Ireland's Finance Minister Brian Lenihan

The most important development in Ireland in the two weeks since this column last appeared was the publication of the draft legislation to set up the National Asset Management Agency (NAMA).  

In fact you could say that this is the most important development in Ireland since, well, probably since the foundation of the state.  That is how critical this draft legislation is, which sets out the government's plan to rescue the Irish banks, and with them, the Irish economy. 

Without it, or some similar drastic action, the Irish banks would be bankrupt and the Irish economy would implode. 

I did economics in college and I find this kind of stuff fascinating.  I am aware, however, that most people are not economics geeks. 

I know that most of you would rather stick your head in a bucket of oil than read any more about the Irish economy.  And a lot of people here feel the same way. 

But this is an economics lesson that cannot be skipped.  You have to understand that the problem in the Irish banks is much worse than that in banks almost anywhere else.  

Yes, the Irish banks were hit with the same global financial meltdown that hit banks in other countries.  But on top of that the Irish banks are also suffering the consequences of their massive, reckless involvement in the Celtic Tiger property bubble, the biggest bubble seen in the western world in many years.

During the boom, the Irish banks gave enormous loans for property development and investment, loans that are now worth a fraction of  their book value.  

The international money markets were wise to what was going on here, and when Irish bank shares crashed last year as a result the Irish government pumped a few billion into each of  them in fresh capital and guaranteed their deposits.  But that only scratched the surface of the problem.

The real problem was the scale of the toxic property loans that the Irish banks had made, a scale that now seems almost unbelievable.  The main Irish banks had always presented a public image of sobriety and conservatism. 

 In reality they were drunken gamblers who bet the house many times over on a property boom that even amateur economists like myself were saying was unsustainable. And they continued to do this even as the property bubble reached bursting point.  

Now they are stuck with the consequences of this madness.  Even after the government's intervention, their capital amounts to a few billion. 

Yet between them they have a mountain of questionable property loans with a book value of around €90 billion ($128 billion).  Optimistic estimates now suggest that the true current value of these loans is about half that and might even be down to 40 percent or even lower. 

What that means is that in reality the Irish banks are bankrupt.  But facing that reality has been postponed here because the Irish banks have kept these loans on the books at their original values, avoiding write downs wherever possible by allowing developers to roll over interest payments and struggle on in a static market.   

By doing that the Irish banks have remained technically solvent.  But of course they can only do this for so long.  

To stop the banks collapsing, the Irish government is now intervening to take over the bad property loans, which they call "assets."  They are going to buy these "assets" from the banks and manage them over the long term, perhaps 15 or 20 years, until the property market recovers and they will be able to sell them again.  

To do this they have set up a special agency, and the foregoing explains why this agency is called the National Asset Management Agency (or NAMA). 

In theory, you could say so far, so good.  That will take the enormous toxic property loans off the books of the Irish banks and allow them to get back to normal activity, borrowing money on international markets, loaning it to Irish business and consumers and generally putting the Irish economy in motion again.          

The scale of what the Irish state is proposing to do is, as I said, mind boggling.  In effect the Irish state will become one of the biggest property owners in the world.  It will be taking a massive gamble with a huge amount of money borrowed on behalf the Irish taxpayer to buy the toxic property assets from the banks. 

At best, the taxpayer will come out of this at  break even; at worst, Irish taxpayers will be ground down by an enormous debt burden for decades to come.

The draft legislation gives NAMA extensive powers to take over land and development projects from borrowers who are not keeping up with their repayments.  For weeks now a NAMA team has been working with the banks identifying and quantifying the problem loans, covering almost all the property developers here. 

It is reckoned that NAMA will take over up to €90 billion in risky loans and that the top 50 developers will be brought into NAMA before Christmas.  Only loans of over €5 million ($7 million) are being included.

Under the legislation, all of the property portfolios of developers who are in trouble are being brought in.   There can be no picking and choosing by the banks between good and bad loans within a portfolio, which means that NAMA will have a better chance of making the scheme work.  

But it is still a huge undertaking and a huge risk.  And the big unanswered question that overhangs the whole NAMA project is how much NAMA will be paying the banks for the "impaired" loans.  

The current market value of these loans is far less that the book value of €90 billion, so NAMA will pay well below that figure.  But how much below?  

If the figure is too high, the taxpayers will get screwed in the long term.  If it is too low, the banks will be bankrupt again in the short term, requiring recapitalization by the state on a scale that would be the same as nationalization.

The Minister for Finance Brian Lenihan has said that the valuation process is going on and that the end of that process will produce an average figure that will apply to the loans being bought by NAMA. 

Some people suggest that the figure should not be much more than €60 billion ($85 billion). Others say that it should be as low as €40 billion ($57 billion) if it is to reflect current values.  

The agreed figure, which Lenihan will reveal to the Dail (Parliament) in the autumn, will be somewhere in between and probably closer to the higher figure. It's a very tricky calculation. 

The government has made it clear that it does not want to end up with nationalized banks, so the figure can't be too low.  On the other hand, there will be taxpayer fury if the government pays too much. 

My guess is that the government will err on the generous side.  The reason is that putting more money into the banks now to get the economy moving again might somehow save their political skins.

The bill for paying too much for property loans now will not be due for at least 10 years down the line, and who knows which party will be in power then?

The urgency of dealing with the present unsustainable situation in the banks here has been borne out by events of the past couple of weeks.  One or two banks have broken ranks (most developers have multiple loans across four or five banks)  and gone to the courts trying to get their money back from developers.  

The biggest developer in the country with impaired loans of way over €1 billion ($1.4 billion) was in court last week seeking court protection to enable him to keep going.   This has started a process that could collapse the whole deck of cards, so action by the government is needed as soon as possible.

Something has to be done - and fast.  But is NAMA the answer?  

The big problem that most people here have with the idea of NAMA is that it looks very like Fianna Fail digging its developer and banking pals out of a hole, at enormous cost to the ordinary taxpayer.  And why should the ordinary worker have to pay more so that the banks' shareholders won't be wiped out? 

There is an alternative.  The toxic property loans could be written all the way down to their current value.  This would mean nationalizing the banks and wiping out the shareholders.  (But then the shareholders took the risk to begin with and enjoyed enormous profits during the boom.) 

The banks could be sold back into the private sector when recovery was underway.  And paying realistic valuations now for surplus development land and unwanted office blocks would give NAMA a real chance of eventually breaking even.  

All of which would be good for the taxpayer.  But then, when did anyone care about the ordinary taxpayer here?