Six Reasons for NAMA, and Critiques

In this blogpost I list the six basic reasons why NAMA might come into existence, and evaluate each of them.

Reason One:  Too-risky loan books.  This is the conjecture that banks have a large overhang of risky loans that are causing the banks to avoid new risky lending.  The overhang of high-volatility loans makes the marginal risk of new lending high.  Therefore the banks are shrinking their loan books, or only lending to the safest classes of borrowers, or hoarding cash assets.  If this is the problem, NAMA is the natural solution. The government purchases the existing too-risky assets at fair market value, and banks are then incentivized to resume normal lending.

Reason Two: Shortage of equity capital.  It is abundantly clear that Irish banks have a shortage of equity capital due to recent loan losses.  To the extent that the loan losses are “unrealized” (not reflected in accounting statements) then this is a shortage in terms of market value of equity but not the book value of equity.  (I think that in the current environment it is the low market value of equity rather than the book value of equity that is driving bank behaviour).  In either case, this equity shortage increases the equity leverage ratio of the bank, making new lending more risky.  Under reason two, NAMA is not a natural solution to the banks’ problem.  If NAMA pays fair market value for bank assets, then it neither increases nor decreases the market value of the bank’s equity. There will still be some impact on bank lending via loan substitution (the government buying 60 billion worth of loans for cash will lead banks to recirculate at least some of the proceeds into new loans).  But in the case of Reason Two, a bank recapitalization is a much more appropriate policy response to the bank problem than NAMA.  (Some technically-inclined readers may want to see here for a detailed technical analysis comparing reasons one and two.)

Reason Three: ECB quantitative easing.  The Irish central bank does not control its currency and so cannot engage in quantitative easing, unlike the USA and UK central banks which have done so recently with evident success.  However, the ECB has agreed to purchase Irish government bonds from Irish banks for a very small discount.  So NAMA provides an indirect quantitative easing within Ireland. NTMA purchases 60 billion fair market value worth of Irish bank loans in exchange for newly issued Irish government bonds. The banks deposit them at the ECB in exchange for cash.  Hopefully, the banks recirculate the cash into new loans. This provides a worthwhile quantitative easing within Ireland.  Ironically, in this case NAMA works best if the banks exchange their safest loans rather than their most troubled ones.  The reason is that these will be easiest for the NTMA to administer and so the effective transaction cost of the operation will be smallest.    

Reason Four: Liquidity Crisis in the Irish Property Market. This is based on the argument that the short-term risk horizon forced on banks by current market conditions is the major cause of the lending pullback.  Banks cannot sell property loan collateral due to a short-term liquidity crisis in this market, leading to realizable prices which are below true economic values. The banks must service these loans until the property market recovers. This justification requires that government analysts are confident they can credibly forecast that the banks’ property-related loans (or the underlying assets) will recover over the intermediate term.  If so, a government agency can take a longer-term perspective than the banks, purchasing the banks’ “illiquid” assets and holding them until property market recovery.  In the interim, freed from these short-term illiquid assets, banks can resume normal lending. 

Reason Five: Bank Behavioural Biases. There is some evidence (this was discussed by Patrick Honohan at the DEW conference) that banks tend to continue servicing delinquent loans to existing large clients, wasting more precious cash,  when rational profit-maximizing behaviour would argue for cutting losses.  This could be due to psychological biases or moral hazard problems of bank management in recognizing loan losses.  If so, perhaps NAMA would allow the NTMA to act more rationally and free the banks from this loss-making behaviour.  This argument requires a lot of faith in NTMA’s managerial expertise and flexibility since it will be operating outside its normal range of activities.

Reason Six:    Special Interest Politics. A number of powerful special interests (Fianna Fail incumbents, bank management and investors, property developers) may benefit from NAMA especially if the NTMA can be convinced to over-pay for the assets.  Whenever there is blood in the water, the sharks will congregate.  I will not comment further on this since it is politics not economics.  However I will note that any statements on NAMA by Irish financial service industry lobbyists or spokespersons must be greeted with deep suspicion.  Their institutional incentive is to push the government to waste billions of taxpayers’ money on over-paying for bank assets, so that some fraction of that sum will return to investors in bank equity share values.  In terms of reason six (the most clearly “wrong” reason for NAMA) the role of the Green Party as the governing coalition’s moral compass (replacing the PDs of the 1990s) is important.  It is worth noting that the PDs collapsed in popular support not when they Did the Right Thing in the nineties but rather when they were viewed as having been co-opted in the naughties.     

