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LQD: Why God made Economists

by Frank Schnittger Fri Nov 13th, 2009 at 03:04:20 PM EST

Originally published on October 14th

I have been planning a follow-up to my "We need a revolution"diary for some time now.  Then I read Morgan Kelly's opinion piece in the Irish Times today and I felt why bother when someone else can say it so much better...

Turning bank debt into equity will save us from Nama ruin - The Irish Times - Tue, Oct 13, 2009

WHILE MOST economists by now simply dismiss Brian Lenihan's utterances on the economy as "not even wrong", this is to miss the Minister's almost eerie ability to predict exactly the opposite of what is going to happen. Merely to contradict Brian Lenihan is virtually to guarantee that you will later be credited with supernatural prescience.

Who else, as Irish bank shares plunged 13 months ago, could conclude: "Our banks uniquely have weathered this storm . . . We are in a zone of financial stability in a very troubled financial world."? Two weeks later, having been panicked into his catastrophic bank liability guarantee, the Minister assured us that we had "the cheapest bailout in the world so far", and six weeks later averred that: "It is not the function of the Government to fund or bail out the banks."

The effortless miscalculations, the assured non sequiturs, the lofty indifference to facts: all reveal Brian Lenihan as a master of what Princeton philosopher Harry Frankfurt defined succinctly in his 1986 paper, On Bullshit .

The Nama legislation, as expected, piles up this material on an Augean scale. Prices have fallen 47 per cent; the long-term economic value of property is 30 per cent below its peak value; the loan-to-value ratio is 77 per cent; prices only need to rise by 10 per cent in 10 years for the State to break even.

To subject these almost poetic flights of ministerial imagination to any sort of rational analysis will seem to many like vandalism, but that is what God made economists for.

Diary rescue by Migeru

So where do all these fanciful figures come from?

Turning bank debt into equity will save us from Nama ruin - The Irish Times - Tue, Oct 13, 2009

First, the estimate that prices have fallen 47 per cent. The reality is that prices can only exist when there is a market, and the market for commercial property and development land has disappeared.

A less futile exercise is to ask how much Nama would have cost at the end of similar credit-fuelled price bubbles. A decade after their peaks, Tokyo land prices had fallen by five-sixths, while Irish farmland, adjusted for inflation, had fallen by three-quarters. Had Brian Lenihan bought €77 billion of either, applying the proposed Nama discount of 30 per cent, he would have lost €35 billion-€40 billion on our behalf, or roughly €20,000 per taxpayer, and that is before adding interest.

At a quarter of national income, Nama would dwarf the cost of previous bank bailouts, which varied from about 3 per cent of GDP in Sweden to 14 per cent in Finland and Japan.

Most baffling of all the Nama numbers is the proposed discount of 30 per cent, implying that the "long-term economic value" of property is at 2004 prices. Not one shred of evidence is offered for this assertion, the keystone of the Government's strategy.

At first, I thought that this mystical 30 per cent number embodied Fianna Fáil nostalgia for a vanished era of innocent greed; a hope that we would wake up one morning and find ourselves back in 2004 forever, basking in the benevolent gaze of Bertie Ahern and Seán FitzPatrick. The reality turns out to be a lot more mundane. The EU simply forbade Lenihan to pay any more. This is not through any dismay at seeing Irish taxpayers fleeced by their Government, but for fear that they will be stiffed into carrying out an Iceland-style rescue here.

The figure of a 77 per cent loan-to-value ratio is equally fanciful. It will take years for the courts and Fraud Squad to disentangle multiple personal guarantees and imaginary collateral. The situation in Anglo Irish Bank appears particularly grave.

Finally, there is the assumption that the Irish Government can continue to borrow forever at low rates from the European Central Bank. However, the ECB is making no secret of its dismay at being turned into a credit union for feckless Micks, and is anxious to end such emergency lending facilities within the next year.

Once the ECB slams the window on its fingers, the Government will be forced to borrow at market rates of 5 per cent or more. In the next decade, this will add another €25 billion or so to taxpayers' losses from Nama.

So what are the likely consequences of Nama?

Turning bank debt into equity will save us from Nama ruin - The Irish Times - Tue, Oct 13, 2009

As well as being expensive, history shows Nama-style bad banks to be profoundly corrupt and corrupting institutions. After the financial crisis in 1931, the US, Germany and Austria all set up bad banks which turned into conduits for directing funds to politically connected enterprises.

Bad banks are the means for governments to choose which oligarchs will survive to emerge even stronger than before. They do not just happen to behave in a corrupt and anti-democratic manner: it is what they are designed to do.

And do not forget that, even after the crushing expense of Nama, Irish banks will still be seriously short of capital. Under the current, deliberately lax, international bank regulations, AIB and Bank of Ireland need capital of around €8.5 billion.

Financial markets, which assume that Nama will go through, value their existing capital at around €3 billion, and adding Government preference shares of €3.5 billion leaves them short about €2 billion each. Once stricter capital requirements are imposed next year (the so-called Basel 3 process), this shortfall will probably rise to €6 billion.

