Economics 29/08/2009: Nama critics are out of touch academics?

Today’s letter in the Irish Times got me going, along with Noel Whelan’s article on the subject…

“Madam, – The professors’/doctors’ thesis was good (“Nama set to shift wealth to lenders and developers, Opinion, August 26th). To a person who has lost over 70 per cent of their entire pension fund invested over 22 years, it is nice to hear their comment from a secure pension position. It is also nice to read that they now want to confiscate the remaining part of my pension fund.” 

Well, I am sick and tired of this ‘their secure pension / job position’ crap – pardon my use of vernacular here. Here, on the record:

• I have no public pension and have to rely on my own savings to generate one;
• I am in the negative equity, just as many Irish people are;
• I have no tenure in any of academic institution and am paid per each course I teach and each student I supervise, despite having brought more business to TCD than my income from TCD recovers;
• I have no PAYE earnings in Ireland;
• Most of my income comes from pure performance-based pay for private clients in Ireland and abroad;
• I know first-hand what it means to have a two-person unemployed family in this country and yet neither myself nor my spouse have ever drawn on unemployment benefits;
• I know first-hand what it means to have a child when your spouse does not qualify for maternity benefits from an employer;
• I know first hand what it means to pay for my own and my family private health insurance;
• I have no desire whatsoever to see my family income go to support this letter writer’s pension fund – private or public. Full stop!

So message 1 from today to the Irish Times – please stop publishing letters and articles that border on slanderous and inaccurate in their allegations.

Now, let us deal with another piece in today’s Irish Times by Noel Whelan titled “Selling Nama to sceptical public requires political will”.

Whelan simply cannot understand the basic difference between a political reform proposal (Lisbon Treaty) and public expenditure proposal (Nama) and in confusing the two reveals something very interesting about our politicians. As a senior (by tenure, if not by accomplishment) politician, Mr Whelan has no apparent idea that any public spending/ investment undertaking requires cost-benefit analysis. Factual evidence, not ‘selling to the public’ is what such undertakings are based upon. Any hard facts, Noel? Nope.

Instead, Whelan:

• Prefers to dismiss those who provide factual arguments as some sort of ‘out of touch’ academics;
• Blabber on about political selling of Nama to the general public;
• Suggests that arguments of numerous specialists in the area of economics, finance and real estate are nothing more than a “populist card” similar to that played in Lisbon I referendum, and that we – critics of Nama – “scaremonger about its consequences or encourage an “if you don’t know, vote no” stance.”

Well, Mr Whelan, do come out with your facts. Will you? Sadly, he does not. Instead he proceeds to deflect the debate about Nama into an imaginary land of make-believe villains (economists, finance experts, independent observers) combated by the noble knights in shining armor (Mr Whelan including). Don Quixote he is not, but the windmills are aplenty in his article.

“In the past three weeks more time has been allocated to squabbling over issues surrounding the proposal than to shedding light on its contents.” Clearly, Mr Whelan cannot get his a***s of the chair to read this blog, or Irish Economy blog, or anything else but the Irish Times. The debate on Nama has been raging on for months now and in the last three weeks myself and others have comprehensively shredded into pulp the entire Government proposed legislation on Nama. Is there any point of repeating this again in detail in a collective letter? No, Mr Whelan, there is none.

Whelan goes on to repeat, parrot-like the ‘arguments’ against the critics of Nama produced by Mr Ahearne and by the official Government note on how to respond to critics of Nama:

“In all that noise fundamental features of the Nama project have been distorted or misunderstood. These include that Nama will buy loans rather than property, that developers will still be liable for the full amount of their loans and that the success of Nama is contingent on a modest improvement in our economy and property market over the next five to 10 years and not on a return to a bubble.”

These are virtually verbatim taken out of Alan Ahearne’s pitiful ‘letter’ to his ‘colleagues’ which itself was a poorly re-edited rendition of the official unpublished, privately circulated “Nama Q&A” note prepared by the DofF to accompany the release of the Nama legislative proposal.

Whelan has no idea what he is talking about here and is, at the very best, slides into blind repeating of the Government official lines. No serious observer has argued that Nama will buy properties, but that it will acquire properties as a collateral in the process of buying loans. No one is disputing that the developers will be liable, but the extent of liability is highly uncertain and nothing is being done to prevent them from legally shielding their properties from Nama. (Noel, perhaps, really has no clue that this can be done in this country, but hey, I am not about to start running a kindergarten Economic 0.0001 course here for him).

“What is surprising, however, is the limited and broad-brush nature of their contribution. One might have thought that such a group giving the public the benefit of its expertise could have done so in a more substantial manner than merely affixing their names to what is in effect a lengthy letter.”

Oh, Noel, please, get your head out of Biffo’s 'Ideas Bog' and read our separate numerous contributions on the ‘substantive’ aspects of Nama made elsewhere. You can start with my own contributions on this blog or with my article in the Irish Independent yesterday, or Business & Finance archives, or the Sunday Times… You can proceed to read Brian Lucey’s and Karl Whelan’s articles in the Irish Times and elsewhere.

And so, the Irish Times’ message 2 of the day: try to avoid publishing political drivel as a factually-based opinion. Unless, that is, you are doing it in a subversive manner of letting the public know just how detached from the reality can our politicos really get…

Economics 27/08/2009: Rabo and Namaeland

And so the news come out of the depths of Irish banking sector, like an old Soviet sub, with its nuclear reactor still glowing red. Rabo is, as logically expected, on its way out with ACC delivering 20% loans losses and values on underlying assets down 50-60%. Well, there’s more to come according to them and there is no hope a recovery mid-term. This is all happening while the Government is spinning the idea that Nama is going to be just fine because, apparently, it will be taking loans with low LTVs… Hmmm...

Let me see – anyone wonders why Rabo is not buying this story? Simple: a loan written in 2007 with an LTV of, say 50% in the amount €100 had collateral underlying it valued at €200 back then. Table below shows the expected losses on Nama purchasing such a loan under Rabo impairments and stated declines in underlying value.

The above factor in the rolled up interest and a 20% impairment rate on loans. Interest accrues over 2007-2010 and all values are brought into 2009 Euro. 2007-2009 inflation is assumed to be cumulative 2%. 2010 inflation is assumed to be zero. Interest roll ups are taken at 7% in 2007, 9% in 2008 and 11% 2009-2010.

