Daily Economics 23/04/09: That place called Dublin

Irish Wholesale Price Index, March 2009
Available (here) from CSO: "Monthly factory gate prices decreased by 1.0% in March 2009. This compares to a decrease of 1.6% recorded for March 2008. As a result, the annual percentage
change showed an increase of 4.5% in March 2009, compared with an increase of 3.9% in February 2009. In the year there was an increase in the price index for export sales of 5.5% and an increase of 0.9% in respect of the price index for home sales." So we are not gaining any competitive edge on FX devaluations in exports trade, then. And there is no factory-gate deflation at home either.

In the month Office machinery and computers prices fell 2.1%, and Basic chemicals were down -1.1%. Some multinationals are taking a hit. There were increases in Pharmaceuticals and other
chemical products (+13.1%), Other food products (+11.8%), and Basic chemicals (+8.9%). SO some other MNCs are doing ok, although short-run price hikes can come back and bite these manufacturers. Building and Construction All material prices decreased by 2.4% in the
year since March 2008 and by 0.6% in March 2009. Not enough, if you ask me, and this leads to a question concerning the Government plans to achieve expenditure 'savings' on the back of cheaper capital construction costs... Year on year, the price of Capital Goods decreased by 0.6%, while there was a monthly price decrease of 0.3%.

Of course, our heroic boys of CER/ESB/EirGrid-controlled energy sector are turning out more and more price gauging as "Energy products increased by 3.2% in the year since March 2008, while Petroleum fuels decreased by 23.7%. In March 2009, there was a monthly decrease in Energy products of 0.9%, while Petroleum fuels decreased by 3.8%." Well, table below does show this in indisputable terms...
Is it time to fire CER? In my view, long overdue!


UK Budget
Some in Ireland are making 'happy faces' at the UK Budgetary numbers released yesterday. The UK forecasted that the General Government Deficit will reach 12.6% in 2009 - some 1.85% points above the 10.75% GGD built into Irish mini-Budget of April 7. A catch here is that I personally do not believe the Irish figure, having predicted (here) that our GGD will reach 12.5-13.0% this year - right about where the UK is placing its own expectations.

Going on with the misguided cheerleaders, today's Davy note says: "Moreover, gross debt to GDP is set to remain much higher in the UK than in Ireland." Hmmm... that is true only when it comes to direct public debt, excluding such 'trivialities' as financial sector commitments and guarantees (which total $641bn or 280% of our GDP in Ireland and only $375bn or 13.4% of the UK GDP: see here). Oh, yes, of course, some of the moneys on both sides of the Irish Sea is going to count as 'investment' on public balance sheet, but to you, me and the rest of the productive economy there is no difference - we will be paying the price in our taxes, investment or not. And the cheerleaders are forgetting another small point - Ireland's total debt (public and private) is actually much larger than that of the UK (see here, and the chart below - from here).
Now, I know I won't be welcomed by Davy in years to come for pointing this out, but Reality Bites!

Just to be fair, though, Davy also say that "Gross debt is a different matter: recapitalisation funds that need to be borrowed affect this metric. So the projected gross debt ratios will be quite fluid". Yeah, so fluid that we'll need buckets, not shovels to get that NAMA mess under control. UK liability under banks recaps is likely to be ca 10% of their overall guarantees commitments - taking into account the already substantial paydown of funds and the maturity of the downturn over there. So take it to be $37.5bn. Ireland's commitments are going to be around the same percentage share, or $64.1bn, of which only $9.8bn has been paid down so far. In the mean time, Ireland's benchmark yields on Gov bonds are in 420bps territory, UK's - 237bps. Shhhh... don't say it out loud, but it does look like Ireland's advantageous debt position, relative to the UK, is a quagmire. And no, this stuff is not simply 'academic'. Financing our 'low debt' position will cost us €1.83bn in interest expenditures pa. Financing the UK's 'perilous borrowings' will cost them €635mln per annum. Doughhhhh, as Homer would say it, all is grand in the Davy-world of voodoo economics...


Regional subsidies
Yesterday, ESRI published an interesting article: Who is paying for regional balance in Ireland? (available here). It is a worthy quick read if only for one reason - after hearing continuously the whingeing that passes for regional economic policy in this country and the anti-Dublin biases out in the country-side, the article puts few facts straight.

"...real resource transfers per head of population (i.e., the per capita excess of expenditure over revenue), have increased over time. In other words, redistribution across regions has increased over time. These transfers tend to flow from richer to poorer areas – a large negative correlation between the implied transfer of resources and real per capita gross value added. ...Expenditure is positively correlated with real per capita output (Gross Value Added), but tax revenue is even more strongly correlated with real per capita output, implying that the fiscal system operates to transfer resources from richer to poor regions."

Put in real (as opposed to ESRI's) terms, this means that few productive parts of the country are subsidising numerous less productive ones. Is this a good thing? Well, no.

• First, such subsidies distort returns to personal capital (physical and human) of those who receive them. In other words, people living in the parts of the country that are the 'gateways to excellence' are ripping off their productive compatriots while being deluded into believing their work actually adds value. It does not, at least not in a competitive way.
  
• Second, the transfers diminish the productive capacity of those who live where real jobs are located.
  
• Third, the subsidies continue to perpetuate the already extensive destruction of the country-side as extensive means of production are being subsidised over intensive economy.

"Overall, Dublin and the South-West region are substantial net contributors. For example, in 2004 both Dublin and the South-West contributed just over €2,000 per person while in the same year the Midlands region received a transfer of just over €3,000 per person." This is nice. As a person living in Dublin, I am apparently sending some €6,000 of my family income to the Midlands. This means that my 1,100sq ft Dublin city household is paying for some folks living in average 2,000 sq ft houses in the middle of nowhere. But should I choose to avail of the landscape and natural amenities that my money is paying for out there, I just might get a shovel-pat on my back from the subsidies-receiving locals. Hmmm...

"In 2004 just over €3 billion were transferred from the ‘net surplus regions’ Dublin, South-West and Mid-West to the other regions. Overall the tax burden (including social contributions) averages at €11,000 per person in 2004 with a high for Dublin of almost €14,000 per person and a low of €8,500 per person in the Midlands." Yes, this does account for those Midlands inhabitants working in Dublin too, so no arguments about 'We work in Dublin, so we are productive too' apply.

"In per capita terms ...Dublin is not favoured when it comes to capital expenditure. Indeed no clear pattern of ‘excess’ per capita capital expenditure can be detected in the data." In other words, we are building capital infrastructure stuff in the middle of nowhere.

But ESRI would not be itself if there was no voodoo of socialist economic dogma in the article somewhere. This comes at the end: "The finding that the system provides a significant degree of regional equity is largely the result of the centralised nature of revenue collection in
conjunction with the aim to provide similar levels of service across the full range of government activities in all regions. In order to achieve a similar level of equity with a less centralised system would require a more sophisticated system of fiscal equalisation payments across regions. Thus, while many have argued that the Irish system is too centralised this centrality turns out to be an asset in terms of achieving regional equity."

Run this by me again, please! 'Equity' apparently happens when younger and more productive workers of Dublin and South-West are paying older and less productive workers in the rest of the country? 'Equity' also means that we must achieve 'fiscal equalisation payments across regions'. This is the same economic illiteracy that argues that Sub-Saharan Africa can achieve growth by taxing the developed world.

One thing that was lacking in this paper, and indeed is lacking in overall research on regional transfers is how much more dependent on subsidies are specific areas. One that comes to mind is the area covered by the patchwork of various Gaelic ethnic enclaves sponsored by the Government. Another one - the patchwork of useless 'gateways' we have created across the country.

Yes, folks, ther eason we are forced to accept gang crime in Limerick and parts of Dublin, roads gridlock in the capital, lack of proper public transport, poor broadband services, horrific quality of landline phone services, overstretched schools and universities infrastructure in Dublin and the rest of the mess we call urban living in the Capital City is because we want 'equity' and 'equality' between those parts of the country that work and those that collect subsidies. Regional policy indeed...

