Germany to the Rescue! - Update I

Now a peak at the CDS spreads again (hat tip to BL). To my earlier post (here) see the chart below: Gheez - we have Irish CDS reaching toward Philippines around mid February...
Of course, per Davy (here) there is no need to panic. “The risk of Ireland not being able to meet ongoing debt payments over the next few years is very low.”

Low? Hmmm.

Ireland government bond CDS at 3.4% and a recovery rate of 40-50% is equivalent to a risk-neutral (frictionless markets etc) default probability of CDS/(1-RR)=3.4%/0.6 = 5.67 pa or (1- (1-0.0567)^5)=25.3% cumulative default probability over 5 years. For 50% recovery rate, the latter figure is 29.7%.

Now, investors are risk averse, not risk neutral, and the Irish bond market is not exactly frictionless which can push the above probabilities down, although we do not know by how much.

What is, however, not accounted for here is the potential downside to the recovery rate - the amount that can be expected to be recovered should a sovereign actually default. For now, the markets price in a 40% recovery, implying that in the case of a default investors can expect to get 40c on each Euro back. But how realistic is this?

One recent experience with sovereign default shows that in the case of Argentina in 2000-2002 (see Andritsky, J (2005) Default and Recovery Rates of Sovereign Bonds, The Journal of Fixed Income, September 2005)
" Uncertainty about the expected recovery value is a main caveat when pricing credit-contingent claims in reduced-form models...The resulting recovery value estimated from Argentine global bonds starts out above 50% and falls to 25% after default."
So back-track from the above to today's Ireland Inc scenario and, suppose the recovery rate of 60% today implies a recovery rate of 30-40% at default and the current probability of default over 5 years of (1-[100-CDS/(1-RR)/100]^5)=36%... Nothing to worry about, folks, then - in plain English the above means that if Ireland Inc is any better than Argentina (the country that routinely and with frightening regularity takes foreign investors to the cleaners), our CDS levels today might be consistent with an equilibrium cumulative default odds of over 1 chance in 3.

But hold on, if the CDS rates are not a decent measure of implied default probability and a purely speculative tool instead (as our Nobel-prize contesting gurus from Davy, the DofF and CB keep telling us), why should the CDS data track closely the yield spreads? Maybe because they 'kinda feel so, man!' or maybe because the speculators in both markets are all in some global conspiracy club (wearing Venitian Canvivale masks and speaking in secret signs), or maybe, just maybe, both markets are really not buying the DofF-led and Davy-repeated story of 'no risk of default for Ireland Inc'.

Either both, the markets for CDS and Irish bonds are wrong, or Davy and the Government are. Take your pick.

IL&P: next in line? Update

And so the papers today follow our lead...

Tribune (here) starting to smell a rat:
"Irish Life & Permanent (IL&P) and Anglo Irish Bank could be facing fines of €5m each if the Financial Regulator determines the two banks engaged in market abuse by executing €8.2bn in circular transactions to make Anglo's customer deposit base appear more robust. ...which it has called 'completely unacceptable'."
It might be not a smoking gun for IL&P's 'new' sins, but it should keep markets on its trail.

That said, the article has a hint on balance sheet questions for IL&P (and others):
"...banks will either have to demand significant equity from developers or renegotiate loan terms. Most loans were given on the basis of a loan to value ratio, meaning that if the sites are revalued downwards the developer has to come up with the difference. This is viewed as unrealistic. As a result, banks have again moved to avoid formal valuations and there are claims some are setting up special vehicles to move loans off their balance sheet so they can amortise them over time, rather than writing them down."
Well put, boys, revaluing on the balance sheet

• land banks that are virtually worthless
  
• sites that are nearly worthless and
  
• buildings that saw their value decline by 30-50%
  

is 'unrealistic' indeed. I have shown the Anglo Irish Bank's annual results as being clearly indicative of some of this engineering going on (see here). And, since the beginning of 2008, virtually every developer plc has 'renegotiated' its loans covenants. Does anyone seriously believe that the rest of the banks posse is somehow above this Anglo practice?

Ireland is inching closer and closer to the 'Bad Bank' solution that should have been enacted some months ago. At the very least, to repair the repairable - household loans and mortgages - thus providing more room for addressing the developers loans.

