29/02/2012: New Old Mini Budget?

Having predicted in my comments on Budget 2012 that we are likely to see an Emergency Budget 2012 closer to half-year results, I thought I was making just a risk assessment, backed by the confusion prompted by the DofF release of two rather significantly distinct forecasts for growth between two days of the Budget 2012 announcement. And now this.

Of course, the development of Budget 2012 took place under the assumed growth rate x2 of what is now being forecast by the IMF, the OECD & the EU Comm and roughly x3 times what is being predicted by other markets participants. My own forecast range is for -0.2 to 0.5 percent growth which at the upper range puts it at roughly 1/3 of the Budget assumptions. These developments since Budget 2012 release bound to rationally drive the Troika to push for revaluation, but one must wonder why on Earth would these not be made public to the people of Ireland? Why do we have to learn this from a leaked document from Germany?

28/02/2012: Reforms in Ireland - at risk? (Sunday Times 26/02/2012)

My Sunday Times article from 26/02/2012 - unedited version.

So far, the explosive nature of Greece’s crisis has been a boon for Ireland, as international perceptions of our economic and fiscal fortunes have turned more optimistic in some analysts’ and investors’ circles. This shift in the sentiment, however, may be threatening to derail the already fragile momentum for economic reforms here.

Irish budgetary dynamics for 2011 were largely on target, although this achievement conceals significant pressures on the tax receipts side and the lack of real progress in tackling runaway spending in three core current expenditure areas – Social Welfare, Health and Education. In fact, much of the previous deficit adjustments have been based on the Governments picking the low hanging fruit of capital spending cuts, administrative savings, and substantial tax increases, soaking the middle and upper-middle classes. Budget 2012 was pretty much the firs attempt by the Irish Government to rebalance the overall budgetary dynamics that, since 2008, have penalized higher-skilled and entrepreneurs. It is hard to see how this approach of piecemeal changes targeting the path of political least resistance can continue delivering ever-rising levels of fiscal adjustments already pencilled in for 2012-2015, let alone maintain the budgetary discipline thereafter.

Accounting for the delayed December 2011 tax receipts that were incorporated in January 2012 figures, the Exchequer deficit in the first month of 2012 was €160 million ahead of that recorded in January 2011. This gap shows that the pressure on Ireland’s fiscal dynamics has not gone away.

There is a more fundamental problem looming on the horizon – the problem of growth. To deflate the public debt that is now well in excess of 107% of our GDP and climbing, we need some serious economic growth. On average, over the next 10 years, we will need growth of over 3% annually over and above inflation in order to bring our Government debt down to 90% of GDP. To sustain some private sector debts deleveraging will require even higher rate of growth. Compare the current situation with that in the 1980s and the maths required for budgetary and households’ deleveraging become dizzyingly high.

In Q3 2011, Ireland registered the twin contraction in GDP and GNP and majority of the analysts expect the same for Q4 figures. For the year as a whole, we are likely to post approximately 0.9% real GDP expansion. Forecasts revisions for Irish economic growth have been driving us beyond the bounds of the fiscal targets we set out for this year. The Budget 2012 assumed economic growth of 1.3% against the IMF, Central Bank, EU Commission, and ESRI forecasts of 0.9-1.1% growth. More recent February forecasts by the markets analysts and ESRI put the range for 2012 growth at -0.5% to 0.9%. Much the same is true for forecasts out to 2015, with Government growth prognoses coming in at a rather optimistic 2.43% annual average against IMF November 2011 projection of 2.25%. Taking the lower range of most current forecasts, the shortfall on Government current assumptions for growth can be as high at €5 billion – a sizeable chunk of change. Under the adverse shock scenario by the IMF, if average growth were to decline to 1% of GDP – a statistically plausible assumption – the shortfall will be close to €10 billion.

This means that the pressure is still very much on to deliver on 2012-2013 fiscal deficit targets of 8.6% and 7.5% respectively. More importantly, the entire recovery framework for Ireland is clearly misaligned. Instead of focusing on the simple short-term targets for fiscal deficits, Irish Government must focus on long-term growth environment. Putting the patient – the Irish economy – ahead of the disease – the fiscal and household debts overhang – is a must.

This puts into the context the events of the last two weeks. Specifically, it highlights the levels of unease with Irish Government plans being expressed, for now rather quietly, by some markets participants. It also underpins the subtle change in the Government own signals to the Troika. And, it is simultaneously contrasted by the Government public rhetoric that has been stressing the PR spin over sombre determination to act. Virtually all recent actions suggest that the Government is hoping that something will happen between now and 2013 to miraculously restore growth, thus alleviating the need for serious corrective measures on the current expenditure side.

