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There are three things one must wonder about when it comes to the Credit Unions in Ireland:
Why aren't we hearing more about the going-ons in these fine credit institutions that play a significant role in this economy? After all, credit unions have assets of ca €14.5bn per end of 2009 figures. €6.8bn of this is in loans and €7.3bn in investments. And they act as, in effect, second tier lenders (correcting per a tip from a reader: not in terms of quality of borrowers but in terms of types of loans), with most loans going to unsecured lending on cars, home improvements, personal spending, etc. Could they have miraculously escaped the fate of the banks in the current crisis? Highly unlikely.
Why do we have a separate regulatory regime for these organizations, if their basic business model is virtually identical to prudentially justified banking?
Well, folks - in the land of endless quangoes (aka, Ireland) we have a financial regulator and a separate credit union regulator. The latter, James O Brien, now reportedly wants new additional provisions to be made by the 20 unions (out of 414 - a whooping 5%) operating in Ireland that face “serious solvency issues”. Oops. That was a sudden one. In effect, back in 2008 the Irish League of Credit Unions (yeah, I know, sounds like a Klingon gathering) issued annual report full of concerns for the Credit Unions' state of health on their investment side. Then there was a report into the impairments charges. Which promptly followed by a dramatic decline in the surprise spot inspections of the Credit Unions - the only real tool for assessing just how bad the loan books might be.
Now, we are being told that there are Credit Unions out there which have 'serious solvency issues' - or translated into common language 'might be trading in insolvent conditions'. Apparently, arrears levels in the Irish credit unions rose from 6% in 2008 to 13.5% in 2009. The Credit Unions Klingon-styled response to this was to lobby Brian Lenihan to allow them continue lending for holidays in the sun to households, some of which can easily be on the verge of running into trouble with the banks. You see, credit unions provide credit after the banks provide secured loans to the punters (again, correcting per a tip from a reader: this does not mean that credit unions lend to a less worthy client than the banks, it means that they supply lower priority - in household budget terms - and largely unsecured loans. Neither does it mean that credit unions provide loans to people who were turned down by the banks.However, it is known that credit unions did provide top up loans for house purchasers who have exceeded mortgage allocation and borrowed to either supply a deposit or cover closing costs on property from the credit unions).
Credit unions do so by taking deposits from the same punters in exchange for the promise of a dividend - an annual payment that is there to replicate deposit rates paid by the banks. Alas, when a company runs into red, unless the company is AIB, the normal practice is to withhold the dividend and use the company earnings to replenish capital base. The credit union movement in Ireland disagrees, arguing that a dividends withdrawal for funding of higher reserves and offsetting losses on loans would damage their 'competitiveness' vis-a-vis the banks.
There is, of course, one major issue with the Unions operations - in effect, absent restoration of the proper functional business banking in this country, Credit Unions are now becoming more actively involved in small businesses operating capital management. This is a risky undertaking for all parties involved and we do not have much data on the matter. Small businesses - sole proprietorships in particular - can blend business cash flow management with personal banking, inducing risk spill-overs from business side to household finances. Increasing reserves requirements on Credit Unions will be likely to put the boot into this, rather atavistic, practice, made necessary by the lack of functional business financing in the core banking sector.
But one must be concerned about the end game here. If the regulator were to listen to the unions, what alternative ways can be found to cover the losses then? None other than a direct injection of cash from the taxpayers. So here we have it - welfare junkies in Ireland have reached a new high. We are being indirectly told that Credit Unions should be allowed to pay dividends out by keeping reserves low, even as they face mounting losses. Surely the taxpayers can provide a cover for these, should the trading environment continue to deteriorate into the future. Happy times, folks!
I have not updated my forecasts for the euro zone growth in some time now, and it is on the 'to do' list. However, as predicted, euro area leading indicator from Eurocoin came in today at a disappointing 0.55% down from 0.67% a month ago and marking a second consecutive monthly decline. The indicator hit 0.79% in March 2010, marking a 3-year high. This time around, declines in the indicator were driven by the adverse movements in the stock markets valuations. However, decline is absolutely in line with PMIs, despite the industrial production indicator showing sustained growth. Also worryingly, consumer confidence remains below waterline and is trending down again:Exports are on a tear up, rising at a faster rate in May relative to April. This might be the good news for overall growth, but it is clear that domestic investment and demand sides are still recessionary. Of course, there's a popular theory out there - in Brussels, and even here at home in Dublin - that exports will lift us out of the recession. If you think so - look no further than Japan. Japan has managed to maintain booming export activity, amidst shrinking overall economy for two decades now.
