Forbearance and Bailouts for Builders

Today’s newspapers report (here and here) that control over Sean Dunne’s properties has been transferred to companies whose main shareholders are Ulster Bank, Co-operative Centrale Raiffeisen Boerleen Bank and Kaupthing (Iceland! Iceland!). Personally, I’m relieved that Mr. Dunne’s bankers are not in NAMA, so the Irish taxpayer won’t be at risk of making losses on his loans, either through NAMA overpaying them or through losses generated for state-owned banks. 

The fact that these non-NAMA banks have intervened on Mr. Dunne’s business reminded me of comments from Minister Lenihan in his Last Word interview on Monday. About ten minutes in, the Minister said the following:

There’s no one being bailed out here. Builders have to pay. We’ve already begun to see spectacular crashes among developers. They’re not being bailed out. That is another line of rhetoric we had to listen to for about six months last year, that this was all about bailing out builders. It’s not about bailing out builders and it’s very clear again to anyone who’s reading the newspapers now that it’s not about bailing out builders. Builders who are not paying their debts are going to the wall. That’s what NAMA’s all about.

I think what this misses is that all of the spectacular crashes that we’ve seen so far have come from developers who had the misfortune to borrow money from banks who didn’t get into the NAMA scheme. Perhaps I’ve missed them, but I can’t recall any stories about big developers being closed on by AIB or Bank of Ireland. Indeed, the contrary is the case. Instead there have been stories such as NAMA-bound banks lending Liam Carroll money to pay off unsecured creditors and accepting patently unrealistic business plans in order to give bankrupt developers more rope.

In addition, NAMA’s infamous draft business plan also states that eighty percent of the loans due will be repaid in full, though very little of the repayments will appear until 2013. This is essentially an official statement that NAMA’s officials are planning a program of forbearance for bankrupt developers.  When one factors in the fact that NAMA will have the power to extend further credit to certain developers, the difference between “extreme forbearance plus additional lending”  and “bailout” may appear to be something of a fine line.

All this means that, much as he would like to, it is unlikely that Minister Lenihan will be able to continue dismissing concerns about NAMA’s relationships with developers quite as easily as Matt Cooper allowed him.

53 replies on “Forbearance and Bailouts for Builders”

Good interviews given on Prime Time last night btw, to yourself and Colm. You got across the basic points quite well. Deputy McGrath had to squirm through a couple of awkward questions – but that is good for the public to see that, and good for deputy McGrath also – to experience what it feels like to be held to account on national television. One cannot do much more.

I am a kind of guy, who believes there is plenty-of-room-at-the-bottom, to resolve many of our difficulties. (Even with regards to property loans) But I am sure that boils down to training, occupation and influences, more than anything else. Working from the bottom, also carries the strange benefit, that one actually feels like one is making some positive contribution. It is nice to be able to refer to the grander, overview picture now and again though. Some of Constantin Gurdgiev’s contributions to The Frontline TV show with Pat Kenny recently, were interesting in that fashion. BOH.

Forbearance makes sense if you honestly believe that property prices will recover over the next 10 years.

I suspect that the Brianeanna (is the the plural for Brian?) honestly believe this, and experienced developers know best with how to make the most of it.

Its all quite logical once you start with the false premise that the developers made good decisions, its just that the market lacks confidence.

“Instead there have been stories such as NAMA-bound banks lending Liam Carroll money to pay off unsecured creditors and accepting patently unrealistic business plans in order to give bankrupt developers more rope.”

I have said this before I think. It is a mistake to think of the large Irish developers, actually, as builders. They started out as builders for definite. I have seen faxes and correspondance, to demonstrate they were still of a very build-er, technical, engineering mindset up until about 2000. (Before the madness started in ernest)

What I mean is, it would be hard for Liam Carroll to work his way back to a realistic business plan, in 2009, because by then, he had been effectively out of the builder game for a number of years. All in his organisation had travelled away from the paradigm of being build-ers, and on to some other world, where they were simply turning the handle on a money printing machine.

Derek Brawn’s explanation here sort of describes it:

http://www.tribune.ie/article/2009/sep/06/phantom-equity-could-haunt-nama-for-years/

It was hard for those of us, with Liam Carroll who still actually thought of ourselves as being in the building game. Because there appeared a cultural divide, between those who wanted to pretend they had left that culture, and it never was their core competency – and those of us, you liked having building as our core competency, albeit, also wanting to advance and develop as much as possible.

It is similar to the arguments about Conrad Gallagher, the famous Irish chef. Many of his colleagues said afterwards, at the end of the day, he was simply a chef. But had built up an empire, and seen the foundations shudder, and it came to the ground. Same thing, exact same thing. You leave behind the culture you originally came up with, because you believe, it is now beneath you, in some way. It happens with chefs, and it happens with build-ers.

The same thing happened at Porsche even, where they bought out Volkswagan in a corporate raid. Porsche have developed a whole separate kind of competency in financial trading, which has precious little to do with build-ing cars.

So the point is, calling Dunne, Carroll, McNamara etc build-ers, is a mistake. They posed less of a threat to Ireland’s stability when they were build-ers. McNamara actually understands that now. But some kind of ‘meme’ travelled around all of the large borrowers – some story was fed to them wholesale by the lenders – which they bought into. Some kind of a builder re-born story. It is like those off-shore accounts to avoid tax, which the banks pushed upon lots of large depositors a generation back.

The banks are always up to something, some scheme, which preys heavily upon the worst fears and predjudices of their largest, and otherwise unsophisticated customers.

BOH.

