Economics 16/09/2009: IDA's latest news... breaking

I will blog on Nama latest figures tomorrow afternoon, so stay tuned, but for now - a piece of better news:

IDA will be launching a new campaign promoting Ireland as investment destination in the USofA. The campaign was prelaunched tonight for bloggers in advance of the official launch. It is impressive in scope (all top notch business media on top of the reliables – Airport ads etc – plus a bit more serious effort to build online presence) and relatively mild in message (more below). So mild, it seems to be slightly underwhelming.

Fair play to Barry O’Leary (Chief IDAologist) and his crew and campaign designers (McConnells) for actually braving the small crowd of usually unruly and unpredictable, often cranky and always suspicious bloggers. Trevor Holmes – IDA’s chief communicatologist, aka PR man – was actually very good in answering pointed stuff and taking a bit of a role of really giving us (the bloggers) some of our own medicine.

So the launch itself was a brave change of heart from the usually rather closed organization like IDA.

Let’s get to the substance.

Corporate brand advertising that is people-centric can be corny. Country brand advertising based on ‘Invest not in dollars, but people’ stuff is a bit corny and old. IDA used to do the same back in the 1970s and 80s, so what’s the BIG IDEA this time around?

Ok, on their web banners they have Facebook chieftain talking about what the company found in Ireland. Guess what – it is European workforce (same is the 1980s ads) and it is not Irish (novelty factor on the 1980s), but the one speaking 48 languages with native skill. You might as well be in London for that.

Microsoft’s Head is talking about how IDA is number one conduit for companies into Irish Government. I though that sort of ‘facilitation’ – important as it is to the companies – is not exactly something we want to highlight as a major selling point, at least not publicly in the airports. Children might conjure the imagery of Bertie Ahearne ‘facilitation’ at a football game somewhere in the UK, or our regulatory authorities engaging in banking sector ‘facilitations’ signing off on intra-banks deposits flows of slightly unusual variety. All fresh in the media minds internationally.

Funnily, when I asked the guys if they can ‘facilitate’ a financial funds management company with speeding up regulatory clearance to trade in Ireland, they immediately stressed that Ireland is not that sort of a country… Innocent me, I couldn’t see much wrong with helping companies to file papers at the FR office, especially when the same FR office got so facilitative of the banks in the recent past… Oh, but IDA can help with preparing documents and reasoning to be brought to the FR “to make the case for…” Hmmmm. Ok.

“Talents, scope and depth, languages spoken, diversity… and foremost Irishness…” are the themes. Judge for yourselves if this really confuses Ireland with a D2 - D4 (Googleland, language schools and TCD/UCD) cluster.

‘Natural creativity and curiosity of Irish’ themes. I know, it sounds bad. But do trust me, the ads are well designed and speak modern, clear and crisp language as are online materials - McConnells delivered again. IDA opened up their closed doors a bit here too with online campaign aiming to be more interactive with target audiences. Cuddos to McConnells Digital on that one - hard client to get to smile, but smiling is what IDA are doing with some parts of the campaign and it is good to see the Big Boys of Ireland Inc getting a little of confidence back. On the net, a good balance of simple messages, simple imagery and compelling arguments.

But there are few things that troubled me and some other bloggers.

1. Are these ads truthful: IDA referred in presentation to IMI research that allegedly proves these directly. I am not sure – would have to see this piece of research to believe it. But the campaign itself does not mention any research. So you are invited to find out for yourself and herein opens a world of our low achievement in the areas of science, relatively average achievements in education and an abysmal record on early and continued education.
2. The ads mention Ireland’s promise in Green energy (not as a distant future, but as current reality). In a country with ESB plants belching smokestacks and heavy reliance on oil to generate one of the most expensive power supplies in Europe, this sounds slightly funny. To be truthful, we had Airtricity – an international success story, but it barely had any significant investments in Ireland proper, preferring to do business in… you’ve guessed it – UsofA. And UK. So who’s ‘greener’?
3. On the same day of the IDA blogger launch, I was speaking to the National Advisory Science Council about my view as to why our R&D and science policies (core innovation inputs) might be in trouble. Innovation Ireland, my eye.
4. Funnily, me recalls seeing in Fortune and Forbes ads for Azerbaijan and Kazakhstan as places where you too can invest not in dollars but in people and innovation... not exactly in same words, but the same message.

