The cost of Ministerial chatter: Irish credit ratings

After a week of incomprehensible gibberish coming out of the Government statements on:

• borrowing restraints (here);
• receipts shortfalls (here and here);
• 'painful' solutions (aka destruction of private sector economy via fiscal policy - here);

and months of policy wobbles, two things came to their logical conclusion today.

The first one - reported (for now in very oblique terms - I will put more flesh on it when the embargo on the documents I received expires) here.

The second one - the S&P downgrade of Irish sovereign credit ratings.

Now, S&P is not known for being the quickest or the sharpest analysis provider on the block (I wrote about the need for a downgrade for some three months now), but at last they have moved, if only a notch, lowering Ireland's ratings from AAA to AA+ and retaining negative watch outlook (meaning more downgrades await).

I was neither surprised nor impressed by the S&P statement:

"March 30 - Standard & Poor's Ratings Services today said it had lowered its long-term sovereign credit rating on the Republic of Ireland to 'AA+' from 'AAA.' At the same time, the 'A-1+' short-term rating on the Republic was affirmed. The rating outlook is negative"

So far so good. Except in my view, a combination of the depth of our crisis, the severity of our economic policy failures and the lack of realism on behalf of this Government, pooled together with Cowen's unwavering determination to 'soak the rich' (middle and upper classes) to protect his cronies in the public sector - all warrant at the very least a downgrade to an A level. Given the structural nature of our deficits and Cowen's willingness to flip-flop on policy - an A- rating will be also justifiable.

Ok, back to S&P statement: "The downgrade reflects our view that the deterioration of Ireland's public finances will likely require a number of years of sustained effort to repair, on a scale greater than factored into the government's current plans," Standard & Poor's credit analyst David Beers said. As I said - lack of realism on behalf of the Government is costly. I have mentioned some recent evidence I got from the Partnership Talks (here). Telling... But what is also telling is the shade of realism that is being brought to the policy discussion table by the S&P, which is completely missed by the quasi-state ESRI (see here) who expect swift (2-3 year time horizon) action on closing structural deficits by increasing taxes.

The S&P is also referencing their belief that there will be further need for additional support for banking sector. I agree. And the Government has been boasting to the Partnership folks that it has resolved the banking crisis...

But here is a really good piece - bang on in line with what I've been warning about for a long time now. Despite our Government's senile belief that soon - a year or two from now - we are going to return to strong growth, S&P clearly states: "We expect that the Irish economy will materially under perform the Eurozone economy as a whole over the next five years, recording minimal growth in real and nominal GDP, on average, during the period. As a result, we believe that Ireland's net general government debt burden could peak at over 70% of GDP by 2013, a level we view as inconsistent with the prospective debt burdens of other small Eurozone sovereigns in the 'AAA' category."For comparison, here is the table from the DofF Junior Nostradamus's' January 2009 Update (below). This shows that our boffins are thinking we will be churning out 2.3% GDP growth in 2011, with 3.4% in 2012 and 3.0% in 2013...

Yeah, may be if we get Michael O'Leary to run this country...

"The medium-term prospects for the Irish economy are constrained by three interrelated factors: first, the impact on domestic demand as the private sector reduces its high debt burden, which stood at 280% of GDP in 2008; second, the scale of the deterioration of asset quality in the banking sector and possible need for additional capital; and, third, the support from external demand Ireland can expect as global economic conditions improve."

Ont the first point, I am again delighted that S&P decided to look beyond their naive insistence on focusing on public debt alone. Private debt mountains choking Ireland Inc (and soon to be added public taxation concrete weighing the economy down as we sink deeper into a recession) have been something I warned about for some time now.

On the second point, it is important to recognise that this Government has done virtually nothing to help repair the banks balance sheets and is not forcing households deeper into financial mess. Banking sector and real economy are linked.

• When a bank gets capital injection, but sees more mortgage holders defaulting because the Government has sucked their cash dry, what happens to banks assets?
  
• When a bank gets a deposits guarantee scheme at a cost to the system of €226mln since inception, but it costs the Exchequer twice as much due to higher cost of borrowing, what happens to the financial system's ability to provide credit finance?
  
• When a bank gets a promise to be rescued in some time in the future, but sees corporate deposits dry out today because the Government actually taxes companies (and sole traders) in advance of their receiving payments on overdue invoices, what happens to bank's capital?

Has Mr Lenihan bothered to take Level I CFA exams, he would have probably understood these brutal A-B-Cs of macrofinance. Alas, he didn't.

Now, next, the S&P avoids falling back into its comfort zone: "The government has already taken steps to contain the budgetary impact of these pressures, and further adjustments in taxation and spending, amounting to 2%-2.5% of GDP, are expected to be announced in next month's supplementary budget. At best, however, these measures will contain this year's general budget deficit to around 10% of GDP and lay the basis for a slow reduction in nominal budget deficits in future years. We are concerned, however, that a credible multi-year fiscal consolidation strategy will not emerge until after the next general elections, due by 2012. Accordingly, on current trends, we believe Irish net general government debt will likely exceed 70% of GDP by 2013 before beginning to trend downwards."

