Sunday, September 20, 2009

More on NAMA

As I write, more information has been provided by the Government on the proposed NAMA rescue plan.
For example we now know that the total value of loans transferred to the Agency will be €77bl. (including €9bl. rolled up in interest). Against an estimated current market value of €47bl., NAMA will be offering €54bl. So on the face of it this would represent a premium to the banks of €7bl.

However much of these calculations are very questionable. If we exclude the interest the remaining value of the loans would be €68bl. To then suggest that these loans would have a current market value of €47bl. seems to me far too high. (The Government claims that the actual value of property against which these loans were issued is in fact €88bl. due to developers commiting the remaining €11bl. of their own funds. However I would remain highly sceptical that this actually is the case!) Therefore the true premium in payment to the banks is likely to much higher than €7bl. So as many critics suggested, this does look very much like a bail out plan for the banks. No wonder therefore that their share prices surged the following day!

In addition one cannot feel reassured by the utter nonsense being used to sell the plan whereby the Minister for Finance tries to convince taxpayers that if property prices rise by just 10% over the next 10 years that they will be actually profiting from the deal. Apart from the fact that this ignores the time value of money (with interest rates likely to rise again in future years) it represents an unacceptable way of assessing value. If one is buying a house for example during a boom one does not calculate the price with reference to some estimated future value in 10 years time (which could conceivably be double or treble present value). Likewise one should not try and calculate the price of property in a recession with respect to an estimated future value (which given the present unprecedented situation cannot be calculated with any accuracy).


As regards the practical working of the plan - which is vital in terms of its appraisal - I still find it very difficult to envisage how it will operate.

As I understand it, NAMA has very few staff at present (though more will be hired before it commences work). However there are many thousands of loans out there which have to be investigated. Many of these are cross collateralised relating to property companies who have deliberated designed their company structures so as to cause the maximum amount of confusion.

Who will exactly be dealing with these loans? Will NAMA officials attempt to directly negotiate with such developers or - as is more likely - delegate them largely back to the bank personnel already involved? In the latter case one can then validly query as to whether there would then be any urgency to resolve the loans. After all the banks will have received a generous payout from NAMA for such loans thus relieving them of immediate pressure. Meanwhile the developers will be only too happy to sit and wait for the property market to pick up (which could take a long time).

So on the face of it therefore NAMA looks like a giant warehouse for storing largely dormant property loans while giving the impression that it is designed to actively resolve the problem.


I will attempt here to address just some of the issues that I feel have been overlooked in discussion.
One of these relates to the fact that there has been a tendency to treat bank shareholders and taxpayers as two distinct groups (with shareholders assumed to benefit and taxpayers, by comparison, likely to suffer a cost).


However a high proportion of these shares are held directly or indirectly by domestic taxpayers. Some will have purchased bank shares outright and be well aware of the value of their holdings. However many more will have contributed to management and pension funds containing Irish bank shares. Such taxpayers therefore stand to benefit through investment and pension fund values rising. However we have very little detail as to the precise composition of bank share holdings. Though some anecdotal evidence suggests that there has been an increase in privately held shares (purchased towards the bottom of the slump) detailed information is not available.
So clearly a significant number of taxpayers stand to gain from any rise in share prices that is directly attributable to NAMA.

Another issue that causes me considerable concern, likewise has received surprisingly little attention. This relates to the fact that not all loans have been transferred to NAMA. The question then arises as to well the non-transferred loans - which are of considerable value - will actually perform. For example I understand that only loans in excess of €5 ml. have been transferred. However it stands to reason that many of these smaller valued loans will also be somewhat toxic relating to speculative property deals. Here, the attitude of the banks is likely to be very different with an incentive to squeeze the borrowers as strongly as possible while the really big defaulters enjoy comparatively a free ride inside NAMA!

A worrying indication is given by the news that Anglo Irish Bank is set to require further billions in capitalisation by the government with respect to expected losses on such non-transferred loans. It is truly a shocking indictment on the supervisory system that this bank, which was of no strategic importance to the economy, already accounts for €28 bl. of the total loans transferred to NAMA. On top of that it had already requested an additional €3bl. - €4bl. for capitalisation purposes. But apparently this is by no means the end of the matter. So the ultimate losses that this one “upstart” bank will entail can only be described as truly horrendous.

As for the supervisory regime, it was already readily apparent that it was operating in a largely ineffective manner and - worse still - deliberately designed to act that way. Since the Financial Services Centre was set up, Ireland has been trying to attract the international institutions with the promise of “light touch “ regulation very much part of the overall incentive package. In addition we have been turning a blind eye for years on the financial activities of multinational companies based here (who form a disproportionately large part of the Irish economy). For example in 2005 it was reported in the Wall Street journal that Microsoft had two subsidiary companies based in a Dublin legal office reporting gross profits of $9bl. and $1bl dollars (approx)respectively!

It seems that these companies were simply set up for tax diversion purposes (due to Ireland’s low corporation profits tax). This begs several questions. What tax diversion activities are being carried on by other multinational companies based here in Ireland? How big a role do such activities play in the decision to locate here? Does the supervisory regime enquire regarding such activities or is there in fact an unspoken practice to simply ignore everything so that firms will continue to invest here?

The point therefore that I am making is that financial regulation does not take place in a vacuum and the very reason why it has been so weak is that it has perhaps suited Ireland to have it this way (to facilitate multinational firms and international financial institutions locating here).

