Daily Economics 25/04/09: John McGuinness & Alan Ahearne

For my comment on John McGuinness' story, scroll to the bottom.

Alan Ahearne, the newly minted adviser to the Government, has gone into an overdrive mode, tackling the 20 dissenters (including myself) who dared to challenge NAMA as a taxpayers' nightmare waiting to happen (in the Irish Times: here) and striking at criticism against his masters in the Leinster House (Irish Independent report today: here).

Per Ahearne's musings in the Times
It is indeed sad to read an article that so flatly denies itself a chance at having an argument, as Alan's treaties on What's wrong with nationalization. Alan spent some time studying our earlier Times piece (see more on this here), but it is also obvious that he had hard time coming up with arguments against its main points.

Let us start from the top.

"The recommendation that nationalisation of the entire Irish banking system is the only way we can extricate the banks and the economy from the serious difficulties we are experiencing risks diverting the debate away from issues that are much more central to the success of the ...Nama proposal." Alan follows up with a list of such 'central issues' from which our article was allegedly diverting the debate. Alas, all are actually covered in our article. As an aside, we never argued for nationalization of "the entire banking system", but of the systemically important banks alone.

"As in other advanced economies, bank nationalisation is seen very much as a last resort." Our article states that: "We do not make this recommendation from any ideological position. In normal circumstances, none of us would recommend a nationalised banking system. However, these are far from normal times..." We clearly were not advocating nationalization as some sort of a good-fun measure.

"It is important to recall that there is an overwhelming international consensus that the so-called good-bank/bad-bank model on which Nama is strongly based presents the opportunity for achieving an enduring long-term solution to the banking crisis." Actually, there is no such 'consensus'. And even if there was one, just because many other Governments have been working with this specific model does not mean that (a) the model actually works, (b) Ireland should follow in their footsteps and (c) this is the best option for resolving the crisis. The model does not work, as in the US, for example it has managed to absorb vast resources (which Ireland does not possess) and had come under heavy criticism as not delivering.

The fact that Ireland should not blindly follow in others footsteps is apparent. But it is also rather amusing, for the Indo (see below) reports today Alan's own insistence that we should not follow the US in stimulating our economy. No tax breaks to the suffering workers, says Alan, because we are different from the US in fiscal policies. NAMA and no nationalization, says Alan, because we want to follow the US lead in financial markets policies. Same Alan, two divergent points of view...

"One of the main issues identified in the article is the need to restore bank lending. This is a central objective of the Nama initiative. Nationalisation, on the other hand, creates a significant risk of undermining the capacity of the banks to raise funds internationally for domestic lending." Two things worth mentioning.

1. Alan clearly contradicts here his own statement that our article risks 'diverting' national attention from the core issues relating to NAMA. Obviously it did not: restoring bank lending is "a central objective of the NAMA" (per Alan) and it was identified in our original article as "one of the main issues".
   
2. The argument that nationalization undermines banks capacity to borrow internationally is a pure speculation. Firstly, our banks have little capacity to borrow internationally as is. Secondly, when they regain such capacity their ability to do so will be underpinned by public guarantees. Third, why a state-owned (and thus a fully state-insured) bank wouldn't be able to borrow from other banks and the markets? What would prevent, say London- based investors buying BofI bonds when these bonds carry a much stronger default protection under state guarantees than the one afforded to them by the half-competent current management?

"Investors would surely give the Irish market a wide berth in the future – not just in the banking sector – if the State undertook such an extreme step." No they won't, Alan. Banks and public finance in Ireland are in a mess. Investors have already priced these factors in. The markets understand the difference between a healthy, albeit not necessarily extremely profitable company like Elan or CRH and the nationalization-bound banks or economically illiterate Exchequer policies. Such are the basics of investment markets.

Nationalizing banks with clear privatization time line and disbursing privatization vouchers to the taxpayers will send strong signals to the markets that Ireland is:

• serious about the banking crisis;
• ready to support household balance sheets in crisis;
• can creatively stimulate its economy without destroying it fiscal position;
• will not waste privatization revenue in a gratuitous public spending boost, thus supporting long term fiscal health; and
• will have a transparent and fixed downside on its banking rescue commitments (i.e no repeated rounds of post-NAMA recapitalizations).

