27/9/2013: Internal Devaluation: Picking a Right Target?

Conventional wisdom of the 'internal devaluation' theory goes as follows: if a country like Ireland were to experience a structural shock, the path of adjusting to this shock lies via reduction in the cost of doing business (improving efficiency). Since adjusting the cost of Government or quangoes or Social Partners in the economy is an impossible task to undertake in a corporatist economy, then the only two things that can adjust to effect the 'internal devaluation' are capital costs (interest rates) and labour costs. In reality, however, capital costs are no longer responsive to interest rates since Ireland is in a major asset bubble bust and banking sector collapse. So we are left with deflating labour costs.

Aside from the knock-on effects such policies might have on aggregate demand and household investment, there is a nagging question of: can they be effective in reducing functional costs faced by businesses? In other words, are reduced labour costs associated with economic efficiency gains?

Logic suggests that even if successful, reductions in labour costs can only be as effective as labour costs' share in total output of the economy. How so? Suppose labour costs fall 10% and labour costs share in the economy is 50%, then, assuming freed resources are used somewhere more efficiently, the output boost can be substantial. If, however, labour costs are only 10% of the economy, then the impact will be smaller.

Now, here's a chart from the Robert Schuman Foundation research paper on Labour Costs and Crisis Management in the Eurozone:

According to this chart, Ireland was the second / third (to Greece and Italy) worst candidate in the euro area to implement internal devaluation policies along the lines of labour costs adjustments. And today Ireland is the second worst candidate (after Greece - the unlabelled purple line).

Yes, Ireland was the best candidate to apply these policies as the place with the worst labour costs competitiveness during the pre-crisis period.

But the adjustments, even though only partially successful, may be not impacting significant enough proportion of the economy to make much of the real difference.

12/8/2013: Sunday Times August 4, 2013: Troika Programme Exit vs Fiscal Reforms

This is an unedited version of my article for Sunday Times August 4, 2013.


Irish political leaders are not exactly known for making logically consistent policy pronouncements. The current budgetary debates are case-in-point. On the one hand, minister after minister from both sides of the coalition benches are repeating ad nausea the tired cliches about their successes in managing the economy. On the other hand, the very same ministers are talking tough about the need for more pain, more adjustments, and more 'reforms' to secure the said recovery and deliver us from the clutches of the Troika. Only to turn around and start praising Troika support as the source of our recovery.

In reality, there are good, if only rarely voiced, reasons for these exhortations: seven hard budgets down, we are not really close to shaking off past legacy of wasteful fiscal practices. The state is still insolvent. The structure of the state policies formation is still dysfunctional. The legacy of pork barrel party politics continues unreformed.

Nothing exemplifies this better than the stalled structural reforms of social welfare and the resulting temporary, risk-loaded nature of much of our fiscal adjustments to-date.


Take a look at the top-line data coming from the Merrion Street.

In the first six months of 2013 tax revenues collected by the Government were EUR3.17 billion ahead of the same period three years ago, while the total voted current expenditure by the Exchequer was up EUR391 million. In other words, the only difference between the current budgetary approach and that practiced by Bertie Ahearn is that today's tax collections are starting from the low levels. Aside from that, current spending continues to ride well ahead of our economy’s capacity to fund it. The 'boom is not getting “boomier”, but the two main current spending lines: social protection and health, are still running at 65.2 percent of the total voted current expenditure, up more than 4 percentage points on 2010.

Things have changed, over the years, to be fair. There have been reductions in current expenditure during the crisis, overshadowed by tax hikes and dramatic cuts to capital spending. Thanks to tax hikes, in H1 2013, Ireland marked the first half-year period when the current spending by the Super-3 Departments: Education and Skills, Health and Social Protection, combined, was below the total tax revenue collected by the State. A significant milestone, but hardly a salvation, as three departments' current expenditure in January-June 2013 still counted for 95 percent of total tax receipts. Thus, even with all the cuts to-date, shutting down all current voted expenditure, excluding the Super-3, will only half our Exchequer deficit from EUR6.59 billion to EUR3.31 billion.

