Economics 13/04/2010: As bad as Northern Rock back in 2008?

So we have some more clarity on the state of our credit flows, courtesy of the latest monthly report from the Central Bank. And boy are we sick. At the height of the financial crisis, Northern Rock had 303% loans to deposits ratio. Ireland Inc? 269% absent risk adjustments on short-term deposits, and 323% once short term deposits risk of call-in is set at 10%.

Ouch! Irish financial system doesn’t resemble Quinn Insurance – it resembles Anglo!

Economics 13/04/2010: Retail sales

Retail sales are out today for February – some singing of good news hymns is being heard. And the headlines do appear to be touchy: “The volume of retail sales (i.e. excluding price effects) increased by 3.0% in February 2010 compared to February 2009 and there was a monthly increase of 14.9%.” This was the first monthly increase in the volume in 25 months.

But, “the year on year increase is primarily explained by the 30.5% year on year growth recorded in Motor Trades in February 2010.” Tax breaks still work, folks, even in the economy mired in a recession. So much for all those Lefties who so ardently argued that taxes don’t change behavior. Apparently they do. Here is an interesting point - may be someone can document it later – a rebate of 1,500 on a tax bill is seemingly doing more to Motor trade than the steep price declines passed directly onto the purchase price itself. Why? Perhaps it is a behavioral issue.

The trouble is – motor purchases tend to be one-offs – we don’t exactly shop for a new car a month or a year after we purchased one. So motor trade pick up cannot be expected to continue into the second half of 2010. Once the Motor Trades are excluded “the volume of retail sales decreased by 3.1% in February 2010 compared to February 2009 and the monthly change was +1.2%.” Ok, still a monthly rise, but remember – 12 months to February 2010 things were bad.

And no they are actually even worse. The impact of the yearly drop – indiscernible directly in monthly figures is that:

• the volumes are down;
• the value of sales is down; and
• the retail price inflation is negative.

In other words, actual sales – as translated into revenue of retail sector businesses – are still going down.

There were, however some sectors with yoy volume increases:

• Department Stores up 10.9%
• Pharmaceuticals Medical & Cosmetic Articles up 1.2%
• Clothing, Footwear & Textiles up 1.8%
• Electrical Goods up 3.5%
• Other Retail Sales up 2.8%

But the largest sector Non Specialised stores, inc. supermarkets, shows a year on year decrease of 1.7% and a month on month decline of 1.9%.

Much overlooked, the actual true indicator of health of the retail sector is the value of total sales achieved. In other words, we might book massive increases in the volume of sales, if we were to start giving stuff away for free. But that won’t restore any jobs lost in the sector. It is, really, the value of sales that we are after. And this has fallen (e-Motors) by 7.4% and the monthly change was only +0.1%.

With the exception of the Motors and Fuel sectors (where the Government collects lions share of the final price in taxes and charges) “most sectors continue to show year on year decreases in the value of retail sales however a number of sectors show monthly increases in the value of retail sales in comparison to January 2010.”

Not exactly a sign of a revival that we might be cheerful about.

Economics 13/04/2010: ESRI's latest forecasts for Ireland

ESRI's latest quarterly commentary is coming out today. Here are the core numbers:

• 2010, "expect GNP to be essentially unchanged from its 2009 volume; the corresponding figure for GDP is ½ per cent less than in 2009".
• 2011, "expect GNP to grow by 2¾ per cent and GDP to grow by 2½ per cent. While this return to growth is to be welcomed, it should be seen as a modest pace of growth."

My double take:

• 2910 figures are fine for GDP, a bit optimistic for GNP
• 2011 figures would be above my forecasts of 1.7-1.9% GNP, 2.0-2.2% GDP.

"In spite of the stability in the numbers employed, we expect unemployment to fall between 2010 and 2011, averaging 13¾ per cent in 2010 and 13 per cent in 2011. This expected fall in the rate of unemployment is related in part to expected migratory outflows – 60,000 in the year ending April 2010 and 40,000 in the year ending April 2011. We also expect to see on-going falls in labour force participation."

My view - if we are to have 60K outward migrants in 2010, what would hold the others back in 2011? There will be no prospects for new employment (and ESRI agree) and there will be improved jobs offers abroad (IMF agrees), so why not 80K in 2011 to follow 60K outflowing in 2010?

"In our analysis, we assume that the Government will implement its indicated budgetary package for 2011 where spending cuts and tax increases will amount to €3 billion. When combined with a return to modest growth and the consequent impact on revenues, we expect to see the General Government Deficit falling to 10¾ per cent of GDP in 2011, down from 12 per cent in 2010."

