NAMA Pricing: Let’s Focus on the Real Issue
This post was written by Karl Whelan
Two days into the public debate about the implications of the proposed NAMA legislation, I have been extremely disappointed at the approach taken by the government to debating the key questions raised by this policy.
It is fundamental common sense that a decision to deliberately pay more for something than anyone else is willing to would generally be characterised as poor financial decision-making. Thus far, the government’s attempts to defend taking this approach to purchasing bank loans have largely focused on the question of whether this might work out in the end if things go right in the property market. And it’s reasonable to discuss that issue—indeed, we have been devoting a lot of time to it here.
However, let’s leave aside for a second the question of what will happen to the property market in the future. Let’s focus instead on the reason for the policy. What is it about our current situation that requires us to deviate from normal financial common sense and pay extra for these assets? The usual answer given is something along the lines of the comments on Thursday’s Prime Time of Pat Farrell of the Irish Banking Federation—our banking system cannot absorb these losses.
But let’s analyse what that means. The government has committed to provide whatever recapitalisation investment is required to ensure that the banks are adequately capitalised after the losses associated with NAMA. So what these comments really mean is that current bank shareholders cannot absorb these losses and the decision to overpay reflects a decision to limit state ownership of the banks in a way that keeps current shareholders from being wiped out. (Remember that whatever capital position for the banks is achieved via overpayment can also be achieved via market value payments plus a corresponding extra recapitalisation from the state.)
So the key question remains whether temporary state control of the banks is a sufficiently bad thing that it is worth overpaying for these bank loans, most likely to the tune of about ten to fifteen billion euros (which, off the top of my head, is roughly the difference between an average haircut of 20% which would keep both banks out of full state ownership and average haircuts of a third or so that would see their equity wiped out.)
And, of course, even if the government had concluded that full state ownership of the banks was a bad thing, this on its own does not justify over-payment to protect current shareholders. As has been discussed here on many occasions (latest discussion here) private ownership could be introduced via debt-for-equity swaps or via negotiations with international banks or private equity firms to quickly take a stake in the cleaned up and recapitalised banks.
I don’t want to go on here about my personal position on these issues. I understand that people can disagree about the questions at hand here (the dangers of even temporary nationalisation, implications of bondholders losing out, whether private investment could be attracted) and I’m all in favour of debating this stuff. However, thus far, I have not heard any of these issues explicitly discussed in the various interviews with government representatives over the past few days. This is partly a poor reflection on our media but what is says about our government is far worse.
The truth is that the government has decided that the real reasons for the NAMA policy of over-payment—the ones the politicians will discuss with each other over a pint in Buswell’s—are not going to be explained to the Irish public.
Tags: NAMA, Nationalisation
August 1st, 2009 at 12:55 pm
Karl, what else should we expect?
The government has decided on this course of action, and having made that decision, will use their full arsenal of distracting legerdemain to hoodwink the undecided/uninterested majority.
Although, even with this in mind, I am still mystified as to the reasons for the NAMA proposal setting a minimum value for the price it will pay for the transfer of ‘assets’. I think think they missed a trick there. It would have improved the optics if they had said that the transfer price would be between “zero and the long-term valuation”.
The proposal was published to allow a public discussion. I fear the only result of this discussion will be to allow some to utter a rather hollow “I told you so..” on the occasion of the publication of each NAMA annual report, the first of which is due in Dec 2010.
August 1st, 2009 at 2:13 pm
Are there only two alternatives - nationalisation or a transfer to existing shareholders via overpaying for the assets?
Perhaps we could ‘nationalise’ the bank, recapitalise it [possibly via NAMA although there would be distorted incentives?] and immediately issue X% of the shares to citizens for free [costly but perhaps more desirable than overpaying for the assets to existing shareholders?] - avoiding state-control of the bank*. The remaining shares can be sold by the state over time to recoup part of the cost…
This would keep the bank mostly in private hands (depending on X) while avoiding a transfer to shareholders…This may have an added benefit in improving equality [which i suspect NAMA will not]
* The idea that we need large/institutional investors to monitor the boards actions may have some merit but they didn’t prevent the crisis….
August 1st, 2009 at 2:23 pm
@Tony
I genuinely think that’s a really nice idea in theory. The difficulty may be the costs associated with running an operation on the scale required. Tracking down every citizen wouldn’t be too easy. Shares for every taxpayers might be easier because the Revenue have lots of information. But with two million taxpayers, even if we were giving away shares worth, say €500 million, that would be €250 per head. But how expensive would be the costs of identifying everyone, getting the paperwork on the shares done and then distributing?
