19/4/2013: More from the IMF on Irish banks...

Getting back to the IMF GFSR report released earlier this week. Some nice charts worth a quick comment or two:

Two things worth noting in the above:

1. Increase in covered bonds for Irish banks, absent, pretty much, any serious issuance between 2007 and 2012 and maturing of some bonds. This may be linked to the deteriorating quality of assets against which the bonds were secured, requiring 'top-ups' with new assets. In effect, this means that to maintain existent level of funding a bank will require more assets to be put aside.
2. Massive, relative to GDP, exposure to MROs + LTROs for the Irish banks. Let's keep in mind that some Irish banks were precluded from participating in the second LTRO due to lack of suitable collateral. Even with that, Irish banking sector exposure to LTROs relative to GDP is the largest of all countries in the sample.

The next two charts plot relationship between banks' lending to households and corporates and the growth forecasts for the economies:

By both charts above, Ireland appears to be basically just on the borderline between the core and the peripheral countries. Of course, this means preciously little, since Irish banks basically are issuing no new loans and thus whatever rates they report are heavily, very heavily biased in favour of higher quality borrowers. Here's how this bias works: the bank in Ireland issues a loan to company A for the amount X and duration W. The rate on this loan is r=f(A,X,W)  such that if A quality is higher then rate r  is lower, if X is larger, the rate is higher, and if W is longer, the rate is also higher. We control all other variables that might influence the rate quoted. If the case of the same company looking for the same loan outside Ireland, the bias above would imply a lower rate quoted, or a smaller loan granted or for shorter duration, or all or any permutations of the above. 

Here is an interesting point. In the first chart above, Irish house loans rates went up during the crisis, but corporate loans rates went dramatically down during the crisis. Now, houses-related loans within the Irish banking system are currently in default at close to 20% rate, while SMEs loans are in default close to 50% rate. High quality corporates are probably in the same rate of default today as in 2007. Which means that corporate loans book of Irish banks should be posting default rates (NPLs) of similar or larger proportions as house lending book. Yet the rates for two types of loans have moved in the opposite direction and very significantly.

On foot of the above, question for our Dear Leaders: Are Irish banks, for purely political reasons (recall Government's repeated exhortations about the need for the banks to 'do their bit for the economy', 'lend to our SMEs' etc), using house loans pricing to subsidise corporate loans issuance?

Just in case you start harping on about Irish corporates having better debt loads than households, IMF has the following handy charts:

And more: Irish corporates have exceptionally poor interest coverage ratios:

Keep in mind - the above applies only to listed firms, not to privately held ones...

26/09/2011: Ireland's Debt Overhang - unprecedented, unmanageable & unsustainable

A recent paper, titled "The real effects of debt" by Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli (05 August 2011) presented at the "Achieving Maximum Long-Run Growth" symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, 25-27 August 2011 put forward evidence on the overall effects of debt overhang - across public, private corporate and household debts - on the real economy.

Here is the summary of their findings, followed by a closer look at the implications of these for Ireland. I have to warn you - the latter are highly disturbing.

The authors argue that although debt can be used to drive growth and development, "...history teaches us that borrowing can create vulnerabilities. When debt ratios rise beyond a certain level, financial crises become both more likely and more severe (Reinhart and Rogoff (2009)). This strongly suggests that there is a sense in which debt can become excessive."

The authors set out to answer a simple question: When does the level of debt go from good to bad? 'Bad' as in producing the effect of lowering long term economic growth in the economy.

To do so, the authors used a new dataset that includes the level of government, non-financial corporate and household debt in 18 OECD countries from 1980 to 2010.

The core results "support the view that, beyond a certain level, debt is bad for growth":

• "For government debt, the threshold is in the range of 80 to 100% of GDP... Our result for public debt has the immediate implication that highly indebted governments should aim not only at stabilising their debt but also at reducing it to sufficiently low levels that do not retard growth. Prudence dictates that governments should also aim to keep their debt well below the estimated thresholds so that even extraordinary events are unlikely to push their debt to levels that become damaging to growth." Furthermore, "when government debt rises to [threshold] level, an additional 10 percentage points of GDP drives trend growth down by some 10-15 basis points."
• "Up to a point, corporate and household debt can be good for growth. But when corporate debt goes beyond 90% of GDP, our results suggest that it becomes a drag on growth."
• "And for household debt, we report a threshold around 85% of GDP, although the impact is very imprecisely estimated."
  

