9/8/17: Euro Area Banks Bailouts: The Legacy Still Hangs Over Our Heads

The Financial Times has published a very neat visualisation of the global banks bailouts net impact to-date:

 Source: https://www.ft.com/content/b823371a-76e6-11e7-90c0-90a9d1bc9691

And the snapshot magnifying European states impact:

None of the Euro area states have recovered all funds deployed in bailing out the banks. And the worst performer of all states is Ireland.

Note: the chart references bailouts as a share of GDP. Of course, in the case of Ireland and Cyprus, GDP is by a mile (in the case of Ireland, by about one third) is unrepresentative of the actual national income available to sustain these.

Another note: the three worst-hit countries, Ireland, Greece and Cyprus, all remain deeply under water when it comes to recovering funds spent in the bailouts, even though the three had, on the surface, different bailout regimes applied. Specifically, Cyprus (and to a lesser extent, Greece) was supposed to be a model bailout, serving as the basis for the future bailouts across the Euro area (including structured bail-ins of private depositors).

So much for the hope of the Euro area 'reforms' working... And so much for the end of the Crisis...

28/11/2013: To OMT or not to OMT?

Per Irish Times report (http://www.irishtimes.com/news/politics/ecb-warns-bailout-exit-limits-ireland-s-options-1.1608426) "In remarks to The Irish Times, ECB executive board member Jörg Asmussen said leaving the bailout without a credit line meant Dublin did not meet conditions for the bank to buy Irish debt under its bond-buying programme." He is referencing OMT programme.

We knew that. Despite the fact that just a week ago, Minister Noonan claimed that "leaving the bailout without a precautionary credit line neither rules Ireland in nor out of accessing the ECB's Outright Monetary Transactions (OMT) programme. It has been speculated that going it alone without the safety net of a credit line would ban Ireland from the ECB scheme. "There is a misunderstanding in Ireland, even at the highest level of economic thinking, about OMT," Mr Noonan told TDs yesterday." (http://www.independent.ie/business/irish/we-can-still-access-ecb-aid-noonan-29771886.html)

Ouch...

Note: I wrote about this problem two weeks ago: http://trueeconomics.blogspot.ie/2013/11/15112013-exiting-bailout-alone-goods.html. I was clearly 'misguided'...

17/11/2013: Ireland to Remain Subject to EU/ECB Oversight post-Exit

On may occasions I have stated that Ireland will remain subject of the enhanced supervision by the EU and ECB of its fiscal policies following our exit from the 'Troika bailout'.

Minister Noonan this week confirmed as much: http://www.irishexaminer.com/ireland/troika-to-keep-eye-on-ireland-for-20-years-249851.html

Here's the relevant legislation governing our required compliance:

Regulation (EU) No 472/2013 of the European Parliament and of the Council
of 21 May 2013
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32013R0472:EN:NOT
pdf link: http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2013:140:0001:0010:EN:PDF

Emphasis in bold is mine:

Article 14: Post-programme surveillance

1. A Member State shall be under post-programme surveillance as long as a minimum of 75 % of the financial assistance received from one or several other Member States, the EFSM, the ESM or the EFSF has not been repaid. The Council, on a proposal from the Commission, may extend the duration of the post-programme surveillance in the event of a persistent risk to the financial stability or fiscal sustainability of the Member State concerned. The proposal from the Commission shall be deemed to be adopted by the Council unless the Council decides, by a qualified majority, to reject it within 10 days of the Commission's adoption thereof.

2. On a request from the Commission, a Member State under post-programme surveillance shall comply with the requirements under Article 3(3) of this Regulation and shall provide the information referred to in Article 10(3) of Regulation (EU) No 473/2013.

3. The Commission shall conduct, in liaison with the ECB, regular review missions in the Member State under post-programme surveillance to assess its economic, fiscal and financial situation. Every six months, it shall communicate its assessment to the competent committee of the European Parliament, to the EFC and to the parliament of the Member State concerned and shall assess, in particular, whether corrective measures are needed...

4. The Council, acting on a proposal from the Commission, may recommend to a Member State under post-programme surveillance to adopt corrective measures. The proposal from the Commission shall be deemed to be adopted by the Council unless the Council decides, by a qualified majority, to reject it within 10 days of the Commission's adoption thereof.

Note: you can track my analysis of the 'exit' announcements following the links posted here: http://trueeconomics.blogspot.ie/2013/11/15112013-beware-of-german-kfw-bearing.html

15/11/2013: Beware of German (KfW) Bearing Gifts?..

As reported in today's press, Ireland has secured a sort-of backstop to its exit from the bailout via an agreement with Germany's state- and local authorities-owned KFW Development Bank (see: http://www.irishtimes.com/news/politics/kfw-is-a-public-bank-providing-development-loans-at-lower-interest-than-commercial-rates-1.1595460 and http://www.irishexaminer.com/ireland/bailout-a-calculated-political-gamble-that-just-might-not-pay-off-249727.html). This was blessed by Germany (http://www.independent.ie/business/irish/merkel-backs-ireland-bailout-exit-without-overdraft-29754656.html). And it may or may not qualify as a backstop for the Exchequer (see speculative analysis here: http://www.irishexaminer.com/archives/2013/1115/ireland/bailout-exit-declaration-exaggerated-half-truth-249716.html).

One can only speculate as to the possible conditionalities imposed by Angela Merkel and her potential coalition partners on Ireland under the exit deal, but here's an interesting parallel development that has been unfolding in recent weeks.

Per reports (see for example this: http://uk.reuters.com/article/2013/11/14/uk-eu-banks-idUKBRE9AD0X820131114 and this: http://uk.reuters.com/article/2013/11/15/uk-eurozone-banks-backstops-idUKBRE9AE08G20131115 and this: http://uk.reuters.com/article/2013/11/14/uk-ww-eu-banks-idUKBRE9AD15520131114 and this: http://www.irishtimes.com/business/economy/spd-rules-out-deal-on-banks-legacy-debt-1.1595352 and this: http://www.euractiv.com/euro-finance/germany-opposes-rescuing-ailing-news-531713):

1. Germany is clearly stating and re-stating its position on use of EU funds to recapitalise the banks (forward from the stress tests to be conducted). The position is 'No Way!' Wolfgang Schauble is on the record here saying "The German legal position rules out [direct bank recapitalisation from the ESM, the eurozone bailout fund,] now…That's well known. I don't know if everyone has registered that." So it is 'No! No Way! I said so many times!' stuff.
2. Euro area Fin Mins are moving toward using national (as opposed to European) funds to plug any banks deficits to be uncovered in the stress tests.
3. SPD Budget Spokesperson clearly states that his party is firmly, comprehensively against use of euro area bailout funds to retrospectively recap banks (the seismic deal of June 2012 is, in their view, not even a tiny wavelet in the tea cup).

