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NAMA plan needs to be fully fleshed-out
Sunday, April 12, 2009
Breathtaking is the word that came to mind when considering the ambitious asset purchase scheme for the banks. Big problems require big solutions, and the scale of NAMA, taking over responsibility for managing and recovering up to €90 billion of bank loans, is certainly big.

Two main benefits are being sought from this operation. First, by exchanging for illiquid and risky property loans marketable bonds that can be used to mobilise funds for on lending, it is intended to put the banks on a more secure basis. Secondly, by centralising the development property portfolio of the banking system – and removing problem loans from the lending teams that made them – it is hoped that a better job will be made of managing loan recovery.

As everyone has noticed, the price to be paid for the assets is a central issue; the taxpayer is in no position to err on the side of generosity here. In contrast to the two big US asset purchase schemes associated with US treasury secretaries Henry Paulson and Timothy Geithner, and despite the forebodings of some, NAMA does not build in over-pricing of the assets bought.

Accordingly, the NAMA scheme does not in itself ensure that the banks have adequate capital. Indeed, official statements have made it clear that the government also envisages buying ownership stakes in the banks as necessary, to ensure they are adequately capitalised.

Whatever price is paid for the assets purchased, the taxpayer is absorbing risks from shareholders and creditors of the banks. This risk-shifting extends beyond the lifetime of the bank guarantee, to those who are not guaranteed, as well as to the shareholders.

I believe that the plan should be refined to achieve a better risk-sharing. Instead of simply paying a fixed best-estimate price for the loans, a somewhat more sophisticated financial restructuring could be envisaged.

Specifically, NAMA should pay too little up front, and compensate by giving the bank shareholders – and possibly other risk capital providers – some stake in the upside of NAMA’s eventual returns (for example, by giving them an equity stake or warrant). This would protect the taxpayer while being fair to the shareholder, and would still remove the risk from the bank. (This idea would deal much more effectively with the danger of overpaying than the levy idea mentioned in the plan.)

This is just one of many dimensions which will require further fleshing-out over the next few months to ensure that the scheme delivers its intended benefits.

For example, everyone agrees that the operation and governance of NAMA is crucial. But this is not easy to ensure. For example, transparency could run up against banking secrecy laws. For the integrity and credibility of NAMA to be assured, this issue cannot be brushed under the carpet. After all, many of the borrowers whose loans are being transferred are high-profile individuals who will vigorously contest efforts of the loan recovery operation. It is hard to see how costly and protracted litigation, not only on the constitutionality of the proposed scheme, but subsequently on individual recovery action, can be avoided.

Ensuring NAMA can overcome these difficulties and achieve the hoped-for efficiencies in recovery will be a challenge.

The mandate of NAMA will also have to be unambiguous: if its recovery actions threaten employment, will it be asked to stay its hand? Like state-owned banks all over the world, it would be very easy for an asset management company to morph into an off budget grant agency incurring hidden additional costs to the taxpayer.

Some of the asset management companies established to deal with bank insolvency in various countries over the past quarter century have been deemed successful. The Swedish case is often mentioned – though, at less than 8 per cent of GDP, it was managing a much smaller portfolio than the one NAMA is likely to have to deal with (50 per cent of GDP). The American and Spanish schemes of the 1980s also did well, but they were even smaller. The jury is still out on others, including the massive scheme in China, now into its second decade of operation. Some did not fare so well, including those of Mexico, Indonesia, Philippines and Senegal, all of which were contaminated by politicisation.

With our stronger societal institutions, we should be able to avoid some of these pitfalls, but only if we plan carefully and set up legal and administrative structures accordingly. There is no obvious template which can be simply transplanted here.

What about nationalisation? This emotive word needs to be parsed and analysed.

When the assets are being priced for transfer, the banks will have to reduce (write down) their assets to the new value represented by the bonds that they will receive. This will likely reveal insufficient capital (essentially the excess of assets over liabilities) and require them to raise additional capital.

Despite the reduced risk of the banks’ balance sheets, given the world crisis, the state is likely to be the only source of such capital, and will accordingly acquire an ownership stake – quite possibly a very large percentage stake in each of the banks. The case regarding temporary 100 per cent ownership can then be argued – there is something to be said on both sides.

Many other countries are facing similar issues, most notably Britain and the US. I had hoped that, by now, an ideal formula easily applicable to Ireland would have emerged. Unfortunately, neither of the leading plans – the insurance approach adopted for RBS and Lloyds in Britain (as well as for UBS in Switzerland and Citi in the US) – suit our conditions, and the US plan seems far more generous to bank shareholders than could be envisaged for Ireland. Maintaining a ‘‘wait and see’’ approach could be increasingly problematic.

I see the NAMA plan as a draft to be improved. In the weeks ahead, as legislation is being prepared, the plan needs to be thoroughly fleshed out. Its key parameters need to be carefully considered. The legislation needs to ensure good governance and transparency, and to feature the flexibility to adapt the scheme to meet implementation challenges that have not been anticipated.

Patrick Honohan is professor of international financial economics and development, Trinity College Dublin

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