Monday, August 31, 2009

Economics 31/08/2009: Myths of Nama's Parrots

The Sunday papers revealed to me the bizarre lack of independent and critical thinking amongst our senior journalists on the matters of policy.

The best example was the Sindo’s editorial on the subject of 46 economists’ signing the article in the Irish Times last week. In effect, Sindo is of the view that publicly employed academic economists and finance specialists cannot criticize Nama. What’s next? As PMD puts it: "Publicly employed physicists cannot assert existence of gravity?"

To his credit, Shane Ross stands tall.

In the mean time the Sunday Tribune article (here) exemplified some of the ‘new’ mythology of ‘official’ Nama position, while simultaneously revealing the lack of media’s ability to question the spin fed to it by the officials. These are worth dealing with in some more detail than Sindo’s article:

Myth 1: The ‘official’ version of Nama now claims that LTV ratios on Nama-bound loans were low, so the face value of the loans covers actually greater original value of the collateral. "But while the loans are for €90bn, the properties secured on those loans cost considerably more (we are not talking about 100% mortgages here).”

As far as I know, this 'arithmetic' was first floated at the official briefing for the journalists by the DofF. 

There is absolutely no evidence that the developers took 75% LTV ratios. Despite this, my earlier post (here) has dealt with this, showing that even at LTV ratios of 50-60% it is unlikely that Nama will be able to break even by 2021. Or for that matter, under majority scenarios until much later than that. Given that some people who’s incomes will be used to finance Nama will by then have lost their

  • Savings;
  • Pensions;
  •  Homes

to Nama – due to the need to finance Nama costs out of our current income, implying much higher taxation – what measure of democratic accountability, equity, fairness etc can compel this Government and DofF to make such claims is simply unimaginable to me.

Contrary to DofF briefing claim on low LTVs, there is plenty of evidence from property consortia and from court cases (e.g Mr Carroll’s) that much higher LTV ratios were used in practice. In many cases the percentage that was not lent on the property directly was made up of additional cross-collateralised loans to the consortia itself, other members of this consortia or to the original borrower (developer) in a personal capacity. There were multiple cases of the same property being cross-collateralised for multiple loans.

Take a 'clean' (as in completely transparent, free of double-borrowing and cross-collateralisation) example. 

If a property was purchased for 100K in early 2005 at 50% LTV and rezoned, this ‘asset’ would have seen its market value rise 3 fold. In late 2006 this property would have the value of 330K and a loan of just 50K. The surplus value or equity of 280K could have been re-mortgaged at, say 50% LTV again. Total loans written against the property would total 190K. The surplus equity of 140K could have been borrowed against again in 2007 at, say 50% LTV ratio, resulting in a total loan volume of 260K. What is the overall LTV ratio on this property? At 2006 value of the property: we have LTV ratio of 79% in the end of these simple multiple loans trips each one of these loans was 50%.

Now, suppose Nama buys these at a 30% discount on the loan value, i.e. for 182K. Nama is instantaneously in the negative equity to the tune of 82K, or 45%.

The property market (depending on the type of property) is now around 2000-2004 (well below 2005 levels). How much below? Well, let us say 10% below. So the underlying property is now worth… 90K, and the negative equity is now 92K or 51%.

What is the rate of growth in the market we should expect to get back from this level of negative equity to a nominal break point on Nama? For 10 year horizon – an annualized rate of +7.2% per annum. For 15 year horizon +4.7%, for 20 year horizon +3.5%.

If inflation averages the ECB target rate of 2% pa over the next 20 years, we need a property prices growth of 5.5% per annum minimum for Nama to break even on this “50% LTV ratio loans package” in 20 years time!

Myth 1 is busted.

Myth 2: property crashes are benign… "Previous property crashes in London, Paris and Stockholm suggest that, within 10 years, prices recover to 30% below the top of the bubble".

I have shown in another post (here) that this is not consistent with the evidence from the past busts. So let me not repeat myself here. Furthermore, do any of us really believe we will get back to within 30% of the madness of the 2006-2007 markets ever again?

