How big is our Capital Stimulus - NDP and Public Policy Waste

In the US, according to Bloomberg, $1.6 trillion has been erased from equities values since January 20, implying that approximately $800bn of this is attributable to "the market's reaction to the stimulus plan". Furthermore, since "a standard assumption is that the marginal propensity to consume out of wealth is 5 percent. That would mean $40 billion less in spending. Then there is the effect on investment of the drop in Tobin's q (the ratio of the market value of capital, reflected in stock prices, to the cost of capital goods). These effects kick in immediately, while much of the [Obama] stimulus will not kick in until next year. So is the multiplier for the stimulus positive or negative?"

A good question to ask in the context of Irish Government policies as well. So let us do the maths. Per Table below,
overall Irish Stock Exchange market capitalization (measured by ISEQ Overall Index Cap) lost €4.1bn since January 1, 2009 and €54.3bn since the arrival of this Government. Thus, losses in consumption out of wealth alone over the latter period can be estimated at more than €2.7bn. For Tobin-q induced losses, the figure is a whooping €39.7bn.

In my analysis of Anglo-Irish shares (here), I showed that the regulatory risk premium on the bank implied a 69% downward revision in the share price from fundamentals-determined values. Let us, for the sake of an argument, assume that a similar process of downgrades applies to the Irish market as a whole.

As picture below shows, current market differential between ISEQ and its US peers is in the region of -53% for ISEQ. This is the total risk premium differential on the Irish shares. Suppose that ca 40-50% of this is due to the Government policies in the markets and on economy. Recall that in the Anglo case it was 69%, while in Bloomberg estimate for the US - a country where the Government and Monetary Authorities were much quicker and proactive in policy formation and implementation than our 'Don't Panic' Brians&Mary. Thus, my 40-50% assumption is a conservative one.

What do we have?

Since June 1, 2008 – the time of the new Cabinet take over – a cumulative wealth-destruction effect of the deficient public policies (imputed on ISE losses alone) has contributed to the consumer demand contraction of roughly €1.1-1.4bn, plus a Tobin effect of €6.4-7.9bn. The grand total losses attributable to our Government's policies failures for June 2008-present comes to €7.5-9.3bn.

Now, recall that the Government has promised repeatedly that we are going to have a significant economic stimulus via an NDP-driven capital expenditure program which was aiming to provide €10.3bn in net capital expenditure (per January DofF estimates) in 2009. Together with 2008, total capital investment for 2008-2009 was to be €21.2bn, or roughly €15.8bn between June 1, 2008 and December 31, 2009.

Even assuming this figure holds through the mini-Blood-Letting-Budget of March 2009, Government's failure to present a strong policy front to the market has already cancelled out some 47-59% of the entire 'stimulus'... And we are only 2 months into 2009!

Irish Boardrooms in Denial

This is an unedited version of the article published in Business&Finance Magazine, February 26, 2009, pages 30-31

Almost a year ago, I warned in this column that Irish companies are going to face a tough recession, with rising bad debts, tighter payments collections and accelerating rate of insolvencies. A recession that is likely to last through 2009 and a good half of 2010. Figures for 2008 show us on track to fulfil these predictions with more than doubling of the number of corporate insolvencies in one year. By all possible indications, 2009 is going to be even tougher than the already abysmal 2008. And yet, when it comes to a realistic assessment of business conditions there is a strange sense of denial of reality taking hold in Irish boardrooms.

First consider recent evidence. Two weeks ago, CSO recorded the first drop in industrial output in Ireland since 1982. A combination of collapsed construction sector activity, decimated domestic consumer spending and ever-shrinking global demand, exacerbated by the overvalued Euro all have contributed to this trend. Even more significantly, these forces’ impact on Irish producers, exporters and service providers is getting stronger by the day.

Exporters under pressure
2008 slowdown in output was primarily due to traditional sectors of the economy – down 4.7% in y-o-y terms, with multinational companies expanding their production by an anaemic 1.7%. There is little hope that this latter trend will not continue through 2009 and into a good part of 2010. More ominously, December figures show broadly based collapse in industrial activity with output contracting by more than 10% m-o-m in both multinational sector and amongst domestic companies. 26 out of 29 broader industry categories recorded contractions in output. Figure below highlights this, while removing some of the seasonal volatility.
Source: CSO

This is broadly in line with international experience. Last week figures showed that in 2008 Europe posted its biggest trade deficit in 10 years – a whooping €32.1bn. This marked a deterioration in the trade balance to the tune of €48bn in y-o-y terms. According to the majority of the analysts, coming months will see severe recessionary pressures for eurozone exporters. Irish exports are particularly vulnerable, given the falling consumer demand and business investment activity in the US and UK, as well as in the emerging countries. Exports to the UK, the main destination for the region’s products, dropped 3 percent in the 11 months through November 2008. Exports to the US, the second-biggest buyer of euro area goods, fell 5 percent. In the case of Ireland, the two countries account for more than 36% of the goods exports flow by value and some 50% of all Irish trade is linked to either the Dollar or Pound Sterling.

The end result – our core industrial exports are facing a decline, as illustrated in the figure below, precisely at the time of already collapsed domestic consumption. Our services exports are also facing decline with financial services and tourism struggling to stay afloat, while broader business services exports are feeling the same pressures of currency overvaluation and high cost of credit as our goods trade.Source: CSO

The expectations are that the 2008 growth sectors – ICT and pharma – might be also hard hit by a slowdown in global demand this year. In particular, ICT is sensitive to households and business investment demand. Lack of new investment in plant and equipment, software and operating systems in the US and across Europe is taking its toll on the likes of Dell, Intel and smaller hardware and software suppliers. By all estimates, this sector is not going to see a significant recovery until the earliest second half of 2009. Dell alone accounts for some 6.5% of Irish exports.