The difference today is that we are out of cash to get such a bank going, thanks to a rushed re-capitalization and the Government's unwillingness to extract real value out of public sector waste. And private money is already smelling the roses (here): €10bn outflows out of Ireland in one week - some 5.6% of our GDP or 3.2% of all main banks deposits gone in smoke. What is the downside to the Exchequer on this? Should the outflow continue unabated, within a week or two we will be facing the need for a new round of banks recapitalization, this time around - ca €10bn... and the money will come from?..

The minute the markets recognize this reality - Mr Lenihan with an empty policy gun and the bear still charging undeterred - things are going to get rough.

IL&P: next in line?

All this week, while the politicians were preoccupied with Anglo's saga, I've been watching what appears to be the next downgrade target: IL&P. Intimately linked to the Anglo Irish Bank's shenanigans, IL&P has had a rough ride alongside its other free-standing (for now) peers: the AIB and BofI. Towards the end of this week, it seems, this term - 'alongside' - has become far less descriptive of IL&P's share price behavior.

Are markets on to something we are yet to discover? I don't know, but here is how strange the things got in the course of last week.
Chart above shows correlation between the daily volumes for IL&P shares and the average daily volumes of AIB and BofI shares since December 2008 through February 20 close. Clearly, things gotten a bit out of pattern ever since the local low -0.5 correlation was approached on February 16. More importantly, Friday the 20th of February saw a reversion of correlation down to below 0.25.

As illustrated in the following chart, this is not surprising, given that both AIB and BofI volumes declines on Friday have been countered by a significant volume uptick in IL&P.Of course the volumes changes - especially pattern reversals over historical averages - are significant as they signal (in this case) a rising support to the general direction of share price movement. At this moment, the market appears rather committed to downgrading IL&P, while treating AIB and BofI much lighter.

Of course, the chart above lends some support to my last hypothesis: while both AIB and BofI are seeing moderating decreases in prices alongside falling volumes, IL&P is seeing increasing downward pressure on price alongside increasing volumes (note the chart above plots the product of price to historic average ratio and volume to historic average ratio). But don't take my word for this: chart below illustrates by referring directly to prices.

And the weekly moving average of correlations between closing prices for AIB and BofI with IL&P are starting to show strain as well.On the net, out of the four main parameters I usually use to gauge the possible shifts in market attitude toward a specific stock:

• divergent price moves relative to historic average and peers;
• volume changes to signal increasing support for one share relative to its peers;
• moving price correlations relative to peers diverging away from strong positive values; and
• moving volume correlations diverging from strong positive values

all four are currently signaling some potentially new concerns about IL&P emerging in the market. Can it be the aftermath of the Anglo affair? Possible. But how likely is such a scenario given extensive downgrades to IL&P on the back Anglo's news in the past and given that by now the company has been devalued as if it were a pure banking sector play, effectively discounting the insurance side of business to nil (chart below).

Can it be that the markets are becoming aware of some new set of skeletons in IL&P's closets? Also, possible. And, given the scandals surrounding Anglo, Irish Nationwide and other players, somewhat probable as well.

Of course, time will tell for sure, but I would watch IL&P very closely on Monday...

PS: Oh, yes and intraday volatility for IL&P is also moving against the peers:

Anglo Irish Bank Annual Report

http://www.rns-pdf.londonstockexchange.com/rns/6782N_-2009-2-20.pdf

The link to the most wanted publication - the Anglo's annual report for 2008.

Let anyone reading this while posessing knowledge in corporate finance and balance sheet analysis (I have none) comment on this and any other findings relating to the report.

So... guess what? The report is a hog wash, containing no real information on

• the impairments outlook,
  
• the reclassification of the loans,
  
• loans under 'watch'
• roll-overs of loans, and so on.

The IL&P loan/deposit scheme is there for all to see, but what it implies is not. It implies that short of IL&P intervention, Anglo had a negative core capital reserves at the time of the announced guarantee scheme. Do the math: Core Tier 1 Capital for 2008: €5,068mln. Per page 4 of report: "At 30 September 2008 the Group’s balance sheet includes €7.5 billion of short term interbank placements with Irish Life & Permanent plc and €7.3 billion of non-retail customer deposits with Irish Life Assurance plc". Oh, my...

Other notables:

• page 6: Ireland lending up from €37bn in 2007 to €42.8bn in 2008. Given lack of demand for new loans and tight credit finance, is a part of this growth due to the rollover of non-performing loans with interest charges absorbed into 'new' loans? The report says: "In keeping with the Bank’s relationship based banking model, lending activity during the year was targeted solely towards the Bank’s longstanding customer base." Should we read this as 'the long-term developers reclassifying and rolling over loans'?
  
