Economcis 10/04/2010: Ireland's Competitiveness - not improving

Often overlooked today (in the usual media focus on credit flows), Ireland's Harmonized Competitiveness Indicators, published by the Central Bank are painting a really troubling picture.

The latest data, released this week in the CB's quarterly update shows that despite all the talk about wages, our competitiveness has not been improving at any significant rate during the current crisis.

Charts below illustrate:
First, the monthly figures above. It is clear that consumer price deflation acts as the only force that is inducing gains in competitiveness in Ireland. Even by this measure, improvements are not dramatic - over the course of the crisis so far, Ireland Inc has managed to improve its competitiveness only to the levels of August 2007! In other words - if 2007 was the year this economy was running on a toxic mixture of drugs and steroids, according to the CB figures, we are still reliant on the same toxic potion of uncompetitive prices and costs, except we are no longer capable of running at all.

Adjusted by unit labour costs, our competitiveness performance is even worse. We are, factoring out the seasonal effects, still in the economy geared to the boom.

The second chart shows quarterly changes:
This is really self-explanatory. Ireland Inc is absolutely out of touch, in economic terms, with its previous, competitive self. Having endured 4 years of unsustainable bubble (2004-2007), we are now lingering at close to the bottom of our historical competitiveness position.

Economics 09/04/2010: Bank of Ireland: strategic insanity

And so, as I predicted in the press some months ago and confirmed (also in the press) following the AIB rate hike and previous BofI hike in the non-mortgage rates, Bank of Ireland had succumbed to the temptation to destroy its own paying clients in order to plaster up the gaping hole in its capital base.

There are, as you have noticed, a number of things going on in the above statement. Let me briefly explain:

• A hike of 50bps on variable rate mortgages announced by BofI is a short-sighted strategy: the bank holds ca 25% of all mortgages in the country (about 190,000) of these, more than 20% are already in negative equity (over 40,000). BofI should be concerned about preserving those mortgages that are currently at risk - in other words, the bank should focus on helping (or at least not hurting) those who are close to the margin of defaulting. Variable rate hike will most severely impact those households with higher LTV ratios, who are younger and thus at higher risk of unemployment. Thus, the interest rate elasticity of the mortgage default rate is the highest exactly for this category of clients. Put in 'can my grandma understand this' terms - BofI move today is equivalent to destroying that parts of its performing loans book which it should be focusing on saving.
• A hike of 50bps on variable rate mortgages will do absolutely nothing to BofI's balancesheet. Bank might be estimating that it can get few million worth of funds from the move. But the wholesome destruction of its own client base and their loans, in my view, will cost it more than it will bring in in the longer-term.
• A hike of 50bps will further amplify the already destructive force of precautionary savings wrecking destruction across the Irish domestic economy. This effect will be driven by two forces. First, any money the banks take in higher mortgage rates will not be recycled into the economy through higher investment or new lending because the banks will force the new cash into capital reserves to pay down defaulting debts. Thus, every penny taken by the banks in will mean a one-for-one contraction in direct consumer spending and household investment, amplified through the usual multiplier effects 3-4 fold in the course of just one year. Second, households will now rationally expect more hikes in mortgage rates, thus increasing further their saving. For every €1 that BofI, AIB, ptsb, and the rest of the gang collect from mortgage holders, consumer spending will therefore decline by at least €4-5.

The BofI move today is, therefore, equivalent to a deranged asylum patient having fallen off the cliff, hanging onto the last available branch of a tree frantically sawing off the said branch with a fervor.

And since we are on the theme of deranged asylum patients, why not mention the latest, and perhaps the most comical idea our state-backed financial engineers can conjure: the Anglo Irish Bank taking over Quinn Insurance. That one is equivalent to AIG being taken over by General Motors. A bank that is as full of bad loans as Hindenberg was full of hydrogen is taking over an insurance company that is so disturbingly short of capital - sparks are flying from underneath its wheels.

What can possibly go wrong here? Oh, just about countless more billions from the taxpayers wasted...

Economics 08/04/2010: AIB first Nama loans

Earlier this week, Nama had completed the first transfer of loans from AIB. Per official report, Nama bought loans with a nominal value of €3.29bn for €1.9bn in NAMA bonds, implying a discount of 42.2%. This was below the discount of 43% announced by the Minister for Finance last week.

But what do these figures mean? Without knowing exact nature of the loans, it is hard to tell just how much did Nama over pay for the loans. Here is an averages-based estimate, however.

