BUSINESS OPINION:The true size of the bill related to bad loans may make further hard measures expedient, writes JOHN McMANUS

WHEN TRYING to get your head around whether the National Asset Management Agency will work, it’s worth bearing in mind the maxim attributed to the 19th century Prussian general, Helmuth Karl Bernhard Graf von Moltke: “No battle plan survives contact with the enemy.”

We are told – admittedly by Wikipedia – that Moltke’s main thesis was that military strategy had to be understood as a system of options, since only the beginning of a military operation was plannable. As a result, he considered the main task of military leaders to consist of extensive preparation for all possible outcomes.

And this is pretty much where the Government finds itself. There are a number of variables that simply cannot be forecast which will determine the direction the Nama plan takes.

The first – and arguably the most significant – is the ability of taxpayers to take on the cost of buying €80 billion to €90 billion worth of bad loans from the banks. Its accepted that the loans will be written down and also have assets backing them, but the bill will still run into the tens of billions. The banks will be paid for the loans through the issue of Government bonds, and although some clever accounting might allow the Government to keep them off the national balance sheet, they will still stand as debt that has to be serviced and repaid.

It’s envisioned that the revenue from the agency’s loan book will offset the cost of servicing the bonds, but this revenue will not be significant in the early stages of the agency’s projected 10- to 15-year life.

All this has to be set against an economic scenario outlined last Wednesday by the National Treasury Management Agency (NTMA), which will be responsible for Nama. The NTMA pointed out that the cost of servicing the national debt – not including Nama-related bonds – will consume 19 cent out of every euro raised through taxation by 2013. Add on €10 or €20 billion for Nama, and you are looking at 25 cent in the euro.

The other – but related – variable is the size of the write-offs on the loans the banks must take before they are sold to the agency. The bigger the write-offs, the lower the price paid by the agency, and thus the bill for taxpayers. But by the same token, the bigger will be the losses that the bank will have to absorb.

As things stand it’s very hard to see the banks taking any sort of realistic writedown on these loans without wiping out their capital bases. Equally, it’s hard at this juncture to see fresh capital coming from any other source than the State. This means – as the Government has acknowledged – further State investment, leading to probable majority control. It also means another bill for taxpayers, although this will be offset by a share in the profits of what should be once again inherently profitable businesses.

It’s possible then to see the agency at the centre of a dynamic system which potentially has an inherent bias to find a point of equilibrium minimising the size of the bank writedowns and the cost to taxpayers. While this seems attractive from one perspective, it is dangerous because it does not automatically result in the correct writedowns of property values.

Also – as is increasing becoming accepted – the economy will not function correctly until property prices are reset.

The Government’s advisers would appear to be alive to this danger, and hence the “Shock and Awe” aspect of the €90 billion scope of Nama and the apparent willingness of the NTMA to countenance adding billions to the national debt.

This does hold out some hope that the concept of the agency will not be compromised by inherent contradictions. By the same token, there is no getting away from the fact that if it works it will cost taxpayers a fortune to clean up the property mess this way.

And this raises an issue which does not seem to have been fully explored, which is, why not nationalise the banks as part of the process? If the banks are nationalised they are explicitly underwritten by the State, as is the case with Anglo Irish Bank. Thus they can better withstand writedowns of the magnitude needed, without the need for big capital injections. There would also no longer be any need for the agency to issue bonds, as it would in effect be one part of the Government buying something from another.

The issue will remain of how to deal with the losses which will remain on the books of the nationalised banks. Resolving this will require radical surgery of the sector, and is an enormous task in itself.

It’s not surprising then that Government policy is not to nationalise the banks as part of the process. They also favour the transparency and discipline imposed by the banks remaining listed, as well as the opportunity for the Government to sell down its stake.

But looking at the exchequer position today, the arguments for and against nationalisation alongside the establishment of Nama seem very finely balanced.

One suspects that once the Nama process gets under way and the true size of the bill to taxpayers of going along lines currently proposed starts to emerge, there will be what you might call a “von Moltke” moment.

At that stage the nationalisation of one or more of the banks as part of the process may become expedient. If that in turns forces a wholesale and long overdue restructuring of the industry, it may not be a bad thing.

At this stage, the important thing is that the offensive has begun.