Sunday, August 16, 2009

Economics 16/08/2009: Alan Ahearne on NAMA - not an ounce of sense

Alan Ahearne has decided to produce a definitive defense of NAMA in today's Sunday Business Post (here). And I would have to respond. As usual - Italics are mine.

The first half of Alan's article is saying absolutely nothing - nothing as in nada, zilch, nul, nil. He simply outlines in a tedious and lecturing fashion a litany of trivial observations as to why a banks crisis resolution is necessary. He does not show that NAMA is either a necessary or a sufficient condition for crisis resolution.

"Nama is also designed to ensure that the resolution to the problem of legacy loans is orderly. Nama can achieve this outcome because it will be patient in disposing of property assets which it has seized from delinquent borrowers." This is an unproven statement that can be argued to be untrue as NAMA can and is being shown to be likely to produce a prolonged period of highly uncertain property markets with buyers and investors holding back in anticipation of future NAMA disposals of property. The longer NAMA holds these properties, the longer it will delay new investment in property in this country. The longer it will keep banks uncertain about future NAMA losses (which - as we were told - will be clawed back from the banks), the longer the mortgage holders will remain in negative equity, withholding from consumption and investment and so on.

"Outside of Nama, a liquidator appointed to wind up a property company has a duty to sell off seized properties quickly. During an economic crisis, when markets are under severe stress and banks are not functioning properly, these properties may have to be sold at a discount to their underlying economic value." Again, Alan presents a dishonest 'extreme' alternative to NAMA as we know it. Outside of NAMA, there can be better mechanisms designed for systemic and orderly adjustment of the property bubble legacy. My own NAMA 3.0 is one. Karl Whelan proposed a similar scheme as well.

"Economists refer to the discount that the liquidator must pay for a quick sale as ‘the price of immediacy’. By design, Nama will not have to pay this discount because it will sell the properties at its own pace. It is important to note that the outcome for delinquent borrowers is identical, whether liquidation occurs inside or outside of Nama. Property companies are wound up and collateral is seized. The difference is in the speed at which the seized assets are re-sold to the market." Again, this is simply not true. NAMA will keep certain projects (and thus certain property developers) in business and will even aim to complete some of the projects. If this is not a rescue clause, I am not sure what is. And as far as NAMA not paying the discount due to long term nature of the undertaking to dispose of the properties, well, this does have a price -
the longer NAMA holds these properties on its books:
  • the heavier will be taxpayers' losses on bond financing (interest);
  • the longer will the property markets take to adjust;
  • the longer will be the period of banks uncertainty as to their costs of NAMA;
  • the longer will be the period of stock markets uncertainty about the banks profitability;
  • the longer will be the period of subdued investment and consumption in Ireland.
There is no such thing as a free lunch, Alan. And NAMA is not getting close to one either.

"It would be impossible to dispose of ten of billions of euro worth of distressed properties in a short time under current conditions -and extremely destructive to even try." Again - no one I know of - neither Karl Whelan, nor Brian Lucey, nor myself have said there should be a fire sale of assets. Why is Alan Ahearne allowed to deflect public attention from the real issues that are being raised against NAMA? Has he morphed into a spin doctor for DofF?

"No wonder, then, that the IMF, in its recent report on Ireland, describes Nama as ‘‘pivotal to the orderly restructuring of the financial sector and limiting long-term damage to the economy’’." Well, IMF has not endorsed NAMA and was actually critical of its provisions. Alan knowingly distorts IMF analysis by selectively quoting its report.

"A key question relates to the value at which the loans will be transferred from the banks to Nama. Some commentators have mistakenly talked about the price which Nama will pay for land and development properties. Nama is not buying properties, but rather buying loans that are secured on properties and other assets -there is a fundamental distinction." Again, Alan uses this article to deflect the real criticism - not a single serious commentator said that NAMA will be buying actual properties. But in buying the loans, NAMA will acquire titles to underlying collateral. So - a play of words for Alan is a fertile opportunity to reduce public focus on the real issues.

"The transfer value will be in accordance with EU Commission guidelines on the treatment of impaired assets. The commission is very clear on this issue: the loans are to be transferred at values based on their so-called ‘real’ -or long-term - economic value. These are the terms used by the commission. Paragraph 41 of the commission’s communication published in February states that “ . . .the transfer value for asset purchase or asset insurance measures should be based on their real economic value’’. Annex IV of the communication states that ‘‘the objective of the pricing must be based on a transfer value as close to the identified real economic value as possible’’. Well, actually, a 'real economic value' is not the same as the 'long-term economic value'. Plus, as several of us have pointed out before (Karl Whelan, Brian Lucey, many others and myself) - 'long-term' economic value can mean anything. Absolutely anything. So what Alan is saying above, just as his masters did earlier is that 'the EU Commission allows us to buy these assets at whatever price we want to pay for them'. This might be good for the Commission. But it is not good enough for us, as taxpayers who will ultimately pay this price.