While I am on the topic of press, IDA will follow up these adverts with a full frontal media assault taking ‘articles’ in the likes of WSJ and other business media and getting Brian Lenihan (who can do some good) and Barry O’Leary (who really does know his stuff). But also Mary Coughlan (I know, don’t start, please... oh, the hell - as Donald Rumsfeld remarked once "As you know, you go to war with the army you have, not the army you might want or wish to have") on the international media ‘telling the Irish side of the story’. I am not sure what it will look like? Advertorials, interviews, hired hacks, ads, talking sale pitches from politicos… It makes me feel like being made a small tangential part of some PR blitzkrieg. Trust, me I am not!

One question I did ask Barry O’Leary was “IDA campaign is going to court Human Capital-intensive businesses for whom the costs of skilled labour and key talent are the main line of spending. Our Government officials will be talking about how we are doing the necessary things to restore economic growth and confidence. Are you concerned that this is the same Government that raised taxes on labour income impacting ‘knowledge’ economy’s future returns to human capital here?” The response I got suggested that yes, the IDA are concerned about the erosion of competitiveness (I presume that does include erosion of our competitiveness in ability to attract highly paid talent). So “tax increases are a concern, but [not too much as IDA prefer for the] …focus to remain on total offering and proposition of Ireland across different value chain segments”.

Is then IDA feeling boxed by the Government perverse policies and are searching to offset the cost of income tax and payroll costs with other concessions? Most likely.

Barry didn't mention if the ‘competitiveness’ concern also covers corporate tax. After all, given the hole Mr Cowen got this country into fiscally, and given that our households are already struggling under the massive burden of Nama and public sector wage bills and welfare rolls, what can be done next to ‘improve’ our fiscal situation other than start dipping into corporate Ireland’s pockets. Indirect taxes will rise for businesses and, quite possibly, there will be a push for higher corporate tax rate too.

A birdie told me that the Government has already discussed (at not a full Cabinet level, though, and I stress that is a tip-off that I am yet to fully confirm) a chance of raising a special corporate tax surcharge on domestic firms, but that they were told that this won’t fly with EU. Don’t worry – most likely, they’ll try again.

Barry was talking some good facts, though, and made a serious pitch as to why we need to get Ireland Inc back into raising the FDI game – something that has been hard to get (although IDA did achieve good progress this year against all odds) in the first 6-8 months of this year. I agree with him fully – and I must add that IDA and EI are about the only two agencies in town that are still doing their jobs (I am sure improvements can be made in both, but hey, in the age of FAS, Forfas, HSE, and the rest of public sector, at least IDA and EI give us some return for money).

When it comes to target businesses, again, there was no BIG NEW THEME – IDA is going after reliable favorites: life sciences (pharma, biopharma and medical devices), ICT&IT, global services (SCM, technical support, financial & shared services). Not a hell of a lot of ‘innovation’ stuff? True, but they are looking at the “Innovation sector: IT&ICT primarily, Hewlet Packard, Intel, IBM, etc; life sciences area (pharma, biopharm, medical devices), international financial services, globally traded business services – digital media, etc and old engineering portfolio.”

So everything flies. A true picture of diversity? I’ve asked the guys: “Loads of smaller companies would probably like to enter European markets through Ireland. What are you doing for them?” It is a loaded question and Trevor Holmes was good answering it – to the point: “can help with limited pilot, test beds”. Better than nothing, but, honestly, not much. The mandate, you see, is still about bringing Big Sharks in, not the smaller Barracudas.

