Economics 12/10/2009: Green Party 'Programme' - a bark without a bite?

First Update: see second section below

It is time now to start chipping at the latest Programme for Government published this weekend.

First, the Programme was clearly written in haste. Forget its economic thesis that fails in its entirety to recognise the scale of the crisis we face. It is simply written in haste: page 1, just above the signatures of Mr Cowen and Mr Gormley reads "It was negotiated prior to the worst to the worst global downtown (sic) since the 1930s."

Now to the core of the 'Programme' itself.

Introduction: "The time for crisis management is over. Now we must set about re-creating the Republic. This Renewed Programme sets out the Government’s vision of national renewal and economic."

This statement is truly extraordinary for several reasons.

Firstly, neither our fiscal nor financial nor economic data show that 'the time for crisis management is over'. If anything, given that this Government is appealing to the EU to extend its holiday from the Stability and Growth Pact (SGP) compliance beyond 2013, the country is yet to face the stage of the real 'crisis management'. GP leadership is simply in the state of an even deeper denial than their FF colleagues.

In fact, the Green Party leaders are now firmly in the denial of economic reality as outlined by

• Jean-Claude Trichet last week when he said that the crisis is far from over,
  
• the IMF as outlined in their World Economic Outlook and GFSR reports from two weeks ago where the Fund economists warned of the upcoming second wave of financial, fiscal and economic crises;
• the OECD which late last month has warned that the Eurozone economies are facing renewed pressures on exports and growth;
• the Bank for International Settlements which, also last month, warned that more banking sector woes are inevitable for the Eurzone (to which we, of course, belong and of which we represent the sickest member state);
• the ESRI which forecasted prolonged recession through 2010 and anaemic recovery through 2013.
  

Second, a promise of 're-creating the Republic' is not a matter for the competencies of the Government (it is rather a matter of an entirely separate mandate which has to be explicitly delivered to the Government and cannot be assumed by the bi-laterally negotiated Programme for Government).

Third, the Programme must have far reaching, wide ranging economic, social and political reforms in order to live up to the promise of 're-creating the Republic'. As all analysis to date shows, it fails to do so, qualifying more as an interim shopping list for a minority partner in an unstable and unpopular coalition than an ambitious 're-creation of the Republic'.

I am amazed that the above-average educated Green voters were actually willing participants to this ridiculous posturing by the party leadership that also reaches beyond their democratic and, potentially, legal mandate. Can the premise that the GP-FF deal attempts to 're-create the Republic' be challenged legally, one wonders? If the claim is a statement of true intent, the Programme is a constitutional challenge to the status-quo. If it cannot be, then it is simply a case of grandiose over-hype - a crime of sick marketing over-reach, perhaps. Let the GP leaders make their choice...

"Any wrongdoing will be uncovered by the institutions of the state and brought to its logical conclusion. We cannot accept a return to the old ways and we will simply not allow this to happen." I would like to point out, to the GP leadership two facts. First, it was not the institutions of the state that unearthed all recent expenses scandals and all past over-spending scandals, the white elephants and corruption scandals. Instead, it was private sector media that did their jobs. Second, there is absolutely nothing neither in the Programme, nor in the conduct of the GP leadership to date that indicates the GP position of a watchdog over ethics and legality of Irish economic and political elites conduct. Nothing whatsoever. What the GP had, so far, contributed to the 'governance' or the banks, for example is a sweetly irrelevant promise to replace the boards of the banks within 2 years of Nama initiation. Given that countries change their entire governments within a span of several months post election, this is a puzzling anaemic 'watchdog' effort by the GP.

"The credit crisis hit more than our banking system. It is hurting homeowners and those in arrears. Government will support families having difficulties with their mortgage payments." Again, a bark that is not matched by any bite whatsoever in the Programme. There are no envisioned supports for the defaulting homeowners, no measures to address the issue of real debt rising in light of negative equity and tax increases. If anything, the Government (and the Programme re-enforces this effect) so far has been at the forefront of increasing financial strains on homeowners.

" Moving to a low-carbon economy, we will take advantage of our own natural resources in energy, forestry and food. " Another statement that is not grounded in reality. For example, Ireland is the least forested country in Europe and as such has no natural resources in this area. We have one of the most expensive food production sectors in the OECD, reliant more than any other OECD country on subsidies for agriculture. Our energy sector is at best can be described as a failure. The GP has neither the capacity to recognize these realities, nor to address them.


Update 1: Economic Policies (Section 2)

Economic policies, section 2: this and section 3 following it are the rehashing of the already woefully outdated and thin on reality December 2008 Smart Economy platform.

“We will introduce a new national performance indicator… formulated … with other quality of life measurements”. In other words, given that we already have non-descriptive stats, such as GDP-based measures that do not reflect our true income, the GP is offering more smoke to cover up the real rate of economic decay in this country. This fits well with their claims that the party stands for more transparency. For example, the new indicator can simply induce an artificial rise in the standard of living by assuming that our public sector spending (all of it, including wasteful pay and pensions practices) yields significantly higher multiplier than 1.

