NAMA and Best Practice

“Buying the assets at inflated prices would amount to a back-door recapitalisation of the banks.”

I think that the man deserves respect for getting on the horse
.
And if any one of the esteemed luminaries here were in his place they would equally be ‘found out’ by something previous?

We shouldnt be looking for perfection, or dogmatic consistency.

Perhaps, by ‘advertising’ the long term economic value first, the international bank investors were placated.
Now, with the push from the other side there will be a creepback from the LTEV.
And in the end, everyone may get something?

Al

I am willing to give him a John Maynard Keynes pass on this, at least until he has a chance to respond.

It must be the way BL says it—-Bank shareholders must be singing his praises. !AIB and BOI up 30% , and still pointing North,since the letter appeared. His “few shares” must have made him a tidy sum over the past few days. Shareholders will be hoping he composes another one.

and of course we have this gem, from September 16, 2007 : Useful when considering NAMA’s fair economic value

“Low inflation, overvaluation in the housing market and a boom which dwarfed foreign experiences, indicates we could be in for a bumpy ride THE housing market busts in the early Nineties in Scandinavia and Japan were very different in terms of intensity and duration. In a way, it’s like the difference between a deep-tissue Swedish massage and a traditional Japanese massage.
The Scandinavian countries suffered several years of collapsing house prices as well as deep economic and financial crises. These economies and property markets subsequently made quick recoveries. In contrast, the Japanese housing bust was less intense but it lasted a long time. Nearly 15 years, to be more precise. Between 1991 and 2004, real estate prices in Japan dropped 60 per cent. House prices in Tokyo plummeted 90 per cent.

To put things in perspective, if house prices here were to follow a similar pattern, the average price for a house in Dublin in 2022 would be about €42,000! Doesn’t bear thinking about.”

Now the last sentence is very interesting….why Alan?

@Tadgh O Laighin
BL Lucey or BL Lenihan ?

Didnt think Brian Lenihan added his name to the letter !!

@Michael Hennigan
Another of R M Nixons famouse quotes comes to mind when one considers the reaction of the government to open debate designed to “build a better NAMA”….
“Solutions are not the answer. “

But that was written back when he was an academic, you can’t expect to hold him to opinions given when he was free from any outside influences or restrictions on expressing what he thought. Oh wait, that’s not right.

Well it should be possible to impute fair market value from rental yield. And from that fair market value to impute development potential. As I pointed out on a separate thread, Ronan Lyons has done some analysis along those lines. The simple David McWilliams-used rule of thumb 12-14xannual rent for residential property could apply.

Now, if only those damned rents would stand still so we could use them…

I am grateful to Alan Ahearne for the example of the Japanese properti market 1991-2004 extrapolation to the Irish situation: 42K for an Irish house in 2022: that sounds about right. The idea properti prices will continue growing again is an extension of precisel the kind of blinkered view that caused the crisis: a species of the growth bias in economics. THis ‘idea’ which underpins ‘long term economic’ value is so flawed u want to cri. Thanks as ever to Brian (Luce) et al for their sterling work. And ‘doesn’t bear thinking about’: actualli Alan it does. The blueshirts realli struck gold with their ‘Double or Quits’ characterisation of NAMA; it’s so right.

Some of the public rhetoric seems to be getting a tad overheated – but this is what I expected. NAMA might be one of the options that could have been proposed – so where are the others? Problem is, NAMA is a problem!

It is notable that significantly important discussions (ie. current media slagging matches) concentrate on only one option, to the complete exclusion of any alternatives. Why, I wonder? Bias?

The market values of property (residential and commercial) with the exception of the few most and least expensive, are going to decline significantly (I est. 80% from top). If, or when, our insolvent banks tip-toe back to lending – will there be sufficient potential borrowers? Probably not – declining incomes and wages and high unemployment. Will interest rate have risen? Yes. Even more of a problem – will there be an energy (liquid fossil fuels) shortage? Definitely. Take care. This economic downturn will experience a beautiful red dawn – then the nuclear winter will sneak in. We won’t be worried about NAMA then, but whether on not we can get enough fuel for our cars, trucks, trains and planes. Est. on this is 5 – 10 years.

Brian P

@GK
I agree with the method of your analysis as it stands, but I think there are problems with the numbers. I think that the ones most likely to default in toto are those with the lowest recovery value, i.e. zero. What is equally likely is that other loans will be modified to be repayable, so, for example, rolled up interest will be abandoned, VAT and CGT will also too. These are consequention losses of working out the loan, but they are not inconsequential!

