Monday, 19 October 2009

Guest post by Stephen Kinsella: NAMA will not get banks lending again

Stephen Kinsella: The primary objective of the National Asset Management Agency is to increase the flow of credit to the ‘real’ economy — that’s you and me, homes and businesses — by clearing banks’ balance sheets of ‘impaired’ assets. The story goes that these assets reduce the banks’ abilities to borrow on the interbank lending market, choking the banks of the necessary funds to lend out to small and medium businesses. Starved of capital, the businesses fold, and people are made unemployed; economy and society generally suffer.

The ‘impaired’ assets to be bought by NAMA are to be seen as the dam obstructing the flow of capital to these businesses, and their removal will start the process of lending by our retail banks off again.

This logic is flawed.

The cleansed banks will not begin lending once the transfer of loans to NAMA is complete, and NAMA’s bonds are swopped for ECB cash. Even completely cleansed banks are not enough to restore lending to previous levels for several reasons.

First, we are in a completely different business environment. Banks as for-profit going concerns are right not to lend to prospective borrowers whose businesses are too risky: that behaviour would throw away the cash NAMA just gave the banks.

Second, banks debt in relation to their equity—their leverage—is too high, meaning they need to pay down their debts quickly, and cannot do so while lending out more money, which would perforce increase their debt.

Third, despite evidence to the contrary, bankers are smart people. Bankers understand instinctively that the level of uncertainty in the economic system is very high, so they will try to increase their cash balances to compensate for that reduction in certainty. As JM Keynes once wrote: “The possession of actual money lulls our disquietude, and the premium which we require to make us part with money is the measure of the degree of our disquietude”. Our bankers now have a ‘liquidity preference’ for cash, meaning we won’t see increased lending to the real economy at reasonable rates of interest. Banks can always manage to lend at unreasonable rates of interest, but that doesn’t help the real economy.

Fourth, all our bankers understand that even if NAMA succeeds brilliantly, beyond even its greatest supporters’ dreams, their balance sheets contain another ticking time bomb: the coming implosion of the Irish residential mortgage market. The ECB will increase its interest rates in the coming year. When hundreds, and perhaps thousands, of homeowners throw their keys back in the bankers’ faces, and create another slew of bad debt to be mopped up, the bankers know they will need cash waiting to cover these bad debts, in addition to another bailout from the taxpayer.

Banks will not lend to risky propositions in riskier times when their balance sheets (and their fiduciary duty) is to deleverage. The bankers will wisely sit on the cash we will have injected into their balance sheets, and wait until the time is right to call for more.

It is now a foregone conclusion that NAMA will be brought in. NAMA’s basic form is unalloyed by months of intense public debate on the merits and demerits of this ‘bad bank’. Given that NAMA will not meet its objective to increase lending to the real economy, we must urgently consider major modifications to NAMA as it moves through the committee phase toward its eventual implementation.
Dr. Stephen Kinsella is a Lecturer in Economics at the University of Limerick and author of Ireland in 2050: How Will We be Living? (Liberties Press)

15 comments:

lorcan said...

I agree that NAMA needs reform if it is too late for an alternative proposal to gain traction. However, I think the criticism that it will not result in increased lending is slightly misplaced. Isn't the logic merely that it would *allow* increased lending, i.e. a necessary but not sufficient condition?

Martin O'Dea said...

Lorcan, the necessity of lending has been the key arguement for the implementation of NAMA. If politicians had argued that they wished to offer the banks the option of lending with a pledge of €54 billion in a digout by buying up porperty debts that will likely be unpaid with taxpayers funds I feel that NAMA would not now be a given. Therefore Stephen's highlighting its likely failure to perform its stated function should really be addressed by government. Also, opposition parties - most likely those of a progressive hue - need to stand against this process - it is perhaps not good enough now to see this proposal as an inevitability. This is surely an item with such major ramifications that voices of dissent should be heard. As pointed out in your recent conference the use of T.O.G.I.T. is not only erroneous in principle but not particularly tasteful when one realises the vast sums and implications involved.

