Economics 07/05/09: Banks: over-exuberant markets?

Forgive me if I am stating the plain obvious, but Ireland Inc is now insolvent. Full stop. And this means I cannot understand how on earth do the markets think BofI and AIB are a good buy at over €1.00. These prices reflect a peer-pricing comparatives, not the specific banks' fundamentals.

Fundamentals of any regional bank must be tied into two things:

1. regional growth prospects relative to the bank's market share; and
2. bank's ability to open new markets.

Both, BofI and AIB are Ireland-only institutions, with some seriously toxic exposures in the UK (both banks hold loads of buy-to-rent mortgages and commercial property deals of recent vintage, many of which are intitiated by the same Irish developers who got their loans in Ireland as well and much of it probably cross-collateralized). AIB also has exposure to Poland and the US, but in the US it has a minor stake in a minor play, while Poland is seriously suffering. Both stakes have no real upside for the bank and are illiquid at this time.

So it is back to Ireland for both banks and thus to points (1) and (2) above.

On point (1), regional economy - Ireland Inc - has no real prospect for growth. If you are in a business of lending you are in for a shock in this country with Ireland's:

• rising (and already high) insolvency rates for businesses (see here);
• contracting domestic demand (down 20% already) that, once stabilized, will remain low until households deleverage, which in the case of Irish households means shedding about 50% of their current mortgages and consumer debts to get themselves in line with, say, the US households (in Ireland, household debt per capita stands at about €2 per each Euro of GNP; in the US the figure is about $0.98 per each Dollar of GDP) - do tell me how can this be done if taxes are climbing up while wages are falling down?
• falling external demand and FX shocks - with Irish exporting sector still performing reasonably well, there will be more bad news on the horizon. Even when the global trade turns the corner, Irish banks are hardly significant players in the MNCs game, having no clout, knowledge and global presence of international banks, so exports-led recovery will do little to improve AIB and BofI balancesheets;
• new business start-ups - this area has low potential for growth becasue we are in a big time slowdown, but it also has very high risk attached to it and, again, BofI and AIB simply have no experieince of normal (non-collateralized) business lending;
  
• housing loans - mortgages lending is going to continue contracting for now and will remain extremely low in years to come because of several factors, including lower incomes, higher income uncertainty, higher taxes (think of us having to actually pay off that NAMA loss over 5-7 years horizon); decimated pension funds, lower disposable savings (just think of people starting to set aside savings for kids college fees and you get the picture), lower cost of housing purchases (smaller transactions volume) and higher costs of house ownership (think of our Greens imposing more and more costs on homeowners while Mr Lenihan & Co are raiding households for more indirect taxation and charges), property tax introduction, etc. etc. etc.;
• competition from other banks - intensifying competition from the foreign-owned banks present here, entering traditionally AIB and BofI territory of personal banking and consumer lending, small business lending and property loans - can BofI and AIB really compete against Barclays, HSBC, or even Rabo, should these banks pursue aggresive growth strategy?

So where, tell me, will the growth come from to bring Irish banks into profitability to sustain their current valuations?

Ah, but they do have some value left in them, I hear you say. Ok, sure, they do. Run two scenarios:

Scenario 1: NAMA takes a bite and swallows them in chunks. Equity dilution means existent shareholders will be stuck with, say 10% of the post-NAMA equity pool. In effect, if you are buying these shares now, you will have 1/9th of the value of these claims against current assets post-NAMA. Now, put differently, if you bought today at, say, €1.20 AIB and €1.17 BofI, you actually bought a claim that is worth €0.12 on AIB and €0.117 on BofI in post-NAMA equity. Does this make any sense? I'll get to it in a second.

The only way the above trades make sense is if you expect the Government to nationalize both banks at a spot price on the day of nationalization. In other words - you are in aconfidence game, which can be less-flateringly described as a game of chicken. You run at the Government at an increasing pace, hoping that you can make Cowen and Lenihan blink and pay up on your gamble. That is a hell of a lot of hope. But it is worth entertaining:

Scenario 2: Government nationalizes both banks paying spot price on the close of the day before nationalization. You wake up one day and your shares are just worth what they were last evening at the closing bell, except the state is giving you an IOU for them and the IOU might even bear a discount on the closing price.

This has to be priced as a gamble, or an option. You can get some eggheads in your pricing department to do the maths, but here is a sketch:

You in effect are paying €1.2 today on a put option giving you a right to sel to the Irish Government a share of AIB at some excercise price X to be paid at maturity T, when AIB stock will be worth S(T).

Now,

• T is uncertain and can be dependent on the S(t) - if Government were to time its nationalization to cheaper price setting;
• S(T) is uncertain, since we do not know T and because the Government can apply a purchase discount d at the day of nationalization, paying you S(T)(1-d) for your shares.
• Discount d can be indepednent of S(T), or it can be increasing in S(T) should the Government decide to extract 'value' out of nationalizing what it might perceive as an overpriced bank.
  

At this point your eggheads would tell you that there is too much uncertainty to price this deal, stay with me for now.

You expected profit on this put is given by the following:
If you are a sensible investor you have a required rate of return, say r, which in turn determines a strike price required for you option to yield such a return, call it X*:
Of course, your price P is just what you pay today for AIB shares.

The above is still unsolvable and your eggheads are now heading for the windows of their high-rise, high-spec office block. So to save them, lets make another reasonable assumption, namely that when you bought AIB shares at €1.20 you expected them to go up by some factor k which might or might not relate to your required rate of return r. Just for fun, assume that k=r - in other words you were adding AIB to your portoflio on a neutral expectation (we can try it to be aggresive, so k>r, but clearly, no sane person would try to price AIB as a defensive play, unless you've been managing Zimbabwe Soverieign Wealth Fund).

Now, we have required strike price of
Parameterising this for r={5%}, d={0,10%}, we have: X*>{2.5, 2.93}. In other words, for you to make money on this deal, you need the Government to commit to a strike price above €2.5-2.93 per share of AIB range.

And we have not dealt with all layers of uncertainty at all...

Put alternatively - as a bet on nationalization, your purchase of AIB does not really add up. Now, if the price of shares was €0.12 for AIB at the time you bought, then ok, you might have been making a rational bet on nationalization. But not now.

Finally, back to the Option 1: so what does NAMA imply about the fundamentally-justifiable share price for AIB?

Post NAMA, Mr Lenihan will own lions share of AIB. Suppose it will be 90%. Impairment on remaining loans is not going to go away, but it will decline on average. Suppose to 5%, while AIB's book will have shrunk by ca 50%. You are now holding a share covering just 10% of the old total, which means that underlying asset base for you shares is now only 5% of the old share. With 5% impairment, there is no significant asset upside anytime soon, so you are stuck with 5%. Suppose that in the next 5 years you expect AIB to get their act together and rise to the levels of valuation that are 75% of the peak of the 52-weeks range, i.e. old pre-NAMA shares trading at €10.69. In post-NAMA terms, you have a claim to just 5% of this, or €0.53 per share.

Your loss on today's closing price is €1.20-0.53/[(1+i)^5]=€0.72 in today's Euros.