So put it another way, 1/3 of the loans are so bad they default with a recovery value of 0% (actually a cost), the rest have varying writedowns of 20% and 40% and in addition there is a 20% loss of tax revenue that would have been expected.

0m + 60m + 80m = 140m, less tax loss to shift the underlying assets = 112m or 62% loss.

Before anyone accuses me of exaggeration, this is the loss rate that Securum sufferred in constant currency terms, having taken loans at par from Nordbanken.

@BL / yoganmahew
I have assumed that one third of the loans go fully bad, the other two are repaid in full. In reality a 1/3 default assumption would be spread across the loans. These figures are just illustrative, if valuations were that simple i’d be in the NTMA offices getting a fortune.
But my point is that looking at property values (which btw i agree have further to fall) are not the sole basis of the values of the property loan book, though certainly part of it.
Far too much of the analysis around this discussion is around property values alone.
@yoganmahew
Many thanks for this, my final question was “am i missing something?” and your Securum / Nordbanken example is helpful. But what was the final outcome for nordbanken, did they make a profit on this transaction? If they did would this not back up AA’s assertion that a spread over time protects the economy from the immediate firesale effect?
There are other issues:
– these loans have already been written down substantially by the banks
– not all of them originate at the very peak, although certainly at excessive prices.
But for me the requirement should be that discussion of the valuation methodology of nama should be a discussion around the valuation of the loan book and the complexities of this, rather than only focusing on property values.

@GK & Ted
Nordbanken were nationalised. The Swedish government overall made a small loss in krona terms when they were cleaned up and refloated. Note well that the profit was made from the equity in the cleaned up bank, not from the loans themselves. There is so much spin and bluster over this issue, I can’t quite credit it. It is simply a lie to say that Securum made money. It made a loss in krona terms. It made a bigger loss in foreign currency terms. It made a 60% loss in constant currency terms.
http://www.clevelandfed.org/research/POLICYDIS/pdp21.pdf

Securum performed most of its work in five years, with sales from the first year. So I don’t think they could be accused of waiting out the market. It wasn’t so much a drip-feed as a controlled torrent. It sold into a declining market and pushed prices down further. The private banks which constituted the other 73% of the banking system did the same. The assets remaining at the end of the five years were sold at a loss to another state asset management company Venatius
http://www.venantius.se/pdf/arsredov_06_eng.pdf

The Nordbanken loans were also written down prior to Nordbanken going bust. A similar exercise would be to take the Anglo loan book (barring the very best assets) and put it through NAMA. A 60% loss of book value is what I would expect. I don’t see anything that says to me to expect otherwise.

@Ted,
Normal commercial lending has an AVERAGE loss in a bust of 12%. In Sweden, commercial property prices in Stockholm fell 70% between 1989 and 1993 ( http://www.riksbank.com/templates/Page.aspx?id=31922 ). Your mileage may vary…

@GK
The problem is not that the loans were issued at the peak, the problem is what commitments were given using any and all equity as security. How much leverage was there? An average 75% LTV is saying that there was 30 bn of available bricks and mortar/fields/site/whatever equity sitting around not making money. I just don’t see this as credible. It would run counter to what has happened in every other bubble. It would run counter to what happens even in normal times! Large-scale portfolio property development is an “all-in” business. If you are not fully invested, you are not going to make money.

See here about what happens when junior loans go wrong:
http://ftalphaville.ft.com/blog/2009/08/27/68911/the-halabi-cmbs-crunch/
So while the senior debt on commercial properties may be at 75% original LTV, you can bet your bottom dollar there is junior debt that is secured against the remaining equity.

To avoid problems with ownership rights, NAMA is planning to take on all loans and buildings that can be grouped together. To my mind, that means they will be taking on both the junior (likely worthless) and the senior debt. So we are talking an original LTV that over all the loans/guarantees/covenants/cov-lites/pledges/etc. attached to a building was probably in excess of 100% and is certainly now if it wasn’t then.

It remains to be seen who the suckers in the room were giving the junior loans and what they are valued at…

I think people have still failed to accept the correlation between LTV and the probability of default.

If a developer has a loan for €100m and the underlying asset is now only worth €50m the probability of default is close to 100% IMO.

How could the developer ever turn the development around so that they generate €100m to repay the loan?

You can make a guess at the likelihood of a default by looking at interest cover, I.e. The EBIT divided by the annual interest bill. This is easy enough to figure out, even with publicly available figures. You can also do fancier analysis by looking at cashflows.

Commercial debt, broadly speaking is a lot riskier than property debt for the simple reason that the collateral is intangible. On the other hand commercial lenders tend to be somewhat skilled, whereas property lenders apparently depended on valuers’ opinions.

