National Asset Management Agency

Going into global news today, from the Financial Times newspaper:

This scheme is poorly designed. If the NAMA makes a surplus from the purchases, the government will keep the money. But if it makes a loss, the government has said it will charge banks to make up the difference. The bad bank, therefore, does not cap banks’ losses – only their profits. This will hardly do much to quell the fears in private investors’ hearts.

http://www.ft.com/cms/s/0/9d23fa0a-85e3-11de-98de-00144feabdc0.html

I couldn’t agree more with this assessment:

But, as the wreckage of the boom is washed away, older, safer sources of growth will be uncovered.

Brian O’ Hanlon

Okay,

I’ll bite one last time. This is ridiculous but, I saw this on the Irish Times website.

http://www.irishtimes.com/newspaper/breaking/2009/0813/breaking29.htm

With our current financial system in Ireland, in order to create more money and hope for prosperity, there needs to be large amounts of debt created at the point in the system where money is created. Whether that debt becomes toxic or not at a later stage is besides the point. The point is, it is still debt.

Let me demonstrate the system by telling a true story.

The ‘better’ idea

I am a builder and I owe €1,100 euro to an Irish bank. I win the lottery somehow, and receive €800 euro. I go to my bank manager and say to him, guess what, I’ve won the lottery. I want to pay down some of that loan I owe you. You would think the bank manager would be delighted. Think again.

The bank manager comes up with the a better idea. I know what, instead of paying down your debt we can invest the €800 euro. We will make more than €1,100 in no time at all with very little risk involved. The builder says, would that work do you think? The bank manager replies sure, no problem, we’ll set things up right now. Everyone is a winner right? We have created more money in the system. The builder and bank manager together manage to make a windfall profit on their investment of say €600, which added to the original €800 comes to €1,400. So we are up €300 altogether by accepting some minor risk. We use the €300 Euro to pay off some trade creditors who are screaming at us, and promise the rest to follow up shortly.

Heck, we are feeling so flip’in confident, we might buy back our own debt and pay interest of cents on the euro. We could in turn, re-package our own debt and sell parts of it to someone else. There are a whole panorama of possibilities once you have created the initial debt amount.

Robustness

Everyone is doing fine and a little bit of profit is made. Creditors gradually get paid and the economy is moving, people are working doing something. The banks are helping to stimulate jobs and raise money for investment. As the economy grows the builder’s debt grows with it. It is fine though, because the economy is larger. There a very robust growth projection figures doing the rounds, based on current performance indicators.

As the builder gets the habit of handling more throughput of money through his or her business, they find out more things to do with the money. They find new suppliers of new components. They find new experts who can advise them on how to assembly components. They get things half assembled from some other supplier who starts up business. All kinds of things go on, to ensure that the process improves. Customers out there are willing and able to pay a higher price for a higher standard of product. Sometimes the builder begins to resemble a little bank in their own right. Financial wizards and trades people begin to mingle together quite comfortably. Sharing funny stories and pints of German beer down the road at the pub.

We don’t want your stinking money.

I think you get the picture, the last thing in the world the bank wants is for the builder to pay back what he owes, because then the economy as a whole shrinks by that amount. If every builder pays back at the same time, the whole deck of cards collapses and no one has money for anything at all. Devil if you do and devil if you don’t. But if the debt stays in the system, the chances are it will act as a magnet for foreign investment from all over the world. Smart foreign investors will say, Wow, look at these crazy Irish guys who are able to convert this debt into net income. We all want a piece of that. The Irish bank then becomes an intermediary between Ireland and giddy foreign investment capital, eager to get in on the action.

The builder comes under huge pressure now to invent new concepts and new ideas. There is no way in the world the bank wants the builder to reign in what he owes. The banks wouldn’t know what to do with all of that cash anyway, if he did give it back to them. Best to extend the credit to the builder, because traditionally he or she has come up with the innovations.

Paraded through the streets

This all works in principle at the lower end of the scale I think. When you are trying to get things off the ground initially. The trouble though is hind sight. As success arrives on our door step, we feel less inclined to change. We are doing well right? Yes, the figures clearly show it. If we change the plan now, we risk it all. Let’s keep going the way we are and see.

Debt based finance when you reach a certain critical threshold can bite you in the ass. When it finally does, everything under the sun is blamed, other than the main cause of the problem itself, the creation of debt. At some stage the small builder no longer is a small builder. That builder becomes a big builder. When that builder finally goes under, we parade him in the streets and point our fingers. There is the cause of it all, or so we convince ourselves.