• page 7: Impairment charge on the loan book went from 0.5% in 2007 to 1.31% in 2008. Again, no guidance on future impairment charges, but should we agree with my/analysts numbers produced in December (here), we are looking at 4-5.3% impairment on property-linked loans or 3.5-4.6% on loan book. Some distance to travel yet.
• page 70 §12: total provisions for impairment were up from €149mln in 2007 to €879mln in 2008. Again, applying this dynamic to the 2008 figures and projecting into 2009, expected impairment charge for 2009 should be around 5%. Even assuming away the counterparty risk under the investment securities impairment (which might be unlikely to remain as high in 2009 as in 2008), we have a consolidated projected loan impairment charge for 2009 of 5.1% - higher than my 4.6% moderate risk scenario forecast.
• page 74 §20: serious fall off in financial assets held, with a rise in unlisted financial assets - is this again showing some financial engineering on the existent loans side? Unlisted assets against customers' liabilities up over 10% y-o-y, listed - down by ca 60%... losing the 'house' while accumulating the 'rubble'?
• page 81 §22: serious deterioration in the quality of loans and advances to banks. AAA/AA rateds down by more than 1/2, A rateds up by a factor of 3+. And this is to September 30, 2008, since when things went even further South globally. Ouch...
• page 82 §24: assets available for sale securities are ramped up in 2007 and unwound in 2008, potentially depleting the assets risk cushion? Per table below, one has to have a laugh at the AAA/AA classification of a lion's share of Mortgage Securities and ABS. Take

1. the financial institutions downgrades across Ireland (assume 10% moves to BBB and 20% to A),
   
2. the mortgage securities at 15% negative equity (corresponding to the estimated 120,000 households) to BBB level and
   
3. ABS at 25% (US-level) downgrade to Sub-investment Grade and further 25% downgrade to BBB and

you get: AAA/AA total drops to €5,751mln from €6,742mln in 2008, while BBB and lower rises from €197mln to €579mln. All sub-AA classed available-for-sale assets fall from €1,993mln in 2007 to €1,410mln per Report (despite the fact that the quality of may underlying asset classes has been deteriorating during 2008 worldwide, although, apparently not on Anglo's books), but rises to €2,212mln in 2008 terms under my assumptions. What is more plausible, folks?

• page 84 §25: total loans and advances to customers per Bank itself were up €12.5bn in 2008;
• page 86 §25: Lower quality, but not past due nor impaired loans: up from €363mln in 2007 to €2,736mln in 2008, past due but not impaired: up from €1,621 in 2007 to €1,782mln in 2008, impaired up from €335mln in 2007 to €957mln. In the mean time, satisfactory quality loans amounts moved from €322ml in 2007 to €6,302mln in 2008. So in common parlance terms, Anglo's 'slury' loans creek has swell from ca €2,641mln in 2007 to €11,777mln in 2008, an increase of 359% - all in the year when impairement charge officially went up by only 162%. Now, taking 2008 impairment ratio at this rate of deterioration in the quality of loans implies 2009 impairment charge of 4.5% across the entire book (see the second bullet point above)... Hmmmm, someone is foolin here?
• pages 148-149 show loans to Directors and related parties. No new skeletons here - Sean Fitzpatrick is the only name on the list, with the rest of Directors names missing next to loans amounts. Anglo issued loans against its own shares as underlying collateral guarantee funds, and held no impairment provisions for Directors loans.
• page 150: a small goodie: "During 2008 close family members of Sean FitzPatrick received rental income from the Group of €31,500 (2007: €35,500) in respect of a UK property that, rather than hotels, is actively used to accommodate Group employees working in the UK on a temporary basis. Total future minimum payments under the tenancy agreement are €7,600 (2007: €8,600)." So buy-to-let UK markets are alive and kicking then...
  

Ah, I might as well stop at this point. Let anyone reading this while posessing knowledge in corporate finance and balance sheet analysis (I have none) comment on this and any other findings relating to the report.

I am staying off Anglo case for now, having done more than our wonderous Minister for Finance, who could not be bothered to read the entire PWC report on banks he was generously recapitalizing with the taxpayers' money.

