Economics 04/11/2009: Live Register - don't touch that champagne yet...

While the Live Register figures (out today) have shown some significant moderation trend for some months now, the latest data remains gloomy. There is a misplaced emphasis on reading the headline statistics too much and ignoring the underlying movements of displaced workers.

The conclusion advanced by many analysts is that October figure shows a seasonally adjusted decline in the LR of 3,000 - the largest drop in LR since the 3,900 decline in April 2005 and the first decline since March 2007. Good news.

The headline numbers of people in receipt of unemployment benefits now stands at 422,500 or 62% above the same period a year ago. This calls for a revision of the expect year-end number to below 500,000. Many analysts jumped in with a conclusion that this will mean the exchequer can breath easier now, because each 10,000 fewer people on LR means the savings of Euro100mln to the Exchequer. Hmmmm... I don't think so.

The savings above reflect the assumption that those off LR are moving into jobs. What if they move into the welfare? Ok, 10,000 people off the LR means savings of Euro 100mln from lower unemployment benefits. If you move to supplementary welfare benefits, the cost of these is identical to job seeker allowance (Euro 204.30 per week), but you will also qualify for more assistance. A temporarily unemployed person might be able to pay out of savings for housing and job searching costs and might be staying outside state-financed training and education programmes. A long-term unemployed person will not, implying a massive cost run up for the state. A 10,000 cost basis for an unemployed LR-listed person quickly turns into a 20-40,000 cost tag for a long-term unemployed.

Now, LR data does not give us a breakdown of tenure in unemployment or other characteristics, but what we do know from today's data is that:

1. Males dominated the reductions in LR numbers with a fall of 2,300 amongst males and just 700 amongst the females. Let me ask you this question - if males increases in LR were driven by construction sector collapse, have any of you seen so many new cranes working in Dublin or elsewhere in the country to warrant 2,300 of these construction workers getting jobs all of a sudden? Neither did I. So most likely, these males are simply exceeding the time limit on unemployment benefits and are now eligible for much more substantial aid available under the general social welfare rates and allowances.
2. Timing of males unemployment increases suggests that we are now seeing reductions in male unemployment coincident with roughly 9-12 months lag from entry point. What does this tell us? Indirectly, this might mean that those who became now long-term unemployed by official definition are simply opting to sign onto welfare rolls and exit the labour force.
3. We are in the beginning of a new academic year. Is it possible that a number of those previously unemployed now became full-time students again? It is. While this is great news, as it means that they will stand a chance of enhancing their education, it is not the good news regarding unemployment in this country.
4. Emigration is another likely factor driving some of the declines in unemployment. Back in September data, details on Irish v Non-Irish nationals on LR showed that the rate of unemployment increases amongst non-nationals was contracting faster than for the Irish nationals. Detailed figures on this matter for October will come out on Friday, so stay tuned.
5. Lastly, the main bit of information relevant to this analysis. Out of 3,000 fewer LR signees, 2,900 came from under 25-year old group. Only 100 of the reductions came from the over 25 years old group. Incidentally, this suggests that LR reductions due to emigration are most likely impacting primarily Irish nationals leaving the state, rather than Accession states’ nationals going back to their countries of origin.

This speaks loudly in support of my assertion that the following forces (in decreasing magnitude of their contribution to falling unemployment) are at play:

• Labour force exits into welfare benefits;
• Net outward emigration of the young.

In my view, both reasons offer nothing to cheer about.

Economics 03/11/2009: Exchequer drama continues

So Exchequer returns for October are in. As usual, charts illustrate:

The miracle of 'stabilising revenues' first. Per above chart, stabilisation, across some categories, has been achieved simply by choosing an unrealistically conservative target for October revenue. The reasons for this conservatism are a matter of guess, but:

• DofF undoubtedly knew that there will be gains in revenue in October due to seasonality, yet they opted to neglect these;
• There was, most likely, an expectation that improved October returns relative to target will provide Government with some added cushion for the Budget day; yet
• Because receipts have deteriorated so far throughout the year, the DofF 'piggy bank' lowering of the target for October was not enough to generate a surplus over the target.

The Grand Plan backfired:

As charts above highlights, tax heads are performing worse and worse relative to 2008 across the board. Worryingly - Corpo taxes and Income taxes are tanking once again and this is before self-assessed tax forms poured in.

Hence, measured in terms of their respective contributions to meeting the tax profile set out in April 2009 Budget, we are now down to just two tax heads with net positive contribution - Corpo (which will see its positive effect eroded as timing changes imply that Corporation Returns are now all but exhausted for the rest of this year) and a tiny positive contribution from Excise that is about to turn negative. In short, it looks like by November all tax heads will be underperforming targets - which will be a real feat of forecasting, then. 

Subsequently, no one should be surprised by the fact that Exchequer deficit is widening on 2008 figure. Borrowing is once again diverging beyond 2008 levels (chart above). And the gap between total receipts and total expenditure is widening (chart below)

Couple more charts: one below showing just how conservative was October target and how this has led to the so-called 'improvement' in on-target performance.

And the following chart shows that the data does not support an assertion that April Budget was successful in arresting or stabilising the expansion of our deficit:

So much, then, for all the brave proclamations about 'making necessary adjustments' and 'taking the right medicine'...

Economics 02/11/2009: Central Bank Credit Data - Renewed Crisis Dynamics

So Irish Central Bank monthly data – out last Friday – provides some more fodder for thought about what is going on with credit flows in the country most dependent on ECB repo window (see here).