Which exposes once again the five-years-old policy dilemma: to balance the books, Ireland will require at least a EUR2.7 billion worth of further cuts on the spending side on top of what is being planned for 2014-2015. Most, if not all of these will have to come from the Social Protection and Health

Sustainability of savings achieved to-date presents a further risk. So far, cuts to the Exchequer spending that dominated the last five years were heavily concentrated on the sides of capital expenditure and public payrolls. Both are at a risk of reversal in the future.

Any return to growth will require heavier capital investment in public infrastructure, schools, medical equipment and facilities and so on. In other words, capital savings are an illusion on the longer time scale.

Meanwhile, much of the current spending cuts fell onto the shoulders of temporary and contract staff, leaving permanent and more expensive staff protected. This protection came at a cost of increased demands on their productivity. With staff feeling the bite of higher taxes and pensions contributions, while being forced to work more and outside their comfort zone of life-long assignments, public sector unions are already itching to get a new wave of wages increases going.

Back in December 2012, the Troika has pointed out that the savings delivered in public sector pay bills under the Croke Park Agreement cannot be deemed sustainable in the long run. The Haddington Road Agreement for 2013-2016 further confirms this assessment. The insolvent state is now fully committed to more rounds of increments payments, no matter what happens to the economy or exchequer finances. Virtually all ‘savings’ to be delivered under the Haddington Road Agreement are to be automatically reversed at the end of the agreement term or earlier.

The risks of policies reversals on capital and public sector pay, relating to the above measures, are non-trivial. IMF forecasts through 2021 showed the current path of fiscal adjustments taking us to a debt to GDP ratio of just over 95 percent in 2021 from the peak of 2013. Using IMF assumptions, my own estimates suggests that reversing budgetary policies to 2013 levels after 2015 can result in our Government debt to GDP ratio stuck at 108 percent in 2021.


All of which points to a simple but uncomfortable fact: to achieve long-term sustainability of our fiscal policies, Ireland requires a longer term reduction in public spending well in excess of what can be delivered without significantly cutting into current health and social welfare expenditures. Given the fact that health spending is already stretched, the above cuts will have to happen on welfare side.

The reforms, to be undertaken across a period of, say 2015-2016 will have to be sweeping and permanent, building in part on some of the piecemeal changes already in place.

To reduce the risk of replay of the devastating 2008-2010 effects of unemployment shocks on exchequer and economy at large, we need to separate unemployment benefits from other welfare supports.

Unemployment Insurance (UI) should provide a temporary, but generous safety net, sufficient to sustain reasonable family commitments to mortgages and children- and health-related expenditures. Thus, UI should be paid as a percentage of the end-of-employment salary, starting with 2/3rds of the salary up to a maximum of the median wage, with payments declining with duration of unemployment. Payments should terminate after 9 months.

Social welfare payments (SWP) to able-bodied adults can kick in following the expiration of the UI scheme on a means-tested basis. A low monthly personal SWP rate should be supplemented with access to childcare and healthcare, as well as educational grants for children, but only in the cases where recipients engage in training and/or active job searching. A recipient cannot turn down a reasonable offer of a job without facing a financial penalty. All benefits should be subject to a life-time cap of 6-7 years to prevent formation of permanent welfare dependency, while providing a broadly sufficient safety net..

All benefits payments above the monthly personal SWP rate, benchmarked for provision under the scheme, such as health, public services and transport allowance, should be cashless to reduce potential misuse of funds. To encourage better health attitudes and more careful utilisation of public services, a share of unused allowances, say 10-20 percent, accumulated in the account at the end of each year can be paid out as an annual bonus.