State of our Democracy

For those of you who missed my today's musings on Irish Democracy in The Irish Daily Mail, here is an unedited text of the article:

We live in time of unprecedented crisis of confidence. Last week, carnage in the financial markets saw Irish shares sliding deeper into the red. Yesterday, for a brief period of time, our Government bonds were trading at the levels indicative of the markets pricing in a 22-25% probability of the state default on the loans – a level that would, in any functional democracy, see the Government facing a vote of no confidence. And yet, the circus of the private sector scandals alternating with policy debacles continues to repeat itself with a frightening regularity, undermining further international opinion of Ireland as a robust economy and a transparent democratic state.

The reason for Ireland’s declining status amongst our peers is that by any measure, be it a measure of ethical and legal compliance in our financial sector or the benchmarks of transparency in governance, we are lingering at the lower end of the developed world league. Yesterday’s events surrounding the Joint Oireachtas Committee on Economic Regulatory Affairs illustrate the point.

The Committee, set up by what in theory should be the most powerful legislative and policy entity in the country – the Dail – was exposed as largely toothless grouping of elected representatives. If the fact that the Committee has no powers to punish or prevent any wrongdoing by corporate and regulatory bodies operating in this country was not enough of an affront to public accountability, the fact that it has no capability to compel private individuals and public representatives to appear in front of the nation’s legislators certainly does the trick.

At the core of this is the refusal by former Anglo-Irish Bank chief Sean Fitzpatrick to appear before the Joint Oireachtas Committee. But, before him, the same Committee heard an equally loud ‘No’ in response to an invitation to testify from Ernst&Young, Anglo’s auditors, the former Financial Regulator and the former FAS chairman.

Despite being perfectly legal under the current system, Mr Fitzpatrick’s refusal to answer legislators’ questions concerning the alleged wrong doings at the now state-owned Anglo-Irish Bank is morally, ethically and economically disastrous for Ireland.

Here is why.

From the moral perspective, Anglo-Irish Bank was taken over by the state at the expense to the taxpayers on the back of the managerial and strategic errors and alleged dubious practices. Mr Fitzpatrick was the Chairman in charge of this institution at the time of its failure. Mr Fitzpatrick – as both a Chairman and a private citizen – was also a party to several questionable transactions that allegedly precipitated the collapse of the Bank. Taxpayers are owed full disclosure of the events that led to the Anglo-Irish nationalization and Mr Fitzpatrick, alongside a number of public officials from the Financial Regulator and the Central Bank, must face open and transparent public questioning by the Dail. Of course, legally, the rights of all questioned should be respected, but compelling them to appear in front of the Joint Oireachtas Committee does not imperil such protection.

From the ethical point of view, the democratic process must grant full respect and complete investigative powers to the Parliament. This simply means that the power of compulsion extended to the Courts must be matched by the similar powers available to the Parliament and its Committees. This is more than a theory – it is an act of establishing practical checks and balances to safeguard the interest of the people against the interest of the narrow groups and state institutions. In a functional democracy, Parliament must act as a guardian of the society, while courts must guard the rights of individuals. We are, clearly, getting that simple formula wrong, with our judiciary pontificating about social conditions in individual judgements and our Parliament incapable of even gathering investigative information.

This Parliamentary investigative function has been imperilled many times before, including in recent months by the former Financial Regulator Patrick Neary and former FAS chairman Rody Molloy, who was forced to attend only by the wave of popular outrage over the FAS mis-spending of taxpayers’ funds. Mr Fitzpatrick’s move this week simply adds to this list of public figures who are allowed by law to ignore this country’s main democratic institution. Then again, what is there to be said about individuals, when the Government itself is unwilling to disclose due diligence information on banks rescue to the Oireachtas?

Lastly, robust and effective markets require robust and effective compliance with the letter and the democratic spirit of the law. Thus, existence of Irish economy itself is predicated on our ability to investigate suspected wrongdoings, publicly disclose relevant information and identify and punish those who breach the law. The investigative work of the Joint Oireachtas Committee is at the heart of this process. Moreover, it is central to the issues of how transparent and open our market makers (top corporate brass, regulators, politicians and others at the helm of Ireland Inc) are. Once again, Dail’s inability to compel Mr Fitzpatrick to testify in front of elected legislators on the issues relating to the Anglo-Irish Bank’s nationalization is nothing less than a public admission of the fact that the Irish economy and society are not meeting the high standards of transparency that are required of the mature economies today.

