29/05/11: Who's to be blamed?

Here's an interesting chart based on ECB data for lending rates charged on various types of loans:
What does this hart tell us? Several interesting things:

1. In so far as the euro area retail rates are linked to the ECB rates, it appears that the lenders were factoring in a positive risk premium on Irish companies for large loans and small loans alike 9as reflected by the positive premia on corporate lending of both types). throughout the 2003-2010 period, Irish companies borrowings were priced at a risk premium relative to the Euro area average.
   
2. This premium has declined (bizarrely) for larger loans (as the risk of borrowers rose during the crisis, the premium fell) and it rose for smaller loans (presumably the SME effect - with SMEs being more risky as borrowers in the crisis).
3. On the net, it is hard to make an iron-clad case that ECB was driving over-lending to Irish corporates, as these corporates did face a risk premium on their borrowings.
4. Where things really break down is in the housing mortgages lending. Here, there was and remains a deep discount on Euro area average when it comes to Irish lenders rates. Only during 2010 did this discount briefly turned to a premium. The trend is still on an increasing discount, which would be consistent with a lenders' perception that Irish house purchasers are lower risk than Euro area average. Which, of course , is a farce.
5. So the net result is that it is hard to make a real direct case that the ECB reckless interest rates policy was the sole or the main driver of Irish over-lending. Instead, the evidence suggests that it was our own lenders' (banks) enthusiasm for underpricing risk in housing finance that was at pay consistently before the crisis onset and since then.
   

Economics 15/06/2010: Negative equity 3

Here is the third and last post in the series on negative equity based on my TCD speech (see here).

Rising negative equity has implications for financial stability:

Domestic mortgage lending by the major banks represents over x5 times their core Tier 1 capital in the UK and roughly 10 times in Ireland. Even post disposal of its assets (assuming rosy valuations), AIB’s multiple will be over x11 of its risk-weighted assets. BofI – x7-8. And these are the better ones of the Irish banking lot. In addition, around 40% of all outstanding UK mortgage debt has been used to back securities.

Large losses on these mortgage loans and associated securities can erode banks’ capital positions, affecting both lenders’ willingness and ability to lend and, in extreme cases, their solvency.

Both of the above effects can have implications for aggregate demand and the supply capacity of the economy, highlighting the interdependency of financial stability and monetary policy. Again, in the case of Ireland, the two effects are reinforced by the large exposure of the Exchequer to banks balancesheets and to the property markets.

The defining feature of the materialised losses, and their associated economic effects, is the value of debt at risk (loss given default) and the coincidence of that with the probability of default.

Rising negative equity has implications for loans default probabilities:

In economic literature, negative equity is a necessary condition for default to occur since borrowers with positive equity can sell their house and use part of the proceeds to pay off their mortgage. Transaction costs (high in Ireland) and transaction lags (also extremely long in Ireland) act to further increase this effect. For example, a household with positive equity of ca 10% will still trigger a partial default on the mortgage if it takes a year to close the sale (8% funding opportunity cost per annum) and if closing costs add up to 2% of the sale price.

However, negative equity is not a sufficient condition for default to occur, as discussed in “Negative Equity and Foreclosure: Theory and Evidence” by C. Foote, K. Gerardi and P. Willen (June 05, 2008, FRB Boston Policy Discussion Paper No 08-03). Similarly, in the UK, May and Tudela (2005) find no evidence that negative equity increased the likelihood of a household experiencing mortgage payments problems between 1994 and 2002, although their sample does extend over a lengthy period of robust economic growth and rising incomes. The latter two aspects of the sample are not present in today’s Ireland.

But, as Heldebrandt, Kawar and Waldron (2009) highlight, “if a household is experiencing difficulties meeting their mortgage payments, negative equity can increase the probability of default by reducing the household’s ability to make payments by preventing equity withdrawals.” Benito (2007) found that households are more likely to withdraw equity from their homes if they have experienced a financial shock. Negative equity can affect a household’s ability to do that because of credit constraints.

