Thursday, March 17, 2011
17/03/2011: 20 years ago
Twenty years ago, 70% of the Soviet citizens freely - with no physical coercion, no vote rigging (although with psychological pre-conditioning/anchoring), in a virtually spontaneous referendum voted to keep a reformed USSR. Ten months later, the USSR was no more. However, the vote only counted in 9 out of 15 republics as a number of republics have decided not to take part in the referendum.
Saturday, March 12, 2011
12/03/2011: Updated probabilities of default
Weekly close data-based estimates of the probability of default on Irish sovereign bonds, based on yields. Note: these are mathematical estimates based on what the markets price in. All complaints should be addressed to the markets.
Marked in black bold are probabilities in excess of 40% (or statistically indistinguishable to 40%) - the benchmark that in the CDS markets considered to be crisis levels of probability of default.
Most of the risk is now concentrated, based on spreads in 3-year horizon, while in absolute terms the markets perceive risk peaking at or before 5 year horizon.
Sunday, March 6, 2011
06/03/2011: The Programme for Government - Part 1
Here are some of my comments (notice - not criticisms, by comments - these are thoughts in progress) on the FG-Labor Programme for Government. Off the top, I think there are some very good objectives outlined in the document, but...
The current post covers pages 2-7 and the subsequent posts will be dealing with other sections.
“The Parties to the Government recognise that there is a growing danger of the State’s debt burden becoming unsustainable and that measures to safeguard debt sustainability must be urgently explored.” Page 5.
[The problem, of course, is that the debt burden is not becoming unsustainable, it is already unsustainable. In other words, the core objective is significantly misplaced in the PfG 2011. Instead of dealing with the core issue of excessive debt, the PfG 2011 is attempting to address the ‘unsustainable rate of growth in debt’.
Imagine achieving such a objective in full and arresting growth in debt. The level of debt of ca €220bn already accumulated by the state in direct and quasi-direct forms will exert interest repayment pressure of ca €12-13 billion per annum depending on financing arrangements achieved. That implies that ca 30% of the tax revenues will be driven into simple maintenance of interest on the debt. Paying this debt down to 60% of GDP over, say, 10 years horizon will cost additional €9 billion per annum in principal repayments (assuming 3% average annual rate of growth through 2021). That means a massive €21-22bn will be outflowing annually from the state revenue to maintain the path to debt reduction consistent with the EU targets over 10 year horizon.
What does this translate into in terms of our tax revenue. If the Government were to achieve the tax revenues of 35% of GDP (roughly consistent with the current plans), in 2011 or debt servicing and repayment plan would swallow 37.5-39.3% of our total tax revenues, declining gradually to 27.1-28.4% of total tax revenues by 2021. Again, these numbers assume 3% pa growth on average through 2021.]
“We will seek a reduced interest rate as part of a credible re-commitment to reducing Government deficits to ensure sustainability of our public finances.” Page 6.
“…we will defer further recapitalisation of the banks until the solvency stress tests are complete and known to the new Government.” [This is fully correct – the process of recapitalization of the banks should start with the full assessment of the capital requirements]
"As an interim measure, we will seek to replace emergency lending to our banks with medium-term, affordable, official financing ...” [I wonder what this means...]
“We will end further asset transfers to NAMA, which are unlikely to improve market confidence in either the banks or the State.” [This is a good starting point, but a much deeper review of NAMA, and, in the end, a full roll-back of NAMA will be required. The PfG 2011 does not reach that deep.]
“We will ensure that an adequate pool of credit is available to fund small and medium-sized businesses in the real economy during the re-structuring and down-sizing programme.” [Where is this pool of credit come from? Who will administer the new lending? How will the new lending be priced? None of these questions are answered neither in principal, nor in sufficient operational detail.]
“The Government accepts that enabling provisions in legislation may be necessary to extend the scope of bank liability restructuring to include unsecured, unguaranteed senior bonds.” [Again, a vaguely phrased, but correct principle.]
“We will create an integrated decision making structure among all relevant State Departments and Agencies to replace the current fragmented approach of State bodies in dealing with the financial crisis.” [This is a good idea, but I cannot understand how a new body can override the independent decision-making across CBofI, NTMA, NAMA and DofF.]
“The new Government will re-structure bank boards and replace directors who presided over failed lending practices. We will ensure that the regulator has sufficient powers of pre-approval of bank directors and senior executives. To expedite this change-over we will openly construct a pool of globally experienced financial services managers and directors to be inserted into key executive and non-executive positions in banks receiving taxpayer support.” Page 7.
[Excellent idea, much need and all, but… (1) How will the Government deal with those directors and executives who should be replaced, while their contracts remain running? Fire them? Breach contracts? (2) What does the ‘pool’ mean? You can’t secure people to ‘stand by’ as a part of the pool while waiting for an appointment – you either will have to pay them to be in the pool, or you will need to hire them in immediately.]
“We will insist on the highest standards of transparency in the operation of NAMA, on reduction in the costs associated with the operation of NAMA, and that decision-making in NAMA does not delay the restoration of the Irish property market.” [Another excellent objective, but again, this raises more questions than it answers. NAMA legislation sets out NAMA as non-transparent, secretive and completely arms-length entity. This was also, in part, conditioned by the funding structure of NAMA. Breaking this structure implies full contagion from NAMA operations and funding to the Exchequer. The implication is that the quasi-Governmental debt might become fully sovereign debt. As far as the NAMA effect on the property market goes, in order to prevent NAMA from continuing to induce market uncertainty, the Government will need to reverse NAMA and force the banks to manage their own exposures. Some immediate sales of properties will be required.]
“Once the banking sector has been restored and is functioning effectively, we will introduce a bank levy based on the size of a bank’s liabilities (other than shareholder capital).” [This is a major problem. (1) A bank levy cannot be set against any new banks or banks that are not covered by State recapitalizations, otherwise no new entries will take place into the Irish market, and the existent non-State dependent banks will exit the market. (2) Any such levy will be in effect another tax on ordinary users of banks services, as in the reduced competition in the market, the banks will be able to pass the full cost of the levy onto their customers. In other words, such a levy will be a tax under a different name.]
“We will establish a Strategic Investment Bank” [Which again raises the issue of fair competition in the market for those banks which currently operate without Government subsidies and/or any potential new entrants. It also raises a huge number of questions as to the nature of the SI Bank, its management, strategy, funding, operations etc.]
“We recognise the important role of Credit Unions as a volunteer co-operative movement and the distinction between them and other types of financial institutions. In Government, we will establish a Commission to review the future of the credit union movement and make recommendations in relation to the most effective regulatory structure for Credit Unions, taking into account their not-for-profit mandate, their volunteer ethos and community focus, while paying due regard to the need to fully protect depositors savings and financial stability.” [A good idea, but might be coming dangerously close to the politicized alteration of both the regulatory regime in financial services and the Credit Unions industry itself.]
“We support the future development of the IFSC as a source of future employment growth, subject to appropriate regulation. We will establish a taskforce on the future of the financial services sector to maximise employment opportunities in financial services for staff leaving employment as a result of downsizing.” [Again, a good idea, but the devil is in the detail. There are plenty of task forces dealing with the future of IFSC and delivering very little on the cost of running these. How will the new task force be different?]
The current post covers pages 2-7 and the subsequent posts will be dealing with other sections.
“The Parties to the Government recognise that there is a growing danger of the State’s debt burden becoming unsustainable and that measures to safeguard debt sustainability must be urgently explored.” Page 5.
[The problem, of course, is that the debt burden is not becoming unsustainable, it is already unsustainable. In other words, the core objective is significantly misplaced in the PfG 2011. Instead of dealing with the core issue of excessive debt, the PfG 2011 is attempting to address the ‘unsustainable rate of growth in debt’.
Imagine achieving such a objective in full and arresting growth in debt. The level of debt of ca €220bn already accumulated by the state in direct and quasi-direct forms will exert interest repayment pressure of ca €12-13 billion per annum depending on financing arrangements achieved. That implies that ca 30% of the tax revenues will be driven into simple maintenance of interest on the debt. Paying this debt down to 60% of GDP over, say, 10 years horizon will cost additional €9 billion per annum in principal repayments (assuming 3% average annual rate of growth through 2021). That means a massive €21-22bn will be outflowing annually from the state revenue to maintain the path to debt reduction consistent with the EU targets over 10 year horizon.
What does this translate into in terms of our tax revenue. If the Government were to achieve the tax revenues of 35% of GDP (roughly consistent with the current plans), in 2011 or debt servicing and repayment plan would swallow 37.5-39.3% of our total tax revenues, declining gradually to 27.1-28.4% of total tax revenues by 2021. Again, these numbers assume 3% pa growth on average through 2021.]
“We will seek a reduced interest rate as part of a credible re-commitment to reducing Government deficits to ensure sustainability of our public finances.” Page 6.
“…we will defer further recapitalisation of the banks until the solvency stress tests are complete and known to the new Government.” [This is fully correct – the process of recapitalization of the banks should start with the full assessment of the capital requirements]
"As an interim measure, we will seek to replace emergency lending to our banks with medium-term, affordable, official financing ...” [I wonder what this means...]