First, take the Memorandum of Understanding (MOU). Last week, the Government review of budgetary adjustments targets stated that 2013 fiscal savings will be “at least €3.5 billion” (page 14 of the MOU). The subtle change of language from the November 2011 version of the MOU which did not include the words ‘at least’ in relation to 2013 target might be a sign that the Government is being forced to accept the reality of its multiannual growth projections being overly optimistic in the current global and domestic growth environments.

Yet, when it comes to outlining reforms agenda, the MOU contains nothing new compared to its previous versions. The already inadequate set of measures on dealing with personal debt announced last night is presented as the end-all reform. Dysfunctional energy and utilities sectors are barely covered with exception for one specific measure – creation of the unified water management bureaucracy. Inefficiencies in the domestic services sectors, poor institutions relating to supporting competitive markets in these sectors and labour markets reforms are treated with generalities in place of tangible proposals. Vague promises of reforms of social welfare system and structural reforms in the state enterprises sector and financial services unveiled and partially actioned in the past are simply repeated once again in the current MOU.

In contrast, the Government has claimed this week that it has rather specific targets for yet another spending project – the ‘jobs creation’ efforts to be financed via privatizations returns. In other words, unlike Charlie McCreevy who spent the money he had, Minister Noonan is eager to spend what he hopes to have. To-date, Minister Noonan has managed to spend quite substantial funds on ‘jobs creation’ with various announcements taking potential total bill for these initiatives to well over €1 billion annually. Outcomes? Well, none, judging by the QNHS and Live Register data. The JobBridge programme is a resounding failure with the vast majority of ‘apprenticeships’ in effect displacing real jobs that would have been created through the normal course of business growth. The ‘Vat stimulus’ to tourism and hospitality sector is another failure. Fas restructuring is shambles.

The privatization plans, supported by the ESB and other state monopolies, are clearly designed to minimize any potential disruptions in the status quo of the semi-states-dominated sectors. Thus, privatization-induced changes in the energy and transport sectors will be purely cosmetic, the structure of the regulated markets will remain as anti-consumer as ever. Vast swathes of the domestic economy will remain protected from private investment and enterprises as ever.

Despite major risks present in the global and domestic economic environments, the Irish Government is slipping into the comfort zone of PR exercises, photo opps, and foreign ‘investment missions’.

By postponing the reforms necessary to boost our economic growth potential, the Government currently is putting an undue amount of risk onto the Irish economy. Its gamble is that sometime over the next 9-12 months Irish economy will be propelled to a miraculously higher growth plane and that this growth will be sustained through 2015 and thereafter. In the mean time, the Government will spend its way into jobs creation, while protecting its vested interests of the shielded sectors and avoiding any real structural reforms.

Chart:

Sources: IMF WEO database and country updates

Box-out:

Much of the latest attention paid to the external trade data has been devoted this month to the sudden and rapid slowdown in exports over the recent months. And this analysis is very much correct: in H1 2011, Irish goods exports and trade surplus grew by 6% and 2.5% respectively. In H2 2011, the same rates of growth were 1.9% and 1.5%. However, there are some very interesting trends emerging from the trade statistics by geographical distribution. Using eleven months data for 2011, annual rate of growth in Irish trade surplus vis-a-vis the EU is likely to come in at -1.7%, against the overall annual rate of growth of 1.5%. In contrast, Irish trade balance with Russia is likely to rise a massive 92% in 2011 compared to 2010. Our trade deficit with China is likely to decline by 9%. Although our trade deficit with India is expected to widen by almost 11%, our trade surplus with Brazil is on track to increase by almost 32%. Courtesy of Brazil and Russia, Irish trade surplus with BRICs in 2011 is likely to have reached close to €238 million, first year surplus on record.

28/02/2012: The truth behind the ELA

We are made actors in the theater of absurd, folks.

Anglo & INBS are now fake banks with their banking licenses retained solely to prop up their ability to borrow from the euro system and for no other reason.

These 'banks' are made up to look like some quasi real entities by a fake lending scheme (ELA) which was conceived by the complacent Government and Central Bank with a nod of the conveniently 'see no evil' ECB.

The sole objective of this scheme is to continue faking the system stability of the Euro area banks many of which are now barely alive themselves. The scheme operates like some Madoffian Dream with banks pretending to use collateral (which in effect is rather dodgy in many cases and assumes that Spanish Government bonds are as risk free as German Government bonds) to borrow money they can't really be expected to repay (does anyone really think LTROs 1 & 2 can be unwound by calling in the loans or liquidating the 'assets' repoed?) so they can buy more Government bonds and put borrowed money on deposits, thereby creating fake demand for Government bonds (lower yields lead to a pack of idiots claiming that Government debt is now sustainable as its cost 'came down') and increasing headline 'deposits' figure for ECB (pretending there is no liquidity shortage in the system).

Of course, the very reason for this ever-growing pyramid of deception is the very same as the underlying cause of this mess - a currency union conceived solely to promote political objectives of the ever-expanding EU. Nothing else.

