27/11/2011: Even with IMF's €600bn - Italy is too big to bail

There are some interesting reports in the media over the weekend, speculating that the IMF is preparing a super package for Italy, rumored to reach €600 billion. Here's a link from zerohedge that outlines the details of these rumors (here). There are several reasons to be skeptical as the feasibility of such a package and the potential effectiveness of it.

Here are these reasons.

Firstly, the IMF is a rules-based organization that normally can lend only 4-5 times (400-500%) of the country quota. Italy's country quota is SDR7.8823 billion or €10.7bn which can allow IMF to lend under normal arrangements up to €53.5 billion (at a severe stretch, I must add as the fund prefers not to lend to the full leverage of 500%).

In addition, IMF has announced two new programmes last week (discussed here). The Flexible Credit Line programme - whereby IMF does not specify lending leverage to be achieved, applies only to "members with very strong track records... based on pre-set qualification criteria to deal with all types of balance of payments problems." So IMF would have to qualify Italy as a country with "strong track record" and its solvency problems as "balance of payments problem". This, of couse, is possible, though not probable, as Italy's "strong track record" is hardly that "strong". In addition, the new lending will have to take place outside the normal arrangements mentioned above, as the deployment of such arrangements would not be consistent with "strong track record" even in theory. So to raise €600 billion, IMF will have to leverage Italy's SDR allocation 6,000%.

Let's put this number into perspective. Lehman Bros TCE leverage ratio was 4,400% at the time of collapse and its average TCE leverage ratio prior to collapse was 3,100%.

At any rate, IMF is most likely to assign Italy a precautionary borrower status under Precautionary Credit Line (see link above) which allows for 24 months leveraging up to 1,000%. This, of course means Italy will be able to raise just €107 billion through IMF loans or about 1/3rd of its roll-over requirements (not to mention new borrowings demand) through 2012.

Secondly, suppose IMF does indeed lend Italy €600 billion - enough to barely cover the country refinancing needs for 2012-2013. Then, two things happen:

1. 1/3rd of Italy's total Gross Government Debt becomes overnight senior to the rest of its debt - as IMF always assumes seniority in lending. This will push existent Italian bonds yields to 15% or 18% or more. We do not know, of course, exactly where the debt will be traded, but what we do know with almost certainty is that there is not a snowball's chance in hell Italy will be able to refinance maturing debt after 2013 on its own. So IMF lending Italy today commits IMF to lend to Italy in 2014 and on.
2. €600 billion is unlikely to cover all Italian needs for 2012-2013, especially if Italian banks are to take a hit on other sovereign bonds. let me run through the EBA banks stress tests model under the following assumptions: Greece haircut 80%, Italy haircut 10%, Portugal haircut 25%, Spain haircut 10% (notice - all very benign) and CT1 ratio of 9%. Italian banks shortfall on capital is €34 billion. Now, recall that Italy also has insurance companies (e.g. A.Gen) and pensions funds - which will see some fall-outs from the haircuts as well. Say €10 billion. Italian bonds downgrade due to IMF lending (see item 1 above) is likely to cost banks and other financial sector companies another  €11 billion and €4 billion. So we are into total bill of ca €60 billion right there. Italian deficits in 2012-2014 are expected to gross €76 billion per IMF latests forecasts. As shown in the chart above, debt maturity, plus new deficits financing will consume some €453.4 billion in 2012-2014 and €630.5 billion in 2012-2016. 

So the total funding that Italy might require is in the neighborhood of €510-690 billion, depending on which period we assume the package will cover (2012 through either 2014 or 2016 respectively).

And this assumes no deterioration in GDP growth (tax revenues) or deficit spending etc. It also assumes that market funding costs IMF built into its deficit forecasts (4% 10-year average pre-November 2010) remain under the IMF lending deal. In fact, of course, that is open to speculation if IMF can lend Italy €600 billion at anything below 5.3-5.8%.

So overall, folks, I am skeptical as to the IMF's ability to conjure €600 billion for Italy. And furthermore, I am skeptical as to Italy's ability to manage cover for its deficits, banks and roll-over needs under such a package. This doesn't even begin to address my concerns as to Spain waiting in the shadows.

Now, lastly, you might suggest that the IMF loans can come in conjunction with EFSF loans. Alas, the EFSF has some serious troubles itself - the following two posts from the zerohedge amply illustrate: here and here.

You see, Italy is too big to bail. Even if it is also too big to fail.

25/11/2011: Eurocoin signals recession for the euro area

And so the euro zone is now most likely in a recession. That's right, the R word is back.

Today, CEPR released its composite leading economic indicator for November - eurocoin - and the measure has posted it second consecutive monthly negative reading on foot of six consecutive monthly declines. Here are the details.

Eurocoin fell to a recessionary -0.20 in November 2011, from -0.13 in October and +0.03 in September.  The 3mo MA is now at -0.1 and 6 mo MA declined to +0.148. A year ago, the indicator stood at +0.45. Chart below updates, including eurocoin-consistent forecast for growth.

The following charts show the ECB decision-making inputs:

So ECB rates consistent with current growth are in the range of 1.0-1.5% - basically bang-on the current rate. However, inflation remains sticky and all indications are it will come in at around 2.7% in November, suggesting that rate expectation is for no change at beast (optimal rates consistent with this rate of inflation is in the neighborhood of 4%).

The ECB dilema continues.

25/11/201: Growth is the only solution to Europe's crisis

My latest post for Canada's The Globe and Mail is up - link here.