Sitting on the gold mine

At some stage in the game one has to find a different way in which to create money, based on assets rather than debt. Money isn’t the best description of it either. Equity would be a better term. At least, when you build a model which creates ‘equity’ based on an asset, that equity stays in the system for good. You can create rules and regulations by which parties can trade their equity for various products and services. A market develops around the creation of equity, rather than only around the creation of money. People who own a lot of assets such as the Middle Eastern countries who own oil reserves, have to set up some system to organise those assets. They have no use for debt based finance at all. They are no in the business of ‘boot-strapping’ themselves up. They don’t have to. They are already sitting on the gold mine, quite literally.

The question becomes, what does one do when you find yourself sitting on the goldmine? A modern thriving economy requires a certain kind of engine once it reaches a certain point. A point where the old debt based incentive to the economy, which boot strapped all things to begin with, is no longer adequate for the task of supporting the said economy.

Riding through the recession

What happens with the debt based system, is that you go through one small turmoil, one bit of rough water and the builder gets choked. There is no riding out the storm, there is no point talking about rescue plans. You are gone before you even get a chance to formulate anything like a rescue plan. Anyhow, with all of the rushing and racing for the last ten years, you never learned how to make plans properly anyhow. The plan was, there is no plan. It was always flexible. As the economy was growing so fast, plans went out of date quicker than Frank McDonald books do. The context for investment was changing and expanding so fast, that making a plan was silly. It is hard to believe now, that some of the chapters of McDonald’s book have become ‘historical archives’ after such a short time of publishing. It goes to show you.

Brian O’ Hanlon

Thanks Jimg. Fair point.

However, what are small businesses in Ireland going to use to trade with? Back to beans I guess.

B.

@garethace wrote:

Thanks Jimg. Fair point.

However, what are small businesses in Ireland going to use to trade with? Back to beans I guess.

B.

There is no shortage of money in the world. It’s just that it costs more to rent it because many of the borrowers have questionable solvency. Cheap and easy credit is like cheap oil – it seems to provide a “free” boost to business and industry; but basing your business model on it’s availability is a folly given historical precedent. Everyone, from the Irish government, to Liam Carroll to the Irish banks are struggling to adopt to this new reality and the small and medium sized business will have to adopt to it too. Financial efficiency is as important as energy efficiency in the world we find ourselves in. And financial efficiency means being getting the most out of your capital – i.e. borrowing as little as you can. Similarly there are some who wish that the age of the petrol guzzling SUV was still with us but it isn’t. It was a historical blip – like the Greenspan age – that has passed.

Govt may mull over taxing expensive family homes…

@jimg wrote:

Only if you’d share in the glee of seeing a country burdening at least 2 generations with a huge tax burden to meet bond repayments..

The position in reality is that the Government had two choices either let the main banks collapse or intervene in some form, the position with the Irish banks was in no way unique; this was a choice made in the US, UK amongst others. You are totally right there is going to be a lot of pain whatever method of stabilisation is selected be it bond insurance, debt transfer, capital injection or collapse in the corporate and private pension structures caused by the loss of the personal and corporate deposit base by letting the banks fail. Not a pleasant picture whatever way you analyse it.

@jimg wrote:

The picture fills me with dread; a combined bank, property portfolio manager, property development and marketing company and property management company all funded from future tax revenue. Run by mostly the same or similar people who got the country into the position it is in. What gives anyone any confidence that a all powerful public organisation can magic tens of billions out of thin air? NAMA will make the HSE look like an impressively run organisation..

You are totally correct if the same attitude that ran the Anglo-Saxon model onto the rocks; which you assert is combined with local possibly negative nuances and if that remains unaltered; then you are probably very right to be scared. There has to be real reform and an acceptance that a model that both respects and can adapt to global economic movements is created.

The model however if it is sufficiently long term in its view and mandate then in can create significant value from where we are now. I agree that if the changes in personnel and mindset are not made then it is doomed to failure before it has commenced. Conversely it is a great opportunity to use market conditions as the only solvent player in the market to exercise their position of power to create long term value.

@jimg wrote:

Apart from the initial guarantee, the Irish government is doing the exact opposite of what the Swedes did. That’s a story they should have studied well but obviously haven’t.