First, let us reproduce the original claimed discount of 42.2% using averages. Table below does exactly this:
In the above, I assume:

1. Vintages of loans transfer running between 2005 and 2007;
2. 2 year roll up on interest maximum allowed in the loan covenants;
3. Roll up of interest commencing at a new rate in year 2008 and running through 2009;
4. 2 scenarios of average interest rates applied (Scenario 1: 5% pa, Scenario 2: 6% pa) – as you shall see below, these are optimistic rates;
5. Declines in values affecting different vintages as follows: loans of 2007 vintage – decline of 50% in value of the loan; loans of 2006 vintage – 40% and loans of 205 vintage – 35%.

As the last row shows, taking a simple average across all scenarios and vintages yields a discount on the loan face value of 41.7%, which, factoring in 0.5% Nama-reported risk margin yields the effective rate of 42.2% - bang on with the desired.

Having matched Nama numbers, let’s examine the assumptions and bring them closer to reality:

1. Let us use the actual average annual lending rates for non-financial corporations reported by the Central Bank Table B2 (here)
2. Let us also adjust the loans for security of collateral claims – remember, per official statements from Nama many loans (in the Anglo case up to 20%) are non-secured, with effective claims against the underlying assets of nil) – to do this, we induce the following security risk adjustments to value: 6% for vintages of 2005, 9% for vintages of 2006 and 12% for vintages of 2007. So the average is 9.9%. Although these are significant, remember – reports of 20% for Anglo loans are based on untested cases. It remains to be seen how higher these will go should other lenders contest Nama take over of the claims.
3. Since Nama valuations were carried out through November 2009, we must factor in further declines in value, so let us push up value discounts to 35% of 2005 vintages, 45% on 2006 vintages and 55% on 2007 vintages. Again, these are conservative, given evidence presented in the commercial courts.
4. Instead of running alternative interest rates scenarios (remember – I am taking actual rates reported by the Central Bank), take two different scenarios on vintages compositions: Scenario A assumes uniform distribution of loans across three vintages, Scenario B assumes a 20% for 2005 vintage, 30% for 2006 vintage and 50% for 2007 vintage split.
5. Finally, let us estimate two other alternative scenarios: Scenario 1 has no mark ups charged on average lending rates, Scenario 2 has a set of mark up reflective of higher risk perception of loans, especially in 2008-2009 period. Remember, lenders became unwilling to provide funding for property investments in 2008-2009, which means they would be expected to charge a higher interest rate (risk premium) on loans related to property than those reflected in the average corporate lending rates.

Tables below show the results of model estimation:
Alternative scenario 1: Nama overpayment over the current market value ranges between 42% and 51% or €561-638 million.
Alternative scenario 2: Nama overpayment over the current market value ranges between 48% and 57% or €617-688 million.

So averaging across two tables: Nama overpayment on AIB tranche 1 loans is estimated at between 42% and 57% or between €561 million and €688 million. At a lower estimate range, this suggests that Nama is at a risk of overpaying some €26 billion for the loans it purchases, should this type of valuations proceed.


Of course, some would say this overpayment reflects the expected long term economic valuation of these loans. Fine. Suppose it does – how long can it take for the LTEV to be realised to break even (real terms) on Nama assets then?

Let’s make two assumptions:

• suppose that Irish property markets see price increases of 150% of expected economic growth,
• suppose that expected long term economic growth will average in real terms between 2% and 3% per annum.

If Nama overpays 48% on the current value of the assets (lower range of my estimate), Nama will break even – absent its own costs of operations and funding – and assuming full recovery of the loans per their value – by the end of 2027 if the growth rate average 3% pa or by the end of 2035 if the growth rate averages 2% pa in real terms.

If Nama overpays at the top of the estimates range – 57%, then real recovery will take up to the end of 2039 if the average annual growth rate is 3% or up to 2053 is the average growth rate is 2% per annum.

Again – notice that these figures do not include:

• Legal costs of running Nama;
• Losses that might occur on the loans since November 30, 2009 valuation cut off date;
• 3 years long roll up interest holiday built into Nama;
• Operating costs of running Nama (inclusive of very costly advisers it contracts);
• Cost of Nama bonds financing
• Cost of actual working through the bad loans

Still thinking Anglo is the worst case scenario for us?

Economics 07/04/2010: Another lesson from Greece

The lessons for Ireland from Greece are just keep on coming. In the weeks when the Irish Government is engaging in talks with the Unions concerning the reversal of budgetary reductions passed in Budget 2010, the Greeks are offering a somber reminder of what happens to the countries with runaway public finances.

