A European solution to wide Irish spreads

Influential Belgian economist Paul de Grauwe argues in a Vox piece that ECB should be buying Irish and other high-yield eurozone sovereign bonds in the secondary market to correct what he describes as “panic” pricing. I think he’s got a point and it would certainly help stabilize expectations about fiscal prospects here and in those other countries.

It’s certainly no more radical than actions currently being taken by the Fed to stabilize their markets. A promising idea?

Foir Teoranta Nua?

A report in this morning’s Sunday Independent flies the kite for a new State Agency to invest equity in private companies. Inevitably, this will remind some of Foir Teoranta, a state agency which was officieally described as a lender-of-last-resort to private companies in the 1970s and 1980s.

Founded in 1972, Foir Teoranta’s stated objective was “to provide reconstruction finance for potentially viable industrial concerns which are unable to raise capital from the normal commercial sources.”

I’m not aware of a systematic analysis of Foir Teo’s effectiveness in that period. Maybe readers can remember more. But my impression is that, on its dissolution in 1991, it was not widely regarded as having been a brilliant success.

So what would make a new company of this type successful? The Indo’s article confirms that it would be well-managed, so that’s all right. But what else? The intended emphasis is said to be on equity, rather than debt (which was Foir’s main instrument). But is that a strength or a weakness in the current climate? How would it complement the European Investment Bank’s EIF, which seems to be in the same territory?

Would it be better to think in terms of a partial credit guarantee scheme instead? After all, if the banks are to receive huge injections of government capital, should one not be thinking of them as a natural source of finance to keep viable firms going? Partial credit guarantee schemes have been the policy instrument of choice for governments wishing to expand credit to small and medium enterprises, and there is an astonishing number of such schemes around the world. However here too there are severe risks; my recent review of these schemes emphasizes the drawbacks and the need for careful scheme design, if damage is to be avoided.

Is the EU fiscal stimulus sufficient?

Much of the recent comment on this blog has understandably focused on the specifically Irish angles in saving the banks and getting credit flowing again, getting on top of the government deficit and improving competitiveness. But any progress towards these goals in a purely Irish context will be set at naught if the global economy continues to head south. We thus have a vital interest in the success of the various stimulus packages intended to reverse, or at least reduce, the slide into global recession.

The IMF’s most recent World Economic Outlook update (published January 28th last) presented its third downward revision of its economic forecasts in just four months. It now projects global growth of just ½ per cent in 2009, with advanced economies expected to suffer their deepest recession since World War II. Collectively, advanced economies are expected to contract by 2 per cent in 2009 – the first annual contraction in the post-war period. Continue reading “Is the EU fiscal stimulus sufficient?”

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. 

Forget Bad Banks, Why Not New Banks?

I’ve written here before about my puzzlement over the widespread international enthusiasm for “bad bank” proposals and I haven’t changed my mind since.

A more attractive proposal, which is getting less attention, is the idea of establishing new banks.  It could be argued that this directly addresses the problems being created by the weak capitalization of the international banking system, without the extreme moral hazard problem associated with TARP-style over-paying for bad assets.  The financial intermediation function performed by banks is crucial to the efficient functioning of the economy and, for a number of reasons, undercapitalized banks do not perform this function well. Understanding this, the approach of govenments everywhere has been to use taxpayers money to prop up undercapitalized banks. But while banks play a crucial role that doesn’t mean that we necessarily need the current set of banks to perform this role.

Kevin already posted a link to Willem Buiter proposing something like this but the idea is now being given wider prominence. Here for instance is a nice clearly-written piece from today’s Wall Street Journal by Stanford’s Paul Romer.  An important benefit of this type of plan, as Romer notes, is that it seems more likely to attract additional private sector equity capital relative to the various plans to attract new investors for existing banks with failed management and murky balance sheets. Indeed, I first read about the idea of new banks in this 2009 predictions piece from celebrity uber-bear bank analyst Meredith Whitney and she was focusing purely on the private sector opportunities. She said:  “I think you’ll see more new banks created. We’ve already seen more applications. And it’s a great idea: You start with a clean balance sheet and make loans today with today’s information. Plus, right now you’ve got a yield curve that’s good for lending.”

Skeptics could point out that these new banks will lack the branch network or knowledge capital of existing banks.  However, branch networks could be purchased pretty cheaply these days and the newly-minted banks could be attractive places for those bankers with good track records to work. Perhaps the best argument against this idea is the time lags involved in getting new banks set up. But the problems in the international banking system seem likely to be with us for some time so useful long-term solutions may be called for.

