Economics 16/08/2009: Alan Ahearne on NAMA - not an ounce of sense

Alan Ahearne has decided to produce a definitive defense of NAMA in today's Sunday Business Post (here). And I would have to respond. As usual - Italics are mine.

The first half of Alan's article is saying absolutely nothing - nothing as in nada, zilch, nul, nil. He simply outlines in a tedious and lecturing fashion a litany of trivial observations as to why a banks crisis resolution is necessary. He does not show that NAMA is either a necessary or a sufficient condition for crisis resolution.

"Nama is also designed to ensure that the resolution to the problem of legacy loans is orderly. Nama can achieve this outcome because it will be patient in disposing of property assets which it has seized from delinquent borrowers." This is an unproven statement that can be argued to be untrue as NAMA can and is being shown to be likely to produce a prolonged period of highly uncertain property markets with buyers and investors holding back in anticipation of future NAMA disposals of property. The longer NAMA holds these properties, the longer it will delay new investment in property in this country. The longer it will keep banks uncertain about future NAMA losses (which - as we were told - will be clawed back from the banks), the longer the mortgage holders will remain in negative equity, withholding from consumption and investment and so on.

"Outside of Nama, a liquidator appointed to wind up a property company has a duty to sell off seized properties quickly. During an economic crisis, when markets are under severe stress and banks are not functioning properly, these properties may have to be sold at a discount to their underlying economic value." Again, Alan presents a dishonest 'extreme' alternative to NAMA as we know it. Outside of NAMA, there can be better mechanisms designed for systemic and orderly adjustment of the property bubble legacy. My own NAMA 3.0 is one. Karl Whelan proposed a similar scheme as well.

"Economists refer to the discount that the liquidator must pay for a quick sale as ‘the price of immediacy’. By design, Nama will not have to pay this discount because it will sell the properties at its own pace. It is important to note that the outcome for delinquent borrowers is identical, whether liquidation occurs inside or outside of Nama. Property companies are wound up and collateral is seized. The difference is in the speed at which the seized assets are re-sold to the market." Again, this is simply not true. NAMA will keep certain projects (and thus certain property developers) in business and will even aim to complete some of the projects. If this is not a rescue clause, I am not sure what is. And as far as NAMA not paying the discount due to long term nature of the undertaking to dispose of the properties, well, this does have a price -
the longer NAMA holds these properties on its books:

• the heavier will be taxpayers' losses on bond financing (interest);
• the longer will the property markets take to adjust;
• the longer will be the period of banks uncertainty as to their costs of NAMA;
• the longer will be the period of stock markets uncertainty about the banks profitability;
• the longer will be the period of subdued investment and consumption in Ireland.

There is no such thing as a free lunch, Alan. And NAMA is not getting close to one either.

"It would be impossible to dispose of ten of billions of euro worth of distressed properties in a short time under current conditions -and extremely destructive to even try." Again - no one I know of - neither Karl Whelan, nor Brian Lucey, nor myself have said there should be a fire sale of assets. Why is Alan Ahearne allowed to deflect public attention from the real issues that are being raised against NAMA? Has he morphed into a spin doctor for DofF?

"No wonder, then, that the IMF, in its recent report on Ireland, describes Nama as ‘‘pivotal to the orderly restructuring of the financial sector and limiting long-term damage to the economy’’." Well, IMF has not endorsed NAMA and was actually critical of its provisions. Alan knowingly distorts IMF analysis by selectively quoting its report.

"A key question relates to the value at which the loans will be transferred from the banks to Nama. Some commentators have mistakenly talked about the price which Nama will pay for land and development properties. Nama is not buying properties, but rather buying loans that are secured on properties and other assets -there is a fundamental distinction." Again, Alan uses this article to deflect the real criticism - not a single serious commentator said that NAMA will be buying actual properties. But in buying the loans, NAMA will acquire titles to underlying collateral. So - a play of words for Alan is a fertile opportunity to reduce public focus on the real issues.

"The transfer value will be in accordance with EU Commission guidelines on the treatment of impaired assets. The commission is very clear on this issue: the loans are to be transferred at values based on their so-called ‘real’ -or long-term - economic value. These are the terms used by the commission. Paragraph 41 of the commission’s communication published in February states that “ . . .the transfer value for asset purchase or asset insurance measures should be based on their real economic value’’. Annex IV of the communication states that ‘‘the objective of the pricing must be based on a transfer value as close to the identified real economic value as possible’’. Well, actually, a 'real economic value' is not the same as the 'long-term economic value'. Plus, as several of us have pointed out before (Karl Whelan, Brian Lucey, many others and myself) - 'long-term' economic value can mean anything. Absolutely anything. So what Alan is saying above, just as his masters did earlier is that 'the EU Commission allows us to buy these assets at whatever price we want to pay for them'. This might be good for the Commission. But it is not good enough for us, as taxpayers who will ultimately pay this price.

"Some commentators have claimed that Nama should instead transfer the loans at what they refer to as ‘current market clearing prices’. It is hard to see how this makes sense. The reality is that there is no price at which the market for land and development can clear under current conditions. This is not to say that land has no value, but rather that the market for these assets is not functioning." In the current markets we do have real valuations of land and development assets. There are sales, there are some investments, there are transactions. Furthermore, today's price can be taken as a short-term valuation based on standard hedonic valuations. The only problem - for the banks, developers and their guardians in the Leinster House - is that these valuations are too low. So they use an academic economist to argue nonsense about 'markets are not there, man, me doesn't know much about what value things might have'.

"There seems to be a misapprehension among some commentators that, for Nama to break even, property prices need to revert to the peak levels seen in 2006-07. This is not the case."
Well, do the maths, apply discount of a% on a property loan of X bought, assuming the loan yields y% annually. Hold it for T years. Assume that the underlying collateral appreciates at k percent per annum. The present value of this loan T years from today if the prevailing rate of interest is R is
(1-a)X{Sum([1+y+k]/[1+R]^i} where i=1,...,T
The cost of financing this loan is at R+g where g is the risk premium, taken over T years and discounted back to today:
(1-a)X{Sum([1+R+g]/[1+R]^i}
The break even on this deal requires that the first identity is equal to the second one. This in turn implies that to break even, NAMA will have to either

• enjoy property yields + appreciation on the capital in excess of the cost of bonds financing and the cost of running NAMA itself - which really means a property boom (in yields terms) will be required well in excess of the 2004-2007 one, or
• enjoy property price appreciation that will cover the cost of bond financing, plus the cost of running NAMA, plus inflation, less the discount a.

This is soo excessively optimistic, that actually it makes me believe that in making his statement, Alan reveals not having done even a basic estimation of NAMA likely costs and losses.

Now, it is also telling that Alan fails to even mention the problems of protecting taxpayers' interests, ensuring transparency of NAMA operations, or any other major issues for which NAMA has been criticised by many commentators, including myself.