What is clear from the above is that even before we factor in the cost of bonds issuance, the cost of subsequent recapitalization, and the costs of operating Nama, the required gains on 2010 expected values of the underlying properties (assuming 20% are completely bust) required to restore Nama to break-even on its purchases in 2021 will be in the range of 2-5.5% annually in the case of 40% discount paid by Nama on assets and between 4% and 8.3% in the case of 30% discount paid by Nama.

Now, let us factor in  the cost of financing the Nama bonds and the cost of recapitalization post-Nama. Table below shows identical results to the table above, except with the bond financing cost (over inflation – of 3% pa through 2021), plus Nama recapitalization demand at 8% on the value of the loans transferred (a gross underestimate, but hey, let’s give them some slack):

Yes, folks, that is right – to get break even (almost, as we still did not count the cost of Nama operations, plus the cost of redeveloping loans, etc, but we can cancel these out with property yields, just to cut these endless estimates) on Nama, Ireland Inc will need to run annual property markets inflation of 12-15.1% per annum for 10 years after 2011! And this is based on 50%-60% LTVs!

I mean, are you surprised Rabo and the likes are not rushing to buy into our “Low LTVs” Namaeland?

Note of caution: I am just using Rabo numbers here - this is clearly not a complete picture of Nama, but it does give us the latest up-to-date picture of what is going to be happening in Nama.

Economics 26/08/09: Nama debate gone dirty

I have missed today's debate between Alan Ahearne and Brian Lucey, although as far as I understand Dr Ahearne failed to actually face Brian in this debate.

Having heard the 'debate' afterward and having obtained a letter from one of the Green Party parliamentary party members to a senior ranking disillusioned member of the party in which a venerable Green legislator claims, as Alan did today, that academics commenting on Nama with a critical perspective are not fully appreciative of complexities of Nama and are not offering any solutions to the porblems Nama is supposed to tackle, I can say the following:

I stand by my original estimates of losses expected from Nama. Alan Ahearne's quoted figures are based on thin air, as Dr Ahearne has failed to produce any evidence to support his assumptions or estimations, while my (and Brian Lucey's) balancesheet for Nama has been in public domain and under public scrutiny for over two months now,

Points raised by myself, Brian Lucey and Karl Whelan (and some others as well) about the lack of safe guards, stop0loss rules, transparency, accountability and ownership of Nama and its assets are not academic, they are as real as Dr Ahearne's salary in the employment of the Minister. Nay, they are actually more real, because families who will be paying for Nama deserve to be the rightful owners of Nama assets and deserve to have full access to Nama operations,

As far as I know, neither Dr Ahearne, nor his masters have offered any, I repeat, any clarifications as to the amendments they plan to propose for Nama legislation. In contrast, everyone can read my proposal for Nama3.0, Karl Whelan's proposals for changing Nama legislation, Patrick Honohan's ideas on how Nama can be fixed and altered, and so on. None of us have been paid for doing so, unlike Dr Ahearne who, having not failed to accuse us all of being 'academic' has (a) called us 'colleagues' (surely this makes his musings on the subject also 'academic', and (b) has managed to produce no new ideas on Nama beyond what his masters produced in the proposed legislation.

I am having a very hard time understanding how myself and other independent observers of Nama can be labelled 'academic' when the questions we raised about Nama are both immediately relevant to the issue of Nama operations and are countered from the opposing side by the nonsense of unsubstantiated numbers quoting and references to us 'not appreciating the complexities'?

Here are couple of questions sent to me by one senior policy person in Ireland with my quick replies to them:

Q: Apparently, in one of the debates, a pro-Nama person suggested that Banks nationalisation cannot occur before Nama is paid for because, while the ECB will do the swap for Irish government bonds as a reasonable discount, they will not give the same deal for a nationalised bank. Or if they do help us, they will insist on their pound of flesh i.e.they will do an IMF on us and we will lose all economic sovereignty. My questions about that are... a) is that really true...

A: It is true in so far as the ECB lending window is for private banks that are solvent. However, it is a technicality, since the ECB will have to offer lending facility to the governments as well. It simply has not been confronted with such a prospect before, but hey, there is always a first one.

b) if Irish government put their shares in Trust for taxpayers as per Nama3.0 - hey presto no link to government - does that get over ECBproblem?

A: Yes, it does, further, recall that I have argued that (steps 3 and 4) the Government can provide for private ownership diluting its own share holding in the banks, so the banks will be owned by a trust (Nama), plus two large groups of private investors, with the Government nowhere to be seen. We can even go further and include as shareholders in Nama some developers/investors by offering them shares in Nama in return for equity in their development projects written against the loans.

Economics 25/08/2009: Mad Maths at Nama

This might come as no surprise to those of you who have been in Ireland over the last few days, but it still btohers me - a week later. Nama is hiring specialist(s) in derivatives management and pricing to take on complex engineered products that the Banks have on their books.

Now, I know we have serious excellence in the ranks of our public sector and we have promissed ourselves to build on it even further. After all, DofF does excellent job in forecasting receipts and expenditure outlays - year after year, even when the trend is so strong, just adding GNP growth factor to last year's returns and then double that to last year's expenditure would do a better job than the entire DofF 'forecasting' team. And our CBFSAI does an excellent job watching the evolution of major fundamentals affecting the financial stability (it took them until the late 2007 to officially notice that the housing market might be in trouble and that construction sector has actually peaked - despite the fact that construction stocks data actually shows a break point in 2005 - full two years ahead of CBFSAI noticing it). And so on... but

The 'but' part relates of course to the fact that Nama-bound derivatives and complex intruments written against loans and real estate development ventures that are polluting our banks books are soooo toxic, I would compare them to a Chernobyl reactor just after the meltdown. The rest of Nama loans will be medical toxicity-levl stuff, compared to the serious s***t based on securitized underlyings. Nama taking these on will be equivalent to the Soviets sending unprotected troops into Chernobyl reactor to manually remove the fuel rods (they did do that).

This, of course, warrants a revision of our balance sheet totalling expected Nama losses. Once we have a clearer view of these derivative instruments extent, we will have to write them down to 'zero' real value, for I suspect there can be no recovery on secondary lending that was extended on collateral with real current value that has fallen 70-80% in the crisis.