First consider the aggregates on money supply side:
This clearly shows that whilst M1 money supply has expanded by just under €3bn (or 3.4%) between August and September 2009, M2 money supply has contracted by over €4.1bn or 2.11%. The contraction is primarily driven by the decline in deposits with set maturity of up to 2 years which have fallen by a whooping €7.43bn or 7.9%. Part of this was probably used to deleverage shorter-term debt securities (up to 2 years in maturity) – which have declined by €2.66bn or just under 5.5%. But whatever happened with the rest of deposits is hard to explain out of the CB data. Deposits with medium term maturity constitute the most stable measure of future lending capacity in the credit sector and this decline does not signal much needed stabilization in future lending conditions.

Now to more detailed data on consolidated balance sheet. First, liabilities side:

The above chart clearly shows that all liabilities, save for Non-Government Deposits and Government Deposits with the Central Bank, are still trending up. Net external liabilities are certainly in reversion after June local trough and are now dangerously reaching for February 2009 crisis levels. Bad news?

Well, aggregates are showing something very similar:
Total liabilities are now in excess of the non-Government credit volumes once again for the second time this year. First this condition was observed in January-February 2009. Next, we have crossed once again to the situation of private sector credit falling below total liabilities in August 2009. September 2009 re-affirmed the trend as the gap between two time series widened to the second highest level in 2009 so far with January gap of €27.7bn and September gap of €22.0bn. So non-Government credit flows are no longer covering total liabilities… Bad stuff? Wait…
On the assets side, the above shows that save for Government debt which is converted through accountancy double-entry into Government Credit (up 77.9% year to date in September), not much else is rising, with fixed assets down 14% year to date, interest earnings on non-government credit down 49.6%, official external reserves up 11.35%.

On private sector credit decomposition:
Total private sector credit (PSC) has declined from the peak achieved back in November last year to current €378.1bn or 6.4%. This is dire and the decline is actually accelerating since beginning of September. Table summarizes:
The same is true for non-mortgage credit and mortgage credit. Importantly, the data on mortgage credit and non-mortgage borrowing shows that there is no deleveraging in sight for Irish households. Residential mortgage lending today continues to remain at well above the peak markets level for house prices. In 2007, average monthly level of mortgage debt in Ireland stood at €131.1bn. In September 2007, the level was €136bn or 8.83% below the latest level recorded in September 2009. Thus, as negative equity pressures continue to increase due to falling house prices and as rents continue to destroy yields on property, Irish mortgage holders are simply prevented from deleveraging in the credit cycle by falling incomes and rising taxes.

This does not bode well for the short-term prognosis for the Irish financial system (reliant heavily on low default on mortgages assumptions amidst a full blown meltdown of the development loans) and for the Irish construction sector and property markets (reliant on some sort of a return of the buyers to the collapsed market for properties). It also does not support any hope of the stabilization in the property-related tax revenues.
Hence, although credit contraction has set in firmly back in June (with credit to private sector posting negative growth in yoy terms since then), mortgages credit is lagging (implying that we are yet to witness true crunch on mortgages – something that is likely to happen once the banks set out in earnest to rebuild their margins by hiking mortgages rates post-Nama) and non-mortgage credit is back on the rise (potentially reflecting accumulation of credit arrears by financially stretched households).

The same picture, of building pressure on the arrears side can be glimpsed from the changes in trends for credit cards spending. New purchasing using credit cards has lagged repayments in January-August 2009. In September, more charges were incurred than paid down. The same (albeit on a vastly smaller scale) took place in business cards. Hence, balances are now rising across all credit card debts, as shown in the chart below.

Net result of all of this: outstanding indebtedness of Irish private sectors is no longer declining. The rate of growth in overall debt levels has hit 0 in May 2009, bounced back to positive territory in June-July 2009 and failed to hit negative (deleveraging territory) since then.

Economics 31/10/2009: Latest data on Irish Resident Foreign Assets Holdings

CSO released (yesterday) latest data on Resident Holdings of Foreign Portfolio Securities. Charts below illustrate the trends.

First the aggregate stuff:
Notice that 2006-2007 overall trend implies peaking of foreign assets holdings by Irish residents at 2007, and a decline in asset holdings in 2008 to the levels below those recorded in December 2006. This is clearly reflective of the general external crisis in asset markets and is expected to record even further and more dramatic deterioration in 2009. Holdings of bonds and notes also declined from a peak on 2007, but less dramatically in relative terms - reflective of flight to safety into public debt markets by many investors. Again, similar trend to global. Equity holdings took the most sever beating, in line with global markets.

One interesting point is that Money Markets instruments holdings (not plotted above) have also declined in 2007 and 2008. This suggests two idiosyncratic developments in Ireland:

• risk reductions took place in 2007, well before the full-blown global crisis of 2008, but in line with a financial markets crunch that began in August 2007;
• both cash and equities were likely to have been used by Irish residents to offset leveraged losses (these are the most liquid instruments that can be used readily to meet margin calls) and this process was on-going in 2007, suggesting serious leveraging exposure to derivatives markets in Irish resident portfolios - a conclusion that would time declines in money markets instruments back to August 2007, when derivatives markets collapse triggered subsequent run on equities).

Now to some more detailed sub-categories of assets. Starting with total foreign asset holdings by country of asset origin:
There is a clear indication here that Irish resident portfolia are heavily geared toward UK and US assets (nothing surprising, as these allocations are only slightly ahead of global diversified portoflia bias toward these two countries). There is also present a relatively heavy allocation bias toward European and EEC securities. However, the real area of geographic diversification imbalance is found amongst the middle income (BRICs) and emerging markets allocations.

