Tuesday, October 13, 2009

Economics 13/10/2009: Nama politicised

Update: a must-read today is Morgan Kelly's article in the Irish Times (here). As I have shown in my Business & Finance column well ahead of Morgan, buying equity in the banks to repair their balancesheets makes financial and ethical and economic sense.

So the Greens are now going on a methodical politicising of Nama. This was predictable, but it is nonetheless ironic, for it is normally the domain of FF to turn every economic policy into a political / interest-groups circus.

As a part of their Programme for Government, the Greens have promised 'protection' of defaulting homeowners. Instead of calling for a reform of our archaic bunkruptcy laws the GP is now considering several possible options for doing so.
  1. Force the banks to purchase homes from defaulting homeowners, writing down existent mortgage. Assuming 5% default by homeowners (conservative number in my view) on roughly €82bn worth of principal residence-tied mortgages will yield a direct hit on the banks balancesheets of €4.1bn in 2010. Given the lags, one can expect this to be followed by a roughly 3-3.5% default rate in 2011, inducing another hit of €2.9bn, for a grand total of €7bn in 2 years. But this is not all - buying these mortgages out will imply the banks will take on assets that are worth significantly less than the outlays implied. For example, assuming 75% LTV ratio and 50% decline is peak-to-trough valuations (note: the first to default mortgages are more likely tied to lower quality properties, so 50% assumption is a reasonable one, if the average peak-to-trough fall was to be around 35%) the banks will be taking on an asset value loss of 0.5/0.75=33% of the mortgages assumed, or an additional €2.31bn. So capital base impact of this scheme will be around: 10% of RWA of 7bn-2.3bn = 470mln + 10%*(1+expected default rate+expected devaluation rate) of 7bn liability or ca 840mln. New demand on capital for banks will be in the region of €1.3bn immediately. Two questions to our GP friends: (1) Where will this capital come from? and (2) Where will the funding for acquisitions come from? If Nama is to be expected to generate commercial lending, what funding is available for buying out mortgage holders?
  2. The Greens are also considering US-styled scheme where lenders are subsidized to reduce payments by those in default. This would be a temporary (presumably) bridge. The problem here is that if you subsidise my neighbour, I will face a choice: (a) continue paying my mortgage at increased rates (someone will have to provide the 'subsidy') or (b) default and get subsidised too. Any guesses as to what a rational agent will do? Once again, who will pay for this scheme and how can it be made compatible with Nama objective of relaunching commercial lending. How will the banks exit this scheme in the long run?
  3. Measures to reduce the interest on mortgages: now this is ironic, given that this coalition has already swallowed IL&P increase in mortgages charges with Brian Lenihan saying that the banks are private enterprises and must be allowed to increase their profit margins.
  4. Banks taking equity in home loans - equity in what? In a negative equity asset?
  5. Mortgage terms extended. Given that we have been saying that 30-year mortgages at 100% LTV were reckless lending, making the same mortgages (now at 140% LTV) a 40-year contract will certainly be a prudent idea.
In the end, Green Party's denial of reality is evident throughout these proposals. The Exchequer is broke and Nama now means that we have no longer any capacity to aid the economy - we have spent the entire family silver on rescuing a handful of banks shareholders and builders. Instead of correcting the Exchequer deficit, the Greens are now full set to expand it to plaster over their disastrous agreement to back Nama. All of the above proposals will contribute to the future deficits and to the ongoing squeze of consumers, mortgage holders and taxpayers.

Months ago, myself and Brian Lucey have told this Government (including our direct briefing of the Green Party leaders) that Nama will trigger a wave of households defaults and that this will induce a new run on banks capital. We were called scaremongers.

The IMF seconded our views. The Fund opinion was ignored.

Now the Greens are running for cover on this issue, having pushed through Nama in the first place. This ethically disastrous stance of the GP leadership is a glaring example of how not to do policy.


Martin said...

So far all the discussion has been on mortgages, and property, what about credit card debt, car loans, personal loans. A lot of people had all of these.

patrick1978 said...

I agree with Constantin, the banks are in big trouble even with NAMA, the best thing would have been to nationalise the banks back in Februrary.

Anonymous said...

Mortgages are recourse loans unlike the situation commonly found in many of the US States.
If there is a substantial number of defaults how will this be handled by the courts?

This represents an existential threat to the whole justice and financial system.If the powers that be dont have the stomach to gaol mortgage defaulters then ordinary Joe's who are financially strapped will view this as a bailout for the feckless.
Naturally enough many more who can service their mortgages will leave the keys in the door and walk away.I expect the same scenario to unfold re short term loans and credit card debt.
In my previous contribution on ethics I stated that ethics and morality cant exist without the rule of law.So appeals to people not to walk away from their debts when the laws of the land are applied unequally because its immoral or unethical will be laughed at and rightly so.

Tommy Ruane ( Citizen Ruane) said...

see my posting on the Irish times article.

www.fixnama.ie >> NAMA-SP (Strategic Plan)

for a strategic and risk managing tool to reduce costs to taxpayer ( that's not risk...) and reducing risk to Taxpayer...
Tommy Ruane ( Citizen Ruane)

Holbrook Fields said...

"Despite its flaws, the NAMA plan seems like an advance over those in some countries—at least it gets something done. America’s scheme to buy toxic assets never got off the ground, while Germany’s bad bank is so punitive that most banks would rather stop lending than turn to it for help. The Irish government has also introduced some innovative risk-sharing elements to its plan. About 5% of the bonds NAMA will issue will be subordinated debt that will erode in value if the agency loses money." - The Economist, 17 September 2009