The most important news in the last week or so was the renewal of the upward crawl in the spread of Greek bonds over German bund. The spreads have jumped from about 300bps to 400bps with Greek 10-year bond yields hitting a high of 7.161%.

Let us put this number into perspective. Irish Government currently is borrowing at around 4.6% per annum. This means that annually we are paying €46 million interest bill per each €1 billion borrowed. Through 2015, the total cumulative and compounded Irish Government cost of borrowing will equal, therefore, to €309.8 million per each €1 billion borrowed.

Now, were we borrowing at Greek rates, the same bill would be €514 million or 66% higher than current. Taking official projections for deficit, this means that at Greek rates of recklessness, Ireland Inc would be facing a deficit financing cost of €18.3 billion, as opposed to the current projected cost of €11.2 billion.

Short term borrowing would also be a problem, with Greek 2-year bonds yields jumping up by more than 1.2% to 6.48% overnight last – a record for any sovereign country.

Now, of course the Greeks are a basket case. Latest Eurostat revisions of its budgetary data show that actual deficit reached 13% of GDP in 2009. But Ireland is a close second here – with our deficit as a fraction of our real economy (GNP) being bang on with the Greek latest revisions. Worse than that, Greek economy has shrunk only by about 1/5 of the decline experienced by Ireland.

If you think that Greek rates extreme moves are a temporary blip on the market radar, think again. Greeks are preparing a Yankee bond offer in the US, and per Bloomberg reports, the markets are expecting pricing in the region of 7.25% yield for 10 year paper, or 410bps premium on the German bunds. Per Bloomberg report, Greek yields are now consistent with corporate junk bond yields.

And in a final note to the Unions here at home, Les Echos Jacques Delpla makes a very strong point that based on Fisher’s theory of debt deflation, it is a mountain of private debt, not public debt, that implies PIIGS are even in more deep trouble than the bond markets might suggest. Wage inflation (in real terms outpacing economic growth) and private debt increases (also in excess of real growth in the economy) during the boom times are now inducing a deleveraging withdrawal of consumers and investors from PIIGS. In the end, this is a much greater threat than the Exchequer deleveraging.

Good luck to all our Bearded Keynesians (or shall me say ‘Marxists’, for I doubt Keynes would have favoured an idea of piling up more Exchequer liabilities when deficits are running in double digits).

Economics 6/04/2010: QNHS - the figures of despair

Time to take a closer look at the latest data from Quarterly National Household Survey - released a week ago. The focus below is on less recognized trends, so endure the charts...

Chart above shows the dramatic declines in our labour force and an even more dramatic decline of those in the labour force who are currently employed. In effect, unemployment has consumed two years worth of gains in jobs, plus another 3.5 years worth of increases in participation. Overall, we are now back in Q2 2004 when it comes to employment figures.

As a result, unemployment soared, but what we tend to forget in looking at the headline figure is that long term unemployment - lagging ordinary unemployment by some 12 months or more - is now precipitously rising...
Chart above shows that contrary to all the talk about 'bottoming out', the latest fall-off in unemployment recorded in Q4 2009 is seasonally consistent with normal patterns, implying that in all likelihood, unemployment figures will remain on the rise from Q1 2010 on.
Looking at employment changes broken down by occupation, it is clear that the crisis has seen most of jobs destruction focused at the bottom of earnings distribution - in areas that are less skills-intensive. There are, most likely, several reasons for this:

• Professional and Managerial grades are usually occupied by people with longer on-the-job tenure, making them more expensive to lay off, and more likely to be part owners of businesses and professional practices;
• Sales and Other are more flexible workforce components, linked closely to internal demand;
• One interesting change is amongst operative workers. This category includes some construction workers, but in general, it does appear to suggest that exporting sectors growth over 2008 was more likely underpinned by transfer pricing by multinational rather than by real expansion of physical production.

Overall, however, it is worth noting that occupations with greater human capital intensity of production are holding up much much better than those where people are closer substitutes for technology and machinery.

Change in working hours also reveals some interesting features of the changing labour force:
We clearly are having a secondary crisis in terms of under-employment, whereby workers might be retaining jobs, but their hours worked are being cut back dramatically. Percentage of full time jobs has clearly declined, while part-time jobs are on the rise.

