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I, Professor Joseph Stiglitz, residing a1258 Riverside Drive Apt 12 CÍD New York, NY 10025, United States of America aged eighteen years and upwards Make Oath and say as follows:


I make this affidavit at the request of the Applicants in the above entitled proceedings, for the purpose of providing an expert opinion to the Court. I

understand that the duty and the role of an expert witness are to assist the court and that experts have a duty to be impartial. I have abided to this duty and make this affidavit from facts within my knowledge, save where otherwise appearing and where so appearing I believe the same to be true.


I am one of ten University Professors at Columbia University. I currently hold joint appointments in the Department of Economics in the Faculty of Arts and Sciences, the Department of Finance in the Gradúate School of Business, and in the School of International and Public Affairs. Prior to assuming this position, I held professorships at Stanford, Yale, Princeton, and Oxford where I taught a wide variety of gradúate and undergraduate courses in economics and finance.


From 1993 to 1997, I served as a member of the President Clinton's Council of Economic Advisers, and from 1995-1997, as Chairman of the Council and a member of the President's Cabinet. As Chairman and Cabinet Member, I was the principie person within the White House responsible for formulating fiscal policy, financial sector regulation and banking policy, and coordinating policy with the U.S. Treasury.


From 1997 to 2000, I served as Chief Economist and Sénior Vice President of the World Bank, in which capacity I had the responsibility of advising countries around the world on the design of fiscal and monetary policies.


Relevant to the topics I discuss in this affidavit, I have published leading undergraduate and gradúate textbooks, authored over 500 scholarly articles, written numerous academic books and a variety of popular books.


In 2001, I was awarded the Nobel Prize in economics for work which is directly relevant to this case. This work includes the study of how Information asymmetries affect economic behavior, the determination of the conditions under which effícient sharing of risk occur, and the economics of fínancial markets.


Additional qualifications can be found in my Curriculum Vitae attached and labeled "JES1."



In preparing this affidavit, I have reviewed the witness statements regarding the role and operations of the National Asset Management Agency ("ÑAMA") within the Irish banking crisis, including its purported role in improving bank balance sheets and enhancing economic performance. My review of these material s indi cates that there is considerable confusion regarding how the banking sector works, the economically appropriate process for addressing bank insolvency, and the role that ÑAMA can play in addressing bank insolvency. I have also reviewed data and affidavits pertaining to the performance of McKillen's portfolio and the extent to which his loans pose a systemic risk to the Irish economy. Based on this review, the economic benefits to

moving the McKillen loans to ÑAMA are questionable at best. To the contrary, McKillen, the banks and the taxpayer are likely to be injured by such a move. 9. I am aware, having been so advised by the legal advisors to Mr. McKillen, that this Honourable Court is unlikely to rule upon the question as to whether the McKillenrelated loans are or are not suitable for transfer to ÑAMA. Rather, I understand it to be the case that the Court is more likely to be concerned with the manner in which the decisión to take a transfer of the McKillen-related loans was made. That being so, I wish to note at the outset that from the perspective of Mr. McKillen there are compelling arguments as to why his loans ought not to have been transferred to ÑAMA, and it is my understanding that he was never given an opportunity to make those arguments. Furthermore, from the perspective of the Irish economy and the banking sector - including in particular the banks lending to Mr. McKillen - there are several factors which strongly indicate strongly that there should not have been a

transfer to ÑAMA. Based upon both what I have revíewed to date and also what I have been told, I see no evidence that any consideration was given to these factors in the taking of the relevant decisión. It is my own strong opinion that there should not be a transfer of the McKillen loans to ÑAMA. Furthermore, in light of the incentives associated with ÑAMA and its structure and powers, it is particularly important to have procedural safeguards and due process, neither of which would be unduly burdensome. 10. My affidavit proceeds as follows. First, I outline the role of long-term relationships in the banking sector in addressing the asymmetric information problems that are pervasive in this industry. Second, I discuss best practices for addressing bank

insolvency, highlighting economic considerations relevant to choosing which assets should be purchased by ÑAMA. Third, I provide analysis of the Irish banking crisis and the creation of ÑAMA, incíuding an economic analysis of NAMA's structure and its statements to shareholders and taxpayers with respect to its performance. Fourth, I explain why NAMA's structure and incentives - in particular its incentive and ability to seize performing loans in the absence of due process - do not reflect best practices for addressing bank insolvency. Fifth, I explain from an information economics perspective why a transfer of the McKillen loans will likely have a negative impact on McKillen. Sixth, I review evidence indicating that McKillen's loans are not impaired and that his portfolio does not impose systemic risk on its lenders. Seventh, I discuss how allowing for due process would improve NAMA's efficiency and reduce the potential for injury to the banks, taxpayers, borrowers, and the Irish economy more broadly. Eighth, I review the testimony of ÑAMA witnesses, Ms. Anne Nolan, Mr. Brendan McDonagh, Ms. Aideen O'Reilly, and Professors McAleese and Lañe. 11. I will use several words íhroughout this affidavit with precise meaning: a. Impaired loan - Means a loan where there is an explicit expectation by the bank and its accountants that a loan loss will occur.1

See discussion of definitions in International Accounting Standards in affidavits of John Trench and Michael Cragg.


b. Technical default - Means that a loan covenant is breached but the loans are being ftilly serviced. c. Payment default - Means that the borrower's cash payment obligations to the lender are not being met. d. Performing loan - Means that the cash flow requirements of the loan (scheduled interest and capital payments) are being met (see Affidavit of John Trench paragraph 32). 12. The conclusions of my anaíysis can be summarized as follows: a. There is a standard process for addressing bank insolvency that creates appropriate incentives for borrowers and lenders. The Irish governmenfs

response to the banking crisis implements parts of this standard toolkit, though some of the distinctive aspects of its response do represent deviations from best practice and raise concerns that require particular attention with respect to the acquisition of assets. In order for the governmenfs process to work well, it is crucial that the government focus on identifying and acquiring those loans for which: (i) principal and interest is not being repaid or (ii) there is a significant risk of nonpayment. b. Although NAMA's role should be confmed to paying for bad loans at fair market valué, it has both the incentive and the ability to underpay banks for good assets. ÑAMA has an incentive to seize bank assets that are performing well because this strategy allows it to create short-term gains for shareholders and demónstrate profitability to the public. ÑAMA is able to act in accordance with this

inappropriate incentive largely because of the extraordinary powers that it has been granted to rewrite contracts and seize bank assets without consultation with borrowers. c. NAMA's incentive and ability to seize good loans is highly problematic. If

ÑAMA is allowed to underpay for performing loans, the banks will be leñ weaker and the taxpayer will be leñ no better off - in fact, they may be worse off, both because of the likely increase in public costs of bank recapitalization and because

of the adverse effects on the economy. Further, NAMA's acquisition of good loans (which it has an incentive to do) will hurt the banks, the economy, and most relevant to this case - good borrowers such as McKillen.2 This is because ÑAMA does not have a bank's reputation, incentives, or information, ñor does it have a bank's ability to issue or roll over credit. In the absence of these resources, ÑAMA cannot recreate the valué generated in normal long-term banking relationships. d. In sum, the structure of ÑAMA (including its short time horizon and its inability to issue credit) create the possibility of value-destroying loan transfers. NAMA's incentives exacerbate this risk, making what would otherwise be a theoretical possibility into a matter of serious matter of concern. Such value-destroying

transfers hurt the banks, the economy, and, most relevant to this case, good borrowers such as McKillen. ÑAMA has disrupted and may well continué to dísrupt McKillen's core long-term real estáte business and it will have an adverse effect on the valué of his assets and his ability to refinance loans. This is because McKillen's business - long-term investment in income-generating real estáte - is a business that relies on predictable sources of credit and predictable tenant behavior. Unlike speculative development, in which a developer builds to sell at prices that he hopes are higher than the costs of acquiring the land and building structures, businesses grounded in long-term real estáte investment are particularly harmed by a transfer to ÑAMA. In more normal times, given enough time, McKillen could presumably transfer his banking relationship to another willing, long-term lender. But these are not normal times, and ÑAMA procedures and timetables may not provide McKillen with the time that would normally be required for a transfer of this scale. e. Consistent with my discussion above, the affidavits provided by ÑAMA do not provide any explanation of why moving McKillen's loans to ÑAMA is good for the Bank of Ireland or Anglo Irish Bank. They also provide no explanation of
While many of these problems are inherent in any good bank-bad bank restructuring, Ireland's structure, with partial prívate ownership of ÑAMA, represents particular risks, and is a structure not 1ike1y to be followed elsewhere in the world.


why such a move is good for taxpayers, save for the nebulous claim that McKillen poses a systemic risk because he is a large borrower. In fact, the evidence shows that McKillen loans are not impaired and pose no systemic risk. f. Based on the foregoing analysis, it is my opinion that the Irish economy would benefít most from leaving the McKillen loans with the banks in which they currently reside. Given the breadth of McKillen's assets, the extent of

diversification in his portfolio, and the fact that McKillen's assets were assembled and fmanced over a three decade period - a period in which McKillen demonstrated himself to be a reliable, long-term borrower - it is in the country's, the banks' and McKillen's best interests for his loan portfolio to remain with the banks that originated the loans. ÑAMA would need to conduct an extensive dialogue with McKillen in order to understand the economic support for this. Instead of engaging in such conversations, however, ÑAMA has exercised its broad powers to purchase assets it considers eligible, even in the face of objections by banks or borrowers. g. As a general matter, it is good policy for ÑAMA to gather information from borrowers who wish to make a case for staying out of ÑAMA. If ÑAMA neglects to gather such information, it will almost surely make economic mistakes that hurt the state, the borrowers, and the banks. Thus, providing borrowers with the

opportunity to object to their loan transfer to ÑAMA is good economic policy that generally makes borrowers, lenders and the state better off. Failing to provide this opportunity creates the risk of a taking, as well as a situation in which the state and the economy is made worse off. II. THE ROLE OF LONG-TERM RELATIONSHIPS IN THE BANKING SECTOR 13. Financial institutions are primarily vehicles for facilitating transactions between those who have capital and those who wish to borrow either: (i) to fmance investments or (ii) to consume now at the expense of future consumption. While conceptually

straightforward, the complex real-world structure of financial institutions and markets