Ditto for bonds and Notes:
In terms of Equity allocations:
There is a clear imbalance in Irish resident positions with equity exposure to only a select subset of OECD economies. There is virtually no presence of high growth economies in the overall equity portfolios in Ireland.

Economics 30/10/2009: Assets/Liabilities data - How IFSC beats domestic investment sectors

See as ever entertaining press release from Ryanair below.

Per CSO release today: End-December 2008, Ireland’s international investment position (IIP) was:

• stocks of foreign financial assets of €2,194bn - a drop of €76bn on the end-2007 level of €2,270bn
• liabilities were down by almost €7bn from €2,307bn to €2,300bn
• Irish residents therefore had an overall net foreign liability (or deficit) of just over €106bn at the end of last year, up over €69bn from 2007 figure of €37bn.

Now, decomposition of these net liabilities is telling: In overall commercial financial sector:

• Monetary financial institutions (MFI - i.e. credit institutions and money market funds) had assets amounting to €1,065bn at the end of 2008. On the liabilities side, the MFI sector accounted for €1,146bn so total net liabilities of MFI sector in Ireland were at €81bn.
• Other financial intermediaries (OFI i.e. investment funds, insurance companies and pension funds, asset finance companies, treasuries, etc) accounted for €980bn of foreign assets. OFI liabilities were €921bn, implying net assets (not net liabilities) of €51bn.

Thus, our commercial financial sector at the end of 2008 had foreign assets of €2,045bn (or over 93% of total foreign assets) and liabilities to non-residents of €2,067bn (or almost 90% of total foreign financial obligations), resulting in a net foreign liability of €21bn.

But the real gem is in the bottom section of CSO report. For months now CSO and Ireland’s CBFSAI were at pains to distance themselves from the IFSC. Every time someone pointed to a massive debt mountain Ireland Inc is bearing on its (private sectors’) shoulders, our Central Bank shouts ‘Foul – it’s all the fault of the IFSC’. Few (including myself) made arguments that this is too simplistic: IFSC is both an asset and a liability to our economy, and thus one cannot simply ignore its debts when one wishes to do so.

Well, CSO’s data actually shows that IFSC is hardly a culprit in the All-Ireland race to become a leading sector in net liabilities: “At the end of 2008, IFSC assets abroad amounted to €1,663bn or over 81% of the sector’s foreign assets (and almost 76% of Ireland’s total foreign assets).” IFSC liabilities stand at €1,646bn (nearly 80% of the commercial financial sector aggregate and over 71% of Ireland’s total foreign liabilities).

Yet IFSC recorded a net asset position at the end of 2008 of almost €18bn. While much smaller in size relative to IFSC, non-IFSC commercial financial enterprises (17% of total foreign assets and 18% of total foreign liabilities) have managed to run up a net liability of €39bn. That is a swing of €57bn between IFSC’s healthier books and non-IFSC’s sicker ones.

Think non-IFSC guys are now firmly on track to win the leading position in that All-Ireland race to highest indebtedness? Nope. The monetary authority, general government and non-financial enterprises had end-2008 foreign assets of less than €149bn (about 7% of the total) and liabilities of almost €234bn (just over 10% of the total). So the public sector net liabilities were a whooping €85bn, a swing against IFSC position of €103bn.

Scary stuff? Well, not yet - look at the following charts:
Chart above shows assets side of our International Investment Positions (IIP). All point to clear declines in 2008, except for 'Other' (aka derivatives written by our speculation-prone folks) and 'Direct Investment' (aka completion of Bulgarian and Romanian property syndicates)...
Chart above illustrates liabilities side of our IIP. All liabilities are up except for FDI into Ireland (which is falling - more on this below), and Portfolio Investments - which were hammered by global equity markets meltdown.

So net positions next:
Clearly, comments in the charts are self-explanatory. Good stuff (FDI) is falling, bad stuff is rising (Portfolio Investment Liabilities, Other Liabilities and Total Liabilities)... But take a closer look at Foreign Direct Investment (FDI) into Ireland, and our Direct Investments out of Ireland:
No more comment needed.

The last standing is the pesky IFSC issue - is it a problem for clean Ireland Inc, or is it actually an asset for lagging Ireland Inc? Take a look:
Conclusion - obvious. Can we get the IFSC guys to run our domestic financial services sector? Please!

Why one has to love Ryanair? Because it does what it promises on the tin:
No comment needed. As always.

Economics 30/10/2009: Reliance or dependency

Quick points on post-Nama recapitalisation, credit flows from ECB to Ireland and Frank Fahey encounter with an egg...

I have done some sums on demand for equity capital by Irish banks post-Nama. Assuming underlying conditions for loans purchases as outlined in Nama business plan, using 6% core equity ratio as a target (remember, this is a lower target by international standards) and assuming no further deterioration in the loans books quality post-Nama:

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

Approaching the same issue from the angle of Risk-Weighted Assets, system-wide demand for equity will be around €10.8bn post-Nama. This will extend Nama-associated rescue costs to:

• €54bn in direct purchases;
• €5bn in completion 'investments' with estimated further €3-5bn in future completion additional funds;
• €1bn in legal, advisory and management costs;
• €9.7-12.4bn in equity injections;
• Past measures €11bn.

Net of interest costs and losses, total price tag looks now like €84-88.5bn. This, for a system that can be fully repaired through a direct equity-based recapitalisation at a cost of roughly €32bn.


Our agriculture is the heaviest subsidised in the EU (and indeed in the world). This fact has never troubled our policymakers, as if subsidies are a sign of industry viability and strength, as long as they are being paid by other countries taxpayers (as in the case of CAP).

