Economics 30/09/2009: Global Financial Stability Report

Update: There is an interesting note in one of today's stockbrokers' reports: "AIB is to review its selection process for a successor to Eugene Sheehy, according to reports this morning. The Government will not endorse an internal candidate based on renewed signals according to the article. Separately, Minister Brian Lenihan said it was "inevitable" that further public capital will be required by the country's banks after the NAMA transfers."

Two points:

1. If Government is so aggressive in staking its control over AIB's selection of a CEO, why can't the same Government commit to firing the entire boards upon initiation of Nama? Governments change overnight, so why banks' boards are so different?
2. I must confess, I like Minister Lenihan's belated (this blog and other analysts have said months ago that there will be second round demand for funding post-Nama due to RWA changes triggered by Nama, and then due to second wave of defaults within mortgage and corporate loans portfolia) recognition of a simple financial / accounting reality. Strangely enough, the brokers themselves never factored this eventuality in their projections of Nama effect on banks balance sheets.
   

Oh, another little point: Minister Lenihan was last night explaining on RTE that BofI and IAB both raised circa Euro1bn bonds each with the issues oversubscribed by a healthy margin and that these were 3-3.5 year bonds. we should be impressed, then? Au contraire: those foreign investors (in the case of BofI 92% of the bond issue gone to foreign institutionals and banks) are making a rational bet that Ireland will continue to guarantee depositors through 2014 if not even longer, and that the Exchequer will rather destroy the households than see banks go under. In other words, the markets priced Irish banks now as being effectively fully guaranteed by the state - bondholders, shareholders, unsecured debt holders, furniture and office suppliers, staff - you name a counterparty working with Irish banking sector... they are all now implicitly guaranteed by you, me, ordinary taxpayers in Tallaght and elsewhere across the nation. Some success, then.

News: IMF's Global Financial Stability Report Chapter 1 is out today. This is the main section of the report and it focuses on two themes:

1. Continuation of the crisis in financial markets - the next wave of (shallower, but nonetheless present) risks to credit supply in globally over-stretched lending institutions; and
2. Future exist strategies from the virtually self-sustaining cycle of new debt issuance by the sovereigns that goes on to mop up scarce liquidity in the private sector, thus triggering a new round of debt issuance by the sovereigns (irony has it, I wrote about the threat of this merry-go-round link between public finances and private credit supply back in my days at NCB - in August 2008).

The report is a good read, even though it is a voluminous exercise - check it out on IMF's main website (at this hour I am still working with press access copy).

Ireland-specific stuff:
Nice chart above - Ireland was pretty heavy into ECB cash window back in 2007, but by 2009 we became number one junkies of cheap funding. Like an addict hanging about the corner shop in hope of a fix, our banks are now borrowing a whooping 7% of their total loans volumes through ECB. This is a sign of balance sheet weakness, but it is also a sign that the banks are doing virtually nothing to aggressively repair their balance sheets themselves. Why? Because Nama looms as a large rescue exercise on the horizon.
But, denial of a problem is not a new trait. Per chart above, through 2006, Irish banks were third from the bottom in providing for bad loans despite a massive rate of expansion in lending and concentration of this lending in few high risk areas (buy-to-rent UK markets, speculative land markets in Ireland, UK and US and so on). Now, taking the path the Eurozone average has taken since then, adjusting for the decline in underlying property markets in Ireland relative to the Eurozone, and for the shortfall on provisions prior to 2007, just to match current risk-pricing in the Eurozone banks, Irish banks would have to hike their bad loans provisions to 3-3.75%. And this is before we factor in the extremely high degree of loans concentrations in property markets in Ireland. Again, why are we not seeing such dramatic increases? One word: Nama.
Lastly, table above shows the spreads on bonds in the US and Eurozone. Two note worthy features here:

1. The rates of decline in all grades of bonds and across sovereign and corporate bonds shows that they are comparable to those experienced by Ireland. This debunks the myth that Irish bonds pricing improved on the back of something that Irish Government has done ('correcting' deficit or 'setting a right policy' for our economy). Instead, Irish bond prices moved in-line with global trends, being driven by improved appetite for risk in financial markets and not by our leaders' policies;
2. Current spreads on Irish bonds over German bunds suggest market pricing of Irish sovereign bonds that is comparable to US and European corporates. In effect, Ireland Inc is not being afforded by the markets the same level of credibility as our major European counterparts. One wonders why...
   