There was a hint of something yet to come – Trevor mentioned that the IDA are working on several new ideas as to how they can facilitate incubation of smaller promising start ups willing to settle in Ireland. That’s the stuff I would love to find out more about. Some years ago I mentioned the idea of incubator for Ireland-bound startups in financial services in a conversation to Barry O’Leary. May be finally the idea has sunk in? Alas, no details were given.

Per Barry O’Leary: “Competition globally for FDI – OECD says it is down globally 30% in 2009, and more competitors in the market – margin squeeze on both ends.” Fair point and the timing of this campaign is spot on too – the US market is about to go into new investment cycle, and we should be ahead of the curve (although the IDA team failed to actually identify this as an opportunity explicitly when they were probed by the bloggers). “We are competitive in combined development and manufacturing, but not in manufacturing alone”. Another good point, and backed by the evidence on what IDA has been bringing into the country over the last year.

Final point – per Barry O’Leary – is that “Strategic review of IDA is 6-8 weeks before conclusion looking at changes and adaptations to such new product offerings in Ireland as smaller digital media companies…”

Looking forward to hearing more on that one.

Economics 15/09/2009: Why there is no hope...

This is, to put it in PMD's words, why there is no hope for long term growth in Ireland (here).

Throughout the years of Celtic Tiger, the Social Partnership presided over:

• The planning system and spatial development strategies that assured the current crisis in property markets and locked tens of thousands of Irish residents in the 'commuter belt' - slaves to cars, spending hours on the roads, and now also facing punitive taxes (here);
• The tax system that created all the incentives for generation of the housing and credit bubble in the economy as it benefited the political, unions and 'Social Pillar' partners at a cost of gross mismanagement and even abuses of public trust;
• The system of governance and policy formation that made FAS, Benchmarking and the likes of HSE inevitable outcomes of paucity and culture of entitlement that exemplify Ireland;
  
• Vast transfers of wealth from the private sector taxpayers to public sector and political classes via ESOTs, privatization payoffs and exclusive employment contracts that are the legacy of the state in former state enterprises;
• Inchydoney Accord, Bertie Ahearn's 'Socialism' and Brian Cowen profligate spending in the budgets of 2005-2008 all were the direct corollaries of the unaccountable and feudal system of economic policy formation that relied on this cronyist 'Good Old Boys Club' operating behind the closed doors - the princely court at which the Bearded Men of the Social Pillar/Unions were outnumbering 3:1 the business representatives and at which the taxpayer was represented by the economic pie being sliced and served;
  
• Retarded competition in the domestic markets that benefited the clients of the state, and so on.
  

Cui bono?

The self-appointed guardians of the public interest - our NGOs and trade unions - had their leadership firmly at the trough which was filled by the Government with the taxpayers cash. It is their signatures that grace every Partnership Agreement. It is their leaders who enjoyed FAS hospitality on the state body board. Their counterparts on employers' side, at the very least, had a better taste of not pretending to stand in for the little man's interest.

Now that the pipeline is dry, the Partnership unravelled. Yet, instead of fighting the legacy of the clientilist, anti-democratic, corporatist reminders of the 1930s, our 'Opposition' parties prefer to advocate the continuation of the political order that assured the current crisis.

Irony? It would be, if not for the lack of alternatives at a voting booth.

Future growth, especially future sustainable growth, will have to rely on freeing economy from the shackles of the policy making exercise that is conducted by those who add no value through their labor and are reliant only on state transfers (of money via subsidies or customers via restricted access) to stay in business. It is that simple, folks. Public sector, FAS, Forfas, all of our Departments add no real value to either productivity growth in this country or to the productive capacity of this country in general. At the very best, they can provide support. Companies are not run by their administrative assistants they are run by entrepreneurs and key personnel at the coalface of productive processes. Neither are economies.

