Economics 22/02/2010: Detailed analysis of Live Register

Updated (below)

CSO published its analysis of the Live Register Data for 2009 which shows some interesting details.

Per CSO data, reproduced below, the highest risk of unemployment by sector was found in:

• Construction (with LR contribution from the sector reaching 170% of the sector own contribution to total employment);
  
• Hotels and Restaurants (with Live Register contribution from the sector standing at 161% of the sector weight in overall employment);
• Other Production Industries (136%);
• Financial & Other Business Services (131%) and
• Wholesale & Retail Trade (120%).
  

All state-dependent or provided jobs were the safest ones (see above marked in blue bold).

Update: since both Health and Education sectors are heavily reliant on public sector workers, we can consider a broader definition of the Public Sector to include the above sectors together with Public Administration & Defense. In this case, broader PS accounted for 23.1% of total employment in Q4 2008 and 6.9% of total number of new LR signees in Q1 2009, implying a 29.9% relative incidence of unemployment by sector - a number that is more than 3 times smaller than the average for the entire economy.

The above relative incidence number for the broader PS is actually biased in the direction of overstating the overall incidence of unemployment in the PS, as a number of employees who lost their jobs in Health and Education sectors were most likely from private firms providing these services.


And here is another table, also slightly adjusted by me. This time around, I am adding several categories together - people who are left on the Live Register (aka the Unemployed), people who moved from the LR to illness benefit (aka also the Unemployed), people who have retired from the Live Register to a state pension and people who are unaccounted for (aka - emigrants who left Ireland, immigrants who left Ireland and people who just dropped off Live Register into gray economy 'entrepreneurship').

Notice couple of things here - virtually the same number of foreigners and Irish who have joined LR in Q1 2009 stayed in some sort of 'Unemployment' by the end of Q2 2009. Actually, this percentage was slightly higher for the Irish LR signees, but the difference does not appear to be statistically significant.

Those over age 25 tended to remain on LR with higher probability than those who are under 25. The trick part here is that many under 25-year olds went off to training and education, dropping off the LR. One hopes they will have a job to go to, once their Fas-run courses and college programmes end.

Males were more likely to remain broadly unemployed (83.46%) than females (80.26%) but the difference is small and there are several factors here. One might wonder how the birth rate increase affects this number and also how it depends on transition to single parent family supplement. Also, younger women are more likely to undertake new training and education than younger males. Can these three factors explain the difference between men and women in re-employment rates?

Once we look at differences across sectors, one striking detail shown in the table above is that sectors with higher wages and better jobs are suffering the largest non-returns to jobs by the Live Register Signees. Table below details:
So in the nutshell - the jobs our LR signees are getting after they lose their primary occupation are of poorer quality and in less productive sectors.

Economics 22/02/2010: Leading indicators of an Irish recovery

For those of you who missed my Sunday Times article yesterday, here is the unedited version (note: this is the last article of mine in the Sunday Times for the time being as Damien Kiberd will be back with his usual excellent column from next week on):


The latest Exchequer results alongside the Live Register figures clearly point to the fact that despite all the recent talk about Ireland turning the corner, the recession continues to ravage our economy. And despite all the recent gains in consumer confidence retail spending posted yet another lackluster month in December 2009. Predictably, credit demand remains extremely weak, with the IBF/PwC Mortgage Market Profile released earlier this week showing that the volume of new mortgages issued in Ireland has fallen 18% in Q4 2009.

Even industrial production and manufacturing, having shown tentative improvement in Q3 2009 have trended down in the last quarter.

As disappointing as these results are, they were ultimately predictable. Economic turnarounds do not happen because Government ‘experts’ decide to cheer up consumers.

Instead, there is an ironclad timing to various indicators that time the recessions and recoveries: some lead the cycle, others are contemporaneous to it, or even lag changes in economy.

In a research paper published in 2007, UCLA’s Edward E. Leamer shows that in ten recessions experienced in the US since the end of World War II, eight were precluded by housing markets declines (first in terms of volumes of sales and later price changes). The two exceptions were the Dot Com bust of 2001 and the end of the massive military spending due to the Korean Armistice of 1953. Residential investment also led the recovery cycle.

Despite being exports-dependent, Irish economy shares one important trait with the US. Housing investments constitute a major proportion of our households’ investment. In fact, the weight of housing in our investment portfolios is around 65-70%. It is around 50% in the US. As such, house markets determine our wealth and savings, and have a pronounced effect on our decisions as consumers.

Consider the timing of events. Going into the crisis, Irish house sales volumes turned downward in the first half of 2007. House prices declines followed by Q1 2008, alongside changes in manufacturing and services sectors PMI. A quarter later, the whole economy was in a recession.

