Here are the slides from a talk the Minister for Finance gave at the Irish Taxation Institute on Friday. Lots of useful material in it, most of which I agree with. Slide 11 is great. It actually says Iceland! (Less fun is the repetition of the de-listing argument as a serious point.)
I guess the news that the Commission has approved NAMA (statement here) will get some attention over the next few days but it’s hardly too surprising. EU guidelines allow governments to introduce an asset management agency of this type and it’s very hard to imagine that the Department of Finance had designed something that wasn’t guaranteed to get approved. However, as I’ve noted before, if you read those guidelines closely, they also suggest that the Commission isn’t in favour of packages that are overly friendly to providers of risk capital. For instance, the guidelines state
(21) As a general principle, banks ought to bear the losses associated with impaired assets to the maximum extent …
(22) Once assets have been properly evaluated and losses are correctly identified, and if this would lead to a situation of technical insolvency without State intervention, the bank should be put either into administration or be orderly wound up, according to Community and national law. In such a situation, with a view to preserving financial stability and confidence, protection or guarantees to bondholders may be appropriate.
(23) Where putting a bank into administration or its orderly winding up appears unadvisable for reasons of financial stability, aid in the form of guarantee or asset purchase, limited to the strict minimum, could be awarded to banks so that they may continue to operate for the period necessary to allow to devise a plan for either restructuring or orderly winding-up. In such cases, shareholders should also be expected to bear losses at least until the regulatory limits of capital adequacy are reached. Nationalisation options may also be considered.
The relatively tough line suggested by these statements has been evident in the Commission’s rulings on payments to subordinated bonds and on various restructuring plans. This approach undoubtedly limits the government’s ability to overpay for the assets going into NAMA and with the assets falling in price with every passing month, the opportunity to keep the banks from actual or near insolvency via overpayment seems to be slipping away.
In my exchanges with our old friend John the Optimist, I have regularly pointed out economists shouldn’t necessarily be judged on their forecasts and I certainly have made calls here that have turned out to be incorrect. However, I will take this opportunity to point out that tomorrow is the one year anniversary of this column that I wrote for the Irish Times. Among other things which I’d still stand by, the column pointed out the following:
In addition to being unfair, it is questionable whether the bad bank proposal could achieve its goal of properly re-capitalising private sector banks. There may be limits on the price the Government can pay for impaired property loans under EU state aid rules. Banks may still have to write down their assets. It is easy to imagine a scenario where banks struggled with weak capital bases even after a bad bank scheme has been put in place.
And here we are.
Writing in the Irish Times, Pat McArdle reckons that criticism of the roll back of the cuts to higher civil servant pay is misplaced. Pat’s key argument is as follows:
The Minister appears to have been influenced by a novel aspect of the review process. For the first time, comparison was made not just with the private sector but also with six other European countries. (Of these, only Britain had any kind of bonus scheme.)
Uniquely, the assistant secretaries were found not to be paid more than in the other countries. This was taken into account by the Minister but not by the Review Body.
Here’s the relevant section of the Review Body report:
4.11 The salary for Assistant Secretary places the Irish post behind the equivalent position in the UK, the latter being 10% ahead of its Irish comparator. The salary for the role in the remaining countries is somewhat lower than that of the Irish post. The rate for the equivalent post in Finland, with which the Irish post is banded, is 74% of the Irish rate.
4.12 When the comparison is made on an adjusted income basis, it is found that the Irish post is behind that of four other countries, viz. the UK, which is 102% ahead, Germany, which is 29% ahead, Belgium, which is 6% ahead and the Netherlands, which is 1% ahead. The adjusted income value of the role in Finland is 97% of that for the Irish position.
It is open to question whether the Irish government should be factoring in high local prices levels when setting civil servant pay, particularly since we are aiming to reduce these levels to restore competitiveness.
The report doesn’t explicitly state how much weight it placed on the adjusted versus unadjusted salaries when arriving at its conclusions. It does, however, note that other considerations were taken into account including the economic environment and the current value in Ireland of the security of tenure:
in Report No. 42, we observed that “the value of security of tenure in present economic circumstances must be regarded as less than that which would apply in circumstances of high unemployment.” We also observed that we would be disposed to discount for security of tenure in different economic circumstances. Since we reported in 2007, the economic environment has, as already mentioned, deteriorated significantly and unemployment is at a very high level and still climbing. Security of tenure is, therefore, more valuable now than in 2007.
So the Review Body was balancing a number of different factors when making its decision and not just looking at the adjusted salary.
McArdle may consider recent criticism to be misplaced but he does not explain why on budget day, the Minister announced that his policy in this area would be based on the Review Body’s recommendations based on its balancing of these various factors and then later announced that it would not. Or whether it is wise to abandon the strategy of following the Review Body’s recommendations. Or whether, as a tactical matter, a government that needs to stick to its budgetary strategy is well advised to start taking steps to overturn decisions on budget day. Or whether, if budget day decisions are going to be reversed, it is advisable to focus only on reversing cuts to the salaries of well-paid senior civil servants.
The government has appointed an expert group to advise on this important issue (press release here).
What are the suggestions from the readership of this blog for this new initiative?
Tim Besley and Andrew Scott advocate the establishment of independent fiscal committees to improve the quality of fiscal policy formation: you can read the Vox article here.
Congratulations to Philip for being the joint winner of the 2010 Bhagwati Award, together with his co-author Gian Maria Milesi-Ferreti. Their work has been extremely influential, and this recognition is richly deserved.
