What NAMA means

Constantin has been giving some of the best NAMA analysis I have read thus far. I will quote two specific sections I believe are important (but read the whole thing on his blog). Light block quotes are from the draft NAMA legislation. All of this is from Constantin:

(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.

(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.