Given speculative reports that Nama will buy into some Euro40bn worth of this stuff, I would say that a clear expected loss on this share of Nama purchases should be in the neighbourhood of
40bn*[Prob(recovery in default)*Prob(default)+(1-Prob(default))*Recovery Rate (No default)*Share (Deriv at recovery)]
Using UK and US data,

• Prob(recovery in default) = 8-11%
• Prob (default)=25-30%
• Recovery rate=40-50%

40bn*[(2%-3.3%)+(28%-35%)]=Euro12-15bn

So total expected recovery on Euro40bn in derivatives to be bought by Nama is around Euro5-7bn, implying the total expected loss on Nama should rise, under the best case scenario, from previous Euro13.4bn to Euro27-30bn over the life time of Nama...

Now, to warn you - these are back of the envelope calculations, and I will re-run full balance sheet to get more exact numbers. But you can already see where this Government is heading - another reckless and completely immoral sell-off of the taxpayers in exchange for a quick fix that has not worked anywhere else before.

Economics 24/08/2009: Alan ''Please read me!!!' Ahearne

The hilarity of a personal Ministerial Adviser sending an article defending his masters' views to a Sunday newspaper was not enough for Alan Ahearne [see that story cover here]. Never mind his article addressed not a single point of criticism levied against NAMA. Alan actually had to send out an e-alert [well, of some 979 words that is] to a list of his "colleagues". The email implored them not to sign up to an article critical of NAMA until they read his own article published in the Sunday B-Post. Given the fact that the said article had no useful information content regarding any potential or alleged NAMA problems, it is hard to imagine why Alan would actually publicise his own "efforts" with Irish academics. Then again, he might be simply keen on publicising his own efforts full stop.

Alan clearly forgot three major things in that email:

1. He failed to include in the email recipients list the names of anyone actually critical of NAMA - surely a majour omission if his intent was to convince us to take another look at NAMA in light of his, then, forthcoming major contribution to the debate;
2. He failed to notice that since he became an employee of the Minister for Finance, he is no longer an academic, so sending an email to academics and saying "Dear colleagues" should really be slightly offensive to the academics, assuming they are really valuing their independence from the political interference (which is, of course, now fully embodied by Alan's position);
3. He failed to provide any real substantive arguments disproving NAMA critics' main positions.

So here we go - two pieces of work by Alan Ahearne, some 1900 words wasted between the two, and not a single coherent point of defense again NAMA critics... Gotta be a record for someone paid to do this kind of work, don't ya think?

Economics 16/08/2009: Alan Ahearne on NAMA - not an ounce of sense

Alan Ahearne has decided to produce a definitive defense of NAMA in today's Sunday Business Post (here). And I would have to respond. As usual - Italics are mine.

The first half of Alan's article is saying absolutely nothing - nothing as in nada, zilch, nul, nil. He simply outlines in a tedious and lecturing fashion a litany of trivial observations as to why a banks crisis resolution is necessary. He does not show that NAMA is either a necessary or a sufficient condition for crisis resolution.

"Nama is also designed to ensure that the resolution to the problem of legacy loans is orderly. Nama can achieve this outcome because it will be patient in disposing of property assets which it has seized from delinquent borrowers." This is an unproven statement that can be argued to be untrue as NAMA can and is being shown to be likely to produce a prolonged period of highly uncertain property markets with buyers and investors holding back in anticipation of future NAMA disposals of property. The longer NAMA holds these properties, the longer it will delay new investment in property in this country. The longer it will keep banks uncertain about future NAMA losses (which - as we were told - will be clawed back from the banks), the longer the mortgage holders will remain in negative equity, withholding from consumption and investment and so on.

"Outside of Nama, a liquidator appointed to wind up a property company has a duty to sell off seized properties quickly. During an economic crisis, when markets are under severe stress and banks are not functioning properly, these properties may have to be sold at a discount to their underlying economic value." Again, Alan presents a dishonest 'extreme' alternative to NAMA as we know it. Outside of NAMA, there can be better mechanisms designed for systemic and orderly adjustment of the property bubble legacy. My own NAMA 3.0 is one. Karl Whelan proposed a similar scheme as well.

"Economists refer to the discount that the liquidator must pay for a quick sale as ‘the price of immediacy’. By design, Nama will not have to pay this discount because it will sell the properties at its own pace. It is important to note that the outcome for delinquent borrowers is identical, whether liquidation occurs inside or outside of Nama. Property companies are wound up and collateral is seized. The difference is in the speed at which the seized assets are re-sold to the market." Again, this is simply not true. NAMA will keep certain projects (and thus certain property developers) in business and will even aim to complete some of the projects. If this is not a rescue clause, I am not sure what is. And as far as NAMA not paying the discount due to long term nature of the undertaking to dispose of the properties, well, this does have a price -
the longer NAMA holds these properties on its books:

• the heavier will be taxpayers' losses on bond financing (interest);
• the longer will the property markets take to adjust;
• the longer will be the period of banks uncertainty as to their costs of NAMA;
• the longer will be the period of stock markets uncertainty about the banks profitability;
• the longer will be the period of subdued investment and consumption in Ireland.

There is no such thing as a free lunch, Alan. And NAMA is not getting close to one either.

"It would be impossible to dispose of ten of billions of euro worth of distressed properties in a short time under current conditions -and extremely destructive to even try." Again - no one I know of - neither Karl Whelan, nor Brian Lucey, nor myself have said there should be a fire sale of assets. Why is Alan Ahearne allowed to deflect public attention from the real issues that are being raised against NAMA? Has he morphed into a spin doctor for DofF?

"No wonder, then, that the IMF, in its recent report on Ireland, describes Nama as ‘‘pivotal to the orderly restructuring of the financial sector and limiting long-term damage to the economy’’." Well, IMF has not endorsed NAMA and was actually critical of its provisions. Alan knowingly distorts IMF analysis by selectively quoting its report.

"A key question relates to the value at which the loans will be transferred from the banks to Nama. Some commentators have mistakenly talked about the price which Nama will pay for land and development properties. Nama is not buying properties, but rather buying loans that are secured on properties and other assets -there is a fundamental distinction." Again, Alan uses this article to deflect the real criticism - not a single serious commentator said that NAMA will be buying actual properties. But in buying the loans, NAMA will acquire titles to underlying collateral. So - a play of words for Alan is a fertile opportunity to reduce public focus on the real issues.

