Economics 7/7/10: Nama New Business Plan

Nama New Business Plan (NBP) was published and it took me some time to dust out my old models and run through the numbers.

Let’s put it in simple terms – Nama’s latest installment in its own version of the hall of mirrors is so distorting, when it comes to representing the reality, that even a person with no education in finance would see that it simply a cover up for a scam.

Here are some points worth mentioning before we depart on the journey through numbers

1. NBP contains no Profit & Loss or cash flow projections. For an undertaking committing between €38.5-40.5 billion of taxpayers cash, this is simply remarkable (arrogance? Or negligence? You decide
2. NBP contains even fewer financial details than its old plan. The only relevant piece of new information it contains that has not been disclosed before is in the table 4 on page 25, which, given that no specific cash flow estimates linked to annual operation is provided, is a complete hearsay – or in scientific terms – an unfalsifiable conjecture. In common terms, it is known as bullsh*t
3. NBP states (then rolls this statement into core assumption) that 25% of loans taken over in Tranche 1 are ‘income producing’. It does not explain the extent of this ‘income’ being generated in relation to the value of the loans. Let me explain – suppose I take out a loan for €100mln at 5% per annum. My payment on interest should be €5mln per annum. Barring capital repayment, if I pay my bank €4,999,999 a year, I am in arrears and the loan is not performing. But if I pay Nama €1.00, it is an ‘income producing’ loan. Get my example? In other words, it is a leap of faith to assume that 25% ‘income producing’ loans is the same as 25% ‘performing loans’
4. NBP states: “the actual LTV ratios that have become evident during the Tranche 1 due diligence process have been higher than those indicated by institutions last autumn”, but never explains by how much. This is critical, since LTVs underpin the expected recovery rate in case of asset liquidation. Suppose Nama takes on a loan for €100mln that is secured against a property worth (at the time of loan issuance) €120mln to LTV of 83%. Suppose that underlying asset deteriorated in value by 60% since loan issuance and that in the long run, it is expected to appreciate by 20% to LTEV of €57.6mln. Foreclosing on this loan will mean a recovery rate of 57.6%. However, were the LTV at loan issuance at 90%, the recovery rate drops to 52.8%.
5. NBP omits any provisions for rolled up interest on the developers’ loans. At €81 billion face value, and taking average retail interest rates for 2004-2007 reported by the CB, we are looking at €18.8 billion of foregone interest – a direct subsidy from taxpayers to developers. In arriving at this number, I used loans depreciation schedule provided in Nama new plan page 10, the average charged rate of 4.7% (assume static over 2011-2018, despite the fact that one can safely assume that this cost of capital is (a) too low, given Irish Exchequer is borrowing currently at 5.4% and (b) is likely to rise in time with upward sloping yield curve).
6. Nama makes an implicit assumption that it can dispose of all properties held by it at the peak of their Long Term Economic Value. This requires something that no one in the world, short of God, possesses: (a) perfect foresight, (b) ability to fully control disposal markets and (c) incur no cost of disposal. Clearly, this assumption is simply a sign of deeply rooted inability of Nama staff and directors to think straight through their own effective costs and valuations
7. NBP makes no provision – at all – for the cost of ECB-linked financing of the bonds, which will have to incur the cost of at least 1% in monetization. This will add up, for the life time of Nama (again, using Nama own depreciation schedule mentioned above) to the total subsidy to the banks from taxpayers to the tune of €2.4 billion.
8. “The fees that NAMA will pay over its expected ten-year life amount to about €1.6 billion. A breakdown of the 2011 budget shows that a significant proportion of these fees will be incurred as payment to the participating institutions to administer loan assets on NAMA’s behalf. It is likely that there will also be significant fees incurred arising from enforcement.” Yet, in the actual estimates on page 25, Nama plan allows for just €2.5bn, in the worst case scenario, in total for the costs of its own operations, banks’ fees on administration of loans, for all legal fees to be incurred by it and all other expenses. This rises to €4.8bn in the best-case scenario. Nama already employs almost 90 officers, not counting various board members and an army of consultants. These alone will be swallowing around €250mln in salaries and perks. Legal costs can be safely put to equal about 2.5% of the loans incurred – a double of the relatively standard closing & operations legal costs, taking up over €2bn. Toss in the fees of €1.6bn provisioned and you have sums that do not add up.
9. There are repeated claims that Nama will pursue debtors to the full extent of the loans. This warrants understanding of Table 4 estimates as the full recovery scenarios, implying that in Scenario A, combined recovery rate on all loans is 55.2%, Scenario B 60.7% and Scenario C 49.6% relative to the €81bn face value of the loans. But these are massively exaggerated numbers. Practice in the UK in the 1990s and in Ireland in the 1980s suggests that real gross recovery cannot be greater than 40% of the face value of the loans. And this is before we take into account the present value discounts and rolled up interest (prior to Nama acquisition of the loans and after).
10. Page 20 of the NBP states: “Derivative transactions with a nominal value of €14bn (principally interest rate swaps) will also be transferred. A substantial number of these derivatives are nonperforming and NAMA will pay nil consideration to acquire them.” If these derivatives are nil value, then why are they a problem on the balance sheet of the banks? Answer: because they are nil value today, but have a non-zero probability of exploding in the future. This is why they are being transferred to Nama. What does this mean? If you are on a wrong side of an interest rate swap, your potential liability is unlimited (as in infinite). This is also why in the current market place, the cost of unwinding these swaps today will be around 10-20% of their face value or €1.4-2.8bn. This, of course, is an approximation, but Nama is now stuck, courtesy of taking on these derivatives, with a liability between €1.4-2.8bn at the very least and an unlimited loss at the worst. A picture of iceberg peacefully floating in the path of Titanic comes to mind. Yet, no provision for unwinding these derivatives was made in the NBP.
11. NBP does not address any of the concern about non-transparent governance of the core Credit, Audit and Risk Committees of Nama, which still contain no provisions for external members presence on them. Neither does it address the issues of full and automatic disclosure of all properties held, development applications lodged and funding disbursed, as should be required of such a massive public undertaking.

