Friday, 28 August 2009

More NAMA debate

The NAMA debate is going round and round. Some good points are coming from all sides of this argument (I am yet to decide for myself where I am looking at a cube or a dodecahedron).

Something that I think is still creating some cross purpose is the lack of a clear delineation of what I believe are the two primary issues here:
  • Reinstating the Irish banking system with a viable and solvent balance sheet
  • Deciding on the fiscal role of taxpayers in the process
The former is an issue of economic efficiency, the latter one of equity.

Once we state this clearly, I think the viable options become more transparent and we are more likely to get a durable (i.e. politically acceptable) solution. I don't think I have seen any knowledgeable commentator disagree with the first objective. So on that there is essentially unanimous agreement. And this isn't really very complicated. What needs to be done is to write down the assets held on bank balance sheets and having done that recapitalise them. NAMA is certainly one way of doing that and I even the most vociferous opponents of the plan don't seem to disagree either.

So clearly the difference of opinion lies in the latter point. Note that this is about two things:
  1. The potential magnitude of cost ot tax payers
  2. The distributional affect
And these two points are partially linked and I will look at them separately below.

Magnitude of cost to the taxpayer

The single greatest irony of all the present debate, which is focused on the price NAMA will pay for the assets, is that it is too often being posed as a debate about "what is the financial loss?". Of course, there is nothing to debate here. The loss is there, it has already occured and has a value, it is simply that we don't know how to measure it yet.

No, the issue is where will this loss (of unkown size) fall. And we can simplify this down to a choice of falling on those took on these assets (or exposure to these assets) in the first place, or tax payers.

Say we let the banks reconstitute their balance sheet internally, by marking down the assets and defaulting on their liabilities, starting from the top tier down (shareholders, top tier unsecured bond holders etc. etc.) until their assets again equal their liabiilties. Or perhaps more accurately, until the assets are close enough to their liabilities that they would have some economic value that would justify someone buying the whole balance sheet (i.e recapitalising them).

If we simply allow that to happen and that "someone" is a foreign bank or a new group of shareholders then the cost will fall on the banks' current shareholders and bond holders - in my mind, exactly where it should fall.

But if the government decides to buy the worst of the assets of the banks at a premium the tax payer is instantly being forced to bear some of the cost - this is NAMA. At the extreme, if NAMA paid the nominal value for the assets the entire, exact same, cost would fall on tax payers and the banks' shareholders and bond holders would be let off scot free.

If we pay something between the true mark-to-market price for these assets and the nominal value the taxpayers will be stumping up some proportion of the cost.

But it doesn't end there, because even if NAMA managed to buy the asset at their market price we are simply back to where we began - the bank marking down their assets. The implications from there are the same - liabilities have to be marked down and losses taken by shareholders and bond holders. NAMA hasn't changed a thing - the banks are still insolvent and someone needs to take the loss in order to reconstitte the banks' balance sheets. Under the "liability guarranttee", thoughtfully provided by the Irish Government, that means taxpayers have to.

But it doesn't have to be that way. The guarrantee expires next year. The government can effectively renege by threatening to string out affairs until its expiry. This can be used as leverage to force the reconstituion of the banks balance sheets by wiping out current shareholders and doing debt-equity swaps on some bond holders to reestablish the banks.

If the shortfalls are too large the government could then force the banks to be declared insolvent and nationalise them on the basis that they tale only those liabilities they are required to - effectively deposits and secured crditors/bondholders. Then use taxpayers' funds if necessary to restore tier 1 capital. Only that way could you ensure that the burden on the taxpayer is kept to a minimum.

And what is funny about this is that this is absolutely no different to simply making the banks properly revalue their assets in situ and have themselves declared insolvent.

So NAMA is clearly a contrivance that adds nothing but the opportunity for taxpayers to indirectly recapitalise the banks on very poor terms.

So to:

Distributional effects

Well, this can be brief. Form the previous paragraphs it is clear that we are looking at a range of potential outcomes which range from a redistribution of the total cost from taxpayers to bank shareholders and bondholders to one where, if we are lucky, all the losses are bourne by shareholders and bondholders.

I don't see that as a difficult issue to grapple with. Let's simply find agreement on these two points, which I would describe as the necessary and sufficient conditions that need to be met:

Necessary condition - is the proposed solution one which will successfully reconstitute the bank
balance sheets?
Sufficient condition - is the proposed solution one which will (not might, if...) succesfully minimise any redistriubtion from taxpayers to current bank shareolders and bondholders?

I think NAMA meets the necessary condition, but not the sufficient condition - back to the drawing board.

My preference? Should have let everyon bar AIB and BoI go under in the first instance and then temporarily nationalised those two and reconstituted their balance sheets at minimum taxpayer cost (possibly as a merged entity) for continuing operation; be that with immediate pass back into the private sector (e.g. debt-equity swap), or interim public ownership for later IPO or sale.

It still isn't too late.

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