19/02/2011: Paying down our debt out of Exports

Let's do a quick exercise. Suppose we take our current account - defined as the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid and remitted profits). Suppose every year we use the current account balance solely for the purpose of repaying our Government debt. How long will it take us to do so.

Let us start with some notes on methodology.

Our current account is in deficit - since 2000, there was only one year - 2003 - when we had a surplus in the current account (charts below), which really means our external trade was not enough to generate a surplus to the economy. So let us assume that the we can reverse this 180 degrees and that the deficits posted in 2009-2010, plus those projected by the IMF to occur in 2011-2015 are all diverted to pay our Government debt.
Notice - this is impossibly optimistic, as our Government does not own current account, but suppose, for the sake of this exercise that it can fully capture net profits transfers abroad and cut the foreign aid to zero, plus divert all interest payments on own debt and private external debts to repayment of the principal on own debt.

Secondly, assume that only Government debt is taken into the account (in other words, we assume away Nama debt, some of the quasi-sovereign financing of the banks resolutions, and all and any potential future banks and spending demands in excess of the EU/IMF assumptions, as well as all future bonds redemptions - the latter assumed to have a zero net effect at roll-over, so no added costs, no higher interest rates, etc).

In other words, here is what we are paying down in this exercise:

Now, suppose we take current account balances for 2009-2015 (projected by IMF) as the starting point. The reason for this choice of years is that they omit fall-off in our exports in 2008 and also the bubble years of 2004-2007 when our current account imbalances were absurdly large due to excessive outward investment and consumption of imports.

Next, assume:

• We deal with present value of the debts
  
• We apply an average 3% annual growth rate to repayments we make (current account transfers grow 3% on average per annum)
  
• Currency effects are removed (so we use flat USD1.33/Euro FX rate throughout)

So here is the result:
And the conclusion is: if Ireland diverts ALL of its net current account (2009-2015 IMF projections taken at 3% average growth rate forward) to pay down Gov debt, it will take us until 2064 to reach 2007 level of official (ex-Nama+banks) Government debt.

Note: incidentally - the charts tell couple of interesting side-points based on our historical debt path:

The Government told us that we are not in the 1980s - as we had much higher levels of debt then. Ok, the figure above shows that as of 2010 - we ARE back in the 1980s: 2011 debt will equal as a share of GDP that attained in 1989. According to IMF database, our debt has peaked at 109.241% of GDP back in 1987. It is projected to be 104.7% in 2013. Not that much off the peak.

But, of course, in the 1980s there was no quasi-Governmental debt - the debt of Nama, some of the banks recapitalization measures and the debts that still might arise post-2013 from the Government banks Guarantees and resolution schemes. If we add Nama's 31bn worth of debt issued, this alone will push our 2011 debt levels to 121.8% of GDP and factoring in coupon rate on these, but 2015 our Official Gov Debt + Nama will stand (using IMF projections again) at 124.8% of GDP - well in excess of the peak 1980s levels of indebtedness.

Secondly, despite what any of us might think about the Celtic Tiger years, the Government never paid down the old debt, it simply was deflated by rising GDP. Which suggests that even during the Celtic Tiger boom years - our exporting economy was NOT capable of paying down actual debt levels.

16/02/2011: Banks issuing loans to themselves

Note from the banks front:

ECB’s printing machine keeps working over time. Greek and Irish banks have issued at least €70 billion of bonds to themselves to create the collateral required to get cash from the ECB before last week. Then, Greeks announced they will issue €30 billion more unsecured bonds to themselves for the purpose of pawning these at the ECB. The European Central Bank's balance sheet now funds the equivalent of 18% of Greek banking sector assets, 15% of Irish and 7% of Portuguese. CBofI holds another 7%.

Some amazing 'innovation' on financial front this is.

16/02/2011: Heading for another round of crisis pressures?

Two nice charts, lest we forget where the crisis is at:

Greek 10y sovereign bonds:
And Irish 10y sovereign bonds
Both courtesy of Goldcore, both are daily yields over 1 year.

13/02/2011: What a Jeopardy champ can do in the world of finance

Here is my article along with Shanker Ramamurthy that was published last Thursday in the American Banker, discussing IBM's Watson super computer system's potential applications in the financial services industry - helping to advance industry thinking on how in the era of "big data" only advanced non-linear analytics can make sense of structured and unstructured data flows to transform it into valuable insights.