Instead, consider the statement itself.

First, this refers to nominal prices. Real prices (inflation adjusted) are much slower to recover.

Second, this refers to a simple price recovery. 

But Nama is about more costs than just the cost of loans bought. It is also about a cost of loans financing. So, suppose we take DofF and the journos for what they claim. 

Suppose our property prices will be back to 30% below the top of the bubble in 10 years from now. At 5% per annum the cost of bonds financing for Nama, 0.75% per annum cost of recapitalization financing (ca 8% shot – one off in 2010, taking into account the present value of this cash, recapitalization will actually cost closer to 1% pa over the 10 year horizon, but let us give the difference as a margin of error in favor of Nama). We have: the original (2007 value) 100K loan with LTV of 75% (DofF number) worth 75K on bank’s book today will be purchased by Nama at a 30% discount for 52.5K in 2010. Within 10 years time, property value is 70K. Nama can sell property for this amount and pay down 52.5K of the original loan purchase prices. Except, by then, Nama would have accumulated additional 33K in interest charges on bonds… 

Total loss to Nama on this transaction = 70K-52.5K-33K=15.5K, so Nama will still be posting a 30% loss on its operations.

Myth 2 is busted.

Myth 3: Bond markets do not like privatizations and they love Brian Lenihan’s policies. "Within five days of Anglo Irish being nationalised, the rate which Ireland is charged for borrowing money internationally had risen."

Firstly, while it is true that the bond spreads rose when the Government nationalised its not at all evident or even apparent that this happened

  1. Because we nationalised Anglo or   
  2. Because we had to nationalise Anglo.

In other words, did Irish Government bond spreads reflect the Government new exposure due to nationalization or did they reflect the fact that nationalization simply showed to the rest of the world just how sick our system really was.

Put differently, did the cardiogram go off charts because the patient went into a cardiac arrest, or did it go off charts because the patient was connected to the machine reading the cardiogram?

Recent research from the ECB (cited by me in the press and here on this blog before, you can find the original paper in the The Determinants of Long-Term Sovereign Bond Yield Spreads in the Euro Area.  Monthly Bulletin, pages  71–72, July 2009) showed no evidence that Ireland’s critically elevated levels of bond spreads at the time before, during and after the Anglo nationalization were somehow out of line with the general model. They were, per ECB model, reflective of the fundamentals in Ireland, not of the ‘nationalization’ one-off episode.

Incidentally, similarly, Greek, Spanish, Portugal’s and other APIIGS’ countries spreads rose at the same time as Irish and in similar proportions. They didn’t nationalize their banks… So what is the DofF talking about here and why is our media parroting this claim as some unquestionable truth?

Now, one of my TCD students has just completed a research paper applying the ECB model to Irish bond spreads. The break point in our bond spreads occurs about the same time that it occurred for other APIIGS -  October 2007. Not that close to Anglo event…

What is also interesting is that the current period of ‘falling spreads’ for Ireland – lauded as a sign that the Irish Government is being trusted by the international markets in all its hard work to destroy our private sector economy… ooops, sorry, to ‘correct our fiscal deficit’ in Leniham-speak, is really fully in line with just one factor – the overall improved sentiment in the global markets. Our ‘leadership’ clowns are riding the coat tails of the US and EU ‘bottoming out’ euphoria, not some miraculous change in sentiment to Ireland they are going to leave behind to the next Government.

Myth 3 is also busted.

Myth 4: "There is a reason why no country has nationalised its entire banking system."

Now, our own journalists simply do not treat other banks operating in this country as a part of the ‘banking system’… Just think two events in the recent past when scaring kids with ‘foreigners’ was en vogue:

1)    Anglo’s “shortsellers from New York and London are out to get us”. Of course it turned out that the shortsellers from abroad were spot on right about their reading of the bank’s position, while all the damage done to the Anglo was done from inside the bank – from its own senior management;

2)    American ‘vulture funds are swooping onto the wounded Irish banking system’. Of course were they to take our sick banks over, we wouldn’t have a need to cull family budgets for generations to come to finance Nama… wouldn’t we?