True that, as they say in the USofA. True that. Can you close your eyes and imagine Brian Cowen telling public sector unions that he is going to cut numbers of paper pushers employed in the public sector? or to trim their pay? or to eliminate our overseas aid budget? or to cut our defense spending by half to reflect the real might of our armed forces? or to privatize health care delivery (not access to services - delivery)? or to introduce efficient system of education fees? or that he will switch all public sector employees of age 45 and less into defined contribution private pension schemes? or that he will no longer automatically index pensions to already retired public sector workers to future wage increases in the sector? or that the corporatist model of centralized wage bargaining is done and over for ever? or that he will impose restrictions on striking activities in the public sector and will end job-for-life conditions of employment in the sector?

No? Neither do I. And neither does the S&P - at last.

Cowen is just 3 weeks behind this blog?

When I was updating my budget deficit forecasts last week, I noted that the Government has been catching up quickly with my predictions from December, followed by February forecast for a shortfall in revenue.

Now, like Ireland behind Iceland (with an alleged 3-months delay), our Government is about 3 weeks behind this blog. Today's papers report that Brian Cowen now expects a tax revenue of €32bn in 2009. Well, I'll be damned... see my latest update here projecting €31.4bn in revenue.

Of course, a speculation is due - the results are to be released on the 3rd of April. Last month, Biffo didn't bother to read these in advance, nor did anyone else in the Government. This ended up looking like the Government that can't handle its own figures (which, obviously, the can't) let alone deal with the crisis in the entire economy (ditto). Maybe this time around Brian^2+Mary decided to set aside some time to govern? Fat chance. I think the entire drip-feeding of new - downward - figures is designed not for the public consumption but for the clandestine Partnership Talks going on.

Per information I gathered from the sources at that Partnership Table, last week, the Government managed to present a half-baked argument that things have bottomed out in the economy already. Improvement is around the corner and thus we can borrow our way through this. Documents I have seen - given to the Partners - showed relatively rosy forecasts for 2009 and 2010. The Government, it appears, also believes that it has resolved successfully the financial institutions crisis via a mix of past policies and the forthcoming scheme for dealing with 'bad' loans. It further claimed that it will be delivering a stimulus package, icnlsuive of some enterprise credit support measures - alongside the mini-Budget next week.

Well the latter might have something to do with a forthcoming document from one serious international organization that we are the members of which (later this week) will show that compared to other developed countries around the world, Ireland finds itself as:

• the worst economically governed in the world;
• in deepest trouble when it comes to housing markets declines to date;
• the country that is applying all the wrong (uniquely Irish) remedies to its fiscal problems; and
• the country that is least well positioned to come out of this recession any time soon.

Incidentally, the same document will show that some 90% of the bonds spreads for the developed countries is explained by the underlying risk of debt default... Hmmm... should we send our DofF 'commentators' (see here) back to school?..

But back to our Taoiseach's pronouncements on fiscal policy matters. At the same time as delivering 'good' news, keeping public pressure on the Partners by sending 'bad news' messages is a relatively unsophisticated practice that our Triumvirate is well capable of. So go figure.

By all measures to date, however, it looks like the March Exchequer returns are going to be very bad, even by our recent standards. Remember - you have read it first here. Biffo is still 3 weeks behind...

ESRI's latest outlook: more waffle, less real news

The ESRI - a largely Government-sponsored quasi-official 'research' institute has issued another of its macroeconomic updates. This one is available here.

In case some people have not noticed it yet (presumably, someone employed in a state-sponsored organization might be detached from everyday reality of our economic collapse), ESRI opens its latest missive with the following statement:
"The combination of the domestic housing bubble unwinding and a world financial crisis has particularly unpleasant consequences for the Irish economy. However, while the bursting of the property bubble makes things much worse ... up to a half of Ireland’s current problems with the public finances and in the labour market arise from the global financial and economic crisis – they would have happened anyway no matter how appropriate fiscal policy had been over the last decade."

So let us get things right here: according to ESRI, at least half of our problems are attributable directly to the Government fiscal policies. Out of the other (at the most) half, domestic housing bubble is not attributable to the Government fiscal policies. So, dear ESRI 'researchers', narrowly targeted tax breaks for developers and property purchases, over-stimulation of construction in the areas with no demand (National Spatial Strategy, hotels, various tax-sections apartments etc), linkages between tax revenue being raised out of property transactions and fiscal spending - these are not related to our fiscal policies and 'would have happened anyway'? How? By spontaneous self-combustion?

ESRI goes on: "The structural [fiscal] deficit is relatively invariant to short term fluctuations in the outside world and is, thus, a more certain and appropriate target for fiscal policy. Our research suggests that the structural deficit this year is of the order of 6-8% of GDP... If Ireland did not currently face a structural deficit, then the appropriate public policy response would have been to let the “automatic stabilisers” work. ... However, we do have a serious structural deficit, which became apparent early last year. This problem, together with the severity of the recession and uncertainty about when a recovery can be expected, means that there is no option but to take severe action to substantially reduce that structural deficit."

Several things here:

1. The structural deficit in fiscal policies has become apparent to the ESRI only at the beginning of last year. They could not see the structural problems emerging since 2004 when the Irish Exchequer chose to pump vast amounts of stamp-duty and other property tax revenues surpluses into current expenditure, permanently raising the latter despite a temporary nature of revenue collected. Indeed, the ESRI has for years egged the Government to raise spending. They issued dozens of papers on 'relative' poverty, the need for more 'investment' in public services, denied for years that there was a significant surplus in public sector remuneration and so on. Now they tell us that the structural deficits are a recent thing?
   
