2/9/16: Getting Back to the Blog

Folks, the joys of moving to my new job have been quite all-consuming over the month of August, and the joys of preparing for the move - over June and July - were testing as well. Now, with things more settled, it is time for me to come back to blogging, so stay tuned and read.

30/7/16: Europe's Bank Stability in Question

My comment for Euromoney on banking sector risks: http://www.euromoney.com/Article/3574602/Europes-bank-stability-is-in-question-say-country-risk-experts.html.

29/7/16: Tax Regime, Apple, Fraud?

We have finally arrived: a Nobel Prize winner, former Chief Economist and Senior Vice-President of the World Bank (1997-2000) on Bloomberg, calling Apple's use of the Irish Tax Regime 'a fraud': http://www.bloomberg.com/news/articles/2016-07-28/stiglitz-calls-apple-s-profit-reporting-in-ireland-a-fraud?utm_content=business&utm_campaign=socialflow-organic&utm_source=twitter&utm_medium=social&cmpid%253D=socialflow-twitter-business.

This gotta be doing marvels to our reputation as a place for doing business and for trading into Europe and the U.S.

The same as Facebook's newest troubles: http://www.irishtimes.com/business/technology/facebook-tax-bill-over-ireland-operation-could-cost-5-billion-1.2738677.

But do remember, officially, Ireland is not a tax haven, nor is there, officially, anything questionable going on anywhere here. Just 26.3 percent growth in GDP per annum, and booming corporate tax revenues that the Minister for Finance can't explain.

22/7/16: Brexit сближает Ирландии...

My comment for Kommersant (in Russian) on Brexit risks for Ireland: http://www.kommersant.ru/doc/3043700.

21/7/16: Article 50: Facts

There is a lot of poorly informed nonsense being pushed around the media (especially 'new media') about Article 50 process relating to the Brexit. The best, most cogent and brief summary of what actually is involved in this process was provided back in February by the Open Europe think-tank here: http://openeurope.org.uk/today/blog/the-mechanics-of-leaving-the-eu-explaining-article-50/.

20/7/16: McKinsey's "Generation Worse"...

A new study from McKinsey looks at the cross-generational distribution of income as a form of new ‘inequality’, in words of the authors: “an aspect of inequality that has received relatively little attention, perhaps because prior to the 2008 financial crisis less than 2 percent of households in advanced economies were worse off than similar households in previous years. That has now changed: two-thirds of households in the United States and Western Europe were in segments of the income distribution whose real market incomes in 2014 were flat or had fallen compared with 2005.”

In other words, McKinsey folks are looking at the “proportion of households in advanced economies with flat or falling incomes” - the generational cohorts that are no better than their predecessors.

Key findings are frightening: “Between 65 and 70 percent of households in 25 advanced economies, the equivalent of 540 million to 580 million people, were in segments of the income distribution whose real market incomes—their wages and income from capital—were flat or had fallen in 2014 compared with 2005. This compared with less than 2 percent, or fewer than ten million people, who experienced this phenomenon between 1993 and 2005.”

So that promise of the ‘sharing economy’ and the ‘gig-economy’ where people today are enabled to derive income (and thus wealth) from hereto under-utilised ‘assets’… pwah! not doing much. The ‘most empowered’ - web and gig-economy wise cohorts? Ah, they are actually the “worst-hit” ones. “Today’s younger generation is at risk of ending up poorer than their parents. Most population segments experienced flat or falling incomes in the 2002–12 decade but young, less-educated workers were hardest hit”.

For those of us who, like myself, tend to be libertarian in our view of the Government, McKinsey study tests some of our accepted ‘wisdoms’: “Government policy and labor-market practices helped determine the extent of flat or falling incomes. In Sweden, for example, where the government intervened to preserve jobs, market incomes fell or were flat for only 20 percent, while disposable income advanced for almost everyone. In the United States, government taxes and transfers turned a decline in market incomes for 81 percent of income segments into an increase in disposable income for nearly all households.”

