Economics 1/8/10: Merrill Lynch & Minister Lenihan's Banks Guarantee

Those who follow my tweeter contributions (@GTCost) would have probably seen the following quotes from the 3 documents relating to Merrill Lynch advice given to the Irish Government regarding the banks guarantee of September 2008. Nonetheless, I've been asked by a couple of readers to provide their summary in a single place so here it is.

In relation to Minister Lenihan letter to the Irish Times (here) which stated amongst other things that: "In the papers on the bank guarantee recently released by my Department and published by the Public Accounts Committee, the Government’s financial advisers Merrill Lynch strongly endorsed the principle that no Irish bank should be allowed to fail against the backdrop of what the Governor describes in his report as “the hysterical state of global financial markets”. Merrill Lynch also recommended a blanket guarantee of Anglo Irish Bank, including, incidentally, subordinated debt."

The Minister was referring to 4 documents available on the Oireachtas site (here) and numbers 3, 4, 5 and 6. Document 6 contains no information on the actual position of the Merrill Lynch.

Transcript of the meeting Merrill Lynch & DoF 26/09/2008: page 1 "On a blanket guarantee for all banks: Merrill Lynch felt could be a mistake and hit national ratings and allow poorer banks to continue" Link: http://www.oireachtas.ie/viewdoc.asp?fn=/documents/Committees30thDail/PAC/Reports/DocumentsReGruarantee/document5.pdf

Same source, page 2: "More generally, institutions should be encouraged to sell assets & get equity." So Merrill referred to equity capital injections (either in the style of Swedish recapitalizations by the state or private equity sales, with the latter being an unlikely outcome. At no time does the document references the need for a blanket bailout! Minister Lenihan was present at the meeting (see last paragraph of the document to prove this, although the official list of attendees at the top of the document does not include his name).

Merrill's presentation on 26/09 does state (p2) that a guarantee, covering subordinated debt holders as well is: "Best/Most decisive/Most impactfull from market perspective" option of considered. It does not state this to be the case from the taxpayers perspective. Minister Lenihan does not represent the markets interests. He represents taxpayers interests. Thus, if he indeed take the advice from the above statement, he thus knowingly or unknowingly altered the terms of his core responsibilities.

The same presentation voices a number of concerns, some of which are blacked out by DofF... What are these? Link: http://www.oireachtas.ie/viewdoc.asp?fn=/documents/Committees30thDail/PAC/Reports/DocumentsReGruarantee/document4.pdf)

Email from Merrill to K. Cardiff from 29.09/08 18:43(just a few hours before the guarantee was issued and containing final advice by the investment bank to the Government) does not contain any endorsements of the Guarantee (or of any other singular option), despite being based on 26/09 presentation cited in the earlier quote.

But the email does say (p2): "There is no right or wrong answer [to strategic options available to the Gov]... preserving flexibility is key & solution may be different for each institution"

Does this advice sound like a call for a blanket guarantee on all debt holders?
Link: http://www.oireachtas.ie/viewdoc.asp?fn=/documents/Committees30thDail/PAC/Reports/DocumentsReGruarantee/document3.pdf

There are even deeper issues involved in Minister Lenihan's statement. One of the most troubling ones is why has the Minister summoned the advice of an investment bank that two weeks before the advice was sought (on September 14th) was taken over by Bank of America in questionable condition?

Congressional testimony by Bank of American CEO Kenneth Lewis, as well as internal emails released by the House Oversight Committee, indicate that Bank of America was pushed into the purchase of Merrill Lynch by the US regulators. BofA executives and board were, allegedly, threatened with the firings and were warned of "damaging the relationship between the bank and federal regulators". Full three weeks before Minister Lenihan engaged Merrill Lynch, the company was severely downgraded by its peers in the market (September 5 downgrade by Goldman Sachs is indicative of this and was public at the time).

However, the main issue that arises from Minister Lenihan's letter is that of the purpose of its existence in the first place. Is Minister saying that the Guarantee decision was the correct one? If so, why does he need the defense of being given such an advice? If no, what does his statement about Merrill Lynch advice really tells us? To say that Guarantee was issued because Government advisers said that it was the best option is equivalent to saying that poor weather forecasts has caused Titanic to sink.

