10/9/2012: Irish Households Debt Overhang: IMF note

IMF published today three papers relating to Ireland's economy. Each of interest on its own merit and I intend to blog about them.

However, here's a chart that actually summarizes pretty well both the extent of the Irish crisis and the sorry state of affairs expected as we exit it:

Here's IMF's explanation for the household deleveraging process out of what is - by the standards of the chart above - a historically unprecedented debt overhang.


"Under the current forecast, households would reduce debt gradually from about  210 percent of disposable income to 185 percent by 2017. Building on the forecast of the
savings rate, the debt path is calculated based on the IMF desk forecast for a muted recovery
of disposable incomes at below GDP growth. Further, the debt path assumes that households use about half of their savings to retire debt, and new lending growth remains moderate, increasing from 1.6  percent of GDP in 2012 to 5.3 percent by 2017."

Now, give it a thought, folks.

1. Irish crisis in mortgages is well in excess of anything represented in the above chart;
2. Irish deleveraging over 9 years (2009-2017) will yield mortgages debt reduction of just 25 percentage points even if we use half of our entire savings to pay down the debts;
3. This painful deleveraging will still Ireland's mortgages markets in wore shape in 2017 than the second worst peak  of the crisis (the UK) back in 2007.

And here's the chart showing that all the debt paydown to-date has had zero effect on arresting the degree of Irish households leveraging (debt/asset value ratio) as underlying asset values of Irish properties continue to fall:

It is clear from the above that the Irish Government is out to lunch when it comes to dealing with the most pressing crisis we face - the crisis of severe debt overhang on households' balancesheets.

Economics 29/06/2009:

IMF Report last week highlighted some pretty nasty sides to our policies of the past, present and the future. For those of you who missed my Sunday Times article this week, here is the unedited version:


“They who delight to be flattered, pay for their folly by a late repentance,” said Phaedrus of Macedonia some 2000 years ago. No matter how much our Ministers herald this week’s IMF report as ‘being supportive’ of the Government policies, these words can be a leitmotif for the international organization’s view of our economy.

The IMF clearly states that the bulk of our economic problems was predictable and stems from our own policies choices.

Structural deficit, notes the report reached 12.5% of GDP back in 2008. Now, even following the savagery of April supplementary budget, the deficit remains at 11% of GDP for 2009.

Profligate in spending, Irish authorities project deficits of 10.75% of GDP in 2009 and 2010 falling to 2.5% of GDP by 2013. IMF projects – as a benign scenario - deficits of 11.75% in 2009 and 12.75% in 2010, and 4% in 2013. Bang-on in line with my forecasts published in January 2009. And this is before we factor in our ongoing short-term borrowing binge and the costs of NAMA.

IMF staff’s baseline scenario implies “stronger expenditure consolidation than currently projected by the authorities”. Read: Minister Lenihan is off the mark in his fiscal consolidation exercise. Over 2009-2014 primary expenditures will have to be brought down by a whooping 9.5% of GDP – a cut of some €16.2bn against additional revenue raising of €4.3bn. A note: An Bord Snip is toiling overtime to reportedly cut just €4bn.

The balance between new taxes and spending cuts that the IMF suggests is so out of line with the Government approach two Budgets and two policy documents issued to date that it is impossible to interpret the Report as anything more than a motivational platitude that a senior scholar would accord to a not-too-bright student attempting a difficult proof. That Minister Lenihan failed to notice this irony is truly remarkable.

The IMF has a right to be critical of our policies. The Fund has been at the forefront of warning the Government about the problems we facing today. Annually, in Article IV Consultation Papers of 2003-2007 Fund analysts said that Ireland must focus on reforming grossly inefficient public services, stabilizing tax revenues, and deflating the property and public spending bubbles. Time and again the Government presented the IMF polite warnings as the marks of its approval of our policies. Cheers were sounded at numerous press conferences and nothing was done to address specific risk factors.

