Ecoinomics 19/7/10: Moody's downgrade Redux

As Brian Cowen has been telling the world that Ireland has turned the corner, the country got some rude awakening.

First, Moody’s – aka the lagging indicator – pushed Irish bond ratings one notch down to aa2. Second - and I will be covering this in a separate blog post - Nama has completed transfer of the second tranche of loans.

With it, Moody’s also downgraded to aa2 that ‘not our problem, says Lenihan’ debt called Nama bonds. Irony has it, for all the SPV accounting tricks deployed by the Government, Nama bonds are rated on par with sovereign bonds and Moody’s statement justified both downgrades as being primarily driven by “the government’s gradual but significant loss of financial strength, as reflected by its deteriorating debt affordability”.

Per Moody’s, the third key factor driving rating cut is “the crystallization of contingent liabilities from the banking system... Overall, the recapitalization measures announced to date could reach almost €25bn …and Moody's expects that Anglo Irish Bank may need further support. … While we do not expect the government -- not even in a moderately stressed scenario -- to incur permanent losses in excess of 25% of the country's 2009 GDP as a result of [Nama] obligations, we believe that the uncertainty surrounding final [Nama] losses would exert additional pressure on the government's financial strength.”

Oh, mighty. So Moody’s believes that Nama will generate final losses. May be not as bad as €41bn (1/4 of GDP), but certainly losses. And notice that losses below 25% of GDP are expected by Moody’s explicitly in the scenarios that are better than or equivalent to their ‘moderately stressed scenario’… Of course, Nama’s Business Plan Redux envisions losses only in the ‘worst case scenario’ and even then, the modest €800mln.

“Moody's notes that the country could experience downward rating pressure in the event of (i) a failure of the economy to rebound in a meaningful way; and/or (ii) a severe deterioration in the country's debt metrics triggered by a further crystallization of bank contingent liabilities beyond Moody's current expectations.”

Err… let me see…

Bank recapitalizations that Moody’s have factored in – at €25bn to date – have already been exceeded, with current running estimate at €32bn committed, plus last week’s open-ended offer to give AIB anything it needs from Brian Cowen. These are likely to rise once again after today’s announcement from Nama on tranche II transfers. So condition (ii) is already satisfied.

Per economy’s likelihood of a rebound – well, give it a thought. Government policy over the last two years was characterized by increased taxes, retained waste, lack of reforms in public sector, lack of reforms in state-controlled private economy, lack of reforms in bankruptcy laws, massive waste of funds on poorly structured banks supports, and laissez fare in relation to banks and semi-state companies ripping off consumers and businesses. None of it is likely to change in 2011-2012. Which part of this litany of economic policies misfires can contribute to an increasing likelihood of a robust economic rebound?


Ireland is clearly not out of the woods when it comes to bonds ratings and this persistent problem of continued deterioration of public debt ratings will be a costly one.

Mark my words – as Ireland’s public finances continue to deteriorate, our debt will become more costly to finance. Should the Government opt for any tax increases in order to raise 2011 revenue, it will face continued fall off in income and transactions taxes collected, as people engage more actively in tax liability minimization. This will trigger widening of our deficits in excess of international forecasts (no one pays attention to our own ‘rosy’ forecasts anymore), leading to further debt downgrades. In particular, I would expect Fitch to move first once again to put two notches between itself, Moody’s and S&P.

One more point before we conclude. Irish banks are heavily dependent for capital and collateral on Irish sovereign and Nama bonds. The latest downgrade must have an adverse longer term impact on the quality of the banks balance sheets. Regardless whether AIB and BofI pass their EU-administered stress tests or not, I would expect the Moody's downgrade to have potentially significant adverse effect on Irish banks ability to tap private markets for funding in the near future. This, of course, might trigger another run on the Exchequer and customers by our leading banks.

