21/11/2014: The Latest Troika Report: Risks, No Buffers, Lots of Hope

The Troika did it bit… flew into Dublin on the 17th and flew out of here today. And left this as a present for all of us to enjoy…

Summary of their statement with my comments (outside quotes).

"Ireland has enjoyed a year beyond all reasonable expectations following the completion of its EU‑IMF supported program. Growth has accelerated to be highest in the euro area, job creation has continued, bond yields are at historic lows, and the fiscal deficit will again be below target. Ireland’s resolute implementation of steady and measured fiscal adjustment has been critical to this success."

Good news all… albeit no mention on the effect of ESA2010 accounting rules on our deficit and debt 'performance', but still, let's bask in some sunshine, for what follows is less sunny.

"Ireland should stick with this proven approach. Why? Growth prospects in coming years are still very uncertain... Current highly favorable international financial conditions may not last as major central banks begin to shift their stance and geopolitical risks can evolve rapidly. A sound fiscal position is a critical buffer in these circumstances."

Hold on there. So there are risks. And these risks included the dreaded prospect of rising interest rates. And our risk buffers are not up to meeting them. Too bad the Government has promised giveaways already for Budget 2016.

IMF goes on: "Ireland’s economic recovery is currently strong, yet major uncertainties remain." Major uncertainties?… "The sharp rebound in 2014 is led by exports and investment and is increasingly supported by consumer spending. …The mission estimates growth at just over 4 percent in 2014, yet there are significant uncertainties owing to the large contribution of offshore manufacturing to exports. Growth is projected to ease to about 3 percent in 2015 but the range of forecasts is wide, in part reflecting risks to growth in Euro Area trading partners and to international financial conditions." Oh dear. What this means is that growth is here, but much of it is based on:

1. MNCs exports, and
2. Hoped-for domestic recovery yet to materialise in any substantial form.

And what about those pesky "financial conditions"? Well, they are allegedly "...highly favorable and lending may be picking up from subdued levels. ...yet nonperforming loans (NPLs) remain very high. Lending has been weak, in part reflecting firms’ reliance on retained earnings, but mortgage loans have recently picked up in the context of sharply rising housing prices driven by job gains, declining household uncertainties, and a weak construction supply response."

House prices driven by jobs gains? Presumably in D2/D4/D6 where the 'middle Ireland' is bidding over 500K for 3-beds. Some jobs creation boost. With the "financial conditions" being fine, except in the real economy, where they are bad, we are back in the 'things are so bad, they must improve sometime' growthology.

Key kicker is Fiscal Policy - something that Government directly controls. Here's IMF on that:
"...a budget deficit that may be over 4 percent of GDP in 2014 remains too large to put Ireland’s high debt firmly on a downward path. Moving to a balanced budget over time would also buttress Ireland’s highly open economy against the broad range of shocks to which it is exposed."

Wait, this is straight from the Fiscal Council textbook (and do note - they are going to wade in with their 'views-to-be-ignored' next week). But it is worse than the Fiscal Council 'below 3% target' - this is about balanced budget aka 'zero % target'.

"The mission estimates that Budget 2015 generates an adjustment of about ½ percent of GDP in structural terms. A somewhat faster pace of improvement would have been preferable in view of relatively strong near-term growth prospects. Hence, any revenue over-performance or additional interest savings should be used to lower the deficit in 2015."

But Budget 2015 was billed by the Government as 'sustaining the recovery' effort. Not so much, says the IMF in the above. Rather looks like 'gambling on the continued recovery' effort to me.

"In the medium term, ... the authorities’ strategy to reach balance centers on fiscal restraint as set out in the expenditure ceilings and in the Comprehensive Expenditure report 2015‑2017. The mission estimates that this entails annual structural adjustment of ¾ percent of GDP over 2016–18, which avoids undue drag on growth. Such a steady approach to consolidation will help cushion shocks and result in faster progress to balance if medium-term growth is stronger than expected, and vice versa. Fully utilizing asset disposals, notably of the banks, to hasten debt reduction will reduce interest expenses, thereby containing the cumulative consolidation required."

