Wednesday, September 29, 2010
The latest data from CSO today shows that my predictions are turning out to be right.
Per CSO (emphasis is mine): "Comparing July 2010 unadjusted sub-indices with July 2009 shows that:
- Milk, potatoes, sheep, vegetables, cattle and pig prices increased by 38.0%, 32.4%, 17.8%, 3.0%, 2.9% and 2.2% respectively, while cereal and poultry prices decreased by 28.9% and 2.8%.
- Energy prices increased by 15.5%, while seeds, feeding stuffs, fertilizers, plant protection products and veterinary expenses decreased by 9.3%, 8.1%, 5.2%, 0.9% and 0.1% respectively.
- increases in state-controlled inputs prices and
- deflation of wages,
In monthly terms, unadjusted output prices in July were:
- Milk down -0.1%
- Cereals no change
"On a seasonally adjusted basis there was a monthly decrease of 5,400 in the Live Register in September 2010. The number of persons on the Live Register now stands at 442,417 which represents an annual increase of 22,563 (+5.4%) in the unadjusted series. This compares with an increase of 30,198 (+6.9%) in the year to August 2010."
It is worth noting that the latest decline in the LR is not a "new event", in so far as there have been other events of declining LR (mom in seasonally adjusted series). It will require more than 1 month move down to establish any sort of confidence about the underlying trends reversals:
In terms of weekly and monthly changes, the latest results are certainly welcome:
But the underlying causes of the decline in LR are certainly continuing to point to further pressures in the job market. Per CSO (comments and emphasis are mine):
"In September there were 39,960 new registrants on the Live Register, which compares with 36,194 in the previous month [new registrants to LR rose significantly month on month in September, implying clearly that decline in overall LR was not driven by improvement in the labour market, but by exits from LR by workers who run out of benefits].
"New registrants consisted of 16,952 JB claims (42.4%), 21,276 JA applications (53.2%) and 1,732 other registrants (4.3%). It should be noted that the number of new registrants is not the same as the overall change in the number of people on the Live Register which is affected by
closed claims and the movement of people between schemes. [It is also worth noting that training schemes increases imply reduced LR, but hardly lead to actual jobs gains]
"On average 9,990 new registrants joined the Live Register each week in September, comprising 5,905 males (59.1%) and 4,085 (40.9%) females. By comparison, in March 2010 9,935 new registrants joined the Live Register each week, consisting of 6,340 males (63.8%) and 3,595 (36.2%) females."
These trends - reflecting in my view exits from LR, rather than new jobs gains - is reinforced by the data that in September there was a monthly decrease of 2,412 (-3.1%) in the number of non-Nationals on LR, which suggest strong outflow of workers due to net emigration.
Implied unempoloyment rate now stands at 13.7%, down from 13.8% in August.
This means I will not be changing my forecast for Q3 unemployment to reach 13.9%.
Tuesday, September 28, 2010
First raw data:
Actually 98.8% close. But recall, QNHS is quarterly, LR is monthly, so what about average quarterly numbers for LR and QNHS?
So 99.2% close.
"The Irish government will reveal the full horror of the cost of rescuing Anglo Irish on Sept. 30. It has already signaled bad news for the 2.5 billion euros of subordinated debt, but it is desperately trying to draw the line and support the 14.1 billion euros of senior debt.
"It's cosseting the bondholders because it fears further damage to its own creditworthiness if it walks away. But if the Anglo bill is as big as outsiders fear, its support will have the opposite effect. Even as the Irish prime minister talked on Sept. 28 of a "manageable plan," the spread on Irish sovereign debt widened to a record 475 basis points.
"The last official estimate of the rescue bill, 25 billion euros, looks hopelessly optimistic. Ratings agency S&P estimates it at 35 billion euros, while BarCap says 48 billion for the sector, or over a quarter of Ireland's 163 billion euro GDP. [My own estimate of 38.6bn on the upper side is now patently below external consensus, despite being branded 'outrageous' and 'outlandish' by several insiders in the past]
"The Sept. 30 statement is expected to contain a best estimate and a worst case. If the best estimate is near S&P's figure, further downgrades of Ireland's sovereign debt are likely. However, if the government were to abandon the senior bondholders, the saving -- equivalent to a tenth of Ireland's GDP -- would give the state the chance to work its way out of its economic hole."
Here we have: S&P, RBS, Barclays, Reuters, WSJ, FT, Sunday Times (Irish edition - hat tip to F.F.) and all genuinely independent analysts are now saying - shave the seniors, burn the subordinates. Government still resisting. For how long can it afford demolishing our own economy to prolong the inevitable?
Monday, September 27, 2010
- Are business owners generally more or less financially conservative than their non-business-owning counterparts?
- Do business owners accumulate more wealth?
- Do business owners hold a smaller share of their financial assets in risky stock holdings?
The study: BUSINESS OWNERS, FINANCIAL RISK, AND WEALTH by Tami Gurley-Calvez Bureau of Business and Economic Research Department of Economics College of Business and Economics West Virginia University (July 2010 (link) Ewing Marion Kauffman Foundation)
The motivation for these questions is straightforward: “If households that own businesses are investing more heavily in relatively safe assets, then policies that reduce financial risk (such as the availability of high-yield certificate of deposit accounts) might spur business ownership among high ability households with lower risk tolerances. Alternatively, business owners may not view their ventures as risky due to asymmetric information or perceptions of their projects. In this case, policies that facilitate the ability to assess the profitability of business ownership, such as a transparent patent process and systems of regulation and taxation, would be better suited for promoting growth in business ownership.”