Economics 19/7/10: Urban growth, education & knowledge intensive services - part 2

In the previous post (here) on the issues of growth, education and knowledge intensive sectors, I showed that

• There is a strong positive resilience in income per capita levels across urban economies, with almost 94% of variation in income per capita in 2007 being associated with the variation in income per capita found in 1999. This strong persistency in GDP levels over time implies there is only a weak (but positive) relationship between the past and the future growth rates.
• Data also shows that there is a weak positive relationship between long term growth in education and long term growth in income per capita. Growth in education between 1999 and 2007 was able to explain just 0.54% of the overall variation in growth in income per capita across various regions.
• However, over time, the relationship between the levels of education of the workforce and the levels income per capita is becoming stronger both in terms of education impact and the overall explanatory power as to the direct positive correlation between education and income. By 2007 over 14.5% of variation in income per capita across major urban regions was explained by variations in education, up from 7.3% in 1999. If in 1999 1% increase in the proportion of population with 3rd level education was associated with a USD336.53 increase in income per capita (PPP-adjusted), by 2007 this effect rose to USD730.92.
• Lagged period education levels were shown to be a better determinant of income per capita than contemporaneous levels of education, which suggests that causality flows from education to growth, rather than the other way around.
  

Chart 7 below explores the relationship between the levels of education in the labour force and two core higher value added sectors of economy: high tech manufacturing (HTM) and knowledge intensive services (KIS).

Chart 7
Consider the blue and the red lines. More educated workforce, it seems, is negatively correlated with high tech manufacturing role in the economy. And this correlation is becoming more negative over time (with lags). In other words, an urban centre that started with highly educated workforce in 1999 is more likely to see declining share of its economic activity accruing to HTM in 2007.

This can be related to the changes in manufacturing that took place over the last two decades, with manufacturing in general becoming increasingly more capital intensive. It is also likely to be due to the fact that with greater outsourcing of core activities and greater offshoring of manufacturing, much of higher value added activities related to high tech manufacturing, such as design and development, and marketing of new products, is now classed separately as services, and geographically removed from manufacturing activities, despite being physically embodied in the value of manufactured goods.

The opposite is true of the relationship between education levels of the workforce and knowledge intensive services role in the economy, although the positive correlation here is not becoming stronger over time (orange and green lines).

Knowledge economics – at least as proxied by education levels – is about the positive role of education in services, but it is not about the links between high-tech manufacturing and education. The dumber is your workforce (in extremely simplistic terms), the higher will be the importance of HTM to your economy… or so it appears…

Chart 8
A look at contemporaneous data reported in the chart above also confirms the previous chart 7 conclusions.

What is even more interesting here are the slopes of the two relationships.

First, the negative correlation between the degree of workforce education and high-tech manufacturing (HTM) had become more negative, from -0.1032 in 1999 to -0.1633 in 2007, while the overall relationship has strengthened (R2 = 0.0836 back in 1999 to R2=0.2341 in 2007).

This relationship is very robust and shows relatively less dispersion in the data than the relationship between education and knowledge intensive sectors.

Second, the slope of the positive relationship between the degree of workforce education and knowledge intensive sectors (KIS) has become weaker over time (from 0.5961, R2 = 0.3104 to 0.3877, R2 = 0.1396).

This result is surprising. Are we hitting diminishing returns to education in terms of increasing importance of KIS in the economy? Or are we simply at the flatter end of asymptotic KIS growth curve with much of knowledge economy already in place so that new education yields lower marginal returns? Alternatively, this might suggest that education is an imperfect instrument for skills and talent and that today, skills and talent gained outside formal classrooms matter more than before.

Finally, it is also worth noting that KIS results are significantly impacted by three observations which tend to drag the slope of the relationship down somewhat. The three, however, do not appear to represent statistically significant outliers.

Another striking relationship is shown in chart 9 below. Greater importance of high-tech manufacturing in the economy is associated with lower GDP per capita, and this negative relationship is strengthening over time, both in the explanatory power and in the size of overall negative effect. This again illustrates, most likely, the growth in capital-intensity of high tech manufacturing and disembodiment of the services-related components of high-tech manufacturing (such as R&D etc).

Chart 9
Lags in data confirm the above conclusion.

