2/10/20: A new mortgage arrears crisis on its way

 

My latest article on Irish banking sector problems with distressed mortgages is out today in The Currency: 

There’s a new mortgage arrears crisis on its way, and official Ireland is not ready for it

The Central Bank of Ireland has started publishing new data on mortgage arrears – and the news is not good. An arrears crisis is brewing. The banks, and the state, are woefully unprepared for it.

https://thecurrency.news/articles/24779/theres-a-new-mortgage-arrears-crisis-on-its-way-and-official-ireland-is-not-ready-for-it/ 

18/8/18: Kiplinger quotes on equity markets

Kiplinger quotes myself on Deutsche Bank, PG&E, and General Electric
https://www.kiplinger.com/slideshow/investing/T052-S001-10-roughed-up-stocks-to-buy-for-a-recovery-rally/index.html.

18/08/18: Euromoney on Italian Banking Risks and Turkey Crisis

Euromoney article on the latent Italian crisis, relative to the ongoing Turkish one: https://www.euromoney.com/article/b19k3zjb7v811r/italian-banks-a-bigger-risk-than-turkey.

9/8/17: Euro Area Banks Bailouts: The Legacy Still Hangs Over Our Heads

The Financial Times has published a very neat visualisation of the global banks bailouts net impact to-date:

 Source: https://www.ft.com/content/b823371a-76e6-11e7-90c0-90a9d1bc9691

And the snapshot magnifying European states impact:

None of the Euro area states have recovered all funds deployed in bailing out the banks. And the worst performer of all states is Ireland.

Note: the chart references bailouts as a share of GDP. Of course, in the case of Ireland and Cyprus, GDP is by a mile (in the case of Ireland, by about one third) is unrepresentative of the actual national income available to sustain these.

Another note: the three worst-hit countries, Ireland, Greece and Cyprus, all remain deeply under water when it comes to recovering funds spent in the bailouts, even though the three had, on the surface, different bailout regimes applied. Specifically, Cyprus (and to a lesser extent, Greece) was supposed to be a model bailout, serving as the basis for the future bailouts across the Euro area (including structured bail-ins of private depositors).

So much for the hope of the Euro area 'reforms' working... And so much for the end of the Crisis...

23/10/16: Too-Big-To-Fail Banks: The Financial World 'Undead'

This is an un-edited version of my latest column for the Village magazine


Since the start of the Global Financial Crisis back in 2008, European and U.S. policymakers and regulators have consistently pointed their fingers at the international banking system as a key source of systemic risks and abuses. Equally consistently, international and domestic regulatory and supervisory authorities have embarked on designing and implementing system-wide responses to the causes of the crisis. What emerged from these efforts can be described as a boom-town explosion of regulatory authorities. Regulatory,  supervisory and compliance jobs mushroomed, turning legal and compliance departments into a new Klondike, mining the rich veins of various regulations, frameworks and institutions. All of this activity, the promise held, was being built to address the causes of the recent crisis and create systems that can robustly prevent future financial meltdowns.

At the forefront of these global reforms are the EU and the U.S. These jurisdictions took two distinctly different approaches to beefing up their respective responses to the systemic crises. Yet, the outrun of the reforms is the same, no matter what strategy was selected to structure them.

The U.S. has adopted a reforms path focused on re-structuring of the banks – with 2010 Dodd-Frank Act being the cornerstone of these changes. The capital adequacy rules closely followed the Basel Committee which sets these for the global banking sector. The U.S. regulators have been pushing Basel to create a common "floor" or level of capital a bank cannot go below. Under the U.S. proposals, the “floor” will apply irrespective of its internal risk calculations, reducing banks’ and national regulators’ ability to game the system, while still claiming the banks remain well-capitalised. Beyond that, the U.S. regulatory reforms primarily aimed to strengthen the enforcement arm of the banking supervision regime. Enforcement actions have been coming quick and dense ever since the ‘recovery’ set in in 2010.

Meanwhile, the EU has gone about the business of rebuilding its financial markets in a traditional, European, way. Any reform momentum became an excuse to create more bureaucratese and to engineer ever more elaborate, Byzantine, technocratic schemes in hope that somehow, the uncertainties created by the skewed business models of banks get entangled in a web of paperwork, making the crises if not impossible, at least impenetrable to the ordinary punters. Over the last 8 years, Europe created a truly shocking patchwork of various ‘unions’, directives, authorities and boards – all designed to make the already heavily centralised system of banking regulations even more complex.

The ‘alphabet soup’ of European reforms includes:

• the EBU and the CMU (the European Banking and Capital Markets Unions, respectively);
• the SSM (the Single Supervisory Mechanism) and the SRM (the Single Resolution Mechanism), under a broader BRRD (Bank Recovery and Resolution Directive) with the DGS (Deposit Guarantee Schemes Directive);
• the CRD IV (Remuneration & prudential requirements) and the CRR (Single Rule Book);
• the MIFID/R and the MAD/R (enhanced frameworks for securities markets and to prevent market abuse);
• the ESRB (the European Systemic Risk Board);
• the SEPA (the Single Euro Payments Area);
• the ESA (the European Supervisory Authorities) that includes the EBA (the European Banking Authority);
• the MCD (the Mortgage Credit Directive) within a Single European Mortgage Market; the former is also known officially as CARRP and includes introduction of something known as the ESIS;
• the Regulation of Financial Benchmarks (such as LIBOR & EURIBOR) under the umbrella of the ESMA (the European Securities and Markets Authority), and more.

The sheer absurdity of the European regulatory epicycles is daunting.

