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!