At the same time, pharma sector is likely to face mounting cost pressures in the US, a significant decline in demand for higher-end drugs from the emerging economies, plus a stronger generics competition. A recent study by the International Pharmaceutical Policy Council has shown that traditional pharma and bio-pharma sectors are facing significant cuts in research spending and employment, with recession undercutting public and private spending on universities-affiliated research. In the mean time, last week, Israel-based Teva Pharmaceutical Industries Ltd., the world's largest maker of generic drugs, said it expects the deepening global recession to spur demand for generics – bad news for the likes of Big Pharma that dominate Ireland’s exports statistics. In other words, even the so-called ‘recession-proof’ pharma companies are starting to feel the heat.

Yet to face the music
Which brings us back to the corporate boardrooms perceptions of the near term future. Last week’s InterTradeIreland Quarterly Business Monitor sheds some light here.

A comprehensive survey of some 1,000 companies north and south of the border has revealed that businesses are more pragmatic in their assessment of the past than they are about the future. In other words, Irish companies are feeling the pain, but are potentially deluding themselves into believing that the first half of 2009 will turn out to be economically stronger than the consensus forecast predicts.

In terms of the current conditions, roughly four out of five businesses indicated that they have experienced an adverse impact on trading conditions in recent months. This is hardly surprising, given that the biggest problems reported by business leaders were impacting their core parameters: tighter cash flow (68%) and decline in demand (66%). Some 87% of businesses noted a fall-off in consumer spending. 61% of the Republic of Ireland businesses saw a fall in turnover as opposed to 44% in the North.

Nonetheless, when asked which policies the Government can undertake to help business,
• 27% cited the need for improving access to borrowing (most likely indicative of the severe pressures on debt-laden businesses to raise new credit and roll over maturing short-term debt),
• 9% called for reduced levels of VAT and 7% for reduced taxation,
• 7% named assistance for SMEs, and 6% identified financial assistance for distressed companies.
The low numbers supporting consumer confidence improving tax reductions measures suggests that majority of businesses are not perceiving the current downturn to be demand-driven. Instead, there seem to be a much stronger conviction that the recession is a function of the credit cycle. Yet, 61% of business in the South (as opposed to 44% of those in the North) reported declining turnover.

Do the companies underestimate the extent of the collapse in consumer confidence at home, demand for exports abroad and the extent of their exposure to debt markets? Judging by the main policy priorities listed above, the answer is yes. The same answer is supported by the fact that few companies so far have taken significant cost-cutting measures. Only 30% of the Republic of Ireland companies (19% in the North) have reduced their workforce to the end of 2008. This is reflective of the fact that just 18% of businesses expected the downturn to have a severe adverse impact on their business in the next 12 months. Majority (63%) still think that this recession will be a moderate and short-lasting one.

And this is despite the fact that forecasters virtually unanimously predict 2009 to be worse than 2008 when it comes to trading conditions. For example, McKinsey Global Economic Conditions Survey last month has shown that 71% of global businesses expected general conditions to worsen in Q1 2009.

Chart below shows that Irish business leaders pessimism about the future has increased only marginally between the end of 2007 and the end of last year, despite the rapid deterioration in Irish economic conditions.

Potential Impact of Economic Downturn, 12 months forward
Source: InterTradeIreland, 2009

Optimism amongst businesses, although having abated in 2008, remains relatively high. Only 39% of all Irish businesses anticipate a decrease in turnover in Q1 2009 as opposed to 52% of global businesses in McKinsey survey. Similarly, for profitability – only 35% of Irish businesses expect a decline in profitability in Q1 2009, against 67% for the global sample.

Thus, only 14% of businesses across the island (18% in the Republic of Ireland) expected more layoffs and redundancies in Q1 2009. This is well below 29% of the global sample firms that were planning layoffs for this quarter.

In short, consistent with the findings on employment, turnover and profitability, the Intertrade Ireland results suggest that Irish businesses, both sides of the border, expect a mild recession to last no longer than 6-8 months. At the same time, global business leaders expect “a battered but resilient economy …[that] implies a recession of 18 months or so”, much in tune with the forecasts by the EU, IMF and the OECD. One side of the sea is clearly foolin itself here…

Box-out: IFSC Liabilities

A research note from the Davy Stockbrokers last week attempted to clarify the issue of the banking sector liabilities in Ireland. According to the Bank for International Settlements data, in Q3 2008 banking liabilities of the Irish-owned banks totaled €575bn, or 309% of GDP – the third-highest in the euro area. The Irish government has guaranteed €440bn (or 237% of GDP) of this. At the same time, the liabilities of all financial institutions resident in Ireland were €1,424bn, or 839% of GDP. But €849bn of that “…is not in any way a liability of the Irish government,” says the Davy note.

Well, sort of. €849bn might not be a liability under the Government guarantee scheme (although it remains to be seen how the foreign banks deposits and loans by and to Irish residents will be treated in the case of default) but from the economy’s point of view – some share of the €849bn debt represents a potential risk exposure for the state.

Here is how. Recall the good old days when our country leaders trotted the globe telling everyone that IFSC is a flagship of our knowledge-based modern economy? How come we now conveniently shrug off any liability inherent in having IFSC on our soil? IFSC is an asset to Ireland: a major contributor to the exchequer, a large employer of Irish workers and a significant purchaser of associated business services, including the services of the stockbrokers.

Now, imagine if excess debt exposure of IFSC-based companies was to drive them out of business. Where would that leave the State, not to mention the economy? A rough guess – ca €700mln in Exchequer revenue, plus the returns from employment of ca 20,000 people, plus commercial rents returns and VAT returns due to business activity. The total state take from the IFSC can easily exceed €1.5bn. If the risk of losing this dough is not a liability for the Irish state, what is?