Now, Ireland is the only country seeking retrospective recap and it is bound to have come up in the Government talks with Germans and the Troika in relation to bailout exit.

Put one and one together and you get a sinking feeling that may be retrospective recaps were the victim of the Government 'unconditional' solo flight from the Troika with KfW sweetener to comfort the pain of EUR64 billion in possible retroactive aid in play?..

Note: I am speculating here. It might be just that the Germans (KfW) decided to simply recycle their trade surpluses into another property err... investment bubble inflation in the peripheral states cause they just were so delighted with the way we paid off their bondholders. Or it might be because they are keen on burning some spare cash. Or both. Or none. If the latter, the reasons might be that it bought them cheaply something they want... How about that retroactive banks debt deal? It's pretty damn clear they want that off the table, right?

You can read my analysis of the exit here: http://trueeconomics.blogspot.ie/2013/11/15112013-exiting-bailout-alone-goods.html and see Ireland's credit risk score card here: http://trueeconomics.blogspot.ie/2013/11/15112013-ireland-some-credit-risk.html and fiscal risk assessment here: http://trueeconomics.blogspot.ie/2013/11/15112013-primary-balances-government.html.

15/11/2013: Primary Balances: Government Deficit Risks

While looking at Ireland's risk dynamics relating to our exit from the Bailout (covered here:  http://trueeconomics.blogspot.ie/2013/11/15112013-ireland-some-credit-risk.html) it is useful to think about the Government deficits ex-interest payments on debt. Here are the latest projections from the IMF:

For now, Ireland is running behind Portugal. By end of 2014, we are expected to overtake Portugal, but thereafter we are expected to remain behind Italy and Greece.

Not exactly a risk-free sailing there for the so-called 'best student in class'... Still, we are heading to posting our first crisis-period primary surplus.

15/11/2013: Exiting the Bailout Alone: 'Goods', 'Bads' and Risks

So Ireland is exiting the bailout without a precautionary line of credit. The news is big. And the news is small.

Small on positives, albeit tangible:

1. Markets got more certainty that any pricing will be a signal - absent a back stop, pricing signalled by the bonds markets is more likely to be the true pricing of debt. Caveat: NTMA's EUR 20 billion+ credit pile-up is likely to still muddle the waters. At last for a while, we are pre-funded.
2. The markets were told by the Government that, like the FF/GP Coalition before them, the current shower can make statements. Whether they can live up to them (see 'bad' points below) is another game.
3. We avoided the unknown to us 'conditionalities' that attached to the pre-cautionary line of credit - be it Precautionary Conditioned Credit Line (PCCL) or the more strict Enhanced Conditions Credit Line (ECCL) (see points below as to the cost of this avoidance).
4. IMF will be gone from the Government Buildings (although it still will be monitoring our performance from the sidelines with bi-annual reviews and the EU 'partners' will still be visiting the Merrion Street).

Small and potentially large negatives, many not yet tangible:

1. Reforms reversals pressures are bound to set in: with elections coming up, trade unions and other lobbyists (yes, that's right - the all are lobbyists) will be pressuring the Government to cut back on 'austerity'. In other words, we are going to see the return of the 'Galway Races' in a slightly less in-your-face form. Taxpayers be warned - fiscal discipline can start drifting even more toward tax extraction away from spending cuts.
2. Reforms fatigue is likely to follow: Irish Government to-date has failed to deal forcefully with the issues of domestic reforms. Interest groups and powerful vested interests they represent are lining up on the starting line to make sure they will continue extract protection from the State in exercising their market power. Consumers be warned - semi-states and protected professions will continue ripping us off.
3. Risks to the fiscal, financial sector and macroeconomic conditions are not going away. Just spot the decline in our goods exports: January-September cumulative exports are down from EUR70.12 billion to EUR65.41 billion year on year. The timing for our exit is fine, but the risks are still there.
4. Creeping up of the longer-term borrowing rates can take place, both in-line with expectations for the future rates policy by the ECB and in pricing in any risks to the macro and fiscal sides.
5. Stepping outside the tent with Troika reduces the pressure that the IMF can apply on our 'partners' in supporting any retrospective banks debt deal.
6. IMF leaving the oversight system (the latter won't go away per 2-6 packs legislation we have signed up to) means we are seeing the back of our only 'protector' in the Troika. Good luck expecting the EU and ECB taking the side of the Irish economy on fiscal and structural reforms policies.
7. Having exited without PCCL or ECCL, we do not qualify for the OMT - the famed and fabled 'silver bullet' from the ECB that was supposed to act as the fail-proof measure for risk management and crisis blowout prevention.

What can we - consumers and taxpayers - expect (these are uncertainty-laden assessments, based on current track record of the Government and internal coalition politics, so they are subject to possible change):

1. Higher costs of semi-states' services to ordinary punters as the protected sectors remain protected and are used increasingly to shore up public finances;
2. Higher costs of financial services as banks ramp up their power vis-a-vis the Government;
3. Higher taxes and charges as reforms policy drifts lifelessly from spending cuts to revenue raising;
4. Higher cost of debt roll-overs in the longer run as markets price in fully the level of debt we carry;
5. Lower competitiveness in the long run and more reliance on the old favourites (property, Government spending and consumption) to drive growth.

May we have good luck avoiding the above 'bads' and risks and enjoying the above 'goods'...

Update: The best headline of the affair award goes to Bloomberg: http://www.bloomberg.com/news/2013-11-15/irish-go-commando-as-noonan-draws-line-under-crisis-euro-credit.html

17/10/2013: Budget 2014 Missing the Targets: Sunday Times, October 13

This is an unedited version of my Sunday Times column from October 13, 2013.