House price declines for January 2010 indicate that roughly €200 billion worth of wealth was wiped out from the Irish households’ balancesheets since the end of 2007. With this safety net gone, the first reaction is to cut borrowing and ramp up savings, to the detriment of immediate consumption and new investment.

So, if housing markets are the lead indicator of future economic activity, just where exactly (relative to the proverbial corner) are we on the road to recovery? Not in a good place, I am afraid.

Per latest data from the Central Bank, private sector credit continues to contract in Ireland, with December 2009 recording a drop of 6% on December 2008. Residential mortgage lending has also fallen from €114.3 billion in December 2008 to €109.9 billion a year later. This suggests that at least some households are deleveraging out of debt – a good sign. Of course, the decline is also driven by the mortgages writedowns due to insolvencies.

Worse, as Central Bank data shows, the process of retail interest rates increases is already underway. In November 2009 retail interest rates for mortgages have increased for all loans maturities and types. Irish banks, spurred on by the prospect of massive losses due to Nama, are hiking up the rates they charge on existent and new borrowers.

And more is to come. Based on the current dynamic of the interest rates and existent lending margins for largest Irish banks compared to euro area aggregates, I would estimate that average interest rates charged on mortgages will rise from 2.67% recorded back at the end of November 2009 to around 3.3-3.5 % by the end of this year, before the ECB increases its base rate. This would imply that those on adjustable mortgages could see their cost of house financing rise by around 125 basis points, while new mortgage applicants will be facing rates hike of well over 150-160 basis points.

On the house prices front, absent any real-time data, all that we do know is that residential rents remain subdued. Removing seasonality out of Daft.ie most recent data, released this week, shows that downward trend in rents is likely to continue. Commercial rents are also sliding and overall occupancy rates are rising, with some premium retail locations, such as CHQ building in IFSC, are reporting over 50% vacancy rates.

Does anyone still think we have turned a corner?

The problem, of course, is that the structure of the Irish economy prevents an orderly and speedy restart to residential investment.

First, there are simply too many properties either for sale or held back from the market by the owners who know they have no chance of shifting these any time soon. We have zoned so much land – most of it in locations where few would ever want to live – that we can met our expected demand 70 years into the future. We also have 350-400,000 vacant finished and unfinished homes, majority of which will never be sold at any price proximate to the cost of their completion. To address these problems, the Government can use Nama to demolish surplus properties and de-zone unsuitable land. But that would be excruciatingly costly, unless we fully nationalize the banks first. And it would cut against Nama’s mandate to deliver long-term economic value.

Second, there is a problem of price discovery. Before the crisis we had ESRI/ptsb sample of selling prices. Based on ptsb own mortgages, it was a poor measure. But now, with ptsb having pushed its loans to deposits ratio to 300%, matching Northern Rock’s achievement, there is not a snowball’s chance in hell it will remain a dominant player in mortgages in Ireland. Thus, we no longer have any indication as to the actual levels of property prices, and absent these, no rational investor will brave the market. The Government can rectify the problem by requiring sellers to publish exact data on prices and property characteristics.

Third, the Government can aid the process of households deleveraging from the debts accumulated during the Celtic Tiger era. In particular, to help struggling mortgage payers, the Government can extend 100% interest relief for a fixed period of time, say 5 years, to all households. On the one hand such relief will provide a positive cushion against rising interest rates. On the other hand, it will allow older households with less substantial mortgage outlays to begin the process of rebuilding their retirement savings devastated by the twin collapse in property and equity markets. Instead of doing this, the Government is desperately searching for new and more punitive ways to tax savings. Finance Bill 2010 with its tax on unit-linked single premium insurance products is the case in point.

Fourth, the Government can get serious about reducing the burden of our grotesquely overweight public sector. To do so, the Exchequer should commit to no increases in income tax in the next 5 years. All deficit adjustments from here on will have to take a form of expenditure cuts. Nama must be altered into a leaner undertaking responsible for repairing banks balancesheets, not for providing them with soft taxpayers’ cash in exchange for junk assets.

Until all four reforms take place, there is little hope of us getting close to the proverbial corner for residential investment, and with it, for economy at large.


