Economics 25/09/2009: Notes on trade flows

Per separate CSO release (see national accounts and broader trade flows discussion here), however, the positive trends in exports shown in the figures for Q2 2009 have not held into Q3: seasonally adjusted exports fell by 8% in July 2009, relative to June 2009 and imports hit a new low point for recent years.

June 2009 exports showed some bounce (due to volatility) having increased by 5% relative to May 2009 while imports decreased by 9%. Thus, July changes erase positive momentum in exports and continue to exacerbate negative movements in imports.

Given that for volatile time series during the periods of contraction seasonal adjustments can mask true extent of falls, taken on an unadjusted basis, the value of exports in July 2009 was 5% down on July 2008, while the value of imports was down 31%. The value of exports in June 2009 was up 5% on June 2008 and the value of imports was down 24%.

This is worrisome, as H1 2009 posted overall rise in exports of 2% on yoy basis. This was led by MNCs-dominated sectors: medical and pharmaceutical products increased by 22%, organic chemicals by 19%, other transport equipment (including aircraft) by 262% (€414m) and professional, scientific and controlling apparatus by 11%. On the back of large layoffs in the sector, computer equipment decreased by 27%. Capital investment cycle hit hard electrical machinery (down 28%), industrial machinery down 37%, telecom equipment fell 23% and power generating equipment contracted by 45%.

Imports decreased 21% in H1 2009. Aside from predictable cars and retail goods, investment-related goods imports also contracted severely: computer equipment by 40%, specialised machinery by 54%, industrial machinery by 36% and electrical machinery by 16%.. Petroleum products imports fell by 38%, signaling that MNCs might be reducing output here, while increasing value of output registered to Ireland (transfer pricing). Ditto for small increase of 4% in medical and pharmaceutical products, and organic chemicals also rising by 4%, - both major inputs into allegedly booming pharma and medical devices sectors. Goods from the United States increased by 34% - again a sign of more value being booked on importation side of MNCs.
Table above shows that MNCs-dominated sector of chemicals and related products (pharma etc) has increased its overall share of exports in June 2009 and in H1 2009. Other sectors remained relatively stable with modest increases in the share, except for computers-dominated machinery and transport equipment sector. But there is more trouble ahead:
In bold in the above table I have marked those sectors where there has been expanding imbalance between exports and imports. This imbalance suggest to me that international companies are shipping fewer inputs into Ireland, while managing to ship more outputs. This can only be done in a wondrous world of accounting procedures designed to reduce tax exposure.

Again, banana republic…

Economics 24/09/2009: There used to be a real economy in there...

Enough of Nama, for now. Data from CSO is coming thick.

Initial estimates for the second quarter of 2009 show year on year declines in both GDP (-7.4%) and GNP (-11.6%), with the gap between GDP and GNP widening. Compared with the corresponding quarter of 2008, GDP at constant. Quarter-on-quarter, GDP remained constant in Q2 2009, while GNP slid 0.5%. It is worth recalling that GDP-wise Q1 and Q2 2008 were already negative growth territory, so current ‘stabilization’ comes on top substantial declines taken in 2008.

Predictable sources of declines: consumer spending (down 6.8% yoy), capital investment (down 24.4% in Q2 2009 yoy), net exports are up yoy boosted by MNCs (goods manufacturing) and by collapse in imports. Industry output down 11.3% yoy and within construction sector – 30.8%. Every sector is posting fall-offs.

Incidentally, do tell me there is demand for credit out there that urgent we have to break the back of the entire country to repair it. I can't see one - capital investment tanked, so companies are not in a mood to invest in future capacity (see stocks changes, too), while personal consumption is bouncing at the bottom, every time a little lower. Oh, I get it, if only the banks were issuing new loans, we all can go out, borrow some more dosh to pay for... hmm... Brian Cowen's excesses in spending? But back into non-Nama land:

Q1 2009 annual rate of decline was 13.1%, so Q2 decline looks positively slower at 11.6% when it comes to GNP at constant prices. For GDP these figures were 9.3% and 7.4%. But, of course, one has to remember that Q1 2009 annual changes were against Q1 2008, when both GDP and GNP grew by 0.1%. Q2 2009 changes, however, came on top of 0.4% growth in GDP and 0.6% growth in GNP.