Putting aside the issue of whether this Government has ability to implement planned cuts, 10.75% deficit in 2011 certainly implies that there is no chance of Ireland meeting its obligations to reduce deficit to below 3% of GDP by 2014.

"We note that the recapitalisation needs of the Irish banks are now likely to be at least €33 billion, assuming that the State investment in Anglo Irish Bank ultimately amounts to €22 billion. In terms of net cost to the State, a figure of €25 billion is possible."

Great, folks, €22-27 billion was my estimate of the eventual cost of Nama produced back in the H1 2009. ESRI finally converged to this forecast of mine. Good to note.

Economics 12/04/2010: The next incoming train has left its first station

My current article on the longer term prospects for global economy, published in the current issue of Business & Finance magazine. This is an unedited version.

Forget the circus of the Euro zone Government’s bickering about Greece’s bailout package and the escapist idea of setting up the EU-own EMF. The real crisis in the Euroland is now quietly unfolding behind he scenes.

Finally, after nearly 15 years of denial, courtesy of the severe pain inflicted by the bonds markets, Brussels and the core member states are forced to face the music of their own making. The current crisis affecting Euro area economy is, in the end, the outcome of a severely unbalanced economic development model that rests on the assumption that exports-led economic expansions in some countries can be financed through a continued massive build up in financial liabilities by their importing partners.

Put more simply, the problem for the world going forward is that in order to sustain this economic Ponzi game, net importers must continue to finance their purchases of goods and services from net exporters by issuing new debt. The debt that eventually settles in the accounts of the net exporters.

One does not have to be versed in the fine arts of macroeconomics to see that something is wrong with this picture. And one does not have to be a forecasting genius to understand that after some 40 years of rising debts on the balance sheet of importing nations, the game is finally up. I wrote for years about the sick nature of the EU economy - aggregate and individual countries alike.

Last week, Lombard Street Research's Charles Dumas offered yet another clear x-ray of of the problem.


Source: Lombard Street Research, March 2010

As Dumas' chart shows, core Euro area economies are sick. More importantly, this sickness is structural. With exception of the bubble-driven catch-up kids, like Spain, Ireland and Greece, the Euro area has managed to miss the growth boat since the beginning of the last expansion cycle.

The three global leaders in exports-led growth: Germany, Japan and Italy have been stuck in a quagmire of excessive savings and static growth. Forget about jobs creation – were these economies populations expanding, not shrinking, the last 10 years would have seen the overall wealth of these nations sinking in per capita terms. Only the Malthusian dream of childless households can allow these export engines of the world to stay afloat. And even then, the demographic decline will have to be sustained through disposal of accumulated national assets. So much for the great hope of the exports-led growth pulling us out of a recession. It couldn’t even get us through the last expansion!

Over the last decade, the Sick Man of Europe, Italy has managed to post no growth at all, crushed, as Dumas’ put it, by the weight of the overvalued and mismanaged common currency. The Sick Man of the World, Japan has managed to expand by less than 0.8% annually despite running up massive trade surpluses. Germany’s ‘pathetic advance over eight years’ adds up to a sickly 3½% in total, or just over 0.3% a year. France, and the UK, have managed roughly 0.98% annualized growth over the same time. Comparing this to the US at 1.27% puts the exports-led growth fallacy into a clear perspective.

I wrote in these pages before that the real global divergence over the last 10 years has been driven not by the emerging economies decoupling from the US, but by Europe and Japan decoupling from the rest of the world. The chart above shows this, as the gap between European 'social' economies wealth and income and the US is still growing. But the chart also shows that Europe is having, once again, a much more pronounced recession than the US.

Europe's failure to keep up with the US during the last cycle is made even more spectacular by the political realities of the block. Unlike any other developed democracy in the world, EU has manged to produce numerous centralized plans for growth. Since the late 1990s, aping Nikita Khruschev's 'We will bury you!' address to the US, Brussels has managed to publish weighty tomes of lofty programmes - all explicitly aimed at overtaking the US in economic performance.

These invariably promised some new 'alternative' ways to growth nirvana. The Lisbon Agenda hodge-podge of “exporting out of the long stagnation” ideas was followed by the Social Economy theory that pushed the view that somehow, if Europeans ‘invest’ money they did not have on things that make life nicer and more pleasant for their ageing populations growth will happen. Brussels folks forgot to notice that ageing population doesn’t want more work, it wants more ‘free’ stuff like healthcare, public transport, social benefits, clean streets, museums and theatres. All the nice things that actually work only when the real economy is working to pay for them.