Daily Economics 22/04/09: IMF's GFSR

IMF's Global Financial Stability Report (available here) is a lengthy read worthy of attention, both for its finance world-view and a diplomatically correct version of the 'Office' comedy. Subtle language turns tell more of a story of IMF's desperation from looking at APIIGS' incompetent macroeconomic management than the direct phrases. That said, there is little in the report, aside from two tests of financial contagion, that is either new or forward-looking.

"The United States, United Kingdom, and Ireland face some of the largest potential costs of financial stabilization given the scale of mortgage defaults."

Emphasis on the word 'mortgage' is mine, of course, added precisely because the IMF concern has not been, to date, echoed by many Irish economists or banks. In fact, all Irish banks currently assume that mortgage defaults will not happen. Instead, policymakers (via NAMA and debt issuance), bankers (via impairment charges and recapitalization funding) and economists (via RTE / Irish Times opinion pages) have been preoccupied with 'toxic' assets (development loans). Poor households have largely been left out of the 'They deserve help too' circle. The Government actually is so confident that mortgage defaults will not be a problem, that it is taxing households into the recession. As I have noted before, this presents a problem - should inflationary pressures rise, interest rates will regain upward momentum and Ireland will be plunged into a mortgages implosion.

How costly are Lenihan's commitments?
Moving on, two illustrations from the IMF report are worth putting together: First, the sheer size of the so-called 'costless' (Brian Lenihan's grasp of economics), guarantees written by Ireland Inc on our banks:Second, the real-world cost of these guarantees...I've identified this link between the throwaway promises Irish Government has been issuing since September and the cost of our debt before. It is nice to see IMF finally saying the same: "Figure 1.37 highlights that the spread on the issues guaranteed by sovereigns perceived as less capable of backing their guarantee is wider than for those that are deemed well able to stand behind their promises, such as the United States and France."
But here is another proof of the link between Brian Lenihan's guarantees and the cost of these to you and me:
Note the coincident timing: September 2008, and spreads on Government debt shooting through the roof to reach banks bonds spreads and trending from there on side-by-side to Anglo's Nationalization (another spike), then to recapitalization (a slight decline)...

Go long, not short...
The IMF advises the Governments to switch debt issuance to longer term maturities. Exactly the opposite is the strategy adopted by the Irish Government that has launched increasing quantities of new 3-9mo bonds into the markets. "...Authorities should take the opportunity of the currently low level of real long-term yields to lengthen the maturity of issuance where possible to reduce their refinancing risk," says the IMF, implying in simple terms that you shouldn't really pile on short term debt at the time of a prolonged crisis.

For all its faults, even the IMF knows that you can't run the country on the back of credit card debt. But Brian, Brian & Mary wouldn't have a clue, would they? All their experience relates to managing a cash cow for the public sector unions that is our public purse.

Shock scenarios
More interesting stuff is in the IMF's modeling of financial shocks: Scenario 1 (pure credit shock with no fire sale of assets - more like a situation in the US in recent months) v Scenario 2(credit shock with fire sale of assets - a more relevant case scenario for the likes of AIB). Here are the results of the latter test:
In scenario 2, Australia shows 7 double-digit responses to shocks to other countries' financial systems, Austria, Italy, Portugal, Sweden & UK 6; Canada, Japan, Spain & US 5; France 8; Belgium, Germany & Ireland 9; The Netherlands 12; Switzerland 13. This hardly supports an assertion that we are driven by external markets crises in our own financial sector to any exceptional degree. Yes, we are less exposed than Switzerland and the Netherlands, but we are way more exposed than the many other countries.

The table below (it is the same table that was reported by me in December 2008) shows that we have the second highest (after Luxembourg) ratio of Bonds, Equities and Banks Assets to GDP in the world - a whooping 900%!

Furthermore, Table 23 provides some amazing evidence: Banks Capital to Assets in Ireland stood at only 4.1% in 2008, down from the high of 5.2% in 2003. Only Belgium and The Netherlands have managed to get lower ratio in 2008. Irish Central Bank actually provided these figures to the IMF and yet the CB has managed to do precious nothing to correct the steadily deteriorating capital ratios throughout 2003-2008 period. This, presumably is why we pay our CB Governor a higher salary than the one awarded to his boss, the ECB Chief.

So the 'comedy' part now being played in Dublin has a simple scenario that IMF, with its diplomatic mission, will not reveal to us, but that is visible to a naked eye though the prism of the IMF report:

1. Incompetent state regulators (CBFSAI and more) get golden parachutes for damaging the financial services sector and the economy;
2. Incompetent and greedy politicos are shielding their unions', banks' and developers' cronies from risk and pain caused by (1);
3. The ordinary people and businesses of Ireland are paying for (1) and (2).

And the markets still show willingness to powder this charade with 110% bids cover on Irish Government bonds? For how long?

NTMA - a problem foretold

For months now I have been saying that soon, very soon, there will come a moment when the markets are not going to take any more of the Irish Government IOUs. At least not at the yields consistent with AAA, AA+, AA or even AA- ratings. The Government, its eager-to-please economic advisers and its boffins in the CBFSAI and DofF were not listening and continued to pile on debt commitments as if they were running a San Fran Fed, not an economy with 4.5mln people in it.

Today's NTMA results show that I was (and am) on the right track. I can't stress the fact that, in my view, NTMA are doing a good job in the current conditions, so whatever is to yet to come - it will be the fault of their masters in DofF and the Government.

In a quick summary, NTMA issued €1bn worth of bonds today in 5 and 9-year paper, with the markets willing to bid only €1.24bn on the offer - a 124% coverage overall. This compares with x3 times cover (300%+) for the previous auction. And, this time around, there was plenty of cash in the sovereign debt markets (not the case with the previous auction) with estimated €19bn worth of funds available for 'fishing'.

So what's at play? The 'bait' was off and the fish were too smart to line up for the Irish cast.

Last point first: Ireland to date has raised €12bn in its annual borrowing requirement (per DofF rosy estimate) of €25bn. This is just the stuff to finance the current deficit with. Again, per my projections we would need another €2-4bn in additional borrowings this year. How this can be achieved is unclear, as markets are getting thinner by the day and at €1bn per month, we are not getting there at any rate. But investors are bound to start getting even less welcoming when they realise that with NAMA, Ireland will have to open the flood gates for bonds issues - even at a hefty 40% discount, €90bn-strong NAMA will require €54bn in bond financing. That is the amount needed before we consider re-issuance of maturing paper...

Now to the wrong bait issue - the pricing of the bonds was very ambitious in my view - at 4% for €300mln worth 5-year paper (cover of 160%) and at 4.5% for a 9-year issue (cover at 110%). In March 24 auction, cover ratios achieved were 380% and 270%.

The next to watch is Thursday auction of short-term paper: 1-mo (€400-500mln), 3-mo (€500-600mln) and 6-mo (€400-500mln) T-Bills. If successful in finding a solid market, these might push Irish Government to switch into more aggressive financing through short-term debt - effectively creating a credit card system of financing for Irish deficits.

But even if the Government keeps short-term paper issuance at the going rate, it does appear to me that a part of the Government strategy is to use short-term bonds to finance spending in a hope that either:
(A) the economy improves dramatically (good luck to you chaps), or
(B) Brian Lenihan will raid the taxpayers in an even more massive robbery, comes Budget, or
(C) The ECB will take the balance off Brian's hands (in effect, we are borrowing recklessly short-term in a hope that a rich uncle rides into town with a wallet full of cash).
Otherwise, issuing 1-9mo debt when your problem is a structural deficit of ca €15bn (roughly 45% of your revenue) per annum is as close to playing a Russian Roulette as one can come.

But either way - (A) implies we can't deal with our mess ourselves (an embarrassing line of policy to take), (B) implies that the Government has no moral right to rule, while (C) implies that the Government is willing to go hat-in-hand to the world only to avoid threatening the Trade Unions. Take your pick.

Daily Economics 21/04/09: AIB and getting reality right

AIB is getting reality, courtesy of the Government...