In constant euros, our Q1 2009 GNP, at €35,182mln was comparable to the level of income in Q1 2005 (€35,238mln), while Q2 2009 GNP of €35,175mln was below that recorded in Q2 2005 (€35,862mln).

Gross domestic capital formation has fallen to €7,659mln in Q2 2009 down from €8,217mln in Q1 2009. We are now at the lowest level in capital formation terms since the end of 2002 (as far as these series stretch). Physical change in stocks has totalled -€911mln in Q1 and Q2 2009 the greatest cumulative drop for half-year of any year on record (since the start of 2003).

Two charts below illustrate some less apparent trends:
Services balance is deteriorating as financial and legal services exports are suffering. Of course, our hospitality and tourism exports have fallen off as well, thanks to economically illiterate Budget 2009. This is a point of alarm. Our exports of services are now below those recorded in 2007 in constant prices. Our total exports have fallen 2.5% in Q2 2009 (yoy) – a less deeper cut than in Q1 2009 when total exports contracted 3.0%. Goods exports have fallen 3.1% in Q1 2009 and 3.7% in Q2 2009, so things are getting worse here. Services exports contracted 2.8% in Q1 2009 and -0.9% in Q2 2009. Imports overall have declined 10.6% in Q1 and hen 7.1% in Q2 2009 – better than before, but still third deepest fall since the series revision in Q1 2004. Goods imports are down 22.3 in Q2 2009 yoy – marginally better than 24.8% contraction in Q1 2009.

Table below compares trade performance relative to corresponding quarters of 2007:


The above chart shows that taxes, public administration and defence contributions to GNP are falling over time – since Q1 2007 and despite April Budget and October 2008 budget, this fall continues today. This is not to be confused with the falling cost of Government in terms of taxation-exerted drag on growth. The decline in Government share of GNP is reflective of two things:
(1) there has been a marked decline in capital investment (i.e we still waste piles of cash on non-investment activities);
(2) the rising interest rate bill on Government debt is now adversely impacting GNP.

Now, GNP/GDP gap illustrated…
Self explanatory, really.

Now, recall those evil Americans who, according to our Taoiseach and his Cabinet members, gave Ireland this recession... Chart below illustrates:
Yeps, they (Americans) sneezed, Europe got a slight fever, the UK is out with a major flu and Ireland is... well... Ireland is busy dumping tens of billions in cash it does not have on public sector wages, social welfare payoffs and, next best thing to Partnerships - Nama...

Economics 23/09/2009: Cost of Nationalization

Today's note from Davy Stockbrokers throws into public domain a challenge and an accusation:

"Regrettably, the public debate on NAMA has been anything but rational and dispassionate. Confusion, misinformation and, at times, rank deception has run riot over the past several months... Tellingly, the brunt of discussion has majored on an anti-NAMA rant, with scant exposition of any credible alternatives."

If Davy is so dismissive of the 'alternatives' - of which there have been several rather involved ones - then Davy should be even more dismissive of the Nama proposal itself, for the Government still has no estimates for costs, returns, time horizons, detailed haircuts, borrowing terms for Nama bonds etc - after 6 months of working on it with an army of civil servants, highly paid consultants and having the likes of Davy on their side!

"Nowhere is this more depressingly obvious than in relation to the nationalisation option, wherein protagonists have tended to confine their treatises to a short paragraph or three, and where the potentially ruinous funding consequences for both the banks and sovereign have been glossed-over..."