We also need to reform our state pensions. Given the fallout from the property bust, large numbers of Irish families are facing the prospect of pension-less retirement. They will require significant state supports - something we cannot afford while carrying the burden of unfunded state pensions.

All statutory state pensions should be means-tested to generate immediate savings and remove absurd subsidisation of the better-off at the expense of those in genuine need. Ditto for age-linked medical cards.

Automatic benchmarking of legacy public sector pensions should end and all current public employees’ pensions should be converted into defined contribution schemes. This will require a legislative decision to alter employment contracts. It will also require recapitalization of the public pensions fund, which can be done gradually over the period of, say, 10 years.

Savings to be targeted in the above measures should apply gradually, over 2014-2017, to generate new substitutes for temporary measures adopted in previous budgets.

However, even with gradual improvements in the labour markets and economy from 2014 on, implementing the above reforms will be nearly impossible. Current political system, with policy decisions based on consensus of the interest groups, is subject to stalling on big reforms and the risk of future reversals by governments seeking popular mandates. This means that we need to take a National Unity approach to structuring and enacting the new legislation dealing with reforms of the social welfare and pensions. Such a consensus is feasible, once all political parties in the Dail realise that Ireland will continue to face subdued economic recovery, elevated unemployment and anemic asset markets well into 2020-2021. With these headwinds, the pressure to carry on with prudent fiscal policies will remain. Thus, the only way of avoiding the contagion from the current long-term economic crisis to the political and state balance of power is to enact irreversible, legislatively protected structural reforms of the social welfare on the basis of bi-partisan legislative engagement.

Box-out:

A note from Davy Research on Mortgages Arrears, published this week, represents a good summary of the current crisis and draws some sensible and well-argued policy conclusions on the subject. Alas, the report commits one common, unnecessary and unfortunate error. Strategic non-payment of mortgages debt is cited in the report eighteen times. Yet, there is no direct evidence presented in the report, or in any study cited in the report, as to the true extent of the problem in Ireland. Instead, like all other analysts, Davy team references unsubstantiated statements by the banks and banking authorities, and simplistic extrapolations of other countries’ studies to the case of Ireland as evidence that "mortgage delinquency has continued to grow despite better-than-expected labour market  conditions” and that “strategic default is now a problem." Like other researchers, Davy team cites increases in employment in Q1 2013 as the evidence of a 'growing problem' with strategic non-payments.  Alas, in Q1 2013, seasonally-adjusted full-time employment (jobs that can sustain payment of mortgages) dropped 4,500 year on year. Broader measures of unemployment reported by CSO also posted increases. This hardly constitutes a material improvement on households' ability to fund mortgages repayments and it certainly does not support the thesis of significant and growing strategic defaults. Of course, absence of evidence is not evidence of absence; the employment data cited above does not prove that there are no strategic defaults in Ireland. It simply shows that absent real, direct evidence, one should take care not to fall into the trap of convincing oneself that an oft-repeated conjecture must invariably be true.

21/05/2012: Sunday Times 20/5/2012: Euro area crisis - no growth in sight

Here's my Sunday Times article from May 20, 2012. Unedited version, as usual.

Welcome to the terminal stage of the Euro crisis. Only two years ago European press and politicians were consumed with the terrifying prospects of a two-speed Europe. This week, preliminary estimates of the Euro area GDP growth for the first quarter of 2012 have confirmed that the common currency area, instead of bifurcating, has trifurcated into three distinct zones.

In the red corner, we have the pack of the perennially struggling economies of Cyprus, Greece, Italy, Portugal and Spain. The Netherlands, with annual output contraction of -1.3% in Q1 2012, matching that of Italy, has quietly joined their ranks. These countries all have posted negative growth over the last six months if not longer. Cyprus, Italy, and Portugal, alongside the Netherlands, registering negative growth over the last three quarters. Ireland and Malta, two other candidates for this group are yet to report their Q1 2012 results, with the former now officially in a recession since the end of 2011, while the latter having posted its first quarter of negative growth in Q4 2011.

