In today’s Irish Times, Fiona Reddan has an interesting short article about Nama’s planned mortgage-enhancement scheme. The scheme is intended to unload some of Nama’s large inventory of houses and flats without unduly lowering property prices. The scheme, at least as it has been described so far, will work as follows. Suppose that Nama wants to sell a particular flat for €100,000. It will offer a buyer the following deal. The purchaser must put down €10,000 in cash, and take out a mortgage from a bank for €72,000. Nama will pay (itself) the remaining €18,000 and record the flat as sold at 10,000+72,000+18,000 = €100,000. If after an initial period, say five years, the fair market value of the house is more than €82,000 (the amount already paid by the homeowner) than the homeowner must “top up” the difference to a maximum of €18,000. If the fair-market value of the house is €82,000 or less at this date, the homeowner has no need to pay the remainder.
Author: Gregory Connor
The excessive flows of bank credit during the bubble, and the shortage of bank credit after the crisis, are key elements in Ireland’s current economic distress. Prior to the crisis, economists thought they understood the behaviour of bank credit flows, but we were sadly wrong. The talks at the conference next week explore the new research frontiers regarding bank credit flows and stability. The conference website now includes a google talk link where participants can pre-submit questions for the panel session, and links to some research papers associated with the presentations. There will also be an opportunity to pose questions during the conference panel session. The panel session will be chaired by Professor Karl Whelan of UCD.
There will also be opportunities for discussion/interaction during conference breaks. If you are a (quote) “faintly dim former rugby player” or a faintly dim rugby dad like me, there will be a corner of the coffee room where we can converse in whispers about the sport and its undeserved bad publicity.
After the planned new €24 billion equity capital injections are completed, the surviving domestic Irish banks will be highly capitalized, with equity-to-assets ratios[1] peaking at extremely high levels (above 20% except for BOI at 16%) and then declining (after projected losses) to still high levels (baseline 10.5%). For details, see this Irish Central Bank report. This puts Ireland in the vanguard of a new regulatory movement, across many countries, to impose substantially higher equity ratios on banks. There is strong and reasonably widespread support for this movement among academic economists and in financial regulatory bodies around the world.
Is Ireland an appropriate test case for this new regime of much higher equity ratios? Higher equity ratios provide a safety buffer for bank depositors and bondholders, but they also provide a safety buffer for bank management. Troubled banks can fall into the “zombie bank” trap in which management squanders new funds endlessly, in order to preserve established banking relationships with failing clients and/or to hide their pre-existing losses. Around the world, state-owned corporations are legendary for their ability to waste shareholder (taxpayer) funds. Will the presence of unusually large equity buffers tempt the managers of state-owned Irish banks toward wasteful and/or politically expedient behaviour?
I have two main points to make in this blog entry:
1. The enforced “over-capitalization” of Irish banks was the correct thing to do in the circumstances, but this new policy requires continuous monitoring. There will be numerous pressures to waste the “excess” capital — these pressures need to be resisted.
2. Ireland is now an important test case in the new international experiment with higher bank equity ratios. No one can predict all the effects.
Save the Date – Conference Reminder
On Friday May 20th from 4 pm – 7 pm there will be a conference on:
Bank Credit Flows and Eurozone Stability: Theory, Evidence and Policy Implications
at the Institute of Bankers, 1 North Wall Quay, Dublin. The conference is jointly hosted by the Financial Mathematics and Computation Cluster (FMCC) at UCD, the Institute of Bankers, and the Department of Economics, Finance & Accounting at NUI Maynooth. Admission is free. We encourage early enrolment to register a place. We are grateful to the Science Foundation of Ireland for their generous sponsorship via a grant to the FMCC.
This article by Martin Walsh in the Irish Times has some convincing analysis (unfortunately the graphics are not shown in the on-line version), and some thought-provoking comments on the Irish government policy conundrum regarding residential house prices. As Martin Walsh notes, to minimize expected future (state-owned) bank losses and Nama losses, policymakers must hope that prices have now fallen to their steady-state equilibrium level. But for the purposes of restoring competitiveness, continued house price decreases would be better.
“… it seems that there is a real dilemma at the heart of national policy. Do we prioritise competitiveness by bringing house prices back into line with incomes or keep them inflated in the hope of reducing further losses to the banks and Nama (National Asset Management Agency), as well as containing the extent of negative equity?”
Most importantly, by most long-term metrics, current house prices in Ireland still seem to be above sustainable levels.
What actions (if any) should Irish policymakers pursue regarding stabilizing the residential housing market, and to what ends?