19/4/2013: More from the IMF on Irish banks...

Getting back to the IMF GFSR report released earlier this week. Some nice charts worth a quick comment or two:

Two things worth noting in the above:

1. Increase in covered bonds for Irish banks, absent, pretty much, any serious issuance between 2007 and 2012 and maturing of some bonds. This may be linked to the deteriorating quality of assets against which the bonds were secured, requiring 'top-ups' with new assets. In effect, this means that to maintain existent level of funding a bank will require more assets to be put aside.
2. Massive, relative to GDP, exposure to MROs + LTROs for the Irish banks. Let's keep in mind that some Irish banks were precluded from participating in the second LTRO due to lack of suitable collateral. Even with that, Irish banking sector exposure to LTROs relative to GDP is the largest of all countries in the sample.

The next two charts plot relationship between banks' lending to households and corporates and the growth forecasts for the economies:

By both charts above, Ireland appears to be basically just on the borderline between the core and the peripheral countries. Of course, this means preciously little, since Irish banks basically are issuing no new loans and thus whatever rates they report are heavily, very heavily biased in favour of higher quality borrowers. Here's how this bias works: the bank in Ireland issues a loan to company A for the amount X and duration W. The rate on this loan is r=f(A,X,W)  such that if A quality is higher then rate r  is lower, if X is larger, the rate is higher, and if W is longer, the rate is also higher. We control all other variables that might influence the rate quoted. If the case of the same company looking for the same loan outside Ireland, the bias above would imply a lower rate quoted, or a smaller loan granted or for shorter duration, or all or any permutations of the above. 

Here is an interesting point. In the first chart above, Irish house loans rates went up during the crisis, but corporate loans rates went dramatically down during the crisis. Now, houses-related loans within the Irish banking system are currently in default at close to 20% rate, while SMEs loans are in default close to 50% rate. High quality corporates are probably in the same rate of default today as in 2007. Which means that corporate loans book of Irish banks should be posting default rates (NPLs) of similar or larger proportions as house lending book. Yet the rates for two types of loans have moved in the opposite direction and very significantly.

On foot of the above, question for our Dear Leaders: Are Irish banks, for purely political reasons (recall Government's repeated exhortations about the need for the banks to 'do their bit for the economy', 'lend to our SMEs' etc), using house loans pricing to subsidise corporate loans issuance?

Just in case you start harping on about Irish corporates having better debt loads than households, IMF has the following handy charts:

And more: Irish corporates have exceptionally poor interest coverage ratios:

Keep in mind - the above applies only to listed firms, not to privately held ones...

19/4/2013: Mountains to climb, canyons to wade across

Nice visual from Pictet gang, sizing up two banking systems:

That was pre-'rescue' of Cypriot economy from itself by the 'benevolent' Troika Partners...

Recall, the package deal includes scaling back Cypriot banks to ca x3 GDP, or cutting the sector back to just about where it was in mid-2012 for Iceland, given the magnitude of GDP contraction from 2012 levels that this would require. It will be the case of roughly 'Look to your left, look to your right - either both of the bank clerks next to you are gone, or you are gone with one of them in tow'.

Updated:

And another visual from Pictet folks:

19/4/2013: Decomposition of Irish GDP & Gross Operating Surplus: 2012

Recent CSO data release shows decomposition of 2012 Irish GDP and Gross Operating Surplus (defined as GDP less taxes and compensation of employees, plus subsidies). Here are annual dynamics:

 Overall,

• Households' contribution in 2012 to the GDP rose 5.66% y/y and is down 21.02% on peak
• Government's contribution in 2012 to the GDP declined -1.76% y/y and is down 12.04% on peak
• Financial Corporations' contribution in 2012 to the GDP rose 2.98% y/y and is down 10.75% on peak
• Non-Financial Corporations' contribution in 2012 to the GDP rose 3.03% y/y and is down 7.27% on peak
• Not-sectorised areas of activity contribution in 2012 to the GDP rose 4.34% y/y and is down 35.70% on peak