Economics 1/8/10: Retail Sales data: to spin or not to spin?

The latest retail sales figures for Ireland highlight two interesting issues. One - deeply fundamental, another - deeply disturbing.

The first issue - the fundamental one - relates to the basic philosophy of 'reporting' the data. CSO's publication on RSI was headlined "Retail Sales volume index increases by 1.0%". The first paragraph of the 'analysis' reads (emphases are mine):

"The volume of retail sales (i.e. excluding price effects) increased by 1.0% in June 2010 when compared with June 2009 and there was a monthly decrease of 0.2%. If Motor Trades are excluded the volume of retail sales decreased by 1.3% in June 2010 when compared with June 2009 and the monthly change was -0.5%."

This, to me, as an example of the poor application of economics to what is essentially a purely economic data series. And it is also an example of poor statistical analysis. Here is why:

1. The series reported are monthly and seasonally adjusted. This means these series are first and foremost about monthly, not annual deviations (annual comparisons can be made unadusted for seasonal / monthly variations). Why does the CSO then elects to report an annual deviation headline?
2. The volume series of retail sales are secondary in importance to the value series. What matters to gauging the overall demand in economy is not the physical quantity of stuff traded, but the value of the sales. Imagine a situation whereby an economy is plagued by a recession (like Ireland). Country largest retailer goes out of business and has a firesale of its stocks. Suppose it sells lock stock and barrel in one month, but at a price of zero euros per item, i.e. it gives stuff away for free. What happens? Volume of sales goes up dramatically. Value of sales goes down. CSO records an increase in volume and reports a headline that implies demand is up, sales are up. Yet, economic impact of this transaction is nill. If anything, it shows that economy has no real demand underlying it. Exchequer returns are nill. Value of stuff sold is nill. Value of transactions is nill. Patient is as dead as it can be!
3. Monthly, not annual series show shorter term dynamics. And it is the dynamics of sales, not their absolute levels or longer term changes that should frame short-term policies, that are suited for a recession.
   

Of course, you might object, saying - hey, you should have read the first paragraph, mate. Not just the headline. Alas, our politicos making bullish noises about turnarounds can't be relied upon to do this much. "It's the good news, folks! Retail sales are up year on year".

CSO has more disturbing analysis presented in the latest release. Paragraph two, in fact, is about as manipulative, as the preceding text:

"A number of sectors showed year on year increases in June 2010, with the most
significant being: Motor Trades up 13.9%, Non Specialised stores up 1.4%, Clothing, Footwear and Textiles up 2.6%".

Now, let's take a look at CSO own data to decipher the spin in the above statement:

• Motor Trades up 13.9% yoy in volume, and 1.4% mom - good news (driven, as I've said before by a tax off-set for new cars - aka the scrappage scheme, and to a larger extent - by the vanity plates for 2010), but Motor Trades are up less significant 9.2% yoy in value and 1.3% in mom terms. So one might ask the question then - why is value of overall Motor Trades lagging behind the volume of these. Is it due to (a) rebates by the Government (VRT offset?) or (b) competition in the Motor Trade sector or (c) because people are buying lower quality, cheaper priced cars? CSO doesn't even attempt to provide an answer. My earlier analysis (here and here) suggests that all three might be at play. If so, Motor Trades figures for the entire 2010 are not exactly a shining example of economic turnaround.
• Non Specialised stores volumes up 1.4% yoy, but down 0.9% in mom terms. Values of these sales are down 3.5% yoy and 1.3% mom. Discounts, discounts, discounts. Selling cheaper doesn't really generate more economic activity, though it does benefit consumers. And this 'cheaper selling' in turn drives up not new demand, but induces a movement right along the same, recessionary demand curve. But wait, seasonally adjusted monthly changes are negative in value, which means that deflation is still there and demand for quantity is not exactly booming.
• Clothing, Footwear and Textiles up 2.6% in yoy volume terms. Really? Well, mom the same series are down 4.1%. In terms of value of Clothing, Footwear and Textiles sold in Ireland in June: yoy sales collapsed 8.1% and mom change was 4.1%. In a normal economy that should start ringing the 'Recession Alert' bells. In Ireland, for CSO this is bunched together with the aforementioned 'good news'.

