Economics 06/04/2010: Return of the markets

Another 'Must Read' from WSJ - Gary Becker on Obamanomics, health care reform and why Americans will opt once again for Smaller Government with more checks and balances on the power of bureaucracy. Read it here.

Perhaps the most insightful - from our point of view here in Ireland - is Becker's arguments about interest groups-driven poor legislation that ossifies into innovation-choking regulatory diktat absent proper competition between interest groups acting as a (limited) check on the corrupting power of tax-and-spend politics.

having just returned from the Western sea board, I can testify to that corrupting power. Take a small town, popular with summer vacationers, I visited. Bungalows piled mile-high - crowding each other and older homes. Local county councilors own, per local paper expose, many of these, with some holding mortgages on 7-9 of such vacation properties, with section 30 tax breaks attached to make the deal sweeter. Scores of developments (not one-offs) were built in violation of planning permissions granted. And scores of planning permissions were granted in violation of the standard building codes.

As a friend of mine has described the countryside: 'You have D4 folks with homes, back then, worth some €4-5 million rushing to buy public-housing-styled vacation homes for a €1 million-plus with an illusion that these were to be their country retreats. And the Government was dishing out tax breaks...'

We clearly have no competing interest groups - just a Social partnership feeding party.

Economics 1/04/2010: Travel time? Not a chance.

Hat tip to the Machholtz's blog - the link to my participation on Wide Angle (Newstalk 106FM) here. Discussing Nama...

The thing is - when all sides of political spectrum agree that we have taken a wrong path to banks crisis solutions, why is the Government failing to listen? Is the answer boiling down to the 1,500 jobs still remaining in the Anglo? Is it all about projecting the optics, buying time at the expense of the future of this country?


On today's data release from CSO:

• Trips to Ireland by overseas residents in January 2010 - down 26% to 313,800 from January 2009, an overall decrease of 110,400
• Visitors from Great Britain - down by 31.6% to 142,400
  
• Visitors from 'other Europe' and North America down by 29.7% and 2.2% respectively
• Trips from residents of other areas rose by 4.2%
• The largest decreases from overseas visitors to Ireland were: Great Britain (-65,900), Poland (-7,800), France (-7,000), Italy (-5,700) and Germany (-5,200)
  

In the mean time, Irish residents made 448,900 overseas trips in January 2010 or 10.6% fewer than in January 2009.
Travel tax, as expected with all trade barriers, is not an effective measure of domestic industry protection. Instead, it is yet another quick fix revenue raising measure that hurts more than it delivers.

Don't believe me? Well, aside from several independent analysts reports, even Aer Lingus (our Government's cheerleader airline) and Bloxham Stockbrokers (not exactly known for their fortitude when it comes to criticising the Government) agree.

Economics 31/03/2010: Nama funding scheme - Maddoffian Risk Pyramid

The saga of Nama continues, folks. Ah, and no, I do not mean the dumping of €8.3 billion to the Anglo which miraculously declared losses of €12bn = €4bn injected by taxpayer in 2009 + €8.3bn injected today. Had the Exchequer given Anglo €15bn last night, the bank would have declared losses of €19bn. And not even the admission on the public airways, by our illustrious 'public interest' director soon-to-be-chief of Anglo, Alan Dukes, that Anglo will most likely need more than additional €10bn promised to it by overly-generous-with-other-people-money Mr Lenihan.

Oh no - the really worrying thing is contained in the notes from March 26th issued by Nama (available here) that detail the financing arrangements that Nama will undertake to cover the purchases of the loans from Irish banks.

Some time ago it was rumored that the Government was setting on the following scheme:

• Nama will issue 12 month bonds
• With interest rate rest at Euribor-Libor plus a margin every 6 months
• Which are to be fully unconditionally and irrevocably guaranteed by the state as ranking pari passu with the Nama other unsecured and unsubordinated debts.

At the time, myself and other analysts said that such a scheme would be a disaster. Now, per latest documentation from Nama - this is exactly the scheme chosen to finance Nama acquisitions.

Let me remind you what the problem with this scheme is.

Nama is buying long-term loans with work-out period stretched over 10-15 years. It will use short term financing to get these through. Problem 1: borrowing short to lend long is what got out banks into this mess in the first place. Now, Nama will have exactly the same risk-loaded funding structure as the worst of our banks. For example, at the peak of risk-loading, Anglo carried about 50% of its funding in short-term inter-banks loans. Nama will do the same for 100% of its funding requirement. Scared yet?

Nama will be loading up with short term debt as the yield curve for Libor and Euribor is pointing up. In other words, every progressive reset (6 months) and roll-over of the debt (12 months) will be more expensive to the State. My third year UCD undergrads last Fall knew that this is a bad risk. Nama, having paid millions to advisers and 'experienced' staff couldn't get it right! Trembling yet?

Nama will be rolling over bonds on an annual basis. This means annual transactions costs (making the entire borrowing much more expensive) and reliance on the ECB to re-collateralize the bonds (putting Frank Fahey's 'free lunch' funding out to new tender annually). Is anyone actually thinking about any of these risks out in the Treasury Building on Grand Canal Street?

