“Overpaying Saves Money” Talking Point Gains Popularity
This post was written by Karl Whelan
I noted last week that a new talking point about NAMA was emerging which went beyond the old canard that “it doesn’t matter” how much we pay for bad bank assets. The new talking point actually suggests that we will be better off if we overpay for these assets. I found it interesting that the new talking point appeared today in two, highly influential, guises.
First, we had the Irish Times lead editorial. Here’s a section from it:
Yesterday’s jump of 8 per cent in AIB’s share price seems counter-intuitive when the prospect of State control looms so large. Investors however are choosing to focus on signals from the Government that it will do all that it can to avoid taking equity stakes in the banks.
The Government’s overriding concern is minimising exchequer borrowing in the coming years. Minimal investment in the banks is part of this strategy …
The critical issue now, and one alluded to by AIB yesterday, is the price at which the loans will be transferred to Nama. Again, a bias towards the banks seems likely.
The Government’s strategy of minimising investment in the banks is expedient – as evidenced by yesterday’s exchequer returns indicating the still sickly state of the State finances. It will also have long-term benefits in respect of the spiralling national debt.
Note that the editorial stresses the idea that overpaying for assets is “expedient” and will have “long-term benefits”! The only drawback the editorial writers see appears to be the absence of the “short-term benefit” of wholesale changes in senior bank management.
Let me explain (again) the flaws behind this idea. Yes, a decision to overpay for assets by, say, €15 billion, will “save” the government from having to invest €15 billion in the banks. However, a decision to not overpay by €15 billion and then invest this €15 billion in the banks results in the same outlay in the short-term but will produce significant long-term benefits in the form of dividend payments and the subsequent resale of the shares. There is no long-term gain from overpayment—quite the contrary in fact.
When you consider how many clear explanations of this issue have appeared in the Times op-ed pages in recent months, it is very disappointing to see such misleading analysis in the editorial comments.
Second, we had Brendan Keenan’s article in the Irish Independent. I know this article had its own thread earlier but it’s very important that the “overpaying saves money” element of it be subjected to some analysis. Keenan wrote:
The budget crisis makes Mr Lenihan reluctant to put capital into the banks. For that he needs real money, whereas he is buying the loans with a huge IOU, to be paid at some unknown date in the future.
So the argument here is that overpaying is a better approach because we can pay for NAMA’s purchases with pieces of paper printed off on Merrion Street, where as recapitalising the banks requires “real money.” The perceived benefit from over-payment—picked up on in comments on this blog—is that we’d have to pay a much higher interest rate on the regular government bonds that would have to raise the “real money” than we’d have to pay on the NAMA bonds used to buy the over-priced assets.
Even aside from the fact that focusing on debt interest savings is a secondary concern relative to the substantial overpayment generating the principal on the NAMA debt, the “real money” idea is simply incorrect.
Why would anybody think that the same banks that are happy to exchange property loans for government NAMA bonds will somehow refuse to accept these same bonds in return for an equity stake?
Perhaps the phrase “capital” conjures up in journalists the idea of cold hard cash sitting in the vaults but that’s not what bank capital is (that’s liquidity—a different thing.) Bank capital is the gap between a bank’s assets and its non-equity liabilities. Giving a bank some government IOUs in exchange for equity raises its assets and has no effect on its non-equity liabilities. So an IOU-for-equity swap boosts bank capital even though there’s no “real money” required.
It’s hard to know what’s generating these arguments. Perhaps it’s government spin but, to be fair, I’ve never heard any government minister make these points. Perhaps it’s the desire to believe that overpayment must have some wise long-term strategy behind it. I really don’t know.
Tags: NAMA
August 6th, 2009 at 11:41 pm
It really is exasperatingly frustrating that independent, intelligent and informed people like Brendan Keenan and the IT editorial board still appear so confused on relatively basic facts.
