25/6/2012: Thinking outloud: Euro Area Banks Levy

Latest reports suggest the EU leaders are pushing for a 'banking levy' to finance common deposit insurance scheme, a banks resolution fund and joint supervision authority.

It has been my view all along that the former two are required for the financial sector future health and to break the onerous link between the banks and the sovereigns. Alas, I must point out the reality of what such a proposals will mean.

To start with, let's us ask a question: What happens when economy enters a recovery stage from even a cyclical downturn?

Answer: surplus savings built during normal downturn alongside accommodative monetary policies result in an increased supply of capital to finance capex expansion in the private sector. This leads to rising cost of capital on demand side (as demand for capex quickly outstrips supply) and on supply side (as monetary authorities tighten rates into upswing cycle).

But here's a problem, Roger, and it's Europe: suppose the economy is about to take off onto capex growth path:

• Savings nowhere to be seen as deleveraging of households will be still ongoing
• Deleveraging of banks, including in anticipation of LTROs expiration means no supply of new credit
• Policy rates might stay low, but retail rates will remain higher than normal as banks balancesheets remain weak and state or EU-held (via 'resolution' vehicle) equity remains high
• In the mean time, five years of the crisis have created a massive penned up demand for capital, so market rates will be even higher
• Equity capital will be scarce, as global recovery will most likely be ongoing, sapping capital into more growth-generative regions, and
• There's that EU levy as an icing on the cake to add to costs and shrink the margins.

Now, posit the above against the following environment scenario:

• Households debts are still high, but incomes are now undermined by five years (plus) of a recession and stagnation
• SMEs and many corproates balancesheets are weak (due to stagnation in exports and internal demand, plus deleveraging costs)

What do you get? Oh, rapid increase in credit costs, leading to more households and business insolvencies. So, go ahead, as Clint The Market would have said, make my day, punk. Raise some more levies...

25/6/2012: Q1 2012 Exports to Russia by Category

Per your requests, here is the breakdown of our exports to Russia by category - these are expressed as percentages of total exports to Russia. Data covers Q1 2012 - the latest we have available.

Update: per further requests: here is comparative table for our bilateral trade with Russia (exports of goods) in terms of each category of goods weight in total exports to Russia, compared against each category of same goods share of our total exports. Cells in bold mark goods which are more significant in our exports to Russia compared to our overall exports.

24/6/2012: Sunday Times June 17, 2012

This is an unedited version of my Sunday Times column from June 17, 2012.

The current Government policy, and indeed the entire euro area crisis ‘management’ is an example of ‘the lesser of two evils’ con game. The basic set up involves presenting the crisis faced by the euro area or the Irish economy as a psychological construct, e.g. ‘We have nothing to fear, but fear itself’. Then present two options for the crisis resolution, similar to the choice given to Neo by Morpheus in the Matrix. You can take the blue pill, the surreal world you currently inhabit will continue unabated (the ATMs will keep working, the banks will be repaired, the economy will turn the corner, etc) but a cost of complying with the demands of the system (the banks bondholders and other lenders must be repaid, the EU systemic solutions must be embraced, confidence in the overall system must continue). Take the red pill, you go to the Wonderland and see how deep the rabbit-hole (of collapsed banks, wiped-out savings, destroyed front-line services, vulture-funds circling their prey, etc) goes.

Unlike in the Matrix, it’s not a strong, cool, confident Morpheus who’s offering the option, but Agent Smith, aka the Government and its experts. And, unlike in the Matrix, we are not heroic Neo, but scared humans, longing for stability and certainty in life. This disproportionality of the power of the State as the offerer of the false choice, and the powerlessness of the society assures the outcome – we take the blue pill and go on feeding the Matrix of European integration, harmonization, and self-validation. The very fact that the blue pill choice leads to the ever-accelerating crisis and ultimate demise of the entire system is irrelevant to our judgement. We are in a con-game.

How I know? I was told this by the Government own statistics.

We all agree that our real economic performance is abysmal. Take unemployment – officially, it rose to 14.8% in Q1 2012, unofficially, broader measure of unemployment – that including those recognized as being under-employed – is hovering over 22%.

But to-date, our fiscal performance has been so stellar, we are ‘exceeding Troika targets’. Right?