You'd think it was a joke (here), but the Government that can't balance its own books and that prices risk as my two-and-a-half year old prices candies is now pushing an unwilling, reluctant, downright denial-bound AIB into re-considering its capital adequacy. What a fitting beginning of an end to the sorry saga of Irish banking.

CBFSAI or rather the more competent PWC hired to assist them, carried out a stress testing exercise on AIB and then the bank 'concluded' that €1.5bn more capital will be needed to keep the bank capitalized. And not just any capital - Tier 1 stuff, the caviar of the capital world.

The key word here is 'concluded' for it shows that, most likely, some back and forth bargaining between the bank and the Minister for Finance have taken place before arriving at the final figure. Which, of course, leaves me wonder - was the original stress test capital shortfall even bigger than that? We won't know unless PWC report is leaked.

AIB had core equity of €7.7bn (5.8%) and core Tier 1 of €9.9bn (7.4%) in January 2009 before getting €3.5bn in your and my money. Then, government preference shares hiked capital T1 to €13.4bn (10%) while equity remained intact at 5.8%.

Another transfer of wealth from us... to them
To plug the existent hole, AIB is hoping to sell its stakes in the US-based M&T and BZWBK (Poland). The book-value of these assets is questionable, with estimates of €2.2bn being on the higher end (Credit Suisse estimate) with €1.9bn estimated by AIB. But it is largely irrelevant, as sale of M&T will require a goodwill write-back yielding about €480mln in net T1 addition. Sale of BZWBK will require an RWA reduction, implying a net gain of €320mln. From €2.2bn of assets sold, AIB will get 75bps on Tier 1 - €800mln. Should the sale reduce the value of both assets by a modest 20%, you get €640mln boost to tier 1 (+60bps). In other words, someone (you and me) will have to cough up the remaining €700-860bn-odd cash injection for the bank.

There are reports of other accounting acrobatics - e.g repurchasing of various termed debts (tier 2) into perpetual paper (tier 1), but at the very least, the Government will end up putting enough cash into AIB coffers to own 30-50% of the bank outright. Another transfer of wealth will be in the works. From you and me to... ultimately - the public sector. Why? Because even if the Exchequer gets 10cents on a Euro, the Government will never rebate the money back to us. The Government will waste this cash on paying off the unionized public sector workers for 'industrial peace' achieved.

In the long run, the sale of both or either of the assets is going to be also a problem for the bank shareholders. Why? Because apart from having exposure to the US market (first to recover and to benefit from stronger trend growth in years ahead) and Poland (likely to show much stronger rebound than Ireland in years to come), AIB has no strategy as to how it will be making money into the future.

So to summarize: the recapitalization-Redux will be a raw deal for the taxpayers and shareholders, a sweetheart deal for the bank management and a modest payoff to the public sector unions and employees in the longer term.

Exposing NAMA scam
And it is back to NAMA. Recall the €80-90bn in loans that Lenihan is keen on shifting off the banks and into our taxpayer-financed vehicle? Remember the haircut to the loans value that the Davy etc were calling for? 15% that is, or a hit on the taxpayer of €68-76.5bn. Well, this is now getting bigger. If AIB needs €1.5bn in capital, before NAMAzation of its book, the two main banks will be going into NAMA with €22.4bn estimated core equity base and will inevitably lead to the Government as the majority shareholder in both banks even under a minor discount.

Now, consider the signals indicating the state of the loan books that the AIB stress-test conclusions suggest.

We do not have an exact split on LTVs for loans held by the banks. Bank of Ireland in November 2008 was reporting low-50% range for probably the most toxic of all loans - development land, but high-70% range for its overall property investment book. AIB reported in summer 2008 residential development book at 77% LTV (65% allocated to undeveloped land), total development book was evaluated at LTV in excess 70%.

So it is safe to assume that LTV on entire 2-banks loans book is averaging around 72-75%, while for development land - at ca 50%. The total development book to be bought up by NAMA will likely reflect a similar split to 35-65% in AIB, which out of €90bn can be ca €60bn (Davy, for example, have a similar number under their assumption). Since last reports, LTVs have gone up, as values dropped faster than loans write-downs reduced the 'L' part of the ratio, so these assumptions are relatively conservative.

For land, 55% LTV is likely to rise even further, as land markets all but ceased to function. How dangerous is this stuff?

Well, take BofI: land loans of €5.4bn, non-land development loans of €7.9bn. If LTV was 55% in November for land, the bank holds loans on the land with initial value of €5.4bn/0.55=€9.82bn. By many accounts, land is now largely valued at agricultural prices, plus a mark-up of say 50% for better locations. This would imply a 'Value' part fall-off of ca 70% for land. Let's be generous and allow for a 65% fall-off, reducing the BofI's land bank valuation to €9.82bn*0.35=€3.44bn. Under this scenario, assuming BofI takes an impressively honest impairment charge on land of 10%, the LTV has risen from 55% to €5.4*0.9/€3.44bn=141%. BofI will have to cover €1.96bn in lost value before NAMA discounts.

AIB's land bank valuation is €7bn*0.35/0.55=€4.45bn on currently-held €7bn in loans, with effective current LTV up from 55% to €7bn*0.9/€4.45bn=142%. AIB will have to cover €2.55bn in lost value before NAMA discounts. Assuming that this loss is taken at 40% knock-back on RWA, with 10% Tier 1 provision against RWA, we have a capital base hit of an odd €425mln due to land banks out of €1.5bn stress-test implied capital requirement.

But wait, this was just land.

Outside land, there is some roughly €48bn in other development stuff to be picked up by NAMA, with current LTVs at over 70% and values falling by over 40% by the time this recession will be over, implying book value adjusted for risk of €25.6bn - a shortfall of €22bn, approximately, which with 30% RWA impact and Tier 1 ratio of 10% assumptions will require €2.8bn in fresh capitalization.

So combined land and ordinary development stuff on the AIB book is roughly adding up to 1/2 of €2.8bn (non-land), plus ca €425mln (land) = €1.8bn in capital... Pretty close to the €1.5bn figure we got from the PWC's stress-testing after AIB 'agreed' with Mr Lenihan...

And the conclusions are:
Now get into the entire development books that NAMA is aiming to buy: at, say, 70% LTV, the €60bn in loans that NAMA will buy originally underwrote €86bn in 'value'. This will be down ca 45-50% by the end of the crisis (a relatively conservative assumption on housing and commercial development values declines), and assuming write-downs on loans at 5%, we have an implied bottom-of-crisis LTV ratios of €60*0.95/(€86*0.55)=121%.

Applying 15% cut on these loans, as Davy suggests, the taxpayers will be paying €51bn on risk-adjusted assets valued at €47bn, financing the purchase at, optimistically, 5.1-5.5% pa. That is equivalent to taking 121% mortgage on a house that has a closing cost of ca 8.5% upfront and is financed at an interest rate that is more than 2.5 times the rate of my current ordinary mortgage. This Government will turn us all into subprime borrowers.

So now we suspect two things:

1. Just on land alone, the pre-NAMA liability for two banks is ca €4.5bn - this the cash they will need to find before we level the NAMAzing discount of 15% (Davy), 25% (Merrrion) and so on.
2. The latest PWC/CBFSAI stress-test was most likely not stressful enough, as it barely covers the expected land & development loans-related capital losses alone.

And we know one thing: NAMA simply cannot work for the taxpayers!

Daily Economics 20/04/09 - US debt problem

For those impatient - there is an estimate of Ireland Inc debt at the bottom... that can be compared with the US debt...

What is going on with the US economy? I expected the figures coming out on economic front (and earnings front outside the Federally financed banks) to be bad, but today's numbers are poor by all measures. According to the Fed's Conference Board, the index of leading economic indicators fell 0.3% in March, after a dip of 0.2% in February (revised up). But decomposition is telling:

• Building permits were the largest negative contributor in March, as builder have finally started to cut production in honest - much of this backed by the decreases in new starts, as finance committed to projects in 2008, signed for in 2007, has dried up. This is a welcome sign, as outstanding stock of unsold houses has to be pared back before any real recovery (as opposed to cliff-and-bottom bouncing) takes place.
• Stock prices, and the index of supplier deliveries also registered large negative contributions to the index in March, showing that real activity is continuing to deteriorate at, seasonally significantly faster rate. There is no spring bounce for now, and these are leading indicators, suggesting that any recovery upwards will require some new alchemy from the White House and the Fed.
  