Last week, before Mr Fitzpatrick’s latest decision, one international investor, previously an active buyer of Irish shares, has told me that his fund is no longer willing to hold any shares in what he termed a ‘cosy cartel that is Ireland Inc’. The reason for such drastic re-assessment of the fund position was that his managers found it hard to believe the corporate and regulatory culture of Ireland in the environment where the Government refuses to openly discuss the issues of due diligence in the cases of state investments in the banks, the regulators who fail their basic functions are getting off with a golden handshake payoffs, and corporate leaders cannot be called to public account.

Sadly, the events surrounding the Joint Oireachtas Committee on Economic Regulatory Affairs this week are proving him right.

Yet, the pathetically inadequate power of the Joint Oireachtas Committee uncovers democratic deficit in our legislative and policy-making systems that is hardly new to anyone living in this country. For over two decades now, a group of unelected and unaccountable public and private sector representatives has presided over economic and social policies in this country. The name of this club is the Social Partnership. Its modus operandi was and remains clandestine negotiations carried out behind the closed doors with the Government acting as a go-for boy to this Big Brother. Its remit over the society was and remains huge – with powers to set wages, promotion and hiring policies, taxes and public spending and investment priorities. To all of this, our elected Parliament is an external observer with no power to change the course of the Partnership agreements.

In effect, Ireland has long ago ceased to be a properly functioning democracy, where policies are set by the Parliament of the people for the people. This week events at the Joint Oireachtas Committee remind the entire world that our legislators can not question our public and corporate leaders even when their decisions and actions expose the Irish taxpayers to potential financial ruin. This is, by all means, an apt conclusion to the corporatist state saga of the Social Partnership – a neutered Parliament, a toothless democracy and a dysfunctional market short on international confidence.

Thanks, Sean, for showing us the true state of this State.

Germany to the Rescue!

And so it comes to pass that my comment yesterday on the German need for a rescue package for Ireland (see WSJ blog here) is today's FT Deutschland topic du jour:

FT Deutschland reports that Germany's Finance Minister, Peer Steinbruck said that the euro area will find a way to 'circumvent the legal no-bailout clause'. Steinbruck was talking specifically about the potential need to rescue Ireland on the back of a dramatic increase in our CDS spreads - those pesky 'speculative' things that our DofF dismissed as being irrelevant minority instruments (see here).

Oh, yes. Brian Cowen can start making the rounds - cap in hand. Just don't send that embarassment-in-a-Ministerial-Merc Mary to do the job, please, and don't tell Germans that we too share their fondness for a pint... We are no longer in a polite-visit-to-Japan territory. We are in a begging mood.

Steinbruck's comment is worrisome in terms of three issues:

1. Last night, the dollar rallied and the US Treasuries yeilds compressed on the back of a flight to safety, including the outflows from European bonds. Should Ireland tap into German funds for a rescue loan, Eurozone's golden standard German Bunds will suffer. If the rest of PIIGS were to follow Irish suit, there will be a wholesale downgrade in the Bund - a calamity for the Eurozone stability. So in the end, there is an argument that a rescue of Ireland might be forthcoming, if and only if that rescue is small enough - €2-3bn would work, €10bn probably won't. But of course Ireland's need for cash is nothing close to €2-3bn. Can Germany afford sacrificing its own bonds stability to plug Mr Cowen's budget deficit? Will Germany stand by and lend money to Ireland with no strings attached? Will German loans be better termed than those of the IMF?
2. No one in the media has mentioned the turn of the phrase used by Steinbruck: that 'circumvent the legal no-bailout clause' thingy. Even in better days of global growth, international markets did not look kindly on Eurozone's penchant for arbitrarilly re-writing its own rules of fiscla and monetary stability, as was done with the Maastricht criteria earlier this decade. Now, the appetite for reckless decisions is even lower. This presents a serious problem for the Euro - young currency's credibility is based on the rules underpinning its existence. Should these rules be 'circumvented', we may kiss good-by the idea of a stable Euro.
3. Steinbruck's comments on Ireland did nothing to explain his view of the risks facing the Eurozone in the context of reckless Irish spending and economic management. This might be signaling that instead of economic stability concerns, Steinbruck was thinking about political issues. Will German rescue of Ireand come at the expense of forcing this country to ratify the Lisbon Treaty? Quite possibly so. Blackmail has been used by the EU before - most notably in the agreements with Norway and Switzerland and in the case of Nice Treaty vote in Ireland, as well as in the case of the Danish rejection of the Maastricht Treaty.