Until the entire political class of Ireland understands it (and thus accepts the logical proposition that follows from it, namely that the Social Partnership is a problem, not a solution), my forecast for Ireland's long term growth will remain 0-1%pa. Good luck sustaining Brian Cowen's salary on this...

Economics 12/09/2009: More NAMA lies exposed

One interesting observation on Nama and a quick follow up to the developing story on ECB alleged unwillingness to deal with nationalized banks.

We, on the critics of Nama side, have expended much gunpowder arguing that there is a natural, legally binding order of rights contained in each asset class held by investors in and lenders to the banks. This order requires that first to take the hit in any balance sheet adjustment will be the shareholders. Then the subordinated debt holders and lastly the secured debt holders. This argument is used by myself and others to show that taxpayer must be last in the firing line - after all of the above take their dose of bitter medicine.

Yet in all of this excitement we forgot the humble contractors. Now, many of the loans Nama will buy into will be written against properties on which some work has been performed in the recent past, or is even ongoing today. The problem is, our heroic developers in many cases have not paid their bills to the contractors providing this work. As far as I can understand, these unpaid contractors are the holders of the priority right on repayment in the case of liquidation of the development firm - ahead of the bank holding lien on the property.

Of course, Nama can go and tell the larger contractors that, look guys, you forget your claims on work done, write it off as a loss on your taxes and we will look after you when time comes to finish the properties. Smaller contractors will be simply told to get lost - suing the state (Nama) is a very expensive business for them. This is dandy in the banana republic we live in. But estimated (rumored) 30% of the properties Nama will claim under loans purchases will be outside this state - in countries like the USA, UK, France, Germany, Bulgaria, Romania. Nama has no sway there and their courts are not going to toe Brian Lenihan's line of National Interest. So in these countries, the unpaid or underpaid contractors can seize the properties ahead of Nama, leaving Nama with loans devoid of collateral.

This should be fun to watch as our legal eagles from Nama fly over to, say,

• Newcastle to fight the UK system that treats people supplying work as real corporate citizens with real rights; or
• Plovdiv to fight Bulgarian courts, where a leather-jacketed Petar would have to explain to them that if you owe money to his cousin, you either should leave now and forget about that unfinished apartment complex 'with amazing views of the local dump' or risk never seeing your own little 4-bed in Howth ever again.

Have our Brian Twins thought of that little pesky complication?

Now to the issue of ECB. Several of us - again from the Nama critics or sceptics - have done some digging on the issue. What my colleagues now firmly claim is that per their sources, there is a mandate on the ECB to actually treat publicly owned banks in exactly the same way as privately held banks so as not privilege the former over the latter.

Here is what I have found:

Per ECB own research paper The European Central Bank: History, Role and Functions written by Hanspeter K Scheller (link to it here) (Second revised edition, 2006), Annex I provides excerpts from the Treaty Establishing the European Community, Part 3 Community Policies, Title VII: Economic and monetary policy, Chapter 1 "Economic Policy":
"Article 101
1. Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.
2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the ECB as private credit institutions."

Emphasis is mine. This clearly states that the pro-Nama supporters are simply wrong in claiming that the ECB will treat nationalized banks or Trust-owned banks any different from the privately held banks.

Further quoting from the same ECB publication:
"Article 21 Operations with public entities
21.1. In accordance with Article 101 of this Treaty, overdrafts or any other type of credit facility with the ECB or with the national central banks in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.
21.2. The ECB and national central banks may act as fiscal agents for the entities referred to in Article 21.1.
21.3. The provisions of this Article shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the ECB as private credit institutions."