Ireland’s Exchequer deficit for the period from January 2012 through May was €6.5 billion or €3.7 billion below the same period last year. This ‘improvement’ in our deficit is due to €1 billion transfer from the banks customers and taxpayers (via banks holdings of Government bonds) to the Central Bank of Ireland that was paid out by the Central Bank to the Exchequer. Further ‘improvement’ was gained by the ‘non-payment’ of the €3.1 billion due on the promissory note, swapping one government debt for another.

Underlying day-to-day Government spending (ex-banks and interest payments on debt), meanwhile, is up year on year. Tax receipts are rising, up €1.6 billion, but if we take out the USC charge which represents reclassified non-tax receipts in the past currently being labelled as tax revenues, the increase shrinks to €726 million. In the mean time, interest costs on Irish national debt rose €1.3 billion on same period of 2011, wiping out all gains in tax revenues the Government has delivered on.

Take that blue pill, now and have a 15% increase on the 2007 levels of budgeted Government spending (protecting ‘frontline services’, like HSE senior executives payouts in restructuring and advisers salaries), or a red pill and face Armageddon. Yet, the red pill in this case would lead us to the realization that the entire charade of our reforms and austerity measures is nothing more than a false solution that risks making the crisis only worse.

This week, Professor Karmen Reinhart of the Kennedy School of Government, Harvard University was dispensing red pills of reality at the Infiniti 2012 conference over in Trinity College, Dublin. Her keynote address focused on the area she knows better than anyone else in this world – debt overhangs and the pain of deleveraging in resolving debt crises. The audience included many central bankers and monetary and fiscal policy experts from around the world, including even ECB. No one from the Irish Department of Finance, the NTMA or any branch of the Irish Government, save the Central Bank, showed up. Blue pills crowd don’t do red pills dispensations.

Professor Reinhart spoke extensively about Europe and, briefly, about Ireland. In our conversation after the speech, having met senior Irish Government decision makers, she reiterated that, like the rest of the euro area, Ireland will have to face up to the massive debt overhang in its fiscal, corporate and household sectors and restructure its debts or face a default. In 26 episodes of severe debt crises in the history of the world since the early-1800s she studied, only three were corrected without some sort of debt restructuring, and in all three, “the conditions that allowed these countries to resolve debt overhang problems absent debt restructuring are no longer present in today’s world”.

Worse than that, Professor Reinhart explicitly recognized that “Ireland has taken debt overhang to an entirely new, historically unparalleled, level”. She also pointed out, consistent with this column’s previously expressed view, that in the Irish case, it is the household debt that “represents the gravest threat to both short-term stability and long-term sustainability of the entire economic system”.

Per claims frequently made by the Government that debt deleveraging is on-going and progressing according to the policymakers’ expectations, Professor Reinhart stated that “in the US, deleveraging process had only just begun. Despite the fact that house foreclosures and corporate defaults have been on-going since 2008, the amount of deleveraging currently completed is not sufficient to erase the build up of debt that took place over preceding decades. With that, the US is well ahead of Europe and Ireland in terms of what will have to be achieved in terms of debt reductions.” Furthermore, “structural differences in personal and corporate insolvency laws between the US and Europe imply the need for even deeper debt restructuring, including direct debt forgiveness and writedowns in Europe. And, once again, Ireland is in the league of its own, compared to the European counterparts on personal bankruptcy regime.”

But don’t take Professor Reinhart’s and my points of view on this. Take a look at the forthcoming sixth EU Commission staff report on Ireland, leaked this week by the German Bundestag. The Troika is about to start dispensing its own red pills of reality to the Irish Government.

According to leaked report, the IMF and its European counterparts are becoming seriously concerned with two key failings of our reforms. The first one is the delay in putting in place measures to address – on a systemic basis, not in a case-by-case fashion as the Government insists on doing – the problem of households’ debts. Incidentally, this column has warned about this failure repeatedly since mid-2011. The second one is the rising risk that accelerating mortgages defaults pose to banks balancesheets. Again, this column covered this risk in April this year when we discussed the overall banks performance for 2011.

From independent analysts, to world-class researchers like Professor Reinhart, to Troika, red pills of reality are now vastly outnumbering the blue pills of denial that our Government-aligned experts are keen at dispensing. The problem is – no one seems to be capable of waking up inside the Matrix of our doomed policymaking.