The only real thing about this mess is the money Irish Government takes out of the pockets of its residents to dump into this pyramid. Nothing else.

To use a literary analogy, it's not that we are about to hear a child scream 'The King Has No Clothes' that is the most apparent feature of this circus. It's that we have NCB, ECB, National Government, EU Commission and Parliament and courts all acting up in collusion to deport all children from the town, lest they might see that the king is, indeed, naked.

26/02/2012: What happens when debt is too high and taxes are distortionary?

An interesting paper: Public Debt, Distortionary Taxation, and Monetary Policy by Alessandro Piergallini and Giorgio Rodano from February 7, 2012 (CEIS WorkingPaper No. 220 ).

In traditional literature, starting with Leeper’s (1991):

• if fiscal policy is passive (so that it simply focuses on a guaranteed / constitutionally or legislatively mandated public debt stabilization irrespectively of the inflation path), 
• then monetary policy can independently be set to focus solely on inflation targeting (ECB) ignoring real economy objectives, such as, for example, unemployment and growth targeting. 

The twin separate objectives of fiscal and monetary policy can be delivered by following the Taylor principle. This means if the monetary authorities observe an upward rise in inflation, they can hike nominal interest rates by greater proportion than the rise in inflation. This is feasible, because in the traditional setting, fiscal policy objective of sustaining public debt at stable levels can be achieved - in theory - by raising non-distortionary taxes that are not linked to inflation (for example, distortionary VAT and sales taxes yield revenues that are linked to inflation, so monetary policy to reduce inflation will lead to reduced economic activity and reduced revenues for the Government at the same time; in contrast, non-distortionary lump sum taxes yield fixed revenue no matter what income or price level applies, so that anti-inflationary increase in the interest rates is not going to have any impact on tax revenue).

Of course, if fiscal policy is active (does not focus on debt stabilization), monetary policy under Taylor rule should be passive (so interest rates hikes should of smaller percentage than inflationary spike). Such passive monetary policy will allow Governments to inflate their tax revenues without raising rates of distortionary taxation and

In many real world environments Governments, however, can only finance public expenditures by levying distortionary taxes (progressive taxation). So in this environment, the question is - what happens to the 'passive fiscal - active monetary' policies mix? According to Piergallini and Rodano, "It is demonstrated that households’ market participation constraints and Laffer-type effects can render passive fiscal policies unfeasible. For any given target inflation rate, there exists a threshold level of public debt beyond which monetary policy independence is no longer possible. In such circumstances, the dynamics of public debt can be controlled only by means of higher inflation tax revenues: inflation dynamics in line with the fiscal theory of the price level must take place in order for macroeconomic stability to be guaranteed. Otherwise, to preserve inflation control around the steady state by following the Taylor principle, monetary policy must target a higher inflation rate."

Ok, what does this mean? It means that if you want passive rules (public debt targeting - e.g. fiscal compact EU is trying to legislate) you need inflation (to transfer funds to the Government from the private individuals and companies).

Per authors: "The analytical results derived in this paper give theoretical support to the argument recently advanced by Cochrane (2011) and Davig, Leeper and Walker (2011) that the large fiscal deficits decided by governments to offset the crisis can lead to the “Laffer limit” beyond which inflation must endogenously jump up according to the fiscal theory of the price level."

Now, we often hear the arguments that in the near term there will be no inflation as slow growth will prevent prices from rising. Sure, folks. Good luck with that.

26/02/2012: Some numbers on Greek Deals 1 and 2

So the number for Greece Deals 1 & 2 are finally emerging and it's a massive one. Here's the tally to-date:

• Deal 1 = €110 billion extended May 2010
• Deal 2 Loans package = €130 billion (though Troika report implies €145 billion requirement)
• Deal 2 PSI package = €107 billion bonds swap
• Deal 2 ECB package = no writedown, but a rebate of profits to NCBs - current level of profits estimated at €11 billion (€50 billion face value of bonds against €39 billion purchase value of bonds)
• Deal 2 Banks support package = the stand by arrangement for Euro area banks €30 billion

Grand total so far: €388 billion (although if NCBs rebate under ECB package above were to go to funding €130 billion Loans package, and if there is no call on Banks support package, this number falls to €347 billion). For comparison, Greek current prices GDP stood at (estimated) €163 billion at the end of 2011 or 42% of the Deals 1 & 2 combined worth.

25/02/2012: Poster-boys of Recovery?

So does this really, I mean really, look like a recovery to any one of you?

The chart above plots evolution of nominal GDP in current US dollars from the pre-crisis peak (set = 100 for every country) through years following the beginning of the crisis (t=0). All data - IMF WEO and September 2011-February 2012 country-specific updates.

25/02/2012: Some interesting recent points on Gold

GoldCore guys have an excellent visualisation of some core facts about gold as a vehicle for store of value - a short video certainly worth watching.