“We will end further asset transfers to NAMA, which are unlikely to improve market confidence in either the banks or the State.” [This is a good starting point, but a much deeper review of NAMA, and, in the end, a full roll-back of NAMA will be required. The PfG 2011 does not reach that deep.]
“We will ensure that an adequate pool of credit is available to fund small and medium-sized businesses in the real economy during the re-structuring and down-sizing programme.” [Where is this pool of credit come from? Who will administer the new lending? How will the new lending be priced? None of these questions are answered neither in principal, nor in sufficient operational detail.]
“The Government accepts that enabling provisions in legislation may be necessary to extend the scope of bank liability restructuring to include unsecured, unguaranteed senior bonds.” [Again, a vaguely phrased, but correct principle.]
“We will create an integrated decision making structure among all relevant State Departments and Agencies to replace the current fragmented approach of State bodies in dealing with the financial crisis.” [This is a good idea, but I cannot understand how a new body can override the independent decision-making across CBofI, NTMA, NAMA and DofF.]
“The new Government will re-structure bank boards and replace directors who presided over failed lending practices. We will ensure that the regulator has sufficient powers of pre-approval of bank directors and senior executives. To expedite this change-over we will openly construct a pool of globally experienced financial services managers and directors to be inserted into key executive and non-executive positions in banks receiving taxpayer support.” Page 7.
[Excellent idea, much need and all, but… (1) How will the Government deal with those directors and executives who should be replaced, while their contracts remain running? Fire them? Breach contracts? (2) What does the ‘pool’ mean? You can’t secure people to ‘stand by’ as a part of the pool while waiting for an appointment – you either will have to pay them to be in the pool, or you will need to hire them in immediately.]
“We will insist on the highest standards of transparency in the operation of NAMA, on reduction in the costs associated with the operation of NAMA, and that decision-making in NAMA does not delay the restoration of the Irish property market.” [Another excellent objective, but again, this raises more questions than it answers. NAMA legislation sets out NAMA as non-transparent, secretive and completely arms-length entity. This was also, in part, conditioned by the funding structure of NAMA. Breaking this structure implies full contagion from NAMA operations and funding to the Exchequer. The implication is that the quasi-Governmental debt might become fully sovereign debt. As far as the NAMA effect on the property market goes, in order to prevent NAMA from continuing to induce market uncertainty, the Government will need to reverse NAMA and force the banks to manage their own exposures. Some immediate sales of properties will be required.]
“Once the banking sector has been restored and is functioning effectively, we will introduce a bank levy based on the size of a bank’s liabilities (other than shareholder capital).” [This is a major problem. (1) A bank levy cannot be set against any new banks or banks that are not covered by State recapitalizations, otherwise no new entries will take place into the Irish market, and the existent non-State dependent banks will exit the market. (2) Any such levy will be in effect another tax on ordinary users of banks services, as in the reduced competition in the market, the banks will be able to pass the full cost of the levy onto their customers. In other words, such a levy will be a tax under a different name.]
“We will establish a Strategic Investment Bank” [Which again raises the issue of fair competition in the market for those banks which currently operate without Government subsidies and/or any potential new entrants. It also raises a huge number of questions as to the nature of the SI Bank, its management, strategy, funding, operations etc.]
“We recognise the important role of Credit Unions as a volunteer co-operative movement and the distinction between them and other types of financial institutions. In Government, we will establish a Commission to review the future of the credit union movement and make recommendations in relation to the most effective regulatory structure for Credit Unions, taking into account their not-for-profit mandate, their volunteer ethos and community focus, while paying due regard to the need to fully protect depositors savings and financial stability.” [A good idea, but might be coming dangerously close to the politicized alteration of both the regulatory regime in financial services and the Credit Unions industry itself.]
“We support the future development of the IFSC as a source of future employment growth, subject to appropriate regulation. We will establish a taskforce on the future of the financial services sector to maximise employment opportunities in financial services for staff leaving employment as a result of downsizing.” [Again, a good idea, but the devil is in the detail. There are plenty of task forces dealing with the future of IFSC and delivering very little on the cost of running these. How will the new task force be different?]
06/03/2011: Kauffman survey of economics bloggers
Kauffman Foundation - non-partisan US-based research think tank studying the issues of entrepreneurship. It describes itself as: "dedicated to the idea that entrepreneurship and innovation drive economic growth". The foundation released their quarterly survey results for Q1 2011 on the opinions and policy positions held by the US-based top economics bloggers.
You can access the survey paper from here and believe me - IT IS WORTH READING!
Here are the highlights:
First: how balanced / non-partisan the panel is:
Oh, sorry, yes, Americans do have some serious talent amongst the bloggers and they tend to come from all 3 sides of economics thinking: Left, Right and purely objective 'quantifiers'.
Another one for us, Europeans. Remember the hoopla surrounding the high-sounding principles, but bad economics (yes, the Congressional Budget Office analysis has proven it to be 'bad economics') of the Obama Healthcare bill? Here's the verdict of the economists:
Ouch: 55% say "Repeal" the beast, 71% say "Don't tax the benefits".
Now more goodies for us, Europeans - how do the US economists rank performance of the ECB?
No "A" marks for ECB, Average mark is solid "D". Only US Congress and the Wall Street score less than the Euro-guardian.
Fascinating results!
You can access the survey paper from here and believe me - IT IS WORTH READING!
Here are the highlights:
- The survey was conducted in mid-January 2011 by soliciting input from top economics bloggers as ranked by Palgrave’s Econolog.net.
- Economics bloggers are less pessimistic in their outlook on the U.S. economy than they were at the end of 2010, though 77% believe overall conditions are mixed, facing recession, or in recession.
- "For an economy in which growth is the norm, 31% of respondents think that the U.S. economy is worse than official statistics indicate, and only 10% believe it is better".
- When asked to describe the economy using five adjectives, "uncertain” remains the most frequently used term.
- "Although the panel is largely non-partisan, a 3:1 majority of top economics bloggers believe the government is too involved in the economy."
- The top policy recommendation is for the government to “reduce regulatory burdens and fees on new firm formation” and “approve trade agreements with South Korea, Colombia, and Panama,” with 92% support. So free trade and lesser burden on business formation. "Promoting entrepreneurship is a consensus agenda among policymakers".
- Only 32% agree with a policy of “subsidizing new firm formation with targeted spending and tax benefits,” with 68% disagreeing (24% strongly).
- The alternative option to “reduce regulatory burdens and fees on new firm formation” is favored by 92% of respondents.
- "Rather than recommending that the government get more involved in helping entrepreneurs, top economics bloggers recommend it simply do less to hinder them."
First: how balanced / non-partisan the panel is:
Oh, sorry, yes, Americans do have some serious talent amongst the bloggers and they tend to come from all 3 sides of economics thinking: Left, Right and purely objective 'quantifiers'.Another one for us, Europeans. Remember the hoopla surrounding the high-sounding principles, but bad economics (yes, the Congressional Budget Office analysis has proven it to be 'bad economics') of the Obama Healthcare bill? Here's the verdict of the economists:
Ouch: 55% say "Repeal" the beast, 71% say "Don't tax the benefits".Now more goodies for us, Europeans - how do the US economists rank performance of the ECB?
No "A" marks for ECB, Average mark is solid "D". Only US Congress and the Wall Street score less than the Euro-guardian.Fascinating results!
Saturday, March 5, 2011
05/03/2011: Our economic meltdown
Our latest paper on Irish economic meltdown (forthcoming in the refereed economics journal Panoeconomicus) is available on ssrn web page for downloads:
Gurdgiev, Constantin, Lucey, Brian M., Mac an Bhaird, Ciaran and Roche-Kelly, Lorcan, The Irish Economy: Three Strikes and You’Re Out? (March 3, 2011) - download here.
Gurdgiev, Constantin, Lucey, Brian M., Mac an Bhaird, Ciaran and Roche-Kelly, Lorcan, The Irish Economy: Three Strikes and You’Re Out? (March 3, 2011) - download here.
Friday, March 4, 2011
04/03/2011: Default probabilities
Some people were asking me recently to give an estimate of the sovereign default probabilities for Ireland based on bonds yields. Here are two tables providing an answer -
Basically, there is a 90% chance of a default (20% haircut) within 10 years and 15% chance of such an event within the year.
The estimates are very much approximate as we use only yields.
- The first table covers yesterday close yields on generic IRL bonds by maturity
- The second estimates probability of default, using, as risk-free rates German yields on comparable paper
Basically, there is a 90% chance of a default (20% haircut) within 10 years and 15% chance of such an event within the year.The estimates are very much approximate as we use only yields.
