13/05/11: CBofI accounts

Update: Namawinelake blog has an excellent post on the lunacy of Government treasury management exposed by the CBofI's latest accounts - read it here.


On April 7, 1775, Samuel Johnson made his famous pronouncement: "Patriotism is the last refuge of the scoundrel". This statement caught the chord with many other illustrious thinkers. Ambrose Bierce's The Devils Dictionary: “In Dr. Johnson’s famous dictionary patriotism is defined as the last resort of a scoundrel. ...I beg to submit that it is the first." In 1926, H. L. Mencken added that patriotism "...is the first, last, and middle range of fools.”

Whether one can separate a scoundrel from a fool or the first refuge from the last, in recent years we have seen Government officials who have exhibited all four attributes of false 'patriotism'.

No doubt, the decision by the Irish Minister for Finance to instruct NTMA to deposit €10.6 billion of state money with the Irish banks were not supposed to be amongst one of them. However, motivated by a 'patriotic' desire to provide a temporary support for the zombie institutions, artificially increasing their deposits base, this was a significant mistake from the risk management point of view.


Irish banks are experiencing a severe liquidity crisis, as the latest figures from the CBofI clearly show (Table A.2, column E). Lending to Euro area credit institutions has risen from 30 April 2010 levels of €81.25 billion to the peak of €136.44 billion by the end of October 2010 and now stands at a still hefty €106.13 billion (April 29, 2011), down €8.37 billion on the end of March. That's folks - our banks debts to the ECB. As far as banks debts to the CBofI itself are concerned, these have declined by some €12.64 billion to €54.15 billion March to April 2011. Chart below plots combined ECB and CBofI 'assets' that are loans to the Irish banks.
So the banks are still under immense pressure on the liquidity front.

As far as their solvency is concerned, BalckRock advisers estimated back in March 2011 the through-cycle expected losses in excess of €40 billion for just 4 out of 6 Irish 'banks'. Although these relate to 'potential' losses, the likelihood of these occurring is high enough for the CBofI to provision for €24 billion of these.

Either way, Irish banks are not really the counterparties that can be deemed safe.

There is an added component to this transaction - under the deposits guarantee, the Irish Exchequer holds simultaneously a liability (a Guarantee) and the asset (the deposit) when Mr Noonan approved the transaction. Before that, the Exchequer only had an asset. In effect, balance-sheet risk of this transaction was to reduce the risk-adjusted value of the asset it had.

Lastly, the entire undertaking smacks of the Minister directly interfering in the ordinary operations of NTMA which is supposed to be independent of exactly such interference.

So whether Minister's 'patriotism' of supporting Irish banks was the first or the last resort or the first and the last range, the outcome of his decision to prop up banks balance sheets with artificial short-term deposits was an example of a risky move that has cost NTMA its independence and reputation. The move achieved preciously little other than destroy risk-adjusted value of Government assets. Not exactly a winning combo...

Economics: Op-ed in the Irish Examiner 12/05/2011

This is the unedited version of my and Declan Ganley's op-ed in yesterday's Irish Examiner.

As you have undoubtfuly heard, I will be moving to a full-time role with StColumbanus AG - a Switzerland-based Asset Management company - on June 1, 2011. I will be setting up economic and financial markets research capabilities within the company and will remain based in Dublin, Ireland. I will also continue teaching in Irish universities and conduct academic research.

This blog will continue its independent existence.


"In December 2010, Olli Rehn joined those of us that had long been forewarning of financial contagion in Europe, when Mr. Rehn declared, “We have to stop the bush fires turning into a Europe-wide forest fire.” Yet the fires continue to rage on, fueled by ever increasing amounts of debt ultimately provided by European taxpayers, an unfairly disproportionate share of them being Irish.

Now, nearly 6 months later, the dead wood of Europe’s financial sector is far from secure against the potential of an even greater conflagration this summer. The ECB-supplied liquidity intended to douse the flames of many local bush fires sparked during the summer of 2010 has grown to proportions few had foreseen – proportions that few are willing to continue subsidizing as evidenced by the growing intransigence of some of Mr. Rehn’s compatriots in Finland who have said, “Enough”.

The Greek spark that initially lit the European forest fires of debt risks is now becoming a consuming fire – after collapse of the interbank lending, many sovereign borrowers today no longer can find a market for their debts. Contagion from the sick banks to the Governments’ balancesheets and now back to the banking system across the EU is nearly complete.

