Economics 1/08/2009: NAMA - alternatives Part IV

June 2009 paper from the IMF, titled The Economics of Bank Restructuring: Understanding the Options by Augustin Landier and Kenichi Ueda is something Minister Lenihan and indeed the entire Irish Cabinet should have read, and probably would have read if their economic advisers actually did their jobs. But, of course, the readers of this free (unlike Alan Ahearne's advice) blog can read it here.

Here is a summary (italics are mine):

"This note ...evaluates various restructuring options for systemically important banks. The note assumes that the government aims to reduce the probability of a bank's default and keep the burden on taxpayers at a minimum [a tall assumption for own Government, but hey...].

...If debt contracts can be renegotiated easily, the probability of default can be reduced without any government involvement by a debt-for-equity swap. Such a swap, if appropriately designed, would not make equity holders or debt holders worse off. However, such restructurings are hard to pull off in practice because of the difficulty of coordinating among many stakeholders, the need for speed, and the concerns of the potential systemic impact of rewriting debt contracts.

When debt contracts cannot be changed, transfers from the taxpayer are necessary. Debt holders benefit from a lower default probability. Absent government transfers, their gains imply a decrease in equity value. Shareholders will therefore oppose the restructuring unless they receive transfers from taxpayers.

The required transfer amounts vary across restructuring plans. Asset sales are more costly for taxpayers than asset guarantees or recapitalizations. [We know thi - NAMA will ask us to pony up €60bn in bonds, plus another €10bn+ in recapitalization funds on top of already awarded €7bn+ - all for bailing out a system that in its entirety is worth no more than €10bn]. This is because sales are not specifically targeted to reduce the probability of default. Guarantees or recapitalizations affect default risk more directly. Transfers can also be reduced if the proceeds of new issues are used to buy back debt.

Depending on the options chosen, restructuring may generate economic gains. These gains should be maximized. Separating out bad assets can help managers focus on typical bank management issues and thereby increases productivity. Because government often lacks the necessary expertise to run a bank or manage assets, it should utilize private sector expertise [Now, if you read NAMA legislation, the system will rely on NAMA-own employees to run risk and credit committees - what 'private sector expertise'?]. Low up-front transfers can help prevent misuse of taxpayer money [Well, NAMA will have up-front transfers of some €60bn!In contrast, my proposal for the banks to take market-driven writedowns before NAMA transfers would minimise this.]. Moreover, the design of bank managers' compensation should provide incentives to maximize future profits.

If participation is voluntary, a restructuring plan needs to appeal to banks. Bank managers often know the quality of their assets better than the market does. This means banks looking for new financing will be perceived by the market to have more toxic assets and, as a result, face higher financing costs. Banks will therefore be reluctant to participate in a restructuring plan and demand more taxpayer transfers. A restructuring that uses hybrid instruments - such as convertible bonds or preferred shares - mitigates this problem because it does not signal that the bank is in a dire situation. [Of course, NAMA is all about one instrument - taxpayers' cash] In addition, asset guarantees that are well designed can be more advantageous to taxpayers than equity recapitalizations. [Well, of course we had no 'well-designed' guarantees - we have a blanket guarantee. And thus we also have subsequent recapitalizations. And now NAMA. And after NAMA - more recapitalizations... I mean this Government and its advisers wouldn't last long in a junior policy research job at the IMF...] A compulsory program, if feasible, would obviously eliminate any signaling concerns. Information problems can also be mitigated if the government gathers and publicizes accurate information on banks' assets. [NAMA is a compulsory programme. And yet, despite the IMF advice, it is reliant on a sweet-heart deal for the banks with total disregard for the taxpayers' interests. Reckless? Venal? You decide.]

In summary, systemic bank restructuring should combine several elements to address multiple concerns and trade-offs on a case-by-case basis. In any plan, the costs to taxpayers and the final beneficiaries of the subsidies should be transparent. [NAMA legislation makes its operations fully concealed from any public scrutiny and fully indemnified against any charges of reckless waste of taxpayers' resources. It even makes it impenetrable to the courts.] To forestall future financial crises, managers and shareholders should be held accountable and face punitive consequences. [This is explicitly prevented in the NAMA legislation] In the long run, various frictions should be reduced to make systemic bank restructuring quicker, less complex, and less costly.

I rest my case. In a nutshell, even by IMF standards, NAMA is a monster that will willingly or recklessly defraud the Irish taxpayers.

Economics 31/07/09: NAMA Part III

The NAMA Legislation provides some stunningly simplistic and outright primitive economic analysis. This is contained in Part 5 of the Bill (once again, italics are mine):

PART5: VALUATION METHODOLOGY

Determination of acquisition values—valuation methodology.