The alternative to forbearance would be something that would rapidly transform into a fire-sale. It would occur at a time when the Irish banks have neither the equity nor the liquidity to lend aggressively to potential purchasers. It would occur at a time when foreign banks were withdrawing from Ireland. It would transform a calamity into a wipe-out. Is this what anyone wants?

The fact that NAMA may delay realising assets (as per thier business plan) does not necessarily translate into forbearance for developers if NAMA has, in the meantime, secured a write-off of their positions and assumed a 100% equity position itself.

The other point you should note is that Sean Dunne is evidence that non-NAMA banks may leave developers with substantial equity positions even if, in Mr Dunne’s own words as quoted by the NYT, they “could be considered insolvent”.

Is that a bail-out? Probably not. It’s more probably a recognition that Dunne is best placed to extract most value from his sites and that the banks don’t themselves have the people to do that. It also avoids delays due to possibly messy and lengthy litigation should Dunne fight his corner.

Bottom line: maybe NAMA is a conspiracy against the tax-payer in favour of developers. But most probably it’s not however appealing that theory might be to those of a certain mind-set. NAMA is the least bad response to our current crisis as it:

a. avoids a fire-sale of Irish property assets.
b. will replace illiquid (developer loan) assets on the balance sheets of Irish banks with liquid (NAMA bond) assets thereby improving the liquidity of Irish banks.
c. will improve the equity position of Irish banks by overpaying somewhat for loans taken over.

“NAMA’s infamous draft business plan also states that eighty percent of the loans due will be repaid in full, though very little of the repayments will appear until 2013.”

Aside from delayed repayments, other aspects of the financial projections in this plan have concerned me. They centre on the differences between the interest income from borrowers (in the cashflow – table 5) and interest income (in the budget projections – table 7). I assume that these differences relate to rolled up interest – amounting to €4.96 bn for 2010-2 alone. More detailed analysis of the projections has raised questions about the accounting for rolled up interest arising over the ten years to 2020. These questions include:
1. What is the total rolled up interest over the ten years? I estimate that it could hit €10.9 bn over the ten years.
2. When is this interest paid and where is it accounted for in the cashflow projections?

Depending on the answers to these (and related) questions, I estimate, in the absence of any projected income statements and balance sheets, that the “real” default rate on the €7 bn loans taken over by Nama could be either 6% or 34%, in contrast to the plan’s assumed 20% default rate.

Having failed to get any response from the MoF, I passed my concerns to the Task Force Financial Crisis at the EU Competition DG.

My analysis is presented at
http://www.planware.org/briansblog/2009/10/nama—the-real-default-rate.html

Surely this desire to see a ltev above where we are now directly conflicts with any national competitiveness strategy?

Al

@ Cormac

I’m reluctant to get dragged back into defending myself against idea that anyone who is critical of forbearance is suggesting a quick firesale of assets — I wasted enough time on that last summer. Let me just say that I don’t see why one position has to imply the other.

I do think that a process involving a rational assessment of the position of borrowers, taking over assets of those who are hopelessly insolvent and then looking to get the best return on the assets would bring in a lot more money over the period 2010-12 than is assumed in the business plan. But that doesn’t mean I’m in favour of the …. F word.

@ KW,

“I’m reluctant to get dragged back into defending myself against idea that anyone who is critical of forbearance is suggesting a quick firesale of assets — I wasted enough time on that last summer. Let me just say that I don’t see why one position has to imply the other.”

Point noted Karl, we’ve all got it, thanks. BOH.

Whatever about not foreclosing on development loans, I cannot understand why developers are being left with the use of rental income from their developments to maintain (lavish?) lifestyles. None of the developers I know of have in any way curtailed their spending. It is hard to see how the taxpayer is not ultimately going to foot the bill for their ski holidays,black Range Rovers etc.. Seems crazy !

@ Cormac Lucey

“It would transform a calamity into a wipe-out. Is this what anyone wants?”

Yes. Anyone in the market to buy a property would want prices as low as possible.

The Business Plan suggests forbearance but no forgiveness (the plan expects to recover 100% on 80% of the portfolio). I’d gladly offer such forbearance, if it would deliver such recoveries.

@ Brian
Many of the plan’s flaws have been highlighted on other posts; though one which deserves a little more attention is where the 74bn (62bn principal, 12 bn interest) cashflow in will come from. Unless it comes from pension funds or private wealth, the “buyers” will require credit. And amounts of credit probably greater than the 54bn in bonds that the banks receive. So (although the type of debt might change) the banks would need to provide credit.

Given Irish banks need to shrink their loan books and the credit requirements for businesses, something looks ambitious.

@ Ahura
“The Business Plan suggests forbearance but no forgiveness (the plan expects to recover 100% on 80% of the portfolio).”

If my analysis is right, substantial rolled up interest (€10 bn?) could be forgiven.

Karl Whelan says:

“I think what this misses is that all of the spectacular crashes that we’ve seen so far have come from developers who had the misfortune to borrow money from banks who didn’t get into the NAMA scheme.”

Also, along another dimension – nationalisation. Isn’t it interesting, that only the nationalised Anglo Irish Bank was able to attract an external director? None of the non-nationalised banks, have done so. A lot of it boils down to the fact, Irish banks are way over-resourced with staff. As Michael Casey would say, their business models are poor and ineffective.

How is the external director going to change anything, if he or she doesn’t have the backing and support of the people? Is (temporary) nationalisation required to demonstrate this backing? And in turn attract external talent? One of the things the new Anglo Irish director did, was to slim down the staffing levels at that bank.