In its 2004 paper the Fund noted, that “Increases in public sector employment ...gradually inched up from a low of 3.7 percent in January 2001 to 4.8 percent by July 2003. Domestic demand was supported by the ECB’s easing of monetary policy and an expansionary fiscal policy.” Later, the Fund told the Government that “progress in improving public expenditure efficiency, controlling public sector wages, and increasing domestic competition has been limited.”

Throwing good money after bad to ‘improve’ public services as the Government preferred to do was never sustainable for the IMF: “the size of government [in Ireland] is not small in comparison with other OECD countries when compared to GNP, the more relevant measure of domestic economic activity.”

Bertie Ahearne’s response to this was to declare himself the last standing socialist in Europe and accelerate spending growth, triggering a wave of public sector waste. By 2007, Ireland became the country with one of the most generous welfare systems in the OECD.

“The ongoing rise in debt levels over the past decade has placed Ireland above the average of household debt-to-income ratio for Euro area countries, only surpassed by the Netherlands and Luxembourg,” said IMF in 2006.

Neither CBFSAI nor the Department of Finance stepped in to reign in this activity, despite IMF warnings. No tightening in reserve ratios or regulatory restrictions on excessive and risky loans took place. Capital to risk-weighted assets ratio has fallen from 14% in 2003 to 12% in 2005 for domestic banks. Contingent and off-balance sheet accounts have risen from 538% of total assets to 879%. Annual credit growth to private sector ballooned doubled to 29%. Today, the Government continues to promote our low public debt with no references to the private sector indebtedness.

In 2007 the IMF warned about the risks to our fiscal sanity: between 2003 and 2006, Irish real GDP grew by 22%, while real primary public spending rose 27%. Unfunded forward expenditure commitments have swallowed all existent and expected future primary surpluses.

Not surprisingly, this week, the IMF found that cyclical public deficit (the deficit that can be attributed to the world-wide recession) accounts for less than 30% of our total shortfall – in line with my own analysis published in August 2008. We are, as a nation, borrowing tens of billions of euros in order to pay grotesquely over-paid public sector employees their wages.

Perhaps the most perverted reading of the report by the Government concerned the IMF assessment of NAMA. Far from being an unguarded endorsement of the Government strategy, the report is tactfully telling our leaders to start thinking about the basics.

Per IMF, the main risks to NAMA are with pricing of the loans, post-NAMA recapitalization, narrowness of its remit and potential lack of flexibility. Protection of taxpayers’ funds is a serious concern. All these issues were raised by a number of critics of the Government approach to NAMA over the recent months. None have been addressed by the Government.

Crucially, the IMF sees a room for considering nationalization of the banks with shareholders taking full hit on their asset values. The IMF suggests that such nationalization can be triggered by either insolvency of the bank or by cash flow constraints. Given that the IMF estimates that some €34bn of the loans can end up in the rubbish bin, the cash-flow constraints that can trigger nationalization may apply to all major banks in Ireland. This is hardly comforting to the Government that categorically ruled out nationalizing well before it got to do the sums on NAMA itself.

Interestingly, a much over-looked sentence inserted in just two places in the report states: “A number of Directors considered that, for bank restructuring, other [than NAMA] options including a greater equity interest by the government should not be ruled out.” Given the current market valuations, any ‘equity interest by the government’ in our ailing banks would spell an outright nationalization to have any meaningful impact on the financial institutions. This hardly constitutes the IMF endorsement of the Government strategy.

On potential for NAMA success, the IMF says that “if well managed, the distressed assets acquired by NAMA could, over time, produce a recovery value to compensate for the initial fiscal outlays.” Note that the Fund says nothing about recouping the cost of final outlays: bond financing, managing NAMA, inflation or recapitalization post-NAMA. These lines of expenditure are likely to yield tens of billions in taxpayers’ losses.