• The real money supply was the largest positive contributor as the Feds printing presses were working overnight amidst deflation. And another sizeable positive push came from the yield spread - a sign that some of the future support might be waning - yield spreads narrowing is underpinned by lower Fed rates (not by healthier financial system, for banks are continuing to drop dead at an accelerating rate - 25 as of today in 2009 alone, and counting). So as the Fed has run out of options (short of setting negative nominal rates - e.g issuing loans with a principal repayment at a discount to the face value of the issued loan) and spreads are likely to start widening into the future as: (a) Uncle Sam's borrowing will remain buyoant, (b) debt refinancing will run rampant, and (c) Fed's helicopter drops of money thin out.
  

"There have been some intermittent signs of improvement in the economy in April," per Ken Goldstein, economist at the Conference Board. Overall, six of the 10 indicators were negative contributors, three were positive, and one was steady. Say what, Ken? Picture below is a telling one:
What Ken-omist from the Fed is referring to is the renewed momentum in the deterioration of the Leading Econ Indicators index that started in December (after a short 1-month flat) and has been going steady through March. The index has failed to bounce up in consecutive 9 months. Current Economic Conditions index is now converging downward to LEI, suggesting that unless things improve significantly in the next couple of months, simple psychology of the markets will lead to a renewed push down on LEI (the vicious cycle of self-fulfilling prophecies might commence).

Overall, in the six months to April 1, the index fell 2.5%, it declined 1.4% in the previous six months before that.

So about the only thing positive I can report has nothing to do with the Fed's own indicators, but with the decline in the new unemployment claims reported last week. If the decline persists for the next 6 weeks or so, then using comparisons with the last 6 recessions, we are at the point of inflection in economic recovery sometime now. But it is a big if, since the series can be reasonably volatile and their deviations from the monthly moving average can be significant (see here).

And here is a good chart on inflation expectations for the US (from the Fed: here) - care to argue this? or shall we start taking pressure on commodities-linked stuff in preparation for the new 2% inflation bout?


Paul Krugman on Ireland today: a good one from Krugman here. But an even better one from a comment to his article by PMD: "...Krugman and most of our own home-grown economists appear to regard cuts in public spending as being the same as tax increases. They have a model in their head with credit and debit on two sides and they are studiously agnostic about how the government should go about balancing the books. Those of us who work in the real economy know that increasing taxes on the productive part the economy - and that's 'productive' as in 'productivity' as in the only way to generate real wealth as in the only way to escape recession / depression - will dampen its productivity and, therefore, harm its capacity to generate wealth in the future - i.e. escape recession. All this 'sharing the pain' talk is just code for: we'll confiscate private sector wealth in order to avoid reform in the public sector. You can imagine a rich Titanic passenger on a half empty lifeboat blowing his nail and calling out to a dying pleb in the sea 'Chilly for this time of year. Isn't it?' I profoundly disagree with the reversion to the cargo cult school of economic management: let rich foreigners turn up and employ us. What on earth do we pay these mandarins for if the best they can come up with is 'something will turn up'? There are core domestic issues of productivity that are not being addressed." I couldn't have put it any better than this myself!

Lorenzo 'the Not-so-Magnificent' Smaghi... (or should it be Maghi?) is ECB's latest loose cannon... In an interview with FT Deutschland, Lorenzo Bini Smaghi of the ECB predicted that the Euro-zone recovery will follow the mirror image of a J-curve – a shallow recovery after the fall. Ok, I agree with this. In fact, I have warned for some months now that any recovery in the Euro-zone and Ireland in particular will be shallow and slow and will leave the continent at the trend growth rate of below 0.75% GDP, with Ireland at below 1% GDP pa. ECB's latest would-be-forecaster also 'predicted' a persistent and significant fall in potential growth rates going forward. Another thing Smaghi went into is inflation expectations: "'Inflation expectations are moving upwards (in euro area, U.S. and U.K.); no expectations of deflation," said the text of his presentation. Again, another theme I've been hammering about for some time now.

But... (S)maghi appeared to suggest that non-conventional monetary policy action would be likely soon, without giving any details. What this might be? Negative nominal interest rates? Unlikely. A policy of accepting all and any bonds issued by the member states? Brian Lenihan can wish... It is all but inevitable that the ECB will have to rescue Ireland and some of the other APIIGS. Such a rescue will have to be unconventional and not only because there is no existent convention within the Euro framework for doing so, but because as Smaghi stated in his presentation, households across Europe have lost faith in sustainability of public finances and have started to hoard cash. Nowhere more apparent than in Ireland. After surviving through a decade of anaemic (embarrassingly low, by some standards) economic growth, this is the second greatest threat point for the Euro.

A pat on the back: A stoodgy, but occasionally interesting quasi-official Euro economics website/blog: EuroIntelligence.com has the following 'news' item today. A long recession, a shallow recovery: The IMF has prereleased chapters 3 and 4 of its WEO. This is from the introduction of chapter 3 “…recessions associated with financial crises tend to be unusually severe and their recoveries typically slow. Similarly, globally synchronized recessions are often long and deep, and recoveries from these recessions are generally weak. Countercyclical monetary policy can help shorten recessions, but its effectiveness is limited in financial crises. By contrast, expansionary fiscal policy seems particularly effective in shortening recessions associated with financial crises and boosting recoveries. However, its effectiveness is a decreasing function of the level of public debt. These findings suggest the current recession is likely to be unusually long and severe and the recovery sluggish.”

Imagine this! See here for March 3 post that uses the exact precursor to Chapter 3 release... Oh dear, sometimes it is worth checking if a 'new' release is actually 'news'...

ESB's disgraceful entry into 'stimulus' economics has moved on to the next stage. As I noted in two earlier notes, the ESB plan for 'jobs creation' is an affront to the idea of competition and consumer interests (here), as well as an insensitive move at the time of economic hardship for many (here). Now, as today's IT reports (here) we are also looking at more Georgian Dublin demolitions... Is this predatory and arrogant monopoly ever going to brought under normal market controls? And is Irish Times ever going to become a paper where journalism stops being platitudinous to state monopolies and all-and-any 'Green' / 'sustainable' labels and starts seeing the likes of ESB for what they really are? And per wages and earnings in ESB... well, indeed in the entire public sector, see this excellent blog post from Ronan Lyons here. A must read.


A late Sunday thought - with Obamamama economics, how much debt is the US economy carrying?

Well, there are many sources of debt:

• National debt = currently at $11.2 trillion (per US National Debt Clock calculator here);
• Federal bailout commitments = so far set at $12.8 trillion (up from $4 trillion left by the previous Administration, per March 30 report by Bloomberg here);
• Federal entitlements commitments under Medicare and Social Security obligations = $52 trillion in current debt from the Federal Government to the system or $117 trillion in the present value of unfunded obligations (per National Center for Policy Analysis, as of December 2009, here);
• Private sector corporate and financial liabilities = $17 trillion (per US Federal Reserve numbers of December 2008, here)
• Private households liabilities $13.8 trillion (ditto), mortgages $10.5 trillion (here and a breakdown here) = $24.8 trillion.
  

Total = $117.8 - 172.8 trillion or 829.6-1,217% of 2008 GDP!
Financed at the current 30-year US Treasury rate of 3.79%, the interest payment on this debt alone will be $4,465-6,549 bln per annum - up to 46.1% of the country annual GDP.

We are not considering the pesky issue of the derivative instruments issued within the US system. These are notional debts, but they can come back and bite you as well. Per the Office of the Comptroller of the Currency (here), as of the end of Q4 2008 US held:

• interest rate derivatives to the tune of $164 trillion;
• CDS at $15.9 trillion,
• other stuff: FX, equities, commodities -based derivatives, to the total of $20.5 trillion

So Derivatives grand total of $200.4 trillion.

