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Long Term Economic Value and NAMA Philip Lane

Long Term Economic Value and NAMA Philip Lane

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Published by James Dwyer
The Irish government is on the verge of creating the largest property company (by value and by assets) in the world. Some people believe it is the wrong response to the crisis in Irish banking brought on primarily by lending too much cash to property developers at the height of the recently deceased celtic tiger boom boom. The mechanism through which the Irish government is currently decided to determine the 'real' value of loans to be transferred to this property and loan company (which is to be called NAMA: the National Asset Management Agency) is what is termed 'long-term economic value'. Many believe that the Government if it must go ahead with NAMA should only pay the market price of loans which have gone sour on the banks. Doing anything elese, crics believe, would constitute a bail out or a subsiddy for banks and their developer friends. Sceptics who believe that the point of NAMA is to facilitate Fianna Fail, Ireland's ruling party since independence, bailing out their greatest donors the developers and the financial services industry. In this paper Philip R. Lane of Trinity College Dublin (see www.irisheconomy.ie) discusses the concept of longterm economic value in this context.

He says: "...There is a prima facie case to employ long-term economic value in determining the price for loans that will be transferred from troubled banks to NAMA.... However, a major implementation challenge facing NAMA is to develop a high-quality model of long-term economic value. Here, I focus on the long-term economic value of the underlying property assets. (Other factors also matter in valuing loans, such as the cost of capital.)".

I (ie. not Philip Lane) wonder will the European Central Bank be willing either 2 exchange hard cash for the second tier (the deferred payment bit) and on what pricing basis or at least count (again on what basis) that promise by the Irish govt/NAMA to pai the ‘ultimatel-realised loan value’ at some point in the future as part of the banks’ current capital. The 2 tier payment might act if done in a certain way for instance as an incentive for NAMA 2 off load loans quickly (2 former developers perhaps or perhaps the likes of Frank Fahey could help NAMA out by arranging purchase of some of Anglos loans in 4 example the USA). The advantage of this would be 2 get the loans off the NAMA balance sheet asap and mean that NAMA could pay off the banks the second tier asap at a discounted (compared to offloading the loan in 20 years) ‘ultimately-realised loan value). The downside however would be the perception of corruption and if anything goes wrong it would be Irish tax payers who would have to pay up.
The Irish government is on the verge of creating the largest property company (by value and by assets) in the world. Some people believe it is the wrong response to the crisis in Irish banking brought on primarily by lending too much cash to property developers at the height of the recently deceased celtic tiger boom boom. The mechanism through which the Irish government is currently decided to determine the 'real' value of loans to be transferred to this property and loan company (which is to be called NAMA: the National Asset Management Agency) is what is termed 'long-term economic value'. Many believe that the Government if it must go ahead with NAMA should only pay the market price of loans which have gone sour on the banks. Doing anything elese, crics believe, would constitute a bail out or a subsiddy for banks and their developer friends. Sceptics who believe that the point of NAMA is to facilitate Fianna Fail, Ireland's ruling party since independence, bailing out their greatest donors the developers and the financial services industry. In this paper Philip R. Lane of Trinity College Dublin (see www.irisheconomy.ie) discusses the concept of longterm economic value in this context.

He says: "...There is a prima facie case to employ long-term economic value in determining the price for loans that will be transferred from troubled banks to NAMA.... However, a major implementation challenge facing NAMA is to develop a high-quality model of long-term economic value. Here, I focus on the long-term economic value of the underlying property assets. (Other factors also matter in valuing loans, such as the cost of capital.)".

I (ie. not Philip Lane) wonder will the European Central Bank be willing either 2 exchange hard cash for the second tier (the deferred payment bit) and on what pricing basis or at least count (again on what basis) that promise by the Irish govt/NAMA to pai the ‘ultimatel-realised loan value’ at some point in the future as part of the banks’ current capital. The 2 tier payment might act if done in a certain way for instance as an incentive for NAMA 2 off load loans quickly (2 former developers perhaps or perhaps the likes of Frank Fahey could help NAMA out by arranging purchase of some of Anglos loans in 4 example the USA). The advantage of this would be 2 get the loans off the NAMA balance sheet asap and mean that NAMA could pay off the banks the second tier asap at a discounted (compared to offloading the loan in 20 years) ‘ultimately-realised loan value). The downside however would be the perception of corruption and if anything goes wrong it would be Irish tax payers who would have to pay up.