I can understand that people might be afraid of nationalising the banks and therefore thinking handing billions over to current shareholders is a better option. I can also understand that advocating “handing billions over to bank shareholders” is politically unpalatable, hence the need to dress this option up with a lot of complex hocus pocus (i.e. NAMA). But I can’t understand how people can genuinely seem to think that recapitalisation through overpayment saves money up front compared with recapitalisation via buying bank shares.
I’m at least as layman as the people thinking this, so I tend to think maybe I’m missing something but it all seems relatively simple to me. And as you say, there has been no shortage of efforts to explain, notably on this forum. Maybe people have some desire to believe it’s all more sophisticated and complicated than it really is?
August 7th, 2009 at 12:03 am
Although a (slightly) off-topic, I would like to see a clause in NAMA that a list of shareholders in the banks which use NAMA be published (and perhaps for a certain period either side of it’s implementation) as a form of check on who is benefiting from this overpayment [and from anticipation of overpayment should it turn out not to be realised] - and the extent to which they benefit and transactions that occur.
Given the large benefits likely to accrue to shareholders I don’t think the waiving of privacy can be seen as unfair…
Another addition which may be useful but perhaps not feasible would be a requirement that shareholders may sell shares upto a value equal to that of their shareholding at some start data prior to NAMA (or date of purchase purchase if a susequent buyer of shares) until some expiry date - maybe 5 years after NAMA to prevent the shareholders getting a quick windfall?
August 7th, 2009 at 12:28 am
Maybe like the rest of us they just got their Pension account statements through the post and reckon its one thing losing the AD. revenue from the property sector but this Pension thing is way past a joke.OOPs sorry just remembered the Fund Managers would have pulled plug on the shares ages ago,being the Prudent fellows we know they are.P.S My Pension fund must have taken a bath on tham pork bellies in Outer Mongolia just as well I was sitting down when I read it.Ah well no one seen that one coming either,damn them Mongolians and their Pork.OOPS sorry again hope that was’nt blasphemy,sorry Dermot.
August 7th, 2009 at 5:38 am
The whole point is that the choice is not one of valuation at all. By conceding this we lose the argument altogether. Why are we susidizing a failed banking system and land development madness when we will not susidize human beings?
We should have no subsidy. Let the market sort it out. When they realize they are not going to get a lifeline the next generation of developers will be more cautious and we will all benefit.
LIQUIDATE! Free up the assets to be used in a lower cost economy.
August 7th, 2009 at 8:09 am
@KW My understanding of this article is that the NAMA bonds that the banks get will be repo’d with the ECB for cash. There will be no bond auction. Whereas if nationalisation went ahead with the consequent investment of capital we would have to issue more debt on the capital markets.
While theoretically NAMA debt is part of the national debt in practical terms not issuing an extra €20-30bn of Irish debt on to capital markets will make quite a difference.
August 7th, 2009 at 8:24 am
@Mark
Again, why is this? I mean, why does nationalisation have to imply a bond auction? Why can’t we just exchange newly issued bonds for bank equity? Surely, if the banks can repo Nama bonds with the ECB, they can repo a different kind of bond just as easily?
The difference isn’t what the Irish government uses to pay, the difference is in what it is buying. Under NAMA, it is overpaying for bad loans; under nationalisation, it will be buying the banks’ equity.
August 7th, 2009 at 8:33 am
What value relative to a normal government bond will these NAMA bonds have? Why are we allowed to simply invent a new form of money to deal with this problem?
August 7th, 2009 at 8:48 am
@George: It’s financial innovation dude, what could you possibly have against that?
@Mark: Just to echo Graham’s comment. You wrote “if nationalisation went ahead with the consequent investment of capital we would have to issue more debt on the capital markets.” I say no we wouldn’t. The argument behind my thinking is in the piece above: “Why would anybody think that the same banks that are happy to exchange property loans for government NAMA bonds will somehow refuse to accept these same bonds in return for an equity stake?” I’d be interested to know what the argument behind your thinking is.