Recent events have led to a significant reframing of the Budget 2014. With these, the Government is now actively signaling a more accommodative stance on next year's cuts. Alas, the good news end there and the bad news begin. Any easing on austerity in 2014 will be unlikely to produce a material improvement in household budgets. In return, the Government will be placing huge hopes on robust growth returning in 2014. If this fails to materialise, lower austerity today will spell more pain in 2015. Like a dysfunctional alcoholic, unable to stop binging at closing time, we ignore tomorrow’s hangover.


A combination of the latest IMF report on the Irish economy and the outcome of the Seanad abolition referendum have settled the debate on the scale of adjustment to be taken on October 15th. Embarrassing defeat in the referendum has meant that the continuation of Taoiseach's leadership required some symbolic gesture toward the electorate. Lowering the 2014 cuts targets on October 15th can serve the purpose for a few crucial months until the New Year.

Meanwhile, ambiguity-embracing IMF lent a helping had. The IMF repeated its insistence on EUR5.1 billion combined 2014-2015 cuts in the latest assessment of the Irish economy. Yet, the IMF avoided specifying the breakdown of these adjustments between 2014 and 2015. This has given the Government confidence to argue the case in favour of partially delaying 2014 adjustment in front of the EU overseers of our budgets.

Immediately after the IMF report publication, Irish media was promptly fed the rumors that the Minister for Finance was seeking a reduction in the level of budgetary cuts. This week Minister Noonan said that the 2014 adjustment will be EUR600 million lower than EUR3.1 billion originally agreed with the Troika. The savings will amount to 0.37 percent of our GDP: a small boost for the Irish economy, but a massive splash in the PR spin terms for the Government.

With some cuts delayed to 2015, Ireland’s debt sustainability and deficit targets now hinge on the Government’s forecasts for growth materializing over the next twelve months. The risks to these are non-negligible. Last week IMF lowered Irish GDP growth forecasts for every year from 2013 through 2018. Compared to the forecasts released in June this year, October forecasts for inflation are also down. This implies that nominal growth – the source of budget deficits and debt dynamics – is expected to be even slower. If back in June this year IMF expected Irish economy to be at EUR205.8 billion by 2018, now the fund is projecting it to hit EUR201.7 billion. Cumulated forecast nominal GDP for 2013-2018 is EUR15.6 billion lower in October report than in June assessment.  Even before Minister Noonan’s latest reductions in fiscal adjustment for Budget 2014, IMF projected worsening of Irish deficits in 2014-2018.

Department of Finance forecasts, released this week and underpinning the Budget 2014 calculations are more optimistic on nominal growth, expecting higher inflation and anticipating more domestic consumption and investment than the IMF. If the Department gets its forecasts wrong, we will pay 2015 for the delays in cuts planned for the next year.



Flying on hopium of rosy growth expectations is a risky proposition for the Exchequer especially ahead of our drawing down the final tranche of the Troika funding. For this risk, the savings to be delivered in the Budget 2014 are likely to be insignificant from economy’s point of view.

Given the precarious position of the Government in public opinion polls, it is a safe bet to assume that the coalition will be putting the money to ‘work’ as an investment stimulus and a cushion against cuts to social welfare and health.

New building programmes in the more sensitive constituencies hold some serious political capital. But planning allocation of large sums to new investment is a lengthy process before construction jobs actually materialise. Growth impact of these measures in 2014 is unlikely to be significant.

But the thrust of 'savings' is likely to go to the second option. Doing as little as possible for yet another year in structurally altering the way we spend on social supports and healthcare will mean that the budgetary changes to health spending in 2014 will likely be identical to those undertaken in the past. Expect more cost shifting to private insurance, more sabre-rattling over cost overruns and more imaginary gains in productivity. Social welfare ‘cost containment’ measures will continue to rely on 'demand attrition' - the declines in demand due to unemployment benefits expiration and emigration. This means zero impact on growth in 2014.

Meanwhile, revenue side of the budgetary equation will keep pressuring the economy.

Fine Gael's side of the Coalition is promising us that the Budget will contain no new taxes. Alas, in Ireland we have a very narrow definition of both terms: 'new' and 'taxes'. In 2014 we will be facing a full annual Property Tax bill, which is expected to take out additional EUR250 from the average household income. The Budget will also likely raise charges on families to fund education and healthcare. The Irish Government is saying these are not new taxes. Anyone expected to pay them would disagree.

Last year, PRSI changes and reduction in child benefits were not identified as 'new taxes' either. These cost an average working family with two children some EUR494 per annum – an involuntary reduction in family income.

Per research note published by Grant Thornton two weeks ago, a family on EUR80,000 with two earners with two children saw their tax bill rise by 54 per cent since 2008. Their disposable income is now down a massive EUR6,132 per annum. Only a small fraction of these were officially recognised as new tax measures.

Meanwhile, the same families have also seen the costs of basic services provided by the state agencies and enterprises, or controlled by the state regulators and heavily taxed, rise dramatically over the course of the crisis. On average Irish consumer prices fell 1.6 percent between August 2008 and August 2013. Health insurance costs more than doubled over the same period, education costs inflated by 29 percent, bus fares have gone up over 46 percent, and motor tax went up 27 percent. Increases in core public services costs have taken out close to EUR3,500 annually out of the pockets of an average Irish family. These came on top of the Grant Thornton tax cost estimates cited above.

What is the opportunity cost for the families of the losses brought about by the fiscal crisis? For an average family with expected working life of 25 years, the above costs of austerity are equivalent to around EUR111,000 in foregone pensions savings. This excludes costs of the same measures continuing beyond December 31, 2013 and the new measures yet to come in 2014-2015.

The devastation of the above financial arithmetic is even more apparent when we realise that we are far from completing the full set of fiscal adjustments needed to restore our public finances to health. Medium-term Government fiscal consolidation forecasts confirmed by the IMF last week, envision total fiscal consolidation for 2014-2015 to be EUR5.1 billion. Of this, new revenue measures for 2014-2015 are to be set at EUR1.5 billion against carry forward measures of EUR0.3 billion. Current spending cuts are set at EUR3.2 billion. These adjustments translate into additional fiscal burden of EUR3,300-3,500 per annum for an ordinary family.

The hope is that the general economic recovery will mop up the household finances blood spilled by the fiscal crisis.  This rosy expectation is in turn driven by Minister Noonan’s worldview in which Irish trade partners are expected to also grow faster in years ahead. Alas, this Tuesday, IMF cut its global growth forecasts for both 2013 and 2014.


