Economics 12/11/2009: ECB's latest view

I will be blogging on the latest monthly bulletin from ECB published today, but here are few early previews:

One interesting snapshot showing just how silly is all the talk about decoupling in growth between emerging economies and the West:
Since mid 2008 there is absolutely no difference in leading indicators for two series. So anyone still thinks that emerging markets up 90% in a year is a good thing?

And here is a latent illustration of the trend I described some weeks ago using raw ECB data:
Of course anyone knows by now that money supply is not growing, despite the ECB vastly expanded liquidity pumping operations as banks hoard cash in capital reserves, while Government mop up all and any liquidity they can get into their vast deficit financing exercises. Clearly, M3 is showing that things are going swimmingly in the euro area economy.

Don't believe me? Well, here is another illustration:
So things are not getting much better on the credit markets side. The mountain of debt on private sector side is still intact, the mountain of debt on Governments' side is rapidly rising. Hardly a sound exit from the crisis.

Economics 11/11/2009: Lagging indicators and leading signals

McKinsey have published their review of the global economic conditions survey for November. Good read as always (here). Few snapshots of main results first:

"For the first time in a year, a majority of respondents—51 percent—say economic conditions
in their countries are better now than they were in September 2008.... [but] only 19 percent say an upturn has begun. This figure rises to a remarkable 33 percent, however, among respondents in Asia’s developed countries."

Cool, but... 49% state that economy either did not improve or worsened relative to September 2008. 64% expect their economy to be better than in September 2008 by the end of Q1 2010 (up from 61% reading in September 2009). So almost 50% believe that their economy is no better now than at the beginning of this recession (full 4 quarters ago) and some 36% believe that it won't come out of the recession even after 6 quarters of straight contraction.

"A larger share of executives also expects the good news to continue, with 47 percent expecting GDP growth to return to pre–September 2008 levels in 2010 or 2011, compared with 40 percent
six weeks ago." Key point here is that this is an improvement in the indicator, not the actual growth signal (which would require a reading above 50%).

"Although the global news is good, there are marked regional differences; executives in the developed countries of Asia are generally the most optimistic, and those in Europe are the least." This tell us what we all knew - European companies are suffering still through the remnants of old pains, banks are yet to suffer most of their pains, and households - well, households in Europe are in a perpetual pain given sticky unemployment and slow consumption growth and household investment. Thus: "Everywhere except Europe, more executives describe the economy over the next several months as “battered but resilient” than say it is frozen, stalled, or regenerated." (see pic below)So much for the European Century story.

But what are the causes of this pessimism in Europe / optimism in Asia scenario? One can speculate:

For example, despite all the crises, all public spending and monetary easing, business leaders worldwide still see Government regulation as one of top three problems (chart below).
What this tells me is that structural issues that have precipitated the current recession have not been addressed. Can one be out of crisis when the causes of crisis in the first place remain intact?

Another interesting issue - future profitability.
I am not sure how you feel about this, but it makes me very uncomfortable for several reasons:

1. Again, Europe acts as a global drag (just as it was before this crisis), and this is before the hefty tax increases necessary for underwriting recent profligate spending are factored in;
   
2. US - think of this as the indicator of future equity values and you can see just how massively is overbought the US equity market;
3. Overall, all countries which used large state reserves of liquidity to finance current crisis measures (India, China, Asia-Pacific) are on the tearing path for profitability relative to Europe and North America.
   

Now take the outlook for 12 months ahead:
Let's look at this closer:

1. Low customer demand for our products or services: the main driver for all types of firms - with profits at risk (66%), static (46%) and expected to rise (41%). Just think what this means for countries that like Ireland are staring at higher taxes into foreseeable future and destroyed households' net worth;
2. Loss of business to low cost competitors: do I need to say anything here in terms of threats to Ireland Inc? Well, let me put 5 cents in - think of wages path in this economy. While private sector did some cutting (and hardly enough to reach long run equilibrium wages) public sector did none and is unlikely to do much (the latest plan for 6.85% cuts is (a) insufficient, and (b) won't happen in real terms). So overall level of wages in Ireland is really stuck somewhere around 2006 levels.
3. Competition from new entrants is the worry for leaders in profitability, but it will also impact the developed world economies. Why? Because to counter such entry you need new investment and to have new investment you need capital. Currently, capital is mopped up by Governments financing their deficits through Central Banks' issuance of new cash. Later it will be cleaned out by higher taxes. Not a good prospect going forward.
4. Low levels of innovation - again go back to capital in (3) and the same investment cycle restart bottlenecks. Ditto for Inability to get funding - Number 7 on the list.
   

We can go on, but you can see where all this is leading us -

• our current fiscal and monetary policies will be haunting us down the line into the so-called recovery,
  
• while more frugal Governments in China, India (you get the irony here?), Asia and so on, having stayed pre-crisis off the path of unsustainable increases in public spending at rates much faster than growth in their real economies, were able to absorb the crisis with lesser burden of debts.

This is where optimism is now resting globally. We are, therefore, back to the paradigm of "Smaller Governments, Happier Economies"... and healthier households, one might add?

Economics 10/11/2009: Our Unique Path to Solvency

Updated: FX outlook (below)

And so two things come to pass in the last few days that will have a significant bearing on Ireland in years to come.