Of course, unlike Davy or other stockbrokers, it is the independents: Brian Lucey, myself, Karl Whelan and Ronan Lyons who actually bothered to estimate - to the best of our resources - the expected costs of Nama to the taxpayers. Instead of focusing on the benefits and costs to the taxpayers, Irish stockbrokers focus on benefits to the banks and their shareholders. This is fine, and I will not accuse them of doing anything wrong here - their clients are, after all, not taxpayers, but shareholders. But it is rich of Davy team to throw around accusations of us, independnt analysts, 'glossing over' aspects of Nama - we are not the ones being paid by anyone for doing this work.

The emphasis on 'estimate' and 'expected' is there to address Davy accusations of 'rants' or 'deceptions'. If estimates are rants, Davy-own entire daily research output can be labeled as such.

But Davy folks are correct in one thing - we, the critics of Nama, have not produced an estimate of nationalization option cost. Instead, it was, me thinks, Brian Lenihan who promised to produce such estimates. May be Davy note was addressed to his attention?

Seeing the eagerness with which Davy folks would like to see some numbers on nationalization, below is the summary of estimates of such an undertaking developed by Peter Mathews (you can see his article on this in Sunday Business Post (here) and confirmed and elaborated by myself and Brian Lucey. (Again, note, one can only assume that our Davy folks do not read Sunday Business Post's Markets Section.)

I have argued in my Nama Trust proposal (aka Nama 3.0) (here) that we can avoid nationalization by buying out equity in the banks to support writedowns and then parking this equity in an escrow account jointly owned by all taxpayers. The banks will, then be owned by the Trust, not by the Government. Their shareholders will be Irish taxpayers as individuals, not the Government. The Trust will be there simply to provide a time buffer for orderly dibursal of shares over time.

Now, whether you call it 'nationalization' or 'Trust' or anything else, the problem with the banks in Ireland is that they need to write down something around 40% of the troubled assets values. This can be done by gifting them bonds (as Nama will do), or by buying equity in the banks in exchange for the same bonds, except, as below shows, at much lower cost.

In the first case, you get a promise of repayment from the banks and a pile of heavily defaulting loans. In the latter case, you get shares in the banks.

In the table above, the first set of red figures refers to the amount of equity capital that will be need for repairing banks baance sheets today (it can be issued form of bonds, just as Nama intends to do, which will be convirtible through ECB repo operations at the same 1% over 12 months). The amount we will need to put into banks under 'nationalization' or Nama Trust option is Euro30.88bn.

The bondholders will remain intact (so no additional cost of buying them out).

This upfront cost is over Euro 23bn cheaper than Nama. And it can be further reduced if we get at least subordinated bond holders to take a debt-for-equity swap, which they might agree to as they will be taking equity in much healthier banks.

The second and third red figures refer to the expected recovery on this equity purchase in 5 years time (not 15 as in the case of Nama). And all assumptions used to arrive at these two scenarios are listed. The figures are net of the original Nama cost. In other words, under these two scenarios, we can generate a healthy profit on Nama Trust, which we cannot hope to generate in the case of overpaying under the proposed Nama scheme.

In addition to the table above, I run another third scenario that assumes:

• 5% growth pa in banks shares (as opposed to 15% and 10% growth under scenarios A and B);
• Banks fully covering 1.5% cost of Government bonds (as in scenario B);
• Banks paying a dividend to the Exchequer of 2% on loans (net of bad loans) and charging 0.5% management fee, so net yeild is 1.5% on loans (as in Scenario B).

The bottom line in this scenario was ca €9bn in net return to the Exchequer on 'nationalization' within 5 years of operations.


Back to Davy note: "...the potentially ruinous funding consequences for both the banks and sovereign have been glossed-over..." Well, let me glance it over.

1. Nationalization can be avoided per my Nama Trust proposal, so there goes entire Davy 'argument'.
2. If the banks balance sheets are repaired with a 40% writedown of bad loans under the above costings while Nama would achieve only 30% writedown at a much higher cost, what 'ruinous' consequences do Davy folks envision for the banks? Their balancesheets will be cleaner after the above exercise, than after Nama!
3. If Irish Exchequer were to incur the total new debt of €30bn (per above proposal) and will end up holding real equity/assets against this debt, will Exchequer balancesheet deteriorate as much from such a transaction as it would from an issuance of €54bn in new debt secured against toxic assets such as non-performing loans? Again, it seems to me that a rational market participant (perhaps not the Davy researcher authoring the note) would prefer to lend to a state with smaller debt and real assets against it than to the one with higher debt and dodgy assets in hand.
   