And unemployment is becoming a long-term condition for an increasing number of workers:
The numbers are pretty self-explanatory, except that one must add to these figures an observation - long-term unemployed are much harder to shift off the welfare than those in shorter term unemployment. Note that 29,400 long-term unemployed back in 2007 were pretty much unchanged since the beginning of the century. Since then, however, we just added 59,700 more of those who are risking to becoming permanently unemployed into the future.
While unemployment increases (chart above) were the feature of 2008 labour market collapse, job seekers (both in education and outside), underemployment rises and full-time employment fall-off were the main features of of 2009. These are likely to remain dominant in 2010 as well as unemployment reaches deeper into skills distribution over time.

This is confirmed in the following chart:
Notice that S3 and S2 (broader) categories of stressed workers are rising faster through out 2009 than the more narrow unemployed category. Should the positive move in Q4 figures be reversed (see above discussion), there is significant likelihood that these broader categories will continue to increase at a faster pace than simple unemployment measure, further increasing surplus capacity in the economy and putting more income uncertainty onto the shoulders of those still in full-time work.

Returning back to the issue of skills: chart above shows that both in 2008 and 2009 workers with greater human capital attainment were in lower risk of unemployment than those with lower educational attainment. Of course, this is a result of several forces:

1. Workers with higher educational attainment tend to be more productive in same occupations;
2. Workers with higher educational attainment tend to have better aptitude;
3. Workers with higher educational attainment are also more likely to engage in continued up-skilling and on-the-job training;
4. Workers with higher educational attainment tend to possess more flexible sets of skills;
5. Workers with higher educational attainment tend to be employed in more competitive and exports-oriented sectors and companies, etc.
   

All of this, however, suggests that human capital matters even in amidst a wholesale collapse of the labour market experienced in Ireland.
And, as chart above shows, workers with higher human capital attainment are also more likely to be fully engaged in the labour force. Which means two things:

1. Human capital is an important differentiator in a recession; and
2. Those currently fuelling longer-term unemployment are more likely to be with lower skills, and thus are more likely to exit labour force and remain outside the labour force for a much longer period of time.

In short, we are now at risk of creating a permanent underclass of under-skilled and under-employed.

And to conclude - two charts on comparisons between Ireland and the rest of EU27:
Participation figures above clearly show that our labour force has experienced a much more dramatic collapse than in any other country in the European Union. At the same time, our unemployment has risen less drmatically:
Which suggests that the gap between us and the worst performing European countries (Spain and the Baltics) masks a much more troubling reality: Irish unemployed are much more likely to drop out of the labour force (and thus out of unemployment counts) than those in other European countries.

This, of course, is a sign of much deeper despair.

Economics 06/04/2010: Return of the markets

Another 'Must Read' from WSJ - Gary Becker on Obamanomics, health care reform and why Americans will opt once again for Smaller Government with more checks and balances on the power of bureaucracy. Read it here.

Perhaps the most insightful - from our point of view here in Ireland - is Becker's arguments about interest groups-driven poor legislation that ossifies into innovation-choking regulatory diktat absent proper competition between interest groups acting as a (limited) check on the corrupting power of tax-and-spend politics.

having just returned from the Western sea board, I can testify to that corrupting power. Take a small town, popular with summer vacationers, I visited. Bungalows piled mile-high - crowding each other and older homes. Local county councilors own, per local paper expose, many of these, with some holding mortgages on 7-9 of such vacation properties, with section 30 tax breaks attached to make the deal sweeter. Scores of developments (not one-offs) were built in violation of planning permissions granted. And scores of planning permissions were granted in violation of the standard building codes.

As a friend of mine has described the countryside: 'You have D4 folks with homes, back then, worth some €4-5 million rushing to buy public-housing-styled vacation homes for a €1 million-plus with an illusion that these were to be their country retreats. And the Government was dishing out tax breaks...'

We clearly have no competing interest groups - just a Social partnership feeding party.

Economics 1/04/2010: Travel time? Not a chance.

Hat tip to the Machholtz's blog - the link to my participation on Wide Angle (Newstalk 106FM) here. Discussing Nama...

The thing is - when all sides of political spectrum agree that we have taken a wrong path to banks crisis solutions, why is the Government failing to listen? Is the answer boiling down to the 1,500 jobs still remaining in the Anglo? Is it all about projecting the optics, buying time at the expense of the future of this country?


