Daily Economics Update 22/03/2009

So we are in a rally, at least in the US.
Financials are again in the lead, as chart below showing.10-year treasuries rise, dollar falls
What can one expect from a relatively rational(ized) market when it is faced with a renewed $1trillion push of cash into draining the toxic pool of mortgages-linked securities.

The DJIA ended gaining 6.84% to close at 7,775.86, the S&P 500 closed at 822.92 (+7.08%), the Nasdaq Comp ended the day at 1,555.77 (op 6.76%).

A friend - high up in international finance - asked me again if this is a sign of a thaw. I again said, it is not - just a rational reaction to a massive push on the dollar. Real values are not changing much, but what is happening is the wholesale repricing for the dollar to reach 1.45-1.50 to euro once again. Here is an illustration of why I am still not buying the permanent rebound hypothesis (courtesy of dshort.com):
What about the Geithner Plan (GP)? Well, whatever one can say about it, words 'original' or 'innovative' are not something that comes to mind. It falls short of a nationalization and nationalization is what will probably be needed. Not a wholesale take over, but certainly not a 20% equity take by the Feds in exchange for a 97% capitalization, as the GP envisions.

Financial services lap-dog economists loves the thing, though. For example, one senior economist from Wells Fargo claimed that the plan "will go a long way toward getting banks... to lend more aggressively and break the deleveraging feedback loop" now in place. This is the lunatic asylum stuff, for it assumes, without even stating so much, that there are hordes of willing borrowers gathering just outside the banks doors. And it further assumes that deleveraging is bad. Given that the whole mess was brought upon us by the excessive leveraging in the first place, either I am losing my mind, or the entire world is now rushing head on to create a new bubble in place of the old one.

The main problem with GP is that it comes on top of the TARP and a host of other asset-purchasing arrangements. Now, all were offering lenders some set of prices for distressed assets. These prices were set arbitrarily high to incentivize the banks to unload their troubled loans. But clearly, TARP was not sufficient, so the GP will have to set prices even higher - at some premium to TARP to further induce the loan holders to part with their distressed paper. And here is a catch. Since inception of TARP, the quality of the loans still on the books in banks have fallen - steadily and rather rapidly. Will this imply that investors are now being incentivized to bid for loans at a price above their true market value? Of course it will and this is precisely why the Feds are offering the bidders a 97% financing package in return for 80% equity in the loans purchased, with Federal financing done on the back of non-recourse loans (loans that are collateralized against the value of the securities purchased alone).

The GP will in effect act as a subsidy to the banks. Hence that nice climb in banks shares in recent days. Geithner's idea is to have a free lunch served to the banks today, for which the taxpayers will pay tomorrow and the restaurant staff (the investors) will get paid a day later. It is, as the Calculated Risk blog puts it, "a European style put option - it can only be exercised at expiration. The taxpayers will pay the price of the option in the future, the investors receive any future benefit, and the banks receive the current value of the option in cash. Geithner apparently believes the future value will be zero, and that is a possibility. If so, this is a great plan - if not, the taxpayers will pay that future value (and it could be significant)."

Note to the Derivatives students: this could have made a good question for exam...

On a somewhat more positive note: sales of existent homes were up 5.1% in February. Although this figure - the largest percentage gain since July 2003 - (a) comes after a 4.6% contraction in yearly sales and (b) was the result of deep price discounts (especially due to rising tide of foreclosures and short sales that accounted for 45% of all transactions), sales rose in all regions. Full 65% of the potential buyers expect the market to bottom out within the next 12 months.

Inventories of unsold homes - once again a sign of deepening foreclosure pools - on the market rose by 5.2% to 3.80 million, equating to a 9.7-month supply at the February sales pace. Although seasonally inventories usually rise ca 5% in February, this time around the increase came after a prolonged period of stalled construction activity. In other words, there is little reason for rising new inventories other than an acceleration in forced sales and foreclosures.

In fact, just as the subprime tsunami recedes by May-June 2009, the next wave of homeowners defaults is about to start hitting the US markets, as the following two charts (sourced here and here) illustrate:

Securitization is not 'evil', neither is short-selling, nor CDS

A recent paper, Securitization of Mortgage Debt, Asset Prices and International Risk Sharing (CESifo Working Paper No. 2527, downloadable here) provides a refreshingly calm and measured assessment of the effects of mortgages securitization on the markets stability via allowing for greater international diversification of macroeconomic risk. According to the authors, "by making mortgage-related risks internationally tradeable, securitization contributes considerably to better international consumption risk sharing: we find that countries with the most highly developed markets for securitized mortgage debt have consumption responses to a typical idiosyncratic business cycle shock that are 20-30 percent less (my emphasis throughout) volatile than those experienced by countries that do not allow for mortgage securitization. Our results are based on quarterly data from a panel of 16 industrialized countries and cover the sample period 1985-2008Q1. They are robust to a range of controls for other aspects of financial globalization, international differences in the structure of housing markets and the financial system etc. Against the backdrop of the subprime crisis, these findings inevitably raise the question whether securitization could not just facilitate risk sharing in tranquil times but that it actually fails to provide international insurance in severe crisis periods. Indeed, we find that international risk sharing decreases in global asset price downturns and increases in booms. But we do not find evidence that countries with more developed securitization markets are systematically more exposed to these fluctuations in the extent to which risk can be shared across national boundaries."