Davy is correct in the strict sense of listing the actual figures. However, ignoring the IFSC-held liabilities creates an illusion that somehow Ireland Inc is independent of what is happening in the Docklands and beyond. It is not. Just as in good times we reaped the benefits of the IFSc, we must, at the time of challenges acknowledge its liabilities as being at least in part our own.

Buffet's Lesson from Ireland

Buffett Can't Find Green in Ireland, says Barron's (here)

"IT'S RARE FOR WARREN BUFFETT to suffer a near-total loss on an investment, but he did so with the purchase of shares of two Irish banks last year.

As he admitted in his annual shareholder letter, Buffett, the CEO of Berkshire Hathaway, invested $244 million in shares of two unnamed Irish banks. "At year-end, we wrote these holdings down to market: $27 million, for an 89% loss. Since then the stocks have declined even further. The tennis crowd would call my mistakes "unforced errors."

What were those two Irish bank stocks? We suspect that one of them is Allied Irish Banks (AIB), whose U.S.-listed shares are down to just $1 from a high of $45 last April...

What might have attracted Buffett to Allied Irish? Assuming he bought the stock, we suspect that he was motivated by the same reasoning that attracted Michael Price, a former mutual-fund star who runs MFP Investments.

At the Ira Sohn investment conference last May, Price recommended Allied Irish Banks, then trading around $41. Price said the stock looked cheap because it held a valuable stake in Buffalo-based M&T Bank (MTB). Excluding the M&T stake and another investment, Allied Irish was trading for just five times annual profits, Price asserted.

One reason we think that Buffett bought Allied Irish Banks is that Berkshire is the second-largest holder of M&T Bank at 6.7 million shares, behind Allied Irish Banks at 26.7 million shares. Buffett may have known about the Allied Irish holding in M&T, a bank that Buffett has praised in the past..."

Buffett's losses were small for Berkshire, but they are material for Ireland Inc.

Berkshire's mistake in buying into AIB had nothing to do with M&T share, which fell by only a third, as opposed to a 90%+ loss on AIB and BofI ("The other Irish bank whose shares were purchased by Berkshire could have been Bank of Ireland" says Barron's).

The real mistake was to buy into the banks run by the likes of Eugene Sheehy - a man who just last summer had a nerve to raise AIB's dividend in a clear case of mad macho bravado. And of course, his mistake was to buy into Ireland Inc regulatory circus - ran by a gang of financially inept political appointees of a regime that itself had one economic policy for all problems: throw more money at its cronies.

Now that Mr Buffett has learned his lesson, he will share it with the rest of the investment world. Who would bother putting any institutional money into this economy ever again? And who would bother buying Irish Government bonds backed by a claim on economy that is built on AIB-BofI-Anglo-IL&P-Nationwide & Co sand and issues bonds to keep this sand from liquefying under our feet?

A sight of carnage: GE

GE - that Titan of global economy - is under a threat of becoming the next AIG.Although the company is forecasting USD18bn in profits this year (on the back of its industrial arm), GE shares have now dipped below USD6.50, their lowest level since 1991. All due to the GE Capital exposure in the risky commercial and residential lending.

Since October, GE sold USD15bn in new shares and USD31bn in new bonds, cut down its loan book and reduced its reliance on short-term debt funding. GE has cut its dividend by 68% to generate additional USD4.4bn.

Sounds good? Not really. GE has set aside roughly USD10 billion in provisions for losses on its USD380 billion in receivables at the finance unit. The company loans total USD680bn against equity cushion of USD34bn in cash and USD36bn in assets. The latter is taking a hit in the current markets, implying today's equity cushion of only ca USD63bn and falling.

It would take a USD9bn hit to earnings and equity for GE were to write down its real-estate portfolio by 25%, according to UBS analysts. GE has transferred some of its real-estate holdings, into real-estate lending. As a result, its total real-estate assets increased USD6 billion, or 8%, last year.

But let us get back to the USD10bn provision. Here is my view on the share price going forward:

Assume they set aside cash (otherwise this set-aside is itself open to downward revaluations over time). This implies expected impairment provision is 2.63% of receivables. Globally, AAA rated CDOs carry the recovery rate of only 32% on face value, while for mezzanine vehicles the recovery rate is only 5%.

So, suppose GE gets a 25% boost on that via higher debt seniority and tighter loans management, etc. Assume the recovery rate of 40% on higher quality junk (hqj) and 8% on lower stuff. Take a blend on the book at 90% hqj, 10% 'stuff', this gives us an average - across-the-book - expected recovery rate of 37%. Suppose 12% of loans are under threat (rather generous in this commercial and residential real estate markets), allowing for some earlier writedowns that already took place. You have a required impairment provision of 12%*(1-0.37)=7.56% or almost 3 times more than the USD10bn they provided for.

This level of provisioning - if set in cash - will take us into a set-aside of an additional USD18.7bn on top of USD10bn set aside today, bringing equity down to USD17.3bn cash and USD34bn in assets or total equity of USD44.3bn - some 30% haircut. Assume deterioration in the assets part of equity pool at 1/4 of the rate of deterioration in broader assets, i.e. 3%pa, you have additional shave-off of 2% on equity, implying equity cushion fall will depress the overall share price by at
least 30% from today's level.

Now, I suspect that when they quote USD34bn cash equity today, they actually include the USD10bn provision into that as well. If so, the total haircut should be based on USD34.3 equity, implying a cut of 45.6% (provisions) + 2.5% (asset deterioration on equity side) = 48% on
today's share price.

So you have USD3.5USD as the equity-underpinned price target. And that is where the stock heading next, in my humble opinion...

Another Day of Carnage

Just pictures...
And this is the day of rates cuts: ECB down 50bps (should have been down 75-100bps, but hey, when was the last time Germans had any guts for serious actions?) and BofE down to 0.5%... If anyone needed a proof that the markets are not treating Irish banks shares as a part of the broader world, preferring instead to price them as sick puppies, here it is:
So is the next stop for this train of sorrow 'Nationalization II: Bank of Ireland'?

