Ireland’s Fiscal Challenge

Brendan Keenan has an excellent analysis of the fiscal challenge facing the government: you can read it here.


Foreclosure Mitigation Efforts

The IMF  has released a ‘staff note’ on how do foreclosure mitigation: you can read it  here.   While the focus is the US, it is a general primer that is also relevant to Ireland.

Fiscal Policy

More on that ICTU plan

It seems that the intellectual underpinnings of the ICTU plan for economic recovery are to be found in the Swedish government’s response to their crisis in the 1980s. A Swedish dimension is no great surprise in itself: David Begg has long been an admirer and advocate of the Scandinavian model. He was on RTE’s Q&A on Monday night and in the context of the ICTU plan, referred to the writings of an economist who worked for Goran Persson, the then Swedish finance minister. 

Curiously, more details emerged in this morning’s Irish Times in a discreet article secreted away on p.7 According to the piece “the work of a Swedish economist who advised its government when its banking sector collapsed is being used by ICTU as the basis for its ‘social solidarity pact'”. The article goes on to name the economist concerned – Jens Henrikkson – and refers to a paper he published two years ago under the aegis of Bruegel, the Brussels-based think-tank (of Alan Ahearne fame).

I was intrigued that David Begg would identify a specific paper as the inspiration of the ICTU position and decided to check it out. I suggest that others check it out too. It is called “Ten Lessons About Budget Consolidation” and was published as part of the Bruegel Essay and Lecture Series in 2007. It can be downloaded (after a little bit of search activity) at

If David Begg is a big fan of this guy and the approach he advocates, there is a light at the end of the tunnel. Henrikkson’s first lesson is: Sound Public Finances are a Prerequisite for Growth; his second: If You Are In Debt, You Are Not Free. He recounts, inter alia, how the Social Democrat government of the day engineered across-the-board cuts in spending, including cuts in welfare benefits.

Henrikkson has quite a few things to say that The Two Brians could usefully take to heart. Some samples: “An ad hoc hodgepodge of measures will only have a limited chance of success” and “It is of great importance that the minister for finance is conservative when it comes to prognosis”.

The downside of all of this is that whatever intellectual debt the ICTU document owes to Henrikkson is not obvious from the document itself. But maybe what Begg is saying is: if you want to know where we really stand, as distinct from the public posture we have to take, you’ve got to read this other stuff too.

Economic Performance

Latest CSO figures underline vulnerability of Irish agriculture

The CSO released its preliminary estimate of agricultural output and income for 2008 two days ago.  The figures underline yet again the highly vulnerable position of Irish farming to possible changes in the EU’s Common Agricultural Policy (CAP) payments after 2013 when the new EU financial perspective is negotiated. Family farm income before direct payments was slightly negative in 2008, indicating that Irish farmers received no market remuneration for their contribution to agricultural production last year.

To understand the extent of this vulnerability and the justification for this conclusion, we need a short introduction to the economic accounts for agriculture. The net value added in agriculture at basic prices (these are the prices farmers actually receive for their output, adjusted by any product-specific subsidies or taxes) in 2008 was €830 million. This value added is divided four ways:

  • Some goes to hired labour in agriculture, €450m
  • Some goes as interest on borrowed capital, €398m
  • Some goes as rent for rented land, €144m
  • And the remainder is available for farm families to remunerate their labour, the use of their own land and the return on their own capital invested in farming.

Doing the sum, family farm income at basic prices in 2008 was minus €162 million. Even if we ignore land rental as the transfer of income within the farming community, family farm income last year was slightly negative.  These means that the work of  most of the estimated 155,000 people working in agriculture (measured in annual work units) as well as the use of 4.3 million hectares of agricultural land and billions of euro of farmer-owned capital stock (the stock of agricultural machinery alone was valued at over €2 billion, see Keeney 2007) added precisely nothing at basic prices to Irish GNP last year.

And we should remember that, for the major commodity outputs of Irish agriculture of beef and milk, these basic prices are artificially inflated by import protection against third country exporters of between 40 and 80 per cent.

So the only income which farm families had from their farm enterprises last year came from direct payments. These totalled €1.9 billion, paid for mainly by the EU CAP but also with contributions from the national exchequer.  In addition, there were substantial capital grants paid to farmers particularly under the Farm Waste Management Scheme which is now likely to cost a total of €900 million over the period 2006-2008. This cost was so far above the budgeted estimate that the Minister has announced that payments will have to be phased in over the period to 2011, leading the farm organisations to demand that the government should in addition bear the cost of the interest payments to which farmers are exposed as a result of the late payment.