A taking is when the government acquires prívate property and fails to compénsate an owner fairly. A taking can occur even without the actual physical seizure of property.


is to a large extent a response to issues arising from differences in information available to borrowers and lenders. These information differences - or asymmetries ~ give rise to problems of moral hazard and adverse selection. 14. Moral hazard in banking arises because key aspects of borrower behavior often cannot be observed by the lender. As a result, once a borrower is insulated from the risks of its actions, it can change its behavior in a way that is adverse to the interests of the íender. For example, real estáte developers may have an incentive to undertake excessively risky investments when they have a limited downside and an unlimited upside when gambles pay off. The Irish real estáte frenzy increased the problems of moral hazard, as developers raced to build and flip properties in the absence of adequate bank supervisión. Similarly, in the aftermath of the Irish banking crisis, banks themselves may have the incentive to take excessive risks. This is because they may perceive themselves as insulated from the full cost of their decisions by the belief that the Irish government will not let them fail. 15. Adverse selection in banking arises both because borrowers differ in the prohability with which they will be able to repay their loans and because lenders are unable to perfectly identify reliable borrowers. As a result, the pool of loan applicants may change once the terms of provisión of credit change. For example, when a lender increases the interest rate that it charges, borrowers with a high probability of repayment may drop out of the pool, leaving only those borrowers with a low probability of repayment. With these changes in the pool of lenders, it is difficult for lenders to ensure that the terms they offer - e.g., the interest rates that they charge appropriately reflect the risks that they face. 16. Many practices have developed to address the moral hazard and adverse selection problems discussed above. For example, banks typically require collateral from

borrowers. Because of concerns of moral hazard, banks making construction loans often require borrowers to meet specifíc milestones before providing additional funds. Banks also use consumer credit scoring to help differentiate potential customers who are likely to repay their loans from those who are not. Banks can then offer better interest rates to those customers who appear to be relatively credit-worthy.


One of the most important ways in which adverse selection and moral hazard problems are addressed in the banking sector is through long-term relationships between bankers and borrowers. Long-term commercial banking relationships, such as those that McKillen has with Anglo-Irish Bank and Bank of I reí and, help banks differentiate borrowers who are good risks from those who are bad risks. As the commercial borrower builds an ever-longer track record with a particular bank, the underwriters gain confidence in the borrower and the bank is able to offer lower interest rates. reduced collateral requirements, reduced information reporting requirements, and greater loan amounts, al! at greater and safer profíts to the bank.4 Long-term relationships also help address the moral hazard problem. Given the

prospect of ongoing benefíts from the relationship, both the borrower and the lender have strong incentives to behave well even under adverse, and often complex, circumstances.5 Long-term "incentive compatible" relationships enable more flexible contracting, based on trust. These relationships are an important part of the reason that parties can agree to short or medium-term loans (such as those McKillen has) even when financing a long-lived asset.6 Institutional practices and understandings between the parties can substitute for explicit contract provisions, reducing contracting costs and enhancing fíexibility and effíciency. 18. With no long-term relationship in place to mitígate concerns with respect to moral hazard and adverse selection, organizations like ÑAMA are severely constrained in their ability to recognize and support successful borrowers. Mo reo ver, NAMA's

incentive to develop such a mutually beneficial relationship with its borrowers is limited, for two reasons. First, unlike traditional lenders that derive their profits from a long-term relationship with a credit-worthy borrower, NAMA's goal is to discharge


6 7

See the affídavit of Joe Belanger for greater detail This is because each party perceives the valué of its future reward to be greater than arty immediate valué gaíned from engaging in opportunistic behavior today. See the affídavit of Joe Belanger for greater detail No contract is ever "complete " in the sense that ií could anticípate every contingency. ít would be prohibitively expensive even to attempt to do so. Economists refer to the understandings that serve as partial substitutes as "implicit contraéis." They not only provide for greater effíciency and fíexibility, they also reduce litigation costs.


its portfolio in a relatively short span of time.8 Second, ÑAMA lacks one of the prímary means for effecting a long-term mutually beneficial reíationship with performing borrowers, the ability to meaningfully extend credit. In a long-term

banking reíationship, credit facilities are rolled over upon expiration of a loan if both the bank and the borrower have behaved well, thus providing profit incentives for future good (non-opportunistic) behavior. However, ÑAMA is not a bank9 and does not have the same ability to provide rollover credit on a long-term basis. Without the promise of future rewards from a mutually benefícial long-term reíationship, both ÑAMA and good borrowers such as McKillen have an increased incentive to behave opportunistically. The response by ÑAMA seems to be rule-based procedures that risk the destruction of valué by requiring relatively rapid sales of assets, even in unfavorable markets. Potential buyers' knowledge that sellers may be under

compulsión to dispose of their assets would adversely affect sellers' bargaining position even in more favorable market conditions. This concern is even more

pertinent in the current climate of high uncertainty and liquidity constraints. 19. Clearly, NAMA's structure and incentives present significant problems for McKillen and other borrowers who run successful businesses that rely on loan refinancing.10 Given these considerations, ÑAMA should not be allowed to acquire and administer loans that are currently performing well, without the full benefíts of due process.

See the affidavit of Joe Belanger for detail. At some points, it seems to make a great deal of this, saying that it should therefore not be called a "bad bank," and therefore cannot have the adverse reputation effects associated with a bad bank. The general nomenclature in bank restructuring is to refer to asset management vehicles like ÑAMA as a bad bank, even though they are really work-out vehicles. But this reinforces the point I am making: work out vehicles are designed to work out bad loans, and the fact that they don't have the tools or long-term horizon of a bank means that they are not suitable for managing performing assets. In the language of economists, NAMA's purchase of McKillen will elimínate the economic benefíts that have accrued to the banks and McKillen as a result of their participation in a repeated game. Through this repeated game, McKillen and its banks have each built up the reputation for non-opportunistic behavior that is needed to effect mutually benefícial transactions. NAMA's purchase of McKillen would replace this repeated game with a one shot game that could well preven! such benefícial transactions from taking place and thereby destroy market valué.


III. BEST PRACTICES FOR DEALING WITH LOAN INSOLVENCY ALLOW GOOD LOANS TO CONTINUE TO BENEFIT FROM THEIR EXISTING LONG-TERM RELATIONSHIPS 20. Lending is risky, even when banks do a good job of assessing creditworthiness and monitoring loans. Bank regulations are designed to ensure that the bank has adequate capital to meet its liabilities, i.e. money that it has "borrowed" from depositors. The greater the amount of bank capital held by these shareholders, the less susceptible the bank is to becoming insolvent, i.e. to have insufficient assets to meet its obligations. 21. Bank regulators are concerned about capital adequacy for a second reason: if banks have insufficient capital, they have an incentive to undertake excessive risk (making bad loans), and this is especially so if they are likely to be bailed out by the government (if they are too big to fail). While bank supervisors are supposed to mitigate this risk, they can do so only imperfectly. 22. In periods of turbulence, assessing whether banks are adequately capitalized may be especially difficult. There may be problems of information asymmetries between regulators/supervisors and banks. Banks often claim that they are illiquid meaning that no one is willing to provide the banks the funds they need (at least at reasonable terms) when in fact they are insolvent - i.e., they are unable to raise additional capital because the valué of their liabilities exceed their assets. In the case of Ireland, the offer of a very broad government guarantee of all bank liabilities meant that the banks were neither illiquid ñor insolvent since they were effectively backed by the government's fulí capacity to tax. If the guarantee is removed, the twin problems and illiquidity and insolvency will immediately emerge.11

This has one further important impücation: There are two rationales put forward for stripping out the bad loans. One is to reduce the uncertainty associated with the banks' balance sheet The second is managerial—to allow one institution (the good bank) to focus on good loans, the other on working out bad loans. But if the bank is essentially insolvent, the first objective becomes largely irrelevant The government will, in any case, have to bear the risks. The government is currently doing so through the guarantees it provides to those providing capital to the banks, and given the effective insolvency, it wí11 have to continué to do so. Moving the risk from one public body to another does not change the overall risk to the economy or the public—something which the markets have already recognized. The consequences depend only on the improved management of the assets that might result My analysis suggests that, to the contrary, a move of a performing loan is likely to result in a worse management of the asset.



Standard rules of capitalism díctate who will bear the losses associated with a bank solvency problem. These rules require that shareholders lose all valué and that

bondholders become new shareholders. Only after bondholders have lost their capital should government inject new capital, through deposit insurance and government bailout funds. The bank, in such circumstances, will need to receive an infusión of new funds (i.e., be recapitalized), typically first firom the government (to make it viable), and then from the prívate sector through a public offering. In either case, the bank can continué to exist and to provide funds. 24. Bank insolvency, if handled in accordance with these standard rules, will not entail a serious interruption of the flow of credit to borrowers. This approach to addressing bank insolvency has worked in very large banks, such as Continental Illinois, and in a variety of countries, including Sweden and Norway. Indeed, as with bankruptcies in other sectors, bankruptcies among banks can lead to better performance, as uncertainty about the status of creditors is resolved and as the Corporation imdertakes changes in management. In contrast, deviations from these standard rules result in inequities, and going forward, can lead to large adverse incentive effects. 25. To prevent banks under prívate control from throwing good money after bad in the presence of a government guarantee and to reduce uncertainty about insolvency itself, it may be desirable to take the bad loans away from the bank. In that case, it is obviously appropriate for a government entity to pay the bank the expected valué of the bad loans. Such payment forces recognition of the (expected) loss, and thereby making clear the shortfall in capital. However, it is important to realize that the governmenfs payment to the bank of fair market valué for its bad loans does not cause the bank to become insolvent. It only makes apparent the insolvency that accounting standards have allowed to be hidden - the bank was already insolvent. If the bank is insolvent, such stripping out of the risky loans will not enable the bank to retum to lending. It will not resolve the banks' financial position. It can only be seen as a first step in the recapitalization process, which, as described above, should entail first converting bondholders into new shareholders, and then, if necessary, further injections of capital.



