Finance minister Brian Lenihan probably picked the best of the bad options for dealing with Ireland's banking catastrophe. The proposed National Asset Management Agency (NAMA) will strip the banks of their most damaging assets and hopefully right the listing financial sector so the broader economy can begin to function normally again.

There are, however, a lot of obstacles between the initial proposal and it ultimate execution. The key issue is how to value property and development loans that are not producing income for the banks and for which there is no market on the underlying securities.

Most commentators have assumed the government would want to get the banks' assets at the lowest possible price. But the government has a delicate path to navigate and may choose a different route.

It would appear the main risk inherent in setting up NAMA is that the government could be forced to nationalise the banks anyway if the scale of writedowns on the toxic assets is so large that it destroys their capital reserves. In other words, there is a danger in recognising the worst-case scenario. However, there is another serious risk on the other side of the equation: that NAMA actually might overpay for the assets and create a situation whereby, instead of owning the banks, the state acquires a monopoly over property development for a generation.

In this scenario, NAMA would have a hard time realising any profit on the assets because buyers for overvalued property will be hard to find – especially in the coming years. Thus, the agency will not be able to recover much on the bad debts or even liquidate the underlying security. It could be stuck with acres of vacant land that nobody wants to build on.

Knowing this, then, why would the state overpay for assets widely believed to be worth far less than their book value? Wouldn't that be a waste of precious money at a moment when we can least afford it?

Well, yes and no.

On the one hand, overpaying is expensive. On the other hand, the government has one huge incentive to do it.

That's because paying as little as possible for the bad assets would force the government to once again recapitalise the banks – probably for more than the €7bn injection approved for AIB and Bank of Ireland earlier in the year.

That's because the written-down losses must come out of the banks' equity. If the losses on the €90bn pool of loans exceed €13bn or so, according to estimates by Davy stockbrokers, the bank capital would dip below minimum levels.

So Lenihan and his NAMA proxies, instead of making the banks take maximum pain, may themselves try to pay just enough today to protect themselves from having to pay even more tomorrow.

Here's how that works: The banks have this huge pile of bad assets – primarily delinquent property development loans – which they need to shift from their balance sheets in order to resume 'normal' lending again. Most of these loans have gone toxic, which means they are no longer producing any cash flow for the banks. If left to fester, the banks will ultimately have to write down their values – possibly to zero. As long as these bad loans stay on the books, the banks are too afraid to take on more risk, as the debts could easily sink them. In the meantime, the banks are stuck in zombie-mode, booking losses incrementally as the toxic loans slowly erode capital.

The good thing about NAMA is that it will finally force the banks, who have become pretty squeamish about the painful reality confronting them, to take the writedowns up front. In effect, NAMA will rip off the big plaster with one decisive tug, rather than prising it off inch by excruciating inch.

This policy gets the banks out of a jam, which is what it is supposed to do, by forcing them to take their medicine. But, from the taxpayer's perspective, the cure could be worse than the disease.

Lenihan surely knows that too aggressive a discount will push the banks into insolvency and force the government to nationalise them, so the fact that he is going ahead with NAMA at all indicates the state is prepared to overpay. If the government, through NAMA, was prepared to pay only the deeply discounted price, that would guarantee nationalisation anyway, and there would be little point to having Nama in the first place.

Two aspects of the plan help the government out with this conundrum: the expected 15-year life span for NAMA and the promise of a clawback levy on the banks should the agency fail to turn a profit.

The levy, which will be paid by the banks if NAMA cannot achieve a profitable return on the assets it is acquiring, is Lenihan's 'get out of jail free' card. Whatever pricing 'mistakes' the minister and Nama make today can be 'corrected' at a later date through this clawback mechanism. Even the banks probably don't mind this provision, as the levy will ultimately be passed on to customers – i.e. taxpayers.

Also, with a 15-year time horizon, Lenihan can long-finger the problem and leave it for one of his successors to sort out. The chances of the minister being around in that time are slim and a future finance minister may have his own contingencies to cope with by the time the bill comes due.

But the big pitfall lurking in a profligate NAMA is that the cost of acquisition may finally be dwarfed by the cost of the state virtually controlling the entire property sector, from ownership of the land through to planning permission to having a say over who and what the banks finance. Lenihan told reporters last Wednesday that he intends to restrict speculative lending by the banks in the future to prevent today's battered developers from reaping the benefits of the bank rescue in the future. But in doing so, it gives the apparatus of the state control of all the levers in a very significant market.

What we might get in 15 years is a government so beholden to the massive sunk costs on bad assets it paid too much for in order to avoid nationalising the banks, that it stubbornly holds on to property that cannot be sold for what it's 'worth'. Just like the banks and developers today.