03/07/2011: SMEs and Corporate Credit: April 2011 data

In the previous post I looked at the latest data on lending rates and volumes for Irish households, which, among other things, showed

• lack of any significant easing in rates themselves (except for consumer credit), and
• lack of any uptick in credit issuance (in fact, there has been contraction in lending volumes in 3 out of 4 categories examined)

Here, let's take a look at business lending. First, loans up to € 1 million in volume (primarily loans that are focused on SMEs). Keep in mind the objectives of:

• creating Nama
• pumping countless billions into IRL-6 zombies
• setting aside specially designated funds within AIB & BofI for small business lending, and
• increasing various seed programmes (EI) and targeted tax reliefs

were to increase supply of credit to Irish SMEs.

Top line numbers for loans under €1 million are:

• Average rates charged on loans under €1 million in volume with up to 1 year fixed duration (or floating) has risen from 4.27% t0 4.74% between March 2011 and April 2011. The rate now stands just-shy of 4.906% historical average and 4.801 average for crisis period of January-2008 through present. 12mo MA is now below April 2011 rate at 4.087%. Volatility of these rates has risen from 1.002 standard deviation for historical period to 1.302 standard deviation for the crisis period. In short, there are no signs of any improvement in the rates charged during the crisis.
• At the same time, volume of non-financial corporate loans under €1 million with floating or up to 1 year fixed rates has fallen from €404 million in March to €250 million in April 2011. Volumes of new loans written in this category now stand well below historical monthly average of €919 million, crisis period average of €832 million and 12mo MA of €448.4 million.
• Fixed-rate loans (with rate fixed for more than 1 year) also became more expensive in April (6.17%) than in March (5.86%). These are now well above the historical average rates of 5.234%, the crisis average of 5.329% and the 12mo MA of 5.008%. Volatility of these rates also rose during the crisis.
• Volumes of over 1 year fixed smaller loans has shrunk to €45 million in April, down from €64 million in March and down on historical average of €160 million, crisis period average of €110 million and 12mo MA of €70.25 million.
  

So to sum this up, small businesses are seeing higher charges and shrinking volumes of loans across both types of loans under €1 million in volume. Anyone wondering why the hell all the above measures are failing to deliver on the promise?

But wait, what about larger loans? Next, consider loans issued to non-financial corporations that are over €1 million in volume:

• Rates charged on loans of €1 million and more that are floating or under 1 year fixed have fallen from 3.51% in March to 3.22% in April and are now standing well below 4.407% historical average, 4.01% crisis period average, but above 12mo MA of 3.048%. Volatility of these loans rates have risen during the crisis from historical 1.159 standard deviation to a standard deviation of 1.518 during the crisis.
• So more of those loans should be pursued by businesses, you'd think? Not really. At least not when it comes to actual issuance of these loans. Volume of larger loans issued on floating or fixed up to 1 year rate basis has fallen in April to €626 million, down from €1,119 million in March. Both numbers pale in comparison with historical average of €3,948 million and crisis period average of €4,654 million and both are below 12mo MA of €1,784 million.
• Rates charged on loans of €1 million and more in volume with fixed interest rate over 1 year have also declined from 2.30% in March to 2.27% in April. The rates are now well below 4.054% average over historical period and 3.666% average over crisis period. 12mo MA is also higher than the current rates - at 2.772%. Lower rates here again come with higher volatility.
  
• Volumes of these loans, however, fell precipitously, reaching €45 million in April, down from €169 million in March. Historical monthly average of new loans of this type issued stands at €632.3 million, while crisis period average is €488.5 million and 12mo MA is €190 million.

Lastly, let's take a look at the spreads between the rates based on loan volume:

• Spreads on corporate loans under €1 million, flexible rate & under 1 year fixed over and above those for over €1 million, should - in theory - be negative, unless there is a selection bias of SMEs predominantly taking smaller loans. At any rate, we would expect the spread to be moving in the direction of lower spreads if Government 'get credit flowing to SMEs' policies were working. Alas, in April 2011, the spread stood at 1.52pp up from March 0.76 percentage points and well above the historical average of 0.499pp and crisis period average of 0.791pp. It was also above 12mo MA reading of 1.039pp. Spread volatility has declined marginally during the crisis. So no, Government policy does not help selecting in favor of smaller corporate borrowers and does not provide support for working capital lending.
  