Even more worrisome in this is the possibility that such a ‘cover-up and pretend all is going on swimmingly’ approach to statistical valuations can be used to ensure that Nama yields a ‘success’ in some future. Thus, the new Programme for Government has started the process of politicization of Nama - the process that the Government was explicitly trying to avoid.

What is even more egregious in the GP policy platform is that it cuts across Brian Lenihan's (unbelievable, nonetheless explicit) promise of no new taxes in Budget 2010. The entire Programme's outlook on public finances is more resembling of the 2004 Social Spending Boost programme rather than anything even theoretically close to what will have to be done to return Ireland to some sort of fiscal solvency.

While re-affirming the Government commitment to bring deficit to 3% of GDP levels by 2013, the Programme for Government envisions more than Euro1.5-2bn annually in new spending and not a single cut to the existent spending. This would imply that reaching the SGP target by 2013 will require freezing all expenditure at the current level and yielding real economic growth of 4.21% per annum on average in real terms over the next 3 years. This is simply an unrealistic assumption of highest order.

"The future of the economy lies in exports... we must drive down our costs..." It is amazing that the focus on exports does not really figure whatsoever in the entire programme, apart from a sickly Euro100mln mixed-used (not exclusive to exports) support fund (see below) - which was already announced back in the beginning of 2009. If the future of our economy does lie with exports, why is the entire Green Party platform focusing on domestic energy independence and broadband and knowledge economy development?

As far as driving down costs - the GP does absolutely nothing (other than very generalist aspirations for productivity improvements in the public sector) to reduce the greatest historical drivers of inflation in the country - public services and state-monopolized or controlled sectors.

Tax Reform section explicitly ignores the need to grow the real economy, focusing exclusively on 'Green and Smart Economy', thus betraying deeply rooted inability of the authors to understand the issues of economic growth.

Serious contradictions emerge in the treatment of income tax policies. The first bullet point claims that the Programme aims to "Abolish the employee PRSI ceiling in parallel with the reduction of the temporary income levy in order to remove the inequity whereby higher paid employees pay proportionately less of their income for social insurance than low paid employees." Several things are simply out of order in this statement:

1. PRSI is paid by self-employed and sole proprietors as well as PAYE workers, yet the former have no access to PRSI-financed benefits. What inequity is the Green Party platform removing here?
2. PRSI and Income Tax are largely paid in this country by those with incomes in excess of 70,000 per annum. Given that some 80% plus of our tax revenue comes from these employees and business owners, what inequity is the Green Party aiming to remove by levelling even higher tax on them?
3. The statement explicitly states that the income levy is viewed by the Green Party as temporary. Will abolition of PRSI ceiling be temporary as well in line with income levy? Not a word on this in the document, implying that the GP wants to replace a temporary levy with a permanent tax increase which will disproportionately adversely impact those on wages in excess of 52,000 per annum and who are already bearing the disproportionately higher tax bill and many of whom have not even a theoretical chance of benefiting from PRSI-financed services.
   

The last point is important, as in the second bullet point of the section, the document states: "simplification and rationalisation of the various levies into the income tax system beginning in 2010". Now, once again, levies were set by the Budget 2009 explicitly as a temporary measure. The Government at the time advocated this approach precisely because they did not want to raise taxes permanently. Now, the Green Party is pushing for a permanent increase in taxation.

The third bullet point is simply an example of 'redistributive' quasi-socialist policies that the Green Party leaders are pursuing across their platform. Imagine two individuals - one earning 50,000 per annum, another 30,000 per annum. If the first person saves 10,000 in a pension fund, her tax reduction will amount to the same 3,000 as that of the second person. Net marginal tax paid by each person will thus be: +2,000 for the first saver and -1,200 for the second one. In effect, the first person will subsidise the second person's pension and consumption to the tune of 2,200 (assuming both share equally in the benefits of general tax revenue). Why? What does this have to do with any notion of fairness? Have Messrs Boyle, Ryan and Gormley think any of this through?

Taxation for sustainable development is perhaps the only thought through section of the entire document. However, on Business Taxes and Local Taxes the GP is once again goes flat.

Overall, GP's platform on economic policies is un-ambitious, unimaginative, poorly thought through and outright destructive to the real economy.


Stand by for further detailed analysis of the Programme

Economics 10/10/2009: Green (or Northern Irish?) Votes

This is to report few bits of information from the Green Party meeting tonight:

• 84% vote for the Programme for Government - which contains some good ideas (Site Value Tax / Land Value Tax) and some pretty bad ones...
• 31% against Nama.
  