The way our Irish banks treated their customers – build-ers were there customers – shows nothing for the Irish bank-ing culture’s grasp of the concept Larry Fish, in the United States describes. That bank-ing is a service based industry. It is about showing a certain amount of courtesy to your customers. That is, not over-burdening them with debt, they simply cannot repay.

If you ask me, it goes back to the Ansbacher scandal, and other ‘off shore’ schemes the banks in Ireland were up to. The trouble is, in Ireland, we should have ‘clean-ed’ up the banks after that. We didn’t. We didn’t have the political structure, which would allow us to do a full clean-up. Apparently, we still don’t. My question of minister Lenehan: How much is that going to cost us, down the road?

I would like the banking inquiry to look at this: The banking culture which produced the ‘off shore deposits’ scheme, also produced the Irish builder mess.

BOH.

Cormac Lucey
You are assuming that the land etc will not further diminish in value. I hope you are correct, but the Brians have so far bet badly wrong on that score and I have nailed my colours on a deflationary depression.

The NAMA mess will then cost far more than a fire sale, which would liberate the land for work to be finished and the buildings occupied to the betterment of the country, but the monetary loss of developers and bankers and international lenders to bankers all of whom did not know their business.

Lowering costs is good for labour but not good for landowners? Lopsided, even stupid economic thinking, I am afraid. What do you do for a crust, Cormac?

@ Brian Flanagan,

I can see where you’re coming from on your spreadsheet, though I suspect the “Interest Income from Borrowers” is supposed to include the roll-up. The plan is too vague to be certain.

Reasoning (& using rough numbers): from page 10 bullet point 2:

“Based on data supplied by the institutions, it is estimated that 40% of the loans to be acquired by NAMA will be cashflow-generating (interest and principal) and that these loans typically pay an average spread of 2% over Euribor. Assuming no major adjustment in average margins, this will produce interest income of €12 billion over ten years.”

If we assume Interest roll-up is excluded from the “Interest Income from Borrowers” column, then in 2011, 40% of 61bn produces 1.6bn interest, which implies an interest rate of c. 6.6%. This seems too high for 2% over projected Euribor.

Assuming the 1.6bn includes roll-up, then the implied rate is c. 2.6%

It would be reasonable to ask if the 9bn roll up of the 77bn (page 7) has increased over the last 6 months and if this will get reflected in the haircut.

@ Ahura

Matters would be much clearer if projected P&Ls and balance sheets had been supplied for all years to 2020. It is very hard to see how anyone (EU, Government, Dail etc.) would consider an investment of billions in Nama without full proformas. I hope that Nama is looking for these from its own clients!!!!

We do know from the draft plan that interest income of €2.851 bn in 2010 (table 7) can be linked to borrowings of €62 bn at start 2010. This gives an interest rate of 4.63%. This was the starting point of my analysis to try and determine rolled up interest arising from start 2010 onwards.

Just one other point about the cashflows in table 5. What is the basis for spreading the €2.64 bn cash ouflow relating to fees/expenses evenly over the ten years. Surely, the highest costs will be incurred in the earlier years.

@ Karl

1. Ireland faces DEBT-DEFLATION in full flight. All of the elements which Irving Fisher set out in his 1933 piece are present in Ireland today:

• Over-indebtedness
• Distress selling
• Contraction of deposit currency (decline in money supply)
• Fall in level of prices
• Greater fall in net worth of businesses
• Fall in profits
• Reduction in output
• Hoarding (rise in savings rate)
• Rise in real interest rates

2. Courtesy of EMU, we are getting an INAPPROPRIATELY RESTRICTIVE MONETARY POLICY.

Firstly we had a decade where, using a Taylor Rule framework, EMU interest rates were too low for us. Our inflation rate exceeded the Eurozone average while our unemployment rate (proxy for output gap) was less than the Eurozone average ergo EMU interest rates that were too low.

Now we face many years where, using a Taylor Rule framework, EMU interest rates will be too high for us. Our inflation rate is well below the Eurozone average while our unemployment rate (proxy for output gap) exceeds the Eurozone average ergo EMU interest rates that will be too high.

3. ONLY OFFICIAL INTERVENTION CAN PREVENT A FIRE-SALE OF IRISH PROPERTY ASSETS. Left to its own devices, the economy would experience a speedy and brutal deleveraging along the lines of various pre-central bank financial crises in the USA during the 1800s as individual economic actors sought to exit the theatre before the fire reached them. Without official intervention, a system-wide fire sale would occur.

4. Left to themselves, and because they are rooted in leverage, the problems in the Irish economy would only deteriorate at an accelerating pace. The only way to prevent that is to somehow slow the pace of bank foreclosure to one the wider economy can cope with. NAMA is the government’s way of doing that. Of necessity, it is built on considerable forbearance.

I share criticisms articulated on this website and elsewhere regarding the generous asset prices that NAMA appears ready to pay. But I don’t think it will make much difference in the end as I expect the existing equity positions in the main Irish banks to be all but wiped out anyway.

5. I support NAMA as it a. prevents an asset fire-sale, b, improves bank liquidity and, c. improves bank equity. I do not see any alternative models that would be better.

It’s interesting that the long established firms Sisks and G&T Crampton didn’t end up in the knacker’s yard like the arrivistes.

Nevertheless, given the prime sites in Ballsbridge and maybe Dunne’s ability to generate cash flow, there is no need for the banks to pass the inevitable upside to someone else.

Developers are important in an economy and they acted as would be expected when the politicians and the banks did their bidding.

