Wednesday, April 29, 2009

Economics 30/04/09: Crime, Dive Reg, Trade Stats & Cars Regs

Crime stats are out today and there are surprises. In particular, a big surprise is the lack of up-tick in property-related crimes in Q1 2009.
The first picture illustrates crime stats for broad categories 1-5: all down, except for sexual offences and kidnappings etc. Nasty stuff, but at least some good news on murder, homicide, assaults etc.
The second chart shows categories 6-12, most are property related and all are down except for robbery7, extortion and hijacking. Given the current economic climate, this is surprising as crime rises in general as recession intensifies. Anecdotal evidence - like local authorities representatives in my area - are telling me that in the last 2 months some 23 burglaries took place in Ringsend, Irishtown and Sandymount area. This is a huge increase. But we shall see if this is matched in the Q2 2009 stats for the rest of the country. For now, however, except for the state robbing us blind, other criminals are staying out of our pockets... or are not being caught...

Live Register
is out and is worth a closer look. The pace of increases in LR is abating, but remains furious. The first observation is expected, given massive increases in previous months. We are seeing a technical correction, not an inflection. January-April 2009 we have added 96,000 of freshly un- and under-employed to welfare rolls. Same period 2008 it was 'just' 28,000. April monthly rise was 15,800 or 52% down on the record-breaking January increase of 33,000. Now, this might be some sort of 'good' news for some spin masters, but if April pace continues to the end of the year, we are looking at 515,000 unemployed by January 1, 2010. DofF Supplementary Budget figures estimate unemployment to close off at 12.6% in 2009. Yeah, right...

Below is a chart with data up to date and my forecasts. First forecast is basically a repeat of last years rates of rise for the following months. The rest of 2009 monthly average for this case is 4.88% - much lower than the 4-months average to date which is 7.34%. One slight departure - in this scnario I assume that December 2009 rise in Live Register will be lower than that for December 2008. Just to be nice... The second forecast is Adverse Scenario, corresponding to the next 8 moths of 2009 running along the rates of increases in the previous 8 months (since September 2008 through April 2009), with January record rise being moderated by roughly 1/2. The average monthly rate of increase for this scenario for the months of May-December 2009 is 5.87%, still below the current running average of 7.34%.

A worrying thing about this is that, as you have probably noticed - both scenarios yield LR figures well above 515,000. Benign scenario produces end of year unemployment rate of 16.7% or 568,842 on the Live Register, and adverse scenario provides for 18% unemployment with 613,200 on the Live Register...

These are plotted in the chart below.

Finally, it is worth mentioning that April saw an increase in the females rate of signing onto the LR, relative to males. 41% of new claimants signing up are now women, the largest proportional increase since May 2008. This is likely a sign that:

  • white collar jobs are now evaporating at a faster pace, thanks to the Government heroic efforts to support the 'knowledge' economy;
  • redundancy payments are wearing thin (with families beginning to run out of redundancy payments cash and thus being forced to sign members onto LR); and
  • tax bills for formerly two-earner households are rising, necessitating more women to sign onto the register.
Trade stats for January and February showed an increase in trade surplus - at a 7 year high now - driven by the declines in imports. February exports were up 6% - good news, imports rose as well up 4% in monthly terms. Table below illustrates.
Per CSO release January figures for 2009 when compared with those of 2008 show that:
  • Electrical machinery exports decreased by 51%, imports fell by 24% - MNCs are shrinking their production levels;
  • Power generating machinery imports increased by 49%, while electricity imports were up 101%;
  • Computer equipment exports were down 22%, imports fell 35% - ditto for MNCs;
  • Edible products by 34% - domestic exporters are suffering here;
  • Industrial machinery fell by 44% for exports and by 34% for imports, specialized machinery imports fell 56%, iron and steel imports down 43% - more MNCs cuts and these are savage;
  • Medical and pharmaceutical products exports increased by 15%, which means imports also rose by 6% - MNCs in this sector are firing on all cylinders and transfer pricing is abating - a cyclical component due to accounting timing;
  • Organic chemicals increased 10% for exports and but fell 22% for imports - again foreign firms cut production while drawing down surplus inventories;
  • Other transport equipment (including aircraft) exports rose by 610%, while imports fell 43% (one wonders if this was due to fire sales of old aircraft and helicopters as Celtic Tiger developers are starting to shrink their consumption);
  • Imports of road vehicles down 71% - say by-by to VRT and VAT receipts and thank you to the Greens and VAT increases;
  • Telecom equipment imports fell 26%;
  • Exports to China decreased by 39%, to Great Britain by 13%, to Germany by 14% and to Malaysia by 44%
  • Exports to the United States increased by 5%, to Belgium by 4%, to Bermuda by €70m and to Switzerland by147%.
  • Imports from Germany decreased by 43%, the United States by 25%, Great Britain by 19%, China by 29% and Norway by 55%.
  • Imports from Argentina increased by 29%, Poland by 10%, Indonesia by 47%, India by 12% and Egypt by 55%.
Chart below shows the extent of imports destruction in Ireland since the beginning of 2008. There is, of course, very little imports-substitution, so any decline in imports demand is a direct hit for our retail sector and no gains to domestic producers.
And imports losses are, of course, lost production by our MNCs and therefore a future loss of exports... and jobs.

New vehicles registrations site (that's right - a new dynamic face of CO with low-res masthead, but much better analysis of data is here) is full of interesting stats - primarily concerning the decline in motor trade since Brian, Brian & Mary decided to horse around with new VRT, increase VAT and rob households of their cash. You can see these for yourselves. But what got me thinking are the longer run trends. Here are some charts:
First, look at all vehicles registered in Ireland. Despite a dramatic fall-off in numbers, long-term moving average shows a clear twin-peaks pattern with sales peaking in and around 2000 - the vanity demand (given our license plates), followed by the fatter peak in 2007 - the SSIAs demand. There is no serious justification for asking for some emergency measures, e.g a scrappage scheme, for the sector as no amount of subsidy will bring us back to the boom days of 2005-2007. There is a room to argue against the VRT, but not on the grounds of some car sales jobs protection.
Second, look at the relationship in sales of new and used vehicles. A 'vanity' dip in sales of second hand vehicles around 2000 was followed by a much more sensible realisation in 2006-2007 that there is no need to pay through the nose for new cars. Gradually, we built up a knowledge curve that our own Irish-based dealers are:
  • taking fatter profit margins that those in the UK; and
  • providing no better service in return.
Hence, more people migrated to buying cars abroad and once there, they were buying used cars. This should have been a good news for the environmentalists (buying a used car implies no added CO2 emissions associated with manufacturing). But it was not, so the tax-hungry Greens followed the tax-hungry FF and hiked VRT levies on all cars. If there is a room for economically justifiable tax reduction - it is in cutting VRT on used cars. Why? Environmental reasons aside, when an Irish person buys a used car from the UK, the cost to this economy of the finds diverted to imports (as opposed to, say, domestic investment) is much lower than when they buy a new car from an Irish showroom.
Chart above dispels the myth of the 'Killer SUV-driving Yummy-mummies' on our roads. Remember the slew of articles in 2007 telling us that we should be ashamed of driving big 4x4s and that Blackrock and South Dublin Yummy-Mummies were out in tens of thousands on our roads for school runs, driving an ever bigger SUVs? Irish Times, as always a guardian against consumerism, led this yellow journalism pack. Now, see the share of vehicles with 2000cc or bigger engines that are on our roads? It is negligible! In fact, chart below illustrates this point in detail.
At no time did vehicles with engines in excess of 2,400CC represent more than 4.5% of the total vehicles numbers registered.
Lastly, the chart above shows how out of touch are our public sector purchasing managers with reality. 2008 recorded an absolute record in new vehicles registrations by the public sector, just as the economy was spinning into a recession. Well done lads.

