Understanding N.A.M.A.
The National Asset Management Agency, more commonly known as N.A.M.A., is a new body which will operate as an independent commercial agency under the aegis of the National Treasury Management Agency. Its task will be to deal with the problems caused by excessive lending by the banks during the property boom. These are massive and complex problems, not easily understood, often understated, and frequently misrepresented. ITIC spoke with Tony Foley, Head of Economic Finance and Entrepreneurship at Dublin City University (DCU), to attempt to explain N.A.M.A. in non-technical language. Here’s the result…
BANKS AND LENDING
Role of banks
Banks obtain money from deposits and from borrowing on the money market. They lend this money at higher interest rates to borrowers. The difference or spread between the interest rates is the source of profits and operating expenses. This provides funds to cover bad debts, operate the banks and give a return to shareholders. Banks normally expect that only a very small share of loans will not be repaid. The loan may be fully lost or there may be an asset, e.g. land, which is used as security and which can be sold by the bank to recover all or part of the loan. Banks also hold reserves which can be used if operating profits are too low to cover the bad debts.
The Problem
The problem which N.A.M.A. is intended to fix is that the Irish banks lent very large amounts of money to individuals, mainly for property related projects, which will not now be repaid according to the original loan agreement, if ever.
An example will illustrate. Suppose a property developer borrows €1 billion to buy various tracts of land on which to build projects such as apartment blocks, housing estates, office blocks, shopping centres or hotels. When completed and sold the projects would have generated enough money to repay the loan and make profits. Let us now suppose that the property market collapses, and the price of land and buildings decline so greatly that there is no point in building on the land. The land and any buildings may now be worth, say, €300 million on the market, but the borrower owes €1 billion and is unable to repay the loan. The banks could seize the land, but its current sale price would not cover the loan.
Some borrowers may have given personal guarantees to repay the loan and, in our illustration, the borrower may have a spare €700 million to add to the land price and repay in full. If so, all would be well. This happy (except for the borrower) situation is going to be very rare indeed. The borrower’s resources just simply will not cover the loans.
Essentially, it means that the banks will not get back large sums which they loaned. This is a serious problem as the monies loaned belongs to depositors or was borrowed on the money markets, and their owners will want it back.
Let the banks sort the problem?
Unfortunately the banks cannot sort the problem. It is too big. There may be about €70 billion to €80 billion in bad loans. Say the banks could recover €30 billion of this, which is optimistic, they would have a bad debt loss of up to €50 billion. They do not have the corporate resources to cover this amount. They would not be able to pay back all the deposits and money market loans made to them. They would be out of business. If all depositors and lenders to the banks looked for their money the Government would have to fill the gap because of the bank guarantee scheme. Even if the bad loans could be worked through over a period of years by the banks they would be limited in making credit available while they improved their balance sheets.
N.A.M.A. and Options
The Government proposes to buy the bad loans and some good ones from the banks. The Government talks of a total of €80 billion to €90 billion of loans. This would relieve the banks of the worry of the bad loans, remove them from their balance sheets and enable banks to make new loans and start providing credit again. N.A.M.A. will manage these loans and seek maximum payment of them. If necessary it will seize physical assets and activate any personal guarantees to ensure recovery of the loans. The big issue is what price will be paid by N.A.M.A. (or we taxpayers) to the banks for the loans.
The closer the price is to the full value of the loans the better for the banks. The bad debt, or write down provision, would be low. The attractiveness of the banks would increase because the bad debts were gone and shareholder value would increase. Unfortunately the gap between the current value of the loans and the amount actually recovered eventually by NAMA would be large, and borne by the taxpayer.
If N.A.M.A. pays a low price for the loans e.g. €30 billion, reflecting their possible current market value, the banks must make a large bad debt provision of €50 billion to €60 billion. They could not remain in operation on this basis, but the Government has said it will provide additional resources for equity in the banks if this arises. The Government would then end up as the majority shareholder. A price reduction (haircut) of about 20% (reflecting possible very hopeful longer term value of the assets relating to the loans) has been discussed but we for now do not know the actual price. With a 20% reduction, the question arises as to whether N.A.M.A. can ever recover the buying price of the loans through its operations.
The argument for nationalisation of the banks is that there is less need to identify an appropriate price as both the banks and N.A.M.A. would be owned by the taxpayer.
The Government has said it would impose a levy on the banks if N.A.M.A. did not break even over some long period of time. However, in the meantime, the taxpayer would be carrying the cost of a high purchase price and the bank shareholders would be happy. But it may not be practicable to threaten to impose a levy, because the threat of a future levy to cover possibly tens of billions of euro would restrict the current operational freedom and value of the banks.
