Economics 10/09/09: A dive into CPI discovers ESB and B Gais monsters

Consumer prices posted the first increase in August - up 0.4% mom on July or double the consensus forecast. This is the first monthly rise since September 2008. Prices rose helped by the nasty predictables, though:

• mortgage repayments were up 3.4% on average - although mortgage repayments are still down 48.2% yoy, the latest tick up is a clear sign that the banks are starting to 'repair' their margins and are driving cost of mortgage financing up - bad news for already demoralized consumers;
• the above trend is likely to accelerate: Irish banks' mortgage rates were the third lowest in the EU in June 2009 (only Portugal and Finland had lower average rates), but this is somewhat simplistic of a comparison as majority of current borrowers in Ireland are taking or holding variable rate or tracker mortgages. In contrast, in other countries of the Eurozone, much higher percentage of mortgages issued are in fixed terms of much longer duration than those in Ireland. But one has o be also concerned with the riskiness of Irish mortgages to the banks - Irish banks spot 173% average loans/deposits ratios and this is a mad level of leveraging for the sector, comparable to the worst 'offenders' - the poorly performing UK banks;
• a bit more on housing costs: "In the month, price increases were recorded for liquid fuels (i.e. home heating oil) (+9.4%) and mortgage interest (+3.4%). Price decreases were recorded for rents (-2.4%) and bottled gas (-0.4%)." Rents falling - bad news for housing markets then;
  
• ex-mortgages (HICP) was up 0.2% in August in mom terms (yoy term we are still in deflation at -2.4%, for comparison Euro area overall HICP is down 0.2% yoy in August - 12 times less than Ireland's);
• but this August things still were worse than a year ago - back in August 2008 mom inflation was 0.5%, this August it is lower at 0.4% despite a massive deflation since then.

In addition to the above main points, other worrying things are in the pipeline for inflation.

Transport costs rose 1.1% mom due to higher cost of fuel (as some analysts claimed in their rushed notes). Alas, CSO detailed sub-indices show that it was not petrol that was the main culprit: "In the month, price increases were recorded for air fares (+7.0%), bus fares (+3.8%), petrol (+1.7%), maintenance & repair (+1.4%), diesel (+1.2%), other vehicle costs (which includes parking fees and car rental charges) (+0.8%) and motor cars (+0.4%). Price decreases were recorded for other transport (-4.3%), spare parts & accessories (-1.8%), sea transport (-1.6%) and bicycles (-0.7%)." So in short - private sectors are still competing on price, but state bus monopoly is ripping off the customers, while airlines are scrambling to cover losses.

"Education costs decreased by 0.3% in the month and increased by 3.9% in the year to August 2009. This compares to an increase of 6.5% for the year to August 2008. A price decrease was recorded for other education & training (-0.7%)." No savings on third level or any level education in sight then which means - wait, CSO won't tell you this in their summary -

• cost of primary education in this country has gone up by 7.6% yoy in August 2008-August 2009 period;
• cost of secondary education went up 7.1% yoy;
• cost of third level education is up 4.5%

We really are doing everything possible to increase the level of educational attainment for kids and adults in Ireland, aren't we?

Of course there was no easing of costs of our two grand state monopolies: ESB and Bord Gais. Year on year, the former dropped 10.9% and the latter rose 6.5%, so given their weights in expenditure, the basket of these two energy sources lost roughly 5.2% of its value. But in the same period of time, oil dropped 36% and gas dropped 63%, so the actual spot market price savings on the basket should have been around 44.9%. Ok, allow for a profit margin of a whooping 10% (we are in a recession) and a cost margin of 15%. Still, you get something to the tune of 25-27% savings that is not being passed onto consumers by ESB and Bord Gais.

Ah, the costs of our glorious state monopolies. I know, some will stop reading here, but - folks, the Exchequer (the same one who is 'protecting' taxpayers interests in Nama, allegedly) is the sole owner of these rip-off monopolies! Shouldn't Brian Lenihan 'protect' taxpayers from their abuses? That would give him at least some credibility in claiming that he actually acts in the interest of this country's people...


I must confess - after Pat McArdle's retirement, I stopped quoting from the Ulster Bank notes. But here is a rare exception: "For the year as a whole we expect an average consumer price fall of 4.2% [CPI, I presume], which would represent the greatest decrease since the 6.4% drop in 1931". A nice piece of history, folks, and possible a good forecast target too.

Economics 09/09/2009: Snakes/Economist Hiding in Tall Grasses

Per previous post: let me give a quick clarification. The tip I received on carbon tax trade-off is a tip. It is marked as such. I have full confidence to trust my source on it, though. Do read analysis - Carbon Tax is coming and it will be a compulsory and consumer-abusing tax, as even in theory, there will be plenty of people who will never be able to modify their behaviour to avoid it.

Now to something that I was holding back for some time, but few people have urged me to post.


I must confess that with some bemusement and irritation I observed the last couple of weeks of debates about Nama.

No, it is not the stranger than Alice-in-Wonderland world of our media that has swallowed line, hook and sinker the selling pitch of Nama-we-need-it-sooo-desperately by the DofF and numerous stock brokers that got me in the end.

And not the fact that the pro-Nama camp had to drag out Garet Fitzgerald out to drum up few obvious and irrelevant factoids about the deficit and string onto them a whoopingly outlandish conclusion that absent Nama we’ll have IMF running Ireland.