Forecasts aside, today, Ireland has run out of the road on tax hikes and revenue raising measures.

Instead of hiking tax rates, the Government is expected to widen the tax base in Budget 2014. The most efficient way for doing so would be to close loopholes on income exemptions. Less efficient, will be to lower income threshold at which upper marginal tax rate kicks in. Middle and upper-middle class families will pay in either scenario, but the costs to them will be higher in the latter.

In addition, the Government has been briefed on the potential for hiking PRSI for self-employed, while opening up access for this category of workers to social security net. Conditions for accessing cover will be so onerous, few self-employed will ever be able to qualify, but the hike will be politically acceptable. Currently, a self-employed person earning the equivalent of minimum wage pays almost six times as much tax and PRSI as an employee. Few interest groups so far have taken up a challenge of pointing this fact out.

Reality is, Ministers Noonan and Howlin have hit the brick wall. All the low-hanging fruit of marginal tax hikes and revenues extraction schemes has been picked. What's left now are two possible options. Option one: cut social welfare and health. Option two: delay adjustments and hope that comes Budget 2015 day, growth will pick up, unemployment assistance costs will fall, and Brussels will be happy enough reveling in the euro recovery to let things slip a bit on targets in Dublin. No prizes for guessing which option the Coalition will pursue comes next Tuesday.

Source: Department of Finance

BOX-OUT:

This week, the IMF published an assessment of the impact of the monetary policies deployed since 2008 by the ECB, the US Fed and the Bank of England. These unorthodox measures ranged from outright quantitative easing to lowering of the key interest rates to direct lending to the banks against riskier collateral. These monetary interventions, it has been argued in the media and by the majority of analysts, helped to ameliorate euro area sovereign crises. Per conventional wisdom, as the result of the central banks interventions, and particularly those carried out by the ECB, government bond yields and borrowing costs declined post-2011 across the euro area periphery. In addition, supporters of these policies have suggested that unconventional MPs were responsible for increasing equity funding in the real economies, thus supporting the recovery.

Rejecting the mainstream claims, the IMF researchers found that over 2008-2012 various monetary policies had zero statistical impact on the sovereign bond yields in Ireland, Portugal, and Greece. The policies have let to a moderate reduction in Italian Government bond yields, and a weak reduction in Spanish yields. In the case of Ireland, the IMF found no benefits to sovereign bond flows or prices that can be associated directly with the ECB interventions. Furthermore, ECB interventions were associated with outflows of liquidity from Irish equity funds. In contrast, Fed and Bank of England interventions resulted in net inflows of funds into Irish equities.

The paper clearly suggests that the ECB has not done enough to support recovery in sovereign debt and equity markets in the euro periphery.

24/8/2012: Perverse logic of Berlin?

An interesting article in the Irish Times today (link) quoting Germany's Fin Min on Irish debt-relief proposals, saying that Ireland's "massive" reform progress should not be compromised by the country efforts to gain relief on banks-related sovereign debts. From the Irish Times: "We cannot do anything that generates new uncertainty on the financial markets and lose trust, which Ireland is just at the point of winning back."

While we should be careful not to read too deeply into Mr Schauble's comments - which can be interpreted in a number of ways - the logic of the German Fin Min is worrisome.

Ireland has raised exceedingly expensive funds in recent bonds and T-bills auctions with explicit desire to test the markets appetite for Irish paper. In many ways, the relative success of these auctions was underwritten by external dynamics in debt markets, but also by the markets perception of Irish progress on reforms and by the markets expectation of the decline in future debt liabilities related to the banks debt deal. In other words, Ireland has paid a hefty price so far for starting the process of recovering some market access for the Sovereign. This is a net positive, albeit severely limited by the cost of funding raised.

Hence, we have a bizarre situation:

1. a member state in the Euro zone is undertaking all the right (from the markets & policymakers point of view) steps, achieving measurable progress, and generally behaving like the best pupil in the class, yet 
2. German leadership - the proxy for the Euro zone leadership - is unwilling to help that state in its efforts.

Surely, if Germany really wants stabilization and recovery in Europe's periphery, writing down €30 billion of promissory notes would be the cheapest approach to take toward reinforcing Irish efforts to deliver on the programme. Since the funds are fully linked to the ELA, this would imply absolutely no negative effect on private markets expectations. If anything, it will signal Europe's willingness to use the monetary system to support the process of resolving banking insolvency-induced stress on the sovereigns. Reduction in Ireland's debt burden in this context will be non-trivial and will help restore bonds markets confidence in both Ireland and the Euro zone system.

The bond markets operate - basically speaking - at the following level of logic:

• If an action reduces supply of debt, ceteris paribus, price of debt goes up, yields go down. Restructuring Irish Government's banks-linked debt will act to deliver exactly this effect.
• If an action reduces future potential haircuts that can expected by the private sector holders of debt in the event of prababilistic restructuring, price of debt goes up and yields go down, since future expected losses on privately held debt will be lower. Restructuring officially (Euro system) held ELA will deliver exactly this.
• If an action improves debt sustainability of the sovereign, yields will go down. Restructuring ELA will do exactly this.
• If an action does not introduce new moral hazard into future funding incentives for the sovereign, longer-term yields will be lower. By restructuring ELA - which has nothing to do with Irish exchequer past poor performance or policy choices, but has to do with rescuing risk-taking behaviour of the foreign funders of the Irish banks - the Euro zone can achieve exactly such long-term consistent repricing of Irish debt.
• If an action reduces the need for future funding, expected future bonds issuance falls and with it, the yields will fall. By removing the need to fund future repayments of promissory notes, the EU can achieve exactly this effect.
• If an action improves economic growth prospects for the nation, thus lowering risks associated with future tax revenues growth, deficits and debt financing, it will reduce yields on Government debt. This, again, is something that a restructuring of ELA/promissory notes will achieve.

Any way you spin it, aggressively restructuring the promissory notes and the ELA will deliver the benefits for the Irish exchequer. If, as Mr Schauble clearly believes, there is a case for contagion of risks across the peripheral sovereigns, such benefits will also be positively felt by other peripheral economies. In addition, such benefits will also help give some much needed credibility to the Euro zone overall policy efforts in dealing with the crisis.