Some housekeeping: a handful of updates

A cleaning up of some of my emails provided for a digest of interesting updates on the topics already covered in other posts. Here is an attempt to combine these...

To the QNHS (here) and Live Register data (here):

Per Davy note: "The worst affected areas [of unemployment] are building and those service sectors related to construction and the global financial crisis. Construction employment slid 7.6% quarter-on-quarter, followed by hotels and restaurants (- 3.2%), retail/wholesale (-2.3%) and financial/business services (-1.9%). No pain-sharing is evident in the data: private sector employment dropped 97,400 over the last 12 months while public employment increased by 10,000."

Last night I was a guest on a Late Debate (RTE Radio 1) alongside a SIPTU rep who was clearly traveling in some parallel reality claiming that:

• public sector took all the pain of adjustment to-date;
• those on higher incomes took no pain to date; and
• layoffs in public sector would be equivalent to layoffs in private sector.

Per point 1 - Davy note says it all, but an update on Exchequer results below also highlights the same.
Per point 2 - October Budget 2009 and its update, November Finance Bill II, both imposed progressively increasing Income Tax Levy on higher earners.
Per point 3 - two facts: (1) wage to value added ratio in Public Sectors (average) is ca 30% lower than in the Private Sector and some 1/3 lower than in the Financial and Business Services, and (2) wage to value added ratio in majority of public sector categories is close to or less than 1, so cutting 1 person out of the public sector would cost economy nothing (for ratio of 1) or would save economy some resources (for ratio is <1).
One caveat - of course, within Public Sector there are people who are highly contributive to the economy. For example: both IDA & Enterprise Ireland are aggregated into the above averages. These agencies have been significant contributors to the economic welfare in this country. Similarly, within each category, there is little understanding as to the variance of wage/ productivity ratios. E.g, do higher salaries in our flagship Universities relative to the second-tier third level institutions correspond to the productivity differentials? Knowing internal operations of Trinity, not exactly, but fairly closely. Thus, raising taxes in a 'proportionate' way as the Unions insist will hurt disproportionately more those who earn higher wages because of their higher productivity, even in the public sector.
Per Unions' 'Alternative Universe' - I got a general sense that our Unionists simply do not understand that in all instances, public sector workers depend for their wages on private sector earnings. Somehow, the Bearded Men of SIPTU/ICTU/CPSU/TGWU and the rest of the alphabet soup do not get the concept of who pays for what in this economy.

Per Exchequer Returns, February 2009 (here): there is significant evidence of deep wage cuts in private sector as income tax revenue continued to slide in January and February, despite the introduction of the income tax levy. In addition, current (non-capital) spending was up 3% y-o-y in February 2009. 2009 current spending is now on track to reach over 38% of Irish GNP - matching the record high achieved in 1983. Pure waste!

Financials and Other Stocks: as Davy puts it in a recent note: at the end of February 2009, the entire Irish Financial Sector accounted for only 3.5% of the Irish Stock Exchange capitalization as compared to 37.5% a year ago. This is diversification through attrition. The ISEQ dropped 10.3% in February - its sixth successive monthly decline. This was "the worst February performance in its 25-year history. It underperformed the FTSE Eurofirst 300 index, which also experienced its worst February performance, by 0.6%." A picture is worth a 1,000 words (all courtesy of Davy):
The last chart of course shows that Ireland is a absolute under-performer in its peer group. Davy do not analyse earnings in this context, but the above valuations are hardly making the shares cheaper. Earnings declines are now precipitous for all companies and my suspicion is that P/E ratios are falling. In other words, there is a question to be asked if there are any bargains out there given the earnings projections?Lastly, Davy provide a good snapshot of the bond markets dynamics in the chart reproduced above. Spot the odd-one-out? Note the timing of our departure to the Club Med of Near-Insolvent States - bang on coincident with Mr Lenihan's Budget... This should be a warning to everyone who is desperate for this Government to do something about the crisis: doing 'something', as opposed to doing the right thing, will make matters worse. Clearly, the markets are not seeing higher taxes and a lack of spending cuts (Budget 2009) as 'doing the right thing'.

Mansergh Calls for 'Celtic Tiger' Fat Cubs to pay their share in the downturn: Mr Mansergh - Bertie's pet in the Dail and a Junior Minister in the Cabinet - called yesterday for the tax measures in the mini-budget to focus on making sure that those who benefited most during the Celtic Tiger era pay more in taxes. Great idea from the Grand Weasel of Irish Politics. How about we start with Mr Mansergh himself - a person whose ministerial salary is out of touch with reality, and whose pension benefits are so lavish, that some bankers would envy the returns on so few years of such a non-demanding work as that of a Junior Minister for State with responsibility for the Arts. Mansergh serves in the cabinet which, with exception of 3-5 Ministers, is remarkable for its inability to do its job at a basic level. Yet the cabinet is being paid more than its counterparts in the US, UK, EU15 or indeed anywhere else in the developed/ democratic world. So, be my guest, Mr Mansergh - pony up, say 50% of your own income - you and your colleagues and their senior public service underlings are the Fat Celtic Tiger Cubs.

Live Register: another month, another record

Remember a record rise in the unemployment benefits claimants of 33,000 in January? Today’s figures show that the new claims rose by an additional 26,700 in February. But do not get your ‘Out of the Recession’ placards yet. January figures were negatively impacted by the cumulative lay-offs following the Christmas holidays. In other words, when seasonal factor is controlled for, February layoffs were probably as bad, if not worse, than the already abysmal January numbers.

Overall, the Live Register now stands at 352,800, the largest on record up 165,000, or almost 90% y-o-y. Now, each new 1,000 claimants cost the Exchequer some €15ml in social welfare and lost tax revenues. This implies that y-o-y the Exchequer lost €2.475bn. Surely, raising taxes (and thus undercutting employment in the private sector) is not a way forward?