I studied the Swedish model as part of the disaster myopia model at college; I agree that what the Swedes did worked in a very impressive timeframe but do not agree that the underlying causes were beyond localised property bubbles sufficiently comparable. The Irish real estate sector is infinitely larger as a share of GDP, a lot of the assets are geographically more diversified. Demographically Ireland has a much more positive position in terms of real estate demand domestically due to the much more favourable household formation patterns than the Swedes had at that time.

KB shares your concerns on the people that if past trends in government recruitment are selected would be involved; I am too remote to comment on that with any real credibility but I have no doubt that if the following happened it would be a great opportunity.

1. Non-performing debt bought at realistic prices

2. Government Investment made in banks via preference stock at say 250bps above bund to bridge the gap between market value and ‘notional mid-term value’ (they take the hit on frothy market lending decisions)

3. Assets transfered to a team with development / investment management expertise

4. Planned development of the most viable parts of the development portfolio to where appropriate rip up existing planning consents and rework in the context of supply having more purchasing power and being more discriminating

5. Select JV partners to carry out or complete the projects on a PRE-DEFINED profit share basis. In some areas it would be better to do this and assume a nil land value than wait for the private sector to even bear the finance costs on a nominal; access to a government guarantee scheme for construction costs would ensure that any recovery is not limited to just Dublin, Cork, Galway and Limerick.

6. Supply that cannot be sold at ‘mid term fair value’ to be put into specialist invetment funds covering retail, business space and residential

7. When mid term fair values are reached fund units sold to Irish private and International institutional and sovereign wealth investors.

All academic in the absence of business culture changes but if executed in a safe and secure way then this could kick start the construction sector, prevent a free for all in development land markets and allow banks to capitalise on rising values in the UK and other International markets taking performing loans away from what should primarily be a domestic project which would dramatically reduce the scale of the Nama project.

@PVC King wrote:

The position in reality is that the Government had two choices either let the main banks collapse or intervene in some form

That’s not the argument I have with your enthusiasm for NAMA.

It is practically a consensus that governments should intervene to protect retails banks from panics (i.e. “liquidity” problems) or to protect the smooth operation of their national payment systems and infrastructure. There is no such consensus that governments should pick up the tab for insolvent banks and in fact I believe that that economists are generally against it.

Doing the latter has cost the government huge sums of money; money that has been diverted to shareholders, unsubordinated bond holders, bond holders, bank employees and managers who certainly do not deserve it. This money that would have been particularly useful at the moment if spent directly to provide fiscal stimulus. The 4 billion gone to pay off some of Anglo’s losses could have built some world class infrastructure in the country. Paying off (by now old) debts does f*ck all to provide stimulus.

And only in the most superficial way can we be said to be following the US model or even the UK model. In both big and small non-viable banks have been allowed to fold. The Swedes were quick to do the same.

The model however if it is sufficiently long term in its view and mandate then in can create significant value from where we are now.

I can assure you that a belief in mean reversion when it comes to markets is a sure way to poverty. The Japanese are still waiting – over 15 years – for their property bounce which will fix everything.

Needless to say I don’t find any comfort in your wish list of events either.

1. Non-performing debt bought at realistic prices

This cannot happen; if the banks are forced to accept market values for their loans, then they will become insolvent defeating the purpose or requiring a capital injection to keep them afloat.

2. Government Investment made in banks via preference stock at say 250bps above bund to bridge the gap between market value and ‘notional mid-term value’ (they take the hit on frothy market lending decisions)

Preference stock is probably the worst way the government can inject capital; you’re the first to lose all your money if things go bad and you get none of the upside if a miraculous recovery occurs. Attaching a generous yield to it is pointless too. Aren’t the banks supposed to be paying us 500 million a year for the guarantee?

3. Assets transfered to a team with development / investment management expertise

So where is this expertise going to come from? You seem to the believe that the government has the magical ability of identifying and procuring such expertise where the private sector can not. Given precedent would suggest the exact opposite, this represents wishful if not delusional thinking.

4. Planned development of the most viable parts of the development portfolio to where appropriate rip up existing planning consents and rework in the context of supply having more purchasing power and being more discriminating

So a government run planning system failed, but if we have a government run planning system, a government run property development company and a government run property management company, all the incompetence will balance each other out delivering a more efficient and sustainable pattern of development.