In reality, of course, with Nama, someone like ECB (not the IMF) will run Ireland. Flushing over €20-50bn into the proverbial toilet of rescuing shareholders and bondholders of Irish credit institutions (yes, this is how much Nama is likely to cost us in the end) will make us completely broke. As someone aptly remarked some time ago ‘what can’t go on usually doesn’t’.

Nor even the fact that we have politicos accusing economists for causing the current crisis and trying to shut down any debate about Nama in the name of patriotism. I thought we passed that stage of the infantile debate with our dear leader Bertie Ahearne a couple of years back.

And even Alan Ahearne’s embrace of a Nationalist idea of the state-bailed ‘Irish banking system for Ireland’ leaves me not as flustered, for one would expect it from the former US Fed employee after all (I am being sarcastic here).

No, all of these egregious abuses of public debate and media mandate pale in comparison with the ridiculous accusations – raised on air by an RTE presenter and in print by a newspaper editorial – that the 46 economists and academics who signed the Irish Times letter somehow withdrew from the debate once the Government hacks came back with irrelevant answers to irrelevant questions.

What these journalists missed is that:

1. The new ‘pro-Nama’ answers contained in Alan Ahearne’s email to the ‘colleagues’ urging them not to sign the Irish Times oped were nothing more than a set of PR cues issued by the public officials following the publication of Nama legislation. Virtually word for word. The Journos, extolling the virtues of Ahearne’s response didn’t have a clue they were being led on a short leash by the Government spin doctors;
2. No one has withdrawn from the debate on Nama, and moreover, as customary, the Gang of 46 has engaged directly with both the media and the public in explaining their views and providing feasible alternatives to the Government’s Nama vision.
   

To the second point: in the week when 46 economists ‘hid in tall grass’ per RTE and the Irish Independent, Karl Whelan and Brian Lucey were very much active in the Nama debate.

But perhaps even more surprising to the said two media outfits would be to find out that I too was busy. Here is a picture taken by my wife in the middle of Friuli wine yards of North-Eastern Italy…
Wait for it – I was doing an interview about Nama on RTE Drivetime, on the same day when RTE’s other august show ‘could not find a single one of the 46 economists’ to talk about Nama. For the record, the other show's guys did call my mobile number twice, but never left a message. And this means that when I called their 'registered' RTE number back, I had no idea which programme called me in the first place – a silly waste of a €1.50.

Oh, and here is the link to my article on Nama published by, wait for it, …the Irish Independent a day after the Irish Times letter of 46 and a day before and a week before the two editorials telling the world that 46 economists have gone into hiding scared off by Alan Ahearne-Brian Lenihan PR blitz.

Well, readers of this blog would know that in the two weeks of my absence from Ireland (physically) I produce 11 blog posts on the topic of Nama.

I also did a briefing for an investment manager in the US and another appearance by phone on a radio programme in Ireland, both dealing with Nama within a day after the Irish Times article publication took place.

I know this is a bit of 'hiding in the grass' by our extremely workaholic journalists' standards, but 11 posts, 3 press articles, several radio appearances and series of professional briefings on Nama in two weeks is, sorry, a bit more than the average number of articles Indo's own columnists produce in a given two weeks period of work, let alone during a family vocation. And they are full time journos, while I am a mere freelancer on the side! Tall grass, gents?

In contrast, Messr Lenihan and Ahearne were allowed (as they are entitled to) uninterrupted taking of their family vacations after publication of Nama legislation. And not a single journalist or politico now accusing the 46 economists of ‘hiding’ away from the debate have voiced a single question as to why neither Lenihan nor Ahearne have never appeared to face any one of the Nama critics from the academic side or professional side in a public debate prior to the publication of Nama legislation?

As anyone who hiked the Wild West knows – tall grass and stealthy snakes usually appear to those who fear them most.

Economics 09/09/2009: Has the Green Party Leadership Sold the Country for a Broom?

Gutless and short of any sort of vision!

The Green Party leadership (per RTE here) has announced a series of "significant changes" to the Nama bill. So what are those significant changes, then?

Before we dive into the details, here is what the papers are not telling you - Green Ministers, the birdie has chirped (hat tip to KOD), received a trade-off from FF: in exchange for introducing a Carbon Tax they signed off on Nama. Why this is the bad news for the Greens and the country? Two reasons:

• First a minor one - Nama is infinitely more important to this country than the Carbon Tax, so much so, that the Greens' leadership in effect sold family jewels to buy a new broom;
• Second a major one - Carbon Tax is simply another punitive unavoidable tax for this country. Do not confuse it with some environment improvement incentive measure. Here is why. If Carbon Tax were to be a true behavior modification tax, then at least in theory its introduction should induce people to opt for greener alternatives: use of more public transport (that should be less polluting), more telecommuting, more energy efficiency etc. All of these are good things. But the problem is that a family that works in Dublin and, because of past FF policies was forced to buy their house in Cavan (for example), there is no alternative to driving and there is no alternative to switch to 'cleaner' energy. Indeed, with ESB (legacy of FF) in charge of generation and Eirgrid (legacy of FF) in charge of the grid, we have no real less polluting alternative. So Carbon tax will be unavoidable to many of us and thus it fails as a real 'behavior modification' tax.
  
• (Note 1: Carbon Tax is not a punitive tax for middle class Dublin and Cork voters - core Green constituency, so the question I would ask Messr Greens - are you selling the entire country in hope that your small number of voters will swallow the pill?)
• (Note 2: Has the Green Party leadership signed off on Nama before their general party meeting in an attempt to prevent democratic process within the party forcing their leadership to take a more ethical position on Nama?)
  

