Economics 30/04/2010: Minister Lenihan's statements in the Dail

Some interesting points on Nama, coming out of Minister Lenihan's answers to Dail questions this Wednesday, April 28 (emphasis is mine):

"The NAMA SPV structure has a subscribed capital of €100m. As explained to the Dail at the time of the legislation, and subsequently agreed with the EU, 49% of this capital was advanced by NAMA and 51% by private investors.

Three private investors, namely, Irish Life Investment Managers, New Ireland Assurance and a group of clients of Allied Irish Banks Investment Managers, have each invested €17m in the vehicle. It is important to note that in each case the beneficial owners of the investment are pension funds or other clients of these investment companies and not the parent credit institution. [It is equally important to note that in each case the full owner of each one of these entities is an institution directly involved either in Nama or in Banks Guarantee scheme, which, of course, under normal rules of engagement would imply potential conflict of interest]

The SPV has been established in accordance with Eurostat rules. The Board of the SPV is chaired by the CEO of NAMA and has three NAMA nominated directors with the private investors retaining the right to nominate a further three directors. Thus the SPV is structured in such a manner that NAMA representatives will maintain an effective veto over decisions of the SPV Board. [Thus the so-called 'veto' is a de facto, not de jure. Should one of the Nama representatives on the board fall ill, be delayed in travel or be absent on some state-sponsored junket, in absence of the said member, it is quite possible - even if only in theory - that the veto power can pass over to the 'private' owners of SPV.]

Further:

"In line with my statement to the House on 30 March on the banking situation, I subsequently issued Promissory Notes on 31 March to Anglo Irish Bank and Irish Nationwide Building Society. These Notes will ensure that both institutions continue to meet their regulatory capital requirements. The initial principal amount of the Note that issued to Anglo Irish Bank is €8.3bn and to INBS it is €2.6bn. As I indicated in my recent statement, it is likely that Anglo will need further capital in due course but the extent and timing of such further support remains to be determined.

The terms of the Promissory Notes that issued to both institutions on 31 March are substantively the same and, inter alia, provide that 10% of the principal amount will, if demanded by the institution, be paid each year and that the first such payment will fall due for payment from the Central Fund on 31 March 2011. An annual interest coupon, related to Government bond yields, is also payable on the Promissory Notes which the Minister has absolute discretion to pay on the due date or to add to the principal amount. [So, in contradiction to the deeply-informed Dara O'Brien TD, it is the state who will be paying interest to the banks. Not the other way around]

This ensures that the Note meets accounting requirements to be “fair valued” at the principal amount in the annual accounts of each institution, consistent with the regulatory capital requirements. [This sentence is an example of Minister's habitual abuse of financial terminology, in so far as it makes absolutely no rational sense to anyone even vaguely familiar with finance. 'Fair valued' must refer to a benchmark, being a comparative/relative term. 'Fair valued at the principal amount' is gobbledygook as principal amount - the face value of the bond/note can only be valued in relation to the price of the bond or yield on the bond, none of which are referenced in Minister's statement. Furthermore, fair value concept does not refer to the regulator capital requirements. It refers only - I repeat, only - to the market value of the bond/note.]

In the event of a winding-up of either institution, the aggregate of the outstanding principal amount and any unpaid interest that has accrued on the institution’s Note falls due for immediate payment. [So, at least in theory, the Exchequer might face an immediate call for billions of euros in cash... what provisions have been made to ensure we will have this covered? How will Minister Lenihan be able to raise such funding even if the economy is not in crisis? What will be the additional cost of having to raise such funding in a fire-issue of a new state bond? Has the Minister established adequate pricing scheme to charge the banks for the taxpayers assuming such a risk or has he 'gifted' this risk premium away, thereby potentially exposing taxpayers to added hundreds of millions in new costs of such emergency issuance?]

The Deputy may also wish to note that, as indicated in my banking statement of 30 March, the use of Promissory Notes means that the institution’s capital requirements are met in a way which spreads the cash payments over a number of years and thereby reduces the funding burden on the Exchequer that would otherwise arise in the current year. [This statement clearly shows that Minister Lenihan does not understand the basics of interest rate/yield curve relationships. He implicitly assumes that in the future, the state borrowing costs will be lower than they are today. There is absolutely no reason for such an assumption.]

