Friday, February 26, 2010

Economics 26/02/2010: EU Commission decision on Nama

The EU Commission has granted its nod of approval to Nama (here). The Note states that:

"The Commission has found that the establishment of NAMA constitutes state aid to the participating institutions pursuant to Article 107(1) of the TFEU, but that this aid is compatible by virtue of Article 107(3)(b)."

It is therefore clear that Nama is a form of aid. If so, who are the logical recipients of such aid - and there simply has to be someone benefiting from aid. How does this square against the Irish Government repeated statements that Nama is not a rescue plan for either the bankers or the developers.

"The scheme and intended operations of NAMA are in compliance with the guidelines set
out in the Commission's Communication on the treatment of impaired assets (see IP/09/322 ) as regards disclosure and ex ante transparency, eligibility of institutions and assets and the alignment of banks' incentives with public policy objectives."

Emphasis above (mine) relates to the following issues:
  • Transparency: what transparency does the Commission have in mind, given that Nama is set to report only to the Minister for Finance and will operate under the veil of total secrecy, outside constraints of public scrutiny?
  • Alignment of banks' incentives with public policy objectives: does the Commission seriously think that incentives for the banks to repair their balancesheets through increased lending margins and higher costs, or reduced competitiveness in the banking sector due to Nama subsidy to select banks, or the need for recapitalization by the taxpayers post-Nama constitute properly aligned incentives for the banks to act in the interest of the public?
"In particular, the Commission has found that the scheme includes an adequate burden sharing mechanism through the payment of a transfer price which is no greater than the assets' long-term economic value, and the inclusion of an adequate remuneration for the state in the rate used to discount the assets' long term economic cash flows."

Of course, when the Commission is talking about public policy objectives, what they mean is the alignment of the scheme incentives with the principles outlined by the Commission. In other words - by focusing on the erroneous objective of ensuring long-term economic value consistency of valuations, the Commission is confusing public interest (interest of ordinary Irish taxpayers) with its own interest (interest of the Brussels to see compliance with its own regulatory framework, which in itself is a simple deus ex machina for concealing the reality of this state aid).

"Today's approval concerns only the NAMA scheme. The Commission will assess the compatibility (and, in particular, the actual transfer price) of the transferred assets when they are separately notified by the Irish authorities. These individual reviews will include a claw back mechanism in case of excess payments."

This is significant as it introduces a new layer of uncertainty for the banks - post-Nama, the banks will remain exposed to the Commission decision on valuations, which in effect will extend Nama process indefinitely, delaying any potential positive effect of Nama.

"Finally, the Commission relies on a number of commitments from the Irish authorities to ensure that NAMA, whilst it performs its goal of maximising the recovery value of the purchased assets, does not lead to distortions of competition through the use of some of the specific powers, rights and exemptions granted in the NAMA Act."

What are these commitments?

In short, the Commission decision on Nama is as holes-ridden as Swiss cheese and signifies a simple pro-forma sign-off on the scheme.

Finally, in his response to the Commission decision, Minister Lenihan stated that:

"Within the [Nama] valuation methodology a higher remuneration risk margin and higher enforcement costs will be applied. There will however be a reduction in the interest rates used for loan discounting purposes. "

This is significant as well, as a reduction in interest rates implies that the long term economic value valuations will have lower rate of discounting to the present value, thus leading to higher rates of over-payment on the loans. In other words, to keep discounts on assets artificially lower, the Government simply can reduce the cost of capital and increase real return on assets by 'cooking' up lower discount rates.

Of course, one must ask Minister Lenihan why exactly does he (or Nama) envision that the interest rates are going to be lower in the future. I know of not a single forecast out there that envisions the yield curve pointing down in the future.
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