Per several Green Party members exiting the meetings:

1. The Greens have sold the country to stay in power for another 6 months - the sentiment of several Party members who spoke to me. Reasoning: "we've been in the Government only a year and we need more time to make our policies reality". A fine argument assuming that once they lose power, their policies cannot be reversed/undone.
2. The country got another taste of the sanctimonious and perverse Green ways (also a quote from a Party member), where members voted for Nama as their price tag for PfG. In other words, they sold the entire nation's future by hoisting Nama on this economy in order to gain few token concessions from the FF - a truly Machiavellian pact.

Now, a note worth looking into in more details. Per my sources at the meeting, there was a number of Northern Irish Green Party members who were voting on both PfG and Nama. One of the discussions at the meeting was even chaired by a Northern Irish academic from Quinn's Uni. Presumably (not being an economist or finance professional) he had a personal stake in how Nama might work out... Greens are an all-island party, so their by-laws allow for this.

One of my sources alleged that these Northern Irish Greens were 'helped' to get to RDS by the party officials / leadership in order to secure today's vote. I was told that buses were used by the party to deliver them to Dublin. (I have no confirmation of this, so this is a rumor.)

So we might have a strange situation developing here:

• the taxpayers of this country have no say on Nama,
  
• while taxpayers of the other country do...
  

Democracy Irish-style?

Economics 10/10/2009: How not to do policy on banks

Corrected

Two independent sources have confirmed to me the following developing story. This is being reported as my sources alleged, with the following correction by an independent source.

Under the Environmental Pillar of the Social Partnership umbrella, several debates on Nama have yielded a wide-ranging support for two possible motions from the Pillar to the Social Partnership framework:

• Amending the Nama legislation to require Environmental Impact Assessment of the entire proposal;
• Opposing the current Nama legislation overall.

The first proposal is a standard procedure for undertaking virtually any policy directive. In fact, absence of explicit EIA study under the National Development Plan was in the recent past been used to launch an appeal against NDP to the EU Commission. The EU has taken the appeal for a review precisely on the grounds that NDP had no comprehensive EIA. Absence of a similar EIA implies that Nama is open to challenges on the grounds of violating required procedures for policy development.

So nothing radical was being proposed within the Environmental Pillar, especially considering the fact that Nama is likely to have significant environmental impact as it will be the final arbiter in deciding the fate of many unfinished property development projects across the nation.

Eight out of ten leading organizations comprising the Pillar are, allegedly, in favour of this proposal as are a number of smaller bodies.

However, despite this wide-ranging support, one Pillar member - representative of animal rights movement - has, allegedly, vetoed any Pillar proposal on Nama before it was even allowed to proceed to a vote. The organization in question is, allegedly, the Irish Seal Sanctuary.


On a related issue:
Per RTE report (here) "European Commissioner for Economic and Monetary Affairs Joaquin Almunia said he wants to see the Dáil pass the legislation to establish NAMA as soon as possible." I wondered earlier if the phrase is correct. Here is the quote: "My wishes for the next couple of months here is first that NAMA will be adopted by the parliament as soon as possible because it is extraordinary needed [sic] instrument to tackle the problems in the banking sector and to organise an orderly restructuring and consolidation of the banking sector here in Ireland, that is one very important issue, and second, I really wish that in December the Irish government and the Irish parliament will discuss and adopt the budget that is needed". Italics are mine.

So here is analysis of the quote:

1. Mr Almunia speaks for himself, not the EU Commission, thereby potentially presenting a private view, not that of a Commission. As a private individual Mr Almunia has no specific experience, factual or knowledge basis to make any statements about expected effectiveness, efficiency or fairness of Nama legislation;
2. Mr Almunia clearly states that in his view, Nama will pursue the objective of 'restructuring and consolidation' of Irish banking sector. In other words, in his view, Nama is not about the benefits to the wider economy but about benefits to the narrow banking sector. Furthermore, is Mr Almunia calling for 'consolidation' (i.e oligopolization or monopolization) of the Irish banking. This highly irregular for an EU Commissioner and cuts across the entire Government-own argument that Nama is needed to prevent nationalization, for, in the view of the Government nationalization can lead to infringement on competition in the sector. You can't really have a cake and eat it. Either 'consolidation' is desired, in which case nationalization cannot be ruled out on competition grounds. Or Nama cannot proceed to consolidation of the sector;
3. The EU Commissioner 'wants to see' a passage of a specific Bill by a sovereign Parliament of the Member State. It is a strange turn of phrase that might imply that the EU Commissioner is attempting to influence the internal affairs of the Irish state. Is that what we voted for in the Lisbon vote?
4. The Commissioner is clearly aware of the crucial Green Party vote on Nama tomorrow. The timing of his statement, its venue and the nature of its delivery suggest that Mr Almunia is either being used by the Government to influence the Green Party vote or he is attempting to do so himself. Either way, this is utterly unacceptable for the member of EU Commission.
   

Economics 09/10/2009: A small win for free trade?

