Monday, July 27, 2009

Economics 27/07/2009: NAMA, ILandP rate hike, US home sales and redemptions

So NAMA failed the first day of Cabinet debate. We know this much - even RTE managed to issue a post, although the Montrose boys lacking anything real to report managed to produce a cheerful note on the debacle. Oh, how much they want the State to succeed in soaking the private sector...

But what really hides behind the Cabinet in-decision? Well, it is rumored that not the (allegedly) ethical Greens, but Mr Cowen's own troops are unhappy about NAMA. Some senior ministers, as I hear, are saying 'Hold on, we'll have to face constituency out there one day and you are about to load an average person (25 yo+) in this country with some €20K in fresh debt from the bankers and developers alone'. Good for them. And I certainly hope the Greens also stand up and tell Mr Cowen where to pack that NAMA idea.

Oh, and apparently, the DofF men are saying that the 'long term economic' value under the NAMA formula will be based on, well, more than 5 and less than 9 years. Hmmm... What does this mean? It means that NAMA should be expected to break even (at the very least) were we to price the property assets to be purchased into NAMA on this 'long term' valuation basis. Ok... but...

First there is one majour issue here - in real world of economics, long-term market value usually means a long-term past average or trend. What it means for NAMAphiles is thatwe will be forecasting the values forward over some long-term horizon. Anyone familiar with forecasting knows that this, in reality, means that we will be in a completely arbitrary forecasting territory. In other words, for DofF to say we want to take current discounts based on future values projected 5, 7, or 9 years ahead is like saying 'we'll name the price and then justify it afterward'.

But wait, there is also a problem with the way the DofF is allegedly timing the cycle.

Calculated Risk blog (see below) - the top forecaster for US housing market shows expected time to the bottom in price in the US residential market of 5-7 years. Do you think we gonna get there in this time here in Ireland? No. We have had worse correction in the market to date than Japan, who are 20 years into the downturn in their property markets and still not seeing the light at the end of the tunnel.

And NBER research paper 8966 (BOOM-BUSTS IN ASSET PRICES, ECONOMIC INSTABILITY, AND MONETARY POLICY by Michael D. Bordo and Olivier Jeanne) has a handy set of charts at the end, showing the most recent busts in property markets in the OECD economies. Ratios of boom length to bust duration are (defining as boom - trough to peak prices, bust - peak to trough):
  • Australia 1980s: 3 years of boom, 7 years of bust: ratio of 3:7;
  • Denmark 1980s: 4 years of boom 7 years of bust: ratio of 4:7;
  • Finland 1990s: 4 years of boom, 6 years of bust ratio of 2:3;
  • Germany 1980s: 4 years of boom, 7 years of bust: ratio of 4:7;
  • Ireland 1970s-1980s: 3 years of boom, 7 years of bust: ratio of 3:7;
  • Italy 1970s-1980s: 3 years of boom, 6 years of bust: ratio of 1:2;
  • Italy 1990s: 4 years of boom, 6 years of bust: ratio of 2:3;
  • Japan 1970s: 2 years of boom, 4 years of bust: ratio of 3:4;
  • Japan 1985-today: 6 years of boom and 19 years of bust: ratio of 6:19;
  • Netherlands, 1970s-1980s: 4 years of boom, 8 years of bust: ratio 1:2;
  • Norway 1980s-1990s: 4 years of boom, 6 years of bust: ratio 2:3;
  • Spain 1970s-1980s: 2 years of boom, 5 years of bust: ratio 2:5;
  • Sweden 1970s-1980s: 4 years of boom, 7 years of bust: ratio 4:7;
  • Sweden 1980s-1990s: 3 years of boom, 7 years of bust: ratio 3:7;
  • UK 1970s: 2 years of boom, 4 years of bust: ratio 1:2;
  • UK 1990s: 4 years of boom, 7 years of bust: ratio 4:7
So average ratio is 1.874 years of bust per year of boom... and that means that, given we had 5 years of a boom that the historical data suggests a bust of 9.4 years duration at an average. That is 9.4 years to a trough in Irish property prices! Not to a realization of some miraculous 'long term economic value', but to a trough.