VIEWPOINT: New Computer, New Modeling Possibilities
By Shanker Ramamurthy and Constantin Gurdgiev
February 10 , 2011 - p8

Next Monday a new IBM computer system called Watson will battle two quiz-show champions in a game of Jeopardy! There is more at stake here than winning a game. The potential applications of this technology to transform the operations of industries such as health care, government and finance are enormous.

In the financial services industry, integrated risk management is an everyday struggle. Financial practitioners and supervisory and regulatory authorities must make split-second decisions using information coming from all sides: the Internet to corporate and call center channels.

The challenge is to efficiently process diverse data streams and pick out relevant data insights to apply to strategic business and regulatory decisions.

In the banking industry today, data "fuzziness" abounds. Uncertainty exists about the quality of data, assumptions and models that are being used to make judgments. This, of course, clouds the true picture of risk and biases our decision-making, often in econometrically undetectable ways.
Most banks today run risk models on a discrete and disaggregated basis while relying on often subjective assumptions. High-performance computing advances, represented by Watson's capabilities, can rectify this - by providing visibility into concentrations of risks and risk-related activities, as they happen. Simultaneously, it deploys nonlinear analytics in selecting both the statistically and operationally important scenarios.

The beauty of a nonlinear computer that "learns" is that it can analyze a complex set of implied possible scenarios and give answers to the broadest set of questions. This potentially can lead to the emergence of analytical systems that not only report on probabilistically likely events but also identify latent "Black Swan" events and even sense deeper levels of uncertainty.

For example, a legislative decision altering a specific set of financial strategies can have no impact on traditional linear models because the outcomes can be weighted by an extremely low assigned or assumed probability. But in a nonlinear world, such an outcome can still be testable as part of the selection list for reporting. More importantly, it can be made recognizable by the analytic system and, therefore, objectively reportable.

A system like Watson has the potential to get answers to incredibly difficult questions about strategic decisions, risks and market changes that can otherwise be elusive.

For example, it has the ability to create an interactive risk-pricing system using a menu of models that evolve as the system learns, detecting structural breaks in data before analysts can spot them and build them into existing programs.

Of even more significance, Watson will be able to deliver scenario analysis based not just on either event probability or expected loss/gain but also on more complex company objectives.

This can involve analyzing corporate strategy inputs, including non-quantifiable questions, alongside fully quantifiable inputs. Imagine asking a computer "How do I increase my loan book profit margin by 10%?" or "What actions can I take to strengthen my capital reserves, with minimum impact to my asset base?"

At a much deeper level, the nonlinear learning capabilities that Watson pioneers can lead to the creation of systems that are able not only to handle traditional risks and their interactions but also to evolve into systems capable of transforming deep uncertainty into explicit models. Though still some years away, this could mean an artificial intelligence able to sense Donald Rumsfeld's famous "unknown unknowns," converting them into specific models suitable for risk analysis and getting meaningful, actionable responses.

The real-time, decision-making capability that is so sought after in the financial industry will be a crucial, competitive differentiator.

As risk intensifies within interconnected global markets, the complexity and exploding volumes of data will only rise.

Shanker Ramamurthy is the general manager of banking and financial markets at IBM Corp. Dr Constantin Gurdgiev is the head of macroeconomics in the Center for Economic Analysis at the IBM Institute for Business Value.

13/02/2011: IMF's statement on Iceland

I twitted about the latest conclusions from the IMF on the state of Icelandic economy post-banks collapse. Here are the exact details of the IMF statement and the statement itself. Emphasis and comments in brackets are mine:

"Financial sector restructuring is moving forward [in contrast, one may add to Ireland's]. Savings banks and non-bank financial institutions are being recapitalized [in Ireland's case, recapitalizations of the banks have been predominantly wiped-out by the continued writedowns, so net increases in actual capital have been negligible], and the supervisory framework is being strengthened by amendments that will be enacted in the coming months [no serious far-reaching amendments have been introduced in Ireland since the beginning of the crisis and the marginal ones that were are yet to be enacted].