Table below shows some valuation scenarios, assuming 1.5% average annual inflation between now and 2014:
In red - is your bet when buying AIB at €1.20 range: you assume that

• post-Nama Irish Government will hold no more than 75% of equity in the banks, and
• by 2014 - 5 years from now, AIB will be trading at the 75% of its past 52-weeks peak valuation - that is very brisk business conditions indeed, roughly consistent with Ireland's GDP growing at 6-7% pa to get you to such valuations;

In blue is the scenario I find more plausible, but which implies today's share price on AIB of €0.43:

• post-Nama Irish Government will hold no more than 90% of equity in the banks, and
• by 2014 - 5 years from now, AIB will be trading at 65% of its past 52-weeks peak valuation;

Now, that 65% past price valuation I find a bit optimistic (as I assumed that only 90% not 95% will be owned by Mr Lenihan, and my assumption on shares valuation implies a rather robust 3-4% growth in Irish GDP), but hey, let's not split hair. AIB's shares shouldn't be anywhere near the current price range...

Economics 06/05/2009: NAMA & Bananas for Brian

January-April tax receipts are down 24% y-o-y or €3.2 bn. Same as in February, but erasing a slight gain (-23% y-o-y deterioration) in March. Some say this is good. I am not sure what they have in mind:

1. the fact the we are back on a steeper February downward curve rather than on an imperceptibly flatter March one; or
2. the fact that we are not down 50%?
   

Worst performing tax heads are in bold in the table above. But seasonality matters, so we compare monthly changes in the shortfalls this year so far against the average monthly shortfall for 2008 for the same period of January-April.
Red marks subheads that deteriorate in performance from month to month, relative to previous year. In other words, red numbers represent the cases where y-o-y shortfalls increase from one month to the next. Several conclusions worth making:

• Compared to average shortfall in 2008, April 2009 is much worse across all, but two categories: CGT and Stamps. This, of course, is just due to the fact that once you have fallen through the basement ceiling, there isn’t much room left to fall further;
• Overall, shortfall in April 2009 is worse than the monthly average for 2008 period;
• In April, shortfall has improved relative to March in Customs, Excise, Stamps, Corporation Tax, VAT and Total Taxes; it has worsened in Income Tax (despite the levies), CAT and CGT;
• VAT leads as a main cause of the overall shortfalls – down €1.043bn – ca 33% of the total shortfall – this, in part, is because of the reckless VAT hikes, not despite them;
• Another 26% of the shortfall came from Stamps and CGT both property related taxes, were down €838 million, making up a further 26% of the shortfall.
  

Now to the deficit matters: in April Budget, tax shortfall for 2009 is estimated at €34.4bn – 15.6% decline on 2008. We are now at a 24% decline in annualized terms, suggesting DofF is waiting for some miracle to significantly raise revenue. What this might be?

Speculation 1: another mini-Budget post local elections with a massive tax hike - doubling income levies and doing some nuclear work on PRSI; or
Speculation 2: Pfizer, Dell, Glaxo, Apple, Microsoft, Google and the rest of the world producing a rescue package for Ireland that is massive and has no lags to build; or
Speculation 3: in response to President Obama threat to tax US MNCs based here, we impose a tax on Irish-Americans.

Looks to me like Speculation 1 is the winner.

Now to the expenditure side:

• Current spending was up 4.5% in the first four months, down from the 8.2% rate of increase in March. Factoring deflation, this is still a hefty increase;
• Capital spend was down 14.5% on April 2008, so no stimulus, Brian, despite all the promises;
• Service of national debt is up from €1.262bn in Jan-April 2008 to €1.501bn this year so far. Total debt management costs along with sinking fund: up from €1.736bn to €2.108bn a rise of 21.4% y-o-y;
• Agriculture & Food – up cool €145mln y-o-y - pork dioxins scare, I presume;
• Community, Rural and Gaeltacht Areas – up minor €5.6mln y-o-y;
• Education & Science down €173mln, so Government priorities on who gets dosh first are pretty clear – building the knowledge economy out on the farms;
• Environment, Heritage & Local Government is being beefed (or biffoed?) for local elections with a juicy €30.1mln increase on 2008;
• Other increases are linked to social welfare and other spending that is most likely unemployment-related;
• Overall, voted Government spending is up €275mln or 1.8% in nominal terms, roughly 5% in real terms – some fiscal crisis they are having…
  

If the last bullet point isn’t enough, public sector salaries, pensions and allowances are up from €16.477bn in the first months of 2008 to €16.69bn in 2009. Now that is an interesting number. Up 1.3% y-o-y in nominal terms, 4.5% in real terms. And one has to recall that 2008 includes the six months of Government’s denial that we are facing a crisis and six months of promises to cut public spending!

But wait, there is more fun in the numbers. We dumped €19.04mln into Carbon Act 2007 Fund in the last 4 months – a 100% increase on 2008. We also managed to stuff more cash - €396mln to be precise – into the NPRF, aka public sector pension piggy bank.

Yes folks, we are still broke, but don’t tell it to the public sector employees. For them, the party is just keeps rolling on. So taxes for us, baNAMAs for Brian and some champagne for public sector workers. Sharing the pain...


NAMA has an 'interim' head... and he, as expected,

• is independent,
  
• is experienced in the private sector and management of stressed assets on a large scale,
  
• is an outsider with no links to the civil service or to the good old boys networks in the public sector
  
• has no past policy fiasco on his report card.
  

Brendan McDonagh is currently director of finance, technology and risk at the NTMA (not many degrees of separation from the public sector here).

He works for NTMA which never did stressed assets management although it does a good job at raising debt - so NTMA is a borrower, and Brendan will be running a Lender. Wolves guarding sheep... or is it the other way around?..

There is no real separation from the DofF / the Government, since NTMA is the financing branch of the DofF / the Government.

This 'outsider' to the old boys network is originally from ESB - that pillar of private sector excellence in Ireland.

I am sure he is an excellent accountant and a good treasurer and a great technology officer (though judging by the NTMA website, there is work left to be done on that front)... But here are some crucial questions to be asked:

• is he any good at investment and risk strategy? (I presume he has a worldwide following amongst asset managers for his strategy insights into asset markets, risks pricing etc. He handled treasury, audit and accountancy for ESB and largely the same for NTMA, but there was some risk management part to his role);
  
• is he any good at portfolio management? (I presume he has managed some real asset portfolios long and short, yield and CG, fixed income and equities, private equity and partnerships, for it will take a lot more than a chartered management accountancy qualification to understand and manage €80-90bn worth of portfolio assets. Does he have vast experience in dealing with diversified (internationally and instrumentally) financial products under macro and micro-economic stress?);
  
• is he any good at saying No to political classes pushing for political payoffs from NAMA - a certain to take place in months to come? (I presume he earned such fierce independent reputation at NTMA which is happy to borrow short (3mo-9mo) to finance our deficit even as the OECD and IMF warn the world not to test their luck and borrow long);
• is he any good at preparing assets for sale and liquidation via private markets (for this is what NAMA will have to do in years time)?

... ah... well, we wouldn't know, because we don't get CVs of the career public servants released to us, but on the last point we actually have some past performance record: http://www.finance-magazine.com/display_article.php?i=3879&pi=162 (here). Mr McDonagh it turns out was instrumental in one 'successful' long-term financial engineering project - privatization of Eircom. That was a resounding success that all of us wish onto NAMA too, don't we?

In reality, Mr McDonagh may or may not be a right candidate for a job. We do not know. And past performance with Eircom privatization is not necessarily an indicator of future performance either. This would be unfair to him had he be given a chance of defending his application for the position in front of us...But Brendan never did defend his candidacy in front of anyone so lowly as us, people whose money he will be taking. Incidentally - was his position advertised in line with the EU law for public appointments?