While, in the "bad bank" approach to addressing banking crises, it may be necessary or desirable for the government to purchase bad loans from banks in order to facilitate recovery, economic logic clearly indicates that it is poor public policy for the government to purchase good loans from the banks. This destroys the valué of longterm banking relationships that facilitate profitable transactions in a sector pervaded by asymmetric information problems and incentives for opportunistic behavior. With the severance of such relationships, bank risks may actually be increased and access to additional funds reduced, all with adverse effects on new potential borrowers and other good borrowers. Further, and as discussed in detail below, there may be follow on effects: risks to the taxpayer may increase, the interest rate government pays may increase, and this may lead to further increases in the cost of capital to the banks, and to borrowers.


BANK INSOLVENCY IN IRELAND AND THE CREATION OF ÑAMA 27. Below, I describe the banking crisis in Ireland and discuss the Irish government' s response to this crisis, including its creation of ÑAMA. I also explain that the role accorded to ÑAMA by the EU is to forcé banks to realize their losses by purchasing bad loans at an amount approximately equal to long run fair market valué. As noted above, NAMA's role need not conflict with an economically consistent process for addressing bank insolvency, though in the best of circumstances, the "bad bank approach" reflected by ÑAMA is one fraught with challenges (see section V below). However, NAMA's current structure provides it with incentives to underpay the banks, seize good assets in order to offset losses from riskier loans on their books, and create short term gains for the ÑAMA shareholders.12 Further, ÑAMA has the ability to act on these incentives due to the extraordinary powers it has been granted to rewrite contracts. NAMA's authority in this regard is well in excess of that afforded to ordinary commercial lenders.

As I explain later, ÑAMA created a SPV for acquiring loans from banks, and it is more accurate to say that the shareholders are shareholders in the SPV. Throughout this report I simplify by referring to the shareholders in the SPV as "ÑAMA shareholders."




As discussed in detail in Dr. Cragg's affidavit, Ireland's economy was hit especially hard during the fínancial crisis of 2008, and those doldrums have continued until today. Unlike the crisis in the United States, Ireland's economic problems were not driven primarily by exotic fínancial instruments. Rather, they represented a "plain vanilla property bubble"13 fueled by large concentrations of lending for propertyrelated purposes.


Ireland's economy was hugely dependent on building and construction; those sectors made up 20% of the country's GDP in 2007. This figure was more than 5% higher than in any other Western European country and more than double the share that building and construction represented in the United States' GDP for 2007.14 Construction also employed over 13% of the workforce at its peak in the third quarter of 2006, which amounted to nearly a doubling of the economy-wide employment share before the property run-up.15


Furthermore, construction accounted for an ever-increasing proportion of Ireland's GNP as the bubble became more inflated. As discussed in Dr. Cragg's affidavit,'6 4% to 6% of Ireland's national income in the 1990s carne from homebuilding, the usual level for a developed economy. By the peak of the boom in 2006-07, however, this percentage had increased to 15%, and other construction endeavors represented another 6% of GNP (€163 billion in 200717). This distortion in the economic

contribution from housing and other construction projects was driven by the overvaluation of Irish real estáte and the excessive availability of credit to fínance housing and commercial real estáte development.


M 15 16 17

Regling, Klaus and Max Watson, "A Preliminary Report on the Sources of Ireland's Banking Crisis," 2010, p. 6 attached and labeled "JES2." Alternatively described as an "old-fashioned property bubble" in Honohan, Patrick, "What Went Wrong in Ireland" May 2009, Prepared for the World Bank attached and labeled "JES3." Cragg Affidavit 1J27. Cragg Affidavit 127. Cragg Affidavit ^28 Central Statistics Office, "National Income and Expenditure: Annual Results for 2009," June 30, 2010, p. 3 attached and labeled "JES4."



In the third quarter of 2006, the number and average size of approved mortgages peaked. By the raiddle of 2007, unsold units were beginning to accumulate. This property slowdown spelled bad news for the Irish banking system, purchases."19 which had "lent

heavily to builders and developers to fmance projects and to make speculative land


The collapse of the building boom left Irish banks facing large losses from builders and developers, and as a result, the major Irish banks' share prices started to slide steadily after March 2007.20 The crisis carne to a head on September 29, 2008, with a run in wholesale markets on one of the largest banks, Anglo Irish. In light of the global fmancial crisis and international concerns about Ireland's fmancial sector, pressure mounted for the government to respond.21 The fear was that, without

government intervention, banks would continué to hoard capital, erasing all liquidity. At tihte extreme* they would become "zombie banks" , representing risks to the 33. economy and the public fiscal sector. In September 30, 2008, in response to the run on Anglo Irish, the government

guaranteed all the deposits and the sénior debt of Irish banks.

In January 2009, the

government nationalized Anglo Irish. On February 11, 2009, the Irish government invested €3.5 billion in preference shares in two large retail banks: Allied Irish Banks and Bank of Ireland.24
18 19


21 22



Cragg Affidavit f 2 9 . Kelly, Morgan, "The Irish Credit Bubble," December 21, 2009, UCD Centre for Economic Research Working Paper Series 2009, Working Paper WP09/32, p. 3 attached and labeled "JES5." Kelly, Morgan, "The Irish Credit Bubble," December 21, 2009, UCD Centre for Economic Research Working Paper Series 2009, Working Paper WP09/32, p. 15 attached and labeled "JES5.". See also Cragg Affidavit 1fl¡32-33 and Figure 6. Second Affidavit of Ann Nolan, July 30,2010, - 7. Zombie banks are banks that should be dead (i.e. have inadequate capital) but remain among the living. Such banks pose a risk to the public fin anees, because they have an incentive to engage in reckless (and worse) forms of lending and other behavior, even with negative expected social returns, typically imposing high future expected bailout costs. Second Affidavit of Ann Nolan, July 30, 2010, - 7. See also "Government Decisión to Safeguard Irish Banking System," Department of Finance of Ireland, September 30, 2008 attached and labeled "JES6" and "Credit I n s t i t u t o s (Financial Support) Scheme 2008 (the "Scheme"): Market Notice ~ Confirmation of Statutory Guarantee," Department of Finance of Ireland, October 22, 2008 attached and labeled "JES7." "ÑAMA Business Plan," June 30, 2010, ÑAMA, p. 10 attached and labeled "JES8." Affidavit of Brendan McDonagh, July 30, 2010, ^jlO.



Dr. Cragg has esíimated that, when fmally realized, Irish bank losses will be líl cxccss of €30 billion. For at least the three major banks participating in ÑAMA, the realized
* 25 *

losses will be well in excess of existing bank capital.

Without a government

guarantee (which allows banks to boixow at the Irish sovereign rate), and the resultant access to the European Central Bank (ECB) and other sources of credit, the Irish banks would be illiquid. This is because the banks' wholesale borrowing costs (at high interest rates representing their junk rating), would be well in cxccss of proceeds from their retail and commercial lending (at lower interest rates reflecting borrower credit quality). Under these circumstances, bank insolvency would immediately

emerge. The only reason that the Irish banks remain functioning is the presence of the blanket government guarantee of bank liabilities. But providing liquidity to banks in this way does not resolve the underlying problems of bank insolvency. Moreover, any value-destroying transfers and/or transfers to ÑAMA at prices that reflect a payment less than the valué of the asset - including the valué of the banks' long-term relationships with borrowers that might be severed or impaired by any involuntary transfer - increase the eventual cost to taxpayers. The market appears increasingly sensitive to such costs, and there may accordingly be a large indirect cost through increased borrowing costs.


As discussed in detail in Dr. Cragg's Affidavit,26 The National Asset Management Agency ("ÑAMA") Act of 2009 (the "Act") provided for the creation of ÑAMA by the Irish government in order to remove bad or impaired assets from the balance sheets of participating Irish banks. This logic behind the decisión was to remove uncertainty about the soundness of the banks' balance sheets and make it easier for them to access funds in the fínancial markets. The Irish government, through ÑAMA, would acquire the loans from the banks for a discount, paying for them with government-guaranteed bonds. ÑAMA is expected to have a finite lifespan and

25 26

Cragg Affidavit <¡54. Cragg Affidavit 1fl}44-47.


requires that 25% of its loans be repaid or refínanced within three years.27 As I shall discuss below, and as I have noted above, this rationale for creating ÑAMA has been vitiated by events. It is now clear that the banks are undercapitalized; there is little uncertainty associated with this. And henee moving the risky assets off the banks' balance sheets will not allow these banks to access fmancial markets. It is only the government guarantee that allows access; and only a substantial recapitalization would allow a return to access without a government guarantee. 36. ÑAMA was given broad powers to complete this mission: "ÑAMA may acquire an eligible bank asset of a participating institution if ÑAMA considers it necessary or desirable to do so having regard tó the purposes of this Act and in particular the resources available to the Minister [of Finance]...NAMA may acquire, from a participating institution, performing or non-performing eligible bank assets." Significantly, the Act gave ÑAMA the power to acquire eligible bank assets even if the participating institution did not consider the loan to be eligible, and even if the participating institution objected to its acquisition. consult with the borrower. 37. With bank losses of over €30 billion and government capital injections into the banks of over €25 billion,29 at least according to some observers, ÑAMA, as originaíly envisaged, would have allowed the Irish government to cover the enormous additional losses through a hidden recapitalization. In particular, the original plan for ÑAMA would have required it to overpay for failing bank loans arising from credit extended to developers.30 However, the EU balked at this original plan (as a form of state aid that was not allowed) and has only allowed ÑAMA to exchange government backed securities for development and associated loans, at long-term economic valué. The extent of the state aid was limited to the difference between what ÑAMA pays to the ÑAMA had no obligation to


28 29 30

"ÑAMA Business Plan," June 30, 2010, ÑAMA, p. 10 attached and labeled "JES8 " Affídavit of Brendan McDonagh, July 30, 2010, f l 0. National Asset Management Agency Act of 2009 attached and labeled "JES9." Cragg affídavit Morgan Kelly, "The Irish Credit Bubble," UCD Centre for Economic Research, WP09/32, p. 16 attached and labeled "JES5."


banks for assets transferred to ÑAMA (at most the long-term economic valué) and current liquidating valúes (current market valué, or CMV). 38. In its final design, ÑAMA merely increases certainty about the state of the Irish banks' balance sheets by replacing illiquid and harder to valué assets with assets that are, for the most part, easier to valué (government paper). The realized bank losses due to the transfer of assets to the ÑAMA portfolio will be on the order of €40 billion, as discussed by Dr. Cragg.32 Thus, ÑAMA will effectively make apparent the current bank insolvency, in what should be seen only as a first step towards recapital ization. But, ÑAMA itself cannot recapitalize the banks. Henee, ÑAMA is not and cannot be the primary policy that saves the Irish banks ~ this role will belong to whatever policy is chosen to replace the bank guarantees which are currently supporting the banks. 39. In fact, when ÑAMA acquires a good asset, it may increase uncertainty because 5% of the payments are with a bond whose valué depends on NAMA's performance. For reasons that will be clear, this bond could have little or no valué, so that even with an accurate valuation, there would be a 5% haircut, increasing the risk and magnitude of bank insolvency.