"The transfer value will be in accordance with EU Commission guidelines on the treatment of impaired assets. The commission is very clear on this issue: the loans are to be transferred at values based on their so-called ‘real’ -or long-term - economic value. These are the terms used by the commission. Paragraph 41 of the commission’s communication published in February states that “ . . .the transfer value for asset purchase or asset insurance measures should be based on their real economic value’’. Annex IV of the communication states that ‘‘the objective of the pricing must be based on a transfer value as close to the identified real economic value as possible’’. Well, actually, a 'real economic value' is not the same as the 'long-term economic value'. Plus, as several of us have pointed out before (Karl Whelan, Brian Lucey, many others and myself) - 'long-term' economic value can mean anything. Absolutely anything. So what Alan is saying above, just as his masters did earlier is that 'the EU Commission allows us to buy these assets at whatever price we want to pay for them'. This might be good for the Commission. But it is not good enough for us, as taxpayers who will ultimately pay this price.

"Some commentators have claimed that Nama should instead transfer the loans at what they refer to as ‘current market clearing prices’. It is hard to see how this makes sense. The reality is that there is no price at which the market for land and development can clear under current conditions. This is not to say that land has no value, but rather that the market for these assets is not functioning." In the current markets we do have real valuations of land and development assets. There are sales, there are some investments, there are transactions. Furthermore, today's price can be taken as a short-term valuation based on standard hedonic valuations. The only problem - for the banks, developers and their guardians in the Leinster House - is that these valuations are too low. So they use an academic economist to argue nonsense about 'markets are not there, man, me doesn't know much about what value things might have'.

"There seems to be a misapprehension among some commentators that, for Nama to break even, property prices need to revert to the peak levels seen in 2006-07. This is not the case."
Well, do the maths, apply discount of a% on a property loan of X bought, assuming the loan yields y% annually. Hold it for T years. Assume that the underlying collateral appreciates at k percent per annum. The present value of this loan T years from today if the prevailing rate of interest is R is
(1-a)X{Sum([1+y+k]/[1+R]^i} where i=1,...,T
The cost of financing this loan is at R+g where g is the risk premium, taken over T years and discounted back to today:
(1-a)X{Sum([1+R+g]/[1+R]^i}
The break even on this deal requires that the first identity is equal to the second one. This in turn implies that to break even, NAMA will have to either

• enjoy property yields + appreciation on the capital in excess of the cost of bonds financing and the cost of running NAMA itself - which really means a property boom (in yields terms) will be required well in excess of the 2004-2007 one, or
• enjoy property price appreciation that will cover the cost of bond financing, plus the cost of running NAMA, plus inflation, less the discount a.

This is soo excessively optimistic, that actually it makes me believe that in making his statement, Alan reveals not having done even a basic estimation of NAMA likely costs and losses.

Now, it is also telling that Alan fails to even mention the problems of protecting taxpayers' interests, ensuring transparency of NAMA operations, or any other major issues for which NAMA has been criticised by many commentators, including myself.

I also find it extremely arrogant and outright rude that this public servant has managed to escape any scrutiny as to:

• why as the economic adviser to the Minister for Finance has he not produced any economic assessments of NAMA?
• why has he failed to consider the economic costs of NAMA (he does attempt something of an analysis - albeit extremely simplistic - of what would happen if NAMA was not enacted)?
• why is he allowed to simply claim - with no evidence or arguments to support such a assertion - that NAMA will restore functional banking system in Ireland?
• why is he allowed, unchallenged, to claim that all external analysts are supporting NAMA, while we know of several Nobel Prize winning economists, numerous other respected international academics, not to mention all internal independent analysts working in Ireland who unequivocally identified NAMA as being a bad idea?

In short, Alan's article is a waste of space - pure and simple, providing not a single fact, not a single logical argument, not a single ounce of economic reasoning to support his thesis.

Read my alternative to NAMA here.

SCAMA - a joke that's touching reality

From http://img218.imageshack.us/img218/9136/scama.gif

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 29/07/2009: NAMA time horizon

Peter Bacon on today's Morning Ireland has stated that the time horizon for the real estate cycle built into NAMA assumptions is between 5 and 10 years. I have written about this assumption in the previous post (here). Assuming that what is meant by the 'cycle' here is peak-to-peak U-cycle, the most conservative Government estimate, then, is for the growth of 14.86% annually in house prices, if we are now at the bottom of the cycle. Oh, that is realistic, of course, but only if the Government spends the next few months blowing up - physically - so much housing stock in this country that it will create a massive overhang in demand over supply. Good luck!

But there is an added complication that was revealed by Liam Carroll's examinership case. As we all knew, loans to developers, by and large - all developers - to date have not been serviced with interest roll overs becoming a routine at the very latest mid 2008. This means that by the time NAMA purchases a given loan with face value €X, given the reasonably expected average rate of interest on refinanced loans of 8-11%, this loan will be refelective of:

• 12.24-16.95% cumulative rate of rolled interest, plus
• the orignal principal of €0.8305-0.8776 to the Euro of the face value of the loan

Now, suppose NAMA applies a haircut of 25% on the loan, so we buy €1 of the loan at a price of €0.75. What do we get for that €0.75? A loan that had at the time of its origination an underlying asset value of €0.83-0.88. So the real face value discount we are getting is 0.75/0.83 - 0.75/0.88 or 9.64% to 14.77%.

But wait, the actual principal (face value) amount has depreciated by, say, roughly 50% since the time the loan was written, so in reality, the discount NAMA will take will be negative 70-78%! What does it mean? Take a simple analogy. You walk into a shop and see a TV advertised 'For Sale'. The signs reads:
Original Price €100.00
Sale Price €178.00
How fast will you walk away from this 'deal'?

NAMA will overpay for the assets it buys on a vast scale!

Economics 27/07/2009: NAMA, ILandP rate hike, US home sales and redemptions

So NAMA failed the first day of Cabinet debate. We know this much - even RTE managed to issue a post, although the Montrose boys lacking anything real to report managed to produce a cheerful note on the debacle. Oh, how much they want the State to succeed in soaking the private sector...