Adding insult to injury - despite being issued by the agent different than the Sovereign, Nama bonds will be tax-exempt. In other words, issued at Euribor of, say 2.75%, the notes will effectively be priced at around 3.44%. Worse, the Guarantee statement obliges the Irish state to cover incidental and other expenses of the bond holders and exempts them from all and any taxes relating to the Guarantee. In other words, should the bond holders resell their Nama bonds at a profit (in part determined by the Guarantee), there will be no tax on such a resale.

In short, it appears that neither Nama, nor an army of its excruciatingly expensive advisers, nor DofF, nor the Government have any knowledge that normal interest yield curves are upward sloping - cost of borrowing, normally rises in time. Or may be they simply do not care. After all, its our money they are gambling with.

Economics 31/03/2010: An expensive joke called Nama

I must confess, the last thing I expected in yesterday's quadruple whammy of one Ministerial speech, one Nama document release, a Central Bank statement and the Financial Regulator's decision was a joke. But there it was. For all to see, for few to notice.

Armed with a law degree-backed mastery of logic, Minister Lenihan has issued a statement that he will be requiring Irish Bankers Federation to run courses for the benefit of our bankers on how to lend money to projects other than property. That statement, coming from the Minister after he announced that the Anglo will be provided with up to €18.3 billion in taxpayers cash, and the rest of our banks will swallow billions more was worthy of a comedian. In an instant - we had a Minister for Finance throwing money at the banks which, by his own admission, have no idea of how to lend.

Anything else had to take a back seat to this farce. And it almost did. If not for another pearl of bizarre twist in the Nama saga. Recall that this Government has promised the world an arms-length entity to control and legally own Nama - the Special Purpose Vehicle arrangement which, in order to keep Nama debts out of the national debt accounts was supposed to be majority (51%) owned by external investors.

At the time of the original announcement of this arrangement I publicly stated that there was absolutely nothing in the Nama legislation precluding parties with direct interest in Nama from investing in this SPV. And boy, clearly unaware of such pithy things like conflict of interest, Nama announced that its majority owners will be:

• Irish Life Assurance (a part of the IL&P that has been at the centre of the Anglo deposits controversy and one of the most leveraged banks in the nation),
• New Ireland (an insurance branch of BofI), and
• AIB Investment Managers.

In other words, the very institutions that will be benefiting from Nama's taxpayers riches will also own Nama and will comprise SPV board. They couldn't have given a share to Seannie Fitz and Mick Fingleton, could they?

Having a good laugh - even at the cost of tens of billions to us, the ordinary folks - is a great end for a day in the Namacrats land. So much for responsible and vigilant policies of the Government.


Now to the beef: Nama release figures.

In its note on the first tranche of loans transferred, Nama provides a handy (although predictably vague) description of the loans the taxpayers are buying as of March 30, 2010. Table below summarizes what information we do have:

Let us take a further look at the data provided in the official release and the accompanying slide deck.
Applying more realistic valuations on the loans transferred against the average Nama discount, while allowing for 11% assumed LTEV uplift (Nama own figure), net of 2% risk margin - the last column in the above table shows the amounts that should have been paid for these assets were their valuations carried out on the base of March 30, 2010 instead of November 30, 2009 and were the discounts applied reflective of realistic current markets conditions.

Thus, in the entire first tranche of loans, Nama has managed to overpay (or shall we say squander away) between €1.2 and €3.1 billion - a range of overpayment consistent with 14-37% loss under the plausibly optimistic assumptions. Returning this loss across the entire Nama book of business and adding associated expected costs of the undertaking implies a taxpayer loss of €9.6-25.3 billion from Nama operations.


In Nama statement, Brendan McDonagh, Chief Executive of NAMA said: “Our sole focus at NAMA is to bring proper and disciplined management to these loans and borrowers with the aim of achieving the best possible return and to protect the interests of the taxpayer. ...NAMA is willing to engage with an open mind to our acquired clients ...”

Pretty amazing, folks - Nama CEO clearly sees the borrowers as his 'clients', while claiming that his organization objective is to benefit the taxpayers. Would Mr McDonagh be so kind as to explain the difference? Is Nama going to serve the 'clients' or is it going to protect the taxpayers? The two objectives can easily find themselves at odds - the fact Mr McDonagh is seemingly unaware of.

Economics 29/03/2010: PS productivity deal will cost us all

Per latest reports on the talks with the Unions, it now appears that the Government will yield on the Budget 2010 pay cuts and accept a premise that our vast structural deficit can be corrected through a long-term change in work practices in the public sector.

