Listening to Richard Downes question Richard Bruton on Morning Ireland earlier today (“The ECB are funding NAMA at a rate of 1.5%”) I am now convinced that very few of even our smartest journalists understand the basic mechanics of how the funding of NAMA will operate or where the ECB fits in. So here goes.
In exchange for property-related loans, the Irish government will print off €X billion in bonds backed by the taxpayer and give them to the banks. It appears that these bonds will differ in yield and maturity from other Irish government bonds. We are being told that the bonds will pay a floating rate linked to one of the Euribor rates for wholesale interbank lending (there’s a bunch of them corresponding to different maturities. See here.) Some people seem to believe that these assets will somehow be “backed” by the property assets acquired by the government and that their value may fluctuate based on how these assets perform. I don’t know why these people think this. They will be government bonds backed by taxes levied on you and me.
A figure of 1.5% has been repeatedly mentioned as the initial floating rate on the bonds paid to the banks but, as far as I know, no formula has been provided to justify this figure. The main point to understand here though is this: The 1.5% is an interest rate the Irish government is paying to the banks. It has nothing to do with the ECB.
What happens next to the bonds? Many people start talking about the ECB at this point. However, that’s getting a bit ahead of things. Alan Ahearne’s column on Saturday stated
Nama will pay the banks for the loans using bonds issued by the Government. These bonds can be exchanged for cash on international markets and at the European Central Bank.
I’ll get to the ECB in a second. However, what’s more important is that Ahearne is telling us that the NAMA bonds can be sold on the open market and don’t have to be held to maturity by the banks.
This has very substantial implications for how the Irish state is going to funds itself over the coming years. NAMA bonds being tradable will in effect make the Irish banks competitors for the issuance of Irish sovereign debt with the NTMA. Indeed, it may be necessary for the banks and the NTMA to co-ordinate sales of NAMA bonds on the secondary market with issuance of new bonds by the NTMA.
Of course, this raises the question of why cash-strapped banks wouldn’t just go straight to the open market with the €X billion of Irish bonds and sell them straight away. After all, according to those who propose the NAMA approach, the government will have also bought assets that will turn out to also be worth €X billion, so its net solvency shouldn’t be affected and markets should be no less willing to buy Irish government bonds.
That’s the theory anyway. In practice, I suspect the markets will have grave doubts about whether NAMA will break even. More importantly X is going to be a big number and there is simply not likely to be a market for that large a quantity of Irish government bonds all to be sold off at once.
Now, and only now, does the ECB come in to the picture. Knowing that there will only be a limited market for the NAMA bonds on the open market, it appears that the government and the banks have made something of a gentleman’s agreement not to sell many (any?) of the bonds at first. Instead, the banks can go to the ECB and look for loans. The ECB requires that a bank have eligible collateral to secure its loans. Dodgy developer loans are not on the ECB’s list of eligible collateral; government bonds are.
So, NAMA allows the banks access to a new source of liquid funds (it appears they are either at or close to their limit in terms of eligible collateral). The interest rate on the loans from the ECB will be at the main refinancing rate. This is currently 1% but it will rise at some point. Note that contrary to what is commonly stated, the ECB will not be buying these bonds—they are forbidden from buying government bonds of member states—they are only requiring that the bonds be available as eligible collateral.
But for how long will this process of large-scale ECB collateralised borrowing go on? Even before the banks receive the NAMA bonds, they have become highly dependent on the ECB, taking about 15 percent of the total liquidity handed out in recent ECB operations. The ECB is currently running unlimited liquidity operations so that any bank with the eligible collateral can get a loan. However, it will at some point return to its usual practice of issuing a fixed amount of liquidity, rationing it off via an auction. One would wonder at that point whether the Irish banks would start selling off the NAMA bonds gradually over time.
For all the information that has been released along with the detailed legislation, I find it strange that none of the issues mentioned here (maturity of bonds, formula to determine interest rates, marketability of NAMA bonds, implications for NTMA issuance, plans for weaning off reliance on ECB operations) have been discussed publicly in any detailed way by the Department of Finance.