 Per chart above,

• Households' contribution in 2012 to the Gross Operating Surplus rose 11.12% y/y primarily due to subsidies increases, and is down 19.86% on peak. Subsidies to households rose 18.30% y/y in 2012.
• Government's contribution in 2012 to the Gross Operating Surplus declined -7.29% y/y and is down 14.89% on peak
• Financial Corporations' contribution in 2012 to the Gross Operating Surplus rose 6.01% y/y and is down 14.68% on peak
• Non-Financial Corporations' contribution in 2012 to the Gross Operating Surplus rose 2.50% y/y and is down -2.1% on peak
• Not-sectorised areas of activity contribution in 2012 to the Gross Operating Surplus rose 2.94% y/y 
• Overall Gross Operating Surplus rose 4.58% y/y and is down 9.75% on peak

Now, on to the relative importance of each broader sector in main areas of determination of the Gross Operating Surplus:

Note that in the above, Government share of any activity defining Gross Operating Surplus ranges from  zero for taxes and subsidies, to 25-27% for compensation of employees, to11.4-13.0% for GDP and overall Government accounts for only 3.18% (2002-2007 average) and 3.31% (2012 average) of the Gross Operating Surplus in the Irish economy. In other words... does it really matter that much?

Consider the disparity:

• In 2002-2007 on average, Households accounted for 17.4% of all GDP generation, a share that declined to 15.87% in 2012. Meanwhile, for the Government, the same figures were 11.41% and 13.04% - significantly less during the boom years and marginally less in 2012.
• In 2000-2007 on average, Households accounted for 26.49% of all Gross Operating Surplus in the economy, with that share sliding to 24.84% in 2012. For the Government, the same figures were 3.18% in 2002-2007 and 3.31% in 2012.
• Notice the gaps?

Consider another interesting thing:

• In 2002-2007 on average, Non-Financial Corporations (NFCs) accounted for 50.4% of all GDP generation, a share that rose to 52.4% in 2012. Meanwhile, for the Government, the same figures were 11.41% and 13.04%. So as GDP share goes, NFCs were much, much more important than the Government, by a factor of 4.
• In 2002-2007 on average, NFCs accounted for 55.6% of all Employees compensation generation, a share that rose to 53.3% in 2012. Meanwhile, for the Government, the same figures were 24.8% and 27.1%. So as Employees compensation share goes, NFCs still more important than the Government, but now only by a factor of less than 2.
• In 2000-2007 on average, NFCs accounted for 56.9% of all Gross Operating Surplus in the economy, with that share rising to 60.6% in 2012. For the Government, the same figures were 3.2% in 2002-2007 and 3.3% in 2012.
• Now, again, consider the above gaps...

19/4/2013: Watch out for overheating Euro area growth...

Ifo Institute issued its updated forecasts for Germany and Euro area 2013-2014. Here are the summaries:

As Euro area aggregate forecast shows, the European Century is rolling on with expected 0.4% annual expansion in real GDP in 2013 and 0.9% roaring growth in 2014 expected. Meanwhile, the speedy engine for Euro area growth - Germany - is expected to post 0.8% boom-time growth in 2013 and globally impressive, future path-inspiring expansion of 1.9% in 2014.

Clearly, we must be watching out for a positive output gap emerging soon, as both economies will be overheating in the next 19 months from all this tremendous growth...

18/4/2013: Legalising Modern Version of Slavery

Insolvency guidelines published today were wholly and fully written by the banks and for the banks.

The core points are that under the new regime, Irish mortgagees will be:

1. Treated as de facto strategic defaulters until they are proven not guilty of such behaviour in a biased process that will see them face fully resourced lenders while having no practical and meaningful means for defending themselves. 'Innocent until proven guilty' principle no longer applies in the Irish State.
2. Permanently branded as defaulters for the rest of their lives as there record of applying for the resolution process will be kept indefinitely, independent of success or failure of the process.
3. Will lose basically any means to sustain real savings, investment, pensions provisions for the duration of up to 6 years or even longer without any guarantee that their engagement with the system will end in resolving the debt overhang at the end of the process.