Except, may be it did not, because counting in disposable income while allowing for taxes and subsidies is notoriously difficult and imprecise. And may be, just may be, all the fiscal imbalances that were accumulated in the process of achieving these supports in some (many) countries will still have to be paid by someone some day?

There is a reduced connection between current growth metrics and income outcomes on the ground (don’t we know as much here in Ireland, with 26.3% jump in GDP in 2015?): “Before the recession, GDP growth contributed about 18 percentage points to median household income growth, on average, in the United States and Europe. In the seven years after the recession, that contribution fell to four percentage points, and even these gains were eroded by labor market and demographic shifts.”

And the forward outlook? Bleak: “Longer-run demographic and labor trends will continue to weigh on income advancement. Even if economies resume their historical high-growth trajectory, we project that 30 to 40 percent of income segments may not experience market income gains in the next decade if labor-market shifts such as workplace automation accelerate. If the slow growth conditions of 2005–12 persist, as much as 70 to 80 percent of income segments in advanced economies may experience flat or falling market incomes to 2025.”

There are some wrinkles in the study. For example, in the U.S. case - cross time comparatives do not provide for the same data base, as pre-2014 data does not include state and local taxes. VAT and sales taxes are omitted across the board. And some other, but overall, the paper is pretty solid and very interesting.

So here is the key summary chart, positing the massive jump in the numbers of households on the declining side of market incomes:

And the chart showing that the taxes and transfers side of income supports is no longer sustainable over time:

Which brings us to the main problem: on the current trend line, politics of income supports from the fiscal policy side are unlikely to be able to contain growth in political discontent. Advanced economies are heading for serious tests of democratic institutions in years to come. Buckle your seat belts: the ride is going to get much rougher.

15/7/16: A Booming Tax Haven? And Why Not?

Yes, we all know, Irish GDP in 2015 grew by an officially idiotic 26%. And yes, I am no longer gracing these illusionary / delusionary numbers with an attempt at any serious analysis. Doing so would be too big of an intellectual subsidy to the world of Irish officialdom. So here are two quite opposite (in their top-line accuracy) views of the same problem, that both, in the end, arrive at the same conclusion:

One view is from Fortune magazine http://fortune.com/2016/07/13/ireland-tax-haven-gdp-up/ where the headline says all you need to know

And another is from the Irish Times, that rows in with a more 'diplomatic' (aka - easier to chew by the Dons of the Irish Civil Service) discourse that is worth reading, despite it containing some pretty delusional (see my twitter stream from today on this) statements: http://www.irishtimes.com/business/economy/ireland-s-gdp-figures-why-26-economic-growth-is-a-problem-1.2722170#.V4i7kuyVTic.twitter.

In the nutshell, Fortune got it right at the top level, Irish Times got some beefier discussion of the details.

13/7/16: Xenophobic Britain, Good Europe Mythology

You know the shrill of the deeply wounded 'Remain' supporters from the UK Referendum that did not go their way? Ah, yes: "Older Britain, that won, is xenophobic, racist, anti-migrant. And the young Britain, that lost, is the opposite of that."

Ok, there are stereotypes. And then there are stereotypes. The 'old Britain' that is allegedly such a terrible place is the one that built one of the most multicultural societies in the world. That's right: the young Britain was not even born when that happened.

But never mind history, here's the most current (1Q 2016) data on attitudes to multiculturalism from the not-so-pro-Brexit source, PewResearch:

By opposition to multi-ethnic society, the UK ranks 5th in the group of these countries, tied with on-so-progressively-liberal Germany, and better than core-European-values Italy and Holland, ahead of the beacon of European democracy Poland. By actual support for multi-ethnicity in society, the UK ranks third, ahead of all other European countries in the survey other than Sweden.

Of course, the U.S. leads all the countries in terms of support for multi-ethnic society. Not surprisingly.

Here's another interesting snapshot from the same study:

So if we are to look at the Left-Right gap, the UK is at the widest differential in opinions on diversity in Europe. But, and here is a major but, with 27% of Conservatives (Right) supporting diversity, it has the most 'liberal' Right in Europe after Sweden. Oh, and notice the little blow up for the 'xenophobic Republicans in the U.S.' meme - that too is absolute bullshit, since U.S. conservatives are more supportive of ethnic diversity liberal / Left Europeans except those in Sweden and the UK.