On today's data release from CSO:

• Trips to Ireland by overseas residents in January 2010 - down 26% to 313,800 from January 2009, an overall decrease of 110,400
• Visitors from Great Britain - down by 31.6% to 142,400
  
• Visitors from 'other Europe' and North America down by 29.7% and 2.2% respectively
• Trips from residents of other areas rose by 4.2%
• The largest decreases from overseas visitors to Ireland were: Great Britain (-65,900), Poland (-7,800), France (-7,000), Italy (-5,700) and Germany (-5,200)
  

In the mean time, Irish residents made 448,900 overseas trips in January 2010 or 10.6% fewer than in January 2009.
Travel tax, as expected with all trade barriers, is not an effective measure of domestic industry protection. Instead, it is yet another quick fix revenue raising measure that hurts more than it delivers.

Don't believe me? Well, aside from several independent analysts reports, even Aer Lingus (our Government's cheerleader airline) and Bloxham Stockbrokers (not exactly known for their fortitude when it comes to criticising the Government) agree.

Economics 31/03/2010: Nama funding scheme - Maddoffian Risk Pyramid

The saga of Nama continues, folks. Ah, and no, I do not mean the dumping of €8.3 billion to the Anglo which miraculously declared losses of €12bn = €4bn injected by taxpayer in 2009 + €8.3bn injected today. Had the Exchequer given Anglo €15bn last night, the bank would have declared losses of €19bn. And not even the admission on the public airways, by our illustrious 'public interest' director soon-to-be-chief of Anglo, Alan Dukes, that Anglo will most likely need more than additional €10bn promised to it by overly-generous-with-other-people-money Mr Lenihan.

Oh no - the really worrying thing is contained in the notes from March 26th issued by Nama (available here) that detail the financing arrangements that Nama will undertake to cover the purchases of the loans from Irish banks.

Some time ago it was rumored that the Government was setting on the following scheme:

• Nama will issue 12 month bonds
• With interest rate rest at Euribor-Libor plus a margin every 6 months
• Which are to be fully unconditionally and irrevocably guaranteed by the state as ranking pari passu with the Nama other unsecured and unsubordinated debts.

At the time, myself and other analysts said that such a scheme would be a disaster. Now, per latest documentation from Nama - this is exactly the scheme chosen to finance Nama acquisitions.

Let me remind you what the problem with this scheme is.

Nama is buying long-term loans with work-out period stretched over 10-15 years. It will use short term financing to get these through. Problem 1: borrowing short to lend long is what got out banks into this mess in the first place. Now, Nama will have exactly the same risk-loaded funding structure as the worst of our banks. For example, at the peak of risk-loading, Anglo carried about 50% of its funding in short-term inter-banks loans. Nama will do the same for 100% of its funding requirement. Scared yet?

Nama will be loading up with short term debt as the yield curve for Libor and Euribor is pointing up. In other words, every progressive reset (6 months) and roll-over of the debt (12 months) will be more expensive to the State. My third year UCD undergrads last Fall knew that this is a bad risk. Nama, having paid millions to advisers and 'experienced' staff couldn't get it right! Trembling yet?

Nama will be rolling over bonds on an annual basis. This means annual transactions costs (making the entire borrowing much more expensive) and reliance on the ECB to re-collateralize the bonds (putting Frank Fahey's 'free lunch' funding out to new tender annually). Is anyone actually thinking about any of these risks out in the Treasury Building on Grand Canal Street?

Adding insult to injury - despite being issued by the agent different than the Sovereign, Nama bonds will be tax-exempt. In other words, issued at Euribor of, say 2.75%, the notes will effectively be priced at around 3.44%. Worse, the Guarantee statement obliges the Irish state to cover incidental and other expenses of the bond holders and exempts them from all and any taxes relating to the Guarantee. In other words, should the bond holders resell their Nama bonds at a profit (in part determined by the Guarantee), there will be no tax on such a resale.

In short, it appears that neither Nama, nor an army of its excruciatingly expensive advisers, nor DofF, nor the Government have any knowledge that normal interest yield curves are upward sloping - cost of borrowing, normally rises in time. Or may be they simply do not care. After all, its our money they are gambling with.

Economics 31/03/2010: An expensive joke called Nama

I must confess, the last thing I expected in yesterday's quadruple whammy of one Ministerial speech, one Nama document release, a Central Bank statement and the Financial Regulator's decision was a joke. But there it was. For all to see, for few to notice.

