Economics 15/7/10: IMF Article IV CP on Ireland: part 2

This is the second post on the IMF's Article IV consultation paper for Ireland. (The first post is available here).

Several issues, previously stressed by this blog have made their way into Article IV – a good sign for those who read these pages regularly, and bad news for the Government. Emphasis is mine, throughout.

21. Given the sharp increase in leverage, this will be a drag on the pace of recovery. In order to achieve the required internal devaluation, some fall in Irish prices is necessary. However, in the transition to lower price levels, deflation will slow the pace of recovery. The debt of households and businesses, fueled by the low real interest rates before the crisis and with unchanged nominal values, has now to be repaid in an environment of falling prices, higher real interest rates, and low GDP growth rates. These factors lead staff to conclude that the normally-sharp bounce back to close the output gap after a large output decline will be muted on account of the deflationary drag.

[Let’s revisit the above comment of mine about the shocking state of economics understanding amongst the Irish ‘authorities’ (see the first blog post on Article IV paper). If the Irish authorities disagreement with the IMF on deflation is correct, then surely the state can drive up inflation in sectors it controls to the full extent of inducing deflation of our debt. No need to worry about, as the IMF does, about the adverse effects of deflation on debt sustainability. Alas, the IMF is much more sophisticated in its analysis. The Fund understands that in order to deflate our debt, Ireland will need inflation in capital goods and consumer goods. Not in state-controlled and economically unproductive services and sectors, such as health, public services, public transport, energy, etc. Inflation, you see, is not the same across all goods and services, contrary to what our economics bureaucrats might think.]

[Page 15 of the report shows two very good charts, similar to what I’ve been posting before. Irish households’ debt roughly, per IMF estimate, is ca 215% of our net disposable income, while Irish corporates’ debt (ex banks and financial corporations) is ca 160% of our GDP. Now, recall that our corporates are our GNP, which is roughly 24% below GDP. By both measures we are more leveraged than Spain and Portugal! We are, per these charts, darn close to being insolvent as an economy. But of course, there is not a peep from the IMF about Government programmes for addressing this core problem. For a good reason – there isn’t such a programme. Instead we have denials from all official sources that debt insolvency might be even an issue here.]

22. As banks emerge from the worst phase of the crisis, they remain weak. While capital ratios of the eurozone banks have risen since the crisis, they have declined for the large Irish banks. Banks’ reliance on wholesale funding—and, hence, high loan-to-deposit ratios—has yet to be corrected significantly. The ratio of nonperforming loans (NPLs) to all loans increased from ¾ percent at end-2007 to 9 percent at end-2009 and can only be expected to increase further, particularly if rescheduled loans fall into arrears. In the meantime, the ability to provision for these NPLs has declined sharply.

[Now, let me see. We, the taxpayers, have been taken to cleaners by the bank rescue measures. Something almost the size of our annual national income has been committed by the Government to underwrite the banks – from the implicit expected liability on the Guarantee to the explicit cash injections. Just this week our Taoiseach has gone as far as tell the banks: “Burn cash away, should you need more, we’ll give you as much as you need”. And for all that, the banks “remain weak”.

And notice the IMF statement on expected losses on loans. We are now beyond 9% (as of the end of 2009) and closer to 12% by the end of H1 2010. Recall that our Nama and Government assumed just 9 months ago – in October 2009 – that the banks losses will be on par with those experienced in the UK in the early 1990s – aka 10%. We are past this number already and the banks ‘remain weak’. In what book do these outcomes constitute a successful policy response? Stage three of the banking crisis, per IMF warning, is looming if ‘rescheduled loans fall into arrears’. In other words, all the toxic loans on the banks books back in 2007-2008 that were rapidly re-negotiated by the end of 2008, many of these ‘new’ loans come to the end of the repayment holidays and interest only periods and fall due for recovery around the end of 2010-2011. When these loans tank – and there is really no reason for them not to – the arrears will shoot up. Ask yourselves the following questions – are those billions committed to BofI and AIB and Nama taking into account those possible defaults? Not really. Why? Because for now, until the recovery begins, these are performing loans! So in real terms, the banks are not just ‘weak’ as the IMF says. They are potentially gravely sick.]


[But just how gravely ill are the banks? The IMF says the following:] 23. Liquidity pressures remain serious. The authorities estimate that over €70 billion (44 percent of GDP [or 55% of our annual national income]) of banks’ obligations will mature by September this year. …Irish banks have also been heavy users of ECB liquidity facilities. The stock of retail bank deposits has been either flat or declining.

[This is pretty dire, if you ask me. As noted by me on many occasions before, our banks are close to being the most over-leveraged in the entire developed world. So they are in the poor state when it comes to solvency issues. As the IMF above states, and many other sources – from BIS to many Irish observers, including myself – confirm: Irish banks are also illiquid. That’s like a patient who is brain dead and has no pulse. Dare to call that a corpse? I am no medical specialist, but something tells me that some shock therapy – Significant bondholders haircuts? National cash for equity swaps on massive scales? Debt for equity conversions with deeper haircuts on lenders? – is needed here.]

[But do recall that by now every Government Minister and almost every Governing Coalition TD have gone out on the record telling us that Nama will restore credit flows in the economy. Of course, people like myself, Brian Lucey, Karl Whelan, Peter Mathews, and a number of other observers were saying that this won’t happen. The IMF has said the same before. This time around on page 17 the state: “…staff analysis was cautionary regarding the ability of the banks to lend for a recovery.” And then on pages 18-19: “deleveraging to reduce the loan-to-deposit ratio and banks’ risk aversion will likely constrain lending and the pace of economic recovery, at least in 2010–11. Higher than expected losses, uncertainties in global regulatory trends, and renewed financial market tensions—that may restrict access to funding—create downside risks. In this environment, targets for SME lending, which have been imposed on two major banks in 2010–11, could have adverse effects on credit quality and hence require strong prudential safeguards, as the nonperforming loans of this sector have grown rapidly.”]

[Oh, my goodness, is that the IMF warning that politically motivated targets the Government has imposed on the banks for lending out in this economy might be… hmm… damaging to the banks objective of repairing their balancesheets? Indeed the Fund is concerned. As should be Irish taxpayers. After all, the taxpayers have been repeatedly and routinely deceived by the official statements as to the expected outcomes of Nama and banks recapitalizations despite having been warned by independent economists and bankers that their claims concerning restored credit flows will not materialise. Anyone to take responsibility for that?]

28. … Governance of NAMA is strengthened by its independent board. However, given the government’s large presence in the property market, implementing the provisions for the oversight of NAMA’s operations, is vital.

