25/10/2012: My notes for the interview on Troika review

Here is transcript of my interview on today's radio programme covering the Troika review of Ireland - warning: unedited material. Italics denote quotes from the Troika statement.

Unfortunately, Ireland's recovery will not be achieved or even started by the exit from Troika funding program. For a number of reasons, conveniently omitted by Minister Noonan, but some of these are hinted at in the Troika assessment:

1) Real recovery will require dealing with private (household) debts. This is not happening and Troika review, as well as increasingly frustrated tone coming from our own Central Bank clearly show that. 

Once Ireland exits the bailout, we will have to fund our Exchequer debt repayments and reduced deficits via borrowing in the private markets. It might be that we will be able to fund ourselves at lower cost than currently, but the cost is likely to be still above that obtainable via ESM or Troika. This means more resources will be sucked out of the weak economy, further reducing the pace of private economy deleveraging. In other words, exit from the bailout will likely make it harder for the economy to recover.

2) Real recovery will require economic activity to start picking up in terms of private domestic investment, household spending, expanded activities by our own firms, not MNCs in exporting. All of this requires credit, it also requires disposable income.  Again, this will be only hindered by Ireland 'exiting' Troika funding.

3) Recovery in the  fiscal space will require lower, not higher, costs of funding for the Exchequer debt roll-overs and paydowns of Troika debts. As above, exit from the bailout will likely assure that this cost will be rising, not falling.

4) Recovery in the economy will require the Exchequer restructuring, significantly, some of the banks-related debts carried by the State. Most notably - the likes of the promissory notes - and this is clearly not going to be consistent with the Exchequer borrowing in the markets, at least not while we restructure the banks-related debt. It is better for Ireland to stay within the ESM and deliver on restructuring, and only after that aim to gradually exit the programme.

5) Lastly, recovery on exit from the program will require more aggressive reforms and stringent adherence to the fiscal discipline established. Alas, once we exit the program, the Government will lose its ONLY functional trump card in dealing with the Trade Unions. The Bogey Man of the Troika will be gone and the Social Partners will most likely exert pressure on the Government to borrow beyond its means to compensate them for the hardships of the Troika period. We can be at a risk of undoing overnight the precious little progress we've achieved to-date.

So, overall, I do not think this economy is going to recover once we exit the bailout. In fact, I think the entire logic of this argument as advanced by Minister Noonan is backwards. We should only exit the bailout once the economy is sufficiently strong to sustain orderly transition from subsidized funding to real world funding. Exiting Troika arrangements will not free Ireland from painful adjustments needed, but will likely risk derailing what has been achieved so far.

On Troika review specifics:

Banks remain well-capitalised and downsizing has progressed well, yet further efforts are needed to address their profitability and asset quality challenges.

Irish banks are well capitalized solely because there are no substantial writedowns of mortgages being undertaken in the banking sector. Meanwhile, mortgages arrears are snowballing, implying that the current levels of capitalization are unlikely to be sustained in the short term future. In other words, Troika praise here is simply a PR exercise.

Real GDP growth has slowed to a projected rate of ½ percent in 2012. Prospects for growth in 2013 are for modest pick up to just over 1 percent as domestic demand declines moderately...

So if I get this right: GDP will grow 0.5% in 2012 and 1.0% in 2013. GNP will shrink in 2012 and 2013 as well. Which means the real economy in Ireland - the one you and I and the listeners to this station are inhabiting will be shrinking 6 years in a row. That's 'strong performance'? In real terms we had GNP of 162bn in 2007, it fell to 127 billion in 2011 and is now, as IMF suggests will fall even further - close to 122-124bn or lower by the end of 2013. This is the much-lauded recovery we are bragging about?!

The authorities are ramping up reforms to restore the health of the Irish financial sector so that it can help support economic recovery. Intensified efforts are required to deal decisively with mortgage arrears and further reduce bank operating costs.

What are these reforms? Anyone noticed ANY progress in the banking sector? Especially on dealing with mortgages? I didn't. May be Minister Noonan can show us some couples who had their debt problems resolved? Not delayed, not shelved, but actually resolved. 

25/10/2012: Icelandic experience on mortgages writedowns

Very interesting post linking Icelandic experience in mortgages writedowns to Ireland's situation from Sigrún Davíðsdóttir link here.

Needless to say, I agree - we need a sustainable long term solution and this will require dealing systemically with private debt overhang.

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

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

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

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

 More charts from the IMF:

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

Meanwhile credit condition remain horrible:

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

Charts below highlight rapidly accelerating problems with mortgages defaults:

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

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

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

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

Summary table:

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

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

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

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

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

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

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

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

Chart: 

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

IMF's overall review conclusions are:

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