11/2/2013: What's David Hall's Case is Now About?

In light of the recent changes to the IBRC position and the Promo Notes, there can be some confusion around the case David Hall has taken against the Minister for finance. In particular, the confusion can arise due to the claims that we have made a "deal" on the promissory note and in light of the IBRC Bill 2013 provisions (Article 17). Let me try to (speculatively, I must add) shed some light.

The promissory notes were a product of the Credit Institutions (Financial Support) Act 2008 passed by the Dail Eireann on October 2, 2008. More specifically, the Minister for Finance, in allocating capital funds to the insolvent Irish banking institutions (see more of the background on this here: ), relied upon the provisions of the 2008 Act, Section 6. However, article 6.3 of the Act clearly stated that “Financial support shall not be provided under this section for any period beyond 29th September 2010, and any financial support provided under this section shall not continue beyond that date.” Furthermore, the Minister was given such powers (limited by the above date) to appropriate “all money to be paid out or non-cash assets to be given by the Minister… may be paid out of the Central Fund or the growing produce thereof” (Section 6(12)).

Furthermore, to the point of Defense in the case, Article 6(4) of the Act stipulates that “Financial support may be provided under this section in a form and manner determined by the Minister and on such commercial or other terms and conditions as the Minister thinks fit. Such provision of financial support may be effected by individual agreement, a scheme made by the Minister or otherwise.” This section is still covered by the 29th September 2010 cut-off date, but in so far as it covers (potentially) multiannual commitments created before that date but with a maturity beyond that date, it is unclear if this section covers the duration of the original Promissory Notes. Regardless of whether it does or not, the section is constrained explicitly by Section 6(5) which states: “Where the Minister proposes to make a scheme under subsection (4) – (a) he or she shall cause draft of the proposed scheme to be laid before each House of the Oireachtas, and (b) he or she shall not make the scheme unless and until a resolution approving of the draft has been passed by each such House.”

David Hall is claiming that in a democracy and under article 17 of the Irish Constitution the Dail and our elected representatives have the power to appropriate funds from the central fund (which, like all the rest of the Government funds, is made up of receipts and our taxes).

The point here is that David Hall is saying that it is not constitutional that one person, namely the Minister for Finance, or any future Minister for Finance, could spend monies (or future moneys) through issuance of bonds, various securities, even using another Promissory Note without any upper limit being set on such payouts and without any cabinet or Dail approval or vote.

According to David Hall’s case, this constitutes the core threat to the democracy enlisted within his claim. He believes that under the constitution that TD should have to vote on such expenditure and that they cannot give away their constitutional powers.

The fact that the current Promissory Note (and only in relation to IBRC notes) has been changed and eliminated does not alter the risk of future breaches of constitutionality (if David Hall is correct in his challenge) or abuses of the public purse.

Economics 04/08/2009: NAMA, Liam Carroll & Short Termist Bonds

I should make it a habit to direct every NAMA post reader to my proposal for NAMA 3.0 here.


Yeps, Supreme Court came in on the side of the Government, throwing a lifeline to NAMA and forcing taxpayers into deeper losses. My earlier note stand now (see here) with all the gory implications for losses on Mr Carroll's loans now being back in the NAMA court.

But two birdies have chirped to me that there is more brewing up in the land of NAMA-fantasy. Apparently, the rumor has it, the Government plan is to issue short term bonds to cover NAMA liabilities. Given that NAMA will start issuing bonds in 2010 for this undertaking, the short term nature rumored is for a 2011-2012 bonds.

This, if true, makes no sense for several important reasons. Here are some:

(1) Issuing short-term debt with maturity before 2013 is equivalent to a financial suicide. The reason is simple - there is no credible (or for that matter even an incredible one) commitment from the ECB that

• such issuance can be rolled over at the same or lower interest rates to cover maturing bonds; and
• the EU will allow these bonds to remain off the balance sheet of the Government upon the roll over.
  

(2) Issuing short term bonds will be a fiscal suicide, for their maturity, and roll-over date, will fall dead on in the years of heavy Exchequer borrowing and maturity of other - 2008-2009 issued bonds. Given that the market demand for fixed income paper worldwide will be thinner then (due to increased appetite for equities-linked risk), a flood of rolled over bonds can risk derailing the borrowing programmes for Irish sovereign debt. Now, if you are a forward-looking investor, expect Irish yields to run away from the benchmarks once again, then.

(3) Short term maturity does not take into account the main risk to NAMA valuations, namely that by 2011 or for that matter 2013, the assets taken over by NAMA will be priced at any significant upside relative to what NAMA will pay for them, implying that, under short-term issuance, this Government will face the need to

• engage in a massive refinancing operations
  
• at the time when its balance sheet liabilities will be almost at their peak (see Department of Finance projections);
• pay higher expected cost of borrowing than today; and
• potentially, load the NAMA liabilities onto Government own balancesheet, while
• facing market prices and demand for real assets that is well below the valuations applied by NAMA.
  

If you look at the latter point. DofF uses 7 year U-shape cycle as its basic assumption. Peter Bacon last week stated that the cycle is expected to be 5-10 years. My estimations, based on NBER research (here), show that the average duration of the U-shaped cycle in historical data for OECD economies for 1970-2003 episodes of house prices collapse co-measurable with the one we are experiencing today is between 18 and 23 years. This range is dependent on how you time the cycle, but it refers to a nominal price cycle, unadjusted for Forex devaluations that accompanied such cycles in other countries and inflation. Japan (in down cycle since 1989-1990), Germany (since 1972-73), Italy (since 1981) and Sweden (since 1979) have not recovered to date.

Considering rolled up interest charges on impaired loans, banks' restructuring of interest payment schedules on so-called 'performing' stressed loans that in any other country would be classified as having defaulted, NAMA will be purchasing assets from the banks at an extremely shallow effective discount.

For example, a discount of 30% applied to a loan with 1.5 years (since July 2008 through December 2009) rolled up interest at 10%, and a built in re-financing cost of 1% will be equivalent to an effective discount of just 18.1% relative to the original principal of the loan itself. If, in the mean time, the underlying asset value itself has depreciated by, say 40%, then
NAMA will be buying a Euro 60 asset for Euro81.86. Now, in order for NAMA to recoup the original cost of purchase (not counting the cost of financing the purchase and managing the asset etc), the asset value needs to appreciate by a compound 36.4% within the span of the bond
finance. Thus between now and 2011 when the alleged bonds should mature, the annualized rate of appreciation required on the assets for NAMA just to recoup the original loan amount would have to be 16.8% per annum!

If anyone in the Department of Finance thinks this is a sane bet on a market turn-around, God help us.

Short-term financing of long-term obligations, as we should have learned in the current crisis, is equivalent to giving steroids to an unfit athlete and sending him out to run a marathon.

Though to repeat once again - this is just a speculation at this moment in time although two independent sources have tipped me on this one.