Some of these subsidies, such as environmental payments under the REPS scheme, have a justified rationale in public welfare terms, even if the schemes are not always well designed to deliver those benefits. On the other hand, if environmental services are being paid for, then the pollution costs of agriculture should also be factored in (particularly water pollution even if this has been significantly reduced in recent years, but also the greenhouse gas emissions from livestock farming). In the case of some other direct payments, there may be a rationale for maintaining farming activity in some marginal farming regions for landscape protection and biodiversity reasons. But there is little clear rationale or justification for continuing the bulk of direct payments to Irish farmers, which were introduced to compensate for price reductions which, in some cases, took place 15 years ago!

As at least some reduction in these payments must be expected following the negotiations on a new EU budget for the period after 2013, these latest CSO figures show just how dangerously Irish agriculture will be left exposed in the years ahead.


The European Commission’s Assessment

You can read the assessment of Ireland’s Stability and Convergence Programme here.  It is also useful to look at the assessments of the other EU countries, in order put the Irish position into a comparative context.


Shortlisted in Irish Blog Awards

We have made the list of finalists in the ‘Best Specialist Blog’ category in the Irish Blog Awards: the details are available here.

Banking Crisis Fiscal Policy

Ireland’s borrowing capacity

I didn’t expect to be asking this question again (I thought about it a lot a quarter century ago), but how much Government debt do contributors believe the Irish economy can support? A lot more than it has at present, of course.

But I raise the point now because Morgan seems sure in his latest newspaper article (not as incendiary as the previous one). It’s OK, he says, if the Banks have “bad debt” of only €10-20 billion; not OK if this number goes up to €50-60 billion.

OK, by “bad debt” I presume he means prospective loan losses. And I suppose he also may be ignoring the fact that the banks still have upwards of €20 billion of book equity capital to burn through before the Government starts taking the hit — but let’s ignore such details.

The interesting point is that the difference between his low figure and his high figure is only 22% of forecast GDP for 2009. Can we be so sure that one figure is affordable, and the other not?

Seems to me that the taxation collapse, and the resulting surge in the deficit on normal operations, is at least as big an issue in terms of a sustainable debt path as the prospective banking losses, large though these are.


Crisis Prevention

The Irish economy is well removed from a full-blown financial crisis.   (I take it that the outstanding feature of such a crisis is the inability roll over liabilities.)  Even so, it is useful to review, with the Irish situation in mind, the list of crisis-prevention actions that received broad assent after the Asian crisis.   A reasonable overall assessment is that Ireland is still in a relatively strong position, but it is worthwhile to concentrate on minimising the remaining tail risk.    Here is a partial list: 

Exchange rate regime:  Avoid soft pegs.   This became known as the “bipolar view” – completely fixed or freely floating exchange rate regimes are the least crisis prone for countries with open capital accounts.   (See here for a recent thoughtful account.)  Being part of the euro zone is an unmitigated blessing in this regard. 

National balance sheet:  Avoid serious currency and maturity mismatches.  Here again the ability to borrow in one’s own currency is a huge advantage.   It also appears that the NTMA is doing a good job managing the maturity structure of the national debt.   The existence of the NPRF is also fortuitous – even if initially put in place for another purpose.   It should be viewed as a critical liquid reserve and not tapped as an easy source of funding.  Although no one likes to hear about IMF intervention or bailouts from our EU partners, I see nothing wrong with careful contingent planning and agreements.   I think it is highly unlikely that Ireland will need such funding.   But I think it is even less likely if arrangements are in place to smoothly access funding under extreme circumstances.   This would be a clear signal that the government will do everything possible to pay its debts, and would limit the risk of falling into the bad equilibrium that Philip Lane discussed in yesterday’s comments. 

Macroeconomic management:  Avoid destabilising fiscal policies.   Although Irish fiscal policy comes in for much deserved criticism, the dramatic reduction in the net debt put the country in a strong initial position.   Unfortunately, the running of a structural budget deficit during the property boom and the reliance on asset-based taxes left the country vulnerable.  The key question now is what deficit can safely be run.  One plausible view is that significant short-term consolidation is required to protect creditworthiness.   The danger is that this will deepen the recession and potentially even deepen the fiscal hole.  An alternative approach is to make the minimum adjustment necessary to show that the public finances are under control – clearly not a risk-free strategy either.  This debate will continue. 

Transparency:  The combination of non-transparent financial-sector balance sheets and implicit or explicit government guarantees is lethal.   It is indefensible that analysts are still trying to figure out how bad the bank balance sheets really are.  An open, Obama-style stress test is urgently needed to reduce uncertainty.

Regulation:  Err on the side of prudential regulation.  Evidently, the emphasis on prudential regulation lost out in the ever-present tradeoff between encouraging innovation and minimising systemic risk.   We have now had further confirmation of the tendency of financial markets to produce bubbles and the incredible damage that ensues when those bubbles burst.   There needs to be root and branch reform of the regulatory system to restore confidence in the system and ensure that balance sheets are never allowed to accumulate such vulnerabilities again.