Tuesday, April 28, 2009

Daily Economics 28/04/09: Ah, those statists at heart

US Consumer confidence index jumped to 39.2 in April from 26.9 in March, according to the Conference Board report. This was the fourth largest gain in the index history (32 years), but most of the gains came from the expectations component (up from 30.2 to 49.5), not from the current conditions gauge. Good comparative - tying in political data (polls) with the recent confidence gauge trend here. This is fine, until one recognizes that misery indices correlation with confidence indices is not in the area of leading indicators of actual activity. What does this mean? In simple terms, if misery index falls, ahead of consumer confidence rising, all we know is that there should be some secular components of the former that are driving the latter. This is exactly what is happening and the driving components are:
  • stock market (bear?) rally; and
  • Bush/Obama tax rebates.
Both are temporary and both have nothing to do with the fundamentals of the cycle. In other words we are still in a recession and there is no:
  • significant fall off in household debts;
  • significant uptick in new jobs creation (drop in unemployment); or
  • significant rise in earnings and wages.
But, one consolation - Americans still harbour confidence in the new White House administration and the Fed to get them out of the mess. In the words of Jack Nicholson's character, President Dale, in Mars Attacks, at least Americans believe that: "they still have 2 out of 3 branches of the government working for them, and that ain't bad". In the case of Tax&Waste Brian, Brian and Mary, of course, an entirely different memorable quote from the same screen classic comes to mind, when evaluating the Irish Government policies - this one from Ricchie Norris character: "Wow, he just made the international sign of the doughnut". Doughnut, as in 'zero' stimulus policy that is.

And Case-Schiller House Price Index numbers are not all that optimistic as some reports suggest - see superb analysis here. Of course, media reports that CS has declined at a modertaing pace. Surely not, as Calculated Risk analysis shows, house "prices are tracking the More Adverse scenario so far" for the second month in the row. And seasonality also matters...

GM bonds valuations: Unlike Brian Lenihan with his optimistic assessment of NAMA, bond holdersin GM have not been overly enthused by the yesterday's offer of a bonds-for-equity swap (see details here) that would have yielded a straight-off recovery rate of a recovery rate of 45% (at flat current price per share of $2.03) on its senior debt. Remember, Brian hopes for a recovery rate of at least 102% on the NAMA-purchased loans financed using Irish bonds over 5-year term (assuming original NAMA discount of 20% on loans value). Why? GM bondholders did the maths and saw that the trade unions would receive a 50% recovery in cash and a 39% stake in a new GM in exchange for their $20bn in debt holdings. The bondholders, holding some $27bn in GM bonds and having the same legal rights as the unions, would only receive a mere 10% of the restructured company and essentially no cash. Rotten deal at 55% discount rate on GM senior debt for US would-be debt-sellers? What about a great deal for debt sellers in Ireland Inc's development fiascos - at 80cents on the euro and an equity-repair via second round recapitalization... No wonder the financiers are lining up to support NAMA.

The Statist Resignation in the EU Parliament:
You might as well think we got an unusually candid interview from a Member of the Supreme Soviet - that notional 'Parliament' of the USSR whose elected members were simply destined to rubber-stamp the decisions taken by unelected Politburo of the CPSU. EU's Parliamentary Socialist group leader, Martin Schulz, in an interview with FT Deutschland said that he holds no hopes of his group having a say in appointing the EU Commission President should it win the European Parliament majority in this year's elections. Per those who missed the main point, let me run it by you once again: your party get elected with a majority, then:
  • in a normal parliamentary democracy, your party appoints the executive leadership of the country; or
  • in a Eurotocracy, your party gets to be presided by (at an executive level) by an unelected 'President'...
Of course, there is a third way - a Presidential system whereby the executive is elected directly by the people, without overlap with the Parliamentary elections. Then again, Mr Barroso never really stood for an election in Europe. Forget the merit of each individual leader (and Barroso is not exactly scoring high marks on his tenure) - this is simply undemocratic. Full stop.

Insider Selling Takes Off: per recent Bllomberg report (here) "Insiders from NYSE-listed companies sold $8.32 worth of stock for every dollar bought in the first three weeks of April... That’s the fastest rate of selling since October 2007, when US stocks peaked... The $42.5 million in insider purchases through April 20 would represent the smallest amount for a full month since July 1992, data going back more than 20 years show. That drop preceded a 2.4 percent slide in the S&P 500 in August 1992." So at least some of the insiders in leading US companies are now feeling that the market is overbought. This would be consistent with the management observing some internal dynamic in the companies' fundamentals pointing that a deflation of a recent rally is imminent.

Economist is back in the fundamentals game: this week's Economist has an excellent table:
Scary thought, but do check out Ireland:
  • 5th worst performing economy by GDP to date;
  • Worst performer in the last quarter in terms of GDP growth;
  • 4th worst forecast for GDP growth in 2009 (if you take 8% contraction per DofF estimates, not the Economist-reported 4.8% which is consistent with December 2008 estimates);
  • 5th worst performing forecast for GDP growth in 2010 (although here again the Economist is out of line with the latest data);
  • 8th worst unemployment rate to date...
Someone from London financial circles was telling me that before we run into troubles, in his estimate, there will be defaults in the Baltics, APIIGS and the UK. I beg to differ - by these (and pretty much all other) numbers we are well ahead of the rest of the 'sick puppies' club, since for the entire APIIGS (Austria, Portugal, Ireland, Italy, Greece and Spain) we rank:
  • the worst in terms of all 4 GDP growth metrics in the table;
  • the best in terms of Industrial Production metric (although most of the data refers to February-March as opposed to Ireland's January data);
  • the worst in deflation metrics, and the worst in prior inflation terms, with second worst performance in expected 2009 full-year deflation after Portugal (although my estimate is that we shall see prices falling by 1.2-1.5% in 2009, not 0.7% as the Economist lists, so my estimate actually pushes us below Portugal); and
  • the second worst in terms of expected unemployment for 2009 (we are, hopefully, not going to fall deeper than Spain here).
So run by me again - we will be in trouble only after the rest of APIIGS?

Monday, April 27, 2009

Daily Economics 27/04/09: Brian Lenihan/NAMA and US opening

GM debt-for-shares swap as an illustrative example for Irish banks?
General Motors is offering an interesting insight into senior debt recovery rates in the US. The company has offered to swap some $27bn worth of new equity in exchange for old debt at 225 common shares per $1,000 in debt - effectively implying a recovery rate of 45% (at flat current price per share of $2.03) on its senior debt.
Now, factoring in the dilution effect of the new shares, this implies a discount rate of ca 65-70% on the existent debt.

The lesson for NAMA: although Irish banks are not in bankruptcy, like GM, much of the stressed property-linked assets are virtually there already. If NAMA were to buy these at a discount of 15-30% - the numbers rumored out there in the NAMA-proximate worlds of Irish finance, such a discount would imply that the Irish state believes our property development and investment loans to be some 220-430% more secure than the senior debt of one of the largest corporations backed by the US Federal Government cash.