15/6/2012: IMF Review : Mortgages Arrears & Household Wealth

In the previous post I promised a closer look at the IMF analysis of the household wealth and mortgages in Ireland. Per Article IV consultation paper:

Mortgage arrears continued to rise as some households struggle with high indebtedness. 

• Household’s net wealth peaked in mid-2007, but has since declined by 37 percent largely due to the collapse in housing prices. 
• By 2011, households’ deleveraging efforts have reduced debt by 13 percent from its end 2008 peak. 
• Declining incomes have, however, meant the overall household debt burden has eased by only 3 percentage points to 208 percent of disposable income in 2011, although there has been some relief from lower interest rates. 
• Income declines, especially on account of the rise in unemployment, have also driven the increase in the rate of mortgage arrears on principal private residences to 10.2 percent of mortgage accounts and 13.7 percent of mortgage balances at end March 2012. 
• The share of mortgages that have been restructured—predominantly through payments of only the interest due or somewhat more—rose to 12.6 percent at end March 2012, but more than half of restructured loans are in arrears, indicating that deeper loan modifications are needed in some cases.

 More charts from the IMF:

In IMF news, rental yields are now closer to stabilization levels, but house prices are averaging 10 times average disposable per capita income, implying ca 4 times average disposable per-family income. In my view, prices will need to reach 3-3.5 times before the property market becomes affordable in the current conditions. This, however, is a longer-term target, with intermediate target being most likely even lower at 2.5 times (given credit conditions and general economic conditions). Also note, the above do not account for upcoming property taxes and for future reductions in disposable income due to tax increases.

Meanwhile credit condition remain horrible:

Chart above clearly shows that although interest costs and interest rates have declined, deleveraging did not take place. This stands in sharp contrast to the US and UK, where deleveraging of the households was more aggressively underpinned by bankruptcies and repossessions. Another issue is that declines in interest rate burden apply primarily to tracker mortgages.

Charts below highlight rapidly accelerating problems with mortgages defaults:

Chart above shows the decomposition of restructured mortgages, highlighting the extent of significant changes in the overall mortgages burden under restructuring (interest only 35%, below interest-only payments at 14%, payment moratorium at 4% and hybrid at 5%, implying that at the very least well over 50% of all restructured mortgages are not delivering on capital repayments).

15/6/2012: IMF Review of Irish Economy: Q2 2012

IMF latest outlook for Ireland. Not so cheerful reading after all. Quoting from the report:

• Growth prospects for 2012 remain modest at about ½ percent, unchanged from the fifth review. 
• Consumption is projected to decline by 1.7 percent as real household disposable income further weakens while the savings rate will likely remain elevated as households continue to reduce high debt burdens, although retail sales data for April suggest downside risks. 
• The decline in fixed investment is expected to continue, in part owing to fiscal consolidation, though at a slower pace than in 2011.  

Summary table:

Further quoting from the report [emphasis and comments mine]:

• An external recovery underpins the projected strengthening in growth in coming years, with support from a gradual revival of domestic demand, but there are significant risks. 
• Net exports are expected to continue to be the main contributor to growth in 2013–14, with support from further gains in competitiveness over time. [Albeit exports contribution to growth will effectively drop like a brick - from 4.5% in 2011 to 1.2% in 2017]
• Consistent with Ireland’s major banking crisis and ongoing fiscal consolidation, the revival in domestic demand is projected to be a protracted process, with a stabilization of demand in 2013, followed by a gradual pick up to about 2 percent growth by 2015–17. 
• Overall, growth is projected to average 2½ percent in 2013–17, which is low in relation to the scale of underutilized resources. [Re: unemployment staying very high and underinvestment continues rampant through the period].

There are, however, a range of interconnected risks to this outlook: 

• An intensification of euro area stress would heavily impact Ireland’s growth and the debt outlook through exports, and also through household and business confidence and spending, with adverse effects on financial sector health. [Not exactly 'just feta', then?]
• The gradual resumption in private consumption and investment growth starting in 2013 hinges on a combination of a bottoming out of housing prices, some pick up in lending to SMEs and the younger cohort of households with less debt [note stress on cohorts effects - supporting my continued insistence that, in effect, the current crisis and lack of Government support for deleveraging of households mean lost generation of highly indebted households], well targeted private debt restructuring over coming years, and public confidence that the crisis is being overcome, which will allow some easing in precautionary savings. [That is a motherload of 'ifs' there - all showing no sign of materializing any time soon.]
• Banks’ capitalization has been greatly strengthened, but their underlying profitability remained weak in 2011, reflecting the low quality of loan portfolios which include significant legacy assets. These factors could hinder a renewal of lending to households and SMEs including by limiting access to funding.
• Gradual recovery and slow reductions in unemployment could imply higher structural unemployment, limiting potential growth in the medium-term, and ongoing high youth unemployment could risk sustained high emigration. [Clear warning on human capital side].

In short, I can't read much of any conviction in the IMF view that the above risks will not overwhelm the economy in its current weak state.

Worse: "The structure of government debt, in particular the promissory notes, is a further challenge. ... [the] lack of burden-sharing on senior bank debt as part of the resolution process added to government debt, exacerbating the political difficulties with the annual payments of €3.1 billion due on the notes until 2023. In these circumstances, the authorities settled the payment due at end March 2012 by placing a long-term government bond with a face value of €3.5 billion with IBRC. The underlying set of transactions was complex and it is not expected that future promissory note payments can be financed in this manner. A more durable extension of the debt service schedule on promissory notes, matched by corresponding stability in the Eurosystem funding of IBRC, is needed to ensure the political sustainability of the substantial medium-term fiscal consolidation planned, and to significantly reduce market financing requirements in the medium term and thereby facilitate regaining market access."

So the 'Bad Cop' IMF is, as I always said before, still playing our side in the game against our wonderful 'European partners' who are screwing Ireland. Hmmm...

On debt: "Debt sustainability remains fragile, especially with respect to medium-term growth prospects. The debt path is projected to peak at 121 percent of GDP in 2013 and to decline to 111 percent of GDP by 2017. The upward shift in the gross debt path compared with the previous review reflects higher cash balances, which are expected to reinforce prospects for regaining access to market funding. The debt outlook remains sensitive to weaker growth, with debt rising to about 133 percent of GDP by 2017 if growth were to stagnate at 1⁄2 percent. Although the disposal of state assets and the planned sale of Irish Life could modestly lower the debt path, this may be offset to some extent in the next few years by potential outlays for restructuring the credit union sector."

