Economics 19/09/2009: Nama, bondholders and shareholders

Setting aside, for now, the issue of who subsidises who in Nama, a quick note on opportunity cost of the undertaking when it comes to the structure of Irish Financial Services in general.

June 2009 paper from a group of US and Canadian researchers, published for the European Finance Association, 2009 meeting (here) provides an interesting read. The study delivers "...a comprehensive analysis of a new and increasingly important phenomenon: the simultaneous holding of both equity and debt claims of the same company by non-bank institutional investors (“dual holders”). The presence of dual holders offers a unique opportunity to assess the existence and magnitude of shareholder-creditor conflicts. We find that syndicated loans with dual holder participation have loan yield spreads that are 13-20 basis points lower than those without. The difference is even greater after controlling for the selection effect. Further investigation of dual holders’ investment horizons and changes in borrowers’ credit quality lends support to the hypothesis that incentive alignment between shareholders and creditors plays an important role in lowering loan yield spreads."

Without giving too much technical detail, the study effectively says that inducing greater share of bond holders to also hold equity (or vice versa) results in lower cost of credit to the firm.

Now, recall that my Nama3.0 or Nama Trust proposal (here) has, as one of the first conditions for taxpayer bailout, a full or partial conversion of Irish Banks' debt holders into equity holders. This would have achieved two positive outcomes simultaneously:

1. reduce demand for taxpayer funds, while assuring that some private markets trading in banks' equity will remain post-Nama Trust implementation; and
2. per above study, lead to a long term improvement in the cost of liquidity for Irish banks.

Incidentally, the third net positive impact of such conversion would be effective risk-sharing, as bondholders will be given a direct stake in the Nama process, something that is not even attempted in the current 'risk sharing' proposals on the table.

Economics 18/09/2009: An Illustration to the Idiot's Guide to Economics

Per chart below, average monthly bond spreads for Irish Government 10-years paper for the last 8 months.We've read Brian Lenihan's lips and here is what he said:

August 2009 (here): "The proposal to establish a National Asset Management Agency has been widely supported internationally by bodies such as the IMF and the OECD and tellingly since
the announcement of the establishment of Nama in April, bond spreads above the German benchmark for Irish sovereign debt have halved, from almost 3 per cent over 10 year German Bonds to now just 1.5 per cent. Irish 10 year bond yields are now 4.8 per cent."

August 2009 (here): "Indeed, during May I had to undertake a tour of EU financial centres to correct misinformation that existed about Ireland. This tour had a positive impact and there has been a significant reduction in the spreads on the State’s borrowing."

Plenty more to be found in the same vein. So per chart above, we've read your lips, Minister and... they produce gibberish so far. As I have remarked on many occasions, Irish bond spreads decline was

• in line with other countries (and in particular - with APIIGS);
• had more to do with the global change in appetite for risk and little-to-nothing to do with Minister Lenihan's decisions or policies;
• lastly, per chart above, while Minister Lenihan was trying to sell his disastrous policies to the nation on the back of declining bond spreads, Ireland has moved from the already dubiously distinctive position of being the second most screwed up economy in the Eurozone after Greece prior to May 2009 to being the worst economy in the Eurozone in terms of its bonds spreads over German bund since Minister Lenihan (per above quote) undertook his courageous road show to Europe.
  

Per one observer comment on this: "we are now the largest pig in the APIIGS pen" - welcome to Lenihanomics?

And on a funny note (credit here)and courtesy of bocktherobber :

Economics 18/09/2009: hard numbers for our delusional leaders

Retail sales for July gotta be hard read for our delusional leaders (here).

Per CSO release today: "The volume of retail sales (i.e. excluding price effects) decreased by 15.0% in July 2009 compared to July 2008. There was a monthly increase of 0.2%... partially explained by the increase in new motor sales in July 2008 that coincided with the introduction of the new VRT system." Ex Motor Trades retail sales decreased by 6.2% in July 2009 compared to July 2008 and fell -0.7% in monthly terms. Things are getting worse once again, after a short reprieve of June.

A good summary above (from Ulster Bank economics team). Food, Bars and Other Goods improved in monthly series, everything else is tanking. But all three categories of 'improved' goods are about people staying at home instead of leaving for a vacation, so here we go - have a sandwich and a pint instead of a break - Lenihanomics at work.