Which brings US total debt obligations to $318.2-373.2 trillion = upwards of 2,628% of US GDP!

Considering that the US current population is 306,251,267, the total US debt per capita is between $1.31mln and $1.22mln, with a servicing cost of up to $46,185 per annum per person!

And amidst this, Obama is talking traditional Democratic drivel of 'spending the economy out of a recession'? While Paul Krugman is wailing that not enough is being spent?

Can anyone really doubt that inflation is around the corner? If so, consider the above figures and do tell me how can the US get out of this corner without a massive debt write-off via inflation and sustained devaluation? Dollar at 1.75 to the Euro in two years time and interest rates in double digits?

Now on to Ireland Inc's debt:

• National debt = currently at €54.245bn (per NTMA here);
• Government bailout commitments = so far set at €400bn (here) under Banks Guarantee Scheme, €70bn (my estimate in the forthcoming B&F article) under NAMA, €87bn (here); Sub-total = €557bn;
  
• Public entitlements commitments under Pensions, Social Welfare and Health obligations = €75bn (Pensions: here), €66.3bn (€38bn per annum spending on health, wages & social welfare taken over 30 years horizon with deficit of 10% per annum over term) in the present value of unfunded obligations; Sub-total = €141.6bn;
  
• Private sector corporate and financial liabilities = Monetary Financial Institutions: €810bn, inc of IFSC, corporate sectors: €551bn; Direct Investment: €183.6bn (here); Sub-total = €1,544.6bn
  
• Private households liabilities (per my earlier estimates here) = €150bn.
  

Total = €2.45 trillion or 1,440% of 2009 GDP!
Financed at the current 5-year rate over 30 year horizon (roll-over) of 4.5%, the interest payment on this debt alone will be €110.25bn per annum - up to 64.9% of the country annual GDP. Put differently - the debt/liabilities of this economy are currently amounting to ca €555,048 per every person living in Ireland...

Daily Economics 18/04/09: Nationwide fall(bail)out

Nationwide - systemic importance?
In today's Irish Times (here), Mr Cowen makes a ludicrous assertion that Irish Nationwide - or as we can call it - Irish Nationvile. How, Mr Cowen? Care to explain?

Irish Nationvile is not a systemically important organization. It is a mutually-owned closed shop (officially) or Fingleton's fiefdom (unofficially) that has done much good to this economy in the past as a safe-house for dodgy directors loans from the Anglo, a default bank for the most speculative developers, and an exemplary case study for corporate mis-governance. By its size, it is roughly equivalent to 10% of the property loans held by the two laregst banks, or just 6.4% of the property-related loans of our 6-banks system. It has virtually no productive net assets outside property sector so should the society go under, the economy of Ireland will hardly notice if, say, €8-10bn in performing loans were to be bought at a discount by the likes of HSBC or Barclays or Ulster Bank or NIB or whoever steps to the plate. Even BofI and AIB might want to step in and pick up depositors and good lending assets from the ruin.

But letting Nationvile sink - publicly and swiftly - will send two important signals to the international markets and to domestic voters. The first one will be to tell the world that Irish Exchequer is starting to manage its downside risk - throwing Nationwide out of the umbrella of state bailouts will make the case for judging Irish Government banks policies as being informed by economic efficiency rationale, not political expediency that Mr Cowen is so skilled in. The second one will be to tell the voters that there is at least some bound to the recklessness with which the Government is willing to use taxpayers hard earned cash to help its own cronies.

So, in my view, let it sink. Now!


ESB - another systemically important waster?
The Royal Bank of Scotland is toning down its flash headquarters to bring the building down to the early realities of the crisis. Many banks and large companies (including some Irish) are turning away from the posh offices they were planning to move to, but not ESB. The state monopoly that has milked its customers for years (and still does) with the second highest cost of electricity in Europe is planning to 'renovate' its (admittedly ugly) headquarters in Dublin as a package of 'stimulus' economics. To create jobs, so to speak. This amazing fact did not trace across Irish official media (Irish Times and RTE) reporting on the arrogant, in-your-face monopoly's last week's announcement.

Daily Economics 17/04/09: GGP & A dead cat bounce?

An open letter in Irish Times: here
Some of you have questioned my logic (sanity) in calling for nationalization of Irish banks. Here is a simple reason that does not involve economic theory. After the mini-Budget, it became all too apparent that Mr Lenihan and his boss are hell-bent on doing two things:

1. destroying the private economy in this country, and
2. using - without any restraint - our (public) money to prop up their power base (public sector unions, developers and banks).

I have less of a problem with the last two targets - at the very least, they are not subtracting from the real economic activity as our public sector unions do. But, following Ronald Regan's dictum (hat tip to M.E.S), if we have to give them public money, we must take the deeds.

My son, and your children - including those yet to be conceived or adopted, you, me, all of us working in the private sector are going to pay for NAMA. Inevitably! But I would like to get at least an IOU in return. Why? I do not trust this Government (and the opposition) to actually repay me my cash. If NAMA is a success, I would like my tax money back with interest, not for it to stash returns on my cash into another piggy-bank fund for public sector pensions and payoffs. If it is a failure, I would like to own the remaining pieces, not let it rest with Brian Cowen and Brian Lenihan who will be able to liquidate these NAMA assets to, you've guessed it, payoff their public sector cronies.

I would also like the shareholders and bondholders in banks to take a hit - over the years they placidly supported the disastrous decisions being made by their banks boards. Now, if my cash were to be used to undo their reckless complacency, they should be taken out altogether (in the case of shareholders) and be forced to pay up to the recapitalization and clean up levels (in the case of bondholders). The latter can be squeezed via a special one-off bond tax or via a direct cut in their coupon payments.

The only way to achieve this return of money to that taxpayers is via a voucher-style disbursal of the banks assets to the households. And this requires first a nationalization. Done...


GGP - the end of a lengthy saga and the start of a new chapter in defaults
At least one of the followers to this blog will know that back in the summer 2008 I wrote a quick note on GGP, valuing the fund at the time to be worth 'asymptotically zero' on the back of a belief that (a) its debt levels and maturity structure were beyond any repair, (b) its most recent $14bn acquisition, financed exclusively by the debt, was an act of suicide, (c) its management team did not know what they were doing over the last three years of operations, and (d) that the commercial real estate troubles cycle was not over, and that it will indeed come back full circle.

Apart from finally seeing the straw giant of REITs collapse under its own weight, today's bankruptcy filing by GGP tells me that the (d) part is now in full swing. This is timely as it is likely this time around to coincide with the peaking of the Alt-A mortgages refinancing, which, in my view, will drive US housing markets deeper into trouble. The question is what will Obama administration do about the new wave of households defaults, especially since this wave is not about sub-prime lending, but about ordinary American families taking a hit.

What is even more worrisome from my point of view is that the new wave of housing/ commercial property collapse will inevitably stress financials. This is tricky for a fragile economy hanging to the ledge created by the recent 6-weeks rally.

Just imagine for a second what dumping of some 158 GGP-owned shopping malls across the US might do to commercial property values there at the time when the market for commercial transactions is virtually non-existent. An idea that Simon Property Group - the largest US REIT still standing - will pick up some of GGPs properties is hardly a point worth considering. Simon is not exactly in a rude health itself and its tenants are suffering. With 158 new properties being in fire sale under Chapter 11 filing and another 42 GGP-owned properties waiting to be sold off as well, what can happen to retail malls yields other than a steep fall off? Prices will follow.


US Consumer Sentiment improved from 57.3 in March to 61.9 - a level that is still below the Consumer Sentiment reading of 70.3 recorded prior to the collapse of Lehman Brothers. Alkl of the improvement was pretty much already priced into market valuations. The index of consumer expectations rose from 53.5 in march to 58.9 in April perfectly in line with the current sentiment reading.