[Clearly, the IMF is concerned that outside of the main board of Nama, the structure itself is not provided with sufficient oversight, transparency and/or accountability. This is not surprising. Core Nama decisions-making committees are rigged up so as to exclude all and any external independent participation. Nama operations will have a limited and not subject to FOI ‘oversight’ only ex post the operational decisions are implemented. Nama strategy and decisions will not be subject to ex ante or contemporaneous oversight of anyone, save for Nama staff itself.

[It is also interesting to note that the IMF report makes absolutely no references to specific policies aimed at restructuring banking operations in the main two Irish banks. Paragraph 31 does attempt to pay lip-service to Government efforts to “reshape the system” but it so miserably fails to note a single implemented ‘reshaping’ measure adopted that it makes it clear that there has been no meaningful change in the ways Irish banks operate. This contrasts with more robust actions on the regulatory reforms side – paragraph 32.]


[Paragraph 34 is the ill-fated section of the report mistakenly identified by the Irish press as an endorsement of the idea of banks levy:] 34. To complement regulatory safeguards, and to reduce and meet the costs of future crises, a financial stability charge could be contemplated.

Such a charge would have two elements. A risk-adjusted levy, tied to a credible resolution mechanism, would provide resources for a resolution fund to be used for future crises. A financial activities tax, levied on the profits and remuneration (of senior executives) would represent a fair contribution from the sector to general revenues but also serve the purpose of reducing the sector’s size and, hence, its systemic risk. Such tax measures remain controversial but are being contemplated in a number of other countries. The authorities noted that Ireland would be guided by the evolving international practice and these initiatives may need to be deferred until more normal conditions apply.

[So let us summarize the argument here: the levies can be contemplated (not a ringing endorsement by the Fund of the idea) and their introduction will lead to a reduced size of the banking sector in the economy.

The latter, of course, would reduce banks’ ability and willingness to supply credit, thus limiting leveraged investment and growth. Now, that might be a fine objective to set for the future, but… how does it square off with the fact that we already have too constrained of a credit supply in the economy which, per earlier IMF statements, is choking off the recovery? Do you sense a contradiction here? I do.

Irish Times folks don’t. Actually, they can't even exactly reflect what the report says. Hence in today’s paper: “The Government should introduce a tax on senior bankers’ pay and bank profits to help reduce the risks the financial sector poses to the economy, according to the International Monetary Fund (IMF).” I failed to notice where the IMF says the Government ‘should introduce a levy’…

More from Irish Times: “It notes, however, that implementation of such measures may need to be deferred until more normal financial conditions apply.” Opps… it was the authorities – as in Irish authorities, not the Fund staff – who stated this to the IMF, as the above quote from the report itself clearly states.

In short, there is no ‘should’ to the banks levy, just ‘could’… which of course may mean that the Irish Government also could do a number of other things, some palatable in a civilized society, some not. Could does not equate to should, unless you are on a preaching podium, such as the Irish Times.]


More to follow, so stay tuned...

Economics 15/7/10: IMF Article IV CP on Ireland: part 1

Amended (hat tip to Paul MacDonnell & Mack)

IMF Article IV consultation paper on Ireland. Several issues, previously stressed by this blog have made their way into Article IV – a good sign for those who read these pages regularly, and bad news for the Government. Emphasis is mine, throughout.


This is the first post of several on the Article IV consultation paper for Ireland:

2. …the path from crisis to stability and recovery is a narrow one. With some reversal in the earlier loss of competitiveness and improvements in the global economy, exports will lead the recovery. But spillovers to the domestic economy will be limited because of exports’ heavy reliance on imports, their tendency to employ capital-intensive processes, and the sizeable repatriation of profits generated by multinational exporters.

[This is bang on with my assessment of the earlier Government noises about the exports-led recovery]

Moreover, the unwinding of home-grown imbalances from the boom years—arising from rapid credit growth, inflated property prices, and high wage and price levels—will create deflationary tendencies that act as a drag on growth. Banks remain a source of downside risks from higher than expected losses, uncertainties in global regulatory trends, and continued financial market tensions that restrict access to funding.

[Note the assessment of the banking sector problems – especially lack of available credit – this will come handy later on when I highlight the self-contradictory nature of the IMF assessment of the banks levy. This is an issue raised as central to the IMF Article IV analysis in today’s Irish Times, which missed the point that the IMF does not actually call for the banks levy, but stresses that it is a controversial measure that will lead to further reduction in credit.]

[So in brief, the opening part of the IMF report does not bode well for the Government claims that we are on a road to recovery. And crucially, it does not put much credit in our Government’s claims that the recessionary adjustments have led to restoration of Ireland’s competitiveness. It also cuts across majority of our economics commentators and some MNC leaders. In contrast, I have always stressed the fact that by most metrics, our competitiveness ‘improvements’ have been either totally invisible or tentative at best.]

3. Along the long-haul path to normalcy, retaining policy credibility will require demonstrated commitment and active risk management. The appropriately ambitious fiscal consolidation plan demands years of tight budgetary control. Likewise, the weaning of the banking sector from public support and its eventual return to good health will proceed at only a measured pace.

[The IMF folks have to be wondering what the hell has happened to our Government commitment when Brian Cowen negotiated the Croke Park deal that effectively prevents any meaningful reforms of our public spending into 2014. That was some ‘demonstrated commitment and active risk management’.]

In the interim, unforeseen fiscal demands may occur. In this context, at times heavily bunched banks’ funding needs and episodes of market volatility could generate unwelcome pressures and disruption. With limited fiscal resources for dealing with contingencies, maintaining a steady policy course will require mechanisms for oversight and transparency, and high-quality communication to minimize risks and sustain the political consensus and market confidence.

[We have seen this all before – in a number of IMF previous statements. What the Fund is saying here is very clear – given the distortionary nature of our banks guarantee scheme and Nama, the Exchequer remains heavily exposed to the moral hazard problem on the banks side. In this environment, one needs a vigilant Exchequer, willing to impose severe pain on the banks in order to keep them in line and prevent future over-loading of publicly guaranteed liabilities. The IMF doesn’t openly claim we don’t have one, but we really do know that we do not. The IMF instead insists on the need for proper checks and balances in the system in order to at the very least cushion the adverse impact of banks perverse incentives to pile on publicly guaranteed debts. But the IMF does not realise (or at least does not acknowledge) that Ireland’s Government and the Dail operate effectively without any real checks and balances. How else can a democratic country run on regular unscheduled appearances of the Minister for Finance to announce another round of banks funding with no real debate, real votes, real accounts given?]