Eight years of solemn promises by bureaucrats and governments on both sides of the Atlantic to end the egregious abuses of risk management, business practices and customer trust in the American and European banking should have produced at least some results when it comes to cutting the flow of banking scandals and mini-crises. Alas, as the recent events illustrate, nothing can be further from the truth than such a hypothesis.


America’s Rotten Apples

In the Land of the Free [from individual responsibility], American bankers are wrecking havoc on customers and investors. The latest instalment in the saga is the largest retail bank in the North America, Wells Fargo.

Last month, the U.S. Consumer Financial Protection Bureau (CFPB) announced a $185 million settlement with the bank. It turns out, the customer-focused Wells Fargo created over two million fake accounts without customers’ knowledge or permission, generating millions in fraudulent fees.

But Wells Fargo is just the tip of an iceberg.

In July 2015, Citibank settled with CFPB over charges it deceptively mis-sold credit products to 2.2 million of its own customers. The settlement was magnitudes greater than that of the Wells Fargo, at $700 million. And in May 2015, Citicorp, the parent company that controls Citibank, pleaded guilty to a felony manipulation of foreign currency markets – a charge brought against it by the Justice Department. Citicorp was accompanied in the plea by another U.S. banking behemoth, JPMorgan Chase. You heard it right: two of the largest U.S. banks are felons.

And there is a third one about to join them. This month, news broke that Morgan Stanley was charged with "dishonest and unethical conduct" in Massachusetts' securities “for urging brokers to sell loans to their clients”.

Based on just a snapshot of the larger cases involving Citi, the bank and its parent company have faced fines and settlements costs in excess of $19 billion between the start of 2002 and the end of 2015. Today, the CFPB has over 29,000 consumer complaints against Citi, and 37,000 complaints against JP Morgan Chase outstanding.

To remind you, Citi was the largest recipient of the U.S. Fed bailout package in the wake of the 2008 Global Financial Crisis, with heavily subsidised loans to the bank totalling $2.7 trillion or roughly 16 percent of the entire bailout programme in the U.S.

But there have been no prosecutions of the Citi, JP Morgan Chase or Wells Fargo executives in the works.


Europe’s Ailing Dinosaurs

The lavishness of the state protection extended to some of the most egregiously abusive banking institutions is matched by another serial abuser of rules of the markets: the Deutsche Bank. Like Citi, the German giant received heaps of cash from the U.S. authorities.

Based on U.S. Government Accountability Office (GAO) data, during the 2008-2010 crisis, Deutsche was provided with $354 billion worth of emergency financial assistance from the U.S. authorities. In contrast, Lehman Brothers got only $183 billion.

Last month, Deutsche entered into the talks with the U.S. Department of Justice over the settlement for mis-selling mortgage backed securities. The original fine was set at $14 billion – a levy that would effectively wipe out capital reserves cushion in Europe’s largest bank. The latest financial markets rumours are putting the final settlement closer to $5.4-6 billion, still close to one third of the bank’s equity value. To put these figures into perspective, Europe’s Single Resolution Board fund, designed to be the last line of defence against taxpayers bailouts, currently holds only $11 billion in reserves.

The Department of Justice demand blew wide open Deutsche troubled operations. In highly simplified terms, the entire business model of the bank resembles a house of cards. Deutsche problems can be divided into 3 categories: legal, capital, and leverage risks.

On legal fronts, the bank has already paid out some $9 billion worth of fines and settlements between 2008 and 2015. At the start of this year, the bank was yet to achieve resolution of the probe into currency markets manipulation with the Department of Justice. Deutsche is also defending itself (along with 16 other financial institutions) in a massive law suit by pension funds and other investors. There are on-going probes in the U.S. and the UK concerning its role in channelling some USD10 billion of potentially illegal Russian money into the West. Department of Justice is also after the bank in relation to the alleged malfeasance in trading in the U.S. Treasury market.

And in April 2016, the German TBTF (Too-Big-To-Fail) goliath settled a series of U.S. lawsuits over allegations it manipulated gold and silver prices. The settlement amount was not disclosed, but manipulations involved tens of billions of dollars.

Courtesy of the numerous global scandals, two years ago, Deutsche was placed on the “enhanced supervision” list by the UK regulators – a list, reserved for banks that have either gone through a systemic failure or are at a risk of such. This list includes no other large banking institution, save for Deutsche. As reported by Reuters, citing the Financial Times, in May this year, UK’s financial regulatory authority stated, as recently as this year, that “Deutsche Bank has "serious" and "systemic" failings in its controls against money laundering, terrorist financing and sanctions”.

As if this was not enough, last month, a group of senior Deutsche ex-employees were charged in Milan “for colluding to falsify the accounts of Italy’s third-biggest bank, Banca Monte dei Paschi di Siena SpA” (BMPS) as reported by Bloomberg. Of course, BMPS is itself in the need of a government bailout, with bank haemorrhaging capital over recent years and nursing a mountain of bad loans. One of the world’s oldest banks, the Italian ‘systemically important’ lender has been teetering on the verge of insolvency since 2008-2009.

All in, at the end of August 2016, Deutsche Bank had some 7,000 law suits to deal with, according to the Financial Times.

Beyond legal problems, Deutsche is sitting on a capital structure that includes billions of notorious CoCos – Contingent Convertible Capital Instruments. These are a hybrid form of capital instruments designed and structured to absorb losses in times of stress by automatically converting into equity. In short, CoCos are bizarre hybrids favoured by European banks, including Irish ‘pillar’ banks, as a dressing for capital buffers. They appease European regulators and, in theory, provide a cushion of protection for depositors. In reality, CoCos hide complex risks and can act as destabilising elements of banks balancesheets.