RTE reports on the CB data on mortgage arrears, stating that: "New figures from the Central Bank show a 13% increase in the number of mortgages [90-days or more] in arrears [relative to December 2009]. However, the figures also show a fall in the number of legal actions taken by financial institutions to enforce outstanding mortgage debt."
At the end of Q1 2010, over 4% of all private residential mortgage accounts in Ireland were in arrears - the total of over 32,000 of 791,000 mortgages worth €118bn. Median duration of arrears was in excess of 180 days.
"The Central Bank notes a drop of 4.8% in the number of arrears cases in which legal proceedings have been issued. There are just over 3,000 such cases. During the first quarter of this year, 91 properties were repossessed by banks, 26 on foot of court orders and 65 by voluntary agreement of the borrowers or by abandonment. At the end of March mortgage lenders held 456 repossessed residential properties."
The issues not raised by either the CB or RTE are:
Have the banks willingness to pursue cases in court been impacted in any way by Nama operations? Nama is a political entity, with potential to influence banks internal decisions.
With median duration of mortgages arrears of 180 days, can we expect the number of cases heard in courts to dramatically accelerate in H1 2011?
Mortgages reported in arrears do not include mortgages where lender and borrower have renegotiated mortgage covenants, avoiding arrears by switching to interest-only mortgages and/or changing maturity profile of the mortgage, and/or extending a payment holiday.
What is the median/average size of the mortgage in arrears. It is likely that mortgages currently under stress are larger and cover properties with much more significant extent of the negative equity.
What is the sensitivity of arrears to interest rate changes. The statistical eagles in the CB - we do have some there, right? - can easily compute the sensitivity of mortgages default to changes in retail interest rates. All they need for this is longer-run data on mortgages defaults, retail rates, macroeconomic parameters, housing prices etc. Shouldn't take much of time or effort for the CB to get this useful estimate. We can then see just how damaging the ongoing increases in mortgage rates by the banks will be to this society and economy.
In effect, we are only seeing the tip of an iceberg here.
Now, one interesting revelation that comes on the foot of these figures is the spread of mortgage debt burden in the country. 791,000 mortgages are outstanding, involving on average more roughly 2 individuals, majority of whom are in employment. This implies that mortgages debt cover in the workforce accounts for roughly 1,580,000 individuals, or 73% of the entire labor force.
Another thing - with 73% of working (or able to work in theory) households already carrying a mortgage (or two), and defaults on mortgages rising 13% per quarter, I guess two natural questions to ask are:
In the short run: What stabilization in the property markets can one discern here?
In the long run: what hope can the Government have to collect any sort of serious wealth tax, when most of our wealth has been tied up in, by now, largely devalued property?
Just a chart - from IMF Fiscal Stability report: Now, as noted - this excludes housing, medical cards, child supports etc. Given that in Austria, Belgium and Denmark rental values are lower, while healthcare is universal for all, where does it put the combined value of long term unemployment benefits in Ireland compared to these two countries? And given our wage deflation since 2008, relative to Austria, Belgium and Denmark?..
Of course, we simply have to omit the petro-dollars fueled economy like Norway from consideration. Notice - this chart reflects comparatives for 2008 data for long term unemployed. Cutting unemployment benefits is a hard target. We will have to face that choice, however. Given this, my view would be to impose more significant cuts on longer term recipients, and lower cuts on short term recipients. This should create stronger incentives to seek employment and skills for those who have the lowest propensity to do so - the long-term unemployed.
As of now, both BofI and AIB are trading below 52-weeks lows. The financials are continuing to experience pressures. But a look back at the overall sector is warranted. Here are some stats: Let's start from a far: dramatic or not, but the current market conditions are in line with the long term time trend in Irish financials. If anything, per almost 11 years of data, we are currently above the long run trend line. Guess there's more room for downward pressures, should long run dynamics matter.
Zooming in: Note the chart above - this shows the totality of value destruction since the beginning of the credit crunch back in July/August 2007.
To see some more dynamics, consider the snapshot from the peak to today: The chart above shows the entire extent of the crisis, with the medium term (through crisis) trend pointing to consistent positioning of the current market valuations. In other words, per trend, nothing dramatic is happening in the markets right now. I also posted some key dates that mark our policy and opinion makers' ability to track markets and predict the future.
Lastly, chart above shows the dynamics in Irish financials over the span of the 'rebirth of optimism' - the last 12 months during which various Government officials and politicians have made a score of statements to the effect that:
Ireland has turned the corner on recession
Irish banks are now in a stronger position than before
Irish Government has made right decisions and these are now evident in the markets' approval, etc.