Thursday, March 3, 2011
03/03/2011: IMF quota goes up, Ireland's rate goes down, but at a cost
Good news, sort of... we gave IMF some €500mln and they reduced out interest bill on their loan by some €220mln... (hat tip to Lorcan for this quick summary). Here are the details of this AIB-esque transaction:
The ad hoc quota increases under the Quota and Voice Reforms of the International Monetary Fund (IMF), (agreed back in 2008), include a 50 percent increase in Ireland’s IMF funding quota (along with 53 other countries around the world).
So we now have 30 days to pay for that quota increase.
Once paid up, Ireland’s quota at the IMF will increase from SDR 838.4 million to SDR 1,257.6 million or SDR 419.2 million = €477 million. That’s the bad news – we gotta come up with cash.
But, the good news is that with the new higher quota, “Ireland’s access to Fund resources under the Extended Fund Facility arrangement is reduced to 1,548 percent of quota, compared with 2,322 percent originally”. Note – countries shouldn’t really borrow at more than 300% of the quotas, but Ireland’s ‘bailout’ was at a massive 7.5 times that rate.
The new quota, therefore, “reduces the share of Ireland’s credit that is subject to surcharges, which are due on amounts in excess of 300 percent of quota. Based on the current SDR interest rate of 0.43 percent, the average lending interest rate at the peak level of access under the arrangement will be 3.04 percent on credit outstanding less than three years (down from 3.17 percent), and 3.85 percent on credit outstanding longer than three years (down from 4.04 percent). This reduction in average interest rate is the result of the implementation of existing Fund policies under the agreed increase in quotas and not of a change in policy."
So basically we have 13bps shaved off our loans with IMF which will save us 13bps on €22.5bn loan (3-year facility) or €29.25 million in annual interest rate. Excitement, folks, is never ending… even Lorcan was wrong on this one - we are to pay 477 million to save (over 3 years) the grand total of 87.75 million.
And there’s more to come: “The proposed quota increase under the 14th General Review of Quotas, which is expected to be effective by the time of the 2012 IMF-World Bank Annual Meetings, includes a further 174.3 percent increase in Ireland’s quota to SDR 3,449.9 million. This would tend to further reduce the average lending rate when it comes into effect.
Can’t wait… we can borrow that money from IMF as well, to pay IMF to increase the quota, so as to save a penny on a million?..
Granted, this was agreed ages ago, but...
Here's the note:
The ad hoc quota increases under the Quota and Voice Reforms of the International Monetary Fund (IMF), (agreed back in 2008), include a 50 percent increase in Ireland’s IMF funding quota (along with 53 other countries around the world).
So we now have 30 days to pay for that quota increase.
Once paid up, Ireland’s quota at the IMF will increase from SDR 838.4 million to SDR 1,257.6 million or SDR 419.2 million = €477 million. That’s the bad news – we gotta come up with cash.
But, the good news is that with the new higher quota, “Ireland’s access to Fund resources under the Extended Fund Facility arrangement is reduced to 1,548 percent of quota, compared with 2,322 percent originally”. Note – countries shouldn’t really borrow at more than 300% of the quotas, but Ireland’s ‘bailout’ was at a massive 7.5 times that rate.
The new quota, therefore, “reduces the share of Ireland’s credit that is subject to surcharges, which are due on amounts in excess of 300 percent of quota. Based on the current SDR interest rate of 0.43 percent, the average lending interest rate at the peak level of access under the arrangement will be 3.04 percent on credit outstanding less than three years (down from 3.17 percent), and 3.85 percent on credit outstanding longer than three years (down from 4.04 percent). This reduction in average interest rate is the result of the implementation of existing Fund policies under the agreed increase in quotas and not of a change in policy."
So basically we have 13bps shaved off our loans with IMF which will save us 13bps on €22.5bn loan (3-year facility) or €29.25 million in annual interest rate. Excitement, folks, is never ending… even Lorcan was wrong on this one - we are to pay 477 million to save (over 3 years) the grand total of 87.75 million.
And there’s more to come: “The proposed quota increase under the 14th General Review of Quotas, which is expected to be effective by the time of the 2012 IMF-World Bank Annual Meetings, includes a further 174.3 percent increase in Ireland’s quota to SDR 3,449.9 million. This would tend to further reduce the average lending rate when it comes into effect.
Can’t wait… we can borrow that money from IMF as well, to pay IMF to increase the quota, so as to save a penny on a million?..
Granted, this was agreed ages ago, but...
Here's the note:
03/03/2011: Banks & debt crisis
Amended below
This was made public late last night and has serious implications for the Irish banks. If you recall, last summer the EU conducted a similar exercise that resulted in a complete failure to:
Here is the announcement on the forthcoming EU tests:
"EBA Unveils Timeline and Details on EU-wide Stress-tests
"This afternoon the European Banking Authority held its second meeting of the Board of Supervisors of the 27 constituent members of the EBA. One of the primary items on the agenda was the agreement and specification of details pertaining to the upcoming EU-wide stress-tests.
Here are the main facts:
Finally, the need to have effective "remedial backstops" in place is part of an on-going discussion with the ESRB and national authorities to ensure that the necessary resources are in place should there be any need to re-capitalise banks. It appears this is still an open question, although the EBA did not rule out the possibility of European funding (EFSF, presumably) being used in a case where a national Exchequer cannot afford to re-capitalise its banks. EBA cited the example of the Irish case and EFSF funds, but clearly, there is no progression envisioned beyond 'cure loans with more loans' solutions.
EBA does appear be doing all it can (given opposition from the EU Governments to transparent and rigorous assessments) to make these tests definitive, credible and part of the comprehensive answer to providing macro-financial stability in the EU.
The link to the EBA announcement is here.
It should be interesting to see how PCAR-II comes out against the EBA tests. That duel of tests will be a backdrop to either establishing credibility of one or the other, or possibly none, but hardly both, as either PCAR-II leads EBA tests into recognizing the reality of our collapsed banking system, or it does not.
And on a related issue of banks, here's a link to the full interview with Professor Barry Eichengreen on the issue of sick European banking system. Few quotes:
But for those more inclined to read some much more really serious stuff, look no further than to
the latest Reinhart-Rogoff work on debt crisis: A DECADE OF DEBT, Carmen M. Reinhart and Kenneth S. Rogoff, NBER WORKING PAPER SERIES 16827 from February 2011 (no point to link it, as it is password protected). Here are the excerpts:
Starting from the top, the authors say (all emphasis is mine): "there is important new material here including the discussion of how World I and Great Depression debt were largely resolved through outright default and restructuring, whereas World War II debts were often resolved through financial repression [in other words through capital controls, forced expropriation of savings via taxation and soft force-induced diversion of domestic investment to financing of the Government liabilities - in effect, a form of expropriating pension funds etc]. We argue there that financial repression is likely to play a big role in the exit strategy from the current buildup. We also highlight here the extraordinary external debt levels of Ireland and Iceland compared to all historical norms in our data base."
Another quote: "For the countries with systemic financial crises and/or sovereign debt problems (Greece, Iceland, Ireland, Portugal, Spain, the United Kingdom, and the United States), average debt levels are up by about 134 percent, surpassing by a sizable margin the three year 86 percent benchmark that Reinhart and Rogoff, 2009, find for earlier deep post-war financial crises. The larger debt buildups in Iceland and Ireland are importantly associated with not only the sheer magnitude of the recessions/depressions in those countries but also with the scale of the bank debt buildup prior to the crisis—which is, as far as these authors are aware—without parallel in the long history of financial crises." And here's a chart from the paper:
Now, average increase in the crisis was 36%. In pre-2008 history of all modern financial crises, the financial crisis saw increases on average of 86%. In the current crisis, Ireland experienced and increase of Government debt of ca 320% (Reinhart-Rogoff estimate is 220% through 2009, but with our 2010 'inputs' - we are now closer to 320%)! And this was just Government's official debt. Quasi-official debts add to more than that. In other words, by historical standards - ca 86% would classify us as being serious bust, 320% (or even 220%) would classify as having been financially vaporized!
Puts into perspective the official Ireland's blabber about 'we can manage this debt'.
But if we need more, Reinhart & Rogoff oblige: "After more than three years since the onset of the crisis, banking sectors remain riddled with high debts (of which a sizable share are nonperforming) and low levels of capitalization, while household sector have significant exposures to a depressed real estate market. Under such conditions, the migration of private debts to the public sector and central bank balance sheets are likely to continue, especially in the prevalent environment of indiscriminate, massive, bailouts." So what the authors are saying here is that:
"...As countries hit debt intolerance ceilings, market interest rates can begin to rise quite suddenly, forcing painful adjustment [guess what's awaiting Ireland when - with current 10% mortgages stress levels - this happens?].
"For many if not most advanced countries, dismissing debt concerns at this time is tantamount to ignoring the proverbial elephant in the room. So is pretending that no restructuring will be necessary. It may not be called restructuring, so as not to offend the sensitivities of governments that want to pretend to find an advanced economy solution for an emerging market style sovereign debt crisis. As in other debt crises resolution episodes, debt buybacks and debt-equity swaps are a part of the restructuring landscape. ...The process where debts are being "placed" at below market interest rates in pension funds and other more captive domestic financial institutions is already under way in several countries in Europe [and recall the cheerleaders for this in Ireland were... the pension funds themselves].