Being realistic was never a strong point of this Government, I guess.

Brian Lenihan on NAMA:
per Reuters report on Brian Lenihan's statement to the RTE yesterday, in addition to repeatedly referring to 'pounds' as Irish currency, our Minister for Finance has managed to state that 'if we nationalise BofI and AIB outright, our entire banking system will be 100% nationalised' (I am using an audio recording transcription here, so the quotes are not exact, but preserve the core of his arguments). Hmmm... one would have thought that the Minister who extended banks guarantee to 6 banks (not just AIB and BofI) and who should be aware of the significant presence of non-Irish banks in this economy would be more careful in phrasing his statements.

I believe it would be very difficult for Ireland to attract funds from abroad, much more challenging, were we to do that.' Now, in effect, as BL points out (hat tip to him), this amounts to an admission that our state is now at or near the limit of its borrowing capacity. Of course, achieving a miserly 110% cover in 9-year bond last week (a bond of very small volume, one must add: see here) suggests just that, but... an admission from the Minister is an all together new dimension to the state borrowing saga.

on the matter. Now, Funny, of course, the Minister should take the same stance as his adviser, Alan AhearneNAMA would require borrowing ca Euro56-60bn to finance a bond-debt swap, with additional Euro4-8bn in post-NAMA recapitalization. A nationalization outright would involve borrowing just Euro2bn to cover existent equity and Euro5bn to shore up some of the capital losses due to transfer of equity and writedowns on the loans books totalling 50% (while driving Capital ratios down to 8% statutory requirement). If we face tight borrowing markets, surely the logic suggest we should try borrowing Euro8bn rather than Euro68bn?

Ah, logic, as well as economics and finance, and fiscal policy and management of public expenditure, are apparently not the strongest skills in DofF - either at the top or at the bottom... So what is then?

Ireland's corporate insolvencies
as predicted back in March, here, (actually, I made a more detailed prediction of the rates of insolvencies increases in 2009 in the December 18 issue of Business&Finance magazine pages 42-43, available here, and that forecast itself was building on the defaults model I created when forecasting corporate defaults back in the spring 2008: here scroll to page 10), Irish companies are facing a dramatic rise in insolvencies in 2009 and the rate of bankruptcies is rising. Table below - courtesy of FGS says it all - Q1 2009 number of insolvencies was 170% above that for the same period of 2008.

Back in December 2008, my forecast was for the average rise of 247% in 2009 across the main sectors of this economy. We are now well on the way to meet this prediction.

Table below summarises two of my previous forecasts, with the later one still holding nicely, in my view... and yes, for those of you aware of it - the first forecast is, judging by the table color, from an even earlier publication (June 2008).

US news front has worsened substantially last week and the stocks snapped their weekly gains accordingly.

Friday’s figures showed demand for durable goods falling 0.8% in March in a seventh monthly decline since July 2008. New orders posted declines in virtually all sectors. Shipments were down 1.7%. On what appeared to some to be a more positive note, inventories fell 1.1% and capital spending by businesses rose 1.5% posting a second consecutive increase, albeit on an abysmally depressing fall-off in January. Both, in my view, are not signs of strength, but of the moderation in the rate of industrial production slowdown. Inventories declines are hardly significant, given rapid and drastic cuts in capacity over the previous months.

The rate of banks closures accelerated. American Southern Bank of Kennesaw, Georgia, was shut down with assets of about $112.3mln and deposits of $104.3mln. Then, Michigan Heritage Bank of Farmington Hills, went bust with total assets of $184.6mln and deposits of $151.7mln. Calabasas, Ca.-based First Bank of Beverly Hills bit the dust with $1.5bn in assets and $1bn in deposits. This time around, no institution stepped up to pick assume the homeless deposits. All within one day – Friday. But before the end of the week, FDIC closed Ketchum, Idaho-based First Bank of Idaho with $374mln in deposits. The grand total of failed US regional banks now stands at 29 since January 1 and 54 since the beginning of this recession. Not many green shoots (other than weeds) out there, amongst the smaller financials.

Now on to more fundamental stuff. I’ve done some numbers crunching and guess what: since 1981, for 27 years S&P500 has outstripped growth rates in the US and global economy in nominal terms. Over the last 27 years annual average growth in nominal GDP in the US stood at 5.8% (2.96% in real terms). Globally, it was 6.2% or 1.37% in real terms. Now, over the same period of time (December 1981-December 2008) S&P 500 moved from 122.55 to 683.38 – a gain of 6.53% pa on average. But this is excluding dividend yield. Thus, should S&P 500 return to some sort of a fundamentals-justified trend, index levels that are justified as sustainable by economic growth standards are in the range between 560-620. In the current range, the implied dividend yield should be around 1.6% pa over the 27-year horizon. In other words, if you think there is something in this economy to drive S&P500 beyond current levels, you better think of a GDP growth rate of 6.2% and a dividend yield of 1.6% in 2009… Otherwise, we are in the over-sold territory.

Then, of course, the US GDP fell 6.3 annualized rate in Q4 2008 and the consensus expectation is for a 5.1% decline in Q1 2009 – adding together to the worst contraction recorded in two consecutive quarters in over 50 years. We shall see this Wednesday when the figures are released.

The data will also give us the trend in inventories and consumer spending contributions to GDP growth. The latter is what many are pinning their hopes on to see the ‘greenish’ shoots of not the recovery yet, but of a stabilization in the rate of decline. Later during the week we will get weekly jobless claims, April consumer confidence and manufacturing sentiment. Of course, the US consumers got some $200bn worth of stimulus in tax refunds and cost-of-living indexation in Q1 2009. (Clearly, not the case in Ireland, where Government advisers, like Alan Ahearne think it’s a bad idea to help consumers by lowering their taxes – see here).

But offsetting the expected consumer spending stabilization will be capital investment. Although there was some increase in capital spending relating to durable goods in March (see above), capital investment is likely to take another hit in Q1 2009 overall, as January and February saw significant cuts in productive capacity by the US firms. Ditto the residential investment: UBS estimated last week that housing investments contracted 38% in Q1.

My bottom line: given that
• inventories did not contribute much to the decline in GDP growth through Q4 2008, and are now likely to show serious deterioration;
• consumer spending is unlikely to post significant upsides despite personal disposable income increases;
• housing and business investment continue to contract; and
• exports are falling precipitously, while most of imports demand contractions have already taken place,
we can expect a 4.9-5.2% fall off in Q1 2009 GDP.

Good luck hunting when the markets open today.

Friday, April 24, 2009

Daily Economics 25/04/09: John McGuinness & Alan Ahearne

For my comment on John McGuinness' story, scroll to the bottom.

Alan Ahearne, the newly minted adviser to the Government, has gone into an overdrive mode, tackling the 20 dissenters (including myself) who dared to challenge NAMA as a taxpayers' nightmare waiting to happen (in the Irish Times: here) and striking at criticism against his masters in the Leinster House (Irish Independent report today: here).

Per Ahearne's musings in the Times
It is indeed sad to read an article that so flatly denies itself a chance at having an argument, as Alan's treaties on What's wrong with nationalization. Alan spent some time studying our earlier Times piece (see more on this here), but it is also obvious that he had hard time coming up with arguments against its main points.

Let us start from the top.