Per our stockbrokers report this am: government commissioned report from the Tourism Renewal Group stated that Minister Lenihan should repeal the Air Passenger Departure tax because of its damage to the tourism industry.

In what was termed, by the Irish Times editorial a 'Gurdgiev-Ryanair' (Irish Times editorial term) campaign (see here) sane economists and industry participants have waged consistent analysis-based factually grounded argument against the tax-driven protectionist scheme that was conceived to support domestic tourism. The scheme, harking back to the dark age of protectionism was aiming to force more Irish people to stay at home instead of traveling abroad. It did not work. Instead, the numbers of Irish people vacationing at home has continued to decline, while the number of foreign visitors to this country has collapsed - tourism is now down 20% in Ireland, while tourism is down under 10% across Europe. More businesses clawed back on international travel amidst recession. All decisions, on margin, were not helped by a completely gratuitous Departure tax.

The Tourism Minister (I am not sure why even have one) now says that the government “will consider its response within the wider context of fiscal sustainability”.

Bloxham's description of the tax effects: "the domestic tourism industry has been disemboweled by a consumer recession, strong euro and this Monty Python air tax... Someone replaced their brain with an abacus to invent this moronic tax (aping the UK) for an island economy dependent on tourism. It requires an adult to stop it. Instead of considering, fiscalising and consulting the Minister needs about one minute to conclude that this regressive tax, that harms lower income passengers most, deserves the boot. It might even re-ignite services to Irish airports, some of which (Cork ?) appear to have been hit by a neutron bomb (undamaged and pristine buildings, no people)."

One fact: the BAA reports a -5.7% year-to-date decline in volume in September at its seven UK airports, compared to 15% decline in Dublin Airport traffic to August 2009 (here).

'Gurdgiev-Ryanair' campaign check-mate to a ridiculous tax policy? One hopes.

Economics 08/10/2009: THE Rankings - World class to poor class

Times Higher Education 2009 world league table of Universities was published last week, confirm what all of us already know:

• There is one world AAA class University in the country: Trinity College, that has risen from a respectable 49th place a year ago to 43th place in 2009 (peer review score=88 or relatively under performing for the peer group of top 50 universities, employer review score=96 good performance, staff/student score=72 average performance, citations/staff score=49 poor performance, international staff score=98 great performance, international students score=83 average performance, and overall score=80.1).
  
• There is one world AA class university in the country: UCD, that has risen from 108th place in 2008 to 89th place this year (peer review score=72 - much poorer than TCD despite a major and sustained drive by UCD to improve research, employer review score=94 slightly lower than TCD but excellent performance overall, staff/student score=67 - a clear sign of funding shortfalls, citations/staff score=37 - very poor mark, suggesting little of influential research being performed, international staff score=95 very solid score, international students score=90 - an excellent score, but one wonders if it is a function of the various artificial exchange programmes sponsored by the EU, and overall score=69.7 - good score and good progress)

Not a single Irish University made it into Global 50 in the areas of:

• Engineering & Information Technology;
• Life Sciences & Biomedicine;
• Natural Sciences;
• Social Sciences; or
  
• Arts & Humanities.
  

What can we learn from the above scores for TCD:

1. Knowledge economy in TCD is happening through teaching and much less through research - our research scores still have ways to go to match our overall score.
2. Knowledge economy is driven, at least in top universities, by international nature of the faculties, not by indigenous talent - as expected for a small open economy. So recent tightening in Green Cards and spouses employment for non-EU workers is a travesty that can cost us dearly in the areas of research.
3. Despite having fewer resources (staff/student ratios being one sign of this), TCD and UCD pair is still managing to outshine our 'Gateways of Excellence' across the country - those heavily subsidised 'junior' Unis and ITs.
4. There is absolutely no evidence that focusing on sciences or biomedicine, or life sciences or any of the rest of 'hard' science disciplines is yielding any real excellence in either TCD or UCD as neither institution has made it into top 50 rankings by a single discipline.

More on the results later... stay tuned

Economics 06/10/2009: Ryanair in sight

I know, you've told me that few care, but I just have to highlight the obvious - love it or hate, but Ryanair is a real flag carrier for Ireland's can do culture in business. Here is a cumulative total of the facts (without any of my interpretation):

• Traffic figures for August 2009:
• “Ryanair’s August traffic grew by 19% or 1.1million passengers thanks to our lower fares and no fuel surcharges while traffic at Dublin Airport collapsed by 15%, a loss of 364,000 passengers in just one month. Dublin Airport is now on track to lose 3million passengers this year."

• Above, Ryanair September numbers.

Now some brilliant phraseology:
and

I will stop there...

Economics 06/10/2009: A stockbrokerage strategist on Nama

And so it comes to my attention that last week in a local Chamber of Commerce hosted a debate on Nama. Per my contacts, “a number of issues arose that may be of interest”.