ÑAMA has established a Special Purpose Vehicle (SPV) for the purposes of acquiring loans from the banks. This SPV is 49% owned by the public and 51% owned by prívate investors. The prívate investors in ÑAMA are restricted in the amount of return they can receive on their investment34 These limitations include an annual dividend of no more than the Irish Government 10 year bond yield at the time

32 33


Affidavit of John Mulcahy, July 30, 2010, 1 and Eurosystem, "Opinión of the European Central Bank on the establishment of the National Asset Management Agency," August 31, 2009, p. 6 attached and labeled "JES 10." Cragg Affidavit H68. "ÑAMA Business Plan," June 30, 2010, ÑAMA, pp. 4, 25 attached and labeled "JES8." "Draft ÑAMA Business Plan," October 13, 2009, ÑAMA, p. 6 attached and labeled "JES11 "ÑAMA Business Plan," June 30, 2010, ÑAMA, pp. 15-16 attached and labeled "JES8." The fact that current projections imply that profits will be below the cap implies that, at the margin, prívate investors will be getting 51% of any incremental profit.


of dividend declaration35 and when ÑAMA meets its objectives and is wound up, no more than 10% of the total capital invested in ÑAMA can be paid out as a profit.36 The bulk of the fmancing for purchasing loans from the banks is derived from government guaranteed bonds. 41. In its October 13, 2009 business plan, ÑAMA projected a total profit of €4.8 billion.37

In its June 30, 2010 business plan, projected profit had fallen to €1 billion.


decline in NAMA's projected profits was much noted in the Irish press. Indeed ÑAMA has been subject to serious criticism. For example. the Labour party finance spokeswoman said that clearly the first ÑAMA draft plan had been "a fantasy." Further, the public appears to be growing increasingly disenchanted with ÑAMA itself.40 Given the decline in expected profits, tax payers and prívate investors are far more likely to be equally splitíing profits from ÑAMA. Thus, ÑAMA appears to be under serious political pressure to provide an improved return for its shareholders both public and prívate.41 42. These results should not be seen as a surprise. If ÑAMA does in fact pay ful! longterm market valué, then it can only make a profit if: (a) it is superior to the bank in the management of the assets; and/or (b) the market performs better than appraisers generally believed to be the case when the valuations occurred. But given the

36 37

38 39



For reference, the current 10 year bond yield, as of 2010, is 5%. National Treasury Management Agency, "Ireland: 5.00% Treasury Bond 2020," January 14, 2010 attached and labeled "JES 12." "ÑAMA Business Plan," June 30 2010, ÑAMA, p 15 - 16 attached and labeled "JES8." "Draft ÑAMA Business Plan," October 13, 2009, ÑAMA, p. 10 attached and labeled "JES 11" and "ÑAMA Business Plan," June 30, 2010, ÑAMA, p. 4 attached and labeled "JES8." "ÑAMA Business Plan," June 30, 2010, ÑAMA, pp. 4, 25 attached and labeled "JES8." See, for example, Irish Times Reporters in The Irish Times, "Ñama 'to make profit of € l b n , ' " July 6, 2010 attached and labeled "JES 13." For example: "Ñama is a macroeconomic three-card trick...." in Sean Barrett, "Ñama will distort market and is economic nonsense," The Irish Times, September 2, 2009 attached and labeled "JES 14;" "ÑAMA will recover €16bn for the taxpayer on the €40bn it intends to spend...." in Emmet Oliver, "ÑAMA to 'recover just €16bm out of €40 bn spend on loans,"' The Irish Times, August 26, 2010 attached and labeled "JES 15;" "It appears many of the worries over ÑAMA ... are coming to fruiíion already." in Gregory White, "Massive Commercial Real Estate Loans Now Blowing Up Tn Treland," Business lnsider, August 24, 2010 attached and labeled "JES 16;" Geoff Percival, "ÑAMA board set to forecast modest profit," Irish Examiner, July 6, 2010 attached and labeled "JES 17;" "ÑAMA is unlikely to ever get back the full amount it is owed...." in Thomas Molloy, "ÑAMA won't recoup full amount owed for land loans," Independent, August 4, 2010 attached and labeled "JES 18." See, for example, Irish Times Reporters in The Irish Times, "Ñama 'to make profit of €1bn,'" July 6, 2010 attached and labeled "JES 13."


deficiency in experience, the inherent disadvantages of being a short temí organization (where valué is maximized with long-term relationships), and the constraints imposed by public sector rules, it would be a surprise if ÑAMA were able to squeeze additional valué out of these assets. Some of those advocating "bad bank" strategies believed that the market was temporarily depressed, and that government with a longer time horizon than markets - could hold the assets until the market recovered. However, ÑAMA has a relatively short time horizon, and within this short time horizon, global fmancial markets have performed far more poorly than many expected earlier on in the crisis. Indeed, increases in interest rates facing Ireland, if translated into increased lending rates more generally (as is often the case) will act to further depress real estáte prices, making losses (in the relevant time horizon) even more likely. 43. NAMA's one effective strategy for increasing profits is to underpay for the loans, but should ÑAMA be successful in doing so, it increases the costs to the public through múltiple channels. Most importantly, if the banks are in fact insolvent, for every €1 of profits for ÑAMA, the public loses half, as half of the gain goes to private investors, and all of the bank losses are likely to be borne by the government.42 44. There is another way of thinking about what is going on. This is cióse to a "zero sum" outcome; assets are just being moved around. Gains by one party (say, as a result of mispricing) are a loss to another. If private investors are to be compensated, it has to be negative sum for government and the bank together, but if the public is picking up the shortfall of banks at the margin (and it appears that it will be, since the banks are likely insolvent) then any gains to the private investor mean a loss to the public. I have also delineated a number of reasons why what is going on is likely to diverge from "zero sum." Reasons that we might observe a negative sum outcome include the fact that: (a) ÑAMA is less experienced than the banks from which it is acquiring the loans; (b) ÑAMA is a short-term organization, which has adverse effects on hiring, implicit contracts, etc. and which means that the benefits which accrue from a long-term relationship cannot be reaped; (c) ÑAMA has adverse

This is, of course, only true if profits are below the capped level, which appears to be the likely case.


incentives (given both its prívate ownership and short term focus), exacerbated by its political positioning, and claims that it will be profitable; (d) the large haircuts, including partial payment in the form of an asset of uncertain valué, combined with the failure to solve the insolvency issues, may increase opportunistic incentives; (e) incentives for borrowers are similarly adversely affected; and (f) the ability of the bank to recruit good borrowers in the future is also likely to be adversely affected.43 Offsetting these negative effects is the possibility of some "positive" gains: (a)

preventing opportunistic behavior by banks and borrowers with respect to bad loans; and (b) diseconomies of scope - allowing banks to focus on good lending. In the case of any particular asset, one has to ask whether the overall adverse effect on the public and the negative sum impacts are greater or less than the positive sum impacts. In the case of performing assets, such as Mr. McKillen's, there is an overwhelming case that the adverse effects dominate. Indeed, with such assets the problem of opportunistic behavior is limited, and the transfer of such assets vitiates the purported benefits of NAMA's specialization in bad assets.44 V. NAMA'S INCENTIVES AND ABILITY TO SEIZE PERFORMING LOANS ARE INCONSISTENT WITH GOOD PUBLIC POLICY 45. As discussed above, it is bad public policy for a quasi-governmental agency such as ÑAMA to purchase performing loans from the banks in which they reside because the severance of long-term relationships between performing borrowers and their lenders needlessíy destroys valué. There may also be long-term adverse reputation effects to Irish banks and commerce, for reasons explained below. 46. However, even if - contrary to economic logic and evidence - there were no valué in these existing long-term relationships, purchases of performing loans by ÑAMA

While ÑAMA only has the power to acquire loans made before December 31, 2008, borrowers are likely aware that the banks' problems have not been fiilly resolved, and that there is therefore considerable risk of further actions, e.g. a ÑAMA II. The compulsory transfer of performing assets to ÑAMA could well have a chilling effect on any good borrower seeking to establish a long-term banking relationship with an Irish bank. In fact, internal correspondence that I have reviewed from ÑAMA would appear to reflect the potential that the adverse effects dominate. E-mail from Michael Connolly, "Coroin/Maybourne," March 11, 2010, 20:59, p. 105 in produced materials and e-mail from Eilish Finan, "Coroin/Maybourne," March 12, 2010, 00:37, p. 122 in produced materials attached and labeled "JES 19."