Funny thing - there is now growing academic literature on the positive effects of such 'evil' forms of fiance as short-selling. See for example here and here (arguing that short-selling is superior to put options and even analysts in predicting negative returns), here, here and here (suggesting that short-selling adds to price efficiency in the case of dividend manipulation), here (arguing that share prices adjust to their fundamentals-justified equilibrium faster when short-selling is less restricted), and here (indicating that bans or restrictions on short-selling can have destabilising effects on even such 'stable' markets as those for government bonds).

While many more papers are available on the subject, what is apparent from the recent events is that politically motivated regulatory interventions in financial markets are exactly what they say they are - politically motivated changes that have little do with markets stability or efficiency. This is precisely why we should actively resist the current political push for restricting securitization, just as we should resist the push for banning short-selling or speculation.

Update: ... and CDS are not bad either... see comprehensive discussion on CDS here. Obviously all evidence flies in the face of our quasi-literate (economically speaking) DofF boffins (recall my post here).

Some good news... at last

Per EUObserver, EU leaders last Friday, have failed to provide any specific commitments on funds for third world CO2 reductions. Instead, the summit, designed to formulate some sort of a unified EU-wide position on the issue ahead of the Copenhagen climate change summit in December, has concluded that the EU "will take on its fair share of financing such actions in developing countries.”

This is the good news because it postpones the absurd and economically illiterate introduction of the direct subsidies to the developing countries from the advanced economies aiming to reduce the developing nations' output of CO2. Here is how absurd the whole debate is. Quoting EUObserver, "if the EU and US stump up significant chunks of cash for cutting emissions and climate adaptation, developing countries may in return commit to considerable CO2 reductions, even though it is the industrialised north that is responsible for most of the emissions that caused the problem.”

Well, not that simple, folks.

First, even if the EU and the US commit actual funding, there is absolutely no compulsion principle to assure that the developing countries actually do anything about their emissions.

Second, there is no ceiling on what constitutes 'sufficient' subsidies. The argument in favour of the subsidies rests on the assumption that absent a pay-off, the developing nations will continue pursuing economic growth - in an attempt to catch up with the developed world in standards of living for their growing population - and thus will continue increasing CO2 emissions. But in order to cut-off the growth in CO2 emissions in the third world, the West will have to offer subsidies that replace that part of growth which can (at least theoretically) be lost to curbed CO2 emissions. So how much of growth will we, Western taxpayers, have to replace? Oh, well, that is an open question. In other words, until there is a final price tag placed, any commitment to buy the third world out of its CO2 emissions will be an open one, and unenforceable to boot.

Third, even if we do provide so massive of a subsidy as to deliver the third world to parity in income with the OECD countries, there is absolutely no guarantee that the third world leadership will actually adhere to its end of the bargain.

Fourth, given that the third world has over 4 times more population than the OECD countries, an idea that we can effectively replace their lost income is an absurd one. Only the lunatic fringe of environmental movement can argue that hoisting the welfare of 4 third world country citizens on each working OECD adult is sustainable development.

Now, Poland was backed by Italy, Lithuania, Latvia, Bulgaria and Hungary alongside UK, Spain and Sweden in opposing the idea of fixed financing commitment and the use of ETS revenue to 'buy-off' the thrid world countries. Overall, only the Netherlands, Slovenia and Belgium backed the deal, implying that 24 out of 27 EU states were not exactly enthused about the proposal. Here you have it - some good news out of the recession...

Private Sector credit supply is being damaged by this Government

A recent working paper from the European Central Bank, titled "Modelling Loans to Non-Financial Corporations in the Euro Area" (ECB WP No 989/January 2009) provided a benchmark model for assessing the impact of twin shocks of increase in the policy rate (ECB main interest rate) and increase in the banking system risk premium on the supply of credit to non-financial corporations across the Eurozone. The authors, Christoffer Kok Sørensen, David Marqués Ibáñez and Carlotta Rossi showed that a 25bps increase in the headline interest rate "causes a reduction in bank lending of about 1.4%, 5.4% and 6.4% after 2, 5 and 10 years, respectively. A 20bp increase in the risk premium on bank lending rate reduces bank lending to non-financial corporations by about 0.6%, 4.0% and 5.1% after 2, 5 and 10 years, respectively."

Of course, the first experiment coincides fully with the ECB's reckless 25bps hike in rates between June 2007 and October 2008. The second, however, is even more dramatically important from the point of view of private credit availability. Between August 2007 and today, Irish bank's risk premia on lending to the banks has risen by some 300%, implying, under the ECB model, an expected drop in the credit supply to Irish non-financial corporations of ca 9-11% in 2009-2010, rising to a whooping 75-99% between 2009-2018.

