NAMA - the ECB roadmap
The European Central Bank on Monday August 31st published its opinion on the draft NAMA legislation, that thankfully, along with the cash it proposes to backstop the whole enterprise, provides a balanced overview of the principles involved.
ECB headquarters, Frankfurt
ECB headquarters, Frankfurt

At its heart it addresses the question of moral hazard that must be placed at the centre of the architecture for a restored Irish banking system, as this publication has consistently argued.

We have also argued that the principle of avoiding moral hazard should apply not just to the interests of past shareholders and other risk investors in the banks, e.g. subordinate debt holders, but it should also apply to future risk investors, with regard to any future clawbacks that may be contemplated (e.g. through a future bank levy), which, while on the face of it will be paid by ‘the banks’, will in reality be recouped from customers and ordinary taxpayers.

The fact that the ECB’s Opinion also addresses this point is also to be welcomed. Perhaps the most satisfactory aspect of the ECB document is that it provides the Government and NAMA with a roadmap by which it can proceed. In essence, this is because it ensures that the principles of diminishing and avoiding moral hazard are adhered to in the detail of the operation, construction, policy, and detailed oversight of NAMA.

The ECB Opinion preserves the essential capitalist principles that most observers in the debate on NAMA would subscribe to (this would include most of the 46 academic signatories to the petition organised by Prof Brian Lucey of TCD, as indeed it may the Labour Party’s Joan Burton, who, in June in the 2nd stage of the Financial Measures (Miscellaneous Provisions) Bill debate in the Dail asked whether moral hazard had any place in the Minister’s universe). The key elements of the ECB Opinion are as follows:

The ECB’s overall position:
“ The Eurosystem has developed a number of guiding principles aimed at attaining the following objectives: (i) safeguarding financial stability and restoring the provision of credit to the private sector while limiting moral hazard; (our emphasis added) (ii) ensuring that a level playing field within the single market is maintained to the maximum extent possible; and (iii) containing the impact of possible asset support measures on public finances.

“The Eurosystem has identified seven guiding principles which can be seen as sufficiently broad to apply to all schemes falling under the wide category of asset support measures. The NAMA asset removal scheme is broadly consistent with these principles:”, it says.

Amongst these are the following three:
(a) Avoiding moral hazard in relation to asset valuation
‘Regarding the valuation of eligible assets, asset-specific haircuts on the eligible assets’ book values appear to be contemplated, and independent third-party expert opinions play a role in the valuation process for the NAMA scheme. The detailed provisions of the draft law regarding valuation issues reflect the fact that the pricing of eligible assets is a crucial and complex issue that is likely to determine the overall success of the NAMA scheme. Although the measures contemplated by the draft law should restore confidence in the Irish banking system, the ECB considers it important, in line with previous opinions that the pricing of acquired assets is mostly risk-based and determined by market conditions. The preference expressed in the draft law for the long-term economic value of assets, rather than current market values, requires careful consideration in this context. In particular, it should be ensured that the assumptions to determine the long-term economic value of bank assets will not involve undue premium payments to the participating financial institutions to avoid creating inappropriate incentives from their side as regards the use of the scheme.

(b) Avoiding moral hazard in regard to a ‘bank levy’:
‘Regarding risk-sharing between NAMA and the participating institutions, the ECB understands that in the longer-term, if NAMA were to fall short of recouping all of the costs of the scheme, the Irish government intends that a levy should be applied to recoup any shortfall. The ECB considers that a guiding principle for the scheme should be that there is an adequate degree of risk sharing in order to limit the cost to the government, to provide the right incentives and to maintain a level playing field across the participating institutions.

In regard to a market principles-led solution:
‘The ECB notes that the Irish Government shares the guiding principle that the preservation of private ownership is preferable to nationalisation. If the NAMA scheme will be successful in this respect, this strategy should help to avoid, in the short-term, the high costs involved in nationalisations and, in the medium-term, the risk of banks’ objectives being diverted from profit maximisation to alternative goals that might distort the market structure and jeopardise the level playing field.
The final NAMA legislation should, and must, take on all of these principles.

It is now possible to amend the draft legislation on NAMA to ensure that the ECB’s advice is adhered to in principle, or, in effect.
It will not be possible to avoid a cost for the taxpayer. The 46 academics in their letter estimated a cost of E30 billion (their estimate of the difference between the ‘haircut’ cost of the acquired NAMA assets of E60 billion, and the market (‘firesale’) value that they put at E30 billion.

Given that E45 billion of the E90 billion in assets is still performing (and that approximately a third of the assets in question are located in other jurisdictions, mainly the UK), this further ‘haircut’ seems excessive.

Nevertheless, even if the further haircut comes out at around half this (say E15-20 billion) there will be a cost to the taxpayer. It will nevertheless, if it can be seen that past shareholder risk capital is not rewarded in any way for future investment by taxpayers, be possible for such expenditure to be seen to be of the nature of capital investment that will provide a return to the taxpayer in the future.

If E15 - E20 billion turns out to be the capital cost of the great NAMA gamble then it can be seen as a wise and necessary investment. After all, the same sums is being wasted in 2009 alone (as distinct from being risked over a decade by NAMA) by the much more serious problem of the daily mismanagement of the public finances , an issue that so far remains unaddressed by the Minister for Finance and his colleagues (see www.financedublin.com/debtclock).