Which brings us to the conclusion on this sad chapter in Irish Green Movement history - Ministers Ryan, Gormley, Sargent and Senator Boyle did indeed agree to Nama in exchange for being allowed to levy another consumer-abusing tax that will feed general budget hole left by the grotesque spending commitments of this Government.

Now to the news:

Just minutes ago Minister Ryan has told the nation that Nama is ok because Ireland will be getting money from ECB at a very low cost. This is the long-mulled 1.5% assertion. To remind you all - Nama supporters have for some time made the claim that Nama will come cheap - at 1.5% ECB financing rate. Of course, they won't tell us the term. We are in the dark as to how long will the maturity of these bonds be.

Here comes the flashlight: 1.5% charge is consistent with 9-month paper. This will be fine, if we are borrowing to cover short term liability. Or if we were looking at ordinary sort of repos volumes, so that rolling the bonds issued at 1.5% would not be a problem on an annual (or even less) basis. But hold your breath -

• We will be rolling over some €55-70bn in Nama paper annually! Plus whatever we get to borrow on short term to finance our ordinary deficits, say odd €15bn. Total amount of Irish bonds to be rolled over at the end of 2010 can thus be €60-85bn, in 2013 this amount will reach €104-120bn once interest is rolled up - that means that by 2013, 34-39% of Irish expected GDP will be rolled over in short term bond markets! I thought, honestly, that borrowing short to buy long term assets has gone out of fashion some time ago in the current crisis!
• A 1.50% is a premium of 1.25% over the ECB rate, and 50bps above the ECB fixed rate tenders. Back in Fall 2008 - amidst raging crisis, ECB rate was 3.25% and tenders were at 4.75% in October 2000. What happens if we go back there? In say 5 years time? By then, cumulated roll over will amount to €120-135bn and our 2016 interest bill on this Green Party legacy will be €5.3-6.4bn. That is interest charge alone!
  

Finally, let us look at the last set of news on the Green Party leadership shameful surrender. Per RTE site report: "Minister Eamon Ryan said the new measures would increase the protection afforded to the taxpayer." How? Apparently via:

• The introduction of risk sharing between the banks and NAMA: "in the case of a small proportion of the loans, the banks will not get all the money immediately. Whether or not the banks would get a further payment would depend on whether NAMA is successful.
• A windfall tax of 80% on profits will apply to developers where they gain from land that is rezoned.
• The amount of money NAMA can borrow will also be cut from €10bn to €5bn.
• The new agency will be obliged to report to the Minister for Finance every three months instead of the annually as included in the earlier draft legislation.

What does all of it mean?

First bullet point above: remember that 'levy' on banks that was deemed unfeasible because it creates an implicit option on the banks? Well, the same, in converse, applies to this risk-sharing scheme. If a share of proceeds issued to the banks will be held back, it simply cannot be brought into banks capital reserves without adjusting for the risk of Nama failing. What should such risk adjustment assume about the probability of Nama failure (which will mean banks don't get that extra cash)? Go back to my and other's estimates of the expected losses under Nama. Even Davy Stockbrokers earlier showed that Nama is likely to generate a net loss of ca 5bn. So even by Nama cheerleaders assumption, Nama cannot be expected to work. Thus, the proposed risk sharing scheme will never pay out that share of funds 'held back'. In other words, the expected value of the 'held back' share is Nil!

Further problem arises in the context of the Nama being lauded by various financial analysts (stock brokers etc) as the 'liquidity' event. In other words, it is supposed to solve the problem of our banks' balancesheets and inject liquidity into banks. Now, the amount to be injected will be reduced by exactly the amount of this 'held-back' payment. So if Nama was to be a success because it was injecting liquidity, holding this liquidity back certainly constitutes now a failure of Nama.

Lastly, Nama was supposed to reduce the risk of banks coming to the Exchequer and asking for direct recapitalization. The more 'risk sharing' is involved, the lower will be risk-weighted capital and the greater will be post-Nama demand for recapitalization. So, again, if Nama was in the first place to reduce secondary round of capital demand, new risk-sharing scheme will increase it.

Second bullet point: folks, I thought we were told that developers are not being rescued by Nama. So which profits are they taxing? You can't, Minister Lenihan, have a cake and eat it. Either Nama will rescue the developers (by helping them achieve profit in which case an 80% tax makes sense) or it will not rescue developers (in which case there will be no profits and an 80% tax makes no sense). I wonder if Eamon Ryan actually gave a single thought to this absurd proposal!

Third bullet point: this is irrelevant, because the proposed bill allows Nama to borrow unspecified (unlimited) amount of money in the future with approval of the Minister. So who cares if they can borrow 10bn or 5bn on day one of their operations if they can borrow 30bn more on day two of their existence? Again, have Ministers Gormley and Ryan actually given a single thought to what they were signing?

Fourth bullet point: reporting to the Minister for Finance (behind the closed doors and no public scrutiny) is simply short of proper transparency and accountability procedures. It does not matter how often it is done. Putting a phone connecting two windowless and door-less rooms ain't going to let any light into either one of them, Messr Gormley and Ryan.

So to sum up - we now have it on the record. Ministers Gormley and Ryan, alongside the rest of the Cabinet have signed off on a document that will:

1. Coercively take ordinary people's incomes;
2. Clandestinely pass the money over to the banks;
3. Creating a buffer of opaqueness and evasion of responsibility and accountability between themselves and us, the taxpayers;
4. The banks will have no incentive to lend to the economy, the households will have no money to pay the bills - a new wave of mortgage defaults and personal loans defaults will be rolling over the banks. The economy will stagnate. Property markets will stagnate. Emigration will be back with the 1980s vengence.
   