There was nothing more summed up the crazy year of 2006 when AIB sold part of it HQ to Dunne to feed its lending machine — basically AIB engaged in an accounting massaging transaction — at a time when the developer was already stretched.

The SFKL blog was looking at this too and noted the case of the Fleming group where the NAMA banks seemed to be again at odds with the non-nama banks.

We should be thankful that some banks were outside NAMA. Otherwise we would be seeing very little happening at all.

The problem with the various deflation arguments (from both left and right) it that we export about 80% of what we produce, and import about 60% of what we consume.

This makes a deflationary spiral a lot less potent in a small open economy.

Anyway, why would a fire sale be so bad? The only reason I can think of is the deposit guarantee.

The sooner the property market reaches an equilibrium and all the dead wood is burned in a fire sale the better.

A couple of observations from someone who has been a student of the property market for many years.

@Karl Whelan
I have always regarded the notion that NAMA is not a bail out for developers as being a bit Jesuitical. Clearly, an effect of the creation of NAMA is forbearance for developers provided with excessive loans by the banks. It is clear also that the intention of NAMA is to be an asset management company to allow for the orderly unwinding of excessive financing of property during the boom much as Cormac Lucey suggests. No doubt some developers who should have gone to the wall will survive because of NAMA. Some will not. No doubt also, decisions made by NAMA will have an influence on who survives and who does not. This is where cronyism will come to be an issue. The answer to this has to be setting up a regime where those charged with running NAMA do so on a way that can be trusted and they can be trusted themselves. Transparency about property deals, say by publishing transaction prices, would help the process greatly, something that should be done anyway to assist the property market generally.

There is much need to be concerned about our national reputation if NAMA is seen to be influenced by cronies of the political class. In the best of all worlds however, some developers who should have gone to the wall will survive. They will owe their survival to NAMA and in truth will have been bailed out.

It is important to note, however, that the NAMA process can work because it recognises and makes use of market realities.

In normal times most purchasers of property assets use finance to augment their equity. This is normally a prudent thing to do for both banks and property purchasers. Given the present constraints on banks, which effectively prevent the provision of property finance, property values are down to levels that reflect the likelihood that only those with ready cash will be in the market.

If anything like normal banking can be resumed it is reasonable to assume that property values will correct upwards somewhat. Thus the concept behind NAMA is reasonable. Of course the scale of the problem brings with it a great challenge but the process can work with a fair wind in the wider economic environment.

@ Brian O Hanlon
I think the distinction you are makeing when you refer to “build-ers” is important and needs to be explored.

Traditional housebuilders would regard development land as a raw material to be purchased infrequently in order to maintain a pipeline of production. Building projects take considerable time to work through and when they come to an end a workforce would be moved to the next site to provide a continuity of employment. The new site would have been bought some time previously and the necessary permissions obtained and preparatory work undertaken prior to starting building. In normal conditions builders can manage to buy land on reasonable appraisal models.

During booms, however, speculators move in and taking a bet on rising prices, buy land with the motivation of, to use the colloquialism , flipping it, perhaps after securing rezoning or planning permission by diverse means.

In the second, property led, phase of the Celtic Tiger era builders were often in competition with speculators for their raw material. They often lost out as they were either unable to raise sufficient finance or could not see how the project could work using their time tested appraisal models.

Inevitably some builders chose to become speculators and joined the fray. Some, the prudent ones, stood aloof and should now survive but the depth of the crisis is proving a real threat to them.

The advent of mezzanine finance and what might be called property carpetbaggers, facilitated by Anglo Irish, stockbrokers and other intermediaries as well as other banks later on in the process, exacerbated the upward pressure on prices, spiralling the boom justifying the speculation but, inevitably, only for a time.

I detect from some comments made by the CIF that there are builders who feel that the distinction between builders and speculators is important and now see debt fuelled speculation as having been the cancer in their industry.

It would be interesting to hear from the CIF on this.

@ Michael Hennigan

“there is no need for the banks to pass the inevitable upside to someone else.”

What inevitable upside?

@ Brian F,

I agree that more detail is required, but I don’t think it exists. Or at least nothing that links start to finish.

It’s not apparent how table 5 and 7 can fit together.

Equally, the logic of LTEV doesn’t sit with the Cashflows In ~ NAMA places a long term economic value of 54bn on the underlying properties, yet expects to generate 78bn (includes 4bn from asset recoveries). My understanding of LTEV is it’s what NAMA considers to be a reasonable future market value. If so, where will the borrowers find the 24bn gap.

With respect to your spreadsheet, I’d make a couple of observations:
1. Column Q: I suspect the interest amount shown in Table 7 seems to refer to contractual interest on 77bn (regardless of whether it’s being paid). As the NAMA model assumes 15bn defaults, it may be appropriate to adjust the interest amount by 62/77.
2. Column O: The Business Plan suggests only 40% of loans generate interest income. If you adjust the values in this column to infer the rate paid, you get values are a good deal higher than Euribor + 2%. This is why I think the Business Plan’s Interest Income may include Roll-up. It would be more appropriate to capitalize the rolled-up interest, but the NAMA plan doesn’t do this as the principal payments add to 62.1bn

@Ahura

Thanks for the comments. Tables 5 & 7 should fit together in the sense that they should be derived from the same fully-integrated proforma financial model – my “day job” is the development and sale of such tools to businesses!

On your observations:
#1. The interest income for the first three years has been taken from table 7 so the amount should not need adjustment. If this is not being paid when due, it should be either rolled up for eventual payment or written off. If the former, it is missing from the cashflow projections. If the latter, then the figures in table 7 are plain wrong.
#2. As you say the projections in table 5 don’t include any rolled up interest in the principal repayments. So where is it?