No doubt I’m being wide-eyed and innocent here.  Perhaps our trusty band of loyal commenters can give me a word to the wise.

Smarter Travel: Motherhood and Apple Pie in the Sky

Ministers Dempsey and Ryan yesterday presented the new transport plan of the government. The document is long on intentions and targets, and short on specific action. It promises significant increases in e-working (from home), public transport, cycling, and walking, but it does not specify the measures that would stimulate this. As far as I know, we do not know whether people would want to work in rural e-offices, or whether their bosses would allow them to. We also lack the empirical basis to predict the effect of, say, road pricing for cars on, say, cycling.

Frank Barry recently came out in favour of congestion charges and road pricing. I fully agree. The government plan, however, does not get beyond a tame “we will think about it”.

The first set of measures in the plan are all about planning. The growing distance between home and work is indeed one of the main drivers of increased transport demand. The underlying forces are simple and hard to control. We would all like to live in a beautiful yet affordable house that is close to our work, our spouse’s work, and our childrens’ school — but such houses are rare. Most of the announced measures are in the mandate of the Department of the Environment, Heritage, and Local Government. Minister Gormley was absent, however.

(Interestingly, Minister Gormley did pronounce on the pay increases at ESB, although Minister Ryan is in charge there.)

The Smarter Travel plan professes faith in the power of government. It announces “We will establish a car-sharing website which will help employers to encourage such initiatives in the workforce. We will also work with our counterparts in Northern Ireland to develop a website applicable to the whole island.” Putting the Northern component to the side, if there were demand for a car-pooling website, would the market not deliver it? (It does in fact, see here.)

The plan is silent on increasing competition for bus and rail, or privatising CIE. Indeed, it announces more subsidies (capital) for Dublin Bus, Bus Eireann and Irish Rail. The document also contains a Freudian slip: “Link increased PSO [public service obligation] subvention to growth in patronage.”

The parts on walking and cycling are interesting too. The Smarter Travel plan reminds the reader of the tax breaks on new bicycles, which supports the owners of bikeshops (e.g., the Belfield Bike Shop) but does not stimulate cycling. The plan proclaims that furthering cycling and walking for recreation and tourism would stimulate cycling and walking for commuting (sic).

It announces that “We will ensure improved road priority for […] cycling access to […] airports”. I cycle anywhere in Dublin, but rarely to the airport because of luggage (long trips) and travel hours (short trips).

The plan announces that, from now on, the government will “[e]nforc[e] the law relating to encroachment on pedestrian spaces by motor vehicles, cyclists, skips and other obstructions”. It is a great good that the government plans to enforce the law. (Minister Ahern was not there either.)

For cars and trucks, the plan is “by 2020” to “maximise the contribution from second-generation biofuels”. Second-generation biofuels are currently in the research stage, with the first demonstration plants planned for 2015. It is unlikely that they will be deployed at any scale by 2020.

The plans for electric vehicles are wishful thinking too. The Smarter Travel document says “We will provide further incentives to encourage a switch to electric vehicle technology with the aim of achieving 10% market penetration by 2020.” Previously, Minister Ryan wanted 10% of the car stockin 2020 to be all-electric. This would have required that at least 50% of the entire world production of electric cars be bought in Ireland. 10% of the cars sold in 2020 is substantially less ambitious, but still hard to achieve. The electric cars currently on the market have two doors at most. The big car companies are betting on hybrids, plug-in hybrids, and smart diesels. The wishes of the Irish government are unlikely to make them change their strategy.

In sum, pious pleas, wonderful intentions, and wishful thinking on technological progress. All measurable targets are for 2020, which is at least two elections away.

Irish bond spreads

I was idly looking for patterns in the daily evolution of eurozone government bond spreads (like you do) and thought I would share some findings. The spread of Irish Government bonds over the 10-year German benchmark have of course trended upward during the period since early September 2008 to last week:

If we compute principal components of the spreads of ten euro-currencies we can try to isolate the different factors: separating factors that affect all countries from those that affect Ireland in relative isolation.

Using daily changes in the spreads, the first three principal components explain 80% of the total variation in the ten series.

All ten bonds have roughly equal loadings on the first PC (which alone explains 62%). We can therefore think of PC1 as measuring fluctuations in general aversion to credit risk.

PC2 seems to measure a component which is irrelevant to Ireland — from the loadings this one looks like Club Med vs the North.

But PC3 is an almost Ireland-specific factor, much smaller loadings on the other countries. The big action in PC3 is on just three almost consecutive days in January: the 16th (Anglo nationalization), 19th and 21st.

