22/4/2012: Sunday Times 15/4/2012 - What if Ireland Defaults?

With some delay, this is my article for Sunday Times April 15, 2012 - an unedited version, as usual.

Since 2008, judging by a number of parameters and metrics, Ireland has been firmly in the grip of a historically unprecedented financial, fiscal, banking and economic crises. This is the consensus that emerges from book, titled What if Ireland Defaults? published by Orpen Press last week and edited by myself, Professor Brian Lucey and Dr. Charles Larkin (here is the link to Amazon page for the book and for ebook version). The book brings together views on sovereign and other forms of default by twenty two academic, media, political and social policy thinkers is designed to re-start the debate about the future trajectory of the Irish economy saddled with unprecedented levels of public and private debt. Coincidentally, What if Ireland Defaults? Was published in the same week as the IMF Global Financial Stability Report that focuses on the issues of household debt overhang. The IMF report too stresses the dangers of the excess debt levels across the economy and provides strong argument in favor of a systemic restructuring of private debt in countries like Ireland.

The roots of the Irish debt problem are historical in their nature, not only in the magnitude of the debt overhang involved, but also in terms of the correlated economic, fiscal and financial crises that define our current economic environment.

First, the Irish crisis has resulted in a deep and protracted contraction in the economy that is unparalleled in the modern history of advanced economies. In current market prices terms, and not taking into the account inflation, our national output is down 24.2% on pre-crisis peak, having fallen to 2003 levels. Investment in the economy is down 59.6%. These rates of decline are so far in excess of what has been experienced in Greece and are ten-fold deeper than those experienced in an average cyclical recession.

The duration of the Irish crisis is also outside the historical records. Since Q1 2008, Irish economy recorded fourteen quarters of nominal contraction in GNP and thirteen quarters of contraction in GDP. In effect, the economic crisis has already erased 8 years of growth. At an average nominal rate of growth of 4% per annum, it will take Ireland fifteen years to regain domestic output levels comparable to 2007. And this is without accounting for inflation.

Second, Ireland is now a worldwide record holder when it comes to the cost of dealing with the banking sector crisis. Combined weight of banking sector capital injections, and Nama is now close to 80% of our GNP. Irish Exchequer exposure to the Central Bank of Ireland ELA and the ECB borrowings by the state-owned banks lifts this number well beyond 200% of the national output. No advanced economy has ever experienced such a massive collapse of the domestic banking sector.

Another unique feature of Irish crises is their inter-connected nature. Economic recession – driven originally by the external demand contraction and debt overhang in the domestic economy was further compounded by the asset bust which itself is of a historic proportions. To-date, Irish property markets are down 49.3% on pre-crisis levels and the decline continues unabated. Large numbers of 30-50 year old families – the most economically-productive cohorts of our population – are now deeply in negative equity and are increasingly unable to sustain debt servicing. Officially, over 14% of our entire mortgages are currently either in a default, officially non-performing or short-term restructured.

The property bubble collapse, twinned with the debt crisis, didn’t just undermine the banking sector and cut into household wealth. The two have also left Irish economy without a growth driver that fuelled it since 2001-2002 when the property and lending bubble replaced the dot.com bubble implosion. Put differently, we are witnessing a structural economic recession. Since 1998-1999, Irish economy has lived through one bubble into another. Currently, excessive indebtedness and lack of a functional financial system are leaving Ireland without even a chance of finding a new growth catalyst.

In these conditions, the most significant problem we face today is the debt crisis. Our combined real economic debt – the debts of households, non-financial corporations and the Government – relative to our GNP is the highest in the advanced world. And, unlike our closest competitor for this dubious distinction, Japan, we have no means for controlling the interest rates at which our economy will have to finance Government and private sector debts.

It is the totality of the real economic debts, not just the debt of the Irish Government, that concern those economists who are still capable of facing the economic reality of our collapse. This point is referenced in the What if Ireland Defaults? by a number of authors, and as of this week, their views are being supported by the IMF, the Bank for International Settlements and a growing number of academic economists internationally.

Frustratingly, at home, our views are seen as contrarian, alarmist, and even populist. As the crisis has proven, year after year, the official Ireland Inc is simply unequipped to deal with reality.

Majority of Irish economic analysts incessantly drone about the threats arising from the Exchequer debts. Some, occasionally, add to this the banking debts. Fewer, yet, might reference the households. None, save for a handful of usually marginalized by the establishment economists, bother to treat the entire debt pile carried by our economy as a singular threat.

The silence about Ireland’s total debt, and the ongoing denial of the long-term disastrous economic and social costs of the total debt overhang are the frustrating features of our current state of the nation. It is this frustration, alongside the realization that Ireland can be blindly stumbling toward a renewed debt crisis, that informed myself and two of my co-editors to re-launch the debate about the potential inevitability and consequences of debt restructuring.

To re-start this debate, What if Ireland Defaults presents a range of views on the current Irish situation, from the basis of sovereign, banking debt and household debt restructuring.

