Economics 29/04/2010: Debt crisis is spreading

Another credit downgrade from S&P, this time for Spain, from AA+ to AA with negative outlook, based on the outlook for years of private sector deleveraging and low growth. Spain, as you can see, is severely in red in terms of debt, ranking 14th in the world. Spain's external liabilities stand at 186.1% or $2.55 trillion (as of 2009 Q3) against estimated 2009 GDP of $1.37 trillion.

The country is actually worse off in terms of debt than Greece which has ranks 16th at debt at 170.5% of GDP or $581.68 billion, with 2009 GDP of $341 billion.

Of course, Ireland is world's number 1 debtor nation with external debt of 1,312% of GDP (IFSC-inclusive) of $2.32 trillion in Q3 2009 against the GDP of $176.9 billion. Of course, part of this debt is IFSC, but then, again, we really do not have a claim on our GDP either, with GNP being a more real measure of our income. So on the net, our debts - the actual Irish economy's debts - are somewhere in the neighborhood of 740%. This is still leagues above the UK - the second most indebted nation in the world - which has the debt to GDP ratio of 'only' 426%!

The S&P also provided estimate for expected recovery rate on Greek bonds, which the agency put at 30-50%. In other words, S&P expects investors in Greek bonds to be paid no more than 30-50 cents on the euro. Yesterday on twitter I suggested that "Greek debt should be renegotiated @ 50cents on the euro - severe default. Portugal's @ 80 cents - mild default, Irish @ 70-75 cents". Looks like someone (S&P) agrees. Before it is too late, before German and other European taxpayers have poured hundreds of billions of euro into the PIIGS black hole of delinquent public finances, Europe should cut losses and force Greece and Portugal to renegotiate their liabilities. If Ireland and Spain were to elect to follow, so be it. Of course, in Irish case, the debt re-negotiations should cover private debts, not public debt.

Just how many billions of euros are EU taxpayers in for for the folly of admitting Greece - a country that spent 90 years of the last 180 (since 1829) in defaults on its debts - into the common currency area? Well, Greek 2-year bonds were traded at yields of 26% yesterday at one point in time. This is pricing that's in excess of pretty much every developing country, save for basket cases which practically cannot issue bonds at all.

IMF's Dominique Strauss Kahn has told Bundestag yesterday that Greek package will be

• €100-120bn for three years;
• Which means German taxpayers are on the hook for €67 billion over 3 years, not €25 billion that Germany ‘s economics minister was signing for in the original deal;
• Ireland's contribution will also have to rise to €4 billion over 3 years, not €500 million we originally were told we will have to contribute;
• Greece will not be forced to restructure or reschedule debt
• The loans to Greece will be subordinated to existent bondholders, which means that if in the end Greece does pay 30-50 cents on the euro to the latter, European taxpayers will be lucky to get 10 cents on the euro.

The whole deal is now looking like a massive subsidy for Greece and entails absolutely no protection to European taxpayers.

But internationally, EU news are getting darker and darker by the minute. Last night Bloomberg reported that EU countries are in for estimated €600 billion bill for the fiscal crises that have spread across the block. That's the cost, in the end, of all the tacky policy follies that Brussels endorsed and pushed through over the last 10 years -

• from the Lisbon Agenda, which was supposed to deliver EU to the position of economic superiority over the US by 2010,
  
• to the Social Economy, which was supposed to deliver... well, who knows what...
  
• to the Knowledge Economy, which was aiming to turn us all into brains in a Petri Dish
• to the absolutely outlandish HIPCI and HIPCII agendas wholeheartedly embraced by the EU, which were supposed to deliver debt relief to the world's real basket cases (before Greece and other PIIGS took the spotlight away from them), and the rest of the international white elephants.

The problem, of course, is that €600 billion price tag for fiscal excesses has generated preciously little in returns (despite what folks at Tasc keep telling us about the fiscal stimulus) which means we will have to pay for it out of our long term wealth. The same wealth that has been demolished by the recession and the financial markets collapse!