To me this illustrates just how easily spooked this particular market is. Anglo nationalization was not even demonstrably bad news. When will it settle down to a realistic assessment of Irish risks?

Note:

The linear regression equation explaining changes in the Irish spread in terms of three principal components is (t-stats in parentheses):

ΔIreland = 0.020 + 0.015 PC1 + 0.042 PC3 + 0.024 PC4
(17.7) (32.7) (32.0) (15.6)
RSQ=0.958 DW=2.16

The constant term reflects the general upward trend in Ireland’s spread (which is not explainable by this method).

(Of course there are many methodological tricks one could explore, but it’s getting late and this seems enough for the present. Probably some readers do this stuff for a living!)

Ireland on PBS

There were two segments with an Irish interest on yesterday’s Newshour with Jim Lerher.   (The Newshour is the probably the most influential news programme in the US.)

The first is an interesting, if not particularly deep, look at the relative fortunes of Ireland and Poland.  You can view the segment or read the transcript here.

The second has a spirited criticism by John Bruton of the “Buy American” bill in the US Congress. 

Deflation and Competitiveness

David McWilliams has expressed concern about the risk of deflation in Ireland and recommends that we “engineer inflation by pumping money into society”: you can read his article here.

For a member of a currency union,  there is a natural limit to national-level deflation.  Ireland may well face a sustained period of inflation below the euro area average (such that it may be negative in absolute terms for a while), this is self-correcting since it implies an improvement in competitiveness, which will in turn generate a boost in economic activity and a return to an inflation rate at around the euro area average. In contrast, no such self-correcting mechanism operates for a country with an independent currency. So long as the ECB avoids deflation at the euro area level, a true deflationary spiral for Ireland is not possible.

Of course, even if deflation (or low positive inflation) is just a temporary phase for Ireland, it can last for several years. It certainly amplifies the extent of the downturn, since it implies the real interest rate (the nominal rate minus the expected rate of inflation)  will be high. This is the mirror image of amplification of the boom period that was generated by the low real interest rate during our prolonged period of relatively high inflation.

One lesson is that it is much better to have a sharp fall in the price level now (generated by wage cuts and efforts to cut markups through more aggressive competition policies), rather than a gradual decline in the price level over several years.

It is worth remarking that the structure of the national pay deal does not provide the appropriate kind of ”incomes policy” that can help this process. In particular, deviation from the national pay deal is only permitted if a firm is in very serious financial distress. Rather, we need cost reductions even in sectors that are still profitable, since prices of all goods and services matter for the level of competitiveness.

A good example is the ESB.  It would be very useful to see wage correction in this sector, which will help to reduce input costs for many businesses.

Another way to express this point is that the national pay deal can accomodate firm-specific shocks but not macro-level shocks. To respond to macro-level shocks, the national pay deal should be re-negotiated to allow a generalised reduction in costs across the economy. (As a complement, competition policies could be reinforced and ‘administered’ prices could be forced down.)

Some Progress in Understanding Fiscal Impact of Pension Levy

As reported by today’s Irish Times, the tax offset means that, while the pension levy saves €1.4 billion in gross terms, the tax offset means that the net saving will be €900 million in a full year: the explanatory articles are here and here. However, according to the Irish Times report, the loss in tax revenue as a result of the levy was already factored into the previously-published tax projections of the government. Accordingly, it is the gross €1.4 billion that is relevant in getting to the target of  €2 billion in savings.

Back to the banks

The policy pendulum looks set to swing back to dealing with credit flow in the banking system.  With so many policy proposals floating around internationally, I would be very interested to hear current views on the best policy course for the government. 

 Taking it as given that there has been a severe contraction of new credit, how much is due to: (i) a collapse in the demand for credit as firms and households repair balance sheets; or (ii) a collapse in the supply of credit?  

 Under (ii), is the main reason for the decline in supply: (a) the declining creditworthiness of potential borrowers; or (b) the risk aversion of bankers as they teeter on the edge of insolvency?

 It seems to me that if the contraction is mainly driven by some combination of (i) and (ii a), the government would be wise to limit the additional fiscal commitment.   A large package would further tighten the fiscal solvency constraint and force a more rapid fiscal correction. 

 The case for a large package seems more compelling if the credit contraction is being driven by the caution of the bankers.   Whatever the size of the package, what is the proper balance between re-capitalisation, insurance for new credit flows, troubled asset purchases, etc? 