As if driven by the idea that economic development can be totally divorced from real businesses, investors and entrepreneurs, the wise men of Europe replaced the unworkable idea of Social Economy with an artificial construct labelled ‘Knowledge Economy’. This promised an exports-led growth fuelled by sales of goods and services in which we, the Europeans, are supposedly still competitive compared to our younger counterparts elsewhere around the world. No one in Brussels has bothered to check: are we really that good at knowledge to compete globally? We simply assumed that Asians, Americans, Latin Americans and the rest of the world are inferior to us in generating, commercializing, and monetizing knowledge. Exactly where we got this idea, remains unclear to me and to the majority of economists around the world.

The latest instalment in this mad carousel of economic programmes is this year's Agenda 2020 – a mash of all three previous strategies that failed individually and are now being served as an economically noxious cocktail of policy confusion, apathy and sloganeering.

But numbers do not lie. The real source of Euro area's crisis is a deeply rooted structural collapse of growth in real human capital and Total Factor productivities. And this collapse was triggered by decades of high taxation of productive economy to pay for various follies that have left European growth engines nearly completely dependent on exports. No amount of waterboarding of the real economy with cheap ECB cash, state bailouts and public deficits financing will get us out of this corner.

The real problem, of course, is bigger than the Eurozone itself. Exports-led economies can sustain long-run expansions only on the back of a borrowing boom in their trading partners. It is that simple, folks. Every time a Mercedes leaves Germany, somewhere else around the world, someone who intends to buy it will either have to draw down their savings or get a loan against future savings. Up until now, the two were inexorably linked through the global debt markets: as American consumers took out loans to buy German-made goods, Chinese savers bought US debt to gain security of their savings.

This debt-for-imports game is now on the verge of collapse. Not because the credit crunch dried out the supply of debt, but because the global debt mountain has now reached unsustainably high levels. The demand for more debt is no longer holding up. Global economic imbalances remain at unsustainable levels even through this crisis and even with the aggressive deleveraging in the banking systems outside the EU.

Take a look at the global debt situation as highlighted by the latest data on global debt levels. The first chart below shows the ratio of net importing countries’ gross external debt liabilities (combining all debts accumulated in public and private sectors, including financial institutions and monetary authorities) to that of their net exporting counterparts. The sample covers 20 largest importers and the same number of largest exporters.

Source: IMF/BIS/World Bank joint data base and author own calculations

As this figure illustrates, since mid-point of the last bubble at the end of 2005, the total external debt burden carried by the world’s importing countries has remained remarkably stable. In fact, as of Q3 2009, this ratio is just 0.3 percentage points below where it stood in the end of 2005. Compared to the peak of the bubble, the entire process of global deleveraging has cut the relative debt burden of the importing states by just 9.8%.

To put this number into perspective, while assets base of the world’s leading economies has fallen by approximately 35% during the crisis, their liabilities side has declined by less than 10%. If 2007 marked the moment when the world finally caved in under the weight of unsustainable debt piled on during the last credit boom, then at the end of 2009 the global economy looked only sicker in terms of long-run sustainability.

The picture is more mixed for the world’s most indebted economies.
Plotting the same ratio for the US and UK clearly shows that Obamanomics is not working – the US economy, despite massive writedowns of financial assets and spectacular bankruptcies of the last two years remains leveraged to the breaking point. The UK is fairing only marginally better.

Of course, Ireland is in the league of its own, as the country has managed to actually increase its overall share of global financial debt during this crisis courtesy of an out-of-control public expenditure and the lack of private sector deleveraging. Take an alternative look at the same data. Ireland’s gross external debt (liabilities) stood at a whooping USD 2.397 trillion in Q3 2009, up 10.8% on Q3 2007. Of these, roughly 45% accrue to the domestic economy (ex-IFSC), implying that Irish debt mountain stands at around USD 1.1 trillion or more than 6 times the amount of our annual national income.

Chart below shows gross external debt of a number of countries as a share of the world’s total debt mountain.
Source: IMF/BIS/World Bank joint data base and author own calculations

And this brings us to the singularly most unfavourable forecast this column has ever made in its 7 years-long history. Far from showing the signs of abating, the global crisis is now appearing to be at or near a new acceleration point. Given the long-running and deepening imbalances between growth-less net exporting states, like Germany, Japan and Italy and the net importers, like the US, we are now facing a distinct possibility of a worldwide economic depression, triggered by massive debt build up worldwide. No amount of competitive devaluations and cost deflation will get us out of this quagmire. And neither a Social Economy, nor Knowledge Economics are of any help here.