Now to the numbers. I took the very assumptions contained in the Nama New Business Plan and added one more scenario, with following additional assumptions to cover the holes in Nama own statements:

Loans taken on board:
(Typo corrected, hat tip to Anonymous). Note: the above estimated recovery is the basis for price appreciation in the following table.

Nama NBP scenarios reproduction and my estimates:

Assumptions, in addition to those in Nama NBP are: property uplift over the lifetime of Nama is 15% (this is 50% higher than Nama optimistic scenario of 10% uplift, thus allowing for a greater margin of error in estimates); 1% ECB discount window financing on bonds plus 25bps charge; €5bn in additional investment by Nama drawn in 2015, reducing overall cost of financing to 5 years. Net present value excludes in my scenario excludes rolled up interest on developers’ loans and discounting to present value (Nama claims that it is discounting its NPV at 5%).

All of this means that my estimated loss for Nama of €14.6bn is extremely conservative, allowing for any errors in other figures and assumptions.

Adjusting for NPV at 5% discount, as in Nama plan produces the following summary estimate:

As a reader of this blog remarked on the topic of Nama new BP, “The effortless miscalculations, the assured non-sequiturs, the lofty indifference to facts: all reveal [the new Plan] as a master copy of what Princeton philosopher Harry Frankfurt defined succinctly in his 1986 paper, On Bullshit.” I couldn’t have said it better. Thanks, Patrick.

Economics 6/7/10: Mortgage Arrears Group Report: soapy and wooly

Mortgage Arrears and Personal Debt Expert Group, Interim Report was published today. Its stated objective is to provide recommendations, "focused on actions/solutions that effectively address immediate priorities and are capable of implementation in a relatively short time frame” to deal with defaulting mortgages and rising arrears.

Apart from the report being about 18 months too late, I missed any actual solutions or actions that would help addressing these priorities. Instead, the report contains 44 pages of rather general, if lofty, talk about the need to do things, discuss things and agree to things. A handful of meaningful recommendations it contains actually set out nothing more than the best practices that all lenders should pursue regardless of the Working Group effort.

In the end, the entire report is roughly 90% rehashment of arrangements that already exist in the industry, with a call to standardize these, plus 10% relating to stronger Social Welfare protection measures. If you are a private homeowner in trouble (negative equity, fallen income, including due to higher taxes, or loss of one income without crossing means tested barrier) you are not covered by the Report.

Let's take a look at those recommendations that do contain at least some substantive proposals.

37. The Financial Regulator should amend its quarterly public report on mortgage arrears to record, amongst other things, the number of mortgages that have been rescheduled. (Page 11)

[It is mind boggling to think that there is a need for a Working Group to get to this done. One would assume that the FR could have established such a reporting system on their own.]

38. The Department of Social Protection should introduce an alternative and more equitable approach to achieving the MIS [Mortgage Interest Supplement] objectives and maintaining its sustainability in light of changes in the economic climate and the mortgage market.
This should cover issues such as:

• No legal action should be taken by the lender while MIS is being paid and the borrower is cooperating with the lender. [logical]
• The ban on paying MIS to a couple where one person is in full-time employment should be removed and a revised means test developed. [logical]
• The current rule which excludes the payment of MIS when a house is for sale should be suspended. [Logical, but there should be a strict limit for such payments – say average duration of sale, plus 3 months – to discourage ‘perpetual’ listings and unrealistic pricing. None are set.]
• The State should not provide MIS where the lender is charging interest above the market rate. [This might be logical, but presents a problem for subprime borrowers who are more likely to be in distress.]
• MIS should only be payable where no capital is being repaid.
• MIS should be paid directly into the mortgage account of the borrower.
• Lenders should agree forbearance options with borrowers for a period of six months and ensure the SFS is completed before the State shares the responsibility by providing MIS support to the borrower. [logical, but potentially too restrictive]
• An overall time limit for MIS should be considered to ensure that the scheme does not act as a disincentive to seeking or retaining work. [What limit? How is it to be determined?]
• The scheme should remain as a short term income support. [How short? Especially, how short relative to expected length of unemployment spells?]
• Where a borrower’s situation is or becomes unsustainable, they should be facilitated, if necessary, in applying for social housing appropriate to their needs. [Errr, sure… why is this even being established here?]

In three words - largely useless fluff.

