Economics 14/12/2009: Nama comparatives

It was an honor today to speak on the issues of Nama and the future of Irish development and construction sectors at the gathering of a number of architects put together by FKL Architects (see the site here). The panel that I was a part of was very engaging and, despite my disagreement with some of its members on the matters of policy, very informative. And the event, highlighted at the above site, was very interesting and engaging - some cool ideas out there, at least to my non-professional eye.

After the event, I was exchanging a couple of views with the representative of our construction sector, who agreed with my prediction that by the end of this crisis, Irish construction sector will shrink to no more than 5% of GNP or just 20% of its pre-crisis peak. And that the risk is for our construction sector to remain at that level (instead of rising to a healthy 10-12% level) for a very long period of time.

Alas, something else has driven me to a realisation that anyone who is hoping for stabilization of our property values at their current (or near) price is inhabiting an invented reality. This:
Now, think of this...
A four-bedroom, two-bath brick historic federal in Little Falls, N.Y., a city of about 5.000 on the Erie Canal, is on the market for $250,000, the house was built in 1827 and is on the National Register of Historic Places.
Off the house's center hall are east and west parlors. Both have fireplaces.
Though it has been renovated several times over the years, it retains some original details, including mantels, and some pine and chestnut flooring.All four bedrooms are on the second floor, two with original pine and chestnut flooring and one with a fireplace and a walk-in closet.

Ok... I can go on and on, but... check it out for yourselves here. And all for €170,000 in one of the wealthiest states of the nation that is the wealthiest on planet Earth.

My prognosis - median price in Ireland in real terms (2009 Euros) of €120,000 by the end of this crisis. Why? Because there is no reason why our average homes should be trading above 4bed historic properties in upstate New York. None.

Economics 13/12/2009: News and confirmations

A quick post - per Sunday Times report today, Irish Nationwide will need 1.2-2 billion in recapitalization post-Nama. This beats my estimate for the society provided here. To remind you - back in October 2009 I estimated that post-Name demand for capital will be:

• AIB €3.2-3.5bn in equity capital post-Nama;
• BofI €2.0-2.6bn;
• Anglo €4.5-5.7bn;
• INBS/EBS & IL&P €1.1-1.2bn.
• Total system demand for equity will be in the range of €9.7-12.4bn.

Since then it was confirmed by various reports and estimates that:

• AIB will require €3.0-3.5bn in equity capital;
  
• BofI will need €2.2-2.6bn;
• Anglo will need up to €5.7bn;
• INBS will require total of €1.2-2bn.

To err on conservative side, I am still sticking to the range of €9.7-12.4bn for total demand.


On retail sales side: October figures released last week show continued weakness across consumer spending - despite some bounce up in car sales (+1.4 mom). Total sales fell 0.3% mom and ex-motors sales declined 1.7% erasing all gains made in September. Core sales 9e-motors) are now at 2005 levels down 13% from the November 2007 peak. Despite seasonal shopping going into Christmas, 'other goods' sales (including toys, jewelry, sports wear etc) posted a drop of 4%. Furniture and lighting posted a fall of 3.2% and would have probably fallen even further if not for Ikea. This, of course implies that a rational forecast for 2010 should be in the region of 3% fall in retail sales, compounding the 7% drop in 2009 and leaving retail sales at some 84% on 2007 peak. More urgently, staying on the established trend, December retail sales are risking to sink 10-15% on 2008, which might trigger a new wave of layoffs in January-February 2010.

Services Exports data also released last week shows that our services trade deficit has widened in 2008 relative to 2007 by 370% as imports rose much faster than exports.
The detailed data clearly shows that we lack geographic diversification of exports in most services, with 76% of our services exports (allocated to specific geographic destinations) destined for Europe. And we are failing to benefit from substantial cost savings from outsourcing services to Asia - with just 2.4% of our services imports coming from Asia (Asia accounted for 7.9% of our exports of services).

In higher value added services:

• Virtually all insurance services exports went to Europe (69%) and the US (22.1%);
• Financial services exports went to Europe (67.2%), the US (10.45%), and Asia (10.3%), but some 12% of financial services were traded into offshore centres;
• Computer services posted a massive surplus, as usual, with 86.7% of all exports flowing to Europe, and just 1.07% to the US, while Asia received 8.7%;
• Other business services exports - comprising a number of high value-added subcategories - went to Europe (69.7%), US (only 4.5%) and Asia (12.9%).

