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.