Back to Davy: "...the retention of impaired assets on bank balance sheets ...would continue to cast a deep pall over perceived solvency risks in the Irish banking system, leaving this country still bereft of the necessary refinancing flows from which green shoots might grow."

I would suggest that this statement is itself either a deception (deliberate) or a wild speculation (aka rant). There is absolutely no reason why fully repaired banks (with 40% writedown on the loans under the above costings and as opposed to Brian Lenihan's proposed Nama writedown of much shallower 30%) cannot have access to the same lending markets as banks post-Nama would. However, under the above proposal:

• Irish Government will take much lower (24bn Euro-lower) debt on its books, implying healthier bonds prices for the Government into the future - some savings that won't happen under Nama;
• Banks enjoy much more substantially repaired balance sheets (again, not the case with Nama);
• There is no second round demand for new capital from the banks (not the case with Nama as proposed).

So, again: judge for yourself. When is the insolvency risk for Irish banking system higher:
Case 1: more substantially repaired banks balance sheets and more fiscally sound positioned Exchequer; or
Case 2: lesser writedowns of bad loans and more indebted Exchequer?
If you vote for Option 1 (as any rational agent in the market would do), you vote for the above 'nationalization' exercise.

Lastly, Davy note lands a real woolie: "When all is said and done, NAMA is not a bail-out of developers, or bankers, but of a banking system and its host economy. In that respect, it is a bail-out of ourselves."

Under Nama, developers will be able to delay or avoid insolvency declarations and subsequent claims on their assets. If this is not a bail-out, it is a helping hand of sorts.

As per 'repairing economy' - there is absolutely no evidence to support an assertion that Nama will have any positive economic impact, but given that it will impose much higher cost than alternatives on households, it can have a very significant negative impact on the economy. Perhaps, Davy think that households are simply there to be skinned and that our economy does not depend on them.

Then again, Davy folks thought CFDs and leveraged property deals were gods-sent manna.

Now, let us get to the more rational side of economic impact debate:

1. Under my proposal above, banks get deeper repairs, so they will be healthier and their reputational capital will not be based on a handout rescue, but on actually having equity capital injection. This is a net positive that Nama does not deliver;
2. Under my costings above, the Exchequer and/or households end up being investors with a strong prospect of higher net recovery value over shorter term horizon than in the case of Nama. This is a net positive that Nama does not deliver;
3. Under the above exercise, the banks will not be able to unilaterally take liquidity arising from the injection overseas, so whatever liquidity is generated, will have to stick to our shores, and thus to our economy. They still can use this liquidity to pay down their expensive inter-bank loans, but at least they won't be able to run investment schemes with taxpayers' money abroad. Shareholders might look badly on this one, since the shareholders will be not foreign institutional investors, but domestic taxpayers. This is a net positive that Nama does not deliver;
4. Under the above exercise, we won't have to pay Nama staff and consultants any costs - banks will continue dealing with their bad loans. This is a net saving that Nama does not deliver;
5. Under the above Irish taxpayers won't have to face a massive tax bill of 54bn, but a smaller (though still massive) bill of 30bn. This is a net saving that Nama does not deliver;
6. Under the above proposal Irish banks will be able to access the same ECB window on the same terms as any other bank in the Eurozone. The will also be able to do the same with Nama, so there is no additional cost when it comes to borrowing.
7. Under the proposal above Irish Government debt will be €23bn lower (and adding the second round recapitalisation demand under Nama - €29bn lower) than in the case of Nama, providing potential easing to our cost of borrowing. This is a net benefit that Nama won't deliver.
   

I can go on with these arguments. But I am afraid it will be a bit too much rant for our Davy folks.

