Open Dissent

by Mike Soden

  Trustees will meet and discuss at length the pros and cons of such investment opportunities but could feel constrained in speaking their minds for fear of alienating the other trustees or, God forbid, their boss on the committee with them. This suppression of different opinions is at the heart of the failure of decision making at committee level. The trade-offs are real – an employee might decide to invest to help to save the company – but eaten bread can be soon forgotten. The consequences of allowing investment levels to rise to excessive heights in this context put the income of existing pensioners and future pensioners at risk. The price of not speaking out is enormous, not just in financial terms but in terms of future human misery. Before companies go to the brink of bankruptcy employees should clearly understand the nature of their exposure. In fact, demands for additional top-ups from the pension fund, if the amount in question is over a certain agreed limit, should automatically lead to a meeting of all associated pensioners.

  As banks and other companies seek ways to recapitalise their organisations during these difficult times, there is one stage of this process that must be carried out by the regulators and the pension trustees. In entities where employees are fortunate enough to have a defined benefit plan but unfortunate in that they are reminded on a regular basis of the size of the pension deficit, it is essential that the trustees as shareholders, employees and future pensioners have an active dialogue with management on recapitalisation, in particular recapitalisation that comes from the sale of key corporate assets. These key assets, by any evaluation, would have been major contributors to the cash flow of the company and in turn would be viewed as potential ways to fill the pension deficit over the coming years. In their absence, what is going to replace these streams of profits? If there is no guaranteed future income stream to be derived then some portion from the proceeds of the sale of the assets should be allocated to the pension fund. The amount to be allocated would be easily calculated as a percentage of the sale that would equate to an appropriate reduction in the pension deficit. The principle here is that those assets that generate the cash flows currently or in the future cannot just be absorbed by the system to allow those who oversaw the destruction of the capital to be given an opportunity to repeat their mistakes. If assets have to be sold in a recapitalisation process, the conservative view would be to reduce or eliminate the pension deficit before any proceeds from the sale would be used elsewhere. Employees are not just workers, working capital or unnecessary cost centres, they are the lifeblood of companies who invest more than money into their careers. The protection of the employee has to be paramount in any investment strategy being undertaken.

  As the Government contemplates nationalising the banks, they are faced with the potential liability of the pension shortfalls in the banks’ balance sheets. If recovery comes, as all of us wish, then we may ask what percentage of the future profits of the banks must be allocated to pension funds. That being said, what effect would action of this nature have on the overall performance of companies and their ability to attract new investors? Fundamentally, if the banks recover, will they be able to generate sufficient profits if they are forced to sell their most profitable assets at this time to generate enough capital to meet the Regulator’s requirements?

  Whether people benefit from personal pensions or major institutional schemes that have taken decades to build, all pensioners are viewed as either long-term investors or traders. For most people, the strategy determined to provide an annuity will take into account many, many factors. The sophistication is extraordinary. It deserves to be as it provides security for the investor for the remainder of their days. On the other hand, an individual who is administering his own fund might be lucky enough to have a good financial advisor but in many instances may only be armed with some financial periodicals and the daily business section of the newspaper. The different skills of investors in managing money are evident in terms of performance and results. But the question remains as to whether we should have an investing mentality or a trading one when it comes to our pension funds. It is fair to say that few people have the training or experience to be traders. In fact, most people do not have the time to be active in the markets, as this concept of trading would imply. However, it is essential for people to stay on top of their pension performance and have a Plan B in the event they observe a potential erosion in the value of their investments.

  People so often abdicate the management of their pensions to others deemed to be better equipped for this activity. Those who have done so in the recent past would have enjoyed the pleasure of hearing the professionals tell them that they have achieved a return on investment marginally above an index or, if unlucky, some percentage below an index. It is only when they tell you that the market index has dropped by some 30 per cent or more that you wake up to the fact that you are a lot poorer than you thought. Paying a fee for this report is galling, like pouring salt in the wound. If you wish to measure performance by an index perhaps you should invest in an index fund or pay the broker only a percentage of your gains when they arise and nothing if there are losses recorded. Investment strategies that encourage us to take a passive position with our funds, meaning we wait to receive a quarterly or half yearly report on the progress of our investments, should be reconsidered. However, a person might feel trapped in this situation as they might feel that at this stage in their mature life it is possibly too late to become market aware and savvy.

  All the foregoing has been raised because of the enormous volatility that exists in the equity, debt, commodity, foreign exchange, derivatives and all other markets. Postcrisis, will the volatility be reduced and will our investments in banks, corporations or sovereign states be secure so that as pensioners we do not have to worry about our security? The 70+ per cent loss on the Irish stock market, the massive haircut NAMA is applying to property loans from the banks, the fall in the value of certain collectables and the enormous volatility being experienced in the foreign exchange markets give one little reason to believe that a passive investment strategy for one’s funds should be adopted or depended upon.