Economics 28/04/2010: 'Duin de rite ting'

A brilliant chart from one of the readers (hat tip to Jonathan):
May Toyota forgive me a pun, but is this a stuck (downward) accelerator problem?.. After all the 'right things' done to our economy, why are we still leagues away from even our fellow PIIGS travelers?

Economics 28/04/2010: More on Greece contagion

Contagion from Greece is clearly a problem for the EU at this stage. Looking back into some older data, February 2010 note from Credit Suisse (linked here)
Spot Ireland at position number 7? That was then. The figures refer to 2009, which means that since then, pressures on Iceland, Hungary and Latvia have receded. In addition:

• Our 2009 deficit has been revised to 14.3%
• Our CA deficit has worsened (as imports are falling at a lower rate and exports are now performing less robustly)

So re-weighting the score in the right hand column of the table, Ireland gets closer to 38.1-38.3, Portugal moves to 39.4-39.5, Greece to 45. We are number 3 on the list...


PS: If you want to see an example of absolutely and even alarmingly distorted logic - read this. One of the best examples of bizarre ramblings that pass for 'analysis' in Ireland. I mean what else can you call a note that:

• Admits that Ireland has record deficits of all EU countries;
• Admits that debt levels are very high;
• Admits that we are close to Greece;
• Admits that Greece is deep trouble, and then
• States that "The Greek recesion [sic] had been milder than the EU average, and recovering, before austerity measures were adopted" and thus
  
• Makes an implicit claim that the spectacular collapse of Greek economy witnessed by the entire world and threatening contagion to all of the EU has been caused by Greece not running enough deficits!
• And concludes that: "By contrast, other EU countries adopted fiscal stimulus measures [without identifying which states did so, what were the implications of these, etc]. Their debt has stabilised along with economic activity [a mad claim, given that stimulus measures were financed out of debt increases] and they have been rewarded with much lower bond yields than Ireland [absolute groundless claim, as none of the countries that adopted stimulus had the same fundamentals as Ireland going into the recession or during the recession and furthermore, none of the countries, other than PIIGS experienced similar bond yields dynamics to Ireland]"

I mean this stuff is actually factually incorrect and logically inconsistent!

Economics 28/04/2010: Our week so far

So will Germany open a 'needle exchange' for Europe's debt junkies (para-phrasing Laughinbear comment)? Check CNBC's rankings of debt by nation (here - all rankings slide show)... Greece is No 16, Ireland is No1! Link here.

Ireland 10-year yields are at 5.6% and moving in tandem with Portugal and Greece. Here is a revealing weekly step-function for our 10-year notes (hat tip to Brian Lucey):

Economics 27/04/2010: Greece - the end is tragic!

2-year yields close of today:
EU = 0.7%
Ireland = 3.6%
Portugal=4.8%
Greece = 16.4%
This is it, folks. No where else to run. Greek interest on public debt would swallow over 19 percent of their GDP annually!

Clearly, Ireland should do what Greece did, according to the folks at Tasc, the Irish Times and in the Siptu building. Ramp up borrowing to stimulate economy...

Economics 27/04/2010: Greece & Ireland - tied by the risk of contagion

As the Greek, Portuguese, Italian and Irish bonds are melting in the markets' gaze at the countries fundamentals, one quick reference number is worth repeating. Per Chapter 1 of the latest Global Financial Stability Report from the IMF (linked here), the overall risk of contagion from a systemic crisis in one Euro area country to another (as measured by the percentage point contribution to total distress probability) for Greece was:

Contagion from Greece to:
October 2008-March 2009

• Portugal = 9.8%
  
• Italy = 9.9%
  
• Ireland = 12.5% (highest of all Euro area countries)
  
• Spain = 9.0% (in line with the Euro area total)
  