2. The ESRI, despite stating that only 'up to a half' of fiscal problems is due to fiscal policies misfires, still manages to attribute jobs losses and unemployment to world recession. Yet, most of our unemployment increases in 2008 were driven not by the IFSC layoffs (which are attributable to global crisis in financial services) but by contraction in domestic construction. Surely this was not due to something that was happening in Bear Sterns or Lehmans?
3. Note that the ESRI implicitly assumes that global economic recovery will lead to a recovery in Ireland - an assumption that is simply undefended in their analysis.

"Before taking account of measures to be announced in the budget on the 7th of April, the general government deficit in 2009 is likely to substantially exceed 10 per cent of GDP." Well, at last, this blog's forecasts are being followed by ESRI (see here), albeit with almost two months delay!

Back to the structural deficits: "It would probably be appropriate for fiscal policy this year and next year to work to roughly halve the structural deficit by the end of 2010. As the economy recovers in 2011 and in subsequent years, further action of a less draconian nature would be needed to reduce the structural deficit to below 3 per cent of GDP by 2013 and to eliminate it by around 2015."

Note my emphasis - up until yesterday, the Government was targeting the total deficit reduction to 2.5% in 2013. Now, ESRI is telling us that we should reduce the structural deficit (which is by their estimate accounting for roughly 7% out of ca 12% total deficit) to below 3%. So do the math - the overall deficit for 2013, according to the ESRI should be somewhere around 4-5% - well above the 3% EU limit.

So how can we do this? According to the ESRI: "In making cuts in expenditure, priority should be given to areas where services are inefficient or of low value. If the public wishes to preserve the current level of public services, then revenues will have be to be raised to between 35 per cent and 40 per cent of GNP. Under these circumstances it seems likely that a substantial increase in tax revenue, combined perhaps with more user charges, will be required to restore the public finances to a sustainable growth path. In choosing the mix of sources of additional revenue it will be important to take account of the likely effects of higher taxes on the labour market. This would argue for developing new sources of revenue such as taxes on carbon and on property."

Ok, I agree with property tax - although it should be structured not as a function of property value (as this will discourage property upgrades and will do nothing to improve land-use efficiency), but as a value of the land on which the property is located, as this will encourage more efficient use of land and will remove distortionary subsidy to developers.

But what about 35-40% of GNP as a tax base? If you consider my budgetary update from this morning (here), you can see that assuming GNP falls 8% this year, this target implies tax revenue of €56.6bn in 2009 - or ca 77% more than the Government is likely to collect under Budget 2009 provisions. How on earth will the Government be able to raise such taxes? In December 2008 report, total tax revenue for 2008 was shown at €40.8bn, total 2007 revenue was €47.9bn. So in effect, the ESRI gang is suggesting we raise tax revenue in excess of pre-crisis levels by some18.2%?

This is mad, irresponsible and dangerous. And this is what informs Government decisions in this country!

Melting Down Lenihan Style & Daily Economics 27/03/2009

According to the Irish Times, Brian Lenihan is now admitting that the revenue receipts for March are going to show even further deterioration in the fiscal position. This time around, Lenihan is claiming we will fall to €34bn in receipts, as opposed to the DofF forecast issued in January, assuming receipts of €37bn. Oh, Brian, thou are an incorrigible optimist. Anyone who has read this blog knows that I predicted this much in February (see here). That was then and despite the fact that our Minister Lenihan, with his new advisers from NUI (or 'yes-men' as I would put it), are catching up with my numbers, I have to move the targets once again.

(can someone figure it out what's the value of all these paid economists working for him if they are a month-and-a-half behind this free blog in forecasting?)

So here is my latest forecast - it will be subject to a revision once the actual Exchequer returns come out for March.Notice that I have dropped expected gross tax revenue to €31.4bn (inclusive of non-tax items), consistent with tax revenue of €31bn. I have also computed the General Government Deficit as a function of my forecast for 6.5-7% drop in GDP this year. Thus, 2009 Gen Gov Deficit is now expected to reach 11.8% of GDP and by the end of 2013 this will drop to 7.13%, not 2.5% that DofF predicted in January 2009 estimates. The reason for this later-years discrepancy is to a large extent driven by the short-term debt being issued by the NTMA to finance current spending.

So, Brian, here is a challenge - how soon will you and your advisers get down to my forecast figures? Or, should you want to save some dosh for the taxpayers - you can fire a couple of them and hire myself - I'll do their jobs (obviously) better and for, say, 1/4 of their price?

Now another update - new Eurocoin forecast for Euro-area economic activity is out, so time to update my own forecasts. Here is the chart. Lines in red denote my forecast forward.

External Trade stats for December 2008 are out and things are looking bad. Jan-Dec 2008 imports down 10%, exports down 3% y-o-y.