Results indicate that business owners are
- financially conservative based on borrowing and savings questions
- but are more likely to be willing to assume above-average risk for financial gain,
- consistent with other studies findings that entrepreneurs save more, business owners accumulate more wealth over time;
- however, business owners and non-business owners invest similar shares of their financial portfolios in safe assets.
So business owners are more risk averse in their own business ventures, but are about as risk averse in terms of their investment portfolios allocations as the rest of us.
“Taken together, the results suggest that policies aimed at increasing business ownership should focus on helping households identify high-value business opportunities through transparent tax, legal, and regulatory systems. Efforts to reduce risk should focus on the business venture, such as full loss offsets, rather than focusing on reductions in other financial risks.” (emphasis is mine).
Some interesting factoids that the study throws:
- A massive 12.26% of US households own businesses.
- Business owners are underrepresented in the lower income categories, making up about 3% and 5% of the lowest and second-lowest income quintiles, respectively.
- At the upper end of the income distribution, business owners account for 18% of households in the 80th-90th percentile range and 37% of households in the 90th-100th percentile range.
- Business owners comprise 2% of the lowest quarter of the wealth distribution and 43% of households in the 90th to 100th wealth percentile range.
But things are not changing much over time. Per authors: “These results are consistent with Gentry and Hubbard (2004) who report that entrepreneurs account for 11.5 percent of the population in 1989 using the same definition
This, however, is a function to some extent of the fact that business owners earn higher incomes and accumulate more wealth, meaning they are unlikely to stay in lower incomes/wealth percentiles even if they start from there.
“Business owners have higher mean and median income levels. The median income for business owners is $87,000, whereas the median for households not owning businesses is $42,000. Likewise, business owners have more assets and net worth overall and by income category. Business owners have a median net worth of $497,000, and non-business owners have a median net worth of $94,000. The difference is large but the ratio of median net worth for business owners to median net worth for non-business owners of 5.29 is lower than the 8.03 ratio calculated from Gentry and Hubbard (2004) using 1989 SCF data.”
So the last figure suggests that over time, the wealth gap with non-business owners is shrinking. Undoubtedly, a housing bubble helped here.
Saturday, September 25, 2010
- We know that Irish Government has little to do with our exports, which are largely determined by demand outside Ireland over which our leaders have no control;
- Exports have been performing strongly over the recession
- Exports, net of imports enter both GDP and GNP figures
Here are the charts, taking our GDP and GNP (seasonally adjusted, expressed in current market prices) and subtracting net exports (exports less imports).
And same in terms of year on year growth rates:
Now, let's put together our growth rates for GDP and GNP ex-net Exports and standard GDP and GNP growth rates (gross of net exports, expressed as before in current market prices, with seasonal adjustments):
To me, this paints a pretty clear picture. Given that the Government has provided virtually no supports for our exporters, the gap between each solid line and each dashed line shows the true extent of net exports contribution to growth in GDP and GNP. And this gap also shows that the economy more directly controlled by the Government has been tanking at a much steeper rate than the economy which includes our exporting firms.
Let's put a cumulative figure to this same picture:
So in those parts of Irish economy where our Leaders had a say (red) we have suffered a decline in domestic income of cumulative 34.35% since 2007. In economy which includes the part which our Leaders have very little control over, the decline was 23.7%. One wonders if there is any truth whatsoever to the leadership claims on economic policy front we've been hearing in recent days?..
Friday, September 24, 2010
Here's the chart:
My forecast for next Eurocoin to reach 0.34 in September and Q3 2010 growth to slide to 0.2-0.25%. My previous forecast for Eurocoin for August-September (issued in June and confirmed in July) was 0.34.
In the real of bizarre, we have two fresh statements from Irish officials.
First, NTMA issued a statement claiming that Irish authorities - aka Irish taxpayers - will make up any shortfall on the banks capital side. One wonders if the NTMA has acquired new powers from the State - this time around, to determine our budgetary policy. You see, per European authorities, capital support for the banks is a matter of national deficits. National deficits are a matter of fiscal policy. Fiscal policy is firmly a matter for the Exchequer (i.e the Government). NTMA is neither the Exchequer, nor the Government. What business does it have in making promisory statements to the markets concerning the matters of fiscal policy?
Second, per Reuters report: "An Irish official told The Daily Telegraph that Dublin will "explore the appropriate burden-sharing arrangements" over coming weeks as it fleshes out its plan to break up the nationalised bank. Anglo Irish may ultimately cost Irish taxpayers as much as €25bn". So let's quickly summarize the statement:
- After the economy posted a double dip (GDP side), having lost some €13,000 per every working person in income since the beginning of this Great Recession,
- After all independent analysis has pointed, for some 21 months now to the need to cut loose the subordinated (and senior) debt holders in Anglo, plus subordinated debt holders in other state-supported banks,
- After the above calls by independents was echoed in recent weeks in the international analysts opinions (e.g. RBS),
- After independent analysts have correctly estimated Ireland's exposure to Anglo to be in the region of €33-39 billion, the estimate once again echoed in international analysts estimates (S&P),
- After international bond markets have shown total disapproval for the Government handling of the recession, bidding both bond yields and CDS spreads to historic highs
The headline number is GDP double dip - Q2 2010 posted a decline in real GDP of 1.2%, deeper than the decline in GNP (-0.3%), signaling weakening side of the external economy.