So the same stands. Now, last year, the ECB issued clarification on Article 101 prohibitions of financing (here) which actually stresses that this prohibition (restricting Central Banks from providing ‘overdraft facilities or any other type of credit facilities with the ECB or with the central banks of the Member States … in favour of …public authorities, other bodies governed by public law, or public undertakings' and Article 21.1 of the ECB Statute that mirrors this provision):

• also applies to any financing of the public sector’s obligations vis-à-vis third parties (so technically, either Nama as a state-own undertaking cannot borrow in the future from the ECB via debt issuance of its own - which will imply that Nama own bonds will have to be priced for sale in private markets only, implying horrific cost to the taxpayers of financing Nama work-out, or nationalized banks will have exactly the same access to the ECB lending in the future as Nama will) and
• crucially, that in dealing with publicly owned credit institutions there is no restriction of Article 1 under the ECB statues.
  

In fact, the legal opinion clearly states that Article 1 is designed to restrict National Central Banks' and ECB being used to finance 'public sector' - i.e to raise funds for the Exchequer, not for the credit institution operations.

Here is another interesting factoid. Chart below clearly shows that many European countries operate state owned banks. In Germany, for example the market share of state-owned banks is in excess of 40%.Source: http://ssrn.com/abstract=1360698

Are pro-Nama advocates saying that these banks have no access to ECB's discount window as well? Or will ECB treat them somehow differently from the nationalized Irish banks? If the latter is true, should this be kept hidden from the Lisbon Treaty debate? (Now, personally, I do not believe Irish banks, if nationalized, will have any trouble in raising funding either via ECB or via private markets, so the above question is a rhetorical one).

Now, logic of Article 1 as stated above, actually suggests that the ECB will have harder time allowing Nama - a state-owned non-credit institution explicitly prohibited from obtaining financing from the ECB - to swap its own bonds for ECB's cash than it would allow state-owned bank - a credit institution explicitly allowed to obtain such funding from ECB - to do so. ECB's own paper and legal opinions are confirming, therefore that it is Nama, not the nationalized banks, that would have much harder time getting support from the ECB!

Economics 12/09/2009: ECB, repos and Nama

It has not became customary for the Government and public officials to provide 'expert commentary' on Nama that in effect attempts to deflect substantive criticism by making unarguable, non-falsifiable assertions on Nama that can neither be confirmed, nor rejected, yes sound plausibly informed.

The latest such 'argument' against Nama critics floated in political circles - opposition parties, FF backbenchers etc - is that, per DofF, ECB will not be willing to take repo bond off nationalized banks.

What does this mean? In the lingo of Nama-supporters, this means that if we nationalize banks (either via a direct nationalization or via equity purchases post-Nama), the nationalized banks will not be able to use Nama bonds (or any other repurchase agreements paper) to swap with ECB for cash. The threat then is that the nationalized banks will have no access to a liquidity window at ECB and will not be able to operate.

Is this a serious threat? If true, it is a serious concern, because in our 'confident' economy of Ireland Inc, a combination of severe recession and Brian Cowen's economic (taxation) policies have effectively assured that no deposit-based lending can take place, so our banks are now fully reliant for funding on ECB and interbank markets.

But is it true? This we do not know and we cannot know, for DofF will neither confirm of deny they are saying this. And furthermore, they will never actually show the ECB statement confirming or denying it.

So what can we conclude about this threat?

Two things, really:

1. The latest DofF threat is bogus in its nature, for there are plenty proposals out there for repairing Nama that do not involve nationalization. If ECB is willing to support privately held banks (as opposed to plcs) and since ECB's definition of a 'supported' bank does not have a limit on how large share of public ownership can be as long as the bank remain private to some extent, then my proposal for Nama 3.0 or Nama Trust will work just fine. The alleged DofF 'fear' is misplaced and it is being floated out there simply to deflect public attention away from viable alternatives to Nama.
   