Oh, dear...

Aha, DofF - and the PIIGS will fly...

This is from Bloomberg (here):

Credit-default swaps (CDS) on Irish government bonds climbed to 386 today from 378.5... Irish swaps last week surged 95 basis points... Contracts linked to French, German, U.K and Spanish debt also rose to all-time highs.

CDS, conceived to protect investors from default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase signals a deterioration in the perception of credit quality.

Ireland’s Finance Ministry said it’s incorrect to draw conclusions about the “soundness of Ireland’s public finances” from credit-default swaps.

“The credit default market is small and opaque,” the Dublin-based Ministry said in an e-mail today. “It is generally used as a speculative tool by a small number of market participants to gamble on movements in the CDS market itself rather than to insure against default.”

Oh, yes, and the DofF would know what they are talking about. After all, they do have on their staff:

• no financial markets economists at a PhD level;
• no financial risk economists at a PhD level;
• no finance professionals at a PhD level;
• no finance practitioners in fixed income with any reasonable senior private sector experience, and so on.

In fact, the DofF can't even forecast its the figures under its own remit. Forget making markets pricing statements.

But, hey, a good preemptive strike at the markets before things go further South is a way to go amongst Irish officials now days. And what a timely preemption this one was. The latest figures from CDS markets for inter-trading period show: 390-405 spreads. As B. puts it, "we are 50% up in a week, and its only Tuesday!"

And what about that ages-old deus ex machina of all incompetent polticians - the referencing to some "small number of market participants" keen on speculating in the financial markets. Surely we've seen them being proved wrong before... many times... hmmm, like with the EMU crisis. It is clear that our DofF boffins are simply too economically illterate to understand that no small handful of speculators can win absent real arbitrage opportunities. Thus, if the small numbers of such speculators still exist in the market, there is something true to their gambles. In other words, there is no smoke without a fire. Dough!

Of course, it is not just the markets that are noticing Irish fairytale story of 12+% deficits and unbelievable DofF-cooked-up figures showing 3% deficit rule being met by 2013. Germans are noticing it too (see above mentioned Bloomberg report). And about time (see my comment to the WSJ blog here). What would Mrs Merkel have to say about the German taxpayers having to rescue our DofF from the clutches of the handful of market speculators?

Back from the snow

I am back in Dublin after a few days of snow-capped Italian Alps, great food, great wine, sunshine, crisp and clean mountains air. Friuli was, as it always is, a marvel!

What did I miss while away?

First, the recapitalization announced last week is not working. The magic, if a promise of the state taking a large chunk out of any future profitability, growth strategies and competitiveness of the Irish banks has had any magic in the first place, is now all gone. Gone because of the terms of this senile arrangement for all sides involved.
Here is how:
(1) The state is borrowing money at ca 5.5-5.7% in the market and injects money into the banks at 8%, earning risk unadjusted 2.5% return implying a risk-adjusted return (assuming our banks CDS spreads for last week) of ca -2-2.5%,
(2) The banks get money at 8%. Hostage to Government's demands on boards composition and lending, their profitability is shot for the foreseeable future,
(3) The banks are required to lend money out to businesses at... 8% (cost of funds) + admin cost (1.5%) so, say, ca 10% to repay the state,
(4) Businesses will stay away from this latest Government-engineered rip-off, while Ireland Inc's corporate and household balance sheets will still carry excessive levels of risk and debt and the economy will continue to spiral downward.
So, Minister Lenihan, the scheme cannot work even in theory. Forget about trying to make it work in practice.

Second, my favourite charts are updated to show that the things I missed while away were duly priced into Irish shares valuations by the market. Hey, at least the market still functions...

Third, I've missed some lively debates on certain 'academic' blogs about the pesky foreign commentators 'talking down' Irish Miracle Economy (and Government credit ratings). Needless to say, I am not amused:
(1) Some of those who made these comments themselves are keen on offering consultancy services advising foreign governments and commenting on their policies. Do their comments suggest that they claim a privilege to do what others should not be allowed?
(2) A part of this debate has finally exposed the undemocratic, technocratic nature of some of the members of the Irish intellectual elite. One commentator went as far as state that any publicly open debate exposes Ireland to the irrationality of the masses and that openness and freedom of expression thus are best reserved exclusively for discussions involving only 'informed' policymakers and analysts.