Armed with a law degree-backed mastery of logic, Minister Lenihan has issued a statement that he will be requiring Irish Bankers Federation to run courses for the benefit of our bankers on how to lend money to projects other than property. That statement, coming from the Minister after he announced that the Anglo will be provided with up to €18.3 billion in taxpayers cash, and the rest of our banks will swallow billions more was worthy of a comedian. In an instant - we had a Minister for Finance throwing money at the banks which, by his own admission, have no idea of how to lend.

Anything else had to take a back seat to this farce. And it almost did. If not for another pearl of bizarre twist in the Nama saga. Recall that this Government has promised the world an arms-length entity to control and legally own Nama - the Special Purpose Vehicle arrangement which, in order to keep Nama debts out of the national debt accounts was supposed to be majority (51%) owned by external investors.

At the time of the original announcement of this arrangement I publicly stated that there was absolutely nothing in the Nama legislation precluding parties with direct interest in Nama from investing in this SPV. And boy, clearly unaware of such pithy things like conflict of interest, Nama announced that its majority owners will be:

• Irish Life Assurance (a part of the IL&P that has been at the centre of the Anglo deposits controversy and one of the most leveraged banks in the nation),
• New Ireland (an insurance branch of BofI), and
• AIB Investment Managers.

In other words, the very institutions that will be benefiting from Nama's taxpayers riches will also own Nama and will comprise SPV board. They couldn't have given a share to Seannie Fitz and Mick Fingleton, could they?

Having a good laugh - even at the cost of tens of billions to us, the ordinary folks - is a great end for a day in the Namacrats land. So much for responsible and vigilant policies of the Government.


Now to the beef: Nama release figures.

In its note on the first tranche of loans transferred, Nama provides a handy (although predictably vague) description of the loans the taxpayers are buying as of March 30, 2010. Table below summarizes what information we do have:

Let us take a further look at the data provided in the official release and the accompanying slide deck.
Applying more realistic valuations on the loans transferred against the average Nama discount, while allowing for 11% assumed LTEV uplift (Nama own figure), net of 2% risk margin - the last column in the above table shows the amounts that should have been paid for these assets were their valuations carried out on the base of March 30, 2010 instead of November 30, 2009 and were the discounts applied reflective of realistic current markets conditions.

Thus, in the entire first tranche of loans, Nama has managed to overpay (or shall we say squander away) between €1.2 and €3.1 billion - a range of overpayment consistent with 14-37% loss under the plausibly optimistic assumptions. Returning this loss across the entire Nama book of business and adding associated expected costs of the undertaking implies a taxpayer loss of €9.6-25.3 billion from Nama operations.


In Nama statement, Brendan McDonagh, Chief Executive of NAMA said: “Our sole focus at NAMA is to bring proper and disciplined management to these loans and borrowers with the aim of achieving the best possible return and to protect the interests of the taxpayer. ...NAMA is willing to engage with an open mind to our acquired clients ...”

Pretty amazing, folks - Nama CEO clearly sees the borrowers as his 'clients', while claiming that his organization objective is to benefit the taxpayers. Would Mr McDonagh be so kind as to explain the difference? Is Nama going to serve the 'clients' or is it going to protect the taxpayers? The two objectives can easily find themselves at odds - the fact Mr McDonagh is seemingly unaware of.

Economics 29/03/2010: PS productivity deal will cost us all

Per latest reports on the talks with the Unions, it now appears that the Government will yield on the Budget 2010 pay cuts and accept a premise that our vast structural deficit can be corrected through a long-term change in work practices in the public sector.

This position represents a drastic reversal of the attempted correction of the structural deficit and has the following long-run implications for Ireland:

1. Since productivity gains do not address the issue of reducing actual spend in the public sector, the entire burden of correcting the structural deficit can be expected to fall on the shoulders of the taxpayers;
2. If the deal commits the Government to no future cuts in public spending in Budgets 2011-2013, the deal will mean that the entire €13-14 billion in Budget adjustments needed before 2014 will have to be carried by the Irish taxpayers. This means taxes will have to rise by a massive €13,000 per annum per current tax payer - a move that would trigger a meltdown in the economy;
   
3. Since higher earning taxpayers are already paying more than half of the income tax bill, the new taxes will have to disproportionately impact lower middle classes, thus in effect inflicting pain on the very workers whom the unions are allegedly aiming to protect;
4. Since the structural deficit will remain unaddressed, Ireland will not reach 3% deficit target by 2014, or for that matter by 2020, implying that we will be facing excruciatingly high cost of borrowing through the next 10 years or so, a cost, once again to be carried by our middle and lower-middle classes.