You know I am a fan of good visualization as a tool to deliver information. And you know my position that gold is a unique diversifier of some core financial risks (based on my academic work available on my ssrn.com page) when held not for speculative or capital gains purposes and accumulated over time allowing for price-peaks averaging.

You can find much more detailed data on gold demand at the World Gold Council site (here), but it's worth posting few charts that illustrate higher frequency data supportive of the aforementioned trends and also trends highlighted in the video link. All are from Q4 2011 World Gold Council report:

First chart to show the relationship between spot price and volatility for gold - while volatility of gold prices is relatively high, it is clearly consistent with changes in fundamentals (news flows and global liquidity shifts, that largely are indicative of future inflation expectations changes):

The 'China' v 'India' effects are strongly pronounced, with the recent economic growth slowdown in India and the talk of hiking import duties on physical gold there clearly leading to slower demand. What is remarkable, in my view, is that both China and India demand appears to have largely converged in Q3-Q4 2011 to the average levels ahead of 2009, but below the peaks. This, in my view, can lead to further moderation in the volatility of the global gold prices, while providing support for gold price levels.

The third chart illustrates the dramatic turnaround in the Central Banks' and Treasuries' propensity to hold gold since Q1 2011. And the dramatic tie-in between the official sector demand for gold and the news flow. They wouldn't tell us this much directly, but it does appear that Governments around the world are hedging against the Euro crisis risks by going into gold.

Lastly, an interesting chart on private sector demand drivers for gold as investment vehicle. Good news ETFs are buying less (though bad news here is that this means more ETFs out in the markets are now synthetic gold holders - see a note here on the dangers of that asset class). Other good news is that OTC gold instruments are on a shallow decline (suggesting no derivatives panic, but some welcome reduction in derivatives risks exposure for gold, with core risk of sudden position reversals).

As a disclosure - I am on GoldCore's Investment Committee as a non-executive member. In this role I do not contribute to public communications by the firm or to the GoldCore's marketing. I receive no compensation for this or any other post on my blog and, as you can see, my blog bears no advertising (although the latter can change at some point in time, the former will not). I am also long gold in long-term, non-speculative stable allocation that remains unchanged over a number of years. I hold no other gold-related assets, ETFs or gold-related stocks. Furthermore, my posting of this link should not be considered as an endorsement of any product or investment vehicle, as per usual.

23/02/2012: ECB - which side of policy divide?

A very interesting interview today in the WSJ with Mario Draghi (ECB) (link here) (and a HT to @LorcanRK). Some top level points:

"In the European context tax rates are high and government expenditure is focused on current expenditure. A “good” consolidation is one where taxes are lower and the lower government expenditure is on infrastructures and other investments.


The bad consolidation is actually the easier one to get, because one could produce good numbers by raising taxes and cutting capital expenditure, which is much easier to do than cutting current expenditure. That’s the easy way in a sense, but it’s not a good way. It depresses potential growth."

Now, EU austerity so far is primarily focused on (1) keeping taxes high, (2) cutting spending and (3) penalizing offending states (e.g. Hungary) by withdrawing funds for investment. In Ireland, meanwhile, the 1990s consolidation was based on lower taxes (corporate and personal income) and increasing investments (including public investments). The 2008-present consolidation is characterized by rapidly increasing taxes, complete choking off of public investment coupled with massive drop-off in private investment and effectively no cuts to current spending by the State.

Err... now, Draghi, supposedly, is the head of one Troika institution that has capacity to drive or influence policies in Ireland. Why is his description of a 'good' consolidation being exactly canceled by the Irish Government policies that the ECB is partially co-determines, then?

"In Europe first is the product and services markets reform. And the second is the labour market reform which takes different shapes in different countries. In some of them one has to make labour markets more flexible and also fairer than they are today. In these countries there is a dual labour market: highly flexible for the young part of the population where labour contracts are three-month, six-month contracts that may be renewed for years. The same labour market is highly inflexible for the protected part of the population where salaries follow seniority rather than productivity. In a sense labour markets at the present time are unfair in such a setting because they put all the weight of flexibility on the young part of the population."

Once again, quite correctly Mr Draghi identifies labor market rigidities that are clearly present in Ireland. And once again, these very same rigidities are not target of the Irish Government reforms. In fact they are precluded by the Croke Park Agreement that Mr Draghi's Troika is not challenging. What is going on here? Out of two core prescriptive policy sets, both are being wrongly pursued / targeted in Ireland under the watchful eye of Mr Draghi's ECB.

And to top up the proverbial cake: "The European social model has already gone when we see the youth unemployment rates prevailing in some countries. These reforms are necessary to increase employment, especially youth employment, and therefore expenditure and consumption."

Really? Well, EU Commission continues to talk about the Social Model. The irish Government and indeed majority of Government in Europe are continuing to run Social Partnership-linked policy making institutions (though of late, the Social Partnership in Ireland has run onto the rocks of insolvency). Where is Mr Draghi with his views on optimal policies?

