"Economic value" versus "market value"

darag

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I read in today's Irish Times that DoF sources are claiming that NAMA will pay the "economic value" and not necessarily the "market value" for the loans.

This is a new one on me even with my amateur interest in economics. Market value is one way of establishing economic value; they are not "competing" theories of value.

There is no accepted definition of "economic value" in finance or economics and in fact the debate concerning value models is as old as economics itself. To show the divergence in this field, one example of a way of calculating "economic value" is to use a variation of Marx's labour theory of value another might use the neo-classical (i.e. capitalist) equating of economic value with the price established in a competitive market. Both in theory can be used to derive a number to represent "economic value" but obviously both are likely to diverge hugely in the values they derive.

This is like saying "we are not going to use a TOYOTA to get from A to B, we are going to use a CAR" - a Toyota is a type of car so this makes no sense.

I am being somewhat pedantic. What the DoF source intended to say is clear; we intend NOT TO USE a standard valuation model (using market value, for example) or one that can be subjected to critical scrutiny but instead want to leave ourselves the option of being able to pull figures out of thin air but claim that the value figures are based on vague and subjective "economic" considerations - not "market" ones - without specifying exactly how their valuation model works.

However, in other ways, I don't think I am being pedantic. Either the source is completely confused about the relationship between values and valuation models or else it is a deliberate attempt to make their valuation process appear in some way scientific or economically justifiable by using a technical term like "economic value" even if the term is used incorrectly.

The implication of the statement is clear 'though whether you agree with the above or not. It is intended that NAMA pay MORE than market value for the loans it is going to buy.
 
I think there is no doubt that NAMA will be paying more than current market value for assets. That is, when you strip away all the surrounding arguments, what it is being set up to do.

Economic value is a slippery customer. It can be related to cost of production, or to income-generation potential, or to use value, or expected (hoped-for) future market value, or a fusion of more than one of those components. You can argue that in recent years the market value of property has been considerably higher than any of these "economic values".

I think that what is involved now is an effort to justify a valuation that is higher than the current market value. That's a big ask, given that market values might still be too high.
 
Firstly there is no way of judging market value. No expert can do this. Market value is what property will sell for and can only be judged by putting the property on the market. This is not going to happen so we cannot know what the current market value is.

Economic value is just a made up 'concept' basically two words to mean whatever price we decide. They can put names on things and try to confuse us but it's really quite simple as OP points out it will just mean at the end of the day a figure plucked purely out of thin air.
 
This is the big development since last Friday and as I commented in another thread fully justifies the G20 letter which suggested, against official denials, that it was inevitable that NAMA would have to pay more than market value for these assets.

Standing back from this, the only point in the exercise is to have our main banks viable again, and I certainly support that. Therefore the amount payable by NAMA should be the minimum to achieve this on a case by case basis.

Instead they will cook up some economic model which just gets the worst bank over the line, fair enough, but if consistently applied will result in windfalls for the shareholders of the banks which are not as badly insolvent.

The market cap of the big two is currently €3.5Bn and that is with all the uncertainty. I would not be surprised that after this exercise it will top €5Bn. That is €5Bn of shareholder value produced entirely by the State intervention i.e. by a subsidy from the taxpayers.

I was wrong and the G20 were right and the Boss articulated this very well on RTE yesterday. The government should nationalise (confiscate) the insolvent banks, clean them up just as they are intending with NAMA and then quickly sell them back into the market - the taxpayer in my book would on a like for like basis be €5Bn better off (less flotation expenses etc.).

Also as the G20 pointed out it wouldn't really matter what formula was used or whether one bank got favoured overed another bank, the residual shareholder value would accrue entirely to the taxpayer.

It's not too late, AAM should lead a campaign in support of the G20 argument, now that their premise has been so starkly vindicated.
 
Which G20 letter is this, Duke? I'm a bit behind on some of the latest happenings here.
 