In constant market prices and seasonally adjusted, Q2 GDP stood at €41,130mln down 1.81% on Q2 2009 and -1.21% on Q12010. Cumulative H1 2010 GDP was 1.28% below H1 2009. Despite shallower contraction in GNP, domestic income has suffered a much deeper contraction in the year to date. Quarter on quarter contraction in GNP between Q1 2010 and Q2 2010 was 0.278%, year on year GNP fell 4.05% in Q2 2010. H1 2010 GNP was 4.42% below H1 2009.
Let's put this into a perspective. Over the course of H1 2010, Irish economy lost €3,087mln in income. Per latest QNHS, there were 1,859,100 people in employment in the country, which means that our economic loss in H1 2010 amounted to €1,660 per working person. Since H1 2007, our economic losses total €13,078mln or €7,035 per working person. Annualized losses in national income now run at roughly €14,000 per working person since the Great Recession began.
The gap between GDP and GNP has narrowed as a result of horrific performance of GDP:
The slight recovery in GDP/GNP gap is, of course of little comfort.
Core components by sectors:
Spending and investment remain depressed:
Tuesday, September 21, 2010
We sold €500 million of 4 year debt due in 2014 at an average yield of 4.767%, compared with 3.627 percent at the previous auction on August 17. Cover on 4 year paper was We also sold €1 billion wort of 8 year paper due in 2018 a yield of 6.023%, up from 5.088% in a June sale.
Short term stuff first:
Cover support is clearly running well above average/trend, indicating potential engagement by the ECB. Price spread is down, suggesting that the yields achieved are reflective in the perceptions compression on behalf of bidders, which in turn might mean that the markets are getting more comfortable with higher risk pricing of Irish bonds.
Next up: yields and prices achieved:
The dynamics are crystal clear - we are heading for a new territory in terms of elevated yields and lower prices. Actually, setting historical record in both, despite likely ECB interventions.
Weighted average accepted price:
Boom! The curve is getting curvier.
On to longer term stuff:
Yield spread down as well - same reason - higher yields are now a 'normal' for the markets as average accepted yield shot up.
Cover slightly up, perhaps being pushed by the bidders flowing from the shorter term paper - crowded out by Jean Claude Trichet's boys. Price spread is down (see yield spread discussion above).
Predictably, longer-term accepted average price is testing historical lows:
And the maturity profile of debt is getting steeper for the folks who'll take over the Government in the next round, and our teenagers (that'll teach'em a lesson, for those, of course who'll stay on these shores):
Sunday, September 19, 2010
So clearly, we have some really powerful analysts out there and keen commentariat (actually one and the same in this case) on the future prognosis for our banks.
But what about recent moves in the index itself?
Take a look at the chart above, which maps the Financials Index for two subperiods:
Period 1: from Guarantee to March announcement of the 'final' recapitalization of our banks,
Period 2: from Guarantee to today.
Now notice the difference between two equations. That's right, things are not getting any better, they are getting worse.
Next, let's put some historical markers on the map:
Surely, our financials are getting better, the Government will say, by... err... not getting much, much worse. The reality, of course is, any index has a natural lower bound of zero. In the case of Irish Financials Index, this bound is above zero, as the index contains companies that are not banks. As far as the banks go, there is a natural lower limit for their share values of zero. Our IFIN index is now at 80% loss relative not to its peak, but to its value on the day of Guarantee!
Having pledged banks supports to the tune of 1/3 of our GDP already, the Government policy still has not achieved any appreciable improvement in the index.
Forget longer term stuff - even relative to Q4 2009, Government policies cannot correct the strategic switchback away from Irish banks shares that took hold:
A picture, is worth a 1000 words. Unless you belong to the upbeat cheerleaders group of the very same analysts who missed the largest market collapse in history, that is.
So here is a quick note: I finally came about to read an interesting study from McKinsey & Co on the importance of talent as a driver of competition between firms, published back in February 2008. It is a very insightful piece.
Here's an interesting quote, referring to two McKinsey Quarterly global surveys (emphasis is mine). "The first, in 2006, indicated that the respondents regarded finding talented people as likely to be the single most important managerial preoccupation for the rest of this decade. The second, conducted in November 2007, revealed that nearly half of the respondents expect intensifying competition for talent—and the increasingly global nature of that competition—to have a major effect on their companies over the next five years. No other global trend was considered nearly as significant."
Furthermore, "Three external factors—demographic change, globalization, and the rise of the knowledge worker—are forcing organizations to take talent more seriously."
Amazingly, there is little evidence to-date that policymakers have any idea the process of global competition for talent is underway in their economies. With exception of the US and Switzerland, every OECD economy puts the heaviest burden of taxation onto shoulders of the very same talent for which companies in these countries compete.
Ireland is the case study here. After a decade and a half of aggressively incentivising foreign investment into the country (not a bad thing in my books), Irish leadership has left human capital - and especially internationally mobile human capital - bearing more than 3/4 of the total tax burden in the country. Now, this proportion is rapidly increasing (see chart), having risen from 75.31% in Q2 2007 to 80.42% in Q2 2010.
This process is accelerating per table below:
Unbeknown to our policymakers (it appears), labour, especially skilled labour in the sectors the Government promotes as the future of Ireland Inc (e.g. the 'knowledge' economy) is the largest cost input for firms. Yet, through the crisis, the Government has elected a two-path approach to resolving our fiscal difficulties:
- massive cuts in capital investment, and
- disturbingly high increases in income tax burden and other tax burden on disposable income by households.