Now, we have become the biggest ECB liquidity junkie by far. Table below from RBS research note shows the dramatic level of financial life support our economy requires.
Note that the above list of countries includes heavily crisis-impacted Spain, the Netherlands, Belgium, APIIGS (less Ireland), aggregated in the 'Other' grouping. And yet... they all have larger economies than Ireland and smaller demand for liquidity injections.

Does anyone still believe that Nama can add liquidity to our economy? Or that such an addition can improve lending conditions? Apparently, ECB-own lending operations were not able to do so to date...


And on related note, there is an interesting quote from Dr Alan Ahearne in a recent article in the Southern Star newspaper (here):

"As one economist warned last year, ‘buying the assets at inflated prices would amount to a back-door recapitalisation of the banks’. Best practice ‘is for the banks to recognise the losses on these loans up front and sell the assets at fair market value’. Whose words? Dr. Alan Ahearne – now economic advisor to Brian Lenihan and one of the chief advocates for NAMA. Go figure."

Well, not much to figure, really - call this miraculous conversion a '€100K effect' triggered by new employment...

Oh, and while we are on Nama, here is an excellent 'Public Anger at Nama' account of the latest Leviathan encounter by Peter Mathews. I wonder if Senator Boyle and Frank Fahey get the point - people are angry at the way the country is mismanaged, but they are even angrier at being pushed into Nama.

Economics 27/10/2009: What credit flows data tells us...

There is a superb blog post by Ronan Lyons exposing the economic nonsense spun by Nama supporting 'economists' - read HERE. In case you still wonder who that 'mysterious' uber-adviser from Indecon was - well, might it have been Time Magazine-famous (see here) Pat 'Never-Heard-of-Before' McCloughan?..


An interesting data from the ECB: The annual rate of growth of M3 money supply has decreased to 1.8% in September 2009, from 2.6% in August 2009. This marks new deterioration in money growth. The 3mo average of the annual growth rates of M3 over the period July 2009 - September 2009 decreased to 2.5%, from 3.1% in the period of June 2009 - August 2009. Table below summarises:
The annual rate of change of short-term deposits other than overnight deposits decreased to -5.3% in September, from -4.1% in the previous month. This implies that banks are bleeding cash at an increasing rate. In the mean time, the annual rate of change of marketable instruments increased to -8.8% in September, from -9.3% in August. Hmmm - has this anything to do with more aggressive repo operations? Or with more aggressive re-labeling of what constitutes 'marketable' instruments? Or both?

On the asset side of the MFI sector, "the annual growth rate of total credit granted to euro area residents increased to 3.1% in September 2009, from 2.8% in August. The annual rate of growth of credit extended to general government increased to 13.6% in September, from 11.5% in August, while the annual growth rate of credit extended to the private sector was 1.1% in September, unchanged from August." So here we have it - the credit pyramid in full swing. Banks borrow against bonds issued by the state (increasing supply of 'marketable' paper to the ECB). The states promptly issue more bonds that are then bought up by the banks, increasing supply of credit to the governments.

In the mean time the real economy is taking more water: "...the annual rate of change of loans to the private sector decreased to -0.3% in September, from 0.1% in the previous month (adjusted for loan sales and securitisation the annual growth rate of loans to the private sector decreased to 0.9%, from 1.3% in the previous month)." [The latter number means that barring accounting shenanigans with re-classifying and restructuring loans, credit to private sector was falling even faster].

"The annual rate of change of loans to non-financial corporations decreased to -0.1% in September, from 0.7% in August. The annual rate of change of loans to households stood at -0.3% in September, after -0.2% in the previous month. The annual rate of change of lending for house purchase was -0.6% in September, after -0.4% in August. The annual rate of change of consumer credit stood at -1.1% in September, after -1.0% in August, while the annual growth rate of other lending to households was 1.5% in September, after 1.3% in the previous month." Again, the last sentence reflects increases in credit due to arrears (short-term lending to households).

So to summarise, economy is still tanking, while the governments are still monetizing new debt through the banks. Expect a bumper crop of profits from Eurozone financial institutions in months to come as they reap the gains of the government-financing pyramid.

Let me show you some illustrations based on ECB data:

First we have Government borrowing:
followed by non-MFIs
...and non-financial corporations
and finally by the households:

As commented in the charts, this data shows conclusively that the private sectors (non-financial corporations and households) have been:

• accumulating liabilities in the years before crisis in a transfer of the debt off the public sector shoulders onto private economy shoulders; and
• were unable to deleverage in the last 24 months since the onset of the financial crisis.
  

This implies that in years to come, weakened consumers and corporates will be exerting downward pressure on European growth, with interest rates hikes potentially inducing a destabilizing pressure on already over-stretched households and corporates. In this environment:

• any talk about ECB and Governments' 'exit strategies' is premature, unless one is to completely disregard the credit bubble still weighing on non-financial private economy; and
• continued public sector spending stimuli and ECB discount window-reliant monetary policy cannot be a workable solution to the crisis. Instead, there is an acute need for orderly deleveraging in the private economy.
  

Economics 27/10/2009: Recessions, Busts and Crunches

I am back from a very enjoyable (as always) trip to Paris and some 150km beyond. Superb retrospective of Pierre Soulages' work in Pompidou - a real master of true dynamism. A mouthwatering Hans Hartung print (some examples here) and two lovely Soulages' prints as well - all in my favorite gallery Paul Proute SA - were hard to resist, but given we are in a depression, while the French art market seems to be only in a recession, judging by prices, resistance was a-must.