In the blue corner, Belgium, France, and Austria all have narrowly missed declaring a recession in the last quarter, while posting 0.5% annual growth or less.

Lastly, in the green corner, Estonia, Finland, Germany and Slovakia have served as the powerhouse of the common currency area, pushing the quarterly growth envelope by between 0.5% and 1.3%.

The red corner accounts for 40% of euro area entire GDP, the blue corner – for 29%. All in, less than one third of the euro area economy is currently managing to stay above the waterline.

Looking at the picture from a slightly different prospective, out of the Euro 4 largest economies, France has shown not a single quarter of growth in excess of 0.3% since January 2011. In the latest quarter it posted zero growth. Germany – the darling of Europe’s growth strategists – has managed to deliver 0.5% quarterly growth in Q1 2012 on foot of 0.2% contraction in Q4 2011. Annual growth rates came at an even more disappointing 1.2% in Q1 2012, down from 2.0% in Q4 2011. Italy decline accelerated from -0.7% in Q4 2011 to -0.8% in Q1 2012, while Spain has officially re-entered recession with 0.3% contraction in Q4 2011 and Q1 2012.

The Big 4 account for 77% of euro area total economic output. Not surprisingly, overall EA17 growth was zero in Q1 2012 both in quarterly terms and annual terms. The latest leading indicator for euro area growth, Eurocoin, reading for April 2012 shows slight amplification of the downward trend from March. In other words, things are not getting better.

The best countries in terms of overall hope of economic recoveries – net exports generators, such as Austria, Belgium, Ireland, and the Netherlands, are all stuck in either the twilight zone of zero growth or in a years-long recession hell.

Ireland’s exporting sectors have been booming, with total exports rising from the recession period trough of €145.9 billion in 2009 to €165.3 billion in 2011. However, the rate of growth in our exports has been slowing down much faster than projected for 2012. If in 2010 year on year total exports expanded 8.1% in current prices terms, in 2011 the rate of growth was 4.8%. Our overall trade surplus for both goods and services grew 12.8% in 2011 – impressive figure, but down on 19.7% in 2010.

So far this year, the slowdown continues.

The latest PMI data suggests that manufacturing activity is likely to have been flat in Q1 2012. Latest goods exports data, released this week, shows that the sector posted zero growth confirming overall readings from the PMI. The value of trade in goods surplus steadily declined since January 2012 peak of €3,813 million to €3,023 million in March 2012, and in annual terms, Q1 2012 surplus for merchandise trade is now down €99 million on 2011. Although the quarter-on-quarter reduction appears to be small due to relatively shallow trade surplus recorded in January 2011, March seasonally-adjusted trade surplus is down 22% or €850 million on March 2011. With patents expiring, the latest data shows that exports of Medical and pharmaceutical products fell €772 million in Q1 2012 compared to Q1 2011. Overall, comparing first quarter results, 2011 registered seasonally-adjusted annual growth of 7.9% in exports and 15.2% in trade surplus. 2012 Q1 results are virtually flat, with exports rising 0.03% and trade surplus rising 0.8%.

Looking at the geographical composition of our merchandise trade, until recently, our exports and trade surplus were strongly underwritten by re-exportation by the US multi-nationals into North America of goods produced here. This too has changed in Q1 2012, despite the fact that the US has managed to stay outside the economic mess sweeping across Europe. In three months through March 2012, Irish exports to the US have fallen 19.3% and our trade surplus with the US has shrunk 47.1% from €3.33 billion to €1.76 billion.

Services are more elusive and more volatile, with CSO reporting lagging the data releases for goods trade, but so far, indications are that services activity remained on a very shallow growth trend through Q1 2012. As in Manufacturing, Services demand has been driven once again by more robust exports, and as for Manufacturing, this fact exposes us to the potential downside risk both from the on-going euro area crisis and from the clear indication that our domestic economy continues to shrink even after an already massive four years-long depression.

