Since the announcement of Patrick Honohan’s appointment as Governor of the Central Bank, there has been a series of media stories implying that the government are going to amend NAMA to feature some version of Patrick’s risk-sharing proposals. The most concrete report is at the bottom of this article in today’s Irish Times:
Government sources yesterday said Ministers have been looking very closely at the issue of risk-sharing and the two-tier model that has been suggested by Patrick Honohan, the incoming governor of the Central Bank.
One of the options given serious consideration, said the sources, was the creation of two classes of bond. This approach provides for one class of bonds to be issued immediately and the other to be deferred and paid at a future date if it were shown the scheme was working. However, it is understood that discussions have not yet moved to the question of what percentage would be made available immediately.
I have also heard this story from a number of sources who rather than describe it in terms of the second class of bond payment being deferred describe it as immediate issuance of two classes of bonds, the second of which is a “subordinated” NAMA bond, which may not pay off under certain conditions.
I think it is important to emphasize that these proposals do not at all correspond to the essentials of Patrick’s plan.
The most detailed description of Honohan’s plan is in his article “Resolving Ireland’s Banking Crisis” in the Economic and Social Review. Page 226 describes the proposal as follows:
Concerns that the taxpayer would end up paying too much because of deficient pricing could be allayed by refining the NAMA proposal in a way that also achieves a better risk-sharing. Instead of simply paying a fixed best estimate price for the loans, a somewhat more sophisticated financial restructuring could be envisaged. Specifically, NAMA should make a two-part payment. One part is in bonds, but is pitched below the estimated value of the assets purchased. In addition, the bank shareholders – and possibly other risk capital providers – would be given some stake in the upside of NAMA’s eventual returns (for example by giving them an equity stake or warrant in NAMA). This would protect the taxpayer while being fair to the shareholder, and still removing the risk from the bank. This plan would, of course, increase the likelihood that the shareholder’s equity in the banks is wiped out following the asset sale, with the Government then holding a 100 per cent ownership stake, at least until new equity investment can be raised.
There are two dimensions under which the described proposals don’t correspond to Honohan’s plan.
First, there is the question of who is receiving the payments.
In every one of the “risk sharing” proposals that have been floated by the media, both payments have been to the banks. In contrast, while Patrick’s proposal does involve two payments, only one of those payments goes to the banks; the second, risk-sharing, component goes to the bank shareholders. Two recent newspaper pieces by Honohan (on August 6 in the Irish Times and on August 30 in Sunday Tribune, four days before his appointment) are also precise about this issue.
Why does this matter? Well it matters greatly for how much capital the banks would need after the bad assets have been removed. When the additional payment goes to the shareholders rather than the bank, then the bank has a greater need for new capital, most likely coming from the state. It also matters greatly for achieving the goal of drawing a line under the past and moving on. If the bank has no contingent exposure at all to the ultimate profit or loss position of NAMA, then they can carry on without ever having to worry again about these bad assets.
It seems likely that the government is ignoring this central element of Honohan’s plan because they want to minimise the extent of state equity investment in the banks (something which the quote from the Economic and Social Review shows that Patrick viewed as likely to be considerable under his plan). However, the government must also understand Patrick’s desire to have the banks free from exposure to bad property loans.
This is where the second key deviation from the Honohan plan comes in. It is clear in each of the three sources linked to above that Patrick’s plan involved the second payment being in the form of an equity stake in NAMA, so that its value would move up and down as NAMA filled progress reports. The government would probably be unhappy with these fluctuations showing up in the accounts of the banks, so it has instead proposed some sort of bond that is somehow linked to the performance of the NAMA assets.
At this point, it’s not at all clear what exactly this “subordinated NAMA bond” would be. But, if it’s a bond, then it probably could be kept on the balance sheet at par value, thus avoiding the fluctuations in value that would be associated with an equity stake.
The whole thing seems a bit strange to me. The idea that any form of “NAMA bond” wouldn’t be paid out on strikes me as very dubious. We have a Minister for Finance who regularly predicts plaugues of locusts if anyone in Ireland defaults on a bond. And we are now to believe that he would be ok with a government agency refusing to pay out in the future on a bond?
Finally, the Irish Times article says that no decision has been made yet on how much of the payment would be split between the two bonds. Again, Patrick has been pretty clear that the payment in the form of full non-contingent bonds should be on the small side.
In his ESR article, Patrick proposes paying “below the estimated value of the assets purchased.” It could be argued that there was some movement in his position on this, however, because the two August op-eds instead refer to paying “what can be confidently expected as recoverable on the loans”. In either case, it is clear that Patrick is proposing to pay far less than “long-term economic value” in the form of full non-contingent bonds.
So, based on the available information, my assessment of the situation is that the government is not preparing to implement Honohan’s plan and that amendments purporting to do so are likely to be little more than token nods in the direction of risk sharing.
Of course, I hope I’m wrong.