To put it to the policymakers face, let me quote Professor Reinhart one more time: “Europe’s solution to the crisis, focusing on austerity instead of restructuring household and sovereign debts will only make the crisis worse. The pain of deleveraging is only starting. …Europe’s hope that growth can help in addressing the debt crisis is misplaced, both in terms of historical experiences and in terms of European economic realities.” And for our home-grown Mr Smiths: “Ireland’s current account surpluses [or exports growth] are welcomed and will be helpful [in deleveraging] but are not sufficient to avoid restructuring economy’s debts.” So fasten your seatbelt, Dorothy, cause Kansas is going bye-bye…

Charts:

Sources listed in the charts

Box-out:

Few months ago I highlighted in this very space the risks poised to the Irish banks and Nama from the excessive over-reliance, in the pre-crisis period on covered bonds and securitization-based funding. The core issue, relating to these two sources of funding, is the on-going deterioration of the quality of the collateral pools that have to be maintained to sustain the bonds covenants. Things are now going from bad to worse, and not only in Ireland. Per latest Moody’s Investors Service report, across Europe, 79 percent of all loans packaged into commercial mortgage-backed securities rated by the agency that came due in Q1 2012 were not repaid on time. Three years ago, the non-repayment rate was only 35 percent. Per Moody’s, “real estate with mortgages that match or exceed the value of the property… suffered defaults in nearly all cases in the first quarter. About a third of borrowers with LTV ratios of up to 80 percent didn’t pay on time.” If this is the dynamic across Europe as a whole, what are the comparable numbers for Ireland, one wonders? And what do these trends imply for the Irish banks and Nama?

24/6/2012: Irish Services: April 2012

For a shocker, folks - a positive set of news.

The experimental time series from the CSO on services sectors performance shows some relatively robust activity in the services sectors.

Here's the headline chart:

Now, to some figures:

• Overall index of activity (value) in Irish Services sectors stood at 101.0 in April 2012, down slightly on 101.2 in March 2012, but up 4.0% on same period last year. 
• This confirms a robust growth trend in the series.
• 3mo MA in April was at 101.2 against 100.9 in March and at the highest level reading since data series began in October 2010.
• Activity is now 1% ahead of 2009 average levels - sounds like not much, but when one considers that it was at 97.3 back in Q4 2010, there is some progress.
• Notice - these are value indices, so not free from price changes variations and inflation in services does increase index performance.

Sub-indices are shown below:

• 3moMA through April 2012 for Wholesale & Retail trade sub-sector stood at 107.7 down on 108.6 in 3mo through January 2012. The sub-index fell 1.4% m/m in April but was up 2.7% up y/y.
• 3moMA through April 2012 for Information & Communication sub-sector stood at 108.4 up on 105.0 in 3mo through January 2012. The sub-index fell 1.6% m/m in April but was up 9.1% up y/y.
• 3moMA through April 2012 for Business Services sub-sector stood at 97.2 down on 98.9 in 3mo through January 2012. The sub-index rose 0.7% m/m in April but was down -0.5% up y/y.
• 3moMA through April 2012 for Transport & Storage sub-sector stood at 105.0 up strongly on 96.7% in 3mo through January 2012. The sub-index rose 3.2% m/m in April and was up 14.4% up y/y.
• 3moMA through April 2012 for Accommodation & Food Services sub-sector stood at 86.9 down on 87.1% in 3mo through January 2012. The sub-index fell -0.1% m/m in April and was down -2.9% up y/y.
• 3moMA through April 2012 for Other Services sub-sector stood at 71.9 up on 69.1% in 3mo through January 2012. The sub-index rose 4.2% m/m in April but was down -0.5% up y/y.

Although a mixed bag overall, the index continues to show expansion in the sector accounting for a large share of our overall economic activity.

24/6/2012: IBRC 'repayment' of €1.14 billion

New wave of outrage: IBRC is about to repay €1,142 million worth of unguaranteed senior bonds this coming week.

Here's a link to the note by Brian Lucey (TCD) and a link to namawinelake post on same.

My view is simple: The repayment is madness - the country is bust & is being propped up by IMF, EU, bilateral and ECB loans. IBRC is a bust non-bank (it retains banking license, but has no meaningful banking activities and is not likely to acquire any of these at any time in the future). IBRC has 'assets' and liabilities (ex-deposits). Hence, IBRC should default on all debts, transfer underlying assets to creditors based on their seniority and close the shop. The bondholders should get no more and no less than the assets of the company. As ELA is super-senior lending secured against specific asset (Promo Notes), quasi-governmental debt (Promos) should remain within CBofI and no private bondholder should have a claim against them.