  CHAPTER 6

  NAMA – The Piggy in the Middle

  There was great controversy when the announcement was made with regard to the establishment of NAMA. A variety of other suggestions were put forward and debated extensively in the media. In my opinion there was no clear simple solution other than that which has been adopted. This is a variation of the Swedish model of the 1990s (see Chapter 7) and has every likelihood of success if common sense prevails in the management and execution of the declared strategy.

  In line with previous incarnations of a good bank-bad bank strategy, NAMA has been created in order to cleanse the balance sheets of the banks, enable the banks to infuse liquidity into the economy and, in turn, through the injection of the liquidity, assist in the economic recovery of the country.

  On 13 April 2010, Brendan McDonagh, CEO of NAMA, addressed the Joint Committee on Finance and the Public Service:

  NAMA is, first and foremost, an asset management agency, established with the aim of transferring key property related exposures from the balance sheets of the participating financial institutions in return for government guaranteed securities. It will manage these loans with the aim of achieving the best possible return for the taxpayer over a 7–10 year time frame. Replacing these property related loans with government guaranteed securities will remove uncertainty about the soundness of the banks’ balance sheets, provide the institutions with much-needed liquidity and make it easier for the institutions to access capital (for some) and liquidity (for all) in the international capital markets. Financial institutions cleansed of risky categories of property loans should be free to concentrate on their core business of lending to and supporting businesses and households.26

  Mr McDonagh went on to say: ‘I want to dispel any notion that NAMA is a bailout for developers. It is no such thing.’

  With this as the foundation speech for NAMA we are
reassured that between the board and the executive there is a group of highly skilled and tough-minded individuals. The time frame annunciated in this speech was seven to ten years and the principal constituent in this great national drama is the taxpayer. NAMA has a clear commercial mandate to recover debt from all borrowers by whatever avenues are open to it. A key objective in its pursuits is to restore the credibility of Ireland’s sovereign name as a borrower.

  These strong pronouncements and policies are reassuring. We are definitely going in the right direction from the start. It would be favourable before too much time passes that a NAMA scorecard is published that highlights the key result areas and objectives of the agency. We may have a misconception that NAMA is going to be a large Irish property company. To put the size of this entity into perspective, when it has received the €81 billion in assets it has contracted to take onto its balance sheet, it will be one of the largest property companies in the world, if not the largest.

  Size isn’t everything but it is a good starting point. A simple plan developed over time, which indicates the anticipated levels of disposals and acquisitions, would be a sure way of keeping people’s feet to the fire and ensuring that the giant does not become a sleeping giant. From a market perspective, it is important that NAMA is seen to be active, and very active at that. It is easy to say that targets must not be given as this discloses too much commercial information to the market or puts too much unnecessary pressure on the board. Whatever the pressure may feel like in these circumstances, it is unlikely to be as much as what the taxpayers are feeling as their homes fall into negative equity or they face the threat of losing their jobs. The purpose of having public targets, which could also include such items as cost-to-income ratios, the anticipated costs of borrowing versus the actual, together with the number of property completions in any given period of time, would be to provide greater clarity as to the performance of NAMA. Plans for alternative use of properties might be made public to ensure that interested parties inside and outside of Ireland can participate. All in all, there will be a litany of ratios adapted by NAMA in the interests of good commercial management. Making public the frequency and form of these ratios will lead to confidence in the existence and structure of NAMA on the part of the public.

  A structured investment vehicle has been put in place to facilitate specific reporting requirements for borrowing. This structure was not designed to obfuscate the transparency that is essential in the monitoring of the performance of the agency, but it may do just that. It will be a crying shame for the agency, the Government and the Regulator if this is permitted to happen. For the taxpayer to wait and see what the performance of the entity is without having something to compare it with would be worthless. It is essential that the performance of NAMA can be measured and the results continually tracked. Legally, NAMA is protected from complying with the Freedom of Information Act. One would hope that the board will not hide behind this for an indefinite period.

  We have gone through endless debates on the establishment of NAMA. What alternatives might have been considered were given an airing and then put aside. We may wish to continue debating this subject but it now has a life of its own and, in hoping for the success of NAMA, perhaps the debate can be put on the backburner as we await the progress reports. We ought to trust the ECB, the International Monetary Fund (IMF) and a number of eminent economists when they say that, by 2012, the green shoots and fruits of this decision will be visible. We should not be standing idly by waiting for some cryptic message as to the progress of NAMA. Knowing the agency’s goals and targets and what is achieved quarterly, half yearly and yearly would make compelling monitoring.