2. The latest claim is also bogus in terms of its logic. Suppose the ECB refuses to swap repos coming through a nationalized bank from Ireland. Since nationalization covers the entire domestic banking sector in Ireland, the ECB then refuses to take any bonds from any of the Irish banks, making the entire system of Irish banking illiquid. Now, Ireland is a Eurozone country. This act by ECB will force at least one Eurozone country into a combined liquidity and solvency meltdown. What do you think will be the expected effect on the Euro? Oh, yes, it will overnight become a twin to the Zimbabwean currency. Will the ECB agree to destroy its own reputation, monetary system and currency only to avoid repurchase operations with a more stable and less risky (post-nationalization) banking system of its member state?

In short, the rumors that DofF is claiming that the ECB will not swap with nationalized banks are so out of line with reality, they either cannot be true, or someone in ECB is flying high as a kite. You judge which one of these two alternatives is a more plausible one.

Economics 11/09/2009: Nama gets some deserved bashing

Brilliant Nama analysis from DKM (available here). Please, do read the whole thing!

Few quotes and comments (emphases are my throughout):

On recovery sources:
“The best that Irish policy makers can do is cheer on the signs of recovery in the Euro area and in the US. Recovery in our main export markets – although far from certain – is likely to be the only source of real green shoots next year.”

And this is not because our banks can’t function without a bailout. It is because our economy has been demolished and demoralized by the public policy that wastes taxpayers cash in tens of billions and taxes Irish workers into consumption growth oblivion. Will Nama solve it or make it better? No. Nama will take tens of billions more out of taxpayers hands and put the money into banks. Banks can do the following with the cash that is surplus on their capital reserves:
1) Lend out to Irish – already heavily leveraged businesses, earning a rate of return on these loans of 3-4%pa at best (they currently earn around 2-3% on their past loans); or
2) Buy European corporate bonds yielding 5-7% pa (blue chips).

Anyone’s guess what they will do with cash? For DKM it is a no-brainer: “Certainly it is hard to see the reconstruction of the banking system through the creation of NAMA contributing much to short-term recovery in the economy. Indeed, it could be argued that there is a very real danger that the operation of NAMA, subject as it is bound to be to the political whims of the moment, could have a prolonged negative impact on construction capital spending in the economy for years to come.”


“It is a racing certainty that the 2010 Budget … will involve substantial cuts in government spending, especially capital spending, and increases in taxes and charges. This reduction in public spending will take place against a background of highly depressed private demand which shows few signs of picking up. ...justified by the need to curtail public borrowing for the sake of future generations (and for the sake of the interest rate margins Ireland has to pay over German borrowing costs). Yet at the same time the Government is proposing to borrow massive amounts – which could be more than all the existing government debt outstanding – in order to become the virtual monopoly developer of land and property in the State for the next decade. It is as if public policy is being determined by the mad offspring of Hugo Chavez and Margaret Thatcher.”

Well, Thatcher reference is overdone - Brian Cowen has shown no ability to deliver any serious cuts in public spending so far. Plus Thatcher actually lowered tax burden. Nonetheless, amazingly, this simple reality of an inherent unresolvable contradiction between two policies pursued by the Government did not occur to that brilliant legal (i.e logic-trained) mind of Brian Lenihan. How?


“Enduring economic hardship now so that the State can become the sole lender to the property sector is a difficult sell.” Yes, folks, ‘Nama will work’ slogan is equivalent to ‘Speculative development and investments will work’ slogan. And we learned a thing or two about the latter one, haven’t we?


“The concept of NAMA was born out of a report by Dr. Peter Bacon, an economist turned property developer.” A pearl!


On Nama effectiveness in terms of credit flow restoration:
“The most likely use of the funds supplied by the NAMA purchases will be to reduce reliance on overseas funding especially funding in the wholesale money markets. In effect the balance sheets of Irish banks will shrink as assets are transferred to NAMA and foreign liabilities repaid. This may lead to a more sustainable banking system but will not lead to an expansion in credit.”

But have they – Leni, Coweee, Ah!Earn & Co – listened to any suggestions for bettering Nama? “The official response to the criticisms of the original NAMA proposals has been ad hoc, indicating that policy is being made on the hoof.”