6. The economy is projected to resume growth in 2010. Short-term indicators present a mixed picture of prospects. After a sharp rise in January, industrial production has pulled back. Goods exports are recovering from a weak performance in the second half of 2009. Sentiment measures have also shown improvement, but they incorrectly predicted a much stronger 2009:Q4 and do not as yet reflect the recent financial market tensions. Recent unemployment data were disappointing.

[Errr… we’v turned the corner, as Brian Cowen keeps repeating on international news channels]

Consequently, likely outcomes are in a larger than usual zone of uncertainty. Even as the economy recovers through the year, staff projects the GDP for 2010 to be ½ percent lower than in 2009, but with a q4-on-q4 increase of about 2 percent.

[In other words, April 2010 forecast remains untouched by the IMF. The Fund sees, apparently no ‘turn around’ that would require it to raise their forecasts. More importantly, the IMF also shows 2011 and 2012 projections for growth. Thus, DofF predicted in its SPU 2010 GDP growth of 3.3% in 2011 and a whooping 4.5% growth in 2012. IMF in contrast expects growth of 2.3% in 2011 and 2.5% in 2012. That’s a massive difference on DofF. And should IMF forecasts come true, Ireland Inc will require even more cuts in deficits in years ahead.]


8. The high and persistent unemployment reflects ongoing structural changes. The headline [unemployment] rate is likely to peak this year at 13¾ percent before declining to a still high 9½ percent by 2015. In addition to the cyclical component, the large increase in unemployment reflects significant structural changes with the unwinding of the boom years. The sharpest decrease in employment has occurred in construction and manufacturing. Some of these lost jobs may never come back, especially as the duration of unemployment increases, with the attendant depreciation of human capital and future growth prospects.

[Oh, and the IMF doesn’t hold much trust in Fas’ ability to retrain all those construction and manufacturing workers with relatively low skills and education into ‘knowledge economy’ workers? I wonder why… The key phrase here is ‘structural unemployment’ – the phrase that implies that no return to growth at the level of long term economic potential will ever reduce that portion of unemployment.]

Persistent unemployment may become a policy challenge going forward, and the younger generation could face discouragement and loss of human capital.

[Again, current policies do absolutely nothing to address this issue. We are facing education cuts, education grants for the unemployed are basically unavailable in real terms.]


10. The pace of recovery remains constrained by continuing imbalances. …By staff’s estimates, the potential growth rate will rise gradually to about 2½ percent by 2015 as the internal imbalances—arising from rapid credit growth, overvalued property prices, and high price and wage levels—are corrected.

[Again, nothing new here for the readers of this blog. I have been on the record for some time now saying that long term growth for Ireland should be around (and below) 2%. In my view, IMF estimate of potential GDP growth of 2.5% by 2015 is pretty much bang on with my view. Potential GDP is the trend line. If the trend line is 2-2.5%, while the economy experiences a long term structural underperformance, then long term growth average of 1.5-2% is highly probable. And this is exactly my estimate for Ireland 2010-2020.]

The analysis cautions that the Irish economy may be in a regime with the relatively-modest potential growth and the high unemployment reinforcing each other. The authorities recognize these dislocations but are more optimistic about the medium-term growth prospects. They judge that the traditional flexibility and international openness of the Irish labor market will provide a self-correcting mechanism towards more robust growth.

[This is really a damning statement. It contains two important things. First, the explicit statement that Irish Government is excessively optimistic in its forecasts and is basically ignoring the risk of twin shocks of unemployment and low growth capacity, despite being aware of them. Second, the IMF put it on the record that the entire long term Government recovery programme is based on the hope that large enough number of Irish people will emigrate to sufficiently reduce the labour force and unemployment. This is really equivalent to a country Government wishing for a natural disaster or a plague in order to reduce economic pressures through Malthusian per capita wealth model.]


13. Even before the crisis hit, the rapid rise of Irish wage levels and increasing global competition had diminished traditional Irish advantages. The departure of Dell, …to Poland in early 2009 was symbolic of a loss of edge in low-end manufacturing [amazing, Dell operates in High tech Manufacturing sector. To call its operations in Europe ‘low-end’ is most likely an honest admission by the IMF that what was going on in its Ireland facilities was nothing more than a 'screwdriver' assembly of imported components - aka a transfer pricing 'manufacturing']. Ireland’s share of the value of global and European manufactured exports, which had risen sharply between 1995 and 2001, fell steadily thereafter. In recent years, export growth has been sustained, though at lower levels than in the 1990s, by the repositioning of Ireland as a service exporter and “knowledge hub.”

[So we were not competitive up until now. Nothing new here, but a good reminder. Again, the bit about ‘knowledge hub’ is puzzling – Ireland doesn’t register on the international radar in terms of exporters of education services or healthcare. We do not export patents produced domestically. We do not ship much of indigenous software or biotech/pharma formulas. What ‘knowledge hub’ are we talking about that accounts for our services exports? Full 90+% of our services exports are MNCs, not indigenous firms.]


14. The recent decline in unit labor costs from their high levels will need to be sustained to close the competitiveness gap and make a material difference to growth prospects. …the high Irish price and wage levels will require a period of “internal devaluation” over the next few years to support export growth. …For now, however, unit labor costs have fallen primarily because of improvements in labor productivity. [Oh, sounds so great – we became more productive… err.. not really:] …the productivity increase reflects mainly compositional shifts in the labor force as the relatively-unproductive construction industry has contracted. Thus staff was concerned that productivity increases may not continue and, hence, the decline in unit labor costs to competitive levels is not yet assured. The authorities expect wage compression to continue on account of continuing weakness in and flexibility of the Irish labor market.

[Great, Mr Cowen’s plan to ship unemployed out of the country, while cutting wages for those remaining behind is working, then… Really, folks, this is IMF’s admission (in polite society terms) of our comprehensive failure to drive up productivity! On a side note – I have been running regularly updated posts on Irish competitiveness indicators based on data from CSO, ECB and CB, so stay tuned for more… And another side note, the IMF do not say anything explicitly about public sector wages, but on page 12 they show a chart that highlights the fact that wages in the public sector and industry (also dominated by unions contracts) have driven up wages across the entire economy in Q3 2009 relative to Q3 2008.]


16. Even with faster growth, the spillover from exports to the domestic economy will remain limited. An increase in Ireland’s exports, being highly correlated with an increase in imports, generates a much smaller increase in domestic value-added. Moreover, foreigners have large claims on the value-added generated in the export activity, as demonstrated by high correlation between the change in net trade and the change in income outflow on account of direct investment—the exceptions being the crisis years when imports fell for domestic reasons. Finally, Irish exporting activity has traditionally been relatively capital intensive, becoming more so with the downscaling of lower-skilled electronic assembly.