Well, let's take a look at the same data from the point of view of time to full return to pre-crisis property prices, or peak to trough (nominal prices):
  • Australia 1980s: 18 years from 1981 through 1998;
  • Denmark 1980s-1990s: 8 years (1979-1986) and 13 years (1986-1998);
  • Finland 1990s: 1989-2004 or 16 years;
  • Germany 1970s: 1973- today... oh yeah, right - some 36 years;
  • Ireland 1979 to 1995 or 17 years;
  • Italy 1981- through today... right, so that's about 29 years;
  • Japan: 1973 through 1986: 14 years;
  • Japan 1990- today: 20 years;
  • Netherlands, 1978 through 1998: 21 years;
  • Norway 1987 through 2003: 17 years;
  • Spain 1978-1987: 10 years;
  • Spain 1991-1998: 8 years;
  • Sweden 1979-today or 31 years;
  • UK 1973-1987: 15 years;
  • UK 1989-2000: 12 years.
So average peak to trough for 'long term nominal economic value' is 17.8 years. Again, given our peak at 2007 we have to look forward to NAMA recovering peak valuations at around, hmmm... 2026... But wait - not all corrections were steep enough to match ours... so let's isolate those that were:
  • Australia 1980s: 18 years;
  • Finland 1990s: 16 years;
  • Germany 1970s: 36 years;
  • Italy 1981: 29 years;
  • Japan 1990: 20 years;
  • Netherlands, 1978: 21 years;
  • Norway 1987: 17 years;
  • Sweden 1979: 31 years;
  • UK 1973: 15 years
Which yields an average of 22.6 years, pushing our recovery to beyond 2030. By this standard, a break even value for NAMA should be based on something closer to 15-16 years, if we are to take a 20-25% haircut on current book values of the loans.

So DofF is talking about under 9 years then... I see... ah, the poverty of expectations...

The Government has time to get it right - they have the entire month of August to sort the new piece of legislation on NAMA, outlining in details:
  • Provisions for taxpayer protection;
  • Complete and comprehensive balance sheet and cost/benefit analysis of the undertaking;
  • Exact amount of equity the taxpayers will receive in return for NAMA funds (hmmm, 100% would be a good starting point);
  • The exact procedures for divesting out of the banks shares in 3-5 years time with exact legal obligation to disburse any and all surplus funds (over and above the costs) directly to the taxpayers in a form of either banks shares or cash;
  • The formula for imposing a serious haircut (60%+) on banks bond holders, possibly with some sort of a debt for equity swap;
  • A recourse to all developers' own assets - applied retroactively to July 2008 when the first noises of a rescue plan started;
  • The list of qualifications for any bank to participate in NAMA, including, but not limited to, the caps on executive compensation at the banks and the requirement to set up a truly independent, veto-wielding risk assessment committee at each bank with a mandatory requirement for a position of a taxpayers' representative on the board that cannot be occupied by a civil servant or anyone who has worked in the industry in the last 10 years;
  • Provision for a taxpayers' board, electable directly by people, to oversee the functioning of NAMA;
  • A condition that the banks must undergo loan book evaluation prior to transfer of any loans to NAMA, the results of which will be made public - on the web - instantaneously - and will impose a requirement on the banks to write down their assets, again before NAMA purchases any of them, by the requisite amounts to balance their own books in line with valuations;
  • A condition that any loan purchased by NAMA be placed on the open market for the period of 2 weeks and that NAMA will not pay any amount in excess of the bids received (if any), with a prohibition for the participating banks to bid on these loans;
  • A condition that every NAMA loan should be publicly disclosed, including its valuations and bids it receives in the auction stage of the process;
  • A stipulation that all and any regulatory authorities (and their senior level employees) that were involved in regulating the banking and housing sector in this country take a mandatory pension cut of 50% and return any and all lump sum funds they collected upon their retirement;
  • A provision for dealing with the speculatively zoned land to be acquired by NAMA, i.e orderly de-zoning of this land and transfer of this land to either public (if no bidders arise) or private use consistent with sustainable agricultural development, environmental improvements, public use or forestry;
  • The measures to prevent banks from beefing up their profit margins through squeezing their preforming customers;
  • The measures to force the banks to reduce their cost bases by laying off surplus workers;
  • The measures for accounting (in a transparent and fully publicly accessible fashion) on a quarterly basis for NAMA operations and the performance of the state-supported banks.
If I forget something, please, let me know...