• Euro area as a whole = 8.8%

October 2009-February 2010

• Portugal = 23.6% (in line with the Euro area total) - up 13.8 pps
  
• Italy = 24.2% - up 14.3pps
  
• Ireland = 31.3% (highest of all Euro area countries) - up 18.8 pps
  
• Spain = 23.9% (in line with the Euro area total) - up 14.9 pps
  
• Euro area as a whole = 21.4% - up 12.6 pps
  

So spot the odd one here. As the crisis evolved, despite our Government's talk about 'Ireland turning the corner' and 'doing the right thing', our economy became actually closer and closer linked to Greece. More so than any other member of the PIIGS club. Some achievement that is...

Now, spot the similarity in responses to the crisis in Greece (here) and Ireland (here) and tell me - are we really that much better off in terms of macro fundamentals than Greece, especially given that Greek policymakers are at the very least not held hostage to a Social Partnership in which the likes of Tasc-informed Unions have a direct say?

Economics 26/04/2010: Bank of Ireland Conversion Deal

Bank of Ireland deal: per latest report from the RTE, the State's shareholding in BofI will increase to 36% from 16% through a conversion of €1.7bn of funds given to the bank last year into ordinary shares. The bank will now attempt to raise the other €1.7bn in equity from private markets with a rumored discount on first-offer of 40%.

Minister for Finance Brian Lenihan said that 'This transaction is good news for our economy, good news for the taxpayer and good news for Bank of Ireland's shareholders and investors.'

This is another extraordinary statement made by the Minister. The Minister has just informed the nation that we are overpaying some 11%+ (see below) for the shares gained under this conversion, since 'the transaction has been agreed on market terms'.

Aside: the Minister does not appear to clearly understand the terms of conversion he agree to, as 'market terms' would mean that the state is converting at a current price (Friday close of €1.80) less cumulated dividends (2 years @8%), less the discount extended to the market (38-42%). 'Market terms' therefore would imply conversion at €0.88 per share, not €1 per share achieved.

Finally, the Minister failed to negotiate a discount that should be due any large-scale investor. All in, the estimated overpayment of 11% is really a likely underestimate. In exchange for our money, we, the taxpayers, got a pile of over-priced shares which are about to be diluted!

Looking closer at the details: BofI plans to raise €500mln from private placements with institutionals, priced at €1.53 or 15% discount on Friday close price. The main issue will be €1.2bn (net) with 38-42% discount. Preference shares held by the taxpayers will be converted at €1 per share (they were bought at €1.2 per share and paid no dividend), which actually means we de facto are paying €1.16 per share, while existing shareholders can get shares at as low as €1.04-1.06. Government-held warrants are priced at ca €491mln.

Economics 25/04/2010: Forfas' mathematical modeling powers

Name and shame, folks. The table below is reproduced from Forfas' "Profile of employment and unemployment" publication from February 2010. The research paper itself is not really worth covering in any depth, as it contains broadly speaking nothing new. But the table below is worth one's attention. Irony has, it is sourced as "CSO Quarterly National Household Survey, Forfás calculations". One can really see the quality of 'calculations' deployed from the sophisticated mathematical Scribbling Model developed by the 3-year olds in a Montessori University and adopted by Forfas research staff. Superb!
Oh, and just in case you might think there are real calculations used anywhere later in the paper in relation to this table, don't be fooled - the entire computational burden here is that of adding percentages! Too bad they never attached a detailed breakdown of their costs that went to cover this glossy production...

Economics 24/04/2010: Greece and Ireland

The unedited version of my op-ed in today's Irish Independent (link here)

“It’s been a brilliant day,” said a friend of mine who manages a large investment fund, as we sat down for a lunch in a leafy suburb of Dublin. “We’ve been exiting Greece’s credit default swaps all morning long.” Having spent a couple of months strategically buying default insurance on Greek bonds, known as CDS contracts, his fund booked extraordinary profits.