Therefore, I see grave problems in now genuinely moving to a stricter environment. True reform would require a very different ethos to the loose practices that historically have been seen to favour Ireland. And as I see no appetite to openly discuss the key underlying issue as yet, I do not expect the supervisory regime to change in any fundamental respect.


With respect to developers I can see many potential problems in the operation of NAMA that are unlikely to be resolved.

Though I accept that we must move on to an effective resolution of the mess that has been caused by the development mania that overtook the Celtic Tiger, social justice requires that some penalty should be imposed on those who rashly squandered enormous sums of money.

Firstly, I see no reason why they should be granted strict confidentiality - as NAMA proposes - regarding their dealings. Taxpayers, who are now paying for their excesses are entitled to know the identity of the major culprits, the amounts that are owned and the extent to which they are cooperating with the Agency.

Secondly, an open investigation - perhaps starting through Dail committees - into the practices and dealings of developers leading up to this crisis should be promised. I expect that in many cases - apart from merely unwise - downright fraudulent behaviour will have been involved (perhaps in many cases also involving bankers). And where such is the case developers and bankers should be prosecuted in accordance with the law. Apart from requiring these developers (and bankers) to answer in some manner for their actions we could learn a great deal from the process that could help perhaps prevent a similar scenario unfolding in future.

Thirdly, we need to end this ridiculous practice of allowing a labyrinth of perhaps hundreds of companies under one developer ownership being set up (deliberately designed to make it extremely difficult for investigators to follow any paper trail). Indeed this could all form part of that necessary investigation of the development crisis.

As I said in a previous offering on the topic, I expect that many developers have already hidden away large amounts of money e.g. through companies registered in other countries that NAMA will never be able to tap.

So I expect that these will just hold tight and plead inability to pay when approached by NAMA officials. Indeed - with money safely hidden - it may well suit some developers to declare bankruptcy if necessary, walk away and get ready for the next property upturn (whenever it occurs).

There is an even more frightening scenario that may unfold when NAMA does eventually seize such assets, in that it may then feel obliged to sell them at low cost to other developers already on their books (with the banks once again rowing in to provide the finance).

One hopeful suggestion here that I would make is that we now have a great opportunity for the State to seize a great deal of land. By carefully controlling its future use the state would then be in a position to prevent a speculative land bubble in a future recovery of the property market.


As for the banks, we must of course strive to move forward and restore confidence in the system. However justice - and thereby acceptance of NAMA proposals - requires again that the bank officials responsible for such appalling lending decisions in recent years face some penalty. Just as with the developers, a detailed investigation into the whole affair should be promised. Indeed perhaps the two proposed investigations (into the developers and bankers) should be combined in one as the issues are very much interrelated. Once again I would expect that many fraudulent practices would be uncovered in the process. And where officials are found guilty the full rigours of the law should be brought to bear.

However people have a right to feel cynical about the present Government’s intentions in this matter. We have already had a clear example where 10 leading business men were invited by Anglo Irish in what appeared as an obvious share price rigging exercise to protect the large investment there of the wealthiest businessman in the land i.e. Sean Quinn. The Director of Corporate Enforcement , we are told, is dealing with this matter with a view to criminal prosecutions taking place. However with nearly a year gone by, nothing has happened. Indeed the same man who is supposed to be the centre of the investigation has since become the sponsor (through Quinn Insurance) to the flagship programme of the national broadcaster. Surely if a genuine criminal investigation is indeed pending the acceptance of such sponsorship is then highly inappropriate!

So there is a huge credibility gap to be bridged by this government in demonstrating that it is genuinely concerned with social justice and this I believe is the greatest barrier to acceptance of their NAMA proposals.

Much more could be done to deal with this overriding issue and the need for those who are most responsible to make reparation in some appropriate way.
This would then make it much easier for people to address practical proposals for moving the situation forward.


Now the government will claim - and I don’t doubt them on this point - that the NAMA proposals are designed most of all in an attempt to restore liquidity to the banking system. They are offering the banks €47bl. in low interest bonds. These can then be placed with the ECB for money. So with the expectation that the banks will now receive a large amount of cash through the Euro system, it is believed that they will be free to lend more to business.

However I would be very doubtful regarding this. The banks will still want to improve their capital base by preserving - rather than lending out - money. Also having had their fingers so badly burnt through lending out for risky purposes they are likely in the near future to move in the opposite direction and act extremely conservatively in assessing risk. And with the economy in recession not many businesses will seem like good options for receiving loans.

This is a general problem that is being experienced worldwide. It reminds me very much of conditions during the Great Depression and the contribution of Keynes who clearly saw that the state had to take the lead in spending where private confidence is very low.

I would consider therefore that the Government should propose its own capital spending injection in a manner that would be economically desirable and also politically popular. For example they could aim to dramatically solve the problem of inadequate school buildings by greatly accelerating this programme over the next couple of years. However this proposal should only be offered on condition that genuine efficiency improvements are agreed to in the public sector.

Of course this would mean even more being added to the national debt. However it would greatly assist a depressed building sector, create many new jobs and through the multiplier effect give a much needed boost to other economic activity. This would also help to arrest the collapse in property prices thus making the whole task of NAMA more plausible.
Above all it would offer much needed hope at a very difficult time.

However it should be made clear that this would be in the nature of a once off gesture designed, not to replace, but rather facilitate recovery in the private sector.

Ireland has ignored a growing loss of competitiveness for some considerable time which urgently needs to be addressed for long term growth to be sustained.
So any temporary injection of government spending must be viewed pragmatically as a short term fillip that cannot be permanently continued.

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