Which brings us to today's news: Irish 5-year CDS spreads have hit 378bps today, with a recovery rate of 40%, implying (assuming frictionless markets and no arbitrage) a lower bound of the Ireland Inc's default rate of 22%. Adding thinness of the markets (Irish bonds being traded in relatively small volumes, plus the half-day trading yesterday in the US) our implied sovereign default rate stands probably closer to 25%.

These are the resignable-level figures for our Brian-Brian-Mary Triumvirate of the Incompetents.

The end of the road?

Prepare for carnage once the markets open tomorrow. Per latest RTE report (here), Irish Life & Permanent admitted that it provided 'exceptional support' to Anglo Irish Bank following the taxpayers-paid-for Government [banks] Guarantee Scheme.

According to IL&P at the times of 'unprecedented turmoil' there was 'an acceptance that financial institutions would seek to provide each other with appropriate support where possible'. It is claimed that the transactions were fully and appropriately accounted for in the books and in regular reports to the Financial Regulator.

Anyone still surprised that the global markets are treating Irish equities as some sort of the corporate governance lepers? Any surprise that some institutional investors are no longer willing to hold any shares in the cozy cartel of 'supporters' that is Ireland Inc?

Here are some questions that must be asked immediately and with a view of taking up resolute corrective measures should any wrongdoing be uncovered:

1. Can these actions by IL&P be interpreted as a deliberate manipulation of the market? Corporate deposits are the components of bank's balance sheet that support share price valuations. Interbank loans - a normal procedure - are not. If deposits were made to provide 'support' to the Anglo, without an immediate publication of these deposits and their underlying causes to the markets, did IL&P and Anglo collude to alter the bank's balance sheet without revelation of this price-sensitive information?
2. Did IL&P deposits undermine own balance sheet and were they properly cleared through the risk-assessment process? Was IL&P shareholder value safeguarded in the process of making this gesture of camaraderie?
3. If IL&P did disclose such deposits to the Financial Regulator, why these deposits were allowed to proceed and why this information was not made public immediately? If the FR knew about the covert nature of deposits, were they de facto a party to concealment of a price-sensitive information?
4. We are all aware of the rumors that both the Guarantee Scheme and the Anglo's nationalization were carried out due to some critical events involving the Anglo and (in the case of the Guarantee) some other banks. Withdrawals of corporate deposits on a massive scale were rumored in late September and December 2008. Why is the Government unwilling to disclose the nature, the extent and the timing of these problems? After all, the Government is (largely rightly, I believe) using taxpayers money to shore up our financial system, committing tens of billions of our own and our children's funds to underpin the Guarantee, the nationalization and the bailouts.
   
5. At an even deeper level: has there been an implicit (hear-no-evil, see-no-evil) or explicit (via refusal by the Government to admit the nature and extent of the triggers for emergency measures) collusion between the Government and the banking sector to sweep under the rug the problems of governance and management at some of our financial institutions?

Not a single revelation about the mis-conduct events associated with the Anglo has been made public by the Government in a voluntary fashion. Not a single piece of information concerning the due diligence process in re-capitalisation decisions by the State has been made public by the Government. In light of this it is legitimate to ask questions of the Government as to the nature of the silence that shrowds the taxpayers' bailout of the banaking sector.

Over recent days there has been a lot of talk in the international finance circles about the skeletons hidden in the closets of Irish banks. Reputational capital of Ireland Inc is no longer running thin - it is, by now, about as hole-ridden as a slice of Swiss cheese!

Functioning markets require compliance with the letter and the spirit of law. The law requires that all price-sensitive information relating to the publicly listed companies should be disclosed in a timely and appropriate manner. The IL&P-Anglo case suggests that, potentially:

1. The law that supports functioning markets might have been severely breached; and
2. Public safeguards that were entrusted to enforce this market-supporting law might have comprehensively failed.

If this is the case, it is time for heads to roll. Now! Starting at the top of the Financial Regulator's office and right through to the companies involved.

And as per re-capitalization scheme, any injection of public money must be preceded by a comprehensive independent (internationally-administered) review of the banks' balance sheets and books, prior to any State-financed repairs can be made.

Paul De Grauwe View: Credit Trouble Ireland

"Spreads of sovereign debt within the eurozone have increased dramatically during the last few months, largely as a result of panic in the financial markets. When it engages in quantitative easing, the ECB should privilege the buying of Irish, Greek, Spanish and Italian government bonds to eliminate the distortions and the externalities that these spreads create,"
says Paul De Grauwe in his yesterday's post on Vox - a worthy reading.

