26/9/2013: Even with Hopium injections, we are not that far from Greece...

Irish Fiscal Council paper "The Government’s Balance Sheet after the Crisis: A Comprehensive Perspective" authored by Sebastian Barnes and Diarmaid Smyth is an interesting read.

The paper sets out a strong promise: "While discussion often focuses around the debt-to-GDP ratio as referenced by the EU Stability and Growth Pact, the reality is far more complex. This paper takes a comprehensive look at the Government’s balance sheet following the financial crisis. This involves assessing assets and liabilities of the General Government sector, off-balance sheet contingent and implicit liabilities as well as the wider public sector."

Alas, the side of the assets equation is a bit wanting...

While it is good to see the broader approach taken by the authors to the problem of fiscal sustainability of public finances in Ireland, too often, broadening of the coverage of the crisis-impacted sovereign balance sheet slips into the stream of extolling the riches of state-owned assets, whitewashing the liabilities using imaginary assets. The paper does not do this. Which is good. However, the paper is still creating loads of confusion because it provides no clear tabulation of the assets and the way they are accounted for in the analysis.

Instead of a concise tabulation, assets analysis is presented in two parts, both overlapping. This makes it nearly impossible to disentangle what the authors include where and to what specific value.

Let's start from the top:

Per authors: "General Government financial liabilities have increased four-fold since 2007, reaching €208 billion (127 per cent of GDP) in 2012. Over this period, Ireland experienced the largest increase in the debt-to-GDP ratio of any Euro Area country." Yep. Nothing controversial here.

"The Government has substantial holdings of financial assets. These increased modestly over the same period to reach €73 billion (45 per cent of GDP) in 2012. The main assets are cash balances, holdings of semi-state entities and investments in the banking sector."

Now, that's a bit of a statement, in my opinion, open to questions.

Firstly, it creates an impression that most of the assets Government has are liquid. Not so, in my view.

Secondly, it creates an impression that the Government has a functional power to seize these assets. Also a bit of stretch in my view.

Thirdly, is suggests that even if individually liquid and recoverable, these assets can be sold in the market or used as collateral in the case of distress. Again, not something I would agree with.

The authors conclude that "The Government’s net financial assets (NFA), subtracting financial liabilities from financial  assets, gives a broader measure of the financial position of government. NFA have  declined from a position of balance in 2007 to a net liability of €135 billion (82 per cent of GDP) in 2012. Using this broader measure, the Irish government was the third most indebted country in the Euro Area in 2012 (as a share of GDP)."

I am not so sure that EUR73 billion is the real number we should be using in computing Government net financial position. My gut feeling is that we are lucky if we can count EUR50 billion in somewhat liquid and accessible funds. And even then we are at a stretch. With that, our Government's net financial assets position rises to a  deficit of 95-96% of GDP and this means that we are now challenging Greece to the Euro area's title of the second most-indebted country. And that is before Greece Bailout 3.0 which will probably result in some sort of a debt write down for the Greeks (see here:http://english.capital.gr/News.asp?id=1877516) even if small.


Here are some details on my sceptical assessment. The paper lists the following Government 'assets' (comments outside quotation marks are obviously mine):

(A.) Shares and Other Equity. "This broad asset category was valued at €24 billion. It includes: (1) the value of semi-state assets, including the equity of General Government in the Central Bank; (2) a portion of the NPRF; and (3) other equity
holdings." (1) is at least in part imaginary. The valuations of semi state companies are 'hoped for' and are not tested in the market. They also do not account fully for the shortfalls in pension funds and the knock on effects to any purchaser of equity in these companies from the role these pension funds play in running the companies' strategies. They also ignore the fact that with transfer of ownership, the semi-states are unlikely to continue enjoy state protection of their dominant market positions. All in, (1) covers EUR12 billion of semi-states equity, plus EUR2 billion of balances in the Central Bank - of which, my guesstimate is, no more than EUR5-6 billion is recoverable. The authors state clearly that "Considerable uncertainty, however,surrounds the value of these assets." per CB reserves, these are euro system money and I wonder how much of this even technically belongs to the Irish state. (2) covers NPRF-held equities and banks shares. Equities component is small, with total EUR9 billion in NPRF 'assets' accounted for mostly by banks shares (excluding preference shares). National Accounts assign EUR11 billion to the total Government holdings of banks assets. These valuations are off the mark, in my view, as the only value of the banks (ex-Bank of Ireland) today is the value of capital injected into them, net the losses they will sustain on mortgages. The rest is awash on revenue side v cost side. At any rate, these assets are not exactly liquid and if released into the market in any appreciable quantity will cause severe dilution of their value. All-in, say EUR9-10 billion of this 'stuff' is a hoped-for value in any scenario of sovereign distress.

