25/10/2012: My notes for the interview on Troika review

Here is transcript of my interview on today's radio programme covering the Troika review of Ireland - warning: unedited material. Italics denote quotes from the Troika statement.

Unfortunately, Ireland's recovery will not be achieved or even started by the exit from Troika funding program. For a number of reasons, conveniently omitted by Minister Noonan, but some of these are hinted at in the Troika assessment:

1) Real recovery will require dealing with private (household) debts. This is not happening and Troika review, as well as increasingly frustrated tone coming from our own Central Bank clearly show that. 

Once Ireland exits the bailout, we will have to fund our Exchequer debt repayments and reduced deficits via borrowing in the private markets. It might be that we will be able to fund ourselves at lower cost than currently, but the cost is likely to be still above that obtainable via ESM or Troika. This means more resources will be sucked out of the weak economy, further reducing the pace of private economy deleveraging. In other words, exit from the bailout will likely make it harder for the economy to recover.

2) Real recovery will require economic activity to start picking up in terms of private domestic investment, household spending, expanded activities by our own firms, not MNCs in exporting. All of this requires credit, it also requires disposable income.  Again, this will be only hindered by Ireland 'exiting' Troika funding.

3) Recovery in the  fiscal space will require lower, not higher, costs of funding for the Exchequer debt roll-overs and paydowns of Troika debts. As above, exit from the bailout will likely assure that this cost will be rising, not falling.

4) Recovery in the economy will require the Exchequer restructuring, significantly, some of the banks-related debts carried by the State. Most notably - the likes of the promissory notes - and this is clearly not going to be consistent with the Exchequer borrowing in the markets, at least not while we restructure the banks-related debt. It is better for Ireland to stay within the ESM and deliver on restructuring, and only after that aim to gradually exit the programme.

5) Lastly, recovery on exit from the program will require more aggressive reforms and stringent adherence to the fiscal discipline established. Alas, once we exit the program, the Government will lose its ONLY functional trump card in dealing with the Trade Unions. The Bogey Man of the Troika will be gone and the Social Partners will most likely exert pressure on the Government to borrow beyond its means to compensate them for the hardships of the Troika period. We can be at a risk of undoing overnight the precious little progress we've achieved to-date.

So, overall, I do not think this economy is going to recover once we exit the bailout. In fact, I think the entire logic of this argument as advanced by Minister Noonan is backwards. We should only exit the bailout once the economy is sufficiently strong to sustain orderly transition from subsidized funding to real world funding. Exiting Troika arrangements will not free Ireland from painful adjustments needed, but will likely risk derailing what has been achieved so far.

On Troika review specifics:

Banks remain well-capitalised and downsizing has progressed well, yet further efforts are needed to address their profitability and asset quality challenges.

Irish banks are well capitalized solely because there are no substantial writedowns of mortgages being undertaken in the banking sector. Meanwhile, mortgages arrears are snowballing, implying that the current levels of capitalization are unlikely to be sustained in the short term future. In other words, Troika praise here is simply a PR exercise.

Real GDP growth has slowed to a projected rate of ½ percent in 2012. Prospects for growth in 2013 are for modest pick up to just over 1 percent as domestic demand declines moderately...

So if I get this right: GDP will grow 0.5% in 2012 and 1.0% in 2013. GNP will shrink in 2012 and 2013 as well. Which means the real economy in Ireland - the one you and I and the listeners to this station are inhabiting will be shrinking 6 years in a row. That's 'strong performance'? In real terms we had GNP of 162bn in 2007, it fell to 127 billion in 2011 and is now, as IMF suggests will fall even further - close to 122-124bn or lower by the end of 2013. This is the much-lauded recovery we are bragging about?!

The authorities are ramping up reforms to restore the health of the Irish financial sector so that it can help support economic recovery. Intensified efforts are required to deal decisively with mortgage arrears and further reduce bank operating costs.

What are these reforms? Anyone noticed ANY progress in the banking sector? Especially on dealing with mortgages? I didn't. May be Minister Noonan can show us some couples who had their debt problems resolved? Not delayed, not shelved, but actually resolved. 

15/3/2012: What's up with 'collateral'?

An interesting point made today by Michael Noonan that carries some serious implications with it (potentially).

"You could take it that the ECB were never particularly happy with the level of collateral provided by the promissory notes and would like stronger collateral," Mr Noonan said in an interview with RTÉ." (as reported on the Irish Times website).

What can this mean? Collateral for the Notes themselves is Government guarantee plus letters of comfort to the CB of I. In other words, the Notes collateral can only be enhanced by making them fully-committed formalized Government debt - aka bonds. Now, Noonan in the recent past had implicitly linked Promo Notes to ESM.

And herein rest the main problem. Right now, Promo Notes are quasi-governmental obligations and as such are ranked below ordinary Government bonds (hence collateral quality concern of the ECB). Although the Notes are counted into our total debt, they are still not quite as senior as other forms of debt. This, in turn, has marginal implications in the valuation of our bonds. Although at this point this is academic, should we return to the markets, potential buyers of Irish Government bonds will consider them as secondary, since the Notes are not traded in the market and represent a tertiary (quasi- bit) claim on the state after ordinary bonds (secondary) and EFSF-IMF-EFSM (soon to become ESM) debt (so-called super-senior obligations of the state).

By converting these notes into ESM funding, the Government will in effect risk making these Notes super-senior, exceeding in seniority those of ordinary Government bonds. Now, the total amount of debt under the Notes - principal plus interest - is €47-48 billion or roughly-speaking 30% of our GDP and ca 27% of our Government debt. This is hardly a joking matter.