Alternatively, between December 2008 and today, the average weekly CDS spreads on Irish Government bonds have risen some 160bps. Given our state's exposure to banks debts, this is a comparatively reasonable measure of the overall increase in the risk premium on banks lending. Thus, within the span of only 3.5 months, our expected credit supply to non-financial corporations has fallen by the estimated 5-6% for the period 2009-2010, 30-35% for the period of 2009-2013 and by 40-47% for the period of 2009-2018.

As I always said, Mr Lenihan should stop blaming the Americans for this crisis. And he should stop saying that there is no cost to the broader economy from his rushed general debt guarantee to the banks. Instead he should look at his Government's fiscal imbalances, wobbling decisions on financial sector rescue, blanket and unsustainable guarantees to the banks, appeasement of trade unions at the expense of the taxpayers, destruction of the private sector via higher taxation and charges, etc - in other words all the policies that undermine international markets' confidence in Ireland Inc. His policies, responsible directly for the rising risk premium on Irish Government debt are also destroying the private credit markets here. Not only today, but well into the future.

Boardrooms in denial: McKinsey study & Ireland Inc

McKinsey has done some homework and published impressive findings on the issue of corporate leadership in the current downturn. You can get the article here, if you have access to the Quarterly, but below are some main findings.

"While half of board members describe their boards as effective in managing the crisis, just over a third say their boards have not been effective; 14 percent aren’t sure how to rate their boards’ effectiveness. At the personal level, roughly half of corporate directors say their boards’ chairs haven’t met the demands of the crisis, and a nearly equal percentage of board chairs believe the same about their board members. Though most boards have implemented various changes to their procedures in response to the crisis, 62 percent say their boards need to change even more." Chart below (courtesy of McKinsey) illustrates.Now, we all by now can be counted as the slaves of 'innovation' fad - the trend in modern management and policy to label every strategy change an 'innovation', but what McKinsey data shows, strategy is still the king when it comes to responding to changing environments.

"Innovative strategies are the key when corporate directors evaluate their boards’ responses. Among the group who say their boards have been effective in responding to the crisis, 60 percent credit the development of new strategies to manage risk and take advantage of new opportunities (chart below). That same area of management is most frequently cited as lacking among respondents at companies with ineffective boards. (This finding is consistent with the results of another recent survey, in which executives said support for innovation should be the overall focus of governments’ actions in response to the crisis.) Other areas that have been addressed by many effective boards are financing and operational needs; at unsuccessful companies, respondents say their boards have been particularly ineffective at tackling talent management and restructuring."
So let me ask you this question. Since November 2008 I spent inordinate amount of time and effort trying to convince some of our top organizations and companies - amongst hardest hit by the current uncertainty in the markets - to set up some formal research function to evaluate various strategic responses to the crisis that they can adopt. The structures I have been proposing are pretty much in line with those summarized by the McKinsey below:
Not a single Irish corporate took up my challenge. Majority of our corporate leaders are sitting on their hands, in words of Leonard Cohen 'Waiting for the miracle to come". But don't take my word for it - here is hard data on the issue.

Here is the truth - 'miracle' ain't coming, folks. Wake up and smell the roses - if you your board/CEO assessments of counterparty contributions is anywhere close to what McKinsey reports, you are screwed. Your corporate structure is rotten from the head down and you need to do an independent appraisal of it from the head down. Waiting around for 'miracles' is not going to do it.

Daily Economics Update 21/03/2009

Weekly analysis: Irish shares

The volume of shares traded on the New York Stock Exchange has topped the 50-day moving average on six of the seven days that the stock market has been up since March 6 (the day on which the S&P 500 touched its most recent low). The broad benchmark index has gained 15% since that low, sparking hopes of a recovery. The significant issue here is in the volume figure, not in the actual rise in the index, as stronger volumes on a rising trend tend to support more risk-taking and signal investors' support for the trend.

Interestingly, the same, but less pronounced, process has been starting on Friday in the Irish markets.
Chart above shows last week's movements in ISE Total Price Index (IETP), Irish Financials Index (IFIN), AIB, BofI and IL&P shares. Strong upward trajectories here, with significant volatility. But all underpinned by good (well above the average) volumes, as per chart below.This is less pronounced when we normalize daily volumes by historical average, as done in the chart below.
Less extraordinary change is underway above, because we are using moving averages as normalizing variable, implying that we actually capture the inherently rising volatility in volumes traded here. So the above chart actually suggests that while Friday up-tick in share prices (and pretty much the last three day's rally) was reasonably well underpinned, it will take some time to see if market establishes a solid floor under the share prices.

Monthly results so far remain weak. Only BofI was able, so far, to recover all monthly losses and post some gains. AIB is just hitting the point of return to late February valuations. Given that at the point of sale - at the end of February, beginning of March - the volumes traded were 5-7 times those of the current week's peak, it is hard to see the present recovery as being driven by pure psychology and the spillover from the broader global markets (US' momentary lapse of optimism).

Two more charts: recall that in mid February I argued that downgrades in all three financials will come to an end by February's expiration and all three will settle into a nice slow bear rally, running at virtually parallel rates of growth. Chart below shows that this is happening, indeed.Once we normalize prices and account for volumes traded, there is nothing surprising in the share prices movements since the beginning of March. And this is exactly where, as I argued before, the markets should be: awaiting news catalysts...