40. Urgent consideration should be given to the effective implementation, in the shortest possible timeframe, of measures for the comprehensive reform of both judicial bankruptcy proceedings and the establishment of a non-judicial debt settlement process.

[You can get this advice without paying for a working group. Just listen to any radio programme about mortgages arrears or read newspapers and you’ll hear or read someone speaking about the need for such a reform, with actually more details supplied than in the current report].


There is a really bizarre, if not outright offensive, claim in the report (chapter 3 - which incidentally provides volumes of rehashed unoriginal information on housing market bust) relating to the negative equity mortgage holders:

“Recent ESRI research estimates the number of mortgage borrowers in negative equity. House price declines to date, coupled with the anticipated price decline in 2010 would take the number of borrowers up to 250,0009. Although this represents a large number of households in absolute terms it is a small proportion of the stock of households in Ireland.”

Now, there are 791,000 mortgages in Ireland according to the same report (page 17). Which means that negative equity is expected to impact roughly 1/3 of all mortgage holders in the nation. How this can constitute a ‘small proportion’ of households, beats me.


“Lenders must not require the borrower to give up their low cost tracker or other existing product if to do so would put the borrower at a financial disadvantage.This must be publicly communicated by all lenders.” (page 19)

This introduces a bit of dilemma for the banks – if the banks are to continue subsidise tracker mortgages, especially non-performing ones, who will cover the banks’ losses? Of course, variable rate mortgage holders, who are, predominantly, at a higher risk of default, and at a higher risk of negative equity. So is this idea of preserving tracker mortgages a cure that can make the disease only stronger?

Needless to say, the working group should have done some work and estimated what would be the impact of continued tracker mortgages losses on costs of mortgages to variable rate holders. And then stress-tested the actual loans against this. But, alas, this was not performed. So hold on to your seats, folks, the working group solutions might give a rough ride in the near future, as banks hike up their mortgage rates to compensate for the working group’s well-meaning, but un-researched recommendations.


Crucially, there is nothing in the Group recommendations preventing lenders from arbitrarily forcing higher and higher repayments on people who might be currently compliant with their mortgage repayments, but are in either severe negative equity or otherwise in breach of loans covenants. In other words, being pro-active – the advice given by the Group to mortgage holders – is not something the Group itself is following.


“All lenders should publish the types of forbearance that are available under their MARP and the guidelines they are employing for decision making on which approach is appropriate for typical sets of financial circumstances. These could include one or more of the following alternative repayment measures [notice – this is really crucial – ‘one or more’, which means that none, collectively, of the below actions are required, page 27]:

An arrangement on arrears could be entered into whereby the amount of monthly repayment may be changed, as appropriate, to help address the arrears situation [Presumably this should not alter conditions to the detriment of the borrower, yet that is not explicitly specified in the statement].

Deferring payment of all or part of the instalment [sic] repayment for a period might be appropriate where, for example, there is a temporary shortfall of income [How this is to be determined remains unknown – if unemployment is deemed ‘temporary shortfall’ then ‘temporary’ might mean 12 months or 36 months].

Extending the term of the mortgage could be considered in the case of a repayment loan - although this may not make a significant difference to the monthly repayments.

Changing the type of the mortgage (e.g. to interest only) might be appropriate if this could give rise to a reduction in the level of monthly mortgage outgoings.

Capitalising the arrears and interest could arise where there is insufficient capacity over the short term to clear the arrears but where repayment capacity exists to repay the capitalised balance over the remaining term of the mortgage. This measure may be considered where a pattern of repayment has been established and where sufficient equity exists. [Does this mean equity sharing with the lender? If so, on what terms? How these terms should be set? Simply to say ‘capitalising can be allowed’ is not good enough for a Working Group report]”

So in brief, this report is hardly worth 47 pages expended on it. It is not even worth the first few pages that serve as a summary. And it certainly not something you'd expect from a really concerned Working Group labouring over it for 5 long months since February 2010.

Economics 5/7/10: The toll of un- & under-employment

Two interesting charts on the ratios of full-time employed and live register signees to total working age population (note, this combines quarterly data from QNHS with monthly LR data, all expressed in quarterly terms):
I can't spot any turn around in either chart, yet both reflect the extent to which the burden of unemployment and under-employment is impacting this economy - on both sides of equation: for those who lost their work (the truly tragic outcome) and for those who have to cover the nation's bills while remaining in employment (also having tougher times).

Economics 5/7/2010: Future of our cities

This is an unedited version of my current article in Business & Finance Magazine:

Global recovery, no matter how tenuous, is poised to present a new set of challenges and opportunities for smaller open economies, such as Ireland. These challenges relate to the changing nature of economic growth and competition worldwide.

Starting with the early 2000s, there is a new ‘brain-and-creativity’ economic growth paradigm that is emerging across more dynamic globally-integrated economies. In this new paradigm, cities and larger urban-centred regions are increasingly competing for highly mobile and diversified human capital, and creativity and innovation capabilities associated with it. This trend represents a far wider change than the much-talked-about ‘knowledge’ economy. In fact, according to our research at the IBM’s Institute for Business Value, it represents a re-orientation of the core sources for future growth away from the traditional ‘bricks-and-mortar’ economy based on physical capital (e.g. buildings and equipment) and financial capital, and toward human capital or talent-intensive growth.

