Wednesday, September 23, 2009

Ireland's Toxic Assets Find a Home

The Economist; Ireland’s Toxic Asset Plan Makes A Good Fist of a Bad Situation.
BBC News; NAMA Q&A; Lenihan Strongly Defends NAMA

Ireland’s previous attempts to save its banking system were apparently not enough. In January of this year, the Irish Government injected €7 billion into the Bank of Ireland and nationalized Anglo Irish Bank, creating a recapitalization that was the equivalent of 4% of the country’s GDP. Despite these efforts, the IMF predicts that Ireland will suffer a 13.5% peak-to-trough loss in GDP and a €35 billion banking-system loss if Irish banks are unable to offload their toxic assets.

To avoid this catastrophe, the Irish Government has come up with a plan to create a new agency called the National Asset Management Agency (“NAMA”). NAMA plans to take €77 billion of land and development loans off banks’ balance sheets in exchange for €54 billion in government-backed bonds. This transaction will provide the banks with about €7billion more than their assets are actually worth. Despite the overpayment, banks will still require additional capital from other sources to cover the 30% decrease in value the assets have sustained as a result of the financial crisis. The plan’s pricing strategy is somewhat mitigated by its risk-sharing element—a subordination of 5% of the value of NAMA bonds that will erode if the agency loses money on the assets. This feature ensures that the banks will share some of the responsibility for the losses.

NAMA will transfer assets from the same six banks that the Irish Government guarantees—Allied Irish Bank, Bank of Ireland, Irish Life and Permanent, Irish Nationwide Building Society, EBS Building Society, and the nationalized Anglo Irish Bank. NAMA’s goals for this plan are three-fold: to restore trust in the nation’s banks so that the Government can lift its guarantees on the banks’ money, to avoid shareholder enrichment at the expense of the taxpayers, and to avoid further state ownership of the banking system. Implementation of these goals, however, is proving more difficult than expected due to the large losses the banks have already suffered.

One challenge of implementation was to determine the appropriate level of contribution from taxpayers and shareholders. The Irish Government has decided to inject more government funds into the system up front by overpaying for the assets (relative to distressed market value), rather than force failing banks to raise additional, hard-to-find capital in a struggling economy. Patrick Honohan, the incoming governor of Ireland’s Central Bank, argues against overpayment, stating that authorities should take a more rigid approach to controlling the fiscal cost of a banking crisis by requiring holders of subordinated bank debt to bear a higher burden than the taxpayers. The extent of NAMA’s success will help determine which approach is better for an economy’s recovery.

1. How is NAMA’s overpayment strategy consistent with its goal of “avoiding shareholder enrichment at the expense of taxpayers?”

2. Will taxpayers always bear the greater burden in a financial crisis, whether it’s sooner in the form of government cash injections, or later when the economy fails from lack of government assistance?

3. Is the 5% subordination element of NAMA’s plan just a fiction to promote the plan, considering that the government overpaid for the assets by about 15%?

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