Chart 10
Chart 10 shows that identical conclusions to those presented in Chart 9 are warranted when we look at the lagged structure of economy with respect to high-tech manufacturing role in overall economic activity, so that regions that started (back in 1999) with greater share of HTM in overall economy tended to have lower GDP per capita 9 years later.

Lastly, unlike High-Tech Manufacturing, Knowledge Intensive Services are strongly positively correlated with GDP per capita, as shown in chart 11 below. This relationship is true for contemporaneous correlations and for the lagged one. And it is increasing in strength (slopes) over time, as well as in statistical significance. Furthermore, between 1999 and 2007 there has been an acceleration in the strengthening of the relationship. Finally, it is worth noting that lagged role of KIS in economy is almost as strong as 2007 contemporaneous relationship, suggesting that there is significant persistence in the positive effect that KIS have on overall income per capita.

Chart 11.


So let me summarize the main results:

1. There is a weak positive relationship between long term growth in education and long term growth in income per capita between 1999 and 2007 across various regions.
2. Over time, the relationship between the levels of education of the workforce and the levels income per capita is becoming stronger both in terms of education impact and the overall explanatory power as to the direct positive correlation between education and income
3. Lagged levels of education are a better determinant of income per capita than contemporaneous levels of education, which suggests that causality flows from education to growth, rather than the other way around.
4. More educated workforce is negatively correlated with the importance of high tech manufacturing in the economy. This correlation is becoming more negative over time (with lags).
5. The relationship between education levels of the workforce and the importance of the knowledge intensive services role in the economy is positive. This positive correlation is not increasing over time.
6. Overall, knowledge economy – as far as it is captured by third level education – is positively linked to services, and negatively linked to high-tech manufacturing.
7. The negative correlation between the degree of workforce education and the extent of the high-tech manufacturing (HTM) in overall economy had become even more negative between 1999 and 2007.
8. The positive relationship between the degree of workforce education and knowledge intensive sectors (KIS) has become weaker over 1999-2007 period.
9. Greater importance of high-tech manufacturing in the economy is associated with lower GDP per capita, and this negative relationship is strengthening over time, both in the explanatory power and in the size of overall negative effect.
10. Regions that started (back in 1999) with greater share of HTM in overall economy tended to have lower GDP per capita 9 years later.
11. Knowledge Intensive Services are strongly positively correlated with GDP per capita. This relationship is true for contemporaneous correlations and for the lagged one.
12. The positive correlation between income and KIS is increasing in strength (slopes) over time, as well as in statistical significance.

Note: you won’t be able to read this anywhere else – the two blog posts on urban economies, knowledge, education and the roles of high tech manufacturing and knowledge intensive services is an exclusive, just for the readers of this blog…

Economics 19/7/10: Urban growth, education & knowledge intensive services - part 1

As promised few days ago, here are the first couple results from an interesting data set from the OECD on regional economies.

Let me first explain what I have done to data in order to derive this (and the next post) analysis:

• Out of 350 regions defined by the OECD, I have selected 50 regions that are directly aligned and dominated by capital cities and major industrial and commerce centers.
• Countries covered are: Austria, Belgium, Canada, Czech Republic, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Korea, the Netherlands, Norway, Slovak Republic, Spain, Sweden, UK and US.
• I tested for, and controlled for influential outliers (in particular Bratislava and Washington DC) where their presence distorted the overall results of estimations.
• Time horizon covered by data is years 1999-2000 and 2006-2007.
• Where the data was available for both 1999 and 2000, 1999 data was used. Where the data was available only for 2000, this data was used with 1999 label. Where the data was available for both 2006 and 2007, data for 2007 was used. Where the data was available only for 2006, it was used with 2007 label.
• There were only 7 occurrences where pairs of 1999 and 2000, and 20006 and 2007 data were not available.
• In addition to the OECD original data, I computed 1999-2007 growth rates.
  

The first chart below precisely plots what I call here Greater Dublin and South region (which, in the case of OECD includes Cork). OECD defines two regions for Ireland: Southern region and Border, Midlands and West region. Obviously, these are proxies for our more detailed traditional regional classification – perhaps, they are a hint that a country with 4.5 million inhabitants shouldn’t really have a Byzantine system of local authorities and Napoleonic system of regions that we have. Either way, the chart provides some very striking comparisons.