Issue 1: the ECB has firmly set its sight on exiting from money printing business sooner rather than later. Per ECB's statement last week, the bank will close off its 1 year discount window, cutting maturity of the loans available to the banking sector in the euro area from 1 year long term maturity to 3 months traditional maturity. This will mean two things for Irish banks who are the heaviest borrowers from the ECB by all possible measures (see here):

1. Irish banks will face much faster transmission of any rates increases into their cost of borrowing increases;
2. Irish banks will see higher cost of borrowing directly due to them being unable to access 3-12 months maturity instruments outside the interbank lending markets (currently they are collecting a handsome subsidy from the ECB’s discount window by borrowing at rates well below those offered in euribor).

And all of this will mean that our banks will once again see their margins squeezed by the credit markets, implying an even greater incentive for them to go after their paying customers with higher mortgage rates, credit cards rates and banking fees and costs.

Issue 2: earlier this week, the EU produced an estimate that the Union members’ total public debt could reach 100% of GDP by 2014 up from 66% in 2007. Last month, the Commission forecast that EU debt levels will rise to 84% in 2010 and 88.2% in 2011. Now, it says that not only the debt will top 100% of GDP in 2014, but that it will keep on rising after that. And the Commission named the row of culprits most responsible for fiscal debacle: Greece, Ireland, Latvia, Spain and the UK. This is linked to the earlier paper from the Commission that looked at long-term demographic challenges to deficit financing, where Ireland and other countries were presented as basket cases in terms of pensions liabilities and expected healthcare costs associated with ageing population.

This, of course means the following two things for Irish economy:

1. Despite all extension for 2013 deadline for Mr Cowen to deliver SGP-compliant budget for Ireland, the EU is going to put more pressure on Ireland to bring its house in order. Not doing so will risk derailing of stimulus exits and deficits rollbacks by the likes of Italy, followed by Austria, Spain, Portugal and France. This simply cannot be allowed for the fear of undermining euro’s credibility and with it any plans Brussels might have for the tidy earnings from reserve currency seignorage in the future;
2. Brussels will be pushing harder and harder for own tax revenue source – some sort of a unified federal tax – in order to divorce itself from the precarious and uncertain (i.e volatile) sources of state-level revenues.

The net effect of all of this – taxes will go up. To put this into perspective, should the EU allow us the deadline of 2014 to sort out our deficit, this will mean our debt will be up by another €20-22bn and our cumulative interest bill will rise (by the end of 2014) by another €5.5-7bn.

Alternatively, consider the annual bill for this debt – at 4.7-6% per annum (a reasonable range starting from today’s low rates and reaching into rates consistent with ca 1.75-2.0% base ECB rate), the new, shall we call it ‘delay the pain SIPTU’-debt, will cost us every year something to the tune of €940-1,320 million, or just about what Mr Cowen is now promising to shave off the public sector pay bill.

So do the math – accumulation of liabilities (interest only) of up to €1.3bn per annum and political process delivering promises of savings of €1.3bn after two years of the crisis… Path to solvency indeed.


Now, per one reader's request, here is my view on what this means for the euro:

Macro side: unwinding of deficits will mean a steep fall off in Government consumption and investment, so both - short term and longer term demand for euro will fall. This will be offset by the simultaneous unwinding of quantitative easing, so supply of euro will also decline. Three scenarios and paths are possible from there:

1. If the two offset each other, we are down to interest rate differences to drive currency pairs against the euro (more on this below);
2. If monetary tightening will be lagging fiscal constraints, then euro will be heading south vis-a-vis dollar but not by much as it is highly unlikely that Obama Administration will be able to sustain its own deficits for much longer;
3. If monetary tightening leads fiscal tightening, then euro might head further north vis-a-vis the dollar.
4. Interest rates effects are most likely to drive euro up for several reasons: the US Fed is likely to continue easing as fiscal stimulus runs out; the ECB has reputation building (re-building?) to do; US has higher tolerance for inflation.
5. Last issue to watch over is the financial sectors demand for liquidity. Here, the US is more likely to face smaller demand for liquidity than euro area and this will imply a net positive to the dollar upside.
   

So my view is that dollar-euro pair will remain volatile over some time, with some limited upside to the dollar in the medium term. Carry trades in dollar will be continuing especially as the BRICs and the rest of the world launch into a new investment cycle in early 2010. Depending on whether this will coincide with monetary/ fiscal tightening in the euro area, we might see temporary testing of $/€1.65 barrier.

Euro-sterling story is a different story. The UK will be unwinding fiscal stimulus, while continuing monetary easing (banks are still in need of capital and writedowns will remain pronounced), which means we shall see plenty excess supply of sterling. The pressure is to the downside here and parity can be approached once again (remember that 0.98 moment in December 2008?).

Economics 04/11/2009: NAMA's first falls in the land of legal finance

International Swaps and Derivatives Association (ISDA) has issued an interesting opinion on Nama worth a read. Here are the main points (mind the legalese):

“…from an international perspective, a particular aspect of the NAMA Bill that has the potential to have a significant adverse effect on the transaction by participating institutions ...of domestic and cross-border financial transactions, including privately negotiated or “over-the-counter” (OTC) derivative transactions (“Relevant Transactions”).

ISDA’s main concern focuses on partial nature of property transfers under Nama.

“We note that ...the fact that the NAMA Bill envisages that partial property transfers – [i.e transfer of of some, but not all, of a participating institution’s rights and obligations arising under a Protected Arrangement, an arrangement with third parties legally protected under the international, Irish, UK, US or other national laws] - may be effected raises a significant risk of legal uncertainty for Protected Arrangements.” [In other words, what might be kosher for the Irish authorities under Nama might be violating international legal rights and obligations of parties related to Nama-impacted loans]

“If some, but not all, of such rights and obligations were “cherry-picked” for transfer pursuant to the NAMA Bill, the net position of that participating institution’s counterparty (and, indeed, of that participating institution) would be disrupted notwithstanding the provisions of Section 213” [of Nama legislative proposal].

