credit, asset values rise which in turn may tempt some investors to exploit rising collateralvalues to over borrow and invest in marginal-quality projects. In the other direction, acredit crunch leads to a decline in asset values and the non-completion of otherwise-viableprojects. While the ideal solution is for the …nancial regulator to engage in counter-cyclicalmeasures and avoid the occurrence of a crisis, these ampli…cation dynamics also providean explanation why market values can fall below long-term economic value if regulationin inadequate and a crisis does indeed occur. (For a classic model of banking, see DougDiamond and Philip Dybvig: “Bank runs, deposit insurance, and liquidity,”
Journal of Political Economy
91(3), 401–419. On the interplay between liquidity and collateral values,see Nobu Kiyotaki and John Moore, “Credit Cycles,”
Journal of Political Economy
105,211-248).In addition, the nature of …nancial markets mean that persistent gaps may emergebetween the the fundamental value of an asset and its current market price. The “limitsto arbitrage” literature explains why a persistent gap may emerge, since arbitrageurs maynot have access to su¢cient liquidity to quickly close the gap between the fundamentalvalue and the current market price. (The classic paper is by Andrei Shleifer and RobertVishny: “The Limits of Arbitrage,”
Journal of Finance
52(1), 35-55.) This mechanismexplains both why bubbles may not be quickly punctured and why post-bubble marketcrashes may “overshoot” in the downwards direction.For these reasons, there is a
prima facie
case to employ long-term economic value indetermining the price for loans that will be transferred from troubled banks to NAMA.However, a major implementation challenge facing NAMA is to develop a high-qualitymodel of long-term economic value. Here, I focus on the long-term economic value of theunderlying property assets. (Other factors also matter in valuing loans, such as the cost of capital.)Such a model should have both macroeconomic and microeconomic dimensions. Macro-economics is required in order to establish the likely economy-wide evolution of averageproperty values, while microeconomics is required to model the cross-sectional dispersionof individual properties around the average value. (Since the NAMA valuation method willbe applied on a loan-by-loan basis, the individual characteristics of each loan and propertyasset must be modelled.) The microeconomic task can be ful…lled by those with expertisein property valuation.In this note, I consider some methodological issues in the macroeconomics of estimating2