[In other words, the GDP/GNP gap is real and it matters to the economy, from the point of view of the IMF. I’ve said this all along. But the Government continues to insist that it collects tax on the gap as MNCs repatriate profits from Ireland. This is the joke that passes for our economic analysis. Tax we collect on profit earnings of MNCs is 12.5% after net deductions on transfer pricing through internal company billings etc. The same profits earned by domestic firms are recycled into the economy in form of dividends, wages, investment etc. Which means that while Exchequer earns at most 12.5% on MNCs profits, it earns multiples of that on profits from the domestic firms. This difference is further amplified by the fact that, as IMF also point out, MNCs are less labour intensive in production and returns on labour are taxed at much higher rates of income tax than returns on capital. It is frustrating to have to point these simple things out again and again in the face of denials from the official commentariate.]


18. The decline in prices reflects the high Irish price levels prior to the crisis and the collapse in domestic demand. Despite Ireland’s extensive trade relationships with the U.K., the depreciation of the British pound relative to the euro does not, in staff’s view, appear to be a primary source of the price decline. Irish import prices seem to have fallen after goods prices. Rather, Irish price levels were substantially higher than eurozone price levels prior to the crisis, mainly reflecting higher services prices but also higher goods prices (possibly because of the domestic distribution component).

[Finally, someone of IMF’s authority has confirmed what myself and a handful of other economists were saying for years – public sector-driven inflation (services such as education, health, sectors such as energy and transport) plus our Governments staunch resistance to introducing meaningful competition into retail and logistics (the Wal-Mart or Ikea effect) – are the core culprits in our prices being out of touch with our trading partners. Has anyone heard any discussion of reforming these bottlenecked areas of Ireland Inc’s economy from the Government? I haven’t. In fact, price inflation continues in state-dominated sectors. In the preceding paragraph, the IMF states that: “The annual pace of price decline was 2½ percent in April, but moderated to 1.9 percent in May, largely due to higher energy costs.” Guess who sets prices for energy in Ireland? Bingo – the Irish state.]

Ireland is currently among the most vulnerable nations to continued deflation. An index, capturing deflationary pressure based on indicators such as GDP growth, the output gap, the real exchange rate, equity prices, housing prices, credit growth, and monetary aggregates, suggests that Irish deflation is likely to persist into next year. After a 1.8 percent decline in prices this year, staff projects a further fall of 0.5 percent in 2011. The authorities expect inflation to turn positive next year. They view staff’s focus on domestic demand as unduly influenced by the experience of larger economies and, noting recent month-on-month price increases, emphasize that in Ireland’s small open-economy setting, exchange rate movements and short-run energy and food price increases would prevent further deflation.

[Again, the backward thinking of our ‘authorities’ is fully reflected in the above paragraph. The IMF staff concerns that deflation will continue are based on their view that Ireland is at a risk of continued slump in consumer demand and investment activities. The disagreement from our ‘authorities’ suggests that they think that charging higher food prices, gauging consumers on energy prices and raising the cost of living in areas where the demand is relatively price inelastic will be the good news going forward. This suggests that our ‘authorities’ really have no clue how economy operates in the real world. Shocking! But more on this in a second…]

Economics 15/7/10: European bailout fund - set up to fail?

I thought it is worth sharing few thoughts on a superb article by Satyajit Das"Debt shuffling will be a self-defeating exercise" in July 12 Financial Times (sorry - no link) concerning the European bailout fund. All quotes are from the article, with some of my additions/explanations etc.

European Financial Stability Facility (EFSF) “…structure echoes the ill-fated collateralised debt obligations (CDOs) and structured investment vehicles (SIVs). …In order to raise money to lend to finance member countries as needed, the EFSF will seek the highest possible credit rating – triple A. But the EFSF’s structure raises significant doubts about its creditworthiness and funding arrangements…”

The €440bn bailout fund created a SPV, “backed by individual guarantees provided by all 19 member countries. …The guarantees are not joint and several…”

This means that SPV – an insurance fund against sovereign defaults – is in the need of an additional insurance mechanism against the risk that one or more of the funders fail to pay up into the EFSF. This is achieved by “…a surplus ‘cushion’, requiring countries to guarantee an extra 20% above their ECB contributions.”

One point, not mentioned to Das is that this ‘cushion’ fund is itself subject to risk as a call on the ‘cushion’ will require some states near default to supply even more funding to the fund. In other words, to any of the PIIGS participating in supporting one of their fellow member states, the cost of the EFSF bears a 20% premium reflective of the ‘cushion’. Just how this is going to be feasible for severely financially stretched states remains to unknown. Take one example – for Ireland this would mean that our €5bn exposure to the EFSF is, in reality, a €6bn exposure.

Das focuses on the overall risk transfer within the EFSF arrangement, saying that the ‘cushion’ “is similar to the over-collateralisation used in CDOs to protect investors in higher quality triple A rated senior securities.”

Das puts some numbers on this: “If 16.7% of guarantors (20% divided by 120%) are unable to fund the EFSF, lenders to the structure will be exposed to losses. Coincidentally, Greece, Portugal, Spain and Ireland happened to represent around this proportion of the guaranteed amount. If a larger eurozone member, such as Italy, also encountered financial problems, then the viability of the EFSF would be in serious jeopardy.”

There are other problems with the EFSF. Das notes the issue of ratings migration – the situation where if one eurozone member state experiences problems, then the ‘cushion’ will suffer to the proportion of that member state contribution to EFSF, thus reducing overall insurance pool and adversely affecting overall EFSF ratings.

There is an added and much more severe problem here that no one dares to talk about. If one of the PIIGS experiences problems contributing to the EFSF, then other eurozone states with tight borrowing constraints might have an incentive to ‘run on the bank’, attempting to hover up EFSF funds before they are depleted while simultaneously withholding all contributions to IFSF. First mover advantage here will guarantee a payoff, while staying on the sidelines guarantees at least an up to 120% hit on the member state own funding.

As Das correctly points, “any ratings downgrade would result in mark-to-market losses to investors. …Given the precarious position of some guarantors and their negative ratings outlook, at a minimum, the risk of ratings volatility is significant. This means that investors may be cautious about investing in EFSF bonds and, at a minimum, may seek a significant yield premium. The ability of the EFSF to raise funds at the assumed low cost is not assured.”

So the problem then is that from a political standpoint, EFSF might be borrowing in the markets at 3.5-4%, while lending out to PIIGS at 5%. Should interest rates rise, or inflation tick up, or Euro devaluation continues, the net of costs safety band of 75-125bps can be exhausted very quickly. As the safety band is being eroded, the pressure on triple A ratings will rise, triggering the need for further insurance provisioning. Which can, in turn, put pressure on the troubled states to cut provisions for the EFSS. The EFSF will then turn into a loss-making subsidy generator to the PIIGS.