The very idea of what constitutes a default is a complex one. In the book we interchangeably use the term ‘default’ as denoting a restructuring of the debt to reduce the overall level of debt. This can be accomplished by reducing the debt level itself, restructuring interest payments, extending the maturity of debt, or any combination of the above. In addition, a default can take place in an relatively orderly and coordinated fashion, as for example in Greece, or as a disorderly, unilateral action, as in the case of Russia in 1998. Lastly, default can be pre-announced, as in the case of Iceland, or unannounced – as in the case of Argentina. All of these differences are reflected in the chapters of the book dealing with historical experiences relating to sovereign defaults.

In the case of Ireland, there is a broad consensus within the book that a sovereign default is neither desirable nor inevitable. In other words, no author sees the situation where Irish Government debt will have to be restructured unilaterally, without prior cooperation with the EU authorities via the ESM or a similar collective structure. However, substantive disagreements do arise among the authors as to whether Ireland will require a structured default on banking and household debts. In this context, some of the contributions to the book pre-date and preclude the research on the necessity of household debt restructuring published by the IMF this week.

The overriding sense from What if Ireland defaults? is of an economy on a knife edge. Given favourable economic circumstances, especially in regard to our exports, a positive change in EU’s political attitudes with regard to the legacy bank debt, and the return of domestic economic growth, the debt levels which Ireland now faces can become sustainable, in that a default on either private or public debts is not probable. However, we cannot consider these developments as guaranteed, and in their absence, restructuring of debts may become inevitable.

In short, both the IMF report this week and the wide range of contributors to What if Ireland Defaults? are in a broad agreement: Ireland should be putting forward systemic policy measures to restructure household (and by a corollary, banking) sector debts. Absent such measures, a combination of the long-term continued growth recession and debt overhang, further compounded by the risks to interest rates and debt financing costs in the medium term future will force us to face the possibility of a sovereign debt default. Avoiding the latter outcome is more than worth the effort of creating a systemic resolution to the household debt crisis.

CHART: 

Sources: Haver Analytics, National Central Banks, McKinsey Global Institute, NTMA and DÁIL QUESTION  NO 122, 14th September 2011, ref No: 23793/11

Box-out:

A recently-published Cleantech Global Innovation Index 2012 shows the potential for the development of the green-focused economies in Ireland. The study ranked 38 countries across 15 indicators that relate “to the creation and commercialisation of cleantech start-ups, …measuring each [country] relative potential to produce entrepreneurial start-up companies and commercialise technology innovations over the next 10 years.” Overall, as expected, North America and Northern Europe “emerge as the primary contributors to the development of innovative cleantech companies, though the Asia Pacific region is following closely behind.”

Ireland is ranked ninth in the world in the cleantech league tables and scored strongly on general innovation drivers (underpinned by the presence of innovation-intensive sectors dominated by MNCs and some domestic exporters) and commercialised cleantech innovation (also largely linked to MNCs and a handful of Irish indigenous companies). We fall below average on cleantech-specific innovation drivers, such as policies supporting innovation in energy and green-IT and IT-for-Green. Ireland has only average scores for supportive government policies and access to private finance, which is disappointing.

What the global rankings, and the Irish experience clearly show is that globally there is an extremely weak positive relationship between cleantech-specific innovation and commercialized cleantech innovation. In Ireland this relationship is stronger than average. This is most likely due to the more advanced MNCs and exporting base in the Irish economy in general, whereby domestic innovation activities, including those booked by the MNCs into Ireland for tax purposes, is aligned with commercialization via exports.

22/4/2012: Irish Crisis Requires Drastic Action, but Not a Euro Exit

In light of Prof Paul Krugman's comments concerning the desirability of the GIIPS remaining in the euro earlier this week, the Sunday Independent has asked myself (amongst other commentators) to provide my opinion on Prof Krugman's proposed solution. Here is the link to the published article and below is an unedited version of my comment:

In his article, Paul Krugman puts forward what he terms an alternative solution to the current course of policies, chosen by the EU in dealing with the Sovereign debt and financial sector crises. The core of his argument boils down to the need for the EU ‘peripheral’ states, notably Greece, Spain, Portugal, and potentially Ireland, to exit the euro and restore national currencies.

In my view, such a course, undertaken in cooperation with the EU member states and the ECB is a correct one for Greece, and possibly Portugal, but is not an option for Ireland, and the rest of the periphery. The reason for this is that unlike Greece and Portugal, Spain and Ireland are suffering not so much from the Sovereign debt overhang, but from a private and banking debts crisis. Resolution of these latter crises will not be sufficiently helped by an exit from the euro, primarily because private debt deflation will not be feasible for debts already denominated in euro. In addition, exiting the euro will entail significant economic and reputational costs to an extremely open economy, like Ireland, reliant on FDI and high value-added euro-related services, such as IFSC.