What this means is that, as predicted in my earlier posts, Ireland is now a prime candidate for an ECB-led rescue. De facto, De Grauwe's proposition implies Irish Government issuing (near-)worthless bonds and placing these with ECB in return for loans - a scenario that is indistinguisheable from an actual lender-of-last-resort rescue or equivalent to IMF lending money to Ukraine, Latvia, Hungary and Iceland.

De Grauwe offers a rather conventional - but not necessarilly wrong - view of the bond markets as being gripped by a speculative panic:
"My hypothesis is that the widening bond spreads within the eurozone are the result of panic in the financial markets. The panic that followed the banking crises has led investors into a stampede away from private debt into assets that are deemed safe. These are mainly government bonds of a few countries. The US, Germany, and possibly France are a few of these countries that, for some strange reason, have been singled out as supplying safety. Other countries do not profit from the same 'panic flight to safety'."

This statement prompted, yesterday, a rushed welcoming from a member of the officialdom of Irish ecnomics (see here). And yet, had Irish econocrats read through De Grauwe's article in full, they would have arrived at the following statement:
"Only Greece and Ireland saw their bond rates increase significantly over the last year, suggesting that the increased spreads of these countries are not only due to panic."

Needless to say - I agree with De Grauwe. Irish (and PIIGS in general) spreads are fundamentally linked not to those of the other Eurozone states but to the lack of national competitiveness (see De Grauwe's chart on unit labour costs reproduced below), economic diversification, cumulative wealth of society, infrastructural and human capital and indeed many other economic fundamentals which determine the resilience of economy in a downturn. In short - not a panic, but a low productivity of the PIIGS economies drives the crisis.

Relative unit labour costs in Eurozone
Source: http://www.voxeu.org/index.php?q=node/3009

In short, our econocrats, so keen on pumping public sector investment into building up Ireland's capital base, infrastructure, education etc somehow managed to convince themselves that our deficit in these areas, alongside our vast and widening Exchequer shortfall, uncontrollable public spending growth, massive banks guarantees and recapitalization commitments by the state and macroeconomic management that requires raising taxes during a severe recession, all matter little to the bonds markets. Instead, the panic - that deus ex machina of economics - is the answer.

No need to panic then...

DofF Forecast: Update II

As promised - here are two scenarios estimating the state of the nation's finances.
The tables are based on DofF Update January 2009. Benign scenario assumes moderately deeper growth contraction (GDP), a fall-off in the tax receipts (as outlined in my previous update - in line with January 2009 Exchequer returns), a contraction in semi-state companies returns and my forecast for the 'savings' to be achieved in 2009-2013. All changes are marked in red. Blue color denotes differences in assumptions between moderate and benign scenarios, with moderate scenario assuming slightly deeper contractions in tax revenue, semi-states returns and shortfall in committed 'savings'.

Perhaps the most important lines to consider in both scenarios are lines: GEN GOV BALANCE and Gen Gov balance as % of GDP, which show that even under benign scenario, current dynamics in tax receipts and semi-states' revenue imply that Ireland will not be able to achieve Growth and Stability Pact limits on Governement deficit of 3% by 2013. The range for Gen Gov Balance Deficit is between €21bn and €22bn in 2009 - a far cry from the DofF forecast of €17.2bn.

Another important aspect of these estimates is the sensitivity of the general deficit to the assumption on 'savings' to be generated in 2009-2013. Given last week's fiasco with Mr Cowen's proposals, it is now absolutely clear to me that:

• the cuts planned by the DofF for 2009-2013 are not going to materialise in full;
• the cuts that will have a cumulative effect over the years forward are not going to cover the entire amounts planned, so that one-off-measures will play a significant role in total savings to be achieved.

Debt Mountain 'Ireland Inc' IV

Spot the odd one out...

Chart 1 shows the most indebted (in absolute terms - gross external debt volumes) nations of this world with their debts expressed as percentage of Ireland's gross external debt. This clearly ranks Ireland as the 9th most indebted nation in the world, and 6th in the Eurozone. Note that in absolute terms, Irish total debt is greater than that of Japan!Now, Chart 2 is even more revealing, as it plots per capita debt levels of the most indebted (in absolute terms) countries in the world. Ireland is a clear outlier!Massive, unpredictable and a (possible) danger to others... Is there something moving in the corner?