Finally, I’d note that I’m not necessarily talking here about financing nationalisation. I’m just discussing the combined financing of the Nama purchases and equity investment and saying that we don’t have to use two different instruments to finance them.
August 7th, 2009 at 9:04 am
@Karl: nothing in particular until somebody explains to me how the hell they are doing it!
August 7th, 2009 at 9:57 am
@ KW
If the government were brave enough to renegotiate the government guarantee on bank liabilities they would neither have to overpay for NAMA “assets” nor recapitalise the banks. The guarantee is creating the either/or situation, both unpalatable so why not work on changing that. A renegotiated or scrapped government guarantee (communicated effectively to the markets) would relieve the pressure the government seem to be under to “save” all the banks.
The most disheartening news of the week was yesterday’s that Anglo Irish Bank have completed the recent capital injection. Talk about throwing good money after bad. Free of the guarantee the government would be able to pick one of AIB or BOI to “save”, which is all we really need. Anglo would be wound down and it would be easier to get a foreign bank such as Santander to invest in the remaining “big bank”.
Yes there would be a write down across the board of Irish property “assets” but let’s be honest that will happen eventually and it’s better to be over and done with than drag on a la Japan. And the cost/risk to the taxpayer would be dramatically reduced than the current plan of action. How the government think they have the firepower to take on all the potential impairments in the Irish banking system’s loanbooks and their massive liabilities from a broken wholesale financed business model is beyond me.
August 7th, 2009 at 10:00 am
@ Pat
Very good point in relation future developers and their risk analysis.
How many years do you think it will be before the next round of tax incentive schemes for property development?
Al
August 7th, 2009 at 11:07 am
Following on from KW and Graham’s replies above to Mark’s post: “While theoretically NAMA debt is part of the national debt in practical terms not issuing an extra €20-30bn of Irish debt on to capital markets will make quite a difference.”
Do you seriously think that bond market investors are going to be fooled for one second by a bit of off-government balance sheet national accounting? Empirical research on the US GSE’s (Freddie Mac/Fannie Mae) in a pre-crisis Fed paper showed that investors in GSE’s (equity/debt) benefited from these implicit guarantees.*
Is there any reason to suppose: (i) why bank equity/debt investors will not benefit from this implicit subsidy and (ii) as a corollary, why government bond investors/rating agencies will not factor in the contingent liability from the Nama debt.
It will be interesting to see whether there will be Nama premia in Irish Govie’s and Irish sovereign CDS as investors may link the implicit guarantee of the Nama bonds to Irish government funding costs.
To date, there has not been any convincing explanation from the government how this free lunch will be achieved.
*The GSE Implicit Subsidy and the Value of Government Ambiguity, W. Passmore, Federal Reserve Working Paper 2005-5
August 7th, 2009 at 11:40 am
@RV
You make some very valid points, but the free lunch the Government hopes to snaffle is being funded by the ECB while it continues to be happy to pump liquidity into Irish banks on the basis of the flimsiest collateral. The expectation is that the banks will be able to access this liquidity using NAMA bonds which, in turn, they will use to buy Government bonds. This will help to shield the Government from the international bond market and minimise the amount of funds it will have to raise there at a coupon that will include a NAMA premium.
August 7th, 2009 at 11:53 am
It really is disheartening, as Karl has pointed out, to see the level of acquiescence by the main stream press in the NAMA debacle.
One glimmer of hope on the overpayment issue is that the liquidation of one developer reported yesterday should set the real value of unfinished property /hotel developments and land (330 acres in Kilternan) in a transparent manner. The receiver now in control will have to file accounts when he disposes of it.
The intriguing issue is how was this allowed to happen when the Gov is effectively in control of INBS. Why the rush ahead of NAMA. Is it simply the case that there is no joined up thinking (as suggested by some of your contributors). Anglo and INBS (both Gov. controlled) are the actors here so no foreigners, such as RABO, can be blamed for going on a solo run.
