23/11/2011: Is there a run on the euro?

So let's ask that uncomfortable question: is there a run on the euro going on that is being carried out by ... the European banks? Or in other terms, have the European banks lost their fate in the invincibility of the Euro?

It appears to be quite possible, folks. Per Bloomberg report (here), 'foreign banks' deposits with the Federal Reserve have risen from USD350bn at the end of 2010 to USD715bn as of September 30. And per Bloomberg report, the number of foreign banks with deposits at the NY Fed in excess of USD1bullion rose from 22 at the end of 2010 to 47 at the end of September 2011.

And there is more: "demand for Treasury securities that mature in under a year has increased as financial institutions boost holdings of the highest-quality assets to meet new regulations set by the BIS in Basel, Switzerland. Bank holdings of Treasuries and government-related debt totalled a record of USD1.69 trillion at the end of October 2011, up from less than USD1.1 trillion in 2008," per Bloomberg.

More signs of a run on the euro: "Rates on 3mo [US Treasury] bills ended last week at zero, down from this year's high of 0.157% in February and 5% in mid-2007..." said Bloomberg report. This is linked in the report to the banks hoarding USD-denominated assets while dumping euro-denominated assets. And the price of 3mo cross-currency basis swaps (used by the banks to convert euro into USD) fell to the levels consistent with the spread of 132bps on euro interbank offered rate. In other words, the price of converting euro into dollars in the interbank markets is now the highest since December 2008.

And things are getting scarier - since the EU plans for bonds, more bonds and quasi-bonds announcement today, the US Treasuries shot through the roof. Today's sale of 5-year USD35bn US Treasury notes came in priced at a yield of 0.937% - the lowest on record. The cover was a hefty 3.15 - the highest since May 2011 and above 2.82 average cover in last four auctions.

This is not going all too well, is it? And then there's ZeroHedge piece on the run on European assets and banks from around the world (here).


Amidst all of this, it is ironic (or may be it is iconic) that just few weeks ago on September 26th (see link here), Mario Monti - or "Fool Monti" as I came to call him in a pun - stated:

"Oggi stiamo assistendo al grande successo dell'euro e la manifestazione più concreta di questo successo è la Grecia, costretta a dare peso alla cultura della stabilità con cui sta trasformando se stessa"
or translated:
"What we are witnessing currently is the great success of the euro, and its most solid demonstration is that of Greece, which is being compelled to adopt the culture of stability and transform itself".

Detached, clueless and in denial, even when appointed as 'technocrats', let alone elected, euro elites are really not a good example of the leaders we need.

22/11/2011: Contagion Complete - IMF goes leverage

So, the IMF has made a ‘bold’ move, announcing two measures custom-tailored to shore up the insolvent Euro zone until something else, miraculously and unexpectedly cures its deadly disease of too much debt against too low of the quality of its growth.

Details of the latest ‘Leverage Like Lehmans’ scheme.

The Precautionary Credit Line (PCL) “has been established to provide effective crisis prevention to members with sound fundamentals, policies, and institutional policy frameworks that have no actual balance of payments need at the time of approval of the PCL, but moderate vulnerabilities that would not meet the FCL’s [The Flexible Credit Line – see below] qualification standard.”

That’s a mouthful of gibberish. According to the IMF, totally healthy economies will be lining up to borrow from IMF even though they can access funding in the normal markets. Otherwise, they’d be in a distress and ‘prevention’ would really mean ‘once sh*t hits the fan’. Oh, and per IMF, it will be countries that actually don’t really need to borrow as such at all, as they will “have no actual balance of payments need at the time of approval of the PCL”. In other words, PCL aims to supply emergency credit to countries not in emergency and in no need of credit. Yes, folks, indeed they will.

“Members may request an arrangement with duration of between one and two years. Access under an arrangement with one-year duration shall not exceed 500 percent of quota, with the entire amount being made available upon approval of such arrangement and remaining available throughout the arrangement period subject to an interim six-monthly review.”

Here we have it again – if the PCL-using members sport “sound fundamentals, policies, and institutional policy frameworks” and “have no actual balance of payments need at the time of approval of the PCL”, why would IMF need to perform an interim review, especially within such a short time frame as 6 months? Normally, such reviews are carried out to ensure compliance with lending conditions that are designed to stabilize and fiscally improve borrowers’ performance. But, clearly, borrowers with ‘sound fundamentals’ etc have no need to improve their fiscal and economic performance.

“Access under an arrangement with a duration of more than one year shall not exceed 1000 percent of quota, with an initial amount not in excess of 500 percent being made available upon approval of the arrangement and the remaining amount being made available at the beginning of the second year of the arrangement subject to completion of the relevant six-monthly review. Purchases under PCL arrangements are repayable in 8 quarterly instalments 3¼ - 5 years after disbursement.”

So in effect, the IMF has created an up to 7 years lending facility (5 years to repayment from disbursement, plus 2 years to repay) which is roughly speaking similar to their ‘normal’ Lender of Last Resort (LOLR) loans. And that is for members with, recall, ‘sound fundamentals’ and in no need of borrowing. Presumably, you can see Sarko applying for one of them PCL loans to build Disneyland Paris Deux.

And notice the number – at 1000 percent the IMF will be leveraging member contribution some 10 times, to lend against SDRs. That’s a hefty leverage, especially in today’s terms.

The second facility created is less bizarre, although no less disturbing.

“Flexible Credit Line The Flexible Credit Line (FCL) has been established to allow members with very strong track records to access IMF resources based on pre-set qualification criteria to deal with all types of balance of payments problems. The FCL could be used both on a precautionary (crisis prevention) and nonprecautionary (crisis resolution) basis.”

So now, distressed sovereigns can borrow from the IMF either on the needs-based principle (just as the current lending by the IMF goes, except without any caps on how much they can borrow – see below) or on the ‘precautionary’ basis (presumably once you smell the rot, you can get IMF pre-approve you for a mortgage). The former is really a blank cheque for loans to existent and future delinquents. The latter is for those delinquents playing chicken with the markets: who finds out who first – the markets find out the dodgy sovereign or the dodgy sovereign finds the IMF.