No good options
The banks need to be fixed and the bad debts removed. There is no good costless way to do this. There are lots of bad loans, and they will not be repaid in full. The taxpayer will inevitably bear a substantial financial burden. If the aim is to minimise the cost to the taxpayer and get a better contribution from the bank shareholders, the high purchase price is not the best option. However, if the aim is to strengthen and improve the attractiveness of the Irish banks, regardless of whether it involves a substantial transfer from taxpayers to shareholders, the high purchase price model is of course the best. The issue is not actually NAMA or an alternative; it is the price that is paid to the banks for the loans in question.
In recent days the Minister for Finance has been at pains to emphasise that banks will not be overpaid for the loans, and that the taxpayer will be protected as far as possible. This emphasis on protecting the taxpayer is a very welcome and belated aspect of the ministers presentation and defence of the project. Of course, as noted above, if the price of the loans is relatively low there will be a major question mark over the ability of the banks to absorb a very substantial bad debt provision, or write down on the loans. We are then back to substantial, or majority, or total Government ownership of the banks. The sooner all this becomes clear the better. If the current Government emphasis on the proper price for the loans is carried through, and the cost to the taxpayer is kept as low as possible and seen to be so (although it will still be large), I can see N.A.M.A. being implemented and accepted by a grudging public.
Our man from DCU, Tony, is of the view that the current approach seems to imply a relatively high purchase price for the loans, which would result in the taxpayer carrying an excessive share of the risk and the burden. But he is also adamant that other institutional structures, including nationalisation, will not make the bad loans go away. The policy task is to get the least bad situation for the economy and for the taxpayer.
So now you understand all about N.A.M.A. VISIT OUR BLOG and let us know what you think.
September 2nd 2009
September 2nd, 2009 at 4:28 pm
Maybe a bit simplistic but why didn’t the Government set up a Good Bank with all the money they pumped into the other banks and let them pay the price for having given out so much money during the boom times. They would then be left to sink or swim but the public and small businesses would be able to get money from the good bank.
September 2nd, 2009 at 5:41 pm
Once the Americans and the world bottled it after Lehman Bros went belly up, there was never going to be an environment in which all the banks that should have gone bust were going to go bust.
Governments moved to protect their own financial systems and their own banks – which led us to the bank guarantee among other things.
The fairest thing to have done from the outset of the credit crunch would have been to allow all banks everywhere that weren’t solvent to go bust. But that would have required global agreement and a commitment to such an agreement. This didn’t happen.
There are 2 main things to know about NAMA:
1. It will be one of the largest property company’s (if not THE largest) in the world.
2. The Irish Government and civil servants will be running it.
As a result it’s quite possible (if NAMA goes ahead) that in 20 years time it will be just another state bureaucracy employing hundreds if not thousands while the electorate of the day wonder what NAMA’s for, why it employs so many and why is it costing so much.
And if the politicians of the day operator as they do now, no doubt they’ll all claim they’ve nothing to do with NAMA and that they weren’t involved in politics when it was set up. Cue a load of buck passing and avoidance of any accountability or responsibility etc. etc.
September 2nd, 2009 at 8:41 pm
NAMA may well be the panacea for the larger developer lead hotels where they can be recycled for best benefit of the banks and investors but there is no result for the underlying over capacity issue that will dog our industry for years to come unless it is tackled. Government is now making noises that they will not contemplate any more tax incentives or relaxation of clawback rules for hotels liquidated before their tax incentives mature. Many such hotels are being propped by banks who have a vested interest since partners or management teams have themselves invested in the schemes or there is a fear that clawback of taxes forgone is greater than the cost of keeping the ailing property alive.
We need an urgent solution to assist in a measured reduction in hotel stock rather than a complete collapse, whaihc will surely happen if the current laissez faire approach is followed to conclusion.
Since the threshold for NAMA’s asset spend is set at loan value of over 5 million only, there are many smaller projects that have no recourse and this is inherently unfair.
There seems to be an ambivalence in Government to the plight of hotels. What we need is policy that will assist with hotels being transferred from developers to operators at a fair market price that gives a fighting chance for survival and a reaslistic hope of re-investment in product in future years We also need a scheme of disposal in an orderly fashion of the properties that simply have no future. Isi It is not much to ask really? !!!!!!