Economics 30/04/2010: Anglo Irish Bank shutdown costs

We are once again swamped with the 'new numbers' from the DofF and Minister Lenihan. This time the latest 'facts' relate to the potential cost of shutting down Anglo. Yesterday, Mary Coughlan stated in the Dail that the cost of an immediate liquidation of the bank had been prohibitive (per Irish times - here). Today, the unquestioning media squad is reporting that the cost of shutting down Anglo will be "more than €100 billion" (The Irish Independent, page 17). This figure has been floated out by the Anglo's paid-public-'experts'-turn-paid-executives, like Mr Dukes, and by the DofF talk-heads.

In reality this number is simply plain wrong, representing, simultaneously, a combination of

• bad arithmetic, and
• poor understanding of finance

Here is why. Take Anglo's balancesheet:

Assets of €72 billion:

• Loans to customers of €65 billion (with €35 billion earmarked for Nama)
• Loans in the interbank markets (loans to other banks) of €7 billion
• Risk-adjusting loans to customers to reflect an impairment charge of 60% implies recoverable loans of €26 billion (without a need to call in Nama at all).

Total recoverable assets of €34 billion.

Liabilities to customers and the ECB of €60 billion

• Customers' deposits of €27 billion
• Banks and ECB deposits of €33 billion

Thus, the real taxpayers' liability is €60bn-€34bn=€26 billion. Not €70 billion, nor €100 billion claimed by the various parties.

You might ask me 2 questions at this junction:

1. "What about bond holders?" Ok, there are €15 billion worth of senior bond holders and €2.3 billion of subordinated bond holders. These bondholders - all institutional - have been begging the State for years to keep banking sector lightly regulated. And I agree with them on this, in principle (omitting details here). As a part of their pleas, we've been repeatedly told that markets are able to price risks better than any regulator can. And I agree with them on this as well. So, as a consequence of their own stated desires and claimed powers, the bond holders should be made to bear the responsibility for their own errors in pricing risks. In other words, the Government should tell them to count their losses. This is what the market is all about and this, not the rescue by taxpayers, is what the real market participants expect from Ireland Inc. Lastly, on this point, there is not a single financial instrument or contract that legally requires the Irish taxpayers to foot the bill for non-sovereign investment undertaking. Full stop. Cut the guarantee on all Anglo bondholders and send them packing. Note: even if we are to cover bondholders in full, Anglo wind down will cost no more than €39 billion. Not €70 billion, nor €100 billion.
   
2. "How can the winding down take place?" Simple - we proceed to gradually, over the next 5 years, to sell assets. Depositors remain guaranteed, so we can rest assured they will not call in their deposits all at the same time. As we realize the value of the assets, we gradually close off the liabilities. To do this, bank staff can be reduced by over 50% and their wages (currently averaging €110,515 per annum per employee) can be cut by the same proportion. This is it, folks - simple.

Now, let me ask you two questions in return:

1. Why are Messrs Dukes, Lenihan etc are claiming that the winding down Anglo will cost €70-100 billion? Is it because (a) they have no idea and are 'inventing' numbers as they go? or (b) they have an ulterior motive to claim improbably high figures to continue dragging out this Anglo saga over 20 years?
2. Why have the Irish taxpayers paid hundreds of thousands of euros to 'consultants' who cannot come up with a simple, straight forward plan for dealing with Anglo to date, despite the fact that people like Peter Mathews (to whom I am obliged for much of the figures quoted above), Brian Lucey, Karl Whelan and myself have provided viable alternatives for dealing with the 'bank' free of charge?

Economics 29/04/2010: House prices peak to peak cycle

Back in October last year I did an estimate, based on the IMF model, of the peak-to-peak duration of the current housing slump. Now's time to do some updating on this matter.

Assumptions:

• Peak to trough correction in real prices of -40-43%;
• Growth rates - resuming in 2011: 2011-2013 +3.6% - in excess of the long-term growth rate estimate for Ireland in the current GFSR (2.6%), slowing to 3% in 2014-2016, then to 2.7% in 2017-2019 and 2.6% thereafter.

