True Economics

Friday, June 14, 2013

14/6/2013: EU's FTT: One Tax, Multiple Problems

FTT - Financial Transactions Tax - has been the pet project of pure love for Eurocrats and Socialistas in the Member States, hungry for revenue. It has been labelled a 'Robin Hood Tax' because the politicians attempted to sell it as a tax on filthy-rich financial services to redistribute to starving unemployed, presumably, despite the simple fact that in the un-competitive and fragmented market for financial services that is Europe, such a tax - any tax - will be fully passed onto ordinary savers, investors, depositors and in general onto the users of financial services.

The EU Commission published volumes of commissioned - made-to-order - research that shows just how brilliant an idea the FTT really is: it will raise loads of revenues, harm no one and will not reduce financial markets efficiency. Stopping just short of declaring the FTT to be a panacea to common cold, the EU enthusiastically propagandized the idea despite the simple fact that vast majority of academic research on the topic of transactions taxes finds that they are either ineffective as means for revenue raising or costly in terms of economic efficiency.

I wrote about this (see link at the bottom of this post below) and will continue to write, not because I long for an easy life for the bankers or financial investors, but because I recognise the fact that investment markets are necessary to the functioning of the society and the economy, and because I also recognise that more open, less restricted, but well-regulated and strictly enforced financial services are better than anything that Brussels et al can conceive in their technocratic dreams.

So in line with the past record, here's another study (http://www.cpb.nl/en/publication/an-evaluation-of-the-financial-transaction-tax) that explores "...whether the FTT is likely to correct the market failures that have contributed to the financial crisis, how well the FTT is likely to succeed in raising revenues, and how the FTT compares to alternative taxes in terms of efficiency."

The study finds (emphasis is mine) "... little evidence that the FTT will be effective in correcting

market failures. Taxing of transactions is not well targeted at behaviour that leads to excessive risk and

systemic risk creation. The empirical evidence does not suggest that the introduction of an FTT reduces

volatility or asset price bubbles. Transaction taxes will likely reduce investment in trading activity and

information acquisition, but also raise the costs of insurance against currency and interest risks by

companies, insurers and pension funds. The welfare effect of that is unclear."

"The FTT will likely raise significant revenues, in spite of the fact that the tax base is highly elastic. In the short term, the incidence of the tax will be chiefly on the current holders of securities. Ultimately, the tax will be borne in part by end users, and we estimate the likely effects on economic growth."

"When compared to alternative forms of taxation of the financial sector, the FTT is likely less efficient given the amount of revenues. In particular, taxes that more directly address existing distortions (such as the current VAT exemption for banks, and the bias towards debt financing) provide more efficient alternatives."

And here's a report from the Open Europe think-tank on the FTT, assessing the EU Commission response to the concerns of the eleven - that right, eleven - member states: (http://openeuropeblog.blogspot.co.uk/2013/05/if-you-had-kept-quiet-you-would-have.html)

Quote: "The Commission's response ranges from weak to capricious to outright ridiculous. For example, when it says that "we're not aware of any credit crunch" in Europe."

What else is new?

Note: I wrote about the concerns around the issues of repos and hedging here: http://trueeconomics.blogspot.ie/2013/05/3052013-ftt-up-down-down-again-climbing.html

Links to past articles on FTT: http://trueeconomics.blogspot.ie/search?q=FTT&max-results=20&by-date=true
You can search this blog for key words and sort the posts by relevance or date.

14/6/2013: Detroit suspends payments on unsecured debt

I recently wrote (albeit in distinct context) about Detroit's bankruptcy. Here's the latest on the saga:
http://www.bloomberg.com/news/2013-06-14/detroit-on-bankruptcy-s-brink-stops-paying-some-debts-orr-says.html

I love this city because it gave me (via Chicago) my greatest partner in the crime of life. And my students in Smurfit Graduate School of Business are certainly familiar with the imagery of the urban collapse from Detroit and Flint, Michigan on foot of my lecture notes slides penchant for dramatic photography.