Of course, the above process would not involve the €1.14 billion worth of bonds to be repaid this week, as these are unsecured (no claim vis-a-vis assets) unguaranteed (not even a theoretical claim against the State) liabilities. And no moral / ethical impact (these are bonds held primarily by speculative  institutional investors). These should just burn to some cheer from the crowds to boot!

23/6/2012: Sunday Times 10/6/2012

This is an unedited version of my Sunday Times article from June 10, 2012.

Last week, the Irish voters approved the new Euro area Fiscal Compact in a referendum. This week, the Exchequer results coupled with Manufacturing and Services sectors Purchasing Manager Indices have largely confirmed that the ongoing fiscal consolidation has forced the economy into to stall. Irish economy’s gross national product shrunk by over 24% on the pre-crisis levels and unemployment now at 14.8%. The most recent data on manufacturing activity shows a small uptick in volumes of production offset by significant declines in values, with profit margins continuing to shrink. Deflation at the factory gates is continuing to coincide with elevated inflation in input prices. In Services – accounting for 48 percent of our private sector activity – both activity and profitability have tanked in May. The Exchequer performance tracking budgetary targets is fully attributable to declines in capital investment and massive taxation hikes, with current cumulative net voted expenditure up 3.3% year on year in May.

On the domestic front, the hope for any deal on bank debts assumed by the Irish taxpayers, one of the core reasons to vote Yes advocated by the Government in the Referendum, has been dented both by the German officials and by the ECB. Furthermore, on the domestic front, the newsflow has firmly shifted onto highlighting the gargantuan task relating to cutting our deficits in 2013-2015 and the problem of future funding for Ireland.

Per April 2012 Stability Programme Update, Ireland’s fiscal consolidation path will require additional cuts of €5.55 billion over the next three years and tax increases of at least €3.05 billion. Combined, this implies an annual loss of €4,757 per each currently employed worker, equivalent to almost seven weeks of average earnings. This comes on top of €24.5 billion of consolidations delivered from the beginning of the crisis through this year. The total bill for fiscal and banking mess, excluding accumulated debt, to be footed by the working Ireland will be somewhere in the region of €18,309 per annum in lost income.

This has more than a tangential relation to the Government’s main headache – weaselling out of the rhetorical corner they put themselves into when they solemnly promised Ireland’s ‘return to the markets’ in 2013 as the sole indicator for our ‘regained economic sovereignty’.

Even assuming the Exchequer performance remains on-target (a tall assumption, given the headwinds of economic slowdown and lack of real internal reforms), Ireland will need to raise some €36 billion over 2013 and 2014 to finance its 2014-2015 bonds rollovers and day-to-day spending. In January 2014 alone, the state will have to write a cheque for €8.3 billion worth of maturing bonds. The rest of 2014 will require another €7.2 billion of financing. Of €36.5 billion total, €19.3 billion will go to fund re-financing of maturing government bonds and notes, plus €6.9 billion redemptions to Troika. Rest will go to fund government deficits.

At this stage, there is not a snowball’s chance in hell this level of funding can be secured from the markets, given the losses in economy’s capacity to pay for the Government debts. Which means Ireland will require a second bailout. And herein lies the second dilemma for the Government. Having secured the Yes vote in the Referendum of the back of scaring the electorate with a prospect of Ireland being left out in the cold without access to the ESM, the Government is now facing a rather real risk that the ESM might not be there to draw upon. In fact, the entire Euro project is now facing the end game, which will either end in a complete surrender of Ireland’s economic and political sovereignty, or in an unhappy collapse of the common currency.

The average cumulative probability of default for the euro area, ex-Greece, has moved from 24% in April to 27.5% by the end of this week. For the peripheral states, again ex-Greece, average cumulative probability of default has risen from 45% to 52%.

Euro peripherals, ex-Greece: 5-year Credit Default Swaps (CDS) and cumulative probability of default (CPD), April 1-June 1

Source: CMA and author own calculations

These realities are now playing out not only in Ireland and Portugal, but also in Spain and Cyprus.

Spain has been at the doorsteps of the Intensive Care Unit of the euro area for some years now. Yet, nothing is being done to foster either the resolution of its banking crisis, nor to alleviate the immense pressures of it jaw-dropping 24.3% official unemployment rate. Deleveraging of the banks overloaded with bad loans has been repeatedly pushed into the indefinite future, while losses continue to accumulate due to on-going collapse of its property markets. At this stage, it is apparent to everyone save the Eurocrats and the ECB, that Spain, just as Greece, Ireland and Portugal, needs not loans from the EFSF/ESM funds, but a direct write-off of some of its debts.