"Moreover, recent agreements to restructure the debts of households and small enterprises will help put households, corporations and banks on a more secure financial footing, which is essential for a sustainable recovery [this stands in contrast with what has been happening in Ireland. In addition this directly and indisputably puts the blame for the policy errors in the Irish case onto our Government and EU shoulders, for it is clear that within the EU/IMF deal framework, the IMF was basing its policy proposals on their experience in Iceland].

“Policy discussions focused on the strategy to liberalize capital controls, fiscal and monetary policies, and financial sector reforms [none of these issues are even on our agenda].

Here is the actual press release from the IMF

13/02/2011: Public Sector Earnings - the need for change hasn't gone away

A quick run through the numbers in employment and pay rates for the public sector for 2010.

A note of caution: these figures do not cover commercial semi-states or local authorities. Thus, per DofF accounts statement, there were 380,953 people on the direct Exchequer payroll in 2010, which includes 277,540 employees and 103,413 pensioned individuals. These exclude commercial semi-state employees 52,300 per latest figures available (Q3 2009) and employees of the regional bodies 37,000 (Q3 2009). The combined figure, therefore, is closer to 470,253 (of course, this omits those who are on semi-state pensions and who are in the receipt of pensions from local authorities and bodies).

Now, on to the numbers.
So HSE accounts for 36.8% of the total numbers in employment and on pensions as well as for 40.2% of the total pay bill. Education & Science account for 32.6% and 33.03% respectively. The third largest employer on the Exchequer balance sheet is Garda Siochana with 6.74% of the total employment and pensions numbers and 7.11% of the total wages and pensions bill.

Now, let's take a look at private-public sector comparatives at the aggregate levels:
Self-explanatory, really. But some more detailed comparisons are here:
The above figures relate (except for Exchequer balance sheet average employees) to CSO data for Q3 2010 on earnings and labour costs.

Next by the departments:

Enjoy the absolutely absurd outliers - the Appeals Commissioners - enjoying the total staff of 4 being paid, on average, 107,500 per annum. If one of these 4 employees a receptionist or staff worker, on, say 40,000 that would make the other 3 earning on average 130,000... that's of course is a pure hypothetical. Then there's the cost of our "International Cooperation" workers - hard at labour, the 190 employees here earn a meager wages of just 78,874 per annum on average. One can understand high earnings in highly professionally-concentrated services, such as for example the Attorney General (75,713 pa - still high, but we can give them a break), but what does the President's Establishment do to earn on average (for its 22 staff) 67,955 - which is in excess of average earnings in ALL subcategories of employment reported in the table above?

In fact, lets take as a benchmark the highest average earnings in the economy by sub-category (omitting public sector employment) - those earned in Information & Communication sub-category (50,203pa). Of the 38 sub-groups on the total Exchequer payroll, 23 sub-groups earn more on average than the highest earning economic group in the private sector. 16 sub-groups actually exceed by more than double digits (in percentage terms) the average annual earnings of the highest paid sub-categories in the private economy, as shown in the table below:
That, folks, takes some doing to achieve...

12/02/2011: Just how much are the bondholders in Irish banks worth to the taxpayer?

In recent weeks the question of bondholders and the extent of our banks exposure to the bonds-linked debts has been hotly debated in the media and by the political parties.

Many supporters of the Government position have repeated, in their defence, the claim that at this moment in time there are virtually no unpaid bond holders left, so applying ‘burden-sharing’ haircuts to their bond holdings will produce little gain, while causing much of pain to Ireland’s ‘reputation’.

So the question is – just how much of bonds is left for a potential haircut and what such a haircut might save for the country.

There is a lot of confusion in this area, some caused by the fact that the Central Bank does not readily publish any real information about the six banking institutions covered by the extended guarantee. I personally heard a number of times the following two figures used as an estimate of the total bonds-backed debt still outstanding: €15bn senior bonds and €6bn subordinated bonds.

This implies that total bonds outstanding amount to €21bn and any savings that can be had from these would be on average around: 40% senior debt haircut + 70% subordinated debt haircut, to the total amount of €10.2bn maximum.

However, the figure of €21bn is simply not a true or correct estimate of the total bonds still remaining outstanding.

The table below provides what we know officially (note: the last column refers to the unpublished document that was Minister Lenihan’s clarification of his own statement on record to the Dail, not published previously).