Economics 22/09/2009: Bleeding jobs...

CSO’s Quarterly National Household Survey (QHNS) Q2 2009 shows ongoing collapse in employment in the country. After peaking at 2.14mln in Q1 2008, employment has now steadily declined and is now down 8.2% - the steepest fall in the history of these series. My prediction – by the year end the fall will total around 8.2-8.5% in annual terms, marking the sharpest decline since 1960s. Current employment stands at 1,938,500 – below the politically important 2 million mark for the second quarter in a row. The pace of employment falloffs is accelerating – in Q1 2009 employment contracted by 7.5% yoy, in Q2 2009 the rate of decline was 8.2%.

Per Ulster Bank note: “To put this in an international context, employment in the US fell by 4.3% from its peak (in Q1 ’08) to the second quarter of this year and that in the UK fell by about 2% on the same basis. So, mirroring the comparative weakness in the broader economy, the Irish labour market is experiencing a much more severe adjustment in employment than is the case among our main trading partners.” Then again, they’ve got a bit more competent political leaderships in the US and UK, that doesn’t raise taxes to pay its cronies wages, don’t they?

Unemployment rate amongst males now stands at 15.1% up from 4.8% in Q2 2007. Female unemployment rate has risen from 4.4% in Q2 2007 to 8.1% in the latest survey. Overall unemployment has gone from 4.7% in Q2 2007 to 5.7% in Q2 2008 and 12% in Q2 2009.



Numbers employed in various sectors are shown in the table below. Public sectors still showing no signs of cost reductions while the rest of economy is bleeding jobs… Public sector employment in Q2 2008-2009 is up ca 16,000. Now, An Bord Snip Nua recommended total numbers reduction of 17,300, which, if delivered would still leave Ireland at ca 2007 levels of public sector employees. Are you laughing yet? For a country borrowing €400mln per week – good half of which goes to pay wages in the public sector – this is really an achievement.
Table above shows another disturbing trend - forced 'entrepreneurship' - notice how more robust are the numbers of self-employed with no employees through the downturn, actually rising between Q2 2007 and Q2 2009. This is a sign of more people being forced to take up self employment in view of lacking full time jobs.

Charts below illustrate some other trends.
Lastly, it is worth noting that QNHS-recorded 2,500 increase in labour force in Q2 2009 is a seasonal aberration as part time employment rises in the summer months. This is going to go into negative territory in Q3-Q4 2009.

We are on track to reach 15-15.5% unemployment sometime in mid 2010. And on track to get close to 10% long-term unemployment by mid 2011. That would be a fitting tribute to the Government that raises taxes in an economy experiencing severe recession...

Economics 22/09/2009: Emigration raging

Per CSO release today, Ireland is now back in the age of net outward migration, or in that ugly 1980s term – emigration. “The number of emigrants from the State in the year to April 2009 is estimated to have increased by over 40% from 45,300 to 65,100, while the number of immigrants continued to decline over the same period, from 83,800 to 57,300. These combined changes have resulted in a return to net outward migration for Ireland (-7,800) for the first time since 1995.”

But, per one net positive outcome of recession, “the number of births reached a new high of 74,500 (not seen since 1896) while the number of deaths was 29,400, resulting in strong natural growth for the year to April 2009 of 45,100.” Of course, as unemployment and higher taxes take a bite out of workforce participation rate and employment (see below) – with women withdrawing into maternity leave as a temporary cover against possible lay offs and as a result of falling returns to second income earners in the family – we are on a path of more children to be borne in Q32009-Q2 2010, after which the rate should start falling slightly.

“The combined effect of the natural increase and migration resulted in a population increase of 37,300 (+0.8%) bringing the population estimate to 4.46 million in April 2009.