But what really hides behind the Cabinet in-decision? Well, it is rumored that not the (allegedly) ethical Greens, but Mr Cowen's own troops are unhappy about NAMA. Some senior ministers, as I hear, are saying 'Hold on, we'll have to face constituency out there one day and you are about to load an average person (25 yo+) in this country with some €20K in fresh debt from the bankers and developers alone'. Good for them. And I certainly hope the Greens also stand up and tell Mr Cowen where to pack that NAMA idea.

Oh, and apparently, the DofF men are saying that the 'long term economic' value under the NAMA formula will be based on, well, more than 5 and less than 9 years. Hmmm... What does this mean? It means that NAMA should be expected to break even (at the very least) were we to price the property assets to be purchased into NAMA on this 'long term' valuation basis. Ok... but...

First there is one majour issue here - in real world of economics, long-term market value usually means a long-term past average or trend. What it means for NAMAphiles is thatwe will be forecasting the values forward over some long-term horizon. Anyone familiar with forecasting knows that this, in reality, means that we will be in a completely arbitrary forecasting territory. In other words, for DofF to say we want to take current discounts based on future values projected 5, 7, or 9 years ahead is like saying 'we'll name the price and then justify it afterward'.

But wait, there is also a problem with the way the DofF is allegedly timing the cycle.

Calculated Risk blog (see below) - the top forecaster for US housing market shows expected time to the bottom in price in the US residential market of 5-7 years. Do you think we gonna get there in this time here in Ireland? No. We have had worse correction in the market to date than Japan, who are 20 years into the downturn in their property markets and still not seeing the light at the end of the tunnel.

And NBER research paper 8966 (BOOM-BUSTS IN ASSET PRICES, ECONOMIC INSTABILITY, AND MONETARY POLICY by Michael D. Bordo and Olivier Jeanne) has a handy set of charts at the end, showing the most recent busts in property markets in the OECD economies. Ratios of boom length to bust duration are (defining as boom - trough to peak prices, bust - peak to trough):

• Australia 1980s: 3 years of boom, 7 years of bust: ratio of 3:7;
• Denmark 1980s: 4 years of boom 7 years of bust: ratio of 4:7;
  
• Finland 1990s: 4 years of boom, 6 years of bust ratio of 2:3;
• Germany 1980s: 4 years of boom, 7 years of bust: ratio of 4:7;
• Ireland 1970s-1980s: 3 years of boom, 7 years of bust: ratio of 3:7;
• Italy 1970s-1980s: 3 years of boom, 6 years of bust: ratio of 1:2;
• Italy 1990s: 4 years of boom, 6 years of bust: ratio of 2:3;
• Japan 1970s: 2 years of boom, 4 years of bust: ratio of 3:4;
• Japan 1985-today: 6 years of boom and 19 years of bust: ratio of 6:19;
  
• Netherlands, 1970s-1980s: 4 years of boom, 8 years of bust: ratio 1:2;
• Norway 1980s-1990s: 4 years of boom, 6 years of bust: ratio 2:3;
• Spain 1970s-1980s: 2 years of boom, 5 years of bust: ratio 2:5;
• Sweden 1970s-1980s: 4 years of boom, 7 years of bust: ratio 4:7;
• Sweden 1980s-1990s: 3 years of boom, 7 years of bust: ratio 3:7;
• UK 1970s: 2 years of boom, 4 years of bust: ratio 1:2;
• UK 1990s: 4 years of boom, 7 years of bust: ratio 4:7

So average ratio is 1.874 years of bust per year of boom... and that means that, given we had 5 years of a boom that the historical data suggests a bust of 9.4 years duration at an average. That is 9.4 years to a trough in Irish property prices! Not to a realization of some miraculous 'long term economic value', but to a trough.

Well, let's take a look at the same data from the point of view of time to full return to pre-crisis property prices, or peak to trough (nominal prices):

• Australia 1980s: 18 years from 1981 through 1998;
• Denmark 1980s-1990s: 8 years (1979-1986) and 13 years (1986-1998);
  
• Finland 1990s: 1989-2004 or 16 years;
• Germany 1970s: 1973- today... oh yeah, right - some 36 years;
• Ireland 1979 to 1995 or 17 years;
• Italy 1981- through today... right, so that's about 29 years;
• Japan: 1973 through 1986: 14 years;
• Japan 1990- today: 20 years;
• Netherlands, 1978 through 1998: 21 years;
• Norway 1987 through 2003: 17 years;
• Spain 1978-1987: 10 years;
• Spain 1991-1998: 8 years;
  
• Sweden 1979-today or 31 years;
• UK 1973-1987: 15 years;
• UK 1989-2000: 12 years.
  

So average peak to trough for 'long term nominal economic value' is 17.8 years. Again, given our peak at 2007 we have to look forward to NAMA recovering peak valuations at around, hmmm... 2026... But wait - not all corrections were steep enough to match ours... so let's isolate those that were:

• Australia 1980s: 18 years;
• Finland 1990s: 16 years;
• Germany 1970s: 36 years;
• Italy 1981: 29 years;
• Japan 1990: 20 years;
• Netherlands, 1978: 21 years;
• Norway 1987: 17 years;
• Sweden 1979: 31 years;
• UK 1973: 15 years

Which yields an average of 22.6 years, pushing our recovery to beyond 2030. By this standard, a break even value for NAMA should be based on something closer to 15-16 years, if we are to take a 20-25% haircut on current book values of the loans.

So DofF is talking about under 9 years then... I see... ah, the poverty of expectations...

The Government has time to get it right - they have the entire month of August to sort the new piece of legislation on NAMA, outlining in details:

• Provisions for taxpayer protection;
• Complete and comprehensive balance sheet and cost/benefit analysis of the undertaking;
  
• Exact amount of equity the taxpayers will receive in return for NAMA funds (hmmm, 100% would be a good starting point);
• The exact procedures for divesting out of the banks shares in 3-5 years time with exact legal obligation 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;
• 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;
• Provision for a taxpayers' board, electable directly by people, to oversee the functioning of NAMA;
• 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...


Oh and on the topic of IL&P predatory rate hike for adjustable rate mortgages, here is a brilliant argument as to why Minister Lenihan must intervene to stop the practice of soaking the ordinary consumers to pay for past banks follies. Read it and think - can any government, acting in the interest of the broader economy and taxpayers and voters be so reckless in its attempts to hide behind 'protecting the markets' arguments as to willingly sacrifice its own people on the altar of cronyism. And do remember - I am a free marketeer, and a proud one, yet I see no moral strength in Lenihan's arguments.