Box-out:

Back in January 2009, unnoticed by many observers, a small change took place in the Central Bank reporting of the credit flows in the retail lending in Ireland. Per Central Bank note, from that month on, credit unions authorized in Ireland were classified as credit institutions and their deposits and loans were included in other monetary financial institutions. This minute change implies that since January 2009, Irish deposits and loans volumes have been inflated by the deposits and loans from the credit unions. Thus, a search through the Central Bank archive shows that between November 2008 and February 2009, the total deposits base relating to resident credit institutions and other MFIs rose from €166 billion to €183 billion, despite the fact that the country banking system was in the grip of a severe crisis. Adjusting for seasonal effects normally present in the data, it appears that some €14-15 billion worth of ‘new’ deposits were delivered to the Irish economy though this new accounting procedure. Of course, deposits on the banks liability side are exactly offset by their assets side, which means that over the same period of time more than €16 billion of ‘new’ credit was registering on the Central Bank radar. Now, this figure is also collaborated by the credit unions annual reports which show roughly €14 billion worth of loans issued by the end of 2007 – the latest for which data is available. This suggests that the credit contraction in the Irish economy during 2009 is understated by the official figures to the tune of €14-15 billion. Not a chop change.

Economics 21/02/2010: Planes, Buses and Swedes

A crucial difference between the Swedish 'socialism' and Irish Government's 'pro-market Partnership' is that the two are misnomers.

Take airline industry:

• Irish Government owns a share of Aer Lingus - 25% and together with its friends (although sometimes quarrelsome) - the Unions the state controls 40% stake in the 'National Flag Carrier';
• Irish Government monopolistically owns the entire airports system in the country allowing no competition whatsoever into the sector - presumably in line with the Irish Government's pro-private enterprise stance;
• The LFV Group that owns and operates main Swedish airports is similar to our DAA / Aer Rianta and is also state owned - clearly in line with the Swedish Government's socialist credentials;
• But in Sweden there are a private airport and a number of independently (municipalities) owned smaller airports;
• The Swedish State currently owns 21.4% of the SAS - 'Flag Carrier Airline' (less than the shareholding by the pro-private enterprise Irish State in Aer Lingus) and
• Earlier this week, Swedish deputy PM (Mary Coughlan's counterpart) announced that her Government is selling all of its holding in SAS. How come? “In the long run we don’t see any intrinsic value in owning shares in an airline,” she said.
  

Actually, in terms of monopolization of the service provision, Irish Airports stand at 100% monopoly ownership, while Swedish airports are close fringe challenging central monopoly, to the situation in terms of services competition one find in Irish bus services. Funny thing - we claim to have a deregulated bus market in Ireland...

Hmm, Bertie Ahearn had a point saying he was the last standing real socialist in Europe.

Economics 20/02/2010: Greeks ahead

Want to understand the extent to which politicians and the public sector workers are failing to understand the fundamental principles of the markets? Look no further than Greek debt issue looming on the horizon.

Some background first. Less than a month ago, Greece put on the market an €8 billion 5-year bond package at a 6.1% interest rate. Seemingly, it was able to attract initial interest of investors - the early bidders were keen on taking high yield paper. Of course, the country bond issuers had no idea why institutional investors had sudden interest in Greek bonds. And this led to a bottleneck emerging in later days of the placement.

Institutional investors, especially diversified portfolio managers, might want a bond for its default risk-adjusted returns. This hardly constitutes a significant proportion of the demand for Greek bonds in recent months. Alternatively, they might down-weight the consideration of the default risk and use the bond purchase to simultaneously hedge their FX exposure elsewhere and earn high returns. It is the second component of the market that drives most of the demand for Greek bonds, aka portfolio management side of demand. This second source of demand is by its nature extremely shallow – there are fewer investors in this complex hedging space and those that are in it have many alternative (to Greek bonds) strategies available to them. It does, of course, help the Greek bond issuers’ cause that their yields are the highest in the Eurozone, making their bonds a solid target for single risk hedging on FX side. But it does not help them that the Euro is at risk of substantial devaluation going forward against the dollar and sterling.

In short, the demand for Greek bonds is not fundamentally driven (i.e not based on pure default risk v yield analysis). Adding insult to the injury, if one should rationally anticipate that Euro is going to continue falling against the dollar in the current scenario of contagion from Greece to the rest of PIIGS, then less faint-hearted amongst us might want to take a short position against the Euro. This can be done by not hedging existent non-Euro exposures. The effect of such implicit shorting is to further reduce demand for Greek paper. The folks at the Greek Treasury have missed these simple points. Thus, the aforementioned issue was simply too large for the markets and failed to sustain prices achieved on placement – within just two days after the issue, price fell 3.5%.

Which brings us to the next week – it is expected that the Greeks will be at the markets again, this time with a €5 billion of new 10-year paper. Even to have a go, the Greeks will have to push spreads on their paper over the German bund to a stratospheric height. Currently – 10-year Greek bonds are yielding 6.5%, up from 5.8% back in the end of December 2009 and 1.5 percentage points above their levels in November 2009. But this will have to rise. 7% anyone? Possible.