This means that the Irish economy will continue to struggle with the debt overhang and, materially, the current change in the regime will only serve the purpose of further shifting financial resources from the households to the banks.

There was no real functional process for consultation with the current providers of services to those facing the insolvency. There was no transparency in developing these Guidelines. Give you one example, there is no reference to the protection of consumers, mortgagees or borrowers in the entire text of the document.

Take it from the top: "A debtor should be able to participate in the life of the community, as other citizens do. It should be possible for  the debtor ‘to eat nutritious food …, to have clothes for different weather and situations, to  keep the home clean and tidy, to have furniture and equipment at home for rest and  recreation, to be able to devote some time to leisure activities, and to read books,  newspapers and watch television" according to the Guidelines.

In other words, from get-go, a debtor is not to be allowed to plan or provide for the retirement, to arrange for health cover, to build functional (as opposed to token) precautionary savings, or to have incentives to better their lives. 

Presumably, Irish social inclusion does not provide an allowance for dental care either. At EUR5 per week in allowed savings, a debtor would have to wait around 140 weeks in agonising pain before they can get a tooth cap. Children braces will take as much if not longer. And you better not dare go to a doctor more than once every two months during your dental affordability waiting period.

Now, let's give it a thought - we are releasing households with children into the wilderness of living without providing a single cent for uncovered (beyond those stipulated by the guidelines) eventualities - e.g. dental emergency or a breakdown of the sole family vehicle. And we give them no capacity to acquire such means by working harder or undertaking different jobs which pay more.

When it comes to access to car, the guidelines do not distinguish between the need to commute to work and to commute to deliver children to schools or childcare facilities. The guidelines also appear to ignore the fact that shopping for a family is not the same as shopping for a single individual when it comes to transportation options allowed. There are no provisions for households that may require two cars. There are no realistic provision for caring for the old-banger vehicle that Guidelines allow for and which cost more in repairs than newer vehicles which the households will be forced to sell.

The real flaw in this approach is that we start from the point of allowed disposable income and work our way back to earned income. This means that a household has absolutely no incentive to earn more, no allowance is provided for them to take up risk and become entrepreneurs, no capacity to fund change in employment. 

This is precisely what wage slavery is all about. And we are now putting people into it.

The Guidelines talk vaguely about the need to incetivise households to engage in economic activity, yet provide a cap on savings of EUR5 per week per adult. None allowed per child. 

In other words, suppose you satisfy the conditions of the Guidelines and you get a new job paying an extra EUR50 per week. You cannot save anything out of this, which means all of the additional income immediately accrues to the banks.

Now, imagine that a new job offer comes with the prospect of better pension down the line, greater promotional opportunities, better life satisfaction and other benefits you might want to have and that can significantly improve your and your family wellbeing, not to mention the economy. Alas, also assume that the new job requires you to commute to work by car while prior to that - with your old job - the Guidelines allowed only for public transportation option. You have no savings to buy the car and no access to new credit. Which means that you will either have to turn down the new job (at a loss to you, employer, the bank and the economy) or to borrower on terms and conditions from the bank with which you have arrangements in place (at a loss to you, as you can't keep the upside of the new job pay). 

This is like taking slave labour and forcing it to consume bank-provided services at prices set by the bank. In the 19th century this was the practice with monopsonist employers and it led to industrial unrest on a massive scale and even revolutions. Welcome to the New Ireland, folks.

Thus, even in theory, the Guidelines are not consistent with one of their intended purposes - that of supporting economic activity and participation in this activity by the households.

In a summary: From the beginning of this crisis I have argued that we need to import UK insolvency regime into Ireland, so as  to allow effective and efficient bankruptcy resolution. 

What we have done instead is put forward a modern-day, democratically legislated slavery in the name of protecting our banks and created an incentive for tens of thousands to convert current bankruptcy tourism into a permanent bankruptcy emigration. 

Welcome to the 21st century model of a Dickensian nightmare grafted onto, as Namawinelake puts it perfectly world's most exemplary Nanny State.