Few charts below (back to my favorite hobby):

It is worth noting that, of course, changes in our retail sales = changes in our VAT receipts. This said, can you spot where the 'No New Taxes' Lenihan's statement yesterday can be supported here?

Economics 18/09/2009: Idiot's guide to the Galaxy

One of my favorite books in the Universe, The Hitchhiker's Guide to the Galaxy has been surpassed, if only momentarily, by a publisher in Ireland producing this superb Idiots' Guide to Science and Economics. Behold, the front page of today's Indo:
Of course, Mary Coughlan's theory of Relativised Evolution or Evolutionised Relativity and the absolutely unfortunate nature of the venue at which she managed to live up to her well-deserved name 'Calamity Coughlan' are straight out of the chapter 'National Embarrassment Exemplified'. It is a serious public blemish on an otherwise worthy event of IDA launching a serious campaign to attract more FDI into Ireland that I wrote about before (here). No need to detail much here, Indo's article speaks volumes, one can wonder now as to what evolutionary process can lead to the emergence of the species so ignorant of basic knowledge as Mrs Coughlan. One note worth making - the fiasco perfectly exemplifies Kevin Meyers' excellent argument in the same paper today (I might not agree with it myself, but Mrs Coughlan has made his case iron-clad).

But Brian Lenihan's lack of grasp of simple realities of public finances and economics is as breathtaking as Mrs Coughlan's lack of basic erudition. After weeks of being fed drivel of FF backbenchers' and hacks' version of economic ("Nama bonds are not debt", "We will get cheap money from ECB", "ECB supports us" etc), it seems our own Finance Minister got convinced that there is such a thing as a Free Lunch. Per Indo's article here, Lenihan "gave his firmest pledge yet that there would be no tax hikes in the December Budget. And Mr Lenihan challenged anyone who doubted him to "watch my lips"... Mr Lenihan said he was committed to introducing a carbon tax... But he gave his clearest indication yet that the Government would not bring in a property or water tax this year. "I am not aware of any other (new tax hikes)," he said.

Ok, three Indo reporters (including senior ones) failed to actually query the details of this statement the Minister made. But the very fact that Lenihan actually said what he did is a testament to the fact that this Government has no real financial brains in the Cabinet at the time of fiscal and financial crises. None at all.

Per statement itself, Minister Lenihan obviously does not consider introduction of the Carbon tax to be a new tax. Presumably, he lived so long outside the real world, in the world of chauffeur driven Mercs and vast taxpayer-paid perks that he might be under the impression that Carbon tax already exists, so 'introducing' it will not constitute an imposition of a new charge on taxpayers.

The Minister also indicated that he has seen no other tax proposals (other than the Carbon Tax and Property Tax). Has he read his own Commission for Taxation voluminous report? Or has it escaped his field of view as the Lisbon Treaty volume had escaped Brian Cowen's view earlier?

Finally, the Minister has to be living in the surreal world where a €20bn-plus shortfall between tax receipts and liabilities can be covered by something other than taxes. Indo's journos refer to the possibility of €4bn savings on the expenditure side as the means for avoiding new taxes. Have they done a simple sum ever before? Has Minister Lenihan done a simple sum ever before?

Even if the Government does deliver on €4bn in savings, and even if part-year measures announced in April 2009 budget continue through the full year 2010, the entire savings will not be able to cover a quarter of the fiscal spending gap. If the Government commits to fully ending all capital expenditure in 2010 and if the economy grows by 5% in 2010, the expected fiscal gap will still be in excess of €8bn in 2010.

This money will have to be borrowed in the international markets. The roll-over of a vast sea of short-term debt issued in 2008-2009 will have to happen. Is Minister Lenihan really buying the idea that these state liabilities - some €30bn worth already accumulated, plus Nama's €54bn expected plus the ones awaiting NTMA's printing press on the back of long term unemployment increases into foreseeable future can be 'deflated' away at the current rates of spending and taxation without raising new taxes?

Well, only in the world where Einstein authored On the Origin of Species, perhaps?

