BUSINESS OPINION:Selecting IL&P or Cardinal will indicate Government opinion on the mortgage market, writes JOHN McMANUS

THE GOVERNMENT is in the final stages of selling the Educational Building Society. It has come down to a straight fight between Irish Life & Permanent and the Cardinal consortium led by Dublin businessmen Nick Corcoran and Nigel McDermott with the backing of billionaire US investor Wilbur Ross and private-equity group Carlyle.

The choice of suitor will reveal, among other things, what the Government and the regulator think is really going to happen in the residential mortgage market and how they believe the l problems with all the banks’ mortgage books will pan out.

The trouble for the Government in that regard is that it appears as clueless as everybody else – including the banks themselves - about the scale of the private sector debt problem.

One of the most telling announcements in recent weeks was the regulator’s call for an overhaul of the Irish Credit Bureau to make it easier for banks to find out about their customers’ other borrowings. The nightmare scenario here is that, in the same way that the banks did not know what other dealings the big property developers had with rival banks, they are in the dark as to the real state of many of their retail customers’ finances.

On the face of it, the offer from Cardinal would be something of a no-brainer if the Government believed the level of mortgage defaults had peaked and that there is not a serious problem with private sector debt waiting to manifest itself if interest rates start to go up before the economy recovers.

Cardinal is offering to put €500 million into the society and has also come up with a structure that could see the Government recoup some €300 million of the cash it has already ploughed in to the EBS.

The only catch is that the State is on the hook for 70 per cent of any losses at the society over and above €450 million.

But the prospect of the Government being called upon in this regard is remote if mortgage defaults do not rise much higher; the property market is close to the bottom and people continue to service mortgages despite levels of negative equity in excess of 30 per cent. All of the above are working assumptions underlying the Government’s policy for bailing out the banking industry.

The Irish Permanent offer does not require such an explicit backstop by the Government, but it does tie the taxpayer in indirectly. IL&P is proposing a merger of the EBS with its own troubled residential mortgage lender, Permanent TSB, which would first of all be recapitalised by IL&P by way of a €925 million rights issue.

The newly capitalised bank would then be merged with EBS, with the Government putting in €500 million in new capital in return for a 40 per cent stake.

The Government would also get a 10 per cent stake in Irish Life, which means it shares some of the expected upside for the life assurance and pensions company once it has unshackled itself from its troubled mortgage bank.

The obvious problem with the IL&P offer is that it adds yet another bank to the growing list of nationalised or quasi-nationalised lenders. In this case the Government would own 40 per cent of a bank that can only repair its balance sheet by putting up lending rates and cutting deposit rates. All the banks face this challenge but in the case of Irish Permanent and EBS the problem is more acute.

The only pragmatic reason for the Government to get deeper into the banking sector at this stage is if it believes that IL&P cannot restructure Permanent TSB without its help.

On the basis of this analysis, a decision to sell EBS to Cardinal could be seen as evidence that the Government believes in the assumptions underpinning its banking policy, while the sale to the IL&P signals it accepts as inevitable that in time the taxpayer will have to shoulder the burden of restructuring Permanent TSB.

A further conclusion to be drawn would be that the Government also accepts that it may have to roll up its sleeves and get involved in the whole area of restructuring negative equity mortgages and the like.

Those who believe there really is a problem in this area that must be adressed would argue that this is actually the right thing to do. But given the imperative to try and win back the confidence of the bond markets, there must be a very strong temptation to not do the deal with IL&P.

Selling to Cardinal would send out a much more positive signal, although it may in time prove to be a bad move for a good reason.