Designing NAMA-contingent claims

In a welcome shift, the government has indicated that NAMA may pay for bank loans by issuing two claims to the participating banks: standard government bonds in the amount of the minimum fair value of the loan assets, and a continent claim against any realized underpayment (I explain these terms below).  It looks like the contingent claim might be classified as subordinated debt against NAMA as a separate government-owned entity.  What are the policy objectives guiding this security design problem, and what would be the best feasible security design? What about the other huge contingent claim held by the banks (the bank liability guarantee)?  Bringing the liability guarantee into the picture, and examining optimal design in the current circumstances, argues strongly for short-term nationalization as the best policy.  However, if nationalization is ruled out for political reasons, then we can search for a second-best optimum excluding nationalization. I hope to write a technical note on this interesting problem over coming weeks, but in this blog entry I just want to make a few general remarks.

Nationalization is Best: According to Table 6 in White and Rankin (July , 2009) as of this past July the six main domestic Irish banks had total tier 1 equity capital of €14.8 billion.  As they note, this does not account for upcoming (as of July) capital additions, so adding a rough-guess 25% to the total gives tier 1 equity capital of €18.5 billion.  NAMA plans to buy €90 billion original accounting value of loans from the banks.  An accounting “hit” of 20.55% of the loans’ original accounting value would wipe out the Irish banking sector’s total tier 1 equity.  Some proportion of the loans’ original accounting value has already been written down by the banks, so a 20.55% “hit” would correspond to a larger discount on original book value.  My own very-limited straw poll of informed sources (excluding those in Irish brokerages and investment firms where there is strong vested interest in a small discount) seems to indicate that the appropriate discount is in the range 45% to 70%.   I have been surprised that several knowledgeable practitioners have told me privately that Lucey’s suggested 70% discount is not unreasonable.  Anything in this 45%-70% range means that a fair value NAMA discount will leave the banking sector with zero or negative cumulative tier 1 equity capital. The uneven distribution of the bad loans across the banks means that some will be deep into negative equity while some others would be limping along, extremely impaired.    

The banks have positive market value of equity because of two assets which do not appear on their balance sheets.  One, they all have very valuable government-backed liability guarantees. Two, except for Anglo Irish, they have valuable franchises.  Both of these assets can now revert back to the taxpayer via nationalization.

It is difficult to put a fair price on the bank liability guarantee due to a deposit-insurance paradox.  Without the guarantee, the banks would fail and most Irish bank equity would be worthless.  However, letting the banks fail would be extremely bad for the economy and taxpayer, and so the guarantee cannot be removed.  The Irish state needs to remove its under-priced guarantee without letting the banks fail – hence short-term nationalization, followed by a renewal of the liability guarantee if necessary.  In this way, the taxpayer will receive the full value of the guarantee and the banks’ franchise values when new shares are issued.

Second Best NAMA plans: Ruling out nationalization, based on the government’s political preferences, how should NAMA payments for banks’ loans be structured?  Paying with government bonds is essentially paying cash (courtesy of the ECB).  What are the objectives of non-cash payment plans? Here are two alternatives:

1. Risk Sharing.  This is the explanation that has been picked up in the popular press.  The banks must share with the taxpayer (through NAMA) the risk that the bank loans turn out to pay less than expected.  Looked at more carefully this is not a consistent explanation. Under the proposed plan, NAMA will pay for the bank assets with a package which is essentially cash plus a covered call option written on the assets’ realized values. This depends on the nature of the subordinated bonds but seems to me a reasonable interpretation.  This is a sensible security design, but it is not risk-sharing.  It means that the banks are given a claim on the upside potential value of NAMA in exchange for a lower cash payment.  The taxpayer is still stuck with the downside risk of NAMA.  The only risk reduction for the taxpayer is that the banks’ call option might expire worthless – that is not much of a risk reduction.  Calling this risk-sharing is a slight misuse of that term.  The term “share the risk” is being used informally to refer to something else. See the next explanation. 

2. Information Asymmetries There are two information asymmetries in the fair valuation of the bank loans.  The banks know more about their value than the government, and the government knows more about their value than the taxpayer-voters. The proposed cash-plus-call-option package is less sensitive to mis-prediction of the realized value of NAMA assets.  So in this sense it “spreads the risk” from the taxpayers to the banks.  Suppose the banks know that the NAMA assets will pay only 40 billion but the taxpayer thinks that they might pay 60 billion or more — the taxpayer is not sure. The taxpayer gives the banks 40 billion cash plus a call option (subordinated debt) with an exercise of 45 billion which is worth (the taxpayer thinks) 10 billion.  The taxpayer thinks that he has paid 50 billion total value but the bank knows that the two-security package is really only worth 40 billion since the call option is worthless.  The total package is fair value despite the information asymmetry.  More generally, the cash-plus-call package tends to mitigate but not completely eliminate mis-pricing given asymmetric information between the two parties.

This explanation also works if the taxpayer does not trust the government as middleman, for example due to special interest influences. Under reasonable assumptions, using cash-plus-call puts the taxpayer less at risk of overpayment by the government. 

Cited Paper: Scott Rankin and Rossa White “Government Finances and Banks” Davy Research Report, July 8, 2009.

29 replies on “Designing NAMA-contingent claims”

I stand to gain a lot more myself, working in the property area, if NAMA goes ahead. That is, if NAMA is a success and doesn’t break the country completely. Brian Lucey commented yesterday, that he is discussing NAMA in his sleep. Lucey said though, the definition of a ‘lecturer’ is somebody who talks in someone else’s sleep. Lucey might indeed, be talking in other peoples’ sleep at the moment.

But certainly, from my own perspective, I didn’t sleep too well this summer for some reason. Then it finally dawned on me. It does not sit well with me as a person, to think that I could support the NAMA plan. Since I have decided not to support it at all, in my comments and my own mind, I have slept a lot better. That doesn’t mean, if NAMA goes through, I will be disappointed. On the contrary, it could be good for me. However, disagree-ing with it, gives me more peace.

In order to disagree with NAMA, in my conscious brain, the really difficult work, was to find a sufficient number of points against NAMA, to tip that see-saw inside of my brain to either one or other side. I will proceed to describe the three things below. Brian Lucey in his latest Irish Times article, has hit on some additional factors, that I could agree with. They are things about bonds and what not, that economists do find interesting.

But the great thing for me, when I read Lucey’s latest article, was I realized, I don’t need his articles so much as I used to, to make up my mind. That, with the three basic ‘weights’ I have now placed on one end of my see-saw, I am happy that by brain is no longer under the same stress it used to be in, all summer. I don’t need to add additional weight to the see-saw to make a decision. Here they are.

(1) The FF government has commissioned numerous expert reports, none of which tie up together to form a cohesive strategy. NAMA in itself, is a wonderfully clever idea. Not to knock that idea, but it hasn’t been tied up with the rest of the consultant advisory projects. In other words, there is no clear overall architect. Which spells disaster to me.

(2) The banks are making their situation appear a lot worse than it is. They haven’t put their cards on the table. The AIB operations in Poland for instance, could be sold up to improve their position. They have not even gestured a willingness to look at that option as a last resort.

It is the same with the Zoe developments court case, the company I used to work for. They are careful to display only the portions of the company they want people to see, in the courts. I.e. In an attempt to say ‘save us’, we deserve corporate wellfare.

(3) The €30 billion hit that ex. Ulsterbank economist Pat McArdle predicted the developers will have to take, in his article in the Irish Times newspaper. Pat called it, having some skin in the game.

I don’t believe the Irish developers ever had their own skin in the game to begin with. They were a miserable, impoverished bunch of guys, who never knew it was to have any real wealth. We won’t hold that against them, you are what you are. But NAMA hinges on the fact, that they were ‘real developers’ instead of developers of convenience the Irish banks needed in order to enlarge their loan books.

The three items above, are all that I really needed to make up my mind for good and glory about NAMA. I have read and listened to Gurdgiev, Lucey, Whelan, Burton, Bruton, Lee, Ryan, Lenehan and all the other excellent commentators to date. The list of people I know now, is far too long to list here. I know more Irish economists, journalists and politicians than I ever knew in my life, simply from following it all.

I don’t think I have purchased this many newspapers or watched the main evening news and studied as many blogs as I have, ever, as I have donevover the last 3 months. For what it is worth Greg, I have become a Fine Gael supporter. Even though, I never had a political opinion in my life. I used to go into ballot boxes and pick out a name basically. It was through listening to Fine Gael in particular over the past 3 months, that I really began to figure out how I felt about NAMA. For real. No more voices in my dreams thankfully.

Short to probably medium term nationalisation could and probably should have been announced and implemented one year ago. Politically, it was doable then – and a National Gov was probably also doable with some know-how and pragmatism across the political parties …….. The guarantee by the state provided both legitimacy and justification.

One full year later we continue to sink further and further into the black hole (look at the size of those deficits!! while decision makers take vacations and farm out focus groups) created by flawed neoliberal ideology (and yes neoclassical economics and the illusion of the market as the primary in the quod of father/mother, son/daughter and holy ghost: the father, the son, the holy ghost and the market) and an out of control system of financialization that benefitted the few, was essentially fraudulent, with little risk of enforcement (check out the golf courses and the offshore accounts – not to be found in MountJoy) ………. and now the policy appears to be to try to return to this flawed system ……… it is BUST- why fix it? Nationalise the credit unions and provide liquidity so that Joe and Joan citizen can borrow, repay and pay bills and eat. Boston or Berlin – we are paying an astounding price for situating ourselves within the US/UK neoliberal culture …….. one might as well place the Island on the market ………… but who has the cash to buy it? and if Naa-Maa ….. if and when Naa=Maa….. will I be back here again in another year waiting for something to happen ……..(or chucked off this list first) ……… the switch from grain to cattle was bad in the early 19th century, the famine was bad, the 1950s were not great but most of my extended family could cross the pond ……… now we are sinking into a black hole of a pond of our own making.

Aplogies for the ‘rantish tone’ but I agree with the first point of this post by Gregory Connor ………. Nationalisaton a year ago and we might be looking up at a way out as distinct from where we are now which is really deep into this black hole (while the paries worry and joust for the better postions within the hole as distinct from thinking about getting out of it!) and perhaps getting near if not already beyond the tipping point ………

economics, politics, law and democracy – tuff, really tuff to be optimistic at the mo ………

I am not a government spokesman and I don’t play one on the ‘net, but the political issue with nationalizing banks is that it involves the government in the banks’ decisionmaking. This is a major headache for them.

The more pessimistic the government are about the state of the banks, the less likely they are to nationalize them. If the banks are really in as bad a state as some people suspect, they will turn out to be impossible to offload to a private investor, even after the debts are cleansed (remember, a bank is much more than just its balance sheet).

It is an understandable reluctance, even if some people, including me, think it is disproportionate.

Like BOH I too have got sucked into the whole debate far more than any single issue that I can remeber. I get the central tenet of BLucey’s KWhelan’s arguement – the banks are bust; giving them money for assets above their market value, in order to keep them solvent and out of public ownership is a transfer of tax payer resources to shareholders / bond holders. The value of these assets is probably 30billion, so paying 60billion is handing over a year’s tax take. (Apologies for the dumb-ass summary.)
But yet, I wonder is it wrong.
So we nationalise, what then? (a) who will run the banks for us and magically clean them up for us on the salary levels that we’ll be restricted in paying senior executives because of political trade union pressure? (b) will absolutely every single decision be the subject of objection from these sources, eg will the banks be free to hold fixed rates (entered into before interest rate reductions) above variable rates even if it costs them a fortune to allow customers to switch over; (c) if or when they are privatised can we not bet for sure that the trade unions will demand their cut? And this is in addition to the negative reaction in markets around the world re wholesale nationalisation of banks. I was also intrigued by AA’s comments re a nationalisation triggering a requirement to immediately settle certain liabilities, which could in turn trigger fire sale of bank assets which further affect the solvency of the banks and require greater capital injections from the tax payer.
Tails we lose, heads we don’t win.
Also, maybe the tax payer should take a hit. Were we not part of the problem? Should the state not have regulated this more carefully? Should we not have voted for a responsible government who would have taken the heat out at an earlier stage? My view is that it is appropriate that the state takes a hit given that we were part of the problem.
However, in the end it comes down to a least worst outcome; the outcome with the least potential risk.
NAMA, we take a 30billion hit now and then it’s all over.
Nationalisation – who the hell knows what disasters are coming down the road?

@Gregory Connor

Your post moves the debate on substantially.

A. Are the Banks Insolvent?

If we are to believe Brian Lenihan, then if the figures your straw poll has thrown up are accurate, then we will have 100% nationalisation. That is why I continue to support NAMA. If I am misjudging the Government’s intentions then I am making a mistake but I do not believe the FF or any other politicians are willing to risk making a mistake of that magnitude because such a mercenary fraud would, I believe, spell the end of FF and destroy the politicians legacies and reputations. Anyway, at this point in time, I believe in Brian Lenihan.

It would be good if you gave some kind of broad brush description of the type of people you polled so we can gauge the credibility of the figures you are using. Are these people familiar with how markets value bank assets and the kind of discount the market could be expected to apply to anticipated hold-to-maturity values?

If I am right on the Governments intentions and your straw poll is right on the state of the banks’ balance sheets, then NAMA will lead to 100% nationalisation to occur at some stage during the NAMA process. I see that as a better outcome than pre-emptive nationalisation for a number of reasons:

1. It means nationalisation can be implemented at a stage when credible figures are available rather than us relying on what many people consider to be rather optimistic figures provided by the banks.

2. It means the mechanism of asset cleaning has been set up and commenced while the banks are in private ownership. The wheels will be turning and the pedals will be easier to push.

3. It means that the period of temporary nationalisation will be shortened as the first 20% of bank assets NAMA deals with, if correctly chosen, could account for 80% of the value of bank assets and could give a pretty safe estimate on which to transfer the rest of the bank assets if it had to be done in double-quick time.

4. It will eave us with a credibly capitalised AMC which will strengthen the credibility of our national balance sheet.

B.Is Risk Mitigation through “subordinated” bonds an improvement?

We really need to see the draft legislation on this one because the secondary type of bond seems like a nonsense to me. As Karl Whelan has pointed out, a fundamental characteristic of Honohan’s NAMA 2.0 proposal was that the contingent payment to bank shareholders was removed from the banks’ balance sheets. This meant it could not be overvalued or undervalued by bankers or the market. Now, I do like the idea that the bonds are limited in value so that the shareholder does not get all the uplift as may have happened under NAMA 2.0 simpliciter (open to correction on that). The banks’/shareholders’ uplift should be capped at “LTEV” and the taxpayer should get anything above that.

Like I said, it is very hard to criticise in a vacuum and we really need to see the legislation. It may be that the NAMA subordinated bonds would go into a separate SPV that would be owned by bank shareholders and not the banks. That is a different matter altogether and would achieve Honohan’s aims.

For me the core issue is rewarding perverse risk taking. AMC’s are designed to bail out banks – they mutate into asset managers after loans have been bought. If capital is loss absorbing in the good times and less loss absorbing in the bad times then risk takers may not be full wiped out. But why should the perversity be amplified by providing for profit sharing in an AMC? I can understand the Honohan distinction and agree with it as it first penalises shareholders and then provides access to the slim possibility of sharing in amc profits. The issue of subbies is less clear although contractually they agree to stand in line to absorb losses. Fully wiping them out is probably a runner for one bank but for 6 banks less so. It’s better to get the subbies off the pitch as they will probably be retired as an element in future loss absorbing capital.
Back to Nama: for me any construct that rewards bank risk taking should be limited to buying debts at less than current market value given the implicit state subsidy – release of capital and profiteering from liquidity. I fear the banks won’t lend but will focus on derisking their balance sheets and increasing income through hiking margins and fees. They will do this to attract private equity to head off any increase in state ownership. Credit starvation and excess profiteering from a dominant market position is a very real prospect.

David O’Donnell
I do not think that you need to apologize to the readers of what you write. It is clear that there is genuine anguish there. Please take heart. Things can be made right.

It is a tragedy that we cannot blame the oul’ enemy for this. We now have to face facts. All this is to the good. We have increased pay in the public arena and ensured that graft is now a choice, not a necessity. But we still have to find those like George Lee whio are willing to forego an interesting career for the lefe of a gent “on the hazard”. But it is a start.

Keep writing!

Gregory Connor
Do you not agree that there is often a difference between the incidence of an impost and the burden of an impost?

By forcing NaaMaa to over pay in the first instance, when the banks later fail and are nationalized, the comntingent liability will still exist but it will be a case of Paul paying Paul by then as those who shuld suffer the contingent losses will have lost all “the skin that the ave in the game” by then. But not as much as if they had been paid the true market vakue.

This then still amounts to an enormous and unfair transfer to cronies!

No change then!

@Gregory Connor,

I find it strange to find myself agreeing with the shade of a former PRC PM, but many thanks also for moving the debate on. I have been very keen to see an analytic framework to evaluate the various options side by side.

My gut instinct (without relying on the substantial intellect input by Karl Whelan, Brian Lucey and many others) has always been to nationalise, clean-up, wind down dodgy loans in a separate vehicle and privatise – and to do it quickly. In all other countries – with the possible exception of Germany – speed has been the defining characteristic of the response and of the execution. It may not have been pretty, there are probably some nasties still lurking in the system, tax-payers are in for probably much more than they should be (though, having elected incompetent governments who appointed and directed inept regulators, that is a moot point), but most other countries are moving on. And these countries were mostly dealing with really novel, almost impossible to value and very toxic stuff. Ireland is dealing with the oldest economic resource known to mankind – land and property, but there, perhaps, is the rub.

Again, I find myself reluctantly agreeing with the Chinese shade – though not with the same politcial blind faith. The time to nationalise was at the end of last Sep., rather than using the bank guarantee. Once this opportunity was passed up something like NAMA, which may end up taking the long road to nationalisation, was inevitable.

The more pressure that is exerted, the more transparency will be enforced and the more taxpayers will be protected. The inevitable result is nationalisation, but we will have taken more than a year to get there.

One of the interesting points raised in the initial post is that NAMA 2.0 is not full risk sharing but is rather limited risk mitigation.

The original paper by Deutsches Institut für Wirtschaftsforschung, “Bad Bank(s) and Recapitalization of the Banking Sector”, which may have influenced Professor Honohan’s thinking, suggested that assets should be transferred at market value or zero at value where there is no market.

Extracts from the above mentioned paper, previously linked to on this site, are set out at the end of this post.

Currently we do have a property market but it is not clear that there is any market for asset backed bank Irish bank securities (although the Govt says it has been approached by private equity in relation to Anglo). Accordingly, it would probably not be seen to be good practice to transfer at less than market value.

It is to be noted that the value Prof. Honohan thought should be paid was a price NAMA could “confidently” expect to get for the assets. I suggest that such a value is somewhat below market value.

The post NAMA 2.0 tax payer risk therefore seems to be a further fall in the market.

The volatility of this risk is highlighted by Mr. Mulcahy’s evidence to the Finance committee where he said that his investigations show that historically property values rise by 88% from trough values over 7 years. We are told NAMA will not assume this but the principle that markets recover from trough is being accepted.

Acknowledging that Mr. Mulcahy’s statement was informative and not a basis for NAMA valuations we can look at how it might work. If values bottom out at 50% of peak, as Mr. Mulcahy thinks they will, then they might recover to 94% (50% * 1.88) of peak in 7 years.
However, if values bottom out at 20% of peak, as others have surmised, then they will only recover to 37.6% (20% * 1.88) of peak in 7 years!! Similarly, for a 30% of peak bottom the typical recovery comes out at 56% of peak.

This mental exercise demonstrates that the issue of whether we are at the bottom of the property crash is crucial. That is the first issue I wished to highlight.

The Minister said in the Dail Committee that if property values fell further then we are in serious trouble nationally. It was almost like saying that we don’t need to plan for that because if it happens NAMA will be the least of our worrries. I don’t know if that is right.

However, it is worth noting that the Minister is hoping for NAMA to build a floor under the market, presumably by stopping fire sales. In this regard the NAMA Bill will be giving the Courts the power to assess the values of realised securities for the purposes of debt enforcement without the necessity for sales.

Can the Govt hope to be successful in building a floor for property values? If so, will we all benefit? If not are we all in deep trouble? Also, is there a risk that the Govt’s actions could back-fire and collapse the property market? That is the second issue I wished to highlight.

Quotes from the paper referenced above:

“Our proposed design and the government’s plan coincide if the fundamental value is set to zero, and if the differential payment would be due immediately. In this case, the bad bank would become shareholder of the good bank to the extent the bank hands over
shares to the SPV. In line with our bad bank design the taxpayers’ hold-up risk would then be zero. In contrast, a high fundamental value implies that the mass of the taxpayers’ compensation for handing over secure bonds is prolonged for at least 20 years. Future contingencies may render the enforcement of the intended gradual loss realization by
shareholders a difficult task. Because of this enforcement problem, the taxpayers’ risk of being held-up remains high
The key element of the plan is the valuation of troubled assets at their current market value – assets with no market would thus be
valued at zero. The current shareholders will cover the resulting losses. Under the plan, the government would bear responsibility for the management and future resale of toxic assets at its own expense and recapitalize the good bank by taking an equity stake in it.
The risk to taxpayers from this investment would be acceptable, however, once the banks are freed of their toxic assets. A clear emphasis that the government stake is temporary would also be necessary. The government would cover the bad bank’s losses, while profits would be distributed to the distressed bank’s current shareholders. Either a separate bad bank can be created for each systemically relevant banking institute, or one central bad bank with a separate account for each institute. Under the terms of our proposed plan, bad banks and nationalization are not alternatives but rather two sides of the same coin. Although we refer mainly to the German situation, the elements of the plan will work in other countries as well.”

An afterthought…

I haven’t seen the Green amendment on a windfall tax for zoning gain but I suspect it will harm the chances of NAMA quickly selling off packages of loans and packages of properties as suggested by the Minister at the Finance Committee meeting. What plc is going to come in to develop in Ireland and spend hundreds of thousands of euros getting urban planners to work on rezoning proposals only for 80% of their gain to be taken in taxes?

Apart from that the purpose of the amendment seems to be an attempt to tax a group of people penally to sate the blood lust of the population. Taxing peole differently because of who they are is against the Constitution.

No doubt the amendment will stay within the letter of the law but the political message of higher taxes for developers who enjoyed great wealth over the last number of years is against the spirit of fairness in the Constitution. I am making a point about economic fairness here rather than the law.

If they blamed the economists would there be a special tax on fees for speaking engagements or private research work? If they blamed the Doctors would there be a special tax on medical fees? If the Greens go down this road then where will they stop? One thinks of the US Senate overturning the House of Representatives decision to tax bankers bonuses at 90%. Others have started down this road in times of economic crises in other countries in the past. If it is tolerated for one group of people then who is next?

Risk Sharing

This nonsense about Equal Risk sharing between the banks and taxpayer (RTE headline news) is now becoming clear. Development land loans are the small proportion of the overall 90billion risk where the banks will receive subordinated bonds. As Zhou has pointed out. the windfall profit tax will ensure there is no market for this land. The doctrine of unintended consequences or a clever plot to socialise land? Either way the taxpayer is likely to be stuck with farmland for a few decades.
Interesting to read Colm McCarthy’s estimate of the cost. If we are lucky = zilch – if we are unlucky 2 years borrowing = 40+ billion. Our luck ran out some time ago, so |I will assume the latter.

I just heard Brian Lenihen interviewed on Newstalk. This so called “risk sharing” as it turns out is a farce. It seems to be a political tool firstly so the Greens can show they have some political power and secondly it seems Lenihen is prepared to do anything rather than dilute shareholders. I cant believe that Lenihen is trying to spin this as the plan put forward by prof Honohan it bears no resemblance to it. Infering that the state may default on its debt, weather subordinated or not is unbelievable, the minister is constantly talking about investor confidence and he suggests we may default on state loans. In reality there is no way the government will default on these bonds as to do so would jepordise future credit for the state. In my opinion this cosmetic change is a smokescreen playing on the fact that most people dont understand whats going on in order to protect shareholders. By the way when is the debate going to start on how NAMA will be transparent, I can see it now secret deals with developers shrouded in secrecy due to commercial sensitivities, depressing times indeed.


Agree with you 100%.

I think the Greens will regret this folly of spinning such an obvious con job.

Zhou, I’d agree with you that a windfall tax is undesirable, but there has been a big problem with excess profits and capital gains being available through playing the property development regulatory (aka planning) system. As you mention doctors, I should say that I think that may be another area where public regulation has distorted the market, making excess profits/incomes available. But, in both cases I think a market based solution would be preferable.

My main concern about a windfall tax is nothing to do with private property rights or the incentives for developers to burn money on planning. It is that it has the potential to create terrible incentives for policy-makers.

If I look forward hopefully to a time past NAMA, I see a future when we want property prices that are much lower relative to income than we have seen through the bubble. There’s the simple personal issue that I want my kids to have the option of living near me without being drowned in debt. But more importantly, I don’t want the competitiveness of the exporting economy being weighed down, or prices in the domestic economy pushed up, by excessively high property prices. I believe that these have both been major problems for Ireland over the last few years.

I accept that national solvency, the preservation of the banking system and the consequences of extreme levels of negative equity may require that property prices be manipulated to a level above that which would be desirable under normal circumstances over the medium term. But we should aim for better over the long term.

A windfall tax will incentivise policy makers to manipulate the design and operation of the planning system to keep property prices high. It will also be highly volatile, which as we now know is not a good characteristic for a tax.

What we need is a planning system that keeps prices at moderate levels relative to income. There are other countries that seem to achieve this, and I think we should be looking to them for lessons. I suspect that moving in this direction would most likely have the incidental effect of limiting developer windfalls too.

The markets are determining the the Equal Risk Sharing is a scam with AIB up 5.6%and BOI up 9% at 2pm.

According to Zhou_Enlai:

“However, if values bottom out at 20% of peak, as others have surmised, then they will only recover to 37.6% (20% * 1.88) of peak in 7 years!!”

I assume the ‘others have surmised’ refers to Morgan Kelly.

Wouldn’t it be better if those, pontificating about future house prices, used real figures, instead of all this gobbledegook about percentages or base years? Then, we might at least have some idea what they are talking about. Most of the scaremongering predictions about house prices are couched in terms of either:

(a) Percentages – so, typically, we get predictions that house prices will fall by 50 per cent, 60 per cent, 70 per cent, 80 per cent or whatever.

(b) Base years – so, typically, we get predictions that house prices will fall back to their 2000 level, or their 1995 level, or whatever.

Morgan Kelly is the master of this sort of scaremongering prediction. You never hear him make a prediction that average house prices will fall to €200,000 or €150,000 or €100,000 or €50,000 or any specific figure. Because, if he put his predictions in specific easily-understood terms like that, it would be much easier to take his predictions apart. As long as his predictions are couched in terms of percentages and base years, they have a certain credibility, because very few actually know what they mean. So, if he predicts that house prices will back to their mid 90s level, unless you actually know what house prices were in the mid 90s, its meaningless.

Contrast this with predictions for future oil prices. Oil analysts don’t go around saying things like ‘the oil price will fall by X per cent by 2020’ or ‘the oil price will rise by Y per cent by 2020’ or ‘by 2020 the oil price will have returned to its 1995 value’. If they did, nobody would have a clue what they were talking about. Instead, they use real numbers. They say things like ‘the oil price will fall to $50 by 2020’ or ‘the oil price will rise to
$200 by 2020’, or whatever.

I suggest that those making predictions about future house prices do the
same. Spell out in terms of euros exactly what they expect house prices to
be when the market hits bottom. If they did that, then, not only would
their predictions be easier to understand, but it would become clear how
ludicrous some of them are.

Let’s take the prediction, made by Morgan Kelly and others, and quoted
above by Zhou EnLai, that average house prices may fall by 80 per cent
from peak to trough. Expressed in those terms, few people have a real
understanding of it. So, let’s look at what this means in euros.

According to the ESRI/Permanent TSB index, average house prices in Ireland peaked at €311,078 in February 2007. According to the same
index, by August 2009, they had fallen to €238,828, a fall of 23.2 per
cent. For an 80 per cent fall from peak to trough, they’d have to fall to
€62,216 sometime in the next few year. So, let’s look at how credible that
is, measured against a number of different yardsticks.

(1) Between February 2007 and August 2009, average house prices fell by
€72,250. This period covered from the top of the boom (both Irish and
global) to the bottom of the recession (both Irish and global). For an 80
per cent fall from peak to trough, they’ll have to fall by another €176,612
over the next few years.

In other words, we are being asked to believe that average house prices
will fall by 2 and a 1/2 times as much during the period from the bottom of
the recession to well into the next boom as they did in the period from the
top of the previous boom to the bottom of the recession.

Its completely daft!

Can any of the supposed experts on house prices give a previous example
of average house prices falling by X per cent between the top of a boom
and the bottom of a recession, and then falling by a further 2.5 times X
per cent between the bottom of that recession and the next boom? Of
course not!

(2) According to the 2007 SILC Survey carried out by the CSO, average
household income in Ireland was €59,820 in 2007. It has risen every year since records began. It will almost certainly continue to rise. But, let’s err on the side of caution and assume it never rises beyond that level. As I calculated above, for an 80 per cent fall from peak to trough (Morgan
Kelly’s prediction), average house prices would have to fall to €62,216
within the next few years. That would leave them at 1.04 times average
household income (even on the assumption that average household income never rises beyond its 2007 level).

Again, its completely daft!

The international norm is for average house prices to be 3.5 times average household income. Can any of the supposed experts on house
prices give an example of a country where average house prices are only
1.04 times average household income? Of course not!

Or let’s compare average house prices with UCD lecturers salaries.

According to the UCD website, a UCD Lecturer’s annual salary is €83,497
and a UCD Senior Lecturer’s salary is €96,795. So, if Morgan Kelly’s
forecast of an 80 per cent fall from peak to trough in average house prices
in Ireland came true, then average house prices in Ireland would be only
64.3 per cent of his (Kelly’s) annual salary.

Again, its completely daft!

Can any of the supposed experts on house prices give an example of a
country where average house prices amount to only 8 months salary for a
university Senior Lecturer. Yet, that’s what Kelly is asking us to believe.

(3) Let’s compare average house prices in Ireland and the U. Kingdom.

The Halifax house price figures for the U. Kingdom were published this
morning. They confirm that house prices there are rising. In fact, they’ve
been rising since April. According to Halifax, average house prices in the
U. Kingdom were £160,973 in August 2009. Applying the exchange rate
for that month puts them at €186,603. House prices in the U. Kingdom are now clearly rising and virtually every expert expects them to continue rising. So, let’s assume they rise to €200,000 by next year (a realistic
assumption), but let’s further assume that they stop rising then and plateau at €200,000 (an unrealistic assumption – they’ll probably continue to rise well beyond that level).

As I calculated above, for an 80 per cent fall from peak to trough in
Ireland, average house prices here would have to fall to €62,216. That
would leave them at 31 per cent of the U. Kingdom level. Does anyone
seriously believe that is likely? When have house prices in Ireland ever
deviated from those in the U. Kingdom by that amount? If you look at the
records over the decades, you’ll find that average house prices in Ireland have rarely deviated by more than 15 per cent either way from those in the U. Kingdom. Hardly surprising since, for all practical purposes, Ireland
and the U. Kingdom are one housing market and one labour market. The
idea that average house prices in Ireland could ever end up at 31 per cent
of average house prices in the U. Kingdom is daft. Vice-versa would also be daft, of course. If average house prices in Ireland ever even looked as
though they were heading towards that level, there would be a mass influx
of people from Britain (many of them retired Irish people living in Britain),
selling their houses their and buying equivalent houses here for 31 per cent of their U. Kingdom selling price.

Meantime, away from all the focus on property prices, two pieces of news from the CSO today:

(a) Out in the real world the recession is melting away before our eyes.
CSO figures out today show manufacturing output up 10 per cent, and at
an all-time high.

(b) The era of deflation is ending. Prices are rising again. They are rising
less fast that in the EU, which is good for our competitiveness, but rising

On the 20%/30%/50%*1.88 thing … I listened very carefully to what Mr, Mulcahy and the Minister for Finance had to say about the 88% historical rise from trough, and neither of them claimed much weight for it. I thought Mr. Mulcahy made it quite clear that it was not the result of a very careful analysis.

When I looked at the data myself, I thought they were too thin to draw useful conclusions, and I was relieved that the Minister had indicated that any price uplift in calculating Long Term Economic Value would come in far less than 88%.


I think that percentages are generally better. When I want to get a true sense of value and a figure is given in Euros I use a current exchange rate to change it to pounds Sterling. That is just me, and 20 years living in England. At least percentage changes are suitably multi-cultural. I agree that Morgan Kelly seems too pessimistic in his recent forecasts, but he was prescient the last time.


I quite understand your point of view. Its best to think in terms that you are comfortable with. Far be it from me to impose my way of thinking on anyone else.

But, I just wonder. If I offered to buy your house for ‘23.2 per cent less than its Feb 2007 value’, would you not be tempted to work out what my offer was in euros before deciding whether I was making you a good offer or not? If you did that, and you saw that my offer equated to 400,00 euros or 350,000 euros, or 300,000 euros, or whatever, I think you’d have a better idea as to whether I was making you a good offer or trying to rip you off.

And, isn’t that how nearly everyone buying or selling a house behaves? If you go to an estate agent, all the house prices are given in terms of euros, not in terms of their percentage change from some arbitrary date in the past.


Firstly, my core point was that the fact that prices historically across different countries have recovered 88% from trough over 78 years bears taking on board because it effect that further drops in current value have on the long term economic value. I’m sorry if you don’t like percentages but that is the core point.

Secondly, I referred to property. The only time I used the word ‘house’ was when I referred to the House of Representatives. I didn’t count the amount of times you used the word ‘house’ but I suggest that, like the amount we will be paying the banks for their loans, it is a significant number. Most NAMA loans are not houses. They are commercial property, development land and developments. There is world of difference.

Thirdly, and this totally beside the point, is the median income not more relevant?

Fourthly, again totally beside the point, I am confident I could find thousands of houses that could be bought for less than €150K in the next year.

On exports in July high tech, pharma and chemical were up 27%, traditional fell 18%. There was a 68% jump in pharmaceutical.

The devil is in the detail and while we should be grateful for the growth the traditional sector (which is more labour intensive) is struggling.

Averages are very dangerous things whether it be unperforming loans, incomes, house prices or export stats. They can hide a multitude.


I’m sure you could find such houses.

But, its average house prices that matter.

Just out of interest, I looked up a website to see what house prices are in the U. Kingdom at the moment. This is the link. I don’t know if you can access it.

This is a website for property in Aylesbury, a nondescript boring town between Birmingham and London. I know its boring and nondescript because I lived there for 2 years some time ago. If you can access the above link, you’ll see that you can today purchase a studio flat in Aylesbury for £144,770, which equates to €167,820. But, move fast, as prices in the UK are rising by 1 per cent a month.

Just think, if Morgan Kelly is correct, the owner of that studio appartment in Aylesbury will soon be able to sell it and buy 3 x 3-bedroom semi-detached houses in Ireland. And pigs might fly.


Did you understand the point about an 88% recovery magnifying the effect of any further drops in property prices???

Sorry, correction on my contribution above. The comments related to the recoveries in residential property prices quoted by Mr. Mulcahy. The 88% referred to commercial property prices. After tracking down commercial property index data in a PhD thesis (, I see three recoveries in Irish commercial property prices since 1969 – excluding the Celtic Tiger boom and its aftermath. Deflated by the Consumer Price Index, these are (trough to peak) 53%, 85% and 76%.

I’m interested to see that Irish commercial property prices appear to have increased much faster than house prices over the period 1970 to 2000. The commercial property index referenced above increased by a multiple of 90.6 over the period, while nominal new house prices increased by a relatively modest 25.3 times. It strikes me as being worth investigating further, and that it would be valid to ask whether the same underlying factors that enabled the high historical rate of increase in commercial property values are still in place.

The explanation for that last point appears to be that the commercial property index I used included the rental yield. Assuming a rental yield in the region of 4% wipes out the discrepency. It also reduces the trough to peak gain.

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