Germans won’t be too happy to see this. The noises from Germany – the main underwriter of the EFSF will put added pressure on the PIIGS to act fast, increasing a probability of a run on EFSF and triggering ratings pressures once again. Notice that to get to this point won’t require an actual run on the fund – a simple rise in the probability of a run will do the damage.

Das’ superb analysis comes at the end of his article (emphasis is mine):

“Major economies have over the last decades transferred debt from companies to consumers and finally onto public balance sheets. A huge amount of securities and risk now is held by central banks and governments, which are not designed for such long-term ownership of these assets. There are now no more balance sheets that can be leveraged to support the current levels of debt.

The effect of the EFSF is that stronger countries’ balance sheets are being contaminated by the bail-out. Like sharing dirty needles, the risk of infection for all has drastically increased.

The reality is that a problem of too much debt is being solved with even more debt.

The EFSF …may be self defeating and unworkable. The resort to discredited financial engineering highlights the inability to learn from history and the paucity of ideas and willingness to deal with the real issues.”

Of course, much of this criticism is pretty close to heart for Nama - an SPV with even lesser transparency, accountability and capability of management. Irony has it, the SPV has no insurance 'cushion' provisions and instead becomes a direct liability of the Irish state as its guarantor. Then again, we already know this much...

Economics 14/7/10: Car sales: Vanity or Incentives?

Using the same data as in the previous post on car registrations (see here), let’s take a look at the underlying demand for cars and see if this year’s increase in new car registrations is really driven by the scrappage scheme or by the ‘vanity’ effects of 2010 license plates. To do this, I separated cars that belong to a luxury segment (priced above €45,000) from other new cars.

Since demand for luxury cars should be less elastic with respect to scrappage scheme, we can treat the number of new vehicles registered in this category of prices as being a control group – the group that would have seen its demand rising pretty much independent of the scrappage scheme.

The >€45,000 vehicles control group is strongly robust as an instrument for overall demand over 2006-present, as shown by correlations in levels and yearly changes, reported in the table below.

As the first chart below shows, this strong correlation became somewhat reduced during the recession, with luxury cars sales suffering more pronounced declines in absolute levels of sales:
and in year on year changes in levels of sales:

However, as the last chart above shows, luxury vehicles have posted a more significant rise in year on year changes in sales over 2010, than their more price elastic (and thus scrappage scheme elastic) counterparts.

So I estimated two structural relationships between levels and yearly changes in car sales, shown in the two charts below:
Notice high coefficients of determination, signalling high explanatory power of the ‘vanity’ effect (sales of luxury vehicles) on overall sales (sales of cheaper vehicles). Given that the demand for cars around January of each year has nothing to do with actual fundamentals-driven demand, tending to follow instead the pinned up demand in realisation of the ‘vanity’ plate effects, these relationships provide an estimate of the ‘vanity’ effects on overall demand for new cars.

A snapshot of the 2010 data here:
Removing this effect from the sales of new cars, table below shows clearly that vanity effects accounted for more cars sold in all months of 2010 so far. In other words, scrappage scheme introduction, alongside all other factors (such as significant depreciation of older vehicles, increases in family sizes, etc during 2008 and 2009 crisis years) have been responsible for lesser number of car sales than the ‘vanity’ effect of having a 2010 license plate.
Of course, this is not a perfect estimate, but the persistency with which the numbers come out to show the power of the completely silly license plates vanity ‘competition with the Joneses’ is frightening. Oh, and it does show that the Government didn’t really ‘save our auto retail industry’, but rather once again helped inflating the artificial demand.

Economics 14/7/10: Car registrations & Emissions policy

I trawled through the CSO database on vehicles registration, trying to find some information concerning the efficiency of our emissions-reducing policies on taxation of vehicles and found some pretty interesting results. Here are the latest charts, for the data ending June 2010.

The first chart above shows all passenger vehicles registered (new and used) on a monthly basis. It clearly highlights the fact that our license plates act as a major vanity point. There are severe peaks in January each year, followed by more demand-driven local peaks in May-July (as families prepare for vacations). It is also interesting to note that despite the scrappage scheme and the psychologically significant change to ‘10’ plates, January 2010 was still posting fewer vehicles registrations than January 2009. Instead, what is significant in 2010 is the return of March local peak – a feature of 2006-2007.

There is a clear and strong dominance of demand for diesel engines, compared with petrol. This trend started in July 2007 – a year ahead of the new taxation system based on emissions was introduced.

And the ‘vanity effect’ is even more evident in new vehicles registrations (chart below):


Chart above clearly shows lack of demand for alternative fuel vehicles. It also shows that prior to 2010, peak demand months for cars was not coincident with peak demand for alternative fuel vehicles, suggesting different structure of the market for normal passenger vehicles when compared to alternative fuel vehicles. However, the data is still thin on alternative vehicles, as their sales prior to the recession are extremely thin. Finally, an interesting feature of this data suggests that during the recession, demand for alternative vehicles has been slightly more robust than for ordinary types of vehicles. This is most likely due to demographic of purchasers – more urban, professional, more secure in their jobs consumers of alternative fuel vehicles are also more likely to weather the recession with greater confidence than the general population. (Note of caution: given the short term horizon of this data, and low levels of alternative vehicles sales, these points are ‘educated guesses’ rather than hard evidence).

Diesel vehicles make up the vast majority of eco-friendlier Band A vehicles in Ireland, while heavily subsidised alternatives are lagging well behind petrol engines in comprising ecologically cleaner segment of Band A vehicles. As a driver of a mid-size diesel with emissions equal to a smaller and less comfortable Toyota Pious (ooops… Prius), I am can testify to the fact that our Government policies currently reward vehicles few of us want to drive, yet which pollute as much as (or as little) as vehicles people actually choose. It does seem to me that should Ireland’s Greens pursue in earnest their objective of cutting emissions, they should provide better incentives to cleaner diesel technologies.

Notice that a greater proportion of the diesel engines registered in 2010 are Band A emissions, compared to all alternative fuels (hybrids etc) combined. In proportional terms, hybrids etc are less emissions-reducing than the average new vehicle registered, while diesels are more emissions abating. This is a new trend since January 2010 and most likely reflects two changes in demand and supply: firstly, there is a new generation of diesel vehicles coming into the market, and second, there demand has shifted in favour of smaller (and cheaper) diesel vehicles (a recession effect?).