58.—(1) In this section—
(a) a reference to the current market value of the property comprised in the security for a credit facility that is a bank asset is a reference to the estimated amount that would be paid between a willing buyer and a willing seller...
(b) a reference to the current market value of a bank asset is a reference to the estimated amount that would be paid between a willing buyer and a willing seller in an arm’s-length transaction...

[In other words, the difference between the two values is that the property value is a valuation of the collateral, while the asset value is the valuation of the loan drawn against this collateral as an asset. This difference should capture: counterparty risk, liquidity risk, expected return risk, lien risk and term structure risks. None are specified or explicitly required for pricing in the NAMA legislation.]

(c) a reference to the long-term economic value of the property [bank asset, per point (d) below] comprised in the security for a credit facility that is a bank asset is a reference to the value that the property can reasonably be expected to attain in a stable financial system when current crisis conditions are ameliorated and in which a future price or
yield of the asset is consistent with reasonable expectations having regard to the
long-term historical average...

[So, implicitly, this statement assumes an imposition of some assumptions on:

• What constitutes a stable financial system and how does this system impact the pricing in operative markets - something that is virtually impossible to ascertain as the only functional markets we have a history of relate to the property bubble period? Was our financial system stable when we were lending x10 times income to home buyers? Or was it stable when the likes of AIB were embroiled in a series of massive scandals?
  
• What constitutes an amelioration of the current crisis - with further issues arising as to what crisis is being meant in this context: the crisis in property markets? in banking? in credit supply? in money supply? in financial assets? in the economy at large? in the Exchequer revenue? in the labour markets? in the markets for land sites? or in demographics? or in all the above?
  
• What is the relationship that determines the future (expected?) price of an asset or a yield on the asset and what is the assumed relationship between the yield and the price? What determines the relevant expectations mechanism?
  
• What is the long-term historical average? A 10-year historical average taken from today back 10 years is one thing. A 5 year one is another. Yet a third number can be obtained if the historic average is taken back from some date in the past (say 2007 to 1998) and so on. In reality, there is an infinite number of long-term historic averages that can be taken. Which one will be selected and on what basis is never attempted to be answered in the document.]
  

(2) Subject to subsection (4), the acquisition value of a bank asset is its long-term economic value as determined by NAMA.

[Well, see above on long-term economic valuation, but in effect this is the statement that says it all - there is no price, there is no pricing model, there is not even a hint at the pricing model fundamentals. This is a botched economic analysis that would not warrant a permission to buy a typewriter for the DofF, let alone to 'invest' Euro 90bn into any undertaking. And this problem is compunded by the fact that this Bill seals the hatches on risk and credit committees operating NAMA by requiring that their members be NAMA employees or directors and not establishing any independent presence on these committees. This is like having a reactor heading into a meltdown and shutting down your monitoring systems because they are flashing red.]

(3) NAMA shall determine the long-term economic value of a bank asset by reference to the following:
(a) the current market value of the property comprised in the security for the credit facility that is the bank asset at a date specified by NAMA;
(b) the current market value of the bank asset, at a date specified by NAMA, by reference to market rates and accepted market methodology;
(c) the long-term economic value of the property referred to in paragraph (a) at the date referred to in that paragraph...

[This is incomprehensible gibberish, folks. It has neither any meaning nor economic or financial justification whatsoever. There are no accepted market rates, for there is no market for these securities and/or assets other than at extremely deep discounts that Minister Lenihan has already ruled out. The legislation provides nothing for testing the market - as I suggested in one of the required bullet points below.]

(4) NAMA may, if it considers it appropriate after consultation with the Minister, and subject to any regulations made by the Minister under subsection (5)... determine that the acquisition value to be assigned to particular bank assets or class of bank assets shall be—
(i) their current market value, or
(ii) a greater value (not exceeding their long-term economic value) that NAMA
considers appropriate in the circumstances.
[But not a lesser value, note. And once again, since there is no market value or a mechanism to attempt establishing some market value testing, this means NAMA will pay above market value for all assets. Furthermore, this section explicitly commits NAMA to use taxpayer funds to pay the real price or more for the given loan! Sickened yet? Ok, let me explain in a bit more detail. There is an auction with only one bidder. The bidder has stated up front that he will pay any price at or above the market price. But there is no market price. Where do you think the seller will set the opening bid at? If the implicit market value, known to the seller, but not the bidder is X, the seller will set an opening bid at X+y, where y is a positive premium on the 'stupidity' of the buyer or on the fact that the buyer has committed to buying the asset and is willing to pay above the market value for it. What will be the reservation price set by the seller? X+y+z, where z is a positive premium on 'desperation' of the buyer to acquire the asset. What will be the price paid by the buyer? X+y+z+v, where v is the premium on seller's skills in convincing the buyer to purchase the asset. v is also non-negative. Done. Basic auction theory, folks. Incidentally, adopting the approach advocated by me in the bullet points below removes: y through forcing the banks to take realistic writedowns first prior to NAMA; and removes z by requiring a simulative establishment of the market which can test the actual price of at least of the assets. One can't really remove v, for the smarter bankers will always be able to sell to the careless or incompetent, or both, authorities that can author this document in the first place.]