Full stop. Nothing else worth adding.

Economics 03/09/2009: Irish Exchequer - Sliding into an Abyss of 'Positive' Group-think

The Exchequer results are in and some analysts – the usual suspects – are saying all’s well, we are hitting the target (set in April Budget). Well, not so fast. August showed some improvement, fully due to the outlandishly rising corporate tax receipts. These, of course, might be due to the forwarding of the returns, or they might be due to increased flow of transfer pricing. So either we are becoming an accountancy trick economy (with constantly changing dates of filings to suit the Master Cowen’s whims) or we are more and more of a banana island (with increasing dependency on multinationals booking more profits through this ‘non-tropical paradise’). Take you pick.

But on the net, headline figure is that we are now 2% below the April 2009 target on overall tax – an improvement on 3% in July 2009, but still worse than 1.2% in June. Go figure what the headline tells us.

Here are some trends.
Chart above shows clearly that ALL tax heads, save for Corpo and Capital Acquisition Tax are still heading down relative to the April target. Income tax has gone from -2% below target in June to -2.8% in July and -3.5 in August. VAT from -3.5% in June to -6% in July to -5.7% in August. Excise was 3.9% ahead of target in June, then 4.4% in July before collapsing to +3.1% in August. Stamps shortfall on the target was -10.3% in June, -17.3% in July and is now -24.4%. For an economy that used to be run off this completely absurd tax, this is as quick sand territory. Customs progressively slumped from 7.4% deficit on the target in June to 12% deficit in August. Improvements, my eye, are evident everywhere. If, that is, you are a hired gun for one of our clientelist organizations of the State.

Chart 2 shows year on year changes.
May be here we can find some improvements, for August 2008 was a full-crisis year and Messrs Cowen and Lenihan have been at pains telling us that we have bottomed out? Ok, let us put this one into a table to see better
Three heads improving, five heads are still getting worse. Judge for your self if we should sound the trumpets of a ‘bottom’s here’ march, yet.

Of course, the main figures are: how much we spend over what we bring in (aka our deficit) and how much we borrow to finance, in effect, massive waste of public resources on unreformed and uncontrollable public sector. Chart 3 below shows these two series.
Look at the two green lines: the solid one is our borrowing so far this year (cumulated) and the dashed one is our borrowing in 2008. Any questions? For those who are so ardently happy to argue pro-Government positions, we are now borrowing more and at a faster rate than in 2008. How on earth can this be if Messrs Cowen and Lenihan have declared the ‘bottoming out’ back in May 2009? Well, only if they themselves do not believe their own spin.

Looking at the two red lines, deficits cumulated from January for 2008 and 2009, it is absolutely clear that the rate of deficit increase has not slowed down since June, but actually accelerated! In August, the deficit increases were outpacing those in August 2008. And we thought that August 2008 was pretty bad.

Now, may be Fionnan Sheehan of the Indo can go now declaring that the Government has carried out some sort of a new policy Blitz, but to me the Irish State remains insolvent and it actually is getting worse, rather than better.
Chart 4 above shows clearly how on earth can our ‘bottoming out’ economy be performing so much worse in fiscal terms even after massive tax hikes and fig leaf decorations of ‘cuts’. The answer is in the distances between solid and dashed lines. While total receipts have fallen year on year in 2009 (and this process is actually accelerated in August 2009, despite of and contrary to the analysts and Government’s cheerleading), total spending has been running well above 2008 levels and the rate of total spending increases is running stronger than in 2008 since the end of April.

Allow me to sum up the situation:

• Receipts are below 2008 and falling faster than in 2008;
• Expenditure is above 2008 and rising faster than in 2008;
• Capital spending has been dramatically cut, so the expenditure increases are all due to two factors:
  

1. a rise in unemployment and social welfare claims – something that is a fault, to some extent, of the Government’s failure to introduce proper economic policies aimed on supporting Irish employers (lowering cost of doing business in this country and reducing taxes on producers and consumers); and
2. lack of real reforms in the public sector pay, pensions and perks, as well as employment numbers.
   

Doing some real sums, per Exchequer end-of-August 2009 statement,

• Irish public spending (gross) was, in 2008, €29.7bn on current expenditure side, plus €5.5bn on capital side, to a total of €35.2bn total gross spending. Tax receipts were €24.8bn. Total deficit (not counting in double-trip tax clawbacks and other ‘non-tax revenue’ that is a pure accounting procedure by the Government) was €10.4bn.
• Gross Irish public spending in 2009 was €30.7bn on current expenditure side, plus €10.8bn on capital side, to a total of €41.5bn total gross spending (a rise of 18percent yoy). Tax receipts were €20.8bn (a fall of 16% yoy). Total deficit (not counting in double-trip tax clawbacks and other ‘non-tax revenue’ that is a pure accounting procedure by the Government) was €20.7bn a rise in deficit of 99% yoy.
• 2008 deficit by August 31 has reached 6.65% of 2008 GNP and 5.55% of 2008 GDP; this year, by the end of August our deficit has reached 14.38% of projected GNP and 12.11% of GDP. Now, Dr Garett Fitzgerald might think it is irresponsible to look at our figures from different angles, but you tell me what’s more irresponsible – to deny there is a massive problem in the way we run this country, or to highlight these figures from various perspectives?
  

Note: I use gross deficit figures, but these are only slightly worse than the net figures.

This is the direct outcome of the courageous and resolute actions taken by this Government in its April 2009 & October 2008 Budgets, the necessary reforms of the public sector enacted by Messrs Cowen and Lenihan, and wondrous pro-business policies implemented by Mary ‘Have you Heard of Her Lately?’ Coughlan.