One telling tale - at a lovely dinner with a small group of friends in the countryside, conversation took a quick turn to corrupt politics. Our French hosts were lamenting about the state of their country politics by pointing to a scandal surrounding Nicolas Sarkozy's plans to appoint his failed-lawyer son to head the Epad, the development corporation of La Défense (see a note here). Epad is a state-sponsored body and the French nation was literally lifted to its feet when nepotist Sarko tried to push his baby-faced offspring into the CEO seat. In return, I recalled for our friends the story of Bertie Ahearne arrogantly telling the nation that he gave state jobs to his cronies not because they provided him with money but because they were his friends. My French hosts couldn't believe that such a statement did not cost Bertie his job leading to years of public investigations and pursuits through courts. Nor could they believe that Bertie's friends are still, mostly, in their places of power.


Now, a couple quick notes relating our own troubles.

Stijn Claessens, M. Ayhan Kose and Marco E. Terro have published their excellent paper "What Happens During Recessions, Crunches and Busts?" (I wrote on it before based on the working paper version here) in Economic Policy, Vol. 24, Issue 60, pp. 653-700, October 2009. Here are couple interesting illustrations:
So per above, combined duration of contractionary segment of the credit crunch and housing price bust can be expected (on average) to last approximately 30 quarters (timing the current Irish crisis to last from Q1 2008 through Q2 2015 if the rate of house price bust and credit contraction here in Ireland was close to an average of the countries surveyed by the paper).

The latter 'if' is a serious assumption to make. Claessens, Kose and Terro show that the average bust/contraction is associated with a roughly 18% fall in credit supply and 29% decline in house prices. Of course, in Ireland, we are already seeing a 70% decline in credit supply and a 40-50% decline in house prices. So make a small adjustment - back of the envelope - to account for these and you get expected the current contraction/bust crisis to last more than 52 quarters, taking us well into the beginning of 2020 before the recovery truly takes hold.

And this dynamic is seemingly also in line with Claessens, Kose and Terro data on the impact of crises on GDP. 2008-2010 Irish GDP is expected to fall by some 13.5-15%. This is approximately 2.5 times the depth of the average adjustment associated with credit crisis and house price bust per Claessens, Kose and Terro, as illustrated in their chart reproduced below:
Oh, and for those 'advisers' who are telling Minister Lenihan that Ireland will recover from this crisis along the same trajectory as the 'average' OECD economy (the same advisers who are talking of 8-year cycles in property prices), here is how average Irish crisis is compared to the rest of the modern world history:
Only 4 countries so far have experienced a combination of Asset Price Bust + House Price Bust + Credit Crunch.


My second note of the day is about the effectiveness of fiscal spending as 'get-us-out-of-recession' stimulus. Given that the Government is now pre-committing itself to not cutting public sector pay, it is worth quickly mentioning that the Unions-supported idea that cutting public expenditure is only going to make our recession worse is simply untrue. A recent (July 2009) note by Fabrizio Perri of University of Minnesota, Federal Reserve Bank of Minneapolis titled "Comment on: Planning to cheat: EU fiscal policy in real time by Roel Beetsma, Massimo Giuliodori and Peter Wierts" provides an estimate of the fiscal expenditure multiplier for European economies. The number is 0.85... or, significantly less than 1. This suggests that cutting public spending will lead to a proportionately smaller reduction in GDP than the savings to be generated.

Here is an additional (excellent) note on the whole mess of fiscal multipliers. Adding to this, one has to recognise that Irish public spending is far less effective as a stimulus to the economy, as it is accounted for (to the tune of 70% of the total expenditure) by social welfare and wages - i.e. non-productive components. Thus, one can expect the above 0.85 multiplier estimated for Europe as a whole to be around 0.26-0.0.29. Which, in turn, means that any fiscal contraction in today's Ireland will likely result in a medium-term expansion of our economy. Then again, we already know this much from the 1980s experiences, don't we?

In reality, of course, taxing private economy amidst credit and asst price crises to continue wasting money on the current public expenditure is a sure way to extend and to deepen the recession, as:

• Our public expenditure level was not sustainable for this economy even at the times of growth, let alone at the time of a severe recession;
• Ireland is now likely to be on a path of permanently lower post-crisis potential GDP/GNP growth, so the cuts in public spending will have to take place no matter what delay in public expenditure adjustment the unions will force onto this Government;
• We are facing the fastest and the longest increase in public debt (ex-Nama) in the OECD over the next 5 years and an additional open ended liability under Nama, both of which make it virtually certain that Ireland will emerge from this crisis as a fully insolvent nation.

Economics 21/10/2009: Ireland = the most leveraged SPV on Earth?

And so we now learn than Nama beast has mutated into a high-risk derivative game with ghost investors, imaginary assets and illusionary payoffs. We are, for all intent and purpose, in the BaNama Republic.

Here is the story: per Annex H of the original statement of intent to establish Nama (April Supplementary Budget 2009 : here), the state will set up a Special Purpose Vehicle (SPV) to issue bonds (Nama bonds) that will be guaranteed by the State. Per Eurostat analysis (here) these bonds will not be counted as Irish Government debt.

First point to be made – we are now the first developed country in history that is about to throw the weight of its entire economy behind a private undertaking of extremely risky financial engineering nature.

€54bn worth of Nama Bonds will be issued by this SPV. SPV will be 51% owned by private equity investors who will supply €51mln worth of capital. Total capital base of SPV will be €100mln. This SPV will be borrowing (by issuing bonds) €54bn – which means that on day 1 of its running, the SPV will be 54,000% leveraged or geared. This will imply that Irish Nama-SPV will be leveraged in excess of LTCM – the infamously riskiest of all major investment propositions that anyone saw in financial history before Nama SPV idea came to being.