US data is now showing more serious signs of an uplift... or does it? Sales of new homes rose 11% in June is a sign that some decided to interpret as a return to growth. I wouldn't be so trigger happy myself - this is the largest rise in new homes sales since... oh you'd think like somewhere in 2006? no - since November 2008. This is volatile series and the seasonally adjusted rate of 384,000 new homes sales in a month is, while impressive, way off the old highs. Thus sales are still down 21.3% on already abysmal levels of 2008 so far this year.

Here is what my favourite US housing guys - http://www.calculatedriskblog.com - had to say about the latest rise: a W-shaped bottoming out is coming. And a superb chart from the source:
Or, in the words of the blog author:"There will probably be two bottoms for Residential Real Estate. The first will be for new home sales, housing starts and residential investment. The second bottom will be for prices. Sometimes these bottoms can happen years apart. I think it is likely that we've seen the bottom for new home sales and single family starts, but not for prices. It is way too early to try to call the bottom in prices. House prices will probably fall for another year or more. My original prediction (a few years ago) was that real house prices would fall for 5 to 7 years (after 2005), and we could start looking for a bottom in the 2010 to 2012 time frame for the bubble areas. That still seems reasonable to me."

And to me too. But what I would caution against is the optimism for the overall property markets. Here are two tidy little reasons:

One: US equitable redemptions are the lags between the property being reported as a non-performing on the loan book of a bank and the time it hits the foreclosure market. Now, these vary by state, with some states having no er provision at all, while others having 9 months plus. The US average is about 4 months. This is what is yet to be reflected in the 'distressed' sales gap - the gap between new home sales and existing homes sales. Chart below illustrates:
Again, the distressed gap is not closing, but both series are pointing up. Now, notice that around November 2008-February 2009, the days of the most fierce destruction of income and wealth worldwide, the number of existent properties on the markets did not rise. Why? The ER lags are kicking in. So take the average of 4 months and get June 2009 to start showing an increase in existent homesales rising - foreclosures are feeding in. This process is likely to continue through months to come.

Two: I would watch the maturity of securitized commercial loans... these are still looming on the horizon for the roll-over (and they are also a problem in Ireland, where most of commercial property lending was securitized)... Comes autumn, expect things to get tough once again... Oh, and then NAMA will coincide with the already tightening credit markets and will take a large chunk of liquidity our of the market... Gotta love that Lenihan/Cowen timing - like two elephants trying to dance polka at a Jewish wedding - loads of broken glass, but not to the delight of the newlyweds...

Economics 25/07/2009: NAMA Presentation

So NAMA... where can it lead us? This is a question I tried to answer for today's very engaging event. I would like to thank all the participants in it for having such tremendous patience to sit through my presentation.

Those of you who attended would remember a comment from the audience that Ireland has a debt overhang on the private economy side and that NAMA is justified as a form of correcting it. This is, in my view, the singular most problematic issue raised for five reasons:

1. Logic commands us to look at a problem to determine whether or not it requires a solution. Once we deem the problem to be grave enough to require a solution, it commands us to devise an appropriate solution. I agree - debt overhang is a severe problem and it requires a solution. However, no logic requires us to undertake a wrong solution to a rightly identified problem.
   
2. Economic efficiency argument tells us that we need to solve the problems relating to the most productive sectors of the economy first so as to rescue our productive capacity. Once that is done, only then can we have a luxury to use limited resources to address problems in less productive sectors. NAMA will concentrate solely on the problem of debt overhang on the developers' side. It will not address debt overhang on consumers' side or on the side of our businesses. Yet, while developers who are in trouble are not a part of the productive sector of our economy (they are, by and large in trouble because of highly speculative re-zoning and building projects they undertook) or at the very least not the most productive part of our economy, households and companies are the productive components of this economy. NAMA will do two things to Irish companies and consumers. It will retain their debts and magnify them by forcing banks to increase their existent loans' profit margins (as we are already seeing with variable rate mortgages and accelerated loans revisions for performing customers on the business lending side). And it will saddle companies and consumers with the debts of developers via NAMA bonds. Which part of this economic policy is economically literate?
3. Financial efficiency requires us to undertake a form of solution that minimises economic and financial costs to the taxpayers. NAMA is the least economically efficient means for doing so, for an alternative - buying out the main banks or forcing a restructuring of their debts (possibly via an debt-for-equity swap) will be cheaper and will offer more control and upside potential to the taxpayers.
4. Any Government policy must apply, without discriminating against or in favour of any particular group of people. And yet, NAMA will create a discriminatory structure whereby the failures in pricing risk by the banks and developers will be dumped unceremoniously onto the shoulders of the ordinary taxpayers. As a taxpayer, I face no chance of doing the same to the banks. In fact, even more egregiously, Minister Lenihan - a lawyer by training has announced recently that he cannot interfere in the 'markets' on behalf of the variable rate mortgage holders who are being fleeced by the banks hiking their rates to push up profit margins. This is the same Minister Lenihan who has no problem interfering with the 'markets' by dumping some €60bn in banks' liabilities on to the taxpayers. This is discriminatory, in so far as both actions are one way streets - the banks cannot be made accountable to the taxpayers, and the taxpayers cannot be allowed to renege on transferring their wealth to the banks.
   
5. Political and ethical legitimacy requires that any solution that uses collective resources must address first the needs of those who provide resources. In the case of NAMA that means the ordinary people. Not of companies (they come second in the tier as employers and creators of added value) and certainly not of the developers (who come in third in the picking order). Which part of NAMA will address the needs of an ordinary family that is going to:

• Pay taxes Messrs Cowen and Lenihan levy on us, while
• Also paying for NAMA, while
• Facing a risk of financial ruin from unemployment and
• Possible home repossession should the default on a mortgage payment because their savings will be wiped out by NAMA debt burden; whilst
• Having the bleak future with no pension provision as
  
• The banks and Messrs Cowen and Lenihan enjoy a nice tidy rescue package paid for by the aforementioned 21st century Irish Government serfs?
  

Hence to argue that we must support NAMA because we have a debt problem in this country fails on five fundamental principals: logic, economic and financial efficiency, non-discriminatory action by the state and political and ethical legitimacy. It is deeply immoral and has not a single rational point in its favour.