So per table above, the total amount of bonds outstanding for the six guaranteed credit institutions is €50bn. Of this

• ca €28.1bn is guaranteed senior bond debt - standard haircut assumption for CDS pricing – 40% or €11.24bn;
• un-guaranteed senior debt roughly of €11.7bn (we can assume a haircut of 50%, which is smaller than the simple average of the senior guaranteed and subordinated un-guaranteed debt), to the potential savings of €5.85bn;
• subordinated debt (all un-guaranteed) of €10.2bn (which can be subject to a 100% write-off, but let’s assume it is haircut at 70%) generating potential for savings of €8.4bn.
  

So total scope for savings under relatively normal (by market pricing) haircuts is a cool €25.49bn (with a full hit on un-guaranteed debt we can save €33.14bn) – more than the cost of rescuing Anglo to-date (€23.9bn).

Note: hat tip to P.D. for providing the two documents referenced in the table above.

Update: related story today here clearly shows that the markets now expect significant haircuts and that any resistance by the ECB to such haircuts is, at this stage, irrelevant from the markets/investors perspective.

4/02/2011: Another glitch in our 'knowledge' economy?

Anyone reading this blog more than once or twice would know by now - I've got plenty of deficit cutting credentials. But sometimes, the absurdity of cuts and associated policies can get even to a hawk like myself. So here we go, again.

Here's an extract from the HEA to administrators and heads of schools in Irish Universities, dated, per my source, from January 19th last:

"As you are aware the Employment Control Framework for the higher education sector expired on the 31st December 2010. A revised framework for the sector, which will operate until 31 December 2014, is currently being drafted. Some further reductions in the number of posts that may be filled will be required under the new Framework. We will inform you as soon as possible of the revised reduced targets for your institution.

Pending finalisation of the revised Framework I wish to advise that all proposals for recruitment of staff, both contract and permanent and regardless of source of funding (core grant, research grant or non-exchequer), must be submitted in advance to the HEA."

Ok, so HEA are requiring explicit approval for all hires. sounds reasonable? Sure, if we are talking about the normal course of business. But imagine the following situation:

A researcher gains a very large EU research grant that requires hiring research assistants and post-doctoral researchers. The funds have nothing to do with the Irish Exchequer deficit. The job is specified and milestones are set in... err... kind of set in stone. But HEA approval requires time - as I've heard, up to 3-6 months. Now, imagine the researcher blowing through the milestones and losing a grant. Some savings to the Exchequer? Nope - actually - a loss. Exchequer loses income tax from the hires who never materialized, from the purchasing done for the purpose of research and so on.

And there's an added danger - if such uncertainty is present in the market for new researchers and promotion, the brighter academics might discount Ireland as a good research location. After all, academic market is truly global, folks.

Is that a serious problem? Yes, a number of researchers I have heard of are currently in this predicament with one being just a few days from giving an offer to a junior research staff.

Now imagine another scenario - also, per my sources close to playing out. A major corporation decides to provide a grant to an Irish University for research. The grant stipulates hiring certain number of researchers and other staff. Oops... the letter goes out to the corporate headquarters, saying that HEA approval is needed. What's the likelihood that the grant is going to travel to the UK? Or another jurisdiction, where fiscal cuts might be in place, but policymakers have some finesse to understand that when the money comes from outside the state coffers, hiring decisions should be made by those managing these funds...

What beats me is why can't the Exchequer simply allocate funds to universities and let the academic and administrative staff manage these funds in line with each university/school/department own objectives? Why is there such a need to micromanage fiscal adjustments.

Oh, and while we are at it, here's another question. If we stop renewing and issuing new contracts for post-docs, how fast will the reality of unemployed phds arrive to our shores? And what will happen to our knowledge economy's grand plan for doubling phds output?..

4/02/2011: Can economy function with shut banks?

Last night on Vincent Browne's programme, Prof. Antoin Murphy (TCD) - an excellent scholar of economic history - stated that absent the Government Guarantee of 2008 and/or in the case of a 'default' by Ireland on its debts, the banking system will collapse precipitating the 'ATMs with no cash' crisis.