I also find it extremely arrogant and outright rude that this public servant has managed to escape any scrutiny as to:

• why as the economic adviser to the Minister for Finance has he not produced any economic assessments of NAMA?
• why has he failed to consider the economic costs of NAMA (he does attempt something of an analysis - albeit extremely simplistic - of what would happen if NAMA was not enacted)?
• why is he allowed to simply claim - with no evidence or arguments to support such a assertion - that NAMA will restore functional banking system in Ireland?
• why is he allowed, unchallenged, to claim that all external analysts are supporting NAMA, while we know of several Nobel Prize winning economists, numerous other respected international academics, not to mention all internal independent analysts working in Ireland who unequivocally identified NAMA as being a bad idea?

In short, Alan's article is a waste of space - pure and simple, providing not a single fact, not a single logical argument, not a single ounce of economic reasoning to support his thesis.

Read my alternative to NAMA here.

Economics 23/09/2009: Cost of Nationalization

Today's note from Davy Stockbrokers throws into public domain a challenge and an accusation:

"Regrettably, the public debate on NAMA has been anything but rational and dispassionate. Confusion, misinformation and, at times, rank deception has run riot over the past several months... Tellingly, the brunt of discussion has majored on an anti-NAMA rant, with scant exposition of any credible alternatives."

If Davy is so dismissive of the 'alternatives' - of which there have been several rather involved ones - then Davy should be even more dismissive of the Nama proposal itself, for the Government still has no estimates for costs, returns, time horizons, detailed haircuts, borrowing terms for Nama bonds etc - after 6 months of working on it with an army of civil servants, highly paid consultants and having the likes of Davy on their side!

"Nowhere is this more depressingly obvious than in relation to the nationalisation option, wherein protagonists have tended to confine their treatises to a short paragraph or three, and where the potentially ruinous funding consequences for both the banks and sovereign have been glossed-over..."

Of course, unlike Davy or other stockbrokers, it is the independents: Brian Lucey, myself, Karl Whelan and Ronan Lyons who actually bothered to estimate - to the best of our resources - the expected costs of Nama to the taxpayers. Instead of focusing on the benefits and costs to the taxpayers, Irish stockbrokers focus on benefits to the banks and their shareholders. This is fine, and I will not accuse them of doing anything wrong here - their clients are, after all, not taxpayers, but shareholders. But it is rich of Davy team to throw around accusations of us, independnt analysts, 'glossing over' aspects of Nama - we are not the ones being paid by anyone for doing this work.

The emphasis on 'estimate' and 'expected' is there to address Davy accusations of 'rants' or 'deceptions'. If estimates are rants, Davy-own entire daily research output can be labeled as such.

But Davy folks are correct in one thing - we, the critics of Nama, have not produced an estimate of nationalization option cost. Instead, it was, me thinks, Brian Lenihan who promised to produce such estimates. May be Davy note was addressed to his attention?

Seeing the eagerness with which Davy folks would like to see some numbers on nationalization, below is the summary of estimates of such an undertaking developed by Peter Mathews (you can see his article on this in Sunday Business Post (here) and confirmed and elaborated by myself and Brian Lucey. (Again, note, one can only assume that our Davy folks do not read Sunday Business Post's Markets Section.)

I have argued in my Nama Trust proposal (aka Nama 3.0) (here) that we can avoid nationalization by buying out equity in the banks to support writedowns and then parking this equity in an escrow account jointly owned by all taxpayers. The banks will, then be owned by the Trust, not by the Government. Their shareholders will be Irish taxpayers as individuals, not the Government. The Trust will be there simply to provide a time buffer for orderly dibursal of shares over time.

Now, whether you call it 'nationalization' or 'Trust' or anything else, the problem with the banks in Ireland is that they need to write down something around 40% of the troubled assets values. This can be done by gifting them bonds (as Nama will do), or by buying equity in the banks in exchange for the same bonds, except, as below shows, at much lower cost.

In the first case, you get a promise of repayment from the banks and a pile of heavily defaulting loans. In the latter case, you get shares in the banks.

In the table above, the first set of red figures refers to the amount of equity capital that will be need for repairing banks baance sheets today (it can be issued form of bonds, just as Nama intends to do, which will be convirtible through ECB repo operations at the same 1% over 12 months). The amount we will need to put into banks under 'nationalization' or Nama Trust option is Euro30.88bn.

The bondholders will remain intact (so no additional cost of buying them out).

This upfront cost is over Euro 23bn cheaper than Nama. And it can be further reduced if we get at least subordinated bond holders to take a debt-for-equity swap, which they might agree to as they will be taking equity in much healthier banks.

The second and third red figures refer to the expected recovery on this equity purchase in 5 years time (not 15 as in the case of Nama). And all assumptions used to arrive at these two scenarios are listed. The figures are net of the original Nama cost. In other words, under these two scenarios, we can generate a healthy profit on Nama Trust, which we cannot hope to generate in the case of overpaying under the proposed Nama scheme.

In addition to the table above, I run another third scenario that assumes:

• 5% growth pa in banks shares (as opposed to 15% and 10% growth under scenarios A and B);
• Banks fully covering 1.5% cost of Government bonds (as in scenario B);
• Banks paying a dividend to the Exchequer of 2% on loans (net of bad loans) and charging 0.5% management fee, so net yeild is 1.5% on loans (as in Scenario B).

The bottom line in this scenario was ca €9bn in net return to the Exchequer on 'nationalization' within 5 years of operations.


Back to Davy note: "...the potentially ruinous funding consequences for both the banks and sovereign have been glossed-over..." Well, let me glance it over.

1. Nationalization can be avoided per my Nama Trust proposal, so there goes entire Davy 'argument'.
2. If the banks balance sheets are repaired with a 40% writedown of bad loans under the above costings while Nama would achieve only 30% writedown at a much higher cost, what 'ruinous' consequences do Davy folks envision for the banks? Their balancesheets will be cleaner after the above exercise, than after Nama!
3. If Irish Exchequer were to incur the total new debt of €30bn (per above proposal) and will end up holding real equity/assets against this debt, will Exchequer balancesheet deteriorate as much from such a transaction as it would from an issuance of €54bn in new debt secured against toxic assets such as non-performing loans? Again, it seems to me that a rational market participant (perhaps not the Davy researcher authoring the note) would prefer to lend to a state with smaller debt and real assets against it than to the one with higher debt and dodgy assets in hand.
   

Back to Davy: "...the retention of impaired assets on bank balance sheets ...would continue to cast a deep pall over perceived solvency risks in the Irish banking system, leaving this country still bereft of the necessary refinancing flows from which green shoots might grow."

I would suggest that this statement is itself either a deception (deliberate) or a wild speculation (aka rant). There is absolutely no reason why fully repaired banks (with 40% writedown on the loans under the above costings and as opposed to Brian Lenihan's proposed Nama writedown of much shallower 30%) cannot have access to the same lending markets as banks post-Nama would. However, under the above proposal:

• Irish Government will take much lower (24bn Euro-lower) debt on its books, implying healthier bonds prices for the Government into the future - some savings that won't happen under Nama;
• Banks enjoy much more substantially repaired balance sheets (again, not the case with Nama);
• There is no second round demand for new capital from the banks (not the case with Nama as proposed).

So, again: judge for yourself. When is the insolvency risk for Irish banking system higher:
Case 1: more substantially repaired banks balance sheets and more fiscally sound positioned Exchequer; or
Case 2: lesser writedowns of bad loans and more indebted Exchequer?
If you vote for Option 1 (as any rational agent in the market would do), you vote for the above 'nationalization' exercise.