Sadly, it is totally, comprehensively, irreparably destroyed. Its only hope is a structured and comprehensive default followed by a bottom-up restructuring of its economy, demographics, politics, policies and institutions. Let's hope Michigan State will not commit the errors committed by the Euro area 'leaders' in Greece, Ireland, Portugal, Cyprus, Spain, Italy...

14/6/2013: G8 Summit: pure laughs

G8 Summit has been transforming Northern Irish country towns into prosperous villages... (see the first image in this post: http://trueeconomics.blogspot.ie/2013/05/3152013-bank-holidays-links-on-art.html), but all along, the real winners in the Best Bizarreville News Contest was the host resort itself:

14/6/2013: Scary table of the week: Irish Property Prices 'Recovery' Dating

Updating my databases, I came across an old exercise of estimating the property prices recovery paths for Ireland based on the CSO Residential Property Price Index. Here's an updated table of dates of expected recovery according to three basic scenarios:

There is virtually no point of repeating the same exercise for real values, albeit the closest this comes to such an attempt is Scenario 3.

All calculations are based on CSO data.

Thursday, June 13, 2013

13/6/2013: Irish Construction Sector Activity Post Some Better News: Q1 2013

Some good news for Irish construction sector (not as impressive as German stuff, but... much more welcome, given the sector dynamics so far through the crisis).

Per CSO: "The volume of output in building and construction was 4.4% higher in the first quarter of 2013 when compared with the preceding period.

This reflects increases of 6.8% and 1.2% respectively in residential building and non-residential building.
There was a decrease of 0.7% in the volume of civil engineering. The change in the value of production for all building and construction was +1.9%.
On an annual basis, the volume of output in building and construction increased by 10.7% in the first quarter of 2013.
There was an increase of 9.5% in the value of production in the same period.
The annual rise in the volume of output reflects year-on-year increases of 26.8% and 2.4% respectively in civil engineering and non-residential building work.
Output in residential building decreased by 2.5%"

Now, graphs and a summary table for more detailed analysis:

13/6/2013: Boom-time in German Building Industry?

Ifo published some new survey data on German economy. One that jumps out is the Architects Survey. Per Ifo (emphasis mine): "The business climate improved significantly at the beginning of the second quarter of 2013 and has not been as favourable since the German reunification boom at the end of the 1990s, according to the remarkable results of the Ifo Institute's quarterly survey of freelance architects."

Freelance architects "assessed their current business situation as significantly better than in previous quarters and business expectations have also improved compared to last quarter's assessments.

The share of architects surveyed who described their cur-rent business situation as "good" increased from 41% to 43%.
Business expectations also improved compared to last quarter’s assessments. The share of partici-pants that expressed scepticism about the future fell considerably from 16% to just 10%.
57% of the architects surveyed signed new contracts in the first quarter of 2013.
Number of new contracts for detached and semi-detached houses in Q1 2013 is the same as in Q4 2012 - at a level that is almost twice as high as the low point reached in 2006 and 2007.
Total number of new orders for the planning of multi-family buildings in Q1 2013 was around 150% higher than the figure just six months previously.

It's a boom-time in Germany and Angela might be feeling a bit more confident, assuming the euro news are not too bad come elections...

Wednesday, June 12, 2013

12/6/2013: Statement, Questions, Facts

Statement: "She pointed out that one in five of credit union loans was in arrears for more than nine weeks. This 20pc figure compares with 11pc of mortgage holders being in arrears for three months or more."

Source: http://www.independent.ie/business/personal-finance/property-mortgages/credit-unions-warned-many-loans-will-not-be-paid-back-29337885.html

Question 1: Given that both Credit Unions and banks are regulated from the same Central Bank, why are we using different time bases for comparatives on NPLs?

Fact: 11.9% is the actual percentage of mortgages in arrears (by account numbers) over 90 days, per latest official data available (Q4 2012), which rounds to 12% not 11%.
Fact: Including BTLs, 13.04% of all mortgages were 90 days and more in arrears (by accounts) and 18.2% by outstanding amounts.