So good news then? Not really. Look at the sentiment underlying fundamentals:

• Unemployment: in March, Michigan again scored the highest jobless rate of 12.6% and the state is dependent on consumer-driven activity (autos). Next came Oregon, 12.1%; South Carolina, 11.4%; California, 11.2% (all-time record for the state); North Carolina, 10.8% (another all-time record for the state); Rhode Island, 10.5%; Nevada, 10.4%; and Indiana, 10.0%. All of these states are either manufacturing centres or sources of soft business investment products (e.g software) - in other words, many of the states are the leading indicators of an upturn. Nine other states and the District of Columbia recorded unemployment at or above 9.0%. So unemployment is not the cause of a bounce in consumer confidence;
• Equity markets: sustained bear rally is now settling into a gently declining trend, but in general, there have been some gains here. So stock market is one of the potential causes for a bounce in consumer sentiment, but it is a shaky ground for a sustained hope for consumer confidence pick up;
• Housing markets: some stabilization here over time, until yesterday's disastrous figures on new construction. It looks like the builders in the US have finally figured out (with a 12mo plus delay) that they have too much stuff on their hands already. SO housing markets are hardly a sustainable underpinning for consumer confidence;
• Personal income: personal after-tax income is falling and will continue to do so. We know that Federal taxes are rising only at the upper margin, so it is local taxes (and in particular local property taxes) and state taxes that are driving declines in personal disposable income. Either way, this is not a support base for confidence;
• Inflation: or rather deflation - with still positive near-zero interest rates, the US is far from gaining new borrowing cycle momentum, so while deflation is a net positive for consumers, positive interest rates are net negative - these cancel each other and we have no gain on support for confidence boost here.

What this really says is that fundamentally, the current bounce in Consumer Confidence is not justifiable - i.e it is a dead cat bounce. This is why the markets reaction has been relatively mild to now. QED...

Time to dump some bad risk? and ESB's rip-off 'investments'

EXCLUSIVE: Is it time to let Nationwide sink?
Here is an opportunity to show the financial world that we are serious about cleaning up the mess. It is also a good opportunity to show the world that we understand, as a country, that finance is about controlling the downside as much as exploiting the upside - in other words, that risky trades must be closed off. Nationwide is one of the riskiest plays in town - so the Government should let the stronger ones - including international banks - bid for the pieces. In other words, the Government should not mix Nationwide in with the systemic banks for nationalization or future re-capitalisations, or indeed NAMA cover.

Here are tomorrow's results from the Nationwide:

1. Loss after tax €243mln on a loan impairment charge of €464m (2007 pre-tax profit of €309mln), Operating profits €260mln
2. Total Capital at 10.2%, Core Tier 1 at 7.2% (not spectacular, but on par with other Irish banks - hardly impressive for internationals)
3. Total assets at €14.43bn - down 10% (unrealistic assessment, given equity and property markets conditions and shut down of land markets - details below)
4. Loan Book at €10.474bn - down 15% (so lending stalled, the patient is dead)
5. Customer accounts €6.785bn, so accounts cover 65% of loans - up from 59% cover in 2007 (but at what cost did Nationwide achieve this gain in cover?)
6. Cost-income ratio at 17% - the lowest among Irish financial institutions (i.e they have no soft-savings left to achieve as a cushion against future losses)
7. Liquid assets stand at €3.26bn - liquidity ratio of 24% - again, good luck to them if they think they can actually sell the stuff they hold against the loans...
8. Society reserves are at €1.2bn

"The Society did a very detailed examination of the loan book with the result that the sum allocated for provisions was a very robust figure of €464m for the year under review in line with market expectations... The Society’s loan book decreased in 2008 to €10,474m from €12,332 at the end of 2007. €1,339 of the reduction was attributable to the decline in the value of sterling; the balance was a reduction in capital balances. The commercial loan book now stands at €8,183m with the residential book at €2,291ml. As a result the total assets of the Society were reduced from €16,099m in 2007 to €14,429m in 2008."

So the impairment charge is of 3.22% of the total asset base and 4.43% of the property book. This is laughable. Also, Nationwide claims that as a part of its strategy it was actively reducing its exposure to commercial loans. But this active reduction took out at most only €331mln (16,099-14,429-1,339) in real assets, or ca 4%. This is in the time when property values fell over 20% and equity values are down more than 80%?

"Because of the reserves built up over the years from cumulative profits the Society was able to absorb the impairment provision. The Society still has total reserves of €1.2 Billion to absorb further impairment charges should they arise."

Well, now, suppose real impairment rises to 15% of the property-related loan book on commercial and 5% on residential. You have a need for €1.34bn in cash right there but you have only €1.2bn... and that is in the form of Tier 1 capital...

So are Nationwide's numbers (especially in the area of impairment) a case of exemplary management? Or of reckless 'ostrich' syndrome? You decide, but it does look to me like something is amiss. Here's what.

In 2008, Nationwide repaid some €750mln plus £500mln in debt securities, and in December 2008 it raised £325mln in new term notes maturing September 2010 (note the date?). But the beast still has €2.23bn in debt maturing in 2009 alone and "the Society plans to finance [this] through reduction of its loan book, the securitization of loans as well as the issue of new loans."

Yes, you did hear this right - securitization of loans (presumably Irish buy-to-let properties in the UK and Irish developers toxic waste in Ireland have strong market with ready buyers?). Of course they have no such hope, so in reality the Society is most likely looking for refinancing.

And here comes the confession: "the ability of the Society to raise wholesale funding on a continuing basis depends on the Government Guarantee. The Government intends in line with its previous indication to put a State guarantee in place for the future issuance of debt securities with a maturity of up to five years... The society's ability to remain a going concern and achieve its Business Plan is dependant on the continuation of Government support. As a systematically important institution Irish Nationwide was included in the guarantee Scheme. The Irish Government is committed to ensuring the continued viability and stability of systemically important credit institutions."

So here is Nationwide's survival strategy in a nutshell: "Give us more tax money! Now!"

In the end, Nationvile has €2.23bn of debt maturing this year alone and needs the extension of the Government guarantee to keep itself going. It also has an acute case of denial when it comes to potential losses it faces on its asset base and its loans, so it will need even more tax money to survive. This looks like they've gone to the markets to raise refinancing, but the markets laughed at them, they've gone to the auditors for a life-line on their NAV and they got that extension, so now its up to rich Uncle Taxpayer to rescue a systemically important private estate. Hmmm...


ESB's 'stimulus'
For shortage of time - more analysis of this is to follow, but in the nutshell, ESB announced new plans to 'create' 3,700 jobs through 2013... The Government & Opposition have welcomed the move that will see a notorious state monopoly

• using consumers' and businesses' cash (remember - it cannot pass cost reductions to its clients because it's out of town subsidiary - CER - doesn't let it)
  
• hire more grossly overpaid (remember, ESB runs a unionized closed shop with highest salaries in the entire public sector and work pracices that allow its employees draw full pay even when are asigned for years to plants producing absolutely nothing)
• to expand its dominance in the market that is so starved of competition, that much of our economy's competitiveness loss can be attributed to the ESB's existence.
  

This is a farce that passes in this country for industrial, fiscal and economic policies. Instead of breaking up a noxious monopoly, the state will allow ESB to piggy-bank the revenue it gains from ripping off its customers into 'developing new infrastructure such as smart metering and a system to allow for the recharging of electric cars'.

You might also notice that the two investment objectives are a red herring. Smart metering is already widely available and does not require any 'infrastructure' - you can install smart meter at your own home. Electric cars are about as widely spread in Ireland (or indeed anywhere else in the world) as dinosaurs. By 2013, this is unlikely to change.

Lastly, the Government has been calling for increasing ESB's and other state monopolies contributions to the Exchequer to compensate for some of the revenue losses incurred in this crisis. Now, the same Government is welcoming ESB chipping into this contribution. Who will make for the shortfall? Well, the same people who will be paying for those 3,700 new jobs to be 'created' by the ESB - you, me and the rest of taxpayers. ESB claims it can raise funding for the investment in private markets. Maybe so, but it can't raise funding for interest charges on the loans and it can't raise funding for paying lavish salaries to its new employees. At over €80,000 per average ESB job, this 'green investment' will cost the consumers some €300mln per annum in wage costs alone. Now that's what I call 'smart' metering.