These issues are important because they largely outline main arguments about Nama made by the proposal supporters out there.


1) Nama supporter (NS) was keen to distance himself and Nama supporters from ‘theoreticians’ and ‘academics’ who exclusively populate the Nama critics land. It is important to note that many of the people who signed the letter of 46 economists, as well as other members of the critics camp are actually practitioners of the same fine art of finance as NS. Many.

How many? Well, just a quick run through

• myself – former business editor who brought finance coverage to the most respectable Irish business magazine, former director of research at NCB, currently head of research and strategy with an American brokerage.
  
• Greg Connor – former director of research for Barra, Fed employee.
  
• Karl Whelan – former Fed employee.
  
• Other members of 46 run options desks, have been bond traders, worked in central banks and finance ministries... you get the picture.
• Brian Lucey - former employee of the Central Bank;
• Ronan Lyons - former economist wit one multinational company and also chief economist of Daft.ie; and so on.
  

NS might think we in academia are just performing random walks in various universities’ squares, but no, we actually advise governments, international organizations, businesses and have some relevant experience in the real world.


2) NS contended that the main problem with Irish banking sector was that after 2001 we had "over competition" from (guess who?) the foreign banks. One assumes he means Rabo and KBC, for the British banks were here before 2001 and in addition we had our banks in their countries as well, aggressively lending to… yes, you’ve guessed it again – property developers there. So the foreign banks, thus, caused a property boom in Ireland. And the foreign banks forced our banks to issue 110% mortgages. And the foreign banks assured that most of our lending has gone to finance property deals of one variety or the other. Of course, it was the foreign banks that made sure that IL&P and Nationwide made strange dealings with Anglo. Why wouldn’t NS read Noel Whelan’s treatise on the crisis (see my comment here) – he might find out that in addition to the foreign banks, 46 economists also caused the crisis.


3) NS also allegedly claimed that as foreign banks leave Ireland, Irish banks will take a "more prudent, even oligopolistic approach to rebuilding their balance sheets". Oligopolistic? I hope the Competition Authority is reading this, plus the folks at the EU Commission. But for those of you who wonder what this means, let me explain. In the case of oligopolistic competition, banks would earn near monopoly profits by charging their customers (aha, you and me) excessive near-monopoly rents. Happy times, folks. A stockbroker calling for oligopoly? Surely not. Though it might happen if our regulators continue sleeping at the wheel. What’s next? Markets for shares becoming too efficient, so NS will call for regulated trade in equities? Incidentally, courtesy of Anglo, we already have had bans on shortselling - an activity that actually has been proven to aid price discovery in the markets.


(4) Per NS, the main aim of NAMA is to get credit flowing. If this turns out to be a problem in a recessionary economy, the profit motive of the banks will induce them to lend after NAMA. Ahmmm, ok, I have one question – why would they seek profit opportunities in Ireland?

• Because our margins are so high? Nope, they are low, Bloxham, Davy and other Irish stockbrokers said so. Can banks raise these margins? Yes, but only at the expense of already strained households, which will mean that their loans books will suffer more defaults. Surely NS wouldn’t call that an improvement in financial stability?
  
• Will the banks have an incentive to lend post-Nama because our lending bears lower risks? No, we are among the worst performing economies in Europe.
  
• Because the banks will simply have excess of cheap cash after Nama? Oh, no – they will still face some €130bn in interbank loans to repay (pricey stuff) (here).
  
• Maybe because they can’t get better returns anywhere else than in Ireland? Well, they can get higher returns pretty much anywhere else other than in Ireland, given our domestic economy will be contracting through 2010.

So, the banks won’t be rushing to lend here. And, incidentally, there won’t be many borrowers rushing in to borrow either – the households will be scrambling to deleverage in the next two years, not to borrow more. What is most likely is that the banks will use our taxpayers’ cash to repay some of the interbank loans, plus buy some discounted debt of which they had €103.8bn worth of senior bonds and €17.7bn in subordinated bonds as of June 2009.


5) Per NS, Nama provides asymmetric exposure to risk to the benefit of the taxpayer as the subordinated Nama bonds will take 1/3 of the risk. As far as I recall, the actual plan was to issue 5% of the Nama disbursed funds in the form of these bonds. Even if the risk weighting on them truly reflects the risk of Nama generating an end loss, this translates into just 5% of risk being shared. Of course, since we have no exact legally defined and enforceable criteria as to what constitutes ‘success’ or ‘failure’ of Nama, any future Government can ‘fudge’ whatever outcome achieved to be called ‘success’, so effective risk-sharing under subordinated bonds is NIL.


6) Allegedly, NS claimed that current commercial property yields are at 6% nationwide and are heading UPWARDS. These numbers were presented as facts in contrast to the ‘nonsense’ figures being quoted by some economists. (See Ronan Lyons on this one: here).