5. Select JV partners to carry out or complete the projects on a PRE-DEFINED profit share basis. In some areas it would be better to do this and assume a nil land value than wait for the private sector to even bear the finance costs on a nominal; access to a government guarantee scheme for construction costs would ensure that any recovery is not limited to just Dublin, Cork, Galway and Limerick.

You obviously believe that property development is the engine or potential engine for the economy. Such a belief, in my opinion, represents exactly why we are in this horrible mess. I know that this forum is going to overrepresent people involved in construction in some way or another but you need to step back; what’s good for the construction industry is not necessarily good for Ireland as a whole.

Property is a cost for most of the productive economy and for most of the individuals in the country not a generator of wealth despite the hype of the last few years.

I understand why this sort of thinking has purchase. All special interests – not just the CFI and their close allies the banks – develop this self delusion of their own primary importance for the national wellbeing right down to the farmers, the pharmacists, the taxi drivers, etc. etc.

6. Supply that cannot be sold at ‘mid term fair value’ to be put into specialist invetment funds covering retail, business space and residential

7. When mid term fair values are reached fund units sold to Irish private and International institutional and sovereign wealth investors.

There is no such thing as “mid term fair value”. There are hundreds of theories of value and even more valuation models. I’ve yet to come across a credible one which bases the valuation on what someone thinks is a “fair” amount, no matter what that persons credentials are. I’m well used to looking at graphs of financial prices and know full well the lure of seeing patterns in what is essentially noise. Technical analysis is quite seductive but ultimately generally considered to be complete b*llox; justifying a future valuation on a historical peak value is a classic technical approach but has been proven, in most markets – property or otherwise, to be useless.

Ok, I’m snipping selectively here but this seems to be a pillar of the governments actions:

prevent a free for all in development land markets

The sooner the property markets in Ireland is allowed to adjust to reflect the adjustment in the global credit markets the better for all concerned. Attempting to prevent such a correction, while ego-massaging for politicians and hugely beneficial to the banks and the others who have overexposed themselves in development land speculation is not just folly but extremely damaging and expensive as all historical precedent shows.

@gunter wrote:

Is that not what it’s just done? or how much further do you think it needs to drop?

Is it not possible to establish some system of valuation based on graphing property value, (by category), globally, or even regionally, starting with places that seem stable?

I see very little evidence that the property market in Ireland has corrected itself. To use market speak, the transaction volume is miniscule and the bid/ask spread is huge suggesting nobody is really sure what a particular property should be worth at the moment. A correction should leave the market in a state where there is low expectation of future volatility.

And yes indeed there are many such models but few or none have much use when dealing with the hard financial realities of property unfortunately. It doesn’t matter what numbers your models produce. The property market can only considered to be “normal” in any sense once the gap between what buyers are willing to pay and what sellers are asking narrows. When that happens, transaction volumes will increase and the implied uncertainty will be gone. At that stage, people like auctioneers, solicitors, furniture/household retailers, plumbers/painters/decorators, even maybe architects and builders, banks, etc. can begin to make a living from a market that hasn’t seized up. This is what the goal should be – allow the normal sort of economic activity associated with the market to return; the final price of a two bed in Christchurch in the end doesn’t matter.

As an aside once I spent months building valuation models (though not for property) and I can tell you, whatever answer you ever want such models to produce can be derived in a perfectly reasonable way; you just need to keep adding factors/variables until the outputs start giving you what you want. E.g. Dublin is still undervalued compared to Copenhagen?? Hold on – if we factor in the number of international companies headquartered in Dublin – then we can see blah blah blah…

I want to pounce on this paragraph written by Jimg also:

So where is this expertise going to come from? You seem to the believe that the government has the magical ability of identifying and procuring such expertise where the private sector can not. Given precedent would suggest the exact opposite, this represents wishful if not delusional thinking.

. . . break . . .

So a government run planning system failed, but if we have a government run planning system, a government run property development company and a government run property management company, all the incompetence will balance each other out delivering a more efficient and sustainable pattern of development.

I wanted to make it quite clear yesterday evening, but I don’t know if I did. During the building boom, the aim of the game and what drove everything inside the larger property development companies in Ireland was the notion of keeping the government out as a player. Except in the rare instances where the government was allowed to walk in, as with the DDDA at the Ringsend site. Or in the case of DLR coco at Cherrywood. Where the government effectively supplied the only ‘real money’ in those deals. The money that was coming from the private sector was only heavily leveraged finance, and made the government’s stake look weaker in comparison. But it turns out now that the private sector contribution to the deal was indeed bullshit. It will be the first loan money to be ushered into a safe keeping at NAMA.

