Committing the NPRF

Should the NPRF be used for bank recapitalisation? 

I have always thought the fund a good idea.   It helped increase national saving by reducing measured budget surpluses.   (These surpluses would have been difficult to sustain politically.)  And I believed it would make pension benefits more secure in the face of a rising tax cost as the population ages.  Along with many others, I thought the fund only a good idea if investment decisions were not politicized.   That seems almost quaint. 

I now think it serves another purpose that I simply did not appreciate.   Others were more prescient.   It provides a valuable bulwark against the tail risk of a real “run-on-the-country” kind of crisis (that includes both bank and government debt).   The risk is nicely captured by Larry Summers in his 2000 Richard Ely lecture on international crises.   As he says, in this kind crisis the mode of investment analysis shifts from “economics to hydraulics.”  Fundamentals become irrelevant as everyone tries to get their money out before everybody else.  

The existence of a large and relatively liquid NPRF makes falling into such a bad equilibrium less likely.   I therefore think the Government should be slow to commit a large chunk of the fund to bank recapitalization.  My sense is that it would be better to borrow the funds, notwithstanding the recently increased spread.   Having a substantial liquid sum on the asset side of the government’s balance is valuable insurance in perilous times. 

7 replies on “Committing the NPRF”

@John: if we borrow the money and have a reserve is it any better than not incurring further debt and paying with funds already held given the large spread the state would face to raise this? Our deficit would also go higher putting further pressure on our national credit rating and because recapitalisation will be paid for by everybody then it would be highly unpopular to borrow more unless absolutely required.

Karl, I hear what you’re saying. But the mode of funding only changes the composition of the balance sheet and not the level of net debt. Under the option of using the NPRF we change the composition of the asset side of teh balance sheet. Under the borrowing option we increase both the libability and asset sides of the balance sheet — assuming the investment in the banks is actually an asset. But the net debt should be the same under each. Hopefully, the markets would be smart enough to see it (though you may be right on that score). I would guess the markets appreciate seeing a large liquid reserve on the asset side of the balance sheet. Again, I am thinking here of worse case scenarios, but we need to do this given the unpredictable way this global crisis is unfolding.

The beauty of the NPR Fund was that it succeeded in reducing government spending so that there would be something left for a rainy day. In my opinion, it’s raining.

At the same time, it should be borne in mind that bank recap does not necessarily require injection of liquid assets. Placing a government bond in the bank’s assets will generally do the trick.

The NPR was always subject to the dynamic inconsistency problem: it would be raided as soon as the government had any excuse to do so. This is exactly what we’re seeing now, and we aint seen nothin’ yet. But anyone could have foreseen this; the US government has always raided its Social Security Trust Fund, which is now full of worthless assets. (Of course, Im not suggesting this is what the Irish government is doing, not at all.) Accumulating such a fund never made much sense politically. Instead, the proceeds should have returned to the public in tax cuts.

@John: Excellent point on the composition of the balance sheet but I feel a difference has to be drawn between bond debt and forward obligation debt, the NPRF is there to cover public sector pensions in the future, whereas the bond is a market debt as well as being payable in a shorter amount of time, we would eat the liquidity of the NPR on servicing that debt and risk a larger real debt deficit, by real debt i mean this: the NPR could be vaporized tomorrow and the state could argue that they feel it is no longer necessary therefore the debt doesn’t need to exist (the obligations of it do but the actual money in a fund today is a different story). The bond doesn’t have that luxury and therefore the NPR raid makes decent sense no?

Personal savings accounts would have achieved the same objective while protecting us from government raids. The reason that surpluses weren’t larger was due to irresponsible and reckless leadership from McCreevy aided and abetted by Ahern and then compounded by Cowen. Excessive Increases in public spending from 2000 were and are unsustainable and killed our competitiveness through inflation, NPRF did nothing to stop this.

Ciaran, I agree with part of that. It would be almost impossible for the government to raid personal accounts. In contrast, the NPRF has shown itself subject to massive political risk.

However, I think Patrick is right that by taking a portion of surpluses off the table the fund did curb spending/tax cuts to some extent. The fiscal excesses of recent years could have been worse.

But we are where we are. The question is what to do with the fund now. Patrick says it’s raining; but it could rain harder yet. I still think that a relatively liquid reserve has significant value in preventing Diamond-Dybvig type bad equilibrium. Keeping it in place also leaves some hope that it will around for its original purpose.

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