Using peak of Q2 2007 to assumed trough in Q3 2010, we have the full cycle duration of between 95 and 87 quarters, taking us back to 2007 peak by either 2029 or 2031.

If bottom hits at -48%, we get return to 2007 peak by 2034, with 107 quarters from peak to peak cycle.

Now, think Nama will run out in 2015? or 2020?

If Nama sets shut-off date in 2015, it is likely to get between 61 and 70 cents on the euro for each value underlying the loan. Assuming loans LTV of 70% and default rate of 30% on loans transferred to Nama (extremely conservative assumptions, but these allow a cushion on some interest collected), the value of Nama realized book will be 26 cents on the euro and 30 cents on the euro, or less than 50% of the post-discounted price paid!

If Nama shuts down in 2020, the above two figures will be 30 cents and 34 cents on the euro paid or just around 50% of the post-discounted price paid!

Now, that's what I would call overpaying for the loans.

Economics 29/04/2010: Debt crisis is spreading

Another credit downgrade from S&P, this time for Spain, from AA+ to AA with negative outlook, based on the outlook for years of private sector deleveraging and low growth. Spain, as you can see, is severely in red in terms of debt, ranking 14th in the world. Spain's external liabilities stand at 186.1% or $2.55 trillion (as of 2009 Q3) against estimated 2009 GDP of $1.37 trillion.

The country is actually worse off in terms of debt than Greece which has ranks 16th at debt at 170.5% of GDP or $581.68 billion, with 2009 GDP of $341 billion.

Of course, Ireland is world's number 1 debtor nation with external debt of 1,312% of GDP (IFSC-inclusive) of $2.32 trillion in Q3 2009 against the GDP of $176.9 billion. Of course, part of this debt is IFSC, but then, again, we really do not have a claim on our GDP either, with GNP being a more real measure of our income. So on the net, our debts - the actual Irish economy's debts - are somewhere in the neighborhood of 740%. This is still leagues above the UK - the second most indebted nation in the world - which has the debt to GDP ratio of 'only' 426%!

The S&P also provided estimate for expected recovery rate on Greek bonds, which the agency put at 30-50%. In other words, S&P expects investors in Greek bonds to be paid no more than 30-50 cents on the euro. Yesterday on twitter I suggested that "Greek debt should be renegotiated @ 50cents on the euro - severe default. Portugal's @ 80 cents - mild default, Irish @ 70-75 cents". Looks like someone (S&P) agrees. Before it is too late, before German and other European taxpayers have poured hundreds of billions of euro into the PIIGS black hole of delinquent public finances, Europe should cut losses and force Greece and Portugal to renegotiate their liabilities. If Ireland and Spain were to elect to follow, so be it. Of course, in Irish case, the debt re-negotiations should cover private debts, not public debt.

Just how many billions of euros are EU taxpayers in for for the folly of admitting Greece - a country that spent 90 years of the last 180 (since 1829) in defaults on its debts - into the common currency area? Well, Greek 2-year bonds were traded at yields of 26% yesterday at one point in time. This is pricing that's in excess of pretty much every developing country, save for basket cases which practically cannot issue bonds at all.

IMF's Dominique Strauss Kahn has told Bundestag yesterday that Greek package will be

• €100-120bn for three years;
• Which means German taxpayers are on the hook for €67 billion over 3 years, not €25 billion that Germany ‘s economics minister was signing for in the original deal;
• Ireland's contribution will also have to rise to €4 billion over 3 years, not €500 million we originally were told we will have to contribute;
• Greece will not be forced to restructure or reschedule debt
• The loans to Greece will be subordinated to existent bondholders, which means that if in the end Greece does pay 30-50 cents on the euro to the latter, European taxpayers will be lucky to get 10 cents on the euro.

The whole deal is now looking like a massive subsidy for Greece and entails absolutely no protection to European taxpayers.