Stephen Kinsella said...

@Lorcan, @Martin,

Thanks for the comments!

I'd echo @Martin's point, largely. The rhetorical strategy has been to promise to free credit into the real economy, and NAMA's pursuance of that line of argument has to be tested, because renewed credit flows are the intended outcome. Its pretty clear, for example, that overly leveraged banks will have less of an incentive to lend into the real economy in any case, regardless of their bad debt provisioning. It's also pretty clear that the macroeconomic malaise we have in Ireland isn't shared by Europe, meaning if they recover, and we're left lagging behind, we'll face asymmetric shocks to our growth as well: we'll need low interest rates, but that's not what we'll see, and widespread defaults in the residential markets as a result.

liam said...

My humble amateur opinion is largely in agreement with you, however talk of reforming NAMA is I think likely to cloud the waters when it comes to highlighting what is wrong with it. What you say make make sense economically, but the only sensible political solution is to seek to dispense with it completely. As you say, the banks are in fact (finally) acting in a fiscally responsible manner and as you say there is no motivation for them to take any risks at all. The idea of somehow forcing them to lend cash in a contracting market was tried by the Japanese in the 1990's and it lead to more dead loans and a deepening of their banking crisis.

We now have NAMA which is a parasitic infection that will pass from the zombie banks to the zombie state and create a zombie economy.

Zombies can only be dealt with by a bullet to the brain. Kill NAMA, withdraw the debt guarantees and be done with it. If one or more of them somehow survive infection and need recapitalisation, then it should be done for a fixed rate of return and/or equity to the taxpayer.

Damian Tobin said...

Interesting points Stephen, but the problem with NAMA and bank lending/behaviour generally is that it is difficult to predict how it will affect future lending.
I'm also not sure that this has anything to do with bankers being smart or clever. Being smart in banking can mean many things and the consequences are not always immediately obvious. One could argue that AIB was smart in overcharging its customers. It wouldn't get caught and shareholders would benefit. You could say that Irish banks were clever to exploit the liquidity offered by inter-bank markets - a clever move to exploit a bubble market it was argued. Goldman Sachs was “obviously” smart in exploiting the demise of its rivals and take advantage of huge government stimulus to make record profits. Or we could say that HSBC and Barclays were smart because they followed more prudent lending practices and did not need government bailouts.
The point I'm making is that being smart in banking is not so much about not lending when you can't anyway (Irish banks), it's about risk management, prudent lending and ethics, even when lending opportunities are plenty!

Stephen Kinsella said...

@liam,

Unfortunately NAMA is now a fait accompli-we won't see any large scale changes to its structure before it passes through the Dáil. The only real recourse we've got is to try and change the parameters of NAMA's execution as it goes through committee stage.

@Damian, when I say 'smart', what I mean is that banks aren't simply mechanistic objects, which the government will get lending again through the introduction of NAMA. These guys have expectations about the future, and those expectations change their present behaviour. The coming wave of mortgage defaults will be weighing on their minds, and will affect lending to SMEs as a result.

Ben Conroy said...

Hi Stephen,

As someone who's quite conflicted about the merits of different solutions to our banking crisis, your argument makes a lot of sense. My question is, what would you do in NAMA's place? Is there a solution that would address the problems you outlined without creating worse ones?

Stephen Kinsella said...

Hi Ben,
Thanks for the comment! The truth is that a NAMA-type operation was necessary from the start, once you realise that Irish banks won’t be allowed to fail. The problem I have with it is that NAMA just isn’t enough on its own—we’ll still see a nationalisation by any other name in a year or two, and the taxpayer won’t be able to share in the benefits if we do actually see a rebound of the property market, in particular. There has been a false dichotomy put in place that it’s either ‘nationalisation’ on the Whelan/Lucey model, or NAMA on it’s own. I think a range of options needed to be explored 8 or 9 months ago, in consultation with interested parties, say over a month or so, but this didn’t happen. One report was commissioned, and that one report, by the very smart Dr Bacon, became the basis for a 54bn euro bailout. Now Dr Bacon, as smart as he is, is just one bloke: I’m sure we could have done better if hundreds of us had a pop at a solution.