“Of the 65,100 people who emigrated in the year to April 2009, EU12 nationals [Eastern Europe] were by far the largest group accounting for 30,100, with Irish nationals being the second largest at 18,400.” Now, CSO won’t tell us the comparative quality of those emigrants, but standard theory and logic suggest that there is a strong selection bias amongst those who leave the country. The emigrants are most likely those who can obtain better employment abroad and/or who can earn higher wages working abroad than the Irish social welfare entitlements provide. In other words, we are losing higher quality people than those who stay behind and sign onto the Live Register in similar circumstances (e.g unemployment spell within family).
Another interesting feature of data is shown in the Table below. Note that only two categories of migrants were either increasing or steady between 2008 and April 2009. Irish nationals returning from abroad (most likely having lost their jobs elsewhere) and EU15 nationals (steady inflow into MNCs employment).
Per US and Rest of World figures - undoubtedly idiotic migration and naturalization restrictions that operate in this country and are actually being tightened by our authorities this year (Green Card regime tightening) are not helping...

Economics 22/09/2009: Two further Nama points

Updated below:

Global Finance Magazine on the concept of ‘long-term economic value’ of distressed assets (here) and on effectiveness of bad assets purchasing schemes:

“Meanwhile, the passage of the Troubled Asset Relief Program (TARP) into law in the United States failed to alleviate strains in the financial markets...

The TARP empowers the US Treasury to buy troubled assets at heavily discounted prices, well below their long-term economic value. “No one yet knows what price will be paid for the toxic paper, or what the default rates will be on the underlying mortgages,” said Carl Weinberg, chief economist at High Frequency Economics. “

Over time, people will realize that all the underlying mortgages are not defaulting, and panicky market conditions should abate, according to Weinberg. “We have seen this game before,” he says. “In the 1980s highly indebted economies like Mexico, Brazil, the Philippines and Argentina bought back their own debt from panicked small banks at 20 cents on the dollar.”

20 cents on the Dollar, folks? Nama is buying defaulting developers loans (not sovereign bonds) at 79 cents of the Euro!!! I’d rather have Brazil’s and Argentina’s bonds, thank you very much.


Another interesting bit:

Robert Boyer’s paper “Assessing the impact of fair value upon financial crises” published in the Socio-Economic Review, 2007 deals with the expected effects of LTEV application to accounting standards, but the implications of this are pretty much the same for pricing (as in Nama). Boyer concludes that LTEV “gives at each instant a seemingly relevant liquidation value, but obscures the value creation process by mixing present profit with unrealized capital gains and losses. This discrepancy increases with an increased degree of uncertainty, which is at odds with widely held beliefs about the efficiency of existing financial markets. Fair value introduces an accounting accelerator on top of the already present and typical financial accelerator. …If fair value accounting is applied to banks, an extra volatility may be created...” What is this about? Three things, as far as Nama is concerned:

1. LTEV will simply translate future value (capital gains) on assets underlying Nama-purchased loans into monetisable value as if all future price appreciation expected under LTEV can be captured in full. This, of course is a matter of timing (knowing when to sell) and efficiency of sales (having zero cost of selling and no impact on selling price of the volumes of sales that Nama will have to undertake);
2. LTEV neglects to price in the effect of large asset holdings off the market (Nama holding vast portfolio of property-backed loans off the property market), which is likely to depress property prices over the life-time of Nama itself. The end result here – a gross overestimate of future expected prices.
3. As the two points above coincide in timing, they act to reinforce each other – an accounting accelerator occurs.
   

Who says you overpay only once?

Here is the rate at which the Government can currently borrow on a 6-months basis:
Let me explain:

• we can borrow in the form of ordinary bonds at 0.481% for 6 months period. These are convertible at repo window of ECB at a discount of 12% on face value and 1% interest rate. Total cost of injecting €1 into bank balance sheet is, thus, 15.2 cents; or
• we can issue Nama bonds at 1.5% with 5% in subordinated bonds, with banks taking these to the ECB repo window at 12% and 16% discounts respectively, borrowing at 1% against both. Total cost of injecting €1 into bank balance sheet is, thus, 16.4-18.1 cents depending on how ECB risk-weights subordinated bonds.

Cheap money in the Frank Fahey World of Stupid Economics?