Lastly, Davy note lands a real woolie: "When all is said and done, NAMA is not a bail-out of developers, or bankers, but of a banking system and its host economy. In that respect, it is a bail-out of ourselves."

Under Nama, developers will be able to delay or avoid insolvency declarations and subsequent claims on their assets. If this is not a bail-out, it is a helping hand of sorts.

As per 'repairing economy' - there is absolutely no evidence to support an assertion that Nama will have any positive economic impact, but given that it will impose much higher cost than alternatives on households, it can have a very significant negative impact on the economy. Perhaps, Davy think that households are simply there to be skinned and that our economy does not depend on them.

Then again, Davy folks thought CFDs and leveraged property deals were gods-sent manna.

Now, let us get to the more rational side of economic impact debate:

1. Under my proposal above, banks get deeper repairs, so they will be healthier and their reputational capital will not be based on a handout rescue, but on actually having equity capital injection. This is a net positive that Nama does not deliver;
2. Under my costings above, the Exchequer and/or households end up being investors with a strong prospect of higher net recovery value over shorter term horizon than in the case of Nama. This is a net positive that Nama does not deliver;
3. Under the above exercise, the banks will not be able to unilaterally take liquidity arising from the injection overseas, so whatever liquidity is generated, will have to stick to our shores, and thus to our economy. They still can use this liquidity to pay down their expensive inter-bank loans, but at least they won't be able to run investment schemes with taxpayers' money abroad. Shareholders might look badly on this one, since the shareholders will be not foreign institutional investors, but domestic taxpayers. This is a net positive that Nama does not deliver;
4. Under the above exercise, we won't have to pay Nama staff and consultants any costs - banks will continue dealing with their bad loans. This is a net saving that Nama does not deliver;
5. Under the above Irish taxpayers won't have to face a massive tax bill of 54bn, but a smaller (though still massive) bill of 30bn. This is a net saving that Nama does not deliver;
6. Under the above proposal Irish banks will be able to access the same ECB window on the same terms as any other bank in the Eurozone. The will also be able to do the same with Nama, so there is no additional cost when it comes to borrowing.
7. Under the proposal above Irish Government debt will be €23bn lower (and adding the second round recapitalisation demand under Nama - €29bn lower) than in the case of Nama, providing potential easing to our cost of borrowing. This is a net benefit that Nama won't deliver.
   

I can go on with these arguments. But I am afraid it will be a bit too much rant for our Davy folks.

16/7/15: Nama: The Gift of Giving That Keeps on Giving...

While Greece is limping to its Bailout 3.0, our national heroes at Nama are busy fighting massive (California-sized) forest fires.

The Northern Ireland story (covered on this blog here) is refusing to go away:

1. An academic legal eagle exposition from the U.S. It's in NYTimes, which is on the 'radar' of all our development agencies (the folks that do have Good Minister's ear to whisper into).
2. And Irish News is covering the statement issued by Mr. Ian Coulter, the former managing partner of Belfast law firm Tughans. Sluggerotool.com covers same with extra details. Same covered in the Journal.ie piece here.
3. A good article from the Irish Times on Cerberus (the fund in the middle of Nama's Northern Ireland's case) and its use of Irish companies as vehicles for purchasing some EUR19 billion worth of assets. "Each of the Irish companies owns hundreds of millions, or in some cases billions, of euro in assets but has no employees in Ireland and in some instances, pays no corporation tax here. Cerberus has established at least 10 such companies in Ireland since it started its European property loan shopping spree in 2013, all of which appear to be owned by Promontoria, a Dutch fund that is 100 per cent owned by Cerberus Capital Management." 
4. Another person in the middle of Norther Irish deal - Mr. Frank Cushnahan was, it appears, a 'serial director' in "over 30 companies" according to this article in the Irish Times. Which, obviously, qualified him to advise Nama.
5. Deputy Mick Wallace went on to add to the story, claiming that Nama was aware of the suspicious aspects of transaction in the North, 'since January'. Nama categorically denied this.
6. The UK National Crime Agency will investigate Deputy Wallace's claims.

Meanwhile, back at the foot of this mountain of proverbial... err... at home in Dublin, revelations that our Government appointments to Nama posts could have been... surprise-surprise... political. Who would have thought this much?

There is a documentary trail now to prove that Nama was a party to Government-related discussions about 'fixing' the land market in the Republic. In this, the State's objective of attempting to control the supply of land for development and improve saleability of assets is uncovered and Nama cooperation is identified. Nothing like manipulating the markets as a direct policy objective, folks. We had, of course, back in June this year, Deputy Mick Wallace's allegations that Nama has some unorthodox dealings with the rental sector in Ireland, allegedly "a “cartel” of big property owners had driven up rental costs in Dublin" as “A small group of players now control a large chunk of the rental market in Dublin"... He also said Nama likes to sell properties in big blocks “that only investment funds, vulture funds, mostly from America, have the money to be buying”.

A good old article from Bloomberg archives covering another Nama deal fiasco. The deal was a dodo: Morgan Stanley bought about 220 million pounds of loans to West Properties for "about 65 million pounds ($103 million), or a 70 percent discount". Nama does not sell properties to parties connected to original developers... you know...

And to top it all, we have a new load of revelations from Mick Wallace, TD on further fun-under-the-sun relating to the Holy Grail of Irish Solutions to Irish Problems: the claim made under "Dáil privilege, ... a person in construction who wanted to exit NAMA and was asked to pay €15,000 “in a bag – in cash.”

Wallace also referenced recently the Chicago Spire case (covered earlier here in my compendium of 10 worst deals on Nama's record). A quote: "I would like NAMA to explain its approach when a bidder went to buy not the loans but the debt of the Chicago Spire, which was at $78 million plus costs which brought it to approximately $93 million. An investor sought to buy the debt, and this was every penny that was owed to the bank. This was not the reduced value, but the par value. In other words, this investor was prepared to pay the debt in full but NAMA gave it to Jones Lang LaSalle in New York to sell. This was a site in Chicago. Even if NAMA thought it could get more for it, it was not in New York that it would have got it. It would have been interesting if it had marketed it in Chicago. Why could NAMA not accept the debt being bought out? It is estimated that it was sold for $35 million. NAMA refused $78 million, plus the cost, and it accepted a figure in the region of €35 million. That was claimed to be in the interests of the taxpayer."

It is worth repeating that Nama has denied any wrongdoing in any of the above cases and has now requested that Gardai investigate Deputy Wallace's claims. All other players in the Northern Ireland saga also denied allegations.

Of course, when it comes to Nama asking Gardai to investigate N. Irish deal allegations and denying any knowledge of wrongdoing, without putting their intent and their denial into question, one might recall that Nama is fully aware of another wrongdoing relating to IBRC interest rate overcharging (as detailed and documented here: http://trueeconomics.blogspot.ie/2015/06/11615-full-letter-concerning-ibrc.html). But so far, Nama is in no rush to address the matter it has been notified about some ages ago (see details here: http://trueeconomics.blogspot.ie/2015/06/12615-anglo-overcharging-saga-ganley.html). Lest we forget, NAMA was the biggest buyer of the IBRC loans to which the interest overcharging applied, and, it is alleged (see here: http://trueeconomics.blogspot.ie/2015/06/1062015-bombshell-goes-off-on-anglo.html), this overcharging continued for loans transferred to Nama and still continues, despite the High Court Ruling of October 2014.