Every time someone says ‘we need to protect our national [insert any business-related noun here]’, I know I am smelling a rat. ‘Protecting national banking’ means, as Nama clearly illustrates, vast transfer of income and wealth from ordinary people of Ireland to shareholders and bondholders of these banks. I have nothing against the latter two groups of fine people and institutions, but I certainly do not love them enough to sacrifice my son’s college tuition fund and my own and my wife’s pensions to bail them out.

In reality, of course, the idea that ‘nationalizing’ 6 banks in Ireland will leave Ireland with no privately-owned banks is bonkers. Ireland has significant international banking sector that would be even greater in size were we not shielding BofI and AIB from competition through supporting their legacy positions. Furthermore, under my Nama3.0 proposal (see here), we would not nationalize any of the banks at all. We would simply change their ownership from that of the few who took wrong risks to that of the many who are now expected to pay for the mistakes of the others.

Myth 4 is busted.


Myth 5: "But the nationalisation option throws up enormous difficulties. The state would have to pay in the region of €5bn to shareholders of AIB and Bank of Ireland,"

Under my Nama3.0 proposal, we would first force the banks to take writedowns, then use remaining share holders’ and bond holders’ equity and debt holdings to offset these losses, then use private investors and swap-participating bondholders to recapitalize the banks. Only after that will there be a cost of the taxpayers. At any rate, this cost will be much lower than the 60bn cost of Nama purchases, plus tens of billions in bonds financing costs associated with Nama.

Furthermore, let us not forget that after Nama we will have to recapitalize the banks no matter what and that this recapitalization is likely to cost us well in excess of 5bn itself.

After all, we paid nothing for Anglo in excess of direct recapitalization costs involved, which are much lower than the cost of Nama buying Anglo’s loans and ‘managing’ them. Furthermore, the same costs were paid to AIB and BofI as well, despite these banks remaining 'private'.

Myth 5 is busted too.

Myth 6: "There is a reluctance to lend money to banks that do not have the transparency that stock market membership brings, and that are viewed as being open to political interference."

This is false.

  1. Irish banks and banking institutions - listed or mutually owned - are not transparent already, as the Anglo saga clearly illustrated, as AIB repeated blunders in public statements have clearly highlighted and as the reluctance of all of these banks to take realistic writedowns on the loans attests. Were the Tribune folks actually to give it a thought - we know that AIB, BofI and the rest of the pack are artificially depressing expected losses on their loans in anticipation of Nama, since, by the entire Nama existence we know that absent Nama they would sustain losses much greater than their current capital reserves allow. So what 'transparency' are we talking about?
  2. Irish banks cannot borrow without the twin ECB and Irish Government Guarantee supports, despite them not being in national ownership;
  3. Irish banks will not be nationalized in Nama3.0 set up and their shares will be fully liquid;
  4. Many private (Rabo, a host of Swiss banks and Belgian banks) and nationalized (Northern Rock) banks are capable of borrowing well better and cheaper than the Irish banks underpinned by full state guarantee.

Myth busted.

It is not the ignorance or the lack of knowledge amongst some of our leading journalists that defies my belief, but the innate lack of intellectual curiosity to question the spin they are being spoon-fed by the ‘official’ Ireland.

Hence, Mary Robinson is being paraded around the press as some sort of a ‘wise’ financial guru full of wisdom to breath new air into the debate about Nama. Spare me this nonsense!


Paul MacDonnell said...

A masterclass in BS detection and destruction. Congratulations and thanks Dr. G.

Adrem said...

Hi Constantin

I'm not going to go through all the myths and (although usually an avid Sunday paper reader) I was away yesterday so didn't get to read any of the stuff you are criticising.

One comment on myth 1 though - your busting of the myth is predicated on NAMA blindly purchasing the loan at a 30% discount even though that immediately puts them at serious negative equity. As you know NAMA will NOT do that. They will value every loan individually and in your example I would expect NAMA would purchase that loan at a greater than 30% discount thus avoiding the issue you raise.