“The question of the bank valuation of a property related loan versus a “market” value becomes more acute when it is realised that NAMA proposes to acquire performing loans… …It will be difficult for NAMA to pay less than the value of the loan to the bank from which the loan is acquired without substantial risk of litigation. Even if the management of banks is cowed by the scale of the public shareholding in the bank there would be no such constraint on private shareholders especially bondholders who face losses due to the acquisition by NAMA of assets at too low a price.”

Now, Brian Lenihan has absolutely no understanding of either finance or economics. Fine. No one is holding it against him personally. But he is a lawyer! Can he not see this argument coming?

“Defenders of NAMA have pointed out that it is a requirement of the EC that the long run economic value be paid for the loans. … this requirement is designed to prevent national governments from over-paying for loans and so subsidizing domestic banks at the expense of competing banks located in other jurisdictions. In any event it now appears that NAMA will not be paying the long run economic value for loans acquired from the banks.”


“The most recent suggestion is that the banks will receive part of the consideration in the form of a bond whose value will depend on the recovery rate of NAMA. This risk sharing sounds attractive but it begs the question as to how the bonds will be accounted for on the banks’ balance sheets.” This is exactly what I’ve been warning about in my recent blog post (here).


“The more enthusiastic supporters of NAMA have begun to sound like stockbrokers promoting an IPO. [Well, it is an IPO for them, for absent Nama, real value of banks shares is near nil – they are insolvent!] NAMA, it is asserted, will be profitable. On analysis, some part of its profit will arise from arbitraging the yield curve. By borrowing short – through the issue of floating rate bonds to the banks – and by lending long through the acquisition of longer term property debt NAMA can make a profit. [Again, do you think this is a way forward after the current crisis lessons on maturity mismatch risks?]

"It is open to the NTMA to make a similar profit by issuing similar short dated securities and
investing the proceeds in long dated German government securities." [Brilliant! In effect, having Nama is like having a state-run hedge fund. We have truly arrived to Alice in Wonderland.]


“NAMA is also expected to make a profit because when the loans are repaid (or the security underlying the loans realised) the proceeds will exceed the original cost. If one assumes that what is ultimately realised is the long term economic value of the assets then NAMA can only make a profit by paying less than the long term economic value.” [And hence we have another contradiction: pay LTEV and you can’t get profit if your estimation of LTEV was correct. There is no free lunch, folks!]

In fact Nama has to realise the underlying properties or close the loans at

• (price paid today = LTEV) +
  
• (inflation cumulated over the holding period) +
  
• (the cost of borrowing over this horizon) +
  
• (the cost of administering the loans by the banks and Nama) --
  
• (cash flow during the holding period)

This, of course, implies that “most of the NAMA profits, if any, will be at the expense of the banks from which it acquired the asset.” How? You bought at LTEV, you sold at LTEV (remember - Nama will get the price right and it will pay the higher of two: current market price or LTEV). The only way you turn a profit is if your revenue stream during the period of managing the loan was greater than the costs of inflation, financing and administering/managing loans. But the latter are paid by the banks...


"In the case of the windfall tax the distant sounds of belatedly closing stable doors can be heard. And, of course, the best way to depress any recovery in future property values is to impose a high tax on appreciation". [So the Greens’ proposal is like shooting your leg off while running] "The requirement that NAMA responds to social and political demands highlights all too clearly the dangers of creating a state-owned virtual monopoly presence in development land and property.”


“The Government has rightly warned of the dangers – mainly in terms of price discovery – of a wholly nationalized banking sector. It does not appear to have the same concerns about a similar nationalization of property development.” Another brilliant point.


“Our best guess is that a recovery in investment in development related construction will be some distance off and some of the longer term economic growth projections which have not taken account of the radically changed institutional environment caused by NAMA are too optimistic.”