Furthermore, negative equity can increase the probability of default by reducing household’s willingness to make mortgage payments, since defaulting can reduce the debt burden of the household. In Ireland, despite our anachronistic bankruptcy laws, this option is still available for anyone willing to emigrate. You might as well call this www.book-your-one-way-ticket.ie effect, as households leaving Ireland fleeing bankruptcy will have:

1. a very strong incentive to emigrate; and
2. a very strong incentive never to return for the fear of debt jail.

Negative equity may significantly increase the probability of default of buy-to-let mortgages over and above that of owner-occupiers as costs of defaulting on a buy-to-let mortgage may be lower because defaulting does not lead to loss of residence. In addition, buy-to-let mortgages are, at least in some cases, registered via businesses, implying no recourse on family homes and wealth.

Overall, available economic evidence does suggest that negative equity plays a significant role in mortgage defaults:

• Coles (1992) presents results from a 1991 survey of lenders in which a high LTV ratio was frequently noted as an important characteristic of borrowers falling behind in meeting their mortgage payments.
• Brookes, Dicks & Pradhan (1994) and Whitley, Windram & Cox (2004) find that a reduction in the aggregate housing equity in the UK was associated with an increase in arrears.

Overall, Heldebrandt, Kawar and Waldron (2009) conclude that “evidence suggests that the level of household defaults, and the impact of negative equity on financial stability, is likely to depend on conditions in the broader macroeconomic environment”. And Ireland is at a clear disadvantage since the combined macroeconomic shocks (decline in GDP/GNP, rising unemployment and contraction in private sector credit) are much more severe here.

Rising negative equity has implications for the size of the expected banks losses:

When bank borrowers face negative equity, as probability of default and the value-at-risk in default rise, banks have an incentive to stave off the actual mortgage default. To do this, banks engage in:

• Renegotiations of covenants (loans extension, provision of a grace period, interest only repayments etc)
• In extreme cases – joint equity ownership in asset (though banks will usually engage in this type of transactions under regulatory duress)
  

All of these measures aim to put the borrower into a position to eventually repay the loan in full.

However, in cases where default in unavoidable, the loss to be realised by the bank on any given loan depends on the recovery that can be achieved if the borrower defaults. Negative equity, or positive equity that does not exceed the sum of the cost of carrying the loan during the sale, plus the cost of sale, will imply a net loss on the default. From the bank point of view, the problem is not in the actual level of individual defaults, but in the combined level (aggregate) of negative equity net of costs and recovery values.

Such net losses impact not only the actual mortgage book, but also securitised pools that can be held off balance sheet, as current negative equity puts at risk future revenue against which the book is securitised. The end result on mortgage backed securities side is to reduce the value of MBS asset and, as Heldebrandt, Kawar and Waldron (2009) point out this can induce a second order effect of changing risk perceptions and investors’ sentiment “regardless of the actual performance of any given portfolio of loans”.

Both types of losses lead the banks to record write downs on their mortgage books and securities held. If these are large enough, banks’ capital ratios will be reduced.

In the case of Ireland the problem is compounded as the banks are actively delaying recognition of losses on negative equity. These delays mean that banks are likely to pay elevated costs of external funding over longer period of time. In addition, these delays lead to losses compression – the situation where banks recognize significantly larger volumes of impaired assets later in the crisis cycle. Bunching together losses creates a much more dramatic investors’ loss of confidence in the bank.

In addition, negative equity-driven impairments, plus delayed recognition of such impairments lead to suboptimally high demand for capital from the banks. If this coincides with the period of severe credit crunch, monetary policy aimed at increasing economy-wide liquidity flows can become ineffective, as banks park added liquidity on their balance sheets, creating a liquidity trap. This is evident throughout the crisis, but by all possible monetary policy metrics, it is much more prevalent in Ireland, where even today credit available to the private sector continues to contract. Irish banks are hoarding liquidity and are raising lending margins to offset expected, but undisclosed writedowns. This problem is compounded by Nama which induces greater uncertainty onto banks balance sheets through its hardly transparent or timely operations.