“...During the UK consultations [on bailout packages] industry put particular emphasis on the possibility that the stabilisation measures provided for in the UK Banking Act 2009, which included a partial property transfer power (the power to effect a transfer of some but not all of the property, rights and liabilities of an affected UK institution), could be used to "cherry-pick" transactions, or even parts of transactions, under a netting arrangement, or otherwise disrupt the mutuality of obligations under a netting or set-off agreement... It is notable that, in the UK context, the validity of the industry concern in this regard was always acknowledged by the relevant authorities (HM Treasury, the Bank of England and the Financial Services Authority), so that the consultation process, in this regard, focused on how best to structure the relevant protections.” [This of course is not the case with Irish Nama case]

“As you are probably aware, the relevant protections were set out in Article 3(1) of The Banking Act 2009 (Restriction of Partial Property Transfers) Order 2009, as amended by The Banking Act 2009 (Restriction of Partial Property Transfers) (Amendment) Order 2009. Article 3(1) provides that a partial property transfer, within the meaning of the legislation, may not provide for the transfer of some, but not all, of the "protected rights and liabilities" between the affected UK institution and a third party under a "netting agreement". [Once more, in Nama case, no due diligence was even performed in this area – it appears from the note by ISDA that the Irish authorities have totally failed to consider the impact of Nama transfers on third parties]


So what does this mean for participating institutions and their counterparties?

“Risk management policies of parties to Relevant Transactions tend to require such parties to monitor credit exposure to counterparties under Relevant Transactions and, where relevant, put in place appropriate risk-reducing close-out netting and collateral arrangements. In the case of a party that is subject to prudential supervision (such as an Irish or foreign bank), whether it can treat its exposure to a Relevant Transactions counterparty as net, and take related collateral arrangements into account for risk reducing purposes, will also be key to the level of capital that the party is required to allocate to Relevant Transactions with that counterparty.” [So standard legal framework requires third parties to hedge risk vis-à-vis Nama-impacted institutions, but this process is at risk under Nama partial transfers. Which implies that Nama actions will spill over to third parties outside Nama jurisdiction. The legal bonanza that will be Nama is now risking crossing many borders…]

“A supervised institution will not be able to recognise close-out netting or a related collateral arrangement unless it can satisfy its supervisor that the close-out netting or collateral arrangement is enforceable with a high degree of legal certainty and with no unduly restrictive assumptions or material qualifications.” [This is the crux of the argument – if Nama will only partially impact security of collateral, this partiality will imply that counterparties to Irish banks’ transactions will not be able to properly assess the security of collateral held by the banks and in cases where such security is jointly held by an Irish institution and a non-Irish one, there will be no means for assessing the risks incurred by non-Irish institutions due to Nama take over of the loans or underlying collateral titles. Nama, therefore, will risk inducing new risk on unrelated institutions.]

Absent Nama “such opinions can be obtained in respect of potential [Nama-]participating institutions in respect of many industry close-out netting and collateral agreements. If the position in this regard were to change [a change which will be triggered by Nama coming into force], the commercial and financial implications for potential participating institutions and their counterparties to Relevant Transactions would be severe in that:

(a) supervised institutions [aka all non-Irish banks and credit providers] would be constrained in their ability to extend credit, or otherwise incur exposures, to participating institutions;

(b) supervised participating institutions themselves would find their own ability to conduct business constrained by much heavier capital requirements and their access generally to liquidity would be impaired”. [In other words, Nama will mean that participating banks will have to pay a heavy premium in terms of capital provisions due to the Nama-induced deterioration of their own collateral rights].

“…a concern remains that a [Nama-]participating institution’s counterparty’s net exposure could be disrupted by a partial property transfer of the type outlined [above]. If such a partial transfer of a bank asset by a participating institution to NAMA or a NAMA group entity occurred (or by NAMA or a NAMA group entity to a third party) occurs, the fact that the participating institution’s counterparty may terminate the agreement with the participating institution and enforce the close-out netting and collateral provisions will not provide comfort [at the immediate and massive cost to the Irish banks participating in Nama] if, as a result of the transfer, the transactions the subject of the netting/collateral arrangement have changed so that its net exposure differs from that which would have pertained but for the partial transfer.”

So, ISDA “strongly recommends that safeguards be introduced to the NAMA Bill to ensure that a Protected Arrangement may only be transferred as a whole under the NAMA Bill, or not at all, and that individual rights and obligations under the Protected Arrangement should not be vulnerable to cherrypicking.”

[In effect this will severely restrict two aspects of Nama operations:

1. this provision will increase the share of non-performing loans in the overall take up of loans by Nama, putting more pressure on Nama bottom line; and
2. this provision will also mean that some of the most toxic loans (with complex collateral rights, significant redrawing of covenants in the past, and/or substantial cross collateralization) will either have to be left with the banks as a whole or bought into Nama as a whole.]
   

But ISDA has expressed another concern: “An additional issue of concern to us is the proposal that, after acquisition of a bank asset by NAMA, …NAMA may change a term or condition of that bank asset where it is of the view that it is no longer reasonably practicable to operate that term or condition. ...the absence of legal certainty that would arise from this unilateral right to amend other contractual terms of Relevant Transactions – particularly when taken together with the provisions of Section 107 of the NAMA Bill – seems likely to have a negative impact on the ability of participating institutions to transact Relevant Transactions.” [In other words, if Nama is to have serious teeth in changing the terms and conditions of loans, it will risk freezing the entire future ability of the Irish banks to have meaningful access to international counterparties.]