"Some commentators have claimed that Nama should instead transfer the loans at what they refer to as ‘current market clearing prices’. It is hard to see how this makes sense. The reality is that there is no price at which the market for land and development can clear under current conditions. This is not to say that land has no value, but rather that the market for these assets is not functioning." In the current markets we do have real valuations of land and development assets. There are sales, there are some investments, there are transactions. Furthermore, today's price can be taken as a short-term valuation based on standard hedonic valuations. The only problem - for the banks, developers and their guardians in the Leinster House - is that these valuations are too low. So they use an academic economist to argue nonsense about 'markets are not there, man, me doesn't know much about what value things might have'.

"There seems to be a misapprehension among some commentators that, for Nama to break even, property prices need to revert to the peak levels seen in 2006-07. This is not the case."
Well, do the maths, apply discount of a% on a property loan of X bought, assuming the loan yields y% annually. Hold it for T years. Assume that the underlying collateral appreciates at k percent per annum. The present value of this loan T years from today if the prevailing rate of interest is R is
(1-a)X{Sum([1+y+k]/[1+R]^i} where i=1,...,T
The cost of financing this loan is at R+g where g is the risk premium, taken over T years and discounted back to today:
The break even on this deal requires that the first identity is equal to the second one. This in turn implies that to break even, NAMA will have to either
  • enjoy property yields + appreciation on the capital in excess of the cost of bonds financing and the cost of running NAMA itself - which really means a property boom (in yields terms) will be required well in excess of the 2004-2007 one, or
  • enjoy property price appreciation that will cover the cost of bond financing, plus the cost of running NAMA, plus inflation, less the discount a.
This is soo excessively optimistic, that actually it makes me believe that in making his statement, Alan reveals not having done even a basic estimation of NAMA likely costs and losses.

Now, it is also telling that Alan fails to even mention the problems of protecting taxpayers' interests, ensuring transparency of NAMA operations, or any other major issues for which NAMA has been criticised by many commentators, including myself.

I also find it extremely arrogant and outright rude that this public servant has managed to escape any scrutiny as to:
  • why as the economic adviser to the Minister for Finance has he not produced any economic assessments of NAMA?
  • why has he failed to consider the economic costs of NAMA (he does attempt something of an analysis - albeit extremely simplistic - of what would happen if NAMA was not enacted)?
  • why is he allowed to simply claim - with no evidence or arguments to support such a assertion - that NAMA will restore functional banking system in Ireland?
  • why is he allowed, unchallenged, to claim that all external analysts are supporting NAMA, while we know of several Nobel Prize winning economists, numerous other respected international academics, not to mention all internal independent analysts working in Ireland who unequivocally identified NAMA as being a bad idea?
In short, Alan's article is a waste of space - pure and simple, providing not a single fact, not a single logical argument, not a single ounce of economic reasoning to support his thesis.

Read my alternative to NAMA here.


Anonymous said...

Alan ahearne would have signed a contract which included a gagging clause thus permitting the ministers officials to check articles for print and to edit accordingly.
AH is his masters voice ,the Minister for Finance.He may disagree with the tone of the finished article but as you have pointed out it is slim on facts and those facts that are represented are ones he could probably live with.

What is curious is the upbeat and pollyannish view of our economic prospects outlined by the FT editorial during the week which AH refers to.
Having read the FT editorial in full it seemed to me that someone had spun the editor.
Perhaps AH was quoting from himself when he inserted extracts from the FT editorial in the Sunday business post.He is well connected and has a reputation beyond these shores.

I say this ,because a few days previous the Lex column in the FT made an assessment of NAMA which could have been written by yourself,Brian Lucey or Karl Whelan.

In relation to calculating the true value of the banks assets:

Banks have to recapitalise before they can lend again even at prudent levels.
The opposite is occurring to what happened in the boom,there is massive deleveraging.
Banks will now only lend if there is a guarantee of a future value consistent with what they expect of the return from their investment.
Therefore there is virtually no finance available to purchase these assets.

If our economy is redirected towards productive investment then there is no point in the future that a market value of these loans can be created that would discount to equal the present cost of the property loans.

The key,in my opinion is to direct the States resources toward productive investment and let the banks go wallop.
There is already a credit union branch system that could clear wages and small loans.This could be expanded quite rapidly to include finance for SME's.

The large multinationals wont have that big a problem with a change as above.As far as I know most of their debt financing is through corporate bond issues or investment bank lending.

Perhaps a corporate bond market could be expanded for indegenous Irish firms as an alternative to bank financing,it would be more rigorous in weeding out the inefficient firms but thats happening anyway in this economy.


BAz said...

Well done Constatin. Youre doing a great job. Hopefully, people will sit up and take notice that the lunatics are running the asylum before its too late.