So what is the alternative?

Turning bank debt into equity will save us from Nama ruin - The Irish Times - Tue, Oct 13, 2009

Nama then, will turn out to be expensive, corrupting, and inadequate. While the abject, almost endearing, eagerness of the Greens to please their Fianna Fáil masters means Nama is almost certain to go ahead, it is perhaps worth asking what would happen if it did not.

All that needs to be done is for ownership of Irish banks to be transferred to their bondholders. This process of converting debt into equity occurs sufficiently often in banking to have a name: resolution. Resolution offers a way for Irish banks to be adequately recapitalised at no cost to the taxpayer, and able to manage their business without political interference.

Under existing Irish corporate law, this transfer would be a recipe for centuries of litigation. That is why most other industrialised economies have, or are introducing, special legislation to resolve failing banks with limited judicial review. Particularly impressive is the UK's Special Resolution Regime introduced last February, which could easily serve as a template for similar legistlation here.

Instead we will get Nama. Brian Lenihan assures us that Fianna Fáil's monument to a decade of waste, corruption, and ultimate ruin will not be wasteful, corrupt, and ultimately ruinous.

Let us hope that, for once, he is not wrong.

The sell-out of the Greens on Nama is perhaps the saddest political facet of the current débâcle.  They currently hold the balance of power in Ireland, and could probably have named almost any price:  such was the desperation of Fianna Fail to avoid an election and the annihilation that was sure to follow.

For a few paltry and temporary concessions on Mink fur farming, ending stag hunting, and rolling back some education cutbacks they have thrown their lot in with Fianna Fail for the remainder of this Government's term of Office.  I will do a more considered analysis of the revised programme of Government when I can find the heart to do it.

However the sell out of the country that is Nama promises to have a far more long term and devastating effect.  God may have made economists for some good reason, but unfortunately in Ireland they haven't had much influence until it is far too late.  Too many were cheerleaders for the economic boom when the bubble was growing ever bigger for them to have much credibility now.  Let us hope that they are just as wrong now on the downside.  Certainly Morgan Kelly's analysis of Nama is hard to gainsay.

He had to do something with the turds of scientists/engineers.  What do I win?

They tried to assimilate me. They failed.
by THE Twank (yatta blah blah @ blah.com) on Sun Nov 8th, 2009 at 03:57:14 PM EST
A free two year old copy of The Economist stating the at a "soft landing" is the most likely outcome for te current economic downturn...

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Nov 8th, 2009 at 04:11:58 PM EST
[ Parent ]
Hey, someone's gotta count the GDP up.

As an economist, I'd like to renounce the Irish portion of my ancestry.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Fri Nov 13th, 2009 at 03:09:07 PM EST
From what I can tell, most economists are just politicians at heart and their tea leaf predictions tend to favor their politics. Am I wrong?

Sorry Jerome, but that's the feeling. On the other hand, I love your politics, er, economics.

by shergald on Fri Nov 13th, 2009 at 03:43:12 PM EST
From what I can tell, most economists are just politicians at heart and their tea leaf predictions tend to favor their politics. Am I wrong?

That depends entirely on how charitable you're feeling.

If you're feeling charitable, most economists are burdened by a set of analytical tools that were almost suitable for the 19th century (though only if you overlook the colonial charter companies), but are clearly anachronistic in the 21st.

If you're feeling less charitable, most economists know which side their bread is buttered on.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Nov 13th, 2009 at 06:14:23 PM EST
[ Parent ]
In the US, the reason for stupidity almost comparable to NAMA in our own dealing with TBTFs is pretty clearly the capture of the US Treasury, White House and Senate by the TBTFs through campaign contributions and through cognitive capture, but especially the former. Of course such action is to be expected from the "pro-business" Republican Party, but the extent of the capture was vividly demonstrated by the continuation of the policies by the Obama Administration.

Fianna Fáil is the dominant conservative party in Ireland, if I correctly remember your diary on Irish political parties, so it is natural for them to want to insure the welfare of the bankers as their top priority. That must seem like the natural order of things to them.  There is a natural hierarchy in society and bankers are at the top. Once it was: "The Land and the King are One!"  If the king suffered, the whole country suffered. Now there is no king but there are bankers.  So to heal the country you heal the bankers. This mythic frame is set forth in the movie Excalibur.

Well, things have gotten a little muddy since those pristine times. The Taoiseach, I guess, would have to pass for the king and his chief retainers are the bankers, rather than knights. But true conservatives would know that the government is actually the servant of the nation and that at the top of the national pyramid are the bankers and thus the needs of the bankers are paramount. And this time it is the retainers, (really the owners), that are stricken, but the principle is the same. The first order of business for the government is to save the bankers. "The Land and the Bankers are One." After all the bankers have mortgaged the land.  

But do not the bankers receive the same kinds of generous bonuses in Ireland as in the US and UK?  And do not their donations dominate the political process, as in the US?  If not it must just be the magic of the myth, otherwise known as cognitive capture.

