Monday, April 12, 2010

Economics 12/04/2010: Nama's economic distorionism

An interesting quote from the just-published paper (Claessens, Stijn, Dell’Ariccia, Giovanni, Igan, Deniz and Laeven, Luc A., Cross-Country Experiences and Policy Implications from the Global Financial Crisis. Economic Policy, Vol. 25, Issue 62, pp. 267-293, April 2010). I reported on this paper last year at length, when it was still an IMF Working Paper.

“An example of distortions between financial institutions and the fiscal conditions is the extension of guarantees in the case of Ireland to the largest banks. Prior to the extension of guarantees, the CDS-spreads for the large Irish commercial banks were very high. Post guarantees, bank CDS-spreads declined sharply, while the sovereign spread increased. Measures like these, now numerous in many advanced countries today, distort asset prices and financial flows.”

This goes hand-in-hand with the EU assessment of Nama as a market distorting mechanism, which, as reported last week by Irish Independent, was concealed from the public when our Minister for Finance issued a press release claiming that Nama was fully supported by the EU Commission.

Further per Claessens et al: “Guarantees on deposits and other liabilities issued by individual countries have led to beggar thy neighbor effects as, starting with Ireland, they forced other countries to follow with similar measures.”

This statement in effect condemns Irish Government claim that our Guarantee was a success because it was copied by other countries. Instead, as Claessens et al confirm, the Guarantee forced risk from Ireland onto our trade and investment partners. Not exactly a high moral ground.

“The rapid spread of guarantees led to further financial turmoil in other markets. Many emerging markets not able to match guarantees suffered from capital outflows as depositors and other creditors sought the safe havens. Distribution of risks sharply changed over time and across circumstances."

More importantly, both – the revealed note from the EU and the above academic assessment – provide a significant warning in terms of the future of the banking and property sectors in Ireland. Given the systemic nature of distortions, subsequent exits and scaling back of foreign banks presence in the country, the lack of transparency and fairness in the property markets, it is now virtually assured that post-crisis interventions Irish banks and property markets will remain in their zombie state. Japan-styled recession is a looming threat for Ireland Inc.

Of course, you wouldn’t notice this, if you were listening to some of our heroic stock brokers – especially those folks like Bloxham who back in mid 2008 ‘forecast’ that ‘markets do come back’. In their latest strategy statement, issued last Friday, the Bloxham’s boys have managed to outperform themselves in terms of Green-jerseying (emphasis is mine):

“Ireland is undergoing some of the heaviest self imposed penalties for the fiscal over exuberance of the 2000s of any EU economy since the global credit crisis began in 2008. From budgetary austerity measures to public sector wage cuts, from crushing additional taxes both personal and indirect, to a mega-costing banking recovery plan; all in the name of stabalisation and repositioning as a viable economy. As Ireland passes through the next major set of hurdles (the transfer of assets to NAMA and the recap of the banking system), the market reaction so far has been favourable.”

Any evidence of this?

“10-year sovereign Irish bonds are still trading at 146 basis points above German bonds, compared with 280 basis points at the worst point for the Irish system in March 2009. Compared with Portugal at 126 bps over Germany, Irish spreads still have strong progress to make.”

The more the things improve in the wake of all the measures passed by the Government, the more the spreads stay the same? Indeed: “Irish sovereign debt costs have remained static in the past week, while Greek debt costs balloon by 100 bps. In relative terms, Ireland sovereign performance has been exceptionally good since the “Super Tuesday” announcements from the National Asset Management Agency (NAMA), the Financial Regulator and the Minister for Finance.”

But hold on to your seats for a wild ride into the land of bizarre logic: “A falling Irish debt cost is largely unappreciated domestically but is a very hansom reward for the pain taken in Ireland thus far.”

I am now thoroughly confused, folks – if the spreads stayed the same, what falling Irish debt costs do the Bloxham folks have in mind? Am I missing something in their vernacular? Or are they missing in the faculty of trivial maths – falling costs mean declining spreads, yet the spreads ‘remained static’ and debt costs did the same.

A real pearl of the note is in its conclusions: “We would expect that the wider Irish stock market will also benefit strongly over the next 6 months, as re-cap plans proceed and the export sector resilience is maintained. Ireland could be finally coming back on the international investor map.”

Indeed it might. Or it might not. I wouldn’t venture a prediction here, but Bloxham guys – having been so right on so many occasions in the past (including that brilliant note from them back in July 2008 (see the note here) surely would know better. Except, hmmm, what does Ireland’s exporting performance have to do with Irish stock prices? Not much – more than 80% of our goods exports and over 90% of our services exports are accounted for by the MNCs – none of which are listed on Irish Stock Exchange. So unless Bloxham guys know something about Fortune 500 companies plans to relocate their listings to Dublin…


Unknown said...

Constantin, do you have an opinion
about what is going to happen to AIB when 280 million preference share dividend falls in May ( only 3 weeks away). At current share price of 1.50 and EU forcing government to be paid in ordinary shares, surely this is BAD news for AIB shareholders- or am I wrong.

Unknown said...

Constantin, do you have an opinion
about what is going to happen to AIB when 280 million preference share dividend falls in May ( only 3 weeks away). At current share price of 1.50 and EU forcing government to be paid in ordinary shares, surely this is BAD news for AIB shareholders- or am I wrong.

TrueEconomics said...

Patrick, to be honest, I am not sure what will happen.

Irish banks=Irish Government has learned to pull 'miracles' at the expense of the taxpayer out of the hat. Rational valuation suggests that another, ough, say 12% of AIB will have to be swallowed by the Upper Merrion Street. But who knows - financial engineering knows no bounds and we might see some sort of the 'Nama'-esque swap, whereby AIB returns some cash/state bonds back to the Government to perform a pro forma act of payment. In the long run, AIB will have to face the music.

I doubt its assets sale will achieve anything near 3.9 billion that is being 'estimated' by the brokers. I would say they should be happy with selling the loot for closer to 3.0 net. That leaves them still on the hook for 4.4 billion in capital requirements alone. Can it raise it?

The bank is also on the hook for 2010 losses. Given the lags in its willingness to recognize impairments and changes in loans covenants they accepted, I would say these will be rising in 2010, and will see a relatively flat profile in 2011.

I simply do not believe the story that AIB will return to profitability in 2011. Especially as it will be facing the upward sloping yield curve on interbank markets and a further pressure on its loans from rising burden of repayments.

Current price range: under 1.50 is a short-term holding pattern, driven - in my view - not by Nama or bank's own fundamentals, but by the global liquidity flows.

That said, March 30 announcement by the Minister of potential demands for capital had a neat, largely overlooked revelation in it - the Government is entertaining conversion of some of the debt it holds in the banks (NPRF actually has invested in the banks bonds over 2006-2008) for equity!

Lastly, as we have seen with 'here's the money, just keep euro alive' crowd from Brussels, who knows - the EU might change its mind and allow Buswells' Boys to delay payment on Exchequer preference shares...

Anything is possible in our little Banama Republic.