National insulation for economic recovery: As second best as it gets

On Feb 8, Ministers Gormley and Ryan announced the National Insulation Programme for Economic Recovery. There is €100 mln on the table, so I will not comment on the last three words of the title. The press release is worth a close examination for those who study spin.

There are two components to the programme, each worth €50 mln.

The Home Energy Saving Scheme subsidises / co-finances investments in energy efficiency improvements for private owners of houses build before 2006. The energy efficiency of the average Irish house is indeed not great. Better efficiency would indeed lower energy bills and reduce emissions, and retrofitting buildings is indeed a labour intensive business. So, did the government find the ultimate win-win-win policy?

Not quite.  If Irish home owners do not sufficiently invest in their house, that is their business. There are externalities, such a carbon dioxide emissions, but these would better be addressed by a carbon tax. (A carbon tax is increasingly likely, and thus the prospect of double regulation.) A carbon tax has the advantage that it brings in revenue rather than increase government spending. Furthermore, it would affect office buildings too.

A carbon tax would also leave home owners the choice how best to improve the energy efficiency of their house. The government programme is heavily biased towards insulation. This is needed in many houses, but in many other houses it may be better to replace the heating system. There are subsidies for that too, but only for a very limited set of heaters that may not be appropriate for all houses.

There are many reasons why home owners do not invest in their houses. A prominent one, “can’t get a builder”, has disappeared but has probably been replaced with financial worries and constrained credit. It is not clear that homeowners will rush to avail of these subsidies.

The Home Energy Saving Scheme is clearly aimed at the middle class. The other component of the insulation programme, the Warmer Home Scheme, is aimed at the less well-to-do. Information is not easily accessible, but it is clear that the Warmer Home Scheme (1) is largely limited to insulation, (2) aims at “communities” rather than individuals, and (3) that eligibility criteria are negotiable. While it will take the sharp edges of “poverty” for some, chances are that these people would rather take the money and decide themselves whether to insulate the attic or not.

Will the insulation programme deliver? First, will it save money? Probably not. Assuming that transaction costs are zero and assuming that homeowners will not use the improved insulation to increase the comfort of their home, the payback period of the investments is 3-20 years (according to the always optimistic calculations of engineers). With more realistic assumptions and current interest rates, only some measures have a positive net present value.

Second, will it bring jobs? The government predicts “thousands of jobs”. If that means 10,000 jobs, then the cost per created job is €10,000; but if “thousands of jobs” means 1,000 jobs, then the cost per created job is €100,000. And, of course, the €100 mln in government funds and the $X mln in private funds is diverted money, not new money.

Third, will it reduce carbon dioxide emissions? Yes, if the subsidies are taken up. Direct emissions of carbon dioxide by households are some 7 million tonnes of carbon dioxide. Let us assume that 5 million tonnes of that are for home heating (too high), and that the insulation programming reduces the energy bill by half (too high) for one percent (too high) of houses. Then 25,000 tCO2 is saved this year, but this is an investment so let us multiply by 10. Saving 250,000 tCO2 for €100 mln is 400 €/tCO2. Last Friday, emission permits traded for 8.65 €/tCO2. The 400 €/tCO2 is conservative on the one hand, but it omits the benefits of warmer homes and lower energy bills. If the two cancel, the government overpays for CO2 emission reduction by a factor 50! (This factor is comparable to getting your hair cut in Florida rather than in Dublin.)

Will the national insulation programme do harm? I do not think so. But, it is a decidedly second best way of reducing emissions, creating jobs, or reducing povery.

Banking Crisis

Patrick Honohan on Bank Rescue Package

Today’s Sunday Business Post carries this article:   “Bank Rescue Package: More To Come“.

(May be helpful in thinking about Karl’s previous post.)

Banking Crisis

A Good Investment?

Writing in today’s Sunday Times about the government’s €7 billion re-capitalisation of AIB and BOI, Damien Kiberd says “The money invested will almost certainly be recovered and, in the interim, it will pay the state an annual interest rate of 8%.  This will bring the exchequer €560m a year”.   Later in the article, Kiberd points to this €560m as one of the key measures that will help to improve the public finances. This idea that the money is a sound investment of taxpayer money has also been raised in recent days by the Minister for Finance and by Brian Goggin, CEO of Bank of Ireland.  Despite this, I was a little surprised to see a high profile journalist endorse this position so strongly.

The scenario outlined by Kiberd is, of course, one possible outcome.  But one can think of others.  For instance, even if these banks remain in private ownership, they may not be able to pay back the government’s preference share investment in the five-year time frame envisaged and we can hardly be confident that a profit would be made from the options to convert the preference shares into ordinary shares at the strike prices agreed in the statement.  More worryingly, if the banks need further recapitalisation or  end up being nationalised, there would be little reason at that point to expect to see all of the original investment back.