Chart: 

Now, Green Jerseys love the number of 117% don't they... oops... IMF is sticking to 121%. Recall, Green Jerseys said in the past that debt < 120% is sustainable. Goodie, then...

IMF's overall review conclusions are:

• Ireland’s policy implementation has been consistently strong during the first half of the EU-IMF supported program, yet considerable challenges remain.
• The Irish economy remains weak, with real GDP broadly flat in the last three years.
• Labor market conditions may be beginning to stabilize, yet they remain adverse.
• The lack of employment opportunities is seen in the rising share of involuntary part-time employment, vacancy rates among the lowest in Europe, and the long- term unemployment share rising to 60 percent [note that this fully corresponds to my estimates and analysis of the 'broader' unemployment figures for Ireland - something that the Government comprehensively ignores.]
• Inflation continues to rise and is now closer to the euro area average [with energy accounting for three quarters of the increase and core inflation (mostly transport and insurance) contributing the remainder - in other words, IMF is noticing our Government's valiant efforts to gouge consumers by hiking state-controlled prices.]
• The current account was broadly balanced at 0.1 percent of GDP in 2011, and the unwinding of competitiveness losses continues. [Good news, but although a continued gradual decline in Ireland’s market share in goods exports suggests further improvements may be needed]
• Bank funding pressures appear to be easing as the overall level of deposits in the banking system has stabilized
• Mortgages - see follow up post, but core conclusion is that household deleveraging is simply not happening fast enough (see my forthcoming Sunday Times article on this)
• The PCAR banks are highly capitalized but report low profitability mostly due to weak loan quality [As warned in my Sunday Times columns]
• Exchequer situation - see follow up post but headline conclusion is: 
  Final data confirm the 2011 general government deficit was well within the program ceiling and Fiscal developments in the first four months of 2012 were in line with expectations.

9/2/2012: What can ECB do?

In relation to the recent statements from Minister Noonan and Taoiseach Kenny on their expectations that ECB involvement in Greece should be matched by ECB extending assistance to Ireland:

What can ECB provide in relief for Ireland:

1) ECB can do a swap of Irish higher coupon bonds for cheaper EFSF/ESM bonds at current or even reduced (via suitable averaging) market value, saving interest charges and reducing outstanding principal of Irish debt. This will not be a credit event, as the transaction will be purely contained within ECB balancesheet.

2) ECB can give a green light to the Central bank of Ireland not to sterilize ELA returns under the promisory notes, effectively rebating the funds back to the Exchequer.

3) ECB can also consent to restructuring of ELA (partial form of (2) above)

So there are a few things ECB can do, but all will de facto open ECB to a major risk of other countries coming to it with similar demands.

Regardless of the outcome, the Taoiseach and Minister Noonan are correct in demanding ECB step forward with solutions to the problems in Ireland that have been created in the first place by ECB policies of the past.

16/1/2012: Irish Bailout Redux - Sunday Times 15/01/2012

Several articles in the press yesterday on why Ireland will require / need a second 'bailout' - here's an excellent piece from Namawinelake and here's a piece from Colm McCarthy.

This is an unedited version of my Sunday Times (January 15, 2012) article on the same topic.

In May 2011, as Greece was sliding toward the second bailout, I conjectured that within 24 months, Ireland and Portugal will both require additional bailout packages as well. This week, my prediction has been echoed by the Chief Economist of the Citi, William Buiter.

According to Buiter, the costs of borrowing in the markets are currently prohibitive and the expiration of the €67.5 billion loans deal with the Torika, scheduled for 2014 will see Ireland once again unable to borrow to cover remaining deficits and refinancing maturing bonds. Ireland should secure additional funding as a back up, to avoid seeking it later “in a state of near panic”.

Buiter’s suggestion represents nothing more than a prudent planning-ahead exercise. In addition to Buiter’s original rationale for securing new lending, Ireland is facing significant fiscal and economic challenges that will make it nearly impossible for the State to finance its fiscal adjustment path through private borrowing in 2014-2016.

Speaking to the RTE, Buiter said that although Ireland’s situation was different from that of Greece, the economy remains under severe stress from banking sector bailouts. Addressing this stress should involve restructuring of the promissory notes issued by the state to IBRC, as the Government was hoping to do in recent months. But it also requires anchoring our longer-term fiscal adjustment path to predictable and stable sources of funding at a cost that can be carried by the weakened economy.

The Government will do well to listen to these early warnings to avoid repeating mistakes of their predecessors.

On November 18, 2011, Carlo Cottarelli, IMF Director of Fiscal Affairs Department gave a presentation in the London School of Economics, titled Challenges of Budgetary and Financial Crises in Europe. In it, Mr Cottarelli provided three important insights into the expected dynamics for debt and deficits that have material impact on Ireland.

Firstly, he showed that to achieve the ‘golden rule’ debt to GDP ratio of 60% of GDP by 2030, Ireland will be required to run extremely high primary surpluses in years to come. Only Greece and Japan will have to shoulder greater pain than us over the next 19 years to get public debt overhang down to a safety level.

Secondly, amongst all PIIGS, Ireland has the highest proportion of outstanding public debt held by non-residents (84%), implying the highest cost of restructuring such debt. The runner up is Greece with 65%. In general, bond yields are positively correlated with the proportion of debt held by non-residents.

Thirdly, Cottarelli presented a model estimating the relationship between the observed bond yields and the underlying macroeconomic and fiscal fundamentals that looked at 31 countries. This model can be recalibrated to see what yields on Irish debt can be consistent with market funding under IMF growth projections for Ireland. Using headline IMF forecasts from December 2011, 2014-2016 yields for Ireland are expected to range between 4.7% and 6.5%. Incorporating some downside risks to growth and other macroeconomic parameters, Irish yields can be expected to range between 5.3% and 7.0%.

Even in 5.5-6% average yields range, financing Irish bonds rollovers in the market in 2014-2016 will be prohibitively costly as at the above yields, Ireland's debt dynamics will no longer be consistent with the rates of decline in debt/GDP ratio planned for under the Troika agreement. This, in turn, means that the markets will be unlikely to provide financing in volumes, sufficient to cover debt rollovers. Thus, Ireland will either require new bridging loans from the Troika or will have to extract even greater primary surpluses out of the economy, diverting more funds to cover debt repayments and risking derailing any recovery we might see by then.