[If anyone thinks things are tough in Irish financial markets now, wait till these aspect of Nama as an entity operating outside international norms and regulations come to play…]

Economics 04/11/2009: Live Register - don't touch that champagne yet...

While the Live Register figures (out today) have shown some significant moderation trend for some months now, the latest data remains gloomy. There is a misplaced emphasis on reading the headline statistics too much and ignoring the underlying movements of displaced workers.

The conclusion advanced by many analysts is that October figure shows a seasonally adjusted decline in the LR of 3,000 - the largest drop in LR since the 3,900 decline in April 2005 and the first decline since March 2007. Good news.

The headline numbers of people in receipt of unemployment benefits now stands at 422,500 or 62% above the same period a year ago. This calls for a revision of the expect year-end number to below 500,000. Many analysts jumped in with a conclusion that this will mean the exchequer can breath easier now, because each 10,000 fewer people on LR means the savings of Euro100mln to the Exchequer. Hmmmm... I don't think so.

The savings above reflect the assumption that those off LR are moving into jobs. What if they move into the welfare? Ok, 10,000 people off the LR means savings of Euro 100mln from lower unemployment benefits. If you move to supplementary welfare benefits, the cost of these is identical to job seeker allowance (Euro 204.30 per week), but you will also qualify for more assistance. A temporarily unemployed person might be able to pay out of savings for housing and job searching costs and might be staying outside state-financed training and education programmes. A long-term unemployed person will not, implying a massive cost run up for the state. A 10,000 cost basis for an unemployed LR-listed person quickly turns into a 20-40,000 cost tag for a long-term unemployed.

Now, LR data does not give us a breakdown of tenure in unemployment or other characteristics, but what we do know from today's data is that:

1. Males dominated the reductions in LR numbers with a fall of 2,300 amongst males and just 700 amongst the females. Let me ask you this question - if males increases in LR were driven by construction sector collapse, have any of you seen so many new cranes working in Dublin or elsewhere in the country to warrant 2,300 of these construction workers getting jobs all of a sudden? Neither did I. So most likely, these males are simply exceeding the time limit on unemployment benefits and are now eligible for much more substantial aid available under the general social welfare rates and allowances.
2. Timing of males unemployment increases suggests that we are now seeing reductions in male unemployment coincident with roughly 9-12 months lag from entry point. What does this tell us? Indirectly, this might mean that those who became now long-term unemployed by official definition are simply opting to sign onto welfare rolls and exit the labour force.
3. We are in the beginning of a new academic year. Is it possible that a number of those previously unemployed now became full-time students again? It is. While this is great news, as it means that they will stand a chance of enhancing their education, it is not the good news regarding unemployment in this country.
4. Emigration is another likely factor driving some of the declines in unemployment. Back in September data, details on Irish v Non-Irish nationals on LR showed that the rate of unemployment increases amongst non-nationals was contracting faster than for the Irish nationals. Detailed figures on this matter for October will come out on Friday, so stay tuned.
5. Lastly, the main bit of information relevant to this analysis. Out of 3,000 fewer LR signees, 2,900 came from under 25-year old group. Only 100 of the reductions came from the over 25 years old group. Incidentally, this suggests that LR reductions due to emigration are most likely impacting primarily Irish nationals leaving the state, rather than Accession states’ nationals going back to their countries of origin.

This speaks loudly in support of my assertion that the following forces (in decreasing magnitude of their contribution to falling unemployment) are at play:

• Labour force exits into welfare benefits;
• Net outward emigration of the young.

In my view, both reasons offer nothing to cheer about.

Economics 03/11/2009: Exchequer drama continues

So Exchequer returns for October are in. As usual, charts illustrate:

The miracle of 'stabilising revenues' first. Per above chart, stabilisation, across some categories, has been achieved simply by choosing an unrealistically conservative target for October revenue. The reasons for this conservatism are a matter of guess, but:

• DofF undoubtedly knew that there will be gains in revenue in October due to seasonality, yet they opted to neglect these;
• There was, most likely, an expectation that improved October returns relative to target will provide Government with some added cushion for the Budget day; yet
• Because receipts have deteriorated so far throughout the year, the DofF 'piggy bank' lowering of the target for October was not enough to generate a surplus over the target.

The Grand Plan backfired:

As charts above highlights, tax heads are performing worse and worse relative to 2008 across the board. Worryingly - Corpo taxes and Income taxes are tanking once again and this is before self-assessed tax forms poured in.

Hence, measured in terms of their respective contributions to meeting the tax profile set out in April 2009 Budget, we are now down to just two tax heads with net positive contribution - Corpo (which will see its positive effect eroded as timing changes imply that Corporation Returns are now all but exhausted for the rest of this year) and a tiny positive contribution from Excise that is about to turn negative. In short, it looks like by November all tax heads will be underperforming targets - which will be a real feat of forecasting, then. 

Subsequently, no one should be surprised by the fact that Exchequer deficit is widening on 2008 figure. Borrowing is once again diverging beyond 2008 levels (chart above). And the gap between total receipts and total expenditure is widening (chart below)

Couple more charts: one below showing just how conservative was October target and how this has led to the so-called 'improvement' in on-target performance.