Short positions in Greek bonds are also signaling that the demand for new issue will be weak. Shorts in Greek bonds have risen to 9.82% up 0.24 percentage points in the first two weeks of February and 1.58 percentage points relative to the end of December 2009. But now they are being closed off. Closing the short means that demand for bonds rises, artificially, in the market – as bonds are being withdrawn for a return to the lender. But this demand is not about market appetite for bonds. Instead it is about a technical need for a re-purchase. With this demand pathway becoming more exhausted in recent days, there will be added pressure on new bond pricing – another aspect of the market the Greeks seemingly do not take into account.

But politicians and their public servants, ignorant as they may be of the markets, might have something else on their minds. Greek’s reckless and silly issuance patterns are driven by more than markets considerations. They are driven by gargantuan deficits and debt overhang – with €20 billion of maturing debt that needs to be rolled over around April this year alone - and the willingness of the Greek Government to sacrifice its own taxpayers (remember – higher yields mean higher cost of borrowing, to be carried by the future taxpayers) in order to force the EU to bailout the country. This strategy, similar to the game of chicken in which both participants hold equivalently credible threats, but one faces asymmetrically higher costs in the case of ‘no bailout’ outcome) is something that the EU leaders themselves do not seem to comprehend.

While the EU is sitting on its hands and issuing conflicting and irresolute statements on the matter, the Greeks are heading straight into a fiasco, should they fail to place new bonds at yields proximate enough to the current 6.5%. At the same time, failure to place this issue will push the Greeks even closer to a direct default on debt, imposing even more pressure on the EU to urgently deal with the matter.

If the EU fails to bail out the Greeks on this round, the Euro will be equivalent to the Titanic grinding against the iceberg. The Greeks will always have an option to walk away from the common currency and default outright – the consequences will be tough, but more palatable than the ones which will hit the country should it go down alongside the Euro. First move advantage is real in the game of chicken.

Economics 19/02/2010: Bank of Ireland deal

And so it comes to pass - the saga of missing dividend from Bank of Ireland, and the taxpayers are left holding the bag... The background to the story is here. Karl Whelan's post here gives the relevant links to the documents. And my analysis is as following:

Following the conversion of dividend due (€250 million) from the Bank of Ireland preference shares owned by the state to ordinary shares on 22 of February, the state will emerge as an almost 16% owner of the bank equity.

The relevant ISE document stipulates that:
"As a consequence of this and, in accordance with Bye Law 6(I)(4), the Directors of the Bank of Ireland announce that on 22 February 2010 it will issue and allot to the NPRFC 184,394,378 units of Ordinary Stock being the number of units equal to the aggregate cash amount of the 2010 dividend of €250.4m divided by 100% of the average price per unit of ordinary stock in the 30 trading days prior to and including today's date. Application will be made in due course for the listing of these units of stock. This increases the units of Ordinary Stock of Bank of Ireland in issue to 1,188,611,367. As a result the NPRFC will own 15.73 per cent of the issued Ordinary Stock (excluding the NPRFC Warrant Instrument)"

Which means a massive shareholder dilution and a significant set back to the BofI ability to raise equity. Recall that the BofI was planning for a €1 billion rights issue which would have meant roughly a 38.6% dilution of existent shareholder rights. Now, with a preemptive 16% dilution by the state, a rights issue planned will mean a 44% dilution post-rights should the price of the shares remain constant at Monday. And this is before we factor in 25% option on ordinary shares that is held within the preference shares we already have.

Of course it won't. A rational valuation model of shareprice will require that the price declines roughly 15% on Friday close post State dilution. Which means that market cap of the BofI will fall, at current average to €1,353 million, implying the post-right dilution of 48%.

In a way, Government taking the stake in BofI prior to rights issue at current valuation means the taxpayer is buying an asset that is likely to drop in value almost 50% within months after the State takes its stake. With one sweep of the pen, Minister Lenihan just signed off on an investment - using our cash - that will be worth 1/2 of its current value once BofI goes into equity raising.

Of, course, a much grimmer reality beckons should the State move tonight spell the end to the BofI equity issue prospects. In this case, today's announcement forces the Government to fully recapitalise the bank out of taxpayers funds, leading to a 90% plus State ownership and a massive liability to the taxpayers.

Irony of all ironies - the Government will end up transferring bad assets from its own bank to its own holding entity - Nama. What can possibly go wrong?


PS: In their September 3, 2009 note titled "Irish Banking - Crossing the Rubicon", Bloxham Stockbrokers said: "There is already a €825 million benefit to taxpayers from recovery in the market value of Allied Irish Bank and Bank of Ireland: Holding options worth a 25% stake in both AIB and Bank of Ireland, the taxpayer has benefited by €825 million as a result of the shareholding. This is apart from the benefit of the annual 8% yield from the €7 billion injection into the two main banks, which adds a further €560 million to the return per annum."