In relation the “guaranteed 8% return”, there will doubtless be a transfer of €560m per year from these banks to the government.  However, to the extent that these transfers further diminish the banks’ equity capital, then any future government injections of capital could be seen as just giving this money straight back so that, on net, the taxpayer doesn’t really benefit from this interest.  And, of course, if the banks are nationalised, then these interest payments will just be transfers from one branch of the public sector to another.

Just to be clear, I am not saying that the rosy scenario can’t happen.  I don’t claim to know the full extent of bad loans at these banks, so I’m not putting forward a judgement here on the need for (or likely extent of) future capital injections.  Still, I’d be interested to know what our band of expert contributors and commentators think about the likely return on the  government’s recapitalisation investments.


The Sunday Times Magazine likes this site

We make the ‘top 100 blogs’  (and are the only Irish-based blog in this week’s coverage of the list) in the printed version of the magazine, listed under the ‘Original Thinkers’ category.

World Economy

Globalization past and future

One of the alarming features of the current crisis is that way in which the short run protectionist pressures it is giving rise to are being superimposed upon longer run pressures that having been undermining support for globalization for some time — in particular, the feeling that it is harming poorer workers in richer countries. Equally alarming is the fact that all this is happening at the start of a century which will be marked by a shifting geopolitical equilibrium — which is always risky — and by renewed concerns about resource scarcity — which is riskier yet.

An essay just published by Bruegel tries to provide some historical context for all of this. Anyone interested in learning more can read this book.


CDS spreads again

Simon Johnson is alarmed about the very striking recent spike in Irish CDS spreads.

Banking Crisis

A Contrary View

Some media personalities and political pundits have over-stated the case for placing the blame for Ireland’s current economic mess on the government’s recent policy decisions.  The two big recent decisions of the Irish government (insured deposits and new bank capital) appear to me quite defensible.  If I may bring some controversy to the blog, here are three statements making the media rounds that I think are false:

1.  The primary cause of the Irish economic crisis was bad decisions by Irish policymakers and banks.

The statement above is false since the primary cause of the Irish economic crisis is the US-generated global credit crisis. This credit crisis in turn was caused by disastrously bad decisions by US policymakers (Congress, the quasi-state agency Fannie Mae, the SEC and Federal Reserve) and the U.S. finance industry (mortgage originators, ratings agencies, investment and commercial banks).  The too-weak oversight by the Irish central bank and financial regulator left the Irish bank sector very vulnerable to an external shock, as did the Irish government through its tax-and-spend policies, but these are both secondary not primary causes of the economic crisis.  It is a counterfactual and impossible to scientifically test, but I speculate that in the absence of the U.S. credit crisis, the Irish economy would have experience a somewhat bumpy “soft landing” from its 2002-2005 excesses. Without the US-generated crash, the 2009 situation would have been nothing like what we are in.

2.  The government decision on September 30th to insure all bank deposits was obviously foolhardy and inconsistent with careful economic analysis.

This statement is false since it might possibly have been foolhardy but that is not obvious. As Brunnermeier notes in his recent JEP article, the 2007-8 credit crisis brought a new type of bank run, what he calls an “investment bank run.”  This is a bank run between institutions, where banks lose trust in one another and the relatively strong banks attempt to cut all credit ties to the weaker ones. As the Lehmann Brothers disaster shows, this can be a very destructive type of bank run due to the complex interlocking relationships between large banks.  Going back to the classic Diamond-Dybvig model, a bank run can be stopped by the monetary authority providing or promising monetized liquidity to all depositors.  As soon as the depositors realize that this monetized liquidity is available, the bank run ends.  There is a long-term moral hazard problem of course, but bank runs can be stopped in this way, and it usually works in practice.  So the government’s action was consistent with reasonable economic analysis of the situation.  Unfortunately Diamond and Dybvig wrote their paper before the advent of the Euro, so they do not explain what happens when the national government does not control monetary reserves.  Still, it seems a defensible policy move under the circumstances.

3. The capital injection into the two big banks is wasted and/or inadequate since they are obviously worthless on a net-value basis.  The current share prices are just the speculative value of an out-of-the-money call option.   

The second sentence of this statement might be true (Patrick Honohan made this point earlier on the blog) but the first sentence seems false.   Relatively big banks in small economies probably have considerable economic value even when their market value is near zero or effectively negative on a net basis.  The two big banks will pull through their current “negative value state” and eventually return to being profit-making institutions, with appropriate government support during the current crisis.  Banks are almost always insolvent on the basis of current liquidation value.  The fundamental nature of a bank is that it is a device for changing liquid deposits into illiquid loans.   Government capital support for the banks at this stage seems defensible.  The alternative of full nationalization of all the banks (not just the rogue bank Anglo Irish) carries too many risks for the economy.