Using a simple prisoners' dilemma game, one can easily show that the Government currently has all the incentives to run the economy deeper into depression. Such a move will ensure that the poisoned chalice the current Government passes to the opposition will be even more toxic, thus giving Fianna Fail stronger chances of election victory in the next 5 years.

In other words, if the Government does indeed sign up to the unions'-conjured 'plan' for 'efficiency'-exit from the deficit, it will be implicitly acting to derail any hope of a fiscal and economic recovery, while optimising its own political objectives.



PS: For all those who are keen on accusing me of being anti-Fianna Fail: nothing I write is designed to attack any political party in general or its members in totality. There are plenty of very good people in FF, and some of my friends are members of the party. There some competent, well-meaning and experienced members of the Government. Sometimes I disagree with them on policies, sometimes on ideologies, sometimes we agree. I express these views in public and privately. I always prefer an open debate.

The collective actions of the current Government, in my view, deserve very severe criticism. And that criticism I tend to provide: not behind the back, but in the open, publicly accessible fora.

Economics 27/03/2010: Breaking News: AIB and FF/Government

Major news breaking in the media rooms:
AIB (the first story below)
RedC Poll (the second story below)


Story 1:

The first story is about the leaks reported by Newstalk (see here) that AIB will announce before opening of trading on Monday that the state will be taking a 65% stake in the bank.

Per senior source in the Dail (hat tip to B) - the reason for AIB guiding 65% ownership now is that in addition to Nama haircuts, they are, allegedly, seeing significant deterioration in the sub-€5mln loans (the loans below Nama-eligible threshold).

This is hardly surprising. Since May 2009 I have consistently supplied estimates as to the eventual state ownership in both AIB and BofI. Depending on various scenarios:

• assumed Nama haircuts,
  
• the actual current risk weighting on the loans being transferred,
  
• share price at the time of announcement and
  
• the willingness of the banks and the Government to recognize future expected losses on the loans not transferred to Nama

RVF approach to valuing AIB and BofI balancesheets suggests that at the end of the current crisis, the state will outright own around 85-90% of equity in AIB and 50-60% in BofI. This eventual outcome, for political reasons, will come in two stages:

• post-Nama injection of capital (with AIB placing around 60-70% of its equity with the State and BofI placing around 40-45%), plus
• second stage recapitalization to correct for continued deterioration in the books over 2010-2011 (adding another 20-30% of equity for AIB and 10-15% for BofI)

The problem with this two stage recapitalization is that the taxpayer will end up paying three times for the same equity:

• Having injected €7 bn into two banks at the time when they were worth less than €2.5 bn for the entire lot,
  
• we are now be left on the hook for some €20 bn worth of largely worthless loans - to be purchased at ca 30-40% discounts (against the real market discount of 65-90%),
  
• plus €7-8 bn in fresh capital post-Nama
• plus the margin of ca 10-15% for further deterioration in non-Nama loan books (requiring another €7-9 bn of fresh capital).

Thus the Irish state is now likely to use up to €20 bn to buy up equity and loans from a bank that is currently worth around €1.5 bn... In the world of finance, even the most reckless bankers never managed such margins.

Alternative: force banks to acknowledge the full extent of their expected losses (as Swedes did in the 1990s), then force them to take the bondholders and equity holders to the cleaners (as Swedes did in the 1990s), and only then take equity - or in effect, take full equity in the banks. The cost for AIB would be around €10-12 bn, depending on how deep of a haircut on senior bondholders the banks can impose.

Story 2:

Tomorrow's RedC poll

Here is a preview - as was supplied to me by my sources (a disclaimer is due here: these are as provided by the source, so check tomorrow's papers for actually confirmed figures). Parties support:
The poll was conducted on Monday-Tuesday, so it does not reflect change of opinion in the wake of Cabinet reshuffling and the dissident TDs comments. Both factors can be expected to contribute to further decline in FF ratings, speculatively pushing core FF support post-Thursday to 21-22%.

Some specific questions:
“Brian Cowen understands people like me” - 31% agree
“Brian Cowen is a good Taoiseach” - 27% agree
“Brian Cowen is a safe pair of hands” - 31% agree
“Brian Cowen is the man to lead us out of recession” - 29% agree

Hat tip to NN.

I wonder what the same punters would say about our leaders now, after the reshuffle debacle and the open dissent amongst the back-benchers.

Economics 26/03/2010: National output figures

Held back by work, I am only now catching up with data released this week by CSO, so do stay tuned - these pages will be featuring more analysis in days to come.