Bit (3) above: 'Other equity holdings' "valued at approximately €3 billion. This includes the value of direct holdings of bank equity by the Exchequer, investments in the insurance sector and capital contributions to the European Stability Mechanism." Seriously? We'd get a rebate on ESM contributions? Insurance sector 'investments'? Shave off some EUR1 billion here for a dose of realism.

(B.) Currency and deposits. "The Government holds a substantial amount of relatively liquid  assets, which are managed by the NTMA. These were valued at €24 billion at end-2012. This figure includes cash balances held by the Exchequer (€18 billion), local government (€1.4 billion) and cash balances held by other Government bodies(such as the NPRF)." Can the Government expropriate the funds belonging to local authorities? Legally and actually? Can the Government capture all balances held by the Government bodies? May be. May be not. Surely it depends on contractual obligations of these bodies and the nature of assets? So suppose that EUR2.4 billion of the above is not subject to capture/recovery.

(C.) Amongst gloriously liquid Irish Government 'assets' the paper (and it is accepted methodology, I must say, which of course doesn't mean it makes any sense beyond purely theoretical exercise) list: "Loans and Other Assets(such as Accounts Receivable). This category was valued at €15 billion and includes a broad range of assets, namely loans from the Housing Finance Authority (HFA)(€4 billion), other Government loans,tax accrual adjustments (mainly VAT and PAYE (€3 billion) and a range of smaller assets such as collaterals, EU transfers and mobile spectrum receipts." Good luck, as one might say, selling these or pledging them as a collateral. The entire notion that all of these assets have the stated face value in the market is questionable. That they might have a stated value in an environment of distress sufficient enough to warrant their seizure is plain bonkers.

And so on… The point is that a claim that EUR73 billion represents assets that can be used to fund any shortfall in Irish Government funding or that they provide any yield that is NOT accounted for on the balance sheet already (remember, current debt is driven by deficits and these are driven by operating costs and revenues of the Government, which in turn are accounting for all asset yields that currently accrue from all of the above assets) is a bit of a stretch and double-counting.

In light of this 'net liabilities' discussion, we need to see some serious, detailed, models-based liquidity and legal title risks analysis of the assets that (a) in total amount to EUR73 billion and (b) amount to EUR45 billion that remains unaccountable in the paper in any appreciable details.


But never mind - on the net, the paper is very useful and worth a read. Here are two little gems (I will blog on rest later):

Ouch! You don't need to be a nuclear scientist to spot the problem above…

The true value of the above is that it shows clearly that even on the 'net liabilities' basis, with all the hopium injected into valuations of assets, Ireland is not that much different from Greece... Have a nice day, ya all...

16/6/2013: NPRF, Stimulus & Futility of Policy: Sunday Times June 9, 2013

This is an unedited version of my Sunday Times article from June 9, 2013.



With the coalition mulling over the idea of investment 'stimulus', there are only two questions everyone in the Leinster House should be asking: Where is the money coming from? and Is there value for money in these investments?