NAMA 3.0 - more weight

My NAMA 3.0 - that includes also some proposals advanced first by Patrick Honohan, Brian Lucey and Karl Whelan - is gaining some speed. Here is a slightly more edited/updated version of it:

Step 1: Require banks to take full mark-to-market writedown on their loan book. This ensures that realistic valuations will be attached to the loans and it is fully consistent with the Swedish Bad Bank model (SBB-consistent);

Step 2: Travel down the capital ranks to draw down shareholder equity, deplete perpetual bond holders, subordinated bond holders and so on to cover the writedowns. This is a natural progression in addressing any insolvency and there is no reason as to why NAMA should be different (SBB-consistent).

Step 3: Force senior bond holders into debt for equity swap (exchanging their bond for shares at a discount), with a possible sweetener on equity conversion formulas relative to the Exchequer valuations (meaning we convert their bonds into shares with a small sweetener or shallower discount than actual valuations will imply). By retaining these guys on board as shareholders, we ensure that the banks will not be 100% state-owned and that potential lenders will have an interest to lend because they will be shareholders in these institutions. This is consistent with GM bunkruptcy proceedings earlier this year;

Step 4: Open enrollment for a share-participation in Irish banks recapitalization to SWFs and private capital. The Government should actively seek such external investors to increase private sector share of overall equity holdings (on top of converted bondholders - point 3 above). This should be done in the period while the banks are drawing down their capital funds to write-off losses to ensure that the banks are not fully nationalized;

Step 5: Cover all the shortfalls in capital base through recapitalization (as in Government's NAMA - or NAMA.G - proposal) after Steps 1-4 are completed and after an independent assessment of the value of the remaining loans is carried out to determine the true extent of banks under-capitalization (SBB-consistent).

To establish independent valuations – set up a Valuations Board of NAMA consisting of 9 individuals: 1 from DofF, 1 from NAMA, 3 valuations experts, 1 finance expert (banks), 1 planning specialist, 2 independents (economist and accountant). There shall be no post-NAMA levy expsoure for the banks as the state will take ordinary shares in those institutions (reducing future uncertainty for banks), thus creating an upside potential to shares (offsetting any losses on NAMA discounts).

Recapitalization, carried out jointly with new shareholders (past bond holders, SWFs, private investors, etc) will see Irish Government taking significant/majority shares in all main banks in Ireland. However, it will not be a nationalization, as the state of Ireland will not own these shares - the shares will be held in the name of Irish taxpayers in an escrow account or holding company called NAMA3.0 (below). Furthermore, significant shareholding in at least 3 banks can be private - through the private placements (step 4 above).

This is constent with SBB, but it is also consistent with the current NAMA-G proposal, as the Government has not explicitly rulled out a possibility of nationalization of the banks in the post-NAMA recapitalization. Furthermore, NAMA3.0 reduces the extent of state ownership of the banks by committing itself to attracting some private sector shareholders - e.g former bond holders and new investors.

Step 6: Hold equity in an escrow account (NAMA3.0) on behalf of the taxpayers, appointing

• The members to the Supervisory Board of every bank recapitalized by the taxpayers money. These should consist of one appointee by the Minister for Finance, 1 independent representative of the taxpayers, who is charged with explicitly guarding the taxpayers' interests, 1 representative of NAMA3.0. Each member (other than those from NAMA3.0 and the bank) will hold a veto power.
• A requirement that risk, audit and credit committees of NAMA3.0 include at 2-3 independent experts who cannot be employees of the state, NAMA3.0 or any other parties to this undertaking
• Set up an independent, bipartisan, NAMA Oversight Oireachtas Committee consisting of non-voting Chair, 1 representative of each Party, 1 independent TD.

Step 7: Accountability:

• no indemnity for negligence and incompetence for any employee or director of NAMA 3.0 organization - no one in the private sector has one (SBB-consistent);
  
• no cross borrowing by the Exchequer from NAMA3.0 is allowed, so Brian Lenihan and his successors cannot raid the nest egg by - at a later date - borrowing funds against NAMA-held assets to spend on other state commitments (current or new). This is SBB-consistent provision;
  
• ownership of shares in the account accrues to the taxpayers, not to the state or the public sector;
  
• NAMA3.0 cannot lend money to continue any of the banks' projects without specific recommendation of the risk committee (unanimous) and an authorization from the special Oversight Committee of Oireachtas;

Step 8: Transparency:

• full disclosure of all recapitalization actions and shares held in NAMA3.0 - on the web, updated live;
  
• full disclosure of all salaries, bonuses etc, CVs of all managers and directors and disclosure of all potential conflicts of interest;
  
• full disclosure and updating of the comprehensive NAMA3.0 balance sheet, cost/benefit analysis of the undertaking and live monthly mark-to-market report on the value of shares held;

Step 9: Operational Efficiencies: NAMA3.0 can, with consent of the Minister for Finance and in orderly (market-respecting) fashion disburse all or a part of its shareholdings so as to maximize the return to the taxpayers. This disbursal should be fully notified to the public immediately post execution, with prices achieved and hedonic characteristics of the properties sold (barring identification information) fully disclosed. NAMA3.0 will then have 60 days to issue every resident of this country - registered at the date of creation of NAMA3.0 as being tax-compliant - his or her share of the sale proceeds net of NAMA3.0 operating costs and a special withholding tax of 40% on Capital Gains, in a form of a cheque;

Step 10: Legal Remit Over Assets: NAMA3.0 in recapitalizing the banks will have a mandate to help the banks collect on outstanding loans by aiding them in seizing requisite collateral. In doing so, NAMA3.0 will have to agree a procedure to address problems of cross-collateralization of specific assets. NAMA3.0 will have a right to seize borrower's property (applicable only to developers) when such property has been legally shielded from authorities or banks at any time after July 2008.

Step 11: Conditions for banks participating in NAMA3.0: banks will be required to adhere to the following rules, including, but not limited to, the caps on executive compensation at the banks set at Euro500,000 maximum with share options not to exceed 75% of the salary, to be taken in long-term options – 5+ years, with the option price to be set as the Moving Average over the last 3 years of Bank’s operations prior to option maturity). Banks must set up fully independent, veto-wielding risk assessment committee with a mandatory requirement for a position of a taxpayers' representative on the board that cannot be occupied by a civil servant or anyone who has worked in the Irish banking or development industry in the last 10 years.

In addition (all below are SBB-consistent):

• the banks must set up independent fully shielded administration offices for managing NAMA-held loans;
• the independent offices must compete against each other in delivering the returns to NAMA loans;
• the annual performance of these offices must be benchmarked also against the annual performance of the banks' own books of loans with the NAMA offices within the banks achieving at least the same average rate of return on its loans as the rest of the bank (adjusted for quality of loans) without any cross-subsidisation of returns to NAMA loans from other loans managed by the banks;
• NAMA offices within each bank must report their results separately from the bank and at the same time for all NAMA offices - quarterly and annually. NAMA3.0 will be responsible for making these reprots public after approval by NAMA board and risk, credit and audit committees.