Run this by us, please, Bloxham - €825 million? Again? Crossing the Rubicon it was.

Wanna see some more fantasy estimates from the brokers? Davy:
"19 June 2009 17:26 Bank of Ireland could raise €1.5 billion in September and pay off some of the €3.5 billion in Government preference shares, according to stockbrokers Davy. ...In a report on Bank of Ireland today, Davy Research says the effect of a rights issue, in which the bank would issue more shares, could be used to pay funds back to the State and potentially leave the Government with a stake of 7%. "

7%? Run this by us, please, Davy Research - 7% state ownership? Right.

Economics 18/02/2010: Ryanair are releasing actual evidence

Another chapter in 500 jobs saga at Dublin Airport: remember that claim that RTE aired that Ryanair could have been planning to use Hangar 6 as a monopoly-busting Terminal 3?

Earlier today Ryanair released its letter to IDA, dated July 2, 2009 - which commits Ryanair to the specific, narrow use of Hangar 6 and suggests DAA can impose a clause that would restrict Ryanair use of Hangar 6 only to heavy maintenance work. Here is the letter:

At the very least, one has to be fair to Ryanair - they are the only party to the entire debacle who are backing their claims with real evidence. DETE or DAA might want to follow the lead... I am certainly going to give them space on this blog, if they need one.

Economics 17/02/2010: Baltic Dry Index & trade recovery

Some interesting reading from the BDI – Baltic Dry Index – that tells us the cost of hiring a bulk commodity shipping cargo. The BDI is a good indicator of concurrent trade and industrial activities globally – rising BDI means tighter supply of shipping capacity and thus increased shipping volumes – spot. Back in 2008 is was at a record high of 11,793.

Now, January 2009 saw BDI falling to 772 low, it then recovered with some tremendous volatility through the year before setting annual 2009 average of 2658. As of today it is at 2598 – below the 2009 average and at only 22% of the 2008 peak.

Not much of a sign of a global recovery here.

Economics 17/02/2010: The Saga of 500 jobs

The story of 500 jobs at Ryanair maintenance facility continues with this:

Economics 16/02/2010: Aircarft Servicing Investment Letters

UPDATE below

Here are actual letters between Michael O'Leary and Mary Coughlan, TD that have made so much press recently.

15th February 2010

Mr. Michael O'Leary
Chief Executive Officer
Ryanair Limited
Dublin Airport
County Dublin

Dear Michael,

Thank you for your letter of 10th February 2010 which was received in my office by post today.

Needless to say I was very disappointed to learn of the decision of Ryanair to locate its new investment in Prestwick despite our best efforts, through IDA Ireland, to secure the investment for Dublin.

You will recall that there were two obstacles to progressing this matter. Firstly, your reluctance to talk to the DAA which owns Hangar 6 and secondly the fact that Hangar 6 was being occupied by another party. A number of options for developing facilities at Dublin Airport were put to you. Those options included the possibility of new hanger facilities being constructed at Dublin which seems also to be the basis on which the new facility at Prestwick is being accommodated.

I can assure you that the Government is most anxious to secure further investment from Ryanair at Dublin or indeed at another Irish Airport. The IDA, in the first instance, are available immediately, as are the DAA, to continue discussions with Ryanair. The IDA are satisfied to continue to act as broker and point of contact for Ryanair.

It has been possible in the very recent past to secure new investment in aircraft maintenance facilities at Dublin Airport and I would hope that with goodwill on all sides we can secure new investment here by Ryanair.

Yours sincerely

Mary Coughlan T.D.
Tánaiste and Minister for Enterprise, Trade and Employment

Nothing else to add here.


Except an update:

This is from Ryanair:

Ryanair, today (16 Feb 10) released photographs of what Hangar 6 is being used for today – precisely nothing. These photographs were taken at approx. 9am this morning and show no heavy maintenance work going on in the hangar, at a time of year when it should be full of aircraft undergoing heavy maintenance. This is why 800 SRT engineers are on the dole today.

Ryanair today made the point that Aer Lingus have a long-term heavy maintenance contract for their entire fleet of 35 aircraft in France and therefore has no requirement for the Hangar 6 facility. Ryanair believes that the DAA lease to Aer Lingus was designed solely to block Ryanair’s request for this facility which was submitted to the Tánaiste last September at a time when Ryanair was offering to create 500 maintenance jobs at Dublin Airport.