Economics 25/09/2009: Don't believe 'our recovery plan' drivel

I like some of our brokers guys and gals, I really do – they are intelligent, ambitious, outwardly mobile in their outlook and hard working. They often spot the rat, although usually warn of its existence only privately. But the current Nama and Lisbon ‘debates’ are just too much for them to bear without assuming the usual 'hand in the sand' positions.

First Davy strategist was telling us all that everyone criticizing Nama is a ranting lunatic (at the very best) or a deceitful manipulator (at its worst). I obliged to reply here.

Now, Bloxham folks lined up to spout nonsense as well. Here is an example from today’s morning note: “A Yes vote [in Lisbon Referendum] would be seen as positive [one assumes by the markets] and would keep recovery plans on track ahead of the critical NAMA vote…”

I don’t give a damn how Bloxham modeled their assertion on the markets' assessment of an outcome of the Lisbon vote. The Wall Street Journal disagreed with them. Studies performed on sovereign default spreads in the Eurozone and bond spreads are inconclusive one way or the other. But one thing is certain when it comes to spotting a lie in their statement: an assertion that either Lisbon or Nama or both can ‘keep [Irish] recovery plans on track’.

This is a first class bullshit.

One minor point why this statement makes absolutely no sense is that the 'distance' between the Lisbon vote and Nama vote is going to take place within a couple of weeks there after, around October 14-16. If Irish economy is so critically sick that a difference of two weeks can push it off the track, I wonder if Lisbon vote would be of any priority for our stock brokers at all.

Now to a bigger lie in the above statement:

In order to keep plans on track, one must first have a plan. Or at least and inkling of one. A handful of morsels of thought saying: we want to do A to achieve B… and a short list of actions to be taken to get there. This is a starting point for any logical ‘keeping on track’. And, guess what, unless you are smoking the same stuff folks at Bloxham are, there are no plans. Let me repeat: there is no plan for an Irish economic recovery.

Fiscal crisis: this is Government’s own backyard, so we should expect that at the very least here the Cabinet has done some homework on getting a plan for recovery started. Nope. McCarthy Report and Taxation Commission Report – two key pieces of policy strategy are now largely binned by the Government. It is clear that there is no will in our Triumvirate to do anything serious about the expenditure side of the fiscal crisis. Even Bloxham guys would probably agree that in the current conditions there isn't anything new they can do on tax side of things either - short of turning us all into serfs. The fiscal stabilization ‘plan’ presented officially by DofF following the Supplementary Budget 2009 was a re-hashing of the exactly identical ‘plan’ from January 2009 which was rehashing the ‘plan’ from October 2008 Budget. All three were not realistic in their assumptions and expectations and all three had not a single year of declining nominal current public expenditure between 2008 and 2013.

Economic crisis (domestic economy): this Government produced only one strategy document on domestic economy. Don’t call it a policy document, for it is too vague and lofty to be a policy. Their vision of the future of Ireland Inc was, and remains, in a nutshell, a combination of lab coats with Petri dishes in hands growing thoughts and knowledge in the foreground and windmills spinning out green energy in the background. The ESB is in existence too, with new sparkling headquarters and, one assumes, smokestacks belching CO2 to offset green energy from the windmills. If Bloxham folks think this drivel passes for a plan, good luck to them. Domestic consumption is being killed off by reckless tax increases. Domestic investment is being kept below the water line by absurd taxes on capital, charges on capital-intensive activities and depressed savings of the households. Households are prevented by the Government from de-leveraging and will be facing increasing costs of mortgages and credit post-Nama due to banks hiking up charges and margins.

Economic crisis (external economy): apart from IDA’s advertising campaign launched last week by our unfortunate choice of a Tanaiste, there is no plan for improving competitiveness of Ireland Inc vis-à-vis foreign investors and domestic exporters. There are no reforms in the pipeline to help improve their operating costs, capital costs, costs of electricity, gas, water supply, costs of currency risks on sterling and dollar side, costs of labour, health & safety, costs of buying out trade unions into agreement not to derail investment and production, costs of state-controlled and regulated transportation, energy, communications, etc services.

Financial crisis: half-thought through idea of Nama is unlikely to do anything significant to improve flow of credit in this economy – I wrote on many occasions about the risk of capital being transferred out of the country and about banks’ incentives to pay down inter-bank lenders, plus about potentially zombie banks and development markets, dormant / dead property market and other potential downsides to Nama, so no need to repeat this here.

So, my dear friends at Bloxham, what is the exact ‘plan for recovery’ that we will 'keep on track' if we vote Yes to Lisbon and/or Yes to Nama? Name one, please…