Which is a long way of saying the NAMA isn’t a total solution to the problem of banks not lending: we need more initiatives to restore the banking system, and I, as finance minister, would have tried them all at once:


1. Nationalise AIB/BOI/NIB, allow the taxpayer to take equity in the banks, or start a debt-equity swop for the banks’ assets as soon as possible.
2. Failing that, I’d clean up AIB/BOI/etc via a NAMA-type vehicle with 70%+ risk-sharing for the taxpayer.
3. Regardless of the outcome of 1 or 2, I’d build a public/private funded ‘good’ bank using NPRF funds, and private capital. This good bank lends out to businesses, primarily. It is publicly funded or guaranteed, but privately run and assessed. It solves the ‘credit constraint’ issue dogging small and medium firms.
Hope this helps!

Damian said...

Indeed, but the alternatives you propose imply a return to "business as normal” without any improvement in risk-management. They also rely on the taxpayer profiting from a rise in property prices (as does NAMA) and presumably a stock market or private sell-off. The Courts seem to have poured cold water on the prospect of such as rise in the Zoe Developments case. Nationalisation is not cost free for the taxpayer (look at Anglo) and we simply have no idea of the full extent of poor practices that prevail at AIB, BOI and NIB - though we have some very good clues from past behaviour!

You are correct that we desperately need alternative perspectives but I would suggest that the question we need to ask is: how do we avoid returning to a banking model that depends on risky and speculative lending practices? It is significant that the Bank of England is having this debate – while we are still mired in a debate over the form and price of a bailout (or the price of bad practices)! The proposals for nationalisation all seem to depend on the taxpayer profiting from a rise in property prices, which in my view provides all the incentives for future bad loans

Finally I wonder how happy future pensioners would be about NPR funds being lent out, government guaranteed - but run and assessed by the same private bankers that have shown scant regard for public money in the past.

Stephen Kinsella said...

Hi Damian,

Very smart comments--the difference I'd percieve is a sharp distinction between Keynesian uncertainty, which implies the system will always blow up in the presence of Black Swan events, and so needs to be policed very effectively, and ordinary risk management which you identify as a crucial factor in improving business decisions going forward. I'm a big fan of economists like Wynne Godley, Paul Davidson, and Hyman Minsky, so I think that both have to be sorted out, but if you have to choose, I'd plumb for draconian regulation to reduce the impact of the black swan events coming from irreducible uncertainty. The return to business as usual can wait!

You ask "how do we avoid returning to a banking model that depends on risky and speculative lending practices?"

I answer that we don't. The nature of finance is that in the presence of cheap credit, asset price bubbles breed their own reversal. We just make it so difficult to 'innovate' in the finance space that smart people become discouraged from doing so and go invent a new physics, or whatever :)

I've a big interest in tomorrow's pensioners, and the role of the NPRF as universal piggy bank is upsetting me at the moment-so we see eye to eye on it. I feel a rant coming on.

Martin O'Dea said...

Stephen, Lorcan, Damien, Ben, Reading your discussion and tuning into various radio shows and other fora, and feeling my blood pressure gradually rise in response to government utterances, I still feel that the central ingredient required at this juncture to tackle most elements, that are generally held as distasteful, is an election.

I feel that the government can not receive the credibility required or importantly the 'buy-in' required for any of their economic measures to work.

I feel also that the vast numbers of dissatisfied members of the public limits the government's own flexibility. Also, the psychology of having a body that inflicted harm on you looking to provide the cure kicks in here. In truth the 15yr old govt. are not only too tied to a static well-defined prevaling social and economic culture which is in defense mode but also we the public are unable to give this government a fair hearing, because we are just angry with them.

There are any number of smart people arguing here on this site, and while much of the arguement is rational, it is framed to varying degrees by the outlook held by the submitters. So the arguement remains that we are more likely to disapprove of and oppose this government's position on all these important elements because of their perceived involvement in the mix with banks and developers etc.