And Deutsche’s balancesheet is loaded with trillions worth of opaque and hard-to-value derivatives. At of the end of 2015, the bank held estimated EUR1.4 trillion exposure to these instruments in official accounts. A full third of bank’s assets is composed of derivatives and ‘other’ exposures, with ‘other’ serving as a financial euphemism for anything other than blue chip safe investments.

The Financial Undead

Eight years after the blow up of the global financial system we have hundreds of tomes of reforms legislation and rule books thrown onto the crumbling façade of the global banking system. Tens of trillions of dollars in liquidity and lending supports have been pumped into the banks and financial markets. And there are never-ending calls from the Left and the Right of the political spectrum for more Government solutions to the banking problems.

Still, the American and European banking models show little real change brought about by the crisis. Both, the discipline of the banks boards and the strategy pursued by the banks toward rebuilding their profits remain unaltered by the lessons from the crisis. The fireworks of political demagoguery over the need to change the banking to fit the demands of the 21st century roll on. Election after election, candidates compete against each other in promising a regulatory nirvana of de-risked banking. And time after time, as smoke of elections clears away, we witness the same system producing gross neglect for risks, disregard for its customers under the implicit assumption that, if things get shaky again, taxpayers’ cash will come raining on the fires threatening the too-big-to-reform banking giants.


Note: edited version is available here: http://villagemagazine.ie/index.php/2016/10/too-big-to-fail-or-even-be-reformed/.

9/2/16: Echoes of 2011 at Deutsche?

Almost 4 and a half years ago, I wrote about the systemic weaknesses in the Deutsche Bank balancesheet: http://trueeconomics.blogspot.com/2011/09/13092011-german-and-french-banks.html, And now we are seeing these weaknesses coming to the front.

It is not quite Europe's Lehman Moment, yet, but if Deutsche goes to the wall at the rates implied by its CDS, we are into more than Lehman-deep pool of the proverbial...

Source: @Schuldensuehner 

12/1/2015: Euro Area vs US Banks and Monetary Policy: The Weakest Link

Cukierman, Alex, "Euro-Area and US Banks Behavior, and ECB-Fed Monetary Policies During the Global Financial Crisis: A Comparison" (December 2014, CEPR Discussion Paper No. DP10289: http://ssrn.com/abstract=2535426) compared "…the behavior of Euro-Area (EA) banks' credit and reserves with those of US banks following respective major crisis triggers (Lehman's collapse in the US and the 2009 [Greek crisis])".

The paper shows that, "although the behavior of banks' credit following those widely observed crisis triggers is similar in the EA and in the US, the behavior of their reserves is quite different":

• "US banks' reserves have been on an uninterrupted upward trend since Lehman's collapse"
• EA banks reserves "fluctuated markedly in both directions". 

Per authors, "the source, this is due to differences in the liquidity injections procedures between the Eurosystem and the Fed. Those different procedures are traced, in turn, to differences in the relative importance of banking credit within the total amount of credit intermediated through banks and bond issues in the EA and the US as well as to the higher institutional aversion of the ECB to inflation relatively to that of the Fed."

Couple of charts to illustrate.

As the charts above illustrate, US banking system much more robustly links deposits and credit issuance than the European system. In plain terms, traditional banking (despite all the securitisation innovations of the past) is much better represented in the US than in Europe.

So much for the European meme of the century:

1. The EA banking system was not a victim of the US-induced crisis, but rather an over-leveraged, less deposits-focused banking structure that operates in the economies much more reliant on bank debt than on other forms of corporate funding; and
2. The solution to the European growth problem is not to channel more debt into the corporate sector, thus only depressing further the reserves to credit ratio line (red line) in the second chart above, but to assist deleveraging of the intermediated debt pile in the short run, increasing bank system reserves to credit ratio in the medium term (by increasing households' capacity to fund deposits) and decreasing overall share of intermediated (banks-issued) debt in the system of corporate funding in the long run.

2/1/2015: Credit and Growth after Financial Crises

Generally, we think of private sector deleveraging as being associated with lower investment by households and enterprises, lower consumption and lower output growth, leading to reduced rates of economic growth. However, one recent study (amongst a number of others) disputes this link.

Takats, Elod and Upper, Christian, "Credit and Growth after Financial Crises" (BIS Working Paper No. 416: http://ssrn.com/abstract=2375674) finds that "declining bank credit to the private sector will not necessarily constrain the economic recovery after output has bottomed out following a financial crisis. To obtain this result, we examine data from 39 financial crises, which -- as the current one -- were preceded by credit booms. In these crises the change in bank credit, either in real terms or relative to GDP, consistently did not correlate with growth during the first two years of the recovery. In the third and fourth year, the correlation becomes statistically significant but remains small in economic terms. The lack of association between deleveraging and the speed of recovery does not seem to arise due to limited data. In fact, our data shows that increasing competitiveness, via exchange rate depreciations, is statistically and economically significantly associated with faster recoveries. Our results contradict the current consensus that private sector deleveraging is necessarily harmful for growth."

Which, of course, begs a question: how sound is banking sector 'return to normalcy at any cost' strategy for recovery? The question is non-trivial. Much of the ECB and EU-supported policies in the euro area periphery stressed the need for normalising credit operations in the economy. This thinking underpinned both the bailouts of the banks and the bailouts of their funders (bondholders and other lenders). It also underwrote the idea that although austerity triggered by banks bailouts was painful, restoration of credit flows is imperative to generating the recovery.

26/7/2014: Of Germans Bearing the Ugly Truth?..