Two years ago, prior to the completion of the contagion from banking debts to Sovereign debt, exiting the euro was a workable solution, albeit a disruptive and a costly one for Ireland. Today, such an exit will require default – most likely an unstructured and disorderly – on both Sovereign and private debts, with simultaneous collapsing of the Exchequer funding and the banking sector. This will lead, in my opinion, to a disorderly unwinding of the entire economy of Ireland.

Professor Krugman is correct in his analysis that “continuing on the present course, imposing ever-harsher austerity on countries that are already suffering depression-era unemployment, is what’s truly inconceivable”. He is also correct in stating, that, “if European leaders wanted to save the euro they would be looking for an alternative course.”

The new course that the European and Irish leaders must adopt is the course that will preserve and strengthen Irish participation in the Euro zone economy, not push Ireland out of the common currency. This course requires a number of steps to be taken by Irish and European authorities in close cooperation with each other.

The first step is to recognize that Ireland’s economy is suffering from a private (namely household) debt overhang and the incomplete nature of the banking sector restructuring here. This means making a choice: either Ireland continues down the current path, with economic adjustments to the crisis stretched over decades of pain, or we jointly, with our European ‘partners’, take real charge of the economic restructuring. The former path implies that Ireland will be sapping Euro area monetary and fiscal resources for many years to come, while being unable to implement deep reforms due to the lack of supportive economic growth and facing continued risks of a Sovereign default. The latter path means that we take a quick, sharp correction in our private debts and get back onto the growth path.

The second step is to devise a solution – most likely via the ECB (to avoid placing burden of our adjustment on European taxpayers) – to write down significant proportion of Irish mortgages and other household debts while simultaneously allowing the banks to deleverage out of the household debts. This can and should be achieved by the ECB canceling all of the Central Bank of Ireland ELA and a part of Irish banks borrowing from the ECB itself and using these cancellation proceeds to write down household debt. Delivering such a deleveraging will open up room for stabilizing Government finances, as reduced debt burden on private balancesheets will allow Ireland to divert resources to paying down Sovereign debt, while a new cycle of domestic investment and growth can commence, allowing for structural reforms in the economy (covering both private and public sectors).

The third step is to create a long-term warehousing facility – within the ESM – to roll over existent Government debt so Ireland will have a period of 10-15 years within which this debt can be reduced without the need to face uncertainty of market funding. This would be primarily a cash flow management exercise. ESM lending rates should be set around funding cost plus administrative margin, or in current terms around 3.0-3.2% per annum, saving Irish Exchequer up to €3.4 billion annually in interest repayments, which can be diverted to more rapid paying down of the national debt. Hardly a chop-change, under conservative assumptions, this approach will allow Ireland to save over €27 billion in funds from 2013 through 2020, reducing overall nominal debt levels by 11.6% by 2020 compared to status quo scenario.

Combined, these policy steps will be able to put Irish economy and Exchequer finances on the security platform from which structural and longer-term reforms can take place without undermining economic growth potential. In addition, good will extended by the EU to Ireland under such a co-operative and coordinated approach to the crisis will assure continued Irish support and participation within the EU. This, in turn, will assure that Ireland can play an active and positive role in the Euro area growth and sustainable development in years to come. Exiting the euro today is neither necessary, nor sufficient for restoring Irish economy to growth. Resolving our debt crisis is both feasible and the least-costly part of the solution to the broader Euro area crises. 

17/4/2012: GIPS vs Default Countries

New IMF forecasts are out for the WEO April 2012 database and so time to update some of the charts. This will happen over a number of posts, but here is the chart I used in today's presentation on the future of Irish banking and financial services.

The chart shows the impact of the current crisis in GIPS against Russia, Argentina and Iceland post their defaults. It sets pre-crisis income expressed in US dollars at 100 and then traces back years of crisis.

17/4/2012: EU27 - Minimum wages v unemployment

A very good infographic on relationship between minimum wages and unemployment from one of the blog readers linked here. Please keep in mind: correlation does not mean causation. There is much of a debate in economics as to the causal links (or their absence) between minimum wages and unemployment (general unemployment, rather than age-specific and skills-specific).

16/4/2012: Italian debt is going up, not down

John Langdon Down - a descendant of an Irishman and a British psychiatrist was, reportedly, the first person to use the French term 'idiot savant' to describe a specific condition in which a brain injury can lead to a person with 'developmental delays' of the brain is being able to demonstrate "profound and prodigious capacities and/or abilities in excess of those considered normal". I am no psychiatrist, but the cheerful reports with today's news that Italian Government debt has declined month on month in February were met suggests to me a manifestation of the similar nature.