  In the same way as taking on loans, completing unfinished projects would be worthwhile if NAMA could enter the market as a buyer. Investment in various partly funded property projects to ensure completion is achieved would provide hope for economic recovery and a jolt of confidence to us all. At the heart of the property market there would be a legitimate market maker with the skills and strength to direct activities and speed up recovery. Confidence will not return in any form unless an organised market exists and the movement of property between buyers and sellers is facilitated.

  When NAMA has completed the process of issuing bonds in exchange for portfolios of loans from the banks, which will be done progressively, the question is whether the banks will invest some of this liquidity into the corporate and consumer sector in Ireland. Having received the liquidity, the banks will be obliged to protect and preserve their balance sheets in a way they failed to do over past years as there will be an obligation on them to do so, along with strong oversight by the regulators. The new capital adequacy requirements are stringent and the new capital ratios will be followed keenly by the marketplace. That may leave little room for new lending.

  However, for the country to get back to an acceptable level of GDP growth, the banks have to succeed in feeding the economy with liquidity. If we examine the option of lending funds to the customer base of the banks, we need to determine which sectors are in most need of liquidity and which of these the banks would view as good risks in normal circumstances. In identifying sectors that have genuine growth potential, it is equally important that the banks don’t overlend into a particular area, causing yet another sectoral credit bubble. Areas associated with exports are clearly in the sights of the lending institutions, but, as many of these are cash rich, what working capital needs would they really have at this time? In addition, the likelihood of the export sector filling in the hole created by the losses in the construction sector is remote. Consequently, the problem for the banks as they examine the risk profile of their customer base is that the riskier credits will require more liquidity than others. Caution and discipline are essential in lending but there is no substitute for good judgment on difficult but potentially profitable projects. Working capital is what is required in all sectors but the security available is likely to have been diluted over the past three years. With €81 billion taken off the balance sheets of the banks at a discount or haircut of over 50 per cent, leaving a substantial injection of liquid assets to go into the banks, we should ask ourselves into what sector would any cautious banker put more than €1 billion?

  The single biggest area that requires investment is construction and property. This sector is on its knees and we all know and understand the history of this. It is this sector we all blame for the poor state we are in today. Having experienced the massive downside of the excessive losses associated with this sector, we must ask ourselves if the economy can recover to an acceptable level within a specified time frame – four to five years – without reinvesting in construction and property. The construction industry is reported to have lost over 200,000 jobs during the past couple of years and a likelihood of recovery in the sector without investment is remote.27

  Before we condemn any sector of our economy to a period of insignificance, it is worthwhile understanding the contribution the construction sector has made to our economy and its capability of contributing to growth in the future. A case must now be made for the construction industry being restructured so that it achieves an optimum size compatible with the needs and ambitions of our country.

  The Construction Industry Federation (CIF) suggests an optimum annual output of €15-€18 billion. The construction industry was a key driver of economic growth over the decade to 2007. By the end of 2007, the industry had reached a value of €38.5 billion, in excess of 21 per cent of GNP, and employed about 400,000 people (direct employment plus 40 per cent indirect employment). This was equivalent to 19 per cent of total employment.28

  The construction industry was likely to have been ahead of the banks in terms of recognising the genuine downturn in the market; the continual denial of the banks left them behind in their understanding of the real situation. The CIF saw that an industry of this size, resulting from a concentrated period of unprecedented economic and demographic growth, had become unsustainable. A very s
harp adjustment is now underway. A further decline beyond 2010, which is now almost inevitable based on current statistics, is essentially eroding the economy’s long-term productivity. On current projections for construction activity, and in the absence of a major stimulus package to reinvigorate the industry, the size of the construction industry will shrink to less than €12 billion during 2010, some 30 per cent below its long-term optimum and 70 per cent below the peak of three years earlier.29

  The industry will be operating at almost half of its optimum level by 2011. This decline has serious consequences, as is already evident in tax receipts, direct and indirect construction employment, and wider economic activity. The result will be a deeper and longer depression which will delay any recovery. From an employment perspective, the deterioration of the industry will continue to exert a major drag on the economy; employment estimates for 2010 and 2011 suggest that total employment in the industry will fall back towards 126,000 by the end of 2011, bringing it back to 1994 levels.30

  Based on the medium-term growth needs of the economy, construction output should be in the region of €18 billion for a number of years, equivalent to 10–12 per cent of GDP.31 If we don’t have this as a goal, Ireland will continue to fall behind the rest of the EU in our accumulated capital stock.