German experts and analysts have an un-Irish capability of speaking their own mind... and when they do (and they do it anywhere, including when visiting this country of ours), they don't mince words. Behold the latest 'visitor' from the land of 'Nein!': Dr. Joachim Pfeiffer, the economic policy spokesman for the parliamentary group of the ruling Christian Democrats. Dr. Pfeiffer was in Dublin this week. Somewhere between a nice dinners and customary ritual of witnessing the Irish 'craic' in a pub, the learned Doktor sneaked a few minutes to tell us that "Ireland has “no chance” of securing a deal on its legacy bank debt" and that "the euro zone’s new bailout fund had not been established for nor would be it used for retroactive bank recapitalisation."

Quoted in the Irish Times: “There is no chance Ireland’s legacy assets will be paid by the European Stability Mechanism (ESM). This instrument is only an instrument for emergency.”

R. Pfeiffer was in Dublin to speak at the German-Irish Chamber of Industry and Commerce, the same Chamber that recently sponsored a cheerful book on Ireland & Germany being the best pals in economic and policy terms. The best pals, alas, do not help each other all too much, and one of them has no problem telling the other that 'your mess is your mess': "Dr Pfeiffer said the financial meltdown in Ireland “did not fall from heaven . . . there were bubbles in the real estate sector, there were bubbles in the banking sector and all of this was home-made”."

As to the reasons why ESM cannot be used for retroactive assistance to the Irish state, Dr Pfeiffer evoked the same logic that I advanced for some years now: "If the ESM was to be used retroactively to compensate Ireland, he said other countries such as Greece, Spain, Portugal and potentially Italy would want similar compensation."

Needless to say, Department of Finance immediately chipped in with a denial of denial that denial is possible as a denial. I am certain Dr. Merkel in Berlin was all ears...

17/5/2014: The Banking Inquiry Shopping List...

This is an unedited version from my Sunday Times article from May 4, 2014.


This week, the Government announced the establishment of a banking inquiry.
The idea is to take a definitive, conclusive and final shot at identifying the events and the actions that have led to the historically and internationally unprecedented financial crisis that has ravaged our economy, society and the lives of millions of our citizens.

Some would say this was long in coming. But, in reality, we have been here before.


Between 2010 and 2011 we had the Nyberg Report, the Honohan Report and the Regling-Watson Report. All were full of generalist discourse about technical and systemic failures, but contained few specifics. In July 2012 we had the PAC report into the crisis. This set out the framework for the current inquiry, but also fell far short of bringing the matter to a closure.

All of these reports and inquiries suffered from similar problems. They were limited in scope, restricted in terms, covered only sub sets of the crisis history and virtually nothing in terms of the crisis fallout, and were disempowered to deliver conclusions in excess of anodyne academism. None of the reports to-date delivered final definitive answers, named names and specific actions by actual players.

This nation, told to pay for the banks and other domestic and foreign actors’ reckless practices, was never given a chance at establishing impartially and substantively the truth about the causes and the drivers of the crisis.

The Anglo Three trial, concluded this week, served as a logical denouement of the aforementioned processes of obfuscation of the causes of the crisis. It loomed large in public minds as a possible source of closure. Excessively technical in nature, restricted in scope and legalistic in terms of discovery, it naturally fell short of achieving that closure. With this failure, public trust in core institutions of this state has been stretched too thin. Even our public representatives now see the urgent need for some sort of a broadly based, non-partisan and open inquiry.


To be effective, the inquiry must mark a clear-cut departure from the past.

It has to be open and broad. Its remit must cover years prior to the crisis, preferably starting from the regulatory, monetary and market foundations laid out in the late 1990s, reaching beyond the night of the 2008 Guarantee, all the way to today.

The inquiry must cover not only the actions of the banks, but also those of our regulators, supervisors, the Department of Finance, the Department of Taoiseach, the roles played by the IFSC-based institutions and the Social Partners. It must deal with technical issues, such as, amongst others, liquidity rules breaches, macro prudential risks build-up and transmission of risks from Government policies to the banking sector and property lending, investment practices violations, and funding risks.

The inquiry must dig deep into the underlying culture, strategic choices and decision-making in our banking system, broader financial services, and economy and policymaking at large.

It must name key names. It must place responsibility on the shoulders of individuals involved - those still serving and since retired. The inquiry must distinguish and allocate legal, regulatory, professional and ethical responsibilities, identifying not just potential violations of the law and regulations, but also systemic weaknesses in competencies, incentives and performance.

The inquiry must achieve clarity as to the role played by banks auditors, consultants, advisory committees and boards, as well as by banks executives, including mid-ranked professionals, such as economists, risk analysts, and lending managers.

We need to know and understand the roles played by European and potentially US policymakers, organisations and investors in fuelling the credit bubble here in Ireland and in structuring the disastrous fallout from the credit bust.

Ireland paid some 40 percent of the overall cost of the euro area financial crisis. The inquiry at least should tell us, who benefited from these payments and who owes us a refund.

Above all, the inquiry must be robust, open, and reflective of the public appetite for closure. It must leave behind evidential record of errors made, strategies adopted, actions taken, regulatory breaches unaddressed and expert opinions supplied. In other words, it will have to break an entirely new ground in terms of all past inquiries ever conducted in the history of this state.

3/4/3014: In the eye of a growth hurricane? Irish National Accounts 2013

This is an unedited version of my Sunday Times article from March 23, 2014


Russian-Ukrainian writer, Nikolai Gogol, once quipped that "The longer and more carefully we look at a funny story, the sadder it becomes." Unfortunately, the converse does not hold. As the current Euro area and Irish economic misfortunes aptly illustrate, five and a half years of facing the crisis does little to improve one’s spirits or the prospects for change for the better.