Which one of these points contributes to the international investors shying away from Irish stocks?

"It is difficult to see a credible exit strategy from wholesale bank nationalisation." Read our article on the topic in Business & Finance magazine, Alan. Also, the original Times article, stated in plain English: "...nationalisation offers an opportunity, should the Government see such a need, to share directly with the taxpayers the upside in restoring banking sector health. Such an opportunity could involve a voucher-style reprivatisation of the banks and could be used to provide economic stimulus at a time of scarce resources, at no new cost to the exchequer." So no real mystery as to how a credible exit strategy can be devised, Alan.

But NAMA without nationalization offers no exit strategy at all (credible or not). In fact, it offers no strategy for ending the rounds of repeated bailouts of the banks either.

"Under the Nama initiative the taxpayer is protected from unforeseen losses through the Government’s commitment to levy the banks for any losses incurred." This is simply wrong! Once NAMA owns the assets, what recourse onto banks will the state have should the quality of the assets bought fail to match the price paid? As far as I can see - none. But under nationalization, the state owns all - good and bad assets, and it can price these assets on the ongoing basis as more information on the quality of loans arrives.

"The State has already, under the recapitalisation programme, potential for benefiting from the upside in terms of the recovery in the share prices of the two main banks. The State has an option to purchase at a very low price 25 per cent of the existing ordinary shares in Bank of Ireland, and will soon have a similar claim on AIB." I am sorry, Alan, the 25% shares in BofI and AIB relate to the €5bn that we, the taxpayers have already paid for these banks recapitalization. These shares are wholly independent from NAMA liability and from the future liabilities we will incur under NAMA-triggered second round of recapitalizations. Whichever way you twist it, Alan, the state will have to spend additional cash buying the shares of the banks after we have paid for NAMA!

About the only statement in the entire article I find myself at least in a partial agreement with is: "Empirical evidence strongly suggests that private banks perform better than nationalised banks. International studies have shown that too much “policy-directed” lending by wholly state-owned banks has retarded economic growth. The simple truth is that nationalisation creates a significant risk of a political rather than a commercial allocation of credit." However, the problem here is three-fold:

1. NAMA is at the same, if not even the greater, risk of becoming politicised;
2. Banks are going to be majority state-owned post-NAMA (if only at double the cost to the taxpayers), so Ahearne's musings do not resolve the problem he posits; and
3. We are not in the normal times when empirical evidence holds...
   

we are in a mess! and Alan's confused rumblings on the topic illustrate the extent of this mess well enough for me.

Per Ahearne's economic policy musings in the Indo
US-styled fiscal "stimulus wouldn't work well anyway in a small, open economy, and, of course, the budget position is such that it just doesn't allow it," Dr Ahearne told Engineers Ireland conference.
Of course he is right on this, but him being right on the technicality does not mean that:

• It is right to raise taxes on ordinary workers and businesses, as the Budget did, amidst the recession;
• It is right not to cut public spending by an appreciably significant amount, as the Budget did;
• It is right to continue awarding public sector wage hikes, as the Government is doing with consultants;
• It is right to rely on senile plans for Irish-styled 'stimulus' that will waste money on unproven projects, as the Government did;
• It is right to continue resisting reforms of the public sector, as the Government is doing.
  

Ahearne further said that 'if the US and the global economy improves next year and Ireland continues to get its public finances in order, then Ireland would be in a position to make a "strong recovery"'. Really, Alan? How so? Through a miraculous return of Dell jobs, Google engineers jobs? Waterford jobs? Tralee jobs? By reversing our losses in exports competitiveness? By scaling down the atrociously high cost of doing business here? Dr Ahearne is so far removed from reality of economic environment that he believes the entire economy can be rescued by the IDA efforts alone?

"Ireland is regaining its competitiveness "very quickly" because of rapidly falling wages, he said", as the Indo reports. "Of course, those declines are painful but they will price a lot of people back into the labour market and, therefore,they are setting the foundations for the recovery." This amazingly callous statement comes from a person who is secure in his own public sector job with high salary. It also comes from an official of this Government.