What Butier statement this week does not consider, however, are the potential downside risks to the Irish fiscal stability projections. These risks are material and can be broadly divided into external and internal.

Per external risks, the latest CMA Global Sovereign Risk Report for Q4 2011, released this week, shows Ireland as the 6^th riskiest country in the world with estimated probability of sovereign default of 46.4% and credit ratings of ccc+. Despite stable performance of our bonds in Q4 2011, CMA credit ratings for Ireland have deteriorated, compared to Q3 2011. And, our 5 year mid-point CDS spreads are now at around 747 bps – more than seven times ahead of Germany. This highlights the effect of a moderate slowdown in euro zone growth on our bonds performance.

Even absent the above risks, Irish debt dynamics can be significantly improved by significantly extending preferential interest rates obtained under the Troika agreement to cover post-2014 rollovers and adjustments. Based on IMF projections from December 2011, such a move can secure savings of some €9 billion or almost 5% of our forecast 2016 GDP in years 2014-2016 alone (see chart).

CHART

Chart source: IMF Country Report 11/356, December 2011 and author own calculations

Looking into the next 5 years, there is a risk of significant increase in inflationary pressures once the growth momentum returns to the Euro area. A rise in the bund rates can also take place due to deterioration in the German fiscal position or due to Germany assuming greater role in the risk-sharing arrangements within the euro area. Lastly, German and all other bonds yields can also rise when risk-on switch takes place in post-recessionary period, drawing significant amounts of liquidity out of the global bond markets. All of these will adversely impact German bunds, but also Irish bonds.

On the domestic front, we should be providing a precautionary cover for the risk of a more protracted slowdown in the Irish economy especially if accompanied by sticky unemployment. The risk of deterioration in Irish primary balances due to structural slowdown in the rate of growth in Irish exports (potentially due to strengthening of the euro in 2013-2016 period or significant adverse effect of the patent cliff on pharma exports) is another one worth considering well before it materializes. Lastly, there is the ever-growing risk that the markets will simply refuse to fund the vast rollovers of debt which is currently being increasingly warehoused outside the normal markets in the vaults of the Central Banks and on the books of the Troika.

Overall, Ireland should form a multi-pronged strategic approach to fiscal debt adjustment. Recognizing future risks, the Government should aggressively pursue the agenda of restructuring the promissory notes issued to the IBRC with an aim of driving down notes yield down to ECB repo rate and push for ECB acceptance of burden sharing imposition on IBRC bondholders to reduce the principal amount of the promissory notes. Pursuit of longer-term objective of forcing the ECB to accept a writedown on the banks debts accumulated through the Emergency Liquidity Assistance lines at the Central Bank of Ireland is another key policy target. Lastly, Ireland needs to secure significant lines of credit with the EU at preferential rates for post-2014 period with longer-term maturity than currently envisaged under the Troika deal.

Given the general conditions across the Eurozone today, the last priority should be pursued as early as possible. In other words, there’s no better time to do the right things than now.

Box-out:

The latest EU-wide statistics for Retail sales for November 2011 released this week present an interesting reading. Retail sector turnover index, taking into account adjustments for working days, shows Irish retail activity has contracted by 0.4% in November 2011 year on year. Overall activity is now down 5.2% on same period 2008, but is up 7.9% on 2005. For all the Irish retail sector woes, here’s an interesting comparative. Euro area retail sales turnover is now down 2.5% year on year and 1.6% on 2005. In terms of overall contraction in turnover, Ireland is ranked 15^th in EU27 in terms of the rate of contraction relative to November 2010 and November 2008 and 12^th in terms of contraction relative to 2005. Not exactly a catastrophic decline. Once set against significant losses in retail sector employment since 2008, these numbers suggest that to a large extent jobs losses in the sector were driven by lack of efficiencies in the sector at the peak of the Celtic Tiger, as well as by declines in revenues.

18/12/2011: Ballyhea & Charleville Protest Against the Bailouts

This weekend I was honored to be a guest of a group of real patriots of our country - a group of extraordinary people who over 40 weeks, one Sunday after another, take their families and friends into the streets of Ballyhea and Charleville to protest against the injustice of the banks bondholders bailouts.

It is a remarkable group of people - coming from all walks of life, united not by an ideology or by a vested interest, but by the knowledge that what is being done to our country behind the veil of the banking crisis is simply wrong. It is wrong on a multitude of levels - ranging from ethics to politics to economics to social justice. The people behind this protest are also united by their concerns for the future of Ireland, for the rising wave of emigration, for the simple fact that our country capacity to recover from this crisis is being destroyed for the sake of rescuing a handful of institutional bondholders.

I felt truly honored - and there can be no other word to describe it - to have been asked to speak to these courageous people last night, to share a delightful pint and a long conversation with them, and to march alongside them today.

Here are a couple of pictures from the march.

The group run a website listing all bonds coming due for repayment, called bondwatchireland.blogspot.com and a Facebook page for their events (link here). These are, in my view, a must to follow for anyone concerned with what has been happening in Ireland over the last 3 years.

03/03/2011: IMF quota goes up, Ireland's rate goes down, but at a cost

Good news, sort of... we gave IMF some €500mln and they reduced out interest bill on their loan by some €220mln... (hat tip to Lorcan for this quick summary). Here are the details of this AIB-esque transaction:

The ad hoc quota increases under the Quota and Voice Reforms of the International Monetary Fund (IMF), (agreed back in 2008), include a 50 percent increase in Ireland’s IMF funding quota (along with 53 other countries around the world).

So we now have 30 days to pay for that quota increase.

Once paid up, Ireland’s quota at the IMF will increase from SDR 838.4 million to SDR 1,257.6 million or SDR 419.2 million = €477 million. That’s the bad news – we gotta come up with cash.

But, the good news is that with the new higher quota, “Ireland’s access to Fund resources under the Extended Fund Facility arrangement is reduced to 1,548 percent of quota, compared with 2,322 percent originally”. Note – countries shouldn’t really borrow at more than 300% of the quotas, but Ireland’s ‘bailout’ was at a massive 7.5 times that rate.