Even without any new tax measures, I expect that the number of unemployment benefits claimants will rise to 450,000-480,000 by the end of 2009 (in annual average terms – 465,000). This will imply a social welfare spending overshoot of some €1.3bn and a tax loss of ca €630mln relative to January DofF budget estimates (here).

The Live Register-based estimate of the unemployment rate was 10.4% in February, up from 9.6% in January. We are back in 1997 world and falling.

Without too many dull details, the official unemployment figures (QNHS) show an unemployment rate of 7.7% for September-November 2008 (just like everything else in the world of the CSO’s apparatchiks, Q4 in unemployment statistics is not the same as Q4 in the real world). Now, the Live Register for this period showed 7.4% unemployment rate – an underestimate on QNHS. And we are now seeing the second quarter of continuous underestimates of the true unemployment rate being produced by the Live Register.

What does this mean? Well, it means that an army of part-time workers that resulted from ‘hidden’ layoffs in 2008 – when large number of construction and other workers were forced into part-time employment – is now becoming full-time unemployed. And the labour force itself is shrinking. By 15,000 in Q4 2008.

Hmmm… Ulster Bank now predicts 14% unemployment rate by the end of 2009. In January, I claimed that the unemployment will rise to 11-12% by December. Oh, how wrong was I. My new estimate – in light of Live Register for the last two months and QNHS for Q4 2008 is that we will be somewhere around 13.8-14.6% and that is assuming that laid-off foreigners leave in bus loads…

And, sadly, that is the fate of our fabled uber-educated Irish labour force, as the Government likes to point out… In immortal words of the Hitchhiker’s Guide:
"Please relax," said the voice pleasantly, like a stewardess in an airliner with only one wing and two engines, one of which is on fire, "you are perfectly safe."

Oh, no, we are not!

How bad will it get? IMF study

Here is a new insight into recessions dynamics. This time from the IMF (see link here).

What Happens During Recessions, Crunches and Busts? by Stijn Claessens, M. Ayhan Kose, and Marco E. Terrones (IMF WP/08/274) looks at "the linkages between key macroeconomic and financial variables around business and financial cycles for 21 OECD countries over the period 1960–2007."

Data set covers 122 recessions, 112 (28) credit contractions (crunches), 114 (28) episodes of house price declines (busts), 234 (58) episodes of equity price declines (busts).

The authors "find evidence that recessions associated with credit crunches and house price busts tend to be deeper and longer than other recessions... Episodes of credit crunches, house price and equity price busts last much longer than recessions do [4 quarters on average]. For example, a credit crunch episode typically lasts two-and-a-half years and is associated with nearly a 20% decline in credit. A housing bust tends to persist even longer—four-and-a-half years with a 30% fall in real house prices. And an equity price bust lasts some 10 quarters and when it is over, the real value of equities drops by half."

Of course we are experiencing far deeper contractions in house prices and equity valuations than an average bust.

"Most importantly, recessions associated with credit crunches and house price busts are deeper and last longer than other recessions do. In particular, although recessions accompanied with severe credit crunches or house price busts last only three months longer, they typically result in output losses two to three times greater than recessions without such financial stresses. There is also evidence that the extent of declines in house prices appears to influence the depth of recessions, even after accounting for the changes in other financial variables, including credit and equity prices, and various other controls."

Where is Ireland in all of this? We have:

• housing bust;
• credit bust;
• equity market bust;
• severe recession.

16-23% contraction in real output in Sweden and Finland in the recent past is a guide, according to the IMF study, for the type of recession we are in. Overall, there were only 4 episodes of coincident credit, equity and house prices busts.

Using econometric estimates (Tables 13.A and 13.B in the paper), we can parametrize the IMF model to estimate the expected contraction in Irish economy during the current crisis. Table below lists the underlying assumptions (in % changes) and results.Thus, under benign Scenario 1 assumptions, overall income contraction in Ireland over the recessionary cycle is expected to reach 13.5%, while under more severe Scenario 2 the contraction can result in a fall in real income of 16.1%. My personal view - we are going to see the latter rather than the former.

IMF study allows us to estimate the share of overall contraction that is attributable to the housing shock absent credit bust - in other words, due to purely domestic factors. This ranges from 66.6% in Scenario 1 to 63.5% in Scenario 2 - in both cases, a lion's share of the recession-induced economic pain is due to 'domestic' causes. At the same time, the share of recessionary decline in income that is attributable to 'external' or global factors (all shocks net of housing price bust) is ranging between 12.7% and 20.7%.

So much for the argument that we are in trouble because the rest of the world.

The Latest Exchequer Figures: can Biffo turn Gruffalo?

Gruffalo is a marvelously hideous and not-so-bright character in my son's favorite books. Today's Exchequer figures and the talk about the need for higher taxes and courageous Government policies remind me of this imaginary animal.

The preliminary Exchequer receipts show that we are on track to deliver on my forecast from February 8 (here) that estimated a tax revenue this year between €33.3bn (moderate case) and €34.5bn (benign scenario). Ulster Bank's Pat McArdle - an excellent economist with good knowledge of the budgetary nitty-gritty - agrees (his forecast produced today is €34bn). Of course, to remind you, DofF official forecast revenue is €37.7bn. Ya wish, baby!

It feels good (even in these sad circumstances) to be the first to deliver a correct prediction. The post - linked above - and the precedent ones (Update I and the original post) were bang on the money. The mini-budget is now inevitable by the end of March - spot on my prediction for tax increases before April made in December issue of Business&Finance and here.