On the bonds issue the fact that the Gov has given the Anglo bondholders a big haircut makes nonsense of the original reason for the NAMA route. The ECB gave cover for this and it could be done with AIB and BOI. The Anglo State haircut has not impacted the bond market one iota, in fact, the position has improved since it was done with long term yield falling on Government bonds.
Is there another agenda - or is NAMA in a chaotic mess.
August 7th, 2009 at 12:02 pm
@p.odubhlain
If my memory is correct, BoI was first to buy back some of its bonds at a discount, then AIB and now Anglo Irish.
Of course if FG policy were followed, no haircut just scalp them, the bondholders would not have got a penny once the guarantees ran out.
August 7th, 2009 at 2:48 pm
@KW
“Why would anybody think that the same banks that are happy to exchange property loans for government NAMA bonds will somehow refuse to accept these same bonds in return for an equity stake?”
I am guessing the answer to this is that the banks are happy to exchange property loans for government NAMA bonds as they realise the government will overpay relative to market values. In return they will as PH outlines continue to support govt bond auctions, backed by the ECB.
Why would they refuse to accept these same bonds in return for an equity stake? I guess because they don’t want to give up onwnership.
August 7th, 2009 at 2:58 pm
@Maurice
I think they issued new paper at onerous rates
The Anglo deal was a real haircut for dosh - hence another 750 million into the black hole yesterday
August 7th, 2009 at 3:57 pm
http://www.rte.ie/radio1/player_av.html?0,null,200,http://dynamic.rte.ie/quickaxs/209-rte-todaywithpatkenny-Friday.smil about 30m from the end….
August 7th, 2009 at 4:14 pm
@Paul hunt
I think that legally NAMA bonds are government bonds.
“For the purposes of this Act and to enable the Minister to provide consideration for the
acquisition of bank assets and the operations of NAMA or a NAMA group entity, the
Minister may, whenever and so often as he or she thinks fit, create and issue debt securities
charged on the Central Fund or the growing produce thereof and ranking pari passu with debt
securities issued by the Minister under section 54 of the Finance Act 1970—”
August 7th, 2009 at 5:19 pm
When the banks are buying back their bonds at a discount they are doing what is best for their owners. They weighed their options, either:
-Lend to an economy in recession (high risk) and get 10-20% return on investment (probably lower)
or
-Buy back their bonds at a discount getting returns of investment in excess of 30% (higher or lower, depends on the perceived risk of default)
I don’t see how increased lending will happen until the return on investment of buying back bonds is lower (significantly lower as the risk is significantly lower).
Debt/equity swap is unlikely until the losses have been recognised.
The bonds will trade at a discount unless the risk of insolvency is reduced. The risk of insolvency will exist as long as the banks bear the risks of their loans. Overpaying for the loans (pricing the risk correctly) is the only way to save existing shareholders. It is not the only way to save the banking system.
Maybe the plan is to overpay so much that the banks won’t have the option of higher ROI of buying back bonds, thus forcing them to start lending again?
If it is, I still think it would be cheaper to follow the steps below:
1. Nationalise
2. Recognise losses
3. Insert equity
4. Sell banks to highest bidder
The difference between NAMA and nationalising as above is that even though the Irish government might be stuck with losses, the sale of healthy banks should recover some of the losses the previous owners incurred.
Overpaying through NAMA is a gift of money to existing shareholders, buying an equity share in the banks or nationalising the banks is making an investment.
August 7th, 2009 at 5:53 pm
Jesper
Can I suggest it goes this way
1. Recognise losses
2. Nationalise
3. Insert equity
4. Sell banks to highest bidder
August 7th, 2009 at 6:52 pm
Jesper & Brian,
“1. Recognise losses
2. Nationalise
3. Insert equity
4. Sell banks to highest bidder”
This is a crystallization of a viable and fair (Fair for the citizens & taxpayers) alternative to the NAMA scam.
I agree with Brian’s re-ordering of the steps. The losses should be recognised up-front before nationalisation (temporary) would take place.