It can have material implications for our ability to access bond markets in the future (both in terms of amounts we can raise and rates we will be charged). But more ominously, it can fully convert quasi-public debt into super-senior public debt.

This will satisfy ECB's concerns about the quality of collateral, but it will also mean that these notes will be put beyond any hope of future further restructuring.

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?

9/2/2012: What can ECB do?

In relation to the recent statements from Minister Noonan and Taoiseach Kenny on their expectations that ECB involvement in Greece should be matched by ECB extending assistance to Ireland:

What can ECB provide in relief for Ireland:

1) ECB can do a swap of Irish higher coupon bonds for cheaper EFSF/ESM bonds at current or even reduced (via suitable averaging) market value, saving interest charges and reducing outstanding principal of Irish debt. This will not be a credit event, as the transaction will be purely contained within ECB balancesheet.

2) ECB can give a green light to the Central bank of Ireland not to sterilize ELA returns under the promisory notes, effectively rebating the funds back to the Exchequer.

3) ECB can also consent to restructuring of ELA (partial form of (2) above)

So there are a few things ECB can do, but all will de facto open ECB to a major risk of other countries coming to it with similar demands.

Regardless of the outcome, the Taoiseach and Minister Noonan are correct in demanding ECB step forward with solutions to the problems in Ireland that have been created in the first place by ECB policies of the past.

24/09/2011: Anglo Bonds and National Accounts

Note: corrected figures below (hat tip to @ReynoldsJulia via twitter).

Per Nama Wine Lake blog - an unparalleled true public service site on Irish debacle called Nama and many matters economic and financial, Irish Government (err... aka ex-Anglo Irish Bank, aka Irish Bank Resolution Corporation*) is on track to repay USD $1bn (€725m) unsecured unguaranteed senior Anglo bond on 2nd November 2011.

The gutless, completely irrational absurdity of this action being apparent to pretty much anyone around the world obviously needs no backing by numbers, but in the spirit of our times, let's provide some illustrations.

According to the latest QNA, in current market prices terms, Irish GNP grew in H1 2011 by a whooping grand total 0f €307 mln from €64,337 mln in H1 2010 to €65,012 mln in H1 2011, when measured in real terms. This means that Anglo bondholders payout forthcoming in November will be equivalent of erasing 28 months and 10 days worth of our economic growth.

According to the CSO data on national earnings, released on September 8, 2011, Ireland's current average earnings across the economy stand at €687.24 per week, implying annualized average earnings of €35,736.48. Irish tax calculator from Delloite provides net after-tax (& USC) income on such earnings of €28,287.39 per annum. This means that Anglo bond payout in November is equivalent to employment cost of 25,630 individuals.

According to CSO's latest QNHS data, in April-June 2011 there were 304,500 unemployed individuals in Ireland. This means the jobs that Anglo bond payout could cover are equivalent to 8.42% of the current unemployment pool.


I am not suggesting for a minute that we should simply use the money to 'create' government jobs - anyone who reads this blog or my articles in the press etc would know I have no time for Government-sponsored jobs 'creation'. But, folks, the above numbers are startling. We are about to p***ss into the proverbial wind the amount of money that is enough to cover our entire economy's growth over 2 years, 4 months and 10 days! For what? To underwrite 'credibility' of the institution that is a so completely and comprehensively insolvent?

* Note 1 that Anglo still calls itself Anglo (until October 14th) and still insists it is a bank as the web page http://www.angloirishbank.ie/ states clearly [emphasis mine] that: "As a Nationalised Bank since January 2009, the key objective of Anglo Irish Bank’s Board and new senior management team is to run the Bank in the public interest... The Bank continues to provide business lending, treasury and private banking services to our range of customers across all our locations."

Note 2:
The above, of course, assumes that €725mln exposure is hedged against currency fluctuations. If not, as Nama Wine Lake points out, the exposure rises to ca €740mln. The above figures therefore change to:

• GNP growth equivalent of 2 years, 4 months and 28 days
• Number of average earnings jobs of 26,160, plus one part-time job
• 8.59% of currently unemployed
  

07/07/2011: What's in the interest rates hikes

Working away on the data for PIIGS, I was interested in a question, what if the ECB were to go to the equilibrium repo rate consistent with the current inflation & growth environment?

In a recent post (here) I did analysis of the ECB historical rates in relation to eurocoin leading indicator of growth. This chart is reproduced here with suggested ranges for the repo rates consistent with current and with higher inflation.
So if the equilibrium rates are in the neighborhood of 2.25-2.75 percent, what would 1% increase in interest rates from June 2011 rate of 1.25% do to the cost of fiscal debts financing across the PIIGS?

Using IMF projections for debt levels for PIIGS through 2016 and assuming that all interest payments are financed out of deficits / borrowing, the chart below shows the extent of the increase in the cost of interest charges on government debt by 2016:
This translates into an increase in the annual cost per capita (2016 forecast) of:

• €560.48 in Greece
• €834.84 in Ireland
• €546.74 in Italy
• €309.24 in Portugal
• €319.02 in Spain

Overall, the increases in interest costs for PIIGS will amount to ca €47.06 billion per annum or 1.23% of the PIIGS GDP and 0.44% of the Euro area GDP. Oh, and by the way, this does not take into account the additional costs of financing banks lending by the ECB.

So that should put into perspective my view of today's hike in the ECB rate, expressed earlier here. So happy wrecking ball swinging, Mr Tri(pe)chet & Co.