The table below shows the core results from the paper and adds the comparable data for Ireland (Ireland was not included in the analysis). Make sure you are seating before reading it:
As shown in the table above, using the study estimates, the potential reduction in Irish GDP growth over the long term horizon arising from the combined debt overhangs is 2.1%.

The table also shows that the largest impact from debt overhang for Ireland arises from corporate debt, followed by household debt. Despite this, our Government's core objective to-date has been to deleverage banks and to contain Government debt explosion. In fact, the Government is consciously opting for loading more debt onto households - by reducing disposable after-tax incomes and refusing to implement significant savings in the public sector expenditure.

Yet, folks, our debt levels are extreme. They are more than extreme - the table below shows comparable combined public and private (non-financial) debt for the countries in the study sample, plus Ireland.
And the reates of our debt increase during the crisis are also extreme:

In fact, we have both - the highest level of debt to GNP ratio, the second highest debt to GDP ratio and the fastest increases in 2000-2010 in both ratios in the developed world. In the nutshell, this means we are more bust than the most bust economy in the world - Japan. Unlike Japan, however, we are faced with:

• No prospect of devaluation
• No prospect of controlling our interest rates
• Young population that requires growth and jobs creation, and
• Much heavier levels of private and corporate debt - i.e. debt that has more significant adverse economic effects than sovereign debt.
  

Yet, even exporting powerhouse of Japan is not delirious enough to believe their debt overhang can be brought under control via 'exports-led' growth.



Now, much of the issues and data discussed in this post relate to the question raised in the Dail by Peter Mathews, TD, who relentlessly pursues, in my view, public interest in raising such questions. The record of his question and Minister Noonan's answer is provided below:

Economics 09/05/2010: Abandonning the ship of fiscal reforms

Here is an unedited version of my current article in the latest edition of Business & Finance magazine.


After two years of frantic crisis management by default and piece-meal recapitalizations, last month, the Irish state has fully committed to an outright dumping of public and banks debts onto the shoulders of the ordinary taxpayers. Since the onset of the crisis in 2008 through 2014, based on the latest Budgetary projections and banks recapitalization plans, the Government will consign ca €221 billion liabilities onto Irish workers, businesses and entrepreneurs. This figure, adding to a whooping €234,000 of new debt per average household with two working parents, is the toxic legacy of our crony corporatism.

Consider the banks. Minister Lenihan’s announcement made on Super Tuesday in March means that over the next two years, the Irish taxpayers will foot a bill of some €37 billion in direct capital injections to the banks. The interest on this bankers’ loot will add up to another €12 billion over 10 years. Nama will contribute the net loss of up to €30 billion to our woes. This comprises the costs of loans purchases, bonds financing and Nama management and operations, less the expected recovery of assets and the cash flow from the undertaking. When all is said and done, Irish people will be left with a gargantuan bill of almost €80 billion for rescuing the banks, not counting tens of billions of written-down loans and ruined businesses.

If you doubt this figure, look no further than the numbers released to accompany Tranche 1 transfer of assets from the banks to Nama. These show that having paid €8.5 billion for the first instalment of loans, Nama financial wizards managed to overpay €1.2-3.1 billion compared to the actual value of the loans. On day one of its operations, therefore, Nama has managed to put the taxpayers billions deep into the negative equity. Minister Lenihan’s choice of the cut-off date of November 30, 2009 for Nama valuations implies that Irish taxpayers stand to lose over €1.5 billion on top of all other previously forecast Nama losses. This addition is a pure waste, as there is absolutely no logistical or economic reason for setting such a date in the first place.

In the mean time, taxpayers’ representatives – from our ‘public interest’ banks’ directors to legislators – continue to insist that Nama is a profit-making opportunity for the state. In a recent encounter with myself on a national radio programme, Darragh O’Brien TD who acts as a Vice-Chair of the Public Accounts Committee has gone so far as to claim that under Nama, the state will be borrowing money from the ECB at 1% and lending it to the banks at 3%, thereby earning an instant gain of 2% on the transaction. The fact is according to Nama own documentation it will be the state who will owe the banks an annual coupon payment at the rate of euribor (currently just over 1.2% for a 12 month contract). This rate will be resettable every 6 months, so looking back at historical data, Nama cost of borrowing can easily go to 4.9% - the euribor level back in 2007 or even higher. Since the banks will be holding the bonds they, not the Exchequer, will be collecting the interest payments. The Irish taxpayers, therefore, can potentially be on the hook for an additional €2.6 billion subsidy to the banks in the form of coupon payments on the bonds.

My estimates of the overall debt burden imposed by the banks onto the taxpayers are erring on a conservative side. The latest figures from the Central bank show that the entire Irish banking sector, inclusive of non-Guaranteed institutions, holds a balance of just €226 billion in customers deposits. Assuming that some 10-15% of these deposits are subject to customer demand in any two weeks period, risk-adjusted customer deposit base of Irish banking sector is roughly €192-203 billion. This is offset but loans to customers amounting to €609 billion, plus bonds in the amount of €73 billion, and short-term ECB deposits of €78 billion. Thus, the ratio of debt and short-term obligations relative to customer deposits in the Irish banking sector currently stands at more than 323%. Liquidity risk-adjusted, this figure rises to 400%. In comparison, UK’s Northern Rock had 306% loans to customer deposits ratio at the peak of its solvency crisis in 2008.

So the entire recapitalization fiasco, coupled with the continued stream of disastrous news from the Anglo and the spectacular collapse of the INBS, should have taught us one simple lesson – people who are in charge of the banking crisis management in this country are either unaware of facts or are willingly distorting the reality.


However, for all of its publicity, the banking crisis pales in comparison with the fiscal meltdown we face. As of the time of going to press, Irish workers and small businesses – the lifeline of our economy – are being held hostage by the ‘deal brokering’ between the Trade Unions and the Government. The likeliest outcome of these talks will be a public sector ‘reforms’ package which will see a deferred reversal of Government intentions to cut wasteful spending. Freezing future pay cuts in the public sector, while pushing forward a naïve (if not deceptive) agenda of ‘improved productivity’ means that while in theory we might get more for each euro we spend, in practice, the overall spending bill will remain well out of touch with our tax receipts. The structural deficit simply cannot be corrected by plastering the expenditure gap over with new work practice rules. Only a dramatic cut in overall spend, plus a significant cut in the numbers employed in the public sector will save this country from becoming Greece-sur-Atlantique.

Looking at the Government own projections for future deficits and factoring in the cost of borrowing, Ireland Inc will have to find some €92 billion from now through 2014. Factoring in deficits cumulated between January 1 2008 and December 31 2009 adds another €37.3 billion, plus interest to the above figure. All in, 2008-2014 fiscal deficits are likely to cost Irish taxpayers some €139 billion based on Government own figures. How realistic these Government projections are is a matter for another debate, but the recent revision of our 2009 deficit from the Government-published 11.7% to 14.3% of GDP by the Eurostat shows that the above estimate of the total deficits-related costs can be even higher. Either way, the fiscal crisis we face is clearly much more significant than the banks crisis.

Having invited the Unions back to the bargaining table, the Government has ex ante turned taxpayers into a bargaining chip that it can (and will) use to appease the intransigent interest groups.

Which brings us back to that top line figure of €221 billion in liabilities that Messrs Cowen and Lenihan have decided to offload from the banks and public sector and onto the shoulders of the ordinary taxpayers. Per CSO’s latest data there are 1,887,700 people in employment in Ireland today. Everyone of these workers – no matter whether currently covered by the tax net or not – will be facing an average bill of some €117,000 for the mistakes made by our past Governments’ public expenditure policies, bankers, regulators and developers.

This is, put simply, an unsustainable mountain of public and quasi-public liabilities. Something will have to give.

Back in 2008, Ireland’s top 11,714 earners (those who earned more than €275,000 in a year), paid almost 18% of all income tax. Forget the fact that many of these individuals are now broke. Doubling their tax rates would deliver less than €10 billion in tax revenue over the next 5 years – hardly a drop in the sea of new public debt being created. Quadrupling taxes on Irish median earners – those with income around €25,000 mark – will yield no more than €5 billion in new revenue through 2014. A full one third of all income earners back in 2008 were outside the tax net. These workers, with incomes below €17,000 per annum, are about to be thrown to the wolves by our policies as the Government sets out to plug the twin budget and the banks black holes. Taxed at the standard rate, they will be in for some €0.9 billion tax burden annually. So where will the rest of €205 billion come from?

In reality, the Government simply cannot avoid hiking taxes on businesses. Budget 2010 forecasts corporation tax revenue to reach €3.16 billion. Doubling the rate of tax to 25% can be expected to yield no more than €12-14 billion through 2014. So even this amount will not correct for the public sector and banks’ debts.

Super Tuesday’s announcements by the Minister for Finance signalled the beginning of an end for the dreams for a better future for this and several subsequent generations of Irish people. Remember when Mr Lenihan asked us to be patriotic in his Budget 2009 speech?

Since July 2007, the Government has shown itself incapable of understanding the nature of the crises we face. The banks, we were told, were suffering shortage of liquidity. This means that replacing dead-weight loans on their balancesheets with bankable quasi-Government bonds will do the job of restarting lending. We now know that the real problem the banks face is that of insolvency, with their balancesheets destroyed by worthless loans offset by hefty liabilities. We were told that the collapse in the Exchequer tax revenue not the excessive permanent spending habits of our State were to be blamed for the fiscal crisis. Now we can see the truth – the Irish Exchequer and economy are facing a problem of insolvency, for not even a restoration of tax revenue to its pre-crisis long-term trend will resolve the problem of excessive deficits.


Box-out
Over the recent weeks, the heated debate about Irish banks’ liabilities has shifted its attention to the elusive bond holders. “Who are, these captains of speculation armada? The sharks of the international financial markets?” some demanded to know. Well, we can’t quite tell you who all of them are, but at least for some of the three big banks’ bond holdings we can tell. These arch-capitalists are… you, me, and the Irish Exchequer. That’s right. Per NTMA own figures, our National Pension Reserve Fund – the pot of gold at the end of the public sector employment rainbow – designed to shore up Exchequer pensions deficit has managed to get its snout deep into the Irish banks bonds feeding trough. In the 12 months between December 2007 and December 2008, NPRF has bought itself into a long position in AIB variable rate bonds - €155 million, Bank of Ireland fixed coupon bonds €205 million, Bank of Ireland variable bonds €35.5 million, hiking its overall exposure to Irish banks’ bonds from €89.2 million in 2007 to €461.7 million in 2008. Given that these long positions withstood the wholesale collapse in banks bonds prices in 2008, this was an incredibly risky bet. Then again, adding up NPRF’s balance sheet exposures to low liquidity, higher risk investment classes, such as unquoted property investments, commodities and private equity, corporate debt in Greece, plus almost €74 million worth of Greek Government bonds, etc, NPRF’s higher risk investments accounted for almost 13% of the entire investment portfolio in 2008, up from 11% in 2007 and 6.3% in 2006.

Daily Economics 31/03/2009

Irish external debt stats for Q4 2008 are out and, guess what, things are looking worse than before. Here is the CSO table:
Now, the Gross External Debt itself is up for the year as a whole: from €1.579 trillion (yes, trillion) in Q1 2008 to €1.661 trillion in Q4 2008. But look closer to the details (see chart below for illustration):

• Gen Government Debt is obviously up - we are borrowing sh***t loads of money. But, GG short-term liabilities are also taking off, which confirms my argument: we are increasingly borrowing short, frontloading future deficits. This is before we factor in the Q1 2009 seriously aggressive short-term debt raising.
  
• Monetary authorities debt is going ballistic - all of this is in short term liabilities.
• Monetary financial institutions (financial sector etc) is declining overall, but slowly, and the short-term debt is rising - gain, trouble ahead refinancing this 'oxygen'.
• Other sectors - the real economy - debt is up and short-term liabilities are also up.
  

So, despite CSO's brave claims - the title of today's note is Ireland’s External Debt decreases to €1.66 trillion at end December - in reality, the debt mountain is still growing (in yearly comparisons) and the nasty short-term debt overloads are getting heavier.

Now, think, what will happen if the Government was successful in restarting banks lending?

Per one of the readers comments, here is the table with actual nominal increases in various debt headlines.