• Spreads on corporate loans under €1 million with fixed rate (>1 year duration) over and above similar loans of volume in excess of €1 million stood at 3.9pp in April up from 3.56pp in March. The spread is now massively above historical average of 1.180pp and crisis period average of 1.663pp, as well as 12mo MA of 2.237pp. Spread volatility has risen during the crisis. Again, no evidence here that SMEs are getting any support from Government policy 'instruments' listed above when it comes to gaining smaller loans as opposed to larger corporates access to credit.

03/07/2011: Household Credit: latest data

Some more analysis of new lending - based on CBofI data through April 2011.

Household loans and consumer loans are covered in this post. So house purchase loans first:

• Rates for the loans for House Purchases floating and up to 1 year fixation have risen from 3.09% to 3.20% in April 2011, relative to March. Historical average rate is 3.743% and the average rate since the beginning of the crisis (January 2008) is 3.574%. Current rates are above their 12mo MA of 2.959%. It is interesting to note that this data clearly shows that there is no statistically significant easing of rates during the crisis as crisis period average rates are not statistically significantly different from those for the entire history of the data series. Another interesting point is that when house purchasers are concerned, volatility of retail rates has risen during the crisis: the historical standard deviation of the series is 0.827 while post-January 2008 standard deviation is 1.072.
• Volumes of loans in the above category has declined from €1.190 billion issued in March 2011 to €1.092 billion in April 2011. Again, current rates of issuance are signaling continued credit tightening: historical monthly average issuance stands at €2.577 billion, while issuance since January 2008 averages €2.0 billion.
  
• Rates for the loans for House Purchases, over 1 year fixation have also increased mom in April from 4.23% to 4.29%. The rates are now above their historical average of 4.213% but below their crisis period average of 4.34%. April rate is above 12mo MA of 4.115%. As in the case of floating rate loans, fixed rate loans rates also risen in volatility during the crisis with overall historical standard deviation for the rates at 0.641 and January 2008-present standard deviation of 0.723.
• However, good luck to anyone trying to get these loans. Fixed rate loans for House Purchases issuance fell from €568 million in March to €331 million in April. New issuance of these loans is now well below historical average monthly volumes of €705 million and below crisis-period average of €521 million. Although 12mo MA is above the crisis average at €526 million.

A chart:
But what about consumer loans not designated for house purchases?

• Cost of consumer credit for floating loans and loans up to 1 year fixation fell from 6.02% in March 2011 to 5.23% in April. Thus, April rates were below their historical monthly average of 5.584%, their crisis period average of 5.565% and their 12mo MA of 5.640%. Note that crisis period was associated with higher volatility of rates in this category as well, with standard deviation rising from historical 0.836 to crisis-period 1.099.
• In terms of volumes of loans issued in the above category, the volume increased from €134 million to €156 million between March 2011 and April. However, volume of new loans issuance remains well below its historical average of €393 million, crisis-period average of €378 million and 12mo MA of €193 million.
• Cost of consumer credit for fixed loans (over 1 year) has fallen from 10.09% in March to 9.90% in April 2011, with current rate still above historical average of 8.589% and crisis period average of 9.494%, but is now below 12mo MA of 10.217%. Interestingly, volatility of rates charged on these types of loans has fallen from historical standard deviation of 0.962 to crisis-period standard deviation of 0.695.
• Again, good luck securing such loans, though, as volumes issued declined from €60 million in March 2011 to €51 million in April. Historical average issuance stands at €169.5 million, while crisis period average is €96 million. Current issuance however remains above 12mo MA of €48.8 million.