05/07/2011: Pre-ECB council meeting note

Here's my (cynical, but) concise summary of the pre-ECB call on rates this week:

We (Euro zone) have:

• Greece being kept alive pretty much for its 'spare parts' (privatizations)
  
• Porto just gone into coma with the latest downgrade of its bonds to junk,
  
• IRL in an ICU on an artificial respirator (see the bottom line on Irish Exchequer expenditure here)
  
• Spain feverish & fading out of consciousness on negative watch and with banks starting to implode (HT to Namawinelake, Spain is facing €660 billion of redemptions in 24 months ahead and with banks providing just 10% provisions cover on €450 billion worth of development loans)
  
• Italy getting the first symptoms of the deadly debt/banks spiral virus (negative watch for ratings and latest signs of banks starting to slip)
  
• Belgium on the trolly about to be wheeled into casualty department
  

In this environment, ECB raising rates this week will be equivalent to shutting off power supply to the entire hospital that is Euro zone.

Economics 14/12/10: ECB/CBofI Ponzi schemes

Last week's ECB figures show that the Irish banks have managed to rake up €136bn worth of borrowing from Frankfurt as of November 26th. This is an increase of €6bn on end-October figures. Mysteriously little? Not really - Irish banks have also borrowed some €45bn from the Central Bank of Ireland - a rise of €10bn on October.

The reason for such a dramatic increase in borrowing from the CBofI instead of ECB is two-fold:

1. ECB is becoming increasingly reluctant to lend to the Irish banks, and
2. Irish banks have run out of suitable collateral to pawn at the ECB discount window.

Which, in turn, means 2 things.

Firstly, Irish banks demand for borrowing is not abating despite Nama and other measures undertaken by the Government. Injecting quasi-Governmental paper into banks balancesheets has meant that the banks face immediate loss without any real means for covering it (remember, they can't really count on selling Nama bonds in the market without incurring an extremely steep discount on the value of these notes). Swapping nearly worthless paper for almost totally worthless loans is not doing the job and the entire banking system simply sinks deeper into debt.

Secondly, Irish banks have now uploaded some €45 billion worth of useless paper (that even ECB is unwilling to accept) into the Central Bank of Ireland. How much of this paper is loss-generative and are we, the taxpayers, on the hook for these losses, should the whole pyramid scheme go belly up?

Oh, and in case you wonder - ECB's equity funds are €5.8bn. It's lending side is over €200bn (it was €139bn total - banks lending & sovereign bonds inclusive - as of the end of December 2009), so as a bank, ECB's 2009 leverage was 24 times. Now, it is closer to 35 times. Lehman Bros territory, folks.

Economics 29/9/10: IMF or EFSF hypotheticals

Hypothetical discussion of options for external assistance for Ireland in today's Irish Examiner - here, text link - here, associated publicity - here.

Economics 23/8/10: ECB & IRL bonds

Per report today: "FRANKFURT, Aug 23 (Reuters) - The ECB said on Monday it bought and settled €338mln worth of bonds last week, the highest amount since early July and bolstering recent market talk it had ramped up purchases of Irish bonds. The amount is well above €10mln of purchases settled the previous week... It follows recent comments by market participants that the ECB bought 60 million euros of 2012 Irish government bonds just over a week ago, after spreads over German Bunds ballooned. The ECB has not given any details of its bond buying."

I speculated after last auction results were announced by the NTMA that extraordinary level of cover (x5.4) on 4 year bonds issue looked strange and that ECB buying might be the case. To remind you - NTMA sold €500mln of 4-year bonds. It now appears that the ECB did indeed engage in potentially substantial buying of Irish bonds. If so, such buying cold have

1. pushed other purchasers out of the shorter term paper into 10 year bonds; and/or
2. pushed yields on both shorter and longer term paper down.

€338mln figure includes trades executed between August 12 and August 14 - the auction of shorter term paper that is known to have involved ECB buying.

All in, we are clearly now in the yields zone where the markets are happy to watch us lean on ECB, the ECB is happy to watch us skip one-legged across budgetary deficit that keeps opening up wider and wider. Clearly, such an equilibrium is unlikely to be stable. Expect some fireworks once markets come back to full swing a week from now.

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: 28/06/2009: Consumer spending and ECB rescue

Two things worth noticing this week: both relating to longer running developments in the economy, and both not discussed widely enough in the past.

First, the issue of consumer spending in light of unemployment data from QNHS. As I highlighted earlier, it is the younger workers who are being laid off in droves. This, of course, puts pressure on spending power, as highlighted by several other economists and commentators. Doh! Younger workers save less and spend more out of their income. Layoffs are an immediate hit to their consumption. More ominously - and less discussed in the media and by analysts - young workers save for two reasons: car purchases and home purchases. That is when they are not scared sock-less with the prospect of unemployment (traditional precautionary savings motive) and by the threat of the older generations ripping them off via higher taxation (unorthodox exclusionary savings motive - piling up of savings to offset future loss of voting power and access to career growth due to unfair competition from established and entrenched older generations: this is my own theory of savings contribution, by the way).

In Ireland's case, precautionary savings motive will always be stronger for younger workers - courtesy of the bearded men of SIPTU/ICTU crowd who routinely betray younger workers in their quest for tenure-based job security and pay awards. Public sector leads here too, as many more temporary and fixed-term contract employees in the public sector are the younger one. Guess who will lose their jobs once Minister Lenihan takes to cuts in the public sector?