“Members may request either a one-year arrangement with no interim reviews, or a two-year arrangement with an interim review of qualification required after twelve months.”

Now there’s something funny going on here. In PCL, a non-distressed sovereign with ‘sound fundamentals’ and in no need of borrowing will be lent to on the back of bi-annual reviews. In the FCL, a dodgy sovereign with unsound fundamentals (BOP crisis) will be borrowing without a review. I have no idea what is going on through the IMF minds, but might this be that the Fund’s effectively abrogating from any enforcement on LOLR loans in the Euro area?

“Upon expiration, the Fund may approve additional FCL arrangements for the member.”

Re: there is no time limit on the loans, so in effect the FCL can be the replacement of the existent more stringent LOLR loans

“Access is determined based on individual country financing needs and is not subject to a pre-set cap. Purchases under FCL arrangements are repayable in 8 quarterly instalments 3¼ - 5 years after disbursement.”

So there is unlimited leverage that is allowed under the FCL. Not even 1,000% or 10,000%, but ‘not subject to a pre-set cap’. Potentially, we are talking Lehman^n where n is any number between zero and… well ‘not subject to a pre-set cap’. The reason such extreme levels of leveraging are needed is that the European clients for whom such programmes are designed need well in excess of their SDR-linked funds, even if these are leveraged at 1,000%.

You see, leveraging SDRs (see allocations here) at 1,000% would allow

• Spain to borrow some SDR40,234mln or roughly speaking (at 1SDR=€1.355) €54.5bn through which Spain will burn, oh, in about 3 months post borrowing.
• Italy to borrow some SDR78,823 or €107bn which won’t float “Fool” Monti for too long.
• Portugal to borrow SDR10,297mln or €13.95bn which is quite below the €20-25bn that it will require in Bailout-2 (see the story here) and that assuming that we leverage it up on top of already leverage-ridden Bailout-1 SDRs.
• Ireland to borrow SDR12,576mln or €17bn – not bad, but not exactly a windfall should Irish economy take a turn for the worst. Note, this is roughly equivalent to what Blackrock estimated will be the losses on owner-occupied mortgages in IRL3 ‘big banks’. Oh, and don’t forget, like Portugal – we are already levered on our SDRs under the Bailout-1.
• Greece, well, assuming Greece can borrow anything else from the IMF, since it managed to double-lever its SDRs in Bailouts-1 and 2 already, to borrow some SDR11,018mln or a miserly €14.9bn.

All of this simply means that if PCL/FCL to have any effect on Euro area debt crisis, it will have to be used as levered borrowing well by the likes of France and Germany to raise funds for… well, might it be EFSF? In other words, solvent member states can claim access to PCL to ‘insure’ private sector buy-in into EFSF. A sort of borrow to buy insurance policy stuff.

We, thus, are no longer in the world with over-leveraged banks, but in the world with over-leveraged banks, central banks, & at last, the over=leveraged lender of last resort. That’s what I call ‘Contagion Complete’. Next stop on the Euro train – the mine shaft. All aboard!

21/11/2011: Sunday Times 20/11/2011 - Exporting our way out of recession

Here's the unedited version of my article for Sunday Times (November 20, 2011).

The latest trade statistics, released this week were, as usual, greeted with enthusiasm by the growing media tired of the adverse newsflows. From the headline figures, preliminary data shows that seasonally adjusted exports of goods rose 2% to €7.9 billion in September, and the trade surplus jumped 11% to €4.1 billion. This makes September trade surplus second highest on record.

Trade in goods in general has been going through a boom, rising from the annual trade surplus of €25.7 billion at the bottom of the peak of the Celtic Tiger era in 2007 to €43.4 billion last year. Data through the first nine months of this year suggests that our annual trade surplus will post another record in 2011, finishing the year at some €43.8 billion.

For years we have been told by two successive governments that Ireland’s recovery will be exports-led. The latest data appears to be supportive of this. Except, appearances can be deceiving.

Consider closer the monthly goods trade data. September increase in trade surplus was, in fact, driven as much by rising exports (up €193 million month-on-month), as by shrinking imports (down €208 million).

Given deep cuts in consumption goods imports in 2008-2010, any recent reductions in imports are primarily reflective of the changes in demand for intermediate inputs into production of our exports. In other words, trade surpluses based on imports reductions are not sustainable in the medium term. This is evident from the longer-term statistics. In H1 2011, Irish trade surplus in goods was up only 3.4% year on year. In H2 2011, based on latest data, trade surplus might actually fall some 2% year on year. Back in November 2010 4 year programme, the Government projected that in 2011 exports will increase 5% and imports will rise just 2.75%, which would have implied an annual goods trade balance of €47 billion this year. It looks now that this projection might be undershot by over €3 billion. Not exactly an optimistic picture.

This performance is worrisome for another reason. The above data, cited most often as the core driver of our economic ‘recovery’ relates solely to trade in goods. Yet, the overall balance of trade for the country includes net exports of services. We have to rely on the Quarterly National Accounts data to gauge overall trade balance in both goods and services.

Full trade data we have covers only the first half of 2011 – the period before the latest slowdown in Euro area, UK and US economies became pronounced. Despite this, the data shows some emerging strains on the side of Ireland’s full trade surplus. Year on year, exports of goods and service through H1 2011 were up 5.8%, but imports increased 6.1%, which means that the trade surplus expanded by just under 4.7%.

Exports-led recovery may be starting to falter. In 2009, trade balance for goods and services grew at a massive 52.5% year on year. Last year it expanded by 19.7%. This year, so far, annualized rate of growth is just under 4.7% and that was under more benign global growth conditions that prevailed through June 2011. Budgetary projections were for a 14.7% expansion on total trade surplus for 2011 – 3 times the current rate.