At a recent international conference, framed by the Swiss Alps, the discussion about Europe's immediate future has been focused not on geopolitical risks or deep reforms of common governance and institutions, but on structural growth collapse in the euro area. Practically everyone - from Swedes to Italians, from Americans to Albanians - are concerned with a prospect of the common currency area heading into a deflationary spiral. The core fear is of a Japanese-styled monetary policy trap: zero interest rates, zero credit creation, and zero growth in consumption and investment. Even Germans are feeling the pressure and some senior advisers are now privately admitting the need for the ECB to develop unorthodox measures to increase private consumption and domestic investment. The ECB, predictably, remains defensively inactive, for the moment.


The Irish Government spent the last twelve months proclaiming to the world that our economy is outperforming the euro area in growth and other economic recovery indicators. To the chagrin of our political leaders, Ireland is also caught in this growth crisis. And it is threatening both, sustainability of our public finances and feasibility of many reforms still to be undertaken across the domestic economy.

Last week, the CSO published the quarterly national accounts for 2013. Last year, based on the preliminary figures, Irish economy posted a contraction of 0.34 percent, slightly better than a half-percent drop in euro area output. But for Ireland, getting worse more slowly is hardly a marker of achievement. When you strip out State spending, taxes and subsidies, Irish private sector activity was down by more than 0.48 percent - broadly in line with the euro area’s abysmal performance.

Beyond these headline numbers lay even more worrying trends.

Of all expenditure components of the national accounts, gross fixed capital formation yielded the only positive contribution to our GDP in 2013, rising by EUR 710 million compared to 2012. However, this increase came from an exceptionally low base, with investment flows over 2013 still down 28 percent on those recorded in 2009. Crucially, most, if not all, of the increase in investment over the last year was down to the recovery in Dublin residential and commercial property markets. In 2013, house sales in Dublin rose by more than EUR1.2 billion to around EUR3.6 billion. Commercial property investment activity rose more than three-fold in 2013 compared to previous year, adding some EUR1.24 billion to the investment accounts.

Meanwhile, Q4 2013 balance of payments statistics revealed weakness in more traditional sources of investment in Ireland as non-IFSC FDI fell by roughly one third on 2012 levels, down almost EUR6.3 billion. As the result, total balance on financial account collapsed from a surplus EUR987 million in 2012 to a deficit of EUR10 billion in 2013.

Put simply, stripping out commercial and residential property prices acceleration in Dublin, there is little real investment activity anywhere in the economy. Certainly not enough to get employment and domestic demand off their knees. And this dynamic is very similar to what we are witnessing across the euro area. In 2013, euro area gross fixed capital formation fell, year on year, in three quarters out of four, with Q4 2013 figures barely above Q4 2012 levels, up just 0.1 percent.

At the same time, demand continued to contract in Ireland. In real terms, personal consumption of goods and services was down EUR941 million in 2013 compared to previous year, while net expenditure by central and local government on current goods and services declined EUR135 million. These changes more than offset increases in investment, resulting in the final domestic demand falling EUR366 million year-on-year, almost exactly in line with the changes in GDP.

The retail sales are falling in value and growing in volume - a classic scenario that is consistent with deflation. In 2013, value of retail sales dropped 0.1 percent on 2012, while volume of retail sales rose 0.8 percent. Which suggests that price declines are still working through the tills - a picture not of a recovery but of stagnation at best. Year-on-year, harmonised index of consumer prices rose just 0.5 percent in Ireland in 2013 and in January-February annual inflation was averaging even less, down to 0.2 percent.

The effects of stagnant retail prices are being somewhat mitigated by the strong euro, which pushes down cost of imports. But the said blessing is a shock to the indigenous exporters. With euro at 1.39 to the dollar, 0.84 to pound sterling and 141 to Japanese yen, we are looking at constant pressures from the exchange rates to our overall exports competitiveness.

We all know that goods exports are heading South. In 2013 these were down 3.9 percent, which is a steeper contraction than the one registered in 2012. On the positive side, January data came in with a rise of 4% on January 2013, but much of this uplift was due to extremely poor performance recorded 12 months ago. Trouble is brewing in exports of services as well. In 2012, in real terms, Irish exports of services grew by 6.9 percent. In 2013 that rate declined to 3.9 percent. On the net, our total trade surplus fell by more than 2.7 percent last year.

Such pressures on the externally trading sectors can only be mitigated over the medium term by either continued deflation in prices or cuts to wages. Take your pick: the economy gets crushed by an income shock or it is hit by a spending shock or, more likely, both.

Irony has it some Irish analysts believe that absent the fall-off in the exports of pharmaceuticals (the so-called patent cliff effect), the rest of the economy is performing well. Reality is begging to differ: our decline in GDP is driven by the continued domestic economy's woes present across state spending and capital formation, to business capital expenditure, and households’ consumption and investment.


All of the above supports the proposition that we remain tied to the sickly fortunes of the growth-starved Eurozone. And all of the above suggests that our economic outlook and debt sustainability hopes are not getting any better in the short run.

From the long term fiscal sustainability point of view, even accounting for low cost of borrowing, Ireland needs growth of some 2.25-2.5 percent per annum in real terms to sustain our Government debt levels. These are reflected in the IMF forecasts from the end of 2010 through December 2013. Reducing unemployment and reversing emigration, repairing depleted households' finances and pensions will require even higher growth rates. But, since the official end of the Great Recession in 2010 our average annual rate of growth has been less than 0.66 percent per annum on GDP side and 1.17 percent per annum on GNP side. Over the same period final domestic demand (sum of current spending and investment in the private economy and by the government) has been shrinking, on average, at a rate of 1.47 percent per annum.