But the exclusionary savings motive is a new one for Ireland and it is the most venal of them all. Up until recently, Irish younger workers were virtually outside the effective tax net, courtesy of larger transfers and smaller wages. Next Budget will see their incomes decimated in order to pay lavish public sector wages. In the society that is much younger demographically than our fellow Eurozone travellers, our younger workers will, therefore, lose not only money, but also political power. This process is fully a result of perverse Social Partnership arrangement that has predominant concentration of power in the hands of the ageing public sector employees representatives and business groups aligned with public sector monopolies (also dominated by older workforce).

While precautionary savings effects are themselves long-lasting - hard to reverse and 'sticky' over time, the effects of exclusionary savings motive are even longer-term, depressing consumption and investment over much longer time horizon, as loss of power in the society cannot be rectified over business cycles and will have to wait for political cycles to play out. Ireland is going to pay for this 'socialism for the geezers' of our Labour Party, FF, ICTU/SIPTU/TGWU/CPSU etc for many years to come through:

• lower innovation in consumption (with young people withdrawing from actively leading the new products/services adoption process);
• lower general consumption (with young people and their families clawing back on consumption);
• lower investment in productive capital (with younger people looking increasingly abroad for jobs and life-cycle investments);
• lower entrepreneurial activity in traded sectors (with younger people preferring the perceived safety of the public sector to risky business of entrepreneurship);
• lower overall career-cycle risk-taking (with less on the job innovation drive);
  
• lower rates of growth both in domestic sectors and exporting sectors;
• net emigration of the most skilled young in search of societies that politically and socially empower their youth, instead of turning them into taxation milk cows for the elderly bureaucrats;
• lower rates of economic growth (per bullet points above).
  

In short, Ireland is now at a risk of becoming like geriatrically challenged Germany, courtesy of Cowen & Co.


Second, there is an interesting issue of ECB rescue for Ireland. My IMF sources told me that they fully anticipate to put in place an IMF team to monitor developments in Ireland as they expect, over the course of 2009-2010 a serious deterioration in Ireland's fiscal position and a renewed risks to the bond market. But the more interesting comment came on the foot of my questions concerning ongoing ECB rescue of Ireland Inc.

The fact: chart below (courtesy of Davy) shows the ECB lending to Irish institutions.Irish retail clearing banks (AIB, BofI and the rest of the zombie pack) have raked up €39bn worth of ECB lending, up from around €2bn a year ago. Non-clearing foreign banks have declined in their demand for ECB dosh. Mortgage lenders (ca €66bn) and non-clearing domestic financial institutions (€72bn) are by far the biggest ECB junkies.

Here is Davy take on this: "Headline private sector credit is off about 3% from its November peak and, if you extrapolate the trend forward to the end of the year, the year-on-year (yoy) rate could be -6% (+2.4% yoy in April). However, the economy is likely to contract by maybe 8-10% this year in nominal terms, which means credit is going to have to shrink by a lot more if de-gearing is to take place in Ireland. Otherwise, we are really borrowing from future consumption and investment."

All I can add is that we borrow from future growth and investment in order to pay wages to the public sector and welfare bills.

"On the deposit side, the resident number was running at -2.5% yoy in April – an improvement on January’s -4.5%. Our discussions with the banks would suggest that current account balances, which are a great barometer of economic activity, are still declining but not at the rate that they were – so another positive second derivative for us to consider."

I do not care for second derivatives, for, as I pointed out many times before, mathematics imply that as we fall toward zero economic activity, we are approaching the point of total destruction with a decreasing speed. Which is neither important, nor significant of any upcoming upturn. It is simple compounding past falls with smaller rates of decline acceleration.

"Finally, we will also be watching the ECB funding number, particularly the clearing bank figure, to see if it stabilises (see chart) at around €39bn. Dependence on ECB funding shot up in Q1 when Ireland Inc was under funding pressure, but the banks would say that conditions have improved since then albeit the market remains tough. Moreover, some banks are still paying up to get money, so there is a margin impact to be considered. However, the new one-year ECB facility will help ease this a little and give some much-needed duration."

Sure, good news, according to analysts is that we are getting deeper into short-term maturity debt with ECB, then? What's next? Calling on banks executives to replenish banks capital using credit cards? Let's consider this Davy-style 'positive'. Suppose bank A used to take 2-year loans from ECB at a rate R, so borrowing €1 today implied that it had to repay (1+R)^2 in 2011, with associated transactions cost of, say X per issue, the total cost of €1 today to bank A was €(1+R)^2+X. Now, the ECB forces bank A to split the borrowing into 50% into 2-year tranche and 50% into 1-year tranche at rates R1, R2, R3 corresponding to years 1 and 2 one-year rates, plus R3 being an annualized rate of borrowing for 2-year tranche. The issuance cost remains at €X. You have the cost of borrowing €1 now standing at 0.5*[€(1+R3)^2+X]+0.5*[€(1+R1)*(1+R2)+2X]=1.5*X+0.5*[(1+R3)^2+(1+R1)*(1+R2)].

Compare the two costs:

• if the cost of borrowing does not rise over time, so that R1=R2=R3, then the 1-year lending scheme introduction will cost the banks more than the old 2-year scheme by the amount X;
• if the cost of borrowing - ECB rates - rise in 2010 by, say Z bps, so that R2=(1+Z)*R1, then a two-year trip will be cheaper relative to the two 1-year trips by a grand total of €[X+Z(R1+R1^2)].

Thus, the idea of 'easing' of borrowing constraints that Davy herald is equivalent to saying 'the banks will be able to borrow more, but at a higher cost'...