MNCs lead in declines, with Computer equipment exports down from €12,577m to €9,322m (-26%) and Organic chemicals from €19,641m to €17,853m (-9%). These are real declines, not offset by transfer pricing. In other words - these are jobs under threat or being lost. In other MNCs-led sectors: Chemicals exports increased from €2,664m to €3,483m (+31%), Pharma from €14,749m to €16,704m (+13%) and Professional, scientific & controlling apparatus from €2,109m to €2,779m (+32%). These are transfer-pricing driven, but at least for now, jobs are being supported, if only by our Bahamas-on-the-Liffey tax shelter, if not by superior productivity. How do we know this? Look at imports: Pharma imports up from €2,397m to €2,866m (+20%), Petroleum & relateds from €4,479m to €4,813m (+7%) and Natural gas from
€1,039m to €1,378m (+33%). These are inputs into the sectors where MNCs-led exports still are growing.

Goods shipped to Great Britain decreased from €15,002m to €14,302m (-5%) - evidence that our exporters are absorbing exchange rates changes into their bottom lines - and to Switzerland from €3,251m to €2,555m (-21%). Goods to the United States increased from €15,825m to €16,657m (+5% - also evidence of significant real competitiveness improvements, given still adverse terms of trade conditions), to China from €1,989m to €2,323m (+17%), to Malaysia from €694m to €1,062m (+53%) and to Spain from €3,281m to €3,587m (+9%). These are strong geographical results, showing, amongst other things that we are moving away from intra-EU trade dependency.

Inter-temporally: December 2008 the value of exports was +10% on December 2007, while imports were down -19%. But seasonally adjusted exports were down 4% on November 2008, while imports were down 11%. Preliminary estimates for January 2009 show exports of
€7,014m, down 1% on January 2008 and imports of €3,946m, down 28%. This is (good) mixed result showing that exports in general remain relatively buoyant when compared against domestic economy collapse.

Per separate data from CSO: the volume of output in building & construction decreased by 26.7% in Q4 2008 compared with Q4 2007. The value of production decreased by 24.3% in the same period. This tells me that the anticipated Exchequer savings due to lower cost of construction are unlikely to be significant: volume falls outstripping value falls implies unit cost of construction is up!

A tale of a missing bonds rally

US markets have seen some strong rally momentum in recent days. Here is a good piece on bond markets in the US.

"If there really are signs of financial recovery, nobody told the bond market. Treasury Secretary Timothy Geithner's plan to rescue the financial system sent the S&P 500 soaring 7% on Monday alone, bringing its gains from March 6 to an impressive 19% through Wednesday. But credit markets have hardly budged. Corporate debt is still priced for disaster... Until investors recover confidence in financial assets, credit spreads are unlikely to tighten significantly. And without a sustained improvement in the credit market -- the seat of the crisis -- it seems irrational to expect a durable move higher in equities."

Yes, pretty much on the money. Here's how the numbers work: in my post on personal income by states - California is overdue a democratic party payoff and it will come, so the municipals markets and TIPS are going to be a good bet for some time to come. But the stock market is running too hot on absolutely nothing new - US Treasury's latest plan is a net transfer to
shareholders, which, obviously, first reduces any possible haircuts for bondholders, thus giving a fundamentals support to bonds ahead of shares.

What does this mean? If shares rises in the last 20 days is justifiable by fundamentals, there
should be at least a noticeable rally in bonds (although not as strong as in stocks, since bonds have already priced in all seniority over equity, thus a boost to equity holders yields is not going to be translated into 1:1 gains on bond prices).

My estimate would be as follows: for a 19% rally in equities, were the new valuations to set a new 'floor', we we will see a 5-6% gain on equity yields (including cap gains) over the next 3 years.

This would imply a yield differential compression to comparable corporate bonds relative to underlying equity. Assuming average yield differential for equity relative to corporate bonds of 8-10% in favour of bonds prior to equities rally, our post rally differential is ca 7.5-9.5% range. So bond prices have an upside potential of ca 16%. This is just straight math.

Now, take a cautious assumption that a part of equity rally is due to a fall in the perceived risk of default on equities (the recovery rate priced in CDS stays put, but expected recovery rate rises). Say 1/2 of the rally is just that. Then, price upside on corporate bonds is in the regions of 8-11%, holding YTM fixed. Until we see at least such a movement, the equity markets are overshooting the floor. And they are doing so pretty dramatically.

Daily Economics 25/03/2009

Opening scene: an ICU bed in Awfully General Hospital. Senior consultant, Brian-I, his two junior colleagues - Brian-II and Mary and an army of senior nurses, all at a bed of the patient. Chart reads: "Irish Economy", but the patient is invisible under a mass of frayed cables, yellow and cracked tubes, sparks-throwing electronic equipment and dingy unwashed and holes-ridden sheets. Brian-I, eagerly staring at a pub across the road is performing some procedure on the patient. "Say, we've been out of the ward for sometime now... what are the vitals on that one?" Mary's senior nurse assistant: "Sir, I am afraid no pulse, sir. Flat-line brain activity and body temperature of near zero, sir! Tough luck, sir!" "Aha," replies Brian-I, turning to Brian-II - "Our intervention worked! The patient is stable now! Pints?!"

Today's three sets of stats confirm the Celtic Tiger has been killed by our Brian, Brian & Mary's HSE-styled treatment.


