Thursday, July 15, 2010

Economics 15/7/10: IMF Article IV CP on Ireland: part 2

This is the second post on the IMF's Article IV consultation paper for Ireland. (The first post is available here).

Several issues, previously stressed by this blog have made their way into Article IV – a good sign for those who read these pages regularly, and bad news for the Government. Emphasis is mine, throughout.

21. Given the sharp increase in leverage, this will be a drag on the pace of recovery. In order to achieve the required internal devaluation, some fall in Irish prices is necessary. However, in the transition to lower price levels, deflation will slow the pace of recovery. The debt of households and businesses, fueled by the low real interest rates before the crisis and with unchanged nominal values, has now to be repaid in an environment of falling prices, higher real interest rates, and low GDP growth rates. These factors lead staff to conclude that the normally-sharp bounce back to close the output gap after a large output decline will be muted on account of the deflationary drag.

[Let’s revisit the above comment of mine about the shocking state of economics understanding amongst the Irish ‘authorities’ (see the first blog post on Article IV paper). If the Irish authorities disagreement with the IMF on deflation is correct, then surely the state can drive up inflation in sectors it controls to the full extent of inducing deflation of our debt. No need to worry about, as the IMF does, about the adverse effects of deflation on debt sustainability. Alas, the IMF is much more sophisticated in its analysis. The Fund understands that in order to deflate our debt, Ireland will need inflation in capital goods and consumer goods. Not in state-controlled and economically unproductive services and sectors, such as health, public services, public transport, energy, etc. Inflation, you see, is not the same across all goods and services, contrary to what our economics bureaucrats might think.]

[Page 15 of the report shows two very good charts, similar to what I’ve been posting before. Irish households’ debt roughly, per IMF estimate, is ca 215% of our net disposable income, while Irish corporates’ debt (ex banks and financial corporations) is ca 160% of our GDP. Now, recall that our corporates are our GNP, which is roughly 24% below GDP. By both measures we are more leveraged than Spain and Portugal! We are, per these charts, darn close to being insolvent as an economy. But of course, there is not a peep from the IMF about Government programmes for addressing this core problem. For a good reason – there isn’t such a programme. Instead we have denials from all official sources that debt insolvency might be even an issue here.]

22. As banks emerge from the worst phase of the crisis, they remain weak. While capital ratios of the eurozone banks have risen since the crisis, they have declined for the large Irish banks. Banks’ reliance on wholesale funding—and, hence, high loan-to-deposit ratios—has yet to be corrected significantly. The ratio of nonperforming loans (NPLs) to all loans increased from ¾ percent at end-2007 to 9 percent at end-2009 and can only be expected to increase further, particularly if rescheduled loans fall into arrears. In the meantime, the ability to provision for these NPLs has declined sharply.

[Now, let me see. We, the taxpayers, have been taken to cleaners by the bank rescue measures. Something almost the size of our annual national income has been committed by the Government to underwrite the banks – from the implicit expected liability on the Guarantee to the explicit cash injections. Just this week our Taoiseach has gone as far as tell the banks: “Burn cash away, should you need more, we’ll give you as much as you need”. And for all that, the banks “remain weak”.

And notice the IMF statement on expected losses on loans. We are now beyond 9% (as of the end of 2009) and closer to 12% by the end of H1 2010. Recall that our Nama and Government assumed just 9 months ago – in October 2009 – that the banks losses will be on par with those experienced in the UK in the early 1990s – aka 10%. We are past this number already and the banks ‘remain weak’. In what book do these outcomes constitute a successful policy response? Stage three of the banking crisis, per IMF warning, is looming if ‘rescheduled loans fall into arrears’. In other words, all the toxic loans on the banks books back in 2007-2008 that were rapidly re-negotiated by the end of 2008, many of these ‘new’ loans come to the end of the repayment holidays and interest only periods and fall due for recovery around the end of 2010-2011. When these loans tank – and there is really no reason for them not to – the arrears will shoot up. Ask yourselves the following questions – are those billions committed to BofI and AIB and Nama taking into account those possible defaults? Not really. Why? Because for now, until the recovery begins, these are performing loans! So in real terms, the banks are not just ‘weak’ as the IMF says. They are potentially gravely sick.]


[But just how gravely ill are the banks? The IMF says the following:] 23. Liquidity pressures remain serious. The authorities estimate that over €70 billion (44 percent of GDP [or 55% of our annual national income]) of banks’ obligations will mature by September this year. …Irish banks have also been heavy users of ECB liquidity facilities. The stock of retail bank deposits has been either flat or declining.