Daft rental report is out today. Some interesting reading of the numbers. As predicted by me on the foot of January data - when the prevailing media song was about 'stabilizing' rental markets - rents are continuing their Southward trajectory.
Relative to peak rent: So no relief in sight. Remember, in this country we call things 'stabilizing' when the rate of fall slows down... Pardon my foreign language skills, but I'd say things are stabilizing when we reach the bottom. In other words, when the numbers above stop increasing in absolute value.
Let me reproduce for you the seasonality chart I did back on the foot of January data: You can see what I meant by January rally back then, and you can see that things have fizzled out since then. When one realizes that since 2008 we virtually had no new units coming into the rental market, this figure looks even more depressing. We are experiencing a real decline in demand as jobless families are dropping out not out of the property market, but out of the rental market! Emigration is, no doubt, also playing its part. All of which means that those first time buyers... well, are rapidly becoming first time lodgers in their moms homes.
What about the dynamics going forward? Well, neither levels of rents, nor rates of change in rents are showing any stabilization. Both series are trending in the negative territory, suggesting that pressure on rents might remain, adjusting for seasonality, for some time. That said, positive monthly territory for now remain in sight, both in moving average terms and in rate of change terms. So expect shallow moves, with a risk to some downside.
Update: Since earlier today, there have been some debates going on as to whether Daft data shows any stabilization in rents. As I asserted earlier, relative to peak, monthly march downward continues (see table above) uninterrupted (once seasonality is factored in for January) and in absolute terms for all 4 months. But what about year on year changes? Table below shows the results: So per annual changes, 2 conclusions are warranted:
While the rate of decline has moderated across 2010 relative to 2009, the declines continued in double digits in February, March and April. Only in March and April have the declines been lower than a year ago.
Probability wise, this was to be expected given seasonal variations, with likelihood of more positive moves in March and April being twice higher than in February.
On the net, I do not see any stabilization so far. Oh, and just in case you wondered - Daft data also shows uptick in properties available for rent... Hmmm...
So, you've paid €0.19-0.32 per rights per share of BofI - following, undoubtedly your brokers advice (for the €0.24-0.32 part of the range, or Friday close per €0.19 bit). You shelved out €0.55 per share on the promise of a discount of 42% on the post-rights price from the brilliant boys at BofI. You are now €0.02-0.15 per share in a hole, or down 2.7-20.8% in a span of 2 trading days (using latest quoted price of €0.725 per share).
Consolation / silver lining?
You could have been an Irish taxpayer (most likely you are), in which case you would be nursing a loss of €0.63-0.83 on your earlier purchases of the same shares, assuming Brian Lenihan cuts the losses and sell the rights (a tall order assumption).
Then again, although all of us lost - either as bank's new shareholders or as taxpayers, there is yet a much more adversely impacted group of people out there - the poor souls who, while paying taxes in this land also bought a-new into BofI rights issue...
Really, a rare example of all lose, no one wins... except for the existent shareholders and BofI management, who so far enjoyed artificial support from the State.
Now, do recall this: on Thursday September 18 2008, our former Leader Supremo Bertie Ahern told George Hook (Newstalk)that: Bank of Ireland shares are €3.80 today. Now, if I meet you here next year, or the year later, do you seriously think Bank of Ireland shares will be €3.80? I'd go out and buy Bank of Ireland shares... that's what I'd do" (quoted from the next day Irish Times - here). Errr...
As a harbinger of good news I bring to you all... Ah, what the hell, here is the announcement: And actually this is the good news - Infinity is the leading international finance academic/practitioner conference in Ireland and it is great to see it back in town this year. It is a truly international venue (as in actually attracting real, not invited & paid-for, experts and speakers, with real - not imaginary or self-appointed - clout in global finance) and it carries hundreds of latest research papers with the focus on different areas of international finance.
Few notes of worth:
Patrick Honohan will open the proceedings - Patrick, of course, has spoken at Infinity before, in his academic capacity, reviewing papers and presenting them. Two years ago he launched a session that introduced the book myself, together with Sharon Jackson and Colm Kearney edited and co-authored on the issue of Global Debt problems. He will, undoubtedly, engage with the audience of peers this time around.
Bill Megginson, the University of Oklahoma will present on “The Value of Investment Banking Relationships: Evidence from the Collapse of Lehman Brothers”. We should ask him few questions as to his view of the Irish Government claims that Lehmans' collapse was responsible for our gravely ill banking sector, instead of the homemade hash of senile lending practices.