(6) In determining the acquisition value of a bank asset under subsection (2) or (4), NAMA shall have regard to the following:
(a) any value that the participating institution concerned submits as being, in its opinion, the current market value of the property comprised in the security for the credit facility that is the bank asset [that's X above];
(b) the acquisition value already determined in accordance with the valuation methodology of another similar bank asset [thats y derived from previous sales];
(c) the credit worthiness of the debtor or obligor concerned [that's v above];
(d) the performance history of the debtor or obligor in respect of that asset [that's v above];
(e) any reports furnished to NAMA in relation to the matters specified in subsection (7) whether prepared before or after the commencement of this Act [that's z above].

[So to recap: NAMA paid price for an Asset = X+y+z+v, where X is 'true' value of the asset; and (y+z+v) is a strictly positive premium accruing to the bank from the economic illiteracy written into this legislation!]

I have covered section 59 of the Act already in the previous post.


I will repeat the list of provisions that must be required before NAMA can be allowed to proceed in every post on NAMA from ehre on:

• Provisions for taxpayer protection and provision for a taxpayers' oversight board filled with only independent observers, who are not in the employment of NAMA, NTMA, the State or any other party to NAMA undertaking;
• Complete and comprehensive balance sheet and cost/benefit analysis of the undertaking;
  
• Exact upper and lower limits for banks equity the taxpayers will receive in return for NAMA funds and post-NAMA recapitalization funding;
• The exact procedures for divesting out of the banks shares in 3-5-7 years time with exact legal commitment by the state to disburse any and all surplus funds (over and above the costs) directly to the taxpayers in a form of either banks shares or cash;
  
• The formula for imposing a serious haircut (60%+) on banks bond holders, possibly with some sort of a debt for equity swap and a restriction that NAMA cannot purchase any rolled up interest acrued since the latest 'restructuring' of a loan;
• A recourse to all developers' own assets - applied retroactively to July 2008 when the first noises of a rescue plan started;
• The list of qualifications for any bank to participate in NAMA, including, but not limited to, the caps on executive compensation at the banks and the requirement to set up a truly independent, veto-wielding risk assessment committee at each bank with a mandatory requirement for a position of a taxpayers' representative on the board that cannot be occupied by a civil servant or anyone who has worked in the industry in the last 10 years;
• A requirement that risk and credit committees of NAMA include at least 51% majority of independent experts who cannot be employees of the state, NAMA or any toher parties to this undertaking;
  
• A condition that the banks must undergo loan book evaluation prior to transfer of any loans to NAMA, the results of which will be made public - on the web - instantaneously - and will impose a requirement on the banks to write down their assets, again before NAMA purchases any of them, by the requisite amounts to balance their own books in line with valuations;
• A condition that any loan purchased by NAMA be placed on the open market for the period of 2 weeks and that NAMA will not pay any amount in excess of the bids received (if any), with a prohibition for the participating banks to bid on these loans;
• A condition that every NAMA loan should be publicly disclosed, including its valuations and bids it receives in the auction stage of the process;
  
• A stipulation that all and any regulatory authorities (and their senior level employees) that were involved in regulating the banking and housing sector in this country take a mandatory pension cut of 50% and return any and all lump sum funds they collected upon their retirement;
• A provision for dealing with the speculatively zoned land to be acquired by NAMA, i.e orderly de-zoning of this land and transfer of this land to either public (if no bidders arise) or private use consistent with sustainable agricultural development, environmental improvements, public use or forestry;
  
• The measures to prevent banks from beefing up their profit margins through squeezing their preforming customers;
• The measures to force the banks to reduce their cost bases by laying off surplus workers;
• The measures for accounting (in a transparent and fully publicly accessible fashion) on a quarterly basis for NAMA operations and the performance of the state-supported banks.

If I forget something, please, let me know...

Economics 31/07/2009: NAMA Part II

And now slightly more on theat NAMAster:

Remember the levy that the Government dangled in front of the taxpayers as a sign of loss protection or minimization to be built into NAMA. Well, word 'lvey' does not appear in the entire legislation. Not even in a tocken fashion. Not even as a lip service.