And the following chart shows that the data does not support an assertion that April Budget was successful in arresting or stabilising the expansion of our deficit:

So much, then, for all the brave proclamations about 'making necessary adjustments' and 'taking the right medicine'...

Economics 02/11/2009: Central Bank Credit Data - Renewed Crisis Dynamics

So Irish Central Bank monthly data – out last Friday – provides some more fodder for thought about what is going on with credit flows in the country most dependent on ECB repo window (see here).

First consider the aggregates on money supply side:
This clearly shows that whilst M1 money supply has expanded by just under €3bn (or 3.4%) between August and September 2009, M2 money supply has contracted by over €4.1bn or 2.11%. The contraction is primarily driven by the decline in deposits with set maturity of up to 2 years which have fallen by a whooping €7.43bn or 7.9%. Part of this was probably used to deleverage shorter-term debt securities (up to 2 years in maturity) – which have declined by €2.66bn or just under 5.5%. But whatever happened with the rest of deposits is hard to explain out of the CB data. Deposits with medium term maturity constitute the most stable measure of future lending capacity in the credit sector and this decline does not signal much needed stabilization in future lending conditions.

Now to more detailed data on consolidated balance sheet. First, liabilities side:

The above chart clearly shows that all liabilities, save for Non-Government Deposits and Government Deposits with the Central Bank, are still trending up. Net external liabilities are certainly in reversion after June local trough and are now dangerously reaching for February 2009 crisis levels. Bad news?

Well, aggregates are showing something very similar:
Total liabilities are now in excess of the non-Government credit volumes once again for the second time this year. First this condition was observed in January-February 2009. Next, we have crossed once again to the situation of private sector credit falling below total liabilities in August 2009. September 2009 re-affirmed the trend as the gap between two time series widened to the second highest level in 2009 so far with January gap of €27.7bn and September gap of €22.0bn. So non-Government credit flows are no longer covering total liabilities… Bad stuff? Wait…
On the assets side, the above shows that save for Government debt which is converted through accountancy double-entry into Government Credit (up 77.9% year to date in September), not much else is rising, with fixed assets down 14% year to date, interest earnings on non-government credit down 49.6%, official external reserves up 11.35%.

On private sector credit decomposition:
Total private sector credit (PSC) has declined from the peak achieved back in November last year to current €378.1bn or 6.4%. This is dire and the decline is actually accelerating since beginning of September. Table summarizes:
The same is true for non-mortgage credit and mortgage credit. Importantly, the data on mortgage credit and non-mortgage borrowing shows that there is no deleveraging in sight for Irish households. Residential mortgage lending today continues to remain at well above the peak markets level for house prices. In 2007, average monthly level of mortgage debt in Ireland stood at €131.1bn. In September 2007, the level was €136bn or 8.83% below the latest level recorded in September 2009. Thus, as negative equity pressures continue to increase due to falling house prices and as rents continue to destroy yields on property, Irish mortgage holders are simply prevented from deleveraging in the credit cycle by falling incomes and rising taxes.

This does not bode well for the short-term prognosis for the Irish financial system (reliant heavily on low default on mortgages assumptions amidst a full blown meltdown of the development loans) and for the Irish construction sector and property markets (reliant on some sort of a return of the buyers to the collapsed market for properties). It also does not support any hope of the stabilization in the property-related tax revenues.
Hence, although credit contraction has set in firmly back in June (with credit to private sector posting negative growth in yoy terms since then), mortgages credit is lagging (implying that we are yet to witness true crunch on mortgages – something that is likely to happen once the banks set out in earnest to rebuild their margins by hiking mortgages rates post-Nama) and non-mortgage credit is back on the rise (potentially reflecting accumulation of credit arrears by financially stretched households).

The same picture, of building pressure on the arrears side can be glimpsed from the changes in trends for credit cards spending. New purchasing using credit cards has lagged repayments in January-August 2009. In September, more charges were incurred than paid down. The same (albeit on a vastly smaller scale) took place in business cards. Hence, balances are now rising across all credit card debts, as shown in the chart below.

Net result of all of this: outstanding indebtedness of Irish private sectors is no longer declining. The rate of growth in overall debt levels has hit 0 in May 2009, bounced back to positive territory in June-July 2009 and failed to hit negative (deleveraging territory) since then.

Economics 31/10/2009: Latest data on Irish Resident Foreign Assets Holdings

CSO released (yesterday) latest data on Resident Holdings of Foreign Portfolio Securities. Charts below illustrate the trends.

First the aggregate stuff:
Notice that 2006-2007 overall trend implies peaking of foreign assets holdings by Irish residents at 2007, and a decline in asset holdings in 2008 to the levels below those recorded in December 2006. This is clearly reflective of the general external crisis in asset markets and is expected to record even further and more dramatic deterioration in 2009. Holdings of bonds and notes also declined from a peak on 2007, but less dramatically in relative terms - reflective of flight to safety into public debt markets by many investors. Again, similar trend to global. Equity holdings took the most sever beating, in line with global markets.

One interesting point is that Money Markets instruments holdings (not plotted above) have also declined in 2007 and 2008. This suggests two idiosyncratic developments in Ireland:

• risk reductions took place in 2007, well before the full-blown global crisis of 2008, but in line with a financial markets crunch that began in August 2007;
• both cash and equities were likely to have been used by Irish residents to offset leveraged losses (these are the most liquid instruments that can be used readily to meet margin calls) and this process was on-going in 2007, suggesting serious leveraging exposure to derivatives markets in Irish resident portfolios - a conclusion that would time declines in money markets instruments back to August 2007, when derivatives markets collapse triggered subsequent run on equities).