[This is pretty dire, if you ask me. As noted by me on many occasions before, our banks are close to being the most over-leveraged in the entire developed world. So they are in the poor state when it comes to solvency issues. As the IMF above states, and many other sources – from BIS to many Irish observers, including myself – confirm: Irish banks are also illiquid. That’s like a patient who is brain dead and has no pulse. Dare to call that a corpse? I am no medical specialist, but something tells me that some shock therapy – Significant bondholders haircuts? National cash for equity swaps on massive scales? Debt for equity conversions with deeper haircuts on lenders? – is needed here.]

[But do recall that by now every Government Minister and almost every Governing Coalition TD have gone out on the record telling us that Nama will restore credit flows in the economy. Of course, people like myself, Brian Lucey, Karl Whelan, Peter Mathews, and a number of other observers were saying that this won’t happen. The IMF has said the same before. This time around on page 17 the state: “…staff analysis was cautionary regarding the ability of the banks to lend for a recovery.” And then on pages 18-19: “deleveraging to reduce the loan-to-deposit ratio and banks’ risk aversion will likely constrain lending and the pace of economic recovery, at least in 2010–11. Higher than expected losses, uncertainties in global regulatory trends, and renewed financial market tensions—that may restrict access to funding—create downside risks. In this environment, targets for SME lending, which have been imposed on two major banks in 2010–11, could have adverse effects on credit quality and hence require strong prudential safeguards, as the nonperforming loans of this sector have grown rapidly.”]

[Oh, my goodness, is that the IMF warning that politically motivated targets the Government has imposed on the banks for lending out in this economy might be… hmm… damaging to the banks objective of repairing their balancesheets? Indeed the Fund is concerned. As should be Irish taxpayers. After all, the taxpayers have been repeatedly and routinely deceived by the official statements as to the expected outcomes of Nama and banks recapitalizations despite having been warned by independent economists and bankers that their claims concerning restored credit flows will not materialise. Anyone to take responsibility for that?]

28. … Governance of NAMA is strengthened by its independent board. However, given the government’s large presence in the property market, implementing the provisions for the oversight of NAMA’s operations, is vital.

[Clearly, the IMF is concerned that outside of the main board of Nama, the structure itself is not provided with sufficient oversight, transparency and/or accountability. This is not surprising. Core Nama decisions-making committees are rigged up so as to exclude all and any external independent participation. Nama operations will have a limited and not subject to FOI ‘oversight’ only ex post the operational decisions are implemented. Nama strategy and decisions will not be subject to ex ante or contemporaneous oversight of anyone, save for Nama staff itself.

[It is also interesting to note that the IMF report makes absolutely no references to specific policies aimed at restructuring banking operations in the main two Irish banks. Paragraph 31 does attempt to pay lip-service to Government efforts to “reshape the system” but it so miserably fails to note a single implemented ‘reshaping’ measure adopted that it makes it clear that there has been no meaningful change in the ways Irish banks operate. This contrasts with more robust actions on the regulatory reforms side – paragraph 32.]


[Paragraph 34 is the ill-fated section of the report mistakenly identified by the Irish press as an endorsement of the idea of banks levy:] 34. To complement regulatory safeguards, and to reduce and meet the costs of future crises, a financial stability charge could be contemplated.

Such a charge would have two elements. A risk-adjusted levy, tied to a credible resolution mechanism, would provide resources for a resolution fund to be used for future crises. A financial activities tax, levied on the profits and remuneration (of senior executives) would represent a fair contribution from the sector to general revenues but also serve the purpose of reducing the sector’s size and, hence, its systemic risk. Such tax measures remain controversial but are being contemplated in a number of other countries. The authorities noted that Ireland would be guided by the evolving international practice and these initiatives may need to be deferred until more normal conditions apply.

[So let us summarize the argument here: the levies can be contemplated (not a ringing endorsement by the Fund of the idea) and their introduction will lead to a reduced size of the banking sector in the economy.

The latter, of course, would reduce banks’ ability and willingness to supply credit, thus limiting leveraged investment and growth. Now, that might be a fine objective to set for the future, but… how does it square off with the fact that we already have too constrained of a credit supply in the economy which, per earlier IMF statements, is choking off the recovery? Do you sense a contradiction here? I do.

Irish Times folks don’t. Actually, they can't even exactly reflect what the report says. Hence in today’s paper: “The Government should introduce a tax on senior bankers’ pay and bank profits to help reduce the risks the financial sector poses to the economy, according to the International Monetary Fund (IMF).” I failed to notice where the IMF says the Government ‘should introduce a levy’…

More from Irish Times: “It notes, however, that implementation of such measures may need to be deferred until more normal financial conditions apply.” Opps… it was the authorities – as in Irish authorities, not the Fund staff – who stated this to the IMF, as the above quote from the report itself clearly states.

In short, there is no ‘should’ to the banks levy, just ‘could’… which of course may mean that the Irish Government also could do a number of other things, some palatable in a civilized society, some not. Could does not equate to should, unless you are on a preaching podium, such as the Irish Times.]


More to follow, so stay tuned...
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