Here are the facts. Italian public debt is down €6.8bn in February to €1,928 billion - a drop of 0.35% month-on-month. With a borrowing requirement down €1.4bn yoy in February, but flat at €12.7bn for two months January-February, compared to 12mos ago. It is the latter part - the static nature of Government borrowing requirements, not the former part - the reduction in debt, that matters most. The reason is simple - see charts below:

You see, in January-February 2011, tax receipts were €56,370mln, against €53,940mln in Government expenditure, yielding 2mos cumulated balance surplus of €5,072mln. In 2012, same period tax receipts were €55,931mln or €439mln below 2011 figures, with Government spending at €54,290mln or €350mln ahead of same period last year. January-February 2012 Government balance was in surplus €5,302mln. So the debt 'repayments' are not a sign of any improvement in the fiscal dynamics.

Now, there is a bit more to consider here, folks. The stated reduction in the Government debt is month-on-month and the statement above syas nothing about year-on-year comparison. Ok, so let's take Table 10 from April 16th Banca d'Italia data release. Column 1... errr... General Government Debt:
February 2011 at €1,875,010 mln, against February 2012 at €1,928,211 mln. Contrary to the cheerful view of 'debt falling €6.8bn', Italian debt went up year on year €53,201mln.

15/4/2012: Some recent links

Few links to chase:

An absolute hero: Sheila Bair (of ex-FDIC fame) ripping into the Fed here.

On the other note - I guess this is the first time I am to mention 'de book' or 'de debt book': What if Ireland Defaults? Sold out of the first print within a week of its launch.

I am talking about the book on Max Keiser here. Recorded during my trip to Moscow in the studio with "Press" helmets - well worn. I had to tip my hat to the real journalists who covered Afghanistan, Tunisia, Beslan siege, etc. Real honor to be in their company!

I am also talking about the core idea behind the book here.

In all, judge the book as you read it - here's the link to amazon order page and Kindle order page. But keep in mind - the credit goes to 22 authors of essays it contains - all equally. And thanks go to the Orpen Press team that put it all together.

My Sunday Times article - mentioning the book - will be up on this blog in a couple of days.

14/4/2012: An interesting data on Europe's capital flight

Capital flight continues within Europe out of the periphery and into core, according to this article from Bloomberg. If you must see a chart today, see this one

One feature worth considering is the data for Ireland, which appears to conflict with the CBofI data. Although outflows have abated in the chart above, they are certainly pronounced. According to CBofI, deposits are flat and according to the Government, other forms of capital are inflowing into the country like there is no tomorrow (which is disputed by Ireland's own BOP data).

14/4/2012: Latest data on EU27 ICT skills

In a recent (April 1, 2012) article for the Sunday Times (link here) I wrote about the results of the Eurostat computer skills survey across the EU27 member states. The report this was based on is E-Skills Week 2012: Computer skills in the EU27 in figures (http://eskills-week.ec.europa.eu/).

Quoting from the article:

“One core metric we have been sliding on is sector-specific skills. This fact is best illustrated by what is defined as internationally traded services sector, but more broadly incorporates ICT services, creative industries and associated support services.

Eurostat survey of computer skills in the EU27 published this week, ranked Ireland tenth in the EU in terms of the percentage of computing graduates amongst all tertiary graduates. Both, amongst the 16-24 years olds and across the entire adult population we score below the average for the old Euro Area member states in all sub-categories of computer literacy. Only 13% of Irish 16-24 year olds have ever written a computer programme – against 21% Euro area average. Over all survey criteria, taking in the data for 16-24 year old age group, Ireland ranks fourth from the bottom just ahead of Romania, Bulgaria and Italy in terms of our ICT-related skills.”

So here are the details of my analysis of the Eurostat data. Note, ranks reference EU27, plus Norway, Iceland and 3 averages treated as countries – EA12 (old euro area states), EU27 and Small Open Economies of EU27. In other words, ranks are reported out of 29 countries and 3 averages.

In terms of the overall proportion of computer graduates amongst all graduates, Ireland performs close to the mid-range of the overall EU27 distribution. In 2005, 2.9% of graduates were in CS disciplines against the EU27 average of 4% and EA12 (old euro area) average of 4.12%. By 2009 this number rose to 3.8% for Ireland, and fallen to 3.4% for EU27 and 3.37% for EA12. However, the averages conceal rather wide dispersion of scores across both the EU27 and EA12. Ireland’s overall performance in this category ranked 12th in 2009 data, below Greece, Spain, Malta, Austria, UK and Norway.

In terms of percentage of population who have ever used a computer as percentage of all individuals, the survey identifies results for two cohorts: aged 16-24 and aged 16-74. In Ireland, 98% of the population 16-24 years of age have used computer, against 81% for those aged 16-74. This compares against: 96.25% for EA12 and 96% for EU27 for those aged 16-24, and 79.2% for EA12 and 78% for EU27 for those aged 16-74. Despite this, Ireland ranks only 19th for 16-24 year old cohort in this parameter.

Now, we should expect a generational effect of higher (statistically) percentage for those of 16-24 years of age. And the gap appears to be present in the case of Ireland – 17 percentage points spread. The gap is consistent with the EU27 and EA12 averages of 18 and 17.8 percentage points. In other words, Ireland’s population computer usage is not exactly stellar to begin with and is not improving at a faster pace than European average with generations.