Now to some more detailed sub-categories of assets. Starting with total foreign asset holdings by country of asset origin:
There is a clear indication here that Irish resident portfolia are heavily geared toward UK and US assets (nothing surprising, as these allocations are only slightly ahead of global diversified portoflia bias toward these two countries). There is also present a relatively heavy allocation bias toward European and EEC securities. However, the real area of geographic diversification imbalance is found amongst the middle income (BRICs) and emerging markets allocations.

Ditto for bonds and Notes:
In terms of Equity allocations:
There is a clear imbalance in Irish resident positions with equity exposure to only a select subset of OECD economies. There is virtually no presence of high growth economies in the overall equity portfolios in Ireland.

Economics 30/10/2009: Assets/Liabilities data - How IFSC beats domestic investment sectors

See as ever entertaining press release from Ryanair below.

Per CSO release today: End-December 2008, Ireland’s international investment position (IIP) was:

• stocks of foreign financial assets of €2,194bn - a drop of €76bn on the end-2007 level of €2,270bn
• liabilities were down by almost €7bn from €2,307bn to €2,300bn
• Irish residents therefore had an overall net foreign liability (or deficit) of just over €106bn at the end of last year, up over €69bn from 2007 figure of €37bn.

Now, decomposition of these net liabilities is telling: In overall commercial financial sector:

• Monetary financial institutions (MFI - i.e. credit institutions and money market funds) had assets amounting to €1,065bn at the end of 2008. On the liabilities side, the MFI sector accounted for €1,146bn so total net liabilities of MFI sector in Ireland were at €81bn.
• Other financial intermediaries (OFI i.e. investment funds, insurance companies and pension funds, asset finance companies, treasuries, etc) accounted for €980bn of foreign assets. OFI liabilities were €921bn, implying net assets (not net liabilities) of €51bn.

Thus, our commercial financial sector at the end of 2008 had foreign assets of €2,045bn (or over 93% of total foreign assets) and liabilities to non-residents of €2,067bn (or almost 90% of total foreign financial obligations), resulting in a net foreign liability of €21bn.

But the real gem is in the bottom section of CSO report. For months now CSO and Ireland’s CBFSAI were at pains to distance themselves from the IFSC. Every time someone pointed to a massive debt mountain Ireland Inc is bearing on its (private sectors’) shoulders, our Central Bank shouts ‘Foul – it’s all the fault of the IFSC’. Few (including myself) made arguments that this is too simplistic: IFSC is both an asset and a liability to our economy, and thus one cannot simply ignore its debts when one wishes to do so.

Well, CSO’s data actually shows that IFSC is hardly a culprit in the All-Ireland race to become a leading sector in net liabilities: “At the end of 2008, IFSC assets abroad amounted to €1,663bn or over 81% of the sector’s foreign assets (and almost 76% of Ireland’s total foreign assets).” IFSC liabilities stand at €1,646bn (nearly 80% of the commercial financial sector aggregate and over 71% of Ireland’s total foreign liabilities).

Yet IFSC recorded a net asset position at the end of 2008 of almost €18bn. While much smaller in size relative to IFSC, non-IFSC commercial financial enterprises (17% of total foreign assets and 18% of total foreign liabilities) have managed to run up a net liability of €39bn. That is a swing of €57bn between IFSC’s healthier books and non-IFSC’s sicker ones.

Think non-IFSC guys are now firmly on track to win the leading position in that All-Ireland race to highest indebtedness? Nope. The monetary authority, general government and non-financial enterprises had end-2008 foreign assets of less than €149bn (about 7% of the total) and liabilities of almost €234bn (just over 10% of the total). So the public sector net liabilities were a whooping €85bn, a swing against IFSC position of €103bn.

Scary stuff? Well, not yet - look at the following charts:
Chart above shows assets side of our International Investment Positions (IIP). All point to clear declines in 2008, except for 'Other' (aka derivatives written by our speculation-prone folks) and 'Direct Investment' (aka completion of Bulgarian and Romanian property syndicates)...
Chart above illustrates liabilities side of our IIP. All liabilities are up except for FDI into Ireland (which is falling - more on this below), and Portfolio Investments - which were hammered by global equity markets meltdown.

So net positions next:
Clearly, comments in the charts are self-explanatory. Good stuff (FDI) is falling, bad stuff is rising (Portfolio Investment Liabilities, Other Liabilities and Total Liabilities)... But take a closer look at Foreign Direct Investment (FDI) into Ireland, and our Direct Investments out of Ireland:
No more comment needed.

The last standing is the pesky IFSC issue - is it a problem for clean Ireland Inc, or is it actually an asset for lagging Ireland Inc? Take a look:
Conclusion - obvious. Can we get the IFSC guys to run our domestic financial services sector? Please!

Why one has to love Ryanair? Because it does what it promises on the tin:
No comment needed. As always.

Economics 30/10/2009: Reliance or dependency

Quick points on post-Nama recapitalisation, credit flows from ECB to Ireland and Frank Fahey encounter with an egg...

I have done some sums on demand for equity capital by Irish banks post-Nama. Assuming underlying conditions for loans purchases as outlined in Nama business plan, using 6% core equity ratio as a target (remember, this is a lower target by international standards) and assuming no further deterioration in the loans books quality post-Nama:

• AIB will require €3.2-3.5bn in equity capital post-Nama;
• BofI will need €2.0-2.6bn;
• Anglo will need €4.5-5.7bn;
• INBS/EBS & IL&P will require total of €1.1-1.2bn.
• Total system demand for equity will be in the range of €9.7-12.4bn.