Saturday, September 18, 2010
It turns out the IMF paper cited in the earlier post is not alone in the gloomy assessment of our realities. Another August 2010 study from German CESIfo (CESIfo Working Paper 3155), titled "Long-run Determinants of Sovereign Yields" and authored by António Afonso Christophe Rault throws some interesting light on the same topic, while using distinct econometric methodology and data from that deployed in IMF paper.
Here are some insights from the paper (available for free at SSRN-id1660368). "For the period 1973-2008 [the study] consider the following countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Sweden, Spain, UK, Canada, Japan, and U.S."
Take a look at table 2 of results from the paper estimation across listed countries. The model is based on 3 variables here - Inflation (P), Current Account (CA) and Debt Ratio (DR). All have predictable effect on the variable being explained. Per study authors: "Results in Table 2 show that real sovereign yields are statistically and positively affected by changes in the debt ratio in 12 countries. Inflation has a statistically significant negative effect on real long-term interest rates in ten cases. Since improvements in the external balance reduce real sovereign yields in ten countries, the deterioration of current account balances may signal a widening gap between savings and investment, pushing long-term interest rates upwards."
Ok, here are those results:
Ireland clearly shows relatively weak sensitivity in interest rates to debt.
But take a look on our sensitivity to deficits. Per study: "Moreover, when the budget balance ratio is used (Table 3) a better fiscal balance reduces the real sovereign yields in almost all countries"
Clearly, Ireland shows 3rd highest sensitivity of interest rates to Government deficits. We are in the PIIGS group, folks, based on 1973-2008 data!
Now, this firmly falls alongside the IMF results - further confirming my guesstimate in the post earlier.
Fortunately, courtesy of the IMF, there is some new evidence on this issue available. IMF working paper, WP/10/184, titled "Fiscal Deficits, Public Debt, and Sovereign Bond Yields" by Emanuele Baldacci and Manmohan S. Kumar (August 2010) does superb analysis "of the impact of fiscal deficits and public debt on long-term interest rates during 1980–2008, taking into account a wide range of country-specific factors, for a panel of 31 advanced and emerging market economies."
In a summary, the paper "finds that higher deficits and public debt lead to a significant increase in long-term interest rates, with the precise magnitude dependent on initial fiscal, institutional and other structural conditions, as well as spillovers from global financial markets. Taking into account these factors suggests that large fiscal deficits and public debts are likely to put substantial upward pressures on sovereign bond yields in many advanced economies over the medium term."
But the detailed reading is required to see the following: "the impact of fiscal balances on real yields provided results that were quite similar to the baseline, although the size of the estimated coefficients was larger: an increase in the fiscal deficit of 1 percent of GDP was seen to raise real yields by about 30–34 basis points." (Emphasis is mine). Table below provides estimates:
By the above numbers, Irish bonds currently should be yielding over 7.54%. Not 6.5% we've seen so far, but 7.54%. This puts into perspective the statements about 'ridiculously high' yields being observed today.
If we toss into this relationship the effect of change in our public debt position, plus a risk premium over Germany (note that the estimates refer to the average for countries that include not just Ireland, but 29 other developed economies, including US, Germany, Japan and so on), the expected historically-justified yield on our 10 year bonds will rise to
- deficit-induced 7.54% +
- country risk premium driven by deterioration in economic growth adjusting for ECB rates) of 1.46%+
- change from initial public debt position 0.30%
Don't believe me? Well here's a historic plot that reflects not a wishful thinking of our policymakers, but the reality of what has transpired in the markets over almost 30 years.
Ooops... looks like our ex-banks deficits warrant the yields well above 10% and on average closer to 15%, nominal (remember the above yields computed based on model results are real). Alternatively, for our bond yields to be justified at 6.5% we need to cut our deficit back to around 5.2% mark and hold our debt to GDP ratio steady.
Someone, quick, show this stuff to our bonds 'gurus' in the Government.
Friday, September 17, 2010
Published by FEEM as a working Paper 89, 2010, titled “Executive Compensation: Facts” it was authored by Gian Luca Clementi and Thomas S. Cooley of NYU and NBER. The link to the paper is here.
Given hysteria around the world about executive compensation and commonly held views that:
- Executive compensation is getting more and more generous over time
- Executive compensation is now more unrelated to firm performance over time
- Executive compensation improving generosity is divorce from shareholder wealth
The study does some basic stats. For example, in contrast to the Trade Unions’ claims that the average US executive compensation for larger corporations was $10.8mln in 2006, the study shows that due to a significant skew in the data, the average metric is meaningless. The median compensation for the largest corporate executives in the US therefore, was much smaller (although still substantial) at $4.85mln.
The study also reflects on the well understood, but rarely cited fact that due to significant share of compensation of CEOs being in the form of stock and stock options, in many years, many CEOs actually experience losses in terms of their overall compensation, not gains.
The study is certainly worth reading as it contains factual analysis unencumbered by ideological bull usually found in the media.
In the case, relevant to Ireland, this logic extends not only to traditional factors, such as:
- Degree of labour force unionization
- Extent of social welfare safety net
- Existence of the minimum wage laws
- Restrictions on mobility into public sector jobs and protected professions jobs
- Structures of pay and promotion divorced from productivity considerations
- Visa restrictions
- Negative equity
- Housing markets access restrictions (e.g. birth-right to development of homes in some areas)
- Cultural restrictions (e.g. Gaeltacht)
- Lack of credit supply, etc
“A cursory inspection of the data yields support for the hypothesis. … [dividing] data from 86 developing countries into three groups based on their relative ranking in the Heritage Foundation’s Economic Freedom Index, with 25% each placed in the least and most free economies and the rest being placed in the middle. … Private returns to schooling for the freest economies average 9.7% per year of schooling, 3 percentage points higher than the average returns in the most restrictive economies. Returns for the middle group fall between the two extreme groups. [The authors] repeat the exercise … for private returns to years of potential experience. Again, average returns are highest in countries rated as the most economically free (5%) versus the middle (4.7%) and least free (4.2%) countries. These results are broadly consistent with the proposition that freer economic institutions raise individual returns to human capital.”