Wage declines have been borne out by the private sector alone, Alan. Unemployment increases have been borne by the private sector alone, Alan. And most of the real income loss to those still in the jobs has come courtesy of your masters policies - the Budget. How is this restoring any sort of competitiveness vis-a-vis other economies where the Governments are putting in place tax cuts?

Here is a lesson that Dr Ahearne failed to learn in all his years of studying economics:

• Higher tax rates amidst the most generous welfare system in Europe mean that marginalized workers will not have an incentive to return to the labour market.
  
• Higher taxes in a restricted labour market (with high costs of hiring and firing workers and high minimum wage rate) hamper jobs creation.
  
• Higher taxes on already debt-loaded households mean that more and more families are facing the ruin and precautionary savings are rising, reducing our internal economy growth potential.
  
• But most importantly, higher taxes on human capital mean that productivity growth is going to be constrained for years to come.
  

It is that simple, Alan, any recovery will require productivity growth in this economy outpacing the cost of living rises and the cost of doing business growth. Your policies have just hiked the latter by some 10% - courtesy of taxes and levies increases in the Budget, while restricting productivity growth by failing to provide any real support for businesses or incentives for workers to get off the dole. You are travelling in exactly the opposite direction to the one that has to be taken if we are to get productivity-driven recovery.

John McGuinness' appearance on the Late Late Show tonight was a logical conclusion of months of pinned up rage that this country is feeling toward the Cabinet - and primarily to Mr Cowen, Mr Lenihan and Mrs Coughlan - towards the public sector at large and towards the scores of mostly nameless, faceless (but sometimes publicly visible) 'advisers' who have systemically destroyed the prosperity of this country and its chances of coming out of the recession as a competitive and growth-focused economy.

McGuinness avoided offering direct examples of gross incompetence and outright insubordination that are so often exemplified by some of our public sector departments and quangoes. This was his choice, but the country needs to know of these acts and it needs to know the names of those who carry on their duties in such a manner. He also avoided placing the blame for the mess we are in where it really belongs, at the feet of:

• the participants in the Social Partnership that managed to squander billions of our money to finance wasteful 'investment' and social cohesion programmes and to set this economy into the rigid infrastructure of inflexible labour laws, senile minimum wage restrictions, mad political correctness and corrupt local governance. Some of the Social Partnership members were the reluctant parties to this outrage - brought in under the threat of union violence against businesses and entrepreneurs. Others made it their life-long ambition to get their organizations to the feeding trough. Roles of all should now be questioned and the entire Partnership model must be scrapped;
• the Government that has for the last 6 years chosen to take no serious policy action to reign in its own employees and their unions and that has retained inefficient and often markets-retarding monopolies. The Government that simply bought its way through the elections, policy conflicts and minor reforms;
  
• the political culture that promotes mediocrity and punishes statesmanship. Our academic and policy debate systems that promote complacency, competition for public funding, anti-entrepreneurial ethos, social welfarism and provide philosophical and ethical foundations for systematic moral and financial debasing of the taxpayers, wealth creators, jobs providers and consumers, promoting instead the unquestioning support for NGOs, quangoes and public sector;
  
• some business elites that, in exchange for state contracts handouts looked the other way as the political and social elites of this country carved our wages and earnings to their own benefits. It is a telling sign of the depreciation of the entrepreneurial spirit in this country that faced with a wholesale destruction at the hands of incompetent (and often outright malicious) policymakers, our business leaders remain largely silent, uncritical of the Government.
  

This should not be held against the person who has now become the first man from inside the FF tent to voice his honest and informed opinion. Instead, there should be firm focus on completing the task he started - the task of recognizing the fact that we are currently being ruled by the three 'leaders' who have shown over the last year complete inability to run the country in crisis. It is time for us not to ask them to go, but to tell them that they must go.

Blunders of Mary: I would encourage the readers of this blog to submit any publicly documented evidence of Mary Coughlan's incompetence at the helm of DETE or indeed of her incompetence at the previous ministerial appointments.