This wasn’t luck. Instead, he took an informed bet against Greece, and won. You see, in finance, as in life, that which can’t go on, usually doesn’t: last morning, around 9 am Greek Government has finally thrown in the towel and called in the IMF.

As a precursor to this extraordinary collapse of one of the eurozone’s members, Greece has spent the last ten years amassing a gargantuan pile of public debt. Ever since 1988, successive Greek governments paid for their domestic investment and spending out of borrowed cash. Just as Ireland, over the last 22 years, Greece has never managed to achieve a single year when its Government structural balance – the long-term measure of public finances sustainability – were in the black.

Finally, having engaged in a series of cover-ups designed to conceal the true extent of the problem, the Greek economy has reached the point of insolvency. As of today, Greece is borrowing some 13.6% of its domestic output to pay for day-to-day running of the state. The country debt levels are now in excess of 115%. Despite the promise from Brussels that the EU will stand by Greece, last night Greek bonds were trading at the levels above those of Kenya and Colombia.

Hence, no one was surprised when on Friday morning the country asked the IMF and the EU to provide it with a loan to the tune of €45 billion. This news is not good for the Irish taxpayers.

Firstly, despite the EU/IMF rescue funds, Greece, and with it the Euro zone, is not out of the woods. The entire package of €45 billion, promised to Greece earlier this month is not enough to alleviate longer term pressures on its Government. Absent a miracle, the country will need at least €80-90 billion in assisted financing in 2010-2012.

The IMF cannot provide more than €15 billion that it already pledged, since IMF funds are restricted by the balances held by Greece with the Fund. The EU is unlikely to underwrite any additional money, as over 70% of German voters are now opposing bailing out Greece in the first instance.

All of which means the financial markets are unlikely to ease their pressure on Greece and its second sickest Euroarea cousin, Portugal. Guess who’s the third one in line?

Ireland’s General Government deficit for 2009, as revised this week by the Eurostat, stands at 14.3% - above that of Greece and well above that of Portugal. More worryingly, Eurostat revision opened the door for the 2010 planned banks recapitalizations to be counted as deficit. If this comes to pass, our official deficit will be over 14% of GDP this year, again.

All of this means we can expect the cost of our borrowing to go up dramatically. Given that the Irish Government is engaging in an extreme degree of deficit financing, Irish taxpayers can end up paying billions more annually in additional interest charges. Adding up the total expected deficits between today and 2014, the taxpayers can end up owing an extra €1.14 billion in higher interest payments on our deficits. Adding the increased costs of Nama bonds pushes this figure to over €2.5 billion. Three years worth of income tax levies imposed by the Government in the Supplementary Budget 2009 will go up in smoke.

Second, the worst case scenario – the collapse of the Eurozone still looms large despite the Greeks request for IMF assistance. In this case, Irish economy is likely to suffer an irreparable damage. Restoration of the Irish punt would see us either wiping out our exports or burying our private economy under an even greater mountain of debt, depending on which currency valuation path we take. Either way, without having control over our exit from the euro, we will find ourselves between the rock and the hard place.

Third, regardless of whatever happens with Greece in the next few months, Irish taxpayers can kiss goodby the €500 million our Government committed to the EU rescue fund for Greece. Forget the insanity of Ireland borrowing these funds at ca 4.6% to lend to Greece at ‘close to 5%’. With bonds issuance fees, the prospect of rising interest rates and the effect this borrowing has on our deficit, the deal signed by Brian Cowen on March 26th was never expected to break even for the taxpayers. In reality, the likelihood of Greece repaying back this cash is virtually nil.

Which brings us back to our own problems. What Greek saga has clearly demonstrated is that no matter how severe the crisis might get, one cannot count on the EU’s Rich Auntie Germany to race to our rescue. We have to get our own house in order. Unions – take notice – more deficit financing risks making Ireland a client of the IMF, because in finance, as in life, what can’t go on, usually doesn’t.