Point two: the Irish state will be engaged in the riskiest derivative instrument undertaking of all known to man to date.

To cover up the farcical arrangement (with folks with €51mln buying €77bn worth of risky (but recoverable, by Minister Lenihan’s assertions) assets), maximum 10% of SPV value can be distributed in profits. 10% of what you might ask?

CSO submission to Eurostat states that: “The profits earned by the SPV will be distributed to the shareholders according to the following arrangement, which reflects the fact that the debt issued by the Master SPV will be guaranteed by the Irish Government:

• The equity investors will receive an annual dividend linked to the performance of the Master SPV.
• On winding up of the Master SPV, the equity investors will only be repaid their capital if the Master SPV has the resources; they will receive a further equity bonus of 10% of the capital if the Master SPV makes a profit.
• All other profits and gains of the Master SPV will accrue to NAMA.”

Two possibilities: 10% of expected (by DofF) Nama profits or 10% of Nama assets?

In the unlikely event of 10% of assets, the lucky ‘private equity’ folks can get 10%*€54bn*51% share – or €2.754bn – on the original investment of €51mln. They face no downside other than their initial capital injection less whatever dividends they collect prior to default, as bonds are guaranteed by the State. I assume this is a fantasy land. But one cannot make any rational assumptions about Nama anymore.

In a more likely event, it will be 10% of Nama profits. Ok, per DofF, Present Value of Nama profit is €4.7bn * 10% * 51% = €239.7mln. With principal repayment this means they will collect a cool €291mln on day last of Nama existence if DofF projections stack up.

We know nothing about the dividends, but we do know that the dividends will be paid out over 10 years. For some sort of decorum the Irish Government will have to allow SPV to appear to be legitimate and therefore it will allow it to pay a dividend on assets managed. Suppose the dividend will be around ½ of the standard management fee for assets, or roughly 100bps on revenue generating loans or 2.5% on net cash flow. Per DofF Table 5 of Nama business plan, this will add up to €12bn*1%*51%=€61.2mln using the first method or €61mln computed using the second method. In present value terms. Thus €51mln in initial investment will generate:

Scenario 1 – Nama works out per DofF assumptions = €352mln (inclusive of principal) – a handy return over 10 years of 690% or 21.3% annualized. Not bad for a government guaranteed scheme…

Scenario 2 - Nama loses money and is pronounced insolvent. Investors lose €51ml of original investment, but keep €61mln in dividends. 100% security, 0% risk...

Which brings us to the third point: as Irish taxpayers, we are now in a business of paying handsome returns to private equity folks (more on those below) in exchange for them covering up the true nature of our public finances. A good one, really.

Who owns this SPV? This is an open question. 51% will be held by ‘private investors’. 49% by Nama. 100% of liability will be held by you and me. Is this a Government throwing the entire weight of the sovereign state behind a privately held investment scheme? You bet.

But wait. Who are those ‘private investors’? Can Sean Fitzpatrick be one of them? Why not? Of course he can. Can Ireland’s non-resident non-taxpayers be amongst these? Why not? Of course they can. So as taxpayers we will be issuing a guarantee to tax exiles? Possibly. But wait, it gets even better – can the banks themselves be investors in SPV? Well, of course they can. Wouldn’t that be a farce – banks get to unload toxic waste on taxpayers and then make a tidy profit on doing so…

One way or another – parents struggling to put their kids through schools, elderly people struggling to pay medical care costs, single parents trying to balance work and raising family, young folks studying to better their lives – all of them and all of the rest of us will be bearing 95% responsibility of assuring that some ‘private investors’ will make a nice tidy profit, so Minister Lenihan and Taoiseach Cowen can go around the world claiming that Irish bonds that underpinned Nama were not really Irish bonds!

Which brings us to the fourth point: Why is Eurostat assured by this massive deception scheme to accept it?

Globally, G20 summits one after another have been focusing on how we will have to deal with the risks of the traditional SPVs and other ‘alternative investment’ assets classes that spectacularly imploded during the current crisis. Yet here, in a Eurozone country, a Government is actively setting up the most leveraged, highest risk SPV known to humankind. Surely there is a case to be made that the EU authorities should be actively stopping such reckless financial engineering instead of encouraging it?

The entire SPV trickery works because the Government has managed to convince the Eurostat that SPV will be fully operationally independent of the state. So far so good. But, Nama will sit on the board with a right of veto over SPV managerial and operational decisions: “The NAMA representatives on the Board will maintain a veto over all decisions of the Board that could affect the interests of NAMA or of the Irish Government.” Furthermore, Minister Lenihan and his successors will have veto power over Nama decisions and will be the final arbiters of Nama. Is that arms-length getting to finger-length?

At this point, there is only one institution still standing between the madness of the runaway train of Nama and the crash site of the SPV-high leveraged high finance gables with taxpayers money. That institution is ECB. The ECB will have to be concerned with non-transparent (Enron-like) accounting procedures that are being created by the Irish Government when it comes to accounting for Nama bonds. It has to be concerned if only for the sake of the Eurozone stability and its own reputational capital. Will ECB step in and tell this Government that enough is enough?

Economics 20/10/2009: Ahead of DofF

A quick announcement:
RDS Concert Hall 8pm Wednesday Oct 21st

HOW NAMA WILL LOSE €12bn: There's a Sounder Alternative
by Banking Expert Peter Mathews, MBA, FCA, AITI.

Peter is the only senior banker with experience in managing large distressed loans portfolio. His work, in collaboration with myself and Brian Lucey is featuring in the current issue of Business&Finance magazine. This should be very informative and worth attending. See Peter's excellent website in the issue of Nama costs: http://www.bankermathews.com.