Balance of Payments data - for Q4 2008 and the entire year of 2008. VAT, VRT, Road tax, Income tax, 'whatever-we-find-in-your-pocket' tax that the Government hiked in October and December 2008 have killed off our imports and flatlined our exports, so that in Q4 2008 we have recorded a tiny CA deficit of €133, "the lowest in four years and €2.6bn below that for the same quarter of 2007. For 2008 as a whole, the deficit was €8,375m, over €1.9bn lower than that for 2007. The merchandise surplus of €7,589m in Q4 was €2.7bn higher than one year earlier, while the invisibles deficit at €7,722m was up €116m. Within the latter aggregate, the services deficit at €2,139m was up €844m while the net income outflow at €6,104m was €721m lower."

So what does this mean?

1. We are a nation of imports and exports. Falling imports volume is falling consumption (and Exchequer revenue). By this measure we are economically dead.
2. As a nation that is predominantly dependent on MNCs to produce stuff for export, flatline exports is a sign that our economy's temperature is collapsing. Given that the latest data (released yesterday) shows global trade volumes falling 20% (in absolute, not relative terms - I am not kidding, see here) in Q1 2009, there is absolutely no way we can sustain positive exporting activity into 2009.
3. Since our MNCs tend to import almost as much as they export (transfer pricing), and given that in the second half of 2008 the MNCs-dominated sectors were booking high level of economic activity, the collapse in imports due to consumer and Irish companies investment demand was even more dramatic than CSO aggregates show. This means that global shock (item 2 above) is now fully merged with domestic shock (demand contraction) and both are exacerbated by our senile tax policy.
4. Our Financial Account Balance for Q4 2008 stood at -€3,604m - the worst quarterly performance since Q2 1999. The annual balance was €18.12bn - but that conceals massive issues of bonds in 2008 and repatriation of toxic commercial paper into IFSC by the 'bad bank' asset pools. Our direct investment balance was negative in all 4 quarters of 2008 (first time since at least 1997), and the decline is accelerating q-o-q. Portfolio investment into Ireland was negative at -€37.7bn in Q4 2008 - the worst quarterly performance in at least 12 years.
   

Recall that debate we were having whether IFSC should count into Irish stats or not? Well, check Table 3 in the CSO release, showing breakdown of BOP data between IFSC and non-IFSC. It turns out that IFSC is a net positive contributor to our Current, Capital and Financial accounts pretty much across all measured parameters. Non-IFSC services are the opposite.


Now, to the beef. Quarterly National Accounts released today are summarized in the graph and table below (both courtesy CSO):
I am not commenting on this in depth because there is nothing to be added to that 7.5% GDP drop figure for Q4 2008, other than - this is bad. Very bad.

Suffices to say that Q4 2008 figures were driven by:

• consumer spending down 2% q-o-q;
  
• investment down a Cowen-rrendous 15.4% q-o-q that follows after a similar drop in housing and non-residential investment in Q3; and
  
• sharp declines in global trade with exports down 2.6% q-o-q.

Forecast update: I am still sticking to -6.8-7.5% real decline in GDP for 2009.


House prices: permanent tsb/ESRI House Price Index released today shows national prices falling 0.8% in February 2009 (after 1.4% fall in January, 0.9% fall in December and 0.5% fall in November 2008) and 2.1% in January-February 2009. This brings average prices to February 2005 level. The rate of decline is obviously faster in Jan-Feb 2009 than a year ago, with Jan-Fen 2008 fall of 1.5% as opposed to 2.1% contraction in the first two months of 2009. So an average price for house nationally is €255,999 in February 2009, relative to the peak of €311,078 in February 2007 - a cumulative loss of 17.7% on peak and a real loss of ca 23%.

Of course, the drones from ptsb, commenting on this data, tell us that all is good - as 'the affordability is improving'. Clearly, these mortgage bankers can't imagine how

• rising negative equity;
• tightening lending standards;
• sky-high unemployment and
  
• falling after-tax incomes

might put a damper on that 'improving affordability'...

Now, Dublin house prices fell hardest in February - 2.1% down (-1.4% in January), while houses outside Dublin were down 0.9% (-0.6% in January). The average price of a Dublin house and outside Dublin in February was €339,042 and €220,741 respectively. The equivalent prices in December 2008 were €351,096 and €223,984. This might be welcoming to those who think Dublin is the seat of evil in Ireland, but be warned - this data is deceptive. I would like ptsb to come out with a detailed analysis of Dublin v outside-Dublin price dynamics by house types, and location types, as I suspect that the Dublin averages are being distorted by the collapsed market for apartments, while outside-Dublin figures are being propped by the lack of turnover in single-family housing.

House prices fell 15.2% and 9.2% y-o-y to February 2009 for first-time and second-time buyers respectively. The equivalent rates to January were-13.5% and -8.9% respectively. House prices for new and existing houses declined 0.6% and 1.0% respectively in February 2009. New and second hand house prices fell by 9.2% and 11.3% respectively y-o-y to February 2009. The latter, of course, is most likely due to the deeper falls in new homes prices during 2008.

Closing scene: pub across the road from Awfully General Hospital. Brian-I and his junior colleagues are having some well-deserved rest. "Stable, I tell ya, lads! Stable!" shouts Brian-I. "Not moving, but stable! Hey, Mary, send some boys from that Nuclear Therapy Medicine Academy - that NTMA thingy - over to Berlin to get some dosh. Tell them we have our real patient's interests in mind, not some vital signs bureaucracy, whatever..." Curtains.