20/02/2012: Greece, Europe, Ireland and the crisis: Max Keiser interview

My conversation with Max Keiser last week on Euro, Greece, Ireland etc.
Link here.

20/2/2012: Irish Banks - Zombies Running the Town - Sunday Times 19/02/2012

This is an unedited version of my article for Sunday Times 19/02/2011.

This week’s announcement by the Government that the Irish banks will be issuing loans to small and medium sized enterprises (the SMEs) under the cover of a sovereign guarantee has raised some eyebrows.

Throughout the persistent lobbying to underwrite credit supply to the struggling SMEs, it was generally resisted by the majority of economists and analysts, who argued that the Irish state is in no financial or fiscal position to provide such a measure. Having backed banks’ debts via the original 2008 State guarantee and emergency loans from the Central Bank of Ireland by the letter of comfort, the Irish state had also underwritten the risks associated with the commercial real estate development and investment assets through Nama. In addition, via rent supplements and mortgage interest supports, the government is propping up a small share of other banks assets and the rental markets.

Now, it’s the SMEs turn.

Per Central Bank’s own stress tests, estimated worst-case scenario defaults on all assets in the core Guaranteed banking institutions are expected to run at around 14.6%. SMEs loans had the worst-case scenario default rate estimate of 19%. We can argue as to the validity of the above estimates, but much of the international evidence on lending risks suggest that SMEs loans are some of the riskiest assets a bank can have. Add to this that we are in the depth of the gravest recession faced by any euro area country to-date, including Greece and you get the picture. Without state backing, there will be no lending to smaller firms. With the state guarantee, there will be none, still.

Subsidizing risker loans in the banks that are scrambling to deleverage their balancesheets, struggling with negative margins on their tracker mortgages and facing continued massive losses on loans might be a politically expedients short-term thing to do. Financially, it is hard to see how the Irish banking system crippled by the crisis and facing bleak ‘recovery’ prospects in years ahead can sustain any new lending to the SMEs.

Eleven months after the stress tests and seven months after the recapitalization by the taxpayers, Irish banking sector remains as dysfunctional in terms of its operations and strategies as ever.

Top level data on Government Guaranteed banks, provided by the Central Bank of Ireland, shows that in 2011, loans to Irish residents have fallen by €63.25 billion on 19% with €30.3 billion of this decline coming from the non-financial private sector – corporate, SME and household – loans. Loans to non-residents are down €40.9 billion or 29%.

Over the same period of time, deposits from Irish residents contracted €42.5 billion or 18%, with Irish private sector deposits down €11.2 billion or 10% on 2010. Non-resident deposits have shrunk 35% or €36.1 billion at the end of 2011 compared to the end of 2010.

The Government spokespeople are keen on pushing forward an argument that in recent months the numbers are starting to show stabilization. Alas, loans to Irish residents outstanding on the books of the guaranteed banks are down 7% for the last three months of 2011 compared to the third quarter of the same year. All of this deterioration is accounted for by losses in private sector loans which have fallen €21.7 billion or 12% in Q4 2011 compared to Q3 2011. Deposits from Irish residents are up €2.04 billion or 1% over the same period, due to inter-banks deposits rising €2.3 billion, while private sector deposits are down €384 million.

The ‘best capitalized banks in Europe’ – as our Government describes them – are not getting any healthier when it comes to core financial system performance parameters. Instead, they are simply getting worse at a slower pace.

The outlook is bleaker yet when one considers top-level risk metrics for the domestic banking sector. On the books of the Covered Banks, domestic private non-financial sector deposits are currently one and a half times greater than all foreign deposits combined. On the other side of the balancesheet, ratio of assets issued against domestic residents to assets issued against foreign residents now stands at 159% - the highest since December 2004. Again, this means that banks balancesheets are becoming more, not less, dependent on domestic deposits and assets, which in turn means more, not less risk concentration.

This absurdity passes for the State banking sector reforms strategy that force Irish banks to unload often better performing and more financially sound overseas investments in a misguided desire to pigeonhole our Pillar Banks into becoming sub-regional players in the internal domestic economy. In time, this will act to reduce banks ability to raise external funding and, thus, their future lending capacity.

Aptly, the latest trends clearly suggest increasing concentration and lower competition in the sector across Ireland. While ECB only reports a direct measure of market concentration (or monopolization) for the banking sector through 2010, the trends from 1997 reveal several disturbing facts about our domestic banking. Firstly, contrary to the popular perspective, competition in Irish banking did not increase during the bubble years. Herfindahl Index – the measure of the degree of market concentration – for banking sector in Ireland remained static at 0.05 in 1999-2001, rising to 0.06 in 2002-2006, and to 0.09 in 2009-2010. Secondly, back in 2010, our banking services had lower degree of competition than Austria, Germany, Spain, France, UK, Italy, Luxembourg, and Sweden. On average, during the crisis, market concentration across the EU banking sector rose by 8% according to the ECB data. In Ireland, this increase was 29% - the fastest in the euro area. Lastly, the data above does not reflect rapid unwinding of foreign banks operations in Ireland during 2011, or the emerging duopoly structure of the two Pillar banks.