would provide no benefit to the public, even though they could provide benefíts to ÑAMA. To see this, it is helpful to consider the impact of such purchases on the bank, on ÑAMA and on society as a whole. 47, As previously discussed, EU requirements prevent ÑAMA from overpaying for the loans that it purchases.45 Henee, when ÑAMA seeks to purchase a loan, it can either pay an amount cióse to fair market valué46 or it can confíscate the loan for a valué below that amount. If ÑAMA pays fair market valué for a good loan, the bank is compensated for its loss and ÑAMA has a good loan on its books. Thus, neither the bank ñor ÑAMA is materially better off and ÑAMA has no incentive to undertake such a transaction. On the other hand, if ÑAMA seizes a performing asset, paying less than that asset is worth, it transfers money from the banks to itself Underpaying banks for their assets exacerbates the banks' insolvency problem. Indeed, the condition under which a bank would not voluntarily transfer a risky loan at long-term fair market valué - a transaction that would provide liquidity without diminution of asset valué - is if it planned to engage in some risky activity that would expose the government to further losses without commensurate benefíts. Unless ÑAMA

believed that the bank's supervisors could not monitor/circumscribe such behavior, there should be a presumption that the unwülingness of a bank to relinquish a loan arises because the bank believes it is not being paid fair market valué for the asset. 48. There is no societal benefít to NAMA's confiscation of performing loans. (Recall the rationale for confiscation of loans: reducing risk and reducing the scope for moral hazard; both are problems only with risky loans.) Indeed, for reasons I have already stated and discuss further below, there may be large societal costs. Given these


If ÑAMA were to overpay banks for bad assets, its payments would represent a hidden recapitalization of the banking system. A government might conceivably want to engage in such a hidden subsidy, recapitalizing the banking system in a way that taxpayers would not see as a direct appropriation. While this is bad public policy and contrary to EU rules against subsidies, it is a course that has been taken or proposed in several countries. For the EU's opinion on subsidies and the desire for the minimum level of state aid see, for example, Eurosystem, "Opinion of the European Central Bank on the establishment of the National Asset Management Agency," August 31, 2009, p. 6 and "Information from European Union Institutions and Bodies," Commission, Official Journal of the European Union, C 72/1, Annex IV, pp. 2021 attached and labeled "JES20." As noted above, the extent of the state aid was limited to the difference between what ÑAMA pays to the banks for assets transferred to ÑAMA (at most the long-term economic valué) and current liquidating valúes (current market valué, or CMV).


concerns, why might ÑAMA want to seize performing assets?

Coníiscation of

performing loans is the most certain way for ÑAMA to make money and thereby fiilfill its previously mentioned promises to shareholders and tax payers. But it should be clear that giving ÑAMA the right to confíscate performing assets provides incentives and opportunities that are adverse to the interests of the overall fmancial system and the economy. Moreover, because there is signifícant prívate ownership in ÑAMA, transfers that take place between ÑAMA and the banks are not just transfers between the taxpayers' pockets. Instead, they constitute, at least to some extent, transfers from taxpayers to private shareholders in ÑAMA. 49. I have seen certain documentation provided by the Respondents on discovery which indicates that ÑAMA is in fact approaching the McKillen loan portfolio on the basis of an incentive to make a profit for itself.47 50. Ironically, those confiscations that make NAMA's performance look good (Le. yield a positive return, as a result of underpaying) weaken banks. Moreover, the performing assets that are most attractive to ÑAMA - i.e., the assets for which eventual disposal is likely to be easiest, because uncertainty is the least ~ are likely to result in the greatest loss of social valué as a result of their confiscation, precisely because these are loans with the highest long-term valué. Further, these seizures do not just represent an unjustified transfer of wealth; their adverse effects run counter to the stated objectives of ÑAMA. 51. In summary, stated taxpayer and shareholder gains on ÑAMA are unlikely to be realized unless the banks are underpaid for their assets. Gains to taxpayers and shareholders that would result if ÑAMA paid banks less than bank assets were worth would be offset by losses to the government, which would simply have to pay more in bank recapitalization. One should be skeptical about the more sweeping claims about the ability of ÑAMA to generate profits - they are not only unproven, but, given its structure, unlikely.

E-mail from Michael Connolly, "Coroin/Maybourne," March 11, 2010, 20:59, p. 105 in produced materials and e-mail from Eilish Finan, "Coroin/Maybourne," March 12, 2010, 00:37, p. 122 in produced materials attached and labeled "JES 19."



ÑAMA has limited resources, and it is important that it use those resources carefully. Given these considerations, economic logic indicates that ÑAMA should focus its attention of nonperforming loans, development properties that are not incomegenerating and that are not likely to become so, and generally borrowers that are illiquid and insolvent, and where the transfer would arguably increase the valué that could be extracted from the asset and not decrease it (because of moral hazard issues arising from "throwing good money after bad" due to bank guarantees and bank insolvency). This specificaíly means that ÑAMA should focus its purchases on loans for property development and not for income-generating assets like housing and ¿ I R tenant-occupied commercial real estáte.


ÑAMA could also play a particular role in helping stabilize the real estáte market in Ireland, by avoiding a rash of liquidity induced fire sales, which are often part of the propagation mechanism of fmancial crises. This suggests that, other things being equal, ÑAMA should focus on loans for development in Ireland, and plan to retain the assets for a long period of time given the leve! of overbuilding in Ireland.

VI. MCKILLEN WILL LIKELY BE INJURED FURTHER THROUGH A TRANSFER 54. NAMA's incentives for dealing with performing assets Hke the McKillen loans are fundamentally different than those of a commercial bank. Thus, while it may be in the interest of ÑAMA, the banks and the government to transfer poor quality real estáte development loans to ÑAMA,49 there is no good economic reason to transfer good assets to ÑAMA, especially in light of the likely harm. As discussed above, there are several sources of harm that arise from the basic information economics and theories of incomplete contracting outlined at the beginning of my affídavit. a. First, ÑAMA does not have the resources, knowledge, or relationships to service and negotiate with borrowers like McKillen.


There may be cases of income generating assets that are "developmental," in the sense that, for instance, they are currently loss making, but with sufficient increased investment, they might be made profitable. 1 emphasize "may" because this conclusión requires (i) inability of supervisors to prevent bad lendíng decisions; (ii) an assumption that ÑAMA has a superior ability to manage the resolution of bad loans; and (tii) the benefits of the long-term credit relationship associated with a bank loan are more than offset by the losses associated with opportunitistic behavior by bad borrowers that cannot be constrained by adequate supervisión. The second hypothesis is particularly questionable.


b. Second, unlike traditional lenders that derive their profits from a long-term reíationship with a credit-worthy borrower, NAMA's business model has a relatively short time horizon and accelerated workout objectives, c. Third, NAMA's stated business model - reducing total loans outstanding by 25% within three years - exacerbates the problem because of the need for asset sales, ín normal times, if an isolated asset were for sale, one would find several willing buyers vying for the purchase, and the buyer would be able to find a source of finance, Indeed, that is what one means by "long-term economic valué," the price that an asset could achieve in the long-term, and the long-term economic valué of a loan is related to the underlying assets. But these are not normal times, and the market is not likely to return to anywhere near normal in 3 years, especially given the scale of the property bubble and the weaknesses in the banking system. Thus, if large numbers of assets are simultaneously put in the market in the ncxt tiuroG years, the market price of these assets would, even in more normal times, likely be depressed; but that is especially so now. d. Fourth, reworking the terms for performing loans whereby total debt repayment is accelerated by 25 percent is even more problematic. When financing income generating properties with long lives, as an economic matter it is simply not possible to generate sufficient income to pay down such loans by 25 percent within 3 years. Competition in the long run will only allow landlords to charge rental income that will cover principal payments, interest payments and normal profits associated with the typically very long lifespan of the asset. e. Fifth, under the ÑAMA plan, McKillen will be required to submit a Business Plan within 30 days outlining how he will radically reduce his debt within a 3-5 year cycle. This is a very short time period for reducing debt exposure on a longlived performing asset. This is a radical restructuring requirement and likely to be unobtainable, given the severing of McKillen's long-term lending reíationship, a move that other potential lenders will interpret negatively. Therefore, given that there is no evidence of McKillen's not being able to service his debt, such a reduction in his debt would not make economic sense. Moreover, rapidly

disposing of assets in the midst of a fmancial crisis is more than likely to result in a capital loss.50 f Sixth, without the promise of future rewards from a mutually beneficial long-term relationship, both ÑAMA and the once-performing borrower have an increased incentive to behave opportunistically. For example, ÑAMA would have an

increased incentive to make onerous demands on McKillen, even going so far as to unilaterally rewrite his loan contract Similarly, without the promise of profits from a long-term relationship, it could become economically rational for the ÑAMA borrower to walk away from property in which it no longer had an equity interest 51 Further, both parties have the incentive to engage in a game of chicken. If a borrower sees his equity being wiped out, he could simply stop managing his assets, which would have a devastating affect on their valué to ÑAMA. g. Seventh, with McKillen's loans transferred to ÑAMA, it could become rational for McKillen's tenants - especially those in fínancial trouble - to stop paying rent since ÑAMA may have a limited ability to find replacement tenants. h. Eighthy given NAMA's purpose, if ÑAMA acquires good loans, the reputation of good borrowers would suffer. For instance, parties who might consider

refínancing the McKillen loans could rationally infer that, like other ÑAMA borrowers, McKillen is a bad credit risk. i. Ninth, because ÑAMA increases the uncertainty about the net worth of any ÑAMA borrower (and rationally would be expected to decrease the expected valué of that borrower), good ÑAMA borrowers - which may entail some of the

In some countries, forced disposition of assets has played a central role in corruptíon, as the assets were subsequently acquired at greatly discounted prices by those with access to funds or who were qualifíed in rigged auctions, where relatively few buyers were qualified. Even a firm with positive equity might undertake riskier actions, given the reduced likelihood of access to credit in the future; in a sense, the valué of the on-going ftrrn has been reduced. The perverse structure of ÑAMA (its short term horizon, the large role played by private equity investors) and the associated incentives to which it gives rise, as well as NAMA's capacity limitations, exacerbate these problems. And these problems are further exacerbated by the global fínancial crisis, which presents great difficulties in getting access to alternative sources of finance.


better entrepreneurs and property managers - will fínd it more difficult to get access to credit. j. Tenth, the diversión of attention to dealing with ÑAMA and its short-sighted demands would rationally lead lenders to curtail funds to such borrowers. k. Eleventh, when performing assets are being transferred to ÑAMA, they are being transferred to a less competent party than a bank. In discussing global banking crises, I often ask, "Do we really believe that the government has an advantage in garbage disposal?"52 The main rationale for the creation of a bad bank (ÑAMA) is that it might develop competence in the disposition of bad assets. However, given the constraints, it would be naive to expect that a bad bank could develop competence in managing performing assets.53 55. In sum, the only way that one could be confident that ÑAMA would not injure McKillen is if it had superior capacities at managing bank relationships, which by necessity requires the ability to extend credit. But ÑAMA is a new institution,

without experience. Moreover, without a bank charter, it cannot meaningfully extend credit for long periods of time in an incentive compatible lending relationship. The

structure of ÑAMA thus creates the incentive for ÑAMA to underpay the banks, seize good assets in order to offset losses from riskier loans on their books, and create short term gains for the ÑAMA shareholders. This potential problem is compounded by the powers granted to ÑAMA to rewrite contracts, well in excess of those afforded to ordinary commercial lenders.