Negative equity and generational asset gap:

In Ireland, the problem of negative equity is further compounded by the generational spread of negative equity to predominantly younger, more productive and more mobile (absent negative equity) households. These households today face higher probability of unemployment (thanks to our unions-instituted and supported ‘last in – first out’ labour market policies). They also much deeper extent of the negative equity because of higher cost of financing their original mortgages and entering the housing market.

The generational effects of negative equity are compounded by geographic distribution of the phenomena – with younger households being more likely to reside in the areas of excess supply of new housing, with poor access to alternate jobs, should they experience unemployment.

Finally, it is the younger households that are subject to twin effects of higher probability (and deeper extent) of negative equity and depleted savings (due to high cost of entry into the housing market). This implies that it is the very same households which have the greatest incentive to engage in precautionary savings motive.


So traditionally, economies grow by:

• encouraging the young to acquire new assets (invest and save); and
• encouraging the old to consume (divest out of savings).

With negative equity, Nama and pressured banks margins, Ireland is:

• forcing the better (more productive today and in the future) young to emigrate;
• keeping the remaining young deep in the negative equity (neither capable of investing in the future, nor of moving to find a lost job today);
• underwriting - at the expense of younger, tax paying generations - continued excessive provision of pensions to retired public sector workers;
  
• forcing younger families to cut deeper and deeper into their children education budgets and own training and education funds in order to assure they continue paying on the asset that will never have net positive return on investment; and
• incentivising the old to remain in their highly priced (if only rapidly losing value) homes backed by slacked consumption due to inability to monetize their pensions savings.

In what economics book is this scenario better than any moral hazard problem that can be incurred in the short run by reforming our bankruptcy system to an American-styled 'restart' button?

Economics 15/06/2010: Negative equity 2

This is the second post of three consecutive posts on the effects of negative equity in Ireland.

Negative equity can lead to a reduction in consumer spending, collateral & credit

This can take place via four main pathways:

1. Housing equity can be used as collateral to obtain a secured loan on more favourable terms than a loan which is unsecured. This channel for lower cost financing is cancelled out by the negative equity.
2. Falling collateral values may also affect the cost of servicing existing mortgages if borrowers have to refinance at higher interest rates when their existing deals expire (eg when exiting temporarily fixed-rate or tracker mortgages). That would reduce income available for consumption, which may further reduce demand.
3. Households on adjustable rate mortgages are facing additional pressure of higher banks margins. Since vintages of many ARMs are coincident with 2005-2007 period, negative equity has direct and significant impact on them. Nama exacerbates this impact by forcing banks to up their margins on performing loans, pushing more and more households into not just negative equity, but virtual insolvency.
4. Fourth, falling values of housing equity also reduce the resources that homeowners have available to draw on to sustain their spending in the event of an unexpected loss of income (eg due to redundancy, illness or a birth of a child). By reducing the value of housing equity, falling house prices may lead some homeowners to seek to rebuild their balances of precautionary saving at the expense of consumer spending and investment.
   

Note that precautionary savings are held in highly liquid demand deposits – a fact that I will use below. In general, households with high amounts of housing equity may not respond much to falling house prices, because their demand for precautionary savings balances may already be satisfied through their positive net worth balances on the house. Households with low or negative equity have an asymmetrically stronger incentive to save in a form of short-term deposits.

Rising negative equity can also result in a reduced supply of credit to the economy as a whole:

Negative equity can raise the loss that lenders would incur in the event of default (loss given default) and the probability of a loss. That can make banks less willing or able to supply credit to households and firms.

Per Benford and Nier (2007) Basel II regulations, which require banks to hold more capital against existing loans when their anticipated loss given default rises, can reinforce that.

If credit is more costly or difficult to obtain, households and firms are likely to borrow less, leading to lower demand through lower consumer spending and investment. This, in turn, can lead to reduced business investment.

Expectation hypothesis suggests that negative equity effects on willingness to borrow and lend can extend beyond those immediately impacted as other households anticipate their own asset value decline toward negative equity.