Ryanair also today released an extract from its DAA lease agreement for Hangar 1, which contains a standard clause in all DAA lease agreements allowing the DAA to terminate leases and relocate licensees (such as Aer Lingus in Hangar 6) should the DAA require the facility.

Ryanair’s Stephen McNamara said: “We are releasing these photographs and this extract from a DAA licence agreement to demonstrate two things:

1. that Hangar 6 is unused and Aer Lingus’ line engineers have no use for this large heavy maintenance building and,

2. to prove that the DAA has lied again when they claimed that Aer Lingus has a 20 year lease over Hangar 6 and cannot be moved.

“These photographs and this information proves yet again that the DAA has lied to the Govt and the public and has, we believe, misled the Tánaiste last September and again recently when they claimed that they had other parties interested in using the Hangar 6 facility for heavy maintenance. These false claims show why Ryanair cannot and will not deal with the DAA”.

Ends Tuesday, 16^th February 2010

Economics 16/02/2010: Daft.ie and rental markets

So Daft.ie numbers for rents for January are out and there is a bit of a hoopla going on in the blogosphere and the media about how things are improving. Well, they might be. 1% rise on December sounds like good news. The first rise in 24 months sounds like fantastic news. Falling net surplus of properties for rent on the market sounds like it is time to rush out to H&MacD office near you and buy-buy-buy those apartments in Dublin 78 for 250K before they are all rented out to… Who, I would wonder?

In my humble opinion, the hype is being overdone. Here is why:

1. There is seasonality issue – explained below – which suggests that January rise might be just a dead cat bounce;
2. There is demand issue – also elaborated upon below – which suggests that there is no fundamentals-based explanation for January rise; and
3. There is a momentum issue – again, more below – which implies that after 24 months of straight downward trajectory, a small correction is long over due and that this will not necessarily establish an upward trend.

So let us take a look at the 3 possible factors listed above.

Seasonality. A chart might help, or two.
The first chart shows Daft rental index, marking in red circles all the cases where January posted an improvement on December (table below brings this out in numbers in terms of m-o-m changes in the index). Only one occasion – end of 2005 – was the case where this local peaking took place one month before the normal January peak. So this January is no exception here.

Some have argued that this January is different because it is the first reversal of the established trend. True, if we take the trend to mean 2007 peak to today. But if you look at the chart above, you notice that January shows exactly the same performance relative to preceding months and following months on the upward trend and on the downward trend. So I do not buy this argument that because we were falling before, a bounce today means a change in trend.

Now take a look at daft own chart (I have no data for transactions from them, so can’t really do any analysis).
Notice the V-shaped segments? Aha, they too take place on end of 2007 to the beginning of 2008, end of 2008 to the beginning of 2009, and end of 2009 to, you’ve guessed it the ‘Great Improvement Month’ of January 2010. But here is more worrying thing: take a look at within-year trend lines for 2007, 2008 and 2009:

• Numbers of properties inflowing and exiting (rented, withdrawn, sold, demolished and soon also Namacised) trend up in 2007 and 2008 almost at the same trend line and intercept.
• Number of properties inflowing and exiting trend still up in 2009, but with higher intercept than before and flattening slope.
• Number of properties listed overall is down, true, but this simply means we have soaked up some of the overbuild into rentals. How much of it? 2007-2010 differential is about 15,000 units. Surely this is about 1/6th of the supply out there in terms of new-built, plus another 20,000 units vacated by the leaving immigrants and emigrants. Good luck if anyone thinks that we are bottoming out in terms of supply. We are just pausing.
  

So what does this tell us about 2010? Little, but… if this continues, numbers of transactions will flatten more, with greater overall average volume (higher intercept and positive slope) in 2010 than in 2009. Does this mean we are out of the woods and that supply is finally catching up (downward) with demand? I don’t know this. Why? Because I do not know anything about the drivers of supply and I know something about the drivers of demand.

On supply side, 2009 saw no new built properties hitting the market.

And it saw some reductions in supply as banks took possessions of some properties that might have been on the market for renting, but never rented. Absent actual contracts for rent, banks have no incentive to go into the expensive rental market themselves. They would rather rent wholesale to the local authorities and may be sign up with rental agents. Rental agents will list in bulk, so one listing on daft might mean a large number of actual apartments behind it. Statistics show improved (reduced) supply, but reality shows increased supply.

Other contractions took place in estates that are now completely frozen. In anticipation of continued work, half-finished estates might have seen developers listing some properties there for rent. Now that estates are abandoned – in court proceedings or simply frozen by cash-strapped developers – the listings ‘exited’ (green line went up in the chart above). Happy times? I doubt it.