And yet, bad and all as this idea might have been, the levy on the banks was announced by Minister Lenihan, repeatedly, as the only means for recouping losses on NAMA. As a friend and colleague remarked, "even that figleaf of taxpayer saving is gone'.


The document reads:
"In making regulations under subsection (1), the Minister may [my emphasis] have regard—
(a) to the rules in relation to State aid and any relevant guidance issued by the Commission of the European Communities [as if he can avoid this under the EU rules], and

(b) in relation to the determination of the long-term economic value of the property comprised in the credit facility that is a bank asset, to—

(i) the extent to which the price or yield of the asset has deviated from the long-term historical average [the half-wits who wrote this don't even understand that our historical averages are so severely skewed by a lengthy bubble in the property markets, that a return to these averages will take well over a decade],

(ii) supply and demand projections by reference to the type of asset and its location,
(iii) macroeconomic projections for growth in the gross domestic product and for inflation,
(iv) demographic projections,
[Who is going to supply these projections? Our forecasters - the DofF, the CB, let alone completely inadequate Forfas and Fas - are so grossly inaccurate in their usual predictions that you might as well use a crystal ball. One good example is the CB - this institution has been frantically issuing new forecasts on a monthly basis in order to catch up with the published forecasts by the private sector.]

(v) land and planning considerations (including national, regional or local authority development or spatial plans) that may exert an influence on the future value of the asset concerned,
(vi) analyses presented by the Minister of the Environment, Heritage and Local Government on the extent to which existing land zoning and planning permissions granted and in force meet or exceed projected growth requirements, and
(vii) analyses presented by the Dublin Transport Office and the National Transport Authority of existing and future transport planning and the associated supply and demand projections for land use.
[As I told the meeting of the Green Party recently, all of this means only one thing - the fig leaf of decorum awarded to the Green Ministers for their singing on the dotted line will see NAMA as a continuation of the development patterns that were based on utterly mad and unsustainable vision of spatial development in Ireland. In effect, the Green Party has lost all and any moral ground to stand on when it signed up to the development model (under NAMA) that cuts across the entire philosophy of the Greens.]

(c) in relation to the determination of the long term economic value of bank assets, to—
(i) the long-term economic value of the property comprised in the security for a credit facility that is a bank asset,
(ii) the net present value of the anticipated income stream associated with the loan asset,
(iii) in the case of rental property, current and projected vacancy rates,
(iv) loan margins,
(v) an appropriate discount rate to reflect NAMA’s cost of funds plus a margin that represents an adequate remuneration to the State that takes account of the risk in relation to the bank assets acquired by NAMA,
(vi) the mark-to-market value of any derivative contracts associated with the bank asset,
(vii) any ancillary security such as personal guarantees and corporate assets,and
(viii) fees reflecting the costs of loan operation, maintenance and enforcement, and

[This lengthy passage tells me right away that NAMA will operate as a banking sector's out of town office. The primacy of taxpayer protection absent in the legislation and the length afforded to the protection of the banks' bottom line is the destruction of the private sector economy on the vast scale. Incidentally, it is also a sealing of banks into servitude to the Exchequer, implying that from the day of NAMA instituion, Bank of Ireland, AIB, IL&P and other participating banks will be Japanese-styled zombies. A short-term pain relief turns a long term cancer!]


I will repeat the list of provisions that must be required before NAMA can be allowed to proceed in every post on NAMA from ehre on:

• Provisions for taxpayer protection and provision for a taxpayers' oversight board filled with only independent observers, who are not in the employment of NAMA, NTMA, the State or any other party to NAMA undertaking;
• Complete and comprehensive balance sheet and cost/benefit analysis of the undertaking;
  
• Exact upper and lower limits for banks equity the taxpayers will receive in return for NAMA funds and post-NAMA recapitalization funding;
• The exact procedures for divesting out of the banks shares in 3-5-7 years time with exact legal commitment by the state to disburse any and all surplus funds (over and above the costs) directly to the taxpayers in a form of either banks shares or cash;
  
• The formula for imposing a serious haircut (60%+) on banks bond holders, possibly with some sort of a debt for equity swap and a restriction that NAMA cannot purchase any rolled up interest acrued since the latest 'restructuring' of a loan;
• A recourse to all developers' own assets - applied retroactively to July 2008 when the first noises of a rescue plan started;
• The list of qualifications for any bank to participate in NAMA, including, but not limited to, the caps on executive compensation at the banks and the requirement to set up a truly independent, veto-wielding risk assessment committee at each bank with a mandatory requirement for a position of a taxpayers' representative on the board that cannot be occupied by a civil servant or anyone who has worked in the industry in the last 10 years;
• A requirement that risk and credit committees of NAMA include at least 51% majority of independent experts who cannot be employees of the state, NAMA or any toher parties to this undertaking;
  