Blanchflower and Oswald (1998) paper showed that a reduction in credit availability may also have some effect on the supply capacity of the economy by reducing working capital for smaller businesses and the capital available for small business start-ups. In addition, a recent (June 2009) paper “Reduced entrepreneurship: Household wealth and entrepreneurship: is there a link?” by Silvia Magri, Banca d’Italia, published by the Bank of Italy (Working paper Number 719 - June 2009) shows that negative house equity can result in reduced entrepreneurship, as many new businesses are launched on the back of borrowing secured against primary residencies or other real estate assets.

Rising negative equity can also result in a reduced household mobility:

Negative equity can affect household mobility by discouraging or restricting households from moving house. Two fathers of behavioural economics, Tversky and Kahneman (1991) argued that households may be reluctant to move because they would not wish to realise a loss on their house. Notice, that our so-called ‘smart’ politicians often claim that negative equity is never a problem unless someone wants to move. Actually, it is a problem even if someone does not want to move, but has to move because of their changed employment or family circumstances.

Tatch (2009) shows that a household in negative equity would be unable to move if they were unable to repay their existing mortgage and meet any down payment requirements for a new mortgage on a different house. This is even more pronounced in Ireland due to the nature of Irish bankruptcy laws.

Hanley (1998) shows that the effect of negative equity on mobility were quantitatively significant during the early 1990s in the UK. The paper estimates that of those in negative equity in the early 1990s, twice as many would have moved had they not been in negative equity. The paper argues that reduced household mobility leads to a reduction in the supply capacity of the economy by increasing structural unemployment and reducing productivity.

Reduced household mobility implies a reduction in the number of households moving home. This can have adverse implications for tax receipts, spending on housing market services and certain types of durable goods as highlighted in Benito and Wood (2005). So as negative equity increases, tax revenues and economic activity in the housing sector and associated white goods sectors falls.

15/06/2010: Negative equity 1

Yesterday, I gave a speech at the Infinity Conference in TCD on the issue of negative equity (see newspaper report here). The following three posts (for the reasons of readers' sanity) reproduce the full speech.

What effects can negative equity have in the case of Ireland?

I did a troll of the literature on negative equity and below I summarize the main findings, relating some to the case of Ireland.

Broadly-speaking there are three dimensions through which negative equity can have an effect on Irish economy:

1. Macroeconomic channels via negative equity impact on aggregate supply and demand;
2. Monetary channels which lead to negative equity impacting adversely banks balance sheets and increasing the cost of default and probability of default for mortgage holders; and
3. Growth channels, which relate to the adverse effects of current negative equity on future demand and investment, and directly on growth.

Here are more detailed explanations of these channels.

Why the problem of negative equity is likely to be greater in Ireland than in the UK

A forthcoming paper “House Price Shocks and Household Indebtedness in the United Kingdom” by Richard F. Disney (University of Nottingham), Sarah Bridges (University of Nottingham) and John Gathergood (affiliation unknown), to be published in Economica, Vol. 77, Issue 307, pp. 472-496, July 2010, used UK household panel data to explore the link between changes in house prices and household indebtedness. The study showed that borrowing-constrained by a lack of housing equity households make greater use of higher cost, higher risk unsecured debt (e.g. credit cards or personal loans). Crucially, when house prices revert to growth, “such households are more likely to refinance and to increase their indebtedness relative to unconstrained households”.

These effects – present in the case of the UK – are likely to be more pronounced in the case of Ireland, because Irish households which find themselves in negative equity today experience much severe deterioration in their net worth base due to the following factors:

• Majority of Irish households have been forced to front-load property taxes into their purchase costs and often mortgages. Thus average LTVs are more likely to be higher here in Ireland, for more recent mortgages vintages, than they were in the UK.
• Ireland has experienced a much more severe contraction in house values than the UK to date.
• Because of significantly higher entry-level taxes, younger buyers in Ireland had to be subsidized more heavily by their parents than their UK counterparts, implying that once true levels of indebtedness are factored in, real mortgages and debts held against a given property of more recent purchase vintage might be higher than those recorded on the official mortgage books.
  