"The next big development on the funding side is the issue of guaranteed senior notes beyond the September 2010 deadline, the legislation for which has just gone through the Dáil. With the likes of Bank of Ireland having 75% of its funding under one year, this will help slow down the
liability churn, although it will come with a cost. We might be looking at 350-375bps all in, which will not help margins either. As we discussed in our recent Bank of Ireland research note ("When September comes: autumn rights issue can be a big catalyst", issued June 19th), we do not need credit growth over the next two to three years to make an investment case for the banks. That is just as well as frankly we are going to get the opposite. Margin expansion would be helpful though, and margins will expand eventually. However, with the ECB likely to sit on its hands for a while and the NAMA benefit likely to come through over time rather than in one big bang, we can expect margins to go down before they come back up again."

This talk about extending the guarantee is a mambo-jumbo that is designed to get the banks off the hook of defaulting loans for just a while longer. In reality, there is only one 'investment case' for Irish banks - NAMA transfer of bad debts to the taxpayers. This is precisely why the banks will need no new lending to extract value. Once they dump their non-performing loans into NAMA and get recapitalization money from the Exchequer, the Great White Hold-up of Irish taxpayers will be complete. Any growth upside for the banks shares will, thus, come solely from impoverishing Irish taxpayers.

A strong investment case, indeed, thanks to the ECB turning chicken when it comes to forcing Irish Government and Banks to obey market discipline.

Economics 08/05/2009: ECB - a bark, but no bite..., Obama's Frying Pen for Ireland

ECB's latest rate cut has a bark, but little real bit...

As we all know by now - the ECB has cut the rate by 25bps to a 'historic' low of 1%. The word 'historic' is suppose to impress us, yet it does not - the US rates are at zero, UK at 0.5%, Japan at 0.1%, Canada at 0.25% and these countries have seen significant devaluations vis-a-vis the Euro and quantitative easing...

Some say - this is the seventh reduction in seven months. "Geez Louise!", as Woody Allen would say. It would have been better if they were to cut the rate once - seven months ago - to 1.25% and not pretend to be 'conservative'. More medicine quickly is what gets the sick back on their feet. Drip-feeding vitamins to a dying patient is not going to do much good. And hence, I am not impressed by today's cut.

More significant was the statement that the ECB delivered alongside the decision. This is worth to be discussed on several fronts:

1) It suggests (and Trichet hinted at the same) that the forthcoming growth data for Q1 2009 is going to be poor. Does ECB know something we don't? My forecast (see April 24 post) was for 1.1% decline - monthly. So quarterly decline of ca 3.3% or more than double on Q4 2008 (-1.6%). Can it be worse? Yes, it can - Germany is forecast to fall 5.6% in 2009, with most of the falling to be done in Q1-Q2 2009. My gut feeling is that no matter what the fall off in Q1 can be (and we will know today), we are now in a 3.5-4% decline territory for Q2 as well. Hold on to your seats, because if this is the case, ECB's posturing that we are at the end of the cuts cycle is a fantasy. Expect a cut to 0.75% in June-July. Why? Because if H1 contraction were to be in a 4-5% territory, we are going to post a similarly deep contraction for the whole year. And that would warrant serious intervention.

So on the net, I must revise my forecast - yet to be quantitatively confirmed (which I will do tomorrow once the Q1 figures are in) - downward, and my feeling is that the full year 2009 figure is now shaping to look like a 4-4.5% fall in the eurozone.

2)Trichet had to mention the 'tentative signs of stabilization' in the economy. Presuming he was not talking about the US, the phrase reflects lack of agreement within the council as to what is taking place in the real economy. This is good news for us, analysts, since we now are no longer alone in not knowing what is going on, but it is bad for the markets. Uncertainty is something that usually spurs the Fed to act, and ECB to stall. Hence, I suspect we will see a month-long pause before another 25bps cut is enacted. Remember, the patient - the euro area economy - is still in ICU...

3)Whether you call it quantitative easing or not, but the plan to purchase €60bn in covered bonds (CBs) is a joke. Brian Cowen alone would burn through that amount in a year (with NAMA - in a blink of an eye). And there are Austria, Italy, Greece, Portugal, Spain still waiting in line for a handout. CBs are debts backed by cash flows from underlying loans (e.g mortgages). It is the sort-of securitization product, with all the stuff - however toxic, as long as it is paying some sort of interest - bunched in. It does appear that Ireland and Spain are the two leading contenders for the first slot at the new 'ECB pawn brokers' window, as our banks have been shifting all sorts of pesky stuff across their books into the ECB already.

The only question to ask here - what will be the associated terms and conditions? We will know these only about a month from now when ECB actually sketches these. But I suspect Brian Lenihan will be phoning Trichet's people to find out the details starting from tomorrow. After all, survival of the Irish financials and the Exchequer is now hanging by the thread, and Mr Trichet has a pair of sharp scissors at his disposal. Significantly, of course, the ECB's newest plan is to come ahead of NAMA legislation, so here is a question: Is this new CBs-purchasing plan a tailor-made device for Ireland to be tested as a guinea pig in European financial rescue experimentation?

On a bit more positive note, the ECB stretched liquidity provision terms to 12 months. It also added the European Investment Bank to the eligible counterparties list, in effect creating an additional supply of credit - ca €40bn. Now, combined the ECB €60bn, plus the EIB's €40bn are just about covering the borrowing requirements for Biffonomics and Lenihanama.