Two charts below plot 12 manufacturers that supply the largest share of Band A vehicles relative to their overall cars supply to the market in Ireland. The rankings are dominated by smaller engine diesel suppliers.
Chart below breaks down alternative fuel vehicles (including hybrids) into new vehicles purchased and used vehicles purchased. It clearly shows that for now, sales of alternative fuel vehicles are dominated by new car purchases, which, of course, means that our drivers of these vehicles are years away from realising real net emissions savings. Remember, production of every new car requires serious emissions, so unless a new car is driven significant number of miles, buying a used car in place of the new one is actually contributing less emissions, especially if the used car belongs to the same emissions band category as the new one.

Thus, once again, economic efficiency argument suggests that incentives for purchase of new lower emissions vehicles should be extended to cover used lower emissions vehicles as well.

Chart below shows the demise of the petrol engine and the rise of diesel engine during the current recession. It also shows a relatively flat trend for alternative fuel vehicles. However, the alternative fuel vehicles trend line remains upward sloping through the current economic crisis.

The really amazing figure is the following one. As can be seen from the chart below, even petrol-fuelled vehicles in Band A category are more prevalent than all alternative fuels vehicles, and the trend is so far driving this difference even further. Once again, a more efficient (from economics) perspective means for reducing Irish motors-related emissions is to have incentives for buying lower emissions vehicles. Not those run on alternative fuels, but ones run on diesel and petrol. As long as they fit into Band A…

Economics 13/07/10: AIB needs your cash

The dogs are barking across Dublin’s RDS. Touring the USofA, our Taoiseach has told the nation that AIB may (oh, just ‘may’?) need further state support to meet new capital targets. That admission, of course, comes after the solemn statement by Minister Lenihan back in March that the announced measures to provide capital to AIB and BofI were final. And on the heels of numerous assertions by our banks’ cheerleaders squad in Dublin’s stockbrokerage houses that AIB will be able to raise capital on its own accord, once the taxpayers pay through the nose for ordinary shares in the bank in round 3 of recapitalisations.

Well, taxpayers did pay through the nose. And AIB still needs more than €7 billion – based on status quo scenario concerning loans quality. Should it see continued deterioration in loans going forward from Q1 2010, the bank will need more than that. How much more? Anybody’s guess. But that open ended nature of AIB’s liabilities won’t hold back our nation’s leader. Last night, Brian Cowen pledged an open ended support to AIB saying that AIB “may need some help, but we will provide that”. How much will Brian be ready to ‘provide’? Not a single word. There is no stop-loss rule operating for this Government. Then again, we know as much from the Government treatment of the Anglo.


And while on the matters of Taoiseach tour of the US, unable to sell the idea that Ireland has turned economic ’corner’ on the recession, our leader is meeting some pretty important people. NYSE CEO Duncan Niederauer and NYC mayor Michael Bloomberg are on the list of those who need to be wooed into ‘Green Jersey’ club. Presumably, they’d love to send some of their companies (listings and HQs) down to the Emerald Isle, but need Taoiseach to convince them.

Messrs Bloomberg and Niederauer will have to be satisfied with playing the second fiddle in Mr Cowen’s sonorous opus ‘Turning Over, Again’. Per Taoiseach: "The first objective will be to give a clear message to key media outlets, business figures and opinion formers that Ireland has turned the corner…"

In other words, accustomed to his own PR hype, economic management is all in the media reporting for Mr Cowen. That, plus what’s being said at business lunches and social dinners in Manhattan. In other words, if the foreigners – especially the important ones – can be made believe things are good back in Auld Dublin, then surely they must be good.

No? Who says so? Oh, those pesky 450,000 unemployed and underemployed back in Ireland? Well, we’ll have jobs for them in no time, once Micheal O'Blumberg and Duncan MacNiedehan send their NYC 'investitors' over to Upper Merrion Street to buy some of those banks shares. After all, Bertie Ahearn thinks they should be a bargain at €5 each, while with Brian Cowen's latest unconditional pledge to plug AIB's capital hole no matter what, Bertie might just be right...

But just in case you think it’s all about Brian Cowen telling the Americans how to properly read our economic stats and banks balance sheets to discern the ‘turnaround’, think twice. Per Reuters report: “Mr Cowen said he will also ask for advice from business and political leaders on how Ireland can continue its fight against the recession and create jobs.”

Oh, wait – what recession? Didn’t we turn that corner?

Does anyone find this a little bit strange? We have an elected leader of the nation whose job description is to govern the state going over to the US to 'ask business leaders for an advice' on how to do his job?

Then again, our Taoiseach can boast of his policies getting us out of the recession. So why would he ask foreigners to provide him with their own ‘get out of recession’ ideas? May be, its because he really hasn’t a policy himself or he might need external validation for his policy of having no policy, or may be it is both. You tell me. But it does seem a bit uncomfortable, in aesthetic terms, to see our head of state travelling to the US to ‘consult’ foreign business leaders on how to solve our problems. I can’t imagine Angela Merkel or Nicolas Sarkozy doing the same. At least, not in front of the media…

Economics 12/7/10: Toyota on electric vehicles

An interesting set of revelations from Toyota (hat tip to Seeking alpha post on this) – the most advanced electric and hybrid vehicles producer in the world and one of the largest producers of car batteries (post-acquisition of 80.5% stake in Panasonic EV Energy). See their site (here).

The range of the plug-in electric vehicle motor: Toyota is preparing to test PHV-13 for its delivery to the markets in 2012. PHV-13 will have a 13 miles-range electric drive. Why so little? Toyota explains: "… the smaller the battery in a PHV the better, both from a total lifecycle assessment (carbon footprint) point of view, as well as a cost point of view."

You’d think that electric vehicles are supposed to provide a meaningful replacement for hybrids, according to Irish Government-ESB plans? Think again. Don’t even try to reach Dublin Airport from your Foxrock house in one of these.

Certainty of success in deploying electric plug in vehicles: recall that Toyota already has 2 million hybrid-electric vehicles running around the world. Yet, Toyota, with all its experience, doesn't believe it knows enough about electric vehicles: "The [electric plug in] Prius PHV will come to market in 2012. The PHV demonstration program [starting in 2010] is designed to gather real world driving data and customer feedback on plug-in hybrid technology. In addition, the program will confirm the overall performance of the first-generation lithium-ion battery technology ..." So Toyota wants to make sure it can meet customers’ demands and satisfy their needs. No such caution for the Irish Government that is putting all its faith and a hell of a lot of taxpayers’ cash into electric vehicles and ESB.

extent of plug in vehicles usability: here’s another interesting bit from Toyota – emphasis is mine: “Toyota believes that PHVs can be part of a solution to climate change and for energy security, for certain customers, in certain geographic areas, with certain grid-mixes, with certain drive-cycles, and with access to charging. There will be an important role for PHVs, but it will not be in high volume until there are significant improvements in overall battery performance…and battery cost reduction.”