 

 

 

 

25 replies on “Six Reasons for NAMA, and Critiques”

It’s certainly time to look at FG’s proposal carefully. NAMA could well brin down the Government. If so FG’s proposal becomes a reality.

Does this mean FG will not propose amendments to NAMA but rather will oppose the legislation altogether? I hope not.

Now that the Greens have announced a convention to debate their support for NAMA it would appear that all bets are off. The Greens are now in the position that they can scupper NAMA( as presently constituted).As the moral compass (hopefully) of Government it is unlikely that they will vote for political oblivion.

@zhou_enlai
Listening to Enda on news at one – he was unable to quantify the cost of their proposal (Good Bank). Joan Burton wants temporary nationalisation and would seem to be closer to views expressed here.
However, the Greens hold all the aces. Time to convince them of the need to protect the taxpayer and bury section 58.

How long will it take a new “good bank” to establish relationships with customers and to evaluate their creditworthiness? Why did FG abandon their initial suggestion of splitting each of the commercial banks into corresponding good and bad banks?

Reason 3: ECB quantitative easing….. Here you need to show that the debt for this is passed on to the Irish taxpayer…… I think a better term for this is the ECB are lender of last resort… but as far as I know they are loaning us the money… they do want it back! They aren’t going to quietly make the debt disappear.

Reason 4: Liquidity Crisis in the property market… Unfortunately there is also..
* An oversupply crisis. We are overbuilt and have too many empty houses, offices and shopping centers….with more in various stages of completion.
* A price collapse. Like the coyote in Roadrunner; people are over the cliff and looking down… Hence the dash for NAMA.

Jack

In event that banks fail to convince their bond-holders to help them recapitalise by selling back their debt at sufficiently discounted prices, FG remains committed to a special resolution regime that, at the expiration of the Guarantee, breaks up the banks into good and bad parts, leaving the toxic assets with long-term investors and funders still locked into the banks at that point (others will remain guaranteed for the purpose of ensuring adequate liquidity and financial stabiity).

But recognising that this process will effectively “zombify” the banks while they try to repair the balance sheets, we have also set out the proposal to get credit flowing by establishing a wholesale “National Recovery Bank” that can take advantage of the ECB’s quantitative and qualitative easing policies by buying existing (performing) and new loans from the retails banks.

This would not take long to establish. It would need about 50 staff with the right banking and legal qualifications, a Central Bank licence and access to ECB liquidity operations. The Good Bank would not have its own retail network. Instead, it would subcontract the existing banks to run its loan book.

Andrew

@Gregory

In fairness, the Government has never offered 2 or 6 as reasons for NAMA. It is clear that the NPRF is going to have to be tapped again for injecting more capital into one or more banks.

Another aspect of Reason One that you don’t mention is the effect of the too-risky loan book on the banks ability to attract liquidity from international markets. The eye-popping jump in ECB support to banks here suggests that banks are having to lean on the ECB (presumably as funds from private investors and depositors are pulled — a modern bank run, of sorts. News of super-big borrowers going belly up over coming months could frighten away more private deposits if still on banks balance sheets. Cleaning them up should enhance their ability to attract private liquidity and allow them to wean off the ECB.

If NAMA hits One, Three, Four and Five simultaneously then it has a lot going for it, no?

Reason 4 ..
… a government agency can take a longer-term perspective than the banks, purchasing the banks’ “illiquid” assets and holding them until property market recovery.

In this case I guess by “recovery” you mean a return to even more inflated values than they have right now. A real “recovery” should see the slide continue for another few years before stabilizing. Isn’t the assumption that property will “recover” upwards more of the same thinking that got us into this mess. But maybe I misread.

@ Andrew
I find the proposal a little unclear about various things – one of which is the distinction between the National recovery bank and the ‘Good’ Bank.
My impression from your last posting is that they are distinct!?