Step 12: Re-legitimising the public system of regulation in Financial Services: as a part of NAMA3.0, the Government must address the ever-widening crisis of markets, investors' and taxpayers' trust in the Irish system of Financial Services regulation. Many steps must be taken to address this problem, and these can be worked out over time. But in my view, there must be a stipulation that all and any regulatory authorities (and their senior level employees) that were involved in regulating the banking and housing sector in this country until now must be forced to take a mandatory pension cut of 50%, a salary cut to put them at -20% relative to their UK counterparts wages, and return any and all lump sum funds they collected upon their retirement. The Government must impose measures to prevent banks from beefing up their profit margins through squeezing their preforming customers. The measures to force the banks to reduce their cost bases by laying off surplus workers must be enforced. From now on, every regulatory office should be required to publish all minutes of its meetings, disclose all its voting, decisions and rulings to the public, create a public oversight board that must include members of the Dail from non-Governing Parties, a taxpayer representative and independent directors.

Economics 04/08/2009: NAMA, Liam Carroll & Short Termist Bonds

I should make it a habit to direct every NAMA post reader to my proposal for NAMA 3.0 here.


Yeps, Supreme Court came in on the side of the Government, throwing a lifeline to NAMA and forcing taxpayers into deeper losses. My earlier note stand now (see here) with all the gory implications for losses on Mr Carroll's loans now being back in the NAMA court.

But two birdies have chirped to me that there is more brewing up in the land of NAMA-fantasy. Apparently, the rumor has it, the Government plan is to issue short term bonds to cover NAMA liabilities. Given that NAMA will start issuing bonds in 2010 for this undertaking, the short term nature rumored is for a 2011-2012 bonds.

This, if true, makes no sense for several important reasons. Here are some:

(1) Issuing short-term debt with maturity before 2013 is equivalent to a financial suicide. The reason is simple - there is no credible (or for that matter even an incredible one) commitment from the ECB that

• such issuance can be rolled over at the same or lower interest rates to cover maturing bonds; and
• the EU will allow these bonds to remain off the balance sheet of the Government upon the roll over.
  

(2) Issuing short term bonds will be a fiscal suicide, for their maturity, and roll-over date, will fall dead on in the years of heavy Exchequer borrowing and maturity of other - 2008-2009 issued bonds. Given that the market demand for fixed income paper worldwide will be thinner then (due to increased appetite for equities-linked risk), a flood of rolled over bonds can risk derailing the borrowing programmes for Irish sovereign debt. Now, if you are a forward-looking investor, expect Irish yields to run away from the benchmarks once again, then.

(3) Short term maturity does not take into account the main risk to NAMA valuations, namely that by 2011 or for that matter 2013, the assets taken over by NAMA will be priced at any significant upside relative to what NAMA will pay for them, implying that, under short-term issuance, this Government will face the need to

• engage in a massive refinancing operations
  
• at the time when its balance sheet liabilities will be almost at their peak (see Department of Finance projections);
• pay higher expected cost of borrowing than today; and
• potentially, load the NAMA liabilities onto Government own balancesheet, while
• facing market prices and demand for real assets that is well below the valuations applied by NAMA.
  

If you look at the latter point. DofF uses 7 year U-shape cycle as its basic assumption. Peter Bacon last week stated that the cycle is expected to be 5-10 years. My estimations, based on NBER research (here), show that the average duration of the U-shaped cycle in historical data for OECD economies for 1970-2003 episodes of house prices collapse co-measurable with the one we are experiencing today is between 18 and 23 years. This range is dependent on how you time the cycle, but it refers to a nominal price cycle, unadjusted for Forex devaluations that accompanied such cycles in other countries and inflation. Japan (in down cycle since 1989-1990), Germany (since 1972-73), Italy (since 1981) and Sweden (since 1979) have not recovered to date.

Considering rolled up interest charges on impaired loans, banks' restructuring of interest payment schedules on so-called 'performing' stressed loans that in any other country would be classified as having defaulted, NAMA will be purchasing assets from the banks at an extremely shallow effective discount.

For example, a discount of 30% applied to a loan with 1.5 years (since July 2008 through December 2009) rolled up interest at 10%, and a built in re-financing cost of 1% will be equivalent to an effective discount of just 18.1% relative to the original principal of the loan itself. If, in the mean time, the underlying asset value itself has depreciated by, say 40%, then
NAMA will be buying a Euro 60 asset for Euro81.86. Now, in order for NAMA to recoup the original cost of purchase (not counting the cost of financing the purchase and managing the asset etc), the asset value needs to appreciate by a compound 36.4% within the span of the bond
finance. Thus between now and 2011 when the alleged bonds should mature, the annualized rate of appreciation required on the assets for NAMA just to recoup the original loan amount would have to be 16.8% per annum!

If anyone in the Department of Finance thinks this is a sane bet on a market turn-around, God help us.

Short-term financing of long-term obligations, as we should have learned in the current crisis, is equivalent to giving steroids to an unfit athlete and sending him out to run a marathon.

Though to repeat once again - this is just a speculation at this moment in time although two independent sources have tipped me on this one.

Economics 11/8/10: Bank of Ireland H1 results

Bof I results for the H1 2010 did represent a significantly different picture from those reported by AIB, with one notable exception – both AIB and BofI are yet to catch up with reality curve on expected future impairments.

BofI profit before provisions was €553mln against €811mln in H1 2009. This, however, doesn’t mean much, as a score of one-off measures were included in H1 2010 figure:

• Losses on sales of loans to NAMA’s were factored in at €466mln
• Debt exchange added a positive of €699mln
• Pension deal brought in a positive contribution of €676mln.
• Net positive of the one-off measures was, therefore around €909mln implying that BofI really was running a loss €356mln before provisions and after one-offs are factored in.
  

Underlying loss before tax, net of charges, was €1.246bn or almost double the €668mln loss last year. The impairment charges amounted to €1.8bn in H1 2010, inclusive of €893mln non NAMA provisions. The impairment charge therefore almost doubled on €926mln in H1 2009.

Big ‘news’ today was that BofI continues to guide for €4.7bn in impairments charges for March 2009-2011. Given that the bank has taken €3.9bn of these provisions to date, it will have to deliver an €1.2bn gain on H1 2010 (roughly 1% of its loan book value) before March 2011 to stick with the impairments estimate. How much can BofI squeeze out of its customers remains uncertain, but to get to its target figures, the bank needs either a helping hand of Nama (on valuations for Tranche 3) or a dramatic reduction in cost of funding (unlikely) or a 30%+ increase in what it charges on loans (without any subsequent deterioration in their quality).

These are unlikely for the following reasons.

Impaired loans are up by a significant €2.1bn reaching 7.1% of the total loan book (these were 5.5% at the end-December 2009). Risk weighted assets stood at €93bn down on €98bn in December. And asset quality is still declining: impaired loans were €15.8bn of which €8.86bn were on non-NAMA book. This compares to €13.35bn in December of which €6.79bn related to non-NAMA book. Provisions were €6.64bn in June of which €3.725bn non-NAMA, implying 42% cover, down from 43% in December when provisions amounted to €5.8bn in total, with €3.0bn non-NAMA.