So there we come to a point, that government money was being wasted hand over fist, and worse, being tied up in dodgy dealings wherever the Irish government had tried to intervene to become a player in the past. What we always needed I believe, was a healthier balance. But in that sense also, the local authorities have a lot of up-skilling to do. Probably the best possibly outcome will happen with the local authorities gaining a ‘new workforce’ on loan from the private sector.

I know this happens a good bit in the United States, where they build a heck of a lot more than we have ever done. Basically, a strong engineering or architectural consultancy offers not its services, but its actual human resources to a local authority, like the New York Port authority for the duration of a project. From the port authority’s point of view, it receives two or three excellent engineers for a duration of a project. From the engineer’s point of view, they get to hold their job with the private consultancy, and get experience working on projects in a way they couldn’t in the private sector.

We need to look seriously at this model now in Ireland. We are never going to see a situation where local authorities are fully staffed with the expertise they require, to become ‘useful’ players in large projects. But at the same time, something has to be done about their human resources situation, which is bad. Having some professionals on loan from the private sector, would be a real plus for the public sector worker also, because they would be getting a different slant, to what they are used to. This is basically my interest in NAMA. In seeing a radical new approach to how we staff our projects going forward.

I have been around all kinds of projects for long enough, all shapes and sizes, to know the human factor is a huge component and has to be designed carefully for each kind of undertaking. What I am talking about of course, is building a new and effective knowledge companies in Ireland. With a view to exporting this as a product in the medium to long term future.

Brian O’ Hanlon

Posted by Jimg:

I see very little evidence that the property market in Ireland has corrected itself. To use market speak, the transaction volume is miniscule and the bid/ask spread is huge suggesting nobody is really sure what a particular property should be worth at the moment. A correction should leave the market in a state where there is low expectation of future volatility.

I do agree, that correction is the only thing that will assert some stability back into the system.

The trouble is, in Ireland, people were hooked on volatility as being ‘their friend’ for too long. Liam Carroll is a perfect case in point. Because in the case of most people who were land owners, volatility meant moving in the right direction. Volatility was a massive, jirky, train ride of over-correction going upwards. Belief after belief, theory after theory about the value of land reinforced itself and sucked everyone and everything in with it, to fuel the surge upwards. I would say it was a bit like a bit monster munching twister phenomenon. A world wrecking kind of device of abominable ingenuity and creation.

No one wants to admit to that now. I know people who had wealth and were very conservative, wanted to suddenly jump in and gamble rather than miss out on the big wins. You have to remember, those people saw the value of there rock solid assets and money diminish the further the boom continued. They were people who had entered the boom extremely comfortable and wealthy, and had spent or invested very little in their life times. By the end of the boom, they were being made into ‘poor people’ almost by the sheer acceleration of the market upwards fuelled by credit. That was their motivation for getting invovled. They simply couldn’t measure risk any more, it had all but been eliminated out of the equation. That is the only logic that can justify the actions of otherwise sensible people.

On the other hand, you had people who never thought about themselves as being of any net financial worth, began to live off of this notion of themselves being suddenly wealthy. Again, these people will now deny that any such notion ever entered their heads. But until they deal with it honestly, they will be in denial for the remainder of their lives. During the boom years this notion of wealthiness, completely altered their world view, and as a consequence their actions and behaviours. Not to mention the values and ideals that they tried to impose on their kids and loved ones. The funny thing about the Celtic tiger boom, was that people who owned nothing much ever, were elated by the drive upwards. They felt as if they were being ‘carried’ by it.

While the people who owned a lot saw this Tiger coming in their direction and it only meant one thing for them, they were being side lined. Or so they imagined. Everyone was either worried to elated to an extreme amount, in opposite ways. So volatility has been a strong feature of Irish peoples’ lives now for too long. We are all sick of it. Whether you had very little and got a little drunk. Or whether you had plenty and worried you were about to lose it all. What Irish people need is to get back to a balance and restore some order again. Many of the human costs of the boom I believe were too high. Bertie Ahern should have understood this. He didn’t take the best care of his people and didn’t buy them the best deal either.

We engaged in something quite silly, which was quite pheripheral to where we should be going today. We are far behind schedule effectively, and need to plot the course immediately.

Brian O’ Hanlon