Once again, poor diversification to new markets suggests that Irish services exports might be in danger of heading for a slow growth path tied to the fortunes of stagnation-bound EU. Diversification out of this predicament will require serious efforts on behalf of the Government to provide meaningful exports credit insurance and some sort of the foreign exchange risk offset mechanism. Otherwise, Ireland is at a risk of becoming the back water to Europe's slow growth model.

Economics 13/12/2009: Nothing exceptional

Last couple of weeks, there have been some pretty severe news flowing from the Irish economy and Irish banks. Is the current bear market in Irish banks shares a temporary adjustment / profit taking or is it a long overdue fundamentals-driven correction?

Here are few charts and my view of the story.
The general trend, per chart above, has been down since 2007 peaks, but also - convergence of the two banks to the same trading range. By 2009 beginning, the investors were no longer willing to significantly distinguish between BofI and AIB shares, preferring to treat them as a single sick puppy, rather than two different banks with different management styles, business models and investment exposures.
And guess what - they still do. The entire 2009 trading was still based on the story of Irish Banks, rather than individual stories of AIB and BofI. Now, over a short period of time, say during general market panic, this can be explained by a temporary loss of fundamentals clarity, implying that investors might see both banks as being the same. We are no longer in this period, as global markets willingness to take risks has improved significantly in H2 2009. But the same markets that are now willing to differentiate Goldman Sachs from Bank of America are still unwilling to differentiate AIB from BofI.

Another interesting feature of the data is that Nama effect (a positive push for shares of AIB and BofI) has now been fully exhausted. And this is pretty impressive - we approve €54bn in funds, nearly bankrupting the entire economy, and in return we get the markets sending banks' share price back to where they were in May 2009, prior to the Nama approval.

So in terms of absolute prices, neither Nama, nor the latest Budget, seem to be working. But what about the risks in actual trading positions on the banks?
Well, if anything intraday volatility in AIB is down, not up, in the last 12 months. And that shows once again that the markets are not buying into AIB story. There is now less heterogeneity in investors' assessment of AIB value proposition than before:The same is true for BofI:The same story for a broader IFIN index

And there is nothing out of the ordinary in terms of volumes either:
Still relatively heavy, but not as heavy as in late 2008 - early 2009.

But now look as spreads (high-low) and monthly volatility: calmer, much calmer seas than over 2008. Again, no panic - just calm and measured trading here.
One can't really say here that investors are treating Irish banks shares in some idiosyncratic way, with an abnormally high sensitivity to risk. There is actually much less sensitivity to risk in the markets today than in 2008 and even 2007. So the current bear trend in Irish banks shares is driven by the markets assessment of fundamentals. In other words, markets are doing the job - spotting the 'dog' and pricing it down...
Any doubt? The above chart confirms that there is no abnormally heightened sensitivity to risk when it comes to AIB and BofI shares. The only outline events of 2009 in these shares relate to the bear rally that has just ended. The downtrend, therefore, is the norm.

Economics 09/12/2009: Budget 2010 - first shot at numbers

I will be blogging on the Budget 2010 over the next few days, but here is the main point:

The Budget did not deliver a significant adjustment to our structural deficit.

1. Claimed adjustments to the deficit totaling €3,090 million on current expenditure side and €961 million on capital side. These are gross figures which imply that we can expect net adjustments of ca €2,600 and €800 million each to the total deficit reduction of no more than €3,400.
2. Per table below, the Exchequer deficit will likely stand at €21,400 million in 2010 and not anywhere near the projected deficit of €17,760 million.
3. Stabilization of deficit is not happening on a significant downside, but in a marginal fashion, which is simply not good enough.

The main conclusion here is that the Budget has not gone far enough in reducing the structural deficit. There is another €10-12 billion worth of cuts looming for 2011-2012. It would be dangerous to assume that this can be corrected for through re-jigging tax system in 2011 as Minister Lenihan appears to imply.

At this junction, I simply cannot see how the Budget delivered anything more than a breathing period for Ireland before we resume our slide toward Greece. 12.4% deficit before we factor in demand for capital from Irish banks is just not enough. Full stop.

The Minister is now talking about €3 billion cut in 2011, then €5 billion cut in 2012-2013. This implies that from next year's standing position we are looking at a deficit of well over €9-13 billion in 2014. Assuming economy grows at a robust 2.5% every year from 2011 through 2014, this would imply a deficit of 4.9-7% of GDP - way long of the SGP-required 3%. If economy grows at even briskier pace of 3% per annum over the same period, the resultant deficit will be around 4.8-6.9%. Again, not much of a fit for our promises to the EU...