Simon Stevenson, Director, Center for Real Estate Finance, City University London; Derek Brawn, Property Economist and Author; Peter Matthews, Banking Consultant and myself will be talking about Real Estate Finance - so expect myself and Peter getting stuck into long term effects of Nama on this vital (for Ireland Inc) sector, while Simon - one of the world's preeminent and prolific researchers in the area (and a good friend and co-author) - will be on hand to tie it all into international markets framework. Simon, by the way, has really first class knowledge of Irish markets as well - just one example of his recent work includes the paper that James Young and myself co-authored with him on property auctions in Ireland, forthcoming in the Journal of Housing Economics (number one venue for academic research in the field of property).
Edward J Kane, Boston College, USA will speak about the “Post-Crisis Financial Reform as Denial and Coverup” - a salient topic given the current state of regulatory reforms proposals coming out of the EU. Judging by the strong title, this is not going to be one of them placid academic discourses on how to find a "balancing act" or "resolve the problems of injustice and equity in financial services"...
On a practitioner interface side: “Investments in the Post-Crisis World” a roundtable organised by CFA Ireland and moderated by Aleksander Sevic of Trinity College Dublin, will be dealing with: “An Update on Latest Trends in Fund Offerings” by David Hammond, CFA, Bridge Consulting; “Major Challenges in Allocations to Irish and Emerging Markets’ Equities, Liquidity Risk and Product Innovation: The Perspective of a Pension Fund Trust” by Stephanie Condra, CFA, Invesco Pension Consultants; “An Update on Current Issues in the EU Government Bond Market” by Catherine McLaughlin, CFA, Irish Life;
For those interested in CDS bond spreads - the hot potato in today's media and politicos discussions - Brian Lucey will be presenting a paper (in which yours truly is one of the co-authors) "CDS Bond Spreads among the PIIGS 2006-2010"
Ok, enough of praise singing - couple of links: programme for Infinity is available here. I intend to blog and twitter on it during the proceedings. I also intend to do one or two interviews with top participants - hopefully might convince Business & Finance to run something on this.
Finally, in a note of custom for this blog - Infinity is a fully self-financed conference, built on work of Brian Lucey, Linda Sorinton and others in TCD School of Business, excellent researchers like Elaine Hutson of UCD and many others. Many involved are co-authors in academic life, so all discussions are frank, open and usually free of agendas. Infinity has no reliance on subsidies of any sort. Unlike many other 'specialist' or 'futurist' conferences out there, richly sprinkled across Irish calendars. So no taxpayers funds will be harmed in the preparation of this event - an example of real academic sustainability!
Thursday was another day of great ideas from Berlin on “How to wreck world financial infrastructure while earning little political capital: the Angela Merkel Way”.
For a couple of weeks now, global investors have shown Madam Chance-a-lot (oops… Chancellor) that Greek Tragedy rule 1 applies: If you want to write a tragedy, set up a story where an irrational, arrogant and morally reprehensible sovereign challenges the Gods. Inevitably, in Greek classical tradition, the Gods win, while having a laugh. Mrs Merkel’s epic battle with the markets is exactly that. Markets, like Greek deities, are inevitably going to prevail. And Mrs Merkel and the retinue of euro area leaders – bent on ring-fencing their own politically connected banking sectors and shielding them from any meaningful pain for the errors committed in the past – will lose. The only thing that still might be at stake here is the degree of vengeance the markets will deal to the EU, should the euro zone embrace German proposals. With every new ‘bright idea’ on punishing the markets coming, the likelihood of an awesome spectacle of the Gods punishment meted out to Europe is rising too.
Following new taxes and short selling ban (covered by me yesterday) Mrs Merkel has now unveiled her third pillar of the reform strategy: a European ratings agency. It’s bonkers, folks. Just as the rest of the European financial sector reforms proposals so far:
EU Rating Agency will never be independent of political interference, so no one, save for the institutionalised writers in the EU official press will ever pay any attention to whatever the agency might produce. In so far as delivering anything usable by the market or by anyone, save Eurocrats, the EURA will be a complete waste of taxpayers’ money.
EU premise for launching EURA will be as crooked as an old local authorities politico with development firm in his backyard. Germany has departed on the EURA trip from the assertion that Euro needs an agency that can honestly upraise the extent of fiscal risks on sovereign balance sheets. Were EURA to do so, its ratings will have to be even gloomier than those of the Big 3 private rating agencies.
EURA is unlikely to have any serious competency in what it does because unlike the Big 3 it will never be a rating agency for non-EU sovereign debt. In other words, EURA, having no recognition of non-EU sovereigns, will be forced to look at the EUniverse, a subset of the world bond markets. Which makes a proposal equivalent to simulating a tsunami in a coffee mug.