Jesper,
Your final comment - “Overpaying through NAMA is a gift of money to existing shareholders, buying an equity share in the banks or nationalising the banks is making an investment.” - sums up the choice to be made between NAMA with its benefits for the few (shareholders/bondholders) and temporary nationalisation which protects the interests of the many (citizens of Ireland).
All of this will not be enough to save our economy from a serious and long recession. As I have stated previously the state may have to intervene extensively in many areas of the economy to save many vulnerable areas of the economy and promote a more sustainable recovery in the long run.
The government should not be allowed blow away up to €30 billion in a gift to speculators when it will be badly needed in the next 5-10 years.
August 7th, 2009 at 7:49 pm
@Brian
Good point on the gov. bonds. How are they going to keep them off the balance sheet (given the explicit wording). The other potential timebomb is what effect a 100% increase in gov. bonds will have in the markets.
The NTMA regard the Deposit guarantee and Gov. Bonds as ranking parri passu.
August 7th, 2009 at 7:59 pm
Is it just perception or coincidence ——from the recent Bank half yearly results in USA and UK that there is a clear feeling that Non Nationalised Banks are performing much better than their Nationalised brothers. If so it bears out the much used argument that a once Nationalised a Bank quickly adopts the ethos and mindset of Civil Servants —-very important for running Government departments but missing the business edge and commercial acumen needed in a competitive arena.
August 7th, 2009 at 8:51 pm
@ Brian
I would suggest the following order
1.proper stress test like UK/US-it could be done in 1 week. it was in UK.
2. recognise losses -take problem loans away at market value utilising an auction process if possible. For example, Irish household securitised mortgages were trading at 50-60 2 weeks ago but are now trading at 80 because a buyer has emerged in a illiquid market
3. inject public equity to recap systemically important banks to a proper level. This takes public ownership to whatever level it takes it to. it could be anywhere from 70-100%. If it were possible to leave a 10-20% stake in private hands it would be a desired outcome as I do not think the “20″ realise the difficulties of funding a fully state owned bank. Look at the run on Anglo since guarantee.
4 Wind up Anglo/INBS burning bondholders in process
5. Get the Stephen Hester playbook on RBS and follow-cut costs, sell non core assets at better time, bring lending discipline back.
August 7th, 2009 at 10:33 pm
@Tadgh
its obervationally equivalent tho that the nationalised banks were so screwed up that they will of course underperform. After all, if they were not screwed, they wouldnt have to have been taken into care.
August 7th, 2009 at 10:45 pm
@JL
Good post. But…look at the run on aib and it aint nationalised. Same % fall in term deposits, nuh?
August 7th, 2009 at 11:19 pm
@Tadgh
Just perception. In addition to what Brian L. said, in the UK, Lloyd and RBoS are not nationalised but reported massive losses. Granted they have massive government stakes but the management remains the same.
No US bank has been nationalised. AIG comes closest to nationalised - and it is not even a bank - and it reported a $2 billion (fake) profit.
August 7th, 2009 at 11:28 pm
@Brian Lucey, AIB’s loss of deposits (€10 bn) in the last six months is only half the story.
Deposits by banks have risen from €25bn (15% of funding) at end of December to €45bn (27% of funding) today. (see page 20 of http://www.rns-pdf.londonstockexchange.com/rns/8370W_-2009-8-4.pdf )
It would be great to know who these banks are, and if any of them have ‘Central Bank’ in their title..
August 8th, 2009 at 8:22 am
@Brian Lucey
Arguably with the blanket guarantee on most of the interest paying liabilities (including gawdbeless us..part of the sub debt) they are effectively nationalised. Hence the run. US wholesale money market do not like nationalised entities. They get crossed off the list.
Here the rock and hard place we face. No capital means no funding means no lending. But state capital means less funding means no lending. With a loan to deposit ratio in excess of 100% (is AIB 150%?), you need wholesale funding. That raises another issue. Are you wise to burn the senior bond holders in the systemically important banks (AIB & BOI) given that you will need them?