Rates of decline, degrees of (construction sector) misery

Earlier today (here), I gave some figures from the CSO data release on planning permissions. Here is what I wrote:

"Also per CSO release, the number of dwelling units approved was down 22.4% in year to the end of Q4 2008. In Q4 2008, planning permissions were granted for 10,375 houses as opposed to 13,135 in the Q4 2007, a decrease of 21%. Only 3,392 planning permissions were granted for apartment units, compared with 4,598 in Q4 2007, a decrease of 26.2%. The total number of planning permissions granted for all developments was 8,977, as compared to 12,330 in Q4 2007, a decrease of 27.2%. Dire stuff once again. I will do the detailed analysis of the sectoral decline dynamics in a follow up to this post."

So, as promised here are some graphs illustrating the dire state of affairs in construction industry.

First chart below shows two things:

1. Numbers of permissions granted (annual totals) for main categories of dwellings and in total - these are now clearly falling at the fastest annual rate;
2. Total area of all construction projects applied for is also falling at the fastest rate of decline.
   

Now, the next chart shows total number of permissions granted per quarter. Here, the most dramatic trend is also found in 2008, most specifically in Q3 and Q4 2008, when quarterly rates of decline in total number of permissions granted were the steepest for any quarter since Q3 2000. And the rates of decline are accelerating, relative to Q1-Q2 2008.
Lastly, more detailed quarterly date below, by each broader category of permits. I also included trend lines for the period of peak-to-present contractions, showing that Q4 2008 dynamics were consistent with generally accelerating deterioration in all categories of permits, save for 'Other'. This means that we can expect this category to actually fall further and faster in months to come.
So here you have it, for construction industry - there is no bottom in sight, yet...

Daily Economics Update 20/03/2009 - II

Ireland

Retail Sales volume decreases by 20.4% in January 2009 relative to a year ago, per CSO report out today. In monthly terms, index fell 9.4%. Mad numbers. And the things are going only to get worse, given the inept, virtually economically illiterate policies this Government has been putting out to date. Motor trades collapsed by 42.2% in January 2009 - in part due to tax hikes in October, in part due to VRT and road tax changes by the Greens, and to a large extent due to income uncertainty being hammered by the additional uncertainty as to the tax hikes the Government is planning to inflict on this already devastated economy. Ex-motor trade the volume of retail sales decreased by 8.1% in January 2009 compared to January 2008 and the monthly change was -0.1%. The value of retail sales decreased by 19.9% in January 2009 compared to January 2008 and decreased by 10.0% in the month. These are the largest annual decreases on record (1974 for volume record, 1962 for value).

Food, beverages & tobacco were down -11.6% in volume and -8.2% in value annually. These are inelastic demand articles, showing the full extent of consumers taking their business out of the Brian^2+Mary-devastated Ireland to the North and the Continent. Virtually every category of durable goods - goods that can be purchased up North and brought back to Ireland - is showing decreases in the 20-30% range. This is the real cost of Government's incompetence and the real indication that for all the wishful thinking our pro-tax-and-spend economists (in academe and SIPTU/ICTU) might deploy arguing that higher VAT will produce higher revenue, the reality of raising VAT (or income tax, for that matter) in terms of Exchequer revenue is going to be brutally contrarian.

Check other commentators' view - here Gerard O'Neill's blog on the topic, comparing the situation to "economic bungee jumping without the bungee". Well put! And here is another good comment worth reading.

Myles' post links to a report produced by the Office of the Revenue Commissioners and the CSO in February 2009, desperately trying to explain away the price differentials between the Republic and NI by all possible means other than those that put blame at the feet of the Government. Myles cuts past the bull&castle stuff in the report and, I think, correctly places most of the blame on the Government policies of squeezing consumers out of their earnings. But the linked report is fun. Fun, because it had to rely on, wait, other Government reports (e.g. June 2008 report by that illustrious data collection and analysis organization - the National Consumer Agency - that wouldn't know a data point if it jumped out of the hedge and bit it, and December 2008 Forfas report that was so poorly prepared and sampled that it was rubbished by several subsequent responses to it, including some from the objective/disinterested organizations and individuals). So I do encourage you to read through the report that Myles links in his blog - it is a good example of self-referential work being done by Government agencies.

Also per CSO release, the number of dwelling units approved was down 22.4% in year to the end of Q4 2008. In Q4 2008, planning permissions were granted for 10,375 houses as opposed to 13,135 in the Q4 2007, a decrease of 21%. Only 3,392 planning permissions were granted for apartment units, compared with 4,598 in Q4 2007, a decrease of 26.2%. The total number of planning permissions granted for all developments was 8,977, as compared to 12,330 in Q4 2007, a decrease of 27.2%. Dire stuff once again. I will do the detailed analysis of the sectoral decline dynamics in a follow up to this post.