BofI maintains that bad debts peaked in H2 2009, showing a charge of 1.4% on gross loans in H1, compared with a charge of 2.9% in Q4 of last year.

This looks optimistic. BofI business side continues to suffer from income declines and costs overruns. Total income was down 8% yoy at €1.76bn. Cost cutting this year will have to come at a premium as BofI prepares to shed some 750 more jobs. Total staff numbers are down by 805 or 5% yoy so far in 2010.

BofI H1 2010 net interest margin was 130 bps down 40bps relative to H1 last year. Causes: higher deposit and funding costs, lower capital earnings and Government guarantee. Assets repricing helped by adding 19bps to the margin. Cost to income ratio increased to 61% relative to 54% a year ago, despite costs falling by 3% to €916mln. This means income is seriously under pressure. Impaired loans on residential lending book have increased by 58.5%.

One improved side – capital ratios came in at Core Equity Tier 1 of 8.2% up on 5.3% in December and ahead of 7% regulatory target, but still low relative to European and US peers. Tier 1 ratio was 9.9% virtually unchanged on 9.8% in December.


BofI might be right in some of its rosy projections. You see, Nama has been rolling over for the bank so far. BofI originally guided Nama discount of €4.8bn on €12.2bn it planned to transfer to Nama, or 39% haircut. Nama obliged so far by shaving off 36% on the €1.9bn of loans transferred in Tranche 1 in April and then 35% on Tranche 2 transfer of €1.5bn in July. This was done despite the fact that impaired loans proportion continues to rise in the sub-portfolio of BofI loans destined for Nama.

And this rise is a serious one. At the end of June, 69% of the loans remaining in the Nama-bound portfolio were impaired, up on 54% in the overall Nama portfolio set aside in December 2009. So Tranche 1 transfer picked out better loans or the loans have deteriorated dramatically since Tranche 1 transfer or both. Either way, lower discount on Tranche 2 loans suggests a blatant subsidy from Nama.


Funding side remains under threat, though BofI put a brave face in stating that it raised €4.6bn in term funding so far (mostly in the beginning of the year before the proverbial sovereign debt sh***t hit the fan). The bank still has to raise €9.5bn more before the end of the year 2010. The balancesheet numbers as well as market conditions suggest that this might be tight.

Total loans held grew by €3bn in H1 2010 to €125bn driven by sterling appreciation. Meanwhile, deposits were down €1bn to €84bn, so bank’s loan-to-deposit ratio, ex-NAMA, rose to 143% from 141% in December 2009. Deposits decline was driven by ratings downgrade for S&P in January 2010 which shaved €3bn worth of value from the ratings-sensitive deposits.

This doesn't make BofI any more attractive to the lenders.

But the bank has done coupple of things right. BofI is gradually improving its funding outlook by extending funding maturity – up to 41% of wholesale funding being in excess of 12 months in H1 compared to 32% back in December 2009. And BofI has been reducing its reliance on wholesale funding – down €3bn in H1 to €58bn total. BofI still holds €41bn worth of contingent liquidity collateral, theoretically eligible for ECB borrowings.

The bank also has €8bn exposure to ECB – same as at the end of 2009. You can either read this as the brokers do, meaning that BofI still has massive reserve it can tap if it needs to go to ECB. Alternatively you can say that in the last 6 months, the bank did nothing to work itself off the reliance on ECB funding.

Finally, virtually all analysis (with exception of one brokerage – if I recall correctly it was NCB) overlooked the data released on the deposits breakdown. Per note, “deposits with a balance greater than €100,000 amounted to €50bn at end-June. …As it stands, the ELG guarantee will no longer cover corporate deposits greater than €100,000 with a maturity of less than three months — presumably a significant proportion of these balances — after September, with the ELG set to go completely at year-end. It seems certain to us that the ELG will have to be extended to shore up confidence and facilitate the as yet unfinished wholesale terming effort.”

Economics 12/09/2009: ECB, repos and Nama

It has not became customary for the Government and public officials to provide 'expert commentary' on Nama that in effect attempts to deflect substantive criticism by making unarguable, non-falsifiable assertions on Nama that can neither be confirmed, nor rejected, yes sound plausibly informed.

The latest such 'argument' against Nama critics floated in political circles - opposition parties, FF backbenchers etc - is that, per DofF, ECB will not be willing to take repo bond off nationalized banks.

What does this mean? In the lingo of Nama-supporters, this means that if we nationalize banks (either via a direct nationalization or via equity purchases post-Nama), the nationalized banks will not be able to use Nama bonds (or any other repurchase agreements paper) to swap with ECB for cash. The threat then is that the nationalized banks will have no access to a liquidity window at ECB and will not be able to operate.

Is this a serious threat? If true, it is a serious concern, because in our 'confident' economy of Ireland Inc, a combination of severe recession and Brian Cowen's economic (taxation) policies have effectively assured that no deposit-based lending can take place, so our banks are now fully reliant for funding on ECB and interbank markets.

But is it true? This we do not know and we cannot know, for DofF will neither confirm of deny they are saying this. And furthermore, they will never actually show the ECB statement confirming or denying it.

So what can we conclude about this threat?

Two things, really:

1. The latest DofF threat is bogus in its nature, for there are plenty proposals out there for repairing Nama that do not involve nationalization. If ECB is willing to support privately held banks (as opposed to plcs) and since ECB's definition of a 'supported' bank does not have a limit on how large share of public ownership can be as long as the bank remain private to some extent, then my proposal for Nama 3.0 or Nama Trust will work just fine. The alleged DofF 'fear' is misplaced and it is being floated out there simply to deflect public attention away from viable alternatives to Nama.
   
2. The latest claim is also bogus in terms of its logic. Suppose the ECB refuses to swap repos coming through a nationalized bank from Ireland. Since nationalization covers the entire domestic banking sector in Ireland, the ECB then refuses to take any bonds from any of the Irish banks, making the entire system of Irish banking illiquid. Now, Ireland is a Eurozone country. This act by ECB will force at least one Eurozone country into a combined liquidity and solvency meltdown. What do you think will be the expected effect on the Euro? Oh, yes, it will overnight become a twin to the Zimbabwean currency. Will the ECB agree to destroy its own reputation, monetary system and currency only to avoid repurchase operations with a more stable and less risky (post-nationalization) banking system of its member state?

In short, the rumors that DofF is claiming that the ECB will not swap with nationalized banks are so out of line with reality, they either cannot be true, or someone in ECB is flying high as a kite. You judge which one of these two alternatives is a more plausible one.

Economics 29/12/2009: Looking back at 2009

For those of you who missed my article in the Sunday Times last weekend (December 27, 2009) here is, per usual, an unedited version of the text.

By all possible measures 2009 will go down as yet another annus horribilis in the history of Ireland. Some 29 months since the inception of the crisis there is hardly any sight of the end of our depression – the worst on the record that any Euro area state has endured in modern history.