"The recommendation that nationalisation of the entire Irish banking system is the only way we can extricate the banks and the economy from the serious difficulties we are experiencing risks diverting the debate away from issues that are much more central to the success of the ...Nama proposal." Alan follows up with a list of such 'central issues' from which our article was allegedly diverting the debate. Alas, all are actually covered in our article. As an aside, we never argued for nationalization of "the entire banking system", but of the systemically important banks alone.

"As in other advanced economies, bank nationalisation is seen very much as a last resort." Our article states that: "We do not make this recommendation from any ideological position. In normal circumstances, none of us would recommend a nationalised banking system. However, these are far from normal times..." We clearly were not advocating nationalization as some sort of a good-fun measure.

"It is important to recall that there is an overwhelming international consensus that the so-called good-bank/bad-bank model on which Nama is strongly based presents the opportunity for achieving an enduring long-term solution to the banking crisis." Actually, there is no such 'consensus'. And even if there was one, just because many other Governments have been working with this specific model does not mean that (a) the model actually works, (b) Ireland should follow in their footsteps and (c) this is the best option for resolving the crisis. The model does not work, as in the US, for example it has managed to absorb vast resources (which Ireland does not possess) and had come under heavy criticism as not delivering.

The fact that Ireland should not blindly follow in others footsteps is apparent. But it is also rather amusing, for the Indo (see below) reports today Alan's own insistence that we should not follow the US in stimulating our economy. No tax breaks to the suffering workers, says Alan, because we are different from the US in fiscal policies. NAMA and no nationalization, says Alan, because we want to follow the US lead in financial markets policies. Same Alan, two divergent points of view...

"One of the main issues identified in the article is the need to restore bank lending. This is a central objective of the Nama initiative. Nationalisation, on the other hand, creates a significant risk of undermining the capacity of the banks to raise funds internationally for domestic lending." Two things worth mentioning.
  1. Alan clearly contradicts here his own statement that our article risks 'diverting' national attention from the core issues relating to NAMA. Obviously it did not: restoring bank lending is "a central objective of the NAMA" (per Alan) and it was identified in our original article as "one of the main issues".
  2. The argument that nationalization undermines banks capacity to borrow internationally is a pure speculation. Firstly, our banks have little capacity to borrow internationally as is. Secondly, when they regain such capacity their ability to do so will be underpinned by public guarantees. Third, why a state-owned (and thus a fully state-insured) bank wouldn't be able to borrow from other banks and the markets? What would prevent, say London- based investors buying BofI bonds when these bonds carry a much stronger default protection under state guarantees than the one afforded to them by the half-competent current management?
"Investors would surely give the Irish market a wide berth in the future – not just in the banking sector – if the State undertook such an extreme step." No they won't, Alan. Banks and public finance in Ireland are in a mess. Investors have already priced these factors in. The markets understand the difference between a healthy, albeit not necessarily extremely profitable company like Elan or CRH and the nationalization-bound banks or economically illiterate Exchequer policies. Such are the basics of investment markets.

Nationalizing banks with clear privatization time line and disbursing privatization vouchers to the taxpayers will send strong signals to the markets that Ireland is:
  • serious about the banking crisis;
  • ready to support household balance sheets in crisis;
  • can creatively stimulate its economy without destroying it fiscal position;
  • will not waste privatization revenue in a gratuitous public spending boost, thus supporting long term fiscal health; and
  • will have a transparent and fixed downside on its banking rescue commitments (i.e no repeated rounds of post-NAMA recapitalizations).
Which one of these points contributes to the international investors shying away from Irish stocks?

"It is difficult to see a credible exit strategy from wholesale bank nationalisation." Read our article on the topic in Business & Finance magazine, Alan. Also, the original Times article, stated in plain English: "...nationalisation offers an opportunity, should the Government see such a need, to share directly with the taxpayers the upside in restoring banking sector health. Such an opportunity could involve a voucher-style reprivatisation of the banks and could be used to provide economic stimulus at a time of scarce resources, at no new cost to the exchequer." So no real mystery as to how a credible exit strategy can be devised, Alan.

But NAMA without nationalization offers no exit strategy at all (credible or not). In fact, it offers no strategy for ending the rounds of repeated bailouts of the banks either.

"Under the Nama initiative the taxpayer is protected from unforeseen losses through the Government’s commitment to levy the banks for any losses incurred." This is simply wrong! Once NAMA owns the assets, what recourse onto banks will the state have should the quality of the assets bought fail to match the price paid? As far as I can see - none. But under nationalization, the state owns all - good and bad assets, and it can price these assets on the ongoing basis as more information on the quality of loans arrives.

"The State has already, under the recapitalisation programme, potential for benefiting from the upside in terms of the recovery in the share prices of the two main banks. The State has an option to purchase at a very low price 25 per cent of the existing ordinary shares in Bank of Ireland, and will soon have a similar claim on AIB." I am sorry, Alan, the 25% shares in BofI and AIB relate to the €5bn that we, the taxpayers have already paid for these banks recapitalization. These shares are wholly independent from NAMA liability and from the future liabilities we will incur under NAMA-triggered second round of recapitalizations. Whichever way you twist it, Alan, the state will have to spend additional cash buying the shares of the banks after we have paid for NAMA!

About the only statement in the entire article I find myself at least in a partial agreement with is: "Empirical evidence strongly suggests that private banks perform better than nationalised banks. International studies have shown that too much “policy-directed” lending by wholly state-owned banks has retarded economic growth. The simple truth is that nationalisation creates a significant risk of a political rather than a commercial allocation of credit." However, the problem here is three-fold:

  1. NAMA is at the same, if not even the greater, risk of becoming politicised;
  2. Banks are going to be majority state-owned post-NAMA (if only at double the cost to the taxpayers), so Ahearne's musings do not resolve the problem he posits; and
  3. We are not in the normal times when empirical evidence holds...
we are in a mess! and Alan's confused rumblings on the topic illustrate the extent of this mess well enough for me.

Per Ahearne's economic policy musings in the Indo
US-styled fiscal "stimulus wouldn't work well anyway in a small, open economy, and, of course, the budget position is such that it just doesn't allow it," Dr Ahearne told Engineers Ireland conference.
Of course he is right on this, but him being right on the technicality does not mean that:
  • It is right to raise taxes on ordinary workers and businesses, as the Budget did, amidst the recession;
  • It is right not to cut public spending by an appreciably significant amount, as the Budget did;
  • It is right to continue awarding public sector wage hikes, as the Government is doing with consultants;
  • It is right to rely on senile plans for Irish-styled 'stimulus' that will waste money on unproven projects, as the Government did;
  • It is right to continue resisting reforms of the public sector, as the Government is doing.

Ahearne further said that 'if the US and the global economy improves next year and Ireland continues to get its public finances in order, then Ireland would be in a position to make a "strong recovery"'. Really, Alan? How so? Through a miraculous return of Dell jobs, Google engineers jobs? Waterford jobs? Tralee jobs? By reversing our losses in exports competitiveness? By scaling down the atrociously high cost of doing business here? Dr Ahearne is so far removed from reality of economic environment that he believes the entire economy can be rescued by the IDA efforts alone?

"Ireland is regaining its competitiveness "very quickly" because of rapidly falling wages, he said", as the Indo reports. "Of course, those declines are painful but they will price a lot of people back into the labour market and, therefore,they are setting the foundations for the recovery." This amazingly callous statement comes from a person who is secure in his own public sector job with high salary. It also comes from an official of this Government.