Daily Economics Update 24/03/2009

Ireland:

I tried to resist commenting too much on Brian Cowen's remarks today concerning the extended borrowing he envisions for Ireland Inc in 2009. I tried, but this is simply an extraordinary statement from a person who is

• either clearly not capable of thinking straight in the crisis or
  
• from a politician, so cynical and obsessed with self-preservation that he is willing to preemptively surrender this nation's hope for economic survival in order to throw another bone to his political cronies.

Either way, Cowen today has managed to achieve nearly impossible in virtually a single breath:

• Putting Ireland closer to fiscal insolvency - by enhancing the (already significant) uncertainty as to how much he will borrow in 2009 (and through 2013) and on which terms (will Ireland be forced to continue borrowing short, front loading 2011-2013 deficits to finance Brian's 'Partners' today?);
• Destroying his own reputation by telling the world that he cannot be trusted on any of his future policy pronouncements (undoing his own pre-commitment to keep the deficit under 10% he stated that no budgetary projection, including yet to be published mini-Budget, from this Government can be trusted);
• Showing that this Government will flip flop not only on soft targets (e.g promises not to tax us to death), but also on hard ones (including his commitments to the EMU);
• Destroying whatever hopes the ECB and the EU Commission might have had that this Government can be a responsible participant in the EMU;
• Forcing the bonds markets into a situation where, from now on, no pricing of Irish debt paper can be conducted on a basis of rational valuation.
  

Only 3 weeks ago, Cowen was fully committed to keeping 2009 borrowing under 9.5% of GDP. He is now telling the world that this was all a matter for him to change his mind over. Perhaps the only reason for such an extraordinary statement I can think of is that possibly (I am speculating here), Cowen saw preliminary figures from the Exchequer revenue for March. Even then, there has to be a real 'nuke' in these figures to justify such a public humiliation of this economy in the eyes of the developed world.

Cowen said in his address that he is not willing to sacrifice the real economy on the altar of public finances. Coming from him, this is rich. Cowen and his Government

• raised taxes in October 2008 and again in December 2008, and is going to raise them in April - 3 times in 7 months - amidst the wholesale collapse of the real economy (incidentally, these tax hikes were necessitated by the decisions on run-away train of public current expenditure growth that he adopted during his tenure as the Minister for Finance);
• raised VAT and other taxes directly impacting businesses, employment and public economic welfare, as his incompetent Minister for Enterprise sat silently beside him;
• raised levies, taxes and charges on all workers, including those who lost their jobs and then cynically turned around to wage an oratorical crusade about 'equality' and 'shared pain';
  
• paid public sector wage increases and then clawed some of these back, posturing as if a heroic leader who broke the mold 'to do the right thing';
• got in bed with trade unions in the Summer 2008 to produce a partnership agreement that committed the private sector taxpayers to servitude to public sector wage demands;
  
• once again cowardly moved into the new Partnership Talks last night as an excuse to surrender his policy making authority;
• presided over a largely failed set of actions on the banks that shored up (temporarily) Irish Developers Country Club at the expense of the real economy;
• watched idly as the real economy was falling off the cliff between June 2008 and October 2008;
• made wild promises of reforms and productivity enhancements in the public sector and delivered none;
• blamed everyone - from Americans to the World - for our economic ills, but not a single time managed to tell the nation that he is sorry for serial errors of judgment his Government committed in only 9 months in power;
• appointed the most incompetent person imaginable to run the key ministry in charge of our real economy (and no, I do not mean DofF here); and now
  
• turned our entire budgeting process into a public farce...

This is really rich!

Richard Brutton put it perfectly when he said today that “The spectacle of a Government thrashing around, unable to set any clear framework for a Budget that is just two weeks away is damaging our international reputation. It is damaging the confidence of markets from whom we hope to borrow €24 billion this year... This Government is destroying its authority to provide ...leadership.”

May I add that it is also destroying the real economy - the same one that Brian Cowen claims to be protecting.


International:

March McKinsey survey of economic conditions is out today, showing that "the percentage of the executives who say economic conditions have gotten worse at the national level hasn’t increased, but fewer than a third expect an upturn this year... 53 percent expect profits to drop in the first half of 2009, and the number expecting to shed workers has jumped eight percentage points in six weeks." Companies that are thought of as being well managed in the downturn are likelier:

• to be reducing both operating costs and capital spending,
• not weakening operations a great deal, and
  
• "are also likelier than others to be improving productivity".

Here is an interesting one: "overall, the results show that most companies are not actively seeking more cash." So there is no significant demand for credit, then? As I've been saying all along, it is hard to imagine that during the extreme hangover period following the leveraging binge that the corporates have embarked upon in the mid-2000s there will be strong demand for new credit.


US:

Existent sales up, prices up and now new home sales are up as well - what is the world (ok, the US) is turning into? Well, not anything resembling of a bull market, at least not yet. Per data released today, new homes sales were up 4.7% in February relative to the record low (since 1963) reached in January, but sales are still down 43.8% compared to February 2008. I worry that this is not a floor yet, but a slight bounce before further falls. Even if the current level signals an upturn in sales, things are bound to remain testing for a while, as inventory overhang remains enormous. A 2.9% fall in inventories of unsold homes in February still leaves 12.2-months worth of stuff unsold - up full 3 months on February 2008.