That is why the catch cry of “nationalise and burn the witches (sorry bondholders) brings as many problems as solutions. I am very dubious about debt equity swaps for the big 2. Most of the bonds are held by dedicated bond funds & banks who do not invest in equity.
August 8th, 2009 at 9:14 am
@jl
“US wholesale money market do not like nationalised entities. They get crossed off the list. ”
Can you provide some support for this assertion? At what level of government shareholding does the crossing off occur? 50%? 90%?
If the statement is that nationalised entities get shut out of the inter-bank markets for deposits, repos, fras, interest rate swaps etc then it is not correct. For example, it was not the case for swedish bank Nordbanken in the 1990s.
August 8th, 2009 at 9:25 am
@Brian L.
Listened to the program this morning. I think you did a good job but you probably need to dumb it down even more. It is very depressing to see otherwise intelligent people like Patsy McGarry - whose piece in yesterday’s paper was great by the way - just throwing up their arms and saying I do not understand this so we should just let the government do what they want.
August 8th, 2009 at 11:14 am
Garo,/Brian,
I think that if Covernment has more than 50% of equity in Bank you can take it as been Nationalised and more than sufficient for the “Civil Service Feel-Touch” to take hold —-so would apply to Lloyds and RBOS. Would go so far as to suggest if there is a strong possibility of Bank been Nationalised the market gets jitters about future and starts to take evasive action.
August 8th, 2009 at 11:16 am
@Bg
I would say the evidence is provided by the depo outflows from the major Irish banks post guarantee. The money that has gone is largely the large corporate & money market funds & has been replaced by ECB funding. No counterparty is going to admit this is the case but nationalised banks with high dependence on wholesale funds will struggle to raise wholesale funding.
As regards the 1990s experience in Sweden, I would say it is of little relevance to now. Was the Swedish banking system in the early 1990s net long of deposits. My hazy memory from the time was that they were not as dependent on international funding as the Irish banks are now.
Also, I think you are probably correct that interbank funding is less of an issue for nationalised banks. They are all in same boat and wll continue to deal with each other. The problem is with their lines to big money market funds, custodians, asset managers, supranationals, large corporates etc. these have been an important source of funds for the Irish system. These tend to have a very low risk tolerance.
August 8th, 2009 at 11:22 am
So : if nationalised banks are going to face leery lenders, and non nationalised banks face leery depositors (lenders in another guise) then ….rocks and hard places indeed. Shrinkage ahead whatever way it would seem. In that case however, if shrinkage is going to happen, then the issue is the differential shrinkage under nationalised and zombified.
For example, the state can pull its banking operations out of Dame Street and back into the high street . That would put c 50b, on average, into the system. Just a quick over coffeet thought….
August 8th, 2009 at 11:34 am
@Brian Lucey
Yes shrinkage until all problem loans go away & banks recapped to satisfactory level. Irrespective of how you do it. The issue is how the bill is divided up between state, eurozone, bondholders, equity holders, employees & customers. Did I leave anyone out?
I don’t get the point of para 2.
A thought that has bugging me on nationalisation is the complete absence of any state body that I could think of that runs itself correctly. Apart from Horse Racing Ireland but that is probably run by Mr. Magnier
August 8th, 2009 at 2:30 pm
So we can’t trust the government to do a good job with the banks if they are nationalized. Is there any reason why we expect them to do a better job of NAMA? The people who are so opposed to nationalization don’t seem to have a problem with the “Civil Service Feel-Touch” becoming the largest real estate company in the world! Does this strike a dissonant note to anyone else?
August 8th, 2009 at 3:35 pm
@Garo
Touché re civil-servants-can-run-reits-but-cant-run-banks……
August 8th, 2009 at 3:35 pm
So far in the nama debate “firesale” seems to be universally accepted as something to be avoided. Is this true? Could actions to prevent firesales make the eventual correction greater? Will a nudge and a wink base restore activity/ could delaying actions hamper recovery in other sectors of the economy?