Wage declines have been borne out by the private sector alone, Alan. Unemployment increases have been borne by the private sector alone, Alan. And most of the real income loss to those still in the jobs has come courtesy of your masters policies - the Budget. How is this restoring any sort of competitiveness vis-a-vis other economies where the Governments are putting in place tax cuts?

Here is a lesson that Dr Ahearne failed to learn in all his years of studying economics:

  • Higher tax rates amidst the most generous welfare system in Europe mean that marginalized workers will not have an incentive to return to the labour market.
  • Higher taxes in a restricted labour market (with high costs of hiring and firing workers and high minimum wage rate) hamper jobs creation.
  • Higher taxes on already debt-loaded households mean that more and more families are facing the ruin and precautionary savings are rising, reducing our internal economy growth potential.
  • But most importantly, higher taxes on human capital mean that productivity growth is going to be constrained for years to come.

It is that simple, Alan, any recovery will require productivity growth in this economy outpacing the cost of living rises and the cost of doing business growth. Your policies have just hiked the latter by some 10% - courtesy of taxes and levies increases in the Budget, while restricting productivity growth by failing to provide any real support for businesses or incentives for workers to get off the dole. You are travelling in exactly the opposite direction to the one that has to be taken if we are to get productivity-driven recovery.

John McGuinness' appearance on the Late Late Show tonight was a logical conclusion of months of pinned up rage that this country is feeling toward the Cabinet - and primarily to Mr Cowen, Mr Lenihan and Mrs Coughlan - towards the public sector at large and towards the scores of mostly nameless, faceless (but sometimes publicly visible) 'advisers' who have systemically destroyed the prosperity of this country and its chances of coming out of the recession as a competitive and growth-focused economy.

McGuinness avoided offering direct examples of gross incompetence and outright insubordination that are so often exemplified by some of our public sector departments and quangoes. This was his choice, but the country needs to know of these acts and it needs to know the names of those who carry on their duties in such a manner. He also avoided placing the blame for the mess we are in where it really belongs, at the feet of:
  • the participants in the Social Partnership that managed to squander billions of our money to finance wasteful 'investment' and social cohesion programmes and to set this economy into the rigid infrastructure of inflexible labour laws, senile minimum wage restrictions, mad political correctness and corrupt local governance. Some of the Social Partnership members were the reluctant parties to this outrage - brought in under the threat of union violence against businesses and entrepreneurs. Others made it their life-long ambition to get their organizations to the feeding trough. Roles of all should now be questioned and the entire Partnership model must be scrapped;
  • the Government that has for the last 6 years chosen to take no serious policy action to reign in its own employees and their unions and that has retained inefficient and often markets-retarding monopolies. The Government that simply bought its way through the elections, policy conflicts and minor reforms;
  • the political culture that promotes mediocrity and punishes statesmanship. Our academic and policy debate systems that promote complacency, competition for public funding, anti-entrepreneurial ethos, social welfarism and provide philosophical and ethical foundations for systematic moral and financial debasing of the taxpayers, wealth creators, jobs providers and consumers, promoting instead the unquestioning support for NGOs, quangoes and public sector;
  • some business elites that, in exchange for state contracts handouts looked the other way as the political and social elites of this country carved our wages and earnings to their own benefits. It is a telling sign of the depreciation of the entrepreneurial spirit in this country that faced with a wholesale destruction at the hands of incompetent (and often outright malicious) policymakers, our business leaders remain largely silent, uncritical of the Government.
This should not be held against the person who has now become the first man from inside the FF tent to voice his honest and informed opinion. Instead, there should be firm focus on completing the task he started - the task of recognizing the fact that we are currently being ruled by the three 'leaders' who have shown over the last year complete inability to run the country in crisis. It is time for us not to ask them to go, but to tell them that they must go.

Blunders of Mary: I would encourage the readers of this blog to submit any publicly documented evidence of Mary Coughlan's incompetence at the helm of DETE or indeed of her incompetence at the previous ministerial appointments.

Here is the first one: on April 2 Mary Coughlan has publicly displayed the lack of knowledge as to the existence (let alone the details) of the new Social Welfare Bill put forward by her own Government and already scheduled for a full debate in the Dail in late April. As the bill provides for adjustments in unemployment benefits and conditions, the bill would be at least partially linked directly to Mary Coughlan's ministerial brief. Responding in the Dail to the question concerning this bill, Mary Coughlan said she had no knowledge of any such legislation.

There was, of course, her infamous failure in the Lisbon Treaty debate (here); and an equally spectacular flop during her tenure as Minister for Agriculture, when an ordinary farmer's question exposed her lack of knowledge concerning her ministerial brief.

She earned herself a nickname of 'Sarah Palin of Donegal' after she told radio listeners on April 11th that Irish shoppers go to Northern Ireland only to buy cheap booze (here). This showed such monumental disrespect for ordinary families her Government has squeezed out of savings, pensions and earnings, that she should have been sacked on the spot for such proclamations.

The rumor mill in the public sector if full of accounts - that are yet to be documented - of her undiplomatic behaviour at foreign missions, outrageous antics at the meetings with international business leaders and arrogant statements in addressing top corporate brass. This is far from being a hallmark of an independently-minded politician - it is a direct result of her gross unsuitability for the position of responsibility that she occupies.

Daily Economics 24/04/09: Euro area forecast and Irish Travel Data

Irish Travel Stats are now available on CSO website through Q4 2008. Charts below illustrate the main trends:

First, domestic travel trends. All categories of domestic travel are in expenditure intensity (Euro spent per night) except for the holidays trips. This represents a departure from the generally upward trend prior to 2008.
However, in line with a small increase in the numbers of trips taken domestically, the overall spending remains relatively well underpinned.
International travel by the residents of Ireland has held up relatively flat or increased for all broader destinations. Length of stay also held up well.
Length of stay abroad has declined (in line with recent trends) for holidaymakers, and has risen - against the previous trend - for those visiting friends/relatives and other categories. There has been a significant increase in the length of stay for business travellers.

The decline in the overall overseas spending by Irish residents travelling abroad has been significant and driven largely by the decline in the expenditure of Irish holidaymakers abroad. Business travellers visiting abroad have reduced their spending only marginally, while other categories of Irish residents travelling overseas have seen a small (insignificant) increase in overall expenditure.
Lastly, considering Irish travellers spending by their destination country, EU15 countries clearly stand out as the dominant spending destination for Irish visitors within the broader EU25 or indeed EU27. Despite or strong connections with Poland and a host of other ECE countries, there is virtually no evidence of Irish residents spending much of their cash in those countries. North America follows EU15 as the most favourite destination for our Euros, with Asia& Middle East managing to outperform Australia & New Zealand in competing for our cash.

Eurocoin results are in for April so the chart below updates my forecast for Euroarea leading indicators and for GDP growth for the Euro area for May:
As you can see, Eurocoin improvements, predicted in March, have indeed taken place, which in my view signals that May is likely to see this leading indicator for growth in the Eurozone climbing higher. However, my longer view is that leading indicators are going to suffer a seasonally adjusted fall-off at the end of Q2, retesting the lows of -0.6. Thus, my forecast for Q2 2009 growth stands at -1.1%.