The survey also assessed what percentage of relevant population used basic arithmetic formulas in a spreadsheet. For EU27 and EA12 the corresponding percentages were: for cohort aged 16-24: 66% and 67% respectively. For Ireland the percentage was 54%, assigning to us rank 30th in the sample, with only Romania and Bulgaria scoring below us. For the full population (16-74 years of age), the EU27 and EA12 averages were 43% and 45.5% respectively, while for Ireland the corresponding percentage was 44%. Again, our inter-generational gap was lower than average either for EA12 or EU27, suggesting that not only we are extremely poorly scoring in this category as a whole, but that our inter-generational change in skills is working against us in comparison to the averages.

As per percentage of those who created electronic presentations, for EU27 and EA12 the averages were 59% and 63.1% for cohort of those aged 16-24 against Ireland’s 36%, earning Ireland 30th rank, ahead of only Bulgaria and Romania. The inter-generational gap for EU27 is 28 percentage points, while for EA12 it was 28.5 percentage points and for Ireland 15 percentage points. Again, we are falling behind and doing so from the weak position to begin with.

In terms of those who have written a computer programme, Ireland’s 16-24 year olds reported 13% of population against EA12 20.5% and EU27 average of 20%. For overall population (16-74 year olds), EA 12 average was 11.6%, EU27 average 10% and Ireland’s 9%. We are ranked 27th in the table in terms 16-24 year olds who have written a computer programme.

In terms of overall score for the younger cohort of 16-24 year olds (summing up percentages for all categories, plus third level CS education proportion multiplied by factor 10), Ireland total score comes in at 321, well below the total score for EA12 (368.5) and EU27 (365). Ireland ranks 28th in the league table in terms of overall computer literacy score, ahead of only Bulgaria, Italy, and Romania. In summing up all ranks, Ireland’s combined rank is 148 against 120 for EA12 and for EU27.

In the last chart above, higher gap signals more advanced skills for the younger cohort compared to general population: Ireland has low rank and low gap, implying that younger cohort skills are advancing at a slower speed than in other countries from already low skills base. In contrast, Finland has relatively low gap combined with high overall rank, implying that Finland's younger cohorts have faster than in Ireland rate of growth in skills compared to much higher overall level of skills already in place for the general population. Slovenia and Latvia are examples of countries where skills are relatively high for the younger cohorts compared to other countries and are growing fast compared to older cohorts.

14/4/2012: Sunday Times 8/4/2012 - Irish banks: The Crunch is Getting Crunchier

This is an unedited version of my Sunday Times article from 08/04/2012.

A year has lapsed since the much-lauded publication of the first set of the Prudential Capital Assessment Review results – the stress tests – by the Central Bank of Ireland.

Covering the four core banking institutions subject to the State Guarantee, AIB, Bank of Ireland, Irish Life & Permanent and EBS, the tests were designed to be definitive. Once recapitalized by the Exchequer in-line with the PCAR, Irish banks were supposed to be returned to health – recommencing lending to the SMEs and households, returning to normal funding markets around 2013, while continuing to shed loans to improve their balance sheets.

The PCAR made some major predictions with respect to the banking sector performance over 2011-2013 that were not subject to Nama-imposed losses and, as such, are expected to continue into the future. Chiefly, the Central Bank allowed in its stress scenario for the lifetime losses of €17.2 billion on the residential mortgages books of the four institutions. Only €9.5 billion of these were forecast to hit in 2011-2013. Owner-occupier mortgages losses provided for 2011-2013 amounted to just 60% of the above. Post-2013, it was envisaged that the Irish banking system will be able to fund remaining losses out of its own operations with no recourse to the Exchequer assistance.

Having published the PCARs, the Irish Government proceeded to take a break from the banking crisis. Throughout the second half of 2011 there was a noticeable ‘We’ve sorted the banks’ mood permeating the refined halls of power.

Fast-forward twelve months. Annual results for the four domestic State-guaranteed banks for 2011 are, put frankly, alarming. Set aside for the moment the entire media spin about ‘lower 2011 losses compared to 2010 records’. Once controlled for Nama effects on 2010 figures, the data shows acceleration, not an amelioration of the crisis on the mortgages side.

Excluding IBRC, total amount of owner occupied mortgages that remain outstanding on the books of AIB and EBS, Bank of Ireland and PTSB comes to €71.8 billion or 63% of all such loans held by the banks operating in Ireland. According to the Central Bank of Ireland, 12.3% of all mortgages held in Ireland were 90 days or more in arrears – some €13.9 billion. Of these, the four State-guaranteed banks had €7.7 billion owner-occupier mortgages in arrears, representing 10.8% of their combined holdings. Given banks’ provisions, by the end of 2012, the expected combined losses on mortgages, can add up to 60% of the total 2011-2013 losses allowed under PCAR.