This is correct, and I will be revisiting my longer term forecasts for Irish economy to reflect Nama costs explicitly in days ahead, so stay tuned.


PS: Per earlier reader/follower request:

List of foreign ‘stars’ who criticised Nama:
Mr Bo Lundgren (a man with real experience handling major bank crisis)
ZEW President, Professor Wolfgang Franz
Robert Engel (Nobel Prize, Financial Econometrics)
Paul Krugman (Nobel Prize)
Professor Roberto Rigobon (MIT)
Professor Michael Goldstein (Babson College)

Domestically - at least 46 economists and finance specialists (many are finance specialists)

On pro-Nama academic side: one Alan Ahearne - an economist with no finance experience

Economics 10/09/2009: Greens' 'proposal' might lead to lingering capital problems post-Nama

Oliver Gilvarry of Dolmen - a clear supporter of Nama As Is proposal in today's note: "The tax will be 80% of the profits gained from the increase in land value following a re-zoning decision. The impact of risk sharing in NAMA will be to reduce the liquidity generated by the banks on the sale of loans to NAMA. It could also reduce the capital relief banks will experience from the transfer of loans as a certain amount of capital may have to be put aside for the subordinated NAMA bonds they will receive unlike the other NAMA bonds."

This is exactly the point I made yesterday (here). The Greens' helping hand can just as well cost the taxpayers when the banks come begging to Leni again... post-Nama.

And this bring us to Mr Cowen's performance on today's Prime Time. Hmmm - the Gods gotta be laughing somewhere in ancient Rome's temples. Mr Cowen now wants to bring living standards back to 2007 peak levels by taxing us to death, issuing more debt against our future incomes than was ever issued in this country history before, spending like a drunken sailor, not reforming public sector pay and pensions, running vast deficits and... hold your breath... restoring credit and liquidity flows with a Nama-style undertaking?

You can almost see this working in theory, can't you.

You can't? Well, to be honest neither can I. Here is why, quickly:

Nama is about working out bad loans written against bad assets. It is, therefore, an investment undertaking with a life-span of decades. Liquidity provision is a short-term undertaking aiming to increase money supply in the economy that is free to move across the economy.

Nama bonds will not provide such a 'liquidity event' for three reasons:

1. As an investment undertaking Nama will need credit of its own to work through the loans and underlying assets, so to assume that banks will simply lend-out the €60bn pot of cash they will get from Nama automatically assumes that the cost of working out Nama loans will be financed through some other sources. Is Brian Cowen actually envisioning another issue of debt to finance this undertaking?
2. As an undertaking to repair balance sheets of the banks, Nama will fund capital base, not lending funds on banks books. In other words, for banks with an average 173% loans to deposits ratio, any cash they can get will have to be locked in a vault. Nama funds cannot be disbursed in new loans.
3. The Greens have just shaved off a large chunk of the 'liquidity' pool through their 'risk sharing' gizmo.

Now, Taoiseach has clearly told the nation when he claimed that Nama is based on 'international advice' and 'best advice available'. Given that the side critical of Nama includes virtually all leading Irish economics and finance specialists from academia and a handful of foreign academics, including at least 3 Nobel Prize winners, plus Swedish politicians responsible for their 'bad bank' work-out, I fail to see how can the 'best advice available' actually completely exclude the truly best advice made available to the Government.

Finally, Cowen refused to step in to offer even a momentary protection to ordinary households when he was asked if mortgage defaulters will be protected. Mr Cowen has made it now record-clear that his Government is unconcerned about consumers, taxpayers and ordinary entrepreneurs. It is banks who must be rescued.

The more they (Leni, Ahearne, Cowen - oh, and why not call Mary Coughlan out of her retirement to pedal Nama-cakes too) dig, the deeper is the hole... after all they did dig Brian Cowen out of his hole where he resided for some 5 months post April Budget and back into the RTE studios - twice within the span of 5 days last...

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.