WSJ today (here) has an excellent parallel story to the ESB circus.

Hush-Hush & Sweep it under the Rug: EU's latest 'transparency' move

Last week EUObserver reported an interesting story (here) about the EU Commission efforts to keep transparency at bay.

Per EUObserver report: "New rules on public access to EU documents have prompted one of the European Commission's key departments to circulate a memo warning officials to be careful about what they write in emails and advising them on how to narrowly interpret requests for information. The 15-page handbook was circulated in January to officials working in the commission directorate for trade, one of the EU's most important policy areas affecting millions of people both within and beyond the bloc.

"Each official must be aware that all his/her documents, including meeting reports and e-mails can potentially be disclosed. You should keep this in mind when writing such documents. This is particularly the case for meeting reports and emails with third parties (e.g. industry)," reads the memo.

It asks officials... to avoid making references to informal contacts, such as meals or drinks, with lobbyists. "Don't refer to the great lunch you have had with an industry representative privately or add a PS asking if he/she would like to meet for a drink." [Hold it, folks - wouldn't such a PS qualify as a solicitation of a payoff in the first place?] The document also tips off officials on how to narrow down the interpretation of a request for information. It points to a past example where a request referred to DG trade meetings with individual companies, meaning the department could avoid making public its contacts with business lobbyists."

Well, there is more the EUObserver report worth reading, but what is absolutely clear is that the EU Commission has absolutely no interest in following the spirit of the disclosure rules, preferring instead to bend the rule-book in order to conceal the extent, nature and effectiveness of lobbyists, as well as to cover up its own governance practices.

Of course, one solution to this problem is to make all information concerning EU public - including the so-called commercially-sensitive one. Taxpayers must be allowed to know who was bidding on which projects, how these bids were evaluated and judged and how the bidding companies spent their lobbying money. This will include a transparent and complete list of lobbying organizations, bureaucrats diaries and other information that can assist us, the taxpayers, in determining who dined with whom, when, why and at whose expense.

In fact, they should also be required to post the actual bills paid - in my humble opinion, if MEPs claim expenses on things like meals and entertainment, I would like to know how many lobsters were eaten in Brussels on the back of my taxes... wouldn't you?

And let's apply the same principles to our local politicians and officials...

A quintessence of Lenihan's economics

Hat tip to Linda - here is a descriptor of the logic of 'shared pain' policies that ask us all - ordinary me and you, a lavishly paid Secretary General of Department of Somethingness, a patrician head of some Quango in charge of Everythingness etc - to make sacrifices in the name of the country - to go that extra step beyond our already up-to-my-ears-in-work existence...

So what makes 100%? What does it mean to give MORE than 100%?
If: A B C D E F G H I J K L M N O P Q R S T U V W X Y Z
is represented as:1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26.

Then:
H-A -R -D-W-O -R -K 8+1+18+4+23+15+18+11 = 98%
and
K -N -O -W-L -E-D-G-E 11+14+15+23+12+5+4+7+5 = 96%
and
A-T -T -I -T -U -D-E 1+20+20+9+20+21+4+5 = 100%

But
B -U -L -L -S -H-I -T 2+21+12+12+19+8+9+20 = 103%
and
A-S -S -K -I -S-S -I -N-G 1+19+19+11+9+19+19+9+14+7 = 118%

So, one can conclude with mathematical certainty, that
While Hard Work and Knowledge will get you close, and Attitude will get you there, its the Bullshit and Ass Kissing that will put you over the top - all the way to Brian Lenihan's national sacrifice economics...

Ireland, ECB & Recent Commentary

Reading Ambrose Evans-Pritchard (Sunday Telegraph, 12/04/09) strikes me as an interesting case-study of stranger than life UK views of ECB - a mixture of truth, more truth and, all of sudden, bizarre ranting...

Judge for yourselves: “If Ireland still controlled the levers of economic policy, it would have slashed interest rates to near zero to prevent a property collapse from destroying the banking system. The Irish Central Bank would be a founder member of the "money printing" club, leading the way towards quantitative easing a l'outrance.”

I am far from being convinced by these arguments. Given that the ECB rates are at historic lows, an independent Irish Central Bank would only have room to move on further, say, 75bps-100bps down maximum. So what would have happened in this case?

Evans-Pritchard claims that “Irish bond yields would not be soaring into the stratosphere. The central bank would be crushing the yields with a sledge-hammer, just as the Fed and the Bank of England are crushing yields on US Treasuries and gilts.”

A maximum 100bps cut in rates would imply that Irish yields on 3-year paper would fall by ca50bps from their current levels. This assumes that the markets will take the same credibility to Irish Government commitments on fiscal policy stabilization as under the ECB oversight. This is highly unlikely. Instead, I would expect Irish yields to rise to 7-8.5% range on 5-year paper – consistent with the market pricing in double-digit deficits through 2012. Has Mr Evans-Pritchard ever seen John Hurley? or the dynamic trio of our Politbureauesque Leaders? Can anyone have confidence in their governance abilities? Being bootstrapped in the long run by the ECB does have a positive impact on our credibility and not having our currency managed by the corporatist consensus Government that we have at the very least insulates us from the monetary policies of disaster.

“Dublin would be smiling quietly as the Irish exchange rate fell a third to reflect the reality of trade ties to Sterling and the dollar zone,” says Evans-Pritchard.

Ok, but how is such a devaluation consistent with yields falling for Irish bonds? Unless these bonds were issued in Euro, devaluation would have acted to increase yields as FX risk increases would have driven bond prices down. In fact, I would suspect that the fall in our currency woud be deepr than that - say 60% (30% to restore references to the UK/US and 30% to reference the unttrustworthy Government). Such a fall would wake up even Mr Hurley - pushing him to raise interest rates to stave off a run on the Punt. The yo-yo of Irish monetary-fiscal-monetary-fiscal... debacles will commence.

“Above all, Ireland would not be the lone member of the OECD club to compound its disaster by slashing child benefit and youth unemployment along with everything else in last week's "budget from Hell".” Clearly, Mr Evans-Pritchard has failed to read the Budget. Our Government did precisely the opposite of what he claims – retained excessively lavish welfare benefits and current expenditure, taxing its way through the entire fabric of the middle class earnings and wealth creation incentives. Even child benefits and youth unemployment benefits cuts that Mr Evans-Pritchard claims to be welfare cuts are predominantly transfers to the middle and lower-middle classes. Majority of our poor are on permanent (not unemployment insurance) welfare and are collecting different types of child benefits.

“But what caught my ear was his throw-away comment that prices would fall 4pc, which is to admit that Ireland is spiralling into the most extreme deflation in any country since the early 1930s. Or put another way, "real" interest rates are rocketing. This is torture for a debtors' economy. You can survive deflation; you can survive debt; but Irving Fisher taught us in his 1933 treatise "Debt Deflation causes of Great Depressions" that the two together will eat you alive.”

I agree with Evans-Pritchard on this: real interest rates and the combination of debt and deflation will be drivers of misery for years to come. What is even more egregious is that our debt is actually growing, not shrinking and that this process will accelerate as Brian Lenihan pillages through our pockets.

“Mr Lenihan hopes to shield banks from the calamitous consequences by creating a buffer agency. It will soak up €80bn to €90bn in toxic debt - or 50pc of GDP. He borrowed the plan from Sweden's bank rescues in the early 1990s, but overlooks the key point - it was not the bail-out that saved Sweden's financial system, the country recovered only by ditching its exchange peg and regaining its freedom of action.”

Evans-Pritchard forgets couple other things that also helped to save Sweden – a rapid growth in the US and subsequently global economies during the 1994-1998 period that helped Sweden’s exports and capital inflows, and a robust programme of reforms that saw large scale privatizations and markets openings in many sectors of previously state-controlled economy.

Nationalize or else?..

I just received a good comment to an earlier post (here) that warrants a separate attention.