Since the beginning of this crisis, the State piggy bank, aka the National Pensions Reserve Fund (NPRF) has been as rich of a target for Government raids as the taxpayers pockets. Back in 2007, NPRF assets were valued at EUR21,153 million with almost 94% of these, or EUR19,817 million, held in liquid financial instruments, such as cash, listed equities and bonds. Q1 2013 data shows that the fund discretionary portfolio (portfolio of assets excluding government-mandated 'investments' in AIB and Bank of Ireland) has declined to EUR6,449 million with only EUR4,243 million of this held in relatively liquid assets that can be meaningfully used to fund any stimulus.

The reason for the NPRF’s disastrous demise has nothing to do with the fund management or strategy - both of which were relatively good, compared to some of Ireland's 'leading' private sector asset managers. The cause of the precipitous 79% drop in liquid assets held by the NPRF was the banking sector collapse and the Government decision alongside the Troika to waste some EUR20,700 million of NPRF funds to 'invest' in two pillar banks equity stakes, with EUR16,000 million of this sunk into the black hole of AIB. As of Q1 2013, the NPRF 'investments' in the banks were valued at EUR8,800 million. This, accounting for dividends paid and disposals made to-date, implies a loss of some 47% of the original investment outlay.

The sheer absurdity of the use of the NPRF to fund every possible twist and turn of the State financial crisis is magnified by the latest Government plans. The exchequer returns through May 2013 released this week show clearly that as in previous years, the heaviest burden of spending cuts by the public sector is once again falling onto the capital expenditure side. January-May current voted spending is running 1.6% ahead of the target, with capital spending outstripping targeted cuts by 12.6%. Now, the same state that has been for years slashing voted capital expenditures is angling to raise a capital investment stimulus by raiding the remaining liquid NPRF funds.

The key issue with NPRF asset holdings is that even theoretically liquid funds will have to be leveraged in order to raise cash for any meaningfully sizeable Government investment. Leveraging NPRF funds via Public-Private partnership-type schemes can yield, realistically speaking, around EUR8-10 billion of total funding for the proposed seven years-long investment envelope, or just about 8% of the cumulated gross domestic capital formation taken at the 2011-2012 running levels.

Use of NPRF funds to finance economic stimulus while the state continues to borrow cash for day-to-day management of unsustainable deficits is of a dubious virtue to begin with. The costs of leveraging the NPRF funds will add further pain to the economics of stimulating investment in the environment of already high levels of government and private sector indebtedness. Worse than that, leveraging NPRF will either increase the Government debt and deficits or put a hefty new cost onto the taxpayers and users of services funded via the stimulus. In effect, the very attractiveness to the Government of the leveraged finance via NPRF is that such funding for capital programmes will most likely be off the official balancesheet of the State. This, however, means that it will also become a direct cost to consumers and, possibly, also to the taxpayers.

Let me explain the last point in greater detail. In 2012, Irish Government spent 3.7% of the country GDP or EUR6,133 million on paying interest on its debts implying an average effective interest rate of 3.19%. With the markets in a relative calm, our latest issue of Government bonds on March 20 this year saw NTMA raising EUR5 billion in 10-year debt at 3.9% annual coupon. This is the benchmark rate for any long-term lending in the country.

Even assuming the markets conditions will not change in the wake of a significant leveraging of funds from the NPRF, current cost of funds to the State is well in excess of recent returns earned by the NPRF on its liquid assets portfolio. In Q1 2013, NPRF delivered annualised rate for return of 2.8% on its discretionary portfolio and over 2000-2011 period, compounded returns earned by the NPRF run at 3.23% per annum.

Now, consider the second question posited above. Much of the public investment in infrastructure and general economic activities, as detailed in September 2011 Strategic Investment Fund (SIF) initiative issued by the current Government requires heavy involvement of the Private Sector co-funding. Quoting NPRF annual report for 2011, under  the SIF, "investment on a commercial basis from the NPRF will be channeled towards productive investment into sectors of strategic importance to the Irish economy (including infrastructure, water, venture capital and provision of long-term capital to the SME sector) and matching commercial investment from private investors would be sought." In other words, we are already leveraging the state finances for previous rounds of stimuli.