Central banks on both sides of the Atlantic have become even bigger players in purchases of government debt, possibly for the indefinite future."
Pretty tough words...
This was made public late last night and has serious implications for the Irish banks. If you recall, last summer the EU conducted a similar exercise that resulted in a complete failure to:
- Identify the banks that required intervention (subsequent the tests, within two months time, AIB and Bank of Ireland required state capital interventions and within 4 months Ireland was in receipt of EU/IMF funds);
- Identify cross- banks risks and the potential for contagion from banks to banks and from banks to the sovereigns; and
- Identify second order effects of contagion from rising Government yields and deteriorating sovereign ratings to the banks balancesheets
Here is the announcement on the forthcoming EU tests:
"EBA Unveils Timeline and Details on EU-wide Stress-tests
"This afternoon the European Banking Authority held its second meeting of the Board of Supervisors of the 27 constituent members of the EBA. One of the primary items on the agenda was the agreement and specification of details pertaining to the upcoming EU-wide stress-tests.
Here are the main facts:
- The official launch date of the exercise is the 4 March - that's right - as in tomorrow!!!
- The exercise follow the same basic formula as before, i.e. a baseline macro-economic and an adverse scenario, to test for solvency of banks, but it is unclear whether it will be restricted to the balance sheets alone, or will consider the impact on the off-balance sheet assets as well;
- Publication of the list of banks to be tested, plus the macro-economic scenarios, will take place on 18 March;
- EBA continues to liaise with relevant bodies such as the ECB and ESRB to finalise the methodology to be used in April;
- "Vigorous" peer review and results in June.
Finally, the need to have effective "remedial backstops" in place is part of an on-going discussion with the ESRB and national authorities to ensure that the necessary resources are in place should there be any need to re-capitalise banks. It appears this is still an open question, although the EBA did not rule out the possibility of European funding (EFSF, presumably) being used in a case where a national Exchequer cannot afford to re-capitalise its banks. EBA cited the example of the Irish case and EFSF funds, but clearly, there is no progression envisioned beyond 'cure loans with more loans' solutions.
EBA does appear be doing all it can (given opposition from the EU Governments to transparent and rigorous assessments) to make these tests definitive, credible and part of the comprehensive answer to providing macro-financial stability in the EU.
The link to the EBA announcement is here.
It should be interesting to see how PCAR-II comes out against the EBA tests. That duel of tests will be a backdrop to either establishing credibility of one or the other, or possibly none, but hardly both, as either PCAR-II leads EBA tests into recognizing the reality of our collapsed banking system, or it does not.
And on a related issue of banks, here's a link to the full interview with Professor Barry Eichengreen on the issue of sick European banking system. Few quotes:
- Europe "must stop attempting to combat the crisis in Greece and Ireland by forcing these countries to pile more debt onto their existing debts by saddling them with overpriced loans." Note that the Der Spiegel journo actually fails to understand what Eichengreen is saying here, for the journalist then launches into a next question: "But at the same time, Europe is stifling any chance of growth in Greece and Ireland by forcing them to comply with harsh austerity measures. Is there any way this strategy can actually add up?" Like the rest of Europe, he does not comprehend the reality of what we are facing. It's not the austerity that is going to kill us, it's the DEBT!
- Eichengreen's response is to attempt once again to stress the very same point: "Essentially, all Germany and France want to achieve with these measures is to protect their own banks from collapsing. ...there is no way around rescheduling Greece's debt -- and that will also involve the banks. For this to happen, there is only one solution: Europe needs to strengthen its banks! Greece lived beyond its means, but in Ireland and Spain it is the banks that are the problem. The euro crisis is first and foremost a banking crisis." Read - it's the banks DEBT crisis!
- Der Spiegel's cool 'I am European, so Government spending is all that matters to me' dude again misses the mark launching back into Government spending question. And Eichengreen - after a pause - gives it a third try: "Europe's banks are in far greater danger than people realize. Most people now understand that last year's stress tests ... were a token gesture and lacked realistic scenarios. ...what would put my mind at rest more would be if the responsibility for carrying out the [new] stress tests went to the European Commission. National regulators are too susceptible to pressure from the regulated."
But for those more inclined to read some much more really serious stuff, look no further than to
the latest Reinhart-Rogoff work on debt crisis: A DECADE OF DEBT, Carmen M. Reinhart and Kenneth S. Rogoff, NBER WORKING PAPER SERIES 16827 from February 2011 (no point to link it, as it is password protected). Here are the excerpts:
Starting from the top, the authors say (all emphasis is mine): "there is important new material here including the discussion of how World I and Great Depression debt were largely resolved through outright default and restructuring, whereas World War II debts were often resolved through financial repression [in other words through capital controls, forced expropriation of savings via taxation and soft force-induced diversion of domestic investment to financing of the Government liabilities - in effect, a form of expropriating pension funds etc]. We argue there that financial repression is likely to play a big role in the exit strategy from the current buildup. We also highlight here the extraordinary external debt levels of Ireland and Iceland compared to all historical norms in our data base."
Another quote: "For the countries with systemic financial crises and/or sovereign debt problems (Greece, Iceland, Ireland, Portugal, Spain, the United Kingdom, and the United States), average debt levels are up by about 134 percent, surpassing by a sizable margin the three year 86 percent benchmark that Reinhart and Rogoff, 2009, find for earlier deep post-war financial crises. The larger debt buildups in Iceland and Ireland are importantly associated with not only the sheer magnitude of the recessions/depressions in those countries but also with the scale of the bank debt buildup prior to the crisis—which is, as far as these authors are aware—without parallel in the long history of financial crises." And here's a chart from the paper:
Now, average increase in the crisis was 36%. In pre-2008 history of all modern financial crises, the financial crisis saw increases on average of 86%. In the current crisis, Ireland experienced and increase of Government debt of ca 320% (Reinhart-Rogoff estimate is 220% through 2009, but with our 2010 'inputs' - we are now closer to 320%)! And this was just Government's official debt. Quasi-official debts add to more than that. In other words, by historical standards - ca 86% would classify us as being serious bust, 320% (or even 220%) would classify as having been financially vaporized!
Puts into perspective the official Ireland's blabber about 'we can manage this debt'.
But if we need more, Reinhart & Rogoff oblige: "After more than three years since the onset of the crisis, banking sectors remain riddled with high debts (of which a sizable share are nonperforming) and low levels of capitalization, while household sector have significant exposures to a depressed real estate market. Under such conditions, the migration of private debts to the public sector and central bank balance sheets are likely to continue, especially in the prevalent environment of indiscriminate, massive, bailouts." So what the authors are saying here is that:
- There has been no resolution to the crisis after 3 years of drastic measures;
- The only outcome of the current approach is private debt (banks) continuation to move onto Government balancesheet, until
- The proverbial sh&&t hits the fan:
"...As countries hit debt intolerance ceilings, market interest rates can begin to rise quite suddenly, forcing painful adjustment [guess what's awaiting Ireland when - with current 10% mortgages stress levels - this happens?].
"For many if not most advanced countries, dismissing debt concerns at this time is tantamount to ignoring the proverbial elephant in the room. So is pretending that no restructuring will be necessary. It may not be called restructuring, so as not to offend the sensitivities of governments that want to pretend to find an advanced economy solution for an emerging market style sovereign debt crisis. As in other debt crises resolution episodes, debt buybacks and debt-equity swaps are a part of the restructuring landscape. ...The process where debts are being "placed" at below market interest rates in pension funds and other more captive domestic financial institutions is already under way in several countries in Europe [and recall the cheerleaders for this in Ireland were... the pension funds themselves].
Central banks on both sides of the Atlantic have become even bigger players in purchases of government debt, possibly for the indefinite future."
Pretty tough words...
Wednesday, March 2, 2011
03/03/2011: Exchequer sums gone wrong in stockbrokers' calculator?
Amended
I did not want to blog about Exchequer receipts and expenditure, primarily because the information that can be derived from two monthly returns is really not that significant. Q1 returns for March will be much more revealing of any emerging ‘trends’.
But then I came the across note from one of our stockbrokers - perhaps one of the poorest in quality I’ve seen in some time. Let me tackle the spin and errors that were presented as analysis.
“Tax revenues at end-February were €4.84bn, 2.2% higher than the same period in 2010 but €128 behind the government tax projections for this stage of the year.” So far – true.
“The shortfall was concentrated in value added tax receipts which were €120m behind expectations. This weakness raises concerns about the strength of consumer spending in 2011.” This ‘weakness' is 2 months in running – what concerns can be raised on the basis of such a short observation span and given seasonality and lags in payments – is open to doubt, but let's use the note own logic in my response.
“Income tax and corporation tax receipts were €45m and €23m behind but were partly offset by higher than expected excise duties.” Ok again – sticking to the numbers computed for them by the DofF seems to work for these folks.