Chart 1
The size of each bubble corresponds to income per capita. This is not what I am after here. Instead, focus on change between blue dots – regional positions in terms of 1999 levels of education and the share of knowledge intensive services in overall economic activity, and green dots – the same data for 2007.

First, observe that while Dublin & South were clearly no better educated than the rest of the country in 1999, their share of higher value added knowledge intensive services (KIS) was much greater back then.

Second, notice that neither part of the country was anywhere near being in the leaders group in terms of either education or in terms of knowledge intensive services back in 1999 when compared to their peers worldwide. I always said that the claimed Irish advantage in terms of educated labour force back in the 1990s was nothing more than an urban myth. We were, frankly speaking below average in terms of education back then.

Third, note how dramatic was the increase between 1999 and 2007 in the levels of education in Dublin and South, especially compared to Border, Midlands & West. Within just 8 years or so, we moved Dublin & South out of the followers or laggards pack and into the lower end of the leaders group of better educated regional economies.

Fourth, notice that BMW region was rapidly catching up with Dublin in terms of its share of KIS in the economy, closing some of the earlier gap between 1999 and 2007, although still remaining out side the leaders group of regions.

This is interesting for a number of reasons, but chiefly, it is interesting since BMW levels of education did not rise as dramatically. There are couple of things going on here, which might explain this strange result. On the one hand, low early starting position in terms of higher value added KIS in BMW region might have resulted in a more significant growth during the financial services boom years. On the other hand, there might be a diminishing return to growth in education in the labour force present in Dublin & South region, especially as lower value added construction boomed during these years. Finally, one might conjecture that with a gradual decline in manufacturing in the country, BMW region saw increased inflows of less educated, but somewhat more experienced workers into KIS activities.

These are speculative reasons, but some are supported by the evidence presented and discussed below.


Chart 2
Chart above shows that there is a strong positive resilience in income per capita levels across urban economies. This implies that future income levels are strongly correlated with past income levels. Almost 94% of variation in income per capita in 2007 is associated with the variation in income per capita found in 1999.

This means that we have to be careful directly interpreting data showing, for example, that in a specific country, such as the US, a number of cities with highly evolved economic environment to support economic growth might be underperforming in terms of actual achieved growth their less advanced counterparts. In fact, across the 350 regions defined by the OECD, there is no statistically meaningful direct relationship between urban economies growth and levels of GDP per capita, neither in 1999, nor in 2007. Rich states in 1999 might have either lower or higher income growth through 2007 and vice versa.

Chart 3 below shows that strong persistency in GDP levels over time implies there is only a weak (but positive) relationship between the past and the future growth rates.

Chart 3

Chart 4
Chart above shows that there is also a weak positive relationship between long term growth in education and long term growth in income per capita. A 1% growth in the proportion of population with 3rd level education between 1999 and 2007 accounted for 0.13% increase in the growth rate of income per capita. Growth in education between 1999 and 2007 was able to explain just 0.54% of the overall growth in income per capita over the same period. Although this contrasts the relationship between levels of education and levels of income per capita as shown in the chart below:

Chart 5
Over time, per above chart, the relationship between the levels of education of the workforce and the levels income per capita is becoming stronger both in terms of education impact and the overall explanatory power as to the direct positive correlation between education and income. In 1999, 7.3% of variation in income per capita across major urban regions was explained by variations in education. By 2007 this has increased to over 14.5%. If in 1999 1% increase in the proportion of population with 3rd level education was associated with a USD336.53 increase in income per capita (PPP-adjusted), by 2007 this effect rose to USD730.92.

Lagged period education levels are better determinants of income per capita than contemporaneous levels of education, which suggests that causality flows from education to growth, rather than the other way around. This is illustrated in the chart below. Notice also that this is true both in terms of explanatory power (R2) and the overall impact of education (slope coefficient). At the same time, compared to 2007 data (previous chart), this relationship (lagged 1999 education to 2007 income per capita) is weaker in the overall effect of education on income, suggesting that in recent years, there has been a significant shift in the importance of education in determining income per capita.