If ‘exports-led recovery’ was really able to carry us out of the economic doldrums, much of the external trade growth now appears to be behind us in 2009-2010. It didn’t happen. Why? Exports growth is good, creates jobs and huge value added in our economy. But exports are not enough, because Ireland is not an exports-intensive economy. It is a multinationals-intensive economy.

Let’s take a look at the National Accounts. In Q2 2011, Net Factor Income outflows from Ireland – largely multinational profits – accounted for 21.4% of our GDP, 20.3% of all our exports and equal to 100% of the entire trade balance in goods and services. In other words, in national accounts terms, trade basically pays for itself, plus small employment pool of workers. And that’s about it.

This is not surprising. In 2010, one category of trade: Organic Chemicals, Medicinal and Pharmaceutical Products accounted for 86.1% of our entire trade surplus. Between 2000 and 2009, the same sector average contribution to trade surplus was 84.1%. Total food and live animals – the indigenous companies-dominated exporting sector – combined trade surplus in 2010 was just €2.4 billion or some 16 times smaller than the trade surplus from the Organic Chemicals, Medicinal and Pharmaceutical Products category.

This reliance on MNCs-dominated sectors presents significant risks to our trade flows going forward.

Firstly, Ireland-based MNCs face the risk of the much-feared ‘patent cliff’ threatening the pharma sector. Various estimates put the effect of the blockbuster drug going off-patent at a staggering up to 80% reduction in revenues within the first 3 months after patent expiration. In the next 3 years, according to some estimates, this fate awaits approximately 30-35% of our MNCs sales. This can see our trade balance dropping by almost €6 billion in the first year of impact.

Secondly, lack of diversification in sectoral patterns of trade – further reinforced by the fact that computer equipment exports are now down 11% year on year in the first 8 months of 2011 – is paralleled by the decline of regional diversification of our exports. In 8 moths through August 2011, 18.7% of our exports went to the countries outside the EU and US. A year ago, the same number was 19.1%. Ireland’s trade with the largest emerging and middle income economies, such as the BRIC countries, remains virtually static and minor year on year at just €2.2 billion or less than 3.7% of our exports. Our trade balance with the BRIC countries stood at unimpressive €80.2 million in January-August 2010 and has fallen to €70.3 million in the same period of 2011. You get the picture: Ireland is missing out on booming trade markets.

Thirdly, recent proposals in Washington – combining a potential reduction in the US corporate tax rate with a tax holiday for repatriation of US MNCs’ profits back into the US can have profound effects here. Just a 25% acceleration in repatriation of profits by the US multinationals can result in GDP/GNP gap rising to 22.5% by 2016 against current 17%. This, in effect, will mean that Irish economy will be sending abroad more funds in repatriated profits than the entire trade surplus brings into the country.

The risks we face on our exporting sectors’ side point to the reasons why exports-led recoveries are rare in general.

Historical evidence, across the euro area states, taken over the period of 1990-2010 clearly shows that, in general, countries do not reverse external imbalances overnight. Only two out of 17 euro area countries, Austria and Germany, have managed to switch from persistent current account deficits in the 1990s to current account surpluses in 2000-2010. Evidence also shows that between 1990 and 2009, no country in the Euro area was able to achieve average current account surpluses in excess of 5% annually and only one country – the Netherlands – was able to deliver average surpluses of over 4% of GDP. Given Ireland’s Government debt overhang, we would have to run over 4% average surplus for a good part of the next two decades if exports-led growth were to be the engine for our economic recovery.

Ireland’s exporters are doing a stellar job trying to break out of the globally-driven patterns of trade and generate growth well in excess of that delivered by other countries around the world. The real problem is the unreasonable expectations for the exports-led recovery that are bestowed upon them by the Government. If Ireland is to develop an indigenously anchored robust export-driven economy, we need serious policy reforms to facilitate domestic investment and entrepreneurship, know-how and skills acquisition and ease access to trade for our services and goods exporters. So far, the Government has been talking the talk on some of these reforms. It is yet to put its words into action.

Box-out:

The continued turmoil in the Euro area sovereign bond markets presents an interesting sort of a dilemma for investors around the world. By all possible debt metrics, Japan is more insolvent than Italy or all of the PIIGS combined. In addition, barring the latest quarter uplift, Japan had not seen appreciable economic growth in ages. And yet, Japanese Government bonds yields are falling and the country is perceived to be a sort of safe-haven for investors fleeing the beleaguered Euro area. Why? The short answer to this question is – investment risks. There are tree basic investment risks when it comes to bonds. The first risk is that of future interest rates increases. If interest rates were to rise, currently trading bonds will see their price drop, devaluing the investment. Japan is less likely to rise interest rates any time in the near future than the ECB, as it faces significant costs of rebuilding its economy and its high debt levels require lower interest rates financing. The second risk is of high inflation. Once again, Japan wins here, as the country had sustained periods of near-zero to deflationary price changes in its recent past. In addition, the country is no more susceptible to importing inflation from the global commodities markets than Europe. Lastly, there is the set of re-investment, credit and default risks, which in the nutshell boil down to the risk that the issuing sovereign will not be able to roll over current bonds for new ones at maturity. Of course, in the case of Japan this can happen only if investors refuse to accept new bonds in a swap for old bonds. But in the case of European states, this can happen also if the euro were to break up between now and maturity period (in which case the swap will not be like-for-like) or if the collective entity – the EU – were to compel sovereign bond holders to accept haircuts at some future date. With both these possibilities being open in the case of, say, Italy, Japan – as sick as its economy might be – presents a potentially lower risk bet for many investors today.

21/11/2011: Residential Property Prices: October

Sorry to break the bad news, folks, but the latest Residential Property Price Index (RPPI) for October is showing accelerating property prices declines on foot of already substantial rates of contraction registered during 2011 as a whole. the bust is getting bustier.