But there is more noisy data coming out today - there was an unexpected and a welcome rise in orders for durable goods - the first increase after six-straight-monthly declines. Offsetting the gain in February somewhat was a sharp downward revision to orders in January (from -4.5% in preliminary estimate, to -7.3% decline).

The best piece of analysis on this is on Bloomberg (here). In my own view - setting aside defense spending and consumer stuff - the gains are reflective most likely of amortization cycle (replacement of capital goods delayed during the previous 15 months) than due to capital inventories build up. There is also a strong 'noise' component to the rebound - given the precipitous fall in orders in Q4 2008, when durable goods orders fell at a rate not seen since the late 1950s.

The fact that we are seeing all this volatility in economic series away from the unrelenting downward trend is a good signal. In my view, as I said before, this is a sign that the markets are now seriously testing the floor of this recession. In other words, I now expect similar modest gains in some parameters and stabilization of other parameters through May, followed by the first positive gains in the capital spending and declines in new unemployment claims in June-August. This will put the US economy onto recovery path by mid-Q3-early-Q4.

Daily Economics Update 23/03/2009

I am putting this link (here) to today's WSJ interview with Gary S Becker in red, bold and at the top of this post (and on the front of my blog page) not only because he is the greatest economist alive today (which he is), and not only because he taught me microeconomics (how poor of a student I was is attested to by my self-deception of believing in being right on more occasions than being wrong), but because this interview is a must read for anyone concerned about the state of our world today.

Ireland

A new invitation is out - from Brian Cowen to the social partners - to enter talks on a new National Agreement. Yes, folks, you've heard it right. The Government that can't do anything worth talking about on the crisis is back to talking about doing something on the crisis. Dust out that Excellence in Services medal for Brian. Instead of facing down the unions in their militant stance on the economy, Brian Cowen has done another one of his 'courageous' and 'decisive' flip-flops that our official media got so accustomed to calling upon him to perform. Expect: more blame for private sector, higher taxes, more pay for public servants, rampant price inflation in state-controlled sectors and... well, just expect more of what we had in Autumn 2008.

This time around, the markets will be searching for what to hit next. Given that Brian's first round of 'dealing with the crisis' has spectacularly collapsed into issuing blanket guarantees to the banks, nationalising one bank, handing taxpayers cash to two other banks, passing no meaningful measures on stimulating economy, hammering consumers and taxpayers, slaughtering retail sector and seeing public debt soar, they will be hard pressed to find a new target still standing.

Revolting, is how I can describe this latest move at best.

Just how senile our policy making has become as of late? Think Nationwide scandal. Mr Fingleton is walking away with millions and the Government and the politicos are issuing salvos of outrage. But they can do nothing - he owns the money. How? The truth is that Fingelton gets to keep his millions only because in September 2008, the Exchequer has underwritten the Nationwide. Would they have said then: "Sorry, buddy, but there is no way Nationwide is a systemic bank and so no guarantee", the bank would have gone into a receivership and Mr Fingleton would have received what he deserves after all these years of running his own 'lille piggy bank' - zilch, nada, zero.

So don't blame the bankers - blame the politicos. And let's ask Brian^2+Mary to see that assessment of the Irish banking system that managed to recognize the likes of the Nationwide as a significant enough institution to have caused a systemic risk to the entire financial system were it allowed to fail.


US:
Forbes is now on the inflation case (here): "On a year-over-year basis, the CPI will turn negative this month and stay negative for many more months. As a result, many believe inflation is a distant memory and those who fear deflation will have data to hang their hats on for much of 2009. But, these deflation-istas will be looking in the rear-view mirror. On a month-to-month basis, inflation is already starting to claw its way back. In the first two months of 2009, consumer prices are up at a 4.1% annual rate, while producer prices are up at a 5.8% rate."

Worth a read. I have warned about this threat of inflation a week ago (here), so we are ahead of the curve...


More on the Geithner 'Trillion-dollar Rescue' Plan (GP): let's do some math

1. The Feds buy $1 trillion worth of banks assets, in partnership with private buyers (95-97% financed by the Treasury - 85% in the form of a non-recourse loans and remaining in the form of equity). Suppose that 5% comes from private investors. Taxpayers liability is $950bn.
2. Now, assume that the average price paid for assets is $0.80-0.85 on the dollar - an assumption consistent with 'clean' assets TARP financing. Banks get an effective disposal of $1tr/0.8=$1.25tr worth of assets. This is the implied value of assets on banks balance sheets. But the banks have marked these assets down already. Suppose the original markdowns were ca 10% impairment. The original, pre-writedown value of the assets that is being purchased under the GP is, therefore $1.25tr/0.9=$1.39tr.
3. Current market price for distressed assets is roughly equal to the recovery rate on such assets - ca $0.40-0.55 per dollar value, so the mark to market value of these assets is now $1.39tr*0.45=$625bn.

Recall that 95-97% is going to be financed by the Feds, and the Government share will be roughly 20% of the entire value. So under GP, taxpayers are getting $125bn in assets in exchange for $950bn in payment... Ahem, that is a rotten deal, indeed.

But what does this deal buy in the end? Combine that with the fact that

• ca 40% of all banks balance sheet assets in the US are in residential mortgages,
  
• ca 24% - in Commercial mortgages,
• of the remaining stuff, 55% is in corporate and industrial loans,
  
• of which good 1/5th is again linked to property.
  

