Nama for the little people finds backer in global giant

BUSINESS OPINION:It would be a travesty of the credit crisis if moral hazard turns out only to apply to ordinary people, writes JOHN McMANUS

THE NOTION of a “Nama for the people” has found an unlikely supporter in the form of the global financial giant Citi, or to be precise in its London-based European economics unit.

Even more interestingly, their support for the concept of some sort of widespread forgiveness of individual and business debt is based on what might be called “sound economics” rather than notions such as fairness, or social justice, which are more normally advanced by supporters of the idea.

The reason it makes sense, according to Citi, is that in countries such as Ireland, the high level of private sector debt is actually a bigger problem than the public sector or Government debt.

In a recent report, Euro Weekly: Sovereign Crisis – How Will Policy Respond,the Citi economists homed in on the problem of private sector debt in the peripheral euro-zone members, Ireland, Spain and Portugal (but not Greece), which is between six and four times larger than their respective Government debt.

They are talking about money borrowed by households and business during booms, fuelled by low interest rates.

They concluded that this debt had be addressed first – or at least in tandem – with any sort of solution to the Government debt crisis faced by these countries.

The reason for this, they argue, is that the measures being put in place in these countries to deal with their government debt problems – massive cutbacks in Government spending and higher taxes – could shrink their economies so drastically that a vicious cycle sets in.

More and more private sector firms and households will go bust, causing more and more problems for the banks, requiring more and more government help, requiring more and more government borrowing, warns the bank.

The solution, argues Citi, is for some sort of upfront measures to reduce the private sector debt burden and stop this cycle setting in. They go so far as to suggest some sort of European Bank Rescue fund that would fund the orderly up-front writing off by banks in peripheral countries of private sector debt; a veritable National Asset Management Agency (Nama) for the people.

It would have to be funded by the euro zone as a whole, believes Citi, and the authors of the report – which predated the €750 billion emergency measures announced two weekends ago to try to head off the sovereign debt crisis – are under no illusion as to how unlikely this might be.

Despite this, Citi’s analysis still amounts to a powerful fillip for those arguing for some sort of measures to help Irish households in negative equity and businesses struggling under the debts run up during the boom.

The biggest weakness in Citi’s argument is that it is too general. It deals with Ireland, Spain and Portugal as a group, and does not appear to take into account the various measures that have been taken in Ireland to date, which hopefully should short-circuit a vicious private debt-public debt cycle of the sort Citi warns about. Also, despite massive cuts, Ireland does appear to be on the cusp of growth.

The obvious point here is that Ireland has already dealt with a very large amount of troubled private sector credit through the establishment of Nama. And while this did involve the issue of a very large amount of Government debt, it is off the national balance sheet, funded by the ECB and hopefully self-financing. It is in effect an EU-funded write-down.

The other point is that the Central Bank has taken a very hard look at the private sector lending remaining on the bank’s balance sheets. It has agreed with each of the banks how much capital they will need in order to absorb the expected losses on these loans and also meet tough new capital requirements.

The additional capital injection required from the State is significant, but in the view of most commentators and Central Bank governor Patrick Honohan, it is affordable.

These are valid points, but they only negate Citi’s analysis if the Central Bank has got its sums right about the non-Nama losses at the banks.

Let’s hope they have. But even so, the approach being adopted here does not address the potentially very debilitating effects of what Citi predicts will be a “prolonged – and potentially disorderly – deleveraging of the private sectors via rising bankruptcies in household and non-financial corporations”. This is in effect a zombie economy.

A really interesting question is: If – as the Central Bank assures us – the banks will by the end of this year have the capital on hand to deal with the expected losses associated with all this deleveraging, then why not front-load the process as Citi suggests? Rather than wait for households and companies to go bust and then pick up the pieces, why not intervene?

There are several obvious reason why not. The first – but by this stage almost laughable – one is the moral hazard. It would be the final travesty of the global credit crisis if it turns out that moral hazard is only for little people.

The real problem is the practicality of implementing a scheme, and its incompatibility with the existing banking model in which the making of provisions and the recognition of actual losses are all part of the black art of capital management.

But, by the same token, dealing with the level of household and business bankruptcy implied by their loan loss provisions will put a considerable strain on the banks’ infrastructure and will require some forethought and planning.

A fully fledged Nama for the people might not be desirable or possible, but could some sort of structure not be usefully put on the deleveraging process? Citi seems to think so.