Obamanomics might, just might, spell a real disaster for Ireland Inc...
It was 100-days in the Hot Seat for Barak Obama last week and, true to his promises to change America, the President has gone for his big pledge: to crack down on the use of offshore tax havens. This time around Ireland will have to do better than sending Mary Coughlan to Washington in order to keep the US taxman at bay.

A key initiative, announced Monday, would partially close a provision that allowed US companies to defer paying taxes on the profits they make on their overseas investments. Another proposed change is to close completely the loophole that allowed companies to treat foreign subsidiaries as non-resident in the US for tax purposes.

A report by the Congressional General Accounting Office found that 83 out of the US top 100 companies have set up subsidiaries in tax havens. Some $20bn in allegedly ‘lost’ annual revenue for Uncle Sam is at stake, as in 2004 – the latest year for which data is available – US MNCs paid just $16bn in Federal tax on foreign earnings of $700bn. That’s an effective rate of tax of ca 2.3%.

Now, an interesting twist in the proposals is to allow deferring tax payments only on R&D investments, so expect Ireland suddenly jump to the top of the league of nations in per capita R&D spending, should the White House plan go through Congress.

It is worth remembering that our much-loved Bill Clinton prepared an even more ambitious plan for shutting down tax havens that would have seen US investment here dry-out like a salty pond in the middle of Sahara. Much-disliked George Bush shelved it, saving our US MNCs-led economy. Now, another Democrat - ah they are such 'friends of Ireland' those Democrats - is going to fry us up crispy...

How're those 4% growth forecasts from DofF looking now?

Daily Economics 20/04/09 - US debt problem

For those impatient - there is an estimate of Ireland Inc debt at the bottom... that can be compared with the US debt...

What is going on with the US economy? I expected the figures coming out on economic front (and earnings front outside the Federally financed banks) to be bad, but today's numbers are poor by all measures. According to the Fed's Conference Board, the index of leading economic indicators fell 0.3% in March, after a dip of 0.2% in February (revised up). But decomposition is telling:

• Building permits were the largest negative contributor in March, as builder have finally started to cut production in honest - much of this backed by the decreases in new starts, as finance committed to projects in 2008, signed for in 2007, has dried up. This is a welcome sign, as outstanding stock of unsold houses has to be pared back before any real recovery (as opposed to cliff-and-bottom bouncing) takes place.
• Stock prices, and the index of supplier deliveries also registered large negative contributions to the index in March, showing that real activity is continuing to deteriorate at, seasonally significantly faster rate. There is no spring bounce for now, and these are leading indicators, suggesting that any recovery upwards will require some new alchemy from the White House and the Fed.
  
• The real money supply was the largest positive contributor as the Feds printing presses were working overnight amidst deflation. And another sizeable positive push came from the yield spread - a sign that some of the future support might be waning - yield spreads narrowing is underpinned by lower Fed rates (not by healthier financial system, for banks are continuing to drop dead at an accelerating rate - 25 as of today in 2009 alone, and counting). So as the Fed has run out of options (short of setting negative nominal rates - e.g issuing loans with a principal repayment at a discount to the face value of the issued loan) and spreads are likely to start widening into the future as: (a) Uncle Sam's borrowing will remain buyoant, (b) debt refinancing will run rampant, and (c) Fed's helicopter drops of money thin out.
  

"There have been some intermittent signs of improvement in the economy in April," per Ken Goldstein, economist at the Conference Board. Overall, six of the 10 indicators were negative contributors, three were positive, and one was steady. Say what, Ken? Picture below is a telling one:
What Ken-omist from the Fed is referring to is the renewed momentum in the deterioration of the Leading Econ Indicators index that started in December (after a short 1-month flat) and has been going steady through March. The index has failed to bounce up in consecutive 9 months. Current Economic Conditions index is now converging downward to LEI, suggesting that unless things improve significantly in the next couple of months, simple psychology of the markets will lead to a renewed push down on LEI (the vicious cycle of self-fulfilling prophecies might commence).

Overall, in the six months to April 1, the index fell 2.5%, it declined 1.4% in the previous six months before that.

So about the only thing positive I can report has nothing to do with the Fed's own indicators, but with the decline in the new unemployment claims reported last week. If the decline persists for the next 6 weeks or so, then using comparisons with the last 6 recessions, we are at the point of inflection in economic recovery sometime now. But it is a big if, since the series can be reasonably volatile and their deviations from the monthly moving average can be significant (see here).

And here is a good chart on inflation expectations for the US (from the Fed: here) - care to argue this? or shall we start taking pressure on commodities-linked stuff in preparation for the new 2% inflation bout?


Paul Krugman on Ireland today: a good one from Krugman here. But an even better one from a comment to his article by PMD: "...Krugman and most of our own home-grown economists appear to regard cuts in public spending as being the same as tax increases. They have a model in their head with credit and debit on two sides and they are studiously agnostic about how the government should go about balancing the books. Those of us who work in the real economy know that increasing taxes on the productive part the economy - and that's 'productive' as in 'productivity' as in the only way to generate real wealth as in the only way to escape recession / depression - will dampen its productivity and, therefore, harm its capacity to generate wealth in the future - i.e. escape recession. All this 'sharing the pain' talk is just code for: we'll confiscate private sector wealth in order to avoid reform in the public sector. You can imagine a rich Titanic passenger on a half empty lifeboat blowing his nail and calling out to a dying pleb in the sea 'Chilly for this time of year. Isn't it?' I profoundly disagree with the reversion to the cargo cult school of economic management: let rich foreigners turn up and employ us. What on earth do we pay these mandarins for if the best they can come up with is 'something will turn up'? There are core domestic issues of productivity that are not being addressed." I couldn't have put it any better than this myself!