Last month, Dublin-based IBM’s Global Centre for Economic Development that forms a part of the Institute for Business Value (IBV) published a study titled Smarter Cities for Smarter Growth: How cities can optimise their systems for the talent-based economy. Co-authored by Susanne Dirks, Dr Mary Keeling and myself, the study looked at the changing nature of competitiveness that cities and larger urban areas around the world will be facing over the next 10-20 years.

It offers important policy and investment priorities insights not only for world’s leading cities, such as New York, London, Tokyo, Shanghai, but also for smaller open economies, such as Ireland.

The core insight from the study is that creativity, knowledge and skills, together with technological innovation are becoming the key drivers of economic growth and activity.

For example, the share of overall economic value added attributable to creativity, knowledge and skills-intensive sectors of the economy (e.g. internationally traded and other higher value-added services, design and innovation-centred manufacturing, etc) is expected to increase by 8.2% over the current decade.

Cities are natural hubs for this growth for two reasons.

Globally, leading cities have GDP shares of their national economies that are up to 5 times higher than their share of national populations. Top 100 cities worldwide accounted for roughly 25% of the world’s GDP in 2005. By 2008 this had increased to over 30%. As charts 1 and 2 in my earlier post (here) on cities weights in domestic economies illustrate, Dublin clearly falls within this category of cities that represent a leadership flank in their respective domestic economies.

Second, cities, and greater urban areas, are at the forefront of global competition in higher value-added, and creativity and knowledge-intensive sectors. Between 1999 and 2007, skills and knowledge intensities of some 350 urban economies comprising OECD member states have increased dramatically.

In 1999 average urban area in the OECD had 25% of its population holding third level degrees or higher. By 2007 this number increased to 29%. Over the same time, the degree of skills and knowledge utilization in urban economies also increased. Modern services – a sector that is at the forefront of the new economic paradigm – saw its share of overall employment rise from 34% to 38% in 8 years to 2007. With these changes, income per capita rose from the average USD27,400 to USD36,050, expressed in constant dollar terms.

A similar dynamic took place in Ireland, where Greater Dublin region, inclusive of commuter belt, saw its proportion of the workforce with tertiary or higher education rise from 25% to 39% between 1999 and 2007. Contrary to most of the commentary on Irish development model, the Greater Dublin area has moved from being average in terms of skills presence in the OECD at the cusp of the new Millennium, to above average by 2007. Over this period, the share of modern services in total regional output rose from 34% to 38% in Dublin, while per capita income rose from USD31,900 to USD46,300.

Our data analysis clearly shows that urban income per capita has been strongly positively correlated with rising importance of skills, innovation and knowledge in the economy. Our forecasts also indicate that this trend is going to strengthen over time. For example, there is a rapid change in the relationship between technological innovation and talent contribution to productivity that is emerging across all industries. Instead of technological innovation serving as a strong substitute for labour, it is becoming a supportive enabler for people and their skills. This relationship is forecast to strengthen by over 70% by the end of this decade in modern sectors and is set to become positive for the first time in over 40 years in traditional sectors as well.

For cities this transformation means new model of development and growth – a model focused primarily on the need to build a diversified, highly skilled and creative workforce capable of developing and absorbing technological, managerial and creative innovation.

Change in demand for skills in EU27
Net increases in excess of demographic factors, millions of jobs
Source: CDEFOP, 2009 and 2010, and IBV analysis

Forecasts show that demand for talent, creativity and skills is expected to accelerate dramatically over the next 10-20 years (Chart above). In the EU27 alone, growth in demand for higher skilled workers is expected to double from 10.1 million in 2007 to 20.1 million in 2020, according to the European Commission. At the same time, demand for low skilled workers is expected to contract by 28.3 million by 2020 having fallen by 8.5 million in 2007.

While pressures of rising demand for skills will be acute, the supply side – represented by demographics and higher education capacity – is going to be strained to deliver sufficient inflow of new skilled knowledge and creativity-enabled workers. Assuming current demographic trends, demand for international students in the OECD will be expected to rise from 6% of total third level student population in the mid-1990s to 30% by 2020, based on our forecasts.

Cities are increasingly competing for internationally mobile and highly diversified workers of the future. For example, between the 1990s and 2020 net international migration flows of highly skilled workers will more than triple from 29.5 million to 98.6 million, according to our forecasts. Majority of these flows will continue to be attracted to Western European and North American economies. However, in a departure from the previous decade, next ten years will see acceleration in the net demand for highly skilled international migrants from the emerging economies of Asia Pacific, India and Latin America. These developments imply that previously taken for granted inflows of talent to the advanced economies are now wide open to competition.

The entire notion of competitiveness will be reshaped by the new growth paradigm. Our research shows that in the near future cities will have to focus their attention on attracting, retaining, creating and enabling people with diversified and high quality skills and knowledge, capable of generating and absorbing creative and technological innovation.

Highly-skilled individual’s location decisions are directly influenced by the quality of core services provided by the cities. And these decisions, in turn, increasingly influence location of FDI. In 2008, according to data for OECD, 69 percent of companies have identified availability of the high quality human capital as a major determinant of their decision to invest in a specific economy. Urban centres will need to change the nature of their core services away from focusing on standardized services aimed at the homogenized populations, toward services that are more citizen-centric: tailored and individualized, green and lean in line with the demands of the internationally mobile highly-skilled employees.