Overall, there seems to be about €10 bn in interest is “floating around” and hasn’t been explained. If I’m correct, this is a massive undisclosed subsidy/support and raises questions about the plan/projections used to secure Eurostat approvals last Autumn.

@ Michael Hennigan, Tom Dunne,

MH said:

“It’s interesting that the long established firms Sisks and G&T Crampton didn’t end up in the knacker’s yard like the arrivistes.”

Good point. When I post on this Irish Economy blog, I always try to work in some explanation, which tries to deal with the systemic problems in Ireland, as opposed to the individuals. (Carroll, Dunne, McNamara are all individuals) Even the example that Karl Whelan gives, of BOI and AIB lending to them, to give them more rope. What Karl Whelan doesn’t understand, not being up to his oxsters in build-er culture, is that Carroll, Dunne and McNamara had walked off the range, as far as their build-ing business was concerned. Saying they were still designing business plans to operate as build-ers, and pay ‘unsecured creditors’ misses the whole point. I know all the ‘unsecured creditors’ and here is how it was. The un-secured creditors would never have taken action against Carroll the build-er. In fact, they wanted Carroll the build-er to keep going. Carroll didn’t.

I have to use an analogy to explain this. It is like the teenage rock band. The drummer, the base guitar player, the support vocalists etc, the work-men and women in the band do all they can. But the lead singer gets ideas, and feels he is being held back by his band. He tries to figure out a scheme to ‘lose them’ but let them down gently. That is what it was like for Carroll in the last few years of the boom. In fact, Carroll attracted too much of the ‘old band’ around the place, after he had quitted. He attracted too much of the riff-raff, at a time, when he had become the largest investor on the Irish stock exchange. Billy Connolly in the movie, Still Crazy, about the band, Strange Fruit is about as close to a representation as you can get.

The systemic part I want to point out, looking at last night’s Prime Time, where the Dragon’s Den lady needed credit to fill her orders. She had orders for 3 no. times the amount of production she could fill. That was Liam Carroll 10 or 20 years ago. He was the guy in the Dragon’s Den, and all of his ‘unsecured creditors’ were working with him. The Irish banks did re-invent Liam Carroll and others, as ‘born-again build-ers’. Having got the guy out of the Dragon’s Den scale of enterprise, they proceeded to inflate and build up this figure. All the Strange Fruit’s could do was look from the side lines and scowl/weep.

That is what I find so hilarious about the Prime Time emphasis on credit for small and medium enterprise. You couldn’t get more ‘small and medium’ and Carroll’s operation 10 or 20 years ago. BOH.

@ all

Riddle me this. A country has a lot of property(& wants to sell), it also has a banking system that will be deleveraging it’s property portfolio for the medium term. Who lends to the buyers?

@ Just a punter,

The buyers (of the loans) more than lightly will be hedge funds. Not Mr. and Mrs. Joe Soap. This is what NAMA is about. Doing the pre-processing, so that the hedge funds can then do the packaging. It is like Intel in Kildare grows the silicon wafers. But Intel in Malaysia, packages the final product. If NAMA does it’s job properly, we can export this problem to some part of the globe, where they are looking for this kind of risk package. Long Term Capital Management turned these kinds of games all the time.

To clarify some issues. We are not a country with a lot of ‘property’. In some key areas of the country, such as Dublin, the over-supply isn’t the big problem. Growth will soak up that problem in due course. What we are, is a country with 3 no. times more debt on our shoulders than 10 years ago, and we have at best, only the same income producing capability. That is the problem, the property related loans. Not the property per se. What NAMA is selling, its raw product, is the risk that Irish people will sort out this ‘3 to 1’ ratio problem, in the next 10 to 20 years.

What the Irish bank(s) have is a concentrated exposure to the risk presented by those property-related loan(s). This prevents them from doing their job(s) in Ireland. Their shareholders are suspicious, and therefore capitalisation becomes a problem. Capitalisation becomes more expensive. Now here is the crux, that Karl Whelan and others may be pointing out. We took successive actions to solve a problem of capitalisation.

(Think of it like a patient in a hospital, and the patient has already been diagnosed and treated according to some visible symptoms. Our doctors must have been over-tired and over-worked, late that night when the patient arrived)

In our attempts at solving capitalisation, we ignored the bigger problem of insolvency. In other words, we might have made the initial problems worse, in how we handled the situation. This puts things in a different light, because now the hospital staff are fighting with one another, to try and figure out who to blame, for screwing up the patient. The patient in turn, now has more leverage with the hospital, because they messed it up. BOH.

@Just a punter
Well clearly the banks only lend on those developments where they hold the developer loan. They are ‘optimistic’ about the value of these. Everything else they are ‘pessimistic’ about.

Conflict of interest? I bet they couldn’t even spell it in your local branch…

@Cormac
I agree with most of what you are saying except for:
“Hoarding (rise in savings rate)”

Like Keynes, Fisher was living in a time of hard currencies. Therefore hoarding was a real possibility. It is not anymore. People don’t keep bags of gold coins under their beds, well, not unless they are surrounded by beans and shotgun shells. Savings are deposited where they are available for use. As banks can fractionally multiply these deposits into more assets (and so more deposits) excess savings are good…

Indeed, one might argue that we have come out of a period of excess savings where assets have been monetised and leveraged. The problem being not so much the amount on deposit, but the amount on margin (the leveraging of those deposits). Hypo Real Estate had a leverage ration of 99:1 counting its off balance-sheet dalliances on the north keys…

@Cormac Lucey:
“It would transform a calamity into a wipe-out. Is this what anyone wants?”