As I said, it is my money and yours that Brendan will be spending and managing. And we need to know, for when we do not know, we are asked to trust the appointing authority. Do we trust Brian Lenihan? With some €80-90bn worth of our last pennies? It is that simple.

Economics 05/05/2009: US' Green weeds

US data, some assert, points to a recovery around the corner. Well, it just might matter how far around the corner the recovery really is, doesn't it? A mile? Few hundred years? Or just at your feet - sitting cap-cap-in-hand and begging to be noticed.

Now, unlike many other economists, I can confess that I can't really tell. We, the economists, are, you see, rather far-sighted - neither good peripheral vision, nor short-sightedness afflict our ability to see into the future. We can tell you with some accuracy what the Euro/dollar exchange rate should be in 3-5 years ($1.10-1.05/Euro) but not what it might be tomorrow.

But there are facts that even we, the mighty economists cannot ignore. Here are some on those alleged 'green shoots'.

Fact 1: Home sales and prices: US new home sales were up in February +4.7% to a miserably low 337,000. At the peak in 2005 the number was 1.4mln. Do the maths.

March pending home sales index rose 3.2% compared with February and was up 1.1% y-o-y. The index covers sales contracts signed on existing homes. About time, given the historically low mortgage rates and an $8,000 tax credit for the first-time buyers. And it takes on average 6 weeks for this to feed through to the existent home sales figures. But housing starts are at 358,000 - 80.4% off their peak of 1,823,000 and the US still has some 12.2 months worth of housing stock on sale - more than 2.4 times the normal average.

Inventory-to-sales ratio for homes is now up at 1.43 (February figures) - relative to normal average of 1.25. In prices terms, median home is now selling for $200.9K - 20% below $251K.

Existing home sales have fallen 1/3 since the peak of September 2005 and the median price is down 28.7% since peak in July 2006. Again, February saw a rise ine xisting homes sales of 4.4% and the median price rose 2.4%, but inventories are still running at double the 5 month level of sales that is considered normal. Not surprisingly (see below under Fact 5), 45% of all home sales in February were foreclosed properties.

Since 2007, 0.9% of GDP was shaved off every quarter due to the 80% collapse in the new housing starts alone. Even if the US economy has hit the bottom in terms of new homes starts, this will only mean that housing starts from Q3 2009 (considering lags) will contribute 0% to GDP growth.


Fact 2: Consumption: In Q4 2008 personal consumption was down 3%. Then the Feds pumped $127bn into personal income via tax rebates (up 11% y-o-y), offsetting an $89bn cut in earnings in Q1 2009. This will slow down in Q2 2009 as the only personal income stimulus will be May Social Security 'bonus' of $250 per person. On the back of this, the engine of US economy, consumers is now showing signs of some revival - as the latest UofM index suggests. The process is aided by lower prices (deflation), lower gasoline costs and lower mortgage rates, although with most mortgages being fixed, the latter is of less help unless you are of the severely endangered species genus - the new buyer.

Demand for durable goods fell 0.8% in March in a seventh monthly decline since July 2008. New orders posted falls in virtually all sectors. Shipments were down 1.7%. On a positive note, inventories fell 1.1% and capital spending by businesses rose 1.5% posting a second consecutive increase, albeit on an abysmally depressing fall-off in January. Both, in my view, are not signs of strength, but of the moderation in the rate of industrial production slowdown – a ‘dead cat’ bounce. Since inventories are still running high, cutting these down to sales levels will mean erasing the loss in GDP growth of up to 2%. But the net contribution to GDP growth is going to be - you've guessed it - zero. And income is not necessarily going to translate into new spending - households first priority right now is deleveraging and the second priority is precautionary saving. What's left might be consumed, however little that might be...

But here is the bad news. All recessions in the modern history have on average saw personal income contracting 4-7%. So far, wages declined at 4% annual rate in Q1 2009, and payroll-tax receipts were down 8.2% in Q1 2009 y-o-y. So personal income growth will not be showing any 'green shoots' any time soon. Should we head for the upper range of the average 'normal' recession estimates, we are in for another acceleration in wages declines, to bring the total annual loss of income (and thus demand) to over $250bn in 2009. Good luck getting those Middle-Americans to consume much more than WalMart crisps and soda any time soon.


Fact 3: Growth in GDP won't yield growth in jobs: Unemployment is a lagging indicator in general, but consumers don't care that much what economists think - they need stability of income and security of job tenure before they start buying big ticket items again. Q2 2008 US had strong positive growth at +2.8% increase in GDP, while unemployment climbed up. In a traditional recession, this does not matter much as devaluation would normally drive investment cycle restart on the exports side, pulling in domestic consumers as well. Not this time around, folks. So we are down to looking at unemployment figures and unemployment sources.

Q1 2009 we saw US unemployment ranks swell by 2mln with unemployment rate moving to 8.5% (up from 7.6% in Q4 2008). US is now running on unemployment that is the highest (per unemployment rate) in over 25 years. And things are getting tougher by the day - March saw unemployment increases in 46 out of 50 states. California has 11.2% unemployment rate - record number for over 68 years. Even Jimmy 'Peanut' Carter wasn't able to wreck as much destruction during his disastrous Presidency.

Worse yet: underemployment (unemployed + part-time workers seeking full-time jobs + discouraged workers) is at 15.6%. Now, here is a tricky thing - underemployment is a leading indicator - temporary employment (a component of the part-time numbers) leads unemployment by 6-10 months. So if we are not seeing temporary jobs gains yet, we won't see ordinary unemployment falling for another 2-3 quarters. And then it will take some time for the labour market to work through the pool of surplus labour before we can expect a pick up in wages. The pesky issue is: in March there were further losses of 71,700 temp jobs - an acceleration on February and well above the monthly average of 47,900 temp jobs lost since December 2007 when the temporary jobs numbers fell for the first time.

Industrial production is down 1.5% in March m-o-m and 12.8% y-o-y, capacity utilization down to 69.3% - record low since 1967. Now, with this excess capacity in place, Goldman Sachs research estimated that even if output gap grows from 7% in 2009 to 10% in 2010, while GDP grws at 4.75% pa, it will take the economy some 5 years to work off excess capacity. This, of course is a powerful drag on business investment, which is good news for software companies and IT solutions speceialists and bad news for investment goods producers.


Fact 4: Financial Services are still in trouble. Banks, especially regional ones, are popping like soap bubbles - the grand total of failed US regional banks now stands at 32 since January 1 and 57 since the beginning of this recession. The rate of closures is accelerating. Two weeks ago - 5 banks were shut down, last week - 4. Not many green shoots (other than weeds) out there, amongst the smaller financials.

Per all the hype about the recent banks' results, here is a good analysis: "Citigroup said it made $1.6 billion [profit]. One of the ways Citigroup achieved this gain was booking a profit of $2.7 billion on the decline in Citi's own debt. ...Under accounting rules, Citi was allowed to book a one-time gain equivalent to the decline in its bonds because, in theory, it could buy back its debt cheaply and save $2.7 billion over time. Of course, Citi didn't actually do that. Even though more consumer loans went bad in the first quarter, Citi reduced its loan loss reserve from $3.4 billion in the fourth quarter to $2.1 billion in the first quarter, thereby picking up another $1.3 billion of 'earnings'. And the recent change in mark to market accounting enabled Citi to book an additional $413 million in 'profit' on impaired assets. Without theses one-time adjustments, Citi's $1.6 billion in first quarter profit becomes a $2.8 billion loss." Hmm... If I were a bank, I bet I could print profits out thin air and on the back of taxpayers cash injections too.