Question 2: Given the above, why is the Registar of Credit Unions referencing 11%?

Fact: Balance of mortgages in arrears over 90 days in Q4 2012 was 15.8%.

Question 3: Should we reference balances for comparatives?

Fact: in Q4 2012 all mortgages in arrears (>30 days or over 4 weeks and given reporting and registration lags, closer to probably 6-7 weeks) amounted to 19.3% of all mortgages by account numbers and 24.9% of all mortgages by outstanding amounts. All of the sudden, that vast difference implied in the quote above is... err... rather much smaller.

Aside: why are we now ca 2 weeks behind the normal release schedule for mortgages arrears data?

12/6/2013: Bond Markets: Is Canary Kicking the Bucket?

I have written before about the prospect of the Fed starting unwinding of the QE operations. Here's my summary forward view.

Stage 1: the Fed will reduce the rate of QE print ('taper on'). This is inevitable and it is already driving 10-year Treasury yields up - in last 40 days, by some 50bps. The same is also inevitable for the Euro area, albeit via a different mechanism (unwinding of excess liquidity supply to the banks, plus scaling down of any expectations for OMT to kick in), driving the Bund up some 35bps.

In both cases, macro news-flows and inflationary pressures pointed to the opposite direction for yields. This is confirmed by the differences in risk pricing indices in the bond markets (MOVE index: Merrill Lynch Option Volatility Estimate (MOVE) Index on US Treasuries) as opposed to the equity market volatility index (VIX). MOVE has gone almost double from around 47-48 in early May to over 80 recently. Levels around 80 are consistent with the height of the peripheral euro area crisis back in 2012. Over the same period of time, VIX is up from around 13.0 to 16.0 and during the height of the euro area crisis it was averaging closer to 40.

Stage 2: In the follow up stage, the Fed will have to engage in more than simply scaling back new purchases. Here, the unwinding will begin in earnest and the Fed will have to sell longer-dated bonds into the market.

For now, we are just embarking on Stage 1. Emerging markets and corporate bonds, as well as euro periphery bonds are all signalling the same story: yields are pressured up. During May, US investment corporate bonds fell 2.7%, while junk bonds were down 2.3%.

Now, in the longer term, when US gross interest rate rises relative to the euro area, forward exchange rate must rise relative to the spot and dollar will weaken forward. This covered parity relationship tends to hold over the longer periods of time under normal market conditions. In May-June so far, Dollar is 5% weaker than EUR, and over 2% weaker than CHF (linked to EUR). However, Dollar is stronger 22% than JPY and virtually unchanged on GBP, dollar strengthened with respect to the emerging currencies.

However, in the short run we are not in a normal economy. As US economy continues to improve, few things will happen:
1) The Fed will continue tapering on the QE in the short-term
2) Expected unwinding of QE (rising rates, instead of lower speed of purchasing of Treasuries as in (1)) will enter expectations in the market but in a longer term, rather than any time soon
3) Bond yields will continue rising and volatility will remain amplified. Long-term US equilibrium is for 10 years at 3.0-3.2% and short-term overshooting that range, for Bund - at current rates, around 2.5-2.8%.
4) Fed will be watching the speed of increases and manage unwinding process accordingly to keep yields from overshooting 3%-or-so target by a significant margin.

All of this means that news-flow will be crucial in months to come as it will be signalling both short-term and long-term changes to the Fed position (usual stuff about the rates), but also strategy (severity of (1) above, or switch to (2) from (1)).

In the short term, dollar will see pressures to appreciate as interest rates will remain intact at policy level and it will take time for higher Treasury yields to transmit into higher real interest rates in the US, inducing slowdown in the economy. Until that happens, economic recovery will be pushing up equities and USD.

In the longer run, however, this pattern will be altered: improved economic news will signal forward switch from (1) taper off to (2) unwinding. Yields will put pressure on real interest rates (3) and policy rates will move up. This will lead to subsequent devaluation of the USD toward equilibrium and a slamming of the breaks on the recovery.