Here is the first one: on April 2 Mary Coughlan has publicly displayed the lack of knowledge as to the existence (let alone the details) of the new Social Welfare Bill put forward by her own Government and already scheduled for a full debate in the Dail in late April. As the bill provides for adjustments in unemployment benefits and conditions, the bill would be at least partially linked directly to Mary Coughlan's ministerial brief. Responding in the Dail to the question concerning this bill, Mary Coughlan said she had no knowledge of any such legislation.

There was, of course, her infamous failure in the Lisbon Treaty debate (here); and an equally spectacular flop during her tenure as Minister for Agriculture, when an ordinary farmer's question exposed her lack of knowledge concerning her ministerial brief.

She earned herself a nickname of 'Sarah Palin of Donegal' after she told radio listeners on April 11th that Irish shoppers go to Northern Ireland only to buy cheap booze (here). This showed such monumental disrespect for ordinary families her Government has squeezed out of savings, pensions and earnings, that she should have been sacked on the spot for such proclamations.

The rumor mill in the public sector if full of accounts - that are yet to be documented - of her undiplomatic behaviour at foreign missions, outrageous antics at the meetings with international business leaders and arrogant statements in addressing top corporate brass. This is far from being a hallmark of an independently-minded politician - it is a direct result of her gross unsuitability for the position of responsibility that she occupies.

Daily Economics 24/04/09: Euro area forecast and Irish Travel Data

Irish Travel Stats are now available on CSO website through Q4 2008. Charts below illustrate the main trends:

First, domestic travel trends. All categories of domestic travel are in expenditure intensity (Euro spent per night) except for the holidays trips. This represents a departure from the generally upward trend prior to 2008.
However, in line with a small increase in the numbers of trips taken domestically, the overall spending remains relatively well underpinned.
International travel by the residents of Ireland has held up relatively flat or increased for all broader destinations. Length of stay also held up well.
Length of stay abroad has declined (in line with recent trends) for holidaymakers, and has risen - against the previous trend - for those visiting friends/relatives and other categories. There has been a significant increase in the length of stay for business travellers.

The decline in the overall overseas spending by Irish residents travelling abroad has been significant and driven largely by the decline in the expenditure of Irish holidaymakers abroad. Business travellers visiting abroad have reduced their spending only marginally, while other categories of Irish residents travelling overseas have seen a small (insignificant) increase in overall expenditure.
Lastly, considering Irish travellers spending by their destination country, EU15 countries clearly stand out as the dominant spending destination for Irish visitors within the broader EU25 or indeed EU27. Despite or strong connections with Poland and a host of other ECE countries, there is virtually no evidence of Irish residents spending much of their cash in those countries. North America follows EU15 as the most favourite destination for our Euros, with Asia& Middle East managing to outperform Australia & New Zealand in competing for our cash.

Eurocoin results are in for April so the chart below updates my forecast for Euroarea leading indicators and for GDP growth for the Euro area for May:
As you can see, Eurocoin improvements, predicted in March, have indeed taken place, which in my view signals that May is likely to see this leading indicator for growth in the Eurozone climbing higher. However, my longer view is that leading indicators are going to suffer a seasonally adjusted fall-off at the end of Q2, retesting the lows of -0.6. Thus, my forecast for Q2 2009 growth stands at -1.1%.

What's wrong with NAMA

For those of you who missed the latest article on NAMA from myself and Brian Lucey in the current issue of Business&Finance magazine, here is the unedited version.

To date, the prevailing discussion internationally on how to rescue failed banks focused on repairing their balance sheets. This ignores the underlying cause of the problem – the deterioration of their asset base. In fact, in the case of NAMA-type ‘bad’ banks arrangements, the cure compounds the asset base problems.

Two major questions arise in the context of NAMA.

First, we do not know how the assets can be priced in order to align the NAMA objective of repairing banks balance sheets (with an incentive to pay high price for transferred assets) and its duty to safeguard taxpayers interest (requiring the price to be set below the expected risk-adjusted value of the loans total).

Second, we do not know how the impaired assets will be treated under NAMA. One option is to keep them alive as zombie development projects awaiting realization decades from today. Another is to shut them down. Which option will be pursued will, in the end, seal the fate of large scale development land banks and half-baked development schemes across the country. It will also underpin political legitimacy of NAMA. And this is before we consider the fallout from a virtually inevitable future creep of NAMA remit to cover defaulting mortgages on principal residencies, credit cards debts and bad car loans.