And the fundamentals are getting weaker too: some 3.22% of consumer loans were delinquent (30+ days overdue) at December 2008 mark - the highest rate of delinquencies in almost 35 years - since February 1974. The late payment rate on dealers-supplied auto loans were at a record 3.53% in Q4 2008, up from 3.25% in Q3 2008, direct auto loans: up from 1.71% to 2.03%. Late payments on home equity credit lines - a record 1.46% up from 1.15%, direct home equity loans delinquencies were up to 3.03% from 2.63%. Credit cards delinquencies rose to 4.52% from 4.20% but remained only slightly above the 4.47% average over the last four years. So with newly minted 2mln unemployed in Q1 2009 - expect these numbers to keep on rising.

There is no point to reiterate the estimates (the latest being from the IMF) that show the US banking sector standing to lose $1.5-2.5 trillion due to writedowns. So far, only $1 trillion of these were taken.


Fact 5: Personal and Business bankruptcies are up and rising. Average personal bankruptcy filings were at 5,945 daily in March - 9% increase in m-o-m terms and 28% up y-o-y. 5.06% of prime mortgage holders have already missed one or more payments, sub-prime mortgage holders (1/3 of the total market) delinquencies are at 22%. Foreclosures are up 46% y-o-y in March and 17% in m-o-m terms. Moody's estimate that number of repossessed homes will rise to 2.1mln in 2009 from 1.7mln in 2008. But business bankruptices are rising even faster than consumers' - last year, 136 US plcs filed for bankruptcy, up 74% on 2007, according to law firm Jones Day in April. IntraLinks, a bankruptcy data analysis group, said in April it had seen a 180% jump in bankruptcy and reorganization deals for the three-month period ended February 15, 2009, compared to the same period last year. US consumers bankruptcy filings jumped 29% in February y-o-y to 98,344, according to the American Bankruptcy Institute. ABI expect 1.4 million consumer bankruptcies in 2009, "at least".

On the net, do tell me if you see some 'green' shoots out there. I would love to seed them.

Turning Unemployment into Work

For those of you who missed my article in the Irish Mail on Sunday, here is an unedited version.

Update: There is an excellent idea from JK in a comment to this post below as to how we can alleviate some of the adverse effects of the rising unemployment amongst the skilled workers. A must read after you get through my post!

And here are my calculations per unemployment / welfare trap:
Single earner, 1 child, on Euro40,000 pa wage: after-tax income Euro 32,368 pa and leisure time of 4,210 hours pa (8,760 hours in a year, less average hours worked by employed 1,630 pa person in Ireland in 2007 less 2,920 hours of sleep).

Single non-earner, 1 child:

• Child allowance and welfare benefits: Euro 12,636 pa, plus
• Housing allowance / council home: Euro800 pm (average rent Euro840) inclusive of housing-related allowances: Euro 9,600 pa, plus
• Health cards and medical bills assistance for primary care: Euro 1,500pa, plus
• Cost of assisted or foregone child care: Euro 900 pm, or Euro 10,800 pa
• Total: Euro 34,536 pa tax free
• Extra leisure time of 1,630 hours per annum - precious.

Buried deep inside the Quarterly National Household Survey (QNHS), below the
general statistics, there is a set of statistics called Table 16. It may sound dull, but it is vitally important: because Table 16 shows the scale of long-term unemployment in Ireland.

To count as "long-term unemployed", someone must be out of work for one year or more. What statistics cannot tell us, though, is how many people have given up looking for a job completely. From society’s point of view, having been granted a social welfare cheque, they are simply written off – alongside the retired.

What is most worrying though, are the signs of what lies ahead in terms of long-term unemployment.

Firstly, as of November 2008, the number of those in the labour force – i.e. either employed or actively seeking jobs – in Ireland was falling by 0.8% a year. A total of 34,000 outright disillusioned workers have altogether stopped participating in the productive economy.

Second, it is now becoming increasingly clear that much of the recent unemployment is going to become long-term. Between 1997 and 2008, Irish economy generated just 1 full-time job for every 3 part-time jobs that were created. Thus, many jobs created in the late Celtic Tiger era were poor-quality shelf-stacker or supermarket counter jobs: designed to attract less skilled workers (but also ones who are less able to move around in search of work).

It is legally easier and less costly for companies to get rid of part-time workers than full-time employees: so now the part-timers face a much bigger risk of being made redundant. And because they have fewer skills and have been working for a shorter period of time, they are also facing drastically lower prospects of finding a new job. They are the key candidates for becoming long-term unemployed and to eventually drop out of the workforce completely.

Between late 2007 and late 2008, the official long-term unemployment rate increased from 1.2% to 1.8% – a gain of 50%. Over the same period of time, the standard unemployment rate rose 71%. But in months to come, this pattern will naturally be reversed. This will create a permanent unemployment gap – a nightmare scenario where the welfare rolls stay at elevated levels into perpetuity, keeping large numbers on the dole for many years to come.

Alarmingly, there is no sign that the reality of this rise in long-term unemployment has been factored into the budgetary projections for 2009-2013. But it is hardly trivial. It is estimated that each new person on unemployment benefits costs on average around €20,000 per annum to the state in lost Exchequer revenue and welfare payments. The loss to the society is at least double this amount due to lost economic output. Long-term unemployment is three times as costly as short-term unemployment because people don't save or invest. The damage to personal dignity, self-worth and social status is simply off the scale.

In purely economic terms, the current rate of increase in long-term unemployment and labour force withdrawals is costing Irish economy roughly €2.4bn per annum. And this cost is set to rise.

When Minister Lenihan chose to opt for a massive tax increases in his Supplementary Budget, he forced tens of thousands younger, less educated and lower skilled Irish workers into the long-term dependency on the State welfare.

The ESRI’s terrifying forecast this week pointed to an unemployment rate of 16.8% next year: implying that between 500,000 and 550,000 people will be on the Live Register.
My own forecasts, published a month ago, suggest that at least 120,000 people will become long-term unemployed. This doesn't even include another 50,000 new workforce dropouts. On this scenario, the total economic cost of the jobs destruction in this country would be a massive €27.4bn pa or over 16% of our expected 2009 GDP. Nearly half of this will be coming out of the Exchequer budget, costing the already financially stretched taxpayers an average of €8,500 per each working person annually.

Worse still, it is becoming ever harder to make as much by working as you would get on the dole, thanks to a combination of declining hourly wages, absence of new jobs creation and higher taxation. This week Garda Representative Association President Michael O’Boyce said that
“There are a number of young guards who have less [after tax] money to live on a weekly basis that those on unemployment benefit”.

By my recent estimate, in 2006 the average welfare recipient would have needed a per-tax wage of €37,000 to earn more than they would on the dole. Today this figure stands at over €41,000.

Think about it. As of last November, 21.5% of our 15-19 year-olds and 15% of our 20-24 year olds were unemployed. How many of them can count on earning E41,000 a year should they try to get off the welfare? The answer is none.

The current system of unemployment benefits and social welfare is trapping many thousands of able-bodied adults in a long-term dependency, costing the economy and the Exchequer billions, while producing no contribution to the society. But this need not be the case.

In the short run, we should engage the long-term unemployed in economically and socially gainful activity.

Unfortunately, the much-discussed and heavily subsidised training programmes, primarily run by FAS, are largely a waste of public resources when it comes to instilling the right skills and aptitude in those who have been out of work for more than a year. At the peak of Celtic Tiger jobs creation, in 2007, 30.3% of Irish unemployed people had been on the dole for over a year.