Oh and on the topic of IL&P predatory rate hike for adjustable rate mortgages, here is a brilliant argument as to why Minister Lenihan must intervene to stop the practice of soaking the ordinary consumers to pay for past banks follies. Read it and think - can any government, acting in the interest of the broader economy and taxpayers and voters be so reckless in its attempts to hide behind 'protecting the markets' arguments as to willingly sacrifice its own people on the altar of cronyism. And do remember - I am a free marketeer, and a proud one, yet I see no moral strength in Lenihan's arguments.

US data is now showing more serious signs of an uplift... or does it? Sales of new homes rose 11% in June is a sign that some decided to interpret as a return to growth. I wouldn't be so trigger happy myself - this is the largest rise in new homes sales since... oh you'd think like somewhere in 2006? no - since November 2008. This is volatile series and the seasonally adjusted rate of 384,000 new homes sales in a month is, while impressive, way off the old highs. Thus sales are still down 21.3% on already abysmal levels of 2008 so far this year.

Here is what my favourite US housing guys - - had to say about the latest rise: a W-shaped bottoming out is coming. And a superb chart from the source:
Or, in the words of the blog author:"There will probably be two bottoms for Residential Real Estate. The first will be for new home sales, housing starts and residential investment. The second bottom will be for prices. Sometimes these bottoms can happen years apart. I think it is likely that we've seen the bottom for new home sales and single family starts, but not for prices. It is way too early to try to call the bottom in prices. House prices will probably fall for another year or more. My original prediction (a few years ago) was that real house prices would fall for 5 to 7 years (after 2005), and we could start looking for a bottom in the 2010 to 2012 time frame for the bubble areas. That still seems reasonable to me."

And to me too. But what I would caution against is the optimism for the overall property markets. Here are two tidy little reasons:

One: US equitable redemptions are the lags between the property being reported as a non-performing on the loan book of a bank and the time it hits the foreclosure market. Now, these vary by state, with some states having no er provision at all, while others having 9 months plus. The US average is about 4 months. This is what is yet to be reflected in the 'distressed' sales gap - the gap between new home sales and existing homes sales. Chart below illustrates:
Again, the distressed gap is not closing, but both series are pointing up. Now, notice that around November 2008-February 2009, the days of the most fierce destruction of income and wealth worldwide, the number of existent properties on the markets did not rise. Why? The ER lags are kicking in. So take the average of 4 months and get June 2009 to start showing an increase in existent homesales rising - foreclosures are feeding in. This process is likely to continue through months to come.

Two: I would watch the maturity of securitized commercial loans... these are still looming on the horizon for the roll-over (and they are also a problem in Ireland, where most of commercial property lending was securitized)... Comes autumn, expect things to get tough once again... Oh, and then NAMA will coincide with the already tightening credit markets and will take a large chunk of liquidity our of the market... Gotta love that Lenihan/Cowen timing - like two elephants trying to dance polka at a Jewish wedding - loads of broken glass, but not to the delight of the newlyweds...


Unknown said...

You seem to be very dismissive of what is a stated government commitment to force house prices back up to previous levels in the next 5-9 years.
With a heavy hand on planning regulations it is surely possible to reduce the stock overhang and favour the NAMA assets at a slow enough rate to force prices back to 2007 levels.

This is what the department of finance is committing to, right?
Or am I missing something?

Anonymous said...

NAMA is in my view unworkable.

It is akin to the Versailles Treaty in 1918 when the victors imposed punitive war reparations on Germany.
It destroyed the productive capacity of Germany and hurt the wrong people ,its ordinary civilians.
In time it generated politics of resentment which coalesced into nazism.The versailles treaty was circumvented by the germans at every opportunity and soon they were expanding their military in violation of the Treaty.

