Country's future mortgaged on sloppy, confused legislation
Questionable assumptions form the basis for the valuation policy of the Nama Bill, writes BRIAN LUCEY
THE COLLAPSE of the property bubble, and the likely losses that the banks will take on their lending has been brought home to many through the operations of the Commercial Court. Dealing with the issue of Zoe Developments, figures laid before the court stated that the company, one of the largest and longest established in property, would if wound up be able to pay just over one-third of its bank loans. Zoe is a microcosm of the problems the banks face. In total Zoe owes €1.1 billion, while the total problem loan portfolio of the banks is estimated to be €90 billion. Taking losses of the Zoe scale on the chin would bankrupt the banks. To avoid this we have seen this week draft legislation to establish the National Asset Management Agency to take the worst of these devalued loans off the banks.
At over 130 pages with nearly 200 sections it is a formidable piece of legislation. Much of the Bill is taken up with operational complexities, but the key to Nama lies in section 58, on valuation of the assets. Section 58 consists of a number of sections, which state that Nama will base its valuation of assets on “long-term economic value”, and then outlines the nature of the issues that will be taken into account in calculating this value. The long-term value is described as “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”.
There are a whole host of assumptions here, at least five conditionalities. What exactly are “current crisis conditions” – are they referring to credit market rigidities, below-trend economic growth, deflationary pressures, compromised tax revenues? By whose perspective would the “reasonable expectation” be measured – a first-time buyer who now expects house prices to fall or a large property developer who expects commercial land to rise. Expectations are reasonable or not only within contexts, here unspecified.
Section 58 is a sloppy, confused and conditional basis on which to mortgage the future prospects of the country. If this is the best we can get from the Department of Finance after nine months of hard work, God help us.
In reviewing this valuation approach it is worth noting that while the banks lent out in excess of €90 billion (three years’ tax revenues) current values of these loans, as evidenced by court proceedings and bond buybacks, is that they are worth less than half of this. But instead of paying €40 billion the Government has made it clear time and time again that it will overpay. Closer to €70 billion is likely to be transferred to the banks. The Government is handing over the equivalent of one year’s tax revenue to the stock and bond holders of the banks, as to pay true value would result in the wiping out of the equity and bond capital. Nama assets cannot by definition cover the cost of this borrowing – they are toxic loans of which less than half are generating any cash whatsoever. Thus, the eventual burden will fall on the taxpayer and this decision is covered by the fig leaf of section 58. In essence the valuation philosophy of section 58 rests on a twin set of assumptions: that we are at or near the trough of the property market; and that the market will rebound over the life of Nama, indicated at seven years.
Both assumptions are questionable. OECD evidence suggests that bubbles deflate in about twice the time that they inflated. A reasonable estimate of the Irish property bubble would be that the inflationary period was the four or five years prior to 2007. That would imply that we are nowhere near the bottom and that we could in fact see at least another three or four years of declining prices. Purchasing at current market values might then be overpaying for these assets. This is reinforced by other OECD research that suggests that nominal property prices can take upwards of 15-20 years to recover to their bubble peak. This would suggest that it may be 2030 or thereabouts before we see prices back to 2007 values.
Section 58 contains a number of items that will be taken into account in constructing the long-term economic value of the assets. We have already noted the first: the asset value relative to history. Point two suggests examining the supply and demand for the asset. We have via the bubble a significant overhang of residential and commercial property which will take years to clear. In addition, the third and fourth points urge evaluation of the macroeconomic and demographic pressures. A significant output gap has opened and will take time to close, with consequent lower economic growth prospectively in the next decade. Demographically, we are at or near the peak of the population bulge, with probable lower demand for housing from household formation. The final three elements relate to planning and zoning, which are political considerations. But, it is to be hoped, we are not to return to the ultra-laissez-faire developer-led planning of the past.
In short, the elements suggested by the Government would, if taken seriously, act to exert downward pressure on valuation. It strains credulity to think that this Government, committed ideologically to preserving the banks in private ownership come what may, would countenance such an outcome.
The truth about Nama is that we are now likely to be stuck with it. Therefore, it is imperative that it be run properly. This must begin with the primacy of the taxpayer’s interest, and this is best protected by Nama paying no more than is absolutely warranted for the assets. But the Nama Bill does not do this, setting up instead a valuation process that is designed to produce a politicised answer.
Brian Lucey is associate professor of finance in the school of business studies, Trinity College;
Garret FitzGerald is on leave