Of course NS explained that higher yields will come about as economy is now in imminent recovery mode and that we will see a positive q-o-q growth in Q2 2010. Thus, Davy’s Rossa White, for example, is a pessimist compared to NS who was not sure what Rossa White forecasted for Irish economy just a day before this event. Hmmm…

Now, Nama is apparently about Irish economy. Which of course is about GNP – in case NS did not know. In this context, I don’t think anyone really expects the yields to go up to 7% or to even 6% any time soon. And, in addition, I presume NS is unaware of such things as lags – it takes time to work through the surplus properties out there in the market, and it takes time before that to get consumers spending again. So Q2 2010? More like Q2 2011 for consumption to uptick significantly enough for yields to start stabilizing.

Suppose NS is right and the yields are heading for North of 6%, say towards 8%. Does he believe that these yields improvements will be driven by rents increases? In the current economic environment, even if there is some nominal growth in 2010 of say 0.5% in GDP, this an unlikely scenario with vacancy rates in commercial sector of 21% plus, and in residential sector with some 200,000+ properties unoccupied. So the only way yields can hit 8% is by price of property dropping further, and dropping by more than 20%. What does this mean for the ‘haircut’ applied under Nama? It means the haircut is too low. Significantly too low. If the yields were to firm up, per NS’s assertion, property prices will have to drop and Nama will instantaneously be overpaying even more than it already does.

And, folks, there is no arguing against this point for the yield is, by definition, a ratio: rent to price movement ratio. Ratio can rise either if the numerator rises (rents) or denominator drops (prices).


7) The good thing is that NS is at least more committed to some sort of accountability in Nama than the Government is. Per NS, allegedly, we will know if NAMA works within months, perhaps as little as three to six, as the restoration of credit would tell us that. And if not? What would NS do if Nama fails to deliver? Surely all stockbrokers have standard stop-loss rules to prevent reckless or rogue trades? Nama does not – and it always was a major part of my criticism of the current legislation. Surely NS would be familiar, therefore, with the need for a strategic Plan B? He is. And…


8) … of course – Plan B is to buy equity in the banks post-Nama – the Government already admitted this much. Which might lead to nationalizing of the banks or at least nationalizing a large chunk of them. But for NS this won’t work, as he said, allegedly, that people who advocate forcing the banks to face up to the losses are in fact advocating that not only should the equity holders bear the losses but also that the depositors should be expropriated. Of course, no one I know of in the debate on Nama has suggested that, not even unreformed socialists did. Furthermore, as far as I am aware, in every country where the banks were forced to face up to their debts – US, UK, Sweden, Denmark, Spain,... you name it – depositors remained intact.

Two more things come to mind here. Even post-Nama NS, taken at the face value of his argument, won’t stand for nationalization no matter what – in other words, should the banks need more capital he would, I presume agree to simply give it to them once again, with asking nothing in return. And also that post-Nama, when the banks ask for more cash we might be expropriating the depositors?

Is this for real? Is he suggesting that fully guaranteed depositors might face loss of their funds? Personally I think this is completely out of line scaremongering.


9) NS, allegedly, also stated, per my contact who noted it down as the meeting concluded for tea and buns, that NAMA will make a profit as the bonds will be euribor+50bps while the loans (apparently all) will be yielding at euribor+200bps. So the 44% of loans that are performing can easily take the strain of those that are not performing. Well, not so quick.

Assume for a second that NS is right. Banks pay the cost of managing the loans, so euribor+200bps is more like euribor+125bps once cost of managing loans is taken out. State pays the cost of issuing bonds, so euribor+50bps in bonds face value is more like euribor+65bps in gross cost to the state. Now, at 44% weighting, the average loans portfolio yield becomes euribor+55bps, which is below euribor+65bps. Nama makes loss even under NS’s rosy assumption of all performing loans paying euribor+200bps on average.

But here are two additional kickers:

(a) If interest rates increase, and NS should know this, more loans will go into non-performing category, plus, as I explained above. If NS’s assertion of 8% yield in near future is correct, again, more loans will go into non-performing category. Thus 44% of performing loans today, might drop to, ough say 35% or 30% tomorrow. This is what is roughly called interest rate sensitivity – as the cost of loans rises, more loans fail.

(b) NS’s assertion on euribor+200bps and on 44% performing loans rests on the assumption that the due diligence on these loans is straightforward, so Nama won’t make mistakes in buying up ‘performing’ loans. Again, any error, driving either 44% down or euribor+200bps margin down will hammer Nama bottom line figures.

10) NS asserted over some answers to specific questions, that there is a ten year property price cycle, in nominal terms. If he really did say this, this now provides yet another bogus ‘benchmark’ for property markets recovery – first there was a 7 year to 80% correction statement from one property specialist in the Dail, then there were 5 year turnaround time estimates from the Government advisers circles, now it is 10 year nominal recovery number from one of the stockbrokers.