Oh, and here is a pearl: Industrial wars are heating up... This is from IFUT - "a professional association and union representing over 1400 staff in third-level institutions" (hat tip to an Anonymous)

"Subject: BALLOT FOR INDUSTRIAL ACTION
I wish to advise you that the Ballot for Industrial Action was counted today and the following is the result:

Total Ballots Cast: 737

Those in Favour: 499 - 67.7%

Those Against: 237 - 32.3%

Spoiled Votes: 1

Therefore, the majority in favour being above the minimum set out in Rule 16 (b) (ii) we are authorised to participate in the ICTU National One-Day Stoppage scheduled for 30 March 2009..." blah-blah-blah, signed by the General Secretary of IFUT.

Note that per IFUT own website, there are over 1,400 members in this organization. Assuming the vote count reported is correct and that IFUT's rounding rules are the same as those holding for the rest of humanity, the ballot was passed with just 35-36% of the total number of eligible voters on a turnout of just above 50%. Hmmm... without a doubt - a mass-movement, supported by popular outrage against the Government.

US
According to the latest data from the US Treasury Department (here) the US public debt just passed $11 trillion. Chart below (courtesy Seeking Alpha - here) illustrates.
If you think Obamanomics will be the New Bill Clinton era, think again - more than $2trillion worth of new US bonds to be issued this year alone is going to see this chart shooting for $13trillion mark by the end of 2009. Thereafter? The sky is the limit.

Although dollar is currently trading on the upside (0.41%) to the euro, given the US public debt trajectory and factoring in the aggressive quantitative easing by the Fed, it is hard to see how the green buck can stay below $1.45-1.47/1euro range...

To update you on General Electric figures concerning GE Capital's (alleged) rude health, here is a link to investor presentation.

An interesting (and pioneering) case is developing in the US: the battle-ravaged AIG filed a lawsuit against Countrywide Financial Corp - one of the largest issuers of MBS. The lawsuit alleges the mortgage lender misrepresented the underwriting standard of loans that the AIG unit insured. The claim is that mortgages packages insured by AIG either violated Countrywide’s own guidelines or contained defects. Surely this paves the road to European insurers to sue mortgage providers and MBS-issuers. The big question for Irish financials is now - how soon can this wave of liabilities reach our own shores?

A Georgia-based FirstCity Bank was closed by the US regulators today, marking the 18th bank failure of 2009. Regulators also shut down some US credit unions with assets of up to $57bn.

Daily economics update 19/03/2009

Excellent piece on Irish Nationwide excesses here - I would certainly encourage everyone to read through it.


On the news front -

Ireland:
Per CSO (here): the number of overseas trips by Irish residents fell by 8.4% to 502,100 in January 2009 compared to the 548,400 a year ago. Brian^2+Mary's tax on travel and recession biting. And euro's steady rise has taken a bite out of travel to Ireland too: there were 424,200 overseas trips to Ireland in January 2009 - down ca3% on 2008. "Visits by residents of Great Britain accounted for virtually all of this decrease, falling by almost 16,000 (7%) to 208,300." Needless to say - this is costing this country. Visits by residents of Other Europe and North America recorded slight increases to 149,500 and 45,200 respectively. No breakdown on vitally important length of stay and locations visited by foreign tourists here was made available. The crucial point missing here is just how bad is it going to get for Irish hotels, located outside Dublin. In recent months, these palaces of rural kitsch built on the back of senile tax breaks to developers, courtesy (in part) of Brian Cowen in his tenure as Minister for Finance, have been popping out of business like flies in late autumn.

Also courtesy of CSO:
Monthly factory gate prices increased by 0.9% in February 2009, as compared with an 0.2% rise recorded a year ago, the annual increase of 3.9% in February 2009, compared with and annual rate of growth of 3.2% in January 2009. Inflation cometh? Well, possibly. In the year the price index for export sales was up 4.3% while the price index for home sales was up 1.7%.

Wholesale price changes by sector of use shows that: Building and Construction All material prices decreased by 1.2% in the year since February 2008 (surprisingly, very small deflation in the face of all but collapsed construction), and there were increases in Cement (+8.0%), and Stone, sand and gravel (+4.8%). At least Sean Quinn can always go back to mining boulders. Year on year, the price of Capital Goods decreased by 0.1%, and the rate is accelerating to -0.4% last month. The price of Energy products increased by 5.2% in the year since February
2008, while Petroleum fuels decreased by 17.9%. So ESB and Board Gais are still ripping us off, while teh Government is fast asleep. In February 2009, there was a monthly increase in Energy products of 0.4%, while Petroleum fuels increased by 1.6%.

But hey, the good news is that we are now in a 'breeding boom'. According to the CSO, there were 19,027 births registered in Q2 2008, an increase of 1,900 on 2007. Q2 2008 total is 40% higher than in 1999. "This represents an annual birth rate of 17.2 per 1,000 of the population, 1.4 above quarter 2 of 2007. This rate is 2.7 per 1,000 population higher than in
1999."

Incidentally, the latest US data shows that the country population is also booming. The preliminary estimate of births in 2007 rose 1% to 4,317,119, the highest number of births ever registered for the US. The general fertility rate increased also by 1% in 2007, to 69.5 births per 1,000 women aged 15–44 years, the highest level since 1990.