No matter how we spin the data, the reality is that exports generation in Europe overall, and in Ireland in particular, is still largely a matter of trade flows between the slower growth North American and European regions.

In many ways than one, Ireland is a real canary in the mine, because of all Euro area economies excluding the Accession states, Ireland should be in the strongest position to recover and because our exporting sectors continue to perform much better than the European average. Yet the recovery is nowhere to be seen.

Instead, the growth risks manifested in significant slowdown in our external trade activity and in overall manufacturing and services sectors are now coinciding with the euro entering the terminal stage of the crisis.

Since the beginning of this week, Belgian and Cypriot, Austrian and Dutch, virtually all euro area bonds have been taking some beating. In the mean time, credit downgrades came down on Italy and Spain, and the Spanish banking system was exposed, at last, as the very anchor that is likely to drag Europe’s fifth largest economy into EFSF/ESM rescue mechanism. This week, in a regulatory filing, Spain’s second largest bank, BBVA stated that: “The connection between EU sovereign concerns and concerns for the health of the European financial system has intensified, and financial tensions in Europe have reached levels, in many respects, higher than those present after the collapse of Lehman Brothers in October 2008.” Meanwhile, Greek retail banks have lost some 17% of their customers’ deposits since mid-2011 and this week alone have seen the bank runs accelerating from €700 million per day on Monday-Tuesday, to over €1.2 billion on Wednesday.

This is not a new crisis, but the logical outcome of Europe’s proven track record of inability to deal with the smaller sub-component of the balance sheet recession – the Greek debt overhang. Three years into the crisis, European leadership has no meaningful roadmap for either federalization of the debts or for a full fiscal harmonization. There is no growth programme and the likelihood of a credible one emerging any time soon is extremely low. Structural reforms are nowhere to be seen and productivity growth as well as competitiveness gains remain very shallow, despite painful adjustments in private sector employment and wages. Inflation is running well above the targets. Austerity is nothing more than a series of pronouncements that European leaders have absolutely no determination to follow through. EU own budget is rising next year by seven percentage points, while Government expenditure across the EU states is set to increase, not decrease.

In short, three years of wasteful meetings, summits, and compacts have resulted in a rather predictable and extremely unpleasant outcome: aside from the ECB’s long term refinancing operations injecting €1 trillion of funds into the common currency’s failing banking system, Europe has failed to produce a single meaningful response to the crisis.

CHARTS:

Box-out:  Speaking at this week’s conference of the Irish economy organized by Bloomberg, Department of Finance Michael Torpey has made it clear that whilst one in ten mortgagees in the country are now failing to cover the full cost of their loans, strategic defaults amount to a negligible percentage of those who declare difficulty in repayments. This statement contradicts the Central Bank of Ireland and the Minister for Finance claims that the risk of strategic defaults is significant and warrants shallow, rather than deep, reforms of the personal bankruptcy code. Furthermore, the actual levels of mortgages that are currently under stress is not 10% as frequently claimed, but a much higher 14.1% - the proportion corresponding to 108,603 mortgages that have either been in arrears of 30 days and longer, or were restructured in recent years and are currently not in arrears due to a temporary reduction in overall burden of repayments, but are at significant risk of lapsing into arrears once again. The data, covering the period through December 2011 is likely to be revised upward once first quarter 2012 numbers are published in the next few weeks. In brief, both the mortgages arrears dynamics and the rise of the overall expected losses in the Irish banking system to exceed the base-line risk projections under the Government stress tests of 2011 suggest that the state must move aggressively to resolve mortgages crisis before it spins out of control.

3/4/2012: Sunday Times 1/4/2012 - Deep Reforms, not Exports-led Recovery, are needed

This is an unedited version of my Sunday Times article from 1/4/2012.