A chart to illustrate:

02/07/2011: SMEs and smaller corproate loans rates

An interesting chart of rates charged on new business loans across SMEs and households - my calculations based on Table B.2.1 from the Central Bank database:
In April 2011, the spread between Non-Financial Corporate Loans volume under €1 mln over those for house purchases were:

• Floating rate and up to 1 year fixation corporate loans v similar house purchase loans: 1.54 percentage points, up from 1.18 in March and well above the historical average spread of 1.16 percentage points. Historical average spread for the period January 2008-present is 1.23 percentage points. April 2011 new business rate spread is the highest since January 2009.
• Over 1 year fixation rates spread stood at 1.88 percentage points in April, up on 1.63 percentage points in March 2011. Historical average is 1.02 percentage points and average spread for the period since January 2008 is 0.99 percentage points.

Hence, overall, setting aside the pesky issue that very little new credit is issued by the banks, current credit conditions are clearly pricing historical highs in terms of risk premium for smaller corporate loans. For businesses operating in Ireland, the credit crunch is only getting crunchier, it seems.

Economics 31/7/10: Credit flows in Ireland

Central Bank quarterly was published yesterday. Here are some updated charts on credit flows (data through May). The main conclusions are:

1. Private sector credit continues to contract and is again accelerating in the annual rate of decline (-10.4% yoy in May as compared to -9.3% declines in April and March).
2. Mortgage credit contractions are steadily declining (-1.8% in May against -1.6% in April & 1.4% in March).
3. Non-mortgage credit is accelerating in the rate of decline (-12.8% in May compared to -11.4% in April)
   
4. Nama - now through 50% of the loans purchases - has had no positive impact on credit supply. If anything, as charts for households lending show blow, it is being accompanied by a dramatic increase in the cost of borrowing for ordinary families.

Charts:
Aggregate private sector credit above. Disastrous trends of the last 2 year continue unabated, despite the already significant contraction in the credit supply. This suggests that we are in a continued downward spiral when it comes to business and household investment (future capacity is under continued pressure down and the only thing that provides some positive support to capital side is, most likely, MNCs own inter-company investments). This goes to explain why one cannot accept earlier DofF projections for 2013-2015 potential rates of growth. We are in a situation very similar to Japan in the mid-1990s, where existent production is being driven at the expense of capital stock.

Mortgages:Clearly, no signs of moderation in the rates of decay anywhere here. But the picture is more sluggish than that for non-mortgages lending:
The reason for the different dynamics is that it is easier for households to cut back on smaller credit demand than on massive mortgages burden. Hence, non-mortgages lending is a leading indicator for what we can expect to follow in the mortgages markets. Not exactly a bright future for the housing markets, then.

Deposits side of our financial system:
Notice that deposits are down, mom, across the board, except for shorter term maturity corporate deposits. But yoy all deposits are down. Combined decline in all deposits in volume since January 2010 is €1,869 mln, or 3.4%. Not a small change. All deposit rates are down year on year - we are being paid less to save, but are charged more to borrow.

Loans stats next.
Loans for house purchases are falling, while mortgages rates are rocketing. The orange line above shows just what is happening with the cost of financing one's own home in Ireland, courtesy of our regulators (keen on talking about 'moral hazard'), all the special 'Working Groups' aiming to address the problems in the housing markets, and Nama. Remember - our Government (by now pretty much every minister in the cabinet) had sworn to us that Nama will restore functional banking. May be this is what they had in mind...

Last year I predicted that the game in the mortgages markets will play as follows:

• Once Nama starts transfers, incentives for the banks to play a Good Fella will diminish - repossessions will remain low, but rates will rise. We now can see this happening around us.
• Once Nama completes transfers, banks will go in earnest at rebuilding their margins & capital, meaning - repossessions will accelerate dramatically and rates will rise to the levels where the burden of financing mortgages will become a driver for more repossessions.
• 3-6 months after the above stage, banks will start hoarding repossessed property on their books. They will be forced to start selling it ca 6-9 months after February 2011 (completion date for Nama purchases).
• Combined effect of massively more expensive mortgages credit and inflow of repossessed properties into the market will drive prices in housing markets even further down.
  

So far, we are through the 1st bullet point and getting closer to the second one.

Meanwhile, in the land of short term loans, rates are more steady and credit supply is falling gently.
Now, let me ask you this question. What should be the priority here? Making sure people are not being skinned to pay for their homes, or making sure that credit cards rates and car loans are being underpinned by more stable interest rates?

