Will it be good 'bad bank' or a bad 'bad bank'?

In April, on the publication of the Peter Bacon report proposing Irish taxpayers buy the property loans clogging up the Irish banks, international law firm Mayer Brown wrote about the plan to set up the so-called 'bad bank', the National Asset Management Agency, or Nama. There were, Mayer Brown told its law clients, "a few issues which will require clarification and detailed regulation concerning, in particular, the valuation to be applied to loans which will have to protect taxpayers (and) ensure banks can remain viable after the write-downs". Five months after the Government decided to go ahead with the bad bank idea, the amount Nama will pay the banks for their loans will determine whether the agency will protect taxpayers' interests over the next decade. If it works well, Nama will be the good 'bad bank'. If it fails, it will be seen as a bad 'bad bank'. Nama has been described as the biggest gamble any government in western Europe has taken on the future of the commercial real estate market. The €87bn sum that the five banks need to purge is indeed so huge that it can only be understood in comparative terms: it amounts to all the taxes the Government will raise over the next three years and about half of the whole economic value of the economy in any one year. It is slightly unfair under the circumstances, however, to describe Nama as the equivalent of the State placing €60bn worth of assets - approximately the amount it will pay the banks for their discounted loans - on the roulette wheel down at the casino. Most governments, regional authorities and big cities take bets on the future all the time. They borrow to pay for roads, rail and big projects that will be funded from future tax revenue. The Government, though, has made such a bad show in promoting Nama that many people believe that it is heading down to the bookies, or more appropriately, the estate agency, with €60bn of taxpayers' cash. Taking a big gamble also suggests some degree of choice. The truth is that the banks need purging of their disastrous lending decisions. Now, there is very little option but for the Government to hope that the price of commercial land and property will, over a number of years, rise back close to the amount it paid for the loans. The loans need removing from the banks and it is taxpayers who are left to mortgage their future tax payments to clean up a particularly dirty banking and economic mess. Leave the bad loans where they are, and the banks will fail to raise foreign funding, meet international capital-holding rules and do the job they are supposed to do, generate credit, when recovery comes. The gamble of Nama involves getting the best deal for taxpayers: pay too big a discount and the taxpayer will have to pay up front large amounts of cash that the Government does not have to hand. But pay too little for the bad loans and the winners are likely to be bank bond-holders and shareholders - mostly foreign pension funds - who will benefit by funding or buying into the Dublin banks with discounted rights issues. For the Government parties, getting it right will not guarantee a single extra vote because the winners and losers to emerge from the Nama process will not be known for many years. Third banking force idea rides again The big banking plan back when Ruairi Quinn was Minister for Finance in 1997 was to create the so-called 'third banking force' by fusing the TSB with the then state-owned ACC and ICC banks. The big idea was to create a lending force to compete with the banking duopoly, AIB and Bank of Ireland. The two big banks applied a grip over loans for small businesses and domestic mortgages. Eventually, competition from RBS's Ulster Bank, Bank of Scotland and the Danske-owned National Irish Bank helped businesses and homeowners enjoy some benefits of proper competition for the first time. A dozen years later, and in circumstances that could never have been imagined back then, a different banking landscape has emerged. AIB and BoI have been rescued by taxpayers, Anglo Irish has been nationalised, Irish Life Group, which merged all those years ago with Permanent TSB, depends on the State guarantee and the smaller London-based lenders are shrinking or thinking of withdrawing altogether. Unsurprisingly, the idea of a third banking force to compete with the big two is having another outing. The lack of banking competition will again be a big issue in the coming years because AIB and BoI will be strengthened when Nama takes their bad property loans off their books. If the Government fails to act, AIB and BoI, which account for huge chunks of the property loans, will be rewarded for their exuberant lending to property developers of recent years. The Government may appear to hold all the cards. Analysts say there are enough jigsaw pieces in Irish banking post-Nama to create a third big banking group to compete with AIB and BoI. The problem is that joining the disparate pieces reveals no obvious effective champion. When recovery comes, the Competition Authority will need to do its job to protect small business borrowers.