This implies that we are currently not on a growth path required to sustain fiscal and economic recoveries. Simple arithmetic based on the IMF analysis of Irish debt sustainability suggests that if 2010-2013 growth rates in nominal GDP prevail over 2014-2015 period, by the end of next year Irish Government debt levels can rise to above 129 percent of our GDP instead of falling to 121.9 percent projected by the IMF back in December last year. Our deficits can also exceed 2.9 percent of GDP penciled in by the Fund, reaching above 3 percent.

More ominously, we are now also subject to the competitiveness pressures arising from the euro valuations and dysfunctional monetary policy mechanics. Having sustained a major shock from the harmonised monetary policies in 1999-2007, Ireland is once again finding itself in the situation where short-term monetary policies in the EU are not suitable for our domestic economy needs.


All of this means that our policymakers should aim to effectively reduce deflationary pressures in the private sectors that are coming from weak domestic demand and the Euro area monetary policies. The only means to achieve this at our disposal include lowering taxes on income and capital gains linked to real investment, as opposed to property speculation. The Government will also need to continue pressuring savings in order to alleviate the problem of the dysfunctional banking sector and to reduce outflows of funds from productive private sector investment to property and Government bonds. Doing away with all tax incentives for investment in property, taxing more aggressively rents and shifting the burden of fiscal deficits off the shoulders of productive entrepreneurs and highly skilled employees should be the priority. Sadly, so far the consensus has been moving toward more populist tax cuts at the lower end of the earnings spectrum – where such cuts are less likely to stimulate growth in productive investment.

We knew this for years now but knowing is not the same thing as doing. Especially when it comes to the reforms that can prove unpopular with the voters.

Box-out: 

This week, Daniel Nouy, chairwoman of the European Central Bank's supervisory board, told the European Parliament that she intends to act quickly to force closure of the "zombie" banks - institutions that are unable to issue new credit due to legacy loans problems weighing on their balance sheets. Charged with leading the EU banks' supervision watchdog, Ms Nouy is currently overseeing the ECB's 1000-strong team of analysts carrying out the examination of the banks assets. As a part of the process of the ECB assuming supervision over the eurozone's banking sector, Frankfurt is expected to demand swift resolution, including closure, of the banks that are acting as a drag on the credit supply system. And Ms Nouy made it clear that she expects significant volume of banks closures in the next few years. While Irish banks are issuing new loans, overall they remain stuck in deleveraging mode. According to the latest data, our Pillar banks witnessed total loans to customers shrinking by more than EUR 21 billion (-10.3 percent) in 12 months through the end of September 2013. In a year through January 2014, loans to households across the entire domestic banking sector fell 4.1 percent, while loans to Irish resident non-financial corporations are down 5.8 percent. One can argue about what exactly will constitute a 'zombie' bank by Ms Nouy's definition, but it is hard to find a better group of candidates than Ireland's Three Pillars of Straw.

23/1/2014: Funding Markets Spring Hits a Bump in the Euro Area: H2 2013 Repo Market Report

ICMA (International Capital Markets Association) report released yesterday showed massive 9.5% contraction in euro area repo markets, leading to lower availability of short-term funding to banks in the market over H2 2013 compared to H1. The core drivers of the decline are

• ECB's supply of funds met by lenders who are becoming more reliant on Central Bank's funding, and
• Cash hoarding by banks.

Here is a summary table showing H2 2013 repo market at the lowest point of any half-year period since H1 2009 and the third lowest reading since H1 2005.

At the same time, the share of anonymous electronic trading jumped unexpectedly to 25% from 19.8% a year ago. This came at the expense of domestic business (down to 26.1% from 29.7% a year ago) and less significantly at the expense of cross-border transactions within the euro area (down to 18% from 18.9% a year ago). The survey suggested that ECB's funding sources are the driver behind these trends in relation to domestic repos.

Summary table:

Net conclusion: things are not running smoothly in the funding markets, some five years since the crisis trough.

Full report here: http://www.icmagroup.org/media/Press-releases/

12/1/2014: Icelandic Banks Crisis: Failure to Enforce?

A detailed account of the Icelandic crisis and the failure of regulatory enforcement (not necessarily of regulatory easing) in propelling risky behaviour by the banks: http://www.voxeu.org/article/gambling-resurrection-iceland

18/12/2013: On Big Advisory Firms Role in the Crisis

EUObserver has a very interesting expose of the role played by a handful of large financial consultancies in shaping Europe's responses to the banking crisis: http://euobserver.com/economic/122415

The article quotes from a number of sources, including myself.

Here is a more in-depth version of my position on the issue:

There are two basic reasons for the Central Banks reliance on external assessment and validation of estimated banks losses. The first one is operational and the second one is reputational. 

Operational reason arises from the fact that during the per-crisis boom in credit creation, National Central Banks of countries with rapid credit expansion lost core personnel competencies and skills to staff migration to the private sector financial services providers. As the result, senior staff with skills at professional certification levels (e.g. CFA) and hands-on experience became virtually extinct in the Central Banks and regulatory authorities. The remaining staff largely performed mechanical tasks of collating and repackaging information supplied to the Central Banks by the financial institutions. Forensic analysis and modelling skills were lost. External analysts can supply these skills and provide more up-to-date specialist knowledge, rarely available in the tenured jobs-for-life setting of the Central Banks that was made even more scarce by the staff migrations to private sector. An added operational constraint faced by the Central Banks in crisis-hit countries was the demand for staff time to cover regulatory and policy changes during the crisis and deploying emergency measures. In simple terms, this meant that the Central Banks were short of staff.