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Published by: James Dwyer on Sep 04, 2009
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09/05/2009

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 Irish Economy Note No. 6“The Macroeconomics of Long‐Term Economic Value”Philip R. Lane (TCD)www.irisheconomy.ie/Notes/IrishEconomyNote6.pdf 
 
The Macroeconomics of Long-Term Economic Value
Philip R. Lane
Trinity College Dublin and CEPRSeptember 3rd 2009
1 Introduction
In line with the European Commission framework, the NAMA draft legislation proposes toincorporate “long-term economic value” in the method employed to determine the appro-priate transfer value for loans to be acquired by NAMA from the banks that participate inthe scheme. In principle, long-term economic value may be interpreted as correspondingto the expected “hold to maturity” value of a loan.Its use can be defended on several grounds. First, where a loan is to be acquired froma bank on a voluntary basis, the transfer value should correspond to the internal shadowvaluation that a bank may reasonably apply to a loan on its books.Second, in the banking and …nance literature, a key role for banks is to fund long-terminvestment projects, where the full value of the underlying asset is only realised over time.If funding for such projects is interrupted, the disposal value of a loan that is backed by anincompletely-developed asset lies below its potential long-term value were the project to becompleted. (Clearly, this point only applies to a fraction of the loans held by Irish banks,since it does not apply with the same force to loans that are backed by mature assets.)Indeed, this characteristic helps to explain why banks exist and why bank loans ratherthan “marked to market” securities play a dominant role in funding long-term projects.It also helps to explain why banking crises are so costly and how there are self-reinforcingamplifying dynamics between credit conditions and collateral values. During periods of easy
Email: plane@tcd.ie. Tel: +353 1 896 2259. Postal Address: Economics Department, Trinity CollegeDublin, Dublin 2, Ireland.
1
 
credit, asset values rise which in turn may tempt some investors to exploit rising collateralvalues to over borrow and invest in marginal-quality projects. In the other direction, acredit crunch leads to a decline in asset values and the non-completion of otherwise-viableprojects. While the ideal solution is for the …nancial regulator to engage in counter-cyclicalmeasures and avoid the occurrence of a crisis, these ampli…cation dynamics also providean explanation why market values can fall below long-term economic value if regulationin inadequate and a crisis does indeed occur. (For a classic model of banking, see DougDiamond and Philip Dybvig: “Bank runs, deposit insurance, and liquidity,”
Journal of Political Economy 
91(3), 401–419. On the interplay between liquidity and collateral values,see Nobu Kiyotaki and John Moore, “Credit Cycles,”
Journal of Political Economy 
105,211-248).In addition, the nature of …nancial markets mean that persistent gaps may emergebetween the the fundamental value of an asset and its current market price. The “limitsto arbitrage” literature explains why a persistent gap may emerge, since arbitrageurs maynot have access to su¢cient liquidity to quickly close the gap between the fundamentalvalue and the current market price. (The classic paper is by Andrei Shleifer and RobertVishny: “The Limits of Arbitrage,”
Journal of Finance 
52(1), 35-55.) This mechanismexplains both why bubbles may not be quickly punctured and why post-bubble marketcrashes may “overshoot” in the downwards direction.For these reasons, there is a
prima facie 
case to employ long-term economic value indetermining the price for loans that will be transferred from troubled banks to NAMA.However, a major implementation challenge facing NAMA is to develop a high-qualitymodel of long-term economic value. Here, I focus on the long-term economic value of theunderlying property assets. (Other factors also matter in valuing loans, such as the cost of capital.)Such a model should have both macroeconomic and microeconomic dimensions. Macro-economics is required in order to establish the likely economy-wide evolution of averageproperty values, while microeconomics is required to model the cross-sectional dispersionof individual properties around the average value. (Since the NAMA valuation method willbe applied on a loan-by-loan basis, the individual characteristics of each loan and propertyasset must be modelled.) The microeconomic task can be ful…lled by those with expertisein property valuation.In this note, I consider some methodological issues in the macroeconomics of estimating2

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