But internationally, EU news are getting darker and darker by the minute. Last night Bloomberg reported that EU countries are in for estimated €600 billion bill for the fiscal crises that have spread across the block. That's the cost, in the end, of all the tacky policy follies that Brussels endorsed and pushed through over the last 10 years -

• from the Lisbon Agenda, which was supposed to deliver EU to the position of economic superiority over the US by 2010,
  
• to the Social Economy, which was supposed to deliver... well, who knows what...
  
• to the Knowledge Economy, which was aiming to turn us all into brains in a Petri Dish
• to the absolutely outlandish HIPCI and HIPCII agendas wholeheartedly embraced by the EU, which were supposed to deliver debt relief to the world's real basket cases (before Greece and other PIIGS took the spotlight away from them), and the rest of the international white elephants.

The problem, of course, is that €600 billion price tag for fiscal excesses has generated preciously little in returns (despite what folks at Tasc keep telling us about the fiscal stimulus) which means we will have to pay for it out of our long term wealth. The same wealth that has been demolished by the recession and the financial markets collapse!

Economics 28/04/2010: 'Duin de rite ting'

A brilliant chart from one of the readers (hat tip to Jonathan):
May Toyota forgive me a pun, but is this a stuck (downward) accelerator problem?.. After all the 'right things' done to our economy, why are we still leagues away from even our fellow PIIGS travelers?

Economics 28/04/2010: More on Greece contagion

Contagion from Greece is clearly a problem for the EU at this stage. Looking back into some older data, February 2010 note from Credit Suisse (linked here)
Spot Ireland at position number 7? That was then. The figures refer to 2009, which means that since then, pressures on Iceland, Hungary and Latvia have receded. In addition:

• Our 2009 deficit has been revised to 14.3%
• Our CA deficit has worsened (as imports are falling at a lower rate and exports are now performing less robustly)

So re-weighting the score in the right hand column of the table, Ireland gets closer to 38.1-38.3, Portugal moves to 39.4-39.5, Greece to 45. We are number 3 on the list...


PS: If you want to see an example of absolutely and even alarmingly distorted logic - read this. One of the best examples of bizarre ramblings that pass for 'analysis' in Ireland. I mean what else can you call a note that:

• Admits that Ireland has record deficits of all EU countries;
• Admits that debt levels are very high;
• Admits that we are close to Greece;
• Admits that Greece is deep trouble, and then
• States that "The Greek recesion [sic] had been milder than the EU average, and recovering, before austerity measures were adopted" and thus
  
• Makes an implicit claim that the spectacular collapse of Greek economy witnessed by the entire world and threatening contagion to all of the EU has been caused by Greece not running enough deficits!
• And concludes that: "By contrast, other EU countries adopted fiscal stimulus measures [without identifying which states did so, what were the implications of these, etc]. Their debt has stabilised along with economic activity [a mad claim, given that stimulus measures were financed out of debt increases] and they have been rewarded with much lower bond yields than Ireland [absolute groundless claim, as none of the countries that adopted stimulus had the same fundamentals as Ireland going into the recession or during the recession and furthermore, none of the countries, other than PIIGS experienced similar bond yields dynamics to Ireland]"

I mean this stuff is actually factually incorrect and logically inconsistent!

Economics 28/04/2010: Our week so far

So will Germany open a 'needle exchange' for Europe's debt junkies (para-phrasing Laughinbear comment)? Check CNBC's rankings of debt by nation (here - all rankings slide show)... Greece is No 16, Ireland is No1! Link here.

Ireland 10-year yields are at 5.6% and moving in tandem with Portugal and Greece. Here is a revealing weekly step-function for our 10-year notes (hat tip to Brian Lucey):

Economics 27/04/2010: Greece - the end is tragic!

2-year yields close of today:
EU = 0.7%
Ireland = 3.6%
Portugal=4.8%
Greece = 16.4%
This is it, folks. No where else to run. Greek interest on public debt would swallow over 19 percent of their GDP annually!

Clearly, Ireland should do what Greece did, according to the folks at Tasc, the Irish Times and in the Siptu building. Ramp up borrowing to stimulate economy...