In other words, you thought austerity is gone? Well, think again:

1. The above says there is more needed, albeit at marginal levels, and
2. The above assumes no slippage on 'savings' achieved to-date. Which is going to be very very hard to maintain as public sector agreements of the past come to renegotiations just at the time when political cycle favours giveaways to powerful interests.

Risks to the above also include, as IMF notes "…age-related demands for public services are rising and other expenditure pressures may emerge after prolonged restraint. Further reforms will be needed to generate savings while protecting public services and investment, and progress in containing the wage bill must be preserved." I flagged the rapid rise in retired numbers in recent analysis of the QNHS data. It now looks like the IMF is concerned we are swapping spending on unemployment supports for spending on early retirement schemes for public workers.

Another perennial headache is mortgages arrears. Much of policy expanded on this and the progress is questionable at best. IMF view is:  "Banks report good progress on workouts in relation to the CBI’s targets. The low rate of redefaults to date is welcome [I wonder if the low rates of re-default are 38% rate of actual redefaults reported by the CBofI in whauch case the Troika shows some humour here], yet some cures with smaller debt service reductions may not prove to be lasting, requiring banks to better target solutions. With about half of arrears cases under legal proceedings, it is important that these proceedings, together with active follow-up by the banks, are effective in motivating borrowers to reengage in a timely manner to reach restructuring solutions where feasible. Substantial unfinished mortgage resolution work requires continued supervisory targets for coming years, with due attention to reversing the continued rise of buy-to-let loans in arrears."

So the crisis has not gone away. And the evidence on quality of resolutions is dubious. But the IMF solution is - hammer more the borrowers, even though hammering them today might backfire tomorrow. I wonder if rational expectations form a part of the IMF economics team heads?

Problem number two: arrears in SMEs loans. "Implementation of lasting solutions for distressed commercial loans is also essential. Corporate, SME, and commercial real estate loans comprise the largest share of NPLs. Supervision should ensure that banks are either encouraging appropriate progress by distressed borrowers in the execution of workout plans or are making timely loan disposals."

Basically, this says "We've given up. Nothing seems to work, so just bankrupt the lot or sell the toxic stuff for someone else to bankrupt the lot". Not good. Not good at all.

Patrick Honohan got a ringing endorsement for his efforts to cool off the property lending (that is nowhere to be seen… which is sort of like evading icebergs in the middle of the Gulf of Mexico):
"New residential mortgage lending rules proposed by the CBI are a welcome step… The introduction of loan-to-value and loan-to-income ceilings will increase the resilience of both the banking and household sectors to financial shocks…"

And the last bit - the fabled Structural Reforms. Here, IMF remains true to its previous commitments of not producing any new thinking. Just keep raising the ghosts of the past, that is construction and employment activation.

"A stronger construction supply response is needed to help contain pressures on housing prices and rents. Housing completions remain low despite a 42 percent rise in Dublin house prices from their trough, which is also contributing to rising rents. A range of factors are impeding an adequate supply response by the construction sector, potentially hindering a renewal of migration inflows. Timely implementation of the government’s Construction 2020 initiatives is therefore important. In particular, the introduction of use-it-or-lose-it planning permissions together with vacant site levies could usefully help counter reluctance to develop properties owing to expectations of further price appreciation."

This is, frankly, a loony bin of policy proposals. The market is utterly dysfunctional - funding is hard to get, land is overpriced, supply of land is effectively controlled by Nama and vultures. Construction costs are sky high due to Government own 'reforms' from the past. And the IMF is offering to make things even more costly for development? Are they for real?

On employment activation: "Efforts to strengthen employment and training services should continue.  High levels of youth and long-term unemployment pose downside risks to employment and hence to growth in the medium term. Steady progress on engaging with long-term unemployed persons is being made and the private sector provision of employment services is expected to start in the second half of 2015. The establishment of regional Education and Training Boards that will collaborate with Intreo offices to facilitate referrals of jobseekers to training is welcome. Ensuring that these new frameworks are most effective in helping the unemployed return to work will require ongoing evaluation and adaptation."


In basic terms, there is nothing new in the above. Keep going the way we've been going: more questionable quality training programmes, more forced participation, more exits from the labour force dressing up unemployment figures. Just shove the long-term unemployed under the rug and pretend there is nothing there.