In many cases – we do not know how many, but anecdotal evidence suggests quite a few – credit unions and building societies, as well as non-mortgage banks were engaged as sources of top up loans to younger buyers, implying that once again the true extent of house purchase-related debt in Ireland, for younger households, might be higher than official records on mortgages suggest.

Another recent study, titled “The Economics and Estimation of Negative Equity” by Tomas Hellebrandt, Sandhya Kawar and Matt Waldron (all Bank of England) published in Bank of England Quarterly Bulletin 2009 Q2 looked at the effects and extent of negative equity between Autumn of 2007 and the Spring of 2009. Over that period of time, nominal house prices fell by around 20% in the UK, suggesting that negative equity impacted around 7%-11% of UK owner-occupier mortgage holders by the Spring of 2009.

By now, in Ireland:

• house prices fell down ca50% already (accounting for the swings in terms of premium to discount on asking prices – by closer to 55%),
• vintage of many purchases was much closer to the peak valuations, so
  

for Ireland, estimated negative equity impact is now around 35-40% of the mortgage holders.

Extent of negative equity here is compounded by:

1. High entry costs into the homeownership (100+% mortgages due to stamp duty costs and poor quality of real estate stock);
2. Lax lending – cross-lending by banks and credit unions and building societies;
3. Hidden nature of some of borrowing – parents’ top ups etc;
4. Coincident borrowing – with younger households being more likely to engage in borrowing for a mortgage, while borrowing for car purchase etc.
   

BofI, which holds ca 25% of all mortgages in the country (about 190,000) has reported that of these, more than 20% were already in negative equity (over 40,000) around the beginning of 2010.

The aforementioned Bank of England paper provides a good starting point for outlining the set of adverse impacts that negative equity can have on the Irish economy.

Negative equity can have implications for monetary policy:

A rising incidence of negative equity is often associated with weak aggregate demand as households in negative equity are more likely to cut their expenditures across two channels:

• due to reduced marginal propensity to consume out of wealth; and
• due to increased marginal propensity to save.

The direction of causation is not always obvious, implying a possibility of feedback loops – as households experience (or even anticipate) negative equity, they start reducing their borrowing against depreciating assets, the effect of which is amplified by the banks reduced willingness to lend against such assets. In addition, households rationally interpret these declines in today’s wealth as declines in future wealth, implying greater exposure to pensions under-provision in the future, plus greater exposure to the risk of sudden collapse in earnings (due to, say, unemployment or long term illness). As the result, these households tend to reduce their consumption today and in the future.

The reduced consumption leads to a loss of revenue to the exchequer and thus to additional pressures on future public pensions and benefits provision. This, in turn, leads households to further tighten their belts and attempt to compensate for the risk of reduced future benefits by lowering consumption exposures today.

Negative equity tends to become more prevalent when house prices fall, which usually reflects weak demand for housing, since housing supply is fixed in the short term. In the case of Ireland, this is compounded by the fact that we have severe oversupply of properties in the market. Demand effect, therefore, reinforces supply effect. Once again, in Ireland there is one more additional channel of induced market uncertainty due to Nama operations.

Weak housing demand often coincides with weak consumer demand in general, due to

1. reduced availability of credit to consumers and potential home buyers; and
2. precautionary savings as households respond to decline in their nominal wealth.

If negative equity leads to a further contraction in the availability of credit to both households and firms, as in Ireland – exacerbated in the case of Ireland by Nama – second order effects reinforce first order effects.

Lastly, as negative equity in Ireland is coincident with construction sector bust, we have twin effects of decreased households’ mobility and increased unemployment. This once more reinforces the uncertainty levels in the markets for housing, implying that risk-adjusted negative equity becomes even more pronounced here.

Economics 29/04/2010: House prices peak to peak cycle

Back in October last year I did an estimate, based on the IMF model, of the peak-to-peak duration of the current housing slump. Now's time to do some updating on this matter.