Clearly NS is unaware of the long-term results for property market busts, and he is unaware that combined shocks to property market, plus to broader financial markets yield much deeper contractions than what his statement implies. I did some actual estimates based on OECD and IMF data and found that past busts across the OECD with an average magnitude being lower than that of expected Irish property prices contraction average 18 years in nominal terms. But what is even more surprising is that a stockbroker would care about nominal, not real, returns. Surely that is not what his usual client advices is based on, one hopes.

Economics 03/10/2009: IMF GFSR: partII

To continue with IMF’s World Outlook (from the earlier post here for GFSR and here for WO Part I):

Remember we left WO Part I on that table estimating expected future contraction in house prices. The table is:
Some interesting estimates of the ‘left to contract’ distance in house prices by countries and by measures of long-term equilibrium pricing, as of Q1 2009, taking into account the contractions achieved to date. As with the analysis of the last table, based on the historical averages Ireland has some room left for downgrades. Loads of room.

As we all know, Ireland is experiencing a perfect storm – a confluence of several simultaneous crises: housing bust, general property bust, general economic recession with global demand contractions, an unprecedented fiscal crisis and a financial sector meltdown. Clearly, these factors warrant much deeper contractions on the long-term adjustment path than what simple averages suggest.
The second chart above shows that indeed, this might be the case – Ireland is distinguished as the country with the greatest remaining room for further downward adjustments in house prices than any other country in the sample. This reflects Ireland’s economic, assets markets and property markets fundamentals comparative to other countries in the sample. So 15% to go still? And that is assuming only property crash has happened…

Chart below actually confirms the above, once we realize that the income measure used by IMF is our GDP. Of course, we are familiar with the following tow facts:

1. GDP in Ireland is currently 18.5% above GNP, and
2. GNP is a closer measure of our income in the country.
   

Thus, adjusting the above figure for GDP/GNP gap implies that instead of roughly 0.2 forward expected adjustment expressed in GDP terms as the income base, we are facing a 0.24 level of adjustment. Furthermore, given that Ireland is currently experiencing deeper income collapse than any of the charted peers, plus, given substantial declines in after-tax income following Budgets 2009 and 2009.II, the real extent of the remaining room to compression for Price-to-Income ratios comparisons is of the magnitude closer to 0.3 – in line with all of our peers. 24-30% still to move down for Irish house prices then?
Lastly, the chart above once again reinforces the conclusions reached by IMF in the second chart above and by my own recalibration of the IMF’s duration-to-amplitude model in the table above. Price to rent ratio still has a room for some contraction of the magnitude of ca 40%. This, of course will be reached through further declines in prices relative to rents and this process is currently being delayed by rents falling off at a faster rate than asking prices in recent months. In rental yield terms, some 40% left to cover for Irish prices. Hmmm… me recalls some stockbrokers recently were saying yields are at 6-8% already and the crisis is nearly over…

Is that really a case? Not per IMF:
So IMF is saying that Irish commercial rents have much further to fall – 30 plus percent more! Say yields also compress – if not by more than that, but at least that much. Ronan Lyons estimated recently that commercial yields in Ireland are around 3% pa. Bringing these to historical average will require prices falling dramatically more from current levels – as chart above implies.

Good prospects for Nama, then, which is overpaying for underlying real assets at today’s prices, let alone at where IMF would expect the prices to be in equilibrium… Will it be -40% from current levels or -30%, or -20% - no one can know for sure. But then again, Nama is a bet on prices actually rising from current levels, not falling.

Economics 03/10/2009: Exchequer receipts - bad news redux

Another month, another set of Exchequer returns and another prediction of mine confirmed: Exchequer revenue is not stabilizing. A second wave of downgrades for Income Tax and VAT, as well as the adverse timing effects on Corpo Tax are now appearing.

This time around, the prediction was not only made on this blog (here), but was also elaborated in my Business & Finance magazine column. A combination of poor forecasting (overestimating the extent of seasonality on tax revenue in August, while underestimating the impact of seasonality on other months revenue) and of a naïve belief that things can’t get much worse from April 2009 Supplementary Budget position are now at play.

In other words, it now appears that summer months’ targets were seasonally adjusted in a simplistic linear fashion. August out-performance by actual returns looks like a DofF failure to see that in a recession more people will be taking forced ‘time-off’ in summer months and that this can boost, temporarily, spending. The DofF also dramatically underestimated the extent of forward payment of corporate taxes, which automatically means that they overestimated corporate revenue expected in the future months.