In short, IMF report, even after rounds of ‘consultations’ inputs and delays by our officials, presents a picture of Ireland as a country that is yet to address the grave and domestically rooted policy disasters it faces – 22 months after the onset of the crisis. Hardly an endorsement we can be proud about.

Box-Out:
Another week, another bond offer from Ireland Inc. Last week, NTMA has sold a syndicated bond offer worth €6bn, with a whooping 5.9% annual coupon. The good news: it was a large issue and the maturity date for the new paper was 2019 – well away from 2012 and 2014 dates in previous two syndicated issues of this year. The bad news was the cost of the latest borrowing to the taxpayers. If the first €4bn bond raised this year was pricing each €1 in borrowed funds at €1.25, once expected inflation is factored in, the latest offer will cost us over €2.31 per each €1 borrowed. Not exactly a deal of a century. Another interesting feature of the syndicated bond offers to date is that the demand from banks, including Irish banks, remains very strong, covering more than 50% in all three placements despite continued problems in the banking sector. Funds allocations into Irish bonds rose steadily from 10% in the earlier offer to 26% in the latest placement. This can suggest two possible things. Either the fund managers re-discovering genuine interest in Irish paper or there is some sort of parking facility arrangement between the dealers and the issuer to store-up bonds for future use in NAMA-related transactions. Of course, one can only speculate…


And here are few quotes from earlier IMF reports on Ireland that did not make it into the article:

In its 2004 Article 4 Consultation Paper the Fund noted, in relation to the 2000-2003 period that: “The substantial contribution of multinationals to Irish output and associated profit flows creates significant differences between measures of output, and the recent cycles in GDP and GNP have not been synchronized. ...Increases in public sector employment ...gradually inched up from a low of 3.7 percent in January 2001 to 4.8 percent by July 2003. Domestic demand was supported by the ECB’s easing of monetary policy and an expansionary fiscal policy.”

Thus, the IMF was diplomatically telling the Government that by 2003 Ireland was running overheated housing markets, slowing productive sectors and unsustainable expansion in the public sector employment and spending. Per IMF “...steps toward improving efficiency in public transportation have been met with resistance by public sector unions,” clearly identifying the main obstacle to the path of public sector reforms in Ireland.

The Fund had also serious criticism of the rising levels of public spending in Ireland. Preserving the emphasis placed by the IMF itself, Article 4 document told the Government that “the size of government is not small in comparison with other OECD countries when compared to GNP, the more relevant measure of domestic economic activity in Ireland. Lower tax rates in Ireland as compared to the EU reflect favorable demographics, prudent fiscal policies that have delivered lower debt and debt-servicing costs, smaller defense requirements and lower unemployment-related social spending.”

2006 Article IV paper identified “several macro-risks and challenges facing the authorities. As the housing market has boomed, household debt to GDP ratios have continued to rise, raising some concerns about credit risks. Further, a significant slowdown in economic growth, while seen as highly unlikely in the near term, would have adverse consequences for banks’ non-performing loans.”

Government response to this was extending a range of property tax incentives schemes and encouraging banks lending. No tightening in reserve ratios or regulatory restrictions on excessive and risky loans took place. Indeed by 2005, regular capital to risk-weighted assets ratio has fallen from 15% in 2003 to 13.6% in 2005 for all banks, and from 13.9% to 12% for domestic banks. Contingent and off-balance sheet accounts as a percentage of total assets have risen from 538% to 879%. This deterioration in the quality of our financial systems took place against the backdrop of rapidly rising lending with annual credit growth to private sector balooning from 15% pa in 2003 to 28.8% in 2005.

In 2006 and later in 2007 the IMF staff “suggested broadening the tax base by phasing out the remaining property based incentive schemes, reducing mortgage interest tax relief, or introducing a property tax.” Despite agreeing with the staff, Irish Government has gone into 2007 election year with double digit growth in current expenditure and massive handouts to the pressure groups. The tax base was not only left unreformed, but new tax measures were introduced that pushed the state deeper into dependency of property tax revenues.