Approaching the same issue from the angle of Risk-Weighted Assets, system-wide demand for equity will be around €10.8bn post-Nama. This will extend Nama-associated rescue costs to:

• €54bn in direct purchases;
• €5bn in completion 'investments' with estimated further €3-5bn in future completion additional funds;
• €1bn in legal, advisory and management costs;
• €9.7-12.4bn in equity injections;
• Past measures €11bn.

Net of interest costs and losses, total price tag looks now like €84-88.5bn. This, for a system that can be fully repaired through a direct equity-based recapitalisation at a cost of roughly €32bn.


Our agriculture is the heaviest subsidised in the EU (and indeed in the world). This fact has never troubled our policymakers, as if subsidies are a sign of industry viability and strength, as long as they are being paid by other countries taxpayers (as in the case of CAP).

Now, we have become the biggest ECB liquidity junkie by far. Table below from RBS research note shows the dramatic level of financial life support our economy requires.
Note that the above list of countries includes heavily crisis-impacted Spain, the Netherlands, Belgium, APIIGS (less Ireland), aggregated in the 'Other' grouping. And yet... they all have larger economies than Ireland and smaller demand for liquidity injections.

Does anyone still believe that Nama can add liquidity to our economy? Or that such an addition can improve lending conditions? Apparently, ECB-own lending operations were not able to do so to date...


And on related note, there is an interesting quote from Dr Alan Ahearne in a recent article in the Southern Star newspaper (here):

"As one economist warned last year, ‘buying the assets at inflated prices would amount to a back-door recapitalisation of the banks’. Best practice ‘is for the banks to recognise the losses on these loans up front and sell the assets at fair market value’. Whose words? Dr. Alan Ahearne – now economic advisor to Brian Lenihan and one of the chief advocates for NAMA. Go figure."

Well, not much to figure, really - call this miraculous conversion a '€100K effect' triggered by new employment...

Oh, and while we are on Nama, here is an excellent 'Public Anger at Nama' account of the latest Leviathan encounter by Peter Mathews. I wonder if Senator Boyle and Frank Fahey get the point - people are angry at the way the country is mismanaged, but they are even angrier at being pushed into Nama.

Economics 27/10/2009: What credit flows data tells us...

There is a superb blog post by Ronan Lyons exposing the economic nonsense spun by Nama supporting 'economists' - read HERE. In case you still wonder who that 'mysterious' uber-adviser from Indecon was - well, might it have been Time Magazine-famous (see here) Pat 'Never-Heard-of-Before' McCloughan?..


An interesting data from the ECB: The annual rate of growth of M3 money supply has decreased to 1.8% in September 2009, from 2.6% in August 2009. This marks new deterioration in money growth. The 3mo average of the annual growth rates of M3 over the period July 2009 - September 2009 decreased to 2.5%, from 3.1% in the period of June 2009 - August 2009. Table below summarises:
The annual rate of change of short-term deposits other than overnight deposits decreased to -5.3% in September, from -4.1% in the previous month. This implies that banks are bleeding cash at an increasing rate. In the mean time, the annual rate of change of marketable instruments increased to -8.8% in September, from -9.3% in August. Hmmm - has this anything to do with more aggressive repo operations? Or with more aggressive re-labeling of what constitutes 'marketable' instruments? Or both?

On the asset side of the MFI sector, "the annual growth rate of total credit granted to euro area residents increased to 3.1% in September 2009, from 2.8% in August. The annual rate of growth of credit extended to general government increased to 13.6% in September, from 11.5% in August, while the annual growth rate of credit extended to the private sector was 1.1% in September, unchanged from August." So here we have it - the credit pyramid in full swing. Banks borrow against bonds issued by the state (increasing supply of 'marketable' paper to the ECB). The states promptly issue more bonds that are then bought up by the banks, increasing supply of credit to the governments.

In the mean time the real economy is taking more water: "...the annual rate of change of loans to the private sector decreased to -0.3% in September, from 0.1% in the previous month (adjusted for loan sales and securitisation the annual growth rate of loans to the private sector decreased to 0.9%, from 1.3% in the previous month)." [The latter number means that barring accounting shenanigans with re-classifying and restructuring loans, credit to private sector was falling even faster].

"The annual rate of change of loans to non-financial corporations decreased to -0.1% in September, from 0.7% in August. The annual rate of change of loans to households stood at -0.3% in September, after -0.2% in the previous month. The annual rate of change of lending for house purchase was -0.6% in September, after -0.4% in August. The annual rate of change of consumer credit stood at -1.1% in September, after -1.0% in August, while the annual growth rate of other lending to households was 1.5% in September, after 1.3% in the previous month." Again, the last sentence reflects increases in credit due to arrears (short-term lending to households).

So to summarise, economy is still tanking, while the governments are still monetizing new debt through the banks. Expect a bumper crop of profits from Eurozone financial institutions in months to come as they reap the gains of the government-financing pyramid.

Let me show you some illustrations based on ECB data:

First we have Government borrowing:
followed by non-MFIs
...and non-financial corporations
and finally by the households:

As commented in the charts, this data shows conclusively that the private sectors (non-financial corporations and households) have been:

• accumulating liabilities in the years before crisis in a transfer of the debt off the public sector shoulders onto private economy shoulders; and
• were unable to deleverage in the last 24 months since the onset of the financial crisis.
  