And, of course, as any other rating agency, EURA will be no more than a lagging indicator, which means that its musings on bond valuations are going to be read only by retired intellectuals, plus pensions funds with automatic quality mandates. And even then, EURA will be forced to follow, in the news hierarchy, the Big 3.
In response to Mrs Merkel’s expensive (and it is expensive, from the point of view of European economy and taxpayers – see here) populism, Canadian finance minister told Mrs Merkel into her face last night that his country would not take part in either one of the three European policy follies. You see, Canada has a healthy banking system. And it has the intellectual and policy capital to understand that finance is crucial to country economic prosperity.
Americans, like Canadians and the Brits, think that the idea of a transaction tax is downright potty. All three have done the right things in trying to reform their banks. The EU, so far, is staunchly refusing to do the same. Why should the sane join the outright gaga club of countries that keep preserving rotten banking system at the expense of the real economy?
Even Finnish finance minister is saying Germany’s short sale ban had surprised everybody, unpleasantly. Finns can see through the German plans to the point where a Tobin tax on financial services will exert adverse selection against smaller exchanges in favour of the larger ones (again, see more on this here).
Why? Because the problem with financial institutions today has nothing to do with volatility in financial assets prices. It has everything to do with reckless lending by the banks and the willingness of bondholders to underwrite excessive borrowing (including that by the sovereigns). In the real world banks are willing to write poor loans because they and their shareholders and bondholders know that they will be rescued by the state, should things go pear-shape. And, of course, governments always oblige. Look no further than Nama. Wrecking regulatory vengeance on the markets in order to address the problems with the banks – as Mrs Merkel is doing – is hardly a way forward.
Only a massive scale intervention by the ECB, going most likely well beyond simple sterilization of €20 billion of sovereign bonds purchased by the bank so far, has pushed the euro up against the dollar. But at what cost, one might wonder, especially in the environment where deflation is creeping back into the US stats? I don’t have the data on ECB operations this week, but something was certainly hitting the markets for FX and bonds. Of course, sterilizing and supporting currency are two individually costly propositions. But for ECB to engage in this double game for a prolonged period of time will spell significant drying up of the liquidity. It is like an overweight elderly amateur playing alone against, simultaneously, Roger Federer and Rafael Nadal. The result will be painful, quick and devastating.
Sterilized cash can be re-injected into the banks reserves, without cash hitting the streets, but that would only mean more real money being trapped in the liquidity sucking spiral of government financing via ECB lending to the banks. We’ve been there for the last 24 months and it is not pretty.
In addition, there is a pesky issue of the US position. In effect, Japan, China, Germany and the entire euro zone are playing beggar-thy-neighbour game with the US by artificially suppressing the cost of their exports to America. The problem, as I have pointed out before (here) is that this requires US consumers to start borrowing again to sustain massive trade deficits. If this fails to materialise, and it is hard to see how it can, then the entire pyramid scheme of global trade will collapse. In the end, the double dip, this time caused by trade tensions and falling exports, is on the cards for all, as undervalued currencies in the three major powerhouses of global trade will prevent their consumers from expanding their own imports demand.
Such an outcome, however, will be preceded by a significant pain for Europe’s domestic economy. While a 10% devaluation of the Euro against a basket of global currencies can be expected to lead to a significant boost in Euro area economy (ca +0.7% in year one after devaluation and up to +1.8% in year 4), this exports-led growth will be associated with massive increases in the interest rates (+85bps in year one, to +220bps in year 3). These estimates are taken from Econbrowser (here). Obviously, the rest of the world will be just cheering EU and Mrs Merkel in this destruction of economic growth... or not?
IRELAND LOSES RYANAIR HANGAR AND UP TO 200 JOBS TO GERMANY AND FRANKFURT HAHN AIRPORT
(Thursday, 20th May 2010) ...At a press conference in Mainz today, hosted by Ryanair’s Michael O’Leary and Minister for Economics and Transport, Hendrik Hering, Ryanair announced that it would invest €25m in building a new two bay aircraft maintenance hangar including two aircraft simulators and a 16 room cabin crew training centre, in a move which will create up to 200 new Ryanair jobs at Frankfurt Hahn Airport.
...This new facility and jobs will replace those previously offered to the Irish Government earlier this year in the empty Hangar 6 at Dublin Airport. Ryanair regrets that even today, many months later, Hangar 6 remains unused for base maintenance, while up to 900 SRT Engineers remain unemployed, drawing the dole. Many of these people could have found skilled, well paid work, with Ryanair, had the Irish Government accepted the airline’s offer to buy or lease Hangar 6 and divert a significant proportion of Ryanair’s base maintenance to Dublin Airport.