In 2008-2009 Irish economy has lost a compound 9.6% of GDP and a whooping 13.2% of our GNP. Over the same period of time, Eurozone economy has contracted by the total of 3.3%.

Based on Department of Finance latest projections, by the end of 2010, our gross domestic output will fall 10.8% and GNP will have declined by 14.7%, against the European Commission forecast for the Euro area income contracting by 2.65% on 2007 levels.

Put into perspective, assuming the current crisis runs its course as projected by analysts, the US will regain the 2007 levels of real annual income in late 2010. For Euro area, this moment will arrive in 2012-2013. Ireland is going to return to the 2007 level of prosperity in 2015 in terms of GDP and 2016-2017 in terms of GNP. And this is under optimistic assumptions of relatively robust growth post-2011.

These figures only begin to describe the extent of our economy’s collapse in 2009. It is now a common realization amongst the economic forecasters that whatever growth we might achieve in the next few years, unemployment will remain at extremely elevated levels.

In Q3 2009 official employment fell 40,200 on Q2 2009. This means that in 12 months to the end of September 2009, Irish economy shed some 183,400 jobs - the highest rate of jobs destruction on the record. In the course of this recession, we have now lost some 236,300 jobs.

Back in December 2007, the live register stood at 173,200. A year later, it rose to 293,000, up 119,800 or 69.2% in 12 months period. This December, live register is lingering at 423,400 – an increase of 44.5% on 2008 levels. Sounds like an improvement? Not really. Such is the nature of statistical optics that an 8.8% rise in the number of people on unemployment benefits looks like an improvement in the rate of unemployment growth.

If in the mid 2008 Irish economy had 17^th highest unemployment rate in the EU27, by the middle of this year it was the 5^th highest.

Do the math: the above jobs losses imply that in 2009 some €13.5 billion was lost in employment-related economic activity in Ireland. This translates into an additional €4-5 billion in lost private consumption while our welfare bill rose by some €3.5 billion.

All of these jobs losses (save for ca 5,900 jobs eliminated through natural attrition in the public sector excluding health services between the end of 2007 and the end of 2009) came out of the private sector. In terms of the drain on Exchequer revenue these losses simply cannot be offset through wage bill cuts imposed by Budget 2010 onto public sector.

Even more problematic is the trend of falling labour force participation rate which has contracted from 64.2% to 62.5% in a year to Q3 2009. This change is extremely hard to reverse within a given generation. Much of the fall in 2009 has been driven by rising long-term unemployment, pushing people into permanent welfare traps, and net emigration.

In 2009, some 45,000 non-Irish nationals left the country. I would estimate that at least 20,000 Irish natives did the same. On the net, CSO data shows that while unemployment climbed by roughly 120,000 over the last 12 months, the actual fall in employment was 185,000.

These people have left their productive employment in this state and moved on to work elsewhere. Many worked in the construction and domestic services sector and had skills beyond their jobs. Many worked in industry – where their skills and future productivity were being enhanced by on-the-job training and through experience. In Q3 2009, industry displaced construction as the leasing source of new unemployment. Quarter on quarter, industry lost 12,200 jobs in Q3 2009 relative to Q2 2009, while construction sector lost 8,700.

But scores of those who are now emigrating out of Ireland worked in traded services and here the losses to our productive potential are even greater. 2,300 jobs were lost in professional, scientific and technical activities in Q3 alone. The future of Irish economy is in traded services – the elusive 'knowledge' economy we've been pursuing. This economy requires more people with cultural, linguistic and skills sets that are distinct from our 'national' averages. Given that we cannot hope to retrain lower skilled workers to take up jobs in professional services exports, the loss of junior non-national staff in finance, professional services and ICT is doing irreparable damage to our international competitiveness.

The good news, of course, is that we are now starting to see some re-hiring in financial services (600 net jobs created in Q3 2009 relative to Q2 2009) and MNCs-supported employment remains strong. The bad news is that serious layoffs are yet to materialize in the state-supported banking.

Lastly, 2009 was another year of banking sector disasters. Irish banks began 2009 teetering on the verge of full blow bankruptcy – with our third largest bank falling into the hands of the state and two largest banks seeing their shareholders’ capital virtually wiped out. The crisis of the early months of 2009 was temporarily resolved by the introduction of Nama, leading to a robust, but short-lived rally in banks shares. The real problems – weak balance sheets, pressured deposits, precipitously collapsing asset valuations, rapidly deteriorating loans performance and dwindling capital reserves – remain unaddressed.

Thus, as was predicted by this column in May 2009, the Nama solution turned out to be nothing more than an expensive means for delaying the inevitable. It is by now an accepted consensus that nationalization of the main Irish banks is an inevitable denouement to the saga of misguided banks rescue measures that began with the regulatory Green-Jerseying of the banking sector against the short-sellers in the late 2007, progressing to the wholesale banks guarantee scheme in September 2008, and via nationalization of the Anglo Irish Bank, on to Nama passage in 2009.

All along, Irish Government and banking sector have made all efforts to evade and silence critical independent analysis of the causes of the current crisis: inept regulation and enforcement, reckless risk-taking in lending and funding, and wrong-footed solutions advanced by the State. The Irish taxpayers are now facing a bill of tens of billions of Euros, as well as the decade-long prospect of zombie banking, development and property markets and construction sectors – courtesy of Nama.

Just as in the end of 2008, only the stock markets are now capable of reflecting the extent of the expected Nama damages back to the economy. AIB shares are now trading some 36% down on their January 2, 2009 levels and 67% down from their 12-months peak. Bank of Ireland shares, having gained 32% on January prices are still down 66% on the 12-months peak.

As Winston Churchill said once: “Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.” One can only wish our policymakers discover the second half of this dictum in the New Year.

Box-out:

Per latest CSO data, average weekly earnings in the Public Sector (ex Health) rose by 2.5% in 12 months to September 2009, reaching €969.11 per week. While the lower rate of increase is a welcome sign of some moderation in public sector pay, the numbers reveal a farcical nature of the Government’s efforts to date to control its own expenditure.

Weekly earnings for the Regional Bodies rose by 4.6% (from €815.58 to €852.71), the Education Sector by 3.0%, from €944.49 to €973.10. An Garda Síochána weekly earnings excluding overtime decreased slightly by 0.1% from €1,077.55 to €1,076.22 for the same period. Now, compare this record with the rates of increases between September 2005 and September 2009 when average weekly earnings in the Public Sector (excluding Health) rose by 14.2% from €848.94 to €969.11 per week.

The same lack of progress on reducing public expenditure is manifested in the numbers employed in the sector. Natural attrition with recruitment bans has produced a decline in Public Sector employment from 369,100 in September 2008 to 360,900 in September 2009. Just 8,200 or 2.22% fewer people worked in the Public Sector in this country despite the nearly total collapse in the Exchequer revenue. In the four years to September 2009, employment in the Public Sector rose by 17,300 to 360,900.

If Ireland’s public sector employment pay and numbers were to be benchmarked against the UK levels, it would take some 15-20 years before these rates of ‘moderation’ bear the fruit of reaching parity with our next door neighbors.

