While there has been a lot of discussion of the draft NAMA legislation’s definition of long-term economic value, there has been very little attention paid to its clause discussing current market values.
There are two interesting aspects to the discussion of market value. First, there is the fact that it is being discussed at all. We know that there is a very limited number of transactions in the current market for development and investment property, so it might have been expected that the government would fall back on the claim that there was no market as a justification for moving straight to the dreaded long-term economic value. (And indeed, the Minister for Finance, did mention illiquidity on Morning Ireland despite its absence from the legislation.)
Second, there is the wording of what is meant by current market value. The legislation defines it as
the estimated amount that would be paid between a willing buyer and a willing seller in an arm’s length transaction where both parties acted knowledgeably, prudently and without compulsion
This sounds eminently reasonable doesn’t it? The parties are acting knowledgeably. They are being prudent. Presumably, then, they are aware of the stuff discussed in the long-term economic value definition—that the current crisis will abate and the financial system will become stable—and are factoring this into their decisions.
Why would we ever intervene to declare that this process would produce a price that is inappropriate for the government to pay? Even beyond the obvious objection that paying a higher than necessary price doesn’t feature in any advice book on investment strategies, what is the intellectual fig-leaf for the idea that the price being set by these knowledgeable and prudential people is somehow wrong?
The only argument that I can think of is the evidence that the market does not appear to price according to rational financial formulae such as the dividend discount model that I described last week or other variants of the so-called efficient markets hypothesis. I have taught asset pricing on a number of occasions and I always emphasise that efficient market models are highly imperfect.
In this week’s FT, behavioural economist Richard Thaler of Nudge fame has a nice article describing many of the failures of the efficient market hypothesis. However, what Thaler’s article does not describe is that his logic—that the market often gets the price wrong—is now being used around the world to justify programs that use enormous amounts of taxpayers’ money to buy (or insure) assets at well above their current market value.
This is the essence of the Geithner PPIP plan, which I never liked and, which thankfully, seems to be having trouble getting out of the traps. US government officials were arguing that the various exotic asset-backed securities being held by their banks were being valued below reasonable long-term prices.
I wonder how comfortable Thaler is with programs of this sort. It’s one thing to say that EMH doesn’t always work well; it’s another to say you can diagnose the extent to which these aberrations will correct themselves over time; and then another thing altogether to say that you’re going to bet large amounts of tax revenues on this diagnosis.
However, based on the legislation’s own wording, this systematic mis-pricing idea is the only potential intellectual argument that could be made for the idea that NAMA could break even.
We can all point back to various assets that, with hindsight, were clearly over-valued by the market. And of course there are cases where can look back and say that certain assets were under-valued by the market.
However, how comfortable should we be with the idea that Irish development and investment properties are good examples of assets that are being under-valued by the market? And how comfortable should we be that our government, lead by a man with a recent history of buying flats in Leeds, are the right people to detect the exact magnitude of this mis-pricing? Needless to say, I am not comfortable with this idea.
As for the separate idea that, even if our government does possess this great skill at spotting mis-pricing, the beneficiaries of this skill should be current bank shareholders rather than the taxpayer, discomfort doesn’t quite capture my thinking.