Economics 27/04/2010: Greece & Ireland - tied by the risk of contagion

As the Greek, Portuguese, Italian and Irish bonds are melting in the markets' gaze at the countries fundamentals, one quick reference number is worth repeating. Per Chapter 1 of the latest Global Financial Stability Report from the IMF (linked here), the overall risk of contagion from a systemic crisis in one Euro area country to another (as measured by the percentage point contribution to total distress probability) for Greece was:

Contagion from Greece to:
October 2008-March 2009

• Portugal = 9.8%
  
• Italy = 9.9%
  
• Ireland = 12.5% (highest of all Euro area countries)
  
• Spain = 9.0% (in line with the Euro area total)
  
• Euro area as a whole = 8.8%

October 2009-February 2010

• Portugal = 23.6% (in line with the Euro area total) - up 13.8 pps
  
• Italy = 24.2% - up 14.3pps
  
• Ireland = 31.3% (highest of all Euro area countries) - up 18.8 pps
  
• Spain = 23.9% (in line with the Euro area total) - up 14.9 pps
  
• Euro area as a whole = 21.4% - up 12.6 pps
  

So spot the odd one here. As the crisis evolved, despite our Government's talk about 'Ireland turning the corner' and 'doing the right thing', our economy became actually closer and closer linked to Greece. More so than any other member of the PIIGS club. Some achievement that is...

Now, spot the similarity in responses to the crisis in Greece (here) and Ireland (here) and tell me - are we really that much better off in terms of macro fundamentals than Greece, especially given that Greek policymakers are at the very least not held hostage to a Social Partnership in which the likes of Tasc-informed Unions have a direct say?

Economics 26/04/2010: Bank of Ireland Conversion Deal

Bank of Ireland deal: per latest report from the RTE, the State's shareholding in BofI will increase to 36% from 16% through a conversion of €1.7bn of funds given to the bank last year into ordinary shares. The bank will now attempt to raise the other €1.7bn in equity from private markets with a rumored discount on first-offer of 40%.

Minister for Finance Brian Lenihan said that 'This transaction is good news for our economy, good news for the taxpayer and good news for Bank of Ireland's shareholders and investors.'

This is another extraordinary statement made by the Minister. The Minister has just informed the nation that we are overpaying some 11%+ (see below) for the shares gained under this conversion, since 'the transaction has been agreed on market terms'.

Aside: the Minister does not appear to clearly understand the terms of conversion he agree to, as 'market terms' would mean that the state is converting at a current price (Friday close of €1.80) less cumulated dividends (2 years @8%), less the discount extended to the market (38-42%). 'Market terms' therefore would imply conversion at €0.88 per share, not €1 per share achieved.

Finally, the Minister failed to negotiate a discount that should be due any large-scale investor. All in, the estimated overpayment of 11% is really a likely underestimate. In exchange for our money, we, the taxpayers, got a pile of over-priced shares which are about to be diluted!

Looking closer at the details: BofI plans to raise €500mln from private placements with institutionals, priced at €1.53 or 15% discount on Friday close price. The main issue will be €1.2bn (net) with 38-42% discount. Preference shares held by the taxpayers will be converted at €1 per share (they were bought at €1.2 per share and paid no dividend), which actually means we de facto are paying €1.16 per share, while existing shareholders can get shares at as low as €1.04-1.06. Government-held warrants are priced at ca €491mln.

Economics 25/04/2010: Forfas' mathematical modeling powers

Name and shame, folks. The table below is reproduced from Forfas' "Profile of employment and unemployment" publication from February 2010. The research paper itself is not really worth covering in any depth, as it contains broadly speaking nothing new. But the table below is worth one's attention. Irony has, it is sourced as "CSO Quarterly National Household Survey, Forfás calculations". One can really see the quality of 'calculations' deployed from the sophisticated mathematical Scribbling Model developed by the 3-year olds in a Montessori University and adopted by Forfas research staff. Superb!
Oh, and just in case you might think there are real calculations used anywhere later in the paper in relation to this table, don't be fooled - the entire computational burden here is that of adding percentages! Too bad they never attached a detailed breakdown of their costs that went to cover this glossy production...