August 8th, 2009 at 4:55 pm
@ Garo,
I don’t think you are correct in your assertion There are some people out there sceptical of both nationalisation & NAMA. More to the point really sceptical of a policy that rules options out with out debate and even more scared of an approach without transparancy.
August 8th, 2009 at 5:08 pm
You call it firesale, I call it market clearing….
August 8th, 2009 at 6:43 pm
Brian,
Market clearing is a more accurate term as the disposal would occur over a couple of years. I’ll use that in future. There’s a real risk that if nama overpays for assets, politicians may not wish to realise losses. This has the potential to cause greater problems.
August 8th, 2009 at 7:08 pm
Ahura : exactly. As the market clears price transparency emerges. But even in a frozen market we can still go a very long way to finding out “true” prices.
See for example Easley, David and O’Hara, Maureen,Liquidity and Valuation in an Uncertain World(September 2008). Johnson School Research Paper Series No. 13-08. Available at SSRN: http://ssrn.com/abstract=1282106
MoH presented (an earlier version of) this at a conference in TCD last year. The abstract is worth noting.
“In the current credit crisis there is little or no trade in a variety of financial assets, even though bids and asks exist for many of these assets. We develop a model in which this illiquidity arises from uncertainty, and we argue that this new form of illiquidity makes bid and ask prices unsuitable as metrics for establishing fair value for these assets. We show how the extreme uncertainty that traders currently face can be characterized by incomplete preferences over portfolios, and we use Bewley’s [2002] model of decision making under uncertainty to derive equilibrium quotes and the non-existence of trade at these quotes. Having established the origin of the quotes, and why the market freezes, we are then able to use our approach to suggest alternatives for valuing assets in illiquid markets. ”
Note the last sentence …..there is a way forward here that doesnt involve beggaring the nation
August 9th, 2009 at 10:51 am
@Brian Lucey,
Does not the first part of the abstract lend some support to Lenny’s decision to “overpay” above market prices. “we argue….illiquidity makes bid and ask prices unsuitable for ….establishing fair value”
Historically, property from a field to a house has relied on credit to close the transaction. We used put up one quarter with the banks putting up three quarters of the proceeds. now with banks unwilling to lend prices will fall to the equity component…ie 25%. In other words house prices will fall by 75% in this example. But if Lenny can argue that this is not normal, credit will come back eventually. Therefore he can afford to pay over the odds. Does he have a point?
August 9th, 2009 at 11:48 am
@JL
No, it doesnt. It means what it says - illiquidity makes bid and ask prices unsuitable.
I cant understand the last point?
August 9th, 2009 at 11:58 am
I think the question of fire-sales and their impact on asset values is an interesting one. And there is a literature in academic finance that discusses how fire-sales can lead to assets being sold at below fundamental values because of various financial market frictions.
However, we need to remember that there is no fire-sale of Irish property assets going on right now. Quite the opposite. There is very little activity. The low prices that people are willing to offer today for hotels in Kilternan, to give a concrete example, reflect what people perceive as a low fundamental value. We are not at a stage where the asset values are low because there are large numbers of similar properties for sale in the market with a limited buying capacity.
So I don’t think arguments about firesale prices justify the NAMA strategy of overpayment relative to its own definition of prices that would take place between two “knowledgeable and prudent” agents. But once NAMA is up and running, I agree they should sequence the sale of properties carefully.
August 9th, 2009 at 6:08 pm
@Brian Lucey,
I will try to explain. Property has always depended on credit for part of the purchase proceeds in the ratio of 1 euro of equity for 3 euros of credit. Remove the credit, as is the case at the moment. this leaves the most that any buyer can pay as 1 euro of equity. This is where we are at the moment.
this is the so called firesale level. therefore, if NAMA can unclog the credit spigot, credit will be restored and buyers can pay more for a given asset.
Therefore, is NAMA justified being prepared to pay more than firesale bids, since they are clearly too low to clear the market.