Lorenzo 'the Not-so-Magnificent' Smaghi... (or should it be Maghi?) is ECB's latest loose cannon... In an interview with FT Deutschland, Lorenzo Bini Smaghi of the ECB predicted that the Euro-zone recovery will follow the mirror image of a J-curve – a shallow recovery after the fall. Ok, I agree with this. In fact, I have warned for some months now that any recovery in the Euro-zone and Ireland in particular will be shallow and slow and will leave the continent at the trend growth rate of below 0.75% GDP, with Ireland at below 1% GDP pa. ECB's latest would-be-forecaster also 'predicted' a persistent and significant fall in potential growth rates going forward. Another thing Smaghi went into is inflation expectations: "'Inflation expectations are moving upwards (in euro area, U.S. and U.K.); no expectations of deflation," said the text of his presentation. Again, another theme I've been hammering about for some time now.

But... (S)maghi appeared to suggest that non-conventional monetary policy action would be likely soon, without giving any details. What this might be? Negative nominal interest rates? Unlikely. A policy of accepting all and any bonds issued by the member states? Brian Lenihan can wish... It is all but inevitable that the ECB will have to rescue Ireland and some of the other APIIGS. Such a rescue will have to be unconventional and not only because there is no existent convention within the Euro framework for doing so, but because as Smaghi stated in his presentation, households across Europe have lost faith in sustainability of public finances and have started to hoard cash. Nowhere more apparent than in Ireland. After surviving through a decade of anaemic (embarrassingly low, by some standards) economic growth, this is the second greatest threat point for the Euro.

A pat on the back: A stoodgy, but occasionally interesting quasi-official Euro economics website/blog: EuroIntelligence.com has the following 'news' item today. A long recession, a shallow recovery: The IMF has prereleased chapters 3 and 4 of its WEO. This is from the introduction of chapter 3 “…recessions associated with financial crises tend to be unusually severe and their recoveries typically slow. Similarly, globally synchronized recessions are often long and deep, and recoveries from these recessions are generally weak. Countercyclical monetary policy can help shorten recessions, but its effectiveness is limited in financial crises. By contrast, expansionary fiscal policy seems particularly effective in shortening recessions associated with financial crises and boosting recoveries. However, its effectiveness is a decreasing function of the level of public debt. These findings suggest the current recession is likely to be unusually long and severe and the recovery sluggish.”

Imagine this! See here for March 3 post that uses the exact precursor to Chapter 3 release... Oh dear, sometimes it is worth checking if a 'new' release is actually 'news'...

ESB's disgraceful entry into 'stimulus' economics has moved on to the next stage. As I noted in two earlier notes, the ESB plan for 'jobs creation' is an affront to the idea of competition and consumer interests (here), as well as an insensitive move at the time of economic hardship for many (here). Now, as today's IT reports (here) we are also looking at more Georgian Dublin demolitions... Is this predatory and arrogant monopoly ever going to brought under normal market controls? And is Irish Times ever going to become a paper where journalism stops being platitudinous to state monopolies and all-and-any 'Green' / 'sustainable' labels and starts seeing the likes of ESB for what they really are? And per wages and earnings in ESB... well, indeed in the entire public sector, see this excellent blog post from Ronan Lyons here. A must read.


A late Sunday thought - with Obamamama economics, how much debt is the US economy carrying?

Well, there are many sources of debt:

• National debt = currently at $11.2 trillion (per US National Debt Clock calculator here);
• Federal bailout commitments = so far set at $12.8 trillion (up from $4 trillion left by the previous Administration, per March 30 report by Bloomberg here);
• Federal entitlements commitments under Medicare and Social Security obligations = $52 trillion in current debt from the Federal Government to the system or $117 trillion in the present value of unfunded obligations (per National Center for Policy Analysis, as of December 2009, here);
• Private sector corporate and financial liabilities = $17 trillion (per US Federal Reserve numbers of December 2008, here)
• Private households liabilities $13.8 trillion (ditto), mortgages $10.5 trillion (here and a breakdown here) = $24.8 trillion.
  

Total = $117.8 - 172.8 trillion or 829.6-1,217% of 2008 GDP!
Financed at the current 30-year US Treasury rate of 3.79%, the interest payment on this debt alone will be $4,465-6,549 bln per annum - up to 46.1% of the country annual GDP.

We are not considering the pesky issue of the derivative instruments issued within the US system. These are notional debts, but they can come back and bite you as well. Per the Office of the Comptroller of the Currency (here), as of the end of Q4 2008 US held:

• interest rate derivatives to the tune of $164 trillion;
• CDS at $15.9 trillion,
• other stuff: FX, equities, commodities -based derivatives, to the total of $20.5 trillion

So Derivatives grand total of $200.4 trillion.

Which brings US total debt obligations to $318.2-373.2 trillion = upwards of 2,628% of US GDP!

Considering that the US current population is 306,251,267, the total US debt per capita is between $1.31mln and $1.22mln, with a servicing cost of up to $46,185 per annum per person!

And amidst this, Obama is talking traditional Democratic drivel of 'spending the economy out of a recession'? While Paul Krugman is wailing that not enough is being spent?

Can anyone really doubt that inflation is around the corner? If so, consider the above figures and do tell me how can the US get out of this corner without a massive debt write-off via inflation and sustained devaluation? Dollar at 1.75 to the Euro in two years time and interest rates in double digits?