Updated:
Two excellent posts on the Guidelines that are a must read:

Brian Lucey's: http://brianmlucey.wordpress.com/2013/04/18/pettifogging-nanny-state-gone-mad/

and

Namawinelake's: http://namawinelake.wordpress.com/2013/04/18/hey-world-if-you-want-to-see-what-a-true-nanny-state-looks-like-look-at-what-ireland-has-just-done/

17/4/2013: Global Banking Sector Roadkill Alley (aka euro area)

Lets play the game of 'Spot the odd one out...' 

Fact 1: Globally, growth is concentrating in Latin America, Asia Pacific and Africa (see earlier post here) and the lowest growth centre is the Euro area.

Fact 2 (via IMF GFSR Chapter 1):

Question: Which banking system has spent almost three years now 'deleveraging' itself out of global growth centres so it can focus its immensely healthy balancesheets on pursuing growth where there is no growth in sight?

Answer on a post-card addressed to:

Mr Mario Draghi 

Kaiserstrasse 29
60311 Frankfurt am Main, Germany

Bonus round: in the Sick Banks Club (aka euro area) which are the sickest and second sickest national banking systems?

For hint, see this post.

17/4/2013: IMF's succinct summary of Irish banking mess

IMF's GFSR Chapter 1 offers a nice visual highlighting the fact that Irish banking system is still the sickest of all banking systems in Europe, bar that of Greece (which doesn't count, for anyone with a will to argue the point, as it has been comprehensively destroyed in rounds of sovereign debt restructuring and by all Troika MOUs is yet to undergo the 'repairs' similar to those allegedly 'completed' in Ireland in 2011):

And a footnote explaining the chart:

17/4/2013: Talking of Being Stuck in a Wrong Hood...

In recent presentations on the global economy, euro area and Ireland I have stressed the fact that we (EA and Ireland) are stuck in the 'wrong hood' - low growth, ageing and socially sclerotic environments with no structural drivers for creation of new value added.

Here's a good visual courtesy of the IMF WEO April 2013 (full publication here):

First, the World of new regionalisation, with:

• Stagnant North-East or Fortress Europe
• Drowsy North-West or Fortress North America
• Dynamic Asia-Pacific or Bad Boys Gang
• Dynamic Latin America or Government Spending Junkies
• Emerging Africa or Catch-up Hare:

 And zooming onto our (Ireland's) hood:

Per IMF (italics are mine): "The near-term outlook for the euro area has been revised downward, with activity now expected to  contract by ¼ percent in 2013, instead of expanding by ¼ percent as projected in the October 2012  WEO (Table 2.1). This reflects declines in growth projections across all euro area countries, with notable revisions in some core members (France, Germany, Netherlands). Growth will strengthen gradually through the year, reaching 1 percent by the fourth quarter, as the pace of fiscal consolidation (at ¾ percent of GDP) is eased by almost half during 2013.

But growth will generally remain subdued as improvements in private sector borrowing conditions are hampered by financial market fragmentation and ongoing balance sheet repair. Further headwinds to growth could result from a sustained appreciation of the euro that lowers competitiveness and dampens export growth."

Table referenced above:

Do note that per above, with exception of France, all euro area economies are expected to pursue 'exports-led' or 'exports-supported recovery' in 2013-2014. And also do note that unemployment in this 'exporting haven' is not expected to improve in 2013-2014.

16/4/2013: One question, Mr Market, please...

A uncomfortable question:

Faith seems to have no bounds once sentiment shifts. The Market seemed to have maintained confidence in EU's crisis-fighting 'measures' despite the fact that Cyprus case revealed an obvious lack of any real crisis-fighting 'measures' to-date.