Irish Economy: a longer view

Yesterday I was asked to give a quick talk to the Marketing Institute - at a lovely breakfast gathering - on my view of Ireland's economic prospects. Here are the notes from my speech:

First, 'we are where we are'...

Fiscal problem - the real crisis:

• 2013= Euro 131bn or 91% of 2009 GNP, Euro 47,640 per adult person in debt. We will be spending 21.1% of our 2009 tax revenue servicing this debt – these are DofF projections-based estimates without Nama.
• With Nama up to 204bn in 2013, 140% of 2009 GNP or 74,200 euro per adult person. We will be spending 33% of our 2009 tax revenue on servicing the debt.
• In effect, Ireland’s debt servicing charge alone will be bigger than the entire health and social welfare bill today.
• It pays for three things - services (some we need, others we can do without), social welfare (mostly excessive in levels) and public sector wages and pensions (absurdly excessive burden). Not a hell of a lot for the loot they collect.
  

Implications:

• Credit conditions will remain very tight in the country so old model of credit-fueled growth is out of the window.
• Households spending will be down, savings will rise, but capital will outflow abroad as banks lending abroad will increase.
• There will be net emigration out of Ireland and inward migration into Dublin.
• Higher taxes are here to stay.
• Opportunities will be limited on public and private sectors sides.
• Irish businesses will be locked in a zero sum game where domestic growth of one company will require domestic losses in another.

Nama problem: a sound of vaporized wealth

• The net cost is likely to be staggering – ca €6,000-12,000 per working-age adult person under benign assumptions.
• Economic cost will be even higher due to zombie banks, zombie developers.
• Even if Nama improves credit supply (doubtful for several reasons) it will destroy credit demand (no deleveraging is possible for the households).
• Investment will be limited to firms with international markets exposure, which means business models will have to change.
• We will be exporting brighter younger people, to be replaced by marginally brighter than the remaining Irish workers younger foreigners from the fringes of Europe and outside the EU – this means our business models will have to change. New consumers will spend minimum in Ireland and will expatriate more cash out in fear of immigration policy reversals and rising nationalism.
• Public sector will remain unreformed, if slightly demoralized, by failed efforts of introducing small reforms. Which means our business models will have to change for all those who relied on public contracts.
  

Economy's problems: dead end in sight?

• What is our ‘next big thing’? Do you know? I can’t see one.
• Is it ‘knowledge economy’? Not likely – late to the races, high taxes, wrong taxes, power rests with entrenched Social Partners (older, non-productive, fearful of competition). We over-rely on Government sponsored research. Private sector in Ireland is adaptive, not creative, which means it does not want to waste money on longer-term research projects.
• Knowledge economy will be happening in only a few bright spots: international finance will be back (can you leverage anything to get into this field?); few internationally traded services (TCD, UCD in education, some smaller education players; may be some private medicine, though unlikely; legal and tax services – but only domiciling into Ireland. One big and growing bright spot might be in MNCs shifting more into traded services areas (IBM model for some, start-up Googlelites, Facebookers etc).
• Domestic economy will see decline of the Irish Brands – we will be more Anglocized in terms of our consumption patterns, especially if Northern Ireland continues to open up to business.
• Is the future a ‘Green economy’? well, sort of – only with much fewer wind mills and other traditional ‘green’ production firms. Instead, there is room for using our countryside much smarter than we’ve been doing so far – tourism, smart and recovery health tourism and work-and-play tourism have some future, if we can clean up our act on bungalow blitz and passage rights with farmers. Also, smaller boutique producers of ‘green’ agricultural products have a future. But these are all small fry to sustain real growth. Spirit of Ireland is a good initiative, but will it fly or will ESB cronies shut it down?
• On house prices and property prices: peak to trough fall of 50-60% on average. Equilibrium, or long-run prices should be at 3.5-4 times average income. This roughly means 210-240,000 per house. This will be our long-time average. Trough will undershoot this target, so we can see 200,000 tested.
  

Business environment: exit the stage

• Indigenous firms will not be looking at higher margin activities, e.g strategy and market expansion at home.
• Companies will be retooling to grow abroad.
• Europe will continue pursuing regulated markets model – can we get any value out of this? Not likely – loads of competitors closer to the feeding trough and loss of our own agility can spell a disaster for out incoming FDI.
• What do businesses need to grow in this environment – step out of the shell of ‘we are Irish, we are European’ and go for ‘we can bring you into Europe, help you grow in here and keep you as a happy client’ – don’t forget to translate this into Chinese?
  