The State of the Nation conference

The Labour Party is hosting a conference on Saturday, 21 February in Dublin to discuss solutions to Ireland’s economic and banking problems. A link to the programme can be found here. I post this notice because I think some visitors to this site might be interested in the event, not because of any political allegiances.

Economic Performance

December Retail Sales imply Rising Household Savings?

The sa volume of retail sales peaked in Q4 2008. This morning’s release for December completes the 2008 picture. There were qoq falls from Q1 to Q4 of 1.8%, 3.3%, 1% and 2.2%. The Dec figure was 8% below Dec 2008.

The quarterly national accounts, available only to Q3 2008 anyway, do not give the income table, and we can only guess at the intra-year patterns. If consumption has followed retail sales volume, there must have been a sharp increase in the savings rate through 08. Household income cannot have fallen anything like 8%, and even in Q4 it is doubtful if the income decline was as much as the 2.2% quarterly fall in retail sales volume. The direct tax increases had not kicked in, and many enjoyed nominal pay rises from September as consumer prices began to fall, offsetting the income loss from employment contraction. Household income will possibly fall more rapidly in Q1 2009, since unemployment seems to be rising faster; direct tax hikes are kicking in; and there seems to be a pay-reduction round going on in the private sector. If the savings rate continues to rise, the implication could be dire retail volumes for a while yet.

Here’s a question: the figures coming out since year-end have been pretty poor overall, suggesting that activity is declining even faster than feared. Does this mean that the downturn could be shorter? Is it the case that there is a given (given by world trade volumes, real exchange rate and competitiveness) macro-correction of x% to be endured, but x does not get bigger just because the economy gets through it faster?

Banking Crisis

Why do bank share prices fall when government buys preference shares?

The two main Irish bank shares fell back again today following the announcement of the details of the recapitalization — down 16 and 14 per cent respectively. There could be lots of reasons. To begin with there was the extraneous factor of the back-to-back deposits between Anglo and ILP mentioned in a previous post. ILP fell back 15 per cent as well.

Then there is the possibility that shareholders expected a more lenient deal? But how lenient could that have been? The interest rate on the preference shares is stiff enough, but not out of line with prevailing practice in other countries and anyway was well-flagged.

To all intents and purposes, however, the share prices are close to zero — down over 95 per cent on their peak.

My purpose in writing, though, is to point out that even though the preference shares are senior to equity, an injection sufficient to assure solvency going forward could nevertheless have been expected to lift ordinary share prices.

I suspect this is not a well-known effect. Permit me to present a very simple model.

Thus, suppose that there are just three periods. For convenience, assume our bank begins with zero capital.

In period 1, the government decides the amount S it will inject through purchase of preference shares.

In period 2 we discover the true state of the world, i.e. the size of the loan losses (H high in the bad state, L low in the good state). If the losses exceed the funds the government injected, then the bank is liquidated and the shareholders get nothing; If the losses are equal to or less than injection, then the bank continues in operation.

In period 3 the bank, if still in operation, earns franchise profits Z on the rest of its business. It is then wound up; the government receives its injection back if possible. Any surplus goes to the shareholders.

Clearly, if the values H and L are known and if the government injects any amount equal to or less than L, the market value of the shares at the end of period 1 is zero. (Of course, the analysis assumes rational market expectations.)

If the government injects more than that, the market value of the shares at the end of period 1 is p*max{0, (Z-L)}, where p is the probability of the good state. A longer expression gives the share value if the injection S is higher than H.

The point is that even an injection S that is only sufficient to ensure the bank’s survival in the good state will, when announced, increase the market value of the shares.

The Irish Government injection of yesterday was insufficient to do that.

Economic Performance EMU Fiscal Policy

There is a Better, Fairer Way (ICTU)

ICTU has released its 10 point set of recommendations: you can find the document here.

I am interested in the readership’s comments on this document, which will be an important input into the next round of social partnership talks.


January HICP and CPI

There are seasonals in the price indices, and they happen to matter when comparing January with December. Both HICP and CPI ‘should’ fall by about 0.7% in Jan. HICP sa changed little from Oct to Nov, but dipped about 0.5% in Dec. It has dipped about 0.1% further sa in Jan. CPI, mainly due to declining mortgage costs, fell almost 1% sa in both Nov and Dec, and has fallen a further 1% in Jan. The main difference between the two is owner-occupied housing costs, excluded from the HICP. It would be nuts to annualise the sa CPI fall of the last three months, would imply minus 12% or more for the year. Interest rates can decline only a little further.

The annual % change in CPI is now about zero. But the last three months sa has shown an average CPI drop of 1% per month. The (preferable, in my view) HICP seems to be dropping about 0.3% per month for the last two months, would give an annual fall about 4%. The twelve-month HICP figure (meaningless) is still showing +1.1%. I reckon, for what it is worth, that HICP could begin to drop (sa) a bit quicker than CPI over the next few months. There is more sterling pass-through on the way, but maybe not much more from ECB.