Credit to non-financial corporations is continuing to slide. Year on year, shorter term (working capital) credit is now off a massive 19.3%. Longer term credit is off 2.7% yoy. What does this tell me about the economy?

1. Capital investment is going nowhere fast, with any rosy figures on volumes we might hear over the coming weeks being most likely driven by the MNCs own in-house investment flows; and
2. Companies have no capacity to refinance shorter term credit obligations, resulting in a cash flow pressures and lack of operating capital.

Not exactly a success story for our financial system administrators and regulators, then.

Economics 11/06/2010: Private Sector Credit data

Central Bank data released yesterday show Private Sector (non-financials) credit fell 9.3% in Q1 2010, to €355 bn. Total outstanding mortgages volume fell €1.2 bn to €146.4 bn. Two thirds of the total amount of credit decline came from writedowns on existing loans, which means that there is continued pressure on loans (keep in mind that Nama transfers are not yet in the data). Charts below update, as usual:
Aggregates first
Notice the rise of securitizations - banks shifting stuff off their balance sheets at an aggressive rate.
Chart above shows monthly flows. There is some improvement here, but absent seasonality corrections it is hard to say what exactly is going on. However, it does appear that the latest monthly transactions uptick is not in line with pre-crisis dynamics for Non-Financial Corps, but in line for Households:Year on year changes:
Clearly, yoy things remain bleak, although the rate of contraction is getting reversed for households. This is a seasonally consistent result, so I would not be reading too deeply into it.

Economics 02/06/2010: Central bank data analysis

Latest monthly data from the CB is out and here are a couple of updates on series I've been covering before.

First harmonized competitiveness indicators (EU-wide data update coming soon):
Notice some serious progression on competitiveness front is finally starting to take place. This is good. The trend is also good - strong downward trajectory in the series since November 2009. Accelerating again since March. Data lags should not be this significant, so I will be keeping a watch on earnings data from the CSO.

For all the good news, so far we are still in the zone of low competitiveness, down to March 2006 level and well above the period when Ireland Inc was performing at much stronger rates in the 1990s. Remember, these are real indicators, so price levels changes since the 1990s are factored in already.

Private sector credit. First the totals:
We are back to August 2007 levels and the fall rate is slowing down. Year on year change, subsequently, is flat at -9.3% same as in March. Too early to call it a recovery or even a full stabilization, as seasonality suggests that we might see some trend reversal in the short run. Remember, these are declines on already bottom-hitting 2009!

Next: mortgages.
Levels are down to July 2008 and the rate of decline is -1.6% yoy, compared to -1.4% in March. This, however, can be due to a significant declines in mortgages due to write-offs of defaulting loans. In addition, this deterioration rate might be also masking the fact that pretty much anyone in distress who could have done so has already re-negotiated their mortgages in 2009. Thus, only the really tough cases are still sitting out there.

The data on actual new borrowing is below. At the aggregate levels, there is no turn around in household investment, which, of course, is the main leading indicator of recoveries. Also worrisome is the fact that there is no deleveraging of mortgages debt.

Private sector credit outside mortgages is dynamically virtually identical to the total private sector credit figure reported above. Year-on-year changes seem to be reflective of some seasonal effects, with improved rate of contraction in April. General trend is for flatter rates of decline overall since about January. This means little, however, as we need a term structure decomposition of credit in order to tell if this is really a flattening of the downward trajectory or simply restructuring of non-performing lines of credit.

Now, let's take a look at actual changes in rates and volumes in PS credit. First, new loans:
Notice that both for corporates and households, longer term rates are moving up, while shorter term rates are moving down. This likely reflects banks' and interbank credit markets' expectation for a steepening in the interest rate curve, plus some easing in wholesale cost of credit in March. Also note that mortgage rates for new, and especially for fixed rates, mortgages are rising. Hardly a robust support for the housing market.

On corporate investment side, sizable declines for short term maturity loans - operating capital, and reasonably improving environment for larger investment-suitable loans with longer term fixes.