"Regarding NAMA, it seems to me that the one big advantage to this scheme is that it means someone will lend us enough money to cover the bank's bad debts, via the sleight of hand of issuing government bonds to the banks and then them redeeming this in hard cash from the ECB. I strongly suspect the Irish government would be hard pressed to borrow this kind of money from anywhere else.

What I don't understand is why we don't first just nationalize the banks. The question of proper pricing then becomes less of an issue. We'd be just moving money between different arms of the state.

One thing I've wondered about: can this device for swapping government bonds for euros only be done by a commercial entity? If we first nationalized the banks would such a move then be precluded? If so, maybe the government do secretly intend to largely nationalize them at a later stage after the cash has already been received from the ECB. I do hope there's some technical reason like this for not first nationalizing the banks, that the reasons are not purely political, because I've no confidence that the taxpayers will end up paying a fair price for these assets. Finbar."

There are several arguments in favour of nationalizing first, then deleveraging bad assets, recapitalizing and re-floating the banks. And there are several arguments against such an approach. I will first deal with arguments in favor of nationalization...

Pro-nationalization arguments:

1. Clarity of valuations: banks are not going to willingly reveal all pertinent information concerning loans quality to NAMA, so nationalizing them and then opening their books will provide much needed clarity concerning fundamentals relevant to valuations and pricing;
2. One-shot recapitalization: whatever price NAMA sets for impaired and stressed assets, such a price will either be too low to allow the banks to continue operating without further recapitalization injections, or too high to allow the Exchequer to recoup significant share of losses. Nationalizing the banks will resolve the problem, as capital requirements can be dropped significantly under a public guarantee on publicly-owned banks. The upside here is significant (see below);
   
3. Ownership-liability symmetry: under nationalization, ownership of banks assets will be fully coincident with the holder of liabilities - the State. This prevents a situation where taxpayers money is being used to underwrite private shareholders and bondsholders objectives;
4. Bond holders can get a haircut: under nationalization scheme, the Government can impose a stamp duty on bondholders in Irish banks, allowing for a partial recovery of funding and imposing a haircut on banks bondholders (currently covered by a blanket taxpayers'-financed guarantee);
5. Maximizing recovery for the taxpayers: if the objective of NAMA is to deliver value to the taxpayers, while deleveraging the banks balance sheets, nationalization, with a clear pre-commitment by the state to disburse banks equity via a voucher-based privatization within say 3-5 years will deliver both (see below for an outline of the scheme);
   
6. Avoiding discriminatory treatment of individual loans: Under NAMA arrangement, some developers / business owners that have performing loans against them might not want to face an arbitrary transfer of their loans to NAMA. This might be a litigious issue that can be fully resolved by an outright nationalization of the banks;
7. Change of the guard: Under nationalization, the Government will have a full right to change the executive structure of the banks and their boards to bring in new blood to run these institutions, breaking away with legacy issues in management.

Voucher scheme
To pre-commit to such a scheme, the Government can issue 3 or 5 year options on shares of the banks. For example, a part of existent equity in AIB can be converted into options at a price on the day of nationalization. Suppose, for the sake of illustration, that nationalization takes place on May 4, 2009.

Suppose that the Government commits to voucher-privatizzing 50% of the value of shares, retaining 50% shares in own account. April 30 closing price for AIB is €X. The European-style call options are issued on May 4, 2009 at an exercise price of €X with maturity date of, say, May 4, 2012.

The Government re-floats a part of its share holding in AIB on May 4, 2012 (Swedish Government retained ca25% of the banks shares on own account after re-privatization, so Irish Exchequer might want to do something similar). This sets the expiration price on AIB shares at S. If S>X, households holding options will exercise them, collecting S-X in profit. If not, they will forefeit any gains with no loss.

Two questions arise concerning such transaction:

• How the vouchers should be disbursed? My preference is to issue vouchers on a flat-rate basis to all households in Ireland in order to achieve a voucher-distribution that is reflective of the economic stimulus in line with an across-the-board tax cut;
• What will happen to AIB shares when vouchers are exercised? Nothing: markets at IPO will be pricing in an inflow of shares from the households as it will be pre-announced in advance.
  

The Government can collect a special rate CGT on such profit realization at, say, 30%, so that in effect there will be a 0.3*(S-X) payout to the Exchequer in addition to the retained shares value.

The upside to capitalization savings

Banks equity capital (BEC) = assets net of liabilities must legally not fall below 8% of the Risk-Weighted Assets (crudely for any given asset - e.g a loan or a bond - held by the bank, RWA =risk weight*asset value=RW*AV).

At the end of 2008 both banks hold ca €80bn in property loans of various quality. Not all of these loans will be earmarked for NAMA, so, having no better guidance from the NAMA itself, assume that the banks would want to off-load ca 3/5ths of this amount or €48bn.

(How do I get to this number? AIB has total assets of €182bn, RWA of €116bn, RW of 116/182= 63.7%, BEC €9.28bn and the actual Tier 1 capital of €9.9bn. BofI has assets of €204bn, RWA of €134bn, RW of 65.7%, BEC requirement of €10.72bn against the actual T1 capital of €10.1bn. Note that RW(BofI)>RW(AIB) implies lower quality of the BofI book. Prior to the first round of recapitalization, combined RWA €250bn, BEC Tiers 1&2 requirement of €20bn (0.08*250bn) just covered by the actual Teir 1 held. Any change in the NAV of underlying assets would have triggered a rise in RW thus driving the banking system below the 8% requirement, so the Government injected €7bn, thereby providing for the €87bn RWA cushion and raising Tier 1 capital to 10.8%. While sounding like a high number, this is pittance compared to the US and UK trend toward raising T1 ratios to 12-14% that would require a further injection of €3-8bn in cash, assuming there has been no deterioration in the assets quality since the end of 2008. Further note that total 6-banks property exposure ex Poland for AIB is €165bn. So far, we do not know how much NAMA will take on, but in the case of Securum - Sweden's bad bank - only took on non-performing loans. Now, AIB assumes max 25% non-performing loans on total development & property investment loan book, with current running non-performing loans at 3.5%, so our €48bn assumption is about coincident with the ca 25% non-performing loans assumption on property exposure across the 6 banks).

As Government bonds carry a RW=0, the value of NAMA bonds replacing specific assets will be excluded from RWA calcualtions. If NAMA buys €Xbn in loans at discount d%, then banks will get to write off €Xbn of assets, get €(1-d)*Xbn in state bonds in return and face a net cost of €dXbn to their capital, so that the combined banks RWA becomes €(250-(1-d)X)bn against Tier 1 capital of €27bn post re-capitalization. Writing off €dXbn of the value of the loans will hit the banks straight into their book value, thus cutting their equity capital - and directly hit their Tier 1 capital as well.

So Tier 1=27bn-dX=8% of RWA=250-(1-d)X. In other words, 0.08*[250-(1-d)X]=27-dX. Now, solving for discount factor:
d=[7+0.08X]/(1.08X).

If the Government wants to buy 3/5ths of the property-related loans, X=€48bn and d=20.9% - a scenario that would see the state issuing €38bn in new bonds - over 1/2 of the entire current Government debt.

Analysts estimate that the total loans impairments across BofI and AIB can run between €19-25bn. Adverse selection under the voluntary NAMA scheme imply that the banks will dump the lowest quality assets first. This means that under the scheme of 60% of loans being purchased by NAMA, the cost of the scheme - €38bn will be underwriting the asset base with expected recovery of just €48bn-19 or 25bn = 23-29bn, making an immediate loss to the taxpayers of €9-15bn.

Under nationalization scheme, the Government can blend assets at its own choosing, spreading the loss-implying assets across the books and it can drive T1 capital to 6% if it wants to. This would imply that, under an unbiased weighting scheme, NAMA will get €11.4-15bn in loss-inducing assets against the book that has
d=[14.9+0.06X]/(1.06X)=[14.9+0.06*48]/(1.06*48)=35%
costing the Exchequer €31.2bn in new bonds for an asset base with underlying recovery of €33-36.4bn - a nice expected profit of €1.8-5.2bn.

And this is the exact value of nationalization...

Arguments against nationalization will be dealt with in the follow up... (I need a smoke break!)