Brian O' Hanlon said...

"If a property was purchased for 100K in early 2005 at 50% LTV and rezoned, this ‘asset’ would have seen its market value rise 3 fold. In late 2006 this property would have the value of 330K and a loan of just 50K. The surplus value or equity of 280K could have been re-mortgaged at, say 50% LTV again."

I am very glad that some of this logic is entering into the debate. It means that what has been absolutely silent in the debate so far - namely, a real story of what went on with loans, and land, and re-zoning during the past ten years - is finally coming to light.

I have been closely watching the NAMA debate as it emerged over the course of the months since last December 2008. No where has there been a decent attempt to analyse what is contained in those 'loans' valued at €90 billion on the banks' books that everyone keeps talking about.

This is ridiculous in my view, to talk about the €90 billion on the banks books. The whole problem to begin with is that the banks were too lazy to exercise due diligence on their own loan book. They still don't want to analyse in any great detail what is in their own book. They only want to shift the entire mess onto someone else as fast as they possibly can.

Having gotten away with that handy trick, my only guess, is that the banks will have learned no lesson whatsoever. They will proceed to create another 'fine mess' which another generation in ten or twenty years time will have to deal with again. At around the same time, that this current generation will be finishing up with the current NAMA work load.

It is time now, that everyone called a spade a spade. If we look very closely at the Liam Carroll portfolio, and his relationship with the banking institutions we can learn an awful lot of useful things. Everyone else in the 'property game' was trying to imitate Liam Carroll, because it appeared to everyone else that Carroll had found a way to churn out gold bars. Which he did, to a certain extent.

But we are slowly beginning to understand was that Carroll was only creating wealth, which was being transferred as a bill to the taxpayer further down the line. That is the point that Fine Gael I hope are raising today. This is why I think a banking inquiry is so crucial. Because it shines a light, not only on the banking institutions themselves, but on the behaviours of those, who operated in cooperation with banks.

We have already seen a court case where two solicitor borrowed several times against the one property, where the banks didn't bother to exercise due diligence. All that happened with land and re-zoing, was that, multiplied a few times more. It is hard to trace down certainly. Perhaps the NAMA vehicle is the best way to sort it all out now. But NAMA should defer payment on its loan book, until such time as we have better information about what is in the loan book.

The 'catch 22' is that we will only learn that, when the loans are transferred into NAMA, and the forensic guys start to un-ravel the whole mess.

Brian O' Hanlon

Fungus the Photo! said...

Well said!

Agreed the media are biased. Did they carry balanced coverage of the doubts that all the debt might not be good for us? No way. They are owned by those who make money from advertizing and that declines unless we have a consumer economy.

Brian O' Hanlon said...

I wrote something today in which I tried to extract some positives from the joint Oireachtas session where minister Brian Lenehan took questions. I also tried to highlight some of the questions raised in the debate. Though, at this stage I have to curtail my involvement with the NAMA process to less hours. It is really time consuming to take in the entire debate and comment on it. I do have respect for any commentators, including Constantin Gurdgiev who make it their business to try and debate matters to whatever extent possible.

There is almost no good condensed material from the joint Oireachtas debate available anywhere in the mainstream media. Short of watching the full four hours on RTE's webcast. Which I did, live, as the debate was happening yesterday. All you get from the news headlines and newspapers even, is a couple of random snipets. Of those snipets you do get in the mainstream media, they are heavily tarnished by the journalist or reporter's own biases and mis-comprehensions. Some of which are trully bizarre. Listening to Nine News on RTE One television last night, I even wondered had the RTE news reporters watched the save four hour debate that I had watched. It seemed to me, that RTE news reporting on the debate was very sloppy and under-resourced. For a debate that can have such a bearing on the nation's economic, social and political future, the amateur way in which it was reported upon by RTE, did give me a lot of food for thought.

Listening to Nine News on RTE television, I noted that the NAMA team was mis-quoted by a reported sitting at the news desk in RTE. This isn't good enough at all. I am sure that minister Brian Lenehan is used to that however. I suppose, it is one of the reasons we do need a proper parliment and we don't rely exclusively on reporters at a newsdesk to make decisions.