Clearly a good sign for Brian^2+Mary, who can now rest asured that Irish families are producing more future taxpayers for the Government to continue ripping off ordinary families. The bright future is at hand at last for public sector wages and pensions.


US:
There are some signs of longer-term lead indicators revival in the US. Much has been said about housing starts bottoming out and the fact that these are only long-term lead indicators for house prices (see here).

Unemployment - new claims have fallen by 12,000 to 646,000 in t he week ending March 14, while the numbers collecting unemployment benefits rose by 185,000 to a record seasonally adjusted 5.47 million by March 7th. The four-week average of new claims also rose by 3,750 to 654,750, the highest level in 26 years. Still, at least some things are starting to move in the right direction.

In the mean time, General Electric said it now expects GE Capital Finance unit to be profitable in Q1 and for the full year 2009. This follows a recent $9.5bn injection of capital by the parent. This, if holds through the year, is good news, as GEFC has been at the forefront of writing dodgy loans and mortgages to distressed consumers in 2005-2007.

Of course, Wednesday data was also showing some signs of the bottoming in the US recessionary dynamics. US consumer prices increased a seasonally adjusted 0.4% in February, primarily on the back of a 3.3% rise in energy costs (8.3% rise in gasoline prices). Food prices fell 0.1% in the first decline since mid 2007. Core CPI (ex Food and Energy) was up 0.2% - a nice range signaling possible end of deflation.

This is not to say that the current rallies are sustainable. So far, we are starting to see some early stage recovery indicators attempting to find the floor. It will take couple of months for them to start turning. But the markets will remain bearish until the second stage indicators start flashing upward turn-around. These are existent unemployment claims, construction indices, pick up in resale markets activity, PMIs etc. Until then, you'll have to be brave to wade out of the cash safety into individual equities.

And the latest news on the second stage indicators is poor. The index of leading economic indicators - designed to forecast economic activity 6-9 months ahead - fell 0.4% in February, following a gain of 0.1% in January 2009. Overall, 6 out of 10 indicators were up in February and 4 were down. According to Ian Shepherdson, chief economist with High Frequency Economics, "The trend remains clearly downwards, consistent with continued outright contraction in the economy."

Trichet's latest interview - much hype, little substance

Here is an exclusive interview, Jean-Claude Trichet (ECB) gave to Foundation Robert Schuman. And here is my quick and dirty walk through its main points:

"Since the introduction of the euro on 1 January 1999, European citizens have enjoyed a level of price stability which had been achieved in only a few countries. This price stability directly benefits all European citizens, as it protects income and savings and helps to reduce borrowing costs, thereby promoting investment, job creation and lasting prosperity. The euro has been a factor in the dynamism of the European economy. It has enhanced price transparency, it has increased trade, and it has promoted economic and financial integration, not only within the euro area, but also globally."

Not really. Price stability in the eurozone has been pretty average - not as good as in Germany and several other countries over the years before the euro, similar to that in the UK, US and pretty much the rest of the developed world in the 2000-2008 period. A picture is worth a thousand words: since the adoption of the euro through mid 2008 (before deflation), inflation in the euroarea exceeded that in the non-euro EU states...
But it is in growth, dynamism and employment where the 10 years of the euro have recorded a very poor performance. I have already posted on this topic (here, here, and here). EU's growth rates since the early 1990s on have been sluggish (lagging behind the US and UK and only notching above a recessionary Japan). Euro area's unemployment remained well above the US, UK and almost all of the rest of the OECD. Eurozone's employment growth has been better than Japan's, but worse than any other OECD economy. So while the euro did enhance price transparency marginally, it did have very little real benefit in improving the quality of life for an average European. Not surprisingly, the euro is not enjoying a strong ride in terms of its democratic legitimacy (here).

"In recent months we have seen another benefit of the euro: the financial crisis has already demonstrated that... Would Europe have been able to act as swiftly, decisively and coherently if we had not had the single currency uniting us? Would we have been able to protect many separate national currencies from the fallout of the financial crisis? European authorities, parliaments, governments and central banks have shown that Europe is capable of taking decisions, even in the most difficult circumstances."

Again, largely untrue - as of today, there is no coherent eurozone-wide response to the crisis. The EU joint response to date is to issue a €5bn in stimulus, and this is yet to be disbursed. While the euro did protect some countries from a run on their currencies, it also boxed majority of eurozone's exporters into a corner of over-valued medium of exchange. Perhaps most importantly, lack of agreement between the European governments - exemplified in a series of failed summits since Autumn 2008 through today - shows unequivocally that "European authorities, parliaments, governments and central banks" are not "capable of taking decisions, even in the most difficult circumstances". The EU itself. this week, put the total size of its recession busting plans at between 3.3 and 4% of GDP, including welfare spending and yet to be specified and agreed measures. This is still short of the US plan to devote 5.5% of GDP to recovery efforts (source: here).

I agree with Mr Trichet that much-talked-about price increases in the wake of euro adoption have been small across the eurozone, but he is plain wrong in claiming that:

"With the benefit of hindsight, it has become clear that the Governing Council of the ECB ...took the correct decisions in order to guarantee price stability in the euro area in line with our mandate and as required by the Treaty establishing the European Community."