Speaking today in Germany, Ryanair’s Michael O’Leary said:
“While we are pleased to announce this new investment in Germany and Frankfurt Hahn Airport, I regret that the Irish Government stood idly by and did nothing to win these new jobs for Ireland. The Irish Government talks a lot about competitiveness, but is short on action.
“At a time when traffic and tourism is collapsing in Ireland, the Irish Government prefers to impose tourist taxes, and order big increases in Dublin Airport’s fees, rather than work with the world’s largest airline to lower access costs, win investment in maintenance or create hundreds of well paid engineering jobs at Dublin Airport.
“Sadly in Ireland, we are stuck with a Government which likes talking about the “smart economy” but prefers implementing “dumb policy”. The sooner they reverse these tourist taxes and slash high costs at the Government owned DAA airports, then the sooner Irish airports and tourism can return to low cost access and traffic growth”.
“Berlin means business” says Spiegel about the latest plans by German Government for an EU-wide revision of fiscal and financial architecture.
This Tuesday, “EU finance ministers announced efforts to both rein in hedge funds operating in Europe and to introduce a tax on financial transactions”.
Wait a second, folks – take Ireland: a sick financial system with plenty of financial services taxes, including a stamp duty on transactions, all the way down to bank cards levies. Has the presence of the Tobin tax here helped to prevent the crisis? Will it work in Europe? Not really. Why? For several reasons:
Tax is avoidable by offshoring trades outside the EU. The effect of this will be – higher cost of capital raising for companies, selection bias in favour of larger companies in access to the capital market (AIG advantage anyone?),lower after-tax returns to investors and higher cost of financial services to all of us. Falling listings in Europe and greater state pensions reliance. Which part of this equation makes any economic sense?
The tax will not fund sufficient insurance provision against the need for future bailouts. When you think of the magnitude of bailouts we’ve witnessed, the levels of taxation would have to be so high, there will be no financial markets in Europe left.
The tax will, however, fund general Government spending in the Eurozone. Which, of course, means more of our money (yes, yours and mine – as long as we have pensions, savings, investments or if we work for companies that have listed shares or have plcs as their clients…) will be going to noble causes of public sector retirement and wages packages, social welfare spending, politically motivated pet projects, and so on.
The tax will retard economic development in Europe. One of the reason why European banks are so sick is because European companies are heavily reliant on banks lending. European businesses are based on loans, not equity - in other words, they are based on debt. Vast amounts of debt. And when such culture of financing collides with an asset bubble drivers of exuberant expectations, banks balance sheets swell with bad loans. The new tax will only perpetuate this inherently inefficient utilization of equity financing across Europe. Which means less growth, fewer businesses and fewer jobs.
Next, of course, in the line of fire are the hedge funds. They had to be reined in because… no wait, remind me, why exactly? Hedge funds did not cause the current fiscal crisis (they have no control over the Governments’ borrowings and spending), nor did they pollute banks balance sheets or caused the property bubbles. Why are they a target then? Because for European leadership, ‘Doing right’ means ‘Doing politically easy’. Hedgies have no strong lobbyist interest behind them, unlike the banks, property developers, sovereign bondholders, sovereign bond issuers, farmers, trade unions and public 'servants' - all who inhabit the vast ques to the trough of Government subsidies. So here you are – we attack a bystander to pretend that we are tackling the criminal in sight.
After hedgies, came in other imaginary villains. On Tuesday night the EU banned naked short-selling and the trading of naked credit default swaps involving euro-zone debt. Oops.. before Tuesday night we knew what markets were betting on into the future – the short positions revealed actual expectations with the power of having real money put behind them. Now we do not. This, per EU leaders, is some sort of transparency. Socratic cave analogy comes to mind.
The EU ban target two types of trading that “have been blamed for exacerbating the financial crisis and Europe's sovereign debt crisis.” Actually, IMF explicitly said (here) in its report last week that the entire CDS markets - not just short sales in these markets - were not enough to cause the crisis. Never mind - EU leaders know how to deal with independent advice from international experts. Any hope, then, that Mrs Merkel's pipe dream of 'independent budgets oversight' (see below) can come true in this land of pure politicization of everything - from rating agencies, to traders, to investors?
It turns out, folks, that European crisis was, after all, not about absurdly high levels of public debt carried by PIIGS, nor by fraudulent (yes, fraudulent) deception by some Governments of investors about the true extent of national deficits. It was not exacerbated by the decade-long low growth recession across the Euro area, nor by a recent severe depression that afflicted Euro area economies. Nope. The cause of this, per Mrs Merkel & Co, were investors who were betting on all of these factors adding up to an unsustainable fiscal and economic situation in Europe. Off we fighting the evil windmills, then, Don Quixote from Berlin!