French balloon shot down over Berlin

Predictably, if sadly, Sarkozy’s idea of a Berlin summit to discuss what should be done if a Eurozone member were to get into trouble has been dismissed by Berlin. Discussing such things ex ante, on a purely theoretical basis of course, will turn out to be preferable to discussing them ex post, if ex post ever arrives. The German reasoning is that some things just shouldn’t be talked about in public:

A Berlin, un porte-parole du gouvernement, Thomas Steg, a estimé qu’une telle rencontre n’est “pas nécessaire dans l’immédiat. L’expérience nous a appris qu’il y a certains sujets relevant de l’Eurogroupe dont il vaut mieux ne pas discuter en public”.

Whether saying publicly that there are certain things that you shouldn’t talk about publicly is in fact reassuring, is probably something that one could debate.

More on the Government Plan

The Department of Finance has released an explanatory document on the plan (including a ready-reckoner to work out how much public sector workers will lose at each income level): you can read it here.

It would be useful to see a more extended presentation of the government’s fiscal plans for 2010-2013. Although the cancellation of the scheduled pay increases will achieve €1 billion of the required €4 billion adjustment in 2010, the balance between spending cuts and tax increases remains unclear for each of the years 2010-2013.  While yesterday’s plan is a start, it is important to present the multi-year strategy as soon as possible. Otherwise, economic performance will continue to be affected by an avoidable level of uncertainty regarding tax and spending levels. If the government wishes to secure agreement with the social partners on the non-pay elements, the process needs to re-start sooner rather than later.

Update:  As noticed by Patrick,  Department of Finance now has a new ‘ready reckoner’ that adjusts for the reduction in taxable income: you can find it here.

The Government’s Plan

The statement by the Taoiseach can be read here.

The plan is quite remarkable in specifying substantial expenditure cuts, including the de facto reduction in the take-home pay of public sector workers via the pension levy. It was also welcome to see the extension of a reduction in remuneration levels to those providing professional services to the government.

Accordingly, this plan represents a welcome initial step in fiscal adjustment. As indicated in the Taoiseach’s speech, the fact that the unions could not agree to the plan does not mean that the social partnership approach has failed (the negotiation process delivered a ‘near endorsement’ of the plan and achieved a common consensus regarding the scale of the problem). Indeed, now that the pay element has been dealt with, it is plausible that social partnership talks could resume quite quickly regarding other elements in the overall strategy.

Internationally, this plan should help to dampen concerns about the state of the public finances.

Balance Sheets

Brian Lucey and Constantin Gurdgiev write in today’s Irish Times about the scale of debt liabilities for various sectors in the Irish economy and illustrate that Irish firms and households have high levels of debt relative to international standards: you can read their contribution here.

A useful complement to their analysis is to examine the balance sheet statements for the various sectors, since the sustainability of debt depends on asset levels and the dynamics of asset valuations (major asset declines in 2008!). The CSO has made considerable progress in recent years in producing estimates of balance sheets for each sector in Ireland: you can read the latest report here and download the data here.

Franco-German manoeuvres

For those of you who have let your subscription to Le Monde lapse, here is a very interesting piece, which may or may not be relevant to Ireland. Whether relevant or not (the article mentions Greece, not ourselves), we should clearly be backing Sarkozy.

L’Europe est sans capitaine, alors que la crise financière est loin d’être achevée et menace la cohésion de la zone euro. C’est le diagnostic de Nicolas Sarkozy, qui veut organiser une réunion exceptionnelle des chefs d’Etat et de gouvernement de la zone euro courant février, sans attendre le Conseil européen des 19 et 20 mars. Objectif : afficher la solidarité de l’union monétaire et s’engager à un minimum de rigueur budgétaire pour dissuader les marchés financiers d’attaquer les Etats les plus faibles, comme ils l’ont fait à l’automne avec l’Islande et la Hongrie.

Un mois après la fin de sa présidence, le chef de l’Etat juge que l’Union européenne (UE) est devenue invisible. La présidence tchèque est jugée passive, tout comme la Commission européenne, qui pourrait faire preuve de plus d’imagination. Son président, José Manuel Barroso, est accusé de ménager les Etats, pour s’assurer d’un second mandat. M. Sarkozy est ressorti très préoccupé de sa conversation téléphonique avec Barack Obama, lundi 26 janvier. Le lendemain, devant les leaders de la droite, il a expliqué que la crise bancaire américaine en était plus à ses débuts qu’à sa fin. Il a fait part de ses inquiétudes sur la vulnérabilité des pays les plus faibles de la zone euro, citant explicitement la Grèce.