This position represents a drastic reversal of the attempted correction of the structural deficit and has the following long-run implications for Ireland:

1. Since productivity gains do not address the issue of reducing actual spend in the public sector, the entire burden of correcting the structural deficit can be expected to fall on the shoulders of the taxpayers;
2. If the deal commits the Government to no future cuts in public spending in Budgets 2011-2013, the deal will mean that the entire €13-14 billion in Budget adjustments needed before 2014 will have to be carried by the Irish taxpayers. This means taxes will have to rise by a massive €13,000 per annum per current tax payer - a move that would trigger a meltdown in the economy;
   
3. Since higher earning taxpayers are already paying more than half of the income tax bill, the new taxes will have to disproportionately impact lower middle classes, thus in effect inflicting pain on the very workers whom the unions are allegedly aiming to protect;
4. Since the structural deficit will remain unaddressed, Ireland will not reach 3% deficit target by 2014, or for that matter by 2020, implying that we will be facing excruciatingly high cost of borrowing through the next 10 years or so, a cost, once again to be carried by our middle and lower-middle classes.

Using a simple prisoners' dilemma game, one can easily show that the Government currently has all the incentives to run the economy deeper into depression. Such a move will ensure that the poisoned chalice the current Government passes to the opposition will be even more toxic, thus giving Fianna Fail stronger chances of election victory in the next 5 years.

In other words, if the Government does indeed sign up to the unions'-conjured 'plan' for 'efficiency'-exit from the deficit, it will be implicitly acting to derail any hope of a fiscal and economic recovery, while optimising its own political objectives.



PS: For all those who are keen on accusing me of being anti-Fianna Fail: nothing I write is designed to attack any political party in general or its members in totality. There are plenty of very good people in FF, and some of my friends are members of the party. There some competent, well-meaning and experienced members of the Government. Sometimes I disagree with them on policies, sometimes on ideologies, sometimes we agree. I express these views in public and privately. I always prefer an open debate.

The collective actions of the current Government, in my view, deserve very severe criticism. And that criticism I tend to provide: not behind the back, but in the open, publicly accessible fora.

Economics 27/03/2010: Breaking News: AIB and FF/Government

Major news breaking in the media rooms:
AIB (the first story below)
RedC Poll (the second story below)


Story 1:

The first story is about the leaks reported by Newstalk (see here) that AIB will announce before opening of trading on Monday that the state will be taking a 65% stake in the bank.

Per senior source in the Dail (hat tip to B) - the reason for AIB guiding 65% ownership now is that in addition to Nama haircuts, they are, allegedly, seeing significant deterioration in the sub-€5mln loans (the loans below Nama-eligible threshold).

This is hardly surprising. Since May 2009 I have consistently supplied estimates as to the eventual state ownership in both AIB and BofI. Depending on various scenarios:

• assumed Nama haircuts,
  
• the actual current risk weighting on the loans being transferred,
  
• share price at the time of announcement and
  
• the willingness of the banks and the Government to recognize future expected losses on the loans not transferred to Nama

RVF approach to valuing AIB and BofI balancesheets suggests that at the end of the current crisis, the state will outright own around 85-90% of equity in AIB and 50-60% in BofI. This eventual outcome, for political reasons, will come in two stages:

• post-Nama injection of capital (with AIB placing around 60-70% of its equity with the State and BofI placing around 40-45%), plus
• second stage recapitalization to correct for continued deterioration in the books over 2010-2011 (adding another 20-30% of equity for AIB and 10-15% for BofI)

The problem with this two stage recapitalization is that the taxpayer will end up paying three times for the same equity:

• Having injected €7 bn into two banks at the time when they were worth less than €2.5 bn for the entire lot,
  
• we are now be left on the hook for some €20 bn worth of largely worthless loans - to be purchased at ca 30-40% discounts (against the real market discount of 65-90%),
  
• plus €7-8 bn in fresh capital post-Nama
• plus the margin of ca 10-15% for further deterioration in non-Nama loan books (requiring another €7-9 bn of fresh capital).

Thus the Irish state is now likely to use up to €20 bn to buy up equity and loans from a bank that is currently worth around €1.5 bn... In the world of finance, even the most reckless bankers never managed such margins.

Alternative: force banks to acknowledge the full extent of their expected losses (as Swedes did in the 1990s), then force them to take the bondholders and equity holders to the cleaners (as Swedes did in the 1990s), and only then take equity - or in effect, take full equity in the banks. The cost for AIB would be around €10-12 bn, depending on how deep of a haircut on senior bondholders the banks can impose.

Story 2:

Tomorrow's RedC poll

Here is a preview - as was supplied to me by my sources (a disclaimer is due here: these are as provided by the source, so check tomorrow's papers for actually confirmed figures). Parties support:
The poll was conducted on Monday-Tuesday, so it does not reflect change of opinion in the wake of Cabinet reshuffling and the dissident TDs comments. Both factors can be expected to contribute to further decline in FF ratings, speculatively pushing core FF support post-Thursday to 21-22%.

Some specific questions:
“Brian Cowen understands people like me” - 31% agree
“Brian Cowen is a good Taoiseach” - 27% agree
“Brian Cowen is a safe pair of hands” - 31% agree
“Brian Cowen is the man to lead us out of recession” - 29% agree

Hat tip to NN.

I wonder what the same punters would say about our leaders now, after the reshuffle debacle and the open dissent amongst the back-benchers.