Reputational reasons are more complex, spanning a number of areas where Central Banks faced and often continue to face significant deficits. Firstly, reputation ally, Central Banks are not known for possessing specialist forensic analysis skills required to bring together balance sheet analytics and forward business modelling. As such they lack credibility as markets analysts. Secondly, stress testing had two functions: identifying approximate potential losses on banks balance sheets and signalling these losses to the markets. In the case of countries severely hit by the crisis, the latter objective had to be served by supplying a credible signal to the markets. This signal could not rely on the internal assessments by the Central Banks which were at the time seen by the markets as being captive to the incumbent banking institutions. This too required bringing in external validation. Thirdly, as in the case of Greece, there was always concern that more realistic assessment of the banking situation will expose Central Banking authorities to renewed public anger and trigger public retaliations. As the result, a third party often had to step in to provide a public buffer between the losses estimates, the banks and the Central Bank. Fourthly, counterposing potential public backlash, the banks themselves were significantly incentivised (in the context of loss assessment exercises) to attempt influencing the Central Banking authorities to alter the results of the exercise. Perceived objectivity of the estimates, therefore, required more external validation.

3/12/2013: GoldCore research note on deposits bail-ins

GoldCore have published an insightful guide to banks bail-ins of depositors that the EU is rapidly falling toward as a default policy for resolving future banks crises.

Here's an inforgraphic from the report:
http://dzswc0o8s13dx.cloudfront.net/goldcore_bloomberg_chart1_03-12-13.png

And the link to the report itself:
http://info.goldcore.com/what-savers-and-depositors-need-to-do-to-protect-their-savings-and-deposits-from-bank-bail-ins

30/11/2013: Is the Central Bank Heading Into a Crisis?

Throughout the crisis, I have been highly critical of the Central Bank's role in the creation of conditions that drove us toward the crisis. And of the weaknesses in the CB's attempts to address the mortgages crisis, as well as the lack of direct and open assessment of the crisis.

At the same time, the CB also deserves praise. With Prof. Honohan in the driving seat, the organisation implemented major changes in operations, strategy, regulatory and reporting areas. It is well on its way toward breaking free from the past.

The CB beefed up reporting and compliance, opened up databases, cleaned up data disclosure, beefed up research. It is also a much more open organisation when it comes to communications with the analysts and the media. In dealing with the banks, the CB took a more pro-active role than is normally required. This reflected the nature and the extent of the crisis in our banking sector, as well as growing realisation within the CB that extend-and-pretend approach to the crisis is not going to help resolve the issues.

These processes of change are still ongoing and are far from being completed. The last thing we need now is a crisis in the Central Bank. With many competent people who took CB through significant and positive changes in recent years leaving, it is imperative that Prof. Honohan is given a chance to rebuild the team and press on with changes. The questions to be asked of the CB should not be limited to 'What is going on?', but must extend to include 'What is next?' We cannot allow the CB to slide back into the swamp of complacency it was prior to the crisis.

22/11/2013: Euro area banks: leveraged through the nose... still

All you need to know about European banks sickness (it is still raging), the state of European regulations and quality oversight over the banks (it is still crap) and just how far we have travelled from the causes of the crisis (not far at all) in one chart:

European bounds set for the banks are a joke. A bizarre joke. And yet, Europeans call this a 'reform'. And regulators in the countries with completely dysfunctional banks (e.g Ireland) harp on about their banks 'compliance' with or 'meeting' the 'European standards'...

Notice, under the US proposed standards, leverage ratio requirement will be raised to 6% for FDIC-insured banks... meanwhile in Europe, 3% is 'rigorous' and 'robust' and 'safe' and 'never again' level...

Time to smell the roses. Going at the current rate of 'reforms', it will be decades before this European mess is sorted and by then, Europe won't matter to the rest of the world... will not matter at all... backwater with a few nice museums and some statues of the Great Leader Hermit von Frompy strewn across the lovely fields of wheat...

Oh, and if you still think that Newbridge Credit Union is a Big Story - my suggestion is: time for a visit to your friendly head doctor?..

21/10/2013: Sovereign Debt & Banking Crises: Emerging Markets Evidence

Recent (March 2013) CEPR Discussion Paper No. 9369 by Sylvester C. W. Eijffinger and Bilge Karataş, titled "Three Sisters: The Interlinkage between Sovereign Debt, Currency and Banking Crises" argues that "the sovereign debt default and the linkages from banking and currency crisis have been rarely explored in the crisis literature." The study attempted "to dive into this unexplored area by applying panel data binary choice model on a sample with 20 emerging countries having monthly observations for the years between 1985 and 2007. The non-linear linkages from currency and banking crises to sovereign defaults are explored by using the interactions of these crises with international illiquidity, appreciated real exchange rates and real international monetary policy rates."

The sample is clearly not applicable directly to the advanced economies, such as the euro area, but the findings still remain interesting.

"It is discovered that currency, banking and debt crises tend to occur simultaneously [an increase in the indebtedness of the public sector, overvalued exchange rates and financial as well as political riskiness of a country plays a role in predicting sovereign default].

"Prior occurrence of a currency crisis increases the sovereign default probability through appreciated real exchange rates, and in countries with high short-term indebtedness the occurrence of banking crisis raises the probability of a debt crisis."


Source: www.cepr.org/pubs/dps/DP9369.asp

27/9/2013: Consolidating Irish Banking Sector is a Bit of a Efficiency Dodo?

A new paper by Anolli, Mario, Beccalli, Elena and Borello, Giuliana, titled "Are European Banks Too Big? Evidence on Economies of Scale" (August 6, 2013: http://ssrn.com/abstract=2306771) "…investigates the level of economies of scale, as well as their determinants, for 103 European listed banks over the period 2000-2011…"

H/T to @brianmlucey for spotting the paper. Brian blogged on this today here: http://www.irishbusinessblog.com/2013/09/26/are-irish-banks-too-big-seems-so/


According to the abstract [emphasis is mine]: "The results reveal that economies of scale are widespread and move together for all size classes, although small and medium-sized banks experience the lowest economies of scale and even diseconomies of scale in some of the years under analysis."