One other factor could be at play.  Christopher Hill described how, during the English Civil War, it became obvious that Charles I was never going to act as the Puritan Parliament wished, but the Parliament could not bring themselves to move beyond the impasse. Hill suggested that they had a "mindstop" that prevented them from deposing and executing the King.  Perhaps a similar "mindstop" is preventing the necessary actions against the bankers in Ireland, the UK and the USA.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Nov 13th, 2009 at 08:17:07 PM EST
Nama is rescue plan for the elite | The Post
The Dublin professional classes had become very wealthy in the boom. And the extraordinary thing about all this was that, in the main, they didn't take any risks. They just worked hard, charged huge fees and, with both eyes firmly set on leafy suburbs, moved up the ladder. They had huge status and, in some cases, egos to match.

In the meantime, the lads who had done pass maths in the Leaving Cert were also on the make, but they were in business and property. They were making even more money than the straight-A boys. They were buying and selling, wheeling and dealing and, most of all, flipping.

They had seemed to be able to make money out of nothing, buying property and then selling the stuff on in a few months - making an enormous and seemingly effortless twist.The `stupid' lads, at least in the eyes of the straight-A students, were achieving far above their abilities - and it all seemed so easy.

This is not what the system and the doting mothers had predicted. They, the professional class, should be on top - after all, hadn't they done honours Latin, Irish, French and maths - not to mention the sciences - for the Leaving Cert? The `stupid' lads just kept buying and selling, and now they had this new thing called leverage, which made the gains astronomical.

So, around 2005, just as the market was peaking, the smart lads decided to get into the game. They were invited by the `stupid' lads they knew in school to get into what were termed `syndicates'. The less academic fellas were putting these things together all day, promising riches beyond their smart lads' wives dreams. They all knew each other, after all, so everything would be grand.

Because the smart fellas had never taken a risk in their life, they had no idea how to access risk. They thought it was easy to become a Dermot Desmond.

They thought that the type of calculations someone like him was doing on a minute byminute basis couldn't be that difficult, particularly as lads four streams below them in school could figure it out. And so, about four years ago, the complexion of the property market changed.

It became a free-for-all for the lads who'd done well in their Leaving Cert, but wouldn't know how to `take their profits' in a month of Sundays.

The people they used to look down on - the pass maths students - saw them coming and began to sell property syndicates to them, pretending that the clever lads were getting the deal of the decade.

So the professional classes, having been told from their childhood onwards that they were geniuses, were too arrogant and hubristic to know they were being had. After all, why would they not think they were smarter than the lads who had sold them the deals? They were smarter, and they had the UCD parchment on their mammies' living-room wall to prove it.

But, in truth, the smart boys knew nothing about commerce, and had just bought a pig in a poke. Then the crash happened, and the chill could be felt in the equity partner offices of our top law and accountancy firms. These guys are now bankrupt, with enormous cash calls being made to finance the syndicates that are now under water. The top barristers and bankers were equally hammered, because they didn't understand the rudiments of commerce. They thought it was easy. We are now left with the destruction of Dublin's - and other cities' - professional classes.

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sat Nov 14th, 2009 at 05:11:38 AM EST
[ Parent ]
I always enjoy reading McWilliams.

The joke is that a debt/equity swap is precisely what's needed - just not the conventional sort of equity the smart boys have in mind.

If NAMA were incorporated and used as a framework, rather than an organisation, then a solution is achievable that the pass maths boys could - and would - implement tomorrow...

...how does one get to the pass maths boys, Frank?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Nov 14th, 2009 at 07:42:25 AM EST
[ Parent ]
Dunno - they're all living it up on the Costa Del Sol -  ask Mig - after they flipped their properties they flipped their climate and decided it was time for some sunshine and golf.  The rest are on the dole in Ireland now.

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sat Nov 14th, 2009 at 02:00:37 PM EST
[ Parent ]
Doesn't sound so "mock" to me, except in the mocking of pretensions.  Perhaps the real problem is that the honors boys are too embarrassed to admit they have been had and thus prefer to be bailed out at the expense of everyone's future rather than admitting the truth, prosecuting and extraditing, if required, the guilty, and cleaning up the system.  Just as long as they can keep up appearances.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Nov 20th, 2009 at 07:04:48 PM EST
[ Parent ]
As much fun as armchair psychiatry is, I think it's much simpler: They bet a lot of (in large part borrowed) money. They lost their bets. They are in a position to get the state to cover their bad bets, so they use it.

What's not to like about it from their perspective?

After all, stealing from the taxpayers is a lot easier than proving in a court of law that the guy who sold you a gamy promotion did something that is considered legally blameworthy.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Nov 20th, 2009 at 09:39:43 PM EST
[ Parent ]
Both and.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sat Nov 21st, 2009 at 02:11:38 AM EST
[ Parent ]
Exactly. It's not always cold black and white commercial calculation.

Just ask the Chinese and Japanese how important 'face' is.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Nov 21st, 2009 at 06:02:57 AM EST
[ Parent ]

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