You can glimpse few more insights into the Pew survey here: http://www.pewresearch.org/fact-tank/2016/07/12/in-views-of-diversity-many-europeans-are-less-positive-than-americans/.

11/7/16: Russian Strategy Change? Perhaps... and Lets Hope So

A rather interesting analysis from The Moscow Times on the emerging directional change in Russian geopolitical strategy: http://www.themoscowtimes.com/opinion/article/a-modest-deal-vladimir-putins-new-d233tente-op-ed/574322.html.

As someone who consistently stressed the need for both, Russia and the West, to (1) actively seek cooperative resolution to the ongoing process of confrontational politics, and (2) pursue consistent policy of de-escalating relations, with a specific focus on potential sources of risks (e.g. accidental encounters in the international air space or waters), recent change in rhetoric from Moscow is certainly welcome. In time, I suspect, we will see more comprehensive strategy emerging from Kremlin statements, but for now, even less-than-comprehensive statements are a good sign.

As a note of caution, I do not agree with the entire set of the author conclusions. Just highlighting the important nature of change. The degree of risks severity here is highlighted by a range of surveys and public opinion views, here is a snapshot of investors' key concerns:

In this environment, last thing anyone needs is more geopolitical risks.

10/7/16: Europe's Banks: Dinosaurs On Their Last Legs?

Europe's banks have been back in the crosshair of the markets in recent weeks, with new attention to their multiple problems catalysed by the Brexit vote.

I spoke on the matter in a brief interview with UTV here: http://utv.ie/playlists/default.aspx?bcid=5026776052001.

Now, Bloomberg have put together a (very concise) summary of some of the key problems the banks face: "Europe's banks have been a focal point of investor skittishness since Britons voted to leave the European Union, but reasons to be worried about financial firms pre-date the referendum. Whether it be the mountain of non-performing loans, the challenge from fintech firms and alternative lenders encroaching on what was once their turf, or rock bottom interest rates eroding margins, the problems facing Europe's lenders are mammoth."

To summarise the whole rotten lot: European banks (as a sector)

• Cannot properly lend and price risk (hence, a gargantuan mountain of Non-Performing Loans sitting on their books that they can't deleverage out, exemplified by Italian, Slovenian, Spanish, Portuguese, Cypriot, Greek, Irish, and even, albeit to a lesser extent, German, Dutch, Belgian and Austrian banks);
• Cannot make profit even in this extremely low funding cost environment (because they cannot lend properly, while controlling their operating costs, and instead resort to 'lending' money to governments at negative yields);
• Cannot structure their capital (CoCos madness anyone?);
• Cannot compete with more agile fintech challengers (because the dinosaur mentality and hierarchical structures of traditional banking prevents real innovation permeating banks' strategies and operations);
• Cannot reform their business models to reflect changing nature of their customers demands (because they simply no longer can think of their customers needs); and
• Cannot succeed in their traditional markets and services (despite being heavily shielded from competition by regulators and subsidised by the governments).

Instead of whingeing about the banks' plight, we should focus on the banks' resound failures and stop giving custom to the patrician incumbents. Let competition restructure Europe's banking sector. The only thing that sustains Europe's banks today is national- and ECB-level regulatory protectionism that contains competition within the core set of banking services. It is only a matter of time before M&As and organic build up of fintech players will blow this cozy cartel up from the inside. So regulators today have two options: keep pretending that this won't happen and keep granting banks a license to milk their customers and monetary systems; or open the hatches and let the fresh air in.

1/7/16: Sunday Night Bailout: Italy

As I have noted on Twitter and in comments to journalists, Brexit has catalysed investors' attention on weaker banking systems. As opposed to the UK banks, that are doing relatively well, given the circumstances, the focal point of the Brexit fallout is now Italian banking system, saddled with excessively high non-performing loans risks and with assets base that is, frankly, toxic, given their exposure to Italian debt and corporates.