These January figures are consistent with recent forecasts of significant price declines for 2009 over 2008. Numbers like minus 3 or 4% for 2009 over 2008 are plausible, even though it is early days. There are obvious implications for indirect tax revenue, and for informally index-linked income variables.


No wonder it’s hard to interpret monetary statistics

Who would be a monetarist these days? Most monetary policy types are scrambling to re-estimate behavioural relationships.

And then there are the window-dressing operations, which are now revealed to have been exceptionally large in Ireland around the time the Government had to rescue the banks at end-September 2008.

No wonder it is hard to make sense of deposit and monetary movements at that time. In a footnote at my paper in the crisis conference I was reduced to hand-waving: “It is striking that these events have not left a very prominent track on the monetary aggregates. The evidence of a cash crunch at end-September is very muted…though of course we do not have day-by-day figures for the last week in September).”

Now we begin to know why.

Banking Crisis

Government buys some bank preference shares

Details of the much discussed recapitalization plan for the two main banks have finally been announced as approved by the Government.

In terms of financial restructuring the plan is modest enough. There is only modest dilution of shareholders; the government’s reluctance to take ownership is evident. And there is nothing yet on removing bad assets to be managed separately (though the government statement expresses interest in pursuing this line in light of international developments).

The bank’s books now imply that between them they will now have close to €20 billion in core Tier 1 capital. Out of the money options embedded in the scheme suggest that at least one side of the deal is anticipating a vigorous rebound in the banks’ ability to raise private capital.

Meanwhile Bank of Ireland have taken the opportunity to revise their estimates of prospective loan losses over the next two years by up to €2.2 billion — less than the injection of capital. Of course this is far less than the figures being bandied around by the more strident commentators, so we may look forward to seeing in due course who is right.

But negligible share price reactions so far this morning and over the past few days suggest that the market still assumes that the underlying value of the banks’ equity shareholders claims may not have moved out of the negative range.

An interesting feature is the way in which the Government is sourcing the funds. They could have just issued some new bonds and placed them in the banks’ portfolio, but they have gone for drawing on the NPRF. However, there’s a wrinkle: “€4 billion will come from the Fund’s current resources while €3 billion will be provided by means of a frontloading of the Exchequer contributions for 2009 and 2010.” I’m still trying to figure out what difference this wrinkle makes to the different measures of Government deficit/borrowing in 2009 and 2010.


Conference: Politics, Economy and Society: Irish Developmentalism, 1958-2008

Politics, Economy and Society: Irish Developmentalism, 1958-2008

 12th March 2009

Research Building, University College Dublin,

All Welcome-No Fee

 Session One 9am – 10am: Governance and Public Administration

Chair Dr Andreas Hess

MacCarthaigh, Muiris (IPA) and Hardiman, Niamh (UCD), Breaking with or building on the past? Reforming Irish public administration: 1958-2008

Barry, Frank (TCD), Interest-Group Politics and Irish External Trade Policy Over the Last Half-Century: A tale told without recourse to heroes

Brownlow, Graham (QUB), Fabricating Economic Development

 Session Two 10.15am – 11.15am: Political Culture

Chair Dr Andreas Hess

Fanning, Bryan (UCD), From Developmental Ireland to ‘Migration Nation’

Girvin, Brian (Glasgow), Before the Celtic Tiger: Change without modernisation in Ireland 1959-1987

White, Timothy (Xavier), From preventing the future to forgetting the past: Irish political culture in the 21st century

 Session Three 11.30am – 12.30pm: Political Parties

Chair Professor Michael Laffan

Murray, Thomas Patrick (UCD), Development and non-decisions: The curious case of socio-economic rights, 1958-89

Murphy, Gary (DCU), Fianna Fail, Irish sovereignty and the European question

Purseil, Niamh (UCD), Lying awake, worrying about the unemployed: politics and inertia in the 1950s


Lunch 12.30pm – 1.30pm

 Session Four 1.30pm – 3pm: Economic Development

Chair Dr. Donal de Buitleir

 Walsh, P.P. (UCD) and Whelan, Ciara (UCD), The Political Economy of Industrial Development in Ireland, 1958-2008

Durkan, Joseph (UCD), Preventing the future: The 1950s as the nadir of protectionism

McDowell, Moore (UCD) and Thom, Rodney (UCD), Ireland’s exchange rate policy, 1958-1998

Murray, Peter (NUIM) Educational developmentalists divided? Patrick Cannon, Patrick Hillery and the economics of education in the early 1960s

 Session Five 3.15pm – 4.45pm: Politics and Society

Chair: Professor Michael Gallagher

 Kissane, Bill (LSE) Comparing Ireland and Finland

Farrington, Christopher (UCD) The strange transformation of Irish nationalism in the late 20th century

Todd, Jennifer (UCD) The evolution of Irish nationalism: The northern dimension

Coakley, John (UCD), How significant is Catholic unionism in Northern Ireland?