Après les banques, ce sont les Etats qui sont victimes de la défiance des marchés financiers. Les agences de notation ont dégradé la note de l’Espagne, du Portugal et de la Grèce. Pour s’endetter à dix ans, l’Etat grec doit verser un intérêt de 5,8 %, l’Irlande, 5,5 %, contre 3,8 % pour la France et 3,3 % pour l’Allemagne. Des écarts jamais vus depuis la création de l’euro. Les taux d’intérêt s’étaient alors alignés sur ceux du pays le plus vertueux, l’Allemagne.

La Grèce ne connaît pas de crise de liquidité puisqu’elle vient de lever 5,5 milliards d’euros et est loin de subir le sort de la Hongrie, qui doit verser un intérêt à dix ans de 9,5 %. Les Allemands et les spécialistes financiers s’exaspèrent à l’idée que Nicolas Sarkozy puisse évoquer le sujet à froid et à haute voix, ce qui risque d’alimenter la spéculation. “Il ne faut pas créer des prophéties autoréalisatrices”, s’afflige un diplomate.

M. Sarkozy, qui devrait s’exprimer à la télévision jeudi, souhaiterait élaborer une doctrine ou un mode d’emploi en cas de crise, pour ne pas être pris au dépourvu. Il a le souvenir douloureux du sauvetage hongrois, réalisé en catastrophe sous l’égide du FMI, et veut s’assurer que les Européens resteront maître chez eux. “Imaginez l’air goguenard du représentant américain du FMI, ricanant sur l’euro et expliquant que si les Etats-Unis avaient un problème en Californie, ils le régleraient eux-mêmes”, explique un haut responsable français. “L’intervention du FMI pourrait être interprétée comme le premier pas vers l’éclatement de la zone euro”.

Pour s’affranchir du FMI, deux solutions se présentent. Soit on laisse l’Etat en question se redresser lui-même, en lui imposant un plan de rigueur draconien. C’est la thèse allemande, adepte du “aide-toi, le ciel t’aidera” “C’est le marché qui forcera les Etats à être plus raisonnables. C’est la juste peine”, explique un spécialiste.

Soit l’on est contraint d’organiser un sauvetage entre Européens, ce qui pose de graves problèmes juridiques et politiques. L’article 101 du traité de Maastricht interdit explicitement que les banques centrales se renflouent les unes les autres et volent au secours des Etats. Cette exigence avait été formulée par l’Allemagne qui ne voulait pas financer les pays dits du Club Med (Italie, Espagne, Portugal, Grèce), accusés d’être incapables de maîtriser leurs finances publiques, et résumée par l’ancien ministre-président de Bavière Edmund Stoiber : “Une Union européenne faite de transferts financiers est aussi probable qu’une famine en Bavière”. Aborder ce sujet en pleine campagne électorale allemande est jugé plus que maladroit. Toutefois, précise un ministre français, “si on s’en tient à la lettre des traités, on va dans le mur”.

Le président de la République est en contact avec le président de la banque centrale européenne Jean-Claude Trichet qui a déclaré qu’il ne croyait pas à un éclatement de la zone euro. Interrogée, la BCE indique qu’elle travaille “exclusivement dans le cadre des traités”. L’expérience a montré que les Européens savaient faire preuve d’imagination. L’hypothèse d’une agence européenne chargée d’émettre des emprunts d’Etat, ce qui mutualiserait les risques et réduirait le coup du crédit pour les Etats les plus faibles, est une hypothèse parmi d’autres. Elle est rejetée par les Allemands. Or, M. Sarkozy veut parvenir à un accord préalable avec la chancelière allemande Angela Merkel, qu’il rencontrera à Munich samedi 7 février. La réunion de la zone euro pourrait se tenir à Berlin autour du 22 février, quand Mme Merkel réunira les dirigeants européens conviés à la réunion du G20 de Londres du 2 avril, censée refonder le capitalisme mondial. Le britannique Gordon Brown serait dans les parages, ce qui permettrait de le convier discrètement alors qu’il ne fait pas partie de la zone euro. La tenue d’une réunion à Berlin permettrait de ménager Mme Merkel qui craint les ambitions de M. Sarkozy et a affiché ses réticences sur les réunions de l’Eurogroupe, susceptibles d’exclure les autres pays européens.

Winds of change

The Guardian has an article today on a topic which we will be hearing a lot more about in the months to come, the ways in which many corporations exploit the possibilities afforded them by globalization to minimise their tax burden. It followed a short piece in yesterday’s Tribune on reports that Ireland is on a list of tax havens currently doing the rounds in Washington. According to the paper,

The Department of Finance told the Sunday Tribune the list had been rejected by the previous Bush administration, which said it oversimplified the issue. It said that it shared the Bush administration’s assessment of the list.

So that’s alright then.