But what is even more concerning in my view is the demand side. We know that there is no growth in demand out there – demographics is slow moving, so expectations based on kids finishing college and renting their first apartment are static. Foreigners are not flooding into Ireland and net emigration is now a reality. So what is happening on demand side to keep things from going bust? People move, given falling rents, to better accommodations. This leads to hollowing out of the cheaper apartments and rise in demand for more expensive (still deflating, though) better quality properties.

Daft really should do some analysis here to see if this is true. But it looks plausible. If this is happening, then we can expect to see: number of exits improving, while number of listings growing slower (lags in re-listing cheaper properties, etc). This is why the green line above is trending up faster than the blue line.

But the implication of this being true – if it is true, that is – is that within a month or so, once contracts are shifted to new and better quality properties, the cheaper, smaller apartments market will implode. And it will also drag down the more expensive market with a lag of, say 3-6 months.

In short, I simply do not buy the idea that the rental markets are signaling improvement. It will take 3-4 months of continued up-trending for me to buy the story.

Economics 15/02/2010: Bank of Ireland ethical dilemma

So here we are folks, the state has run into a bit of a trouble.

Remember those dividends that our (taxpayer-bought) preference shares in the BofI and AIB were supposed to generate? Ok, there is a problem here.

On February 22, BofI is supposed to pay out some €240 million to us (the taxpayers, in case if you wondering) in dividends on these shares. Alas, if you recall, the EU has imposed severe restrictions on the banks dividends. This means that we are now in a no-man's land when it comes to getting paid on that €3.5 billion we put into BofI. The Government has an option to circumvent the EU rules and ask for shares to be paid in instead of cash, but this surely will open claims from the bondholders who are not being paid their coupons. And, of course, if shares are issued in the way of payment, there will be dilution. At current price, €240 million worht of BofI shares will be, ahem, 24% of the expected €1,000 million rights issue or 19.1% of the market capi of the bank. Some serious dilution, unless the EU grants an exemption to the State.

But an exemption for the Government is an ethically dubious move for several reasons:

• In all other bank support schemes, the EU did not lift restrictions on dividends/interest/coupon payments for sovereigns. Should it do so for Ireland, what's next?
• Payments to other bondholders who have identical rights to the state (on paper) will not be made, opening up the entire process to legal challenges.
  

And we (the taxpayers) were told by the Government and its stockbrokers that we've made a sound investment in the BofI preference shares... Ouch...

Economics 15/02/2010: Ireland and the Euro

Sunday Times, February 14, 2010.

Like a namesake of Federico Fellini’s 1983 classic, E la nave va (And the ship sails on), the Greek debt saga continues its course toward the increasingly inevitable default. Another week, another impenetrable web of announcements, and no real solutions. At this stage, the EU’s ability to resolve the crisis is no longer a matter of markets trust and the reputational costs for the euro are becoming more than evident.

So much so that conservative and forward-looking ECB is starting to think of contingency planning. A source close to Frankfurt has told me earlier in the week that some ECB economists are contemplating the likely run on the euro leading to a 20-25% devaluation of the currency to bring it virtually to parity with the dollar. If that happens, an interest rates hike of 50 basis points or more will be a strong possibility sometime before the end of Q3 2010. A derailment of the nascent economic recovery in the core euro zone countries will be virtually assured.
The plan, currently under discussion at the EU level, involves a guarantee on Greek debt, plus a package of subsidised loans both underwritten by other euro zone countries (re: Germany). The problem is that this is unlikely to be enough.

Greek problems are not cyclical and will not go away once the markets calm down. Country structural deficit, in line with Ireland’s is around 60-70 percent of the overall exchequer annual shortfall. And unlike Ireland, Greece is facing an acute problem refinancing its gargantuan public debt. Worse than that, the latest revelations concerning the complex derivative contracts used by the Greek authorities to hide a significant share of its deficit over the recent years clearly show that the country will have to be much more aggressive in scaling back its annual deficits in order to be able to issue new bonds. The EU latest plan does not facilitate any of these measures. Neither does it have a credible enforcement mechanism. Should Greece decide at any point in the future to renege on its obligations under the rescue package, the entire crisis will be replayed tenfold. And the threat of this gives the Greeks a trump card against the EU Commission under collective guarantees.

Thus, currently, there are only three economically feasible structural solutions to the ongoing crisis in the euro area.

The best option would be a massive injection of liquidity across the common currency area. Minting a fresh batch of euros worth around €1-1.5 trillion and disbursing the currency to the national Governments on a per-capita basis would allow the PIIGS some breathing room in dealing with their deficit and debt problems. At the same time, countries like Germany, with more fiscally sound public spending habits, would be able to use this money to stimulate domestic demand and savings through tax credits and investment.