“Overall tax revenue remains broadly on track to meet the government's targets”. Oh, really? Let’s recap the above: Income tax is 2.237% below target, Vat is 5.894% behind target, Corporate tax is 17.829% behind target. So 1st, 2nd and 4th largest tax heads are behind target appreciably. Tax receipts overall were 2.21% ahead of 2010, but 2.5765% behind the target. If that ‘broadly on target’ performance were to continue through the year, so we will be losing 2.56% off the target every 2 months, cumulative shortfall on target will be 14.5% for the year or a whooping 5,060.5 billion (I am, of course, using the very same logic that led this analyst to draw a conclusion about the VAT receipts above). Some ‘on track’ that is.
And then arrives tour de force - the breakdown of someone's copying abilities:
“Tax measures introduced in Budget 2011 including the new universal social charge had an impact for the first time on the February receipts. Income tax receipts were 25% higher than in the corresponding month of 2010, albeit slightly behind the expected target for this stage of the year.”
Here comes a sticky: income tax receipts were 1,835mln through February 2010, they were 1,967mln through February 2011 – which makes them 7.2175% above yoy not 25%. The most bizarre thing is that the DofF note provides correct (7.2%) figure.
The mystery of 25% was explained to me by the analyst overnight. It was NET February income tax receipt that rose 25% yoy, not the cumulative tax receipts reported by the DofF. Net February 2011 receipts were €980mln as opposed to €784mln in February 2010. Of course, the note did not mention that this 'achievement' was due to the inclusion of the Universal Social Charge into the February 2011 figures. Here is how the DofF itself described the situation:
"PAYE receipts in the month of February amounted to €676 million, some €38 million or 6% up year-on-year. While PAYE receipts in February show the impact of the income tax measures introduced in Budget 2011, they do not include receipts from the USC and therefore allow for a comparable year-on-year analysis to be made."
What's missing in the above is the fact (stated elsewhere by the DofF, but again omitted by the analyst) that 2011 Income Tax Receipts include Health Levy that previously was not counted in the income tax. Here is from the Exchequer note for January 2011:
"The forecast growth rate in tax revenues for the year as a whole is 9.9%. This is driven by two significant factors: (i) The reclassification of health levy receipts, which heretofore had been collected as a Departmental receipt paid directly to the Department of Health & Children, to form part of the new Universal Social Charge, to be collected as part of income tax, and (ii) The large Budget day tax raising package, primarily on income tax, of €1.1 billion."
So 25% figure, while not in itself a bogus one, does not support any sort of a conclusion to be drawn about year on year comparatives, unless we net out health levy equivalent receipts.
However, the conclusion that can and should be drawn (downplayed by the DofF) is that PAYE receipts are growing at 6% and that after a significant shrinking of the tax bands.
Now, let's compare the dynamics of the current structure income tax to-date, cumulative through February 2011 to the target. By end of February 2010 Irish exchequer netted 16.27% of its annual income tax revenue. If the same share is applied to 2011 receipts through February 2011, the annual receipts for 2011 will fall somewhere around 12,087mln or a massive 14.43% below the target set for the year (14,125mln) for the income tax.
Let's, however, recall that January returns did not reflect USC inclusion as the returns related to December 2010 incomes. Correcting for this - take DofF forecast for total income tax measures of €1,100mln in 2011 and take out the share of January-February from these, adding them to the 2-months receipts attained and then extrapolating into the rest of the year. Cumulative income tax shortfall on the target then is 6.22% for the full year 2011 or €879mln. Not good.
So
Here is the table of calculations:
I did not want to blog about Exchequer receipts and expenditure, primarily because the information that can be derived from two monthly returns is really not that significant. Q1 returns for March will be much more revealing of any emerging ‘trends’.
But then I came the across note from one of our stockbrokers - perhaps one of the poorest in quality I’ve seen in some time. Let me tackle the spin and errors that were presented as analysis.
“Tax revenues at end-February were €4.84bn, 2.2% higher than the same period in 2010 but €128 behind the government tax projections for this stage of the year.” So far – true.
“The shortfall was concentrated in value added tax receipts which were €120m behind expectations. This weakness raises concerns about the strength of consumer spending in 2011.” This ‘weakness' is 2 months in running – what concerns can be raised on the basis of such a short observation span and given seasonality and lags in payments – is open to doubt, but let's use the note own logic in my response.
“Income tax and corporation tax receipts were €45m and €23m behind but were partly offset by higher than expected excise duties.” Ok again – sticking to the numbers computed for them by the DofF seems to work for these folks.
“Overall tax revenue remains broadly on track to meet the government's targets”. Oh, really? Let’s recap the above: Income tax is 2.237% below target, Vat is 5.894% behind target, Corporate tax is 17.829% behind target. So 1st, 2nd and 4th largest tax heads are behind target appreciably. Tax receipts overall were 2.21% ahead of 2010, but 2.5765% behind the target. If that ‘broadly on target’ performance were to continue through the year, so we will be losing 2.56% off the target every 2 months, cumulative shortfall on target will be 14.5% for the year or a whooping 5,060.5 billion (I am, of course, using the very same logic that led this analyst to draw a conclusion about the VAT receipts above). Some ‘on track’ that is.
And then arrives tour de force - the breakdown of someone's copying abilities:
“Tax measures introduced in Budget 2011 including the new universal social charge had an impact for the first time on the February receipts. Income tax receipts were 25% higher than in the corresponding month of 2010, albeit slightly behind the expected target for this stage of the year.”
Here comes a sticky: income tax receipts were 1,835mln through February 2010, they were 1,967mln through February 2011 – which makes them 7.2175% above yoy not 25%. The most bizarre thing is that the DofF note provides correct (7.2%) figure.
The mystery of 25% was explained to me by the analyst overnight. It was NET February income tax receipt that rose 25% yoy, not the cumulative tax receipts reported by the DofF. Net February 2011 receipts were €980mln as opposed to €784mln in February 2010. Of course, the note did not mention that this 'achievement' was due to the inclusion of the Universal Social Charge into the February 2011 figures. Here is how the DofF itself described the situation:
"PAYE receipts in the month of February amounted to €676 million, some €38 million or 6% up year-on-year. While PAYE receipts in February show the impact of the income tax measures introduced in Budget 2011, they do not include receipts from the USC and therefore allow for a comparable year-on-year analysis to be made."
What's missing in the above is the fact (stated elsewhere by the DofF, but again omitted by the analyst) that 2011 Income Tax Receipts include Health Levy that previously was not counted in the income tax. Here is from the Exchequer note for January 2011:
"The forecast growth rate in tax revenues for the year as a whole is 9.9%. This is driven by two significant factors: (i) The reclassification of health levy receipts, which heretofore had been collected as a Departmental receipt paid directly to the Department of Health & Children, to form part of the new Universal Social Charge, to be collected as part of income tax, and (ii) The large Budget day tax raising package, primarily on income tax, of €1.1 billion."
So 25% figure, while not in itself a bogus one, does not support any sort of a conclusion to be drawn about year on year comparatives, unless we net out health levy equivalent receipts.
However, the conclusion that can and should be drawn (downplayed by the DofF) is that PAYE receipts are growing at 6% and that after a significant shrinking of the tax bands.
Now, let's compare the dynamics of the current structure income tax to-date, cumulative through February 2011 to the target. By end of February 2010 Irish exchequer netted 16.27% of its annual income tax revenue. If the same share is applied to 2011 receipts through February 2011, the annual receipts for 2011 will fall somewhere around 12,087mln or a massive 14.43% below the target set for the year (14,125mln) for the income tax.
Let's, however, recall that January returns did not reflect USC inclusion as the returns related to December 2010 incomes. Correcting for this - take DofF forecast for total income tax measures of €1,100mln in 2011 and take out the share of January-February from these, adding them to the 2-months receipts attained and then extrapolating into the rest of the year. Cumulative income tax shortfall on the target then is 6.22% for the full year 2011 or €879mln. Not good.
So
- comparing likes with likes (2011 structure with 2011 structure) - you get a shortfall,
- comparing PAYE to PAYE (2010- v 2011) you get month on month rise of 6%,
- comparing 2-months in 2011 (with health levy in) against 2 months in 2010 (with no health levy in it) gives a rise of 7.2%
- BUT, comparing the analyst's basket of apples and oranges to a basket of apples alone (2011 February income tax with USC in it against a 2010 February income tax absent USC) gives a 25% rise
Here is the table of calculations:
02/03/2011: Village Magazine - March edition article
Here is an unedited version of my column in the current edition of the Village magazine
Top legislative/policy priorities for the new Government should focus on addressing the four crises we face – the banking sector renewal, the debt crisis, the need to dramatically reform our economy and the long-term reform of our political and governance systems. The inter-connected nature of these crises implies that some of the reforms undertaken in one of the areas, such as, for example, fiscal adjustments, will have a positive long term effect in other areas, e.g. in stimulating private sector economic growth.
Given the constraints of the space, let me deal here first with the decisions that should take priority for the new Government over 2011 in the areas of banking and finance.