And, as international evidence strongly suggests, no state training agency in the world has managed to achieve a decent ‘back-to-work’ success record. The OECD countries which spent most on labour training saw below-average productivity growth between 1997 and 2007. In contrast, countries which had fixed-term unemployment and social welfare benefits and lower minimum wages outperformed the OECD average in labour productivity growth.

Thus, the only real solution to the problem of the long-term unemployment is to close our welfare trap. Traditionally, this means cutting the level of direct and indirect benefits to below the minimum wage earnings. This, however, is unimaginable at the time of a recession.

Instead, the government should consider converting current payments to the long-term unemployed able-bodied adults into a public works wage, payable in exchange for performing public services.

This yields two benefits. First, and foremost, it restores dignity to those who are long-term unemployed by making them once again active participants in the economy. Bringing home an earned wage is psychologically and socially superior to a state handout. Second, this will provide for at least some economic return in exchange for public funding. Cleaner streets and parks, improved road repairs and other public and social works (some of which can be in line with the participant's skills/training/past experience) will be a form of re-payment to the taxpayers. All at no added cost to the existent welfare rolls.

As the long-term unemployed acquire some on-the-job skills and tenure, their prospects for gaining proper employment will also improve. Economic recovery can start taking such workers off the state employment scheme, allowing to phase-out the expenditure. The compulsion to work for your public wage will also reduce the welfare trap by requiring at least some effort on behalf of the long-term unemployed in exchange for assistance.

In the long run, we will need to move to a capped system of benefits and allow for the significant deflation of benefits relative to the minimum wage. However, while the crisis persists, we should put the long-term unemployed back into the position of participating in this society. This, in itself, might prove to be more important to our future than all other state spending programmes taken together.

How the Government is defaulting private contracts

Per report in today's Sunday Times, the Government 1% levy on life insurance products might be deemed illegal. You can read the details of the saga in the paper - cover of Business section, but the matter is important for several reasons.

First a foremost, governments routinely default on implicit contracts they create with their own citizens. For example, you might naively believe that there is a promise from the state to pay an old-age pension (however meager it might be) in exchange for your social security contribution. Alas, you are wrong. Courts in US, UK, Australia and elsewhere around the world have stated time and again that what we term 'Social Contract' (we pay taxes, they - the Government - provide service) is not a contract at all, hence it cannot be enforced.

Secondly, the Governments are created at least in part to safeguard the legality of private contracts. This is why we have a state-run judiciary. No party to the contract or any third party can alter the conditions of a private contract without consent of the contracting parties. Force majeure conditions apply, but these are extraordinary - reserved for the time of war, arbitrary acts of oppressive regimes etc. You just don't expect these to be a norm in a mature democracy.

Thirdly, what Irish Government is doing with the insurance levy is exactly that - it arbitrarily decided to alter the terms and conditions of the private sector contracts between the insurer and the insured. Nothing less, nothing more.

Gary Becker (of Nobel fame) once started our lecture in Microeconomics by writing words "Theft", "Taxes" on the board and then setting an equation identity: "Theft=Taxes" to illustrate the concept of involuntary exchange. I took this example from him and use it in some of my lectures - as some of you might have witnessed. But from now, we can generalise this beyond the narrow function of the state to collect taxes. Post Supplementary Budget 2009 the new equation should read "Irish Government=Theft" for our Government is now engaged in full-out forcefull conversion of private contracts to its own benefit.

It is a sad day for democracy when the courts become the last line of citizens' defense against the abuse by the State.

Children and Parents Caught in HSE-created nightmare

I would encourage everyone reading this post to check the comments below. As one of the commentators puts it, the reason these comments are unsigned is because HSE has created such an atmosphere of intimidation, that people forced to deal with it are concerned about the reprisals against their cases. This is truly despicable.


This post is not about economics, though my old prof Gary Becker might disagree... It is about a monumental screw up that is our system of family support and the horror of the HSE monopoly in adoption process administration. And it makes me absolutely sick to think that there are thousands of couples in this country - either in the process of adoption or thinking about starting on that long road - who are being failed by the HSE, the Irish state and our politicians.

Here is the story.

Over the last 5 years almost 75% of all inter-country adoptions into Ireland came from three countries: Russia, Vietnam and China. Several of my friends have happily adopted kids from all three of these countries, giving both the adoptive parents and the children a real future as families. At present some 1,000 Irish families are seeking to adopt from Russia and Vietnam.

By my personal experience of seeing homeless kids in Russia, I know that there are tens of thousands of small children without parents in Russia who are facing years of hardship and very few opportunities to have a successful, fulfilling life. They need love, they need a family, and they need a chance to have a future.

Thus, in harsh econospeak - there is supply and demand. In human terms, the future of kids and adoptive parents is at stake here. You can - and should - get the feel for the issue of human hurt and suffering this HSE-screw up is causing here.

The interim bilateral agreement between Ireland and Vietnam expired on May 1 this year - another present of this Government, on top of higher tax levies, stolen mortgage relief and extorted child benefits, that came our way that day. No new agreement has been signed or, as far as we know, even prepared. The Irish authorities, also to the best of our knowledge, are the sticking point here, despite the fact that they knew of the expiry date well in advance. Irish authorities have managed to send a lowly case worker to Vietnam to sort out the issue of a new agreement - a bizarre twist of protocol and managerial logic. Instead of a decision maker, we sent a clerk.

Now, Russia - as the adoption country - has been also shut down because HSE cannot be bothered to adhere to the legal conditions imposed by the Russian authorities on adopting countries. The procedure is a simple one and a logical one. As a part of the adoption process, Russians would like to know that the kids are doing well in their families and in the new country. Thus, the adopting country is required to submit updates on the kids conditions, health, etc. In the case of Ireland-Russia adoption process, this procedure has been in place for 4 years. However, this year, the HSE - the organization with a state-run monopoly power in the adoption process - simply failed to deliver such reports.

In my conversations with the office of Barry Andrews, Minister for Children, I was unable to obtain a clear (let alone convincing) explanation as to what exactly has happened, but to the best of my understanding, HSE simply failed to collect post-adoption reports and send them to Moscow. My conversation with a contact in HSE revealed that they simply "couldn't be arsed to follow up on the process". Just like that - 'we didn't feel like doing it'... And when I suggested to Barry Andrews' office that there should be someone responsible for the mess, the story got even more confusing. I was told that HSE is not even sure it can compel the parents (at the first mention) or its own social case workers (at the second mention) to collect such reports. Not even sure? Four years after the condition was imposed and after three years of complying with the condition?

Here is what we should know and yet we do not know (courtesy of the HSE, Dept of Health, Adoption Board and so on):

• We have no idea how many post-placement reports are outstanding in the case of Russia;
• We have no idea if HSE is even doing anything to rectify the situation (Russian authorities have told me - and I have no reason to question their sincerity - that Russia is ready to restore full adoption process with Ireland as soon as the post placement reports are delivered. HSE cannot tell me anything!);
• Is there an actual copy of a legal agreement with Russia in existence and if yes, why is it not posted on the HSE and Adoption Board websites? Why are the prospective and adoptive parents not given a copy of such an agreement as it stipulates their fundamental rights and duties?
• Is Ireland ever going to conclude bilateral agreement on adoption with Russia? Will Ireland be in a position to renew the expired bilateral agreement with Vietnam?
• Why there has been no high level delegation to Vietnam to renew the bilateral agreement?
• Why doesn't the Adoption Board extend the validity of adoption applications while this mess continues, so that prospective parents whose declarations expire during the time it takes HSE to get its head out of its posterior are not required to go through a renewal process again?