So here are the slides...

Economics 24/07/2009: getting deeper into NAMA Wonderland

NAMA is a quagmire that is only getting bigger the longer we are looking at it. The latest reports now claim that the NAMA remit will be extended to cover foreign banks operating here, suggesting that cross-collateralised loans and holdings will be facing embarrassingly lengthy legal challenges otherwise. Of course, it was never the original Government intent to share the spoils of a taxpayer-paid bailout to prop up foreign banks. But hey, if sharing the trough is what it takes to rob the taxpayers, then our Government has no problem with this.

A revealing research note from Davy published today says it all: "From an equity investor’s point of view, an examinership process for a big developer such as Carroll would be preferable to
receivership/liquidation. The banks concerned would still have to take a write-down, but it offers the developer the prospect of survival and provides the banks with an opportunity to get back the remainder of their money. Having said that, it would obviously be preferable if these
actions stopped altogether, allowing NAMA to proceed unobstructed.[Read: the spoils will be richer if the lawyers stayed away from the feeding corale.] It is important to understand that examinerships are likely to occur only where developers are forced into a corner such as we have seen recently with ACC. Voluntary examinership is unlikely given that any successful restructuring of debt does not cancel a developer's personal guarantee to the lender (which many of them have)."

Now, examinerships are also possible, of course, if the developers are insolvent and have cash flow problems. But Davy would not mention that small tid-bit because they are fully aware that majority of the troubled developers are, in collusion with the banks, restructured. Anticipation of NAMA has also made many of them, undoubtedly, transfer all liquid assets to the shelters where no NAMA can touch them. So all of this implies two things:

1. The idea that NAMA will pursue vigorously non-performing developers is bonkers - there will be nothing to pursue comes 18 months since NAMA or the banks rescue (depending on how smart a given developer was) was first rumored. By the time NAMA is operative, there will be nothing left that is held in the name of each one of these developers that has any chance of ever being liquified.
2. The question as to whether this amazing delay in rolling out NAMA was knowingly applied by the Government to allow an escape clause for some loans holders. This is, of course, a speculation, but as any student of undergraduate economics knows, if you want to prevent people from taking preventative actions, any policy change should be unaticipated. Of course, as always, there is an alternative, but equally unpleasant, explanation as to why the Government chose to announce well in advance its desire to set up NAMA - the explanation of a panic response to a perceived crisis.

So do tell me now, how can Minister Lenihan claim that, based on the information he has seen,
it was "not inevitable" that NAMA would result in the state taking majority ownership of AIB and BofI. How? Well, this can be possible if and only if either

1. the haircuts applied to the NAMA purchases are deep enough to compensate for the cost of bonds, plus the impairment rate on loans transferred. Do the math - at 5% over 15 years coupon, applied to a purchase yielding 3% in revenue - 26% (not factoring in any inflation), the latter is anyone's guess, but judging by NIB, ACC, Nationwide etc examples, should be around 20-30%. Do the math, or
2. post-NAMA recapitalization of the banks will be done as a give-away of taxpayers money, while the banks post-default 'liability' on assets that Mr Lenihan was so keen to promote as a 'safeguard' for the taxpayers only few months ago will be nill.

Again, take you pick, but either the Government is aiming to be reckless with our money or deceitful.

Oh, and another thing - the new talk about NAMA liabilities being off the state balance sheet. This is kind of what Messrs Leniham and Cowman assumed will happen with the banks guarantees, until the international observers and analysts got a wind of it. Ditto with NAMA. Last week's decision by Eurostat, titled The statistical recording of public interventions to support financial institutions and financial markets during the financial crisis does allow for the possibility for Minister Leniham to hide NAMA liabilities off the front ledger of his Government. In particular, Eurostat's Section 8: Classification of certain new bodies allows the state to separately account for a funded entity "where ...the identification of an institutional unit in the national accounts requires that the body has "autonomy of decision" in respect of its principle function and either keeps a complete set of accounts or it would be possible and meaningful, from both an economic and legal viewpoint to compile a set of accounts if they were required". Now, if Cowen/Lenihan due can convince the readily convinceable EU Commission that NAMA undertaking has nothing to do with the General Government and has its own life and management. Never mind that the same taxpayers paying for Messr Lenihan and Cowen wages and their spending plans under the General Government expenditure will be underwriting NAMA. The charade of 'low debt Ireland' will then go on unperturbed.

In other words, if Lenihan is successful, some €60bn of bonds might be called something other than the official Irish Government debt. This is pure farce, but hey, may be as the taxpayers we can go on strike and tell Mr Lenihan to pay for NAMA out of its own pocket - afterall, it will be fully autonomous from the Government and therefore from us, the taxpayers?

Wake up calls for Irish Government

My new article in Business&Finance magazine:

Last week two international reports provided an interesting analysis of Irish policies to date and highlighted some scepticism amongst the international analysts as to the ability of our Government to lead the necessary reforms.

First, caught up in the media feeding frenzy, the IMF Article IV Consultation Paper has raised some serious questions about NAMA. Second, much unnoticed by Irish media, the EU Commission report on public finances in the Euro area have provided an in-depth look at Irish fiscal position relative to our peers.

Let us start with the IMF’s analysis, focusing on the major area of the Fund’s oncerns that received little cover in the media. Our policymakers were quick to present the IMF statement that NAMA can be a break-even proposition for the taxpayers as a major endorsement of the Government plan.

Here is what the IMF report actually did say on the topic: “If well managed, the distressed assets acquired by NAMA could, over time, produce a recovery value to compensate for the initial fiscal outlays.” In other words, the IMF is benchmarking NAMA ‘success’ solely against a possibility for earning zero return on initial public investment. The IMF is simply unconcerned here with the associated costs, such as the cost of bonds financing, NAMA management and the cost of post-NAMA recapitalization of the banks. Yet, these costs are non-trivial from the point of view of expected taxpayers’ losses due to NAMA.