Ulster Bank note (full credit to Pat McArdle) shows the rate of DofF's descent into forecasters' hell:

Forecast date: 6 Dec 2006 - €56.3 billion

Forecast date: 5 Dec 2007 - €51.8 billion

Forecast date: 14 Oct 2008 - €42.8 billion

Forecast date: 9 Jan 2009 - €37.0 billion

Current figures: Ulster Bank - €34.0 billion, my - €33.3-34.5 billion

As of today, we are some €22-23bn ahead of DofF-forecast for the shortfall. This, as McArdle rightly points out (I produced the same figure back in February) is approximately what we have to find to plug the hole in the side of our public spending Titanic.

Think about it: the hole is almost 70% of the entire revenue projected for this year. Can we plug the hole with a Gruffalian (draconian) 50% income tax increase?

Here is the breakdown of the revenue figures (again from Ulster Bank note):

I've said time and again that the Laffer Curve and tax minimization will imply that the revenue will fall as taxes rise or at the very least it will not rise in 1-to-1 relationship to tax rates increases. We have evidence of this. VAT receipts have fallen at more than 4 times the rate of fall in national income and in line with retail sales. Income tax receipts are down at ca 1.5 times of income contraction (and this is before self-assessment returns come in).

And as far as tax minimization goes - many of those on both high and low incomes are sole traders or business proprietors. These categories of workers do not pay income tax on a regular basis, bunching much of their payments into October. They do pay more regular VAT and this smooths quarterly VAT returns. Comes October, they will do everything legally possible to make sure Biffo-the-Gruffalo, Bromidic-Brian and Mary-the-Lottery-Winner don't get their paws on hard earned cash. In addition, the sole-traders on lower earnings will never be brought into the tax net, no matter how much the Government widens it, because they will 'adjust' their income to just below any feasible new threshold.

I did some crude maths on the two effects and here are my estimates.

First the assumptions. I assume that both Laffer Curve and Tax Minimization effects will reduce 1% increase in the rate of:

• Income tax to a 0.68% increase in underlying revenue (with Laffer effect reducing tax rate increase contribution by 20% and a Tax Minimization effect reducing it by further 15%),
  

• Corporate tax to a 0.6% increase in underlying revenue and
• Excise taxes to a 0.4% increase in underlying revenue.

Now, note I am not assuming that the Laffer effect will result in a fall off in revenue, but that it will only undermine the rate of revenue expansion. I then computed two scenarios:

Scenario 1: 'Biffo gets upset' - increasing excise tax rates by 20%, income tax rates by 25% and corporate tax rate by 10% across all possible bands. Under this scenario, gross annual revenue rises to €33.5bn assuming January-February slaughter of the Exchequer continues. To assure that budgetary deficit does not exceed DofF estimate of 9.5% of GDP, promised by Biffo to Brussels in January, and allowing for a 5% decline in GDP, Brian-Brian-and-Mary must come up with €6bn in fresh public sector cuts on top of the above tax increases and the pensions levy!

Scenario 2: 'Biffo goes Gruffalo' - increasing excise tax rates by 25%, income tax rates by 50% and corporate tax rate by 25% across all possible bands. The Gruffalo-Biffolo must come up with €3.1bn in fresh public sector cuts!

And that's before any second order effects of tax increases (dynamic Laffer Curve) and no spillover from higher taxes into weaker economy.

Pat McArdle estimates the required additional cuts to be around €4bn this year. Ok, close enough... An impossible task for Mr Cowen's gang of public sector appeaseniks.

A sight of carnage: US

DJIA has fallen past the psychologically important 7,000 marker to trade at 6,763.29 at the time of writing this - well below its previous 52-week intraday low of 6,952.06. As it stands, the Dow is now at the levels last seen in April 1997. The chart below illustrates.The drivers for the latest slide are clearly the renewed pressure on financials and the fact that the Obama Honeymoon is over - the markets are now turning sceptical about the new administration's ability to push the economy out of a depression spiral. Concerns are mounting as to the inflationary effects of the current policies amidst a general conviction that there will be no upside to economic growth. The traditional partisan Democrat policies are now being seen as setting the stage for a return to the dark ages of Jimmy Carter in the near future.

The graph below (courtesy of Calculated Risk) illustrates:Notice that although the downgrades are much steeper today than in the 1970s, the trajectory of the most current downgrades (slope) is virtually identical to the 1973-1974 crisis. A fellow in the US investment community (thanks for the question HM) just asked me how this can happen, given oil is scrapping the bottom of the barrel in price terms while inflation is yet to rear its ugly face - the opposite of the stagflationary 1970s scenario. Here is an explanation.

The fiscal stimulus package unveiled by Obama is designed to increase inflation-inducing public spending by unprecedented amounts. At the same time, personal income is rising again, while propensity to consume is improving. These are the driving forces of the renewed inflation that can appear just as suddenly as deflation set in late last year.

On the other hand, today's energy in he economy is no longer oil. Instead it is credit and cash. Both are in short supply and near peak level of prices. The oil price is largely irrelevant lagging indicator of global demand, not of the productive capacity of economy. The flow of credit is the latter and not the former.

So the Obama-styled Carterism is going to manifest itself in higher inflation down the road and falling or stagnant real output, as price of the modern 'energy' - credit and money - is going to remain high.
Then again, the US has had it easy so far, compared to Ireland... Chart above illustrates.

May be Mr Cowen can bring some Irish bonds as a gift to the White House for the Paddy's Day? Cheaper than shamrocks and equally symbolically useless.

P.S. There is an excellent summary of the US Economic Conditions for February 2009 at Calculated Risk site (here).

Heard enough? Part 2: Coughlan Loses Her Briefs... literally

The following is based on the Address by Tánaiste and Minister for Enterprise, Trade and Employment Mary Coughlan to the 72nd Fianna Fáil Ardfheis.


“Just like the wider public therefore, all of us in this room are, or someone close to us is, in some way affected by the current economic downturn. It could be the PAYE worker, anxious about the threat of redundancy hanging over her job,” says Ms Coughlan who spent last months scavenging across the country in search of new jobs launch ceremonies instead of working late nights in her office on how best to alleviate the crisis. Her job and the jobs of those her Government protects - the public sector workers - are not on the line.