Still, I think it would be popular with the public and perhaps worthwhile as a symbolic action.
August 1st, 2009 at 2:51 pm
Thanks Karl,
I agree there could be substantial costs involved. One worry re: taxpayers would be people who have lost their jobs being excluded (and pensioners etc). Maybe the eircom flotation could be a template [despite negative connotations] I’m not sure who the offers to buy shares in Eircom were sent to, but perhaps it was sent to each household? Maybe the census data could be used?
Perhaps it would be better to do the following, rather than issue them, we could have it as an opt-in system where people have an entitlement [which must be used within 5 years say] whereby they must prove they are citizens to avail of the share? Of the share is worth a few hundred euro I suspect many people would opt-in….
August 1st, 2009 at 3:00 pm
Though I’m guilty of looking at motives, I’m not sure how effective that is sometimes. The core questions are
1/ How much?
2/ Who is the money being paid to?
3/ What are we getting for the money?
And what money back rights do we will have if these goods aren’t delivered or are found to be faulty.
Those who claim NAMA will saving the banking system, making more lending available to business, whatever, have the responsibility of proving their business case….
If they are asking the taxpayer for 2 years total tax take, thats the least that should be expected
August 1st, 2009 at 3:15 pm
It looks like that we are stuck with NAMA as the Government’s preferred option to sort out the Banks presumably because they have not got or perceive that they cannot raise the Funds to recapitalise them if there were Bad debt provisions of say 50% against the dodgy loans of Euro 90 Billion in their accounts. So theGovernment are opting for a tight discount on these loans using NAMA to get the Balance Sheets cleaned up over a 10 - 15 year period. Nationalising the Banks in my opinion is more dangerous as the Politicians will not be long waiting to interefere when their local pet project is under threat. The Bank Balance Sheets would never be cleaned up. My preference as a self employed person is for “New” Banks to be set up as I fear post NAMA clearout in the Banks they will not lend anymore to the Private Sector than is happening now. With “New” Banks at least we would have the hope that they would pitch for our business and make the existing Banks sit up and realise that the people who really count are the everyday good customers who need credit lines to run their businessses and for their customers to pay and finance their purchases. This situation has been completely lost sight of in all of the discussions about NAMA.
August 1st, 2009 at 3:45 pm
The way I see it the success of NAMA depends on what it is intended to achieve.
Is the intention to transfer losses from the bank to the Irish government or is it to recapitalise the banks?
If it is to recapitalise then the Irish government should only be buying the loans that are expected to perform. Examples of those would be mortgages to people working in the public sector (apologies if this is a bit cynical), loans for developements where the customer is well financed and the purchase contract is iron clad. For these kind of loans, the value is easy to calculate, as the payments are guaranteed, the value is a simple Net Present Value (NPV) calculation of the cashflows.
If the loans are not performing, then and only then, the value of the underlying security is important. The value of the underlying security depends on quite a lot of factors. My belief is that it is impossible today to calculate what office space, retail space and homes will be worth in 10, 15 or 20 years. The economic climate is to uncertain, the demographic and the migration patterns is too uncertain.
For the non-performing loans, I’d say that the risk premium (the haircut asked) would be so high that any purchase of such assets would make the banks insolvent.
Then again, if the intention of NAMA is to transfer the banks losses to the Irish people through their representatives the Irish governement then NAMA can be a success.
And my personal opinion is: Even if the recapitalisation of the banks through NAMA buying performing loans would be a success I believe the banks would still run the risk of insolvency due to the risk of underperforming loans causing losses large enough to make the banks insolvent.
August 1st, 2009 at 3:49 pm
@Tony, Karl W
The suggestion for voucher recapitalisation was floated first, I think, by Constantin Gurdgiev in April. http://trueeconomics.blogspot.com/2009/04/nationalize-or-else.html
August 1st, 2009 at 4:47 pm
The government have sat down and realised that the only way to resurrect the Irish economy is to bring the construction industry back to life as it will not be possible to deliver innovative manufacturing jobs before the next election. NAMA is Fianna Fail’s Dr Frankenstein experiment on the construction industry.
Ireland inc. is now going to become the biggest property hedge fund in the world and NAMA like Dr Frankenstein will be put fully in charge of reanimating the Irish construction sector. They will do this by taking out this €10 billion loan to finish off the all the carcasses dotted around the country thereby putting all the “harry the hammers” currently standing in the dole queue back to work.