Joseph Stiglitz, Free Fall: America, Free Markets, and the Sínking of the World Economy (New York: W.W. Norton and Company, Inc., 2010), 122. The best thing for ÑAMA to manage is nonperforming loans and only nonperforming loans. Indeed, that is one of the key rationales for creating a specialized institution like ÑAMA in the first place. (Given the likely insolvency of the banks, the other rationale, moving risk off the banks" balance sheets, is of limited valué, as 1 have already explained.) It is straightforward for ÑAMA to culi the nonperforming loans from the bank balance sheets, especially if it allows for bank and borrower input in the event of a dispute about how the loan is performing.






The key questions which ÑAMA should consider in determining whether or not to acquire a loan portfolio are: (i) is the loan portfolio impaired? And, (ii) does the loan portfolio pose a systemic risk i.e., could the failure of this loan portfolio cause a chain of subsequent failures that could potentially bankrupt the entire system? My review of the evidence in this matter indicates that for McKillen's loans, the answer to both questions is no.



That the McKillen loans are not impaired is demonstrated by evidence presented in the affidavits of Mr. John Trench and Mr. Patrick McKillen. These affidavits show that the McKillen properties are meeting all of the loan servicing requirements and that the portfolio is generating income in excess of its fínancing costs with an average interest cover of 1.7 which in my experience is well in excess of typical interest coverage for well performing loans.


In contrast, NAMA's measure of McKillen's impairment and payment default risk is far less reliable. To assess McKillen's portfolio, ÑAMA compares the amount of McKillen's loans to a valuation of the commercial real estáte financed by those loan. The reason that NAMA's measure is unreliable is that commercial real estáte valuations obtained during a period of extreme illiquidity in the real estáte market can fluctuate dramatically.


Indeed, that is the reason that most countries do not forcé mark to market accounting on commercial banks that have a practice of retaining (and rolling over) mortgages. In the United States, even impaired assets - where the borrower may be delinquent in payments - do not have to be written down in the midst of the crisis.


In order to obtain a reasonable approximation of long-term property valuation for use in NAMA's loan to valué ratios, ÑAMA would need to undertake extensive consultation with the property owners and managers. I understand that ÑAMA

appraisers did not pursue such consultations with respect to McKillen's portfolio.


However, I further understand that appraisals in which such consultations were pursued showed that the valué of McKillen's properties is well in excess of his loans.

1. 61.

The Size of the McKillen Loan Portfolio does not Imply that it Poses a Systemic Risk According to Ms. O'Reilly, ÑAMA decided to acquire McKillen's loans "...because of our belief that the extent of aggregate exposure of relevant participating institutions to Mr. McKillen and his companies ... under credit facilities granted by those institutions being the sum of approximately €2 billion was such as to create a systemic risk....The risk to the banking system of any potential impairment in an exposure of €2 billion and the potential losses hat would be suffered by the participating institutions, which were already in receipt of substantial State support due to their individual systemic importance was such that ÑAMA considered the acquisition of Mr. McKillen's credit facilities was necessary to further the purposes of the Act."54


In fact, however, ÑAMA is mistaken in its basic assumption that the size of McKillen's loan portfolio provides a good measure of the degree of systemic risk that it imposes. To see this, consider an owner of several, separately incorporated assets who faces a series of value-impairing events (shocks). As long as these shocks are uncorrelated with common ownership, there is no reason to believe that the single owner would be more likely to go into default than individual owners of similar assets. In order for the large single owner to face greater default risk, it would have to be the case that common ownership causes correlation in shocks.


Common ownership could produce some increase in correlation among the shocks that a business experiences - e.g., correlated judgment errors and/or correlated liquidity problems, with the "owners" being unable to provide additional capital as required. But, with a macro-economic shock, and a well capitalized owner, that correlation could actually be less than the average correlation.


Affidavit of Aideen O'Reilly, July 30, 2010 %43.



Moreover, one owner who se loans contain cross default clauses (i.e. contractual clauses that, in the event of a default on one loan, precipítate default on all loans) may even lower systemic risk. This is because the strong incentives that the borrower faces not to default are viewed as outweighing the risks imposed.55


In any case, an economic analysis of systemic risk needs to take into account the magnitude of the losses that might be incurred, if loans were not repaid. Given the lower loan to valué ratios and the high income generation of the McKillen assets, there is in fact little risk, let alone systemic risk. In fact, there is little risk that banks would not be able to generate enough income from the assets to pay interest obligations to depositors, or even less risk still that the bank would breach (because of a non-payment) capital adequacy standards.


On the contrary, acquiring the assets at too low a price could increase systemic risk for the banking system, and rapid disposition of the underlying assets could contribute to capital losses to be experienced by ÑAMA. In fact, was ÑAMA to systematically pursue this policy of acquiring good loans, it could lead to broader systemic risk for the country as ÑAMA underpays for the loans and destroys valué. Pursuit of such a policy would raise the amount required for recapitalizing the banks, increase the costs associated with the guarantees to the banks and increase the cost of the ÑAMA debt, all three of which place additional costs on the state at a time when sovereign risks associated with the Irish government are rising.

2. 67.

Review of Evidence on Systemic Risk Posed By McKillen Portfolio Mr. John Trench's affidavit pro vides further evidence reftiting the notion that the McKillen loans impose systemic risk just because they are large. A review of the McKillen loans quickly fmds that the McKillen loans are diversifíed across many countries, with approximately one half in the UK, one quarter in Ireland and the remainder throughout Europe and North America. Further, the McKillen loans are diversifíed across the various Irish banks and McKillen has extensive holdings at each of Bank of Ireland, Anglo Irish and Allied Irish.

Of course, if lenders worried about the systemic effects of the simultaneous operation of such cross default clauses, the different assets could be separated, and cross default clauses eliminated.



While the majority of McKillen's loans are with Anglo Irish, in terms of systemic risk this is hardly a problem since Anglo Irish has already been nationalized. Indeed, once we take this fact into account, McKillen's loans make up far less than even one percent any one bank's total loans.56 Therefore, the argument that any bank is

overexposed to risk via the McKillen loans is incorrect. 69. Dr. Cragg' s affidavit also shows that the banks in which the McKillen loans reside are already suffering massive amounts of impaired loans relative to their Tier 1 capital and are effectively insolvent,57 However, even if one were to cali all of the McKillen loans impaired it would not appreciably worsen the situation at any of these banks. To illustrate, 1 refer to the following figure from Dr. Cragg's affidavit. Figure 1: Impaired Loans as a Percentage of Tier 1 Capital, by Bank¡58



a 600% « S 500%

w 400%


4 >

£ 300% <x

I 200%

100% -



! ü w / o McKillen Bw/McKillen



C r a g g Affidavit f 7 1 .

57 58

Cragg Affidavit 1154-57. Cragg Affidavit Figure 12.



As Figure 1 shows, the difference in impaired loans relative to bank capital with and without the McKillen loans is hardly noticeable in the case of AIB and Bank of Ireland. Therefore, there Is no question that McKillen's BOI and AIB loans do not represent a further systemic risk to the banks. Further it is irrelevant if the Anglo Irish loans are impaired since, as the figure shows, this bank has already failed.









Economists have recognized that it may be important that the State seize private assets for public use. However, two due process safeguards are typically put in place in recognition of the importance of the rule of law and private property. These two due process safeguards are as follows: a. First, it must be possible to show that the acquisition is for public benefit (and implicitly, that there are reasons that the acquisition cannot be effected through voluntary transactions). For example, when land is acquired for a road, there is a well-defined public purpose, where the refusal of a single party to sell could impose large costs. In such case, it is clear why socially benefícial voluntary transactions may not be possible. However, there are many other cases in which the justifícation for a taking may not be as apparent. The main benefits may accrue to

private parties.

When there are private beneficiaries (like

developers abutting the new roads), one needs to be especially sensitive to prospects for abuse, and one has to look particularly closely at the putative public benefits. b. Second, the private owner must receive fair compensation for his property. This compensation should be based on the valué of the existing valué of the asset, not the valué of the asset after, say, the public investment. Further, valuation of the existing asset must take into account reasonable future prospects. For example, the compensation for a vacant lot should not be based on its current use (zero), but on the fact that on that lot a building could be built. If there is a high valué public


use of the asset, then the valué after acquisition should be greater than the valué before acquisition, and the owner should receive compensation based on the asset's pre-acquisition valué. 72. Given the principies outlined above, it is clear that the valué to be paid for McKillen's portfolio should be based on the portfolio's pre-acquisition valué; and this valué should include the benefíts associated with an ongoing bank reíationship (which the transfer of the assets to ÑAMA would terminate). In contrast, the asset's post-

acquisition valué is likely to be less than the pre-transfer valué, since the valué of the ongoing bank reíationship will be lost upon acquisition. Thus, if the price to be paid for the McKillen loans is justifíed, it must be justifíed by external benefíts, such as increased economic stability. Such benefíts will offset the fact that the asset is worth less in NAMA's hands than it is in the hands of McKillen's long-term bankers. It goes without saying that to justify the involuntary acquisition the social benefíts of the acquisition must exceed the prívate costs. 73. In McKillen's case, I have shown that the transfer is more likely to be associated with no social benefíts, possibly even social costs. If that is the case, it is unlikely that the social benefíts suffíce to offset the prívate costs experienced in the transfer. 74. Further, the transfer of the loan to ÑAMA involves no compensation to the borrower for his lost long-term relationships with his lenders, and resulting collateral damage. Indeed, no provision was made for such compensation, perhaps because it was never contemplated that good assets (where there was a positive valué to the lender/borrower reíationship) would be transferred.