All properties index fell to 71.2 in october from 72.8 in September, posting a monthly decline of 2.20%. This is the sharpest rate of monthly contraction in prices since March 2009 and the third fastest rate of decline in the history of the series! 3moMA for RPPI is now at 72.63. Year on year prices are now down 15.14% - the highest yoy decline since February 2010. Relative to peak prices are down 45.44%. 12 mo MA is at -1.36% for mom rate of decline and year-to-date rate of prices declines average -1.49%.

When it comes to Nama, relative to its cut-off date of November 30, 2009, property prices are now down 24.17%. When fully set up, Nama called bottoming out of the markets for Q1 2010. Since then, prices are down 20.62%, so those highly paid geniuses employed by Nama to 'value' properties and 'assess' markets are really shining stars. Recall that Nama paid an uplift of LTEV on assets purchased of an average 10%, plus carries a burden-sharing discount / cushion. Factoring these two into the equation, Nama-assessed properties are now held at a loss of 27.79% on their Nama valuations, even with burden sharing cushion 'savings' factored in. Taken across Nama book value, these (for now paper) losses can be assessed at ca €8.3bn.

Let's drill deeper. House prices sub-index is now at 74.3 against 76.0 in September, a decline mom of -2.24% the largest monthly drop since June 2011. 3moMA now stands at 75.77 and year on year change in the sub-index is 14.89% - the steepest annual decline rate since February 2010. relative to peak house prices sub-index is now -43.71% off. 

Apartments prices sub-index fell from 53.2 in September to 52.2 in October, a mom drop of 1.88% shallower than September mom decline of 3.10%. 3moMA is now at 53.43 and year on year sub-index is down 19.81% - the steepest annual decline since April 2010. Relative to peak, apartments prices are now off 57.87%.

Recalling that Nama holds loads of assets written against apartments, Nama cut-off-date valuations, LTEVs and burden sharing cushion included, Nama valuations for apartments-related properties are now off 35.10%.

Chart above shows the price dynamics for Dublin properties. Dublin sub-index stands at 63.1 against September reading of 65.1, a mom decline of 3.07% - steepest since the catastrophic drop of 3.76% in August this year. 3mo MA is now at 64.9 and year on year prices in Dublin are down 17.52% - largest yearly decline since March 2010. Relative to peak, Dublin residential prices are down 53.09%.

Given the above, we can update projections for the core index and sub-indices for 2011 as a whole. These are shown below.

Depressing is the word that comes to mind. The picture is made even less palatable when we recall incessant blabber from our Government reps and stuff-brokers, as well as property 'experts' that inundated the earlier parts of the year with 'property prices will bottom out in H2 2011' noise.

18/11/2011: Mortgages Arrears for Q3 2011

Data for Irish Mortgages defaults for Q3 2011 was released today by the Central Bank and is already causing some commotions. That is because by the broader metric I deployed recently, including in last week's Sunday Times article (see here), we are now beyond 100K number when it comes to mortgages at risk.

let me un through the figures. Note that the CB has changed methodology for reporting back in Q3 2010, expanding reporting. So I estimated some of the sub-series back to Q3 2009 when the narrower reporting was first introduced. Thus, caution should be applied to taking Q3 2009-Q2 2010 data. Also, note that 2011 figure - corresponding to Q4 2011 - is a forecast based on mortgages arrears dynamics by each subcategory of mortgages.

• In Q3 2011 there were 773,420 mortgages outstanding in Ireland a decline of 3,901 on Q2 2011 (-0.5% qoq) and 15,325 yoy (-1.94%). This represents a drop of 2.7% or 21,189 mortgages on Q3 2009.
• The outstanding value of mortgages has declined €676,166 or 0.59% qoq to €114.41bn down from €115.09bn in Q2 2011 and €117.40bn in Q3 2010. Note that in Q2 2011 Irish household deposits were €87.00bn which implies that Mortgages to Deposits ratio in Ireland is at 131.5% well ahead of the LTDs mandated for the irish banks for all loans at 125.5%.

Of the above mortgages:

• In Q3 2011 there were 62,970 mortgages in arrears 91 days and over with the balance of €12.37bn. This represents an increase of 7,207 mortgages qoq (+12.92%) and 22,498 mortgages yoy (+55.59%). Compared to Q3 2009, the number of mortgages in this category is estimated to have risen by 36,699 mortgages or 139.7%. In terms of value of the mortgages in arrears, the value rose 14.13% qoq and 58.7% yoy. I mentioned in the previous articles on the subject that we can expect faster increases in mortgages in arrears values, rather than numbers as arrears primarily hit most those households that tended to borrow more in the years around the peak of the property markets.
• Repossessions also rose from 809 in Q2 2011 to 884 in Q3 2011 (+75 or 9.27% qoq). Repossessions are now up 69.7% yoy (+363) and are estimated to have risen 501% on Q3 2009 (+737).
• Restructured loans that are no in arrears are down from 39,395 in Q2 2011 (value of these loans was €6.66bn) to 36,376 (€5.93bn) - a decline of 3,019 mortgages qoq or 7.7%. Year on year these mortgages are up 9.7% or 3,212.

Based on the above we can define mortgages at risk and defaulted to include all mortgages that are currently in arrears, all mortgages that are restructured, but are not in arrears and mortgages that went through the repossessions. 

• In Q3 2011 total mortgages at risk or defaulted stood at 100,230 with the total value of €18.3bn, up 4,263 mortgages (+4.4%) qoq and 26,073 mortgages (+35.2%) on Q3 2010. Since Q3 2009 these mortgages rose in number some estimated 125.9%. In value, mortgages at risk or defaulted have risen €803mln qoq (+4.6%) and €10.5bn yoy (+134.7%).

As chart above summarizes, percentage of mortgages at risk relative to overall number of mortgages has risen in Q3 2011 to 12.96% from 12.35% in Q2 2011. The value of mortgages at risk has increased from 15.2% of all mortgages value to 15.99%.