“T. P. Schultz (1998) found that about 70% of the income inequality in the world is due to country-specific fixed effects that would include the impacts of country-specific political and economic institutions on earnings. Acemoglu and Robinson (2005) argued that these institutions were formed in response to exogenous influences existing at the time of a country’s founding, and that these institutions tend to persist across generations. [World Banks study] use measures of economic and political institutions to determine if they can alter returns to human capital across countries sufficiently to explain some of the persistent cross-country income inequality reported by T. P. Schultz. [The study found] that, consistent with the T.W. Schultz hypothesis, human capital is significantly more valuable in countries with greater economic freedom. Furthermore, the positive effect is observed at all wage quantiles. Economic freedom benefits the most skilled who get higher returns to schooling; but it also benefits the least skilled who get higher returns from experience.”
Now, this has three basic implications for Ireland.
Secondly, the study also implies that if Ireland were to be focused on developing a viable knowledge economy (aka human capital-intensive economy), the country needs more market, more freedom, less protectionism and lower restrictions in the labour market.
Thirdly, the study suggests that environments with lower tax burden on labour and lower Government/State interference in private activities are more likely to produce better human capital base.
Instead of farcical Mr Top Hat Kapitalist, it looks like free markets and societies benefit Ms Advance Degree Holder.
Thursday, September 16, 2010
A very interesting paper that a year ago should have alerted this Government to the fallacy of its preferred path to interventions in the banking crisis. Alas, it did not.
Michael King Time to buy or just buying time? The market reaction to bank rescue packages, BIS Working Paper Number 288, September 2009 (linked here).
The paper suggests and tests the following three hypotheses concerning banks rescue packages put in place at the beginning of the crisis (January 2008):
- H1: The announcement of government rescue packages will be associated with a narrowing of bank CDS spreads relative to the market.
- H2: Capital injections will be associated with a rise in bank stock prices relative to the market if the benefits of lower leverage and a lower probability of financial distress outweigh the potential dilution of existing shareholders or restrictions on payment of common dividends.
- H3: Asset purchases and asset insurance will be associated with a narrowing of bank CDS spreads and a rise in the stock price relative to the market.
What the study found is that rescue packages confirm H2. But there was significant difference in the effectiveness of interventions.
- In the US, “bank stock prices outperformed reflecting the decline in the probability of financial distress and the favourable terms of the capital injections. The risk of US bank failures was high following the failure of Lehman Brothers and IndyMac, and the government take-over of AIG, Fannie Mae, and Freddie Mac. While the US Treasury’s preferred shares included warrants with the potential to dilute shareholders, the favourable terms of the capital allowed the average US bank share to outperform the market following the announcement of government support.”
- In contrast in Europe, “the risks of financial distress were also high as seen in the capital injections for Fortis and Dexia and the nationalisation of Bradford & Bingley. While banks were recapitalised, the cost and conditions of European rescue plans were punitive for existing common shareholders leading to an underperformance of bank stocks in most countries.” In other words, Europeans, predictably soaked equity holders but didn’t touch bondholders.
- “The UK package appears to have been the most costly for existing shareholders, which explains the fall in stock prices when the terms were disclosed. Given that only three out of six banks accepted the capital, the fall for banks receiving capital was offset by the positive response of banks that did not.”
- “Swiss banks were the exception as the average Swiss bank was relatively unaffected.”
Turning to the cases of asset purchases or asset insurance schemes, “market reaction provides only partial support for the third hypothesis (H3) that creditors took comfort from the reduction in potential losses and the decline in risk-weighted assets”. Oops, I’d say for the Leni/Nama plans. And this was known as of September 2009, despite which our Government has charged ahead with Nama.
“Overall, globally, asset purchases or insurance were used in only four cases with mixed results.”
Bingo – only in 4 cases: “the Dutch, Swiss, and US governments supported specific financial institutions by purchasing impaired assets or providing insurance against losses on specific portfolios. In an asset purchase, the government buys impaired securities or loans from the bank, reducing the bank’s risk-weighted assets and lowering the amount of capital it must hold against potential losses. While the government bears the risk of losses, it also retains the profits if the assets recover. While the US and Germany announced asset purchase plans, only the Swiss had taken action by the end of January 2009, buying $39.1 billion of illiquid assets from UBS on 16 October. The assets were removed from UBS’s balance sheet and placed in a special purpose vehicle, significantly reducing UBS’s risk.”
So in the end in the duration of 2008, no country has undertaken a significant Nama-like operation with exception of Switzerland in relation to UBS alone. Clearly the claim that Minister Lenihan was acting consistently with other countries in setting up a Nama vehicle is not true.