A lot of what we discuss on here of late is really more to do with corporate finance than economics.

@jimmyc says
“the current market price is not fair value since the market for certain types of property is not functioning and banks are not lending to potential buyers”

Can someone explain why if “the banks are not lending to potential buyers” the current market price is not fair value?

If there’s no access to credit, then is the market price not the cash price? i.e. what people have in liquid assets they can spend, instead of borrowing to pay for stuff?

I’m open to persuasion or convincing, earlier this week, I thought bondholders should be wiped out, posts here explained why this is a bad idea. So could anyone explain why a lack of access to credit makes the market unfair?

The current situation seems to be
“I’d buy your property for X, It’s just I don’t have X and no-one will lend it to me. So the market isn’t working. boo hoo. ”
If another actor in the market is willing to step in and offer 2X/7 for the same thing, but the seller thinks it under values the asset, is that not a valid market?
If the buyer offers X/20 is it still a valid market? what set’s the lower bound on an offer price?

If one was to auction a single piece of property would that not set a price on property all around the country? Can someone explain this meme going around saying there’s no market?
If someone sold an acre in Ballsbridge for a euro, there’d be buyers. same for a grand and same for a hundred grand. It’s just at the high end there’d be problems finding buyers.

For any asset without liabilities, isn’t there always a market price?
Just a lower than the owner hoped asset price?

Brian Woods

I agree completely!

Carrawaystick

That is the point, isn’t it? NaMa was and is a way of fudging the market cos government by FF knows best! Except we know their record is appalling on property and integrity and the banks.

The only honest open and public mechanism is the market. Why borrow to bail anyone out? Does this not mark us out as a fat mark for any old con? Nigerians will be coming by the A380 load to dump property into the conmans charity known as NaMa.

Let the market work, it will surprize you and ABOVE ALL it will enable some development to go forward! The buyer hopefully, will have doen their sums well and provide added value by construction jobs.

Debt is not cheap even if it stays at this level. Add in the deflation and it is nearly as high as in 1982. Remember 18%? It only lasted 2 months. This will last years! Let us all try to minimize the number of tose years?

Desmond Brennan
What is wrong with using the market? Is it because you fear that the assets are massively over valued?
So what?
You seem to be a user of “other peoples money” to have so little faith in the market.
Have you an undeclared conflict of interest?

Anyone with capital:

Please come to Australia! Our banks are safe. Our politicians and judges are placed in prison when they transgress.

Or stay in a country where you pay politicians to get planning permission and the banks supply inflated credit to those bidding against you and where they borrow billions to pay off stolen capital, while allowing the perpetrators to walk around free?

Your choice!

@jms

You wrote the following:

“I can’t see that Alan Ahearne has said anything different in this article than he is saying now. I do however wonder why Karl Whelan with Brian Lucey chipping in saw fit to bring it up now. Actually that’s not true to say, I don’t wonder at all, but it still seems pretty shoddy stuff from two of our supposed leading economists.

We don’t need insider parlour games or PR/damage limitation exercises right now, we need some honest, straight forward information from agenda free sources.”

My apologies if you think posting a relevant contribution from a colleague and offering it up for wider discussion is “shoddy stuff.” Clearly, one of the positions that could be taken in such a discussion is that “fair market value” might not be the same as “current market value” and that’s your position and, as you can see, it’s been allowed here in what is (contrary to some discussion this week) an occasionally moderated blog — we can delete comments if we want, though I hardly ever do.

That said — and I’m surprised this hasn’t come up — I would lean against interpreting “fair market value” as being the same as “long-term economic value” as defined in the legislation. I would have noted this in the post itself but I was genuinely offering the passage up as an interesting piece worth discussing from today’s perspective, rather than trying to write a polemic.

Unfortunately, what this shows is that even inviting people to have an open discussion on a blog results in receiving nasty personal insults from people who hide behind anonymous codenames.

Depressing really.

I wrote earlier this week that AA was very unwise to give so many hostages to fortune by insulting his colleagues, all of whom have long memories.

@GK

It is misleading to talk about a 1/3 default rate.
It assumes a degree of diversity in the loan portfolio that is a complete illusion. So the usual ways of evaluating loans go out the window when you look at these development and property loans.

Lets first only discuss the Irish loans.
Most of these were to a limited number of people operating off the same business model. If someone as modest in his lifestyle as Liam Carroll and who only has sites and properties in good locations is 75% insolvent, then what hope for most of the others.

All these people were using leverage to the maximum. The equity that they put into projects was a mirage. It is not as if they were using something independently valuable such as government bonds that they held as their equity. So even if they bought something in the early years, you can be sure that they refinanced or used the inflated value as equity in other projects.

