Economics 25/08/2009: Mad Maths at Nama

This might come as no surprise to those of you who have been in Ireland over the last few days, but it still btohers me - a week later. Nama is hiring specialist(s) in derivatives management and pricing to take on complex engineered products that the Banks have on their books.

Now, I know we have serious excellence in the ranks of our public sector and we have promissed ourselves to build on it even further. After all, DofF does excellent job in forecasting receipts and expenditure outlays - year after year, even when the trend is so strong, just adding GNP growth factor to last year's returns and then double that to last year's expenditure would do a better job than the entire DofF 'forecasting' team. And our CBFSAI does an excellent job watching the evolution of major fundamentals affecting the financial stability (it took them until the late 2007 to officially notice that the housing market might be in trouble and that construction sector has actually peaked - despite the fact that construction stocks data actually shows a break point in 2005 - full two years ahead of CBFSAI noticing it). And so on... but

The 'but' part relates of course to the fact that Nama-bound derivatives and complex intruments written against loans and real estate development ventures that are polluting our banks books are soooo toxic, I would compare them to a Chernobyl reactor just after the meltdown. The rest of Nama loans will be medical toxicity-levl stuff, compared to the serious s***t based on securitized underlyings. Nama taking these on will be equivalent to the Soviets sending unprotected troops into Chernobyl reactor to manually remove the fuel rods (they did do that).

This, of course, warrants a revision of our balance sheet totalling expected Nama losses. Once we have a clearer view of these derivative instruments extent, we will have to write them down to 'zero' real value, for I suspect there can be no recovery on secondary lending that was extended on collateral with real current value that has fallen 70-80% in the crisis.

Given speculative reports that Nama will buy into some Euro40bn worth of this stuff, I would say that a clear expected loss on this share of Nama purchases should be in the neighbourhood of
40bn*[Prob(recovery in default)*Prob(default)+(1-Prob(default))*Recovery Rate (No default)*Share (Deriv at recovery)]
Using UK and US data,

• Prob(recovery in default) = 8-11%
• Prob (default)=25-30%
• Recovery rate=40-50%

40bn*[(2%-3.3%)+(28%-35%)]=Euro12-15bn

So total expected recovery on Euro40bn in derivatives to be bought by Nama is around Euro5-7bn, implying the total expected loss on Nama should rise, under the best case scenario, from previous Euro13.4bn to Euro27-30bn over the life time of Nama...

Now, to warn you - these are back of the envelope calculations, and I will re-run full balance sheet to get more exact numbers. But you can already see where this Government is heading - another reckless and completely immoral sell-off of the taxpayers in exchange for a quick fix that has not worked anywhere else before.