It is worth noting that Q3 dynamics represent a marked slowdown on the rates of increases in mortgages at risk in previous quarters. This decrease is accounted for as follows:

• Total number of mortgages outstanding paydown slowed from -0.65% in Q2 2011 relative to Q1 2011 to -0.50% in Q3 2011 relative to Q2 2011. This means that the base decline was slower, pushing down the percentage change in the relative share of mortgages at risk.
• Number of mortgages in arrears rose +12.9% in Q2 2011 relative to Q1 2011 and this rate was +12.4% in Q3 2011 relative to Q2 2011 - hardly a marked slowdown here.
• Number of mortgages restructured but not in arrears rose +7.5% in Q2 2011 relative to Q1 2011 and declined -7.7% in Q3 2011 relative to Q2 2011 - this is the core driver of mortgages at risk growth slowdown. Unfortunately we do not know if this decline was driven by these mortgages exiting the restructuring arrangement by going into arrears, or returning back to performing mortgages (for how long can these be expected to remain there is another question), or going into new renegotiations for further restructuring.

17/11/2011: INTO is correct on JobBridge Scheme

INTO has issued a direction to its members not to co-operate with the Government's JobBridge scheme. The details are reported here.

While I extremely rarely find myself in agreement with INTO, this time around I think their position is compelling. If JobBridge scheme were to be used in the case of teaching staff, then this means that there are:

1. Teaching positions unfilled (otherwise how can a JobBridge position materialise), 
2. Teachers with incomplete qualifications who can benefit from on-the-job training, and
3. There are no teachers who are fully qualified and are unemployed.

It appears that this is not the case. Per INTO, there are unemployed qualified teachers (violating 3 above) and there are, supposedly, no vacancies to employ these qualified teachers (condition 1 violated). In this environment.

If there are positions that are unfilled in the presence of unemployed teachers, these unemployed teachers should be hired with normal pay to do their jobs. 

If there are no positions unfilled, and the schools want to create new positions, there should be no discrimination between those coming into the new jobs that are identical to existent jobs in terms of responsibilities.

The JobBridge scheme should not be used to employ people doing normal work at lower pay. It should only be used to provide skills training in very limited set of circumstances where apprenticeships are suitable. In fact, we need a real apprenticeship schemes, not a JobBridge scheme.

16/11/2011: Irish Mortgages Crisis

Unedited version of my latest Sunday Times article (November 13, 2011).

Per latest data available to us – at the end of June 2011, there were 777,321 outstanding mortgages in Ireland. Of these, 55,763 mortgages were in arrears more than 90 days, up 53% on same period a year ago. In addition, 39,395 mortgages were ‘restructured’ but are currently ‘performing’ – in other words, paying at least some interest. Adding together all mortgages in arrears, repossessions, plus those that were restructured but are not in arrears yet, 95,967 mortgages (12.3% of the total) amounting to €17.5 billion (or 15.2% of the total outstanding mortgages amount) are currently at risk of default, defaulting or have defaulted.

Given the trend in these developments to-date, we can expect that by the end of 2011 there will be some 114,000 mortgages in distress in Ireland. By the end of 2012 this number can rise to over 161,000 or some 21% of the total mortgages pool in the country.

This is a staggeringly high number. When considered in the light of demographic distribution and vintages, 21% of all mortgages that are likely to be in arrears around the end of 2012-the beginning of 2013 will account for up to 30% of the total value of mortgages outstanding.

Mortgages at risk of default

Source: Central Bank of Ireland and author own calculations

This is a simple corollary from the fact that mortgages crisis is now impacting most severely families in their 30s and 40s, with more recent and, thus, larger mortgages signed around the peak of the property bubble. These households are facing three pressures in today’s environment.

Firstly, they are experiencing above-average unemployment and income pressures. Per Quarterly National Household Survey, in Q2 2011, unemployment rate for persons aged 25-34 was 16.5% and unemployment rate for those in age group of 35-44 was 12.4, both well ahead of the 8.95% average unemployment rate for older households. By virtue of being more concentrated in the middle class earning categories, they are also facing higher tax burdens than their lower-earning younger and more asset-rich older counterparts.

Secondly, they are facing higher costs of living, further depressing their capacity to repay these mortgages. More likely to live on the outer margins of commuter belts, our middle-income earners are facing more expensive cost of commute, courtesy of higher energy prices, high taxes associated with car ownership and the lack of viable public transport alternatives. In September this year, prices of petrol were 15.4% above their levels a year ago. Inflation in diesel prices is running at 14.8%. Cost of road transport increased 5% in a year through September, and bus fares are up 10.8% These households are also facing higher costs associated with raising children. Since the time these families bought their houses (e.g. 2005-2007), primary and secondary education costs went up 21-22%, and third level education costs rose 32%. On average, larger families require greater health spending, the cost of which rose 3.4% year on year in September and now stands at 16% above 2005-2007 levels. The three categories of costs described above comprise ca 19% of the total household budget for an average Irish household and above that for a mid-aged household with children.

Thirdly, as their disposable incomes shrink and mortgage costs rise (mortgages-related interest costs are up 17.2 year on year and 11% on 2006), the very same households that are hardest hit by the crisis are also missing vital years for generating savings for their old age pensions provisions and most active years for entrepreneurship and investment.

In short, courtesy of the crisis and the Government policy responses to it to-date, Ireland already has a ‘lost generation’ – the most economically, socially and culturally productive one. And this generation is now at the forefront of the largest homemade crisis we are facing – the crisis of mortgages defaults and personal bankruptcies.

Against this backdrop, the forthcoming Personal Bankruptcies Bill should form a cornerstone of the Government’s policy.

This week, the media reported some of the specifics of the forthcoming legislation, which include two crucial details: the 3-years release period for personal bankruptcy and the non-recourse nature of the arrangement. Under the former, the current period of bankruptcy will be cut from 12 years to 3 years, while under the latter, the new bankruptcy law will limit the extent of the household liability to the current value of the property underlying the mortgage. It is uncertain, at this stage, what claims, if any, can be levied against personal and family savings and other assets.

The provisions, as reported in the media, appear to be well-balanced for a normal bankruptcy reform, but remain excessively harsh for the legislation designed to tackle an acute crisis. Here’s what is needed.