Extent of the NAMA-bility

With respect to the first question, the US Treasury Department identifies the bad assets before they are actually fully impaired using financial models that estimate future loan values under different economic scenarios.

Ireland is yet to make even this first step, but currently neither the CBFSAI nor the Department of Finance and least of all the infant NAMA have the capacity to develop and administer such model-based testing procedures. Even after years of operations, CBFSAI have virtually no real expertise in risk management and pricing, while DofF has no real economics, finance and analytical capabilities to oversee a minor credit union, let alone to control NAMA. Thus, ex ante pricing transparency is the only guard the taxpayers have to limit NAMA’s monopoly powers.

So let us consider the loans that are non-performing, stressed or rolled over with little chance of repayments any time soon. Banks provisions for future impairment charges are currently running at ca 4-5%. Independent and even in-house analysts are forecasting that some 12-15% of the entire asset pool of the Irish banks can be under stress by 2010.

In our view, this is a lower bound of the true state as:

• loans under threat to date will almost certainly remain under threat through 2010;
• the first quarter of 2008 saw a relatively benign trading environment, so 2009 is going to see even greater rates of impairment; and
  
• the economic troubles underlying the rapid asset quality deterioration are set to deepen in 2009.
  

We know nothing about the recovery rate on these risky assets. But globally, AAA rated CDOs carry the recovery rate of only 32% on face value, while for mezzanine vehicles the recovery rate is only 5%. The default rates on the US corporate junk bonds (which are less risky than Irish development-linked loans due to their higher diversification, liquidity and transparency) is estimated to reach a whooping 53%, with a recovery rate of zero. Given the perilous state of Irish economy, and the extent of the property-related exposure for Irish banks we see as reasonable (or potentially even generous) a 45-50% average recovery rate on the stressed loans. This implies that the expected final losses on the entire 6-banks pool of €165bn in property exposure (ex-Poland) will be closer to 25-30%, or €50bn. For anyone who thinks that this figure is unrealistic, a recent McKinsey study showed, that out of $2 trillion of impaired assets the eventual writedowns may total $1.5 trillion or 67%.

The above loss rate implies that NAMA will be purchasing the impaired assets at less than 28% discount to their face value, should the Government set the price to keep the 6-banks capital ratios at 8% minimum required levels. Such a discount will imply an issuance of €36bn in fresh bonds to the banks, underwriting only €25bn in risk-adjusted assets on NAMA-held €50bn book of loans. The implied expected loss to the taxpayers from such an operation is €11bn in capital cost, plus ca €11.5bn in interest costs for a 5-year bond to be covered out of tax revenue and higher cost of banking.

It is worth noting that these costs of over €22bn for NAMA operations assume that Irish banks keep capital ratios at the required legal minimum after deleveraging their balance sheets. In other words, these losses do not fully insure the banking system against future capital demands.

But 8% capital requirement is now considered to be insufficient for operating a private bank. Instead, markets are demanding a minimum 10% capital ratio, with 12-14% being a golden target. If NAMA were to keep Irish banks private, the recapitalization demand for the 6-banks system due to the NAMA assets transfers will add another €4-8bn in costs to the Exchequer bill.

Note: should NAMA buy into €80bn in loans, as discussed in recent reports, the associated required maximum discount rate will be 23% and the total losses to the taxpayers will be €43-51bn.

How can toxic assets be priced?
Generally, assets on bank balance sheets are valued either at hold-to-maturity value or at fair value. Both frameworks fail in the current environment.

An alternative solution is that the Government can set up a two-stage process of buying stressed assets into NAMA. The first stage will involve a quasi-voluntary scheme that would establish a functional resale market for the stressed loans to be used in the second stage of purchasing.

To do so, the Government should set a basic level of discount on the assets based on the publicly verifiable valuation model. The discount should be fixed on the date of the scheme announcement to prevent future manipulation of the fair value by the banks. It should apply to all systemically important banks regardless of who holds the specific loan or what project it is written against. This will avoid political interference in the pricing of stressed assets.