Here is another good look at the CSO own data, not brought up to anyone's attention by CSO:

• All Businesses excl Motor Trades & Bars: Value down -1.3% mom and -3.9% yoy, Volume down -1.1% mom and -0.2% yoy. Some turnaround!
• All Bus. Excl. Motor Trades, Fuel & Bars: Value down -1.9% mom and -5.3% yoy, while Volume is down -1.1% mom and 0.3% yoy. No turnaround here either.
• Non-Food (Excl Motor Trades, Fuel & Bars): Value off -1.2% mom and -7.1% yoy, while Volume is off -1.7% mom and -0.6% yoy.
• Household Equipment (white goods stuff) Value down -3.1% mom and -6.3% yoy, Volume off by -2.6% mom and -0.1% yoy. Now, this category is important as white goods are subject to demand due to depreciation and new demand. We've had at least 2 years of collapsing demand for these goods, implying that things are so bad, people are reluctant to replace depreciated washers, dryers, dishwashers, fridges etc. Forget buying new jeans and coats...

So to do what I usually do on this blog - here are updated charts plotting actual data (no spin):
If you look closely at the last three months in the series, you can see continued deterioration pressures in both. But to highlight this trend - check out the chart below:
Monthly changes are now in the negative territory, and a positive annual volume bounce of the first quarter 2010 is about to be exhausted.

Removing motor trade:

Why wouldn't CSO just report data, plus charts and leave 'commentary' to others? At least they would be purely objective reporters of data, instead of playing the amateurish 'Spin Economics' commentators?

Economics 31/7/10: Credit flows in Ireland

Central Bank quarterly was published yesterday. Here are some updated charts on credit flows (data through May). The main conclusions are:

1. Private sector credit continues to contract and is again accelerating in the annual rate of decline (-10.4% yoy in May as compared to -9.3% declines in April and March).
2. Mortgage credit contractions are steadily declining (-1.8% in May against -1.6% in April & 1.4% in March).
3. Non-mortgage credit is accelerating in the rate of decline (-12.8% in May compared to -11.4% in April)
   
4. Nama - now through 50% of the loans purchases - has had no positive impact on credit supply. If anything, as charts for households lending show blow, it is being accompanied by a dramatic increase in the cost of borrowing for ordinary families.

Charts:
Aggregate private sector credit above. Disastrous trends of the last 2 year continue unabated, despite the already significant contraction in the credit supply. This suggests that we are in a continued downward spiral when it comes to business and household investment (future capacity is under continued pressure down and the only thing that provides some positive support to capital side is, most likely, MNCs own inter-company investments). This goes to explain why one cannot accept earlier DofF projections for 2013-2015 potential rates of growth. We are in a situation very similar to Japan in the mid-1990s, where existent production is being driven at the expense of capital stock.

Mortgages:Clearly, no signs of moderation in the rates of decay anywhere here. But the picture is more sluggish than that for non-mortgages lending:
The reason for the different dynamics is that it is easier for households to cut back on smaller credit demand than on massive mortgages burden. Hence, non-mortgages lending is a leading indicator for what we can expect to follow in the mortgages markets. Not exactly a bright future for the housing markets, then.

Deposits side of our financial system:
Notice that deposits are down, mom, across the board, except for shorter term maturity corporate deposits. But yoy all deposits are down. Combined decline in all deposits in volume since January 2010 is €1,869 mln, or 3.4%. Not a small change. All deposit rates are down year on year - we are being paid less to save, but are charged more to borrow.

Loans stats next.
Loans for house purchases are falling, while mortgages rates are rocketing. The orange line above shows just what is happening with the cost of financing one's own home in Ireland, courtesy of our regulators (keen on talking about 'moral hazard'), all the special 'Working Groups' aiming to address the problems in the housing markets, and Nama. Remember - our Government (by now pretty much every minister in the cabinet) had sworn to us that Nama will restore functional banking. May be this is what they had in mind...