EU/IMF ‘bailout’ package: the new Government will be forced, willingly or not, to renegotiate the terms of the original agreement. Given the level of debt carried by this economy courtesy of the previous Government commitments, the question of the need for such a revision of the ‘deal’ is no longer a valid one. Instead, the real question we face is what path to a ‘default’ or debt restructuring do we take and resolving this issue should be the top of our Government agenda.
Overall, there are three possible scenarios that the new Government can face in this respect.
The first one – the scenario of exogenously imposed resolution – implies that the impetus for altering the terms of the original November 2010 agreement can come from the EU itself under the auspices of the broader EFSF reforms. Under this scenario, expected eagerly by many pro-status quo or ‘do nothing’ advocates, the EU is likely to marginally reduce the cost of the EFSF funding to, say 5% from the current 5.83% and potentially extend the duration of the loans (up to 20-30 years), while creating a ‘flexibility fund’ which will make additional funding available to Ireland post-2013, but at higher rates of interest incorporating any future increases in the ECB core policy rate. In exchange for such a ‘rescue from previous rescue’ package, Ireland will be asked to accept the need for enhanced fiscal coordination– re: tax harmonization.
The second path is of structured and orderly ‘default’ involving banks debts. Under such a scenario, Irish Government should first prepare significant buffers for dealing with the funding failure in the currently insolvent banks. Since not all of our Government-guaranteed banks are insolvent, this means that the damage limitation is relatively better contained than the current full exposure scenario. In fact, an orderly restructuring will require replacing the blanket Guarantee with the one that covers fully only the deposits held in the Irish banks. This will significantly reduce taxpayers’ future exposure to the banking sector.
At the moment, the entire banking system in Ireland holds €168.3bn in deposits. However, not all of these are held in the 6 covered banks. In addition, of the above deposits, €10.5bn is held under the termed contracts with maturity in excess of 2 years. Roughly, only ca €100bn of domestic deposits are held by the Irish banks and is subject to a withdrawal demand within the next 2 years. This means that to underwrite these deposits, the Government will need a funding buffer of ca €30-50bn over the next 2 years (providing a 30-50% cover). This buffer can be provided by a combination of new currency issuance by the CBofI, NPRF funds and a stand by facility from the IMF not exceeding €5-15bn. A far cry from what the Government, alongside the EU and IMF, are planning to burn already.
Of course, the scenario means that we will need to effectively radically reduce our banks exposure to their largest lender – the ECB. This can be done by restructuring the share of Irish banks debt held by the ECB and the CBofI into a combination of a 10 year loan at a fixed interest rate of 0.5% and a haircut of, say, 40%, in effect reducing the risk of future rollovers, while cutting the overall burden of repayment and the cost of financing. Along with it, the EU/IMF should also agree to a restructuring of the €67.5bn loan extended under the November 2010 agreement into, for example, a €35bn perpetual loan at 3% pa interest rate and a €30bn loan extended for 10 years at 1.5-2% pa interest. The key in both deals should be to achieve not only a reduction in the cost of financing the quasi-Governmental (banks) and Government debt, but also cutting the overall level of gross debt assumed.
The worst-case scenario would arise if the markets were to force Ireland into a disorderly default. In this case, the markets will execute a massive sell-off of Irish Government debt preceded by a complete collapse of the secondary markets in banks debts. This will leave the ECB with some €185 billion worth of Irish banks debts that will have virtually no real market value and an unknown (but sizeable) volume of Irish Government debt which will be selling at a 20-30% discount on the face value. Both, the sovereign bonds and the banks debt markets will cease. Overnight and demand deposits will be frozen and the country will find itself in the situation where the Central Bank will have to monetize the very same costs of the orderly restructuring scenario, plus the disruptive costs of a bank run at the same time. Instead of holding the buffers of cash and committed funds it might not have to draw down in full, the ECB system will end up in a situation where all cash will have to be delivered as soon as technically possible.
It is clear that a prudent Government action should be from day one to prepare for the second, less disruptive scenario.
Following the entry into the resolution process of the banks debts, the Government should swiftly address the banks balancesheets problems. Here, the actions should follow the Swedish model and start with the abandonment of the misguided Nama-based approach. The Government should order the six banks to supply – by the end of June – a full accounting of the loans they hold, with clear indication as to the riskiness of these loans with respect of the probability of their repayment, the quality of the underlying collateral and titles. By the end of August 2011, the Government should complete detailed evaluation of this information by an independent panel of economic, property, lending and finance experts. Parallel to this, the Government should set an exact target for banks bondholders writedowns to offset at least in part loans losses in the banks. All bonds repayments and interest payouts for banks debts due for 2011 should be suspended. The balance on the expected losses net of the funds recoverable from bondholders should be financed by the purchase of the direct equity in the banks by the Government at a price for banks shares at the time of the publication of the assessment exercise. The time-frame for such closing of the balancesheet gaps should be set for no later than November 2011.
Nama loans that belonged to the banks should be valued as banks’ own in the above exercise and following the completion of the valuations, Nama should be shut and loans transferred back to the banks for management.
Subsequent deep reforms of the banks strategies and operations should be scheduled for the first quarter 2012.
Parallel to this, the Government should submit to the Dail no later than June 2011 a full draft bill dealing with reforms of our personal bankruptcy codes. These reforms should at the very least:
Make past and future loans for the purchase of personal residence non-recourse against the person of the borrower and his/her future income and assets;
Reduce the period of bankruptcy restrictions to just 2 years and complete removal of the bankruptcy history from credit history after 5 years of continued financial probity performance; Replace a blanket ban on companies directorships for individuals in bankruptcy with a restriction on their holding such directorships subject to satisfactory financial probity conduct during the bankruptcy period;
Restrict applicability of the Loan-to-Value ratio covenants in forcing the liquidation of the existent loans where the borrower continues to pay at least 75% of the interest on the mortgage.
The new bankruptcy laws should come into force as soon as possible and prior to that, the Government should impose a requirement that no state-guaranteed institution can bring new bankruptcy proceedings against homeowners.
Lastly, the Government should act swiftly to put in place an independent expert panel consisting of independent economists, financial analysts and banking experts that will function as a check on the Government decisions in the area of banking and financial services reforms. The panel should be required to provide quarterly reports and testimonies to the Dail which will be made public. The panel will have the powers to propose specific measures to the Government, to request and receive any information from the banks and financial services provider (subject to upholding the required confidentiality clauses) and question any bank official. The panel remit will only cover those institutions in which the Government holds at least a 35% stake and those that are covered by the State guarantee.
Of course, the above measures will help addressing a large share of our debt problem, effectively reducing the Government and banks’ debts, while alleviating the burden of personal debt for mortgage holders. However, other changes will have to take place in the areas of economic, fiscal and political reforms. These proposals will be outlined in a follow up article, so stay tuned.
Top legislative/policy priorities for the new Government should focus on addressing the four crises we face – the banking sector renewal, the debt crisis, the need to dramatically reform our economy and the long-term reform of our political and governance systems. The inter-connected nature of these crises implies that some of the reforms undertaken in one of the areas, such as, for example, fiscal adjustments, will have a positive long term effect in other areas, e.g. in stimulating private sector economic growth.
Given the constraints of the space, let me deal here first with the decisions that should take priority for the new Government over 2011 in the areas of banking and finance.
EU/IMF ‘bailout’ package: the new Government will be forced, willingly or not, to renegotiate the terms of the original agreement. Given the level of debt carried by this economy courtesy of the previous Government commitments, the question of the need for such a revision of the ‘deal’ is no longer a valid one. Instead, the real question we face is what path to a ‘default’ or debt restructuring do we take and resolving this issue should be the top of our Government agenda.
Overall, there are three possible scenarios that the new Government can face in this respect.
The first one – the scenario of exogenously imposed resolution – implies that the impetus for altering the terms of the original November 2010 agreement can come from the EU itself under the auspices of the broader EFSF reforms. Under this scenario, expected eagerly by many pro-status quo or ‘do nothing’ advocates, the EU is likely to marginally reduce the cost of the EFSF funding to, say 5% from the current 5.83% and potentially extend the duration of the loans (up to 20-30 years), while creating a ‘flexibility fund’ which will make additional funding available to Ireland post-2013, but at higher rates of interest incorporating any future increases in the ECB core policy rate. In exchange for such a ‘rescue from previous rescue’ package, Ireland will be asked to accept the need for enhanced fiscal coordination– re: tax harmonization.
The second path is of structured and orderly ‘default’ involving banks debts. Under such a scenario, Irish Government should first prepare significant buffers for dealing with the funding failure in the currently insolvent banks. Since not all of our Government-guaranteed banks are insolvent, this means that the damage limitation is relatively better contained than the current full exposure scenario. In fact, an orderly restructuring will require replacing the blanket Guarantee with the one that covers fully only the deposits held in the Irish banks. This will significantly reduce taxpayers’ future exposure to the banking sector.