I tried to compile a few more of the positives from the question time at another blog entry yesterday evening.

Brian O' Hanlon

adrem said...

BO'H you say you have been "closely watching" the NAMA debate - not so close me thinks. The 90bn loan book is being gone through with a fine tooth comb to establish exactly the kinds of issues you and constantin are raising. Issues like what is the real value of property, is this field ever going to be more than a cattle field and if not how can we pay more than ag prices for it, how exactly are assets secured on these properties etc etc etc etc - what we've seen in Carroll is the byzantine maze of companies and cross collateralisations which mean that they need to go through each loan individually and ascertain what it is secured on, what value that (or those) asset(s) have and therefore what price to pay for the loan.

They agree with you and with Costantin and are engaged in this process as we speak.

TrueEconomics said...

Adrem, two points to your comments.

Per your earlier comment - I've spent much time and effort to show that at any reasonable discount Nama will not break even (I think the lowest discount I ever got at which, under very unlikely dreamy assumptions, Nama does break even is 47% on current value).

Per your most recent comment - this is what you believe that they do. I do not believe it for a second. And besides, the real point is that Nama should not rely on us - the taxpayers - believing it or its officials - this is why transparency of operations, properly aligned incentives and chains of reporting and, ultimately, the actual ownership of the bloody undertaking are so crucial.

Until we own Nama, until Nama is made transparent and fully accountable to us, the taxpayers, until we have full reporting and proper oversight, independent directors and members of committees - you might wish to believe they are doing their jobs. But I may wish not to. So why shouldn't your family pay for the entire thing, since you are a believer, and my family can keep our income...

Lastly, how can you believe the clowns who brought you Fas, HSE, DofTransport, CIE, ESB, DAA, I can go on and on, to do anything, and I mean anything, right?

Brian O' Hanlon said...

I would submit that what Constantin described in last Friday's Irish Independent article, and what is contained in the NAMA legislation in terms of accountability and reporting, do contrast quite a bit. I don't fully understand the requirement for so much concealment of the NAMA operations myself. I think it is useful to have Constantin's suggestions out there, along with the solution suggested by Fine Gael. Because both contrast strongly with the solution proposed in NAMA's draft legislation.

What is starting to come to light though, is not alone is NAMA a very radical departure in global terms, that the entire world is watching because of it's scale. But also, contained within NAMA itself is a very new and experimental system for valuation of property. One which has not been tried or tested anywhere else in the world. Not alone is NAMA an alien beast from another planet, it is also pregnant with something else inside. Yesterdays joint Oireachtas Financial committee meeting was an opportunity to get more familiar with the new, very strange creature.

I understand minister Brian Lenehan's point that that NAMA was designed to insulate the Irish nation from risk on a number of levels. But if such radical and innovative new vehicles and sub-vehicles (valuation methods) are required - if we are going to all of this trouble to do something ground breaking - then why is it so difficult to tie it all back to the main problem, lending to business?

This is the obvious point that George Lee pointed out today. George Lee said small businesses are none the wiser about their future after yesterday.

Brian O' Hanlon

Unknown said...


Fair enough . . . but in the same way that just because I believe it doesn't make it true, equally just because you disbelieve it doesn't make it false. Your numbers are based on a premise - if your premise is false (as I believe it to be) then your numbers don't add up. I know you argue the same is true of the government's numbers.

I think the PAC and CAG oversight is reasonable. I think the risk sharing will appear in the final legislation and I think that until the bond issue (when we can get a better handle on what was paid) the rest is speculation and (at least in part) intellectual naval gazing.

jpc said...

Amazing that Mr Gurdgievs dissection of the NAMA dogma has not reached a wider audience.
The rush and panic atmosphere being created at this moment, is quiet at variance with the leisurely holiday break our elected representatives decided was appropriate given the financial catastrophe that has occured.
I would also like to know how the maintenance of the empty "assets" will be funded over the next decade or so.