In September 2007 the IMF took a look at the quality of Irish Government targets delivery. Table A.1 of the report contains an often neglected line specifying the rising disconnect between the policymakers’ rethoric and the actual outrun. Between 2003 and 2006, Irish primariy surpluses rose from 1.1% to 3.4%. Over the same period of time, real GDP grew by 21.8%, while real primary public spending rose 27%.

Economics 25/06/2009: Unemployment and IMF

While many of you are wondering where is my comment on last night's IMF report, I must ask you for your infinite patience - it is forthcoming in this week's Sunday Times and I will be posting more on the issue over time.


In the meantime, the US Bureau of Economic Analysis (BEA) reports today that the real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 5.5% in the first quarter of 2009, (that is, from the fourth quarter to the first quarter), according to final estimates released by the Bureau of Economic Analysis. In the fourth quarter, real GDP decreased 6.3%.

I can see our strategy to wait for Americans to turn around working... thanks to the Irish Government tough choices on policy side, US GDP contractions are flattening out. Happy times are just around the corner.

Of course, one cannot suggest that the Irish Government is not doing more than just help the Americans in their troubles. Indeed, hat tip to BL, Politics.ie have the following itinerary for our Dear Leader of Offaly, Knight of the Bogs and Lord of the Bord Na Mona Mansions:
23.06.09:

• Brian Cowen attends the official re-opening of Shinrone National School, Birr, Co. Offaly
• Brian Cowen raises the First Green Flag at Coolderry Central School, Birr, Co. Offaly; and
• Brian Cowen attends the Official Opening of Isotron Ireland’s new Electron Beam Sterilisation Facility, at Tullamore, Co. Offaly

Of course, Mary Coughlan, the Grand Dame of Diplomatic Etiquette and the Lady of Jobs Announcements Junkets was equally busy jet-setting across the nation to announce jobs:

• 45 at Boston Scientific plant in Galway (after cutting 240 jobs in Galway last August and as another motor trade company sheds 70 jobs in Galway the same day as Mrs Coughlan arrived there);
• alongside Gaeltacht Minister Eamon "Gimme More Subsidies" O'Cuiv visiting west Donegal today to assess the damage caused by flash floods (I didn't know the DETE is also responsible for emergency services in this country); but
• Flooding aside, she did have a chance to pull an unveiling string at the launch in Finnabair Business Park in Dundalk...
  

All in the day's work for Tanaiste, directly responsible for dealing with our soaring unemployment rate (on the exact day when CSO unveiled the latest unemployment data from QNHS).
Of course, neither Biffalo-Gruffalo, nor Scary-Mary are much of the IMF/Economic Policy men (women), so why not let poor rookie, Brian Lenihan deal with the opposition fire on the issue of yesterday's damming report? Afterall, as the US data shows, things are already getting better (by getting worse at a slightly slower pace than before)... "The heart attack patient has no pulse, Doctor," shouts the nurse. "Excellent, things have bottomed out then," retorts Dr Biffalo, "Pints!"

Daily Economics 22/04/09: IMF's GFSR

IMF's Global Financial Stability Report (available here) is a lengthy read worthy of attention, both for its finance world-view and a diplomatically correct version of the 'Office' comedy. Subtle language turns tell more of a story of IMF's desperation from looking at APIIGS' incompetent macroeconomic management than the direct phrases. That said, there is little in the report, aside from two tests of financial contagion, that is either new or forward-looking.

"The United States, United Kingdom, and Ireland face some of the largest potential costs of financial stabilization given the scale of mortgage defaults."

Emphasis on the word 'mortgage' is mine, of course, added precisely because the IMF concern has not been, to date, echoed by many Irish economists or banks. In fact, all Irish banks currently assume that mortgage defaults will not happen. Instead, policymakers (via NAMA and debt issuance), bankers (via impairment charges and recapitalization funding) and economists (via RTE / Irish Times opinion pages) have been preoccupied with 'toxic' assets (development loans). Poor households have largely been left out of the 'They deserve help too' circle. The Government actually is so confident that mortgage defaults will not be a problem, that it is taxing households into the recession. As I have noted before, this presents a problem - should inflationary pressures rise, interest rates will regain upward momentum and Ireland will be plunged into a mortgages implosion.

