Economics 21/12/2009: Nama - perpetuum mobile of ethics and objectives

For those of you who missed my Sunday Times article yesterday - here is the unedited version of the text.

But before we begin on Nama - here is a superb article on the prospects of potential sovereign defaults in Europe (read: Baltics, Greece and Ireland) from the FT today.

And here is a fantastic compendium of Brussels-imposed costs to the UK economy as estimated by the UK Government own assessments studies. One wonders if Irish Government bothered to do the same exercise and what its outcome might be. In the UK, the cumulative present value cost of these measures is ca £184 billion through 2020. If the same apply to Ireland, proportional to the overall size of the Irish economy, the combined cost of these Brussels directives could be around €18.6 billion - more than 77% of our annual deficit.



In the real world economics there is one Newtonian-level certainty: what can’t go on, doesn’t. We should have learned this some years ago, following the 1980s economic debacle and the 2001 collapse of the tech bubble. We had another opportunity to understand it last year. But in Ireland, real economics is reduced to the domain of an eccentric hobby. The real business of the nation leadership is preservation of the status quo – first at the state level, then political, and now – in banking.

Nama is a focus of all three. Through it, even in the midst of the current historic crisis, our political and executive elites continue to inhabit a parallel universe where responsibility and accountability are for the commoners, and transparency and governance are decorations for EU summits.

Aptly, in its current form, Nama reigns supreme as the most non-transparent financial institution in the developed world. Its ‘independent’ directors are being selected behind the closed doors by those who presided over the systemic failures of our regulatory and supervisory regimes. Its risk, audit and strategy functions will be fully contained within the secretive and unaccountable structure of the organization itself.

Nama will not publish a register of properties against which it will hold the right of seizure. This, we are being told, is done to protect privacy of the developers involved. But a register does not have to declare the names of the borrowers – property location, purchase price, vintage, LTV ratio and valuation by Nama would do just fine.

Nama accounting and audit functions will not comply with the requirements imposed by our regulators on public companies. Its directors, management and consultants will enjoy a blanket indemnity that is unparalleled by the standards of any public office or company law. Their remuneration will not face even the farcical constraints that senior banks executives face.

Nama owner – the SPV – is a bogus shell entity with ghost investors and a minority shareholder (the state) in charge. That this scheme has been concocted not in a distant off-shore location, but by our own state in our name and with our money adds insult to the injury.

As if the existent shortfalls of the legislation establishing Nama were not enough, even after the entity approval by the Dail, the goalposts for its operational performance continue to shift. Just weeks after the TDs voted to approve it Nama is now a different beast altogether.

Take the issue of discounts. Throughout the approval process, the Government doggedly refused to accept the need for realistic writedowns on the loans. Hence, all official estimates for Nama were incorporating an extremely optimistic 20-23% average discount. A handful of independent analysts, including myself, Professors Karl Whelan (UCD) and Brian Lucey (TCD), and an independent banking expert Peter Mathews, kept on showing analytically and factually that the final discount must be closer to 35-40% if Nama were to become anything but the skinning of the taxpayer.

The latest revelations from the banks and our stockbrokers, who insisted earlier this year that a 12-15% discount would be just fine, put an average Nama discount at over 30%. Nama cheerleaders now admit that applying a low discount is simply bonkers. This week, international agencies – Fitch and Moody – also waded back to the shores of reality. Both highlighted the fact that going forward Irish banks will remain in their current insolvent state. Nama won’t repair their balancesheets and it will not change their ability to raise capital privately.

With this change in direction, Nama became an exercise in racing to the top of recapitalization heap, as banks scrambled to issue new estimates of their expected demand for additional capital.

Two months ago I estimated in a public note that Bank of Ireland will require up to €2.6bn in capital after Nama loans are transferred, AIB will demand close to €3.5bn, Anglo €5.7bn and the rest of the pack will need approximately €1.2bn. The total demand for recapitalization costs post-Nama – none of which is factored into that work of fiction known as Nama Business Plan – will be €10-13 billion.

All of these figures could have been glimpsed from the banks balancesheets, but the Department of Finance, NTMA, and an army of advisers have opted for creative accountancy in place of realistic estimates.

Over the recent months, virtually every vested analyst in the country has confirmed the above figures for the banks. In one case – that of INBS – the analysts actually exceeded my worst case scenario projections. The result of this delayed admission is the current bear run on Irish banks stocks.

Now, recall that consensus estimates prepared by the independent analysts show that in the end of its operations, the ‘bad bank’ is likely to yield net losses to the taxpayers of between €11 billion and €17 billion. Not a single estimate, short of the fictionalized official Nama accounts, shows the entity breaking even on the loans.

Do the maths: expected losses of €11-17 billion, plus recapitalization costs to date of €11 billion, plus expected post-Nama recapitalization costs of €10-13 billion (only partially reflected in the expected losses estimates). The total bill for this bogus ‘rescuing’ of the Irish banking system is likely to be in the neighbourhood of €29-40 billion.

And, judging by the public pronouncements from the top bankers of AIB, Bank of Ireland, Anglo, permanent TSB and EBS – there is not a snowballs’ chance in hell Nama will repair lending to Irish companies or households. Instead, as the US experience with TARP shows – a liquidity trap is awaiting our economy. Put in simple terms, no rational banker would forego an opportunity of borrowing from the ECB and lending at ca 5% to the state instead of providing capital to SMEs and households.

Contrary to the hopes of restarting the lending cycle, what we have to look forward to in 2010 is the strengthening of the margins by the banks. A combination of the ‘risk sharing’ scheme built into Nama legislation, costlier interbank funding markets (courtesy of reduced liquidity supply from the ECB), falling corporate deposits base and the deterioration in the capital reserves of the banks will mean that the cost of existent loans and future borrowing will rise. And it will rise dramatically.

The first taste of this was the implementation by permanent TSB of a rate hike on adjustable rate mortgages. ESB preannounced the same move some months ago. Bank of Ireland, AIB and the rest of the pack will follow. When this happens, even absent ECB rates hikes (anticipated by the market in mid-to-late 2010), the retail lending rates will rise, triggering a wave of defaults by households on credit cards debt, consumer loans, car loans and ultimately home loans.

Short term lending facilities for businesses and export supports will also come under pressure as banks address the twin problems created by Nama – the deficit of capital and the uncertain nature of risk sharing scheme. The lack of exports supports either in the form of state-backed export credit insurance for indigenous exporters or the currency risk offset scheme in the Budget 2010 will further exacerbate the problem.

All of this is fuelling the current run on the banks shares. Even with their wings clipped, stock markets investors are indirectly ‘shorting’ Irish banks by withdrawing their cash from the AIB, Bank of Ireland and Irish Life & Permanent valuations. The markets are shouting: ‘We are not buying your story that Nama will work for Irish economy!’ The Government is not listening.

Box out:
A study based on the Standard & Poor’s data released this week shows that over the last 5 years, active funds managers have managed to under-perform broader market indices in four out of four asset categories. Thus, only 37% of active funds managers with large cap strategy orientation beat S&P500 large cap index to July 1, 2009. Only 32% of funds specializing on small cap equities outperformed S&P Small Cap 600 index, and abysmal 13% of funds with international (as opposed to US) orientation have managed higher returns than S&P700 index of global equities. Just 20% of bonds funds beat Barclays Intermediate Government/Credit index. And that is before we factor in cost differentials between actively managed funds and plain vanilla index-linked ETFs. Ouch…