A conditional bankruptcy release period for mortgages taken in the period of 2003-2008 should be set at 12 months subject to satisfactory completion of court-set conditions. Full release should apply after 3 years. There should be no restriction on companies directorships for those in the process, so as not to reduce entrepreneurship and small business ownership.

The lien against the personal income and assets should be designed as follows. No more than 25-35% of the after-tax disposable income can be diverted to the repayment of the mortgage, to allow for private sector rent payments. No more than 30% of the household assets below €25,000 can be used to repay the residual mortgage post-foreclosure. The amount can rise to 50% for assets valued between €25,001 to €50,000 and to the maximum of 70% for assets valued over €50,000. This will minimize losses to the banks, disincentivise strategic defaults and reduce moral hazard, while still allowing families to retain safety cushion of savings to offset the risks of sudden income losses or illness.

Banks objections to relaxing bankruptcy laws, raised this week, is that the new law will trigger a significant demand for capital as losses due to non-recourse clauses will be borne by the lenders. This is simply not true.

Firstly, with some claim on family assets in place, bankruptcy process will still be used only in the cases of extreme financial distress. A combination of a limited liability applying to some family assets and a 3-year repayment period will create both a disincentive to abuse the system and a cushion of burden sharing, reducing the end losses to the banks.  Savings on interest payments supports and legal costs will further reduce taxpayers potential exposure.

Secondly, the stress tests carried out earlier this year were supposed to provide ample supports for the banks against mortgages defaults. Blackrock estimates of the worst-case scenario losses on Irish mortgages over the life-time of the loans amount to €16.3 billion split between €10.2 billion owner-occupier and €6.1 billion for buy-to-let borrowers. Central Bank of Ireland assumed 3-year losses amount to the total of €9 billion. Reformed bankruptcy law is unlikely to raise the Blackrock estimates for life-time losses, but is likely to push forward the defaults that would have occurred outside the Central Bank-assumed time frame of 2011-2013. In other words, unless the stress tests performed were not rigorous enough, or the Central Bank assumptions on 2011-2013 defaults were not realistic, capital supplied to the banks post PCARs already incorporates expected losses.

Either way, there is neither an economic nor moral justification for using bankruptcy laws as a tool for locking borrowers in servitude to the lender. During the boom, the Irish state and banks have acted recklessly toward the very same borrowers. The duty of care to protect consumers and investors was abandoned by the previous Financial Regulator, the banks, public authorities in charge of regulating property markets and, ultimately, the Governments that presided over the system, which put full burden of risks associated with property purchases on the buyers. Remedying this requires giving distressed borrowers some powers to compel burden sharing vis-à-vis the banks.

Box-out:

This week, the entire world was consumed with the saga of Silvio Berlusconi’s resignation. Played out across the media – from print to facebook – the story of the ‘departing villain’ was almost comical, were it not tragic in the end. Tragic not so much in the inevitable rise in Italian bond yields, but in the sense of denial of reality that the media and political circus that surrounded Mr Berlusconi’s departure from power. Italy is a Leviathanian version of the zombie economies of Greece and Portugal. Between 1990 and 2010, Italian real GDP grew at an average rate of less than 1% per annum, less than half the rate of Spain, Greece and Portugal. Italian growth in exports of goods and services, over the same period was roughly one half of the rate of growth in Spain and 1.5 times lower than that for Greece and Portugal. Italy’s unemployment rate averaged just below that for other 3 countries. Italian fiscal deficits, at an average of 5.2% per annum, were greater than those of Portugal (3.3%) and Spain (3.1%), but lower than those in Greece (7.8%). Ditto for structural deficits. These are hardly attributable to Mr Berlusconi alone and are unlikely to be altered dramatically by his successors. While it is easy to point the finger at the internationally disliked leader, the truth remains the same – with or without Berlusconi, Italy is a nation with a dysfunctional economy.

15/11/2011: Q3 2011 Growth in Euro area

Latest data on euro area economies:

• France posted a quarter-on-quarter +0.4% in GDP in Q3 2011 after -0.1% contraction in Q2. Household spending +0.3% in Q3 from -0.8% decline in Q2. Domestic demand +0.3% from -0.3% fall in Q2. Production in goods and services +0.4% in Q3 compared to -0.1% drop in Q1.
• Germany GDP +2.6% y/y in Q3, 0.5% qoq and Q2 is revised up to +0.3% from +0.1% in preliminary release.
• Spain posted 0.0% growth qoq and 0.8% yoy growth in Q3 2011 against 0.2% qoq and 0.8% yoy growth in Q2 2011.
• Italy is yet to report data
• Overall, Euro area 17 posted 0.2% growth qoq in Q3 2011, same as in Q2 2011, with yearly growth of 1.4% in Q3 2011 down from 1.6% in Q2 2011. The slowdown is now evident in the yearly growth terms with Q4 2010 coming at 1.9%, rising to 2.4% in Q1 2011 and falling to 1.6% in Q2 2011 followed by the latest preliminary growth estimate of 1.4% for Q3 2011
• EU 27 also posted a slowdown in Q3 2011: Q4 2010 annualized growth was 2.1%, rising to 2.4% in Q1 2011, and falling back to 1.7% in Q2 2011 and 1.4% in Q3 2011. Quarterly growth rates in EU27 were 0.2% in Q3 2011 against 0.2% in Q2 2011, down from 0.7% in Q1 2011.

The above compares against:

• Q3 2011 growth of 0.6% qoq against Q2 2011 growth of 0.3% in the US. Yoy growth in the US was 1.6% unchanged from Q2 2011.
• Q3 2011 growth of +1.5% qoq against contraction of -0.3% in Q2 2011 in Japan. Yoy growth in Japan in Q3 2011 was -0.2% against -1.0% growth in Q2 2011.