Our research has identified four core services areas that will need to be prioritized for investment with the greatest expected impact on highly skilled, knowledge, creativity and innovation-enabled workers. These are Government Services and Education, Public Safety, Health and Transport.

Given the constraints on fiscal spending, faced by many Governments around the world, including the Irish Exchequer, such investments will have to deliver optimal gains in quality of life while demanding minimal public outlays. Based on our analysis of the best practices around the world, this can be achieved by deploying advanced technologies to understand, predict and intelligently respond to services systems behaviour and demand.

For example, cities like Singapore, Tokyo, Amsterdam, London and Stockholm have been able to successfully leverage real-world data generated by their public transport providers. This allowed not only to optimize the existent city services, but to simultaneously increase both capacity and demand for public transport. Several cities worldwide are currently building new modes of public transport that attempt to seamlessly integrate the concept of mass public transit across various modes of transport while delivering extensive customization of routes and modes.

In Singapore, creation of a seamless, smarter national transport fare system has resulted in $40 million annual savings from reduced congestion on expressways alone, as well as gains in workforce productivity equivalent to more than 5 million man-hours. Singapore’s Land Transport Authority can now optimize routes, schedules and fares based on the insights from the 20 million trip-related transactions generated each day. As the result, usage of mass public transport increased by 14.4% between 1996 and 2007.

Congestion negatively impacts on the quality of life in a city by decreasing personal and business productivity. It also imposes negative externalities on the overall quality of life. The cost of congestion ranges between 1.8% of GDP in Kuala Lumpar to a massive 4.1% in Dublin.

Smarter transport systems can integrate traffic, weather, business and traveller information to provide real time services to users to create more efficient and user-friendly services. A number of cities in Japan are now moving to new models of delivering public transport that aim to bring greater degree of routes flexibility, on-demand capacity and more organic links between daily demand changes, external factors, such as weather and seasonality of demand, and the supply of public transport.

Of course, public transport is just one area of services where the Greater Dublin area and other cities in Ireland will be facing significant competition. Health, education, government services and public safety are also important determinants of the quality of life in the city and thus city’s ability to attract, create, retain and enable the workforce of the future. And we have quite a distance to travel in these terms. If in 2007 Dublin ranked 20^th in the world in terms of overall quality of living the city delivers to its citizens, this year it has slipped to the 26^th place. These rankings do not reflect even poorer quality of services delivered in the commuter belt of the Greater Dublin area.

The core conclusion that emerged from our report is that cities that adopt a pro-active approach to investment in citizen-centric services will position themselves to thrive in the new age of human capital-intensive growth. Those that continue to invest in traditional infrastructure designed for mass population are set to struggle.

Economics 4/7/10: Global PMIs signal some pressures ahead

Based on WSJ blogs info, I pooled together a comparative table for the last three months OECD Purchasing Managers Indices. An interesting dynamics for Ireland, compared to peers and some other countries (24 in total):
Note: relevant competitors are in bold.

An interesting observation on PMI levels:

• In April Ireland ranked 18th in terms of its PMI reading (remember, PMI above 50 signals expansion);
• In May, this rank improved to 15th;
• But in June we slipped to 20th place of 24 countries.

In terms of changes mom in PMI readings, we fared much better, registering:

• 3rd highest gain in mom between April and May;
• falling to 19th rate of change between May and June;
• between April and June we recorded 12th ranked result in terms of changes in PMI
  

Overall, within the sample of 24 countries, it is clear that April to June changes showed 17 countries of 24 posting declines in PMIs, with only Greece, Hungary and South Africa continuing to post contractions in activity (below 50).

Most notable is stellar performance of Switzerland.

Average PMI has declined from 56.1 in April to 53.9 in June, while standard deviation has fallen slightly from 4.4 in April to 4.3 in June. This means Irish PMI drop was broadly in line with the average.

Economics 4/7/10: Burden of the state & tax system changes

Some more insights from the Exchequer figures. Over the last three years, Government budgetary policies have resulted in a dramatic shift of the burden of this state onto the shoulders of ordinary families.

Income tax accounted for 25.05% of tax revenue at the start of 2007, rising to 28.70% by the end of 2007. 2008 Q1 revenues from income tax accounted for 28.07% of the total, rising to 32.31% by year end. In 2009 the corresponding figures were 34.23% and 35.82%. So far this year, Q1 2010 income tax revenue accounted for 36.10% of total revenue. Q2 2010 figure is 35.49% - higher than corresponding Q2 2009 figure of 35.23%. Chart below illustrates:
In year-end terms:
One can (roughly, as an approximation) split taxes into the following three categories: business-related (corporate, excise -

• attributable to business (Corporate & Vat - adjusted for the share of non-household consumption);
• attributable to households (income tax, Vat adjusted for personal consumption share of total expenditure), and
• transactions taxes - Stamps, CGT & CAT

When one realises that less than 50% of those working in the State pay income tax and majority of them barely avail of much of the public services, this really does put into perspective the burden of the state spending on our more productive middle and upper-middle classes.