Economics 23/04/2010: As Greece crashes, Finns are talking gibberish

Sometimes, it is wise for policymakers not to speak to the media. This is usually true when the policymakers have no idea what they are talking about. Case in point – FT’s story (here) about the Finnish PM backing German plan for a new treaty on tougher fiscal deficit and debt measures for the Euro area.

“Finland is sympathetic to controversial German proposals for a fresh European Union treaty if necessary to enforce fiscal and economic discipline in the eurozone after the Greek debt crisis.” Mr Vanhanen, PM of Finland, said “the priority should be to look for ways to tighten rules within the existing treaty, including the withdrawal of EU structural funds from countries that ignore official warnings from Brussels over excessive budget deficits”.

So far, so good.

Per FT, “his comments came amid the most serious crisis in the euro’s 11-year history, with Greece on the brink of a bail-out from the IMF and fellow eurozone countries. “Greek debt is not so big but there is a domino threat so we need to isolate the problem as early as possible,” said Mr Vanhanen” (italics are mine, of course).

Oops! Did he really say that? At 117% of GDP at the end of 2009, and pushing toward 130% by the end of this year, Greek debt is ‘REALLY BIG’, folks. This is precisely why Greek bonds are trading now at the yields close to those of junk-rated Pakistan!

Mr Vanhanen “insisted the crisis must not be allowed to disrupt plans by Estonia to join the euro next January and said the eurozone must keep its doors open to aspirant members.” Why not? He warned that “any delay would “send totally the wrong message” to other aspirant members, such as Latvia and Lithuania, which are making tough budget cuts and other reforms to keep alive hopes of euro entry.”

So hold on, Mr Vanhanen. You say that these countries are undertaking reforms only in order to comply with the euro entry rules, not because these are the right things to do? What hope do we, the Eurozone taxpayers, have that once admitted into the club these countries will not turn Greek? None, certainly, judging by Mr Vanhanen remark.

My humble advice – if you are a politician with no expertise in economics or finance, don’t give interviews.

Economics 23/04/2010: Further details on Irish deficit numbers

More detailed analysis from the Eurostat on reclassification of the Irish deficit is available now. The link to the document is here. Go into Ireland file, spreadsheet for 2009.

Here is what is now apparent from the Eurostat analysis (italics are mine):

"In normal circumstances, under the National Pensions Reserve Fund Act, an amount equivalent to 1% of GNP (about €1.5bn) is paid by the Exchequer into the NPRF every year, in 12 equal monthly instalments. In May 2009, the total due to be paid under this arrangement for the remainder of 2009 and 2010 was paid in one tranche, in order to allow NPRF to fund the bank equity purchase entirely from liquid assets. (The actual 'extra' amount paid at this time was some €2.5bn, given the amount already paid or due to be paid under the normal Exchequer- NPRF funding arrangement.) The impact on Government D4_pay in 2009 is therefore the cost of borrowing this extra €2.5bn earlier than it would otherwise have to have been borrowed..."

In other words:

• The Government has by-passed voted-in Budgetary procedures to inject €2.5 billion in additional funding into Anglo by front-loading future NPRF funds into 2009 provision. There was no Dail vote on this.
• The Government pretended that the additional 2010 funds injected were not borrowed for under General Government Balance, thereby de facto claiming a right to transfer future expected receipts into 'liquid' current receipts. There was never any Dail vote to allow for this, as far as I know.
• This is not the only time that the Government exceeded its remit in by-passing the Dail vote in relation to recapitalizations. One can argue that the entire Anglo recapitalization was planned and committed in advance of the Dail vote on the issue.

Furthermore, under contingent liabilities section 7:

"7. Special purpose entities included here are those where government has a significant role, including a guarantee, but which are classified outside the general government sector (see the Eurostat Decision and accompanying guidance note for details). Their liabilities are recorded outside the general government sector (as contingent liabilities of general government)."

