Hyperbolics, Banks and Elections

There is an interesting opinion piece in the Irish Times today, by Michael Noonan, the finance minister.   It is being spun as “were going to get our money back from the banks”.   This is not the first or second time of course we have heard that we are going to get the money back, and it will not be the last.  We need to take enormous caution when interpreting what politicians say, especially when they talk about banks, and especially when they talk about banks in the run-up to an election.

What Michael Noonan does in this piece is actually very useful, in that he lays out, again just how gargantuan was the cost of the Irish banking collapse.   Just under €30 billion was invested in the three surviving banks. The remaining €34 billion was flung into the black hole of Anglo/INBS.

Right now the value of AIB, we are told, is €11.7 billion.  This independent valuation was carried out by accountancy firm EY, and I have no doubt that it was carried out with the exact same rigor as the same firm carried out its audit of Anglo Irish Bank, which stated that there was nothing to see here, just before the bank collapsed costing state €30 billion.   The 14% stake in Bank of Ireland is valued at €1.4 billion, and some other capital investments brings the total state value to just about €15 billion. We might in passing note the following strange situation.   The market, truly independent if not always rational, valuation of Bank of Ireland from the above is €10 billion.   If you know anybody who really thinks that AIB is worth more right now than Bank of Ireland then I’d like to sell him or her this bridge that I have in Brooklyn.

Nonetheless, let’s take this at face value, let’s pretend for a moment that state does the €15 billion worth of value in the banks.   Another independent company, Goldman Sachs International, chaired by longtime Fine Gael grandee Peter Sutherland, has been appointed (I’m sure after rigorous searching) to provide financial advice as to what to do with AIB.  If it’s really worth €11.7 billion in the obvious thing to do would be to sell it.  The revealed preference that they are not selling it suggests that they don’t think that is worth anything close to €11.7 billion. It’s clear in fact that they don’t, and this is explicitly stated in the next paragraph

I am confident that, over time, we will at a minimum fully recover the funds this Government invested in AIB, Bank of Ireland and Permanent TSB. If economic and trading conditions continue to improve over the next decade or so, the cash returned to the State combined with the value of any remaining shareholding may exceed the funds invested.

Here is where the commentators are going to get this all wrong.   It’s going to be sold as the state to recoup the money.   In a nominal sense, that is to say just simply adding up the value of money as received, regardless of when they are received, this may well happen.  Over time…

First of all, as Keynes famously stated, in the long run we are all dead.   If in 2027, or 2032 some future Minister for Finance states that the last piece of AIB has been sold and the state has now fully recouped the monies invested, that will be of scant comfort to those who have suffered unnecessary sterility as a consequence of having poured vast sums of state about into bankrolling private capital debts.   That we would have had to have austerity, and lots of it, regardless of the banking collapse is not the issue.  €64 billion of state money was used to underpin private debt.  That’s a large, and perhaps the most important, element of the increase in Irish state debt.

Second, this ignores completely the time element.  Money received in 2024, or 2039 cannot be treated the same as money received in 2015.  It needs to be discounted.   The state does this, every day, when it evaluates projects.  There is a rigorous and well-structured approach within government for evaluating what is called the present value, that is to say the discount is to todays value, of projects.  The bulk of this money was invested in 2010.   It is now 2015, let’s imagine that in 2020, five years from now, the state miraculously Sells AIB for €12 billion.   At a discount rate of 5% the 2010 value of this €12 billion is given as 12/(1.05)^10, discounting it 10 years.  This is 12/1.63,  €7.4 billion.  From today’s perspective it is 12/(1.05^5) or  €9 billion.    We cannot simply pile up nominal sums of money, to be received at different times in the future, and treat them all the same.
Third, it is in fact even worse than that.   People do not simply discount using the same discount rates across long periods of time.   There is a tendency to have what is called hyperbolic discounting.  This is where people generally prefer, even allowing for discounting, smaller awards sooner than larger awards later.  In the words there seems to be not only a discounting feature at work but also some situation where the amount of time which people have to wait is in another itself an important element.   Not only is jam today preferred over jam tomorrow but even relatively small amounts of jam today are preferred over the possibility of large amounts of jam at some stage in the future.   Interestingly, when the time at which the jam/sale of the banks to recoup the full amount of money is set, in other words the delay in gratification is known, then people seem to be prepared to wait.   Thus by suggesting that at some stage we might well get money back, but by not setting the time at which that money will be recouped, the government set themselves up for failure.  It’s not that people don’t believe, it simply that our minds are set up to not believe

Fourth, all of the above is predicated on the idea that there is a positive rate of discount.   We are in a deflationary environment, where instead of sums of money over time being discounted to become smaller they in fact a discounted to become larger.   The nominal value of debts stays the same but the real value of debts gets larger, when we are in deflation.

I have no doubt that some stage the total amount of monies inputted into the banks will be recouped.   I equally have no doubt this will be some considerable time in the future.   One thing we can be certain of, and that is that the government are, more or less, a year out from an election.  It is very obvious that they are in full-blown election mode.  Every piece of news will be spun to make it seem as though it is the best thing to happen since the invention of the frying pan.  That’s what governments do.  What the media cannot, but will of course, do is to swallow one critically these pieces of government propaganda, spin, and electioneering.  Nor can they swallow the premises coming from the other side, but again this remains to be seen.

The Irish state, and the people, took on €64 billion debt.  This was not the cause of the austerity, but deepened it unnecessarily.   Much of this taking almost done at the behest of our partners in Europe, who now admit that this was the incorrect thing to do, but have no intention of doing anything to actually alleviate debt burden.   We are where we are.  And where we are is in an election cycle ramping up into high mode.  Expect more of this.