This statement is bordering on being offensive and arrogant. Mr Trichet is fully aware that his action of raising interest rates at the very end of the bubble has done too little too late to cool the markets. Similarly, his reckless increases in the interest rates in July-October 2008, as well as keeping the rates high in the first half of 2008 have spelled a disaster for the eurozone economies and also led to an overvaluation of the euro. His failure to act in July-August 2007 to lower rates was an act of mad denial of the unfolding credit crisis. Between July 2007 and September 2008, Mr Trichet stubbornly insisted that the credit crisis was not a problem for the eurozone.

"According to the ECB staff macroeconomic projections published on 5 March 2009, annual real GDP growth in the euro area is projected to be between -3.2% and -2.2% in 2009, and between -0.7% and +0.7% in 2010."

This is a much more gloomy (and much more realistic) outlook than the EU Commission -1.9% forecast for GDP growth in 2009. But note 2010 figures -0.7 to +0.7 or a central point of 0%. An optimist at heart.

"Since the outbreak of the financial turbulence in August 2007, the Governing Council of the ECB has taken unprecedented action in a timely and decisive manner."

Chart below illustrates...
So nothing short of a failure above.

But what about rescuing troubled countries (APIIGS)? "...My response to questions of the type "What would happen if...?" is that I never comment on absurd hypotheses. I have confidence that the Member States will face up to their responsibilities, including with regard to fiscal policy." In other words, is the answer yes or is it no? Is this answer consistent with what Mr Lenihan told reporters about ECB's readiness to rescue Irish banking system (here)?

Overall, a pretty vacuous interview from a man who obviously has no way of re-assuring anyone that he can handle the current economic crisis in the eurozone. A bit more competent than our Brian^2+Mary partial-indifferential-equation, but a lot less competent than, say, the US Fed&Treasury gang.

Irish credit III

NTMA is brewing up a plan again (here). This time around, reportedly for a 5-year bond to be launched next Tuesday at 4.5%. Which would be a wishful thinking - the current bid yield is 60bps above that - if not for the possible caveat.

Oh no, the caveat is not about launching the bonds into the outter space from Baikonur Launching Station in Kazakhstan (although potentially only Martians would willingly take Irish paper on these terms and only Borat-land would underwrite such a launch). The caveat - speculative at this junction - is that the 'launch' will aim to place the bond in Irish banks and some into the eurozone CBs. The banks will then go to the ECB and get, ugh, 85c on a euro. A helicopter drop of money with Mr Trichet in the driving seat.

Now, don't take me wrong - NTMA has done some seriously competent job to date and, in my view, represents pretty much the second half of the two functioning financial organizations in this state (the Revenue Commissioners being another). But they are facing an increasingly impossible task of feeding the Brian-Brian-Mary T-Rex of fiscal excesses.

Last time around (see here) only 21% of the bond issue has gone to the willing private buyers. That issue was priced to the market median. This time, 4.50% implies only a 75bps premium over German 10-year bund placed earlier this week. Today's YTM on 10 Plus Bond Index was at 5.90% and no outstanding bond with maturity beyond 2014 was priced at YTM below 5%. So where does it leave the newest issue? My guess - at the ECB via a primary orbit of the Irish banks.

So let's speculate together:

Take 4.5% at 15% ECB discount on, say 79% of bonds placed via banks (and with CBs), 2018 10-year bond and March 16th closing (clean) price of 91.35. You have YTM of 4.64-4.89% - darn close to 4.5% NTMA dangling about, except it is priced off the February issue (extending the maturity horizon).

Now, move forward to 2019-2020 and take the same 4.5% bond at 15% discount, 85% placement with ECB and get 5.6% YTM at today's opening price. What is the YTM consistent with 100% placement at ECB? 6.4%, which in March 16th market corresponds to 11.5 cents discount on a Euro. Also nicely close to today's 15 cents discount at ECB window.

It all adds up iff we are setting up a sale to ECB. At ECB's discounts on near-junk paper (here)...

A wish list: asking for the right policies

For those of you who missed it, here is my take on Mr Cowen's White House visit - an unedited version of the article in yesterday's Irish Daily Mail.


There is always much ado about the Taoiseach’s visit to the White House on St Patrick’s Day. And yet, for all the opportunities such occasions present, it is only in rare instances of major crises, either North or South of the Border, that any meaningful discussions take place. Well, it is the Annual Shamrock Presentation Ceremony today and we are in a crisis of monumental proportions. So, within the context of the long-running tradition of crisis requests, what exactly should Brian Cowen be asking of Barack Obama today?

First and foremost, a flight of fancy - he should ask for the US to allow Ireland to adopt the dollar as our currency. What a prospect that would be. Set at roughly $0.80-0.85 to 1 euro at conversion, the dollarization would lead to an instantaneous and adequate repricing of our labour, business and capital costs to ensure that these are reflective of our true productivity and real inefficiencies. It would also allow us to fall into the US interest rates regime which is much closer to our real economy’s need than the Germany-focused ECB rates can ever be.