Here’s an interesting bit: see if you can spot where Mr Lenihan has gone the path differing from everyone else back in 2008. “Under asset insurance, the government assumes a share of the potential losses on a specified portfolio after a first loss amount (or deductible) is absorbed by the bank. In return, the bank pays the government an insurance premium based on the riskiness of the portfolio. By limiting the bank’s potential losses, asset insurance also reduces a bank’s risk-weighted assets and lowers the capital it must hold. The government, however, is left with a large potential liability if the assets fall substantially in value. The US and the Netherlands offered asset insurance to three banks. The US provided protection to Citigroup and Bank of America against the possibility of unusually large losses on asset pools of $301 billion and $118 billion, respectively. In both cases, the US government bears 80% of the losses after the deduction of a first loss tranche paid by the bank but does not share in any profits. The Dutch authorities created an illiquid asset backup facility to insure most of the risk from $35.1 billion of Alt-A securities owned by ING. The Dutch government shares in 80% of the downside and the upside. Asset purchases or asset insurance should be positive for both the stock price and the CDS spread, as both interventions lower the potential losses faced by common shareholders and reduce the risk of default. As a result, the share price should rise and CDS spreads should narrow. In three out of four cases the government’s actions coincided with the injection of capital.”
To conclude: “the October  rescue packages provided governments with time to assess the situation and formulate their policy responses. At the same time, these policy interventions did not represent a buying opportunity as seen in the underperformance of bank stocks in most countries studied.”
Predictably, our stockbrokerages analysts, Nama, Department of Finance, Government and the usual crowd of suspects claimed that:
- Nama will lead to significant improvement in the banking sector health;
- Irish Government interventions were value additive for shareholders - all stockbrokers in Dublin and majority of them outside had 'Buy' recommendations on banks based on Government rescue package;
- Banks guarantee scheme is structurally important to the resolution of the crisis (not a delay, but a resolution),
- The rest of the world was doing the same.
All I need to add here is that this paper was available to Minister Lenihan's advisers, to Nama and to DofF and Central Bank handlers. The latter, alongside their Financial Regulator counterparts are linked to BIS.
This is an edited version of my article in today's edition of the Irish Examiner.
Two weeks into September and the crisis in our sovereign bond markets continues unabated. Ireland Government bonds are trading at above 6% mark and given the perilous state of the Irish banks, plus the path of the future public deficits, as projected by the IMF, Ireland Inc is now facing a distinct possibility of our interest bill on public debt alone reaching in excess of 6% of GDP by 2015. [Note: by now, the magic number is 6.12% as of opening of the markets today].
Sounds like a small number? Here are a couple of perspectives. At the current cost of deficit financing, our Exchequer interest bill in 2009 was 1.7% of GDP or €2.8 billion. Within 5 years the interest bill can be expected to reach over €12 billion, based on the Government own projections for growth. By this estimate, some 30% of our expected 2015 tax receipts will go to pay just the financing costs of the current policies.
It is precisely this arithmetic that prompted the Financial Times this Monday to question not only the solvency of the Irish banking sector, but the solvency of the Irish economy. The very same inescapable logic of numbers prompted me to conjecture in the early days of 2009 that our fiscal and banks consolidation policies will lead to the need for an external rescue package for Ireland.
This external rescue package is now available, fully funded and cheaper (financially-speaking) to access than the direct bond markets. It is called the European Financial Stability Fund (EFSF). More than money alone, it offers this country a chance to finally embark on real reforms needed to restore our economy to some sort of a functional order.
The EFSF was set up to provide medium term financing at a discounted rate of ca 5% per annum for countries that find themselves in a difficulty of borrowing from the international markets. With effective yields on our bonds at 6.05% and rising – we qualify.
The EFSF requires that member states availing of European cash address the structural (in other terms – long term) deficit problems that got them into trouble in the first place. In Ireland’s case this is both salient and welcomed.
It is salient because, despite what we are being told by our policymakers, our problems are structural.
Banks demands for capital from the Exchequer – a big boost to Irish deficit last year and this – are neither temporary, nor dominant causes of our deficits. In the medium term, we face continued demands for cash from the banks. By my estimates, total losses by the Irish banks are likely to add up to €52-55 billion (ex-Nama) over the next three-four years. These can be broken down to €36-39 billion that will be needed in the end for the zombie Anglo, €6bn for equally dead INBS, at least €8 billion for AIB and up to €2 billion for the ‘healthiest’ of all – Bank of Ireland. These demands will come in over the next 24 months and face an upside risk should ECB begin aggressively ramp up interest rates in 2011-2012.
No economy can withstand a contraction in its GDP on this scale. Least of all, the one still running 5-7% of GDP structural deficits over the next 4 years. In 2009, banks demands for Exchequer funds managed to lift our deficit from 11.9% to 14.6%. This year, absent banks bailouts, our deficit will still reach around 11.3%. Only 3.3% of that due to the recessionary or temporary effects. In 2011, IMF estimates our structural deficit alone to be 7% and 5.9% in 2014.
Which brings us to the point that the use of the EFSF funds should also be a welcomed opportunity for Ireland.
A drawdown on EFSF funding will automatically trigger a rigorous review of our fiscal plans through 2015 by the European and, more importantly, IMF analysts. This is long overdue, as our own authorities have time and again proven that they are unable to face the reality of our runaway train of fiscal spending.
Since 2008 in virtually every pre-Budget debate, Minister Lenihan has been promising not to levy new taxes that will threaten jobs and incomes of the ordinary people of Ireland. In every one of his budgets he did exactly the opposite. Under the EFSF, the IMF will do what this Government is unwilling to do – force us to reform our tax system to broaden the tax base, increase the share of taxes contributions by the corporate sector and start shifting the proportional burden of taxation away from ordinary families.
Minister Lenihan has repeatedly promised reforms of spending. In every budget these reforms fell short of what was needed, while the capital investment was made to bear full force of the cuts. Drawing cash from the EFSF will make Mr Lenihan scrap the sweetheart Croke Park deal and start reforming current spending. Politically unacceptable, but realistically unavoidable, deep cuts to social welfare, public sector employment and wages, quangoes, and wasteful subsidies will become a feasible reality.