Paraphraisng Cypher in the original Matrix: “It means fasten your seat belt, Dorothy, ‘cause Kansas of debt-financed global trade flows is going bye-bye”.

Economics 12/04/2010: Nama's economic distorionism

An interesting quote from the just-published paper (Claessens, Stijn, Dell’Ariccia, Giovanni, Igan, Deniz and Laeven, Luc A., Cross-Country Experiences and Policy Implications from the Global Financial Crisis. Economic Policy, Vol. 25, Issue 62, pp. 267-293, April 2010). I reported on this paper last year at length, when it was still an IMF Working Paper.

“An example of distortions between financial institutions and the fiscal conditions is the extension of guarantees in the case of Ireland to the largest banks. Prior to the extension of guarantees, the CDS-spreads for the large Irish commercial banks were very high. Post guarantees, bank CDS-spreads declined sharply, while the sovereign spread increased. Measures like these, now numerous in many advanced countries today, distort asset prices and financial flows.”

This goes hand-in-hand with the EU assessment of Nama as a market distorting mechanism, which, as reported last week by Irish Independent, was concealed from the public when our Minister for Finance issued a press release claiming that Nama was fully supported by the EU Commission.

Further per Claessens et al: “Guarantees on deposits and other liabilities issued by individual countries have led to beggar thy neighbor effects as, starting with Ireland, they forced other countries to follow with similar measures.”

This statement in effect condemns Irish Government claim that our Guarantee was a success because it was copied by other countries. Instead, as Claessens et al confirm, the Guarantee forced risk from Ireland onto our trade and investment partners. Not exactly a high moral ground.

“The rapid spread of guarantees led to further financial turmoil in other markets. Many emerging markets not able to match guarantees suffered from capital outflows as depositors and other creditors sought the safe havens. Distribution of risks sharply changed over time and across circumstances."

More importantly, both – the revealed note from the EU and the above academic assessment – provide a significant warning in terms of the future of the banking and property sectors in Ireland. Given the systemic nature of distortions, subsequent exits and scaling back of foreign banks presence in the country, the lack of transparency and fairness in the property markets, it is now virtually assured that post-crisis interventions Irish banks and property markets will remain in their zombie state. Japan-styled recession is a looming threat for Ireland Inc.


Of course, you wouldn’t notice this, if you were listening to some of our heroic stock brokers – especially those folks like Bloxham who back in mid 2008 ‘forecast’ that ‘markets do come back’. In their latest strategy statement, issued last Friday, the Bloxham’s boys have managed to outperform themselves in terms of Green-jerseying (emphasis is mine):

“Ireland is undergoing some of the heaviest self imposed penalties for the fiscal over exuberance of the 2000s of any EU economy since the global credit crisis began in 2008. From budgetary austerity measures to public sector wage cuts, from crushing additional taxes both personal and indirect, to a mega-costing banking recovery plan; all in the name of stabalisation and repositioning as a viable economy. As Ireland passes through the next major set of hurdles (the transfer of assets to NAMA and the recap of the banking system), the market reaction so far has been favourable.”

Any evidence of this?

“10-year sovereign Irish bonds are still trading at 146 basis points above German bonds, compared with 280 basis points at the worst point for the Irish system in March 2009. Compared with Portugal at 126 bps over Germany, Irish spreads still have strong progress to make.”

The more the things improve in the wake of all the measures passed by the Government, the more the spreads stay the same? Indeed: “Irish sovereign debt costs have remained static in the past week, while Greek debt costs balloon by 100 bps. In relative terms, Ireland sovereign performance has been exceptionally good since the “Super Tuesday” announcements from the National Asset Management Agency (NAMA), the Financial Regulator and the Minister for Finance.”

But hold on to your seats for a wild ride into the land of bizarre logic: “A falling Irish debt cost is largely unappreciated domestically but is a very hansom reward for the pain taken in Ireland thus far.”

I am now thoroughly confused, folks – if the spreads stayed the same, what falling Irish debt costs do the Bloxham folks have in mind? Am I missing something in their vernacular? Or are they missing in the faculty of trivial maths – falling costs mean declining spreads, yet the spreads ‘remained static’ and debt costs did the same.