Please note, when I say 'growth' or 'economic growth' I obviously do not have in mind a bubble re-inflation or growth based on weak fundamentals. Hence, the concept of growth I accept and support is growth that is anchored in both demand and supply fundamentals, aka sustainable growth.

Enjoy and comment.

24/11/2011: Beggar thy citizens

Things are desperate on a new level across Euro area, folks. So desperate, the Euro leadership delusions have shifted up a notched from already feverish levels they reached before.

Until now, the talk was all about the miracle pills of first "The Firewall of EFSF" then "ECB rescue" + "Euro bonds", now the convoluted plans to underwrite the failures of the last decades are getting more esoteric and, oh so European, at the same time.

Recall the EFS 'Firewall' - launched at first with ca €275 billion in lending capacity, enlarged to €440 billion capacity, then planned for a 'leveraged' enlargement to €1 trillion capacity. Now, with realisation that (1) €1 trillion is no longer enough of a 'Firewall' once Italy caught fire and the rooftop of Chateau France is getting steamy too; and (2) There is no €1 trillion worth of international idiots (oops... err.. investors) willing to part with their money for the greater good of European 'solidarity' the EFSF 'solution' has fallen off the radar.

Next, enter the idea of the ECB rescue and Euro bonds. These too are largely problematic. The ECB 'rescue' option at this stage will have to involve €1.5-2.5 trillion worth of assets purchases - something that will be (a) costly (imagine what will happen to bonds prices if the ECB were to wade in with that sort of cash into the secondary markets) and (b) internecine to ECB's mandate and reputation (in other words, turning your Central Bank into the financial toxic waste warehouse will do to the Euro just what the PIIGS combined default can - destroy it). The Euro bonds option requires two impossible to achieve things: (1) finding idiots... err... investors willing to pony up even more cash than for the EFSF for an undertaking written against largely non-controllable borrowers with little prospect of achieving economic growth to sustain repayments of their debts, and (2) balancing the need to get another credit against the risk of destroying credit ratings (as Euro bond will in effect simply give Governments more debt and this debt will be senior to their own previously issued national debt). And, of course, the Euro bond idea requires much closer political integration first - something that will take years to deliver.

Smelling the rat... err... failure in the above magic bullets, some Governments are now desperate enough to resort to the classic European response to the crises: fleecing their own citizens to pay for their spending habits. Behold tax increases across Europe and Belgian plans to sell their unwanted bonds to their citizens (the story here). In the nutshell, the idea is that there are no idiots... err... investors out there willing to buy Belgian Government promissory notes (note: Belgium, of course doesn't even have a Government). So the solution - just as Joe Stalin did in the 1930s-1950s - is to sell these bonds to unsuspecting ordinary people of Belgium. To make the 'deal' even more egregious, the bonds are to be sold at a discount on the yields provided to banks purchasers. Not only will Belgian pople join the line of those who hold dodgy paper, cross-linked to their entire risk profile of living and working in Belgium and paying Belgian taxes, but they are expected to do so for less reward!

Priceless, really, folks. Comparable only to Irish Government 'Solidarity Bonds' and efforts to sell state junk to national pensions and insurance companies. In economics, there's a concept of policies that 'beggar thy neighbors' by shifting risks/costs/losses onto other countries via trade and investment restrictions, taxes and subsidies. In Europe, we are getting to the point of having 'beggar thy citizens' policies.

24/11/2011: Insolvent Europe

The following link is to my article on EU-wide debt crisis for presseurope.eu (and no - not just that Government debt crisis  we've heard all about): here.

23/11/2011: A longer term view of Ireland's structural deficits

Someone recently requested the analysis of structural deficits for Ireland. So here's a quick note. All data is taken from IMF WEO database for September 2011. IMF estimates 2011 deficit and forecasts deficits for 2012-2016. All frequencies and cumulative data calculations are my own.

Let's start with graphing our structural deficits. Remember, these are measured as % of total potential GDP, omitting the effects of business cycles on volatility in GDP. This makes structural deficits to be less precise than actual deficits, but useful in so far as they tell us the story of the long-term sustainability of the Exchequer spending.

Chart 1 below shows the overall structural deficits expressed as the percentage of potential GDP and in absolute national currency terms.

In the nutshell, the above chart shows that Ireland remained structurally insolvent for the entire history of the series since 1980 through 2010 and is expected to remain insolvent through 2016. It also shows that:

• Ireland was least insolvent in 1997-200 when the average structural annual deficit was just -0.65% of potential GDP
• The closest we came to structural balance was in 1997 when structural deficit hit -0.394% and in 2000 when it was at -0.209%
• Our peaks of insolvency were 1981 (-14.034%) and 2008 (-13.323%)
• Our worst periods of insolvency were the early 1980s, when 1981-1986 average annual deficit stood at -12.125% and 2007-2010 when structural deficits averaged -10.555% annually (omitting 2007 raises this to -11.266%)
• In 2011 we are expected to run structural deficit of 6.761% and in 2012-2015 we are expected to run average structural deficits of -3.753%.

All of these deficits add up to a nifty number. Chart below shows cumulative structural deficits. Per this, by the end of this year, our structural deficits since 1980 on will be adding up to €162.3billion. By 2016 these numbers are forecast to rise to €193.6 billion.

In terms of the frequencies of various solvency performance conditions, Irish structural deficits historically exceeded 3% per annum in 26 out of 32 years, implying a 84% chance of excessive unsustainable structural deficits. In contrast, relatively safe deficits (<2%) occurred in only 4 years in 36 years of history plotted above: 1997-2000. Thus, Ireland was close to sustainability only 13% of the time.

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.