What's wrong with NAMA

For those of you who missed the latest article on NAMA from myself and Brian Lucey in the current issue of Business&Finance magazine, here is the unedited version.

To date, the prevailing discussion internationally on how to rescue failed banks focused on repairing their balance sheets. This ignores the underlying cause of the problem – the deterioration of their asset base. In fact, in the case of NAMA-type ‘bad’ banks arrangements, the cure compounds the asset base problems.

Two major questions arise in the context of NAMA.

First, we do not know how the assets can be priced in order to align the NAMA objective of repairing banks balance sheets (with an incentive to pay high price for transferred assets) and its duty to safeguard taxpayers interest (requiring the price to be set below the expected risk-adjusted value of the loans total).

Second, we do not know how the impaired assets will be treated under NAMA. One option is to keep them alive as zombie development projects awaiting realization decades from today. Another is to shut them down. Which option will be pursued will, in the end, seal the fate of large scale development land banks and half-baked development schemes across the country. It will also underpin political legitimacy of NAMA. And this is before we consider the fallout from a virtually inevitable future creep of NAMA remit to cover defaulting mortgages on principal residencies, credit cards debts and bad car loans.

Extent of the NAMA-bility

With respect to the first question, the US Treasury Department identifies the bad assets before they are actually fully impaired using financial models that estimate future loan values under different economic scenarios.

Ireland is yet to make even this first step, but currently neither the CBFSAI nor the Department of Finance and least of all the infant NAMA have the capacity to develop and administer such model-based testing procedures. Even after years of operations, CBFSAI have virtually no real expertise in risk management and pricing, while DofF has no real economics, finance and analytical capabilities to oversee a minor credit union, let alone to control NAMA. Thus, ex ante pricing transparency is the only guard the taxpayers have to limit NAMA’s monopoly powers.

So let us consider the loans that are non-performing, stressed or rolled over with little chance of repayments any time soon. Banks provisions for future impairment charges are currently running at ca 4-5%. Independent and even in-house analysts are forecasting that some 12-15% of the entire asset pool of the Irish banks can be under stress by 2010.

In our view, this is a lower bound of the true state as:

  • loans under threat to date will almost certainly remain under threat through 2010;
  • the first quarter of 2008 saw a relatively benign trading environment, so 2009 is going to see even greater rates of impairment; and
  • the economic troubles underlying the rapid asset quality deterioration are set to deepen in 2009.

We know nothing about the recovery rate on these risky assets. But globally, AAA rated CDOs carry the recovery rate of only 32% on face value, while for mezzanine vehicles the recovery rate is only 5%. The default rates on the US corporate junk bonds (which are less risky than Irish development-linked loans due to their higher diversification, liquidity and transparency) is estimated to reach a whooping 53%, with a recovery rate of zero. Given the perilous state of Irish economy, and the extent of the property-related exposure for Irish banks we see as reasonable (or potentially even generous) a 45-50% average recovery rate on the stressed loans. This implies that the expected final losses on the entire 6-banks pool of €165bn in property exposure (ex-Poland) will be closer to 25-30%, or €50bn. For anyone who thinks that this figure is unrealistic, a recent McKinsey study showed, that out of $2 trillion of impaired assets the eventual writedowns may total $1.5 trillion or 67%.

The above loss rate implies that NAMA will be purchasing the impaired assets at less than 28% discount to their face value, should the Government set the price to keep the 6-banks capital ratios at 8% minimum required levels. Such a discount will imply an issuance of €36bn in fresh bonds to the banks, underwriting only €25bn in risk-adjusted assets on NAMA-held €50bn book of loans. The implied expected loss to the taxpayers from such an operation is €11bn in capital cost, plus ca €11.5bn in interest costs for a 5-year bond to be covered out of tax revenue and higher cost of banking.

It is worth noting that these costs of over €22bn for NAMA operations assume that Irish banks keep capital ratios at the required legal minimum after deleveraging their balance sheets. In other words, these losses do not fully insure the banking system against future capital demands.

But 8% capital requirement is now considered to be insufficient for operating a private bank. Instead, markets are demanding a minimum 10% capital ratio, with 12-14% being a golden target. If NAMA were to keep Irish banks private, the recapitalization demand for the 6-banks system due to the NAMA assets transfers will add another €4-8bn in costs to the Exchequer bill.

Note: should NAMA buy into €80bn in loans, as discussed in recent reports, the associated required maximum discount rate will be 23% and the total losses to the taxpayers will be €43-51bn.

How can toxic assets be priced?
Generally, assets on bank balance sheets are valued either at hold-to-maturity value or at fair value. Both frameworks fail in the current environment.

An alternative solution is that the Government can set up a two-stage process of buying stressed assets into NAMA. The first stage will involve a quasi-voluntary scheme that would establish a functional resale market for the stressed loans to be used in the second stage of purchasing.

To do so, the Government should set a basic level of discount on the assets based on the publicly verifiable valuation model. The discount should be fixed on the date of the scheme announcement to prevent future manipulation of the fair value by the banks. It should apply to all systemically important banks regardless of who holds the specific loan or what project it is written against. This will avoid political interference in the pricing of stressed assets.

Loans with interest and principal non-payment of less than 3 months can be sold at a fixed discount of, say 15% (reflective of the current expected default rates), loans with non-payment of 3-6 months can be sold at a fixed discount of 25% (a rate that is more consistent with the US experience and the ECB discount lending criteria). Non-performing loans in excess of 6 months and repeated roll-up loans can be traded at a 50% discount equal to their estimated default risk. This first-stage transfer will remove the most toxic paper off the balance sheets of the banks.

After the first stage establishes quasi-market pricing of the assets transferred to NAMA, the Government can retain the face value discount on other stressed assets, while allowing for some recapitalization support to be given to the banks that need it. The second stage involves using the same discounts on loans as in the first stage with the Government using additional bonds to swap for banks shares to cover some fixed proportion of the discount. In other words, the banks will still sell most impaired assets at 50% discount, but they will have an option to receive a roll-back of say 10-15% of the discounted value in the form of the NAMA taking new shares in the banks. For example, a loan package of €10bn with average non-payment of more than 6 months will be sold to NAMA for €5bn, but the bank involved will have an option to sell €500-7500mln worth of new equity to NAMA at the same discount on the share price as on assets sold to NAMA.

The advantage of this scheme is that the clean up of banks balance sheets will be systematic and non-distortionary.

The disadvantage is that it still saddles the taxpayer with the task of recapitalizing the banks after they take a hit on their capital base under the NAMA. This, however, is inevitable under all possible scenarios for toxic assets removal. In our view, the only real option to avoid the need for endless rounds of recapitalizations is to nationalize systemically important banks outright. Nationalization option will allow the Government to keep capital base of the banks at 8% limit, outside the markets demand for higher capital reserves. In addition, under nationalization NAMA can choose and pick specific assets off banks balance sheets to create a blended portfolio of loans with lower expected default rates.

Avoiding zombie land banks
The second problem with the Government proposal is that we do not have any idea as to how the impaired assets will be treated under NAMA. Upon purchasing the loan, the Government will have an incentive to keep the underlying assets alive as a zombie development projects. This is so because as long as the development-zoned land remains ‘active’ as an investment project it will retain some notional value on NAMA balancesheet, creating an illusion of value to the taxpayer. Of course, much of the existent recent vintage land banks that NAMA will end up holding will cover speculatively purchased agricultural and industrial land with virtually no hopes of being developed in the next 15-20 years.