That's a great letter; it's the most lucid and clear analysis of this situation that I've read in a while.

Even tiny enterprises generally start - before wading in - with setting out clearly a goal, looking at the various paths to the goal, describing the pros and cons for each, followed by a clear recommendation on the best path.

It boggles the mind given the financial scale of the problem that the government are unable to articulate what they are doing in such terms. This could be deliberate because it has the effect of stifling criticism of the government's strategy and goal as nobody really knows what they are beyond the general platitudes.

The fear is that they cannot communicate it because they don't seemed to have thought about it in such terms; there is no real goal or strategy - it's been treated as a firefighting exercise since mid 2008. The talk about using "economic value" for the price NAMA is to pay for loans represents a prescription for more of the same; i.e. we will deal with things when they happen.
 
Well if the g20 says to nationalise the banks,the big question is why are our gov. going on their present path. I mean who is advising them or who is directing this path of action.I presume this bunch of solicitors and teachers are not making up this strategy,that could bankrupt the country,by themselves.....or are they?????????
 
That's a great letter; it's the most lucid and clear analysis of this situation that I've read in a while.

.

I totally agree with you. It makes sense.

The NAMA solution is exactly the opposite. Arbitrary prices decided for property, no clear sign that the taxpayer will win, developers bailed out and the bankers stay in place and the shareholders keep their equity and make profits as the banks get stronger.
 
Well if the g20 says to nationalise the banks,the big question is why are our gov. going on their present path.

There is a huge flaw in the nationalisation argument. Supporters of nationalisation justify it on the basis that as the State will own the banks, it will be able to sell them for a good price at a later date to recoup its money. This would work fine if we were the only people doing this - the big flaw is that most of the developed world has nationalised banks for the same reasons and is intending to sell them off at a similar time. The glut of of nationalised banks on the markets will mean that there will be zero chance of recouping any meaningful amount of money - simple supply & demand economics. So those countries who've nationalised banks have paid way over the odds for them.

You may argue that NAMA might pay over the odds for property, but we can be 100% certain that any Government that has nationalised HAS paid way over the odds.

The counter argument to the above is often..."we can hold onto our banks for longer and sell them off at a later date". Problem with this argument is that if the banks stay in State ownership too long, they'll begin to "go native" which will cause even bigger problems and lose even more money. As financial institutions, banks need to operate in the real world, not the public sector.
 
There is a huge flaw in the nationalisation argument. Supporters of nationalisation justify it on the basis that as the State will own the banks, it will be able to sell them for a good price at a later date to recoup its money. This would work fine if we were the only people doing this - the big flaw is that most of the developed world has nationalised banks for the same reasons and is intending to sell them off at a similar time. The glut of of nationalised banks on the markets will mean that there will be zero chance of recouping any meaningful amount of money - simple supply & demand economics.

If the banks were to become profitable again, they would be saleable at a price that reflects their level of profitability - simple supply & demand economics.

... As financial institutions, banks need to operate in the real world, not the public sector.

I think you are ignoring the lessons of recent history.
 
As financial institutions, banks need to operate in the real world, not the public sector.

NAMA has been created just so the banks who certainly are not operating in any real world that I know of can continue as they are. A couple of guys have left and that's it. No fundamental changes and it's even worse because they now know they are too big to fail and goodness knows what they will now get up to, always safe in the knowledge they will be bailed out by government.
 
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You may argue that NAMA might pay over the odds for property, but we can be 100% certain that any Government that has nationalised HAS paid way over the odds.
Please explain. It is widely accepted that nationalisation would mean the State acquiring the banks for almost Nil. The State is going to get the toxic assets anyway but the difference between the current approach and nationalisation is that in the former the existing shareholders will be left with windfall value of about €5Bn which should be the taxpayers.