Now, allow me to conclude by saying the following. What the exchequer figures continue to show is that the fiscal policy in this state remains on the path of insolvency. Alan Ahearne, other advisers to the Minister for Finance, are either not doing their jobs or are ineffective in doing their jobs. I will let them take a pick as to which option they prefer. Brian Cowen and Brian Lenihan can score as many brownie points with the journalists as they would like, but – clearly people like Fionan Sheehan are beyond the point of understanding this simple reality – the question as to whether the deficit is going to be €20bn or €30bn this year is secondary to the facts that:

1. The Irish state is insolvent and cannot be made solvent by increases in taxation;
2. The Government cannot be trusted to balance its own books, let alone to ‘invest’ €60bn-plus of our money into high risk junk-investment schemes, like Nama;
3. Whether they are on balance sheet of the state or on the balance sheet of NTMA (which is, of course, the state), Nama costs will only exacerbate our status as an insolvent nation.

Economics 02/09/2009: ECB legal eagles picking at the NAMA carcass

The ECB  legal opinion note on Nama provides some interesting reading.

Per ECB (§1.1) Nama is designed to “expeditiously deal with the assets acquired by it and protect or otherwise enhance the long-term economic value of those assets, in the interests of the Irish State”. Several things are going on here.

1. the ‘expeditious’ nature of Nama is referred to in Part 1 §2 (b) line (viii) of the draft bill and Part 2, Chapter 1, §10 (1)(b). However, §2 page 21 states: “
2. So far as possible, NAMA shall, expeditiously and consistently with the achievement of  the purposes specified in subsection (1), obtain the best achievable financial return for the State…” Has anyone spotted a slight contradiction? Assets will be disposed expeditiously, Nama will act expeditiously, but asset pricing will be based on long-term valuations. This is known as a maturity mismatch risk – the objectives are ‘expeditiously’ short-medium term, pricing is long-term.
3. As the ECB states, repeating Nama legislation language correctly, Nama will aim to guard the interest of the Irish state. Now, the State does not have the existent allocated means for such an undertaking, so to pay for Nama, it has to use taxpayers’ money in an emergency draw on resources. Since the Irish State is not spending on Nama the money that belongs to it, why should the State interests be protected by Nama and not those of the payee, i.e the taxpayer? Of course, the only way that Nama legislation makes sense from the point of view of protecting our property rights and liberty is if State interest = Taxpayer interest. This is, alas, not so. Irish State under the current Government has been run as a thiefdom of public sector unions and vested interest groups. This, of course, is not and should not be of concern to the ECB. But it should be of concern to ourselves, the taxpayers, and to the opposition.

Further per ECB §1.1: “As noted by the Minister, replacing property related loans with Irish Government bonds will strengthen the balance sheets of the banks”. So this is it, then, the ECB has clearly agreed that Nama bonds will not be off-balancesheet for the Exchequer, but will be ‘Government bonds’ and thus countable into the overall:

• Public debt;
• Future public bonds risk premia;
• Future demand for public bonds issued by the Irish Exchequer

Now, note that consistent with what minister Lenihan told the Oireachtas committee yesterday – something that the Government evaded saying out loud – the bonds will have to be ‘marketable’ in the open market, so their pricing cannot bear artificially low interest rates. This validates my (and other’s) earlier assumptions on long-term Irish bonds pricing for Nama at a coupon of 5-6%pa in 2021.

ECB §1.3 recognizes that Nama is planning to purchase a wide range of assets, including “any other class of assets” (other than loans and collateralized products). This, of course, opens Nama to political favouritism with the banks (in exchange for no layoffs and for not skinning their customers) and with the specific developers. It also, potentially, allows Nama to expand its mandate to cover mortgages and other loans. In the end, this little clause opens up a possibility to a wholesale redrawing of the already blurred boundaries between Irish businesses and the State.

The same paragraph in the ECB note also acknowledges that Nama will cover rolled up interest and re-financed products – a land mine when it comes to overall portfolio pricing and quality.

§1.10 states that “NAMA (or a NAMA group entity) may, with the  Minister’s  approval, borrow, with or without the Minister’s guarantee, such sums as it determines to be necessary for the performance of its functions (including debt securities borrowed from the Minister or NTMA and debt securities issued by NAMA or a NAMA group entity to provide consideration for the acquisition of bank assets).” What does it mean? Well, the first part (before the brackets) means that Nama can borrow funds on its own. The liability for such borrowing will fall on Nama or on the taxpayers. Care to tell what happens if Nama cannot meet its liabilities on borrowings not guaranteed by the State? Yes, right, the Minister will have to rescue Nama from Nama… using the taxpayers funds! Why would we allow a state-owned entity with defined remit an open access to borrowing?!

The bit in the brackets is also telling. It shows that Nama will be able to issue its own bonds (debt securities) and that it will be able to ‘borrow’ bonds from the Government. The latter, of course, means that the following scheme to finance Brian Cowen’s egregious public sector payoffs (oh, sorry – deficits) can be run:

Step 1: Nama, with a permission of Brian Lenihan, ‘borrows’ from NTMA freshly issued bonds.

Step 2: Nama ‘lends’ these bonds to the banks who then monetize them through the ECB;

Step 3: Banks ‘repay’ Nama with cash;

Step 4: Nama ‘repays’ the Exchequer;

Step 5: end game is: Brian Lenihan gets Mr Cowen more dosh to waste on public sector expenditures; Nama is clear, and the banks got a shave off the transaction. The taxpayers are, without being informed, soaked for the amount of bonds issued by NTMA.

