ANALYSIS:IT IS striking that what is certainly one of the largest and most complex financial policy initiatives ever undertaken by the State has been reduced not just to a soundbite, but to an apparent toss-up between two words: Nama and nationalisation, writes PATRICK HONOHAN
How can there be a reasonable public debate on such an important issue when these apparent alternatives are not in fact mutually exclusive? The proposed National Asset Management Agency could be employed to deal with distressed assets of nationalised banks, as have comparable asset management companies in many countries.
Furthermore, the compulsory purchase by Nama of a huge volume of property assets at realistically discounted prices will surely leave the big banks in need of so much additional equity capital that the Government will likely end up as a majority or even outright owner.
So why has the Irish debate on the banks arrived in this cul de sac? Partly, it reflects a parallel debate in the US, where many feel that treasury secretary Tim Geithner’s asset purchase scheme might end up giving shareholders of weak US banks a large covert subsidy from the US taxpayer.
Noting the reluctance of the Irish Government to end up as outright owner of the banks, several commentators have extrapolated from the US case to assume that Nama would pay too generously for the assets it buys, leaving the banks with ample capital and in effect giving the shareholders of the Irish banks a free gift at the expense of the Irish taxpayer. This fear explicitly underlies the recent advocacy by some economists for a pre-emptive, temporary, nationalisation of systemically important banks.
Nationalisation conveys to many a comfortable and secure alternative to what has evidently been a most disastrous recent experience with private bank ownership. It will seem to many that, in this time of economic distress, the cash resources of State-owned banks should be deployed to save as many jobs as possible.
But of course any new unrecoverable loans made by State-owned banks to prop up firms in difficulty would amount to a back-door use of taxpayers’ money. That is why the main professional proponents of nationalisation have not only been careful to insist on its temporary nature, but have also asserted that, during the period of State ownership, the new bank management should continue to strive to maximise the value of the bank shares.
To stiffen the resolve of bank management, I am hopeful that it will prove possible to have even a small non-government shareholding in the recapitalised main banks, whether this comes from existing providers of risk capital, or by some new investors.
One important category here is the holders of unguaranteed subordinated bank debt. Though not holders of common equity, these investors always knew they were providing risk capital to the bank. They may well prefer to swap their debt claims for equity now, given the questionable ability of the banks to meet these debt obligations fully from their own resources over the coming years, as is reflected in the low prices at which subordinated debt has been trading. Certainly, a pre-emptive nationalisation carried out in such a way as to extend, explicitly or implicitly, the Government guarantee to subordinated debt payments not already covered would be a costly error.
It is easy to caricature Nama, especially given the enormous scale on which it has been envisaged and the difficulty of identifying a fair price for the loans to be purchased.
I prefer to strip down the Nama proposal to its essentials: an asset purchase scheme that can (i) free the banks from being preoccupied with the mistakes of the past, thereby allowing them to focus on identifying the borrowing needs of healthy customers; and (ii) replace problem loans of uncertain value in the banks’ portfolio with sound, marketable assets that can be used to mobilise liquid resources.
If Nama goes ahead, these are the two essentials to be retained. Other details will need to be refined.
In particular, instead of getting stuck on the difficulty of fixing the right price for loans, it would be preferable to settle on a two-part payment, with only a relatively small fixed amount to be paid up front to the bank in bonds, and the remainder in the form of a claim on Nama’s future loan recoveries (to be held by the bank shareholders). That would still separate the bad loans from the bank, while sharing the pricing risk fairly between taxpayer and shareholder. (The two-part risk-sharing approach is far superior to the idea of a levy to be imposed after the event if loan recoveries disappoint.)
I would also be inclined to have Nama start small: at first buying only the worst of the banks’ development loans.
Much has been made of the legal difficulties that are likely to be encountered by Nama. That is not my area of expertise. If such difficulties prove insurmountable, then of course the plan must be abandoned. But, given how widely these kinds of transactions have been used in other countries, I wonder if this could really be such a problem.
We need banks to have an adequate cushion of capital, safe marketable assets that they can use to mobilise funds at low interest rates for onlending, and a management focus on sound lending. The taxpayer also needs to ensure the maximum recovery possible on bad loans. “Just nationalising” doesn’t hack it: almost all of the organisational and cost challenges that have been mentioned for Nama will also be faced if individual banks are left trying to recover on their problem loans.
Although political interference has doomed the effectiveness of similar entities in some developing countries, they have worked well in some richer countries. Implemented skilfully, in a transparent manner, and making use of the best available professional resources, a suitably refined Nama process could yet prove quite serviceable. Whether it will do so depends on establishing clear objectives, to which the incentives of all concerned are aligned, and ensuring transparency of operations and governance.
These are, of course, also key prerequisites for successful nationalised banks.
Patrick Honohan is professor of international financial economics and development at Trinity College Dublin