Meanwhile, the banks continue to nurse yet-to-be recognized losses on household, SMEs and corporate loans as recent revision of the personal bankruptcy code induced massive uncertainty on risk pricing for mortgages at risk of default. In addition, Nama constantly changing plans to offer delayed repayment loans and mortgages protection, destabilizing banks risk assessments relating to existent and new mortgages, property-related and secured loans. The promissory notes structure itself pushes the IBRC to postpone as much as possible the winding up process.

To summarize, evidence suggests that seven months after the Exchequer completed a €62.9 billion recapitalization of the Irish banks, our banking system is yet to see the light at the end of the proverbial tunnel. Far from being ready to lend into the real economy, Irish banks continue to shrink their balancesheets and struggle to raise deposits. Their funding profile remains coupled with the ECB and Central Bank of Ireland repo operations – a situation that has improved slightly in the last couple of months, but is likely to deteriorate once again as ECB launches second round of the long term refinancing operations at the end of this month. In short, our banking is still overshadowed by the zombie AIB, IL&P, and IBRC.

Let’s hope Bank of Ireland, reporting next week, provides a ray of hope. Otherwise, the latest Government guarantees scheme can become a risky pipe dream – good for some short-term PR, irrelevant to the long-term health of the private sector and damaging to the Exchequer risk profile.

CHART

Source: Central Bank of Ireland

Box-out:

This week, Minister Richard Bruton, T.D. has made a rather strange claim. Speaking to RTÉ's News, Mr Bruton said that last year's jobs budget had created 6,000 jobs in the hotel and restaurant sector. Alas, per CSO’s Quarterly National Household Survey, the official source of data on sectoral employment levels in Ireland, seasonally adjusted employment in the Accommodation and food service activities sector stood at 119,100 in Q3 2009, falling to 118,200 in Q3 2010 and to 109,700 in Q3 2011. While jobs losses in 12 months through Q3 2011 – the latest for which data is available – were incurred prior to June 2011 when the VAT cuts and PRSI reductions Minister Bruton was referring to were enacted. But even if we were to look at seasonally adjusted quarterly changes in hotel and restaurant sector employment levels, the gains in Q3 2011 were a modest 1,400 not 6,000 claimed by the Minister. In reality, any assessment of the Jobs Programme announced back in May 2010 will require much more data than just one quarter so far reported by the CSO. That, plus a more careful reading of the data by those briefing the Minister.

19/2/2011: Wall Street Journal on EU Debt/GDP ratio

The Wall Street Journal article on EU's debt/GDP sustainability target of 120%, quoting yours truly: link. 

18/2/2012: Mortgage Arrears Q4 2011

The Central bank of Ireland has published Q4 2011 stats for mortgages arrears. And it's a trend-breaking one. Not quite touching my forecast from Q3 2011 data for 114,000 mortgages at risk (see definition below), but jaw-dropping 108,603 and counting mortgages that were written off since Q34 2010 when more detailed records were first published - closer to 102,200.

Now, let me run through the core details of the data.

The number of outstanding mortgages accounts has fallen from 786,745 in Q4 2010 to 768,917 in Q4 2011 - a drop of 2.19% or 17,247. In previous quarter, yoy decline in mortgages numbers was 1.94% or 15,325. The outstanding balance of mortgages has dropped from €116,683.25 mln in Q4 2010 to €113,477.28 mln in Q4 2011, so yoy Q4 2011 decrease in mortgages balances was 2.75%, against 2.55% decrease yoy in Q3 2011.

Of all mortgages, 17,825 mortgages were in arrears 91-180 days in Q4 2011, an increase of 7.39% qoq and 35.35% yoy. In Q3 2011, qoq increase in same type of mortgages was 5.6% and yoy increase was 33.62%. So the rate of mortgages in arrears 91-180 days category is accelerating in qoq and yoy terms. Mortgages in arrears 91-180 days have accounted for €3,273.8 mln in Q4 2011, which is 7.02% ahead of Q3 2011 and 34.37% ahead of Q4 2010. This means than we are now seeing smaller mortgages (in absolute size) on average entering into arrears. Amounts of arrears in this category rose 10.04% qoq and 13.61% yoy in Q4 2011 to €89.15 mln. This represents another acceleration from Q3 deterioration.