In short, the Troika review is a dud: it found little new, it offered no new policies, save for making things worse for developers and builders. But it, usefully, pointed the hotheads from the Government 'spend and be merry' side in the direction of the cooler winds of risks painting our horizon in unpleasantly steely hues.

8/5/2013: Olli Rehn Departs Reality Once Again

If one needs an example of out-of-touch, reality-denying and self-satisfied EU Commissioner, travel no further than Olli Rehn. Here's the latest instalment from Court's Favourite Entertainer of Things Surreal:
http://europa.eu/rapid/press-release_SPEECH-13-394_en.htm

The speech focuses on what went wrong in Cyprus.

In the speech, Mr Rehn commits gross omissions and conjures gross over-exaggerations.

Nowhere in his speech does Mr Rehn acknowledge that Cypriot banks were made insolvent overnight by the EU (including EU Commission, where Mr Rehn is in charge of Economic and Monetary affairs) mishandling of PSI in Greek government bonds.

Nowhere in his speech does Mr Rehn acknowledge that Cypriot banks were massively over-invested in 'core tier 1 capital' in the form of zero risk-weighted sovereign bonds (Greek bonds) on the basis of direct EU and Basel regulations that treated this junk as risk-free assets. Mr Rehn states that "The banking problems were aggravated by poor practices of risk management. Lacking adequate oversight, the largest Cypriot banks built up excessive risk exposures." But Cypriot banks largest risk mispricing took place on their Greek Government bond holdings and this was (a) blessed by the EU regulators and (b) made more egregious in terms of risks involved by the EU madness of Greek PSI.

Mr Rehn claims that "The problems of Cyprus built up over many years. At their origin was an oversized banking sector that thrived on attracting foreign deposits with very favourable conditions." Nowhere is Mr Rehn making a statement that the size of Cypriot banking sector was never an issue with the EU, neither at the point of Cyprus admission into the euro, nor at the accession to the EU, nor in any prudential reviews of Cypriot financial system. Mr Rehn flat out fails to relate his statement on deposits to the fact that the EU is currently pushing banks to hold higher deposits / loans ratios, not lower, and that higher deposits / loans ratio is normally seen to be a sign of banking system stability. Mr Rehn is also plain wrong on his claims about the nature of deposits in Cyprus. Chart below shows that Cypriot banks' deposits more than doubled in Q1 2008-Q1 2010 on foot of the EU-created mess in Greece and the rest of the periphery.

Source: @Steve_Hanke

And here's proof that Cypriot banks were running a shop with deposits well in excess of loans, implying low degree of risk leveraging, until Mr Rehn and his colleagues waltzed in with their botched 'rescue' efforts:

Source: Washington Post.

Olli Rehn could not be bothered to read IMF assessment of Cypriot economy from November 2011 (Article IV report) - despite him citing EU Commission June 2011 'warnings' - where IMF clearly states that the core problems faced by Cypriot banking system stem from Greece (page 14) and local commercial banks' loans, not depositors or foreign depositors. On deposits, IMF states (page 17 paragraph 21) "non-resident deposits (NRD) in Cypriot banks (excluding deposits raised abroad by foreign affiliates) are €23 billion (125 percent of GDP), most of which are short-term at low interest rates." Thus, IMF directly, explicitly and incontrovertibly contradicts Mr Rehn's statement about foreign deposits having been extended on "very favourable conditions".

IMF further states that when it comes to deposits, significant risk is also poised by "€17 billion in deposits collected in the Greek branches of the three largest Cypriot-owned banks could be subject to

outflows in response to difficult conditions in Greece. Outflows in the first half of 2011were close to €3 billion (nearly 15 percent of the total), although a portion of these returned to the Cypriot parents as NRD." ECB chart below confirms this risk materialising in the wake of Mr Rehn's structured disaster in Greece:

This outflow knocked out billions out of deposits cushion that Cypriot banks needed to reduce their financing needs. And Mr Rhen - the architect in charge of this disaster - has nothing to say about it.

I can go on and on. Virtually every paragraph of Mr Rehn's statement is open to critical examination. 