Last year I predicted that the game in the mortgages markets will play as follows:

• Once Nama starts transfers, incentives for the banks to play a Good Fella will diminish - repossessions will remain low, but rates will rise. We now can see this happening around us.
• Once Nama completes transfers, banks will go in earnest at rebuilding their margins & capital, meaning - repossessions will accelerate dramatically and rates will rise to the levels where the burden of financing mortgages will become a driver for more repossessions.
• 3-6 months after the above stage, banks will start hoarding repossessed property on their books. They will be forced to start selling it ca 6-9 months after February 2011 (completion date for Nama purchases).
• Combined effect of massively more expensive mortgages credit and inflow of repossessed properties into the market will drive prices in housing markets even further down.
  

So far, we are through the 1st bullet point and getting closer to the second one.

Meanwhile, in the land of short term loans, rates are more steady and credit supply is falling gently.
Now, let me ask you this question. What should be the priority here? Making sure people are not being skinned to pay for their homes, or making sure that credit cards rates and car loans are being underpinned by more stable interest rates?

Credit to non-financial corporations is continuing to slide. Year on year, shorter term (working capital) credit is now off a massive 19.3%. Longer term credit is off 2.7% yoy. What does this tell me about the economy?

1. Capital investment is going nowhere fast, with any rosy figures on volumes we might hear over the coming weeks being most likely driven by the MNCs own in-house investment flows; and
2. Companies have no capacity to refinance shorter term credit obligations, resulting in a cash flow pressures and lack of operating capital.

Not exactly a success story for our financial system administrators and regulators, then.

Economics 30/7/10: No double dip for the euro area, yet...

New data from eurocoin is out - time to update euro area forecasts. Aptly in line with the US Q2 growth now coming at a slower 2.4% annualized rate, both the leading eurocoin indicator of activity (down to 0.4 in July from 0.46 in June) and my forecast for Q2 and Q3 2010 growth for the euro area are also moderated. Chart below illustrates:
GDP forecast range is for quarterly growth of -0.1% to +0.05% in Q3 2009.

So no double dip for the euro area yet, but things continue to head that way...

Economics 29/7/10: PTSB house prices

PTSB/ESRI house price index is in for Q2 2010. The core result: house prices were down, again, by 1.7% qoq in Q2 2010 - a lower rate of change on Q1 2010 contraction of 4.8% qoq. Thus, prices are now off-peak by 35% to an average of €201,364.

Dublin prices are down 3.5% qoq in Q2 2010 and are off 44% relative to peak. This gap between nation average and Dublin, assuming (as seems to be reasonable) that capital prices appreciation prior to the current crisis were significantly affected by underlying demand, should be erased over the next 12 months plus. Which means we can expect at some point that Dublin will lead the recovery across the country, while other regions continue to contract toward the 45-50% nationwide average off-peak pricing.

NCB stockbrokers gave a good comparison to fundamentals-determined prices. Per their analysis,

• Rental yield model implies house prices equilibrium at between €118,000 and €157,000, or a mid-range house price of €137,500;
• Earnings multiples model implies €170,000;
• Present value model (although not detailed as to the assumptions built in) implies the range of €158,000 to €236,000 for an mid-range of €197,000

You can see where these valuations are heading, don't you? Take a full range of estimates mid-range point of €177,000 - that would be a decline of 43% off the peak prices. Take the simple average price of all mid-range points to get 46% decline.

Now, recall - these are equilibrium prices. In normal price adjustments, there is a relatively pronounced undershooting in prices - in other words, we can expect prices to fall below equilibrium levels before reverting toward longer term values over time.

The depth of this undershooting and its duration depend on some external factors, such as the ease of getting mortgages approvals, mortgage conditions etc - none of which are currently helping the housing markets. So there is a very strong possibility for prices to hit the floor at around -55-60% off the peak.

Lastly, there is a question to be asked as to the validity of PTSB's data - the country largest mortgages holder might no longer be the country largest mortgages issuer. And the sample size globally has shrunk substantially. In other words, if a desperate homeowner in the distant province sells a house for, say, €120,000 while a dozen of his neighbors are not braving the market, does this really tell us anything about the market clearing price? Not really. Imagine what the said homeowner would have got for his dwelling if 12 more identical dwellings in the neighborhood had a 'For Sale' sign.

So a grain of salt is due - the size of an orange...

Economics 27/7/10: Stress tests of Irish banks? Get real!

An excellent comment on AIB and BofI 'stress tests' results from Peter Mathews, worth a direct post (rather than 'just' a comment) on this blog. Read it here.