I believe here that economics and politics are absolutely entangled and only after an election will there be any possibility of rectifying much of what is occurring, in a rejuvenated environment (Ialso believe Eamon Gilmore needs to be Taoiseach, but easier said than done). Clearly if members of the government were offered opposition seats right now they would gladly abdicate, they will argue otherwise but only they could possibly believe that arguement; however our problem remains that it is not having any seat, and so no job, no income that terrifies them into sticking this out.

What I believe then is that the moral compass of the Green Party be alerted to what is occurring here, invite members of the green party to argue these points on this forum and try to put across the 'good' effect of their no longer supporting this lame-duck government. Maybe that was the rant, Stephen!

Stephen Kinsella said...

Hi Martin,

It was a good rant, well done!

I worry that the moral compass of the green party may get immolated along with the rest of the party come the next general election. I spoke to several gatherings of green party members before the preferendum, and many of them are very smart people who fully understood the risks of operating a NAMA-type vehicle. I'm sure my Dublin colleagues were doing likewise, and yet the green vote on NAMA took place in accordance with FF wishes, leaving many of us disappointed if not that surprised!

Martin O'Dea said...

Agreed Stephen, but again I just feel that this then forms a purely intellectual exercise.
We observe the error of the broad governmental approach and highlight alternative approaches, to no avail. However, when the scenario in question has overacrhing influence for all of us over many years; is it that we inhabit a society constructed in such a manner that this remains absolutely beyond any recourse.

Surely democracy must continue between elections. Is there not an arguement that 85% of 4.5 million people having gone unconsulted for such an important decision with such far reaching consequences - should if they were voicing their call for a general election via a petition - then not go ignored, if implicit in ignoring was an even greater political pummeling when the opportunity arose.

This is developing into another rant! Could someone start an online/offline exceptional petition calling for a general elction. Also, could a green, i.e. a progressive and member of green party, please come on in and explain to me how your long-term or any other term are being served by continuing in power. I do understand some achievements etc. but there will be other governments, further green causes and only one NAMA

Stephen Kinsella said...

HI Martin,

I'd love to have a green of any stripe defend their party's position with respect to NAMA and with respect to the overall macro framework we're being led into. It would make for an interesting discussion.

Martin O'Dea said...

I re-read my previous post and imagined myself as a Fianna Fail or Green governmental player viewing it as unreasonable and irrational; and ultimately just some non-reality based complaining with a changed economic reality.

Of course, I also conveniently ignored that this whole scenario was largely caused by an international market collapse, or Lehman Bros.

Finally, this kind of rant is unfair. People in Fianne Fail are not 'Badies' or anything else, there are good and bad and 'we' are doing the best we can in a bad situation (that reminds me ye weren't complaining too much during our celtic tiger)

Ok, then. That seems to me to be the general gist of it, and I would have some familiarity. What's the problem then??
Well, the truth of the matter is that there is any grouping a unique culture which can, of course, be analysed, categorised and criticised; though we must remember that it is in fact quite complex as it grows on unique circumstances and individual interactions over a period ot time.
Does culture affect the individual, or the individual's morality and ethics - yes, it most certainly can. Enron dod not use a recruitment ad that said 'only truly corrupt people may apply' yet a large group of well qualified professionals oversaw and participated in a rampantly corrupt operation. Obviously, there are many other historical examples but I don't want to be too controversial.
In any organisation members are introduced to particular norms, values and priorities; and, of course, a groupthink mentality may emerge with all of its proven difficulties, particularly in an environment where the group feels under threat.
Fintan O'Toole eloquently outlined historical weaknesses among the political classes and Fianna Fail and clearly in recent leaders, who have a large influence in organisational culture we have added behaviour that can be analysed as contributing to the malaise. The truth in the end is that this party is now not good for this country - maybe its just as simple as being in power too long, and winning that third general election behind a very large and just about staying together smokesccreen. In either event change is necessary, now, and as is clear for contributions on this website - it is urgent, due to the long-lasting implications of this moment.
I too would love to see a green defence, Stephen