Mortgages in arrears over 180 days (usually seen as mortgages that are extremely highly unlikely to ever rise from the ashes) now stand at 53,086 up 14.5% qoq and 69.4% yoy. Yep, that right, in Q4 2010 there were just 31,338 mortgages in this category. Compare these dynamics to Q3 2011 when same category of mortgages in arrears rose 15.8% qoq and 65.32% yoy. So the dynamics are slightly shallower on qoq but are sharper yoy. Balance of all mortgages in arrears over 180 days now stands at €10,667.02mln - up 14.56% qoq and 72.34% yoy. The dynamics are very much the same as with the number of mortgages - qoq slightly slower growth, yoy accelerating growth.

So total number of mortgages over 90 days in arrears is now 70,911, up 12.61% qoq and 59.32% yoy. In Q3 2011 the quarterly rate of increase in these mortgages was 12.92% and yoy increase was 55.59%. Balance of all mortgages over 90 days in arrears is now €13,490.8mln - up 12.7% qoq and 61.62% yoy, compared to Q3 2011 increase of 14.14% qoq and 58.69% increase yoy. Total amount of arrears registered is €1,117.12mln which is 12.7% ahead of Q3 2011 and 61.62% higher than Q4 2010.

 The above means that a massive 12.29% of all mortgages accounts in Ireland are now in arrears 90 days or over by total volume of mortgages in arrears and 9.22% by the number of mortgages accounts in arrears.

Now, take all mortgages in arrears 90 days or over, add to them those mortgages that were restructured, but are currently not in arrears and the mortgages currently in the process of repossessions. Call this 'mortgages at risk of default, in default or defaulted' or for short, mortgages at risk. Chart below illustrates the stats:

 In Q4 2011 total number of mortgages 'at risk' stood at 108,603 - a number that represents 14.12% of all mortgages in the country. This represents an increase of 8.35% qoq (in q3 2011 qoq rate of increase was 4.44%) and 35.25% yoy.

As chart above shows, there is deterioration in mortgages performance even amidst those mortgages that have been restructured.  Total number of restructured mortgages in Q4 2011 was 74,378, which represents an increase of 6.66% qoq and 25.58% yoy. In Q3 2011 there was a qoq decrease of 0.15%. Of the restructured mortgages, 36,797 were not in arrears in Q4 2011 - an increase of 1.16% qoq and 4.52% yoy. However, while number of restructured mortgages not in arrears rose by 421 in Q4 2011 (qoq), the number of total restructured mortgages rose by 4,644. Which means that some 4,223 restructured mortgages went into new arrears in Q4 2011. Overall, percentage of mortgages that are restructured but are not in arrears has dropped from 59.44% in Q4 2010 to 49.47% in Q4 2011. Restructuring of mortgages now works for less than 50% of restructured mortgages - and that is only within 2 years of the beginning of the entire data on these!

Now, do keep in mind that restructuring was quite severe in many cases. See bottom of CBofI release on this here. And it doesn't seem to work all too well for just over 50% of those entering new temporary arrangements. So what will happen to these families when the 'temporary' arrangements expire?

17/2/2012: ECB Swap Creates a New Structure of Seniority

This week marked a significant point of change in the very fabric of the fixed income markets. On Friday, the ECB announced that it has completed the swap on the old Greek bonds it held on its books for new bond.

The ECB swap in effect exchanged old Greek bonds for bonds of identical structure and nominal value, implying that the ECB has received the full face value of the bonds it has purchased in the markets at the discount on the face value. The ECB will also not forego the coupon payments due on the bonds, implying that over time, ECB will book profit from its purchases of Greek bonds. It is worth noting that this is based on the reports in the media, citing various official sources. The ECB has no inclination of clarifying any details of the transaction.

The ECB also precluded National Central Banks (some of which do hold Greek bonds) from participating in the swap. However, the ECB has signaled that it might (again, no commitment or compulsion) distribute the profits earned from the Greek bonds purchases to the national central banks of the countries contributing to the bailout.

Currently, the ECB holds some €219.5 billion worth of sovereign bonds (primarily those of PIIGS states) that it has began accumulating since May 2010.

The greatest significance of today's swap is not, however, in the fact that the ECB is likely to make a tidy profit from its operations designed to help Greece. No, the real significance is that in one step, the ECB has completely re-shaped the seniority structure of sovereign bonds issued by all of the euro area governments.

Before the swap, the seniority of bonds was established under the bonds terms and conditions alone, implying equal treatment of all bondholders, with any variation in sovereign bonds security arising from any potential (and highly costly and uncertain) court actions by investors against the sovereigns. Now, the structure has ECB as the holder of the Super Senior bonds with ECB seniority imposed over and above all other bondholders.

In addition, by not bringing into the swap National Central Banks, the ECB threw open the possibility of another sub-tier of seniority emerging over time. In the case of imposition of Collective Action Clauses by Greece or any other sovereign, such clauses will automatically imply non-zero probability of a loss on bonds held by the NCBs. Arguably, they too might follow the ECB line and demand, collectively or separately (as Germany, the Netherlands and Finland are currently already doing) that their holdings of bonds should also be exempt from such a clause. This means that ECB swap opens up a possibility of a new tier of security forming - the tier subordinated to Super-Senior ECB holdings. This can take a form of a Senior tier or Senior Secured tier (if collateral or other security arrangements are put in place, e.g. some sort of an escrow account etc).