Thus, total balance sheet exposure to property in the case of the US banks is somewhere in the region of 68%. Of these, at least 40% is toxic, so that we can assume that 25% of the entire banks' balancesheets is of reasonably nasty quality. Suppose banks sell (via GP) these assets at $0.80 on the dollar. The required post-sale writedown on the loans will be 25%(1-0.8)=5% of the entire asset base. Per latest statement (December 31, 2008) by the Bank of America, this venerable (if vulnerable) institution has tangible equity to total assets ratio of 5.0% and Tier 1 ratio of 9.2%. This is excluding the toxic stuff it inherited from Merrill Lynch. Thus, in effect, participating in GP will wipe out all of the bank's tangible equity and more than 1/2 of its Tier 1 capital, pushing it well below the 6% Tier 1 ratio required of reasonably sound banks.

So this implies that very few banks will be willing to sell at $0.80 on the dollar. A more acceptable price for banks would be $0.95 to a dollar, but at that price, the US taxpayers will fall some $833mln short on the deal.

Could someone please tell me why we are talking about GP as some sort of a market-turning deal? Unless, that is, we are buying into the plan because it is the first, and so far the only plan that a new Democratic Party White House has contrived?


US Personal Income data: "US personal income growth slowed to 3.9 percent in 2008 from 6.0 percent in 2007 with all states except Alaska sharing in the slowdown," according to the data released by the US Bureau of Economic Analysis. The U.S. growth was the slowest since 2003. Inflation, as measured by the national price index for personal consumption expenditures, rose to 3.3 percent in 2008 up from 2.6 percent in 2007. Here is a nice map of heaviest (and lightest) hit states:
Can you see the pattern? Well, here is another map:

House Prices (US): Home prices rose 1.7% in January relative to December 2008, says Federal Housing Finance Agency - the first monthly increase in 12 months. This leaves home prices down 6.3% in the past 12 months and -9.6% off from their peak in April 2006. In December, the year-on-year decline was 8.8%. One note of caution - this is the preliminary estimate subject to at least two future revisions. For example, December 2008 preliminary estimate was showing 0.1% fall in prices, but this was revised today to -0.2% decline. Overall, in January, home prices rose in 8 out of 9 regions (only Pacific states registered a decline -0.9%), with strongest gains in East North Central (+3.9%) and South Atlantic (+3.6%) regions.

'Happy Times' at NTMA: Updated

Remember that unrivaled shot of Borat sun-bathing on the banks of the river? Green unitard thong and brownish sand of post-Apocalypse industrial wasteland of a landscape? This is probably the scenery at NTMA today. The guys, and my heart goes to them for their effort (honestly - they did as good of a job as was possible under the circumstances), have gone away with loading into the markets a €700mln worth of 10-year Irish bonds. They wanted to upload €1bn, but stopped selling 30% short of the target. Why, you might ask? Well, it all comes down to terms. There is no actual information on bid spreads, but the average was 5.80%, lowest price of 89.6, average price 89.527. Yikes.

Some time ago I predicted that we might see 6.5-7% yields on Irish Government paper by the year end. Well, that was before the latest 50bps drop in the ECB rate (March 11), implying that at 5.80% today we are in the territory of 6.00-6.10% already if compared with the situation before March 11th.

What is even more telling is that I was right on March 10 when I priced 10-year bonds in the range of 5.7%-5.9% (here).

Lastly, it is worth looking at the volume of issue - €700mln... sunflower seeds for the public sector - at current rate of spending, Brian^2+Mary are going to get through this amount in less than 4 days and 1 hour 30 minutes. NTMA is better start issuing new paper weekly at that rate of spend! Or maybe they should pick up a phone and dial Leinster House, asking to stop the madness of bleeding the taxpayers and companies to feed the beast of our public sector and start cutting fat. Showing the markets that Ireland's Government is not just a public sector unions' crony and is capable of getting its fiscal policy under control just might bring down the cost of borrowing.

Happy Times?


Update: the media is singing praise for yesterday's issue, but hold on: they say we raised €1bn, in reality, we raised only €700mln in 10-year paper and €300mln in 3-year paper. You don't have to be genius to see that the 3-year stuff is going to mature before the expiration of the 2013 deadline for putting our finances in order. So in effect, we kicked €300mln worth of a problem into the scoring zone... This is equivalent to a drug addict's miraculous 'recovery' reports when the chap simply stashed some powder for a quick hit in a couple of hours time. Some success.

More details from NTMA itself: for the 10-year bond, lowest price 89.46 at yield of 5.818%, weighted average yield 5.808%. Pricey stuff this is and wait until the mini-budget shows the rest of the world that Cowen has no intention of seriously tackling the deficit - where will we be next time we shove pile of debt into pre-2013 maturity?

And you don't have to be a genius to recognize that if the state completes one 'successful' auction like the one yesterday per month, NTMA will have, by the end of 2009:

• raised maximum of €10bn, while we need €15bn just to stay afloat this year;
• pushed some €7bn (€3bn in monthly auctions, plus €4bn in February sale) in new debt into 2011;
• reached €63.5bn national debt level (up from €52.5bn as of the end of February); and
• forced Ireland Inc even further away from meeting its commitment to the European Commission of getting under 3% budget deficit limit by 2013.

Yesterday's success is starting to look more like a Pyrrhic victory to me.

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...