Alternatives to a slump: Doing the right thing

Reform public sector and policymaking: Introduce separation of payer and provider in public services. Let the state pay for access to service while we, the private sector, provide such services – growth opportunity space is converting some 20-25% of our GDP into world class competitive services and growing them by adding non-public customers.
Examples:
- Medical tourism
- Education
- Legal domiciling
- Logistics and distribution services
- Outsourced sales
- Marketing and advertising outsourcing?

Reduce the size of public sector and use this reduction to cut taxes on personal income at the upper margins. This introduces proper incentives for investment in Human Capital. It also feeds growing education sector that is actually productive.

Eliminate reliance on outsourcing bodies (Quangoes, FAS, Forfas and Social Partnership) in setting public policies. Rebate savings to taxpayers, but also force more direct democratic interactions between people and policies. Require that best practice analysis and economic feasibility (including environmental and social impact assessment) must be performed for any Government ‘investment’ – this improves quality of investment and returns.

Ireland as Western Hong Kong model

Make public procurement and salaries and wages costs transparent – publish them on the web.

Introduce Land Value Tax – infrastructure returns, reduced speculative holdings of land.

Abandon national spatial strategies – focus on Dublin, Cork, Galway and Limerick. This simply reflects the reality of where growth will be concentrated.

Reform immigration policies: we will still depend on inflow of talented foreigners, but we must incentivise these flows:

• Create a meaningful Green Card – giving people full rights (save for voting) and allowing them to travel visa-free across the EU (Schengen plus UK). Green Card should be issued for 1 year, then 3 years, then permanent.
• Allow no access to welfare of any kind for the first 5 years of residence for all foreign nationals. Sign bilateral agreements with other EU states whereby Irish Government will as EU states to pay for their citizens’ access to social welfare and unemployment assistance and in exchange Ireland will assume provision of those services for Irish citizens abroad.
• Have language and educational/experience – tested system of admissions (not a sole route for entry, but one of them).
• Streamline citizenship naturalization to reduce red tape. Access to naturalization should be allowed on the points system basis – number of years in residence in Ireland, having Irish family members, employment type etc should add points and speed up both naturalization eligibility and the processing time to naturalization.
  

Reform bankruptcy and directors laws:

• We must allow those who try and fail to get up back on their feet, so personal and business bankruptcy restrictions should apply for 1 year at most, the record of bankruptcy should apply only for 3 years. It should be fully cleared after 3 years.
• Stop the idiotic practice of pursuing people personal assets in collection of mortgage arrears.
• Directorship disqualifications must be reduced to cases of clear abuse.
  

Reform regulatory systems:

• Link regulators pay and pensions to their performance in office – assessable by the independent review board. If we pay them well, they should perform well.
• Reduce the number of regulators – does a small-town economy really need a Taxi Regulator? a SMS Regulator? and so on.
  

Reform banking:

• Most of reform will come from abroad – EU, G20, Basle III. Most of these reform will be painful and costly – Nama Squared?
• Domestic reforms must include:

1. Breaking a cozy ‘Old Boys’ cartel between banks and other elites. Sadly – we have no record of doing this even after all the banking scandals of the past;
2. Introducing more competitive domestic banking by reducing market shares of Irish banks – sadly, we have no record of doing this either;
3. Using Nama to bring more transparency into Irish banking – sadly, we are doing the opposite.
   

Hope is in a short supply, treat it carefully. We need some serious drastic changes and these will have to take place at the head of the table.

Economics 16/09/2009: IDA's latest news... breaking

I will blog on Nama latest figures tomorrow afternoon, so stay tuned, but for now - a piece of better news:

IDA will be launching a new campaign promoting Ireland as investment destination in the USofA. The campaign was prelaunched tonight for bloggers in advance of the official launch. It is impressive in scope (all top notch business media on top of the reliables – Airport ads etc – plus a bit more serious effort to build online presence) and relatively mild in message (more below). So mild, it seems to be slightly underwhelming.