Basically, everyone was practically 100% borrowed.
Add on a bit of interest roll-up and people may even have been over 100% before the crash.

OK – they may have brought in people to provide mezzanine finance but surely it was mostly the investment bank part of the bank that was doing that. Even if there were independent people providing mezzanine finance, how many of them brought real outside equity to the party?

Now look at their foreign adventures.
Surely they used their well honed business skills, so highly praised in the mid noughties, in their assault on foreign markets – “buying up London”.
Same bankers, same developers, the only difference is that the decline in the underlying value will be less.

So it is not necessary to know the details of every loan.
The few cases that have come before the courts for examination/receivership or liquidation tell us all we need to know.
And what we see if that it is a house of cards – a piece of financial engineering with worse foundations than the Broadmeadow viaduct.

So a reasonable calculation might be :
A 75% decline on the Irish 60 billion and a 30% decline in the foreign 30 billion gives a loss of 45+9 = 54 billion leaving a fair value of 36 billion.

Karl Whelan,

My comments were based on the following from yourself & Brian lucey,

KW, “by then-ivory-tower economist Alan Ahearne”
It’s true that you don’t say much on the article itself, but what you do say was enough for me to form an impression as to why the article was put out at this time.

Brian Lucey, “and of course we have this gem, from September 16, 2007”

You must forgive me for forming the impression that there was a bit of tit for tat going on in the above comments from both of you.

On the article itself, you could argue from here until Christmas on what exactly is meant by “fair market value” or “long term value”. However as he clearly does not mean firesale value, I would be inclined to think that “long term value” as envisaged by NAMA & “fair market value” are one and the same concept or at the very least not very far removed from each other, but quite a distance from “firesale”

My apologies if you thought my remarks were a “nasty personal insult”. In my defence I would say that was how you received them rather than their intention.
I was just posting as I see it, if you think my intention was merely to insult, please feel free to delete my comments.

“If you have the facts on your side, pound the facts. If you have the law on your side, pound the law. If you have neither on your side, pound the table.”

Noel Whelan , barrister ,former Fianna Fáil electoral candidate and political commentator is pounding the table in the Irish Times today, http://www.irishtimes.com/newspaper/opinion/2009/0829/1224253462315.html in his opinion article, “Selling Nama to sceptical public requires political will.”

“While academics have the luxury of always questioning, debating and redebating, ultimately the decisions about Nama must be made in the political realm.”

And we all know that Fianna Fail TD’s and Jackie Healy-Rae are “always questioning, debating and redebating” all areas of government policy and vote as well informed representatives of the citizens of Ireland. Even when that are whipped through the lobbies to pass Bills using the guillotine. Yea right, Noel.

@BL

“Personally, its a job i wouldnt touch with a chain of bargepoles.
If, for whatever reason, AA cant get influence then he has to decide what the way forward is; there are only three and they are exit, voice or loyalty”

Go easy on him Brian. He got the call and he answered it and it was the right thing to do. He must be in a very difficult position. It’s better that he’s in there.

Anyone who claims that average house prices in Ireland are going to fall to €42,000 is completely bonkers, and probably being deliberately malicious as well. Clearly, a number of posters here fall into that category.

We can get some idea of likely future house prices in Ireland by looking at house prices in the U. Kingdom. Because of the free movement of people, cultural similarities, common language etc etc, house prices in Ireland are always going to be in the same ball-park as house prices in the U. Kingdom. Sometimes a bit higher, sometimes a bit lower. But, never totally out-of-line. So, let’s look at recent house price trends in the U. Kingdom.

What is clear from recent data is that house prices in the U. Kingdom hit their bottom in 2009 Q2 and are now rising again, and rising quite strongly indeed. They have been rising for 4 or 5 months at a rate of 1% to 1.5% a month. The trend is likely to accelerate. Currently, average house prices in the U. Kingdom are in the region of £180,000 (or €205,000). At current rates of increase, average house prices in the U. Kingdom will probably be in the region of £205,000 (or €235,000) by end 2010 and £225,000 (or €260,000) by end 2011.

So, if average house prices in Ireland fell to €42,000 in the next few years, as some posters are predicting, they’d be about one sixth the level prevailing in The U. Kingdom (and even that is assuming that the current increase in house prices over there stops in a year or two and they remain flat for the subsequent decade).