The drawback of such a plan is that it can reignite inflationary pressures within the euro area. This risk, in my view, is misplaced. Given structural weakness in consumer demand and continued cyclical weakness in new business investment, it is unlikely that much of the freshly-minted cash will go anywhere other than savings. Incidentally, with most the money flowing back into the banking sector, the ECB can then use this increase in deposits to close down some of the asset-backed lending positions that euro area banks have built up with Frankfurt.

Two other solutions involve introduction of a parallel ‘weak’ euro for PIIGS, or an outright bailout of Greece, Portugal, and possibly Spain and Ireland, through a partial pay-down of these countries debts. Both would have dire consequences for the euro itself.

The logistics of running two parallel currencies within a block of countries under a single-handed management of the ECB will produce more than confusion in the markets. The monetary policy required for the ‘weak’ euro state would entail interest rates at roughly triple those in the ‘strong’ euro countries, with the resultant potential for an explosion of carry trades unfolding within a single monetary union.

In addition, there is no mechanism by which either Greece or any other country can be compelled to switch to a ‘weak’ euro. In Ireland’s case, being forced into a ‘weak’ euro will be a disaster for the longer term prospects of maintaining strong presence of the US and UK multinationals here who rely on out full membership in the common currency club to drive their transfer pricing.

An outright paydown of the PIIGS debts – no matter how tough the EU Commission gets in terms of talking up ‘conditional lending’ and ‘direct supervision’ provisos of such an action – will result in an unenforceable lending from Germany to the PIIGS.


From Ireland’s point of view, however, the inevitable outcome of all possible alternatives for dealing with Greece will be devaluation of the euro close to parity with the US dollar. And here may lie the best news Irish exporting firms have heard since the beginning of this recession.

Given the dynamics of our exports-producing sectors, Ireland desperately needs a shot in the arm to stay alive as economy through 2010.

Per CSO, our MNCs-dominated modern manufacturing – the source of most of our goods exports – has managed to post a spectacular 14.5% seasonally-adjusted drop in production in Q4 2009. Pharmaceuticals output declined a 7.5% in the last quarter, while computer, electronic and optical equipment sector – another pillar of our exporting activities was down 14.9% in December 2009. It all points to growing weakness in exports-driven high value added segment of our manufacturing. In short, Ireland can use a serious devaluation of the euro on the exporting side.

But a silver lining never comes without some cumulus clouds in tow.

A devaluation – while a boom for exporters – will act to reduce consumer spending and, through higher cost of imports, will further reduce income available for domestic savings and investment. Given the already abysmally low levels of personal consumption, it is highly likely that this will trigger more household defaults on debt and mortgages.

Furthermore, a devaluation can trigger rising inflation across the euro area which, once imported into Ireland, will undermine the gains in competitiveness achieved during the current crisis. For comparison, consider the case of Ireland v Greece. In his recent note, NIB’s Chief Economist, Ronnie O’Toole highlighted the fact that between mid 2008 and the end of 2009, Irish consumer prices have fallen some 4.6%. In contrast, Greece saw its prices rise some 2.3% over the same period. Of course, falling price levels imply that it is much easier for companies and governments to cut nominal wages. A new bout of inflation induced by the EU solutions to the Greek crisis can wipe out this advantage.

Alas, no one so far has noticed that in both, Ireland and Greece, a cut in nominal wages in line with inflation will do two things. One – it will leave real wages – the stuff that private sector producers really care about – intact. And it will be a magnitude of 3-4 times too little for repairing the Exchequer balance sheet. With both countries facing a 2010 deficit of 10-11% of GDP, a 5% cut in public sector wages is equivalent to applying Bandaid to a shark bite.

And a rise in euro area inflation will have an adverse impact on Irish exporters. Despite devaluation, many of our MNCs and indigenous exporting companies buy large quantities of raw and intermediate inputs from abroad. The rise in the cost of imports bill will partially cancel out the gains in final prices achieved due to devaluation. This is especially significant for the companies trading in modern higher value-added sectors, where geographically diversified multinationals use Ireland as a later stage production base with intermediate inputs coming from other EU countries and the US.

Lastly, a devaluation of the euro close to the dollar parity is likely to trigger monetary tightening by the ECB, with interest rates rising by 50 basis points in the next six months. Coupled with reduced provision of new liquidity by Frankfurt, the resulting credit crunch on the Irish banks will trigger a massive jump in the burden of mortgages here. Needless to say, even with booming exports, Ireland Inc will be in deep trouble as trade credits, corporate funding and personal loans will be pushed deep into red by rising costs of borrowing.

At this stage, we really are caught between a rock and a hard place.