Another option is to shut these projects down, de-zone the land and either release it into the market as agricultural land or retain it as public-use land. This option implies NAMA writing down the asset value of such land.

In our view, the Government will be wise to opt for the second option, converting improperly zoned development land into a mixture of leasable publicly-owned land (useable for sustainable developments) and commons (for public amenities, such as parklands). Incidentally, our pricing scheme described above incentivises such conversion as most of speculative land banks will fall under the heaviest discounted price category, minimizing the value of the write down and maximizing land rents to be collected on leasable lands.

This process will only be further enhanced by imposing a direct land-value tax on development sites, mentioned in this column in the previous issue.

Box Out: 8 reasons to mistrust ba-NAMA-rama

  1. The potential for politicisation of the property and land valuations, combined with further politicisation of planning and development.
  2. The lack of adequate oversight capacity in the Oireachtas even with the enhanced committee structure.
  3. The lack of transparency in the pricing and valuation process.
  4. The monopoly which it is to be granted on development and land related activity which is backed by lending from Irish institutions. There is a prima facia case here for very careful consideration of domestic and EU competition issues.
  5. NAMA is to be granted portfolios of assets, regardless of whether these are performing or otherwise. Will performing borrowers whose loans are transferred to NAMA injunct such transfers on the grounds of reputational damage?
  6. The skillsets required to manage a fundamentally distressed asset portfolio (NAMA) are lacking not only at NAMA, but across the entire public sector and most of the private sector.
  7. The portfolio approach, where all loans in a portfolio regardless of quality are transferred, leaves NAMA open to mission creep with for example the potential for credit card, or auto loan portfolios being transferred in the future.
  8. Finally, and most important there is the issue of the price to be paid for the assets of the banks.

Thursday, April 23, 2009

Daily Economics 23/04/09: That place called Dublin

Irish Wholesale Price Index, March 2009
Available (here) from CSO: "Monthly factory gate prices decreased by 1.0% in March 2009. This compares to a decrease of 1.6% recorded for March 2008. As a result, the annual percentage
change showed an increase of 4.5% in March 2009, compared with an increase of 3.9% in February 2009. In the year there was an increase in the price index for export sales of 5.5% and an increase of 0.9% in respect of the price index for home sales." So we are not gaining any competitive edge on FX devaluations in exports trade, then. And there is no factory-gate deflation at home either.

In the month Office machinery and computers prices fell 2.1%, and Basic chemicals were down -1.1%. Some multinationals are taking a hit. There were increases in Pharmaceuticals and other
chemical products (+13.1%), Other food products (+11.8%), and Basic chemicals (+8.9%). SO some other MNCs are doing ok, although short-run price hikes can come back and bite these manufacturers. Building and Construction All material prices decreased by 2.4% in the
year since March 2008 and by 0.6% in March 2009. Not enough, if you ask me, and this leads to a question concerning the Government plans to achieve expenditure 'savings' on the back of cheaper capital construction costs... Year on year, the price of Capital Goods decreased by 0.6%, while there was a monthly price decrease of 0.3%.

Of course, our heroic boys of CER/ESB/EirGrid-controlled energy sector are turning out more and more price gauging as "Energy products increased by 3.2% in the year since March 2008, while Petroleum fuels decreased by 23.7%. In March 2009, there was a monthly decrease in Energy products of 0.9%, while Petroleum fuels decreased by 3.8%." Well, table below does show this in indisputable terms...
Is it time to fire CER? In my view, long overdue!

UK Budget

Some in Ireland are making 'happy faces' at the UK Budgetary numbers released yesterday. The UK forecasted that the General Government Deficit will reach 12.6% in 2009 - some 1.85% points above the 10.75% GGD built into Irish mini-Budget of April 7. A catch here is that I personally do not believe the Irish figure, having predicted (here) that our GGD will reach 12.5-13.0% this year - right about where the UK is placing its own expectations.

Going on with the misguided cheerleaders, today's Davy note says: "Moreover, gross debt to GDP is set to remain much higher in the UK than in Ireland." Hmmm... that is true only when it comes to direct public debt, excluding such 'trivialities' as financial sector commitments and guarantees (which total $641bn or 280% of our GDP in Ireland and only $375bn or 13.4% of the UK GDP: see here). Oh, yes, of course, some of the moneys on both sides of the Irish Sea is going to count as 'investment' on public balance sheet, but to you, me and the rest of the productive economy there is no difference - we will be paying the price in our taxes, investment or not. And the cheerleaders are forgetting another small point - Ireland's total debt (public and private) is actually much larger than that of the UK (see here, and the chart below - from here).
Now, I know I won't be welcomed by Davy in years to come for pointing this out, but Reality Bites!

Just to be fair, though, Davy also say that "Gross debt is a different matter: recapitalisation funds that need to be borrowed affect this metric. So the projected gross debt ratios will be quite fluid". Yeah, so fluid that we'll need buckets, not shovels to get that NAMA mess under control. UK liability under banks recaps is likely to be ca 10% of their overall guarantees commitments - taking into account the already substantial paydown of funds and the maturity of the downturn over there. So take it to be $37.5bn. Ireland's commitments are going to be around the same percentage share, or $64.1bn, of which only $9.8bn has been paid down so far. In the mean time, Ireland's benchmark yields on Gov bonds are in 420bps territory, UK's - 237bps. Shhhh... don't say it out loud, but it does look like Ireland's advantageous debt position, relative to the UK, is a quagmire. And no, this stuff is not simply 'academic'. Financing our 'low debt' position will cost us €1.83bn in interest expenditures pa. Financing the UK's 'perilous borrowings' will cost them €635mln per annum. Doughhhhh, as Homer would say it, all is grand in the Davy-world of voodoo economics...

Regional subsidies
Yesterday, ESRI published an interesting article: Who is paying for regional balance in Ireland? (available here). It is a worthy quick read if only for one reason - after hearing continuously the whingeing that passes for regional economic policy in this country and the anti-Dublin biases out in the country-side, the article puts few facts straight.

"...real resource transfers per head of population (i.e., the per capita excess of expenditure over revenue), have increased over time. In other words, redistribution across regions has increased over time. These transfers tend to flow from richer to poorer areas – a large negative correlation between the implied transfer of resources and real per capita gross value added. ...Expenditure is positively correlated with real per capita output (Gross Value Added), but tax revenue is even more strongly correlated with real per capita output, implying that the fiscal system operates to transfer resources from richer to poor regions."

Put in real (as opposed to ESRI's) terms, this means that few productive parts of the country are subsidising numerous less productive ones. Is this a good thing? Well, no.
  • First, such subsidies distort returns to personal capital (physical and human) of those who receive them. In other words, people living in the parts of the country that are the 'gateways to excellence' are ripping off their productive compatriots while being deluded into believing their work actually adds value. It does not, at least not in a competitive way.
  • Second, the transfers diminish the productive capacity of those who live where real jobs are located.
  • Third, the subsidies continue to perpetuate the already extensive destruction of the country-side as extensive means of production are being subsidised over intensive economy.
"Overall, Dublin and the South-West region are substantial net contributors. For example, in 2004 both Dublin and the South-West contributed just over €2,000 per person while in the same year the Midlands region received a transfer of just over €3,000 per person." This is nice. As a person living in Dublin, I am apparently sending some €6,000 of my family income to the Midlands. This means that my 1,100sq ft Dublin city household is paying for some folks living in average 2,000 sq ft houses in the middle of nowhere. But should I choose to avail of the landscape and natural amenities that my money is paying for out there, I just might get a shovel-pat on my back from the subsidies-receiving locals. Hmmm...