Economics 4/7/10: Exchequer receipts: not a sign of any recovery

From my previous posts on the Exchequer deficits, you have probably guessed that unlike other economists, especially those from the official commentariate, I am not too fond of comparing current receipts to 'targets' set out by DofF. This aversion to focus on how closely the receipts are running relative to targets is driven by two factors:

1. I don't care for DfoF targets. What matters is how the economy performs in reality, not how closely it resembles someone plans;
2. I don't think that DofF targets have much meaning - real world deficits have two sides to them: receipts and expenditure. In receipts, tax collections signal the extent of economic activity. And changes in receipts year on year also signal future economic capacity. Full stop. Targets are irrelevant here.

So I've done some homework - manually (because DofF is incapable of delivering usable databases) trolling through Exchequer Statements, and compiling my own database of tax receipts. From now, this will form a stable feature of monthly Exchequer Statements analysis.

Here are some startling revelations from the latest results released on Friday.
Income tax receipts are currently running behind all years from 2007 on. This is a clear indication that our income tax policy has collapsed. If in June 2009 income tax receipts were -9.02% below June 2007, by June 2010 this difference has widened to -16.82%. And this is despite (or may be because of) higher taxes imposed in Budgets 2009-2010. Mark my words - should the Government increase income tax rates or shrink income tax deductions in the Budget 2011, this effect will most likely increase once again.

Vat has performed just as poorly so far this year, despite all the parroting going on amongst commentariate about improving retail sales etc. In June last year, Vat receipts were off 23.48% on 2007. This year this difference expanded to -29.63%. And this is despite significant weakening in the Euro and with price wars amongst the retailers. Let me ask Irish banks' economists so eager talking up our consumers' return to the shopping streets.

Corpo tax is doing slightly better so far, but there are timing issues here, plus there is an issue of profits booking by the MNCs - rather spectacular in June 2010. Overall, corporate receipts are subject to a massive uncertainty until November figures come out, so let's wait and see.

Excise taxes are clearly settling into a new equilibrium, way below 2007 and 2008 figures. June 2007-June 2008 the returns on this line were down -26.04%. This year, the decline is -27.97%.

Stamps are next: some spectacular rates of deterioration here. June 2007-June 2009 = -79.72%, to June 2010 = -83.55%.
Capital gains tax - should be booming, according to the 'Green Jersey' squads. After all, allegedly we are doing so well now in terms of equity markets that Ireland is having a booming number of millionaires. Remember that claim? Well, CGT shows none of this 'boom' and, of course, QNA shows continuous deterioration in our investment position. So between June 2007 and June 2009, CGT receipts fell 80.98%, by end of June 2010 they declined 89.10%. Surely, things are booming as we roared out of the recession...
Almost the same story for Capital Acquisition Tax, with this category performance being only slightly better year to date on the back, potentially, of something really strange going on in the Exchequer own capital spending and automatic stabilizers (timing?).

Customs duties are also down, tracing the trajectory of consumption excises.

So let's take a look at the total receipts:
Again, I am failing to see any sort of 'stabilization' in public finances (receipts are running behind 2009 levels), or any significant uplift in economic activity relating to Q1 2010 'exit from the recession'. We apparently had full 6 months of 'recovery' and there's not a blip on the tax receipts radar screen.

So my advice to the 'official IRL economics squad' out there - stop chirping about 'tax heads running close to target'. Look at the actual numbers!

Economics 2/7/10: Exchequer's sick(ly) arithmetic

Exchequer statement is out today. As usual, for the sake of the markets and the media - right before the closing of the working day. It's either a pint with friends, a dinner with the family, or dealing with Brian Lenihan's problems. Forgive me, the first two came ahead of the third one.

Mind you, not because Mr Lenihan's problems are getting any lighter. They are not. Second month running, tax receipts are under-performing the target. Sixth month in a row, the only saving grace to the entire shambolic spectacle of 'deficit corrections' is the dubious (in virtue) savaging of capital investment spending.

Let's take a look at the details: there was €80 million shortfall in June tax take. All tax heads receipts came roughly in line with the DofF monthly plans, except for income taxes (off €84 million behind expectations).

To hell with 'expectations', though, look at the reality
Tax receipts dipped below down-sloping long term trend line. Which is seasonally consistent. The deviation from the trend line was small, compared to previous 2 years. These are the good news. Total spending is below the flat trend line and roughly seasonally consistent. Given the scale of capital budget savaging deployed this year, this is not the good news. You see, it appears that the Government has back-loaded capital spending while front-loading capital receipts. If that is true, expect serious explosion (hat tip to PMD) of deficit in Autumn. If not,m and the cuts to capital budgets are running at the real rate observed so far, expect mass-layoffs by late Autumn. Either way - things are not really as good as they appear on the surface (more on this 'capital' effect later).