 Keynote Lecture 5pm – 6pm

Chair: Professor Louden Ryan

 Professor Tom Garvin (UCD), Dublin Opinion, 1948-1962



Banking Crisis

Lenihan on Insurance and Bad Bank Proposals

Here are the latest comments from the Minister for Finance on the “bad bank” idea.  (And just to be clear, commenters, the bad bank proposal as currently understood in policy circles means governments overpaying for bad assets – a bad idea – and not the process of maximizing the sales value of these assets after banks have been nationalized – a good idea if nationalisation is indeed required.)

The headline “Lenihan says Government will consider setting up ‘bad bank’” confirms what anyone who watches RTE will already know (and what anyone who reads this blog will know I’m not very happy about).  However, the piece starts out promisingly.    “We can’t be jump-led by markets and market expectations into solutions that suit the banks rather than the people,” said Minister for finance Brian Lenihan last night, who noted banks were using the media to try to force politicians to adopt these types of state rescue plans.   Well said Minister!  Couldn’t have put it better myself.

And then some more good stuff: “Some of the proposals that have been advanced today such as risk insurance seem to involve a payment of a definite premium to the taxpayer in return for the assumption of an indefinite risk. And that is not something that any government could commit itself to,” said Mr Lenihan.   That’s the spirit!

But then things get a bit murky:  He said one of the difficulties with creating a scheme to deal with toxic assets was that it would add to the exposure of the state in relation to its sovereign debt. But he said it could be argued that if the Government had enough information on toxic assets – and Ireland was a small enough country to do this – and it could eliminate the risk then it would improve the risk posed by the existing Government bank guarantee scheme.  “We are at a great advantage that many of the larger (European) states have very extensive loan books and it is very difficult for them to do the type of comprehensive trawl through their banking system that we have been able to do,” said Mr Lenihan, who noted that a lot of the toxic assets held by European banks related to commercial paper, which was much harder to value than the property-based debts held by Irish banks.

This sounds a bit like grasping defeat from the jaws of victory, the minister bending over backwards to figure out why the current-vintage bad bank proposal — while generally a bad idea — might actually be a good idea here.  

I’m not exactly sure what the Minister is driving at here.  But I will point out that the most coherent argument put forward in comments yesterday in favour of bad banks rather than just re-capitalisation (from Mick Costigan) involved the Knightian uncertainty provoked by toxic assets.  Because people don’t know the distribution of losses, even a big re-capitalisation could still leave uncertainty about the potential for even bigger losses and thus doesn’t deliver confidence in the banking system. 

This is an interesting argument though I don’t think it’s relevant to the Irish case.   Firstly, there has to some figure for a large enough re-capitalisation (for instance, the full value of the bad assets) that gets rid of any Knightian uncertainty concerns.  Secondly, our toxic assets aren’t rocket science CDO-squareds built by physicists which can’t be valued because nobody understands them.  They’re bad loans to builders and we can go about making a reasonable guess at what they’re worth today.   Indeed, the minister seems to be making exactly this point.  So, as far as I can see, the Minister’s arguments seem to further point against the need for a bad bank scheme.

Economic Performance EMU

Achieving Devaluation Inside EMU

There is a fascinating press release from SIPTU (the largest union) today: you can read it here.  The key segments of the press release are:

“Speaking after the meeting, the Union’s General President Jack O’Connor said, “The assault under way is about correcting the problem in the public finances without the wealthy contributing a single cent. It is equally about achieving the adjustment, which would normally be brought about through a currency devaluation, by driving down wages across the private sector as well.”


“While a devaluation would affect all sectors of society, cutting pay achieves the same results exclusively at the expense of workers.”

For a member of a monetary union, the analogue of currency devaluation is to engineer a reduction in the general price level relative to the price levels of trading partners (measured in the same currency). This indeed involves a reduction in the inflation-adjusted level of wages across the economy. In relation to the owners of firms, the impact on margins is ambiguous and depends on the structure of each industry. Firms that are exporters and are price takers on world should see an improvement in profitability, as should firms that produce goods and services that are close substitutes with imports. In contrast, firms in ‘nontraded’ sectors may well experience a decline in profitability, especially if these firms use imported inputs.

These considerations are basically similar whether the real devaluation takes the form of a currency devaluation or a decline in the general level of domestic wages and (domestically-influenced) prices.

The major problems with the current situation are:

(i) the national pay agreement is not supporting the attainment of real devaluation. Since the pay increases are still being implemented by ESB, Bank of Ireland and others, the goal of a ‘uniform’ movement in wages across the economy is being inhibited.  It would be better to cancel the existing agreement (the macroeconomic conditions now are far worse than when the deal was reached in September 2008).

