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News : Irish Last Updated: Aug 4, 2009 - 4:14:26 AM


BaNama Republic, NAMA and "long term economic value" as "demographics" is disinterred from bubble wreckage
By Michael Hennigan, Founder and Editor of Finfacts
Jul 31, 2009 - 8:02:12 AM

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UCD economist Professor Karl Whelan

UCD economist Professor Karl Whelan, has been a prominent critic of the Government's handling of the banking crisis and following Thursday's publication of draft legislation on the planned "bad bank" NAMA, he titled his post on the Irish Economy blog, "BaNama Republic," taking aim at the plan to use "long term economic value," as the basis for valuing toxic property loans. "Demograhics," the favourite  crutch of the boosters during the property bubble, has also been been disinterred from the wreckage.

Caution is always required when politicians use assumptions about the future as it is rare that there is not some self-serving angle.

Minister for Finance Brian Lenihan said on Thursday, that some assets will be valued at their current market value or over this value, at “a long-term economic value.” This will be based on factors such as demographics, demand and supply, and future economic growth.

Lenihan says the value of some land backing loans will increase over time because there is no current market for certain property. He said the agency would not be paying “bubble property prices” to the banks for the loans and expressed confidence that in the long term the agency would be able to operate on a break-even basis.

However, it can take at least a decade for prices to recover to former real values after a bust. The current crash is the worst in peacetime since the Great Depression and every developed country faces years of challenging growth. So the recovery period is likely to be much longer.

Besides market supply/demand issues in coming years, where will the new significant funding necessary for starting projects and completing others, come from?

The Minister said he would be in a position to announce on September 16th, when the Bill comes before the Dáil, what the overall figure to be paid will be.

  "In particular, I suspect it is possible that the valuations will completely ignore the risk premium element in pricing these assets and will make highly positive assumptions about future cash flows. And as long as the calculations are presented in a coherent fashion according to a model like the one above, I suspect that the Commission will declare that they have met the guidelines"  -- Professor Karl Whelan

Lenihan raised the prospect that banks and building societies participating in NAMA will not be able to set off their loan losses against their tax bills.

Although he told reporters at a press conference that he would not comment on tax matters in advance of the budget, his statement on the draft legislation made it clear that a restriction on set off is under discussion.

“The issue of the set-off of tax by the banks against the losses will be addressed by the Minister in the publication of the [Nama] Bill in September,” a Department of Finance statement said.

NAMA will become one of the world's biggest property companies and it could impact Irish economic prospects fro many years. Property loans at a current nominal value of up to €90 billion, will be transferred to the agency.

The bizarre aspect to the promoters of demographics during the boom, was that they could have used population growth in such places as Africa and Pakistan, to signal hotspots of prosperity to Martians.

In  a Sunday Independent article in March 2008, titled "Property: bottoming out -- so it's time to spend," economist Marc Coleman wrote: "As overlooked by almost all commentators -- with the honorable (sic) exception of NCB stockbrokers -- out of a population of 4.25 million souls, this state boasts a million people between the ages of 14 and 26. Nothing less than an army of housebuyers is marching towards the economy and they are going to need somewhere to live. What is more they will be having children. In the 12 months to April 2007 alone the State's population rose by 106,000 persons."

Even more bizarrely in that same month, the economists at NCB argued housing was not the engine of growth.

SEE: Housing market not the engine of growth; Exports contribute minimal impact to growth because of high import level - Demographics are the key

In January 2008, in a review of Coleman's book, "The Best is Yet to Come," UCD economist Colm McCarthy commented: "Population growth can just as readily be seen as a consequence of economic success, a far more plausible take on the Irish story than this demographic version of Say's Law, the venerable notion that supply creates its own demand. If rapid population growth were the key to economic prosperity, sub-Saharan Africa rather than East Asia would be the current Wirtschaftswunder."

Professor Karl Whelan commented on NAMA and valuation, on the Irish Economy Blog, Thursday evening: "Well, the legislation is out though I’m not sure we’re really much the wiser.  Needless to say, my favourite bits have already been highlighted by commenters in our long-term valuation thread.

(a) a reference to the current market value of the property comprised in the security for a credit facility that is a bank asset is a reference to the estimated amount that would be paid between a willing buyer and a willing seller in an arm’s length transaction where both parties acted knowledgeably, prudently and without compulsion,

(c) a reference to the long-term economic value of the property comprised in the security for a credit facility that is a bank asset is a reference to 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.

I could rant on about the craziness of paying according to (c) rather than (a) but it pretty much speaks for itself and, in any case, you already know what I think."

In a previous posting, Prof. Whelan said that "while the Commission allows for assets to be transferred according to “long-term economic value” their preference is that assets be priced according to market value and the alternative approach should only be introduced where it is not possible to ascertain this value. On this issue, I am in agreement with Peter Bacon (discussed here) that the idea that there is no market value for Irish property investments is a dubious one."

He said it is true that there is very little activity in this market right now. But this partly reflects the fact that if developers sell at any reasonable price, they will incur huge losses and many will be bankrupt. In the absence of pressure from their banks (who are waiting for NAMA to take over the loans) the preference of developers is to sit, Micawber-like, hoping something will turn up that will get them back to solvency. However, despite the low levels of activity, one can, as Bacon has noted, use current residential house prices to come up with a maximum possible value for residential development land and in most cases this will imply a very large discount. Similar exercises can be undertaken for commercial development land.

Whelan said last May: "If the argument here is that the Irish government are confident that current market prices for development projects are below their “long-term economic value”, let me outline some reasons to be less confident:

  • There are good reasons to expect that even after recovery, we will never return to the rates of growth seen prior to 2008.  The slides from my talk at last week’s TCD event provide evidence.

  • Even if labour force participation and unemployment rates return to their 2007 levels, we will face higher tax rates than 2007 levels for very many years, thus reducing people’s abilities to pay rents and mortgages.

  • There is an enormous excess supply of properties that will take years to work off. 

  • Tighter financial regulation will rule out a return to the high LTV loans of recent years and funding of speculative property projects will be particularly closely monitored.

  • A less competitive mortgage market will most likely mean higher interest rates on average.

  • Property mania is probably gone for many years to come and future investors will probably look for higher average yields on commercial property investments.

In light of all this, can we really be sure that taking an over-market-value punt on a bunch of development properties is really going to pay off?  And what business of any government’s is it to be engaged in this kind of speculative activity with the taxpayer’s money?"

Prof. Whelan said it will be very easy for any NAMA official who wanted to do so, to pluck out an appropriate set of assumptions about the future that will end up delivering whatever haircut is deemed desirable. "In particular, I suspect it is possible that the valuations will completely ignore the risk premium element in pricing these assets and will make highly positive assumptions about future cash flows. And as long as the calculations are presented in a coherent fashion according to a model like the one above, I suspect that the Commission will declare that they have met the guidelines," he added.

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