Take a look at Kamakura Corporation's data on default probabilities across European financial institutions:

Nine out of twenty five top European financial institutions suffering massive increases in default probabilities over the last 30 days and 90 days are Italian, followed by five Spanish ones. Of five UK institutions on the list, only two are sizeable players worth worrying about.

Not surprisingly, as reported by the WSJ (link here) the EU Commission has approved, quietly and discretely, over Sunday last, use of Italian government guarantees "to provide liquidity support to its banks, ...disclosing the first intervention by a European Union government into its banking system following the U.K. vote to leave the EU." The programme includes EUR150 billion in Government guarantees and is supposed to ease the short term concerns about Italian banks that, based on Italian officials estimates will require some EUR40 billion of new capital.  No one quite has any idea who on earth will be supplying capital to the banks heavily weighted by high NPLs, burdened with massive fallouts in equity valuations and faced with low returns on their 'core' assets (especially Government bonds).

As WSJ notes: "Italian banks have lost more than half of their market capitalization since the beginning of the year, as investors fret about some EUR360 billion in bad loans still logged on their balance sheets. That drop in market value compares to an average decline of less than one third for European lenders. Some Italian banks have seen their shares plummet by some 75% in the first half of the year." Anyone looking into buying into their capital raising plans needs to have their heads examined.

Of course, we know that there is only one ready buyer for the Italian banks 'assets' - the Italian state. Back in April this year, Italy announced the creation of the Atlante fund, designed to "buy shares in Italian lenders in a bid to edge the sector away from a fully-fledged crisis".

As noted in an FT article (link here): "the fund... can also buy non-performing loans." The background to it is that "Italian banks have made €200bn of loans to borrowers now deemed insolvent, of which €85bn has not been written down on their balance sheets. A broader measure of non-performing debt, which includes loans unlikely to be repaid in full, stands at €360bn, according to the Bank of Italy. So is Atlante — with about €5bn of equity — really enough to keep the heavens in place?"

Sh*t no. Not even close to being enough. Which means the State is now fully hooked in banks risks. As the FT article details, the idea is that the Italian Government will buy lower-seniority tranches of securitised trash [sorry: assets] at knock-down prices, leaving senior tranches to private markets. In other words, the Italian Government will spend few billion euros borrowed from the markets to subsidise higher valuations on senior tranches of defaulting loans.

An idea that such schemes are anything other than Italian taxpayers throwing cash at the burning building of the country banking system is naive. Despite all the European assurances that the next bailout will be 'different', it is clear that little has changed in Europe since the days of 2008.

26/6/16: Black Swan ain't Brexit... but

There is a lot of froth in the media opinionating on Brexit vote. And there is a lot of nonsense.

One clearly cannot deal with all of it, so I am going to occasionally dip into the topic with some comments. These are not systemic in any way.

Let's take the myth of Brexit being a 'Black Swan'. This goes along the lines: lack of UK and European leaders' preparedness to the Brexit referendum outcome can be explained by the nature of the outcome being a 'Black Swan' event.

The theory of 'Black Swan' events was introduced by Nassin Taleb in his book “Black Swan
Theory”. There are three defining characteristics of such an event:

1. The event can be explained ex post its occurrence as either predictable or expected;
2. The event has an extremely large impact (cost or benefit); and
3. The event (ex ante its occurrence) is unexpected or not probable.

Let's take a look at the Brexit vote in terms of the above three characteristics.

Analysis post-event shows that Brexit does indeed conform with point 1, but only partially. There is a lot of noise around various explanations for the vote being advanced, with analysis reaching across the following major arguments:

• 'Dumb' or 'poor' or 'uneducated' or 'older' people voted for Brexit
• People were swayed to vote for Brexit by manipulative populists (which is an iteration of the first bullet point)
• People wanted to punish elites for (insert any reason here)
• Protests vote (same as bullet point above)
• People voted to 'regain their country from EU' 
• Brits never liked being in the EU, and so on

The multiplicity of often overlapping reasons for Brexit vote outcome does imply significant complexity of causes and roots for voters preferences, but, in general, 'easy' explanations are being advanced in the wake of the vote. They are neither correct, nor wrong, which means that point 1 is neither violated nor confirmed: loads of explanations being given ex post, loads of predictions were issued ex ante.