Clearly, if that happened, there’d be a mass influx of retired people from the U. Kingdom. They could achieve an immediate huge increase in their standard of living by selling their house in London, Manchester, Leeds, Cardiff, or wherever and moving to Dublin, Cork, Galway, or wherever. All the Irish emigrants of the 1940s and 1950s, most of whom are now retired, would flock back to the land of their birth and be €200,000 or so richer to boot. This, of course, would send house prices in Ireland soaring back up again to be in the same ball-park as those in the U. Kingdom. Which, indeed, is where they have been for a couple of hundred years.

@Sarah Carey

I agree

@KW

Isn’t the whole point of the post as to whether “fair market price” = “long term economic value”? I note you think they are different things.
Perhaps you would explain why they are different to put this discussion on an even keel.

If you are correct and they are different then the question becomes has Alan Ahearne changed his mind and if so why has he changed his mind.

The next step is to ask does the legisaltion reflect a “fair market value” or is the “long term economic value” as defined something different. It is to be noted that the use the most offending phrase “long term” comes from the EU Commission Communication of March 2009 at paragraph 40:

“As a second stage, the value attributed to impaired assets in the context of an asset relief program (the ‘transfer value’) will inevitably be above current market prices in order to achieve the relief effect. To ensure consistency in the assessment of the compatibility of aid, the Commission would consider a transfer value reflecting the underlying long-term economic value (the ‘real economic value’) of the assets, on the basis of underlying cash flows and broader time horizons, an acceptable benchmark indicating the compatibility of the aid amount as the minimum necessary.”

I think it is natural to be a bit concerned as to how long “long term” is. The legislation reads as follows:

“Section 58 (1)…

(c) a reference to the long-term economic value of the property comprised in the security for a credit facility that is a bank asset is a reference to the value that the property can reasonably be expected to attain in a stable financial system when current crisis conditions are ameliorated and in which a future price or yield of the asset is consistent with reasonable expectations having regard to the long-term historical average, and

(d) a reference to the long-term economic value of a bank asset is a reference to the value that it can reasonably be expected to attain in a stable financial system when current crisis conditions are ameliorated.”

My one problem with the legislation is that it is giving a future value when the crisis has ameliorated. I think it should be based on what the value would be if the crisis conditions were ameliorated now rather than in the future.

I also think that we should be clear as to what we mean by “crisis” and “crisis conditions”. The crisis should be limited to the inability of the Irish banks to borrow based on doubts over their balance sheets. It should not include the international crisis. It should not include the employment crisis. It should not include the limited nature of international liquidity!! It should not assume a recovery in the world economy. The legislation needs to be tidied up on those points.

The fundamental principle should be that NAMA should only use a long term value which is based on the assumption that the discrete problem which NAMA is designed to solve, i.e. the uncertainty as to bank losses, has been solved.

As for deconstructionism, my only knowledge of it is a short TV documentary on Jacques Derrida and the one reading of Watson’s “A Terrible Beauty” on the history of non political thought in the 20th century. With that said, as you have pointed out the essence of your first post revolves around the meaning of “fair market value”. I almost feel like I am being baited 🙂 !

@BL

Perhaps we should leave off the gentle ripostes? People have thin skins. My skin is certainly particularly thin when it comes to Alan Ahearne. As an Irish citizen I am hugely appreciative of his not asking for the cup to be taken from his mouth, of his giving hostages to fortune and at his putting his neck on the line. Criticise what he says by all means, but if, as you say, you would not be willing to walk in his shoes then you shouldn’t take grave offence at references to “ivory towers”.

@KW

I agree that trying to look inside Alan Ahearne’s historical head probably won’t bring us on further. As you say, it is the concepts in the legislation that counts. I think you put it nicely on the Noel Whelan thread where you said:

“From this economist’s perspective, the crucial aspects of the NAMA bill are (a) Sections 58 and 59, which define long-term economic value in a highly unsatisfactory ambiguous fashion and (b) The complete absence of any clause protecting the taxpayer from losses that may be incurred from purchasing these assets. These aspects render the bill extremely unsatisfactory and have attracted most of the attention from economists.”

I think there is risk for the state and the taxpayer in leaving the definition of long term economic value too wooly. If a phrase does not have a proper meaning then it shouldn’t be in this important legislation.

If there is unavoidable uncertainty then the legislation should provide (i) that such uncertainty will be resolved in favour of the tax-payer, i.e. with the value being pegged at the lower end of the uncertain range and (ii) that there will be risk sharing for those assets.

I also think the Minister needs to reserve the right to tweak the meaning of “long-term economic value” within reason (i.e., cannot tweak below current market value) by statutory instrument and that the banks must sign up to this on trust.

Instinctively, I would also like to see the words “long term” come out and “medium term” come in, although I don’t know how this would play.