Spain’s problems are immense. On the upper side of estimated demand for European funds, UBS forecasts the need for €370-450 billion to sustain Spanish banking sector and underwrite sovereign financing and bonds roll-overs. Mid-point of the various estimates is within the range of my own forecast that Spanish bailout will require €200-250 billion in funds, a move that would increase country debt/GDP ratio to 109.9% in 2014 from current forecast of 87.4%, were it to be financed out of public debt, as was done in Ireland or via ESM.

Overall, based on CDS-implied cumulative probabilities of default, expected losses on sovereign bonds of the entire EA17 ex-Greece amount to over €800 billion, or well in excess of 160% of the ESM initial lending capacity.

Europe is facing three coincident crises that are identical to those faced by Ireland and reinforce each other: fiscal imbalances, growth collapse, and a banking sector crisis.

Logic demands that Europe first breaks the contagion cycle that is seeing banking sector deleveraging exerting severe pressures and costs onto the real economy. Such a break can be created only by establishing a fully funded and credible EU-wide deposits insurance scheme, plus imposing an EU-wide system of banks debts drawdowns and debt-for-equity swaps, including resolution of liabilities held against national central banks and the ECB.

Alongside the above two measures, the EU must put forward a credible Marshall Plan Fund, to the tune of €1.75-2 trillion capacity spread over 7-10 years, with 2013 allocation of at least €500 billion. This can only be funded by the newly created money, not loans. The Fund should disburse direct monetary aid to finance private sector deleveraging in Spain, Ireland and to a smaller extent, Portugal. It should also provide structural investment funds to Greece, Italy and Spain, as well as to a much lesser extent Ireland and Portugal.

The funds cannot be allocated on the basis of debt issuance – neither in the form of national debts, nor in the form of euro bonds or ESM borrowings. Using debt financing to deal with the current crises is likely to push euro area’s expected 2013 debt to GDP ratio from 91% as projected by the IMF currently, to 115% - well above the sustainability threshold.

The euro area Marshall Plan funding will require severe conditionalities linked to long-term structural reforms. Such reforms should not be focused on delivering policies harmonization, but on addressing countries-specific bottlenecks. In the case of Ireland, the conditionalities should relate to reforming fiscal policy formation and public sector operational and strategic capabilities. Instead of quick-fix cuts and tax increases, the economy must be rebalanced to provide more growth in the private sectors, improved competitiveness in provision of core public services and systemic rebalancing of the overall economy away from dependency on MNCs for investment and exports.

Chart: Euro Area: debt crisis still raging

Source: IMF WEO, April 2012 and author own calculations

The core problem with Europe today is structural policies psychosis that offers no framework to resolving any of the three crises faced by the common currency area. Breaking this requires neither harmonization nor more debt issuance, but conditional aid to growth coupled with robust resolution mechanism for banking sector restructuring.

Box-out:

This week’s decision by the ECB to retain key rate at 1% - the level that represents historical low for Frankfurt.  However, two significant developments in recent weeks suggest that the ECB is likely to move toward a much lower rate of 0.5% in the near future. Firstly, as signalled by the euro area PMIs, the Eurozone is now facing a strong possibility of posting a recession in the first half of 2012 and for the year as a whole. Secondly, within the ECB governing council there have been clear signs of divergence in voting, with Mario Draghi clearly indicating that whilst previous rates decisions were based on a unanimous vote, this time, decision to stay put on rate reductions was a majority vote. A number of national central banks heads have dissented from previous unanimity and called for aggressive intervention with rate cuts. In addition, monetary dynamics continue to show continued declines in M3 multiplier (which has fallen by approximately 40 percent year on year in May) and the velocity of money (down to just under 1.2 as opposed to the US 1.6). All in, the ECB should engage in a drastic loosening of the monetary policy via unsterilized purchases of sovereign debt and cutting the rates to 0.25-0.5%, with a similar reduction in deposit rate to 0.25% to ease the liquidity trap currently created by the banks’ deposits with Frankfurt. The ECB concerns that lower rates will have adverse impact on tracker mortgages and other central bank rate-linked lending products held by the commercial lenders is misguided. Lower rate will increase banks’ carry trade returns on LTROs funds, compensating, partially, for deeper losses on their household loans.