Speaking on RTE’s The Week in Politics (about 16.20 minutes in) Minister for Health, Mary Harney noted repeatedly that NAMA would take on good loans as well as bad loans and then said the following:
This is an important issue. From the good loans they will get cash to run on a break even basis on a day-to-day basis. The ESRI has done a simulation study and they have suggested that over ten to fifteen years this will break even as far as the taxpayer is concerned and that’s the reason as well to take the good loans to raise the cash.
Two aspects of this statement are worrying—the discussion of good loans and the comments about breaking even.
The Good Loan Confusion
As I have written before, the “buying good loans to pay for the costs” statement, despite its regular repetition in the media, simply makes no sense.
It appears that the NAMA purchases will be financed with marketable interest-bearing bonds. Adding good loans to NAMA will increase the interest bill from these borrowings. If these good loans yield a higher level of income than the interest rate on government debt, then this strategy could be profitable in a risky, hedge-fund-like way, though it’s unclear why a government would engage in this kind of activity.
However, it is simply fanciful to imagine that the good loans would generate so much income that they can cover the interest cost associated with the funds borrowed to pay for them as well as the interest costs associated with purchasing loans backed by properties that are currently not generating any income. This is the intellectual equivalent of saying that you are taking out two mortgages for new homes and renting out one of them to raise the cash to pay for the cost of both mortgages. It would be a nice trick if you could manage it, but you can’t.
More worrying is Minister Harney’s characterisation of NAMA as likely to break even. To the best of my knowledge, the ESRI has not done a “simulation study” on NAMA.
I believe it is most likely that the Minister is referring here to a recent comment made by the ESRI’s David Duffy to the Sunday Tribune that those who bought houses at the peak of the boom in 2007 may have to wait until 2030 before they value of their homes return to what they paid for them (note that this does not mean that the home-owners will be in negative equity until 2030 as the headline implies, since they will be paying off principal.) I have been in touch with David and he told me that he based his comments on the perfectly reasonable assumption that house prices will grow in the 2%-3% per year range after hitting bottom.
My point here is not be harsh on Minister Harney regarding her understanding of what the ESRI did or didn’t say about NAMA or house prices—there are lots of reports published every week and it’s easy to get things mixed up on live TV. Still, let’s just accept that the Minister believes that the nominal value of the assets purchased by NAMA will return to the value paid for them by 2030.
Without doubt, if this came to pass, then some future government could characterise NAMA as having broken even, implying that it didn’t cost the taxpayer a cent. However, by any reasonable reckoning, this would be a gross mischaracterisation of the cost to the taxpayer.
The funds to purchase the NAMA assets will be borrowed, perhaps at an interest rate of about 5% per annum. This would mean that, over 20 years, the state would have to pay out €3 billion for year in interest on the €60 billion in NAMA bonds. The final return of €60 billion from sales of NAMA assets will cover the principal on the bonds, still leaving the taxpayer €60 billion worse off because of the interest payments. (And, of course, the interest rate that the government will have to borrow at in the coming years may be raised by the risk the government is taking on with the NAMA project.)
The substantial interest bill means that to fully cover the costs incurred by the taxpayer, the assets purchased by NAMA will need to significantly increase in value in the coming years. This can only be achieved by purchasing them at a steep discount relative to their peak valuations. Any suggestion, whether explicit or (as in this case) implicit, that the government can purchase assets for NAMA based on near-peak property prices without inflicting costs on the taxpayer, is simply wrong.
If Minister Harney’s comments are an indication of the thinking about NAMA from senior government ministers (and it’s hard to interpret them any other way), then things are every bit as bad as the most pessimistic among us have warned.
Update: Thanks to the ESRI’s John Fitz Gerald (and Michael Crowley — see comments below) for pointing out the more likely source of Minister Harney’s comment on breaking even. In its recent Recovery Scenarios document the ESRI included a scenario in which NAMA purchased $80 billion in book value loans for €50 billion and ended up breaking even, after controlling for interest costs. The document makes clear, however, that this scenario “is used strictly for the purposes of illustration.” So, it is not accurate to say that the ESRI “have suggested” that NAMA is going to break even. The key point, however, is that recovering the nominal value of the initial outlay should not be the appropriate metric for assessing the cost of NAMA to the taxpayer.