(ii)  Wage adjustment is best accompanied by policies to promote competition among firms and, in regulated sectors, to ensure monopoly power is not abused.

(ii) while it is obvious that the overall fiscal adjustment package will require substantial tax increases (including a higher tax take from high income groups), the delay in announcing this component of the deal raises perceptions of unfairness, in addition to increasing uncertainty about the expected level of post-tax incomes for all groups in society. The government could do more in terms of explaining the likely nature of tax increases over the coming years (at least in broad terms). While the Commission on Taxation may have ideas in terms of expanding the tax base, much of the adjustment will be in terms of income taxes and (possibly) VAT.  The general strategy regarding these components could be communicated more quickly.

Banking Crisis

Toxic Assets and Recapitalisation

Last night’s RTE news was full of breathless commentary from Brussels and Montrose to the effect that governments needed to do more than just re-capitalise the banks.  From Brussels, Sean Whelan excitedly talked about “toxic assets” and how it was going to be necessary to “buy the toxic assets at a steep discount, leaving the banks to continue with the viable parts of their business.  Simply re-capitalising the banks isn’t seen as enough.”  Back in Montrose, David Murphy authoritatively informed us that “In terms of doing something else in addition to re-capitalisation, they have an option of setting up a bad bank or, for instance, insuring the banks against the some of the bad loans that are coming down the track.  But it’s pretty clear that the re-capitalisation on its own won’t be enough.   And if they do something that isn’t enough, the markets won’t like it one little bit and Ireland will be punished for that.”

Despite the confident tones in which this expert analysis was delivered, as far as I can see it doesn’t make any sense. 

There is no logical distinction between the issue of undercapitalisation and the problems created by so-called toxic assets.    Banks could get rid of all their toxic assets in an instant if they just wrote them down to zero.  But then they would be undercapitalised—and that’s the problem with toxic assets.  What appears to be going on is that the various re-capitalisation programs around the world have not managed to offset the likely losses from bad loans.  However, this is a problem with the size of the re-capitalisation programs, not their nature.  There is no logical argument for now augmenting these programs with a scheme to systematically overpay for impaired assets.  (Sean Whelan may think the proposal is for buying assets “at a steep discount” but that discount is relative to what they were originally worth, not what they are worth now.)

What appears to be going on is that neither banks or governments want to inject more government equity capital because going any further than we are now requires effectively admitting that the banks need to be nationalised.  Government concerns about nationalising banks are well-founded but it seems that, in many cases, we are well beyond that point.  If the banks can’t find private equity to re-capitalise them and government is willing to do so, then that’s where we should end up.

As a final point, it’s worth noting that despite the constant commentary about toxic assets and all the problems created by the evils of structured finance (CDO-squared and all that), this stuff is essentially irrelevant to the Irish banks.  Their toxic assets are largely plain old loans to bankrupt developers and rocket science isn’t required to come up with a guess at the size of the loan losses.  As Colm McCarthy has joked “We didn’t import any toxic assets, we grew our own.”

As usual, I have the sneaking feeling that I’m missing something.  Perhaps our team of commenting pundits can explain to me what I’ve got wrong.

Economic Performance

Linkages between Ireland and the International Economy

While domestic factors are clearly important in explaining Ireland’s current predicament, it is also true that the deep global recession has compounded the economic difficulties.  A new ESRI research study by Jean Goggin and Iulia Siedschlag provides empirical evidence on the transmission to Ireland of international business cycle shocks: the study is here.


More bad publicity

This article in the Guardian is going to infuriate British readers — not that they have any particular right to be infuriated, while British territories continue to operate as tax havens.

None of this is sustainable in the long run, and we need to start planning for the long run now.

EMU European politics

It gets worse

It was always obvious that the crisis would put global economic multilateralism under pressure. But today’s roundup from Eurointelligence makes grim reading. Incredibly, the crisis seems to be threatening economic openness within the European Union itself, as a result of President Sarkozy’s comments on French car companies operating in eastern Europe.

I don’t believe that the future of the European project will depend on what happens in a couple of peripheral economies of marginal significance. Rather, it will depend on the answer to two fundamental questions. How much do the Germans really want the Single Currency? And how much do the French really want the Single Market?

While I remain optimistic, we are only a year into this crisis. By the time we are through with it, the answer could yet turn out to be: ‘not enough’.


Setting the Record Straight

Some time back I was guilty of mentioning the rumour that the public might be hoarding “German” euronotes (X-rated!) and getting rid of those issued by the PIGS.  My attention has been drawn to a trenchant piece by Willem Buiter that shows there is no logic behind this mischievous piece of British Euroscepticism.