The Brexit event is likely to have a significant impact. Short term impact is likely to be extremely large, albeit medium and longer term impacts are likely to be more modest. The reasons for this (not an exhaustive list) include: 

• Likely overshooting in risk valuations in the short run;
• Increased uncertainty in the short run that will be ameliorated by subsequent policy choices, actions and information flows; 
• Starting of resolution process with the EU which is likely to be associated with more intransigence vis-a-vis the UK on the EU behalf at the start, gradually converging to more pragmatic and cooperative solutions over time (what we call moving along expectations curve); 
• Pre-vote pricing in the markets that resulted in a rather significant over-pricing of the probability of 'Remain' vote, warranting a large correction to the downside post the vote (irrespective of which way the vote would have gone); 
• Post-vote vacillations and debates in the UK as to the legal outrun of the vote; and 
• The nature of the EU institutions and their extent in determining economic and social outcomes (the degree of integration that requires unwinding in the case of the Brexit)

These expected impacts were visible pre-vote and, in fact, have been severely overhyped in media and official analysis. Remember all the warnings of economic, social and political armageddon that the Leave vote was expected to generate. These were voiced in a number of speeches, articles, advertorials and campaigns by the Bremainers. 

So, per second point, the event was ex ante expected to generate huge impacts and these potential impacts were flagged well in advance of the vote.

The third ingredient for making of a 'Black Swan' is unpredictable (or low predictability) nature of the event. Here, the entire thesis of Brexit as a 'Black Swan' collapses. 

Let me start with an illustration: about 18 hours before the results were announced, I repeated my view (proven to be erroneous in the end) that 'Remain' will shade the vote by roughly 52% to 48%. As far as I am aware, no analyst or media outfit or /predictions market' (aka betting shop) put probability of 'Leave' at less than 30 percent. 

Now, 30 percent is not unpredictable / unexpected outcome. It is, instead, an unlikely, but possible, event. 

Let's do a mental exercise: you are offered by your stock broker an investment product that risks losing 30% of our pension money (say EUR100,000) with probability of 30%. Your expected loss is EUR9,000 is not a 'Black Swan' or an improbable high impact event, but instead a rather possible high impact event. Conditional (on loss materialising) impact here is, however, EUR30,000 loss. Now, consider a risk of losing 90% of your pension money with a probability of 10%. Your expected loss is the same, but low probability of a loss makes it a rather unexpected high impact event, as conditional impact of a loss here is EUR90,000 - three times the size of the conditional loss in the first case. 

The latter case is not Brexit, but is a Black Swan, the former case is Brexit-like and is not a Black Swan event. 

Besides the discussion of whether Brexit was a Black Swan event or not, however, the conditional loss (conditional on loss materialising) in the above examples shows that, however low the probability of a loss might be, once conditional loss becomes sizeable enough, the risk assessment and management of the event that can result in such a loss is required. In other words, whether or not Brexit was probable ex ante the vote (and it was quite probable), any risk management in preparation of the vote should have included full evaluation of responses to such a loss materialising. 

It is now painfully clear (see EU case here: http://arstechnica.co.uk/tech-policy/2016/06/brexit-in-brussels-junckers-mic-drop-and-political-brexploitation/, see Irish case here: http://www.irishtimes.com/news/politics/government-publishes-brexit-contingency-plan-1.2698260) that prudent risk management procedures were not followed by the EU and the Irish State. There is no serious contingency plan. No serious road map. No serious impact assessment. No serious readiness to deploy policy responses. No serious proposals for dealing with the vote outcome.

Even if Brexit vote was a Black Swan (although it was not), European institutions should have been prepared to face the aftermath of the vote. This is especially warranted, given the hysteria whipped up by the 'Remain' campaigners as to the potential fallouts from the 'Leave' vote prior to the referendum. In fact, the EU and national institutions should have been prepared even more so because of the severely disruptive nature of Black Swan events, not despite the event being (in their post-vote minds) a Black Swan.