On volumes side, there is a worrisome increase in all shorter term loans - a sign that both companies and households are reliant increasingly on short bank finance for operational and short-term credit. This might mean two things:

1. These increases might reflect increase in supply against a pinned up demand; or
2. These increases might be consistent with increased cash flow pressure on companies (if non-payment and defaults by clients is rising) and households (if arrears are building up on the side of unemployed and underemployed after the households have gone through their savings and redundancies).

We can't tell which one of these forces is operative here. But it does not look to me like operational demand is rising naturally. Remember, so far we only have strong exports performance across the economy. This means you would expect an increase in trade credits (short-term). Most of trade finance in Ireland is actually not done via Irish banks, but through MNCs-own global arrangements. Apart from exports, it is hard to see where organic demand for short term loans would come from.

An even more interesting picture is emerging when we look at existing clients:
Notice how all of the rates changes (except for 5 year plus maturity corporate loans) are trending up? Are the banks ripping off their existent client base to beef up their margins? Well, lets put these changes side by side:
Notice that the above table comparisons are really only loose approximations. But there is a remarkable regularity with which existent loans holders are being loaded with the almost opposite type of changes in rates charged as compared with new clients.

Economics 19/01/2010: Irish banks - a rational model of risky strategies

I just came across a very interesting paper, written back in November 2007 and published by the Bank for International Settlements as a Working Paper No 238. Authored by Ryan Stever and titled “Bank size, credit and the sources of bank market risk” the paper “…examines bank risk by investigating the equity and loan portfolio characteristics of publicly-traded bank holding companies.” The study is based on the US banks, with sample being a panel of ‘at least 339 publicly trades BHCs at each point in time” for the period of 1986-2003. “These range in size from American Bancorporation at $31 million in book assets (200 employees) to Citigroup at $1.26 trillion (over 280,000 employees).”

“Unlike the pattern for non-financial firms, equity betas of large banks are two to five times greater than those of small banks. In explaining this, we note that regulation imposes an effective cap on banks’ equity volatility. Because the portfolios of small banks are less diversified, this cap has a greater effect on small banks than large banks.”

In other words, there is plenty of evidence that even when effective, regulators can induce some unintended consequences onto the banking system and that these consequences, if unaddressed can lead to systemic failures.

Here is how it works:

• Regulators (and/or shareholders through exercise of their voting rights) place a limit on the total volatility of each bank’s assets regardless of size, which tends to minimize bank risk; however
• Small banks have more idiosyncratic risk inherent in their loan portfolio “because they cannot diversify away idiosyncratic volatility as well as large bank” (practically – smaller banks are more specialized, making their loans books more exposed to idiosyncratic strategy risk).
• Smaller banks inability to diversify comes about in “a number of different ways – for example; less total loans held, less diversity in borrower type (they do not have access to large borrowers) and geographic restrictions (small banks tend to be more localized);

 Because their total equity volatility is limited by regulation smaller banks must then find a way to eliminate their idiosyncratic volatility that is in excess of larger banks’ idiosyncratic volatility. To do this, small banks do not necessarily pursue higher levels of equity capitalization or lending to different sectors in the economy – in other words, they do not strive to become like larger banks, but instead they either:

•  make loans with less credit risk than large banks (Swiss private banks, for example). This has the effect of reducing idiosyncratic volatility (as desired) and also reducing the beta of each loan (and thus the equity beta of small banks); or
• demand more collateral (e.g. Irish banks).
  

Of course, the problem with selecting the latter path (beefing up collateral) as opposed to the penultimate pathway (more conservative, risk-sensitive lending) – as Irish banks should have learned from the current crisis – leads to additional problem, not highlighted in the study. This problem is manifested in the selection bias induced onto collateral – smaller banks opting for higher collateral requirements will take on less diversified collateral that is more likely to be positively correlated with their own (risk-skewed) loans books. Thus collateral risk becomes positively correlated with loans risk.

Just think of what type of collateral Liam Carroll was supplying for his property development loans? You’ve guessed it – property-based collateral.

In fact, the study does find that small banks did not lower their equity volatility through lower leverage. Instead, “the reduced ability of small banks to diversify forces them to either pick borrowers whose assets have relatively low credit risk or make loans that are backed by relatively more collateral.”