The bigger problem, however, is that under the current system the HSE - that impenetrable fortress with a formidable 125-strong disinformation department (PR & Media Relations that is) - is a monopoly gatekeeper to the process of parent assessment. Thus, intimidation, veiled threats, delays, and now outright failure to comply with international standards and, potentially, law - all are the norm for the ways in which HSE runs its fiefdom.

Clearly, there is an argument to be made here, that what Ireland needs is a well-regulated, competitive system for assessment and processing of adoption cases. In other countries, such a system exists. Hence, for example, the same Russian document that blacklists HSE also blacklists some privately run organizations operating the adoption system in the US. Of course, American adoptive parents have a choice to continue with the adoption process via another agency. Irish adoptive parents have only one choice of waiting for the demi-Gods of HSE to, as I put it earlier, pull their head out of their postrerior.

At the rollercoster site: here, you can find an open letter on the issue (search for the post by blmf ID:- 27687 Date:- 02/05/2009 15:14). I would suggest we all send a copy to that list of our TDs.

Economics 30/04/09: Crime, Dive Reg, Trade Stats & Cars Regs

Crime stats are out today and there are surprises. In particular, a big surprise is the lack of up-tick in property-related crimes in Q1 2009.
The first picture illustrates crime stats for broad categories 1-5: all down, except for sexual offences and kidnappings etc. Nasty stuff, but at least some good news on murder, homicide, assaults etc.
The second chart shows categories 6-12, most are property related and all are down except for robbery7, extortion and hijacking. Given the current economic climate, this is surprising as crime rises in general as recession intensifies. Anecdotal evidence - like local authorities representatives in my area - are telling me that in the last 2 months some 23 burglaries took place in Ringsend, Irishtown and Sandymount area. This is a huge increase. But we shall see if this is matched in the Q2 2009 stats for the rest of the country. For now, however, except for the state robbing us blind, other criminals are staying out of our pockets... or are not being caught...


Live Register is out and is worth a closer look. The pace of increases in LR is abating, but remains furious. The first observation is expected, given massive increases in previous months. We are seeing a technical correction, not an inflection. January-April 2009 we have added 96,000 of freshly un- and under-employed to welfare rolls. Same period 2008 it was 'just' 28,000. April monthly rise was 15,800 or 52% down on the record-breaking January increase of 33,000. Now, this might be some sort of 'good' news for some spin masters, but if April pace continues to the end of the year, we are looking at 515,000 unemployed by January 1, 2010. DofF Supplementary Budget figures estimate unemployment to close off at 12.6% in 2009. Yeah, right...

Below is a chart with data up to date and my forecasts. First forecast is basically a repeat of last years rates of rise for the following months. The rest of 2009 monthly average for this case is 4.88% - much lower than the 4-months average to date which is 7.34%. One slight departure - in this scnario I assume that December 2009 rise in Live Register will be lower than that for December 2008. Just to be nice... The second forecast is Adverse Scenario, corresponding to the next 8 moths of 2009 running along the rates of increases in the previous 8 months (since September 2008 through April 2009), with January record rise being moderated by roughly 1/2. The average monthly rate of increase for this scenario for the months of May-December 2009 is 5.87%, still below the current running average of 7.34%.

A worrying thing about this is that, as you have probably noticed - both scenarios yield LR figures well above 515,000. Benign scenario produces end of year unemployment rate of 16.7% or 568,842 on the Live Register, and adverse scenario provides for 18% unemployment with 613,200 on the Live Register...

These are plotted in the chart below.

Finally, it is worth mentioning that April saw an increase in the females rate of signing onto the LR, relative to males. 41% of new claimants signing up are now women, the largest proportional increase since May 2008. This is likely a sign that:

• white collar jobs are now evaporating at a faster pace, thanks to the Government heroic efforts to support the 'knowledge' economy;
• redundancy payments are wearing thin (with families beginning to run out of redundancy payments cash and thus being forced to sign members onto LR); and
• tax bills for formerly two-earner households are rising, necessitating more women to sign onto the register.

Trade stats for January and February showed an increase in trade surplus - at a 7 year high now - driven by the declines in imports. February exports were up 6% - good news, imports rose as well up 4% in monthly terms. Table below illustrates.
Per CSO release January figures for 2009 when compared with those of 2008 show that:

• Electrical machinery exports decreased by 51%, imports fell by 24% - MNCs are shrinking their production levels;
• Power generating machinery imports increased by 49%, while electricity imports were up 101%;
  
• Computer equipment exports were down 22%, imports fell 35% - ditto for MNCs;
  
• Edible products by 34% - domestic exporters are suffering here;
  
• Industrial machinery fell by 44% for exports and by 34% for imports, specialized machinery imports fell 56%, iron and steel imports down 43% - more MNCs cuts and these are savage;
• Medical and pharmaceutical products exports increased by 15%, which means imports also rose by 6% - MNCs in this sector are firing on all cylinders and transfer pricing is abating - a cyclical component due to accounting timing;
  
• Organic chemicals increased 10% for exports and but fell 22% for imports - again foreign firms cut production while drawing down surplus inventories;
  
• Other transport equipment (including aircraft) exports rose by 610%, while imports fell 43% (one wonders if this was due to fire sales of old aircraft and helicopters as Celtic Tiger developers are starting to shrink their consumption);
• Imports of road vehicles down 71% - say by-by to VRT and VAT receipts and thank you to the Greens and VAT increases;
• Telecom equipment imports fell 26%;
  
• Exports to China decreased by 39%, to Great Britain by 13%, to Germany by 14% and to Malaysia by 44%
• Exports to the United States increased by 5%, to Belgium by 4%, to Bermuda by €70m and to Switzerland by147%.
• Imports from Germany decreased by 43%, the United States by 25%, Great Britain by 19%, China by 29% and Norway by 55%.
• Imports from Argentina increased by 29%, Poland by 10%, Indonesia by 47%, India by 12% and Egypt by 55%.

Chart below shows the extent of imports destruction in Ireland since the beginning of 2008. There is, of course, very little imports-substitution, so any decline in imports demand is a direct hit for our retail sector and no gains to domestic producers.
And imports losses are, of course, lost production by our MNCs and therefore a future loss of exports... and jobs.


New vehicles registrations site (that's right - a new dynamic face of CO with low-res masthead, but much better analysis of data is here) is full of interesting stats - primarily concerning the decline in motor trade since Brian, Brian & Mary decided to horse around with new VRT, increase VAT and rob households of their cash. You can see these for yourselves. But what got me thinking are the longer run trends. Here are some charts:
First, look at all vehicles registered in Ireland. Despite a dramatic fall-off in numbers, long-term moving average shows a clear twin-peaks pattern with sales peaking in and around 2000 - the vanity demand (given our license plates), followed by the fatter peak in 2007 - the SSIAs demand. There is no serious justification for asking for some emergency measures, e.g a scrappage scheme, for the sector as no amount of subsidy will bring us back to the boom days of 2005-2007. There is a room to argue against the VRT, but not on the grounds of some car sales jobs protection.
Second, look at the relationship in sales of new and used vehicles. A 'vanity' dip in sales of second hand vehicles around 2000 was followed by a much more sensible realisation in 2006-2007 that there is no need to pay through the nose for new cars. Gradually, we built up a knowledge curve that our own Irish-based dealers are:

• taking fatter profit margins that those in the UK; and
• providing no better service in return.
  

