Colm’s columns

Colm Rapple
Irish Mail on Sunday April 11, 2009

It is hard to be critical of the broad thrust of Brian Lenihan’s Budget but the detail is another matter. Within its broad parameters of raising taxes and cutting spending it contains a number of nasty impositions on the lower paid, equally nasty cut-backs in benefits to the vulnerable and some inexplicable omissions. It’s impossible to avoid the conclusion that not all of the lessons from the past have been learnt.

Tax increases were inevitable. There will be no return to the windfall tax revenues generating by an over-heated property sector and spending cuts alone will never bridge the gap.

But while plenty of lip service was paid to the need for a broader tax base, some 85% of the extra tax imposed in Tuesday’s Budget will be raised from income taxes. Only 2.4% will come from capital taxes, 3.6% from company taxes. Some 4% will come from excise duties and 5% from levies on insurance premiums which are effectively spending taxes that will be borne by all.

It can be said, in favour of the Budget tax measures, that the combination of levy and PRSI changes is progressive. The more you earn, the more you pay both in absolute and percentage terms. It can also be claimed that these are emergency measures designed to raise revenue quickly and simply and that the fundamental structuring, so badly needed, is properly being delayed until after the report of the Commission on Taxation has been published and digested.

But it would have been nice to see some additional impositions on wealth, the elimination of long-standing anomalies and more determined action on discredited tax breaks. Maybe we have to suspend judgement until we see the 2010 Budget later this year but some of the decisions unveiled last Tuesday don’t provide any reason to hope that this Government can produce an equitable system of tax and social spending.

The measures include a new tax on the lower paid, a cut in social welfare payments and additional spending taxes that will hit almost everyone.

From next month those earning more than €289 a week will pay a tax of 2% on all of their income. That’s what someone would earn working 33 hours a week on the minimum wage. It’s a crazy imposition and is unlikely to bring in much revenue.

A family with even one child taking home less than €500 a week is entitled to Family Income Supplement which provides a payment equal to 60% of the gap between their actual net income and the relevant threshold which for a one-child family is €500. It’s €590 a week for a two-child family and €685 for those with three children.

A significant proportion of low-earners, who will suffer this new imposition, are entitled to Family Income Supplement and will be entitled to a claw-back of 60% of the income levy in increased benefits.

But the Government seems wedded to this idea of making almost everyone bear some of the pain. That dates back to last October when it was initially intended to have everyone pay the income levy irrespective of income level. It was forced to back down and introduce a threshold of €18,304 which was a little below the level at which a single worker becomes liable for income tax and close to what someone on the minimum wage makes in a week.

That made some sense. Dropping the threshold to €15,028 doesn’t.

The same rationale of targeting the vulnerable is evident in the decision not to pay a Christmas bonus to social welfare recipients this year. It normally amounts to an extra week’s benefit paid early in December so instead of getting 53 payments this year, claimants will only get 52.

In effect its nearly a 2% cut in social welfare benefits. It’s a particularly nasty decision and the net effect on the Exchequer may be far less than anticipated. All of that money would be quickly spent, most of it on goods liable for VAT at the top rate of 21.5%. The revenue raising impact would spread out from there. And unfortunately many of those who won’t get the payment will have to fall back on supplementary welfare benefits to provide some small measure of Christmas cheer.

It may be that Scrooge will have a change of heart in the months to come, although it is doubtful if that is currently intended. From a political point of view it hardly makes sense to announce such a measure before the local and European elections, only to recant it later.

Some of these impositions could have been avoided had Mr Lenihan gone that one step further with his income taxes and greatly increased the tax take from those on very high incomes.  The ideal would be a tax on wealth but that’s not easy to devise in the short-term and a extra tax on high incomes is a good alternative since it can safely be assumed that most of those on very high incomes added greatly to their wealth holdings during the Celtic Tiger years.

Some who invested unwisely have lost out but for everyone who bought at inflated prices there was someone who sold. The profits may have shifted around but they haven’t gone away.

To paraphrase that old Fianna Fáil slogan, there is very little done and a lot more to do. For Brian Lenihan it’s a B+ for effort and a D- for content. Can  he do better in December?

Colm Rapple
Irish Daily Mail April 9, 2009

The Government has ruled out nationalising the banks but it may end up with majority shareholdings in one or more of them as a result of its decision to take over their portfolio of good, bad and indifferent property development loans. The banks are to be forced to face up to the fact that much of the €80 to €90 billion they are owed by property developers will never be repaid and that in many case the land and property titles given as security is worth far less than the outstanding loans.

That could put them in need of extra capital over and above the €7 billion already committed to AIB and Bank of Ireland. If the Government puts up extra money it will demand shares in return.

But that’s all in the future and may not arise. Even if it does, it isn’t seen as a doomsday situation although it is obviously hoped that the banks won’t need extra capital, or even if they do, that it can be sourced from private investors.