Economics 02/11/2009: Central Bank Credit Data - Renewed Crisis Dynamics

So Irish Central Bank monthly data – out last Friday – provides some more fodder for thought about what is going on with credit flows in the country most dependent on ECB repo window (see here).

First consider the aggregates on money supply side:
This clearly shows that whilst M1 money supply has expanded by just under €3bn (or 3.4%) between August and September 2009, M2 money supply has contracted by over €4.1bn or 2.11%. The contraction is primarily driven by the decline in deposits with set maturity of up to 2 years which have fallen by a whooping €7.43bn or 7.9%. Part of this was probably used to deleverage shorter-term debt securities (up to 2 years in maturity) – which have declined by €2.66bn or just under 5.5%. But whatever happened with the rest of deposits is hard to explain out of the CB data. Deposits with medium term maturity constitute the most stable measure of future lending capacity in the credit sector and this decline does not signal much needed stabilization in future lending conditions.

Now to more detailed data on consolidated balance sheet. First, liabilities side:

The above chart clearly shows that all liabilities, save for Non-Government Deposits and Government Deposits with the Central Bank, are still trending up. Net external liabilities are certainly in reversion after June local trough and are now dangerously reaching for February 2009 crisis levels. Bad news?

Well, aggregates are showing something very similar:
Total liabilities are now in excess of the non-Government credit volumes once again for the second time this year. First this condition was observed in January-February 2009. Next, we have crossed once again to the situation of private sector credit falling below total liabilities in August 2009. September 2009 re-affirmed the trend as the gap between two time series widened to the second highest level in 2009 so far with January gap of €27.7bn and September gap of €22.0bn. So non-Government credit flows are no longer covering total liabilities… Bad stuff? Wait…
On the assets side, the above shows that save for Government debt which is converted through accountancy double-entry into Government Credit (up 77.9% year to date in September), not much else is rising, with fixed assets down 14% year to date, interest earnings on non-government credit down 49.6%, official external reserves up 11.35%.

On private sector credit decomposition:
Total private sector credit (PSC) has declined from the peak achieved back in November last year to current €378.1bn or 6.4%. This is dire and the decline is actually accelerating since beginning of September. Table summarizes:
The same is true for non-mortgage credit and mortgage credit. Importantly, the data on mortgage credit and non-mortgage borrowing shows that there is no deleveraging in sight for Irish households. Residential mortgage lending today continues to remain at well above the peak markets level for house prices. In 2007, average monthly level of mortgage debt in Ireland stood at €131.1bn. In September 2007, the level was €136bn or 8.83% below the latest level recorded in September 2009. Thus, as negative equity pressures continue to increase due to falling house prices and as rents continue to destroy yields on property, Irish mortgage holders are simply prevented from deleveraging in the credit cycle by falling incomes and rising taxes.

This does not bode well for the short-term prognosis for the Irish financial system (reliant heavily on low default on mortgages assumptions amidst a full blown meltdown of the development loans) and for the Irish construction sector and property markets (reliant on some sort of a return of the buyers to the collapsed market for properties). It also does not support any hope of the stabilization in the property-related tax revenues.
Hence, although credit contraction has set in firmly back in June (with credit to private sector posting negative growth in yoy terms since then), mortgages credit is lagging (implying that we are yet to witness true crunch on mortgages – something that is likely to happen once the banks set out in earnest to rebuild their margins by hiking mortgages rates post-Nama) and non-mortgage credit is back on the rise (potentially reflecting accumulation of credit arrears by financially stretched households).

The same picture, of building pressure on the arrears side can be glimpsed from the changes in trends for credit cards spending. New purchasing using credit cards has lagged repayments in January-August 2009. In September, more charges were incurred than paid down. The same (albeit on a vastly smaller scale) took place in business cards. Hence, balances are now rising across all credit card debts, as shown in the chart below.

Net result of all of this: outstanding indebtedness of Irish private sectors is no longer declining. The rate of growth in overall debt levels has hit 0 in May 2009, bounced back to positive territory in June-July 2009 and failed to hit negative (deleveraging territory) since then.