The emerging markets and corporate bonds squeeze are not simple reallocations of liquidity. Truth be told, there is nowhere for liquidity to 'reallocate', given yields. Instead, these are early warning systems at work. Now, to see the underlying iceberg we are heading for, recall this http://trueeconomics.blogspot.ie/2013/04/2242013-who-funds-growth-in-europe.html

Updated: series of very interesting interviews on the issue of monetary exit: http://www.voxeu.org/article/exit-strategies-time-think-ahead

and an interesting post on term premia due to QE:
http://www.econbrowser.com/archives/2013/06/update_on_the_y.html

Tuesday, June 11, 2013

11/6/2013: Irish Services Index: April 2013

Good news is: on an annual basis, per CSO, in April 2013:

Administrative and Support Service Activities rose +21.3%,
Information and Communication went up +15.4%,
Other Service Activities +4.2%,
Transportation and Storage +1.4% and
Accommodation and Food Service Activities (+0.3%) increased

On bad news front:

Wholesale and Retail Trade were down -4.2% and
Professional, Scientific and Technical Activities fell -0.6%.

The seasonally adjusted monthly services value index increased by 1.2% in April 2013 when compared with March 2013 and there was an annual increase of 4.1%.

As you would know, I am not covering Services PMIs anymore, as these are no longer being released in any useful data format (Markit has decided to exclude reporting of actual levels of sub-components for PMIs, preferring to practically give instead its analysts personal opinion about these levels).

However, I will continue reporting CSO data.

So here's more detailed analysis:

Wholesale Trade sub-index rose from 106 in March to 114.1 in April, marking a 7.64% rise m/m and a decline of 4.68% y/y. 3mo MA through April 2013 stood at 110.23, down on 116.67 3mo MA through January 2013 and down sharply on 122.07 3mo MA through April 2012. 6mo MA through April 2013 is at 113.45, down on 121.10 6mo MA through April 2012.
Wholesale and Retail Trade, repair of vehicles sub-index improved from 102.3 in March 2013 to 105.7 in April 2013 (+3.32%), but the index is down 4.17% on April 2012. 3mo MA through April 2013 is at 104.3 against 3mo MA through April 2012 at 111.27; 6mo MA through April 2013 is at 106.32 against 6mo MA through April 2012 at 110.80.
Transport & Storage sub-index is at 113.4 in April 2013 up marginally (+0.62%) m/m and up 1.43% y/y. 3mo MA through April 2013 is at 111.83 up on year ago 3mo MA of 106.83. 6mo MA through April 2013 is at 111.18, up on 6mo MA through April 2012 at 106.73.

Accommodation & Food Services slipped from 105.9 in March 2013 to 102.7 in April 2013 (-3.02%) and the index is up only 0.29% y/y. 3mo MA through April 2013 is at 103.2, which is up on 3mo MA through April 2012 at 101.2. Similarly, 6mo MA through April 2013 is at 103.77 which is up on previous year level of 101.3.
Much of the improvements in the above sector was driven by rising value of food services, up 3.51% y/y. Accommodation services actually fell 1.35% y/y and were down 9.07% m/m.
Administrative and support services activity also improved m/m (+1.66%) and rose strongly by +21.31% y/y. Huge gains were recorded in the activity on 3mo MA basis y/y and 6mo MA y/y basis. I have no explanation to this other than possibly reclassification of some activities into this category, plus boom in on-line services centres in Dublin (much of google and other ICT services firms activities here relate to support and admin, rather than R&D or professional work).

ICT services continue to boom, rising 15.42% y/yin April, although slipping 1.59% m/m from the historical record-breaking levels in March 2013. on 3mo MA basis, April 2013 stood at 122.13 strongly up on previous year levels of 109.87. On 6mo MA basis, April 2013 came in at 120.42, up on 110.42 a year ago.
In contrast to ICT services and Admin services, Professional, scientific and technical activities index declined for the third month in a row, falling to 91.0 in April 2013 from 91.2 in March 2013 (-0.22%) and is marginally lower (-0.55%) y/y. 3mo MA through April 2013 is at 91.4 and it is virtually flat on 3mo MA through April 2012 (91.2). 6mo MA through April 2014 at 91.0 is down on 94.5 6mo MA through April 2012.