This implies that in years to come, weakened consumers and corporates will be exerting downward pressure on European growth, with interest rates hikes potentially inducing a destabilizing pressure on already over-stretched households and corporates. In this environment:

• any talk about ECB and Governments' 'exit strategies' is premature, unless one is to completely disregard the credit bubble still weighing on non-financial private economy; and
• continued public sector spending stimuli and ECB discount window-reliant monetary policy cannot be a workable solution to the crisis. Instead, there is an acute need for orderly deleveraging in the private economy.
  

Economics 27/10/2009: Recessions, Busts and Crunches

I am back from a very enjoyable (as always) trip to Paris and some 150km beyond. Superb retrospective of Pierre Soulages' work in Pompidou - a real master of true dynamism. A mouthwatering Hans Hartung print (some examples here) and two lovely Soulages' prints as well - all in my favorite gallery Paul Proute SA - were hard to resist, but given we are in a depression, while the French art market seems to be only in a recession, judging by prices, resistance was a-must.

One telling tale - at a lovely dinner with a small group of friends in the countryside, conversation took a quick turn to corrupt politics. Our French hosts were lamenting about the state of their country politics by pointing to a scandal surrounding Nicolas Sarkozy's plans to appoint his failed-lawyer son to head the Epad, the development corporation of La Défense (see a note here). Epad is a state-sponsored body and the French nation was literally lifted to its feet when nepotist Sarko tried to push his baby-faced offspring into the CEO seat. In return, I recalled for our friends the story of Bertie Ahearne arrogantly telling the nation that he gave state jobs to his cronies not because they provided him with money but because they were his friends. My French hosts couldn't believe that such a statement did not cost Bertie his job leading to years of public investigations and pursuits through courts. Nor could they believe that Bertie's friends are still, mostly, in their places of power.


Now, a couple quick notes relating our own troubles.

Stijn Claessens, M. Ayhan Kose and Marco E. Terro have published their excellent paper "What Happens During Recessions, Crunches and Busts?" (I wrote on it before based on the working paper version here) in Economic Policy, Vol. 24, Issue 60, pp. 653-700, October 2009. Here are couple interesting illustrations:
So per above, combined duration of contractionary segment of the credit crunch and housing price bust can be expected (on average) to last approximately 30 quarters (timing the current Irish crisis to last from Q1 2008 through Q2 2015 if the rate of house price bust and credit contraction here in Ireland was close to an average of the countries surveyed by the paper).

The latter 'if' is a serious assumption to make. Claessens, Kose and Terro show that the average bust/contraction is associated with a roughly 18% fall in credit supply and 29% decline in house prices. Of course, in Ireland, we are already seeing a 70% decline in credit supply and a 40-50% decline in house prices. So make a small adjustment - back of the envelope - to account for these and you get expected the current contraction/bust crisis to last more than 52 quarters, taking us well into the beginning of 2020 before the recovery truly takes hold.

And this dynamic is seemingly also in line with Claessens, Kose and Terro data on the impact of crises on GDP. 2008-2010 Irish GDP is expected to fall by some 13.5-15%. This is approximately 2.5 times the depth of the average adjustment associated with credit crisis and house price bust per Claessens, Kose and Terro, as illustrated in their chart reproduced below:
Oh, and for those 'advisers' who are telling Minister Lenihan that Ireland will recover from this crisis along the same trajectory as the 'average' OECD economy (the same advisers who are talking of 8-year cycles in property prices), here is how average Irish crisis is compared to the rest of the modern world history:
Only 4 countries so far have experienced a combination of Asset Price Bust + House Price Bust + Credit Crunch.


My second note of the day is about the effectiveness of fiscal spending as 'get-us-out-of-recession' stimulus. Given that the Government is now pre-committing itself to not cutting public sector pay, it is worth quickly mentioning that the Unions-supported idea that cutting public expenditure is only going to make our recession worse is simply untrue. A recent (July 2009) note by Fabrizio Perri of University of Minnesota, Federal Reserve Bank of Minneapolis titled "Comment on: Planning to cheat: EU fiscal policy in real time by Roel Beetsma, Massimo Giuliodori and Peter Wierts" provides an estimate of the fiscal expenditure multiplier for European economies. The number is 0.85... or, significantly less than 1. This suggests that cutting public spending will lead to a proportionately smaller reduction in GDP than the savings to be generated.

Here is an additional (excellent) note on the whole mess of fiscal multipliers. Adding to this, one has to recognise that Irish public spending is far less effective as a stimulus to the economy, as it is accounted for (to the tune of 70% of the total expenditure) by social welfare and wages - i.e. non-productive components. Thus, one can expect the above 0.85 multiplier estimated for Europe as a whole to be around 0.26-0.0.29. Which, in turn, means that any fiscal contraction in today's Ireland will likely result in a medium-term expansion of our economy. Then again, we already know this much from the 1980s experiences, don't we?

In reality, of course, taxing private economy amidst credit and asst price crises to continue wasting money on the current public expenditure is a sure way to extend and to deepen the recession, as:

• Our public expenditure level was not sustainable for this economy even at the times of growth, let alone at the time of a severe recession;
• Ireland is now likely to be on a path of permanently lower post-crisis potential GDP/GNP growth, so the cuts in public spending will have to take place no matter what delay in public expenditure adjustment the unions will force onto this Government;
• We are facing the fastest and the longest increase in public debt (ex-Nama) in the OECD over the next 5 years and an additional open ended liability under Nama, both of which make it virtually certain that Ireland will emerge from this crisis as a fully insolvent nation.