§2.1 of the Note clearly is extremely guarded when it comes to assessing the potential effectiveness of Nama on liquidity markets and on the Irish banking sector. It does not show full credence of the ECB in the scheme’s ability to repair our broken banking sector. This, in itself, is understandable, as ECB is always reluctant to go out of its comfort zone endorsing adventurous member states’ plans. But it is a serious concern, given that the Government has no plan B should Nama fail to repair credit flow or inter-bank funding in the Irish economy. In addition, §2.1 is not really dealing with the issue of credit flow, but rather with the ability of Irish banks to access funding. So ECB is being cautious in endorsing Nama as a tool for clearing banks’ balance sheets, not as a tool for repairing the overall credit flows.

§2.4.3 is worth quoting in full: “Third, regarding the valuation of eligible assets, asset-specific haircuts on the eligible assets’ book values appear to be contemplated, and independent third-party expert opinions play a role in the valuation process for the NAMA scheme. The detailed provisions of the draft law regarding valuation issues reflect the fact that the pricing of eligible assets is a crucial and complex issue that is likely to determine the overall success of the NAMA scheme. Although the measures contemplated by the draft law should restore confidence in the Irish banking system, the ECB considers it important, in line with previous opinions that the pricing of acquired assets is mostly risk-based and determined by market conditions. The preference expressed in the draft law for the long-term economic value of assets, rather than current market values, requires careful consideration in this context. In particular, it should be ensured that the assumptions to determine the long-term economic value of bank assets will not involve undue premium payments to the participating financial institutions to avoid creating inappropriate incentives from their side as regards the use of the scheme.”

Several things worth noting here:

1. Unlike in the case of Nama effectiveness on economy and inter-bank credit, the ECB is clear that “the measures contemplated by the draft law should [not ‘might’] restore confidence in the Irish banking system”. This, of course, simply means that banks’ shareholders and bond holders will win unambiguously from Nama. And the economy and the taxpayers, well, they just might see some improvements… Any questions, anyone, as to who benefits?
2. The ECB is clearly unhappy about the ‘long-term economic value’ being used as a basis for pricing. The ECB is also clearly concerned that Nama pricing will provide an ‘undue premium payments’ to the banks – in other words, a pay off at the expense of the taxpayers. Now, per ECB remark, the entire process hinges on whether we can trust Nama (i.e Irish Government) not to skin the taxpayers to give a helping subsidy to its cronies (national banks). You be the judge if you can extend them this trust.
3. The ECB, alongside myself and other critics of Nama, and in contrast with the Government position, clearly states that ‘assumptions’ are crucial. Assumptions that go into pricing models are, of course, of preeminent importance for they will determine exactly the level of pricing deployed. The Government, to date, has not produced any basic assumptions to be used in pricing, other than those contained in overly optimistic statements by the Taoiseach and other members of the Cabinet. These, of course, have ranged from calling the end of Irish recession back in May this year, to a ridiculously uninformed estimates of the speed of property prices adjustments post bust in other countries (7-8 years estimate by the Government officials and consultants), 15 years plus estimated by academics (my own estimate based on IMF and OECD data for past busts since 1970 through 2003 is that for the serious busts similar to the one experienced by Ireland today, the correction takes on average 18 years and in some instances can take more than 20 years).

 To repeat here a simple mathematical exercise. If our current values are at 50% of the 2006-2007 peak, and we are to get back to the same peak values in 8 years, the required rate of growth in property prices to achieve this feat will be 9.1% per annum on average. To get to 80% of the peak price in 8 years requires over 7.6% annual average growth rate from 2010 on.

Oh, and as I’ve said before, this is before you factor in the cost of financing. At, say 5% pa, we are looking at double digit growth required annually on average for the next 8 years to get us to within 60% of the peak value in 2006-2007, let alone to 80%!

You be the judge if we can get such growth stats out of the property market, especially with Nama sitting on a pile of surplus properties, but to put it into perspective – the craze of 2003-2007 have not seen such rates of price inflation.

§2.4.4. clearly states ECB’s dislike of the levy idea as being potentially destabilizing to the banking sector. It is also hinting at possible illegality of such a levy as being a challenge to the need to provide a ‘level playing field’ for participating institutions.

§2.4.6 refers to the risk of political interference in Nama and the potential impact of Nama under political tutelage on banks in the longer term. This is related to the fact that the ECB is cautious about endorsing Nama’s economic effects. And the same is confirmed in §2.4.7, but this time around from the point of the banks themselves. Here the ECB is noting that Nama might lead to credit markets remaining tight as banks might focus on “preserving and rebuilding their own equity, instead of lending into the economy”. But, of course, the ECB’s note on this is not an accident – Nama legislation, that is allegedly designed explicitly to ensure restoration of functioning banking system in Ireland has absolutely nothing to say about this crucial factor. 

So on the net, I wouldn’t count the ECB note as a sound endorsement of the Nama plan as outlined so far by the Government. And I am not surprised – the entire idea of Nama, inclusive of the proposed legislation leave more questions unanswered and more concerns unaddressed than a first year undergraduate paper on how to manage the economy.

Economics 31/08/2009: Myths of Nama's Parrots

The Sunday papers revealed to me the bizarre lack of independent and critical thinking amongst our senior journalists on the matters of policy.