Private co-investment requires two things to succeed: sovereign assurances and preferential treatment to reduce overall levels of risk, plus annual return well in excess of sovereign debt returns. In other words, in any PPP and joint co-investment scheme, the State must assure premium return to the co-investing private sector agents.

If the State investments were to be financed at a sovereign cost of funding absent any negative effects on Government bond yields from increased borrowings, the underlying returns on public investments through the 'stimulus' scheme, based on a 50:50 split with private funding, would have to be yielding well in excess of 7-8% per annum. These returns will have to come either from the users of services backed by the PPP investments or from the taxpayers via minimum return guarantees.

Do the math: we can borrow at 3.9% in the markets or we can borrow at 7-8% via PPPs. The only difference is that under the latter arrangement, Minister Noonan can pretend that we didn’t borrow at all, as most of the money to repay the PPP investments will simply come out of the economy directly, instead of via the Exchequer.

That is the hope that is driving the Government to use NPRF instead of its own funds to fund capital spending. This hope, however, is based on rather thin analysis of the economic realities of the PPPs.

It is worth noting that between 1999 and the end of 2011, the total volume of PPP-based investments in Ireland, both committed and allocated, was just over EUR6.4 billion - or a fraction of the hoped-for amount of funds currently under the discussion for the next stage stimulus on foot of NPRF assets. This excludes EUR2.25 billion stimulus announced in July 2012 by the Government, which is not producing much of a desired effect of a stimulus on the economy so far.

Setting aside the issues of financial returns feasibility, it is highly doubtful that this level of investment can be economically efficiently deployed in the economy. And this is on foot of rather poor PPPs performance documented for pre-crisis period, as was highlighted in a number of studies on the subject. Several reports found that the final PPP deals involving capital funding for schools, water infrastrcture and transport programmes returned final costs well above the costs of direct procurement. Severe cost transfers to the state from the PPP projects have been found in the cases of major roads contracts in Ireland, including Clonee-Kells project and Limerick Tunnel project.

An in-depth research note on the problems inherent in PPP funded capital investments in Ireland published by the NERI Institute in January 2013 concluded that "it is striking that after thirteen years of procurement under PPP, there has been no official in-depth analysis of the experience to date. Yet PPP is now a major part of the current governments plan to stimulate the economy. The absence of any publicly available body of evidence in support of this plan represents a major shortcoming in terms of the formation of economic policy."

In contrast to the pre-crisis periods, current business, investment and economic environment in Ireland is characterised by high levels of debt overhang in the private sector, involuntary entrepreneurship, falling rates of growth in global demand for indigenous exports out of Ireland, stagnant or declining real assets valuations and a number of other factors significantly increasing the risk of any new investment. In other words, any new stimulus will have to come at the time when investment opportunities are thinner on the ground and risks associated with such investments are higher.

All of the risks associated with PPP-funded projects, thus, are only exacerbated in the current economic environment.

Instead of first attempting to fix the problems with the core financing schemes, the Government is setting out to drive more forcefully into the troubled waters of privately co-funded schemes. Previously announced stimuli, ranging from capital investment supports to stamp duty and R&D tax incentives, to the 2011-2012 announcements of similar PPP-based leveraged capital investment programmes have been insufficient to stimulate the domestic economy out of its structural collapse. This time around, the Government is attempting to up the ante by increasing the amounts of funds it aims to pump into the economy. The hope, obviously, is that doing more of the same on an increasing scale will yield a different outcome.

More likely, the outcome will be a further debasing of the consumers’ disposable incomes via higher taxation and higher cost of services, in exchange for wiping out completely the NPRF – our only remaining cushion against any potential future risks. Doubling-up when losing repeatedly in the economic policy roulette is not a good idea.  Doubling-up using granny’s pension cheques might be outright reckless.

