Tuesday, August 4, 2009

Economics 04/08/2009: NAMA, Liam Carroll & Short Termist Bonds

I should make it a habit to direct every NAMA post reader to my proposal for NAMA 3.0 here.

Yeps, Supreme Court came in on the side of the Government, throwing a lifeline to NAMA and forcing taxpayers into deeper losses. My earlier note stand now (see here) with all the gory implications for losses on Mr Carroll's loans now being back in the NAMA court.

But two birdies have chirped to me that there is more brewing up in the land of NAMA-fantasy. Apparently, the rumor has it, the Government plan is to issue short term bonds to cover NAMA liabilities. Given that NAMA will start issuing bonds in 2010 for this undertaking, the short term nature rumored is for a 2011-2012 bonds.

This, if true, makes no sense for several important reasons. Here are some:

(1) Issuing short-term debt with maturity before 2013 is equivalent to a financial suicide. The reason is simple - there is no credible (or for that matter even an incredible one) commitment from the ECB that
  • such issuance can be rolled over at the same or lower interest rates to cover maturing bonds; and
  • the EU will allow these bonds to remain off the balance sheet of the Government upon the roll over.
(2) Issuing short term bonds will be a fiscal suicide, for their maturity, and roll-over date, will fall dead on in the years of heavy Exchequer borrowing and maturity of other - 2008-2009 issued bonds. Given that the market demand for fixed income paper worldwide will be thinner then (due to increased appetite for equities-linked risk), a flood of rolled over bonds can risk derailing the borrowing programmes for Irish sovereign debt. Now, if you are a forward-looking investor, expect Irish yields to run away from the benchmarks once again, then.

(3) Short term maturity does not take into account the main risk to NAMA valuations, namely that by 2011 or for that matter 2013, the assets taken over by NAMA will be priced at any significant upside relative to what NAMA will pay for them, implying that, under short-term issuance, this Government will face the need to
  • engage in a massive refinancing operations
  • at the time when its balance sheet liabilities will be almost at their peak (see Department of Finance projections);
  • pay higher expected cost of borrowing than today; and
  • potentially, load the NAMA liabilities onto Government own balancesheet, while
  • facing market prices and demand for real assets that is well below the valuations applied by NAMA.
If you look at the latter point. DofF uses 7 year U-shape cycle as its basic assumption. Peter Bacon last week stated that the cycle is expected to be 5-10 years. My estimations, based on NBER research (here), show that the average duration of the U-shaped cycle in historical data for OECD economies for 1970-2003 episodes of house prices collapse co-measurable with the one we are experiencing today is between 18 and 23 years. This range is dependent on how you time the cycle, but it refers to a nominal price cycle, unadjusted for Forex devaluations that accompanied such cycles in other countries and inflation. Japan (in down cycle since 1989-1990), Germany (since 1972-73), Italy (since 1981) and Sweden (since 1979) have not recovered to date.

Considering rolled up interest charges on impaired loans, banks' restructuring of interest payment schedules on so-called 'performing' stressed loans that in any other country would be classified as having defaulted, NAMA will be purchasing assets from the banks at an extremely shallow effective discount.

For example, a discount of 30% applied to a loan with 1.5 years (since July 2008 through December 2009) rolled up interest at 10%, and a built in re-financing cost of 1% will be equivalent to an effective discount of just 18.1% relative to the original principal of the loan itself. If, in the mean time, the underlying asset value itself has depreciated by, say 40%, then
NAMA will be buying a Euro 60 asset for Euro81.86. Now, in order for NAMA to recoup the original cost of purchase (not counting the cost of financing the purchase and managing the asset etc), the asset value needs to appreciate by a compound 36.4% within the span of the bond
finance. Thus between now and 2011 when the alleged bonds should mature, the annualized rate of appreciation required on the assets for NAMA just to recoup the original loan amount would have to be 16.8% per annum!

If anyone in the Department of Finance thinks this is a sane bet on a market turn-around, God help us.

Short-term financing of long-term obligations, as we should have learned in the current crisis, is equivalent to giving steroids to an unfit athlete and sending him out to run a marathon.

Though to repeat once again - this is just a speculation at this moment in time although two independent sources have tipped me on this one.


Anonymous said...

tell me your making this up....

Anonymous said...

Could explain this story in the times


Sources close to the government said Nama will pay an annual interest rate of just 1.5% on the bonds it will issue to the banks as payment for their property portfolios.

Philip said...

He's not making it up.

This whole NAMA exercise is about one thing only - buying time. Pretending to be doing something while something else gets underway. The thing is...what is the something else?

Anyone any ideas for my idle conspiratorial mind :)

TrueEconomics said...

No gentlemen, I am not making it up... And that 'something else' has been already disclosed to us all: Messr Cowen & Lenihan, like the main character in the excellent film Downfall, have arrived at three insights:
1) The US economy is about to turn the corner and the Yanks will rescue us;
2) Emigration of some 150,000 from the country will relieve pressures on dole payments; and
3) Knowledge Economy is happening.

Except, in the case of Downfall, the main character was, of course, has been moving his imaginary divisions against the advancing Soviets. Messr Cowen and Lenihan have gone past that point - they have by now assumed the enemy no longer exists. 'Poooof, and the Devil is gone'...

And I am not making this up either - these are consistent policy guidelines that the Government has established on numerous occasions, and I wrote about the state of denial that exists in our corridors of power on my Long Term Economics blog: http://trueeconomicslr.blogspot.com/2009/06/department-of-finance-fairy-tales-june.html.

Unknown said...

I have read the various commentaries on NAMA including the material on www.nama.ie. It appears that all economic commentators are against the proposition of NAMA and yet the Government will proceed for whatever reason. Their intention is to clean the balance sheet of the main banks of the toxic debt in order that the banks will start to advancew credit to the "real economy" which is the country's small and medium size businesses. From what I have heard from the banks in the media and from their address to the Dail Committee recently they say they are lending and open for business!
What can we do about NAMA? We will certainly not be given the opportunity to vote on it, at least in an election. It appears that we will not take to the streets in protest as would happen in many other democracies. Could we however have a silent revolution/ national strike? Could we allow the markets to regulate the crisisby allowing normal market forces deal with the banks and the toxic debt. This can be done by everyone private individuals and business defaulting on debt at the same time. If there was a designated "polling day" say Sept 1st where we are all asked to "vote". To vote against NAMA we all default on personal debt ( overdrafts, credit card,mortgages, finance agreements etc) and business do likewise in respect of business debt. This could be coupled with a withdrawal of deposits from the main banks (notwithstanding that the deposits are covered by the Govt Guarantee) but deposited in another bank covered by the Guarantee. If this threat did not reverse the thinking on NAMA then the implementation of the threat could cause the collapse of the already fragile main banks and remove the need for NAMA.
Then perhaps the Government could create a good bank and use the capital to get the real economy moving again.
As far as I am concerned the banks will not start lending to business post NAMA as by then most business in this economy, having been strangled for the past 12 months will simply not present as viable prospects and will be refused loans by the banks applying lending criteria that they should have applied for the last 10 years but did not. To rely upon the banks to advance capital to business again the banks would have to take the same risk with business as NAMA ia prepared to take with their impaired loans, and the banks are not capeable of doing so.
If they dont the strangulation of small and meduium sized business will continue and gradually many will fail.