The entire periphery-fixing policy tool kit in Europe - now into the sixth year running - still boils down to

1. Rolling out unfulfilled promises (ESM banks-sovereigns break, OMT, a banking union, fiscal policies coordination, fiscal supports for growth - do recall that EU keeps talking about the need to 'support' growth and yet does nothing about providing such supports), 
2. Dogmatic ECB stuck in a rates and money supply policies that neither ease currency and interest rates pressures, nor provide a break from the failed transmission mechanism, and 
3. Internal devaluations of the worst kind (ad hoc loading of debt on economies already carrying too much debt & lack of reforms in the real economy - keep in mind, setting deficit targets ≠ reform). 

So would The Market please run this by me: What HAS changed between Ireland 2008 (the beginning of the euro crisis) and Cyprus 2013 (it's latest iteration) other than the channels by which more debt is being piled onto over-indebted economies hit by crisis?

Well, not much. Yesterday, IMF has issued a statement on Greece (that's right - the second country that was 'repaired' by the EU approach to crisis, ...and then repaired again... and again) claiming that with the fourth round of 'reforms' promised, Greece is now (still?) on a sustainable debt path. Never mind that the 'sustainable debt paths' so far for Greece have meant debt/GDP ratios bounds for sustainability rising from 'under 120%' within Programme 1 to 'under 200%' within Programme 4.

15/4/2013: Advanced economies exports: converging in growth trends?

Quite an interesting new trend that emerged since the late 2000s and is reaching well into 2012-2013 so far is the trend of convergence in the rates of growth in exports of goods and services between euro area, the US and Japan.

Here are few charts:

 Note, the above correlations convergence is also confirmed on a 20 year rolling basis.

One thing is pretty clear from the above: while prior to 2004-2005 the US exports dynamics remained relatively weak compared to those of the euro area, since 2005, the picture has changed dramatically, with the US exports dynamics falling pretty much in line with those of the euro area.

Here are some interesting facts:

• On a cumulated basis, from 1981-2012, volume of exports has expanded from index reading of 100 in 1981 to 406 in 2012 for Japan, 352 for the UK, 505 for the US, 812 for the Advanced Economies and 715 in the euro area, highlighting the fact that the euro area overall cumulatively outperformed all other economies in the comparison group.
• Similarly, on cumulated basis, from 2000 (index=100) through 2012, volume of exports index rose to 156 in the case of Japan, 137 in the case of the UK, 156 in the case of the US, 227 in the case of the Advanced Economies and 237 in the case of the euro area, once again confirming euro area outperformance over the period.
• In contrast, on cumulated basis, from 2004 (index=100) through 2012, volume of exports index rose to 124.5 in the case of Japan, 122.1 in the case of the UK, 151.6 in the case of the US, 166.4 in the case of the Advanced Economies and 154.8 in the case of the euro area, showing closing gap in euro area outperformance compared to the US over the period.

The drivers for these changes are most likely a combination of factors including:

• Technological and supply chains convergence in traditional sectors;
• Increased openness in the euro area to trade;
• Changes in currency valuations with the introduction of the euro and the effects of the current crisis on currency valuations;
• Improving energy component of the total cost basis in the US, and
• Shift in exports growth toward services sectors (composition effects).

15/4/2013: Bonus Culture: A model of social efficiencies in the presence of bonuses

The global financial crisis has exposed the absurd effects of short-termism when it comes to bonuses on long-term sustainability and efficiency of enterprises. However, the idea that bonuses can be effective in creating a compensation wedge over relatively standardised salary scales to reward performance and/or human capital (on the supply side of labour) and to provide competitive advantage to firms in attracting human capital (on the demand side of labour) is not necessarily out of touch with reality in many other sectors and occupations. Still, some worrying lessons that we should learn about the distortions introduced by bonuses from the crisis do apply to other sectors as well.

An interesting paper, albeit purely theoretical, titled "Bonus Culture: Competitive Pay, Screening, and Multitasking" by Roland Bénabou and Jean Tirole (NBER Working Paper No. 18936, April 2013) looked at "the impact of labor market competition and skill-biased technical change on the structure of compensation."