First, QNA for Q4 2009 came in, putting annual decline in GDP at 7.1% for 2009 and GNP at a whooping 11.3% (per table below):
This is slightly better than my predicted annual declines of GDP to the tune of 7.3% and GNP to 11.5-11.7%. Nonetheless, as CSO admits, these figures mark historical record of declines.

Throughout the year, I have traced the paths for the main QNA series in charts. A picture, after all, is worth a thousand words. So here they are, updated for the latest figures:

The first chart above shows GDP and GNP time series. Two things are apparent from these figures: first, all three series peaked at the same time - in 2007. This is significant for as we shall see below, the same does not hold for growth rates. Second, notice how factor cost-based GDP is showing more mild downward trend than market prices-based GDP measure? This suggests that deflation (market prices change) has been so far much more significant than declines in factor costs. This does not really bode well for our hopes of improving our competitiveness through this cycle.

Next chart shows components of GDP and GNP:
Notice how two state-supported sectors - public sector and agriculture (the latter supported, of course, via CAP) show no signs of a recession? Both are having jolly good time - courtesy of taxpayers (Irish and European). Also, do keep in mind that some of the public sector activities fall into other categories - e.g. transport was probably supported by the semi-state companies and their ability to ignore recession when it comes to hiking prices and charges (DAA is one good example here). So in real terms, private sector activity in each one of these sub-sectors is down by more than the CSO aggregates suggest.

Next chart illustrates another historic record:
The gap between our MNCs-dominated exporting economy and our domestic economy is now at historic highs - reaching 23% in 2009. This means that almost a quarter of what Ireland claims to produce (GDP) is really an accountancy trick and has nothing to do with this country. Of course, for years we have been conditioned to think that we are filthy rich because our GDP is so high. Oh, how deep the fallacy runs.

Now, think about the core metrics of state solvency deployed in international markets. Take our national debt. At current €77.6bn (per NTMA) it officially stands at just 45.6% of our GDP (46.2% if we are to use more time-consistent estimate from Finance Dublin). In the real world, this figure should reflect our real national income, for we can't seriously expect the foreign MNCs to be responsible for Ireland's debt. So the real figure should be 55.5% of GNP. Almost a 10 percentage points spread.

Now, let's take our current position and take a peek into the future. Suppose we take last 6 years' average growth rates for respective series. How long will it take for our various measures of income (bogus GDP and more honest GNP) to bring us back to the prosperity of 2007?
As chart above illustrates, should our MNCs continue racing ahead as they did up until now, happy days will come back to our shores again in 2018. Of course, relying on our domestic (real) economy to chug along as it did in 2003-2009 period means we will be back to 2007 levels of income some time around 2026. Mister Cowen can keep telling us that things have bottomed out and that all will be well once growth returns. Numbers are a bit more honest here.

What else did the QNA release give us that CSO omitted in its release?

Let's take a look at quarterly frequency:
Notice how both GDP and GNP are running close to (but below) 4-quarter moving averages? This is the third time it is happening in the current crisis and every time it is followed by a renewed pull away from the MA line downward. GNP is seemingly poised to cross over in Q1 2010, posting a possible quarterly gain. Of course, this is just a momentum force, which has to be backed by fundamentals. And the fundamentals are still pretty nasty. But there isn't a hope of even a technical rebound indicated in the GDP line. So:

• Will we see a GDP/GNP gap contracting somewhat in Q1 2010 with GDP starting to show much more weakness than GNP?
• Will GNP loose technical momentum building up and renew its downward slide?

Only time will tell, but, here is an interesting snapshot. Remember the latest QNHS? Q4 2009 marked the return of Construction sector to the leading role in driving unemployment higher. This is collaborated by the following figure:
Activity in construction and building sector shows absolutely no willingness to move above the moving average line. If anything, it is still contracting at a massively rapid rate.

Lastly, let me show you an interesting chart on annual rates of change in the GDP/GNP series:
Notice that in contrast with levels in overall activity (the first chart above), growth rates actually peaked in two different years, with 2007 decline in the growth rate of GNP clearly providing a warning signal for the Government that things might be getting slightly unsteady. Coupled with what was going on at the time in the financial markets (remember, the crisis in financial markets started actually in July 2007), that was a warning shot. I recall interpreting it this way in a couple of my columns - back in Business & Finance and in the Sunday Tribune.

I will cover trade figures contained in QNA release in the later post dealing with overall trade issues, so do stay tuned.