The unknown at this stage is the issue of seniority of non-euro area sovereigns holding euro area government bonds. In particular - will China and Japan, the US and Australia etc demand some sort of Senior or even Super-Senior seniority now that the ECB has elevated itself to the level of IMF?

This means that any private investor in Government bonds (note, these are themselves senior to special Government-issued bonds, such as postal certificates, domestic savings bonds etc) is now left a holder of the Junior or Subordinated bonds, despite the fact that on the 'box' the bonds are identical to those held by the ECB, NCBs, Foreign Governments, etc.

The entire market for euro area bonds is now wholly mispriced when risk-return relationships are concerned. Just like that, in a blink of an eye, the European system destroyed legal and financial order and undermined private property rights.


Note: The above arguments are taken from the simple investment risk perspective. Legal perspective is yet to be defined and I welcome any comments on this and/or links to it.

17/2/2012: Struggling Households

Last week we saw the release of the special module from QNHS on Response of Households to the Economic Downturn – Pilot module Quarter 2 2011. This is undoubtedly a topic of much interest to economists, but also to the general public. The results are mixed - some surprises, and some 'I've told you' moments.

Summary of the findings as follows (via CSO):

• Overall, 79% of households cut back their spending on at least one of the listed items as a result of the economic climate in the two years before the survey. Which is not surprising, given the duration and the depth of the recession. In every economy there are always those (not necessarily the rich) who have relatively stable incomes even during the downturns.
• More than half (56% of all) households cut back their spending on groceries.
• More than half (57%) cut back spending on going out.
• Similarity in the two cut backs above suggest that much of these impacted the same households which were forced to cut on both - highly discretionary (going out) and necessary (food) items.
• Almost two thirds (64%) of households cut back their spending on clothing and footwear.
• Spending on health insurance was reduced by 15% of households and 11% of households cut back spending on pension contributions. This highlights the dangers for the Exchequer from the current course of Irish policy to continue increasing indirect tax charges and semi-state charges. Health and Pension Levies are undoubtedly likely to have the adverse impact on both expenditures, thus increasing the Exchequer exposure to health and pensions liabilities in the future. Note, the results of the survey do not cover changes in demand since June 2011.
• One fifth of households delayed or missed paying their bills (21%) in order to meet their outgoings on basic goods and services. 
• One in ten delayed or missed loan repayments and a further one in ten delayed or missed paying their credit card bill.
• In the two years prior to the survey 45% of households spent some or all of their savings to pay for BASIC goods and services over the last 2 years. And this in the environment of the elevated 'savings' across the nation.
• 62% of households reduced the amount being saved.
• The most financially impacted are families with 2 adults and children, which highlights the plight of the middle classes in Ireland.
• One in ten households borrowed money from family or friends to pay for basic goods and services in the two years prior to the survey. Unfortunately, we have no idea how many received transfers from the family members in kind or in cash, not in form of debt.

There were some clear differences in the behaviour of households depending on the age of the household reference person, whether or not they were working and whether or not there were children in the house.

• Cutbacks were far more likely in a household where the reference person was aged less than 55 years. Among households where the reference person was aged less than 35 or between 35 and 54 years, three quarters had cut back on clothing and footwear, compared with half of households where the reference person was aged 55 or older.
• While 64% of households where the reference person was younger than 35 had cut back spending on groceries, this compares with 42% of those where the reference person was 55 or more.
• Some 81% of households where the reference person was unemployed reported that they had cut back their spending on groceries in the previous two years, compared with 57% of households where the reference person was working.
• Households with children were more likely than those without children to cut back their spending on groceries, clothing and footwear, going out, and lessons or classes

The above age- and household- related results are not surprising. Older households tend to have lower unemployment rates, higher security or stability of income, greater savings cushions to offset cutbacks. Families with children face far smaller share of their income in the form discretionary spending, which means they generally will be forced to make more painful cuts. Families with children also have smaller savings cushions.

Overall, the picture of the household financial and consumption patterns revealed in the report shows that Irish households are facing severe recession and that the economy is unlikely to benefit from significant increases in 'confidence'-related spending and investment for a long time, including in the first few quarters of any upturn in national income, as households will most likely only slowly return to higher levels of consumption, preferring to rebuild lost savings and to repay family loans.

Crucially, the above changes are taking place while majority of Irish households are still struggling under the massive debt overhang. Going forward, this implies that (1) any hikes in interest rates will drive households deeper into cutting spending and using savings for necessities, (2) any increases in future income are likely to be consumed by debt repayments, without benefiting national consumption.