Assumptions:

• Peak to trough correction in real prices of -40-43%;
• Growth rates - resuming in 2011: 2011-2013 +3.6% - in excess of the long-term growth rate estimate for Ireland in the current GFSR (2.6%), slowing to 3% in 2014-2016, then to 2.7% in 2017-2019 and 2.6% thereafter.

Using peak of Q2 2007 to assumed trough in Q3 2010, we have the full cycle duration of between 95 and 87 quarters, taking us back to 2007 peak by either 2029 or 2031.

If bottom hits at -48%, we get return to 2007 peak by 2034, with 107 quarters from peak to peak cycle.

Now, think Nama will run out in 2015? or 2020?

If Nama sets shut-off date in 2015, it is likely to get between 61 and 70 cents on the euro for each value underlying the loan. Assuming loans LTV of 70% and default rate of 30% on loans transferred to Nama (extremely conservative assumptions, but these allow a cushion on some interest collected), the value of Nama realized book will be 26 cents on the euro and 30 cents on the euro, or less than 50% of the post-discounted price paid!

If Nama shuts down in 2020, the above two figures will be 30 cents and 34 cents on the euro paid or just around 50% of the post-discounted price paid!

Now, that's what I would call overpaying for the loans.

Economics 14/12/2009: Nama comparatives

It was an honor today to speak on the issues of Nama and the future of Irish development and construction sectors at the gathering of a number of architects put together by FKL Architects (see the site here). The panel that I was a part of was very engaging and, despite my disagreement with some of its members on the matters of policy, very informative. And the event, highlighted at the above site, was very interesting and engaging - some cool ideas out there, at least to my non-professional eye.

After the event, I was exchanging a couple of views with the representative of our construction sector, who agreed with my prediction that by the end of this crisis, Irish construction sector will shrink to no more than 5% of GNP or just 20% of its pre-crisis peak. And that the risk is for our construction sector to remain at that level (instead of rising to a healthy 10-12% level) for a very long period of time.

Alas, something else has driven me to a realisation that anyone who is hoping for stabilization of our property values at their current (or near) price is inhabiting an invented reality. This:
Now, think of this...
A four-bedroom, two-bath brick historic federal in Little Falls, N.Y., a city of about 5.000 on the Erie Canal, is on the market for $250,000, the house was built in 1827 and is on the National Register of Historic Places.
Off the house's center hall are east and west parlors. Both have fireplaces.
Though it has been renovated several times over the years, it retains some original details, including mantels, and some pine and chestnut flooring.All four bedrooms are on the second floor, two with original pine and chestnut flooring and one with a fireplace and a walk-in closet.

Ok... I can go on and on, but... check it out for yourselves here. And all for €170,000 in one of the wealthiest states of the nation that is the wealthiest on planet Earth.

My prognosis - median price in Ireland in real terms (2009 Euros) of €120,000 by the end of this crisis. Why? Because there is no reason why our average homes should be trading above 4bed historic properties in upstate New York. None.

Economics 27/10/2009: Recessions, Busts and Crunches

I am back from a very enjoyable (as always) trip to Paris and some 150km beyond. Superb retrospective of Pierre Soulages' work in Pompidou - a real master of true dynamism. A mouthwatering Hans Hartung print (some examples here) and two lovely Soulages' prints as well - all in my favorite gallery Paul Proute SA - were hard to resist, but given we are in a depression, while the French art market seems to be only in a recession, judging by prices, resistance was a-must.

One telling tale - at a lovely dinner with a small group of friends in the countryside, conversation took a quick turn to corrupt politics. Our French hosts were lamenting about the state of their country politics by pointing to a scandal surrounding Nicolas Sarkozy's plans to appoint his failed-lawyer son to head the Epad, the development corporation of La Défense (see a note here). Epad is a state-sponsored body and the French nation was literally lifted to its feet when nepotist Sarko tried to push his baby-faced offspring into the CEO seat. In return, I recalled for our friends the story of Bertie Ahearne arrogantly telling the nation that he gave state jobs to his cronies not because they provided him with money but because they were his friends. My French hosts couldn't believe that such a statement did not cost Bertie his job leading to years of public investigations and pursuits through courts. Nor could they believe that Bertie's friends are still, mostly, in their places of power.