“It could be the border shopkeeper, struggling to compete against his Northern neighbour,” says a Minister whose Government imposed increases in VAT and other business-impacting tax hikes that helped to push Irish consumers across the border.

“It has become clear that over the past two decades, our rate of growth and success has been such that, as a nation, we perhaps started to believe our own publicity. While the severity of the current global downturn was not predicted, our own exuberance in recent years has left our public finances, and our banks, more exposed to the whims of international money markets than may otherwise have been the case.”

Surely by ‘we’ Ms Coughlan means herself and the Governments in which she served over the years. The same Governments that produced and publicised the propaganda about our economy. That indulged in an orgy of waste on the back of stamp duty windfalls. That fueled these windfalls by tax breaks and restrictive planning practices. That wasted billions on projects that no one needed only to secure the votes of narrow interest groups. That were led by a person who declared publicly to be a socialist (aka tax-and-spend appeasenik of every political interest at the expense of the country) and whose integrity and honesty have been publicly questioned in the court of a Tribunal. Surely by ‘we’ she meant herself and her colleagues in senior ministerial positions?

“We will not shirk our responsibility when making tough decisions around controlling our public finances, stabilising our banking sector and implementing our strategy for recovery,” said Ms Coughlan whose Government has managed to evade any serious decisions on economy (from cutting spending to introducing a meaningful recovery plan) since it came into office in Summer 2008. The Minister who, in a moment of patent departure from reason, proposed last week that banks can benefit from 'business expertise' of Enterprise Ireland - an organization that by its own brief limitations has never been involved in managing businesses or even assisting a company with revenues in excess of €100mln.

So let us get to that unpalatable veiny single morsel of boiled-out beef in Ms Coughlan’s views.

“People must be confident that Fianna Fáil is solid in its resolve to secure their children’s futures on this island, through our commitment to education, training and the creation of good jobs.” In other words – there is nothing new in Mary’s thoughts beyond a feeble attempt at economic development policy the Government produced last Fall (reviewed here). But hold on, we already have, according to Mary-Brian-and-Brian spin, a highly educated world class labor force. FAS schemes for training have been expanded already – in December 2008 and again in January 2009 - despite that organization's comprehensive failure to even audit its own accounts.

And as far as creation of good jobs is concerned, well, take Mary’s words on this: “Delegates, it has fast become a politically expedient national pastime to run ourselves down and to oppose for opposition sake. It is a philosophy that professes ignorance of the so many positives that we have going for us on this island. These are the positives that saw me announce [Euro] 24 million in research funding to create the jobs of future on Wednesday; that had me announcing new jobs in Carlow on Thursday; and 134 new jobs in Shannon on Friday.”

Ahem, at say €60K a pop per annum for a ‘good job’ Ms Coughlan is whimpering about no more than 200-250 jobs being created in the environment where a weekly jobs loss is averaging ca 9,000!

But for Mary, “these are the positives that make Ireland the location of choice for the Googles, Facebooks, Ebays, Yahoos and Amazons of the world. So delegates, the dangerous spiral of negativity must stop.”

Indeed, Mary, we are a location of choice for transfer pricing. For now and not for long. All of these companies carry out primary R&D and core business activities outside of Ireland. And scores other multinationals are closing plants and laying off workers. Google itself is on the verge of transferring the handful of R&D staff it has here out of Ireland.

The Live Register published last month and the QNHS published last week (here) are a testament to the comprehensive failure of Ms Coughlan to secure competitive business environment for Ireland Inc. What is even more egregious in her remarks is that Ms Coughlan seem to have no time for an idea that Ireland needs to become something more than a tax clearance warehouse for the MNCs. That it needs competitive indigenous firms and competitive multinationals adding real value to this economy.

“As members of Fianna Fáil, we will remain steadfast in this commitment, irrespective of the temptation of short term political popularity.” I have commented on the idea of this Government’s steadfastness in its commitments to cut budgetary overspend before (see here), so without going into details, here is a summary: in July, September, October, December 2008, January and February 2009 the Government went on the record claiming the 2009 cuts will add up to €2bn on top of €440mln that was promised in savings for 2008. In the end, the Government is still (8 months since the original promise) walloping about implementing a cut of no more than €1.1bn in 2009 and has missed its savings target for 2008 by more than €700mln. Clearly, Ms Coughlan was out to lunch, oops - out launching new jobs - all this time since July 2008 to notice.

Mary used a promise of local elections as “an opportunity for Fianna Fáil, not only to address local issues, but to explain the seriousness of the situation facing our country…” to the voters.

I certainly hope FF backbenchers are not as daft as Mary thinks them to be. Imagine FF local council candidates knocking on the door of PAYE families who were skinned by Mary's Government and are facing a significant chance of losing one or even two wage earners, declaring ‘Man, Fianna Fail is here to tell you that things are hard!’ In light of Ms Coughlan’s speech her Government’s platform for local elections should be printed with ‘Don’t Panic!’ on its front cover followed by ‘Now, Panic!’ on the back.


Overall, Ms Coughlan’s speech was so devoid of any serious meaning that it confirms her comprehensive failure as a Minister for Enterprise, Trade and Employment.

As a Minister for Enterprise, Ms Coughlan has managed to use the words ‘enterprise’, ‘firm’, ‘company’, ‘corporation’ and ‘plc’ zero times in her speech. She used the word ‘business’ only once in the context of a hypothetical reference to a small business owner only.

As a Minister for Trade, Ms Coughlan failed mention once our exports, exporters or trading sectors, she did not use words ‘imports’ or ‘trade’ or ‘investment’ (except for a reference to shares losses), nor the words relating to foreign exchange fluctuations or transport costs and infrastructure - all vital aspects of trade. She comprehensively failed to mention anything related to retail competition or policy, to planning, to development, local authorities charges, VAT, minimu wage, work permits, anything that forms a core of our country's competitiveness - her core job responsibility.