In the same way that planting new saplings is essential for forest management after a major forest fire, there is a need for new institutions to emerge now, in the midst of the crisis, to establish themselves in order to serve the economy in years to come and to grow into a more substantive role as the failed institutions are finally allowed to fail.

St. Columbanus AG is committed to a long-term vision for economic vitality based upon sound business and investment practices in order to create the commercial opportunities for growth and development necessary for a strong European future.

The approach of Switzerland as a global financial center is shifting; the old model of "tax-neutral" capital is fading. A new model of secure "tax-declared" capital is developing, based firmly on the
foundations of sound risk management and long-term investment strategies. Thus, throughout the current crisis, Switzerland continues to provide Europe its traditional role of a safe haven.
St. Columbanus seeks to participate in this push toward tax-declared assets/capital, to learn from it and to develop on the basis of Swiss financial model new products that can address the concerns of today’s clients.

In the past years, we have seen an overemphasis upon derivatives and exotic products that maximize profits for a few people, but to what real benefit of society as a whole? Our own analysis, as well as global market research, clearly show that ordinary investors today are now more concerned with safety, security, long-term growth, transparency and clarity of products and strategies.

On the other hand, failed model of financial engineering has taken hold of the policy responses to the crisis. This makes the world around us inherently less safe. Consider for example the new strikes in Greece as a sign of "social stability" made possible by the efforts to financially engineer Greece's balance sheet?

In our view, Europe today needs competition, and sound financial innovation that is in tune with the clients needs and not with the margin demands of the asset managers. We need to create and to sustain an healthy financial sector. Playing a part in this renewal is the long term vision of our asset management initiative. We will seek to fully participate on several levels in strengthening the fundamental financial landscape across Europe.

Returning to Mr. Rehn’s metaphor, a Forest take generations to grow and only hours to destroy. While a single undertaking like St Columbanus AG cannot be the sole driver of the change required to renew Europe’s financial health, we hope to play a role in this by planting one of the first saplings of the new asset management model.

Declan Ganley & Dr. Constantin Gurdgiev."

27/03/2011: Annual GDP and GNP - few lessons to be learned

I haven't had time to update QNA numbers on the blog, but here's a nice preview charts of analysis to come.

First annual GDP and GNP:
When I often say that over the last 3 years we've lost a war, I mean it: relative to peak 2007 levels, our real GDP is down 12%, our GNP is down 16%. Our 2010 GNP clocked the level of 2003-2004 average, erasing 7 years of growth. Our GDP is now at the level of 2004-2005.

What about the composition of our GDP and GNP?

The above is just a snapshot. Here are headline figures:

• Agriculture, forestry & fishing sector output in constant prices is now 10% down on 2007 (remember - we were supposedly having a boom in this sector in 2010 according to the various CAP-dependent quangoes, and still the preliminary output came out at a miserly €3,328 million - the lowest in 8 years).
• Industry had a better year, with output rising to €48,111 million, up on €45,841 million in 2009, but still 7% down on 2007.
  
• Building & construction sector shrunk 58% on 2007 levels, posting output worth just €5,754 million in 2010, down on €8,433 million in already abysmal 2009.
• Distribution, Transport and Communications sector shrunk 13% in 2010 relative to 2007. 2010 sector output was €21,509 million against 2009 level of €21,845 million.
• Other services have fared better than other sectors, posting a decline of 6% on 2007 levels. In 2010 the sector brought into this economy €71,828 million against €73,823 million recorded in 2009.
• Public Administration and Defence - the sector that has been allegedly (per our Government and Unions claims) hit very hard by the austerity has managed to "contribute" €6,243 million in 2010 - slightly down on €6,416 million in real euros in 2009. Relative to peak 2007 levels, Public Administration and Defence "contribution" to our GDP/GNP has fallen by a whooping ZERO percent. That's right - zero percent. In 2007 the 'sector' posted GDP contribution of €6,266 million.
• Taxes, net of subsidies, have fallen 31% in 2010 relative to 2007 and 'contributed' just €16,027 million in 2010 compared to €16,807 million in 2009. Tax hikes are working marvels for the Government, then. Keep on the course, Captain!
• Net Factor Income from the Rest of the World has increased steadily from 2007 levels, posting an outflow of -€29,313 million in 2010, up on outflow of -€28,184 in 2009 and a massive 31% above 2007 levels. These outflows represent the GDP/GNP gap that has expanded from 15.17% local minimum in 2006 to 21.67% today.
  

Now, let's take a look at percentage contributions to GDP and GNP from each line of QNA:
So while economy shrunk, Public Administration and Defence grew in overall importance as a share of GDP.