The best example was the Sindo’s editorial on the subject of 46 economists’ signing the article in the Irish Times last week. In effect, Sindo is of the view that publicly employed academic economists and finance specialists cannot criticize Nama. What’s next? As PMD puts it: "Publicly employed physicists cannot assert existence of gravity?"

To his credit, Shane Ross stands tall.

In the mean time the Sunday Tribune article (here) exemplified some of the ‘new’ mythology of ‘official’ Nama position, while simultaneously revealing the lack of media’s ability to question the spin fed to it by the officials. These are worth dealing with in some more detail than Sindo’s article:

Myth 1: The ‘official’ version of Nama now claims that LTV ratios on Nama-bound loans were low, so the face value of the loans covers actually greater original value of the collateral. "But while the loans are for €90bn, the properties secured on those loans cost considerably more (we are not talking about 100% mortgages here).”

As far as I know, this 'arithmetic' was first floated at the official briefing for the journalists by the DofF. 

There is absolutely no evidence that the developers took 75% LTV ratios. Despite this, my earlier post (here) has dealt with this, showing that even at LTV ratios of 50-60% it is unlikely that Nama will be able to break even by 2021. Or for that matter, under majority scenarios until much later than that. Given that some people who’s incomes will be used to finance Nama will by then have lost their

• Savings;
• Pensions;
•  Homes

to Nama – due to the need to finance Nama costs out of our current income, implying much higher taxation – what measure of democratic accountability, equity, fairness etc can compel this Government and DofF to make such claims is simply unimaginable to me.

Contrary to DofF briefing claim on low LTVs, there is plenty of evidence from property consortia and from court cases (e.g Mr Carroll’s) that much higher LTV ratios were used in practice. In many cases the percentage that was not lent on the property directly was made up of additional cross-collateralised loans to the consortia itself, other members of this consortia or to the original borrower (developer) in a personal capacity. There were multiple cases of the same property being cross-collateralised for multiple loans.

Take a 'clean' (as in completely transparent, free of double-borrowing and cross-collateralisation) example. 

If a property was purchased for 100K in early 2005 at 50% LTV and rezoned, this ‘asset’ would have seen its market value rise 3 fold. In late 2006 this property would have the value of 330K and a loan of just 50K. The surplus value or equity of 280K could have been re-mortgaged at, say 50% LTV again. Total loans written against the property would total 190K. The surplus equity of 140K could have been borrowed against again in 2007 at, say 50% LTV ratio, resulting in a total loan volume of 260K. What is the overall LTV ratio on this property? At 2006 value of the property: we have LTV ratio of 79% in the end of these simple multiple loans trips each one of these loans was 50%.

Now, suppose Nama buys these at a 30% discount on the loan value, i.e. for 182K. Nama is instantaneously in the negative equity to the tune of 82K, or 45%.

The property market (depending on the type of property) is now around 2000-2004 (well below 2005 levels). How much below? Well, let us say 10% below. So the underlying property is now worth… 90K, and the negative equity is now 92K or 51%.

What is the rate of growth in the market we should expect to get back from this level of negative equity to a nominal break point on Nama? For 10 year horizon – an annualized rate of +7.2% per annum. For 15 year horizon +4.7%, for 20 year horizon +3.5%.

If inflation averages the ECB target rate of 2% pa over the next 20 years, we need a property prices growth of 5.5% per annum minimum for Nama to break even on this “50% LTV ratio loans package” in 20 years time!

Myth 1 is busted.

Myth 2: property crashes are benign… "Previous property crashes in London, Paris and Stockholm suggest that, within 10 years, prices recover to 30% below the top of the bubble".

I have shown in another post (here) that this is not consistent with the evidence from the past busts. So let me not repeat myself here. Furthermore, do any of us really believe we will get back to within 30% of the madness of the 2006-2007 markets ever again?

Instead, consider the statement itself.

First, this refers to nominal prices. Real prices (inflation adjusted) are much slower to recover.

Second, this refers to a simple price recovery. 

But Nama is about more costs than just the cost of loans bought. It is also about a cost of loans financing. So, suppose we take DofF and the journos for what they claim. 

Suppose our property prices will be back to 30% below the top of the bubble in 10 years from now. At 5% per annum the cost of bonds financing for Nama, 0.75% per annum cost of recapitalization financing (ca 8% shot – one off in 2010, taking into account the present value of this cash, recapitalization will actually cost closer to 1% pa over the 10 year horizon, but let us give the difference as a margin of error in favor of Nama). We have: the original (2007 value) 100K loan with LTV of 75% (DofF number) worth 75K on bank’s book today will be purchased by Nama at a 30% discount for 52.5K in 2010. Within 10 years time, property value is 70K. Nama can sell property for this amount and pay down 52.5K of the original loan purchase prices. Except, by then, Nama would have accumulated additional 33K in interest charges on bonds… 

Total loss to Nama on this transaction = 70K-52.5K-33K=15.5K, so Nama will still be posting a 30% loss on its operations.

Myth 2 is busted.

Myth 3: Bond markets do not like privatizations and they love Brian Lenihan’s policies. "Within five days of Anglo Irish being nationalised, the rate which Ireland is charged for borrowing money internationally had risen."

Firstly, while it is true that the bond spreads rose when the Government nationalised its not at all evident or even apparent that this happened

1. Because we nationalised Anglo or   
2. Because we had to nationalise Anglo.

In other words, did Irish Government bond spreads reflect the Government new exposure due to nationalization or did they reflect the fact that nationalization simply showed to the rest of the world just how sick our system really was.

Put differently, did the cardiogram go off charts because the patient went into a cardiac arrest, or did it go off charts because the patient was connected to the machine reading the cardiogram?