Box-out:

Back in April this year, the IMF stole the headlines in Ireland after pointing that combined unemployment and underemployment rate in Ireland stood at a staggering 23%. However, the only really surprising thing about the IMF statement was that this data was already reported by the CSO before. In fact, CSO reports quarterly broader unemployment statistics since Q1 1998. Last week, CSO database showed that in Q1 2013, the broadest measure of unemployment – the measure that includes unemployed, discouraged workers and underemployed workers – has hit 25%, rising from 23.7% in Q1 2011 when the current Government took office. However, the above measure is still incomplete, as it excludes those workers who are drawing unemployment supports but are classified as participants in state training programmes, e.g. JobBridge. Adding these workers to the broader measure referenced by the IMF, Irish broad unemployment rate in Q1 2013 stood at a massive 29% - a historical high for the metric and up 2.7 percentage points on Q1 2011.

19/7/2012: Minister Noonan's 'valuations' & NTMA's latest scheme

An interesting - and potentially revealing - contribution from Minister Noonan on the prospective ESM involvement in purchasing Irish banks assets held by the Government - see full link here (H/T to Owen Callan of Danske Markets).

Here are some interesting bits (from my pov - note, emphasis in quotes is mine):

"...if Europe's new rescue fund takes over the government's stakes in its banks, it would need to do so at prices significantly above their current low valuations."

So what should be the prices benchmark to be paid by ESM for Irish banks?

We know what Minister Noonan thinks what they should not be:
"We wouldn't think we were being assisted or treated fairly if we were only offered the terms we could get from a willing hedge fund who wanted to purchase the stake the Irish government has in the banks," Noonan told a news conference"

Ok, a willing hedge fund is mentioned as a benchmark floor. What willing hedge fund? 1) Have there been approaches that set out some valuation? 2) Have these approaches involved sufficient depth of discussion to show the actual price the fund was willing to pay, other than the low-ball first bid? 3) Have these approaches been systematic or random?

Now, suppose there has been a series of approaches and the hedge funds' willing price is €X million. Suppose Minister Noonan insists on ESM paying a minimum price of €Y million that is above €X million, which means there is a positive premium to be paid by ESM.

What principle should guide this premium valuation? "The valuation will be an issue for negotiation but before we could agree, they would need to be significantly in advance of those figures," Noonan added, referring to figures showing that investments by the country's National Pension Reserve Fund (NPRF) in its top two banks were now worth 8.1 billion euros."

Is Minister Noonan seriously suggesting ESM should pay Irish Government more than €8.1 billion? Since NPRF valuations of the banks stakes are make-believe stuff with absolutely no proven testability in the actual markets, will ESM be buying into a loss then? Ex ante?!



Another interesting comment in the article cited above is the following one:

"The NTMA also confirmed plans to diversify its sources of funding later this year with its first sovereign issuance of annuity bonds to Irish-based pension funds and inflation-linked bonds also aimed at domestic investors.

Corrigan said it was not inconceivable that it could raise 3 to 5 billion euros over the next 18 months from the two new instruments.

"International investors don't owe us a living, they don't have to buy our paper, and if the local investors don't have the confidence to invest in the market and aren't seen to have that confidence, it's going to be very difficult to get international investors back," he said."

Which, of course is all reasonably fine but for two matters:

1. Domestic pension funds will be acting against normal practice and investing in low-rated (high risk) government securities within the very same economy in which they face future liabilities (reducing risk diversification). In other words, Irish insurance funds will have to be compelled to undertake such investment in violation of acceptable international standards. Have the Government now also taken over the pensions industry to add to their banking sector portfolio?
2. If foreign investors 'won't owe Irish Government a living' why should domestic investors owe Irish Government anything? By treating two investors differently rhetorically, does Mr Corrigan explicitly differentiate treatment of domestic investors from foreign investors? It appears to be exactly so because the products he references are not going to be offered to foreign investors. Which begs the third question:
3. Will NTMA create sub-category of seniority for Irish pension funds and 'domestic investors' to effectively load even more risk onto them compared to foreign investors? After all, he seems to suggest domestic investor owe him something that foreign investors don't?