And this is before we recognise the risks contained in a number of mortgages restructured in 2009-2010 that will come off the forbearance arrangements. Many are likely to go into arrears once again in 2012 and 2013. Recall that the entire Government strategy for dealing with mortgages defaults rests on the extend-and-pretend principle of delaying the recognition of the loss by giving borrowers some relief from repayments, e.g. via interest-only periods. This approach is patently not working.

Looking at EBS and AIB results tells much of the story behind the forbearance risk factor. In 2010, the two banks had 16,992 restructured residential mortgages amounting to €3.7 billion. Of these, residential mortgages amounting to €3 billion were interest-only. Of all forbearance mortgages, 92% were classed as performing. By 2011, AIB and EBS held 32,266 forbearance residential loans totalling €6.2 billion – almost double the levels of 2010. Total amounts of mortgages in forbearance arrangements that went into impairment or arrears over the course of 2011 jumped more than seven-fold. One third of the forbearance mortgages are now in arrears.

While Bank of Ireland data is not as comprehensive on 2010 and 2011 comparatives, current (end of 2011) levels of restructured mortgages run at €1.25 billion, of which €249 million were impaired or past-due more than 90 days. This means that €999 million worth of restructured mortgages remain at risk of future arrears. PTSB report for 2011 shows restructured mortgages rising from €1.7 billion in 2010 to €2.1 billion, with those in arrears rising three fold to €524 million.

Taken together with the aforementioned 2010-2011 dynamics, changes to the insolvency regime imply that mortgages losses can exceed Central Bank’s forecasts for 2011-2013 period. Of all four banks, Bank of Ireland remains the healthiest, and the likeliest candidate when it comes to mortgages-related losses. Of course, the banks can continue extending recognition of the losses past 2013, but that will mean no access to non-ECB funding at the time when ECB is increasingly concerned about extending more loans to Irish banks. Worse, with the first LTRO maturing in 2014, Irish banks will be staring into a new funding storm, when their healthier competitors all rush into the markets to fund their exits from LTRO.

Which, of course, means that the entire Government exercise of shoving taxpayers cash into insolvent institutions is unlikely to resolve the crisis. The core banks will continue nursing significant losses well into 2014-2015, with capital buffers remaining strained once potential losses are factored in. And this, in turn, will keep restrained their lending capacity.

Recent Central Bank estimates show that Irish economy will require up to €7 billion in SMEs lending and €9 billion in new mortgages in 2012-2014, while banks are to accelerate deleveraging of their loans books to meet lower loans to deposits standards. At the same time, there will be huge demand for Irish banks lending to the Exchequer, once some €28 billion of Government debt come to mature in 2013-2015. As we have seen with the Promissory Notes ‘deal’, so far, the Government has difficulty getting Irish banking system to buy into Government debt in appreciable amounts.

In other words, we are now staring at the basic conflict inherent in running a zombie banking system that continues to face massive losses on core assets. At the very best, the choice is: either the banks’ will lend to the real economy, while foregoing their support for Exchequer post-2013; or the state uses banking sector resources to cover its own bonds cliff, starving the real economy of credit. The first choice means at least a shot at growth, but the requirement for more EFSF/ESM borrowing (Bailout 2). The second choice means extending domestic recession into 2015.

It is also likely that we will see amplifying politicization of the banking system, with credit allocated to ‘connected’ enterprises and politically prioritized sectors, at the expense of overall economy. Reduced competition – from already below European average levels, judging by the ECB data – will continue to constrain credit supply.

The lesson to be learned from the 2011 full-year results for Irish banks is a simple, but painful one. Banks going through a combination of a severe asset bust and a massive debt overhang crisis are simply not going to survive in their current composition. We need to carry out a structured and orderly shutting down of the insolvent institutions, in particular, IBRC, EBS and PTSB. We also need to restructure AIB. At the same time, we should use the process of liquidation of the insolvent banks to incentivise emergence and development of new service providers.

This can be done by using assets base of the insolvent institution to attract new retail banking players into the market. This process can also involve enhancing the mutual and cooperative lenders models.

Given current funding difficulties, it is hard to imagine any significant uptick in lending in the Irish economy from the traditional banking platforms. Thus, we need to create a set of tax and regulatory incentives and enablers to support new types of lending, such as facilitated direct lending from investors to SMEs. Such models already exist outside Ireland and are gaining market shares around the world, in particular in advanced Asian economies.


The State Guaranteed banking model is, as the 2011 results show, firmly bust. Time to rethink the strategy is now.