Overall Services sector activity index rose 1.21% m/m from 107.7 in March 2013 to 109.0 in April 2013, and is up 4.11% y/y. 3mo MA through April 2013 is at 107.63 which compares marginally positively against 105.4 3mo MA a year ago. 6mo MA through April 2013 is at 107.62, also marginally up on 105.47 6mo MA through April 2012. However, 3mo MA through April 2013 was identical to 3mo MA through January 2013, implying zero growth, and 6mo MA through April 2013 was slightly ahead of 6mo MA through October 2013 (107.6 relative to 105.9).

Monday, June 10, 2013

10/6/2013: Fitch on Irish Banks

Both Fitch and S&P have in the recent past questioned the model of Irish banking sector crisis resolution on the foot of the apparent link between the banks balance sheets and the exchequer.

Today, Fitch issued another report on Irish banking sector, titled "Peer Review: Irish Banks"

The report claims that Irish banks' current ratings "are constrained by the significant risks that remain in the Irish banking system. However, support remains an important rating driver and Fitch considers that the Irish authorities' propensity to support the 'pillar' banks, Bank of Ireland (BOI) and Allied Irish Banks, p.l.c. (AIB) remains undiminished, despite the withdrawal of the Irish Bank Eligible Liabilities Guarantee (ELG) in March 2013."

Crucially, "Fitch believes that the pillar banks' performance will continue to track within the stress case scenario of the 2011 Prudential Capital Assessment Reviews (PCAR), however these tests were framed on a Basel II basis. Since then capital expectations of market participants have increased. The 2014 PCAR may revise the stress assumptions and requirements to align more closely with Basel III." The kicker is that the banks will need new capital ('might need' another state injection as opposed to 'will need' capital).

"As Irish banks' capital ratios continue to be eroded and a return to profitability only appears feasible in the longer term, the banks may need to raise additional capital before they can contemplate a future independent of state support", Denzil De Bie, a Director in Fitch's Financial Institutions Group told Reuters.

The old kicker is that assets and capital held by the Irish banks remain weak, "with high NPLs and impairment charges, especially against commercial real estate and residential mortgage loans. Although the rate of deterioration slowed at BOI and AIB in 2012, Fitch believes impairment charges could increase during 2013 and 2014, with arrears reaching a peak in 2014, as the banks accelerate the resolution of mortgage arrears in line with new targets set by the Central Bank of Ireland in March 2013."

"Asset quality is weak in the Irish banks, with NPL ratios of 16%-40% in the Fitch-rated
institutions at end-2012. The banks also report a significant portion of their loan book to be past
due but not impaired."

Peaking of mortgages arrears per PCAR2011 starts in 2014 and goes on in 2016-2017.

"Underlying pre-provision operating profitability is structurally very weak because of the long-term, very low-yielding mortgage loans in their books. Until rates rise, Fitch considers that a return to sustainability will only be possible as the various restructuring and cost control plans of the banks begin to yield results. Fitch expects a return to operating profitability to be delayed until at least 2015 because of the continued erosion of earnings from high but reducing impairment charges."

Now, recall that per PCAR2011, Irish banks were supposed to fund their full losses out of operating profits starting with 2015. So far, Fitch is not saying there is excess (above PCAR2011 stress test assumptions) level of stress in the system, but Fitch does seem to point to the already recognised two pressure points:
- continued deterioration on the assets quality side, and
- Basel III.

And the banks are still dependent (and will remain for some time to come) on state/central bank supports: "with loan/deposit ratios still at a high 130%-230% in the Fitch-rated banks at end-2012, wholesale, government and European Central Bank funding still forms an important, albeit reducing, component of the Irish banks‟ funding bases." Why? Because deleveraging is by far not complete: