In this note, I explain some of the macroeconomics of the long-term economic value concept and some of the methodological issues in trying to estimate long-term economic value. I also highlight trend real exchange rate depreciation as a factor that may act as a drag on nominal property prices over the coming years. Finally, I emphasise that any estimate of long-term economic value is bound to be quite uncertain, further reinforcing the case for a ‘two-part’ payment scheme.
I have written a piece for the Ireland for Europe Blog.
Patrick Honohan has been appointed Central Bank governor—Irish Times story here. Congratulations to Patrick and to the Minister for Finance for making a truly excellent appointment.
A legal question. What exactly is the Minister’s role in the NAMA valuation process?
Everybody’s favourite Swede has weighed in again, this time in an interview with RTE’s Tony Connolly. Morning Ireland had a excerpt from the interview this morning and apparently there will be more on the Six-One TV News tonight.
It is interesting to see Mr. Lundgren make an intervention again on this topic. After his appearences here a few months ago, the government spin was that he was wholly supportive of their approach—see for instance, here. I found that interpretation untenable but the sublety of Mister Lundgren’s words and the effectiveness of the government’s PR approach meant that they got away with it.
I think it’s pretty clear now that Mr. Lundgren does not support the government’s approach and one must wonder whether his intervention was prompted by a discomfort at being misrepresented by the Irish government.
I guess it’s back to the drawing board on international support for NAMA and long-term economic value. Time to fall back to claiming that the IMF fully support this approach. No, wait. we mean the ECB. No, wait, we mean Alan Ahearne. Listen, we’ll get back to you.
What it set me thinking about though was the following. As I’ve said, I think the statement in the article about the deficit is accurate and wholly defensible. However, what if it wasn’t? What if it was as badly thought out as Dr. FitzGerald seemed to think on Monday morning?
Would such an intervention actually cause problems for Ireland in the sovereign bond market as Dr. FitzGerald believes? The argument in favour of this position is something to do with its effect on “investor sentiment.” The argument against is that the sovereign bond market is populated by hard-headed individuals who rely on expert analysts that do their sums on revenues, expenditures and fiscal sustainability for every country and won’t pay any attention if some group of idiot economists put out a bad forecast.
I’d be interested in the thoughts of those who read this blog and have a closer connection to these markets than I do.
More generally, I do wonder whether “Don’t Scare the Horses” is just another version of the regular exhortation not to “Talk Down the Economy.” My feeling is that consumer and investor sentiment play a role in the economy but that this can never justify calls to limit free speech regarding economic fundamentals.
Update: A report on the latest Exchequer statement on the websites of both the Irish Independent and Irish Examiner states “The figures, published this afternoon, show a budget deficit of €18.7 billion for the first eight months of the year, compared to €8.4 billion for the same period last year.” Does this mean that the Independent and Examiner are now also being irresponsible and destabilising for referring to the Exchequer deficit as the budget deficit?
TCD Economist Seán Barrett argues against NAMA in today’s Irish Times. Note that Seán was not one of the signatories of the 46 guys piece from last week.
Yesterday’s Oireachtas Committee meeting left me more certain than ever that the NAMA “stockbrocking scenario” of something like a 20% discount is going to happen and that long-term economic value will be adjusted to deliver it. The transcript provides the strongest evidence yet.
The following exchange between Richard Bruton and Minister Lenihan shows that the NAMA pricing process has effectively already been decided. First, Bruton makes a point that I have emphasised on this blog many many times (for instance, here and here) which is that the Minister has effectively set a lower limit on the average NAMA haircut with his public statements:
If NAMA decides a €50 billion write-down is to be applied to the loans that are being transferred, and the shareholders’ funds are, for example, €20 billion, while the subordinated bondholders hold another €10 billion, it seems that the write-down will wipe out the shareholders and the bondholders. The legislation which purports to allow NAMA be independent in setting its prices has not shown us what will happen if NAMA, acting independently, wipes out the shareholders and the bondholders and is then left further below the water. That is a crucial issue.
On the one hand the Minister is saying that NAMA will be independent and that whatever happens with the valuation the cards will fall where they will and the State may have to put in more money. However, at the same time he is saying the banks will remain in private hands. He cannot pretend these two positions are consistent. To be honest, one cannot pretend that those the Minister engages as valuers – who are supposedly independent – will be immune from the knowledge that the Minister is saying every day of the week that at the end of this process the bank shareholders must be left intact. That may not be a written directive but it is certainly directive in its implications to those who are setting values. People who set values are fairly flexible in the way they work.
Lenihan’s answer is priceless. Read the following carefully. Referring to AIB and BOI he says:
Why would I outline the fact that there may be a residual or substantial shareholder interest left in these institutions if valuations established that their entire shareholder value was wiped out? The reason is on the basis of the information that I have at my disposal. This is not information that only I have at my disposal because markets have assessed that information in the context of their current share prices and rating agencies have used it in their assessment of these institutions. Were these institutions in the condition which Deputy Bruton suggests they would not have these positive market ratings and they would not have the degree of shareholder value they do. That is why in my public statements I do not envisage a complete wipeout of all shareholder interests in those—
Deputy Richard Bruton: What valuation of the loan book transferred to NAMA underpins those views?
Deputy Brian Lenihan: Bear with me for a moment. With regard to those two institutions, the current market assessment is based on their entire balance sheets which include the assets to be transferred to NAMA. Even on that basis the current market analysis is that they are viable trading entities based on their share price and rating assessments. That is why I speak as I do. I have to maintain confidence in a system in which world markets have confidence. When one speaks of the total wipeout of shareholder value it is unlikely to materialise on the basis of the information I have to hand and that will be the basis of my Estimates in the middle of September.
Now sit back for a moment and take this in.
Lenihan is saying that he knows the assets have a high enough value that the underlying losses won’t wipe out shareholder value. And he says that he knows this because the stock market says the banks currently have positive value! When he says “Why would I outline the fact that there may be a residual or substantial shareholder interest left in these institutions if valuations established that their entire shareholder value was wiped out? The reason is on the basis of the information that I have at my disposal” —it certainly appears to me that he is saying that even if NAMA came back and told him that the their asset purchases would render the banks insolvent, he would over-rule them, based on current share price valuations.
But anybody who has every studied financial economics knows that the stock market is valuing these banks based not on what the assets are truly worth but based on what NAMA is expected to pay. Bruton’s interjection is an attempt to explain this to the Minister. However, the Minister ignores it, ploughs on and essentially repeats the same point.
So there we have it. NAMA is a self-fulfilling prophecy. The markets expect something like a 20 percent discount. That’s built into the current share price. And the Minister will use the current share price to decide the discount.
It would be funny if it was happening somewhere else. To actually be living through this is very depressing.
The FT carries an interesting article today on the decision by Norway’s sovereign wealth fund to increase its allocation to green-friendly investments in the developing world: you can read the article here.
The ISNE annual conference takes place in UL on October 2nd. There are almost 60 speakers including PhD students from TCD, UCD, NUIG, UCC, NUIM and UL as well as researchers from a number of international institutions. The programme is now available on the link below. All are welcome to attend. No registration charge. The organising committee are Stephen Kinsella, Martin Ryan and Dominic Trepel.
This is a guest contribution from Luke O’Neill, in response to some of the criticisms levelled at his original Irish Times piece. Thanks to Luke for submitting the comment:
Good to see the debate on Science funding in Ireland proceeds apace. 2 things- first I’m always surprised at being accused of having a vested interest. Of course I have a vested interest having been at this profession for 25 years and really believing in scientific research as an extremely important activity that should in part be funded by governments. Doesn’t everyone have a vested interest of some sort?
The second thing I get accused of is of not providing enough facts. Well there are so many facts out there when trying to measure ROI and its been going on for years and years with no absolute answer. The one conclusion that most countries draw is that it is a good thing for governments to support basic research. I guess in Ireland since the budget is tight the question is can we afford it or not? If we decide that we can’t afford it I think this would be very negative indeed but obviously many think it would not be negative, although what they want instead is not necessarily spelt out. The question then arises as to where a govt should put its money regarding science and technology. What would be good would be for there to be a debate on this and to compare the alternatives with agreed metrics.
Today’s Irish Times carries an interesting article by Eoin McDermott, a chartered surveyor, on the issues relating to valuing property assets.