We will also hold a Q&A session after the speech, with yours truly also on the panel.

Free for students.



A quick note:

Apparently the latest Government projections for 2009 tax intake are €31bn. Pre-budget estimate in April 2009 was €34bn, while January 2009 addendum to the Finance Bill was €37bn (here).

My forecasts earlier this year gave this figure (here) back in August, May (here) and April (here). In fact, since December 2008 I have been giving forecasts for revenue figures that were ahead of the official numbers produced by a sizable department responsible for doing these forecasts within DofF. Table below lists their projections before the April Budget:
Latest Government admission - €31bn... welcome to TrueEconomics, folks...

Economics 19/10/2009: A proud member of National Mediocrity

Sunday Sunday Business show on Today FM. Minister Lenihan commenting on the anti-NAMA economists (podcast here):

"What I notice about them is that there’s about forty of them. There is about two hundred economists in the state. Most of the rest of them have approached me privately and said that these gentlemen and ladies are wrong. But of course they are not prepared to say so publicly because in Irish academic class, people don’t criticise other people’s books. That’s part of our national mediocrity. ...If you look at the press in the United Kingdom or the United States, you’ll see robust academic criticism of others works but we’re reluctant to do it."

Karl Whelan has his view on this - read it here.

My view is a simple one. Want to have some criticism - compare publications records of Mnister's advisers to that of, ough, say Karl Whelan or Brian Lucey. Want to have some criticism - compare supporters and critics of Nama:
Supporters:

• Stockbrokers and Irish Banks' economists - all with a major conflict of interest implied in their positions as their respective organizations will be the intended beneficiaries of Nama. In my books, this does not invalidate their points and analysis, but it does raise a question or two;
  
• EU Commissioner who actually negotiated with Minister Lenihan Nama solution;
• Ghosts of other - possibly independent - economists who have spoken to the Minister in private?..
  

Critics:

• 4 Nobel Prize winners, several senior faculty members from the top 5 Finance Departments in the world, and one former SEC Board Member;
• 46 academic and practicing economists and finance specialists;
• 4 authors of comprehensive analysis of Nama proposals (myself, Brian Lucey, Ronan Lyons and Karl Whelan - in alphabetic order) that provided more detailed and more accurate costings of Nama and alternatives than the one supplied by Minister's own staff;
• 1 former banker - Peter Mathews - who has extensive experience in managing bad loans within a special division for such loans set up by ICC bank in the 1980s;
• A range of independent economic commentators some with extensive finance experience in the past;
• A number of top class finance entrepreneurs, including Dermot Desmond;
• Hundreds of people from finance, international finance and economics who comment on this blog and the Irish Economy blog;
• One Governor of the Central Bank who proposed significant changes to Nama that were subsequently taken out of context by His Intellectual Excellence's Government colleagues and reshaped into an unrecognizable watered-down versions to suit original Nama.

Not that excellence is measured in numbers (as Gallileo and Copernicus and many others have proven before), but you get the point.

As far as Minister Lenihan has a stomach to talk about mediocrity, I wonder how he feels sitting at the Cabinet table. Or how he feels about the Nama analysis being pushed forward by his staff - analysis that has been time and again proven as:

• coming after the mediocre Irish economists put forward their figures; and
• turning out to be wrong and proven to be wrong by the mediocre Irish economists.

Hmmm...

One real sign of intelligence and excellence is ability to listen, seek truth and change your views/plans in response to overwhelming evidence that disputes one's original proposition. To date, after months of factual analysis by many of us, this Government has been showing complete lack of ability to do either one of the above.

Let us all be judged, then, alongside Minister Lenihan, as to where the real mediocrity in this country resides.

Economics 18/10/2009: Soros-Nama, R&D spending, Pat McArdle v Morgan Kelly

Update 1:
Karl Whelan is very good on McArdleism - read here.
As does Stephen Kinsella (first hand account) - here.

Update 2: What Apple's latest numbers tell us about R&D investment

Apparently, our Montrose journos have no respect for both - the basic right of freedom of speech and expression and the basic premise that true patriotism is about telling the truth, not about donning 'green jerseys'... This is why I stopped watching majority of RTE programmes long ago - at least BBC (for all its biases) has balls to support freedoms of speech and expression.


Couple of housekeeping items... one on Nama and another one on Knowledge Economy, plus Pat McArdle on Morgan Kelly and more...


Reading through September 2009 interview George Soros gave to Bloomberg Markets magazine, I can across the following quote from the legendary speculator:
Q: "Is this economic contraction something new or something we've seen before?"
GS: "No, you haven't seen it before. Historically, you have the 1930's, the Depression, but since then, whenever you had a financial crisis, the authorities always took care of it and stimulated the economy, extended credit and got it going again. And that just made the bubble grow bigger. (Emphasis is mine) This time it is the end of an era and this is different from any of the financial crises that you have experienced in your lifetime."

The interviewer did not pursue any of the points made by Soros above in any detail. He moved on to the next question. This is a sad opportunity missed because what Soros was saying here (or hinting at) is of potentially great significance. If the current crisis is an end of an era of credit-fulled bubble then:

• Restarting a new credit cycle is not a solution to the systemic problem, but another attempt to temporarily re-inflate the bubble. In terms of Nama, why are we assuming that the Irish economy needs another credit expansion, especially the one that is (hoped) to be restarted on the back of purely domestic credit injection? Ireland is a tiny drop in the ocean of global finance and an idea that we can, at the expense of our own taxpayers, relaunch a credit mechanism in this country's banking sector is patently absurd. It is equivalent to pouring a cup of water into a desert of quick sands in hope that life will return...
• Even more fundamentally, if this is an end of an era of credit expansion-driven growth, then what will be the new paradigms for future growth? A topic worth exploring before we commit to a futile effort of reigniting lending in one of the world's most indebted economy.
• Lastly, if credit-financed growth is the thing of the past, then will new growth path be steep enough to achieve returns on peak-of-valuations loans Nama is taking in? Most likely, the answer will be no.
  