Economics: 15/05/09: Ned 'Homer' O'Keeffe & ESRI's latest trip

So we have Ned O'Keeffe as Irish Politics answer to Homer -
except the former's daftness is actually intended as political and economic view points... read here...

"What has Tesco offered us since they came over to Ireland?" said Deputy O'Keeffe. "I think we would be better off if Tesco were to leave Ireland altogether. Their absence from the Irish market would be taken up by other supermarkets who would fill the gap and hopefully it would lead to less exploitation of Irish food suppliers. We’ve already seem the damage that foreign banks have done to Ireland and how the Irish banks were forced to make up for their mistakes. Well the same could happen in the retailing sector with the foreign retailers such as Tesco ruining the Irish supermarket industry and putting thousands of people out of work around the country", Deputy O'Keeffe concluded.

This is either delusional or clinically mad. And it comes from a sitting TD. In fact, the statement is so historically, economically and socially illiterate, Mr O'Keeffe deserves no comment on this blog other than one word: FRIGHTENING!


And in case you are not scared enough by Ned 'The Belching Brain' O'Keeffe, look no further than the latest trip-to-the-light-fantastic from ESRI: Recovery scenario for Ireland in the medium term, calling for 6.5% GDP growth. Yes, you are reading it right - 6.5%!

How did they got so high? Well, they estimated that Irish potential GDP growth post-crisis will be 3.0% (down from their previous estimate of 3.6%). Then, they slapped on top of this an additional 3.5% to account for the severity of the downturn we are currently experiencing. So the logic is - the further you fall in a recession, the steeper will be the climb on the way up. Ah, if only the world evolved according to the ESRI model.

Per IMF earlier studies (including the one I covered in several previous posts and in my column in Business & Finance), current recession, globally and in specific countries, like the US, is likely to lead to a flat-line recovery in output. But don't trust my words - see in the excellent note from NCB's Brian Devine (here):
So ESRI is in effect assuming that Ireland will be unique in the world in experiencing stronger recovery post-crisis than other economies, including those that will drive Irish recovery - i.e. the US and UK.

Alternatively, you can read ESRI's 'forecast' as being driven by the rate of FDI inflows into Ireland outstripping in the rate of growth the US/UK domestic capital investment expansion post recession 2:1.

As Brian put it in his Friday note: "The ESRI have assumed that this catch-up process will cause Irish economic growth to average 6.5% over the period 2011-2015. We would be highly cautious of this growth rate because of: a) The difficulty in measuring potential output especially in light of the current shock to the domestic and global financial system. b) The uncertainty surrounding the pace of global growth, again because of the difficulty in assessing the potential output of our main trading partners arising from the damage to the global financial system. c) The uncertain effects on consumption of further tax hikes. We also believe that consumption will remain subdued because of the rise in the level of real indebtedness."

Well argued, although I would have put it in less polite terms.

Per NCB note, the summary of ESRI 'forecasts' and NCB latest forecast, alongside with my own estimates are shown in the following table:
The difference between NCB's forecast, my estimate and ESRI's absolutely acid-sharp predictions is in assumptions...

As NCB note explains: "The conventional view of economic growth is that business cycle fluctuations in GDP represent temporary deviations from trend. In other words the economy eventually returns to a path determined by the potential of the economy. It is not abundantly clear that the current deviation from trend is transitory in nature. In other words it is quite possible that the problems in the economy are more structural in nature i.e. there has been a permanent loss of output relative to previous potential. The ESRI have acknowledged this and lowered the potential growth rate from 3.6% to 3.0% over the period 2005-2020 (driven by a significant part of the capital stock being rendered obsolete, the increase in taxes, the risk premium on borrowing and the reduction in global output potential). As a result of the current recession the ESRI estimate that there will be a permanent loss of the level of output relative to previous potential of 10%."

Ok, but... is 3.0 a relevant figure for the future? What reasons can ESRI bring about to set our potential growth rate close to the US and well above our main Eurozone competitors? Superior education system? Super-human entrepreneurship drive? Low cost base? Low tax rates? Fit and efficient public sector? Effective and pro-market Government? Workers who are accustomed to giving that extra effort and not expecting to be paid for it on the double? Competitive domestic service providers ensuring low cost of doing business in Ireland? Not likely. Shamrocks planted on a White House garden patch from the last Taoiseach's visit for Paddy's Day? More like it.

But here is more from NCB note: "As the ESRI note “In considering how the Irish economy is likely to exit from the current recession the key lies with the timing and nature of a world recovery.” Most of the world’s economies are forecast to grow at rates close to potential over the period 2011-2015 in the ESRI forecast." So why, again, does the ESRI assume that Irish economy will grow at more than double its potential GDP?

NCB also highlights timing issues in ESRI forecast: "Despite the fact that the pace of the decline in global downturn is likely behind us ...things are only getting less worse not better and the outlook remains highly uncertain, with the possibility of policy error large. The ESRI do take this into account by running an alternative scenario in which global growth does not recover until 2012 – in this case GDP growth in Ireland averages 5.5% over the period 2011-2015." So feel free to wonder - the world will still be in a recession in 2012, but ESRI's Ireland will be looking at a growth of 5.5% pa over 2011-2015? Let's take it apart: suppose 2012 the world is still in a recession, with growth of -1% - for the sake of an assumption. In 2011, obviously, things wouldn't be much better either, so let's say GDP growth is at -1.5% then. Now, to post average growth rate of 5.5% over 2011-2015 as ESRI predicts, Ireland would have to grow at a cumulative compounded rate of 34% between 2013 and 2015, or at an average annual rate of 10.25%! The ESRI use this as their pessimistic scenario...

So why are these unrealistically high numbers? Why now? Why from the ESRI? We can only speculate.

NCB's note says: "We think the greatest domestic risk to economic recovery is that the fiscal consolidation which has begun is not seen through or that taxes bear even more of the adjustment than currently envisaged (ironically the ESRIs document could halt the process of adjustment as unions/ government point to the fact that the economy is forecast to average growth of 6.5% in the future). This would have a major knock effect on consumption, competitiveness and borrowing costs and as such GDP growth."

That is, as far as I can understand it, a hint at something that I completely agree with. ESRI is a quasi-Governmental organization with no real independence in sight. In fact, what passes for 'independent' thinking in the ESRI's usual policy work is a mix of Labour's leftism in social policy department and Garret Fitz FG's legacy in taxation thinking (i.e the inherent inability of the ESRI to actually think rationally about tax burden and the damage it does to our economy). Hence, ESRI saying today that 'look - things are going to be just fine in couple of years' can be interpreted as their masters' signal to the unions and the social partners that the discomfort they might feel to be will be rewarded out of the spoils of the growing economy once again tomorrow. The timing of this rosy forecast - close enough to the elections is also, at the very best, an unfortunate coincidence.

Which brings us back to NAMA - why isn't the Government pre-committing itself to disbursing NAMA proceeds (if any gains occur) in the future to the taxpayers? Why isn't it ringfencing these proceeds? Perhaps, the NAMA upside is being held back to pay off the unions in the future through a compensatory wages increases after the crisis to the public sector workers for the income reductions they have suffered? or perhaps such a commitment has already been made? After all, the Bearded Men of the unions are not exactly fighting against NAMA, are they?..