According to Prof. Murphy - such an outcome would be more disastrous than loading up some €185bn worth of banks debts onto ECB and our own CBofI and pushing Irish taxpayers into even more debt to the tune of ca €100bn.

I do not wish to engage (for the lack of time and space now) in the arguments as to which outcome (debt death spiral or cashless ATMs) is the worse one. Nor do I wish to argue here (for the very same reasons) as to whether a 'default' (I prefer - restructuring) of our banks debts will trigger a crisis leading to the total shut down of the banking system in the country.

But let me provide you with the following summary of the economist's opinion on the matter of an economy's viability in the case of a systemic banking crisis with no cash circulating via the banking system (a hat tip to B. Lucey):

Quote (original source here):

"Since banks create money under fractional-reserve banking, we would expect the closure of banks severely to disrupt the functioning of an economy. The Irish experience in 1970 an interesting counterexample. In that year, a major strike closed all Irish banks for a period of six and a half months. All the indications from the start, moreover, were that this would be a long closure. As a consequence of the strike, the public lost direct access to about 85 percent of the money supply (M2). Irish currency still circulated, of course, British currency was also freely accepted in Ireland, and some North American and merchant (commercial) banks provided banking facilities. Increases in Irish and British currency and in deposits in these banks, however, accounted for less than 10 percent of M2.

Somewhat remarkably, checks on the closed banks continued to be the main medium of exchange during the dispute. Despite the increased risk of default, individuals continued to be willing to accept personal and other checks. [The author] summarizes the situation as follows: “a highly personalized credit system without any definite time horizon for the eventual clearance of debits and credits substituted for the existing institutionalized banking system.”

According to [the author], it was the small size of the Irish economy (the population of Ireland was about 3 million at that time) and the high degree of personal contact that allowed the system to function. Stores and pubs took over some of the functions of the banking system. “It appears that the managers of these retail outlets and public houses had a high degree of information about their customers—one does not after all serve drink to someone for years without discovering something of his liquid resources. This information enabled them to provide commodities and currency for their customers against undated trade credit. Public houses and shops emerged as a substitute banking system.”

Presumably as a result of this spontaneous alternative banking system, economic activity in Ireland was not substantially affected by the banking strike. Detrended retail sales did not differ much on a month-by-month basis from average levels in the absence of banking disputes, and a central bank survey concluded that the Irish economy continued to grow over the period (although the growth rate fell)."

The paper referred to in the above citation is: A. Murphy, “Money in an Economy without Banks: The Case of Ireland,” The Manchester School (March 1978): 41–50.

Once again, let me repeat, I do not believe that such a cashless economy is a good idea, nor do I believe that the banks debt restructuring will lead to a significant disruption in supply of cash or access to deposits, especially if such restructuring is pre-planned, with liquidity buffers set in place by the CBofI. But I find it interesting that a superb economic history researcher - Prof Murphy - would argue the inevitability of something happening today which did not happen in the less financially and economically advanced 1970.

Yes, the conditions have changed - we are less personal of a society today than back in the 1970s. But we also have much stronger presence in the country of other banks and we have access to the global markets (currently shut by the insolvent banking system). We also have, presumably, our European partners, who can help, and most importantly - for now - significant funding buffer in the form of NPRF. The CBofI has printed enough cash already to cover a large share of our deposits (except it chose to dump this cash into the banks balance sheets instead). In fact, between CBofI cash printing for the banks and NPRF and pre-borrowed money, Irish state has potential access to more cash than the 80% deposits base for deposits at a risk of flight (those with demand withdrawal terms of <3mo and overnight).

Virtually none of these were there in 1970... and still, the economy did not collapse after losing some 85% of cash from circulation!

3/02/2011: Services PMI for Ireland

NCB released their PMI for January for Irish Services sector. Headline news is good:

• After contracting in December, Irish Services sector showed modest growth, signaled by PMI rising to 53.9 (up from December contractionary 47.4)
• January reading of 53.9 was ahead of 12 months average of 51.5 and well ahead of Q1 2010 reading of 47.6
• January 2011 reading, however was below Summer 2010 peak readings of 55.4 and 55.7 in June and July

Or over the entire series history:
And a more recent snapshot with the core driver of increase:

New business orders have actually fallen in January, with a reading of just 47.7, marking 5th consecutive month of declines. 12-months average was 50.0 but Q1 2010 reading average was 47.1, so realistically speaking, the latest reading is not an improvement.