Starting with December 2009, the Irish Government faced numerous calls from within and outside this state (headed by the EU Commission and the IMF) to provide clarity on its plans to achieve the Stability and Growth Pact criteria of 3% deficit to GDP ratio by 2014-2015. The Government has failed to do this. Drawing funds from the EFSF will help us bring clarity as to the size and scope of fiscal adjustment we will have to take over the next 5 years.
Lastly, the EFSF conditions will include a robust change in the way we are dealing with the banks. Gone will be the unworkable Government strategy of shoving bad loans under the rug via Nama and drip-recapitalizations. These, most likely, will be replaced by haircuts on bond holders and equity purchases by the State.
Contrary to what the Government ‘analysts’ say, drawing down EFSF funds will not shut Ireland from the bond markets. Instead, swift and robust restoration of fiscal responsibility and more a more orderly exit of the exchequer from banks liabilities are likely to provide for a significant improvement in the overall markets perception of Ireland. After all, bond investors need assurances that we will not default on our debt obligations in the future. Only a strong prospect for growth and recovery can provide such an assurance. Ministerial press releases and Nama statements are no longer enough.
The rationale for AIB selling its profitable divisions to plug the holes in its collapsed domestic business (notice, more detailed analysis of exactly the same fundamentals argument was supplied by Prof Brian Lucey back in March in his article in the Irish Times - see here). The logic of this AIB's perverse move was:
- sell the stakes in M&T and BZWBK to provide capital to write down bad loans on homegrown turf;
- put the bank assets squarely into the geography where it has proven time and again to be incompetent in lending (aka Ireland);
- reinforce the incompetence of the management of the bank by showing to the rest of the world that over the last 10 years, AIB could manage to make money only in those divisions/investments where it had no managerial say (I mean, really, folks - AIB's competent managers - who need to be paid wages comparable to other bankers around the world, cause, you know they are being actively headhunted by global banking syndicates for their ability to turn funding into bad loans - had nothing to do with only two profitable sides of the bank: M&T and BZWBK)
AIB needs not €7.4bn (the minimum regulatory requirement capital top up), but more like €10bn to plug the hole in bad loans. It has managed to under-report (thanks to an accounting rule) losses in H1. The bank is now being stripped of the very few assets it has that actually make sense, leaving it with the legacy of its own actions and choices that is purely toxic. The markets don't buy the management 'plan' (what plan?) nor do they by the management team itself. The only thing that separates AIB from heading the Anglo route is the willingness of the Government to throw taxpayers guarantees and cash at the bank to rescue its shareholders and bondholders. How long will that last is an academic point at this moment in time. The real point is - AIB simply has so far shown no capacity to produce viable banking business short of buying into foreign-run assets.
The first chart below shows historical trends in HCIs.
On the surface, it looks like:
- The story of dramatic improvements in our competitiveness (at least as measured by the HCIs) has been true - we are now back to competitiveness levels not seen since June 2007 (in Nominal HCIs), February 2003 (when it comes to HCIs deflated by consumer prices) and January 2006 (as measured by HCIs deflated by producer prices)
- At the same time, the gap between our performance in HCIs deflated by producer prices and consumer prices clearly shows that these gains in competitiveness were not due to producer cost deflation (improved productivity), but due to massive deflation in consumer prices (margins erosion and collapse in domestic demand).
Starting with the peak year for our bubble (2007), our gains in competitiveness since the beginning of this recession in Q1 2008 are hardly impressive at all. To summarize these, here is a table of relative changes:
Loss of 1.4% (nominal) in competitiveness, contrasted by gains of just 2.4% in producer prices-termed HCI and 5.6% in consumer prices-termed HCI are hardly a matter of bragging rights for Ireland Inc.
Irish HCI data is strongly suggesting that so far in the recession, Ireland's producers have failed to gain significant inroads into productivity gains. Instead, lower retail prices so far remain the primary drivers of the improved indices reading.
In my presentation yesterday at IBM's Extreme Blue event, I mentioned that we know very little about the location decisions of the modern migrants - people with high skills, education, aptitude, creativity and innovation capacity.
An interesting new study from the Bank of Italy (“HOW DOES IMMIGRATION AFFECT NATIVE INTERNAL MOBILITY? NEW EVIDENCE FROM ITALY by Sauro Mocetti and Carmine Porello, Working Paper Number 748 - March 2010) assessed the relationship between “native internal mobility and immigration in Italy”. The study attempts to analyse “the impact of immigration on local labour markets and to gauge the consequences for the socio-demographic composition of the local population”.
Traditionally, immigration into a given geographic region is seen as a driver of outward migration of the natives due to jobs displacement (the argument that by taking lower wages migrants force indigenous workers out of their jobs). This is known as a substitution effect. Alternatively, there is a view out there that migration induces clustering of both migrants and domestic workers.