The authors found that "Competition for the most talented workers leads to an escalating reliance on performance pay and other high-powered incentives, thereby shifting effort away from less easily contractible tasks such as long-term investments, risk management and within-firm cooperation. Under perfect competition, the resulting efficiency loss can be larger than that imposed by a single firm or principal, who distorts incentives downward in order to extract rents. More generally, as declining market frictions lead employers to compete more aggressively, the monopsonistic under-incentivization of low-skill agents first decreases, then gives way to a growing over-incentivization of high-skill ones. Aggregate welfare is thus hill-shaped with respect to the competitiveness of the labor market, while inequality tends to rise monotonically. Bonus caps and income taxes can help restore balance in agents' incentives and behavior, but may generate their own set of distortions."

Furthermore, "The extent to which [such a correction via bonus caps and income taxes] is achievable depends on how well the government or regulator is able to distinguish the incentive versus fixed parts of compensation packages, as well as on the distortions that may arise as firms try to blur that line or resort to even less efficient screening devices."

One issue with the study is that the model does not allow for heterogeneity between agents and between various sectors of economy. The authors acknowledge this much by stating that "…task unobservability may be less of a concern for some (e.g., private-equity partnerships) and more for others (large banks), but if they compete for talent the high-powered incentives efficiently offered in the former may spread to the latter, and do damage there. Heterogeneity also raises the question of the self-selection of agents into professions and their matching with firms or sectors, e.g., between finance and science or engineering."

Other shortcoming, also mentioned by the authors in their 'what can be done next' discussion is that in some  "settings in which high-skill workers become more valuable as firms compete harder for customers, for instance because the latter become more sensitive to quality."

15/4/2013: Irish Labour Costs: IDA spin and reality

IDA presentation claims loudly & boldly that Ireland is one of 3 countries where nominal wages have dropped (slide 5).

This raises two questions.

1. An existential one: are dropping nominal wages a good thing? Well, not really. For a number of reasons. Firstly, declining wages = declining domestic demand and investment. Now, IDA - focused on MNCs and FDI - might not give a damn about these two aspects of the economy, but sadly they are more important to Ireland than IDA-sponsored multinationals, as the last 6 years of the Great Recession clearly show. Secondly, declining nominal wages = lower incentives to locate talent into Ireland and develop human capital here. Now, that is something IDA should care about, since this cuts the ability of its MNCs to continue creating the illusion of productivity here. Thirdly, declining nominal wages may mask loss of efficiency and productivity in some sectors and superficial gains in efficiency in other sectors. How so? Ok, suppose wages in a less productive sector, like construction or retail fall, while wages in more productive sector, like ICT rise. Average or median wages across economy might fall, but competitiveness might also decline where it matters - in higher growth sectors. Sadly, IDA seem to have no clue that this is what appears to have been happening in the economy, presumably because it would put a bit of a brake on the IDA spin. But see table below to verify that the above factor 3 does indeed apply to Irish data.
2. A factual one: is this claim true. Now, here's Paul Krugman's article saying it is not true: http://krugman.blogs.nytimes.com/2013/04/13/dnwr-in-the-ea/ . But what about raw, direct data from Ireland? CSO provides: http://cso.ie/en/media/csoie/releasespublications/documents/earnings/2012/earnlabcosts_q42012.pdf and the end game is: average hourly earnings in Ireland in Q4 2012 were +0.6% y/y and +0.7% q/q in the private sector, and down -0.4% y/y and +0.6% q/q in public sector. So unless IDA cares about labour costs in the public sector (presumably because IDA have discovered a treasure cave full of MNCs in Irish public sector), Irish nominal earnings are up, not down.

There are other problems with claims IDA makes. Wages might fall, but cost of labour might still go up due to increased cost of Government related to payroll and income taxes. Conveniently, CSO provides raw data on this too. Total labour costs in Ireland as of Q4 2012:

• Increased in the private sector +2.6% q/q and +1.3% y/y
• Compared to 2008, these were down from EUR23.51/hour to EUR23.31/hour - a massive decline of 0.86% in 4 years, cumulative.

Judge for yourselves as to what the dynamics in Irish wages (earnings and total labour costs, to be more precise) are (for all sectors reported by CSO):

No comment needed.