becomes how much can you go to the ECB with and for how long and how much falls on the Government to finance in the absence of a funding franchise in the banks’ shortfall and that may come sooner rather than later. So it is all very finely poised. The maintenance of the private sector funding franchise of the bank totally depends on the [Government] guarantee. The Government has been able to issue [bonds] within its capacity but it has only been able to do this by giving the banks support on its assets. Those assets are going to the ECB and the ECB is taking them.”

But this arrangement will come under pressure when the tensions grow between the core and periphery euro zone countries. Germany is roaring ahead, which means that it will have different interest rate and liquidity requirement to countries like Ireland in the future.

The country is approaching the second anniversary of the Government’s blanket guarantee of the banks. Again the guarantee has become a greatly vexed issue. Should it have been introduced in the first place? Should Anglo have been covered?

Both Anglo executives argue that the Government had no choice. If the guarantee was not introduced, the banking system could have collapsed, which would have triggered a debt default,

The economist David McWilliams has argued repeatedly that defaulting on the national debt should be considered. Take two years on the sidelines, repair the economy and then go back on the markets, he reasons. Aynsley says this is not an option. “Defaulting might solve one problem but it would create many others. It might be an option for energy and resource rich countries, but not an export dependent economy like Ireland. A lot of damage can be done in the two years that Ireland would not have access to funding. The academic evidence says that Ireland would be out of the markets for longer than the two years McWilliams suggest. A recent report by the IMF says it could be up to seven years.”

The optics of what is happening with Anglo is a huge part of the problem. Politicians are accountable to an electorate that wants Anglo closed down immediately. International investors, who look at Ireland on an irregular basis, see it as a “rotting corpse” to quote a Financial Times Editorial.

Only when all the facts about the state of Anglo’s balance sheet and the implications of closing it down or splitting it into a good/bad bank are put in the public domain can a decision be taken in the best interests of the taxpayers. There are many things that could get in the way of this happening, not least the public backlash against keeping it open.