What is certain at the moment is that the Government is to press ahead with its plan to detox the banking system of all property development loans. They are going to buy those loans off the banks. Bank shareholders will take an immediate hit but the fate of bank directors and senior executives remains uncertain.

As taxpayers’ money continues to be poured into the banking system, it will remain a sore point that very few banking heads have so far rolled. Finance Minister Brian Lenihan pointed out yesterday that he expected every member of both the Bank of Ireland and AIB boards to step down at their next annual general meetings. But he has not yet decided, he said, how he will use his influence to determine the replacements.

Irrespective of who is to be in charge, clearing the banks of bad debts and uncertainty is clearly a priority. From a bank’s point of view a loan can be seen as an IOU. The borrower gets the money and the bank gets the IOU for the face value of the loan plus, if you want to be entirely accurate, a provision for the ongoing interest charges. So long as the bank believes that the loan is going to be repaid, the associated IOU is worth its full face value.

But the value of that IOU can fall significantly if the borrower gets into financial difficulties or if the security backing the loan declines in worth. The loan becomes, in bank parlance, impaired or non-performing. The bank faces a bad debt and at some stage has to recognise that fact in its profit and loss account.

The Irish banks have been accounting for some bad debts but a large proportion of the current risk on property related loans have still to be formally recognised. Thanks to a study undertaken on behalf of the Government by Dr Peter Bacon, Brian Lenihan has some idea of how much of that €80 to €90 billion in property loans can either be repaid by the borrowers or else realised by foreclosing on the loan, taking the land or property put up as security, managing and eventually selling it.

It is certainly far short of €80 or €90 billion but Mr Lenihan isn’t saying although he does point out that the initial loans were on average about 70% of the then estimated value of the securing properties. So even if the property value has since halved, it would cover about 71% of the loan.

Take for example a loan of €70 million to a developer who put up a land bank estimated to be worth  €100 million. But that land bank is now worth only €50 million while the loan still stands at €70 million. The bank has an IOU for €70 million but it is certainly not worth any more than €50 million.

Taking into account the hassle in trying to collect the debt and the fact that property values could fall further, someone buying that IOU from the bank might well be only prepared to pay €40 million.

That’s the type of assessment that the new National Asset Management Agency will have to make with regard to all the property development loans in each of the banks’ portfolios. The intention is to take over all such loans so that the Agency will end up with a significant proportion of good performing loans which, together with asset sales could yield a sufficient return to pay the interest on the money that the Government will have to raise to buy these IOUs off the banks.

The banks themselves are going to provide the money. They will lend the necessary finance to the Government and get Government bonds in return. It’s not quite as daft as it may first appear. The banks raised the money themselves to advance it to the developers. With the loans off their books, they’ll have unused resources that can be loaned back to the Government.

They’ll end up with a good quality IOU from the Government having sold off a doubtful IOU from a property developer.  That removes uncertainty, cleans their balance sheets of real and potential bad debts and leaves them free to get back to their essential task of providing credit for Irish business and individuals.

But they take a major hit. They’ll have sold their property IOU at perhaps 60% or 70% of their face value. Their reserves will be reduced and, depending on how much has been written off the value of their property loans, they may need to raise extra capital and that may have to come from the Government, if not, as mentioned earlier, from private investors.

At that stage the banks, cleaned of their bad debts, could have some attractions. If the Government does end up as a majority shareholder in one or more of the banks, the intention would be to maintain its stock market quote providing the Government with a facility to sell its investment at any time.

So how much it is all going to cost us. Both Brian Lenihan and  Michael Somers, head of the National Treasury Agency were at pains to point out yesterday how low, by EU standards, Ireland’s national debt is as a proportion of national income. Even by the most rigorous measurement Ireland’s debt/GDP ratio was 41% at the end of last year, well down on the EU average of 61%

Italy is up at 104%, France at 65%, and Germany at 64%.

If the new Asset Management Agency were to borrow €50 billion to buy the banks’ loan, our ratio could go up to 107% by 2011 but that was described by Mr Somers as manageable.

The Government did look at alternatives, in particular, an insurance scheme under which the Government would, in return for an insurance premium, underwrite the banks’ bad debts. Dr Bacon considered it at length but while he recognised an advantage in the fact that the Government wouldn’t have to initially put up any money, the taxpayer would be taking a major risk.

The uncertainty would be removed from the banks’ balance sheets but would overhang the State finances while bank executives would continue to manage the property loans. Bank shareholders might be better off, Dr Bacon conceded, but taxpayers would bear an extra risk.

Either way we are all taking a risk but urgent and speedy action is needed to get the banks working again. That’s what the Government is providing with its current plan. It is the best of the options available. We can only hope that it works.

The plan requires legislation which it is hoped to enact before the summer so it will be towards the end of the year before the new agency gets fully up and running. As the plan evolves it seems inevitable that there will be some restructuring of the Irish banking system with smaller lenders such as the Irish Nationwide Building Society subsumed into one of the larger groups.