A set of studies in the 1990s and early 2000s have produced mixed results as to the relationship between inward migration and flows of the native workers:
- Frey (1996) shows “a strong correlation between immigrant inflows and native outflows in US metropolitan areas, and argued that this behaviour was bringing about a ‘demographic balkanization’”. Borjas et al. (1997) report a strong negative correlation between native net migration and immigration from abroad. Hatton and Tani (2005) find a negative displacement effect in the UK. Brűcker et al. (2009) find that “foreign immigration replaces native internal mobility in Italy”. (substitution in levels)
- Wright et al. (1997) disagree by showing that “immigrant inflows are unrelated to native outflows in large metropolitan areas.” Card (2001) confirms this in a broader setting. (independence)
- Card and DiNardo (2000) find that “increases of the immigrant population in specific skill groups lead to small increases in the population of native-born individuals in the same skill group.” (clustering)
- Borjas (2006) finds that “immigration is associated with lower in-migration rates, higher out-migration rates, and a decline in the growth rate of the native workforce.” (substitution at the level of growth rates)
In their study, Mocetti and Porello find that “immigration has a negligible impact on overall native mobility while it does have a significant impact on its skill composition” in Italy. Crucially, immigration leads to
- a displacement of low-educated natives,
- immigrant clusterization in the northern regions has partially substituted South-North mobility flows of less-skilled natives,
- immigration is positively associated with highly-educated native inflows
- the impact is concentrated among the young population and is somewhat stronger in more urbanized areas.
Interestingly, the devil is not in the details, but in interpreting the results: “is not clear how these results may be interpreted. If we consider the arguments in the literature on labour, we should read these findings as evidence of the substitution effect for low-educated natives and of complementarities for highly-educated ones. Task specializations and complementarities between immigrants and highly-educated natives might induce higher demand (and productivity) for natives in areas with a higher share of immigrants; having said this, if low-educated natives and foreign workers compete for the same jobs, then immigration might have a depressive effect on labour demand for natives.”
Labour market story aside, and related to our own study at the Institute for Business Value (here), immigration has skills-specific effects on internal mobility due to what I would term quality-of-life considerations. Inflow of migrants can alter quality of state in the recipient city. Mocetti and Porello refer to this effect as “the impact of immigration on natives’ location choices [that] might also work through other channels such as the housing market and the preferences for ethnic composition of the local context.”
Their study includes “house prices in the regressions to control for the effects through the real estate market; regarding “racial” preferences, they are likely to affect neighbourhood choice within a city rather than displacements across regions. Therefore, we argue that our estimates can be reasonably interpreted as the result of the interaction between immigrants and natives in the labour market.” The authors find that housing costs, associated with higher inward migration, do have a negative effect on the regions’ ability to retain domestic workers of similar skills levels.
So on the net, while the study does not deal specifically with the high quality of human capital group involved in migration, the study does suggest that better skilled/educated workers tend to produce a clustering effect leading to complementarity with the native workers of similar skills and creating a pull factor for inward migration of highly skilled workers to a specific location. The offsetting deterioration in living conditions (due to higher house prices etc) is not sufficient in size to cancel out this positive effect.
Monday, September 13, 2010
In today's FT (here), Wolfgang Munchau clearly states that (emphasis is mine): "...Irish banking sector is insolvent, and there are questions about the capacity of the Irish state to absorb those losses. ...two years have passed [since the crisis acknowledgement by the state] and nothing has been resolved.
…As we saw last week, this strategy [of shoving bad loans under the rug via Nama and quasi-recapitalizations] came badly unstuck in Ireland. The Irish government massively underestimated the scale of the problem in its banking sector. On my own back-of-the-envelope calculations, the cost of a financial sector bail-out may exceed 30 per cent of Irish gross domestic product, if you make realistic assumptions about bad debt write-offs and apply a conservative trajectory for future economic growth.
[Note: this blog has previously (here), on a number of occasions estimated the overall impact of the net losses realized by the banks to Irish taxpayers will be in the region of €62-75 billion, inclusive of Nama. Based on the Department of Finance own figures, this can be expected to amount to 38.5-46.6% of Ireland’s 2010 GDP or 48-58.1% of our GNP. Either range of numbers is significantly in excess of Munchau’s back-of-the-envelope estimate.
However, even at 30% of annual GDP, the expected hit on this economy from the banking sector debacle is simply insurmountable.
No economy on earth can be expected to withstand a 30% contraction in its GDP over two-three years, while still running a 7-8% of GDP structural deficit in every one of these years. The insolvency of Irish banks recognized by Munchau, therefore, automatically implies the insolvency of our economy, unless the banks are isolated from the rest of our economy by a removal of the blanket guarantee on the bondholders, while retaining a guarantee on depositors.]
Munchau goes on to say that: “We know from economic history that countries enter into longish phases of stagnation after a financial crisis.
[My estimates based on the IMF and OECD models of fiscal and financial crisis imply that Ireland can expect at least another 33 quarters of continued crisis pressures in Exchequer finances, house prices and asset markets, as well as a permanent decline in the potential rate of economic growth to below 1.5%]
Ireland suffered an extreme crisis. In the light of what we know, the safe assumption to make for Ireland – and Greece – is that there will not be much nominal growth in the next five years. If you make that assumption, you realise Greece will almost certainly not be in a position to repay its debts. While Ireland’s situation is marginally better, there are justified doubts about the country’s long-term solvency.”
[The above are not some idle words. They are, as I mentioned early, fully in line with the existent econometric models of crises based on historical experiences in the advanced economies in the past.]
Per Munchau: “….In Ireland, the cure would consist of nationalisation and wiping out the bondholders of Irish banks through bond-to-equity conversions.”
[Needless to say, since April 2008 I am on the record – in the press, media, on this blog, in public meetings and private briefings to the policymakers – these are exactly the first steps that need to be taken in order to begin – note, just to begin – the process of restoring order to our banking system. Irony has it – on a number of occasions, I have written to the Financial Times precisely about these issues, raised by Mr Munchau, with, needless to say, not a peep back from the broadsheet offices].