NAMA is being imposed on the ordinary folk who had little responsibilty for corrupt politics and the fake boom.
It is ,I believe,the patriotic duty of every Irish citizen to thwart NAMA.

Regarding the US real estate market:

There are many anomolaies which can distort stats in the US unless viewed over a long period of time.
For instance mortgage applications were counted as housing sales in some States even if the mortgage did nt go through.

Also honeymoon conditions will soon expire on many mortgage loans.These include interest only for 3 years or a teaser interest rate for the first couple of years.
The obama administration were trying to pressure the banks to extend the periods of these teaser rates to ease foreclosure.


Another John M said...

Regarding Permanent TSB's predatory rate hike: This is a terrible move for consumers. It is also the sting in the tail of low rates. I was expecting them to go up but I had been looking at a recovering Germany to drive rates higher.
Slapping struggling households with this rate hike will further tighten the screws and embolden the banksters in the other institutions to follow suit.
Personally I am on a tracker mortgage. When rates began to fall I pegged my mortgage repayments at the high value. I thought I would pay off the debt earlier, right?
Wrong, the Clowen Economic Posse started in on levies and tax hikes. Like most middle-class people we don't have a lot of money to spare. After the last batch of tax hikes I had to go back to my mortgage holder and reduce my payments.
This situation is playing out across the land, except many are in worse pain because of unemployment or partial layoffs.

Martin said...

Should the Banks be allowed to fail? They are private institutions after all. Would it not make more sense to use the money that is being ploughed into NAMA to setup new state banks that could be floated on the stock exchange at a later date.

MK1 said...

Hi again Constantin,

The boom bust duration ratio's are of interest but they are not statistically comparable or scientific. Why? Because they a nominal, priced in local currencies and hence dont take into account significant fctors such as real inflation, currency exchange rate fluctuations, etc.

What we can take and what is well known is that bubbles inherently go up faster than they come down. Prices of property are sticky on the way down. Thats why reaching the so-called bottom can never be an overnight or rapid change. The supply-demand push and pull dynamics of an economy will be a factor.

Average wages and disposable income and the availability of credit and the amounts will play in. As will human sentiment, that nebulous factor which has lemming-like qualities yet will defy any economic modeller.

Martin said: Should the Banks be allowed to fail?

Yes, they should have, and we the state could have come in and picked up any crumbs that any private companies didnt want and at rock bottom prices.


TrueEconomics said...

Great comments. Thanks to all. I am nursing my son today, so my posting is a bit restricted a little bit, but do keep commenting. One note off the start - this blog broke 1,500 readers mark yesterday, so people are starting to get involved and are opening their eyes to what's happening in the corridors of power.

David: I am dismissive of the commitment to push house prices up. I am in a negative equity myself, clearly, but I do realise that we need to lift our real economy before we can return to house prices. And I do not believe that our Government has done anything to improve either the real economy or the housing markets. The idea that NAMA is going to reduce over-supply of properties is a naive view of the undertaking. NAMA is more likely to perpetuate the disastrous state of Celtic Tiger planning, zoning and development that got us into this mess in the first place, because this Government has no incentives and no guts to tackle the unsustainable idiocy of our spatial 'development' policies. They are accustomed to building bungalow blitzes around the country in a hope of fulfilling the naive dream of Kevin Kostner's 'If you build it...' Oh no, no matter what you build in the country, no one will come there just because there is a shining Celtic Tiger monument placed in the middle of the fields. What NAMA will do is to derail the relatively chaotic, but necessary process of creative destruction that our markets have been undergoing. We desperately need higher density high specs and quality urban development in Dublin brownfield sites (Spencer Dock to Poolbeg). We desperately need improvement of quality of our countryside as a back up for recreational and environmentally sustainable services - sustainable recreation and tourism, higher value-added agriculture. None of this will or can be delivered by NAMA. Hence what we need is a breakdown of the loans and zoning on many land sites, we need a forceful cleansing of the speculative and demand-irrelevant projects. De-zoning of some land. Re-pricing of other land. We need to give breathing space to those few developers who actually build what cities of Ireland demand.