Put another way, you have bids that are too low and offers to high to clear so you have a Mexican standoff, therefore does NAM not by definition not have to pay up to set a clearing level.
I am not sure, I buy this point in toto. I am just interested in exploring it,
August 9th, 2009 at 7:20 pm
@JL
Ok. clearer. But why do we need NAMA to come in? Eventually, with no purchasers at the high ask some one will come in with a lower. Frinstance, there are now sub 100k apartments in Dublin on Daft.ie. So why pay more? Wait a while. The market will clear - just not at these prices.
August 9th, 2009 at 10:25 pm
@Brian & jl
Bought our 4 bed semi in D18 for €65k in 1987. The vendor had no other offers and even let us stew for 3 weeks before accepting. Less than 20 years later we were given a valuation of €700k on it.
At the same time average industrial wage was €18k in 1987 while it was about €38k in 2007.
The house had increased about 11 times while wages just over doubled.
Why?
1. Population increase? But the population is probably no more than 10% higher than it was 20 years ago. Even if you argue migration Dublin population can’t have gone up more than 50%
2. Lower interest rates? When we borrowed interest rates were around 11%. The question is do lower interest rates effectively get balanced out by higher house prices. People can afford to borrow more and bid higher so they do.
What is the real fundamental value of my house? And if it is nearer €700k than €65k why is this when none of the other fundamentals (population, income) have shifted the same way.
August 10th, 2009 at 1:28 pm
@ Brian Lucey,
I had a quick look through the paper (skipped their model). I couldn’t help but feel that I’d rather be in the buyer’s position. If there are potential buyers, there is a market, yes? A key difference with this report is that many Irish sellers are leveraged and can’t afford the loss. I think it’s even reasonable to consider banks as being leveraged on their core capital. It’s where sellers can’t afford to hold, that activity will pick up. In this case the market price can be established through foreclosures, executor sales etc.
@JL
“credit will be restored and buyers can pay more for a given asset”
Why should credit be diverted to such unproductive uses? Is it healthy that asset prices are dependent on credit?
August 10th, 2009 at 9:48 pm
@ Ahura Mazda,
That is a big question. if you mean home ownership, typically you buy somewhere close to the early part of your adult life on credit and hopefully pay down over your working life winding up free and clear at the end. Is that a bad thing? What is the alternative, save up and buy after 20 years or live in a cardboard box or rent accomadation. Who then provides the credit to the owner of that asset?
All asset prices are somewhat dependent on credit. How are factories financed?
August 11th, 2009 at 1:53 pm
The only explanation for not nationalising the major banks is what political explosives for all parties are contained in their loan files.
August 11th, 2009 at 8:36 pm
@George How can we invent our own money?
Simple - ask the ECB nicely, as Mr. Bacon suggested in his NAMA proposal. They say “yes, but it has to look like this”.
The government invent NAMA bonds. It’s all their own work, honest sir.
The whole proposal is based on the idea that the NAMA bonds can be repo’d (either at the ECB or on the interbank markets). This lets the banks swap them for cash at a low interest rate, less than the coupon on the NAMA bonds is paying. The result is the banks make some money on the trade and they now have cash to loan on rock-solid assets with - houses, offices, development lands, breakfast rolls, you name it, those whizz-kids will loan you money for it. They’re financial genii.
Can somebody tell me why we want to give our bozo banks money again? At least now they’re broke they can’t screw up.
August 12th, 2009 at 9:49 pm
@JL
I don’t think it’s a good idea that an assets price is determined/dependent by credit available. This isn’t limited to house buyers. Developers competed with each other, outbidding each other with credit.
You correctly point out that first time buyers are unlikely to require credit. I think the key is that that it doesn’t cause asset price inflation. Given very low population density, real house prices should be pretty static. In 2007, they were at 3 times what they should be.
March 31st, 2010 at 9:57 pm
[...] that were issued by NAMA could also be issued to recapitalise state-owned banks. An example was this [...]