During the boom, underestimated revenue projections by DofF were routine. Nay, they were annual regularity, so much so that the Government came to depend on these ‘windfall revenues’ as a sweetener to various Social Partnership deals – a little annual bonus for cronies. This time, looking to September, the DofF folks grossly underestimated the extent of the recession impact on income and thus the direction of the income tax. Having stabilized and even improved (very slightly) through July on the back of new levies, Income Tax has since taken a dive again. The implicit assumption that ‘things always improve in September might hold at the times of a boom, when July and August mark mass exodus of consumers from Ireland, while September marks return of the school year and back-to-work spending rises. But it will not hold in a recession, where economic activity remains slow in September or even falls (due to falling tourism and recreational spending).
For some inexplicable reasons, DofF set targets for income tax to rise through September at a constant rate of roughly €1bn per month from May on. Given timing of self-employed filings and seasonalities in their incomes (with many taking unpaid ‘holidays’ during the summer), plus given the fact that the numbers of self-employed are rising due to redundancies and high unemployment, such an assumption of relatively static growth in Income Tax revenues is a bit amateurish.

The same factors have a knock on effect on VAT revenues. As income falls, consumption drops. As people get more leisure time, they tend to shop for cheaper goods and might take two trips up North instead of one. All point to the significant possibility that VAT receipts will be losing ground in summer months. Furthermore, the DofF forecasters also missed the effect of unemployment and falling incomes on parent’s willingness to spend vast fortunes of kids ‘back-to-school’ shopping. More importantly, what DofF clearly had no idea about is the psychology of ‘bundled shoppers’ – parents going to buy kids school-related items. If in Celtic Tiger days such a shopping outing was bound to end in a department store where parents can indulge in some compulsive shopping of their own, this year back-to-school shopping took them more likely to Aldi and Lidl, with only compulsive co-purchases taking place relating to the luxury items of, say, a box of chocolate biscuits. Not exactly an item where 21.5% tax rip off means much.
To be fair to DofF folks, they don’t really have much data to go to get an accurate model working. But to assume that July-September 2009 tax receipts will be directly proportionate (at a virtually constant rate) to those in 2008 is, at very best, naïve. Yet, per chart below, this was simply 'assumed'…
Now, September numbers confirmed more than just a shoddy quality of forecasting by the DofF (with an accumulated error for just 5 months-ahead forecast now standing at 3.91% we really do have a shoddy quality forecast here). Instead they show that all tax heads (apart from artificially inflated by timing changes) tax heads are tanking through 2009 relative to the already crisis-ridden 2008. Chart below and table illustrate:
As far as state solvency goes, there is surprising one off change in our borrowings, which have apparently fallen back by some €5.2bn in September. I have no explanation for this, other than potential maturity of some earlier issued bonds or an error in reporting of the figures. Meanwhile the deficit trend continues to diverge from last years in the direction of further widening in fiscal deficit this year. Chart below illustrates.
Income and expenditure gap is also still widening as the chart above shows. But there is something else that can be glimpsed from the data. Remember that in May 2009 this Government started a campaign to assure the markets and domestic taxpayers that their policies are working, that the worst is almost over and that the economy is in the state of having ‘bottomed out’. Chart below shows that even in the Government’s own back yard such statements were completely unjustified. Suppose that May did mark a month of arrested downward slide in this economy. One would expect at the very least that Government finances will not continue deteriorating at a greater rate than before April Budget. The path of fiscal deficit that is traced out by the black arrows in the chart below corresponds to exactly such an assumption.
It is clear that we are not, currently, anywhere near the state of ‘improvement’ in the economy (as far as the Exchequer figures are concerned), or even the ‘bottoming out’ stage. We are still in a relative free-fall stage.

And this clarity is magnified by the expenditure side of the Exchequer balance sheet. Per Ulster Bank research note, the chart below shows the break down of the excessive spending by two main categories:Minister Lenihan is more than willing to cut into Government's only official stimulus to the economy - capital spending. This is a right way forward as much of our capital 'investment' was, in reality, simply masked-up wasteful current expenditure on soft targets like 'training & education', 'social cohesion' etc. But the chart above shows that current spending cuts to date have been extremely shallow. This is not a policy consistent with the claims of rigorous addressing of the deficit - cyclical or structural.
Table above clearly indicates the following facts about our Exchequer's spending side:

1. Capital spending is down significantly, at -13.1% yoy, but not really enough still - cutting capital spending back by 50% would do a better job;
2. Current spending is still rising +0.7% yoy in September (and no, increased social welfare and unemployment payments are not the only story here);
3. Waste on current spending side is still abundant - table shows those articles of reductions where cuts in spending for each department are the deepest. Predominantly, these cuts are on the capital side and not on the current expenditure side;
4. Increased spending on social welfare is now clearly indicating that early job cuts in 2007 are now translating into people signing off unemployment benefits and onto the dole - a move that is likely to lead to a very long-term dependency on social welfare.
   

The verdict from all of this is a simple one - this Government is not doing enough to correct for structural and cyclical fall off in revenue. Tax increases and levies passed in October 2008 and April 2009 are not working. While cuts promised since July 2008 are not forthcoming. We are still on a path to state insolvency.