Now on to Ireland Inc's debt:

• National debt = currently at €54.245bn (per NTMA here);
• Government bailout commitments = so far set at €400bn (here) under Banks Guarantee Scheme, €70bn (my estimate in the forthcoming B&F article) under NAMA, €87bn (here); Sub-total = €557bn;
  
• Public entitlements commitments under Pensions, Social Welfare and Health obligations = €75bn (Pensions: here), €66.3bn (€38bn per annum spending on health, wages & social welfare taken over 30 years horizon with deficit of 10% per annum over term) in the present value of unfunded obligations; Sub-total = €141.6bn;
  
• Private sector corporate and financial liabilities = Monetary Financial Institutions: €810bn, inc of IFSC, corporate sectors: €551bn; Direct Investment: €183.6bn (here); Sub-total = €1,544.6bn
  
• Private households liabilities (per my earlier estimates here) = €150bn.
  

Total = €2.45 trillion or 1,440% of 2009 GDP!
Financed at the current 5-year rate over 30 year horizon (roll-over) of 4.5%, the interest payment on this debt alone will be €110.25bn per annum - up to 64.9% of the country annual GDP. Put differently - the debt/liabilities of this economy are currently amounting to ca €555,048 per every person living in Ireland...

Ireland, ECB & Recent Commentary

Reading Ambrose Evans-Pritchard (Sunday Telegraph, 12/04/09) strikes me as an interesting case-study of stranger than life UK views of ECB - a mixture of truth, more truth and, all of sudden, bizarre ranting...

Judge for yourselves: “If Ireland still controlled the levers of economic policy, it would have slashed interest rates to near zero to prevent a property collapse from destroying the banking system. The Irish Central Bank would be a founder member of the "money printing" club, leading the way towards quantitative easing a l'outrance.”

I am far from being convinced by these arguments. Given that the ECB rates are at historic lows, an independent Irish Central Bank would only have room to move on further, say, 75bps-100bps down maximum. So what would have happened in this case?

Evans-Pritchard claims that “Irish bond yields would not be soaring into the stratosphere. The central bank would be crushing the yields with a sledge-hammer, just as the Fed and the Bank of England are crushing yields on US Treasuries and gilts.”

A maximum 100bps cut in rates would imply that Irish yields on 3-year paper would fall by ca50bps from their current levels. This assumes that the markets will take the same credibility to Irish Government commitments on fiscal policy stabilization as under the ECB oversight. This is highly unlikely. Instead, I would expect Irish yields to rise to 7-8.5% range on 5-year paper – consistent with the market pricing in double-digit deficits through 2012. Has Mr Evans-Pritchard ever seen John Hurley? or the dynamic trio of our Politbureauesque Leaders? Can anyone have confidence in their governance abilities? Being bootstrapped in the long run by the ECB does have a positive impact on our credibility and not having our currency managed by the corporatist consensus Government that we have at the very least insulates us from the monetary policies of disaster.

“Dublin would be smiling quietly as the Irish exchange rate fell a third to reflect the reality of trade ties to Sterling and the dollar zone,” says Evans-Pritchard.

Ok, but how is such a devaluation consistent with yields falling for Irish bonds? Unless these bonds were issued in Euro, devaluation would have acted to increase yields as FX risk increases would have driven bond prices down. In fact, I would suspect that the fall in our currency woud be deepr than that - say 60% (30% to restore references to the UK/US and 30% to reference the unttrustworthy Government). Such a fall would wake up even Mr Hurley - pushing him to raise interest rates to stave off a run on the Punt. The yo-yo of Irish monetary-fiscal-monetary-fiscal... debacles will commence.

“Above all, Ireland would not be the lone member of the OECD club to compound its disaster by slashing child benefit and youth unemployment along with everything else in last week's "budget from Hell".” Clearly, Mr Evans-Pritchard has failed to read the Budget. Our Government did precisely the opposite of what he claims – retained excessively lavish welfare benefits and current expenditure, taxing its way through the entire fabric of the middle class earnings and wealth creation incentives. Even child benefits and youth unemployment benefits cuts that Mr Evans-Pritchard claims to be welfare cuts are predominantly transfers to the middle and lower-middle classes. Majority of our poor are on permanent (not unemployment insurance) welfare and are collecting different types of child benefits.

“But what caught my ear was his throw-away comment that prices would fall 4pc, which is to admit that Ireland is spiralling into the most extreme deflation in any country since the early 1930s. Or put another way, "real" interest rates are rocketing. This is torture for a debtors' economy. You can survive deflation; you can survive debt; but Irving Fisher taught us in his 1933 treatise "Debt Deflation causes of Great Depressions" that the two together will eat you alive.”

I agree with Evans-Pritchard on this: real interest rates and the combination of debt and deflation will be drivers of misery for years to come. What is even more egregious is that our debt is actually growing, not shrinking and that this process will accelerate as Brian Lenihan pillages through our pockets.

“Mr Lenihan hopes to shield banks from the calamitous consequences by creating a buffer agency. It will soak up €80bn to €90bn in toxic debt - or 50pc of GDP. He borrowed the plan from Sweden's bank rescues in the early 1990s, but overlooks the key point - it was not the bail-out that saved Sweden's financial system, the country recovered only by ditching its exchange peg and regaining its freedom of action.”

Evans-Pritchard forgets couple other things that also helped to save Sweden – a rapid growth in the US and subsequently global economies during the 1994-1998 period that helped Sweden’s exports and capital inflows, and a robust programme of reforms that saw large scale privatizations and markets openings in many sectors of previously state-controlled economy.