Global Finance Magazine on the concept of ‘long-term economic value’ of distressed assets (here) and on effectiveness of bad assets purchasing schemes:
“Meanwhile, the passage of the Troubled Asset Relief Program (TARP) into law in the United States failed to alleviate strains in the financial markets...
The TARP empowers the US Treasury to buy troubled assets at heavily discounted prices, well below their long-term economic value. “No one yet knows what price will be paid for the toxic paper, or what the default rates will be on the underlying mortgages,” said Carl Weinberg, chief economist at High Frequency Economics. “
Over time, people will realize that all the underlying mortgages are not defaulting, and panicky market conditions should abate, according to Weinberg. “We have seen this game before,” he says. “In the 1980s highly indebted economies like Mexico, Brazil, the Philippines and Argentina bought back their own debt from panicked small banks at 20 cents on the dollar.”
20 cents on the Dollar, folks? Nama is buying defaulting developers loans (not sovereign bonds) at 79 cents of the Euro!!! I’d rather have Brazil’s and Argentina’s bonds, thank you very much.
Another interesting bit:
Robert Boyer’s paper “Assessing the impact of fair value upon financial crises” published in the Socio-Economic Review, 2007 deals with the expected effects of LTEV application to accounting standards, but the implications of this are pretty much the same for pricing (as in Nama). Boyer concludes that LTEV “gives at each instant a seemingly relevant liquidation value, but obscures the value creation process by mixing present profit with unrealized capital gains and losses. This discrepancy increases with an increased degree of uncertainty, which is at odds with widely held beliefs about the efficiency of existing financial markets. Fair value introduces an accounting accelerator on top of the already present and typical financial accelerator. …If fair value accounting is applied to banks, an extra volatility may be created...” What is this about? Three things, as far as Nama is concerned:
- LTEV will simply translate future value (capital gains) on assets underlying Nama-purchased loans into monetisable value as if all future price appreciation expected under LTEV can be captured in full. This, of course is a matter of timing (knowing when to sell) and efficiency of sales (having zero cost of selling and no impact on selling price of the volumes of sales that Nama will have to undertake);
- LTEV neglects to price in the effect of large asset holdings off the market (Nama holding vast portfolio of property-backed loans off the property market), which is likely to depress property prices over the life-time of Nama itself. The end result here – a gross overestimate of future expected prices.
- As the two points above coincide in timing, they act to reinforce each other – an accounting accelerator occurs.
Here is the rate at which the Government can currently borrow on a 6-months basis:
Let me explain:- we can borrow in the form of ordinary bonds at 0.481% for 6 months period. These are convertible at repo window of ECB at a discount of 12% on face value and 1% interest rate. Total cost of injecting €1 into bank balance sheet is, thus, 15.2 cents; or
- we can issue Nama bonds at 1.5% with 5% in subordinated bonds, with banks taking these to the ECB repo window at 12% and 16% discounts respectively, borrowing at 1% against both. Total cost of injecting €1 into bank balance sheet is, thus, 16.4-18.1 cents depending on how ECB risk-weights subordinated bonds.
7 comments:
mmmm - not sure I want phillipino or mexican sovereign debt even at 20c in the $ Constantin. I didn't read the article but presumably they also transferred over substantial property assets at the same time?? Just to make the comparison valid? Oh right - so a meaningless comparison so !!
If you don't apply some level of premium to the purchase price of the assets then you aren't engaging in asset recovery at all - that argument isn't one against NAMA it's against the policy of an asset recovery based resolution of this issue. And as you know asset recovery models HAVE worked in the past.
Adrem, per your first statement - sovereign bonds do not transfer any collateral securities. Despite this, their risk ratings would be much higher than private sector loans.
Per your second comment - are you arguing that if we do not overpay for loans there can be no asset recovery? In other words, that overpayment in a necessary or sufficient condition (or both) for asset recovery to work?
Sorry, I think you are smarter than that...
Best, C.