Err… what was that? But what about Irish Government plans for large-scale switch to electric vehicles in Ireland? Have Toyota heard Minister Ryan speaking on Prime Time about his dreams? May be the Japanese manufacturer can do with a dose of our Green Optimism? Ironically, Richard Tol from the ESRI appearing on the aforementioned programme clearly warned that Minister’s plans for electric car fleets in Dublin will require massive breakthroughs in battery technology.

Cost of technology: Lastly, we are being told that Ireland’s electric vehicles fleets of the future will be powered cheaply (by ESB’s second highest cost electricity in Europe, one presumes). But Toyota guys are not so sure. Again from the Prius PHV site: "During [2009] testimony [at the National Academy of Science in Washington, D.C.] …Toyota said …that the very rough estimate was approximately $1200 per KWH for a complete pack ... Significant reductions in cost will require major technological breakthroughs."

Hmm… so are we going to get cheap and clean electric vehicles in Ireland? According to the world leader in this technology, the 2012 generation of electric vehicles is likely to be about 2-3 times more expensive than running a mid-range Beemer or a Merc. And that’s before we factor in our ESB’s tariffs and the cost of infrastructure to deliver their electricity to the cars’ batteries… dream on, man, of those Green pastures…

Economics 12/7/10: ECB - cooking up the (banks') books?

Something fishy is going on at the ECB. Having all but destroyed its own reputation (for the n-teenth time), the ECB has swung into its usual modus operandi – ‘We are tightening, tightening no matter what!’ First, in the face of clearly sluggish writedowns by the Euro zone banks, the ECB decided to close its longer-maturity lending window. Despite a clear warning from the Bank for International Settlements stating that there is a worldwide rising risk of a severe maturity mismatch on banks balancesheets.

Now, the ECB is signalling that it will cut government bond purchases – just in time for euribor climbing up and sovereign spreads shooting past their pre-Greek crisis highs. Last Friday, Jürgen Stark said that declining scale of the ECB’s bond markets interventions reflects improving market environment for sovereign bonds. In May the ECB was hovering ca €33bn in bonds per month, last week this has fallen back to €16bn in monthly purchase rates. “If the situation improves further, then there is no need to continue [with bonds purchases]”, he told FT.

Funny thing, the IMF has just urged the ECB not to discontinue bond purchases. But, to Mr Stark “The IMF has not caught up with the reality in Europe.” Oh, poor IMF, apparently a quick reprieve in some credit default swap indices last week (e.g. Markit iTraxx Financial, down 25bp, its largest decline in two months) is not exactly convincing for the IMF as far as prognosis of markets confidence in Europe goes. It looks like either the ECB is betting a house on its own forecasting prowess or setting itself up for another ‘Fool’s stumble’ through monetary policy. Expect bond purchases to resume once the summer is over and the markets re-open for business.

Oh, and just in case you might think that the IMF is really not getting the ECB’s “Europe is Great” vision, here’s the note from the WSJ blog (here) which shows that the ECB will be facing not just a steep sovereign bonds purchase curve, but will be getting more of the Euro area dodgy collateral into its vaults very soon. Apparently, the rest of 2010 through 2011, Euro area banks are facing a mind-blowing level of debt refinancing – the whooping €1.65 trillion worth of stuff. Don’t think they’ll be highlighting that in the shambolic stress-testing PR exercises that will be released July 23. I wrote about Euro zone’s banks propensity to stick their heads into sand when it comes to recognizing loans losses. But now, it also looks like they are doing the same with their funding sources – a dangerous game given the direction in which borrowing rates are going (see my earlier post on euribor).

Here is a nice pic I reproduced from the IMF GFSR database showing those dogs. The tail is wagging, noses are wet, barking mad… furry friends of ECB’s discount window.

I know, I know – Stark would say that the WSJ also ‘doesn’t get Europe’s great progress to prosperity’. But the little problem is – if the banks are to refinance these borrowings at current rates, between 2010 and 2015, Europe’s borrowers, consumers and investors will have to come up with a whooping €152-187 billion worth of interest rate cover. Yes, that’s right – while ECB is playing an outright silly game of ‘We are tough and things are great’, European economies will have to deliver almost 2% of their domestic output to plug interest rate hole alone.

But do not worry, the stress tests deployed by Europe are not designed to reckon with reality – they are simply a PR exercise. How else can one see a test that prices Greek default losses at 10% and Spanish at 3%, when the markets are pricing these at 4 times higher. Or how does one really test the banks if there are no scenarios for loans defaults and/or yield curve tests for debt refinancing?

If you need an indication just how shambolic these tests are, look no further than banks actions in refinancing markets over the last week. Clearly fearing that the investors might, just might, come to their senses and label the whole stress testing a farce, Euro banks have gone aggressively into the markets to raise €18.4bn worth of bonds last week, up from €4.8bn a week before. Do you think they are doing this because of cheaper cost of finance? Not really, costs remain high, though they are off their June peaks. So they are doing this only because they anticipate further increases in the cost going forward.

Yet, the ECB is drumming up the beat that the stress tests will reveal Euro area banks to be well-capitalized (haven’t we heard this before in Ireland? Ca 2008 from our own CB?). So the banks do not believe that the stress tests, which they all pretty much have passed already, per ECB assertions, are going to reduce risks perceptions in the markets. Why would that be the case, if the tests were honestly designed to really test their balancesheets? Last week’s survey of money managers by US-based Ried Thunberg ICAP found that 95% of the 22 survey respondents (controlling $1.39 trillion in assets) said most major European banks will receive positive test ratings.

Hmm… that, I would say, is a darn good evidence that the tests might be rigged. In which case, prepare for a rally in the banks that will turn South as soon as serious analysis of the tests assumptions comes through.

Economics 7/7/10: Nama New Business Plan

Nama New Business Plan (NBP) was published and it took me some time to dust out my old models and run through the numbers.

Let’s put it in simple terms – Nama’s latest installment in its own version of the hall of mirrors is so distorting, when it comes to representing the reality, that even a person with no education in finance would see that it simply a cover up for a scam.