Historically, you can see where we are from here:

Other sub-components showed weaknesses, with exports orders being trend breakers and the driver of the positive improvement in overall PMI reading:

Hence:, quoting from the NCB report:

• New Export Business In contrast to the trend seen for overall new business, new export orders rose markedly over the month, with the UK a key source of new work. New export business has now expanded in the sector in sixteen of the past seventeen months
• Backlogs of Work Falling new business alongside increased activity led to a further reduction in backlogs of work during January, extending the current sequence of depletion to forty-one months
• Providers expect economic conditions in Ireland to improve over the coming year, leading to higher new business and subsequently increased activity. According to respondents, export markets will remain a key source of growth over the year. The level of optimism in the service sector improved to the highest since last September

• Input cost inflation accelerated over the month, but remained much weaker than the long run series average. Where input prices increased, panelists mentioned higher fuel costs as well as rising taxes [My comment - the wedge between input and output prices points to severe pressures on services providers' margins]
• Irish service providers were unable to pass on higher cost burdens to their clients during January. Intense competition was the main factor leading firms to cut charges, which fell at a substantial pace that was steeper than that seen in the previous month
• Profitability at Irish services companies continued to decline over the three months to January, extending the current period of decline to thirty-seven survey periods. Moreover, the pace of reduction was the sharpest since the three months to February 2010, with panelists reporting a combination of lower sales and strong competition

• Employment continues to be a bad performer with jobs losses continued
  

So on the net Services have jumped into expansion zone, but the recovery at the very best is jobless and volatility of the series implies that it will take several months of continued robust improvements in index sub-components to provide comfort in the sector improvements overall:

2/02/2011: Dependency ratios

Looking over LR data earlier tonight, I decided to update the charts for dependency ratios, based on a combination of LR and QNHS. Here are some charts.

From the top: in Q1 1998 there were 1,619.8 thousand persons aged 15 years or older in Ireland that were not in full-time employment and 1,237.4 thousand of the same age category persons who were in full time employment - a ratio of 1.3. By Q1 2000 this ratio fell to 1.1. The same was attained in Q1 2005. This ratio declined to 1.0 in Q4 2005 and stayed there until Q4 2008. Then in Q 12009 the ratio rose to 1.3. As of Q3 2010, there were 2,075.9 thousand 15 year old and over persons who were not in full time employment in Ireland. Against this, there were 1,436.8 thousand persons of the same age category in full time employment. The implied ratio there for has rise to 1.4. Chart below illustrates:
Not scared yet? Ok, another shot:
Oh, and another angle:
The above shows just how bad is the dependency ratio getting in Ireland during the current crisis.

2/02/2011: Live Register for January

Live Register was out today for January with some positive news. The headline figure shows a seasonally adjusted decline in LR of 6,900. Unadjusted, LR rose 5,598 over the same month. It's hard to argue just how accurate are seasonality adjustments off the trend line, but let's stick to seasonal figures, so we can at least feel somewhat better about our predicament.

Charts below shows the slight decline in LR-implied rate of unemployment and the drop in LR itself:
So LR-implied unemployment rate is down from 13.6% in December to 13.4% in January.

Average weekly dynamics are looking pretty strong (in part, these are due to 4 weeks month - December, for example covered 5 weeks):
Monthly rate of change:
Also looks strong.

These are all headlines so far. Now, let's dig a little deeper:
Number of LR signees who are non-Irish nationals rose 1,882 to 78,527 in January 2011 - an increase of 2.46% mom and a decline of 3.52% yoy. Number of Irish nationals on LR rose 3,716 in January 2011, a rise of 1.03%mom and 2.42%yoy. So as chart above clearly shows, the two series are moving in the opposite directions. There were 4.64 Irish nationals on LR per each non-Irish national in January 2011. The same number for January 2010 was 4.37.

Another alarm bell is ringing for the increasing number of those in part-time and occasional employment (presumably not all happy to undertake less than full employment). This number rose from 82,058 in December 2010 to 83,232 in January 2011, with monthly increase of 1.43% and a year on year rise of 8.29%.