Chart 6

I will explore some of the possible explanations for these results in the next log post on the matter, so stay tuned…

Economics 16/7/10: IMF Article IV CP on Ireland: part 3

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

V. THE FISCAL OUTLOOK AND CONSOLIDATION AGENDA

35. To counter the deteriorating fiscal position, the authorities moved early to make substantial, balanced, and lasting consolidation efforts. As the fiscal situation deteriorated and a large structural deficit emerged, the authorities acted repeatedly to take additional measures and raise the ambition of their fiscal consolidation goals. This was achieved in a remarkably socially-cohesive manner and represented a balance of economic and social considerations. The strong upfront measures are expected to yield a net adjustment of 5½ percent of GDP over 2009–10.

[The Fund is generally positive on the measures taken so far. However, in the chart at the bottom of page 22, the report shows the overall contribution to fiscal imbalances across various categories of spending and receipts. Picture 1 reproduces, with added details, the IMF analysis. Several things that are not covered by the Fund analysis stand out as significant omissions, most likely politically motivated. First, there is a very substantial role played by the continued deterioration in transfers (social welfare, health etc) which the Fund glances over. Second, public sector wages bill continues to represent further downward pressures on fiscal deficit despite the measures taken in 2009.
Third, noted (to the IMF credit) in the footnote on the following page, banks supports are likely to exert additional pressures in years to come. Per IMF: “A re-classification of a capital injection (2½ percent of GDP) as a capital transfer raised the 2009 deficit to 14¼ percent of GDP. In the first half of 2010, the government issued promissory notes worth 8½ percent of GDP to increase capital in one bank and two building societies. If these injections are considered capital transfers, the 2010 deficit would increase by this amount. As it would represent a once-off adjustment, it would not impact on the trajectory of the deficit for 2011. The further possible capital injection of 5 percent of GDP would add correspondingly to the 2010 deficit.”

Clearly, the Fund is not interested in making any predictions about the markets reaction to such an one-off adjustment. But one must wonder, if the Irish deficit shoots past 20% of GDP mark, even on one-off measures – what will our bond yields be at? And if 2011 brings about more capital injections into the banks, how long can these ‘one-off’ measures continue to hammer our deficits before someone, somewhere screams ‘The Irish Exchequer has no clothes!”]

[In the box-out on page 23, the IMF states:]

When adjusting for the impact of asset prices, the Irish structural deficit reached 8 percent in 2007, spiking to 12 percent of GDP in 2008. Spain and the U.K. also experienced sharp but smaller increases in structural deficits. However, after fiscal adjustment of 5½ percent of GDP, the Irish structural deficit is expected to decline to 8½ percent of GDP in 2010, while discretionary fiscal stimulus has raised the structural deficits in Spain and the U.K.

[Two things worth mentioning here. One: if the Bearded Ones of the Siptu/Ictu alphabet soup economics have their way, what would our structural deficit look like today? 8.5% is a hefty number. Recall that structural deficits won’t go away once economy is back on long term growth path. Second: at 8.5%, structural (long-term) sustainability of our Exchequer finances would require a combined reduction in expenditure, plus increases of taxation (assuming 50:50 split between the two) of roughly speaking a further €6.5 billion cut in spending and €6.5 increase in tax revenues. Given that roughly 700,000 households pay income, stamps & CGT taxes in this country, that would mean an annual tax bill increase of a whooping €9,300 per household. Does the Fund or the Government, or even the Bearded Ones think this is feasible?]

36. The 2010 budget adheres to the consolidation track, but risks remain. The authorities project the 2010 deficit to be 11½ percent of GDP. Because of lower nominal 2009 GDP than assumed in the 2010 budget and a weaker growth projection, staff projects lower revenues, leading to a deficit of 11.9 percent of GDP in 2010. The accounting treatment of the government’s equity injections into the troubled banks is still being determined but could raise the 2010 headline deficit substantially. The authorities noted that the associated fiscal outlays have already been incorporated into the official debt figures.