Yes.

Should I care who (as long as it’s not me qua me or me qua taxpayer) owns these sites and crumbling concrete?

But I’d prefer if we could have crucifixions as well. We could charge for admission (and sell TV rights), which would help to reduce the national debt.

bjg

@Karl Whelan

I wish you had the kind of PR/media resources at your disposal that FF do so that you could get things like this known to a wider (mass) audience.

As for journalists not challenging minister Lenihan when he comes out with guff like this….. don’t get me started. When I was first studying journalism, the first question we were taught to ask was “Is that true?”

There’s obviously too much attention in journalism these days on being able to build a website or scouring Facebook for photos of the recently deceased than there is on actually being a professional journalist and challenging what people say.

@Joseph,

I can only echo your heartfelt cry for much more “speaking truth to power”, but when that power is virtually absolute in a domestic context and is only constrained by the state’s involvement in sovereign debt markets and by the extent to which national sovereignty is pooled via international treaties it is “saothar in aisce”.

I used the example of the ‘Strange Fruits’ fictional music band above to try and illustrate a phenomenon. You could relate it back to nature – the lead animal and the pack. When the banks over-extended lending to property companies, the leader became detached from the pack. Neither leader nor pack, had any real coordination thereafter. To make a business plan work, requires a leader or a captain. Signed cheques may still arrived from the leader, but without instruction or guidance it is not much use. You can find yourself sailing a huge vessel, carrying billions of euro of debt. Where the lenders had managed to helicopter the ‘captain’ off the vessel. This is something the banking inquiry should look at. The banks knew these vessels were without a captain to navigate, and still they loaded them up with toxic cargo, with no destination port to sail to.

Ulster Bank extended enormous amounts of credit to Carroll to gain control of Greencore. Everyone working for Carroll said, he will be a genius if he pulls off the Greencore deal. The company doesn’t need a ‘genius’, but it does need a leader or a captain if it wants to execute any business plan. The major torpedo which sunk Carroll’s vessel was North Wall Quay. It was brought to a sudden hault, by the intervention of Sean Dunne, whose major lender was Ulster bank. We know Sean Fitzpatrick helped to rubber stamp, the permission for North Wall Quay development, which turned out to be false. We also know Fitzpatrick was trying to flog Anglo Irish to anyone who would listen, at that time. This is something the banking inquiry should look at. BOH.

“The major torpedo which sunk Carroll’s vessel was North Wall Quay.”

BTW, to clarify something: I don’t care about Carroll per se, but I do know a whole crew who had tried to keep that over-loaded vessel on some course, for a long time, deserved more than the raw deal which they got. BOH.

i don’t see why the same set of well connected people who steered us onto the rocks are those best placed to extract maximum value from “their” assets.

the next generation of builder/developers will in due course no doubt be well up to the task.

zhou_enlai

Well said! The well off are now even better off as Cormac Lucey has noticed the deflationary spiral in which they will be better off and need no incentive to save. Taxes increased and few people suffer! You begin to live down to your name, you old socialist you!

Joseph
If the masses knew, we would have a rerun of the French Revolution. Part of me looks forward to that, but the rest thinks it might not be a good idea! It maybe a superb lever to convince government to live up to the term! Brian J Goggin may have a good idea about the executions but it is not original. Bags I the Madame LaFarge caps concession?

Tod says: “i don’t see why the same set of well connected people who steered us onto the rocks are those best placed to extract maximum value from “their” assets. The next generation of builder/developers will in due course no doubt be well up to the task.”

It can go a number of ways. We need to bring in professionals into the picture more. There are problems with this however, as professionals have been excluded from the picture, and therefore lack sufficient experience in the trenches. The idea with construction, is that you divide the various tasks into specialities, and these specialities draw strict dividing lines around themselves, and work at arm’s length from one another. The important function that the builder/developer provided, was to glue this mess of remote experts together, into some kind of system, which could be financed and execute some work. Note, there are many stipulations with professionals, against their getting involved in anything sordid, that has to do with the business of building. It is a bit like the Jewish bankers, who were not prevented by their religion to charge interest. The old bankers of Venice found ways around that etc.

The problem with the system above, as I described is this: You send one group of people off to university and train them, educate them in the best models and to learn the best judgement. That party of experts, can communicate amongst themselves, the concepts and the ideals. But then, what happens in the boom, is another class of people, more motivated and driven, but with much less formal training become the drivers and decision makers of the industry. I would compare it to Steve Jobs at Apple. He was hardly what you could call a brilliant engineer. But he had the sense to travel up the road to Xerox Parc Laboratories, which invented everything in technology – they had 30% of the best brains in technology in the 1970s and 80s. The construction professionals in Ireland though, set themselves up to be raided is such a manner. Like Xerox Parc who had not intention of bringing any of their stuff to market, it took a motivated Steve Jobs to come along and go for the gamble. BOH.

All I really want to add to that, is a quote by Craig Barrett.

““What I said is that [having] smart people (good education) is important, smart ideas (investment in research) is important, and then letting smart people get together with smart ideas to do something is the third thing (the environment).”