Hence, more people migrated to buying cars abroad and once there, they were buying used cars. This should have been a good news for the environmentalists (buying a used car implies no added CO2 emissions associated with manufacturing). But it was not, so the tax-hungry Greens followed the tax-hungry FF and hiked VRT levies on all cars. If there is a room for economically justifiable tax reduction - it is in cutting VRT on used cars. Why? Environmental reasons aside, when an Irish person buys a used car from the UK, the cost to this economy of the finds diverted to imports (as opposed to, say, domestic investment) is much lower than when they buy a new car from an Irish showroom.
Chart above dispels the myth of the 'Killer SUV-driving Yummy-mummies' on our roads. Remember the slew of articles in 2007 telling us that we should be ashamed of driving big 4x4s and that Blackrock and South Dublin Yummy-Mummies were out in tens of thousands on our roads for school runs, driving an ever bigger SUVs? Irish Times, as always a guardian against consumerism, led this yellow journalism pack. Now, see the share of vehicles with 2000cc or bigger engines that are on our roads? It is negligible! In fact, chart below illustrates this point in detail.
At no time did vehicles with engines in excess of 2,400CC represent more than 4.5% of the total vehicles numbers registered.
Lastly, the chart above shows how out of touch are our public sector purchasing managers with reality. 2008 recorded an absolute record in new vehicles registrations by the public sector, just as the economy was spinning into a recession. Well done lads.

Daily Economics 28/04/09: Ah, those statists at heart

US Consumer confidence index jumped to 39.2 in April from 26.9 in March, according to the Conference Board report. This was the fourth largest gain in the index history (32 years), but most of the gains came from the expectations component (up from 30.2 to 49.5), not from the current conditions gauge. Good comparative - tying in political data (polls) with the recent confidence gauge trend here. This is fine, until one recognizes that misery indices correlation with confidence indices is not in the area of leading indicators of actual activity. What does this mean? In simple terms, if misery index falls, ahead of consumer confidence rising, all we know is that there should be some secular components of the former that are driving the latter. This is exactly what is happening and the driving components are:

• stock market (bear?) rally; and
• Bush/Obama tax rebates.
  

Both are temporary and both have nothing to do with the fundamentals of the cycle. In other words we are still in a recession and there is no:

• significant fall off in household debts;
• significant uptick in new jobs creation (drop in unemployment); or
  
• significant rise in earnings and wages.
  

But, one consolation - Americans still harbour confidence in the new White House administration and the Fed to get them out of the mess. In the words of Jack Nicholson's character, President Dale, in Mars Attacks, at least Americans believe that: "they still have 2 out of 3 branches of the government working for them, and that ain't bad". In the case of Tax&Waste Brian, Brian and Mary, of course, an entirely different memorable quote from the same screen classic comes to mind, when evaluating the Irish Government policies - this one from Ricchie Norris character: "Wow, he just made the international sign of the doughnut". Doughnut, as in 'zero' stimulus policy that is.


And Case-Schiller House Price Index numbers are not all that optimistic as some reports suggest - see superb analysis here. Of course, media reports that CS has declined at a modertaing pace. Surely not, as Calculated Risk analysis shows, house "prices are tracking the More Adverse scenario so far" for the second month in the row. And seasonality also matters...

GM bonds valuations: Unlike Brian Lenihan with his optimistic assessment of NAMA, bond holdersin GM have not been overly enthused by the yesterday's offer of a bonds-for-equity swap (see details here) that would have yielded a straight-off recovery rate of a recovery rate of 45% (at flat current price per share of $2.03) on its senior debt. Remember, Brian hopes for a recovery rate of at least 102% on the NAMA-purchased loans financed using Irish bonds over 5-year term (assuming original NAMA discount of 20% on loans value). Why? GM bondholders did the maths and saw that the trade unions would receive a 50% recovery in cash and a 39% stake in a new GM in exchange for their $20bn in debt holdings. The bondholders, holding some $27bn in GM bonds and having the same legal rights as the unions, would only receive a mere 10% of the restructured company and essentially no cash. Rotten deal at 55% discount rate on GM senior debt for US would-be debt-sellers? What about a great deal for debt sellers in Ireland Inc's development fiascos - at 80cents on the euro and an equity-repair via second round recapitalization... No wonder the financiers are lining up to support NAMA.


The Statist Resignation in the EU Parliament: You might as well think we got an unusually candid interview from a Member of the Supreme Soviet - that notional 'Parliament' of the USSR whose elected members were simply destined to rubber-stamp the decisions taken by unelected Politburo of the CPSU. EU's Parliamentary Socialist group leader, Martin Schulz, in an interview with FT Deutschland said that he holds no hopes of his group having a say in appointing the EU Commission President should it win the European Parliament majority in this year's elections. Per those who missed the main point, let me run it by you once again: your party get elected with a majority, then:

• in a normal parliamentary democracy, your party appoints the executive leadership of the country; or
• in a Eurotocracy, your party gets to be presided by (at an executive level) by an unelected 'President'...

Of course, there is a third way - a Presidential system whereby the executive is elected directly by the people, without overlap with the Parliamentary elections. Then again, Mr Barroso never really stood for an election in Europe. Forget the merit of each individual leader (and Barroso is not exactly scoring high marks on his tenure) - this is simply undemocratic. Full stop.


Insider Selling Takes Off: per recent Bllomberg report (here) "Insiders from NYSE-listed companies sold $8.32 worth of stock for every dollar bought in the first three weeks of April... That’s the fastest rate of selling since October 2007, when US stocks peaked... The $42.5 million in insider purchases through April 20 would represent the smallest amount for a full month since July 1992, data going back more than 20 years show. That drop preceded a 2.4 percent slide in the S&P 500 in August 1992." So at least some of the insiders in leading US companies are now feeling that the market is overbought. This would be consistent with the management observing some internal dynamic in the companies' fundamentals pointing that a deflation of a recent rally is imminent.

Economist is back in the fundamentals game: this week's Economist has an excellent table:
Scary thought, but do check out Ireland:

• 5th worst performing economy by GDP to date;
• Worst performer in the last quarter in terms of GDP growth;
• 4th worst forecast for GDP growth in 2009 (if you take 8% contraction per DofF estimates, not the Economist-reported 4.8% which is consistent with December 2008 estimates);
• 5th worst performing forecast for GDP growth in 2010 (although here again the Economist is out of line with the latest data);
• 8th worst unemployment rate to date...

Someone from London financial circles was telling me that before we run into troubles, in his estimate, there will be defaults in the Baltics, APIIGS and the UK. I beg to differ - by these (and pretty much all other) numbers we are well ahead of the rest of the 'sick puppies' club, since for the entire APIIGS (Austria, Portugal, Ireland, Italy, Greece and Spain) we rank:

• the worst in terms of all 4 GDP growth metrics in the table;
• the best in terms of Industrial Production metric (although most of the data refers to February-March as opposed to Ireland's January data);
• the worst in deflation metrics, and the worst in prior inflation terms, with second worst performance in expected 2009 full-year deflation after Portugal (although my estimate is that we shall see prices falling by 1.2-1.5% in 2009, not 0.7% as the Economist lists, so my estimate actually pushes us below Portugal); and
• the second worst in terms of expected unemployment for 2009 (we are, hopefully, not going to fall deeper than Spain here).
  