At the moment, the entire banking system in Ireland holds €168.3bn in deposits. However, not all of these are held in the 6 covered banks. In addition, of the above deposits, €10.5bn is held under the termed contracts with maturity in excess of 2 years. Roughly, only ca €100bn of domestic deposits are held by the Irish banks and is subject to a withdrawal demand within the next 2 years. This means that to underwrite these deposits, the Government will need a funding buffer of ca €30-50bn over the next 2 years (providing a 30-50% cover). This buffer can be provided by a combination of new currency issuance by the CBofI, NPRF funds and a stand by facility from the IMF not exceeding €5-15bn. A far cry from what the Government, alongside the EU and IMF, are planning to burn already.
Of course, the scenario means that we will need to effectively radically reduce our banks exposure to their largest lender – the ECB. This can be done by restructuring the share of Irish banks debt held by the ECB and the CBofI into a combination of a 10 year loan at a fixed interest rate of 0.5% and a haircut of, say, 40%, in effect reducing the risk of future rollovers, while cutting the overall burden of repayment and the cost of financing. Along with it, the EU/IMF should also agree to a restructuring of the €67.5bn loan extended under the November 2010 agreement into, for example, a €35bn perpetual loan at 3% pa interest rate and a €30bn loan extended for 10 years at 1.5-2% pa interest. The key in both deals should be to achieve not only a reduction in the cost of financing the quasi-Governmental (banks) and Government debt, but also cutting the overall level of gross debt assumed.
The worst-case scenario would arise if the markets were to force Ireland into a disorderly default. In this case, the markets will execute a massive sell-off of Irish Government debt preceded by a complete collapse of the secondary markets in banks debts. This will leave the ECB with some €185 billion worth of Irish banks debts that will have virtually no real market value and an unknown (but sizeable) volume of Irish Government debt which will be selling at a 20-30% discount on the face value. Both, the sovereign bonds and the banks debt markets will cease. Overnight and demand deposits will be frozen and the country will find itself in the situation where the Central Bank will have to monetize the very same costs of the orderly restructuring scenario, plus the disruptive costs of a bank run at the same time. Instead of holding the buffers of cash and committed funds it might not have to draw down in full, the ECB system will end up in a situation where all cash will have to be delivered as soon as technically possible.
It is clear that a prudent Government action should be from day one to prepare for the second, less disruptive scenario.
Following the entry into the resolution process of the banks debts, the Government should swiftly address the banks balancesheets problems. Here, the actions should follow the Swedish model and start with the abandonment of the misguided Nama-based approach. The Government should order the six banks to supply – by the end of June – a full accounting of the loans they hold, with clear indication as to the riskiness of these loans with respect of the probability of their repayment, the quality of the underlying collateral and titles. By the end of August 2011, the Government should complete detailed evaluation of this information by an independent panel of economic, property, lending and finance experts. Parallel to this, the Government should set an exact target for banks bondholders writedowns to offset at least in part loans losses in the banks. All bonds repayments and interest payouts for banks debts due for 2011 should be suspended. The balance on the expected losses net of the funds recoverable from bondholders should be financed by the purchase of the direct equity in the banks by the Government at a price for banks shares at the time of the publication of the assessment exercise. The time-frame for such closing of the balancesheet gaps should be set for no later than November 2011.
Nama loans that belonged to the banks should be valued as banks’ own in the above exercise and following the completion of the valuations, Nama should be shut and loans transferred back to the banks for management.
Subsequent deep reforms of the banks strategies and operations should be scheduled for the first quarter 2012.
Parallel to this, the Government should submit to the Dail no later than June 2011 a full draft bill dealing with reforms of our personal bankruptcy codes. These reforms should at the very least:
Make past and future loans for the purchase of personal residence non-recourse against the person of the borrower and his/her future income and assets;
Reduce the period of bankruptcy restrictions to just 2 years and complete removal of the bankruptcy history from credit history after 5 years of continued financial probity performance; Replace a blanket ban on companies directorships for individuals in bankruptcy with a restriction on their holding such directorships subject to satisfactory financial probity conduct during the bankruptcy period;
Restrict applicability of the Loan-to-Value ratio covenants in forcing the liquidation of the existent loans where the borrower continues to pay at least 75% of the interest on the mortgage.
The new bankruptcy laws should come into force as soon as possible and prior to that, the Government should impose a requirement that no state-guaranteed institution can bring new bankruptcy proceedings against homeowners.
Lastly, the Government should act swiftly to put in place an independent expert panel consisting of independent economists, financial analysts and banking experts that will function as a check on the Government decisions in the area of banking and financial services reforms. The panel should be required to provide quarterly reports and testimonies to the Dail which will be made public. The panel will have the powers to propose specific measures to the Government, to request and receive any information from the banks and financial services provider (subject to upholding the required confidentiality clauses) and question any bank official. The panel remit will only cover those institutions in which the Government holds at least a 35% stake and those that are covered by the State guarantee.
Of course, the above measures will help addressing a large share of our debt problem, effectively reducing the Government and banks’ debts, while alleviating the burden of personal debt for mortgage holders. However, other changes will have to take place in the areas of economic, fiscal and political reforms. These proposals will be outlined in a follow up article, so stay tuned.
02/03/2011: Irish Daily Mail - February 28
Here is an unedited version of my article for Irish Daily Mail for February 28, 2011.
The hardest thing in the General Election 2011 for Fine Gael and Labor is yet to come. After Sunday rest and celebrations this week will start for both parties with a political wrangle over positions of power. This too will be the easy part.
However, comes the week of March 7th, the entire weight of the ongoing crisis will fall on the shoulders of Mr Kenny and his colleagues. There is no rulebook the new Government can consult in these times of need. Old policies, having comprehensively failed to stabilize our banking system, will be of no use. In fact, some – like Nama and the extended guarantee – will have to be unwound or scrapped altogether and fast. New policies touched upon during the campaign – like ‘renegotiation’ of the EU/IMF loans – will be just a side-show to the escalating crisis.
The problem is that, largely unseen by us, the banking crisis continues to rage. We’ve heard about the perils of ATMs running out of cash should we ‘unilaterally burn the banks bondholders’. Alas, our banks are now running ATMs on the back of IOUs they issue to themselves. In other words, every time we dine out or buy a newspaper, we are spending cash that Irish banks have borrowed from the ECB or the Central Bank of Ireland against the collateral that is only worth anything because the taxpayers promised to repay the loans. You might think that your Laser card is a debit card – taking money you own from your account. Courtesy of our bust banking system, it really is a credit card with the debt being spread across the entire economy.
Tens of billions of new debt have been created over the last few months through this ‘backdoor’ borrowing. And the new Government will have to stop this merry-go-round before the taxpayers, and with them the entire economy, collapse under the weight of this debt.
On top of this, there is a new instalment in the series of horror shows looming on the horizon, as AIB is set to report its 2010 results in days to come. For AIB is most likely to reveal this time around that it is not that much better off, when it comes to lending and investment books quality, than Anglo and INBS. AIB spent last three years in active denial of the extent of its impairments. Now, it will have to start airing its dirty laundry. Again, the Government will have to react to put some active policy buffers between the markets – easily spooked by the zombie giant rearing its head – and the bank.
Add to that much anticipated Prudential Capital Assessment Review (PCAR) – the new set of ‘stress tests’ on Irish banks balancesheets – and you have some seriously disastrous newsflow that the Government is heading into. To be credible, the PCAR will have to be really honest. We already had a number of previous reviews that spectacularly failed to reveal the truth about banks, including the ones carried out by the EU which gave AIB and Bank of Ireland their clean bills of health just before AIB was nationalized and Bank of Ireland required new financial wizardry from the Government to avoid the same fate. An honest PCAR expected next month will most likely send AIB into a tailspin.
Last, but not least, the Government will be facing the EU negotiations relating to the Franco-German push to ‘reform’ EU-wide macroeconomic stability rules. During these talks, our fiscal position will come under renewed scrutiny by the very same EU Commission and ECB who have already voiced concerns that the Government 4 year plan for restoring order to our public finances is a castle built of sand. Should the EU take a keen interest in our economic assumptions and forecasts, the Government might be forced to either increase the ‘savings’ planned for 2011-2014 by, possibly, as much as €5-6 billion, or sacrifice something else in return. No prizes if you guessed that it will be our corporate tax rates.
Here is an example. We all heard about unrealistically high assumptions on economic growth that underlie our recovery plans. Over the last couple of weeks, things have gone from bad to worse. For example, Government plan, supported in principle by Fine Gael, assumed oil price inflation of just 10.4% in 2011. Alas, since plan’s publication, oil prices have risen on average by over 20% already. Every 10% increase in oil price in Ireland translates into roughly 0.5% cut in our GDP growth. So if the Budget 2011 projected expected growth of 1.75% in GDP over this year, all signs to-date suggest that in reality we will be lucky if we can get 0.5% (0.1% for larger and less oil-dependent economies, like Germany). And this means that in year 2011 alone, to keep up with the 4 year plan, the Government might need to find additional ‘savings’ of some €200 million net.