As a side benefit, dollarization would bring our real per capita income in line with that of the median US State – a slightly optimistic valuation, given our lower standard of living. But a good starting point for bringing a sense of reality to our political elites who still believe that we are all fat kittens of the Celtic Tiger when it comes to taxing our incomes.

Too drastic? Indeed, I hear the protests already from the Department of Foreign Affairs. When I asked a senior Irish academic as to what his top priority for the White House visit would be, his reply was: 'Number one? A statehood for Ireland or something similar to the Puerto Rico model!' Now, that might be going a bit too far.

Humour aside, we can restore Irish competitiveness through an alternative, much longer and more painful process of deflating our real wages and cutting excessive fat in the public sector spending. Instead of dollarization-induced devaluation, we can opt for a, say, 30% cut in public sector wages, plus a 20% cut in public sector employment numbers, leading to a ca 40% cut in the Government’s current expenditure. Add to this some 20% cut in the private sector average earnings (by now we are almost half way there in real terms), and we will be on the road to a recovery.

Mr Cowen should also ask the US to fully open bilateral labour and capital markets with Ireland.

In practical terms, the former would imply Brian Cowen announcing today that any US citizen or legal resident can work and reside in Ireland without any restrictions. Following this unilateral opening,the Taoiseach should ask President Obama to reciprocate by opening up the US labour market to Irish citizens and residents.

As a side-benefit, we can also open our education systems to students from both countries, guaranteeing that American students coming to undertake their degree studies in Ireland will face EU resident tuition rates, while Irish students traveling to study in the US will have access to the same merit-based study grants and tuition as US students.

While a less dramatic broadening of the work visa regime is likely to be acceptable for Mr Obama, Ireland should stake a more ambitious goal of achieving a fully mobile labour flow between the two countries.

Extending this mobility to education will make it possible for Ireland to become a real player in international knowledge economics and give us a significant competitive advantage over our EU counterparts. In effect, the UK is already enjoying relatively free mobility of its students when it comes to top US universities, with the likes of University of Chicago even opening a campus there. For Ireland to be able to supply a better educated labour force than that of our closest neighbour, and to compete globally for best students, Brian Cowen needs to either bring about strong incentives for US universities to set up their European campuses here, or to gain access for our best students to US education system, or both.

In capital markets, we should aim to maximally align our regulatory standards while preserving Irish competitive advantage in the area of taxation. Of course, President Obama might have a question or two about our corporate tax regime, especially when it comes to the repatriation of FDI-generated profits. Brian Cowen should stand firm on the issue, asking the White House to exempt Ireland from any forthcoming legislation aiming to restrict US multinationals’ ability to book overseas profits.

During his election campaign, Mr Obama made some sweeping statements about the role played by the ‘temporary’ tax exemptions for corporate profits earned outside the US in fueling the drive for ‘outsourcing of American jobs’ to other countries, including Ireland. This is misguided from the US economy’s perspective, and extremely dangerous from the point of view of Ireland. Mr Cowen can do the US and Ireland a favour by reminding President Obama that higher value activities in the US operations (e.g R&D, managerial innovation, marketing and sales) depend crucially on companies ability to access restricted markets of Europe including via Irish operations.

In exchange, as a goodwill gesture and, coincidentally, to the benefit of our own traded services sector, Mr Cowen should promise President Obama to veto all and any EU proposals for unified international financial regulation. This is something that the US Administration opposes because of the threat such bureaucratization poses to the largest services sector in the world. Incidentally, this is also something Ireland should oppose if we were to retain and expand our competitive position in the sector.

Closely linked to this should be a request to extend US accountancy and governance rules to Irish plcs. Think of the benefits that Securities and Exchange Commission (SEC) oversight and law enforcement would have brought to the Anglo Irish Bank shenanigans or to the financial acrobatics at the Irish Nationwide and the IL&P? In the wake of the latest annual results publication, only SEC had the guts to question AIB’s bad debt provisions.

Think of the savings to the Exchequer and the gains to regulatory efficiency that this country would have achieved were our regulators acting under the US conditions. Of course, Mr Cowen might suggest that Ireland and the US also jointly do something about restricting careless lending practices by the banks in the future and limit the excessive risk-adjusted gearing in the countries’ financial systems.

Mr Cowen might also ask President Obama to extend his latest US Federal Government pay containment measures to Ireland. In fact, Mr Cowen can benchmark our public sector wages to those in the US – starting with a ca 60% cut of his own and Cabinet’s salaries. Our senior regulators and civil servants can also enjoy US-comparable earnings at a ca40-50% discount to their current wages.

Lastly, as a personal favour, I would like Mr Cowen to ask the US President to place a limit on the number of Irish public and local authorities officials flying to the US for St Patrick's Day celebrations and to impose a strict limit on FAS’ spending during its visits to NASA, Disneyland and Sea World in the future. As vital as these locations might be to generating future employment for numerous Irish astronauts, aquarium minders and fantasy castles managers, we are, after all, in a crisis. Time to slim down and get fitter. Presenting shamrocks and drawing pints will have to wait.