The next question asked of Soros is even more significant:
Q: "Are we trying to have a pain-free crisis? Is a consolidation needed?"
GS: "I'm afraid that is the case. We should have taken the pain and recapitalized the banks. Instead of that, we kept them alive and gave them hope that they can rebuild their balance sheets, and that is going to drag and weigh on the economy for a long time to come. We suffer from an inability to face an unpleasant reality. We expect our politicians to effectively deceive us, to tell us things are better than they are. That is our weakness."

A brilliant statement, reflective much more of the Irish realities than of those of the US.

• Nama is par excellence a 'repairing of balancesheets' exercise, not a recapitalization one (hence the Government is now committed to post-Nama recapitalization). My article in the current issue of Business & Finance magazine clearly shows that a recapitalization via direct purchase of equity is more cost efficient than Nama. It will also address the problem of capital adequacy, while leaving the banks to manage the loans. Soros is talking about this type of a solution. And yet, official Ireland remains indifferent to any proposals other than Nama.
• We really do, culturally, ethically and economic policy-wise look into Government's mouth in hope of hearing them utter something re-affirming, something positive. We take distorted estimates for hope, half-truths for optimism and huge tax bills for 'necessary corrections'. If Nama will drag this economy down for many years to come, our innate desire to rely on the state for 'tough solutions' while we avoid the truth is going to hold us in this crisis for decades.
  

Oh, and there is an interesting note from Crimson Observer blog (here) - it looks like some old bubble-time hawks are jostling to position themselves as the buyers of distressed properties in Ireland as Nama bites into the market... Interesting. But taking this further - will Nama trigger re-transfer of defaulted properties back to the, pretty much the same, hands of old developers at a knock-down price? Possibly...


Short note from the land of high R&D spending (sorry 'investment'):

"The 908 million euro ($1.3 billion) goodwill write-down on Nokia Siemens Networks, ...certainly contributed to the unexpected 559 million euro ($833.9 million) loss reported by Nokia in the third quarter. However, Nokia had forewarned that it would be writing down the value of the business after successive quarterly losses. A more worrisome and unexpected trend, however, is the lackluster demand for Nokia's smart phones, essentially phones that double as mini computers such as the N97 and the E60. The company's share of that market globally fell to 35% in the quarter ending in September, from 41%."

So (quote above is from Forbes magazine) Nokia (aka Finnish economy) is suffering from:

• Lagging position in smart phones (despite Finland having higher civilian R&D spending as a share of GDP than it's closest rival in smart phones market - the US);
• Lagging strategy to the market - Nokia unveiled details of its forthcoming N900 phone in the middle of the third quarter, well after new launches by Google and Apple;
• heavy competition in China and India from low-cost producers (despite Nokia's vast outsourcing and off-shore production network, partially financed by Finnish taxpayers).

Run through the above 3 points and you can see that R&D spending on labs and technicians has nothing to do with Nokia's woes. Simple business management, marketing, strategy and business processes flexibility are behind it losing ground to its rivals.

In contrast to Nokia, Apple just posted (Monday) a 46% increase in its fiscal Q4 earnings and higher revenue than a year ago led by better-than-expected sales of iPhones, Mac computers and iPods (here). You can read about Apple strategy in terms of introducing new products at higher frequency than its rivals and launching upgraded software to coincide with new products offerings in the above-linked article. But what actually put Apple back into the global competitiveness game was not just product innovation - it was i-Tunes concept for selling music and then Apple Store concept for selling hardware, followed by, yes - i-Phone APS online 'store'. It is retailing that reinforced product innovation for them - something that Nokia with its government-supported R&D spending programmes can't replicate to date.

Still want to chase Finns in putting more R&D spending onto the Exchequer books?..


The news that Pat McArdle (reported here) had a total meltdown in his challenge of Prof Morgan Kelly did surprise me. I have deep respect for Pat's work back in the Ulster Bank - he was one of the most knowledgeable bank economists of recent times and I always valued his research notes for an inimitable ability to link intuition and data. Ditto for Prof Kelly.

Hence, I was shocked to learn that Pat McArdle questioned Morgan's right to express his views. I certainly hope that Pat will publicly apologise to Morgan for this outburst. And I certainly hope that Kenmare organizers would have guts to openly defend Morgan's liberty to say what he wants on the subject of economics and economic policy when he wants to say it.

One would expect censorship to be despised and rejected in academic setting and amongst social scientists. Alas, I know first hand that this is where it is practised. For example, a birdie chirped to me recently that one department of economics in Ireland has recently explicitly banned its junior members (senior faculty of course said 'Non' to the ban) from speaking to the press or expressing their opinions in public on the matters of economic policy unless they obtain a prior consent of the Department Head. How's that for 'democratic' and 'socially active or relevant' academia? Standard job descriptions for academic posts in this country state that one of the parts of our work involves service to a broader community outside the halls of academic institution.

This is precisely why I hope my colleagues who attended Kenmare and were first hand witnesses to Pat's attack on Morgan (alongside Kenmare organizers) issue a clear statement as to the value of the freedom of speech and expression and the value of freedom of thought.

For now, I am saddened by the fact that an economist for whom I have nothing but respect had joined a pack pursuit of independent thought...