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News : Irish Last Updated: Sep 2, 2009 - 5:48:04 AM

 European Central Bank, NAMA and long-term economic value
By Michael Hennigan, Founder and Editor of Finfacts
Sep 1, 2009 - 5:29:39 AM

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The site of the former Irish Glass Bottle plant, Ringsend, Dublin (within red contours). It was purchased in 2006 for €412 million, by a consortium led by developer Bernard McNamara.

The European Central Bank (ECB) has urged the Government to exercise caution on using long-term economic value as the basis for valuing toxic property loans, which will be purchased by the Irish "bad bank" NAMA  -- the National Asset Management Agency.

The ECB issued a formal opinion on NAMA on Monday, which said: "the ECB considers it important, in line with previous opinions that the pricing of acquired assets is mostly risk-based and determined by market conditions. The preference expressed in the draft law for the long-term economic value of assets, rather than current market values, requires careful consideration in this context. In particular, it should be ensured that the assumptions to determine the long-term economic value of bank assets will not involve undue premium payments to the participating financial institutions to avoid creating inappropriate incentives from their side as regards the use of the scheme."

The ECB also said that it "considers that a guiding principle for the scheme should be that there is an adequate degree of risk sharing in order to limit the cost to the government, to provide the right incentives and to maintain a level playing field across the participating institutions."

On Monday, Minister for Finance Brian Lenihan, told the Oireachtas Joint Committee on Finance and the Public Service, that NAMA would take on 1,500 borrowers and 18,000 loans, and that “hopelessly insolvent developers” will be put into liquidation.

John Mulcahy, an auctioneer advising NAMA on how to value the loans, told the Oireachtas committee that property values had fallen 50 per cent from their peak and the property market had reached the bottom of the cycle.

Mulcahy said the long-term economic value of loans would be set looking back at property market cycles - - which had averaged seven years in duration - - since 1971.

He said that an analysis of historical property cycles since then had showed that commercial property values rose on average by 88 per cent from the bottom of the market, while residential property values increased by 96 per cent.

The ECB opinion document summarises the issue of valuation as follows:

The Minister may make regulations providing for adjustment factors to be taken into account in determining the long-term economic value of a bank asset and the property comprised in the security for a credit facility, having regard to: (a) Community State aid rules and any relevant Commission guidance; (b) in relation to determining the long-term economic value of the property, the extent to which the price or yield of the asset has deviated from the long-term historical average, supply and demand projections by reference to the type of asset and its location, macroeconomic projections for growth in GDP and inflation, demographic projections, land and zoning considerations, and future transport planning; (c) in relation to the long-term economic value of bank assets, the net present value of the anticipated income stream associated with the loan asset, current and projected vacancy rates for rental property, loan margins, an appropriate discount to reflect NAMA’s cost of funds plus a margin that represents an adequate remuneration to the State that takes account of the risk in relation to the bank assets acquired by NAMA, the mark-to-market value of any derivative contracts associated with the bank asset, any ancillary security (e.g., personal guarantees, corporate assets), fees reflecting the costs of loan operation, maintenance and enforcement; and (d) any other matter that the Minister considers relevant.

John Mulcahy agreed with Fine Gael TD George Lee that the current property crash was unprecedented.

The standard pattern is that the bigger the boom, the bigger the crash.

Also on Monday, the building firm McInerney reported thatthe value of its property holding in Ireland had more than halved since mid-2008.

Arthur Beesley of The Irish Times says the company has 5,100 plots in Ireland, 2,700 with planning permission and 1,200 held as long-term strategic assets.

He says McInerney has no involvement in the apartment market and these plots are held mostly for the construction of three-bed and four-bed houses. In the main, they are in Galway, Limerick, Cork and Waterford.

The firm generally avoided buying lands in towns, big or small, and it avoided buying lands in peripheral villages. Neither has it assets in Dublin.

As such, the outcome of its writedown exercise is not distorted by the wide variations in value that inevitably arise in the diverse Dublin market. Neither is it distorted by exceptionally significant impairments of rural lands on which houses will never be built.

In an article in The Irish Times today, Eoin McDermott who is a chartered surveyor and chairman of the gp/valuation division of the Society of Chartered Surveyors, writes:"Whether or not the development of this new model of “long-term economic value”, as set out in the draft NAMA legislation, is appropriate will continue to be the subject of debate. From a chartered surveyor’s point of view, it will represent a departure from conventional valuation that has been developed and well tested over a period of 40 years."

Auctioneer John Mulcahy illustrated the danger of property people making valuations based on multiple assumptions.

Using a seven-year time horizon, without reference to experience in other developed country markets, would be ridiculous.

Irish real (stripping out inflation) houses prices in the seven year period 1970/76 rose 6 per cent.

Oil prices were quadrupled in late 1973 and inflation jumped to double-digit levels.

In Ireland in 1978, real house prices were up 34 per cent compared with 1970.

This wasn't part of a normal business cycle but a public spending fuelled boom that resulted in a budget deficit of 17.6 per cent in 1978 - - a record for developed countries according to the IMF, for the period 1970-2008.

Following a trebling of the national debt by the early 1980s, the payback cycle began.

Irish property prices began to recover in 1988 because of greater domestic control of public finances and crucially, the positive international environment.

The property people are not likely to be versed in international economics, but Ireland's main economic partners are saddled with debt, while the age of high leverage and easy credit will not be replicated soon.

The assumptions can always be found to meet a desired outcome and the history of judgment and willingness of Irish insiders, to  sail against the conventional wisdom, is simply lamentable.

Not one senior civil servant or central banker, took a stand against the tide of economic illiteracy.

 A US Federal Reserve study on earlier crashes, says it took a full ten years for the real land price index to return to the level at its previous peak in many cities - - the recovery aided by the evolving US high-tech boom.

Economist average peak to trough for "long term nominal economic value" is 17.8 years.

Finally, it's ironic that the system of Irish rezoning, that makes land scarce in a country that is 4 per cent urbanised and has spawned both bad planning and endemic corruption, is now being used as a basis for supporting property valuations.

The truth is that it's a massive stealth tax on property purchasers and has underpinned high prices, unsupported by economic fundamentals.

SEE: Finfacts article for house price data from 1970:

International House Price Comparisons 1970-2006: Irish price growth in 36-year period third highest among 18 Developed Countries

SEE: Finfacts article, which contains information on studies of teh time period of recovery from property crashes:

Lenihan, NAMA versus the “leave it alone liquidationists” or potential saviours of the Irish economy

SEE: Finfacts article on the Irish land system where no official data is published on development land.

Irish Farmers and Sacred Cows

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