Here are some points worth mentioning before we depart on the journey through numbers

1. NBP contains no Profit & Loss or cash flow projections. For an undertaking committing between €38.5-40.5 billion of taxpayers cash, this is simply remarkable (arrogance? Or negligence? You decide
2. NBP contains even fewer financial details than its old plan. The only relevant piece of new information it contains that has not been disclosed before is in the table 4 on page 25, which, given that no specific cash flow estimates linked to annual operation is provided, is a complete hearsay – or in scientific terms – an unfalsifiable conjecture. In common terms, it is known as bullsh*t
3. NBP states (then rolls this statement into core assumption) that 25% of loans taken over in Tranche 1 are ‘income producing’. It does not explain the extent of this ‘income’ being generated in relation to the value of the loans. Let me explain – suppose I take out a loan for €100mln at 5% per annum. My payment on interest should be €5mln per annum. Barring capital repayment, if I pay my bank €4,999,999 a year, I am in arrears and the loan is not performing. But if I pay Nama €1.00, it is an ‘income producing’ loan. Get my example? In other words, it is a leap of faith to assume that 25% ‘income producing’ loans is the same as 25% ‘performing loans’
4. NBP states: “the actual LTV ratios that have become evident during the Tranche 1 due diligence process have been higher than those indicated by institutions last autumn”, but never explains by how much. This is critical, since LTVs underpin the expected recovery rate in case of asset liquidation. Suppose Nama takes on a loan for €100mln that is secured against a property worth (at the time of loan issuance) €120mln to LTV of 83%. Suppose that underlying asset deteriorated in value by 60% since loan issuance and that in the long run, it is expected to appreciate by 20% to LTEV of €57.6mln. Foreclosing on this loan will mean a recovery rate of 57.6%. However, were the LTV at loan issuance at 90%, the recovery rate drops to 52.8%.
5. NBP omits any provisions for rolled up interest on the developers’ loans. At €81 billion face value, and taking average retail interest rates for 2004-2007 reported by the CB, we are looking at €18.8 billion of foregone interest – a direct subsidy from taxpayers to developers. In arriving at this number, I used loans depreciation schedule provided in Nama new plan page 10, the average charged rate of 4.7% (assume static over 2011-2018, despite the fact that one can safely assume that this cost of capital is (a) too low, given Irish Exchequer is borrowing currently at 5.4% and (b) is likely to rise in time with upward sloping yield curve).
6. Nama makes an implicit assumption that it can dispose of all properties held by it at the peak of their Long Term Economic Value. This requires something that no one in the world, short of God, possesses: (a) perfect foresight, (b) ability to fully control disposal markets and (c) incur no cost of disposal. Clearly, this assumption is simply a sign of deeply rooted inability of Nama staff and directors to think straight through their own effective costs and valuations
7. NBP makes no provision – at all – for the cost of ECB-linked financing of the bonds, which will have to incur the cost of at least 1% in monetization. This will add up, for the life time of Nama (again, using Nama own depreciation schedule mentioned above) to the total subsidy to the banks from taxpayers to the tune of €2.4 billion.
8. “The fees that NAMA will pay over its expected ten-year life amount to about €1.6 billion. A breakdown of the 2011 budget shows that a significant proportion of these fees will be incurred as payment to the participating institutions to administer loan assets on NAMA’s behalf. It is likely that there will also be significant fees incurred arising from enforcement.” Yet, in the actual estimates on page 25, Nama plan allows for just €2.5bn, in the worst case scenario, in total for the costs of its own operations, banks’ fees on administration of loans, for all legal fees to be incurred by it and all other expenses. This rises to €4.8bn in the best-case scenario. Nama already employs almost 90 officers, not counting various board members and an army of consultants. These alone will be swallowing around €250mln in salaries and perks. Legal costs can be safely put to equal about 2.5% of the loans incurred – a double of the relatively standard closing & operations legal costs, taking up over €2bn. Toss in the fees of €1.6bn provisioned and you have sums that do not add up.
9. There are repeated claims that Nama will pursue debtors to the full extent of the loans. This warrants understanding of Table 4 estimates as the full recovery scenarios, implying that in Scenario A, combined recovery rate on all loans is 55.2%, Scenario B 60.7% and Scenario C 49.6% relative to the €81bn face value of the loans. But these are massively exaggerated numbers. Practice in the UK in the 1990s and in Ireland in the 1980s suggests that real gross recovery cannot be greater than 40% of the face value of the loans. And this is before we take into account the present value discounts and rolled up interest (prior to Nama acquisition of the loans and after).
10. Page 20 of the NBP states: “Derivative transactions with a nominal value of €14bn (principally interest rate swaps) will also be transferred. A substantial number of these derivatives are nonperforming and NAMA will pay nil consideration to acquire them.” If these derivatives are nil value, then why are they a problem on the balance sheet of the banks? Answer: because they are nil value today, but have a non-zero probability of exploding in the future. This is why they are being transferred to Nama. What does this mean? If you are on a wrong side of an interest rate swap, your potential liability is unlimited (as in infinite). This is also why in the current market place, the cost of unwinding these swaps today will be around 10-20% of their face value or €1.4-2.8bn. This, of course, is an approximation, but Nama is now stuck, courtesy of taking on these derivatives, with a liability between €1.4-2.8bn at the very least and an unlimited loss at the worst. A picture of iceberg peacefully floating in the path of Titanic comes to mind. Yet, no provision for unwinding these derivatives was made in the NBP.
11. NBP does not address any of the concern about non-transparent governance of the core Credit, Audit and Risk Committees of Nama, which still contain no provisions for external members presence on them. Neither does it address the issues of full and automatic disclosure of all properties held, development applications lodged and funding disbursed, as should be required of such a massive public undertaking.

Now to the numbers. I took the very assumptions contained in the Nama New Business Plan and added one more scenario, with following additional assumptions to cover the holes in Nama own statements:

Loans taken on board:
(Typo corrected, hat tip to Anonymous). Note: the above estimated recovery is the basis for price appreciation in the following table.

Nama NBP scenarios reproduction and my estimates:

Assumptions, in addition to those in Nama NBP are: property uplift over the lifetime of Nama is 15% (this is 50% higher than Nama optimistic scenario of 10% uplift, thus allowing for a greater margin of error in estimates); 1% ECB discount window financing on bonds plus 25bps charge; €5bn in additional investment by Nama drawn in 2015, reducing overall cost of financing to 5 years. Net present value excludes in my scenario excludes rolled up interest on developers’ loans and discounting to present value (Nama claims that it is discounting its NPV at 5%).

All of this means that my estimated loss for Nama of €14.6bn is extremely conservative, allowing for any errors in other figures and assumptions.

Adjusting for NPV at 5% discount, as in Nama plan produces the following summary estimate:

As a reader of this blog remarked on the topic of Nama new BP, “The effortless miscalculations, the assured non-sequiturs, the lofty indifference to facts: all reveal [the new Plan] as a master copy of what Princeton philosopher Harry Frankfurt defined succinctly in his 1986 paper, On Bullshit.” I couldn’t have said it better. Thanks, Patrick.