One can only assume that, as the NTMA has no experience in property development, all the developers’ whose loans will reside in this entity will be either given additional loans to finish the work or be hired by NAMA to do so. This may have the effect of putting the developers effectively in permanent examinership until the crisis passes. If they do manage to finish the property, sell it on and pay back all the interest on the loans inside NAMA assumably the developers will be allowed keep the profit.
Maintaining Fianna Fail’s grip on power by providing the jobs through NAMA is the elephant in the room.
August 1st, 2009 at 6:18 pm
Riddle me this.
Who exactly is pulling the string’s here?
Is it the Central bank/ Dept of finance/Politicans.
or is it the ECB??
August 1st, 2009 at 7:54 pm
@Richard
The exuberant cheerleeding by Tom Parlon would tend to convince me you are right. The “tent” has moved.
August 1st, 2009 at 8:14 pm
Excuse this post being somewhat off-topic, but I’m wondering if someone with better knowledge of corporate finance than I possess could illuminate a puzzling story in today’s Irish Independent (http://www.independent.ie/business/irish/anglo-to-generate-large-windfall–by-buying-back-836432bn-assets-1835654.html) ?
I find the “spin” here, that Anglo has cleverly gained itself a “much-needed windfall”, by paying approximately 50% on bonds which were outside of the guarantee, worryingly doubtful. Is it not the case that in truth (if there is such a thing in this morass) Anglo has just used some €1.5Bn of funds provided by the exchequer to pay bond-holders who had no claim under the guarantee, and who would have had no claim either if Anglo had gone into liquidation?
August 1st, 2009 at 9:08 pm
I think all agree that what is needed is a banking system which efficiently (& cheaply) allocates capital.
I believe that currently, this is my personal opinion, the banks operating in Ireland are not doing so and this is the central problem.
Ignoring the moral implication of allowing investors (shareholders & bondholders) to take profits and walk away from losses leaves a pure financial decision to be made on how to increase the efficiency and lower the cost of capital allocation in Ireland.
Without overpaying, I don’t see how NAMA can work. The costs I believe to be compared are:
-Cost of overpaying through NAMA.
-Buy the banks outright & then split them into good and bad banks like in the Swedish crisis
Both involve taking over loans that it seems many expect will not be repaid and as a consequence the underlying securities will be taken over at a loss.
Without NAMA, what would be the cost of buying AIB and BOI (assuming they are not liquidated)? The market capitalisation (value of all shares issued as priced on the stockexchange http://www.ise.ie/) of them gives an indication of the upfront cost.
Or the reasons for going with NAMA can be something completely different. It might be that the reasons cannot be disclosed for state security reasons, if it isn’t a state secret I believe it should be disclosed in public.
August 2nd, 2009 at 5:11 am
Rapa Nui
There was once a happy island nation living well under the sun and in the shade of their beautiful trees. Then they fell under the thrall of the bankers who said we can make you rich! So they set about selling land to one another and lo and behold in several months, they were all rich! They all owed enormous sums to the kind and wise bankers, but they also owned their own homes which were now worth a multiple od what they used to be!
But then the bankers decided that they had suffered enough insults from the ignorant savages and demanded their money. Well they got it all back, but the natives had to sekk off their land and their trees to others kindly funded by bankers, to do this. But they all had their wonderful homes that were worth……….. errrrr a lot? But they no longer felt rich.
Important policy change:
Due to the impressive stupidity of the natives, I have decided to use a different slogan.
Remember Easter Island!
August 2nd, 2009 at 5:14 am
@ALAN
Yes Alan. Disturbing isn’t it. Remeber the Texas co that hornswaggled the money for debt insurance? Look back in the posts. A lot of po faced economists decried the opportunism. But then they did not share in the tasty profits….
Welcome to Easter Island! Anyone but the ignorant natives will get wealthy by buying a politician or three!
August 2nd, 2009 at 7:21 am
H’mmmmm….. everyone making money seemed happy enough with ‘market value’ when prices were spinning upwards so why not when they are going down?
@Richard
That’s an interesting conspiracy theory and nothing about FF would surprise me. I’m not sure that ‘going back to the way things were’ would make this a better place though - or benefit FF - as it’s unlikely to work. They would just be digging a deeper hole for themselves.
