Guest Post: International Credibility Does Not Need NAMA; It Needs Determination

Here is a guest post from Ciarán O’Hagan (fixed income strategy, Société Générale, Paris). Ciarán had submitted some of this material as a comment on an earlier post but we thought they were worth giving their own dedicated thread. Text below the fold.

Alan Ahearne brilliantly foresaw in 2007 the consequences  of the housing blow up, “You see, when housing markets go bad, lots of money is lost. Be it homeowners, property investors, developers, banks, and taxpayers, someone has to take the hit” (16 Sep 2007, Sunday Independent). We could of course add to Alan’s list, not just the different categories of bond holders, but also the social welfare recipients, etc.

I could see some wanting to portray the Gang of 46 as part of a kind of malicious anti-bank, anti investor conspiracy from the ivory towers. Yet I’m sure that all the signatories would love to see the investors get their monies back.

That would be far easier if the outlook for the public budget was comfortable. However cash in 2010 is likely to prove very scarce, and scarcer even than the government would like to admit.

Part of the concern about NAMA stems from the fear that, unfortunately, the outlook for the economy and public finances offers not the slightest room to show  generosity to any particular interest group. And least of all, to pamper the fortuned.

Trying to keep all parties happy is laudable. But this raises the risk of a sudden, forced and substantial macro and/or political adjustment in the future. That is worth avoiding. But it requires the government – this or the next one – taking far tougher decisions than envisaged to date. I am afraid that the penny has not quite dropped, neither for the government, the press nor the public, on this score.

The government it seems has a working hypothesis of a deficit of some €20bn next year, just like the figure planned for 2009. The Gang of 46 sees more €30bn. But let’s suppose it is “just” €20bn. The amount is not that large compared to the amount many bigger states borrow. Yet that does not mean it is sustainable. To the contrary. The government estimate of €20bn still works out at net borrowing of almost €10,000 per employee per annum. No country, ever, has achieved such a feat two years in a row.

And at the same time, this pro-rich, pro-saver government is adding heavily to the state’s future contingent liabilities, with NAMA. NAMA does have one advantage – little upfront cost However that comes at the price adding heavily to future contingent liabilities, and maybe unsustainably so. No one can be sure.

Yet as far as good policy making is concerned, most economists would agree that cancerous banks needs to be dealt with very quickly. Alan Ahearne in Sep 2007 put it eloquently, “Japan’s biggest problem was that they attempted to sweep the consequences of the housing bust under the carpet”, adding “The Japanese wasted a decade-and-a-half arguing over how to allocate the losses, and their economy stagnated in the meantime. Let’s hope we don’t do that.”

Ireland has lost a year now, almost. And looks like losing more time, unless there is a dramatic change in policy.

At the same time, the same government seems to shut the door on extensive and immediate hikes in taxes, even though Irish tax rates and the Irish tax base are all very low in relative terms (while sizeable cuts in spending are not being implemented with the urgency they deserve).

You’d want to be wildly optimistic to believe that this coup can be pulled off, without the forced-feeding of far tougher medicine at some stage.

Little surprise than to see Irish government bonds are still trading cheaper than A-rated Greece. And the further out the yield curve you go, the more Ireland cheapens to Greece. Yikes!

And the government wants us to believe that NAMA will help restore international investor confidence in Irish sovereign debt? If that were really the case, the medicine has not worked so far.

Of course, for banks and many bank investors, government policy has worked brilliantly so far. The performance of bank debt has been magnificent over the past few months (largely helped of course by optimism that the worst is over for the global economy).

For international sovereign investors, the story is different. NAMA will be seen to work well by when it deals effectively with the cost of bank liabilities – not over the next 10 or 20 years – but when the pain is taken on the chin.

That is when international credibility will be truly restored. At that point, we can look forward to Irish government bonds richening heavily, and trading once again in line with their ratings (and at richer levels than the likes of Greece or Italy too).

Foreign investors *in Irish sovereign debt* share much the same interest as the Irish taxpayer. They want to see the government extricate itself from liability for the banks, rapidly. At the same time, they need to see sharp cuts in the public deficit, and a banking system that works (even if that means, inter alia, flogging off the branch networks).

So if it is credibility of the sovereign you are talking about (the proponent of NAMA love to fudge this notion by the way) then we need more penny pinching policies. Policies more on the lines of what Fine Gael propose go in this direction.

If instead you want to be everybody’s best friend (the quintessential trait of the Irishman in foreign company), and you want to try to keep everybody happy (somewhat), at the risk of sinking the whole boat, … than sure, dole out money like there is no tomorrow (or as if on tap from the ECB ad vitam eternam).

These notions are hardly very difficult to understand, are they? Even for those outside the ivory tower? Even for non-economists?