The cost of Ministerial chatter: Irish credit ratings

After a week of incomprehensible gibberish coming out of the Government statements on:

• borrowing restraints (here);
• receipts shortfalls (here and here);
• 'painful' solutions (aka destruction of private sector economy via fiscal policy - here);

and months of policy wobbles, two things came to their logical conclusion today.

The first one - reported (for now in very oblique terms - I will put more flesh on it when the embargo on the documents I received expires) here.

The second one - the S&P downgrade of Irish sovereign credit ratings.

Now, S&P is not known for being the quickest or the sharpest analysis provider on the block (I wrote about the need for a downgrade for some three months now), but at last they have moved, if only a notch, lowering Ireland's ratings from AAA to AA+ and retaining negative watch outlook (meaning more downgrades await).

I was neither surprised nor impressed by the S&P statement:

"March 30 - Standard & Poor's Ratings Services today said it had lowered its long-term sovereign credit rating on the Republic of Ireland to 'AA+' from 'AAA.' At the same time, the 'A-1+' short-term rating on the Republic was affirmed. The rating outlook is negative"

So far so good. Except in my view, a combination of the depth of our crisis, the severity of our economic policy failures and the lack of realism on behalf of this Government, pooled together with Cowen's unwavering determination to 'soak the rich' (middle and upper classes) to protect his cronies in the public sector - all warrant at the very least a downgrade to an A level. Given the structural nature of our deficits and Cowen's willingness to flip-flop on policy - an A- rating will be also justifiable.

Ok, back to S&P statement: "The downgrade reflects our view that the deterioration of Ireland's public finances will likely require a number of years of sustained effort to repair, on a scale greater than factored into the government's current plans," Standard & Poor's credit analyst David Beers said. As I said - lack of realism on behalf of the Government is costly. I have mentioned some recent evidence I got from the Partnership Talks (here). Telling... But what is also telling is the shade of realism that is being brought to the policy discussion table by the S&P, which is completely missed by the quasi-state ESRI (see here) who expect swift (2-3 year time horizon) action on closing structural deficits by increasing taxes.

The S&P is also referencing their belief that there will be further need for additional support for banking sector. I agree. And the Government has been boasting to the Partnership folks that it has resolved the banking crisis...

But here is a really good piece - bang on in line with what I've been warning about for a long time now. Despite our Government's senile belief that soon - a year or two from now - we are going to return to strong growth, S&P clearly states: "We expect that the Irish economy will materially under perform the Eurozone economy as a whole over the next five years, recording minimal growth in real and nominal GDP, on average, during the period. As a result, we believe that Ireland's net general government debt burden could peak at over 70% of GDP by 2013, a level we view as inconsistent with the prospective debt burdens of other small Eurozone sovereigns in the 'AAA' category."For comparison, here is the table from the DofF Junior Nostradamus's' January 2009 Update (below). This shows that our boffins are thinking we will be churning out 2.3% GDP growth in 2011, with 3.4% in 2012 and 3.0% in 2013...

Yeah, may be if we get Michael O'Leary to run this country...

"The medium-term prospects for the Irish economy are constrained by three interrelated factors: first, the impact on domestic demand as the private sector reduces its high debt burden, which stood at 280% of GDP in 2008; second, the scale of the deterioration of asset quality in the banking sector and possible need for additional capital; and, third, the support from external demand Ireland can expect as global economic conditions improve."

Ont the first point, I am again delighted that S&P decided to look beyond their naive insistence on focusing on public debt alone. Private debt mountains choking Ireland Inc (and soon to be added public taxation concrete weighing the economy down as we sink deeper into a recession) have been something I warned about for some time now.

On the second point, it is important to recognise that this Government has done virtually nothing to help repair the banks balance sheets and is not forcing households deeper into financial mess. Banking sector and real economy are linked.

• When a bank gets capital injection, but sees more mortgage holders defaulting because the Government has sucked their cash dry, what happens to banks assets?
  
• When a bank gets a deposits guarantee scheme at a cost to the system of €226mln since inception, but it costs the Exchequer twice as much due to higher cost of borrowing, what happens to the financial system's ability to provide credit finance?
  