Charts:

Box-out:

On the positive front, Q1 2012 Exchequer results released this week showed total tax take rising to the levels, not seen since 2009. Total tax revenues came in at €8,722 million, just below €8,792 in 2009. Year on year tax take is up 16.2%. But hold that vintage champagne in the fridge for a moment. Tax revenues for Q1 this year include reclassified USC charges which used to count as departmental receipts instead of tax revenues. The department of Finance does not provide estimates for how much of the income tax receipts is due to this change, but based on 2010 figures it is close to ca €525 mln. They also include €251 million of corporation tax receipts from 2011 that got credited into January 2012 figures. Netting these out, tax revenues are up 8.2% year on year – still appreciable amount, but down 7.6% on 2009. Compared to Q1 2008 – the first year of the crisis, we are still down in terms of tax receipts some 26.2%. Even at the impressive rate of growth, net of one-off changes, achieved in Q1 this year, it will take us through 2017-2018 before we get our tax take to 2007-2008 levels. As the Fianna Fail 2002 election posters used to say “A lot done. More to do.”

13/4/2012: Short-selling - more evidence that restriction hurt, not help financial stability

Keeping up with some old topics of interest, here is another paper studying markets efficiency within the context of short-selling bans of 2007-present. The study, titled “Price Efficiency and Short Selling” by Pedro A. C. Saffi and Kari Sigurdsson, forthcoming in Review of Financial Studies covers a unique, large set of stocks across a number of countries for the period of January 2005 - December 2008. Data is daily, covering lending and borrowing transactions in 12,621 stocks in 26 countries. The study covers more than 90% of global stocks in terms of market capitalization.

The core questions the authors attempted to answer are:

• What is the impact of short-selling constraints on financial markets?
• Do they make markets more or less efficient?

After Lehman Brothers’ bankruptcy in September 2008, in the US, SEC and the UK FSA restricted the short selling of particular stocks. The emergency order enacting the short-selling restrictions in 2008 by the SEC recognized the usefulness of short-selling for market liquidity and price efficiency, but it also claimed that: “In these unusual and extraordinary circumstances, we have concluded that, to prevent substantial disruption in the securities markets, temporarily prohibiting any person from effecting a short-sale in the publicly traded securities of certain financial firms, (...), is in the public interest and for the protection of investors to maintain or restore fair and orderly securities markets. This emergency action should prevent short selling from being used to drive down the share prices of issuers even where there is no fundamental basis for a price decline other than general market conditions.” Securities Exchange Act Release No. 34-58952 (September 18th, 2008). Following the US and UK, Germany banned short-selling in June 2010 for eurozone sovereign bonds and credit default swaps, claiming that short-selling “had led to excessive price shifts, which could have led to significant disadvantages for financial markets and have threatened the stability of the entire financial system.”

The study considers whether short-sale constraints affect price efficiency and characteristics of the distribution of stock returns of firms around the world. The study defines price efficiency “as the degree to which prices reflect all the available information, both in terms of speed and accuracy.”

The study finds that:

• Lending supply influences price efficiency so that “stocks with limited lending supply are associated with lower efficiency.”
• Higher level of lending supply is “associated with a greater degree of negative skewness and fewer occurrences of extreme price increases, but is not linked with extreme price decreases.” In other words, absence of restrictions on short-selling is not associated with significant presence of extreme downward pressures on stocks – something the bans on short-selling were designed to reduce.
• In the presence of short-selling restrictions, the decrease in skewness is “due to less frequent extreme positive returns, in line with the view that arbitrageurs cannot correct overvaluation as easily when short selling constraints are tighter.” Or put differently, presence of a short-selling ban reduces volatility – if at all – via reducing upward movements in the stocks, not the downward ones.
• Limited lending supply – consistent with short-selling restrictions – “does not affect downside risk and total volatility. We actually find that less lending supply and higher loan fees are associated with greater downside risk and total volatility.” In other words, the short-selling restrictions act in exactly the opposite direction to their intended objectives.

“These findings do not support the view expressed by regulators that unrestricted shorting can destabilize prices, while simultaneously supporting the academic findings that short-sale restrictions generally make market less efficient.”   

“The negative relationship between short-sale constraints and stock price efficiency is found at a stock level all over the world, and equity lending supply is an important driver of differences in price efficiency.”

Interestingly, the findings are robust to membership in the Organization for Economic Cooperation and Development (OECD) countries, and to endogeneity concerns.

13/4/2012: Ireland's Green Economy

Wading through some old (relatively) papers, I came across the Cleantech innovation study: “Coming Clean: The Cleantech Global Innovation Index 2012”. The study ranked 38 countries across 15 indicators that relate “to the creation and commercialisation of cleantech start-ups, …measuring each [country] relative potential to produce entrepreneurial start-up companies and commercialise technology innovations over the next 10 years.”

Overall, expectedly, North America and northern Europe “emerge as the primary contributors to the development of innovative cleantech companies, though the Asia Pacific region is following closely behind.”

Top-line results:

• Denmark leads the global rankings, “with its unique combination of a supportive environment for innovative cleantech start-ups, evidence of those start-ups gaining momentum, as well as a strong track-record of companies commercialising their cleantech innovations and scaling them up to widespread market adoption, particularly in wind.”
• Scandinavian (or Nordic countries more broadly) “performed notably well, as Sweden and Finland also placed third and fourth respectively. These countries … are behind [Denmark and Israel] on their ability to scale-up entrepreneurial cleantech companies to wider commercial success. (A pattern shared by fifth place country the United States.)”
• “China and India placed 13th and 12th respectively, but stand out as having a strong potential to rise through the ranks in the coming years. While not currently creating innovative cleantech companies in great numbers relative to the size of their economies, they are already strong centres for cleantech production, and have increasingly supportive governments, large sums of private money ready to be invested, and massive domestic markets.”