Economics 08/12/2009: Irish businesses ICT use

Per CSO release yesterday: “in 2009, 95% of all enterprises had a computer connected to the internet while 66% had a website or homepage. Access to the internet using broadband remained high in 2009 with 84% of all enterprises having a broadband connection. High-speed DSL broadband was used by 45% of enterprises compared with 41% in 2008. The use of mobile broadband reached a level of 27% in 2009 compared with 24% in 2008. As a consequence there has been a decline in the use of lower-speed DSL broadband and other fixed connections (e.g. cable, leased line etc).”

Sounds good? Well, actually… More detailed data shows the following worrisome trends:

• Use of computers has actually fallen from 98% of enterprises surveyed in 2008 to 97% in 2009. It has remained static at 98% in Manufacturing sector, fallen from 99% to 96% in Construction sector (possibly a function of inactive enterprises, or in the opposite direction – a surprising result if the survivourship bias applies to the sample). In Services sector there was a decline from 98% to 97% between 2008 and 2009. These results are rather strange. On one hand, if the sample included inactive firms, then one can expect the declines due to companies folding operations in Construction and lower value-added Services sectors. But if only actively trading firms were included, then this suggests that survivourship bias was actually selecting against the ICT-using firms for some unexplainable reason.

• Interestingly, the proportion of firms with a written ICT strategy has increase overall from 20% in 2008 to 21% in 2009, and in no sub-sector was there a decline in proportion. Construction sector firms led here with an increase from 8% in 2008 to 11% in 2009, which suggests that CSO sample incorporates survivourship bias. And this is really bizarre – on one hand, sample selection clearly favoured surviving firms that have ICT policies, but on the other hand the same sample favoured survivor firms with lower penetration of ICT… Hmmm…

• Proportion of firms using internet fell from 96% to 95% between 2008 and 2009. The declines were showing in all three broader sectors, with Construction firms registering the largest drop from 99% to 96%. This is again inconsistent with survivourship bias apparently present in the data. But even more strange were the results for the percentages of firms having their own websites. In Manufacturing, the number of firms with their own websites rose strongly from 72% a year ago to 77% in 2009. In Construction sector, surviving firms actually dramatically increased their websites presence from 48% to 58% despite having shown a decline in internet use in general. There was a decline in proportion of companies with their websites in Services sector – from 65% to 64%.

• Overall use of e-services (interfacing either with the public sector or private sector clients) has declined across the board except for Manufacturing sector.

• E-commerce is growing strongly with percentages of purchases and sales via e-commerce pathways as a share of total purchase costs and turnover, respectively, rose strongly between 2008 and 2009. But as in 2008, most of e-Commerce appears to be driven by purchases, not sales. And in volumes, e-Commerce has declined in line with overall economic activities. There is only tentative evidence that e-Commerce has taken up some of the traditional purchasing and sales activities share during this recession.

• Another interesting and surprising feature of the data shows that enterprises with access to broadband have reduced their e-Commerce-based purchases from 60% to 54%, and also reduced their e-Commerce-based sales from 28% to 23%. Enterprises with no connection to broadband have lowered their purchases via e-Commerce vehicles from 29% to 24% and their sales from 14% to 9%. This seem to show that access to broadband does not result in more resilience to the recessionary contraction in enterprise activities. But, enterprises with broadband connection have retained their propensity to employ workers who e-work at 37%, while enterprises with no broadband connection have increased this share from 9% to 10%. Rising workforce mobility and flexibility for those with no broadband connection while static workforce mobility / flexibility for those with broadband connection? Clearly this can’t be happening…

Economics 06/12/2009: Replacement rates for Irish social welfare payments

Department of Finance has published (unnoticed by most) its estimates of the replacement rates for Irish Social Welfare system. Per DofF, any replacement rate in excess of 70% is problematic, as it creates significant disincentive for the recipients to seek reentry into the labour force. Well, yes. I agree.

However, what DofF fails to recognize in its estimates is the fact that welfare recipients avail themselves of free healthcare (medical cards) and subsidized drugs scheme, plus, having no jobs to attend to, they do not have to spend a penny on childcare.

I have updated the DofF own estimates to reflect these costs wherever they apply and this is reflected in the table below which also reproduces DofF own estimates.

Effective wage in my estimates refers to the earnings that must be attained in the workplace in order to supply the same level of real income as provided by social welfare. My estimate is based on DofF replacement rate estimates, plus additional benefits as outlined in the footnote.
Telling picture. For a country with average income of ca €25,000 per capita, we are talking about virtually all groups of welfare recipients, case-studied by DofF, getting more on welfare than in average employment.

Red-bold cases are clear welfare traps with replacement income in excess of 70% relative to reference group.