I have long argued over the course of my career that there are grounds for circumscribing unfettered property rights. Firms should not, for instance, be allowed to engage in anti-competitive behavior, and compulsory licenses have an important role to play in access to medicines. However, my concern in the current matter is that ÑAMA has not made a compelling case for a breach of McKillen's basic property rights.



A closer examination of ÑAMA shows that it is structured with incentives that go against the purported public interest of helping the economy revive in this moment of crisis. Worse still, while some private entities (including possibly the fmancial

system itself) may bear substantial costs, other private entities (including NAMA's private shareholders) may be the benefíciaries of the powers granted to ÑAMA. 77. Public policy structures that allow - or even worse, provide incentives - for this kind of transfer of wealth should be particularly suspect. The fact that NAMA's conduct in transferring performing assets to itself is consistent with its incentives should be even more troubíing. 78. Governments always have an incentive to underpay for assets, and even more so when there are private benefíciaries (e.g. when the assets are sold to private developers). This is why systems of checks and balances, judicial scrutiny and the like, are importan! These longstanding legal doctrines are grounded in concerns of equity; but they also are motivated by economics; security of property rights and the "sanctity" of contracts - both explicit and implicit - are foundational to a market economy. Involuntary transfers of assets represent a "taking" which should be

undertaken only when there is a compelling public interest. Even then, it is important that there be full and adequate compensation. So too for the breaching of long-term relationships. 79. If these basic principies are not followed, there is a serious risk to Ireland's reputation as a country respecting the rule of law, with consequent adverse short-term and longterm effects on its economy. It is striking that NAMA's only defenses are the

argument regarding systemic risks and the more troubling argument that transparency and due process in a democratic society can be ignored because they may complícate the implementation of the policy objectives embodied in ÑAMA.59 80. A relatively straightforward and expeditious model of due process that includes borrowers can be easily designed for ÑAMA and applied broadly on a voluntary basis, or, more narrowly just to borrowers that are deemed to be potential systemic

Affidavit of Brendan McDonagh, July 30, 2010, T|17.


risks. Recall that the magnitude of risk is a ñinction of the potential size of a loss, the likelihood this loss will occur, and the correlation with other risks faced by the bank. If systemic risk is a consideration, it is crucial to understand that the magnitude of risk is a function of the potential size of a loss and the likelihood this loss will occur. For systemic risk, the magnitude of risk is further extended to not only include the potential size of the losses from an individual owner, but the potential losses must then be suffíciently large and interconnected that it will lead a cascade of effects that threatens the entire fmancial system. (A further element of systemic risk is presented when a quick seíl-off of large numbers of assets exacerbates further asset price declines, especially in the presence of more widespread lxquidity problems, leading again to cascade effects. The appropriate response to such problems is to keep them off the market until there can be time for an orderly disposal and/or until the liquidity crisis has been resolved. As I have noted, however, NAMA's business model risks exacerbating this form of systemic risk. And this aspect of systemic risk is likely to be most relevant to properties within Ireland and not the McKillen properties.) 81. Therefore, the due process I imagine must allow for borrowers to present, ínter alia: (1) the strengths and sources of their credit-worthiness; (2) the quality of the incomegenerating capacity of the financed property; (3) the valué of any collateral and other properties; (4) the nature and likelihood of potential threats to servicing the loans; (5) any factors that mitígate these risks including, the geographic and industry diversifícation, the centrality and importance of the properties, and the experience and track record of the borrowers; and, (6) likely correlation with other losses that might be experienced by the bank in the aftermath of the breaking of the Irish property bubble. Without consideration of these factors it is simply not possible to assess the systemic risk. In addition, recall that one of the basic rationales for ÑAMA taking over the assets and their management is to enhance the valué that can be extracted from those assets, given the moral hazard risks that have been identifíed. But I have also raised a concern that, at least in some instances, there is a substantial risk that such a transfer will actually reduce the valué of the assets. Therefore, both economic fairness and economic effíciency require that both the lender and the borrower be able to present evidence relating to the magnitude and nature of the moral hazard risks and


the extent to which those risks have been, or could be, mitigated, and the risks that a transfer be valué decreasing rather than valué enhancing. In designing a process, the following points might be borne in mind: (1) the number of borrowers that might conceivably present systemic risk is very limited, and therefore the resources and time required to implement an appropriate procedure would be limited; (2) even if there was an opportunity for all borrowers to make representations the overwhelming probability is that many, perhaps most, borrowers will not avail of the opportunity because as a matter of fact relatively few borrowers are likely to have a real incentive to make representations because their loans are chronically impaired. If there were concerns of excess burden be posed by such a process, it might be permissible from a policy objective to limit the entitlement to representation depending upon the level of impairment of borrowers' loans and incorpórate strict but nonarbitrary time limits that do not negatively impair the borrower.


In 1 11 of her affidavit, Aideen O'Reílly suggests that McKillen's statements of choosing the Bank of Ireland based on trust and a strong relationship are fallacious due to the fact that there exists covenants in the loans at issue that would have enabled the loans to be transferred to another fínancial institution or a third party without McKillen's consent. This completely ignores the well estabíished principies of

relationship banking, as detailed in Mr. Belanger's affidavit. Further, her claim that a transfer of the McKillen loans to ÑAMA is not inconsistent with the original contract is completely baseless since before ÑAMA was created, no one could have reasonably foreseen that such an entity would exist. Further still, Ms. O'Reilly

attempts to portray ÑAMA as a lender, even though ÑAMA freely admits it is a workout vehicle and not a bank. This last point is evident since ÑAMA is not even licensed as a bank in Ireland. 83. In % 17 Ms. O'Reilly describes how ÑAMA may not seize an eligible bank asset when the "land or development exposure is incidental to the main business." Ms. O'Reilly provides no standard for determining whether or not a particular degree of exposure 35

meets here definition of the incidental. However, in f 30 and % 32 Ms. O'Reilly states that the Maybourne Loan is a development loan due to some GBP 30 million of the GBP 472 million total loan being development-related. It would seem that such a small fraction, just over 6%, would be considered incidental by most. 84. In % 35 I note that Ms. O'Reilly suggests that ÑAMA was always intended to acquire loans secured on investment properties and not just land and development loans. However, it would seem clear that ÑAMA never intended to acquire investment properties unless they were tied to some larger problem. Certainly, this is what was contemplated by the EU when it stated that "assets that cannot presently be considered impaired should not be covered by a relief programme. recession. «60 85. As noted above, in f 43 of her affidavit, Ms. O'Reilly gives the sheer size of the McKillen asset portfolio as the rationale for NAMA's decisión to acquire the assets since the €2 billion total posed a systemic risk is compared to a total of €50 billion for the 100 largest borrowers. Such a comparison has no meaning in determining Asset relief

should not provide an open-ended insurance against future consequences of

systemic risk because it takes no account of the likelihood of loss and the potential magnitude of losses regarding either the €2 billion or the €50 billion. What Ms. O'Reilly apparently fails to realize is that the McKillen loans are small relative to the total Irish banking sector, and in particular are diverse across geography, across funding sources and the loans are generating cashflow well in excess of financing costs (recall the 1.7 interest coverage). Indeed, due to the tenancy agreements that others have reviewed many of the rent rolls are locked in at quite favorable rates and it would take a very large increase in financing costs for the McKillen portfolio to even begin to have cashflow difficulties.61 The strong fiscal position and

diversification of the portfolio shows that individually McKillen poses a minimal risk and certainly not a systemic risk.



"Information from European Union Institutions and Bodies," Commission, Official Journal of the European Union, C 72/1, 35 attached and labeled "JES20." See % 24 in Mr. John Trench's affidavit.



In f 55 of her affidavit Ms. O'Reilly again plainly ignores basic banking practice when she says that NAMA's 7-10 year view is not really short since many of the credit facilities would expire by then anyway. As Mr. Belanger's affidavit describes in detail, renewal of credit facilities rather than full repayment of principal is the norm. Ms. O'Reilly instead focuses on the strict wording of the contract and ignores the real-Iife applications of relationship banking would clearly be in play here absent ÑAMA. While I agree there may not be a "right" to extend the loan, as she implies McKillen suggested, it is the normal pattern and practice of the banking industry and there would be no rationale reason to think a respected individual like McKillen would not have that option available. As I noted earlier, a well functioning economy requires implicit understandings (what are called implicit contracts) - not just explicit contracts. It is not possible to deal in any contract all possible contingencies, and a well functioning economy requires the flexibility provided by implicit contracts. But their proper functioning is based on long-term relationships, based in turn on the incentive compatibility provided by the reputations of the borrower and lender alike.


Ms. O'Reilly's statements in % 58 of her affidavit are patently false. If the McKillen loans were acquired by ÑAMA it is in no way similar to just "step[ing] into the shoes of the transferring bank." Normal ly, the acquirer would be a bank; the party willing to pay the most for such a contract would be someone who would take into account the valué of the long-term relationship ~ something that I have already argued is destroyed by ÑAMA. Moreover, normally the acquirer would have competency in both banking and real estáte; such competency and agreed understandings of common practices, motivated by good will and long-term relationships, are essential for the conduct of business and reaching mutually beneficial agreements. The structure,

conduct and plans of ÑAMA give good reason for concern on the part of the borrower. At the very least, there is a comprehensive business plan required within 30 days that has to highlight plans for massive debt-restructuring that may otherwise not be a part of the business' plans. Even if ÑAMA were to accept this and never bother the borrower that is an immediate difference. Secondly, ÑAMA admits that its goal is reduce its total debt load by 25% by 2013. To assume that every borrower has such a plan for such a quick debt reduction is simply ridiculous as a matter of economics -


and especially in the context of a financial crisis, where long run disposition makes more sense. Finally, if the loan were still held by the transferring bank there would be the possibility of the option to refinance it since the lender would still be the bank. By NAMA's own admission it is not a bank. To try and suggest that there would be no difference is absolutely untrue.