Worse than that, on top of the ridiculous policies decisions made over the last two days, Chancellor Merkel has also been working hard “on far-reaching changes to the treaty underpinning Europe's common currency, the euro.” Per Der Speigel, “Merkel would like to see increased monitoring of member states' annual budgets, the introduction of stiff sanctions for those in violation of euro-zone debt rules and the suspension of voting rights in the European Council. Furthermore, Germany wants to establish bankruptcy proceedings for insolvent euro-zone countries.”
Really? I wrote about the actual chances of any of this working to the desired effect in the earlier post (here). But now we have some details to the plan:
“According to the document, Germany would like to see annual budgets in euro-zone countries undergo a "strict and independent check." Berlin proposes that the job be taken over by the European Central Bank or by a collection of economic research institutes.”
Now, the problem with this part is that there are no independent organizations in Europe left. The ECB is now a full hostage to Europe’s push for retaining fiscal sovereignty while maintaining unsustainable prolificacy. ‘Institutes’ Mrs Merkel has in mind are a host of EU-funded ‘Yes, Minister’ organizations that populate the realm of economic policymaking on the continent (with a number of them operating in Ireland). By-and-large, they have no capability of delivering anything of real value, let alone anything independent. Even the likes of the OECD – a very capable organization with some degree of independence – is not free from European political interference.
"Euro-zone member states that do not conform to deficit reduction rules should temporarily be disallowed from receiving structural funds," the draft reads. In extreme cases, that funding could be permanently eliminated.”
Imagine Greece today, receiving €110 billion bailout today, being told, ‘Naughty! We will withhold some €5 billion in funds.”Apart from being unrealistic, this idea is potentially quite dangerous. Structural funds go to finance infrastructure and other longer term investment programmes. Many of these rely on co-funding from the Member States and/or private partners. All have private contractors. Impose this potential penalty and cost of public projects financing will have to rise due to uncertain nature of the funding stream.
Withholding these funds will either be meaningless (if the funds withheld are small, as it will cause no damage and will have no power of prevention) or it will cause an economic mayhem as bills go unpaid and workers lose jobs (in which case the sanction will be undermining the process of fiscal recovery and triggering more bailouts).
In short, the threat is either toothless or self-defeating. Either way – it is a cure that threatens to make the disease incurable.
Two more proposals are mentioned in the Spiegel.
“Earlier this month, Schäuble had mentioned the possibility of suspending member states' votes should they find themselves in violation of European debt rules, an idea which is mentioned in the draft proposal.”
This should make wonders of the EU efforts to strengthen its democratic legitimacy. And would this extend to suspending MEPs powers too? European court judges? Commissioners? Where does the buck stop? Should this come to pass, Italy, Greece… no wait – at 60% debt to GDP level, virtually the entire EU will be suspended (see table here). Who will end up voting in Europe? Germany won’t – its own debt/GDP ratio is 72.5%... Ditto for the deficits benchmark.
Finally, per plan: “Should all else fail, the draft calls for a plan to be established for euro-zone members to declare bankruptcy.”
Err… what? Hold on – bankruptcy? Given that the EU own rules to date have so spectacularly failed to contain debts and deficits from breaching EU-own rules, that would be a collective bankruptcy then… One presumes with Germany in tow?
So the Euro has hit 1.219 against the USD last night and has been bouncing erratically throughout today. The markets are flashing red across pretty much entire listings on the back of German 'talking tough' to the speculators. Rumors of Greeks contemplating an exit from the euro are swirling across the forex traders'-frequented blogs. ECB has abandoned all caution and previous policy mandates and is now pumping euros out of FX markets. Sterilizing Europe's economy into a liquidity crisis, before the insolvency crisis is resolved.
In short, there is a clear lack of conviction in the markets about the Euro area plans for more fiscal discipline, as well as a general apprehension about the bans of naked shorts. This is a direct corollary of the 'rescue' package and the political rhetoric that surrounded German Government decision to back the PIIGS - or more aptly BAN-PIIGS - debts. Yesterday, John Cochrane of UofC, my old professor - had a superb analysis of the whole circus (here).
Of course, banning naked shorts for their alleged role in causing market panics is like banning oxygen for its role in causing fires. Short sales positions are about the last bastion of transparency in the murky waters of sovereign finances.
But take a look as to why the entire package of 'fiscal oversight' proposed by the EU has no legs.