Economics 24/04/2010: Greece and Ireland

The unedited version of my op-ed in today's Irish Independent (link here)

“It’s been a brilliant day,” said a friend of mine who manages a large investment fund, as we sat down for a lunch in a leafy suburb of Dublin. “We’ve been exiting Greece’s credit default swaps all morning long.” Having spent a couple of months strategically buying default insurance on Greek bonds, known as CDS contracts, his fund booked extraordinary profits.

This wasn’t luck. Instead, he took an informed bet against Greece, and won. You see, in finance, as in life, that which can’t go on, usually doesn’t: last morning, around 9 am Greek Government has finally thrown in the towel and called in the IMF.

As a precursor to this extraordinary collapse of one of the eurozone’s members, Greece has spent the last ten years amassing a gargantuan pile of public debt. Ever since 1988, successive Greek governments paid for their domestic investment and spending out of borrowed cash. Just as Ireland, over the last 22 years, Greece has never managed to achieve a single year when its Government structural balance – the long-term measure of public finances sustainability – were in the black.

Finally, having engaged in a series of cover-ups designed to conceal the true extent of the problem, the Greek economy has reached the point of insolvency. As of today, Greece is borrowing some 13.6% of its domestic output to pay for day-to-day running of the state. The country debt levels are now in excess of 115%. Despite the promise from Brussels that the EU will stand by Greece, last night Greek bonds were trading at the levels above those of Kenya and Colombia.

Hence, no one was surprised when on Friday morning the country asked the IMF and the EU to provide it with a loan to the tune of €45 billion. This news is not good for the Irish taxpayers.

Firstly, despite the EU/IMF rescue funds, Greece, and with it the Euro zone, is not out of the woods. The entire package of €45 billion, promised to Greece earlier this month is not enough to alleviate longer term pressures on its Government. Absent a miracle, the country will need at least €80-90 billion in assisted financing in 2010-2012.

The IMF cannot provide more than €15 billion that it already pledged, since IMF funds are restricted by the balances held by Greece with the Fund. The EU is unlikely to underwrite any additional money, as over 70% of German voters are now opposing bailing out Greece in the first instance.

All of which means the financial markets are unlikely to ease their pressure on Greece and its second sickest Euroarea cousin, Portugal. Guess who’s the third one in line?

Ireland’s General Government deficit for 2009, as revised this week by the Eurostat, stands at 14.3% - above that of Greece and well above that of Portugal. More worryingly, Eurostat revision opened the door for the 2010 planned banks recapitalizations to be counted as deficit. If this comes to pass, our official deficit will be over 14% of GDP this year, again.

All of this means we can expect the cost of our borrowing to go up dramatically. Given that the Irish Government is engaging in an extreme degree of deficit financing, Irish taxpayers can end up paying billions more annually in additional interest charges. Adding up the total expected deficits between today and 2014, the taxpayers can end up owing an extra €1.14 billion in higher interest payments on our deficits. Adding the increased costs of Nama bonds pushes this figure to over €2.5 billion. Three years worth of income tax levies imposed by the Government in the Supplementary Budget 2009 will go up in smoke.

Second, the worst case scenario – the collapse of the Eurozone still looms large despite the Greeks request for IMF assistance. In this case, Irish economy is likely to suffer an irreparable damage. Restoration of the Irish punt would see us either wiping out our exports or burying our private economy under an even greater mountain of debt, depending on which currency valuation path we take. Either way, without having control over our exit from the euro, we will find ourselves between the rock and the hard place.

Third, regardless of whatever happens with Greece in the next few months, Irish taxpayers can kiss goodby the €500 million our Government committed to the EU rescue fund for Greece. Forget the insanity of Ireland borrowing these funds at ca 4.6% to lend to Greece at ‘close to 5%’. With bonds issuance fees, the prospect of rising interest rates and the effect this borrowing has on our deficit, the deal signed by Brian Cowen on March 26th was never expected to break even for the taxpayers. In reality, the likelihood of Greece repaying back this cash is virtually nil.

Which brings us back to our own problems. What Greek saga has clearly demonstrated is that no matter how severe the crisis might get, one cannot count on the EU’s Rich Auntie Germany to race to our rescue. We have to get our own house in order. Unions – take notice – more deficit financing risks making Ireland a client of the IMF, because in finance, as in life, what can’t go on, usually doesn’t.