In f 7 of bis affídavit, Mr. McDonagh suggests that ÑAMA has the capacity to take long-term perspectives on loans and debtors "as it makes commercial sense to do." Its structure and conduct seem inconsistent with such a claim, as I have already noted. As an example, debtors are required to make significant reductions in loans outstanding in a brief time period. Indeed, in aggregate ÑAMA has promised a 25% reduction by 2013 (as he himself discusses in % 10). What Mr. McDonagh is

implicitly assuming to make the statement he does, is that for each debtor and each loan ÑAMA will acquire it makes commercial sense to have them meet NAMA's guidelines and large goals for reductions in outstanding loans. While there may be individual loans for which this is true, it is not the case for all loans and almost certainly not the case for performing loans the McKillen loans. Indeed, the

willingness to make such a sweeping goal in the current circumstances by itself raises questions. 89. In K 9 of his affídavit Mr. McDonagh states that one of the statutory purposes of ÑAMA is to "obtain the best achievable financial return for the State." This goal is incompatible with many of the claims made by Mr. McDonagh and other ÑAMA representatives, such as Mr. McDonagh's statements m\l where he talks of ÑAMA

doing what makes "commercial sense" since that as sumes that achieving the best financial returns for the State and the commercially sensible business practice are one and the same. Indeed, there is a more troubling aspect of this approach: if there were merely a commercial transaction, there would be little rationale for government action, and little justification for the powers given to ÑAMA. It is because of the externalities associated with the management of the financial crisis (including via bank lending) that government intervention is justified. The "best achievable


fínancial return to the State" focusing narrowly on ÑAMA, could be achieved by underpaying for the assets. But that would be very bad from the broader perspective of Ireland, or even from the perspective of Irish public finances. For by achieving better returns to ÑAMA, the need for public funds for filling the hole in the banks' balance sheet would be more than commensurately increased, and the adverse effects on the public finances as a result of increasing bond rates faced by government would present further costs. 90. In f 10 of his affidavit Mr. McDonagh states "ÑAMA invites each debtor to submit a business plan and reviews the debtors' immediate working capital requirements." But what is entailed is more than a kindly invitation to submit a business plan. ÑAMA clearly states that business plans have to be submitted within 30 days, and the business plan is entails not just "immediate capital requirements" but also detailed forecasts of debt reduction and property over the next three years (plus a plethora of other details which are more trivial, though certainly no less burdensome to produce). Indeed, he describes that requirement in f 30 of his affidavit, though this time saying that it is a "request" rather than a requirement. However, he highlights that ÑAMA may reject whatever plan is submitted or have it referred back to the borrower for amendment. This highlights the fact that these plans must be exhaustive to pass ÑAMA muster. NAMA's powers are large, making its requests not just invitations. It can revise loan contracts. 91. In 1 16 of his affidavit, Mr. McDonagh states that the banks selling their loans to ÑAMA is no different than the banks selling their loans to other third parties which happens in the normal course of business. While this certainly does happen in normal commercial operations, what Mr. McDonagh fails to recognize is the role of relationship banking in normal commercial operations, as discussed in the affidavit of Mr. Joseph Belanger. What Mr. McDonagh does is ignore the fact that there is real valué in the bank preserving its good relationship with borrowers. I do not mean to suggest that banks would never sell loans to other banks, or assign the loans to SPVs in order to prudently manage risks and finance their loans portfolios. However, they would certainly consider the impact on their reputation in general and on the


reíationship with that borrower in particular; the valué of both may be considerable, and especially in the case of the McKillen loans, is non-trivial. And the acquirer — e.g. the party willing to pay the highest price for the contract - in most cases would be a party who too would valué the long-term reíationship. 92. In 17 of his affidavit, Mr. McDonagh states that any consultation between ÑAMA

and the borrowers would be costly and wasteful, and henee it does not happen. What is implicit in his statement is his assumption that every borrower would appeal to ÑAMA about seizing their loans, rather than just those with real concerns and valid objections about the seizure. As I have discussed, it is simple to design a due process that allows all borrowers to make representations since in this instance, only the good borrowers have an incentive to engage in such discourse. 93. In 31 of his affidavit Mr. McDonagh describes ÑAMA as having "the same rights as the Participating Institution would have had to pursue debts, and follow the same legal procedures as a bank would, where necessary." This is patently false due to NAMA's ability to change terms and conditions of a loan agreement if ÑAMA believes that a certain term or provision "is no longer reasonably practicable," as he describes in the very same paragraph. This is certainly not a right that the bank had prior to transfer, ñor is it one that exists in general.


In % 9 of her affidavit, Ms. Nolan states that loan impairment was the key concern to the Irish fínancial systems recovery and a policy was needed to remove doubts about banks' capital adequacy and ability to manage their loan books. While dealing with impaired loans is certainly a necessary step in recovery, as has been clearly shown the McKillen loans are not impaired. Indeed, given the strong fínancial position of the McKillen properties they are not likely to be become impaired. Thus, the McKillen loans should not be subject to the policy discussed by Ms. Nolan.


In K 20 of her affidavit, Ms. Nolan describes how if a loan is in technical default and the loans of a large entity are interlinked through cross default and/or cross guarantee clauses it would cause all related loans to be in technical default. Like her colleagues,


Ms. Nolan completely ignores the pattern and practice of the banking industry, as discussed in Mr. Joseph Belanger's affidavit, of treating payment and technical default very differently. Further, she incorrectly states that being in breach of a loanto-value covenant would cause this massive default by the borrower "unless waived." As Mr. Belanger discussed, the opposite is actually true. Indeed, unless the bank serves a notice of default the borrower is not considered in default. As I explained earlier, written contracts are inevitably incomplete, and drawn up on the basis of understandings and industry practices, in ways that maintain flexibility, but with an appreciation of reputation effects and incentive compatibility.



20, 21, 24, 29 and 31, Professor McAleese asserts that McKillen is mistaken in

his argument for avoiding ÑAMA because McKillen assumes his banking relationships would remain unchanged. There is no doubt that Irish banks are imposing stricter loan terms and that lending standards have increased,62 but McKillen acknowledges this in his second affidavit and is finding this in his ongoing banking relationships. However, as Mr. John Trench found in his portfolio review, McKillen has very strong interest coverage, a fact that Professor McAleese does not acknowledge. Therefore, Professor McAleese is making the same error of which he accuses McKillen, namely not considering the relevant economic reality in analyzing the confíguration of alternative lending relationships. 97. It is, however, reassuring that Professor McAleese acknowledges that there are no justifícations of overwhelming importance as to why ÑAMA was set up to take on performing as well as non-performing loans (f 38). Flowever, the fact that ÑAMA was set up this way does not provide an economic justification for ÑAMA to use this right when it can meet its objectives without taking on performing loans.

Central Bank & Financial Services Authority of Ireland, "Irish Responses to the Euro Area Bank Lending Survey," July 2010 attached and labeled "JES21



There is no economic basis for Professor Lane's claim that since McKillen's loans are performing, even when he goes to ÑAMA he can still get financing elsewhere (f 12). Even if there were no adverse reputation effect and even if it were possible for McKillen to get financing elsewhere in normal times, these are not normal times. In particular, lenders are constantly making inferences about the credit quality of borrowers, and the only rational inference for potential lenders to make in seeing a borrower moved to ÑAMA is negative.


At fl 9-10, Professor Lañe claims McKillen's reputation will not be hurt because ÑAMA is not a bad bank and it has adopted a universal acquisition approach that does not taint property developers whose loans its acquires. As I have articulated earlier, ÑAMA is principally designed to acquire bad loans (and best practices indícate it should do so, in accordance with EU expectations). As such, the principies of

information economics indícate that any borrower improperly moved to ÑAMA will suffer a reputationaí loss, and certainly a loss of any benefits from a trusting banking relationship. While ÑAMA may claim it is not a bad bank, it looks like what

everyone else in the world calis a bad bank and the rationale for its existence is precisely that of a bad bank's. And, whether ÑAMA considers itself a bad bank or not is not the issue. The issue is, do others? The Financial Times, for instance, is unequivocal in referring to ÑAMA as Ireland's "bad bank" that was purchasing "toxic assets."63 While there were alternative ways of restructuring Ireland's banking system that might have resulted in the creation of a good bank, Ireland chose the "bad bank" approach and now has to deal with the consequences. One of these consequences is that moving borrowers to ÑAMA will certainly affect their reputations negatively. Therefore, any claim that being moved to ÑAMA is benign is simply false.


Editorial in The Financial Times, "Pluck of the Irish," August 26, 2010, accessed August 31, 2010 (http://www.ft.eom/cms/s/0/ef7fbe7c-bl54-l Idf-b899-00144feabdc0.html) attached and labeled "JES22."



ibscríbed and fóglitz.

to befo re me ott the ^

day of September 2010, by Dr. Joseph £.

Notary Public for the State of Residing at
^ ^ " « • • t ^ g r A R I A L SEAL) ¿Y v t AR y \ \

: ' : Hotarv Pubtic, State of New York ^ ^íít: No. 01HA8007604 \ p ü ^V^ j Q s • ; Qualífi&d in Msw York CounW i / '• Commlsskxi Expires May 28,2014 ^p^-A:ífidavit isfíledby Eugene F. Coüins, Soíicitors, Temple Chambers, 3 Burlington "R'oad, Dubiin 4» soíicitors on bebalf of the Applicants* this dav of Sentember 201 day of September 2010,




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