First there is an argument to be made that the 'new package' is really 'old news'. In effect it simply front-loads the Stability Programme Updates reporting (currently submitted to Brussels for approval ex post adoption of the budgets). In theory, supplying SPU statements prior to the budget is supposed to provide for (1) time to adjust budgetary positions in response to the Commission criticism; and (2) a chance for 'peer-review' of the budgetary proposals. Apparently, no individual lines of either spending or taxation will be considered, but instead, the headline figures (macro side) will be looked at.
What's wrong with this picture? A lot.
Stability & Growth pact already tasks the EU Commission with such oversight and with tools to fine serial abusers. Yet, countries like Greece have been in an obvious violation of the SGP criteria since at least the late 1980s and nothing was done to enforce the existent compliance mechanism. France has been in violation for about 8 out of 11 years of SGP application. Italy - since the foundation of EMU. The list can go on.
Peer-review by fellow countries does not work in international policy processes. Look no further than heavily edited (by Member States) 'consultative' documents from the IMF, the OECD, the World Bank and so on. States do not criticise states and there is no real mechanics for ensuring that euro area peer review is going to have any more integrity than the 'business-as-usual' Brussels approach to policy making and analysis.
Creation of a formal Eurozone-wide supervisory mechanism will de facto guarantee future bailouts, thus inducing a massive moral hazard on future Governments and fueling risk appetite for the markets. After all, if the budgets are approved collectively, there is at least an implicit collective responsibility when things go wrong. As rightly argued in John Cochrane's article linked above, such a guarantee will be an open invitation to continued unsustainable risk-free lending to the reckless sovereigns from the bond markets.
With peer review mechanism having no real power, the power to police deficits will fall with the Commission. Does anyone have any serious belief that the Commission has whereabouts to enforce the restrictions it cannot adhere to itself? After all, the Commission has failed, repeatedly, to clear its own budgets in the past. And very little positive can be said about the Commission historical ability to produce high level macroeconomic policy analysis. Do we need to be reminded of the Lisbon Agenda or the Social Economy or the Knowledge Economy or the latest pie-in-the-sky Agenda 2020?
Lacking specific powers to go through the member states' budgets line by line - covering all of the expenditure and revenue measures - the oversight process will simply be out of power to either alter anything in response to adverse findings, or to even understand the nature of and risks involved in each headline budgetary projection.
Front loading SPU reporting will do nothing to the Budgetary outcomes, as SPUs, alongside the Budgets are subject to built-in assumptions/expectations. Are we really saying the Commission will be able to tell, for example, Irish Government: 'Boys, you are assuming here economic growth of 4% in year X. That's not going to happen. Revise?' I doubt it.
Notice, I am disregarding the longer-term economic side of the proposal. The EU Commission, as well as many peer states in the review process will have a heavily pro-tax Government spending-favoring and economic growth retarding policies. The Commission, alongside many peer member states consistently believe that budgetary / fiscal health is assured when tax revenue equals tax expenditure (roughly speaking). And they believe that more expenditure is a good thing. Thus, the process is likely to be biased heavily in favour of high-tax, high-spend economic development model. Of course, there isn't a country on earth that has been able to deliver such a model while maintaining dynamic economy. Are we settling Europe into a slow decay model that suits declining demographics of the Continent?
Here is the comparative table on tax revenue collected by the various advanced economies in the boom year of 2007. Notice that the countries currently in trouble - the BAN-PIIGS (Belgium, Austria, Netherlands + PIIGS): What does this analysis tell us?
Tax revenues as a share of economy is well above average for BAN-PIIGS. So low taxes are not a problem that caused their bankruptcy.
The structure of taxation - the spread over various tax heads, is pretty much even across various heads, suggesting that over-reliance on a specific tax head is not a cause of excessive deficits.
The deficits, at least on revenue side, simply could not have been caused by the adverse recessionary shocks.
All of this means that the deficits are structural. And that the debt accumulation was not only visible well before the crisis (which of course means that SGP supervision has failed) but was also caused by the expenditure side of the Government balance sheets.
Remember, these figures are from the boom-time 2007! And take a look at Ireland, expressed in GNP terms. The table below is self-explanatory: So we do live between Boston and Berlin, folks? And we do have exceptionally low tax burden? We really do need more the Brussels-styled fiscal discipline?
This blog represents my personal views and is not reflective of the views or opinions held by any company, contractor, client or employer I work for currently or have worked for in the past. These views are not an endorsement to take any action in the markets or of any political position, figures or parties.
This blog represents my personal views and is not reflective of the views or opinions held by any company, contractor, client or employer I work for currently or have worked for in the past. These views are not an endorsement to take any action in the markets or of any political position, figures or parties.
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