After four years of the crisis, there are four empirical regularities to be learned from Ireland’s economic performance. The first one is that the idea of internal devaluation, aka prices and wages deflation, as the only mechanism to attain debt deleveraging, is not working. The second is that the conventional hypothesis of a V-shaped recovery from the structural crisis, manifested in economic growth collapse, debt overhang and assets bust, is a false one. The third fact is that Troika confidence in our ability to meet ‘targets’ has little to do with the real economic performance. And the fourth is that exports-led recovery is a pipe dream for an economy in which exports growth is driven by FDI.

Restoring growth requires structural change that can facilitate private companies and entrepreneurs search for new catalysts for investment and consumption, jobs creation and exports.

For anyone with any capacity to comprehend economic reality, Quarterly National Accounts (QNA) results for Q4 2011, showing the second consecutive quarterly contraction in GDP and GNP, should have come as no surprise. In these very pages, months ago I stated that all real indicators – Purchasing Managers indices, retail sales, consumer and producer prices, property prices, industrial turnover figures, banking sector activity, and even our external trade statistics – point South. Yet, the Government continues to believe in Troika reports and statistical aberrations produced by superficial policy and methodological changes.

The longer-range facts about Ireland’s ‘successes’ in managing the crisis, revealed by the QNA, are outright horrifying. In real (inflation-adjusted) terms, in 2011, every sector of Irish economy remains below the pre-crisis peak levels. Agriculture, forestry and fishing is down almost 22%, Industry is down 3%, Distribution, Transport and Communications down 17%, Public Administration and Defence down 6%, Other Services (accounting for over half of our GDP) are down 8%. In Q4 2011, Personal Consumption was 12% below Q4 2007 levels, Gross Domestic Fixed Capital Formation was 57% down on 2007. The only positive side to Irish economic performance compared to pre-crisis levels was Exports of goods and services, which were just 1.2% ahead of Q4 2007 level.

Meanwhile, factor income outflows out of Ireland – profits transfers by the MNCs – were up 19% relative to pre-crisis levels. Despite a rise of 0.7% year on year, Irish GDP expressed in constant prices is still 9.5% below 2007 levels. Our GNP, having contracted 2.53% year on year in 2011, is down an incredible 14.3% on the peak. All in, Irish economy has already lost nine years of growth in this crisis, once inflation is controlled for.

We are now three years into an exports boom and the recovery remains wanting. Here’s why. Between 2007 and 2011 exports of goods rose €2.5 billion or just 3%, while imports of goods fell 31.3% - a decline of €19.6 billion. Over the same period, exports of services rose €5 billion, while imports of services increased €5.5 billion. All in, rising exports of goods and services accounted for just 35% of the increase in Ireland’s trade surplus. Almost two thirds of our trade surplus gains since 2007 are accounted for by collapse in imports. Taken on its own, the dramatic fall-off in imports of goods amounts to 91% of the total change in trade surplus in Ireland.

Both the Government and the Troika should be seriously concerned. Taken in combination with accelerating profits transfers out of Ireland by the MNCs, these numbers mean that Irish economy is struggling with mountains of private and public debts that exports cannot deflate.

Remember all the noises made by the external and domestic experts about Ireland’s current account surpluses being the driver of our debt sustainability? Last week, the CSO also published our balance of payments statistics for 2011. In 2010, Irish current account surplus stood at a relatively minor €761 million. In 2011, current account surplus fell to €127 million. If the entire current account surplus were to be diverted to Government debt repayments, it will take Ireland 579 years to bring our debt to GDP ratio to the Fiscal Pact bound of 60%.

The immediate lesson for Ireland is that we need serious changes in the economic fundamentals and we need them fast.

First, Ireland needs debt restructuring. We must shed banks-related debts off the households and the Exchequer. In doing this, we need drastic restructuring of the banking sector. Simultaneously, an equally dramatic reform of taxation and spending systems is required to put more incentives and resources into human capital formation and investment. Income tax hikes must be reversed, replaced by a tax on fixed and less productive capital – particularly land. All land, including agricultural. Entrepreneurship-retarding USC system must be altered into a functional unemployment insurance system.