Loans with interest and principal non-payment of less than 3 months can be sold at a fixed discount of, say 15% (reflective of the current expected default rates), loans with non-payment of 3-6 months can be sold at a fixed discount of 25% (a rate that is more consistent with the US experience and the ECB discount lending criteria). Non-performing loans in excess of 6 months and repeated roll-up loans can be traded at a 50% discount equal to their estimated default risk. This first-stage transfer will remove the most toxic paper off the balance sheets of the banks.

After the first stage establishes quasi-market pricing of the assets transferred to NAMA, the Government can retain the face value discount on other stressed assets, while allowing for some recapitalization support to be given to the banks that need it. The second stage involves using the same discounts on loans as in the first stage with the Government using additional bonds to swap for banks shares to cover some fixed proportion of the discount. In other words, the banks will still sell most impaired assets at 50% discount, but they will have an option to receive a roll-back of say 10-15% of the discounted value in the form of the NAMA taking new shares in the banks. For example, a loan package of €10bn with average non-payment of more than 6 months will be sold to NAMA for €5bn, but the bank involved will have an option to sell €500-7500mln worth of new equity to NAMA at the same discount on the share price as on assets sold to NAMA.

The advantage of this scheme is that the clean up of banks balance sheets will be systematic and non-distortionary.

The disadvantage is that it still saddles the taxpayer with the task of recapitalizing the banks after they take a hit on their capital base under the NAMA. This, however, is inevitable under all possible scenarios for toxic assets removal. In our view, the only real option to avoid the need for endless rounds of recapitalizations is to nationalize systemically important banks outright. Nationalization option will allow the Government to keep capital base of the banks at 8% limit, outside the markets demand for higher capital reserves. In addition, under nationalization NAMA can choose and pick specific assets off banks balance sheets to create a blended portfolio of loans with lower expected default rates.

Avoiding zombie land banks
The second problem with the Government proposal is that we do not have any idea as to how the impaired assets will be treated under NAMA. Upon purchasing the loan, the Government will have an incentive to keep the underlying assets alive as a zombie development projects. This is so because as long as the development-zoned land remains ‘active’ as an investment project it will retain some notional value on NAMA balancesheet, creating an illusion of value to the taxpayer. Of course, much of the existent recent vintage land banks that NAMA will end up holding will cover speculatively purchased agricultural and industrial land with virtually no hopes of being developed in the next 15-20 years.

Another option is to shut these projects down, de-zone the land and either release it into the market as agricultural land or retain it as public-use land. This option implies NAMA writing down the asset value of such land.

In our view, the Government will be wise to opt for the second option, converting improperly zoned development land into a mixture of leasable publicly-owned land (useable for sustainable developments) and commons (for public amenities, such as parklands). Incidentally, our pricing scheme described above incentivises such conversion as most of speculative land banks will fall under the heaviest discounted price category, minimizing the value of the write down and maximizing land rents to be collected on leasable lands.

This process will only be further enhanced by imposing a direct land-value tax on development sites, mentioned in this column in the previous issue.

Box Out: 8 reasons to mistrust ba-NAMA-rama

1. The potential for politicisation of the property and land valuations, combined with further politicisation of planning and development.
2. The lack of adequate oversight capacity in the Oireachtas even with the enhanced committee structure.
3. The lack of transparency in the pricing and valuation process.
4. The monopoly which it is to be granted on development and land related activity which is backed by lending from Irish institutions. There is a prima facia case here for very careful consideration of domestic and EU competition issues.
5. NAMA is to be granted portfolios of assets, regardless of whether these are performing or otherwise. Will performing borrowers whose loans are transferred to NAMA injunct such transfers on the grounds of reputational damage?
6. The skillsets required to manage a fundamentally distressed asset portfolio (NAMA) are lacking not only at NAMA, but across the entire public sector and most of the private sector.
7. The portfolio approach, where all loans in a portfolio regardless of quality are transferred, leaves NAMA open to mission creep with for example the potential for credit card, or auto loan portfolios being transferred in the future.
8. Finally, and most important there is the issue of the price to be paid for the assets of the banks.

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...