“FG remains committed to a special resolution regime that, at the expiration of the Guarantee, breaks up the banks into good and bad parts”

So the ‘Good’ bank is not set-up initially. However –

“The Good Bank would not have its own retail network. Instead, it would subcontract the existing banks to run its loan book. ”

So I wonder why when dividing the banks would we leave the retail network with a (possibly/probably) insolvent ‘bad’ bank and then subcontract them to run the good banks loans? I cannot imagine employees left behind in the ‘bad’ bank are the optimal group to ensure the loan book is properly ran.

This would appear to go against the sentiment that:
“10. The vast majority of the staff would transfer to the “good banks”. [from http://www.finegael.org/upload/file/National%20Recovery%20Bank%20revised%2014-05-09.doc%5D

@Andrew McDowell

As it is unlikely that the banks would agree to voluntarily shed their performing loans to a new recovery bank, it is difficult to see how this proposed action/solution would avoid constitutional challenge.

@Aidan McGrath
Agree that any “recovery” is going to take a number of years. Looking at Property bond prices performance today, the particular bond i looked at was down 52% over the last 3 years. Presumably these funds only invested in performing commercial property so the toxic stuff decline must be far greater.

@podubhlain
Yes and if the conversion of the good loans to cash would have helped the banks drammatically – I imagine this would have occurred already to as – as the link above made clear) – the prices for these sorts of assets are fairly clear

@ Aiden McGrath – Yes you are correct that general property prices are more likely to decline than increase in the next five years, so this puts a big shadow over reason four on my list. When I said I was listing the “reasons” I did not mean that I agreed with all of them. The argument supporting reason four would presumably focus on the current prices of half-finished developments and similar assets, and claim that their current market realizable prices are near zero. One might argue plausibly that at least some property assets of this unfinished or otherwise problematic type might be exceptionally low at the moment. But I agree with your main point — the forecastable trend in Irish property prices over the next five year is likely to go against reason four on my list. This reason four has appeared prominently in several things I have read so it belongs on the list. You give a sensible counter-argument.

Surely the reason for NaMa is to avoid liquidation of bad investments. Thus avoiding all moral hazard and ensuring that certain unspecified persons are immune from loss. Pure and simple.
The avoidance of such massive loss is to be put at the door of future taxpayers for an indeterminate period. And those who will be unable to use those assets which secure those bad loans. These assets will be in limbo, overhanging the market such as it is, making it worse, and further crushing the construction industry.
Banks will not lend money in a deflationary spiral except for small amounts and to persons who will not lose their jobs. No asset is immune from deflation and security would have to be max 50% LTV.
While the loans are held by NaMa, the interest will roll up and increase the likelihood that the debt will never reach the valuation at which it was transferred. Aside from creating a few very highly paid jobs, there appear to be no benefits to NaMa for the economy as a whole.

Hi Greg

For reason #2 you are quite correct, its the low equity value, not low book value. Most likely book values are still over stated (not just in Ireland) relative to economic values. This is primarily because of the way the accounting for loan losses is working. There is one of the main conclusions of a report by a working group called the Financial Crisis Advisory Group (FCAG) in last few weeks. Its on the website of the International Accounting Standards Board.

Greg

I’m curious why are you skeptical about this short run liquidity pricing story? While I’m not up to date on the Irish property market, it seems that this has a lot of the institutional characteristics of a setting where one could get short run liquidity pricing (insolvent banks, so no access to credit, large idiosyncratic assets, limited number of potential buyers that are all insolvent).

Policymakers in the US seem to buy this liquidity pricing story. The accounting rules have been relaxed in the last year to allow banks to stop marking a lot of assets to market when the underlying market is illiquid and prices are driven by distressed selling. The types of assets we are taking about are CMO and CDO.

@podubhlain

NAMA has been set up in a way that the banks apply to join it – they would be mad to refuse the free gift of say 30 billion from us taxpayers – and that avoids any constitutional problems. The AG thinks that it is fully constitutional to make a free gift of this magnitude to private institutions. I hope he puts me back on his Xmas list (Paul – I love you, always have, always will).