and back to the receipts: H1 2010 so far, income tax receipts are down €227 million cumulatively. Other tax heads are running €76 million above plan. Vat is actually improving, backed by falling value of the Euro and serious cuts in prices by retailers. There is a tendency to attribute this to 'improved retail sales', but in reality most of this 'improvement' is simply due to better weather and smaller savings margins to be had in Newry. Not exactly a graceful cheering point for Ireland Inc... but let's indulge:
€1 billion cut was applied to the expenditure side. Or so they say... Deficit on current account side is now €8.045 billion, up on 2009 €7.212 billion. Vote capital expenditure is down from €1.844 to €2.870 billion. But, wait, in 2009 (well, after Eurostat caught the Government red-handed mis-classifying things) there was €6.023 billion drain on Exchequer 'capital' side from Nama and the banks. This time around, the Exchequer posted only €500 million worth of banks measures on its balance sheet. Something fishy is going on? You bet. Anglo money are not in the Exchequer figures. At least not in six months to June. So things are looking brilliantly on the upside.
Hmm... but what about Anglo? and AIB? BofI? All the banks cash that flowed since January? Well, for now, this remains off-balance sheet. And, there's missing (we actually spent it last year forward) NPRF contribution. Were these two things to be counted, as they were in 2009, the true extent of cuts, the Government has passed through would be revealed. And, fortunately, we can do this much. Take a look at what our cumulative balance looks like to-date, compared with 2008 and 2009.

First - absent adjustments for the banks:
And now, with banks stuff added in:
Notice how all the improvement in deficit to-date gets eaten up by the banks? Well, this is simply so because when we are talking about the improvement on 2009, we are really comparing apples and oranges. Ex-banks in both years, there is virtually no improvement. Cum-banks both years - there is no improvement. But Minister's statement today compares cum-banks 2009 against ex-banks 2010...

Net voted expenditure by departments is running €141 million below expectations for June. Cumulatively, H1 2010 is below expected Budgetary outlook by some €500 million - 2.3% savings on the Budget 2010. Even more impressively, it is now 6.2% behind 2009, 'saving' us €1.4 billion. Not exactly the amount that gets us out of the budgetary hole we've dug for ourselves, but...

I'd love to stop at this point for a pause to enjoy the warm rays of achievement for Ireland Inc. But I can't - it's all due to cuts in capital spending - running some €609 million below Budget 2010 plan for the first xis months of the year. €400 million plus of this comes out of DofTransport budget. All in, current cuts to capital budget represent whooping 36% reduction on 2009 levels. Surely, this will cost many jobs in a couple of months ahead.

And on the other side of this equation - current spending is actually running ahead of Budget 2010 forecasts (actually made in March 2010, so no - DofF has not improved its forecasting powers, it simply is missing targets closer to its own estimation date). And this is true for the second month in the row. Overall, we are now in excess of forecasts by 0.5% and only 1.9% behind comparable figures for H1 2009.

Last few charts:

Now, keep reminding yourselves - the last chart above does not include banks funding in 2010 to-date... Your final tax bill - will. Get the picture?

Economics 2/7/10: The markets way of saying 'No'

Just in case anyone reading the vitriolic blogosphere stuff about my conclusions questioning the 'turn around' in the Irish economy based on the 'nominal data' (apparently there are people out there capable of commenting on economy, yet unable to read in plain English), here's another take on our 'turning the corner' path. This time from the bond markets: 10-year bond yields for Ireland (red) and Portugal (black) - hat tip to Brian:
Notice Ireland hanging above Portugal in the chart, and notice the path we took since January 2010.

My entire analysis of Irish data to date is consistent with the markets pricing of Irish economy. So either a couple of nameless commentators on Irish posting boards are off in their views of reality, or the entire market is plain wrong. What was it, that someone once said about doing something against the gale force wind?

Economics 1/7/10: Finland - Broadband access is a universal right

An interesting follow up to our Digital Economy Rankings 2010 released jointly by EIU and IBM's Institute for Business Value earlier this week (see here for global results and here for detailed data on Ireland).

Finland - ranked 4th in the world this year by DER2010 - has just announced that its residents will have the legal right to broadband access. A law passed in October 2009 came into force today requiring all telecomms providers to offer 24/7-on high-speed internet connections to all of the country's 5.3 million residents. A minimum speed of at least 1 megabit per second must be guaranteed.

For comparison,

Finland achieved the following scores in Connectivity and Technology Infrastructure category (relating to quality and supply of broadband):

• Overall Connectivity & Technology Infrastructure score = 8.0/10.0
• Broadband penetration = 7.0
• Broadband quality = 1.0
• Broadband affordability = 9.0
• Internet user penetration = 9.0
• International internet bandwidth = 10.0
• Internet security = 10.0

In comparison, Ireland scores, relating to broadband) in this category were:

• Overall Connectivity & Technology Infrastructure score = 7.20/10.0
• Broadband penetration = 5.0
• Broadband quality = 1.0
• Broadband affordability = 9.0
• Internet user penetration = 7.0
• International internet bandwidth = 10.0
• Internet security = 10.0

Spot the difference?

Economics 1/07/10: Left behind by the 'turning' Ireland

Stephen King's traditional plots involved mundane occurrences of banal middle-class lives punctuated by the extraordinary events that completely reshape the world around the protagonists: a family fight in the foreground broken apart by zombies invading the entire town in the bay windows of the family room behind warring spouses.

The last two days in statistical releases from Ireland have a similarly absurd quality, juxtaposing dynamic foreground (QNA's assertion that Ireland is 'out of the recession') with a macabre background (Live Register data for June) that, one intuitively knows, will inevitably come to dominate the entire plot.