That is hardly news - Mr Rehn has made so many gaffes and outright bizarre statements in the past (including his assertions at every pre-bailout junction that each peripheral country heading into bailout was fully solvent, fiscally sustainable, etc), he became not just a laughing stock of the markets, but a contrarian indicator for reality. What is of concern is that Mr Rehn is still being given the task of speaking for the Commission on Monetary and Fiscal affairs.

Olli Rehn should read something more cogent than his own speeches on what has happened in Cyprus (e.g. business.financialpost.com/2013/03/28/seeds-of-cyprus-disaster-planted-months-ago-by-eu/ and www.reuters.com/article/2013/04/02/us-eurozone-cyprus-laiki-insight-idUSBRE9310GQ20130402 or http://online.wsj.com/article/SB10001424127887323501004578386762342123182.html) and preferably do so free of charge to European taxpayers, on his own time, while up-skilling for his next job.

7/8/2012: Once forgotten Growth & Jobs Plan

So, by now we all have forgotten that little bit of June-July newsflow that promised a Compact for Growth to help the EU recover from the euro area-induced depression. And for a good reason - whole thing was a complete fudge. The problem is - this was supposed to be the second half of the EU policy equation. If the entire half of that equation is really a pure fake, what confidence can we have in the validity or sustainability of all other euro area commitments delivered at the last summit of June?

Answer - none.

Now, here's the reminder of the June 'growth fudge'. Alongside the euro area council, the European Commission singled out the European Investment Bank as the core instrument for stimulus measures - which in reality, given EU Commission's total lack of economic policy imagination amounts to public works and infrastructure investments. On July 31, the EU Commission issued a paper covering EU construction sector and calling for the sector to become the core driver of its grandiose scheme to kick-start the euro area economies. Let's keep in mind - the construction sector accounts for just about 10% of total GDP in the euro area, while being responsible for the lion's share of total losses in the euro area banking sector and for the majority of debts in the private sector that currently hold the economies of the euro area hostage.

Back on June 30th, the EU agreed a 'new' stimulus package worth €120 billion - the Growth and Jobs Pact. This 'new' measure, of course consisted of €55 billion of already allocated in the budget, but will be diverted from such worth-while activities as building EU's 'social(ist) / green / nano / smart / knowledge-filled economy' to EU's 'bricks-and-mortar economy'. Of the remaining €60 billion, only €10 billion will come from actual funds, which will be 'leveraged' by EIB (read: more debt) to raise up to €60 billion in funding which the EIB can then lend out to the 'struggling' economies for the purpose of building 'stuff'. There's a problem, Roger, as some would say. Last year, EIB has managed to lend out just €61 billion on the foot of raising €76 billion. In other words, apparently, EIB sees not enough worthwhile investment opportunities to allocate funds it already has. Back in 2010, EIB lent out €72 billion. But with the EU Commission plans, the bank should simply double its lending overnight. 

Despite the fact that by EIB's own admission (see annual report) the levels of lending in 2010 were 'exceptional' and the bank would like to return back to 'normal' lending volumes.

Recap the above: EIB is already lending at 'exceptional' levels and would like to scale this lending back, and EIB would have to double its lending capacity to deliver on EU Commission plan.

Now, what can possibly go wrong with this?

Eurozone: The High Cost of [Corporatist] Complacency

An interesting article from the Economists’ Voice (Éloi Laurent "Eurozone: The High Cost of Complacency", January 2009) argues that while the Euro is politically and economically attractive to a host of collapsing smaller economies, the Eurozone itself "is inert".

"How to make sense of this seeming contradiction?" asks Laurent. "It is tempting to blame America for Europe’s recession, but... Actually, if we view the last decade as a whole, we see that European passivity has cost it dearly and there lies the key to the Eurozone’s still unfulfilled promise."

Laurent's view of the Eurozone's failures reads like a description of what has happened in Ireland.

"...The ten years between 1999 and 2008 have been a golden era. There probably was not a better time in contemporary history to launch a monetary union and, learning by doing, to build efficient and resilient economic policy institutions to ensure its prosperity and sustainability. Yet, the decade was largely lost by Europeans in vain doctrinal debates and sterile blame game sessions. ...The reason [that technocratic debate] absorbs so much time and energy [of the European leadership] is that, absent a true democracy, economic doctrine has become over the years the justification of political power in Europe."