A real pearl of the note is in its conclusions: “We would expect that the wider Irish stock market will also benefit strongly over the next 6 months, as re-cap plans proceed and the export sector resilience is maintained. Ireland could be finally coming back on the international investor map.”

Indeed it might. Or it might not. I wouldn’t venture a prediction here, but Bloxham guys – having been so right on so many occasions in the past (including that brilliant note from them back in July 2008 (see the note here) surely would know better. Except, hmmm, what does Ireland’s exporting performance have to do with Irish stock prices? Not much – more than 80% of our goods exports and over 90% of our services exports are accounted for by the MNCs – none of which are listed on Irish Stock Exchange. So unless Bloxham guys know something about Fortune 500 companies plans to relocate their listings to Dublin…

Economics 10/04/2010: HSE fails children and families

Updated below

On several occasions last year I wrote about HSE failures to carry out its job and provide requisite follow up support for adoption process in Ireland. This week, the chickens came home to roost for our healthcare bureaucrats. Except, as is usual in such cases, it is not the bureaucrats who are bearing the cost of such gross failure to do their job, but ordinary families and children.

A disclaimer is due - this is not an academic analysis post. It is an angry post.

Since at least May 2009, HSE was on the notice that it is failing to comply with the documentation support required by Russian authorities in the cases of cross-border adoptions of Russian children. The Ministers for Children and Health were fully aware of the situation.

The problem is a simple one. After a Russian child is adopted into Ireland (or any country for that matter), the agency supporting the adoption (in the case of Ireland - HSE monopoly behemoth, plus a small organization relating to the Church of Ireland - PACT) must supply a report on how the kids are adapting to their new family and environs. It is a brief standardized assessment document and HSE is required to collect and transmit it to the Russian authorities. HSE has staff on its usual lavish pay who are responsible for doing the work. It has managers, on an even more lavish pay, who are responsible for making sure the process is adhered to. There is no nuclear science involved. Just a routine follow up.

Unlike PACT (which appears to be fully compliant), HSE has simply decided not to do its job. Yes, this is exactly what they did. Since May 2009 the HSE has failed to provide the Russian authorities and the Irish adoptive parents with any information as to when and how the HSE will comply with the international obligation. Adopting couples - years into the process and even those already approved by the Russian authorities - were stonewalled by the HSE. In other words - the usual practices of 'do nothing, say nothing' that marks HSE work in virtually all areas of its responsibilities has been applied.

Between 50 and 70 reports were not submitted to the Russian authorities over a couple of years, prompting last May a blacklisting of Ireland by Russian adoption agencies. The blacklisting was not enforced by Moscow in order to give HSE enough time to comply. 9 months later, with no progress from HSE, and actually nearly total stonewalling by HSE not only of the Irish families, but also of the Russian authorities, Moscow's patience has run out. Thus, last week, HSE regional bodies responsible for providing adoption support were blacklisted by Russia again, preventing hundreds of families from proceeding with adopting children.

At the same time, tiny PACT seems to have been able to do their job and avoid blacklisting. Despite not having all the vast resources of HSE nor the Department of Health.

I have no personal interest in the adoption process. But, like any normal person in the country, I have a general human interest in seeing families being able to adopt kids who are in the need of having a proper family. I do have a number of friends who either have adopted kids from different parts of the world or who are currently in the process of adopting kids (so I can see the great potential these fantastic people bring to the lives of formerly orphaned children). And as a fellow human being, I cannot stomach an unaccountable bureaucracy, like HSE, standing between these families, these kids and their dreams.

More than anything else in these times of the crises, the callousness, the laziness and the arrogance of some of our official bodies responsible for adoption highlight the need for a deep reform in this country's public sector. Those in HSE, who failed to do their jobs must be fired, barred for life from ever taking another public sector job and left pension-less, for their victims are the most vulnerable people in this world - innocent children and fantastic families that go though years of hard work to adopt them.


Update: per readers tip-offs (hat tip to B & A), The Minister for Children, Barry Andews TD has presided over the de facto closing of the intercountry adoption in this country. On his watch, China, Vietnam, and Russia all have either seen their adoption treaties with Ireland expire or not complied with. Mr Andrews was fully aware of the problems in the cases of Russia and Vietnam treaties since Spring 2009 and despite having assured the adoptive parents that the issues will be resolved has, so far, failed to do much about it.

The Adoption Board itself has apparent difficulties communicating with the adoptive parents and the broader public. The latest Annual Report the organization has bothered to issue dates back to 2008. This document represents the latest public communication from the Board available on its site. Done truly in HSE's best traditions of public communications, then.

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.