Today's data on Building and Construction sectors output for Q1 neatly fits the 'invading zombies' framework: per CSO's release today, Q1 2010 output for the sector has fallen 34.1% yoy, while the value of production decreased 34.8% in the same period.

Clearly, yesterday's turn of the corner greeted us with a blank wall, as far as the road to real recovery goes.

Per CSO: "The fall in the volume of output largely reflects declines of over 48% and over 32% respectively in residential building work and non-residential building work. Output in civil engineering fell by over 18%".

Over the same period of time, output in the building and construction sector fell by just 7.8% in the EU27 and 9.9% in the Euro area. Sweden (+3.4%), Finland (+1.6%) and the UK (+1.2%) posted increases. The largest decreases were in Latvia (-43.4%), Lithuania (-42.9%) followed by Ireland. which means that we managed to beat off Spain for the dubious prize of being the worst performing advanced economy in the world when it comes to construction sector bust.

Makes you wonder - what the Live Register look like when the 110,000 odd workers remaining in the sector finally finish work on the few remaining sites still left from the boom?

Economics 01/07/2010: Recovery or a triple dip?

So the recession is over… or it just went into a triple dip… you have a say.

Today’s QNA for Q1 2010 showed a 2.7% increase in real GDP compared with the final quarter of last year. This brings to an end eight consecutive quarters of economic contraction – the longest recession of all advanced economies to date.

What happened? Have you felt that warm wind of spring back in March and decided that it is time for Ireland Inc to start upward march to renewed prosperity?

Err… not really. What did happen was a simple trick: Deflation took out a bite out of the price level adjustment, as nominal GDP grew a fantastically unnoticeable and statistically indifferent from zero 0.0956%. Yes, that’s right, less than one tenth of one percent. Take a snapshot: in Q1 2010, our MNCs-led exporting economy was better off than in Q4 2009 by a whooping €37 million, while our domestic economy shed another €2,199 million. Don't know about you, I feel so much richer today than back in December 2009...

One has to be sarcastic about the Government that needs a massive deflation to generate economic growth. Industry gains - again driven by MNCs manufacturing - are clearly not supported by domestic services and construction.
Oh, and subsidies-reliant sectors - Government and Agriculture - are going relatively strong. Clearly CAP is recession proof - per chart below - with Agriculture up 84% on Q4 2009. Investment continues to compress: capital formation down 14% qoq, and 30% yoy. And that’s gross! Government spending was down a paltry 0.9% qoq or €96 million – a clear slowdown in deficit reduction efforts. Give it a thought, we will be borrowing this year some €17bn - not accounting for banks alone. At the current rate of Government spending contraction, Q1 2010 reductions in public spending (net!) will cover just 10% of our annual interest bill on one year worth of borrowing!
Consumer spending contracted further by 0.2% supported from hitting much greater decline numbers by services spending and, potentially, 2010 registration plates fetish. Remember, total retail sales are down more than 6% in Q1 2010. Added support to consumer spending was winter freeze, which was a boost to the likes of state-owned ESB and Bord Gas – carbon footprint notwithstanding, good news for state monopolized energy sector.

Time for champagne, then? Perhaps not quite vintage variety yet, but some bubbly? I am afraid not.

There’s another trick to the data: Net exports boomed – as we imported fewer things to consume, invest and use in future production, while Ireland-based MNCs booked on massive profits. So massive in fact that net increases in transfers of profits abroad were literally bang on (take few euros) with net increase in our trade balance.

This has to be the fakest ‘recovery’ one can imagine.

Before charts, illustrating the above, few more points. Services exports were particularly strong (good news):

• volume of goods exports rose 2.4% yoy in Q1 2010,
• volume of services exports was up 9.5% yoy.

Services – the Cinderella of our external trade policies – now account for 46% of total exports.

As MNCs-driven economy steamed ahead, domestic economy continued to contract -0.5% in Q1 2010, in qoq terms. Profits expatriation by the MNCs reached €7.9bn in Q1, up from €7.1 in Q4, and GDP/GNP gap widened to over 20% in quarterly terms.

Should things stay on this 'recovery' course, by the end of this year some 26% of our entire economy's output will be stuff that has nothing to do with our economy. That would put us on par with some serious banana republics out there as an offshore centre. And not that I, personally mind. It's just fine that companies book profits via Ireland Inc. The problem is when we, the natives, start believing the hype that our GDP generates.

Seeing much of a recovery anywhere?

And a more detailed look at exports and imports - the causes of our today's celebration:

As I have pointed out many times before, our MNCs need imported components, goods etc in order to generate exports. So as imports fall, two things come to mind:

1. A serious concern that lower imports might reflect slowing down of MNCs-led exporting; and/or
2. A serious concern that our consumers (dependent on imports) are still running away from our retail sector.

You be the judge as to what really goes on, but either way, this is not a good omen. The 'recovery' might be a Pyrrhic victory.

At any rate, you'd need a microscope to notice that we are out of a recession in the chart below:
But you can clearly see what's going on on that side of economy which generates jobs, pays our bills and actually translates into our standards of living (aside from Government stuff, that is):

Welcome to an MNCs-led recovery, then:
If it doesn't feel like much of a boom, then don't listen to anyone saying 'We've finally turned the corner'. Or be warned it might be a dead-end alley, or worse a brick wall...