So run by me again - we will be in trouble only after the rest of APIIGS?

Daily Economics 27/04/09: Brian Lenihan/NAMA and US opening

GM debt-for-shares swap as an illustrative example for Irish banks?
General Motors is offering an interesting insight into senior debt recovery rates in the US. The company has offered to swap some $27bn worth of new equity in exchange for old debt at 225 common shares per $1,000 in debt - effectively implying a recovery rate of 45% (at flat current price per share of $2.03) on its senior debt. Now, factoring in the dilution effect of the new shares, this implies a discount rate of ca 65-70% on the existent debt.

The lesson for NAMA: although Irish banks are not in bankruptcy, like GM, much of the stressed property-linked assets are virtually there already. If NAMA were to buy these at a discount of 15-30% - the numbers rumored out there in the NAMA-proximate worlds of Irish finance, such a discount would imply that the Irish state believes our property development and investment loans to be some 220-430% more secure than the senior debt of one of the largest corporations backed by the US Federal Government cash.

Being realistic was never a strong point of this Government, I guess.


Brian Lenihan on NAMA: per Reuters report on Brian Lenihan's statement to the RTE yesterday, in addition to repeatedly referring to 'pounds' as Irish currency, our Minister for Finance has managed to state that 'if we nationalise BofI and AIB outright, our entire banking system will be 100% nationalised' (I am using an audio recording transcription here, so the quotes are not exact, but preserve the core of his arguments). Hmmm... one would have thought that the Minister who extended banks guarantee to 6 banks (not just AIB and BofI) and who should be aware of the significant presence of non-Irish banks in this economy would be more careful in phrasing his statements.

'I believe it would be very difficult for Ireland to attract funds from abroad, much more challenging, were we to do that.' Now, in effect, as BL points out (hat tip to him), this amounts to an admission that our state is now at or near the limit of its borrowing capacity. Of course, achieving a miserly 110% cover in 9-year bond last week (a bond of very small volume, one must add: see here) suggests just that, but... an admission from the Minister is an all together new dimension to the state borrowing saga.

on the matter. Now, Funny, of course, the Minister should take the same stance as his adviser, Alan AhearneNAMA would require borrowing ca Euro56-60bn to finance a bond-debt swap, with additional Euro4-8bn in post-NAMA recapitalization. A nationalization outright would involve borrowing just Euro2bn to cover existent equity and Euro5bn to shore up some of the capital losses due to transfer of equity and writedowns on the loans books totalling 50% (while driving Capital ratios down to 8% statutory requirement). If we face tight borrowing markets, surely the logic suggest we should try borrowing Euro8bn rather than Euro68bn?

Ah, logic, as well as economics and finance, and fiscal policy and management of public expenditure, are apparently not the strongest skills in DofF - either at the top or at the bottom... So what is then?


Ireland's corporate insolvencies as predicted back in March, here, (actually, I made a more detailed prediction of the rates of insolvencies increases in 2009 in the December 18 issue of Business&Finance magazine pages 42-43, available here, and that forecast itself was building on the defaults model I created when forecasting corporate defaults back in the spring 2008: here scroll to page 10), Irish companies are facing a dramatic rise in insolvencies in 2009 and the rate of bankruptcies is rising. Table below - courtesy of FGS says it all - Q1 2009 number of insolvencies was 170% above that for the same period of 2008.

Back in December 2008, my forecast was for the average rise of 247% in 2009 across the main sectors of this economy. We are now well on the way to meet this prediction.

Table below summarises two of my previous forecasts, with the later one still holding nicely, in my view... and yes, for those of you aware of it - the first forecast is, judging by the table color, from an even earlier publication (June 2008).

US news front has worsened substantially last week and the stocks snapped their weekly gains accordingly.

Friday’s figures showed demand for durable goods falling 0.8% in March in a seventh monthly decline since July 2008. New orders posted declines in virtually all sectors. Shipments were down 1.7%. On what appeared to some to be a more positive note, inventories fell 1.1% and capital spending by businesses rose 1.5% posting a second consecutive increase, albeit on an abysmally depressing fall-off in January. Both, in my view, are not signs of strength, but of the moderation in the rate of industrial production slowdown. Inventories declines are hardly significant, given rapid and drastic cuts in capacity over the previous months.

The rate of banks closures accelerated. American Southern Bank of Kennesaw, Georgia, was shut down with assets of about $112.3mln and deposits of $104.3mln. Then, Michigan Heritage Bank of Farmington Hills, went bust with total assets of $184.6mln and deposits of $151.7mln. Calabasas, Ca.-based First Bank of Beverly Hills bit the dust with $1.5bn in assets and $1bn in deposits. This time around, no institution stepped up to pick assume the homeless deposits. All within one day – Friday. But before the end of the week, FDIC closed Ketchum, Idaho-based First Bank of Idaho with $374mln in deposits. The grand total of failed US regional banks now stands at 29 since January 1 and 54 since the beginning of this recession. Not many green shoots (other than weeds) out there, amongst the smaller financials.

Now on to more fundamental stuff. I’ve done some numbers crunching and guess what: since 1981, for 27 years S&P500 has outstripped growth rates in the US and global economy in nominal terms. Over the last 27 years annual average growth in nominal GDP in the US stood at 5.8% (2.96% in real terms). Globally, it was 6.2% or 1.37% in real terms. Now, over the same period of time (December 1981-December 2008) S&P 500 moved from 122.55 to 683.38 – a gain of 6.53% pa on average. But this is excluding dividend yield. Thus, should S&P 500 return to some sort of a fundamentals-justified trend, index levels that are justified as sustainable by economic growth standards are in the range between 560-620. In the current range, the implied dividend yield should be around 1.6% pa over the 27-year horizon. In other words, if you think there is something in this economy to drive S&P500 beyond current levels, you better think of a GDP growth rate of 6.2% and a dividend yield of 1.6% in 2009… Otherwise, we are in the over-sold territory.

Then, of course, the US GDP fell 6.3 annualized rate in Q4 2008 and the consensus expectation is for a 5.1% decline in Q1 2009 – adding together to the worst contraction recorded in two consecutive quarters in over 50 years. We shall see this Wednesday when the figures are released.

The data will also give us the trend in inventories and consumer spending contributions to GDP growth. The latter is what many are pinning their hopes on to see the ‘greenish’ shoots of not the recovery yet, but of a stabilization in the rate of decline. Later during the week we will get weekly jobless claims, April consumer confidence and manufacturing sentiment. Of course, the US consumers got some $200bn worth of stimulus in tax refunds and cost-of-living indexation in Q1 2009. (Clearly, not the case in Ireland, where Government advisers, like Alan Ahearne think it’s a bad idea to help consumers by lowering their taxes – see here).

But offsetting the expected consumer spending stabilization will be capital investment. Although there was some increase in capital spending relating to durable goods in March (see above), capital investment is likely to take another hit in Q1 2009 overall, as January and February saw significant cuts in productive capacity by the US firms. Ditto the residential investment: UBS estimated last week that housing investments contracted 38% in Q1.

My bottom line: given that
• inventories did not contribute much to the decline in GDP growth through Q4 2008, and are now likely to show serious deterioration;
• consumer spending is unlikely to post significant upsides despite personal disposable income increases;
• housing and business investment continue to contract; and
• exports are falling precipitously, while most of imports demand contractions have already taken place,
we can expect a 4.9-5.2% fall off in Q1 2009 GDP.

Good luck hunting when the markets open today.