Fair play to Barry O’Leary (Chief IDAologist) and his crew and campaign designers (McConnells) for actually braving the small crowd of usually unruly and unpredictable, often cranky and always suspicious bloggers. Trevor Holmes – IDA’s chief communicatologist, aka PR man – was actually very good in answering pointed stuff and taking a bit of a role of really giving us (the bloggers) some of our own medicine.

So the launch itself was a brave change of heart from the usually rather closed organization like IDA.

Let’s get to the substance.

Corporate brand advertising that is people-centric can be corny. Country brand advertising based on ‘Invest not in dollars, but people’ stuff is a bit corny and old. IDA used to do the same back in the 1970s and 80s, so what’s the BIG IDEA this time around?

Ok, on their web banners they have Facebook chieftain talking about what the company found in Ireland. Guess what – it is European workforce (same is the 1980s ads) and it is not Irish (novelty factor on the 1980s), but the one speaking 48 languages with native skill. You might as well be in London for that.

Microsoft’s Head is talking about how IDA is number one conduit for companies into Irish Government. I though that sort of ‘facilitation’ – important as it is to the companies – is not exactly something we want to highlight as a major selling point, at least not publicly in the airports. Children might conjure the imagery of Bertie Ahearne ‘facilitation’ at a football game somewhere in the UK, or our regulatory authorities engaging in banking sector ‘facilitations’ signing off on intra-banks deposits flows of slightly unusual variety. All fresh in the media minds internationally.

Funnily, when I asked the guys if they can ‘facilitate’ a financial funds management company with speeding up regulatory clearance to trade in Ireland, they immediately stressed that Ireland is not that sort of a country… Innocent me, I couldn’t see much wrong with helping companies to file papers at the FR office, especially when the same FR office got so facilitative of the banks in the recent past… Oh, but IDA can help with preparing documents and reasoning to be brought to the FR “to make the case for…” Hmmmm. Ok.

“Talents, scope and depth, languages spoken, diversity… and foremost Irishness…” are the themes. Judge for yourselves if this really confuses Ireland with a D2 - D4 (Googleland, language schools and TCD/UCD) cluster.

‘Natural creativity and curiosity of Irish’ themes. I know, it sounds bad. But do trust me, the ads are well designed and speak modern, clear and crisp language as are online materials - McConnells delivered again. IDA opened up their closed doors a bit here too with online campaign aiming to be more interactive with target audiences. Cuddos to McConnells Digital on that one - hard client to get to smile, but smiling is what IDA are doing with some parts of the campaign and it is good to see the Big Boys of Ireland Inc getting a little of confidence back. On the net, a good balance of simple messages, simple imagery and compelling arguments.

But there are few things that troubled me and some other bloggers.

1. Are these ads truthful: IDA referred in presentation to IMI research that allegedly proves these directly. I am not sure – would have to see this piece of research to believe it. But the campaign itself does not mention any research. So you are invited to find out for yourself and herein opens a world of our low achievement in the areas of science, relatively average achievements in education and an abysmal record on early and continued education.
2. The ads mention Ireland’s promise in Green energy (not as a distant future, but as current reality). In a country with ESB plants belching smokestacks and heavy reliance on oil to generate one of the most expensive power supplies in Europe, this sounds slightly funny. To be truthful, we had Airtricity – an international success story, but it barely had any significant investments in Ireland proper, preferring to do business in… you’ve guessed it – UsofA. And UK. So who’s ‘greener’?
3. On the same day of the IDA blogger launch, I was speaking to the National Advisory Science Council about my view as to why our R&D and science policies (core innovation inputs) might be in trouble. Innovation Ireland, my eye.
4. Funnily, me recalls seeing in Fortune and Forbes ads for Azerbaijan and Kazakhstan as places where you too can invest not in dollars but in people and innovation... not exactly in same words, but the same message.

While I am on the topic of press, IDA will follow up these adverts with a full frontal media assault taking ‘articles’ in the likes of WSJ and other business media and getting Brian Lenihan (who can do some good) and Barry O’Leary (who really does know his stuff). But also Mary Coughlan (I know, don’t start, please... oh, the hell - as Donald Rumsfeld remarked once "As you know, you go to war with the army you have, not the army you might want or wish to have") on the international media ‘telling the Irish side of the story’. I am not sure what it will look like? Advertorials, interviews, hired hacks, ads, talking sale pitches from politicos… It makes me feel like being made a small tangential part of some PR blitzkrieg. Trust, me I am not!