Ultimately, NAMA has to dispose of these assets and I just have a horrible vision of the usual suspects standing on the other side of NAMA, waiting to pick these assets up cheaply while the taxpayer foots the bill for the difference. NAMArbitrage anyone?
August 2nd, 2009 at 10:58 am
Alan:
Your question is more a financial accounting issue than a corporate finance issue. Irish banks carry long term debt on their balance sheets at historic cost (roughly, what the debt was issued at). Suppose Anglo originally issues 10 year bonds with a face value of 100 Euros. This means that 5 years later Anglo is carrying a liability on its balance sheet that is close to 100 Euros (it wont be exactly 100, but lets keep it simple)
However, Anglo is now bankrupt, so the debt which has 5 years still to run is now trading at, say, 27 Euros in the market: deterioration in Anglos credit rating causes discount rate to shoot up.
So, Anglo has a liability on its balance sheet at (close to) 100 that it can settle for 27. They pay out 27 in Cash (decrease assets by 27) and settle a liability of 100 (decrease liabilities by 100). The residual 63 gets booked as a “gain” which increases shareholders equity. Banks do this to boost your capital ratios. AIB did this some time ago.
In essence, they are profiting from the decrease in the value of their own liabilities. The more bankrupt you are the bigger the accounting gain and the bigger the boost to your capital ratios.
August 2nd, 2009 at 1:07 pm
@Donal Byard
Anglo Irish bank should have been closed and run down in an orderly fashion. They don’t need to boost their capital ratio, just close it down at least cost.
These bondholders should have got nothing. Instead they walk away with €1,580,000,000.00 of our money.
August 3rd, 2009 at 12:20 am
Anyone want to join me in setting up a new bank? Clear market opportunity here right now.
August 3rd, 2009 at 11:56 am
Further to my previous post:
http://www.independent.ie/business/irish/836410bn-on-offer-to-finish-projects-1847677.html
August 3rd, 2009 at 12:22 pm
While finding this debate stimulating and informative I’m curious no one queries the extent of the insolvency among the major developers/borrowers. If most are insolvent or effectively so when no-performing loans are counted why not have them wound-up let the banks assume control of the assets and then bring in NAMA. Why should we, the taxpayers, have to pursue these people. Let AIB etc follow ACC and gain possession as they would if if was any ordinary borrower.
Also, why are we so obsessed with the need for multiple ‘Irish owned’ banks surely within the EU we can have HSSC, Rabobank etc provide us with financial services - it works with our supermarkets!
August 3rd, 2009 at 5:22 pm
@Frank,
I’m sure the resident academic experts would be able to answer your question more accurately and eloquently, but my take is that the Government wants to create fantasy land where taxpayers pay large amounts of money to sustain the belief that the banking system isn’t as bust as it really is and developers aren’t as broke as they really are.
And for your second question, roll on the internal EU market in financial services - but that would cause serious pain for the “wrap the green flag around me” boyos.
August 3rd, 2009 at 6:04 pm
The words “off balance sheet” also create the illusion of it being a no cost solution in the short term.
August 4th, 2009 at 10:59 am
An interesting side issue that I have not seen discussed is:
How many of these developers made their companies unlimited, to avoid publishing full accounts, during the peak of the boom?
Surely that means that everything is on the line.
Racehorse, helicopter, trophy wife’s collection of Manolo Blahnik shoes.
August 4th, 2009 at 3:22 pm
Let the bankruptcies begin, as the banks tip into receivership the gov’t can buy them for the price the stocks and bonds are trading at. I expect that would be zero for the stocks and cents on the Euro for the bonds. The gov’t would run the rescued banks until they become profitable and then sell them as Initial Public Offering stocks at auctions open to all in about five years.
Wages and property values have to come down substantially for the country to grow at a moderate pace. NAMA provides crutches for banks and property owners who will remain crippled for decades because the economy will remain moribund. In other words the bubble must burst, it can do that in three months or it can die a slow, lingering, painful death that prolongs the misery of the unemployed and failing businesses. Indeed the gov’t itself would be better off to resign and get it over with before life becomes really unpleasant for them and the rest of us.
August 21st, 2009 at 1:18 pm
Maurice O’Leary
My post was an explanation of why accountants label a particular transaction as a gain (and, thus, how it was reported as such in the Indo). My main point was that this is a setting where the accounting rules do not reflect the underlying economics. There is nothing in my post that endorses any particular policy action for Anglo Irish bank.