[Here is an interesting one. So banks-related outlays are in the debt figures already, but they are not in the deficit figures yet. How can Brian Cowen sit with a straight face in front of CNN cameras and tell the world that fiscal consolidation is working if Ireland Inc is heading for a deficit in 2010 that is vastly in excess of the deficit in 2009? And if he can, then why is DofF already factoring in the banks numbers into official debt? Gosh, it does begin to appear that we can’t even do a banana republic thing right.]


37. The remaining sovereign financing need in 2010 is limited. The average maturity of Irish treasury bonds is high—at 7½ years—and the rollover need is therefore limited. [That’s the good news…] For 2010, about three quarters of the planned government bond issuance (€20 billion) had been obtained as of June. The annual financing needs in 2011–12 are projected at about the 2010 level. The authorities maintain sizeable cash balances, financed by short-term debt, which could act as a buffer against any temporary difficulties in issuing long-term debt.

[Two things jump out: one the annual financing requirements for 2011 and 2012 are around €20 billion each. Which really means that the Government is not planning any substantial reductions in overall size of its expenditure. The con game of taking spending out of one pocket and shifting it into another pocket, while calling its transition from hand to hand a ‘saving’ will keep going on through the next elections… This explains why, for all our talk of ‘taking the pain’ the Government expenditure stubbornly keeps climbing up. Second, there is a quick sighting of the substantial additional costs of our overspending habits here. Short-term buffers kept by the DofF in order to insure ourselves against the possible tightness of the normal borrowing channels are ‘substantial’ per IMF. These buffers are subject to the higher risk of rising interest rates and also have no productive role in financing public spending. The costs of funding these buffers is a pure insurance premium we have to pay on top of standard borrowing costs in order to keep on rolling the vast social welfare/public spending machine we have created.]


38. Staff supports the appropriately ambitious fiscal consolidation plan through 2014 but cautioned that the required adjustment may be larger than projected by the authorities. The consolidation plan, outlined in the December 2009 Stability Programme Update, aims to reduce the deficit to below 3 percent of GDP by 2014. The plan envisages fiscal adjustment of 4½ percent of GDP over 2011–14, of which about 1 percent of GDP represents reductions in capital expenditures. The staff’s macroeconomic projections imply that the required medium-term adjustment could be larger than projected by the authorities. Starting from a higher projected deficit in 2010 and based on less optimistic macroeconomic projections, staff estimates that the adjustment need over 2011–14 would be 6½ percent of GDP, 2 percentage points of GDP higher than the authorities do.

[Quite a nasty turn for the ‘authorities’ here. The Fund clearly has little faith that the Irish Government can reach the set target of 3% by 2014. In fact, the IMF now projects that Irish Government deficits will be 5.9% of GDP in 2014 (driven by macroeconomic and target differences between DofF projections and IMF forecasts), with our debt to GDP ratio reaching 97.7% ex-banks supports in 2010 (5% of GDP additional to 8.5% announced in March) and 2011 (by my estimates around 5% of GDP). Worse than that – 5.2% of GDP will be our structural deficit in 2014 – a massive 88% of the total deficit.

A little footnote to the table on page 24 gives explanation: “The difference between the fiscal projections of the Department of Finance and the IMF staff is due in part to assumptions of lower growth on the part of the IMF staff. The IMF staff’s baseline fiscal projections for 2011–12 incorporate the adjustment efforts announced by the authorities in their December 2009 Stability Programme Update, although 2/3 of these measures remain to be specified. For the remainder of the period, the IMF staff’s projections do not incorporate the further adjustments efforts outlined in the Stability Programme Update.”

In other words, folks, in IMF terms, these projections include what has been promised but is not specified. And furthermore, the IMF doesn’t really believe anything this Government has set out to do beyond 2012 elections. They rightly suspect that any commitment of FF/Greens made before 2012 will face a serious uphill battle in implementation should the coalition fall apart.]

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...