September 3rd, 2009 at 12:43 pm
The Government don’t seem to get it – and why should they? Few of them seem to have any experience of surviving in business or the private sector.
As a result they seem more interested in sparing various vested interests and the public sector than in helping sectors that are the backbone of our economy – tourism being an obvious example.
In Germany they introduced a car scrappage scheme to ensure their auto sector would survive and thrive when the upturn comes. Similar supports have been given in America and Britain, to viable and important indigenous private sector industries that are required to generate profits that generate taxes that fund the public sector. Other countries have aided their own indigenous industries.
Similar strategies have been adopted everywhere except it would seem in Ireland, where the stragety appears to be backwards. Because in Ireland it seems that the viable private sector has been largely abandoned while vested interests and the public sector are largely spared the full extent of the contribution they should be making. It’s as if our Government bizarrely regards our public sector as ‘the’ primary indigenous Irish sector to be saved at all costs – as well as a few unviable private sector vested interests.
This is madness because without a healthy and profitable private sector to generate wealth, there is no public sector. A change of focus and a sense of urgency from our Government is long overdue. Because two long years of dithering and time wasting followed by taking the summer off to ponder the McCarthy report is a dreadful performance.
September 3rd, 2009 at 3:02 pm
That’s a very clear expose of Nama, which I imagine most of us don’t understand. The use of the phrase ” medium-term economic value” must be a mistake, as it arouses suspicions that this is some stroke deal, based on the culture of “the tint”
The statement that the banks lent too much money is true – indeed they were reckless and it amazes me, for one, that the directors have the bnerve to hang on in there, even on reduced fees. Hve they no shame?
But you might have mentioned as well that many people borrowed far too much – these were not innocents. They took advantage of the bank’s stupidity.
Keep smiling!
September 4th, 2009 at 9:27 am
Bank Stupidity? It wasn’t stupidity at work in the banks. It was greed, pure and simple.
Property values were hyped to ridiculous levels by everyone involved in property, from estate agents to auctioneers to the media who made fortunes from property advertising and supplements. Developers got greedy on the back of the hype and borrowed too much. The banks got greedy on the back of the hype and lent too much to the developers.
‘Joe & Josephine Soap’ got sucked in too, either through being panicked into getting a foot on the property ladder or if they already had a property, by using it as collateral to invest more in order to make a quick profit. The banks lent them too much too, and while I’d have some sympathy for the former, I’ve none for the latter. Investments can go up or down after all. The insanity went on.
Much of the ‘wealth’ involved never really existed however. It was paper wealth based on over valued property which has now evaporated due to the property crash. What is puzzling though, is why so few people including the Government listened to the clear warnings that were being issued for years from many sources.
Since 2002 Ireland has been in the midst of an unsustainable domestic boom that wasn’t export led (as opposed to the sustainable 1997-2002 period). We engaged in a domestic orgy of ripping each other off. The inevitable result of this was that a crash was always inevitable sooner or later, and the higher we pushed things, the further we were going to fall. And while the external global economic problems haven’t helped, much of our problems are home grown despite Government denials. Even if there was no global problem Ireland would still be in trouble.
September 4th, 2009 at 10:47 am
By the time property prices in parts of Dublin were ahead of London, New York and Paris etc., serious alarm bells should have been ringing. It’s not as if we’re strapped for land after all, or that we’ve got a massive or high density population. At least in Japan their property boom was based on a scarcity of flat land and high density living among other things. Here it seems to have been based mainly on greed and profit with many contributors in the mix taking their cut.
There were lots of people watching from abroad who thought we were mad, and as it turns out, rightly so.
September 5th, 2009 at 7:35 pm
Michael Vaughan (Sept 2nd) – “There seems to be an ambivalence in Government to the plight of hotels.”
There’s an ambivalence in Government towards a whole lot of things, except for a few vested interests and the public sector. Unfortunately I don’t see this changing. The Government is too disconnected.
Spanner-Island (Sept 4th) – “We engaged in a domestic orgy of ripping each other off.”
You’re not wrong Spanner, and it’s exactly this which has made us uncompetitive. Higher prices led to higher salaries which led to higher prices etc. etc. And while this might be fine in huge economies like America with populations large enough to sustain this to an extent, Ireland doesn’t have a large enough population which means we only survive by exporting. This means we cannot indulge ourselves like we have been.
In times past we could have devalued the punt among other things to restore competitivness. That option isn’t available now. Therefore we’ve got to cut costs, prices and wages across the board whether the trade unions and the rest of those who seem to believe we can survive in a high cost bubble like it or not.