• When a bank gets a promise to be rescued in some time in the future, but sees corporate deposits dry out today because the Government actually taxes companies (and sole traders) in advance of their receiving payments on overdue invoices, what happens to bank's capital?

Has Mr Lenihan bothered to take Level I CFA exams, he would have probably understood these brutal A-B-Cs of macrofinance. Alas, he didn't.

Now, next, the S&P avoids falling back into its comfort zone: "The government has already taken steps to contain the budgetary impact of these pressures, and further adjustments in taxation and spending, amounting to 2%-2.5% of GDP, are expected to be announced in next month's supplementary budget. At best, however, these measures will contain this year's general budget deficit to around 10% of GDP and lay the basis for a slow reduction in nominal budget deficits in future years. We are concerned, however, that a credible multi-year fiscal consolidation strategy will not emerge until after the next general elections, due by 2012. Accordingly, on current trends, we believe Irish net general government debt will likely exceed 70% of GDP by 2013 before beginning to trend downwards."

True that, as they say in the USofA. True that. Can you close your eyes and imagine Brian Cowen telling public sector unions that he is going to cut numbers of paper pushers employed in the public sector? or to trim their pay? or to eliminate our overseas aid budget? or to cut our defense spending by half to reflect the real might of our armed forces? or to privatize health care delivery (not access to services - delivery)? or to introduce efficient system of education fees? or that he will switch all public sector employees of age 45 and less into defined contribution private pension schemes? or that he will no longer automatically index pensions to already retired public sector workers to future wage increases in the sector? or that the corporatist model of centralized wage bargaining is done and over for ever? or that he will impose restrictions on striking activities in the public sector and will end job-for-life conditions of employment in the sector?

No? Neither do I. And neither does the S&P - at last.

Private Sector credit supply is being damaged by this Government

A recent working paper from the European Central Bank, titled "Modelling Loans to Non-Financial Corporations in the Euro Area" (ECB WP No 989/January 2009) provided a benchmark model for assessing the impact of twin shocks of increase in the policy rate (ECB main interest rate) and increase in the banking system risk premium on the supply of credit to non-financial corporations across the Eurozone. The authors, Christoffer Kok Sørensen, David Marqués Ibáñez and Carlotta Rossi showed that a 25bps increase in the headline interest rate "causes a reduction in bank lending of about 1.4%, 5.4% and 6.4% after 2, 5 and 10 years, respectively. A 20bp increase in the risk premium on bank lending rate reduces bank lending to non-financial corporations by about 0.6%, 4.0% and 5.1% after 2, 5 and 10 years, respectively."

Of course, the first experiment coincides fully with the ECB's reckless 25bps hike in rates between June 2007 and October 2008. The second, however, is even more dramatically important from the point of view of private credit availability. Between August 2007 and today, Irish bank's risk premia on lending to the banks has risen by some 300%, implying, under the ECB model, an expected drop in the credit supply to Irish non-financial corporations of ca 9-11% in 2009-2010, rising to a whooping 75-99% between 2009-2018.

Alternatively, between December 2008 and today, the average weekly CDS spreads on Irish Government bonds have risen some 160bps. Given our state's exposure to banks debts, this is a comparatively reasonable measure of the overall increase in the risk premium on banks lending. Thus, within the span of only 3.5 months, our expected credit supply to non-financial corporations has fallen by the estimated 5-6% for the period 2009-2010, 30-35% for the period of 2009-2013 and by 40-47% for the period of 2009-2018.

As I always said, Mr Lenihan should stop blaming the Americans for this crisis. And he should stop saying that there is no cost to the broader economy from his rushed general debt guarantee to the banks. Instead he should look at his Government's fiscal imbalances, wobbling decisions on financial sector rescue, blanket and unsustainable guarantees to the banks, appeasement of trade unions at the expense of the taxpayers, destruction of the private sector via higher taxation and charges, etc - in other words all the policies that undermine international markets' confidence in Ireland Inc. His policies, responsible directly for the rising risk premium on Irish Government debt are also destroying the private credit markets here. Not only today, but well into the future.