Now, a couple quick notes relating our own troubles.

Stijn Claessens, M. Ayhan Kose and Marco E. Terro have published their excellent paper "What Happens During Recessions, Crunches and Busts?" (I wrote on it before based on the working paper version here) in Economic Policy, Vol. 24, Issue 60, pp. 653-700, October 2009. Here are couple interesting illustrations:
So per above, combined duration of contractionary segment of the credit crunch and housing price bust can be expected (on average) to last approximately 30 quarters (timing the current Irish crisis to last from Q1 2008 through Q2 2015 if the rate of house price bust and credit contraction here in Ireland was close to an average of the countries surveyed by the paper).

The latter 'if' is a serious assumption to make. Claessens, Kose and Terro show that the average bust/contraction is associated with a roughly 18% fall in credit supply and 29% decline in house prices. Of course, in Ireland, we are already seeing a 70% decline in credit supply and a 40-50% decline in house prices. So make a small adjustment - back of the envelope - to account for these and you get expected the current contraction/bust crisis to last more than 52 quarters, taking us well into the beginning of 2020 before the recovery truly takes hold.

And this dynamic is seemingly also in line with Claessens, Kose and Terro data on the impact of crises on GDP. 2008-2010 Irish GDP is expected to fall by some 13.5-15%. This is approximately 2.5 times the depth of the average adjustment associated with credit crisis and house price bust per Claessens, Kose and Terro, as illustrated in their chart reproduced below:
Oh, and for those 'advisers' who are telling Minister Lenihan that Ireland will recover from this crisis along the same trajectory as the 'average' OECD economy (the same advisers who are talking of 8-year cycles in property prices), here is how average Irish crisis is compared to the rest of the modern world history:
Only 4 countries so far have experienced a combination of Asset Price Bust + House Price Bust + Credit Crunch.


My second note of the day is about the effectiveness of fiscal spending as 'get-us-out-of-recession' stimulus. Given that the Government is now pre-committing itself to not cutting public sector pay, it is worth quickly mentioning that the Unions-supported idea that cutting public expenditure is only going to make our recession worse is simply untrue. A recent (July 2009) note by Fabrizio Perri of University of Minnesota, Federal Reserve Bank of Minneapolis titled "Comment on: Planning to cheat: EU fiscal policy in real time by Roel Beetsma, Massimo Giuliodori and Peter Wierts" provides an estimate of the fiscal expenditure multiplier for European economies. The number is 0.85... or, significantly less than 1. This suggests that cutting public spending will lead to a proportionately smaller reduction in GDP than the savings to be generated.

Here is an additional (excellent) note on the whole mess of fiscal multipliers. Adding to this, one has to recognise that Irish public spending is far less effective as a stimulus to the economy, as it is accounted for (to the tune of 70% of the total expenditure) by social welfare and wages - i.e. non-productive components. Thus, one can expect the above 0.85 multiplier estimated for Europe as a whole to be around 0.26-0.0.29. Which, in turn, means that any fiscal contraction in today's Ireland will likely result in a medium-term expansion of our economy. Then again, we already know this much from the 1980s experiences, don't we?

In reality, of course, taxing private economy amidst credit and asst price crises to continue wasting money on the current public expenditure is a sure way to extend and to deepen the recession, as:

• Our public expenditure level was not sustainable for this economy even at the times of growth, let alone at the time of a severe recession;
• Ireland is now likely to be on a path of permanently lower post-crisis potential GDP/GNP growth, so the cuts in public spending will have to take place no matter what delay in public expenditure adjustment the unions will force onto this Government;
• We are facing the fastest and the longest increase in public debt (ex-Nama) in the OECD over the next 5 years and an additional open ended liability under Nama, both of which make it virtually certain that Ireland will emerge from this crisis as a fully insolvent nation.