The new quota, therefore, “reduces the share of Ireland’s credit that is subject to surcharges, which are due on amounts in excess of 300 percent of quota. Based on the current SDR interest rate of 0.43 percent, the average lending interest rate at the peak level of access under the arrangement will be 3.04 percent on credit outstanding less than three years (down from 3.17 percent), and 3.85 percent on credit outstanding longer than three years (down from 4.04 percent). This reduction in average interest rate is the result of the implementation of existing Fund policies under the agreed increase in quotas and not of a change in policy."

So basically we have 13bps shaved off our loans with IMF which will save us 13bps on €22.5bn loan (3-year facility) or €29.25 million in annual interest rate. Excitement, folks, is never ending… even Lorcan was wrong on this one - we are to pay 477 million to save (over 3 years) the grand total of 87.75 million.

And there’s more to come: “The proposed quota increase under the 14th General Review of Quotas, which is expected to be effective by the time of the 2012 IMF-World Bank Annual Meetings, includes a further 174.3 percent increase in Ireland’s quota to SDR 3,449.9 million. This would tend to further reduce the average lending rate when it comes into effect.

Can’t wait… we can borrow that money from IMF as well, to pay IMF to increase the quota, so as to save a penny on a million?..

Granted, this was agreed ages ago, but...

Here's the note:

Economics 5/12/10: Default, debt and 'Rescue of Ireland' deal

Today's Sunday Independent article on inevitability of default, with comprehensive figures on the impact of the IMF/ECB/EU deal for ordinary Irish households and the levels of our indebtedness. Link here.

Economics 26/11/10: Contagion is spreading to Spain & Italy

Another day, another spike of contagion from Ireland's Sovereign bonds to other Eurozone countries:
Yesterday's closing bell marked another day in which markets have completely disagreed with the EU officials and Irish Government view of the reality of our and PIIGS' ability to weather out the current crisis.

Economics 22/11/10: November 12 - on the record re 'bailout'

This is an unedited version of my November 12 article in the Irish Examiner. Of course, since then the events have taken over the core premises of the article, but for archival purposes and also to posit the article into the context (at the time of print, the official position was 'we don't need a bailout'), I am posting this here.

Despite all the intensifying talk about the EU support, despite the growing number of assurances from the various officials and social partners that we can ‘grow out of our difficulties’, this week has clearly shown that Ireland is nearing the end game of the crisis. Tellingly, even the usual official policies cheerleaders, our stockbrokers, have by now one by one deserted the State-side of the arguments. As one analyst from IFSC put it earlier this week: ‘you know the game’s up when you can’t round up your own sales team to sell Irish bonds’.

The game is almost up. Were we to go into borrowing today, Irish debt will be more costly to finance than that of any other developed country, save Greece. On the assumption of a 70% recovery rate, the Irish 10 year Credit Default Swaps imply an 85% probability of Ireland defaulting sometime in the next 10 years. This, of course, is not the real probability, but an estimate. However, in comparison, even countries that availed over the last 3 years of IMF assistance, including Iceland, are enjoying much greater confidence of the markets.

We all know how we got into this predicament. Three years into the crisis, Irish Government continues to spend well beyond its means. Our current spending keeps rising. Tax revenue, despite significant tax hikes, is running below 2008 levels.

The markets know that the Irish Government has by now exhausted all means for extracting more cash out of this devastated economy. If, as expected, Minister Lenihan hikes taxes in the Budget 2011 again, he will be shifting more of our economic activity into the grey market where the taxman is a distant and powerless overlord.

Much anticipated Budget 2011 is unlikely to solve this problem. Cuts of €6 billion from the deficit this year will do very little to restore any credibility to the Government policy. As anyone with an ounce of common sense will know in the current conditions, the whole exercise will be equivalent to taking money out of one pocket – Government total spending – and putting it in the other – the banks, bondholders, social welfare and pay and pensions bill.

By avoiding soaking the bondholders from the start of this crisis, the Government has boxed itself into a proverbial corner. Instead of standing on a morally and economically high ground and soaking the bondholders early on in the crisis, as Iceland did, we have created a full-blown contagion from the banks to the sovereign. With liquidity evaporating from the shorter end of the banks funding market, this contagion is now a two-way street. Untangling this today, without going into a renegotiation of the sovereign bonds and/or guarantees, cannot constitute a credible policy position.

All of this comes before we even consider the real economy-side of the matters. With private investment on its knees, and companies, starved of trade and operational credits, operating outside the realm of normal corporate finance, can anyone really claim that we have a private sector capacity to escape a restructuring of the private or public or both debts?

Irish families are now so deep in debt and negative equity that consumption and household investment stalled, while deposits are vanishing to pay rising state and semi-state bills. Squeezed on both ends of their incomes – by falling earning and rising taxes and charges – these very households cannot be expected to provide more funding for our fiscal policy pyramid scheme.

But the final straw that broke the proverbial camel’s back is the belated realisation that the EU has no plan B for dealing with this crisis. In fact, it doesn’t even have a plan A. This was made absolutely clear by the vacuous nature of statements issued by the EU Commissioner Olli Rehn during and after his visit to Dublin this week.

The fundamental EU problem is that the much-lauded EFSF (European Financial Stabilization Facility) – the fund used to put Greece into a bond markets deep-freezer earlier this year – is not designed to address the problems we face. EFSF is designed to help cash strapped governments for a period of 3 years at ‘near market’ rates. Ireland is not cash-strapped. Nor are ‘near-market rates’ a sustainable lending option for us.

We are plain insolvent when one takes three to five years forward view. Our sovereign debt to GNP ratio is likely to exceed 140% by the end of 2015 and this is before we factor in the highly probable wave of mortgages defaults. Our household and corporate debts are more than double those of Greece. And we are staring at the abyss of rising interest rates and strong euro into the next 3-5 years.

EFSF is simply not fit for the purpose of rescuing Ireland.

At current yields, Ireland will need to grow its economy at some 6.5-7% on average annually for the next decade to counterbalance the mountain of debt we are carrying. At the ESFS rates – at ca 4.5%. Anyone expecting this to happen without radical and extremely painful structural reforms of the economy (not just budget cuts) should really go back to the basics of economics. With exception of exporting sectors our economy has slipped into a coma. Jolting it out of this state will require complete rethinking of our fiscal and economic policies.

As an optimist, I can tell you that this can be done. As a pragmatic observer of the current policy and economic environment, I have little hope that it can be done without restructuring our debts – either public or private or both – and issuing a new policies mandate for the political leadership.