Laurent is only partially correct. Indeed, the technocratic economic doctrine debates have been a marker for European political landscape since 1999, but the debates became so central to the EU functioning because of the dogmatic pursuit of social consensus as the only benchmark for policy success. In other words, absent real democracy, the EU had to devise a deus ex machina replica of legitimizing democratic institutions. This is what social consensus - or corporatism, as it became known in Europe in the 1930s and 1940s - predicated upon.

The problem is that social consensus fails when ti comes to the need to formulate potentially unpopular and decisive policies. "With virtually the whole planet booming over the past decade, the Eurozone has, since its creation in 1999, displayed the worse performance in terms of growth and unemployment of the developed world, barely ahead of a depressed Japan."

What was the EU response to this crisis of insufficient growth? "One might conclude from [international comparisons] that the value added of the Euro is so far, at best, dubious and wonder why. But the European Commission did not, and recommended instead more of the same economic policies, stressing the importance of “budgetary surveillance” for the future and dismissing calls for improving economic cooperation and coordination among member states. [Thus] the ECB made in 2008 the exact same mistake as in 2001 by resisting a necessary cut in interest rates (actually, it increased interest rates in July 2008), waiting for the worst to be certain instead of trying to prevent it."

Laurent omits to mention the laughably naive EU Commission road maps and 'agendas' - the Lisbon I and Lisbon II frameworks for economic growth, the Barroso's Social Economy lunacy, and lastly the idea that geopolitical enlargement will resolve economic growth and political legitimacy deficits. For their claim that European Unification is predicated on a deeply historical rooting of European people, this Commission is failing a primary school lesson in history: the same strategies for legitimization have marked the Ottoman and Austro-Hungarian Empires, as well as a bag full of unsavory regimes in the early 20th century Europe.

But, getting back to the economy: few probably remember today the 1970s. Back then, it took European countries more than double the length of time it took the US to come out of the crises, despite the fact that Europe had at the time much lower dependency on imported oil than the US. Why? That European disease of not willing to take the necessary economic policy adjustments. The same sclerosis is present within the Eurozone today. "After the 2001 recession, [thanks to the Fed active intervention] it took a year for the US to go from negative to vigorous growth. In the Eurozone, it took five years to fully recover. As for fiscal policy, ...a true European stimulus is still nowhere in sight, even as the economic outcome worsens by the day."

Taking real policy decisions and implementing new policies is something that is clearly not en vogue in Brussels. "Facts speak for themselves in this regard: the financial and banking crisis started to receive an adequate response after an improvised meeting of head of states and governments of the Eurozone last October, a standing body that does not even exist in
European treaties. As [Jean-Paul] Fitoussi observed: “the structure of power is such in Europe that those institutions who have the instruments to react have not the legitimacy to do so while those which have the legitimacy no longer have the instruments. Hence the passivity of European policy reaction.”

This is a sweeping (and absolutely apt) description of the entire political illegitimacy of the current EU power structures. But it is also an apt description of the Irish governance disease.

Just as an unelected and unaccountable EU Commission (and its Directorates) has no capacity to legitimize its rule, except via an elitist consensus bought by providing a guarantee of access to the feeding troughs of Brussels, so the elected European Parliament has no capacity to exercise its democratic mandate. Just as an unelected and unaccountable Social Partnership in Ireland has no capacity to rule except by bribing its way through all and any changes in economic environment, the elected Dail has been reduced to a nearly irrelevant student debating society. In both cases, corporatism has won and society has lost.

In 1934, Eoin O'Duffy - an Irish corporatist - stated: "We must lead the people always; nationally, socially and economically. We must clear up the economic mess and right the glaring social injustices of to-day by the corporative organization of Irish life; but before everything we must give a national lead to our people... The first essential is national unity. We can only have that when the Corporative system is accepted."

Am I the only one who sees clear parallels between this historical statement and our Government's (and EU's) active suppression of any dissent and the pursuit of a social-consensus model of policy formulation?