"In 2004 just over €3 billion were transferred from the ‘net surplus regions’ Dublin, South-West and Mid-West to the other regions. Overall the tax burden (including social contributions) averages at €11,000 per person in 2004 with a high for Dublin of almost €14,000 per person and a low of €8,500 per person in the Midlands." Yes, this does account for those Midlands inhabitants working in Dublin too, so no arguments about 'We work in Dublin, so we are productive too' apply.

"In per capita terms ...Dublin is not favoured when it comes to capital expenditure. Indeed no clear pattern of ‘excess’ per capita capital expenditure can be detected in the data." In other words, we are building capital infrastructure stuff in the middle of nowhere.

But ESRI would not be itself if there was no voodoo of socialist economic dogma in the article somewhere. This comes at the end: "The finding that the system provides a significant degree of regional equity is largely the result of the centralised nature of revenue collection in
conjunction with the aim to provide similar levels of service across the full range of government activities in all regions. In order to achieve a similar level of equity with a less centralised system would require a more sophisticated system of fiscal equalisation payments across regions. Thus, while many have argued that the Irish system is too centralised this centrality turns out to be an asset in terms of achieving regional equity."

Run this by me again, please! 'Equity' apparently happens when younger and more productive workers of Dublin and South-West are paying older and less productive workers in the rest of the country? 'Equity' also means that we must achieve 'fiscal equalisation payments across regions'. This is the same economic illiteracy that argues that Sub-Saharan Africa can achieve growth by taxing the developed world.

One thing that was lacking in this paper, and indeed is lacking in overall research on regional transfers is how much more dependent on subsidies are specific areas. One that comes to mind is the area covered by the patchwork of various Gaelic ethnic enclaves sponsored by the Government. Another one - the patchwork of useless 'gateways' we have created across the country.

Yes, folks, ther eason we are forced to accept gang crime in Limerick and parts of Dublin, roads gridlock in the capital, lack of proper public transport, poor broadband services, horrific quality of landline phone services, overstretched schools and universities infrastructure in Dublin and the rest of the mess we call urban living in the Capital City is because we want 'equity' and 'equality' between those parts of the country that work and those that collect subsidies. Regional policy indeed...

Wednesday, April 22, 2009

Daily Economics 22/04/09: IMF's GFSR

IMF's Global Financial Stability Report (available here) is a lengthy read worthy of attention, both for its finance world-view and a diplomatically correct version of the 'Office' comedy. Subtle language turns tell more of a story of IMF's desperation from looking at APIIGS' incompetent macroeconomic management than the direct phrases. That said, there is little in the report, aside from two tests of financial contagion, that is either new or forward-looking.

"The United States, United Kingdom, and Ireland face some of the largest potential costs of financial stabilization given the scale of mortgage defaults."

Emphasis on the word 'mortgage' is mine, of course, added precisely because the IMF concern has not been, to date, echoed by many Irish economists or banks. In fact, all Irish banks currently assume that mortgage defaults will not happen. Instead, policymakers (via NAMA and debt issuance), bankers (via impairment charges and recapitalization funding) and economists (via RTE / Irish Times opinion pages) have been preoccupied with 'toxic' assets (development loans). Poor households have largely been left out of the 'They deserve help too' circle. The Government actually is so confident that mortgage defaults will not be a problem, that it is taxing households into the recession. As I have noted before, this presents a problem - should inflationary pressures rise, interest rates will regain upward momentum and Ireland will be plunged into a mortgages implosion.

How costly are Lenihan's commitments?
Moving on, two illustrations from the IMF report are worth putting together: First, the sheer size of the so-called 'costless' (Brian Lenihan's grasp of economics), guarantees written by Ireland Inc on our banks:Second, the real-world cost of these guarantees...I've identified this link between the throwaway promises Irish Government has been issuing since September and the cost of our debt before. It is nice to see IMF finally saying the same: "Figure 1.37 highlights that the spread on the issues guaranteed by sovereigns perceived as less capable of backing their guarantee is wider than for those that are deemed well able to stand behind their promises, such as the United States and France."
But here is another proof of the link between Brian Lenihan's guarantees and the cost of these to you and me:
Note the coincident timing: September 2008, and spreads on Government debt shooting through the roof to reach banks bonds spreads and trending from there on side-by-side to Anglo's Nationalization (another spike), then to recapitalization (a slight decline)...

Go long, not short...
The IMF advises the Governments to switch debt issuance to longer term maturities. Exactly the opposite is the strategy adopted by the Irish Government that has launched increasing quantities of new 3-9mo bonds into the markets. "...Authorities should take the opportunity of the currently low level of real long-term yields to lengthen the maturity of issuance where possible to reduce their refinancing risk," says the IMF, implying in simple terms that you shouldn't really pile on short term debt at the time of a prolonged crisis.

For all its faults, even the IMF knows that you can't run the country on the back of credit card debt. But Brian, Brian & Mary wouldn't have a clue, would they? All their experience relates to managing a cash cow for the public sector unions that is our public purse.

Shock scenarios
More interesting stuff is in the IMF's modeling of financial shocks: Scenario 1 (pure credit shock with no fire sale of assets - more like a situation in the US in recent months) v Scenario 2(credit shock with fire sale of assets - a more relevant case scenario for the likes of AIB). Here are the results of the latter test:
In scenario 2, Australia shows 7 double-digit responses to shocks to other countries' financial systems, Austria, Italy, Portugal, Sweden & UK 6; Canada, Japan, Spain & US 5; France 8; Belgium, Germany & Ireland 9; The Netherlands 12; Switzerland 13. This hardly supports an assertion that we are driven by external markets crises in our own financial sector to any exceptional degree. Yes, we are less exposed than Switzerland and the Netherlands, but we are way more exposed than the many other countries.

The table below (it is the same table that was reported by me in December 2008) shows that we have the second highest (after Luxembourg) ratio of Bonds, Equities and Banks Assets to GDP in the world - a whooping 900%!

Furthermore, Table 23 provides some amazing evidence: Banks Capital to Assets in Ireland stood at only 4.1% in 2008, down from the high of 5.2% in 2003. Only Belgium and The Netherlands have managed to get lower ratio in 2008. Irish Central Bank actually provided these figures to the IMF and yet the CB has managed to do precious nothing to correct the steadily deteriorating capital ratios throughout 2003-2008 period. This, presumably is why we pay our CB Governor a higher salary than the one awarded to his boss, the ECB Chief.

So the 'comedy' part now being played in Dublin has a simple scenario that IMF, with its diplomatic mission, will not reveal to us, but that is visible to a naked eye though the prism of the IMF report:
  1. Incompetent state regulators (CBFSAI and more) get golden parachutes for damaging the financial services sector and the economy;
  2. Incompetent and greedy politicos are shielding their unions', banks' and developers' cronies from risk and pain caused by (1);
  3. The ordinary people and businesses of Ireland are paying for (1) and (2).
And the markets still show willingness to powder this charade with 110% bids cover on Irish Government bonds? For how long?