I have found through my experience, that Craig is probably correct. However, we need the government in Ireland to create the environment – as far as construction goes anyhow. The government is good at being ‘the biggest employer in the country’ as Tanaiste Ms. Coughlan said. But what we also want the government to become, in the next couple of years, is like an investor. To fund and develop small teams to work together, integrating many different layers of the problem in some coordinated and intelligent fashion. This is something the private sector construction industry has found it difficult to do. I expect, all of the private consultants out there could become involved and become sponsors of such a program, in a way, by providing the human resources, young people, to a series of programs, designed to solve problems. In that way, the private sector would get to retain employees, fresh out of college, in some small way – but to allow them the experience of working closer with their fellow colleagues in other disciplines. I would imagine this model would work well, with many more industries too. I penned something called ‘The Shoe Box King’ at the blog recently, to describe what I had in mind. Minister for Foreign Affairs, Michael Martin, isn’t doing a bad job. But what other entreprises abroad really want to see, is working prototypes of a smart-er economy working in Ireland, at a youth-based level. Being smart-er, in 2010, has less to do with more gadgets I think, and more to do with the human relationships and smart-er cooperation amongst people. BOH.

@ Rory O’Farrell
You wrote:

” “It would transform a calamity into a wipe-out. Is this what anyone wants?” Yes. Anyone in the market to buy a property would want prices as low as possible. ”

@ Brian J Goggin made the same point.

Comment: true. A total wipe-out would be favoured by those with cash reserves who are looking for a real multi-decade buying opportunity.

I have no borrowings and I have cash reserves (in economic matters, I eat my own cooking) so I would profit personally from such a development. But it would be a calamity for Ireland and I therefore would rather if we, as a society, could avoid it. (Having a big house is a bit pointless if family and friends are in deep financial and personal distress).

@ Pat Donnelly
You wrote

” Cormac Lucey You are assuming that the land etc will not further diminish in value. ”

Comment: not so. I actually expect that further substantial price falls are still to come.

To take residential housing as an example, I believe that the long-run trend price was only one third of the actual 2007 peak in 2007. Since then both rents and incomes have fallen, meaning that the gap between trend price and peak price has got even bigger.

I further believe that actual prices will not drop to trend prices and stay there. I believe that they will overshoot on the downside because:

a. that tends to happen anyway in such circumstances;
b. we are now in a deleveraging, sub-par growth state; and
c. ECB monetary policy is overly restrictive for Ireland’s conditions.

The challenge facing policy makers is to minimise the overshoot on the downside so as to minimise the number of citizens/companies that are forced into bankruptcy during this process.

@ yoganmahew wrote

” @Cormac I agree with most of what you are saying except for:
“Hoarding (rise in savings rate)” Like Keynes, Fisher was living in a time of hard currencies. Therefore hoarding was a real possibility. It is not anymore. People don’t keep bags of gold coins under their beds, well, not unless they are surrounded by beans and shotgun shells.

Comment: not so.

In the 1930s the dollar ceased to be a hard currency when FDR broke the link with gold. He underlined this by then proceeding to expropriate gold holdings in the US.
http://en.wikipedia.org/wiki/Executive_Order_6102

In any event, a hoarding of cash or a net repayment of debts each have the same macroeconomic result: a rise in the savings rate. That was experienced in the US in the 1930s and is being experienced by us today.

Bottom line: debt-deflation has a contagion effect which, without official intervention to stem it, would lead to a much greater national economic calamity than a mere return to long-run trend values.

The remedies are (i) an aggressively reflationary fiscal policy, (ii) bank rescue and repair, and (iii) bank forbearance (not to avoid equilibrium values restoring themselves but to avoid trough prices way below those equilibrium values which would pauperise additional hundreds of thousands of citizens).

@Cormac Lucey:
“I have no borrowings and I have cash reserves (in economic matters, I eat my own cooking) so I would profit personally from such a development. But it would be a calamity for Ireland and I therefore would rather if we, as a society, could avoid it.”

Why would it be a calamity for Ireland?

bjg

@ Brian J Goggin

“Why would it be a calamity for Ireland?”

Because under our economic conditions …

a. massive property overvaluation;
b. massive private sector overleverage;
c. severely restrictive monetary policy conditions;
d. broken banking system; and
e. aggressively pro-cyclical fiscal policy

… property prices would probably fall very far below below their trend/long-term value, without an aggressive state response (NAMA or something like it).

The difference between allowing the property market operate freely (and fall to well below trend / long-term value) and intervening to limit the extent of property price falls (to somewhere near trend/long-term value) could be the difference between many tens of thousands of personal bankruptcies and some hundreds of thousands of personal bankruptcies.

@Cormac
“In the 1930s the dollar ceased to be a hard currency when FDR broke the link with gold. ”
Eh, the US dollar was only off the gold standard for a year, the link was re-established in 1934 at a lower rate. It was a devaluation and expropriation, not going off the gold standard. It was an attempt to overcome hoarding, in effect…

@ yoganmahew

Post I February 12th, 2010 at 11:52 pm
“I agree with most of what you are saying except for:
“Hoarding (rise in savings rate)” ”

Post II February 14th, 2010 at 3:04 pm
“It was an attempt to overcome hoarding, in effect…”

What exactly is your point?

My point is that hoarding is only a problem when you have a currency that is convertible to specie, whether gold, silver, land, or chocolate. The US in the 1930s only had a floating currency for about a year (1933-1934). The gold confiscations were an attempt to prevent hoarding which would have reduced the effect of the devaluation by dint of repegging the dollar to gold.

In the modern world, two things can happen easily without a keynsian hoarding effect:
1. You can buy as much gold as you like and bury it under the patio. Who cares?
2. If the central bank thinks that some of the currency in circulation is missing they can just print more. Physical notes make a tiny fraction of the notional currency that exists at any one time.

So a rise in the savings rate is not hoarding as Keynes would have known it.