Updated:


NY Fed manufacturing index reached back into positive territory, albeit barely, in November following five consecutive months of negative readings. Index rose to 0.6 in November from negative 8.5 in October. However, underlying conditions remained generally poor: new orders index fell to negative 2.1 in November from 0.2 in October and inventories fell to negative 12.2 in November from negative 9.0 in October. The employment index fell to negative 3.7 in November from 3.4 in October while the average workweek rose for the first time in six months. The prices paid index fell to its lowest level in nearly two years and this pressured margins.


U.S. retail sales were up 0.5% in October, driven by higher purchases online and higher spending on electronics and appliance. Sales of autos rose just 0.4% after a big surge in September while gasoline sales fell. Ex-auto sector, retail sales increased 0.6%. Retail sales for September were up 1.1%, were unchanged. Yoy through October retail sales are up 7.2%.

14/11/2011: Tourism to Ireland - Q3 2011 data

Q3 2011 data for overseas travel to and from Ireland is out today and here are the updates.

From the top figures:

• In Q3 2011, total number of overseas trips to Ireland rose 6.49% yoy (+129,600 visitors). Relative to peak of Q3 2007, the number of visits to Ireland remains down 19.66% (-520,200 visitors).
• Number of overseas trips from Ireland fell 7.02% yoy (-150,000) and is down 15.64% on peak of Q3 2007 (-368,500 visitors).
• Net travel to Ireland in Q3 2011 was 139,000, up on 10,600 in Q2 2011 and up on -140,600 in Q3 2010, making this quarter the second highest in terms of net number of visitors to Ireland since Q1 2007 and the highest since Q3 2007.

• Numbers of visitors to Ireland from Great Britain rose to 910,500 in Q3 2011 (+6.79% yoy) but remains 28.27% (-358,800) down on same period in 2007.
• Numbers of visitors from Other Europe rose 5.84% yoy to 741,800 in Q3 2011, but remains down 15.09% on Q3 2007 (-131,800).
• Numbers of visitors from North America rose 5.17% yoy (to 350,000) and is down 10.33% on Q3 2007.
• Proportionally, visitors from Great Britain to Ireland comprised 42.82% of all visitors to Ireland in Q3 2011, up on 42.7% in Q2 2011, but down on 47.96% in Q3 2007.

So overall, some encouraging news for tourism and transport sector. This is especially encouraging since Q3 2011 was a quarter of heightened economic concerns across the EU, UK and the US, so it is hard to argue that some sort of 'recovery bounce' is driving tourists to Ireland. Which might suggest that improved costs of hotels and associated services are working through to make Ireland more attractive destination. That and PR stunts by the Queen and the US President?

PS: after I have posted the above, one of the twitterati @hayspender came back with a comment:
"you dont think zombie hotels have a influence also? ie not true economics!" I agree, sometimes, when you write, not all possible permutations of potential causes can be captured. Of course, part of the 'improved competitiveness' is the factor of NAMA-owned hotels which receive an implicit (and very real) subsidy on their capital costs, allowing them to offer rooms at rates well below true cost that is faced by other hoteliers.

Yet another potential factor, also overlooked by me and flagged by another twitterati, is that some of the overseas travel relates to people commuting for work. This, however, does not appear to be reflected in the data, since the CSO releases data based on surveys which do collect information about the residency of travelers and reasons for travel.

13/11/2011: Non Performing Loans and links to macroeconomy

‘Often, the banking problems do not arise from the liability side, but from a protracted deterioration in asset quality, be it from a collapse in real estate prices or increased bankruptcies in the nonfinancial sector’’ (Kaminsky and Reinhart, 1999).

How true this sounds today. Take Euro area banks:

1) Collapse in US and European real estate valuations in recent years has triggered fall off in the value of linked assets held on the banks balance sheets

2) Collapse in the European bonds valuations has triggered a precipitous decline in core assets, including capital-linked assets

3) General recession have further undermined core assets on the loans side in corporate, SME and household lending.

A recent IMF paper: “Nonperforming Loans and Macrofinancial Vulnerabilities in Advanced Economies” by Mwanza Nkusu (2011) (IMF WP/11/161, July 2011) looks into the asset-focused linkages between financial and macroeconomic shocks, aiming “to uncover macro-financial vulnerabilities from the linkages between nonperforming loans (NPL) and macroeconomic performance in advanced economies”.

Based on a sample of 26 advanced countries from 1998 to 2009, the paper deals with two empirical questions on NPL and macrofinancial vulnerabilities: 

1) the determinants of NPL and 

2) the interactions between NPL and economic performance. 

With respect of the first question, the literature suggests that the determinants of NPL can be macroeconomic, financial, or purely institutional. In addressing the second question, the paper investigated “the extent to which falling asset prices and credit constraints facing borrowers may backfire and lead to an extra round of financial system stress and subdued economic activity”. 

The findings show that “NPL play a central role in the linkages between credit markets frictions and macroeconomic vulnerabilities. The results confirm that a sharp increase in NPL weakens macroeconomic performance, activating a vicious spiral that exacerbates macrofinancial vulnerabilities. …The broad policy implication is that, while NPL remain a permanent feature of banks’ balance sheets, policies and reforms should be geared to avoiding sharp increases that set into motion the adverse feedback loop between macroeconomic and financial shocks.”

Per authors: “empirical regularities …shape the modeling of NPL, …include the cyclical nature of bank credit, NPL, and loan loss provisions. In particular, in upturns, contemporaneous NPL ratios tend to be low and loan loss provisioning subdued. Also, competitive pressure and optimism about the macroeconomic outlook lead to a loosening of lending standards and strong credit growth, sowing the seeds of borrowers’ and lenders’ financial distress down the road. The loosening of lending standards in upturns depends on the existing regulatory and supervisory framework. In downturns, higher-than-expected NPL ratios, coupled with the decline in the value of collaterals, engenders greater caution among lenders and lead to a tightening of credit extension, with adverse impacts on domestic demand.”

In other words, first order effects of ‘positive’ pressures on lending expansion are reinforced by ‘positive’ second order effects of reduced risk management provisions, regulatory slackening and counter-cyclical capital buffers. Once things blow, however, the same effects again reinforce each other. The bubble acceleration is supported by both moments as well as the bubble explosion – yielding higher peaks and deeper troughs.