How costly are Lenihan's commitments?
Moving on, two illustrations from the IMF report are worth putting together: First, the sheer size of the so-called 'costless' (Brian Lenihan's grasp of economics), guarantees written by Ireland Inc on our banks:Second, the real-world cost of these guarantees...I've identified this link between the throwaway promises Irish Government has been issuing since September and the cost of our debt before. It is nice to see IMF finally saying the same: "Figure 1.37 highlights that the spread on the issues guaranteed by sovereigns perceived as less capable of backing their guarantee is wider than for those that are deemed well able to stand behind their promises, such as the United States and France."
But here is another proof of the link between Brian Lenihan's guarantees and the cost of these to you and me:
Note the coincident timing: September 2008, and spreads on Government debt shooting through the roof to reach banks bonds spreads and trending from there on side-by-side to Anglo's Nationalization (another spike), then to recapitalization (a slight decline)...

Go long, not short...
The IMF advises the Governments to switch debt issuance to longer term maturities. Exactly the opposite is the strategy adopted by the Irish Government that has launched increasing quantities of new 3-9mo bonds into the markets. "...Authorities should take the opportunity of the currently low level of real long-term yields to lengthen the maturity of issuance where possible to reduce their refinancing risk," says the IMF, implying in simple terms that you shouldn't really pile on short term debt at the time of a prolonged crisis.

For all its faults, even the IMF knows that you can't run the country on the back of credit card debt. But Brian, Brian & Mary wouldn't have a clue, would they? All their experience relates to managing a cash cow for the public sector unions that is our public purse.

Shock scenarios
More interesting stuff is in the IMF's modeling of financial shocks: Scenario 1 (pure credit shock with no fire sale of assets - more like a situation in the US in recent months) v Scenario 2(credit shock with fire sale of assets - a more relevant case scenario for the likes of AIB). Here are the results of the latter test:
In scenario 2, Australia shows 7 double-digit responses to shocks to other countries' financial systems, Austria, Italy, Portugal, Sweden & UK 6; Canada, Japan, Spain & US 5; France 8; Belgium, Germany & Ireland 9; The Netherlands 12; Switzerland 13. This hardly supports an assertion that we are driven by external markets crises in our own financial sector to any exceptional degree. Yes, we are less exposed than Switzerland and the Netherlands, but we are way more exposed than the many other countries.

The table below (it is the same table that was reported by me in December 2008) shows that we have the second highest (after Luxembourg) ratio of Bonds, Equities and Banks Assets to GDP in the world - a whooping 900%!

Furthermore, Table 23 provides some amazing evidence: Banks Capital to Assets in Ireland stood at only 4.1% in 2008, down from the high of 5.2% in 2003. Only Belgium and The Netherlands have managed to get lower ratio in 2008. Irish Central Bank actually provided these figures to the IMF and yet the CB has managed to do precious nothing to correct the steadily deteriorating capital ratios throughout 2003-2008 period. This, presumably is why we pay our CB Governor a higher salary than the one awarded to his boss, the ECB Chief.

So the 'comedy' part now being played in Dublin has a simple scenario that IMF, with its diplomatic mission, will not reveal to us, but that is visible to a naked eye though the prism of the IMF report:

1. Incompetent state regulators (CBFSAI and more) get golden parachutes for damaging the financial services sector and the economy;
2. Incompetent and greedy politicos are shielding their unions', banks' and developers' cronies from risk and pain caused by (1);
3. The ordinary people and businesses of Ireland are paying for (1) and (2).

And the markets still show willingness to powder this charade with 110% bids cover on Irish Government bonds? For how long?