If people don’t make their money available electronically by not keeping it on deposit (keeping it in current accounts for example), Central Banks can just legislate that one away – Mr. Greenspan authorised sweeps of checking accounts to increase the ‘efficiency’ of money usage.

My argument is not that there has been too much saving, but that there has been too much use made of it. Leverage ratios are too high, so savings have been recycled too much. Too much growth has been sought in an attempt to check recessions (a natural part of the cycle). The easy way to get growth now is to borrow from the future. That is what has been done.

@Cormac,

While NAMA is now the chosen vehicle for rescuing the banking system there has been insufficient attention paid to how it will operate. Basically, for it to succeed we need luck in terms of a global economic upturn and a rise in global inflation. Domestically, we need pro property policies from the government. The early indications are not favourable. The gradual withdrawal of mortgage tax relief, 80% windfall taxes, user charges all reduce the investment returns from investing in property or even buying v renting. Finally NAMA wil be the main owner of distressed property in the nation. Does it have the requisite finacial skills to maximise value for the state? We know very little about the qualifications of those runnning it. Will it be run to maximise value. The evidence internationally from asset recovery vehicles such as Credit Lyonnais in France is no supportive. Moreover, the evidence here in Ireland of the operation of state monoplies in any sphere is not comforting.

In short while NAMA may be the best idea available in theory, the likely outcome is going to be a disaster for future generations of taxpayers.

@Cormac Lucey:
“… property prices would probably fall very far below below their trend/long-term value ….”

Why would that, and the bankruptcies you anticipate, be a problem?

bjg

@ property gal

I agree totally with you.

NAMA (or something like it) is the right prescription (in my opinion) but that doesn’t mean it will work in rescuing the Irish economy from a savage reversal.

@ Brian J Goggin
” “… property prices would probably fall very far below below their trend/long-term value ….” Why would that, and the bankruptcies you anticipate, be a problem? ”

Answer: because without something like NAMA, the scale of bankruptcies (hundreds of thousands?) would so vast as to pauperise a nation.

Consider the scale of credit build-up in Ireland over the period 1997-2007. It was huge. I am not aware of many precedents for so quick a credit build-up. Implication: without official policy leaning against debt-deflation, we could face an equally vast bust.

Consider the the rise in Irish property values over the decade 1997 – 2007. It was also huge. I am not aware of any other countires where the rise was so huge over that period. Implication: without official policy leaning against debt-deflation, we could face an equally vast bust.

As a banker, you will be familiar with the concept of margin calls. As the value of a customer’s collateral falls, banks make margin calls: either invest fresh equity or liquidate the asset.

The further Irish property values fall, the greater will be the number of margin of margin calls that Irish banks should be making. The implications are:

1. The more margin calls are made, the further will property values fall triggering further rounds of margin calls. In debt-deflation, there is a contagion factor at work. Something like NAMA is needed to avoid this.

2. If Irish property falls go no further than down to trend / long-term value, the number of margin calls can be minimised and so too the extent of bankruptcies. Something like NAMA is needed to attempt this.

@Cormac Lucey:
“As a banker ….”

Moi? You may be confusing me with an unrelated person who is or was involved in trade.

But I still don’t see the problem with letting property prices fall. You seem to see the “vast bust” [memo to self: don’t make jokes] as a problem in itself. But you haven’t said what ill consequences the bust will have. Property prices would fall; folk would be forced to acknowledge that some of their “wealth” was imaginary. So what?

bjg

BJG

Apologies for confusing you with someone else.

We clearly have different opinions about the societal dangers of a truly vicious bust.

@Cormac,

If property prices collapsed to say 20% of their pre crisis levels, the banks capital cushion would be completely eroded & they would be deeply insolvent. In such a case, they would be unable to meet the claims of their bond holders and probably some of their depositors. The guarantee would be triggered and sovereign default would follow?

Alternatively, the state buys the toxic loans in a vain attempt to restructure them, warehouses them for a few years and given it is the Irish state, run by FF, fails to recover the full measure of value through a combination of incompetance and corruption. Result=sovereign default?

Given your insight into the working of the Irish state please handicap the outcomes.

@ Brian F,

Apologies for not replying sooner. I’m not saying you’re wrong. What you say is possible. Though I think it’s also possible that Interest Roll-up is included in Interest from Borrowers.

Below Table 5, Second Bullet point: “Based on data supplied by the institutions, it is estimated that 40% of the loans to be acquired by NAMA will be cashflow-generating (interest and principal) and that these loans typically pay an average spread of 2% over Euribor. Assuming no major adjustment in average margins, this will produce interest income of €12 billion over ten years.”

Working through a simple example, let’s assume it’s 2011 (full year) and 61bn outstanding loans. So interest income comes from 40% of pool. 61bn*40%*2.6% (asssume euribor @0.6% +200bps) = 634.4m, rather than the stated 1.6bn. If we assume the 1.6bn includes interest roll-up (i.e. 100% instead of 40%), then the 2.6% seems to work.

This does beg the question, where will the money come from to pay the coupon? I expect that NAMA would use lender advanced interest which is fairly common in MBS and very noticeable at present in Subprime pools. In effect the lender makes the interest payments for non-paying loans and this is rolled-up and deducted from recoveries at foreclosure. This supports cashflows for a period, but increases eventual loss severities.

@Ahura

Thanks for pursuing this with me. As previously stated, we are working off (very) incomplete data. Note that the interest income for 2011 (in table 7, budget projections) is €3.25 bn as compared with €1.6 bn (in table 5, cashflow projections). It was the difference between these interest figures that triggered my interest (excuse pun) and concerns.

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