Policy supports should shift on breaking the systemic barriers to domestic firms exporting and restructuring dysfunctional internal services markets that are holding companies back. Public procurement changes and markets reforms in core services – energy, water, transport, public administration, etc – must focus on prioritising facilitation of inward and domestic investment, entrepreneurship and jobs creation.

Delivery of health services must be separated from payment for these services, with Government providing the latter for those who cannot afford their own insurance. Private for-profit and non-profit sector should take over delivery of services. Exports-focused private innovation, such as for example International Health Services Centre proposal for remote medicine and ICT-related R&D, should be prioritized.

In education, we need a system of competing universities, colleges and secondary education providers. A combination of open tuition fees plus merit and needs-based grants for domestic students will help. We should incentivise US universities to locate their European campuses here, and shift more of the revenue generation in the third level onto exports. In the secondary education, we need vouchers that will encourage schools competition for students. In post-tertiary education we need to incentivise MNCs to develop their own corporate training programmes and services here.

This will simultaneously expand our skills-intensive exports and provide for better linkages between formal education and, sectoral and business training – something the current system is incapable of delivering.

One core metric we have been sliding on is sector-specific skills. This fact is best illustrated by what is defined as internationally traded services sector, but more broadly incorporates ICT services, creative industries and associated support services.

Eurostat survey of computer skills in the EU27 published this week, ranked Ireland tenth in the EU in terms of the percentage of computing graduates amongst all tertiary graduates. Both, amongst the 16-24 years olds and across the entire adult population we score below the average for the old Euro Area member states in all sub-categories of computer literacy. Only 13% of Irish 16-24 year olds have ever written a computer programme – against 21% Euro area average. Over all survey criteria, taking in the data for 16-24 year old age group, Ireland ranks fourth from the bottom just ahead of Romania, Bulgaria and Italy in terms of our ICT-related skills.

Not surprisingly, at last week’s Digital Ireland Forum 2012 the two core complaints of the new media and ICT services sector leaders were: lack of skills training domestically and draconian restrictions placed on companies ability to import key skills from abroad.

The Irish economy and our society are screaming for real change, not compliance with Troika targets and ego-stoking back-slapping ministerial foreign trips.

Box-out:

On the foot of my last week’s questions concerning the role of securitizations and covered bonds issuance by the Irish banks in restricting banks’ ability to control the loans assets they hold on their balancesheets, this week’s move by Moody’s Investors Services to downgrade the ratings of RMBS (Residential Mortgage-Backed Securities) notes issued by two of the largest securities pools in the country come as an additional warning. On March 26^th, Moody’s reduced ratings on RMBS notes issued by Emerald Mortgages and Kildare Securities on the back of “continued rapid deterioration of the transactions, Moody’s outlook for Irish RMBS sector; and credit quality of key parties to the transactions [re: Irish banks] as well as structural features in place such as amount of available credit enhancement.” The last bit of this statement directly references the concerns with over-collateralization raised in my last week’s note. Although Moody’s do not highlight explicitly the issue of declining pools of collateral further available to shore up security of the asset pools used to back RMBS notes, the language of the note is crystal clear – Irish banks are at risk of running out of assets that can be pledged as collateral. This, of course, perfectly correlates with the lack of suitable collateral for LTRO-2 borrowings from the ECB by the Irish banks, other than the Bank of Ireland last month. As rated by Moody’s, half of the covered RMBS notes were downgraded to ‘very high credit risk’ or below and all the rest, excluding just one, were deemed to deteriorate to ‘high credit risk’ status. Surprisingly, the Central Bank’s Macro-Financial Review published this week makes no mention of either the RMBS, covered bonds or the impact of securitization vehicles on banks’ balance sheets. See no evil, hear no evil?