TrueEconomics said...

Anonymous: spot on - NAMA is being imposed onto ordinary people who had nothing to do with the corrupt practices in zoning, land speculation or development. The worst we can pin on the ordinary Irish participants in the housing boom is that they rationally responded to the incentives created by our policymakers. To punish them for the acts of the few is to promote both the moral hazard and unaccountability.

On your point about the US housing - correct again. The resets of Alt-A mortgages peaks next year and is rising right now. If the Fed keeps interest rates at the current levels, the adverse impact of these resets will be minimised. But, if there is renewed inflationary pressures or the banks move in to improve profit margins (as IL&P is doing here), then the US housing market will see another significant dip.

Another John M: the problem is not only with the banks, and the banks-supporting Government of ours, but as you pointed out - with the overall economic policy. Mary Coughlan - in charge of Enterprise policy in this country has absolutely no capacity to understand basic economics. Brian Lenihan, in charge of the fiscal policy here has absolutely no capacity understand a common productive factor for all economic activity. Brian Cowen, well, I wonder if he can understand anything at all, including the Sunday papers he reads. The basics are simple: entrepreneurs take risks, workers produce added value, investors provide capital. All three have no incentives today to do their jobs in Ireland courtesy of the reckless destruction of wealth and income undertaken by this Government and courtesy of feudal system of privileges awarded to the public sector and trade unions. This economy cannot function even at a basic theoretical level. Full stop. We need to either have a Boston Tea Party or to elect a functional Government. I am a Democrat, which means that I would support the latter, were it a feasible alternative. Given the quality of our opposition - it is not. So my civic duty calls upon me to actively resist this Government in its attempts to destroy my own family well-being. Like in the 1980s - when endemic corruption of elites and predatory state practices fully warranted public withdrawal from financial participation with the Exchequer, today we have a civic duty to do everything possible within constraints of the law to reduce our tax liability. It is a role of a responsible person denying a drug addict money to purchase more drugs!

TrueEconomics said...

Martin: yes, the banks should be allowed to fail. We can provide support for BofI and AIB and IL&P - that's all. And this support must be provided after they properly reprice their books. My post lists measures that have to be taken before we undertake any public financing of the banking sector and yes, these measures will lead to the Exchequer taking virtually 100% control of these banks equity. First Tier 1 capital is written off, then Tier 2, and so on, before a single hard earned penny of an Irish resident should flow to them. And no, we don't need new banks - we can recapitalise the existent ones once they have depleted their capital bases in taking write-downs and once we have control over them. If we give them public money, we must take over the deeds!

MK1: your point on validity of comparisons is correct - I do mention in my post that these are not PPP-adjusted prices. This makes, however, my case against the lunacy of the DofF 'benchmarks' of 5-9 years even stronger. You see, what gets me is that we pay these people six figure salaries to produce the simpleton analysis that does not even hold by their own - error-prone - measures. That is my point, not that I am trying to actually time the correction in the Irish housing markets.

CoachingByPeter said...

Every investment has risks and drawbacks. The important thing is to recognize them, to be aware of what can happen to your investments, and to make sure you aren't exposed to risks you can't afford.

MK1 said...

Hi Constantin,

Thanks for your detailed responses and I'm sure I speak for the other posters on that. Child-minding or not, you gave these responses a lot of attention.

Constantin: We need to either have a Boston Tea Party or to elect a functional Government. I am a Democrat, which means that I would support the latter, were it a feasible alternative. Given the quality of our opposition - it is not.

It will take a lot more pain for there to be a revolution of sorts. Politically, whilst the alternatives may not seem too attractive, they at least should be tried. What I find strange is that there doesnt as yet seem to be a ground support to produce a new alternative party.

I am sure if a few of you economists got together to instigate a new Party that something could be done and a new alternative could get a lot of support IF their policies seemed reasonable. I am sure that a new party would attract like minded folk and perhaps seem defections from the legacy parties.