In Effect

Simon Carswell tells us that, due to the extent of the damage to their balance sheets, an injection of state capital into AIB and Irish Nationwide could

in effect take control of the two institutions.

We're hearing that word 'in effect' a bit too much lately. Either the state has some measure of control which we can measure, from 1 to 100%, or it does not, and that measure is 0. Tacit control of a large financial institution is not the way to do business, because it creates uncertainty, and the one things Irish banks need less of is uncertainty. Then there is the issue of governance. Senior department of Finance officials are not bankers. Bankers are bankers, they know their businesses at least as well as civil servants do. I'm not saying we should leave the same bankers running their businesses after the recapitalisation, but it is clear to me that  The extent of state control for these banks needs to be made explicit right away today during the series of speeches from the Minister, the Governor of the Central Bank, and of course from the Financial Regulator.

Karl Whelan has more on this here, but also falls into an 'in effect' trap. We've got to be careful about this, because the extent of state control determines the type and range of exit strategies the state and these banks can pursue from each other's clutches. I, for one, do not want AIB and Ireland's other wayward banks on my tab for a moment longer than necessary.

7 Replies to “In Effect”

  1. Great post! The 'in effect' concept comes from the idea of there being a majority shareholding, but it doesn't mean the government will fix pricing or anything else for that matter, the directors will have a fiduciary responsibility to the shareholders to do what is best for the shareholders 'all' not just the majority shareholder. There is a minority interest that also must be served so much of the 'hype' is no more than just that. Dilution is a given, but don't forget, there is actually a market out there with thousands of observers, institutional and private alike, some of this is already being reflected in the market. Not the share prices - which is the crack-cocaine end of the game at present (and personally much of the volatility is likely on technical trades within trading ranges), but in the bond market, why is the LT2 trading at a premium rather than a discount? The future of the bank, at least in the eyes of those who put their money where their mouth is, is that it will continue trading and the state will stay out of it inasmuch as they will be a shareholder and not the overall controlling mechanism.

  2. Just to be a little pedantic, the directors have a duty to the success of the company as a whole, not directly to the shareholders. The shareholder duty interpretation is conventional not legal, and the shareholder value interpretation is just a couple of decades old.

  3. @Karl,
    Cheers for your comment, I take your points, but really I'm railing against the slightly jesuitical language being used around the place in relation to NAMA and the bailouts and injections, etc. Of course people have to be circumspect when writing these things up for publication in a paper of record, and of course most people writing about these issues don't have all the facts, and so have to hedge a bit, but given the scale of the dilutions we've witnessed, and the vast sums being bandied around at the moment, it seems unwise to be so imprecise.

    @Ciarán, you're dead on about the shareholder value concept being relatively new, but when was it introduced first? I can't remember, but these distinctions do matter when it comes down to just what is being maximised here. Clearly the Minister is under the impression he is safeguarding taxpayers by fortifying the financial system, and so maximising the long term benefits of the populace in that regard.

  4. Hi Stephen, apologies in advance for the long comment!

    I'm not sure about it having been introduced. There was always a 'cake and ales' tone to company law, at least in this part of the world, whereby directorial action had to be to the benefit of the company on behalf of its members. Shareholder value is a new and relatively odd subset of that. I think that Manne might have started using the term in the mid-1960s, but even then SV would have been understood as being about dividends (I think: I haven't gone back to check).

    The idea that the corporate purpose ought to focus on the actual sale-values-of-shares emerges alongside the nexus-of-contracts tone of the corporation post 1970ish. Academic theory on this sort of thing really tracked financialisation, the 1980s leveraged buyout boom, increasing turnovers both of shareholders and of CEOs etc. It's never been a legal thing. It's more of an interpretation of legal doctrine that justified new kinds of corporate behaviour.

    Anyway, what we're left with is the idea, for instance, that government ought not prescribe duties for banks (say, lending to SMEs) because even the hint of interference would interfere with banks delivering value for shareholders, in this case, the state. As some bloke from KPMG said in the FT last week, “An adjudicator who can overrule bank credit decisions, combined with the setting of artificial lending targets, is not consistent with the idea of maximising shareholder returns in RBS and Lloyds for the taxpayer.”

    I think the last point covers what you say above. A public duty to lend might conceivably be pursued by a public institution (in certain circumstances this may be preferable to leaving it to THE MARKET (tm)), but in actual fact what the UK and Irish governments are doing does not involve wielding publicly owned institutions for public ends. Rather they hope that the benefit will come ultimately from the sale of shares at a level that will compensate the taxpayer for their investment.

  5. @Ciaran, never apologise for long comments!

    I suppose I asked because there's clearly a conflict within NAMA and the government and our nationalised and quasi-nationalised banks between helping the system's 'client', 'taxpayer', and 'depositor' bases. They all want different things. But the Minister for Finance is the only shareholder in Anglo, for example, so one would think the taxpayers' interests would dominate there, not so in BoI. But AIB? The public duty is in clear conflict in some cases, though perhaps at different times, as you say in the last paragraph there--right now everyone's interests do not seem to be served by letting these banks fail, but certainly, we've a shot at some upside if the system recovers enough--but who benefits from that upturn first?

  6. Did anyone see the TV show about the Chancellor of the Exchequer in Britain's political system? About devaluation of the pound several times in the course of history in post war Britain. It was broadcast on BBC 2 over the weekend. I didn't catch the exact details of the show however. The difficulty the British had in tackling inflation, despite having a strong Keynesian belief in the Treasury organisation, before Thatcher. Of course, then came monetarism and later Gordon Brown, who all left their imprint on the institution.

    I was looking at Liam Delaney's blog and he links to several other blogs about behavioural economics there. But one blog entry at Economic Logic, reminded me of the show on the BBC 2 station this weekend. Here is a quote:

    The limited use of credit made money demand and supply much more predictable, but this still could not prevent hyperinflationary episodes.

    http://economiclogic.blogspot.com/2010/04/managing-money-in-centrally-planned.html

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