Using the balance sheet model for NAMA developed by Professor Brian Lucey and myself, table below provides estimated discount rates that would achieve break-even for the taxpayers on total costs of creating and operating our bad loans bank.
* All in billion 2009 Euro, assumed inflation: 3% pa, 15-year horizon
** ca 33% of the total value of bonds issued, plus the face value of loans purchased into NAMA
*** Ex-operating cost of €20mln pa (rising at 2% pa from 2010)

Even under optimistic scenarios of 10% impairment on loans, and assuming current cost of financing Irish bonds of 5.9% (consistent with last week’s syndicated bond issue) for 2009-2014, and moderate bond finance costs for 2010-2024, the discount on assets purchased by NAMA required to achieve zero loss on NAMA-associated public outlays ranges between 27% and 50%. Higher impairment charges (12-15%) and/or financing costs raise the required break-even discount above 60%.

In other words, there is no reasonably probable scenario whereby NAMA will end up breaking even on total taxpayers outlays in real terms. Perhaps this is precisely the reason as to why the Government has to date produced not a single estimate for expected costs and returns under NAMA, despite making numerous unfounded claims that it will not result in significant taxpayers losses.

In fact, the IMF report was rather clear in its critical assessment of the Irish authorities lack of proper cost-benefit analysis of this undertaking. “The authorities did not formally produce any estimate for aggregate bank losses. …Staff noted that losses are likely to extend beyond the property-development sector as the economy weakens and the design of NAMA should incorporate that possibility.”

Furthermore, “the debt to be incurred to support the financial sector remains uncertain,” says the IMF. “If the losses suffered by banks are about 20 percent of GDP, as estimated by staff, then bank recapitalization needs could be around 12-15 percent of GDP.” These numbers correspond to the two most extreme scenarios presented above. But the IMF Report also states that in such an eventuality “assets would be acquired against this debt...” Injecting €21-25bn in public funds would do the shareholders in Irish banks will be a de facto nationalization – a scenario consistent with IMF staff estimates, yet denied by the Government.

One day before the IMF report, the 300-pages strong EU Commission paper, titled Public Finances in the EMU, 2009 put forward the picture of Irish Exchequer presiding over the worst performing (fiscally) economy in the entire EU.

The diplomatic Commission said in its report that the scale of the downturn was unexpected by the Irish authorities, “with the end-2007 update of the [Government] stability programme expecting real GDP growth of +3% in 2008, while the Commission services’ interim …forecast estimated growth at -2% in 2008”. Irish “deficit was not considered temporary”, suggesting that the EU Commission disagrees with the Government view that most of our troubles are cyclical.

As per credibility of our Exchequer plans to bring the deficits under control by 2013, Commission said that “the January 2009 addendum to the [Government] stability programme targeted a deficit …below 3% of GDP in 2013, based on yet to be specified consolidation measures. In view of the above, the Commission concluded that the deficit criterion in the Treaty was not fulfilled.” In other words, Brussels does not believe that our plans to reduce the deficit in line with the EU rules by 2013 are credible and, therefore, we are now in a full breach of the EU Treaties.

Just to make it more clear the Commission provides a graphic illustration as to how far off we really are in delivering on the 2013 targets. Like IMF in its report last week, the Commission data shows that whilst the Government has proposed a ca 2.75% of GDP contraction in its deficit in 2009-2010, the required rate of reductions should be more than 3 times greater – at ca 8.5% of GDP.

Using the change in the current level of the structural deficit required to make sure that the discounted value of future structural balances covers the current level of debt as the indicator for long-term sustainability of current Government policies, the Commission puts Ireland in the highest category of fiscal instability risk – one of only two Euro-zone countries (alongside Spain) in the group. At the same time, we came out as the most impaired country in the Euro area in overall assessment of our fiscal position.

The IMF and EU Commission papers do agree on another point. Both state that the start of the fiscal crisis we experience today predates the current crisis by at least 4 years. At the same time, clear downward trend in our fiscal stability was visible, according to the EU Commission back in 2003.

There are some serious discrepancies between the Commission and the Government assessments of the ongoing budgetary consolidation process. According to the Commission spring 2009 forecast, “the deficit is projected to widen further to 12% of GDP in 2009, the highest in the euro area.” The deficit target set out by the Government in April 2009 is 10.75% (up from 6.5% in budgeted for in October 2008). “The projected deterioration of the deficit would take place despite successive consolidation efforts since mid-2008, …with an estimated overall net deficit reducing effect of around 4% of GDP in 2009.” Thus, the EU does not buy into the Department of Finance estimate that the total consolidation to date yields 5% of GDP reduction in the deficit, as table below illustrates.

And in contrast with the Government’s rosy projections of 9% deficit for 2010, the Commission projects the deficit to widen to 15.6% of GDP on a no-policy-change basis. “The difference to the authorities’ target …is mainly due to different projections for the 2009 budgetary outcome and ...the non-inclusion of the indications for the budgetary measures for 2010 presented in the April supplementary budget.” Once again the Commission appears to be sceptical about the willingness of this Government to actually follow through with the targets set out in April.
Thus, in major reports published in one week, two international bodies gave a rather forceful negative assessment of the current Government plans for dealing with the banking and fiscal crises. And yet, the Fitzgaraldo of self-congratulatory remarks from Irish public officials pushes on – ever deeper into the denial of our bleak fiscal reality.


Box-Out:
All last week we have been hearing about the IMF endorsing Irish Government ‘austerity measures’ aimed at bringing under control our runaway train of public spending. Rhetoric aside, real numbers suggest that at least in one area – that of public sector employment – months after setting itself some modest targets for public workforce reductions, the Government is nowhere near delivering the real progress. Chart below, taken from the latest Quarterly Household National Survey data released last week, clearly illustrates the prevalence of past trends in overall employment.
While private economy employment shows catastrophic collapse in total numbers working in industry, construction, wholesale and retail services, basic repairs, accommodation and food services, administrative and support services and professional and technical support services, the same data shows precipitous rise in employment numbers across all three broadly defined public sectors.

Subsequently, the chart below shows an even more disconcerting trend.
In addition to by-now customary steady and precipitous rise in unemployment, we are also experiencing rapid withdrawals from the labour force participation as more and more people are falling into our deep welfare trap or undertake an emigration option. This trend – of collapsing employment and rising unemployment – now poised to threaten our long-term demographic dividend, or the expected higher returns to younger labour force that many of Irish policy makers and analysts close to the Government circles are so keen on referring to in their rosy forecasts.

Well, of course the public sector is rolling in the dough as we are taking a pay cut: