Perhaps the most contentious issue in NAMA planning is the distinction made between the long-term economic value and the current-market prices of bank assets, particularly developer loans collateralized by Irish property portfolios.
Optimists see a strong case for a liquidity-related price bounce in these bank assets, that is, low current-market prices recovering to higher “true economic value” prices over coming years, as financial market distress dissipates. This optimistic view, forecasting a bank asset price bounce, provides a strong justification for setting up NAMA, and also justifies paying the banks more than current-market prices for their bad loan portfolios (but still much less than accounting book value).
Pessimists forecast either flat or declining market prices for these bank assets over coming years. This pessimistic view implies that NAMA (if it comes into existence) should pay current-market prices or less for bank assets.
I think that the optimists might be over-extrapolating from the current US environment. There are important differences for the case of Irish bank assets. In my opinion, the market prices of US bank assets will bounce up strongly sometime during the next few years, whereas the prices of Irish bank assets will recover more modestly or not at all.
The reason for my bold prediction has to do with the prevalence of securitized loan assets (collateralized mortgage obligations, collateralized debt obligations, credit default swaps on securitized assets) on US bank balance sheets, and their near-absence on the balance sheets of Irish banks. There is now a wealth of empirical and theoretical work on the severe liquidity crisis in securitized asset markets in the US, including the effective closure (no meaningful prices) in several key markets such as the mortgage-security-related credit default swap market. There is also an emerging academic consensus about the basic causes of this market collapse: see Diamond and Rajan, Gorton, Acharya, Gale and Yorulmazer, and Heider, Hoerova and Holthausen (German case). The securitized-asset market breakdown combines market-for-lemons failures plus dynamic trading failures related to the hot-potato paradox (a rational player will only accept a hot potato if he is confident the next player will accept it from him). The interbank lending market liquidity freeze-up was related to that in securitized loan assets. See the four papers cited above.
The liquidity-related market failure evident in US securitized asset markets now seems explicable based on economic theory and empirical analysis. This type of market failure is most likely to occur in asset markets which are information-demanding (collateralized mortgage and debt obligations require detailed, accurate forecasts of prepayment and default rates and technical analysis of the cash flow implications of these forecasts for each tranche) and/or in which natural holders of the assets have typical holding periods which are short relative to the cash flow lives of the assets (also very true of CMOs and CDOs which can have 30 year maturities when most natural holders want an assurance of quick access to their capital).
With the collapse of attainable prices, US banks have done the rational thing and are hoarding their mortgage-related and debt-related securities. If they sell they can only receive firesale prices, but by holding them they can await eventual price recovery, or just keep them for ongoing yield.
To arbitrage the expected price bounce requires long-term risk capital and sophisticated expertise in valuing the securities. There is not enough of either of those to get the market going again, yet.
The nature of troubled Irish bank assets is different. The banks lent recklessly to property developers who purchased land and existing property at bubble prices and then built extravagantly. This is not 50-50 hindsight of an academic; this reflects the regret-filled view of thoughtful participants among both bankers and developers.
Why should these Irish property assets experience any strong price recovery? There may be some liquidity shortage in the market for Irish development properties, but the situation is quite different from the US case. Property asset markets attract buy-and-hold investors rather than investors planning to trade quickly. The valuation of property assets seems not that technically sophisticated. This market has neither of the two properties that give rise to liquidity-based market failures. Reinhart and Rogoff find that property asset prices tend to trend downward for six years following banking crises. So what are the grounds, in the Irish case, for forecasting a price recovery?