No I'm saying that it is a bailout - implicit in that is that someone has to pay more than the assets are currently worth to get them off the balance sheets of the banks, warehouse them and then get a higher value in the future for them. If the alternative option was available i.e. just pay the current underlying firesale value then surely the banks would be better off just fire-selling the assets themselves rather than NAMAing them?? I think the point is that if the banks only get the firesale value for the assets then either the banking market collapses or the state puts up multiple billions of cash now - multiple billions more than it has already put in and money that it hasn't got. The NAMA model allows the state not to have to pay anything up front. Yes it fundamentally requires the ultimate sale price of the assets (in the future) to be above the price they now pay (c.10% assuming the next point is achieved) and yes it requires the ongoing NAMA income to meet the cost of the debt repayments (at ECB plus 50bps) but there isn't an alternative that I can see that won't cost us an awful lot more now.
On the interest rate question - are you saying that the State can always access the ECB rate ? I thought that the "concession" the State got was a commitment from the ECB for a long term rolling facility at ECB + 50bps. If you adopt your approach would you not have to hedge the potential for the repo rate exceeding ECB plus 50bps? At least the proposed position (as I understood it) means certainty of the margin? Am I missing something?
Can someone explain to me how Nama is not in total contravention of the original Treaty of the European Union, and also ultimately of Lisbon too - in that it constitutes a MASSIVE interference in competition - something expressly forbidden by the Union. This notion of "long term economic value" is a makey-uppy term to cover the fact that the only decider of the "value" of any commodity is a freely functioning efficient market - property market in this case. The government has totally skewed this market now, in total opposition to the letter and the spirit of past and present treaties - or am I wrong?
Adrem, there is nothing wrong in letting sick banks die and better banks take their place. It happens in all areas of commerce, and yes, even banks can do it too.
I agree that the state could enter the private market for buying firesale assets when there is no other buyer. It makes no sense to overpay for assets by an estimated amount in the hunch and hope that at some time in the future, most likely better if there is another property bubble that a recovery/gain can be made.
If the only game in town is to have a working banking system, then tere are a myriad number of ways of doing that, and NAMA does NOT do that. It hopes that.
Constantin> which is at odds with widely held beliefs about the efficiency of existing financial markets.
Widely held beliefs can be wrong! I dont think that financial markets are purely efficient. They cant be because there is not 100% guaranteed information of ALL transactions. I have no idea what IKEA sold yesterday in Ballymun, or in Stockholm. With lack of information comes hunches and volatility and lemming effects.
At one time people in this country thought that property would only go up and those that even contemplated otherwise were told to commit suicide by the voted in leader of the state.
You couldnt make it up .....
MK1
couragefrou> NAMA constitutes a MASSIVE interference in competition - something expressly forbidden by the Union. The government has totally skewed this market now, in total opposition to the letter and the spirit of past and present treaties - or am I wrong?
You are correct. Most of the EU governments are being allowed to intervene in their markets on a massive scale due to the perceived severity of the financial holes that have been dug. All thats needed is European Commission approval to 'avoid' the law.
Its one reason why agreements of Heads of State are no more legally binding tham a beermat signed by two drunks.
baNAMA republic .....
MK1
MK1 - there is no need for a bubble in prices for NAMA to work -assuming (for the moment) that the running costs can be met from the performing loans and ongoing sales then a 10% uplift in property prices creates a break-even position. Over 10 years that isn't unachievable by any stretch. Of course I accept that the running costs might not be met from the performing loans and ongoing sales. And I accept that if prices keep falling from now then the 10% uplift from now becomes harder to achieve.
But none of that resolves the banking crisis - and it is a crisis. We have to get operational banks that don't have a massive property mess on their balance sheet.
Why did Iceland nationalise it's banks if its ok to let your major banks fail? Constantin - do you think you can let AIB and BoI fail without systemic damage to the economy? I think Anglo and Nationwide should be wound down - but in an orderly and controlled manner so as not to spook the market. Because we rely on that market so much as a country and even moreso now with the ridiculous fiscal deficit we are running.
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