You write that there could conceivably be a constitutional difficult with the FG “special resolution regime” as described by Andrew McDowell. As I understand it, it would require powers similar to those exercised by FDIC in the USA.

If it is constitutional in the USA, I think we can safely say that it can also be done constitutionally here.

@Donal: I agree that in the USA and some other markets there is credible evidence for liquidity-based mispricing of property-based derivatives (Mortgage backed securities, mortgage pool credit default swaps) since trading in these markets which require hedging opportunities for support has evaporated. Also, the US admin feels that by supporting this mortgage-based derivatives market (possibly with some risk of overpaying) they can pull it out of its liquidity crash. However the Irish financial sector environment is different since it is just straight property development loans on conventional-ish property portfolios that are hurting the banks. The mortgage-based derivatives market is too small to matter. So the USA (and UK, German) situation with very illiquid MBS and CDS is not relevant. So here I think that some of the Irish government policymakers are over-stating the parallels between foreign and Irish asset purchase plans. Property derivatives may easily have big price recoveries but pure property (in Ireland) seems less likely to recover its bubble prices. I agree to make an exception for unfinished projects and some other similar development projects which are currently un-saleable.

@Maurice O’Leary
I think you misread my point = removing the good assets as proposed by FG would, as Andrew has admitted, effectively “zombify” the banks. That result would be difficult to justify legally. I cannot see the banks agreeing to enter such a scheme. Legislation to force them would create major constitutional difficulties.

@podubhlain
“I cannot see the banks agreeing to enter such a scheme.” you are probably correct but the banks have very few options without state protection. As far as I can tell, both BOI and AIB are insolvent without state backing.

@podubhlain

You seem to misunderstand.
Because of the special priveleged position of banks, they are subject to the sweeping powers that the US authorities have in FDIC to put them into special resolution regime.

The banks don’t have to agree.
The federal government acts in the interest of the common good.
While not being a lawyer, I have no doubt that we can do the same if we choose.

Anglo Irish Bank didn’t request nationalisation – they just accepted it because the state had the power to do it. I don’t see any constitutional challenge happening..

FG have already dealt with the zombie-ism of Irish banks between now and Sept. 29th 2010 with the NRB proposal.

i liked this post, but i have to draw some attention to this: ‘any statements on NAMA by Irish financial service industry lobbyists or spokespersons must be greeted with deep suspicion.’

there are plenty of people in industry with opinions that may be for or against that are not motivated by profit, to say that this isn’t the case basically hi-jacks the entire concept of independence and places it only with academics – who, to be fair, often have their own agenda and theoretical axe to grind (ferguson/krugman).

I have said before that one of the tragedies in this crisis is the massive divide between practitioners and academics, and some people say this doesn’t exist – but it clearly does when it comes to signing petitions! – others feel that practitioners can’t be trusted to be honest which is an indictment on the market facing end of the spectrum.

in fact, everybody is full of rubbish on some level, everybody without exception.

@ Karl Deeter: Sorry about the offence I agree that the phrase I use is somewhat badly worded. However I stand by the claim that the reading public must be very careful in evaluating authoritative claims about the bank bailout, particularly but not only when spokespersons have business or political reasons for tilting their argument in one direction. There was a specific example of a finance industry spokesperson quoted recently in the Irish press. He made it sound like he was offering public-interest advice, with the authority of someone in the finance industry and in an industry-official capacity. But in my opinion the advice he was offering the public sounded self-serving for the Irish financial services industry, not in the public interest. It was easy for a reader unfamiliar with the bank bailout impacts to not see that there was a special-interest conflict in what he said.

There are a huge number of thoughtful and fair-minded finance industry practitioners in Ireland and they will not let industry interests tilt their views on the public interest. I was a research-practitioner myself for 4 years (at Barra Inc. in their London office) and I have had numerous industry co-authors so I am not really a pure academic economist myself.

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@Gregory – “But in my opinion the advice he was offering the public sounded self-serving for the Irish financial services industry, not in the public interest”

It’s supposed to be the job of (us) journos to challenge those kind of statements on behalf of our readership. It doesn’t happen enough here in Ireland imho.

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