So forget the 5 points plans. The new Government will have to get off to a fast start on drawing up the realistic plans for dealing with the crises we faced. Comes Monday week, the honeymoon will be over for Fine Gael and Labor.
The hardest thing in the General Election 2011 for Fine Gael and Labor is yet to come. After Sunday rest and celebrations this week will start for both parties with a political wrangle over positions of power. This too will be the easy part.
However, comes the week of March 7th, the entire weight of the ongoing crisis will fall on the shoulders of Mr Kenny and his colleagues. There is no rulebook the new Government can consult in these times of need. Old policies, having comprehensively failed to stabilize our banking system, will be of no use. In fact, some – like Nama and the extended guarantee – will have to be unwound or scrapped altogether and fast. New policies touched upon during the campaign – like ‘renegotiation’ of the EU/IMF loans – will be just a side-show to the escalating crisis.
The problem is that, largely unseen by us, the banking crisis continues to rage. We’ve heard about the perils of ATMs running out of cash should we ‘unilaterally burn the banks bondholders’. Alas, our banks are now running ATMs on the back of IOUs they issue to themselves. In other words, every time we dine out or buy a newspaper, we are spending cash that Irish banks have borrowed from the ECB or the Central Bank of Ireland against the collateral that is only worth anything because the taxpayers promised to repay the loans. You might think that your Laser card is a debit card – taking money you own from your account. Courtesy of our bust banking system, it really is a credit card with the debt being spread across the entire economy.
Tens of billions of new debt have been created over the last few months through this ‘backdoor’ borrowing. And the new Government will have to stop this merry-go-round before the taxpayers, and with them the entire economy, collapse under the weight of this debt.
On top of this, there is a new instalment in the series of horror shows looming on the horizon, as AIB is set to report its 2010 results in days to come. For AIB is most likely to reveal this time around that it is not that much better off, when it comes to lending and investment books quality, than Anglo and INBS. AIB spent last three years in active denial of the extent of its impairments. Now, it will have to start airing its dirty laundry. Again, the Government will have to react to put some active policy buffers between the markets – easily spooked by the zombie giant rearing its head – and the bank.
Add to that much anticipated Prudential Capital Assessment Review (PCAR) – the new set of ‘stress tests’ on Irish banks balancesheets – and you have some seriously disastrous newsflow that the Government is heading into. To be credible, the PCAR will have to be really honest. We already had a number of previous reviews that spectacularly failed to reveal the truth about banks, including the ones carried out by the EU which gave AIB and Bank of Ireland their clean bills of health just before AIB was nationalized and Bank of Ireland required new financial wizardry from the Government to avoid the same fate. An honest PCAR expected next month will most likely send AIB into a tailspin.
Last, but not least, the Government will be facing the EU negotiations relating to the Franco-German push to ‘reform’ EU-wide macroeconomic stability rules. During these talks, our fiscal position will come under renewed scrutiny by the very same EU Commission and ECB who have already voiced concerns that the Government 4 year plan for restoring order to our public finances is a castle built of sand. Should the EU take a keen interest in our economic assumptions and forecasts, the Government might be forced to either increase the ‘savings’ planned for 2011-2014 by, possibly, as much as €5-6 billion, or sacrifice something else in return. No prizes if you guessed that it will be our corporate tax rates.
Here is an example. We all heard about unrealistically high assumptions on economic growth that underlie our recovery plans. Over the last couple of weeks, things have gone from bad to worse. For example, Government plan, supported in principle by Fine Gael, assumed oil price inflation of just 10.4% in 2011. Alas, since plan’s publication, oil prices have risen on average by over 20% already. Every 10% increase in oil price in Ireland translates into roughly 0.5% cut in our GDP growth. So if the Budget 2011 projected expected growth of 1.75% in GDP over this year, all signs to-date suggest that in reality we will be lucky if we can get 0.5% (0.1% for larger and less oil-dependent economies, like Germany). And this means that in year 2011 alone, to keep up with the 4 year plan, the Government might need to find additional ‘savings’ of some €200 million net.
So forget the 5 points plans. The new Government will have to get off to a fast start on drawing up the realistic plans for dealing with the crises we faced. Comes Monday week, the honeymoon will be over for Fine Gael and Labor.
02/03/2011: Irish Mail article - February 23
Here is an unedited version of my Irish Daily Mail article from February 23, 2011.
With the new Government standing to inherit a ca 10% deficit this year and a prospect of the sovereign debt in excess of €240 billion by the end of 2013, Friday elections will deliver only one certain outcome – our next Toiseach will most likely enjoy the shortest honeymoon with the voters in the history of the state. Given all the opinion polls, Enda Kenny will be redecorating the offices occupied previously by Brian Cowen. Fresh ‘IOU’ forms with Fine Gael’s insignia and new Taoiseach name will be gracing the desk. The change, alas, risks stopping there.
On a serious note, given the gravity of our economic and financial situation, it is virtually certain that the new Government will have to abandon, at least for the next 24 months, all of its 5-point plans. Fighting forest fires sweeping across our banking landscape will, once again take priority. No matter who wins in these elections, our State Guaranteed (and mostly State-owned) banks will continue to print own bonds (also State-Guaranteed) to roll over €9.7 billion of the older paper maturing this year. No matter what parties will end up forming the Government, deposits flight will go on, powered over, under the un-blinking eyes of the Financial Regulator and the Central Bank, by more borrowing. In the mean time, state finances will continue flopping along the ‘road to recovery’ like a deflated tyre.
By the end of 2013, the state will run out of the EU/IMF funds and own cash (aka NPRF), so forget whatever promises you heard throughout the current campaign about ‘stimulating growth’ and ‘improving competitiveness’. In the mean time, with the blessing of the Croke Park agreement, the public sector reforms will continue in the pages of newspapers, but not on the ground. All signs suggest that by the end of this year, the EU will face a severe banking crisis of its own, which will further exacerbate our local problems and will risk derailing our exports – the only bright spot on otherwise leaden horizon.
All of this suggests that the new Government will have to go into yet another crisis management exercise and this time around possibly without a safety cushion of the EU. The radical, unthinkable today, solutions will have to be considered. This is why the current elections are unlikely to give us much of a relief from the disasters of the last three years.
The only real uncertainty worth considering in the context of the Friday vote, therefore, is that of the new emerging power of the independents. Should the outcome of the vote this week return, as forecast, some 20 independent TDs, Ireland will be on a road to formation of at least two new parties, each with popular votes close to the combined votes of PDs and Greens, averaged over the last 4 elections. A combination of such robust support for independent alternatives to the 4 main parties and continued and amplifying economic crisis will then set the stage for a watershed change in the next elections. That date, in my estimates, is now no more than 18-21 months away.
With the new Government standing to inherit a ca 10% deficit this year and a prospect of the sovereign debt in excess of €240 billion by the end of 2013, Friday elections will deliver only one certain outcome – our next Toiseach will most likely enjoy the shortest honeymoon with the voters in the history of the state. Given all the opinion polls, Enda Kenny will be redecorating the offices occupied previously by Brian Cowen. Fresh ‘IOU’ forms with Fine Gael’s insignia and new Taoiseach name will be gracing the desk. The change, alas, risks stopping there.
On a serious note, given the gravity of our economic and financial situation, it is virtually certain that the new Government will have to abandon, at least for the next 24 months, all of its 5-point plans. Fighting forest fires sweeping across our banking landscape will, once again take priority. No matter who wins in these elections, our State Guaranteed (and mostly State-owned) banks will continue to print own bonds (also State-Guaranteed) to roll over €9.7 billion of the older paper maturing this year. No matter what parties will end up forming the Government, deposits flight will go on, powered over, under the un-blinking eyes of the Financial Regulator and the Central Bank, by more borrowing. In the mean time, state finances will continue flopping along the ‘road to recovery’ like a deflated tyre.
By the end of 2013, the state will run out of the EU/IMF funds and own cash (aka NPRF), so forget whatever promises you heard throughout the current campaign about ‘stimulating growth’ and ‘improving competitiveness’. In the mean time, with the blessing of the Croke Park agreement, the public sector reforms will continue in the pages of newspapers, but not on the ground. All signs suggest that by the end of this year, the EU will face a severe banking crisis of its own, which will further exacerbate our local problems and will risk derailing our exports – the only bright spot on otherwise leaden horizon.
All of this suggests that the new Government will have to go into yet another crisis management exercise and this time around possibly without a safety cushion of the EU. The radical, unthinkable today, solutions will have to be considered. This is why the current elections are unlikely to give us much of a relief from the disasters of the last three years.
The only real uncertainty worth considering in the context of the Friday vote, therefore, is that of the new emerging power of the independents. Should the outcome of the vote this week return, as forecast, some 20 independent TDs, Ireland will be on a road to formation of at least two new parties, each with popular votes close to the combined votes of PDs and Greens, averaged over the last 4 elections. A combination of such robust support for independent alternatives to the 4 main parties and continued and amplifying economic crisis will then set the stage for a watershed change in the next elections. That date, in my estimates, is now no more than 18-21 months away.
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