Recent research from the ECB (cited by me in the press and here on this blog before, you can find the original paper in the The Determinants of Long-Term Sovereign Bond Yield Spreads in the Euro Area.  Monthly Bulletin, pages  71–72, July 2009) showed no evidence that Ireland’s critically elevated levels of bond spreads at the time before, during and after the Anglo nationalization were somehow out of line with the general model. They were, per ECB model, reflective of the fundamentals in Ireland, not of the ‘nationalization’ one-off episode.

Incidentally, similarly, Greek, Spanish, Portugal’s and other APIIGS’ countries spreads rose at the same time as Irish and in similar proportions. They didn’t nationalize their banks… So what is the DofF talking about here and why is our media parroting this claim as some unquestionable truth?

Now, one of my TCD students has just completed a research paper applying the ECB model to Irish bond spreads. The break point in our bond spreads occurs about the same time that it occurred for other APIIGS -  October 2007. Not that close to Anglo event…

What is also interesting is that the current period of ‘falling spreads’ for Ireland – lauded as a sign that the Irish Government is being trusted by the international markets in all its hard work to destroy our private sector economy… ooops, sorry, to ‘correct our fiscal deficit’ in Leniham-speak, is really fully in line with just one factor – the overall improved sentiment in the global markets. Our ‘leadership’ clowns are riding the coat tails of the US and EU ‘bottoming out’ euphoria, not some miraculous change in sentiment to Ireland they are going to leave behind to the next Government.

Myth 3 is also busted.

Myth 4: "There is a reason why no country has nationalised its entire banking system."

Now, our own journalists simply do not treat other banks operating in this country as a part of the ‘banking system’… Just think two events in the recent past when scaring kids with ‘foreigners’ was en vogue:

1)    Anglo’s “shortsellers from New York and London are out to get us”. Of course it turned out that the shortsellers from abroad were spot on right about their reading of the bank’s position, while all the damage done to the Anglo was done from inside the bank – from its own senior management;

2)    American ‘vulture funds are swooping onto the wounded Irish banking system’. Of course were they to take our sick banks over, we wouldn’t have a need to cull family budgets for generations to come to finance Nama… wouldn’t we?

Every time someone says ‘we need to protect our national [insert any business-related noun here]’, I know I am smelling a rat. ‘Protecting national banking’ means, as Nama clearly illustrates, vast transfer of income and wealth from ordinary people of Ireland to shareholders and bondholders of these banks. I have nothing against the latter two groups of fine people and institutions, but I certainly do not love them enough to sacrifice my son’s college tuition fund and my own and my wife’s pensions to bail them out.

In reality, of course, the idea that ‘nationalizing’ 6 banks in Ireland will leave Ireland with no privately-owned banks is bonkers. Ireland has significant international banking sector that would be even greater in size were we not shielding BofI and AIB from competition through supporting their legacy positions. Furthermore, under my Nama3.0 proposal (see here), we would not nationalize any of the banks at all. We would simply change their ownership from that of the few who took wrong risks to that of the many who are now expected to pay for the mistakes of the others.

Myth 4 is busted.

 

Myth 5: "But the nationalisation option throws up enormous difficulties. The state would have to pay in the region of €5bn to shareholders of AIB and Bank of Ireland,"

Under my Nama3.0 proposal, we would first force the banks to take writedowns, then use remaining share holders’ and bond holders’ equity and debt holdings to offset these losses, then use private investors and swap-participating bondholders to recapitalize the banks. Only after that will there be a cost of the taxpayers. At any rate, this cost will be much lower than the 60bn cost of Nama purchases, plus tens of billions in bonds financing costs associated with Nama.

Furthermore, let us not forget that after Nama we will have to recapitalize the banks no matter what and that this recapitalization is likely to cost us well in excess of 5bn itself.

After all, we paid nothing for Anglo in excess of direct recapitalization costs involved, which are much lower than the cost of Nama buying Anglo’s loans and ‘managing’ them. Furthermore, the same costs were paid to AIB and BofI as well, despite these banks remaining 'private'.

Myth 5 is busted too.

Myth 6: "There is a reluctance to lend money to banks that do not have the transparency that stock market membership brings, and that are viewed as being open to political interference."

This is false.

1. Irish banks and banking institutions - listed or mutually owned - are not transparent already, as the Anglo saga clearly illustrated, as AIB repeated blunders in public statements have clearly highlighted and as the reluctance of all of these banks to take realistic writedowns on the loans attests. Were the Tribune folks actually to give it a thought - we know that AIB, BofI and the rest of the pack are artificially depressing expected losses on their loans in anticipation of Nama, since, by the entire Nama existence we know that absent Nama they would sustain losses much greater than their current capital reserves allow. So what 'transparency' are we talking about?
2. Irish banks cannot borrow without the twin ECB and Irish Government Guarantee supports, despite them not being in national ownership;
3. Irish banks will not be nationalized in Nama3.0 set up and their shares will be fully liquid;
4. Many private (Rabo, a host of Swiss banks and Belgian banks) and nationalized (Northern Rock) banks are capable of borrowing well better and cheaper than the Irish banks underpinned by full state guarantee.

Myth busted.

It is not the ignorance or the lack of knowledge amongst some of our leading journalists that defies my belief, but the innate lack of intellectual curiosity to question the spin they are being spoon-fed by the ‘official’ Ireland.

Hence, Mary Robinson is being paraded around the press as some sort of a ‘wise’ financial guru full of wisdom to breath new air into the debate about Nama. Spare me this nonsense!