 

I am not going to pass a judgment on the viability or sustainability of the cleantech activities, but it is clear that the Irish Government continued the rhetoric of prioritizing the ‘Green economy’ ideals it inherited from its predecessor. In this light, how did Ireland score in the cleantech rankings for 2012? It turns out not too bad for a Small Open Economy and that our strong performance is driven by what we are actually good at: selling stuff. Which, in my opinion, risks making this a strong positive in terms of sustainability of cleantech activity.

Per study: ‘Ireland scores especially well on general innovation drivers [e.g. policy and legacy enterprises in innovation-intensive sectors, such as services MNCs and some domestic exporters, but not specific to cleantech] and commercialised cleantech innovation [e.g. MNCs activities], but falls below average on cleantech-specific innovation drivers [e.g. policies supporting innovation in energy and green-IT and IT-for-Green]. Ireland has very strong general innovation inputs, yet lacks public R&D spending, and has only average scores for supportive government policies and access to private finance [which is surprising, given significant VC funds and incubation centres we have deployed via EI and universities system]. Ireland stands out less for emerging cleantech innovation due to its low output of environmental patents and lack of high impact cleantech start-ups. In contrast, the country scores well for commercialised cleantech innovation, with a large percentage of the population working in cleantech, and good numbers for private equity and M&A deals. Ireland falls just ahead of the neighbouring UK.”

Ireland ranks 9th in the world in the global cleantech tables and its scores, compared against peer economies, per categories, are shown below.


What is revealing, perhaps, is that globally there is only a weak positive relationship between cleantech-specific innovation and commercialized cleantech innovation and in Ireland this relationship is stronger than average. This is most likely due to the more advanced MNCs and exporting base in the Irish economy in general, whereby domestic innovation activities, including those booked by the MNCs into Ireland for tax purposes, is aligned with commercialization via exports. Worldwide, the weak relationship suggests continued non-commercial nature of much of cleantech – serving as a proxy for subsidies dependence of the industry. In which case, Ireland overall is a good stand-out again.

11/4/2012: Irish Construction Sector PMI for March

Irish construction PMI for March 2012 (published by Ulster Bank) posted a 58th consecutive monthly contraction with a reading of 46.7 against 45.8 in February 2012. In other words, construction sector activity has now been below 50.0 reading every month since June 2007.

Commercial sector activity showed accelerating decline at 47.4 in march 2012 against 49.1 in February 2012. This puts to a test some of the assertions made in recent months by sector analysts and in the media that commercial construction activity is showing a rise on the foot of robust FDI investments.


Engineering sector activity - primarily driven by public projects - was showing decline at 37.0 in march, slower rate of decrease than consistent with 35.6 reading in February. Housing sector activity remained on a relatively constant rate of decline at 42.3 in March compared to 42.4 in February.


Desperate reports of some analysts have decided to focus "positive" attention on allegedly broadly unchnaged new orders sub'index and improved business sentiment. However, actual data release stated that (emphasis and commentary mine):

• New orders were broadly unchanged in March, having declined solidly in the preceding month (thus unchanged in March means unchanged from the losses sustained previously). Some firms indicated that small contracts had been secured during the month, but others indicated that a reluctance among clients to commit to projects had prevented a rise in new orders. (If this is a net positive, I should be probably joining the Russian Ballet)
• Business sentiment was at its highest since January 2007 in March and, as such, was the strongest since the current downturn in activity began (in June 2007). Exactly 46% of respondents  predict that activity will increase over the next 12 months, with signs of improving economic conditions and a forecast rise in new orders supporting optimism. (Alas, the Ulster Bank release fails to give us any data on business sentiment sub-index. In fact, this is the only indicator missing in the charts supplied by the Markit note).

What no report that I have seen so far mentions is that, per Ulster Bank-Markit note: Construction sector "workloads remained insufficient to generate a rise in employment in the sector during March. That said, staffing levels decreased at a rate that was much weaker than seen throughout much of the current downturn." So employment continues to drop. And profit margins are also continuing to fall: "The rate of input cost inflation accelerated for the third consecutive month in March, and was the fastest since April 2011. Higher prices for fuel and other oil-related products were reported by panellists."

On the foot of this information, and presumably with an aid of some tealeafs floating in a cuppa, one respectable analyst concluded (emphasis and commentary mine): unchanged new orders and unverifiable "spike" in business sentiment "...may tentatively signal that the Irish market is approaching stabilisation, albeit at a very depressed level." Ok, then, Bolshoi School is recruiting for Junior Infants... I am off for an audition.