19/03/2011: Retail sales & Consumer confidence

In the previous post I suggested that the latest inflation figures do not bode well for 'growth-linked inflation, but signal instead the worst kind of inflation - inflation that is driven by either imports or regulatory factors. Here's more evidence - consumer confidence and retail sales figures:
Larger markers in the above chart show February values - clearly, no sign of demand drivers for price increases anywhere in sight here. Same holds for consumer confidence as a driver.

19/03/2011: CPI update for February 2011

Some belated data charts updates. Irish CPI:
The chart above shows the uptick in February CPI (up 0.9%mom and 2.2% yoy) and HICP (up 0.9% mom and 0.9% yoy).

Annualized rates below:
Should we read this as a welcome catch up of prices due to demand changes or due to factory gates tightness? Not really. Take a look at components:

Housing, Water, Electricity, Gas & Other Fuels up +9.5% yoy, Miscellaneous Goods & Services +4.8%, Health +4.1% and Transport +3.5%. Deflation continued in Clothing & Footwear -4.6%, Education -2.9% and Furnishings, Household Equipment& Routine Household Maintenance -2.6%.

Food & Non-Alcoholic Beverages prices were up +0.7% mom and +1.2% yoy to February 2011. This compares to deflation of -8.0% yoy in February 2010. Mom, food prices increased by 0.7% while non-alcoholic beverages prices increased by 2.0%. So we know it wasn't the commodities prices inflation that drove our food prices. Especially since commodities-linked prices of bread&cereals deflated by -3.8%, other milk products -0.9%, other cereals -0.7%, cheese -0.6% and margarine & low fat spreads -0.5%, while butter rose +3.8%, preserves by +15.3%, as sweets and chocolate fell 1.3%. And so on... all over the place, really.

Housing, Water, Electricity, Gas & Other Fuels costs increased by 0.5% mom and by 9.5% yoy. There was a decrease of 10.6% yoy to February 2010. Mom, prices rose for liquid fuels (i.e.
home heating oil) +2.7%, materials for maintenance & repair of dwelling +1.5%, rents +1.0% and bottled gas +0.5%. A price decrease was recorded for mortgage interest -0.1%. But wait, yoy rents rose 0% and mortgage interest rose 20.3%. Clearly, credit crunch is raging for homeowners. One of the core remaining construction-related sub-sectors still standing is maintenance & repair of dwelling. This was down 0.1% yoy in terms of materials, but a significant -5.5% in terms of services - so work wages are down, but inputs on materials side is basically flat. Materials were up 1.5% mom and services were flat in February 2011. Given we import much of the former and retain domestically much of the latter, the news of overall monthly inflation in this category is really not good for Irish economy. We got the wrong end of inflation, folks - inflation that undermines our real incomes without supporting new jobs!

Electricity, gas and other fuels were up 10.5% yoy as a category, electricity up 3.2%, natural gas double that at 6.4%, liquid gas up 37.3% yoy. Again, wrong inflation for growth and much of it is due to changes in taxation structures, state companies surcharges and so on.

Health is a standout in the above chart. Down 0.6% mom but up 4.1% yoy. No need to explain why the cost of hospital services rose 11.5% - say 'Thanks' to our semi-state insurance company policies and the Budget, but not for the insurance prices increases - those are in the Miscellaneous Goods & Services where health insurance rose a massive 17.6% yoy and 14.4% mom.

Now - my exclusive - as usual, the breakdown of inflation by state v private sectors:
Or cumulative Rip-Off Government Policies effects:
Yet another legacy of the Social Partnership folks - as the Big Domestic Business (aka semi-states), State Quangonoids and Unions - the Real Golden Circle - take another bite at the economy's pie. The real economy is still on the edge of continued deflation (+0.1% mom), while the surreal Social Partnership-controlled economy is roaring ahead with 1.04% mom inflation, to 2011 fat bonuses. Happy times, as Borat would put it.

19/03/2011: Updated probabilities of default

Updated probabilities of default and spreads on Irish bonds. As usual, a preventative disclaimer - this is just simple mathematical estimate - what the numbers say. No comment to be added.
Cumulative spreads tell us how much more we are expected to pay for our borrowings over Germany's cost of fiscal deficit financing, over the period of bond maturity. 85% more for 10 years borrowing currently.

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.

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.

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. [See comment above]

“…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:

• 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."
  

Now some most excitingly interesting charts:

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!

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.

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 -

1. The first table covers yesterday close yields on generic IRL bonds by maturity
2. 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.