The economies of scale concept as applied here is whether banks become more cost efficient when their size increases. In other words, the issue is are TBTF banks more efficient and are smaller banks, perhaps created by a regulatory breaking up of larger institutions in the wake of the crisis less efficient?

According to the authors, in the wake of the crisis: "An intense debate on the “make-them-smaller” is ongoing, and we aim to contribute from a quantitative perspective."

To do so, and "to fill the gap of evidence on European banks over the most recent years, this paper aims to investigate whether, among EU listed banks, there is evidence of economies of scale also for the largest banks in terms of total asset. Moreover it aims to isolate the effects of risk-taking, diversification in the business model and profitability on economies of scale."

"We find that economies of scale are widespread across different size classes of banks, and that they are especially wide for the largest banks. Moreover, there is a scale effect of the financial system, the smallest financial systems (Iceland, Belgium and Finland) and the countries most affected by the financial crisis (Ireland, Iceland, Belgium, Portugal and Spain) experience the lowest economies of scale (if not even diseconomies of scale) probably due to the small/reduced use of their production capacity."

Put differently, in countries like Ireland, the study finds that there is small or negative effect of larger size on greater efficiency of the banking system. Now, wait, but what about Government/Central Bank plans for consolidating the banking system into 3-pillar banks? Ooops...

"As for the effects of risk-taking, diversification in the business model and profitability on economies of scale, higher economies of scale are documented for banks more oriented towards investment banking (in all periods), banks with a higher liquidity but only up to a liquidity ratio of about 5.3 percent (convex curve during the crisis only), banks with a smaller amount of Tier 1 capital (concave, although almost flat, curve during the crisis only), and banks contributing less to systemic risk. The Granger causality tests suggest the existence of unidirectional causality for liquidity, Tier 1 and systemic risk."

So in plain English, this means that authors found that larger banks are more efficient when they are more liquid, take on more risky assets (investment banking), hold less capital (i.e. run greater risk of potential need for larger bailouts) and for banks that are less wired into the economy (contribute lower systemic risks). Oh, and the casualty for the economies of scale efficiencies goes from riskier behaviour and less connection to the economy to greater efficiency related to scale. Which part of these conclusions supports the irish Government/CB plans for 3-pillar banking system? Err… none!

Now onto country-level results: "Table 4 reports the average economies of scale for each country and for the different size classes of banks during the entire period 2000-2011."

"…Three countries (Belgium, Finland and Iceland) show overall diseconomies of scale. Meanwhile in the other European countries…, large significant economies of scale are reported (in particular for banks in the Netherlands and Switzerland). When we combine country and bank size, we observe that diseconomies of scale are experienced by the smallest banks in Finland, Germany, Ireland and Spain, the small banks in Finland, Germany, UK, Iceland and Portugal, and the medium banks in Belgium and the UK. Large banks exhibit diseconomies of scale in Ireland only, whereas largest banks show diseconomies of scale in Belgium only."

Oh, wait, so the 3 Pillars are getting worse (at being efficient) as they get bigger? You betcha… And the solution is… per Irish Government plans... to grow them even more mighty by consolidating the entire banking space in their hands. But more to come on these giants of greatness in the next table.

"Table 5 shows the average values of economies of scale for each country and in each year under analysis."

"Diseconomies of scale are more pronounced during the global financial crisis. In 2007 the number of countries that experience constant economies and diseconomies of scale (Finland, Ireland, Iceland and Spain) increases, but it is especially in 2008 that the number of countries that encountered diseconomies of scale (Belgium, Finland, Greece, Ireland, Portugal and Spain) increases. This evidence confirms, as expected, that the scale of European banks, when volumes declines due to the crisis, resulted to be excessive and inefficient due to excess capacity."

Wait a second, folks… between 2010 and 2011 Irish 'banks have: (a) shed much of their bad assets into Nama; (b) got recapitalised, and (c.) spent the last few years trimming down their operations to deliver on efficiencies demanded from them by the Central Bank… And yet - the economies of scale declined for them between 2010 and 2011.

Crazy stuff, until you realise that none of the 'reforms' we put forward to our banks have anything to do with increasing their efficiency or their capacity to function like proper banks. All our 'reforms' have been designed to suppress the explosion of bad risks on their balanceshets. Extend-and-pretend across the banking system doesn't add up to gains in efficiencies in the banking system? Who could have thought that up to be the case?

Now, how about a novel approach to repairing Irish banking system? How about getting real competition going by encouraging new entrants and freeing up (regulatory) credit unions and post offices to move into banking and consolidate within their sub-sector to form medium-sized banks? That might reduce market concentration and increase the numbers of banks with economies of scale?..

15/9/2013: BIS Quarterly: a tale of two banking systems

Two hugely revealing charts from the BIS Quarterly Review, September 2013 (http://www.bis.org/publ/qtrpdf/r_qt1309e.pdf) show exactly the remaining adjustments yet to be undertaken by the banking sector in Europe, compared to the US.

Here they are:

 and

 
note how European banks lag US banks in assets deleveraging, and in raising capital, and are slightly lagging in terms of changes in the ratio of risk-weighted assets. In risk-weighted capital ratios, the european banks are about 1/3rd of the way shy of the US, and in terms of capital, roughly 1/2 of the adjustment to the US levels is still required.

And per operational weaknesses of the European banking system? Next we have a table:

Although different across periods, the divergences between the European and US banks are still qualitatively the same for pre-crisis and crisis periods. In particular, US banks operate at higher cost than European ones, but generate more interest income and other income.