As a Minister for Employment she has managed to avoid the word ‘unemployment’ (and its derivatives), and used the word ‘jobs’ only in the context of the positions she either launched herself or provided funding for.

As a Minister in a democratically elected Government she has managed to denounce the critics of her Government’s handling of this crisis at least twice, devoting absolutely none of her speech to covering her own Ministerial briefs.

In your words, Ms Coughlan, “the dangerous spiral of negativity must stop”. I agree. Lets do it by removing its cause - you, Minister!

Heard enough? Part 1: Mr Lenihan's cheap talk

In a series of 3 post I will look at the speeches delivered by Brian Lenihan, Mary Coughlan and Brian Cowen to their party ardfheis this weekend.

Tax increases part of economic solution - Lenihan
Based on Irish Times report from February 28, 2009, 20:31


“Higher taxes for everybody will be introduced in Ireland, the Minister for Finance, Brian Lenihan has declared, ‘Yes, the wealthy groups will have to pay. But everybody will have to pay something,’ the Minister told the Fianna Fáil ardfheis.”

Back in August 2008 and later in the annual edition of Business & Finance, I predicted exactly this outcome and timing for the tax increases announcement.

The sad part, of course, is that were we to cut the waste choking our public sectors, we would have had no need to raise taxes. Once again, since late July 2008 I offered proposals that would have provided requisite and ample capital repairs to the banks while reducing the burden of this recession on the households. Brian Lenihan decided instead to sacrifice the financial security of private sector workers in order to appease his protected constituency around the Liberty Hall.

There was one truth in what Mr Lenihan was telling his party: no matter how much he taxes the rich (aka anyone earning over €100,000), the tax impact of such measures will be minimal.

Why?

Firstly, per Minister Lenihan, “two in every hundred people earn more than €200,000 a year, and they pay 28 per cent of all the taxes; while six in every hundred earn over €150,000, and they contribute 28 per cent of the total; while 6 per cent earn more than €100,000, and they pay nearly half of the Exchequer’s returns." Raising their tax bill by 10% will yield less than 3-4% of the current returns, or around €1.4bn. A chop change for Mr Lenihan’s public sector cronies. At the rate of spending to which our public sector became accustomed, the entire 10% tax hike would evaporate in 24 days!

Secondly, any tax increases will lead to a wholesale tax optimization drive by anyone outside the PAYE system – and that covers the majority of the Lenihan's ‘rich’. Taking an assumption that some 3/5 of the 'rich' own their business or professional practice and they can reduce their tax exposure by a modest 20%, a draconian 10% hike in taxes will yield well below €1bn in added revenue.

One should acknowledge the fact that after some 8 months of continuous failure to govern, Mr Lenihan finally offered a flaccid apology to his party (the country is still waiting for one, Brian): “if we could have foreseen the extent of the international crisis, we would have done things differently… There is little to be gained in beating ourselves up over this."

But he reversed even this attempt at humility by charging the country for the deficit financing that he and his predecessor in DofF have pursued. Let's be honest, Minister, it was you and Brian Cowen who decided to award lavish wage increases to the public sector. The country did not ask for the wages of the ESB workers to be hiked to above €80,000 pa on average. Nor did it ask for e-voting machines, €250K+ contracts for consultants, pay rises for Ministers and senior civil servants, an army of paper pushers you've hired for HSE, billions wasted on white elphant projects around the country in attempts to buy votes in advance of each election, and so on. The blame for this mess is your Government's.

"We have to get on and do what we can and do it in a united way.” Oh yes, Minister. United we stand: you with your aristocratic salary, drivers, cars, pensions and so on, your colleagues and immediate subordinates enjoying most of the same, and the people you are going to tax out of their homes, childcare and schooling money, the elderly whose meagre incomes you are going to butcher with higher VAT and other charges. Spare us your whingeing, Brian – take a pay cut yourself! A 50% cut would restore your wages and pension in line with those in other advanced democracies.

“We have an €18 billion hole in the public finances,” said our well-informed Minister. Actually, the hole is more like €21bn and that was before we add new unemployed to welfare rolls. NTMA admitted this much when it said last week that we will have to borrow up to €25bn in 2009. Where were you, Minister, when they made this announcement?

“The world is looking on,” said the Minister. It no longer does. Last Friday the world sold some 90mln shares in BofI and AIB. The world holds no belief in you and your Government and neither does the country. Why? You did nothing to address the real crises for some 8 months since you took the reigns of the Exchequer in July 2008. Between July 2008 and today you've repeatedly insisted that your Government will implement at least €2bn in savings this year. Your Department has built this into the budgetary forecasts for 2009-2013. To date, you've deliverd a puny €1.1bn in savings. The world is no longer willing to be fooled by you!

“We need to persuade those who might invest here that we are capable of taking the tough decisions now to get our house in order.” Too late to sob, Brian. The numbers of those who would consider investing in this country is now standing so dangerously close to nill that even companies with substantial capital already allocated to these shores are cutting their operations and laying off workers. After years of your and your colleagues waffle about 'competitiveness', 'productivity', 'education', 'knowledge economy' they have no trust in this Government.

He went on: “We voted through the Bill that gives effect to levy that will see public servants pay on average 7.5 per cent to the cost of their pensions. …The public service pay bill accounts for one third of all expenditure”. So let’s do the maths. That 7.5% levy, net of tax deductions, is going to take only 1.5% of the total Exchequer expenditure or ca €700mln. But in July, September, October, December 2008, January and February 2009, you, the Minister, went on the record claiming the cuts will add up to €2bn on top of €440mln that you promised to save (and also did not deliver) in 2008!

What a farce!