Thus, the determinants of NPL “are both institutional/structural and macroeconomic”.

The institutional / structural determinants are found in financial regulation and supervision and the lending incentive structure. “Intuitively, disparities in financial regulation and supervision affect banks’ behavior and risk management practices and are important in explaining cross-country differences in NPL.” 

The macroeconomic environment drivers work by altering “borrowers’ balance sheets and their debt servicing capacity. The set of macroeconomic variables [includes]… broad indicators of macroeconomic performance, such as GDP growth and unemployment...”

The core findings of the study are: 

• “A sharp increase in NPL triggers long-lived tailwinds that cripple macroeconomic performance from several fronts. …of all the variables included in the model, NPL is the only one that has both a statistically significant response to- and predictive power on- every single [macroeconomic performance] variable over a 4-year forecast period. …Regardless of the factors behind the deterioration in loan quality, the evidence suggests that a sharp increase in aggregate NPL feeds on itself leading to an almost linear incremental response that continues into the fourth year after the initial shock.”
• “The confluence of adverse responses in key indicators of macroeconomic performance—GDP growth and unemployment—leads to a downward spiral in which banking system distress and the deterioration in economic activity reinforce each other.”
• “The broad policy implication [is that] …policies and reforms should be geared to avoiding sharp increases that set into motion the adverse feedback loop between macroeconomic and financial shocks. … preventing excessive risk-taking during upturns through adequate macroprudential regulations is the first best.”

In other words, folks, you can’t ignore the macroeconomic effects of Non Performing Loans, as Ireland’s Government is implicitly doing by refusing to focus on repairing household debt overhang here. And, via a link between negative equity and NPL (the study cites evidence that house prices have direct negative effect on NPL – with house prices collapse leading to increased NPLs), we can’t ignore negative equity effects either.

13/11/2011: Euro area - history of insolvency

Nouriel Roubini makes a very compelling argument as to the nature of the Euro area crisis - the nature revealed by unsustainable economic model based on running excessive external deficits and accumulating debt (see his blogpost here).

I have frequently referenced this problem to a deeper underlying force - the propensity of the European social democratic models to spend beyond their means. As the Euro area economies pursued populist agendas of 'social' services and subsidies expansion throughout the 1990s and 2000s, some (indeed majority) of the European economies stagnated, implying diminished capacity to sustain subsidies transfers within the vested interests-run Union. Thus, current account deficits - mask both Government and private sectors imbalances (with Governments in effect pumping the private economy with steroids of debt and cheap interest rates to extract tax rents that can be used to finance political largesse).

To see this, look no further than the links between Current Account deficits (external imbalances across entire economy - public and private) and Government deficits (fiscal imbalances), as well as Structural deficits (fiscal imbalances corrected for recessionary impacts).

Chart below shows cumulated current account deficits for 12 years since 2000 as well as cumulated structural deficits.

The striking feature of this chart is that over 12 years horizon, only 6 countries of the Euro area have managed to post a cumulative external surplus, while only one country (Finland) has managed to live within its means both in terms of external balance and fiscal balance. Any wonder that Finns are so opposed to the idea of 'burden sharing' that will see their surpluses transferred to the profligate states?

Another striking feature of the graph is that, contrary to Mr Roubini's assertion, France too was running dual external and fiscal deficits. Albeit, its deficit on current account side was small. Germany - another paragon of 'stability' run structural deficits on the fiscal side - i.e. spent beyond its means when it comes to Government expenditure outside that needed to correct for recessionary imbalances. Ditto for the Netherlands.

Ireland - our engine of 'exports-led growth' - is, alas, firmly NOT an engine of external balances. Cumulated current account deficit for the country is -19.5% of GDP. Any hopes for reversing 12 years of that experience, folks, will require re-wiring of our economy, preferences, political and institutional structures etc. Good luck getting there before the whole house of cards comes tumbling down.

In fact, deficits are sticky - hard to reverse. Past deficit experience, it turns out, shapes much of the future achievement, as illustrated in the chart below.

Once you are insolvent for a decade (1990s) you are likely to remain insolvent for the next decade too (2000s). And, hence, the headwinds against us (Ireland) reversing that and moving into strong surpluses on current account in years ahead are strong. Not that they can't be overcome. If we look at transition from 1990s external balance position to 2000s position, the following holds:

• Finland and the Netherlands stand out as the only 2 countries that managed to improve their surpluses on the current account side between 1990s and 2000s averages
• France, Belgium and Luxembourg are 3 countries that managed to retain surpluses, but weakened their performance between 1990s and 2000s
• Malta was the only country that managed to reduce its external deficits between 1990s and 2000s in terms of averages
• Portugal, Greece, estonia, Cyprus, Slovak Republic, Sapin, Ireland, Slovenia and Italy all saw average deficits of the 1990s deepening in the 2000s
• Only two economies - Austria and Germany have managed to reverse previous deficits (in the 1990s) to surpluses in the 2000s. 

That means that, historically, a chance of reversing average current account deficit in the previous decade to a surplus in the next decade is 2/17 or less than 12%. not an impossible feat, but an unlikely one.

And current account deficits do appear to relate closely to the General Government deficits and Structural fiscal deficits as the two charts below show (note of caution - the equations estimated below are imprecise, of course, due to small sample).

At last, a table to summarize:

Yep, insolvency - of the deepest (across all three measures) variety is the domain of 10 out of 17 member states when it comes to the last 12 years of Euro area history. Another 5 member states are insolvent by two out of three criteria. Lastly, only two member states - Finland and Luxembourg - were actually fully solvent since 2000.

That, folks, makes for a rather spectacular failure of the Euro area institutional design.

12/11/2011: Russian economy - Summary 2011

Summary of the Russian economy in the light of the removal of the final barriers to the country accession to the WTO (see the related note here). To see the slides, click on the individual frame to enlarge