• A condition that the banks must undergo loan book evaluation prior to transfer of any loans to NAMA, the results of which will be made public - on the web - instantaneously - and will impose a requirement on the banks to write down their assets, again before NAMA purchases any of them, by the requisite amounts to balance their own books in line with valuations;
• A condition that any loan purchased by NAMA be placed on the open market for the period of 2 weeks and that NAMA will not pay any amount in excess of the bids received (if any), with a prohibition for the participating banks to bid on these loans;
• A condition that every NAMA loan should be publicly disclosed, including its valuations and bids it receives in the auction stage of the process;
  
• A stipulation that all and any regulatory authorities (and their senior level employees) that were involved in regulating the banking and housing sector in this country take a mandatory pension cut of 50% and return any and all lump sum funds they collected upon their retirement;
• A provision for dealing with the speculatively zoned land to be acquired by NAMA, i.e orderly de-zoning of this land and transfer of this land to either public (if no bidders arise) or private use consistent with sustainable agricultural development, environmental improvements, public use or forestry;
  
• The measures to prevent banks from beefing up their profit margins through squeezing their preforming customers;
• The measures to force the banks to reduce their cost bases by laying off surplus workers;
• The measures for accounting (in a transparent and fully publicly accessible fashion) on a quarterly basis for NAMA operations and the performance of the state-supported banks.

If I forget something, please, let me know...

Economics 31/07/2009: NAMA legislation Part 1

Over the next few days I will be posting my thoughts on NAMA legislation. But here is a quick first installment:

A search of PDF document reveals that:

1. The word 'taxpayer' appears in the entire legislation only once. Despite the taxpayers being the sole payee for the scheme;
2. Words 'Taxpayers representation' do not appear in the document at all;
3. Words 'Taxpayers interest' do not appear in the document at all;
4. Words 'stop-loss' do not appear in the document at all;
5. Words 'transparency', 'public interest' (outside the scope of court decisions) and 'public information' do not appear at all;
   
6. 'Public disclosure' only applies to restricting such in the cases of expert opinions;
   
7. Word 'loss' appears in the legislation only in the areas of:
   

• Giving NAMA power to issue complex derivative instruments to hedge against "the risk of loss arising from changes in interest rates, currency exchange rates or other factors of a similar nature, to eliminate or reduce the costs of raising funds or borrowing or the cost
  of other transactions carried out in the ordinary course of business, or increasing return on investment. No stop-loss rules on these derivatives are envisioned, as if they are risk free;
• In making sure that "participating institutions to indemnify NAMA. 111.—(1) If NAMA or a NAMA group entity so directs, a participating institution shall indemnify NAMA or the NAMA group entity and its officers against any liability or loss..." In other words, the Government employees and NAMA will be protected from any loss claims, but not the taxpayers. Minister Leniham did his job of shielding his cronies well.

6. "30.—(1) As soon as practicable after the establishment day, the Board shall establish 3 committees, and appoint members to them, as follows: (a) an audit committee; (b) a credit committee; (c) a risk committee." There is no independent committee membership requirements, with all, save two members of each committee appointable by the Board of NAMA, and the remaining two - by the Minister.

Actually, worse that that: "(5) The members of the credit committee and the risk committee shall be members of the Board or officers of NAMA. At least 2 members of each of those committees shall be members of the Board." Thus, there will be no independent oversight over risk and credit decisions by NAMA. Not even in theory.

"31.—(1) The Board may establish such advisory committees as it considers necessary or desirable to advise it in the performance of its functions. ...(4) The Board shall determine the terms of reference and procedures of an advisory committee." There will be no statutory requirement for independent oversight of NAMA - cronies run cronies' loans.

7. "Indemnification of members of Board and officers of NAMA, etc. 32.—(1) This section applies to the following: (a) each member of the Board; (b) each officer of NAMA; (c) a director of a NAMA wholly owned subsidiary; (d) a director of a NAMA group entity; (e) a member of the staff of the NTMA. (2) A person to whom this section applies is indemnified in relation to anything done or omitted in the performance or purported performance or exercise of any of NAMA’s functions or powers under this Act, unless it is proved that the act or omission was in bad faith." So the incompetence can never be penalised - a standard practice for Mr Leniham's pets in the public sector.

And a succinct summary of the legislation (hat tip to Richard W):


More to come, so stay tuned, but this already bad enough...