One question I did ask Barry O’Leary was “IDA campaign is going to court Human Capital-intensive businesses for whom the costs of skilled labour and key talent are the main line of spending. Our Government officials will be talking about how we are doing the necessary things to restore economic growth and confidence. Are you concerned that this is the same Government that raised taxes on labour income impacting ‘knowledge’ economy’s future returns to human capital here?” The response I got suggested that yes, the IDA are concerned about the erosion of competitiveness (I presume that does include erosion of our competitiveness in ability to attract highly paid talent). So “tax increases are a concern, but [not too much as IDA prefer for the] …focus to remain on total offering and proposition of Ireland across different value chain segments”.

Is then IDA feeling boxed by the Government perverse policies and are searching to offset the cost of income tax and payroll costs with other concessions? Most likely.

Barry didn't mention if the ‘competitiveness’ concern also covers corporate tax. After all, given the hole Mr Cowen got this country into fiscally, and given that our households are already struggling under the massive burden of Nama and public sector wage bills and welfare rolls, what can be done next to ‘improve’ our fiscal situation other than start dipping into corporate Ireland’s pockets. Indirect taxes will rise for businesses and, quite possibly, there will be a push for higher corporate tax rate too.

A birdie told me that the Government has already discussed (at not a full Cabinet level, though, and I stress that is a tip-off that I am yet to fully confirm) a chance of raising a special corporate tax surcharge on domestic firms, but that they were told that this won’t fly with EU. Don’t worry – most likely, they’ll try again.

Barry was talking some good facts, though, and made a serious pitch as to why we need to get Ireland Inc back into raising the FDI game – something that has been hard to get (although IDA did achieve good progress this year against all odds) in the first 6-8 months of this year. I agree with him fully – and I must add that IDA and EI are about the only two agencies in town that are still doing their jobs (I am sure improvements can be made in both, but hey, in the age of FAS, Forfas, HSE, and the rest of public sector, at least IDA and EI give us some return for money).

When it comes to target businesses, again, there was no BIG NEW THEME – IDA is going after reliable favorites: life sciences (pharma, biopharma and medical devices), ICT&IT, global services (SCM, technical support, financial & shared services). Not a hell of a lot of ‘innovation’ stuff? True, but they are looking at the “Innovation sector: IT&ICT primarily, Hewlet Packard, Intel, IBM, etc; life sciences area (pharma, biopharm, medical devices), international financial services, globally traded business services – digital media, etc and old engineering portfolio.”

So everything flies. A true picture of diversity? I’ve asked the guys: “Loads of smaller companies would probably like to enter European markets through Ireland. What are you doing for them?” It is a loaded question and Trevor Holmes was good answering it – to the point: “can help with limited pilot, test beds”. Better than nothing, but, honestly, not much. The mandate, you see, is still about bringing Big Sharks in, not the smaller Barracudas.

There was a hint of something yet to come – Trevor mentioned that the IDA are working on several new ideas as to how they can facilitate incubation of smaller promising start ups willing to settle in Ireland. That’s the stuff I would love to find out more about. Some years ago I mentioned the idea of incubator for Ireland-bound startups in financial services in a conversation to Barry O’Leary. May be finally the idea has sunk in? Alas, no details were given.

Per Barry O’Leary: “Competition globally for FDI – OECD says it is down globally 30% in 2009, and more competitors in the market – margin squeeze on both ends.” Fair point and the timing of this campaign is spot on too – the US market is about to go into new investment cycle, and we should be ahead of the curve (although the IDA team failed to actually identify this as an opportunity explicitly when they were probed by the bloggers). “We are competitive in combined development and manufacturing, but not in manufacturing alone”. Another good point, and backed by the evidence on what IDA has been bringing into the country over the last year.

Final point – per Barry O’Leary – is that “Strategic review of IDA is 6-8 weeks before conclusion looking at changes and adaptations to such new product offerings in Ireland as smaller digital media companies…”

Looking forward to hearing more on that one.