Per table 2 in the same spreadsheet, the above does not cover the Guarantees which amount to over €281 billion in 2009 (line 5). And in fact, these refer to Nama. Now, notice that 'imputations relating to the financing costs should be included' in line 4, which does count as a full General Government liability. Guess where the euribor cost of Nama bonds should be entered? Thus, Irish deficit might also include the 1.25%-odd payments to the banks from Nama bonds, or, assuming €35 billion issuance of these bonds - €437.5 million in additional deficit not accounted for in the Budget 2010.

Now, recall that in 2007 euribor has reached well over 4%. Suppose we go to a 3-3.5% euribor pricing on Nama bonds, rolled over annually. In subsequent years, if Eurostat retains this classification of liabilities, up to €1,225 million will be added to our deficits courtesy of Nama.

Economics 22/04/2010: Ireland's deficit tops Greece

Updated below

Breaking news: Eurostat just revised Irish General Government Deficit figures from 11.7% officially reported in Budget 2010 to a whooping 14.3%, raising our deficit above revised Greek figure. Here is the link to the note.

Excerpt: "Ireland had its budget deficit revised even more [than Greece] -- to 14.3 percent from the initially reported 11.7 percent. Irish Finance Minister Brian Lenihan said this was a result of a technical reclassification associated with government support provided to the banking sector. "It is important to note that the underlying 2009 general government deficit for Ireland is 11.8 percent of GDP, which is broadly similar to that projected in December's budget," he said. "There is no additional borrowing associated with this technical reclassification. This is a once-off impact, and will not affect the government's stated budgetary aim of reducing the deficit to below 3 percent of GDP by 2014," Lenihan said."

That would be putting a brave face on what now amounts to the most deficit-ridden country in the EU!

One question remains to be answered - given that all 2009 recapitalization funds for banking sector came from NPRF, what 'technical reclassification' yielded this massive upward revision?

Update: There has been a lot of talk in the blogosphere about the 'silver lining' to today's news. In particular, one argument is making rounds that goes as follows: "Since our deficit has increased for 2009 to 14.3%, then the reduction to 10.6% envisioned in the Budget 2010 will be even more impressive to the markets".

Here is why this argument is fallacious:

1. Today's revision of deficit for 2009 represents a reflection by Eurostat that cash injected into the Anglo Irish Bank by the state was borrowed via general spending fund in the open markets and as the result constitutes deficit financing. If so, where do you think this year's banks recapitalization will come from? Uncle Sam? or may be Angela Merkel? These recapitalizations are not, repeat not factored in the Government Budgetary projections per Budget 2010. The Eurostat rulling means that should the Government borrow the €10-12 billion to recapitalize the banks in the markets this year, this too will be reflected in our deficit. Now do the math - Government budget allows for €18.7 billion in General Government Deficit or 11.6% of GDP in 2010. If we add to this the lower bound of recapitalization estimates, our deficit rises to over €28 billion or a whooping 17.4% of GDP. Even if the Government wrestles out of the NPRF more cash to plug the banks balancesheet black hole, and assuming that our borrowing for banks purposes goes up by just half of the announced requirement, our Gen Gov Deficit will reach 14.7% of GDP. At which point we can all shout 'Eat our shorts, Greece!' once again.
2. Today's revision clearly shows that the Government has been caught red-handed in attempting to avoid labeling our true General Government liabilities as such. This is about as reputation-destroying as Greece's use of financial derivatives in the past.
   
3. An argument of a 'silver lining' assumes that as a one-off increase, this deficit revision does not matter going forward. This, in effect, is equivalent to saying that no cyclical deficit matters, no matter how big it is. Of course, such an argument is absolutely devoid of any anchoring in finance or economics. Cyclical deficits add up to total deficits. Total deficits - cyclical or not - add up to the total debt. This is exactly how Greece got itself into the bin!