Nationalisation has all sorts of post war British Labour type connotations. I prefer the term "Recycling". The State could gather up all the current shares by CPOs at their true value which is near nil (without State support). Then it should cleanse the balance sheets with NAMA and refloat the shares. Okay it mightn't get the full €5Bn but anything at all would be a taxpayer bonus.

This share recycling should be done as quickly as possible and need not involve the State in any more hands on management than is envisaged in the current approach.

It is probably too late for this recycling/nationalisation strategy but as the debate intensifies I see great political pressure to leave very little residual windfall for existing shareholders and this could be achieved by deep NAMA discounts followed by highly dilutive State equity injections.
 
Long term conomic value = Political BS spin to convince the Irish tax payer that they are not being ripped off
Market Value = What something is worth
 
Please explain. It is widely accepted that nationalisation would mean the State acquiring the banks for almost Nil.

Not quite true. The reason banks are nationalised is because they are insolvant. While the State may be acquiring them for nothing, they end up pumping them full of cash to cover get them out of insolvancy - e.g. UK. So there is a very real and substantial cost to the State of nationalising a bank. Every nationalised bank in the developed world has received substantial cash payment in tandem with nationalisation. The important word here is CASH. Its not bonds or guarantees, its raw cash.
 
csirl the banks are going to be bailed out by the taxpayer under either approach. Under the current approach existing bank shareholders are going to enjoy a windfall (compared to their proper entitlement which is Nil). Under recycling/nationalisation that windfall goes to the taxpayer.
 
Darag said:

It boggles the mind given the financial scale of the problem that the government are unable to articulate what they are doing in such terms.

The government is restrained in what it can say. It can't fully show its hand.

It also has more information at its disposal than we have. It has seen the books in full.

No one knows what the current value of any loan is. The market value is meaningless because there is no market. The economic value is dangerous, because it will make some huge assumptions which may well be wildly wrong.

I am ideologically opposed to nationalisation. Can you imagine a nationalised Irish Life and Permanent making the commercially necessary decision to raise mortgage rates?

But I am even more ideologically opposed to giving windfalls to shareholders. Let the NTMA buy the shares in AIB and Bank of Ireland at €1 each. So they can still be run as privately owned banks with at least some layer between the politicians and the management to reduce the political meddling.

What we are doing at the moment is nationalising the bad bits and leaving the shareholders with the good bits.

Let the NTMA buy the banks and then we won't have to worry about market value, economic value, political value or supervalue.

Brendan
 
I have been thinking a bit more about market value vs. economic value.

If I own an office building which has a firm of accountants as tenants with a 21 year lease paying €100k a year rent with upward only rent reviews. I would guess that it worth around €1.5m giving a yield of around 7%. But I am not selling it, so the value is irrelevant.

Now let's say that I have to sell it to reduce the loans I have on some residential development land. The market value today is probably around €1m if I can find a buyer.

Now let's say that I have to sell it before Friday or else ACC Bank will appoint a Receiver to it. The market value is probably around €500k.

So if I have a loan on this property of €800k and this loan is going to NAMA, what value should NAMA put on the loan? I would say €800k.

If I have a loan of €1.2m on the property, what value should NAMA put on the loan? I would say €1.2m

Brendan
 
The market value is meaningless because there is no market.
If there is no market; they are not worth anything..

But I am not selling it, ....Now let's say that I have to sell it ....The market value today is probably around €1m if I can find a buyer. ... The market value is probably around €500k..... I would say €1.2m

From the sounds of it, it's worth €500k but the more pressing issue is your mental disorder ;)
 
There are three different markets for this property

1) There is the market where I don't have to sell the property. If someone approaches me to buy it, I would probably sell it for €1.5m

2) There is the market where I am forced to sell the property.

3) There is the market where I am forced to sell the property by Friday.


In most cases, NAMA will be in market 1). They will not be under any obligation to sell the property and they won't sell properties which have good tenants and good income. They would see a loan of €1.2m on this property, so they don't need to make any adjustment for it.

Brendan
 
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