Normal people are hard-wired to dislike inequality, it appears.
It reminded me of the famous quote from Keynes, in this beautiful essay:
The love of money as a possession -as distinguished from the love of money as a means to the enjoyments and realities of life -will be recognised for what it is, a somewhat disgusting morbidity, one of those semicriminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.
On Tuesday night near the end of his TV3 show, Vincent Browne returned to one his favourite themes, the taxation of those on higher incomes. He put the following statement to Fianna Fail TD, Timmy Dooley
In June of last year, the Department of Finance showed that in spite of efforts to close off tax loopholes in the 2007 and 2008 budgets, people earning over a half a million still pay only 20 percent of their income in tax. Now why weren’t they targeted rather than people on social welfare?
Dooley told Browne that the budget had seen an increase in the effective tax rate for these individuals to 30 percent, to which Mister Browne responded, “Not true, It’s just not true.” Later, after Mister Dooley discussed other steps taken to stabilise the public finances, Browne asserted that “You could have achieved the same thing by targeting people earning half a million and you didn’t bother.”
On the same theme, in his column in Wednesday’s Irish Times, Browne stated
How come there was no crisis when a report by the Department of Finance last June disclosed that, in spite of the alleged attempt to close tax loopholes, the average effective tax rate for people earning over €500,000 was just 20 per cent?
I’d like to address three aspects of the TV exchange and this column.
In addition to the acute problems caused by the economic crisis, Ireland (along with all other countries) must also resolve chronic policy challenges, with the financing of healthcare near the top of that list.
This article in The Economist provides an interesting cross-country survey of the pros and cons of private insurance.
Today’s media coverage of the Bank of Ireland share issuance contained a number of inaccuracies, which to be fair, probably isn’t too surprising given the complexities of the issues.
On RTE’s Drivetime show, its reporter said that the share issuance occurred because the European Commission was preventing banks from paying dividends on the preference shares. Technically, this isn’t correct. The Commission is preventing banks from paying coupons on subordinated bonds. These bonds, in turn, have dividend stopper clauses and it is these clauses that prevented the payment of the cash dividends.
This is perhaps a technical distinction and it may be difficult to get across the true picture in a short space of time. More misleadingly, however, when I appeared on The Last Word today, I heard Fianna Fail TD Frank Fahey state that the Commission had merely put a hold on cash dividend payments to the government while it is assessing BoI and AIB’s restructuring plans. Fahey thus asserted that in a few months time, AIB’s business plan would have been approved and the government would be receiving the cash dividend from AIB in May.
However, as I noted last week, the coupon stopper is in place “to prevent the reduction of own funds by financial institutions which are still reliant on State aid to fulfil regulatory capital requirements.” It seems likely that AIB will still be reliant on state support in May so by that reasoning the coupon stopper is likely to still be in place.
I’ve been a little surprised that there has been no coverage of the fact that the shares were paid out despite the NTMA CEO John Corrigan and the Minister for Finance both stating in public last week that they could wait to collect the cash dividend. It appears, however, that Bank of Ireland’s own bylaws required it to pay out the shares on the deadline day (see this report by the Independent’s Emmet Oliver). It seems a little strange that Mister Corrigan and the Minister were not aware that the shares were going to be issued.
Governor Honohan’s characterisation of the whole affair as “untidy” seems about right (comments reported on the Six-One TV news). He is, of course, also correct that this payment is small beer compared with the amount of recapitalisation that the banks are going to need after the NAMA transfers. With AIB transferring €24 billion to NAMA, and BoI transferring €15.5 and mooted discounts of about a third, recapitalisation requirements will be a lot more than €250 million. But the fact that €250 million acquires 15.7% of BoI tells us that a far more serious dilution of ownership is on its way.
It is a truth universally acknowledged, that the purpose of blogs is to provide free advertising for a blogger’s own books. Let me buck the trend then, by giving a plug to Cormac’s latest offering, a great example of the power of economics (and history) to illuminate the human condition. I discussed it on last Saturday’s Off the Shelf, which you can download here.
The profile article is here.
You can read the latest speech from Governor Honohan here.
The Irish Independent got it right: Long-distance commuters are hit hardest by the carbon tax (no surprise there). The Irish Examiner somehow turns this into “rural Ireland”. The paper clearly shows, though, that the tax incidence is lowest in the city centres, increases in the commuter belt, and falls again in the “deep countryside”.
Today’s IT carries an article by Brian Lucey on recent banking developments. You can read it here.
Wolfgang Munchau of the FT says no (at least for the euro area): you can read his article here.
Despite NTMA chief John Corrigan’s position last week that the state expected to receive its cash dividend of €250 million from Bank of Ireland at some point soon and so would not be getting ordinary shares in lieu, the Bank has today announced that they will be issuing ordinary shares for this amount to the government on Monday February 22. Announcement here. The Department of Finance response to is here. Hat tip to commenter Frank Galton.
A couple of new papers from the IIIS may be of interest:
Philip R. Lane, Trinity College Dublin and CEPR
Gian Maria Milesi-Ferretti, International Monetary Fund, Research Department and CEPR
IIIS Discussion Paper No. 316
Abstract: We document and assess the role of small financial centers in the international financial system using a newly-assembled dataset. We present estimates of the foreign asset and liability positions for a number of the most important small financial centers, and place these into context by calculating the importance of these locations in the global aggregate of crossborder investment positions. We also report data on bilateral cross-border investment patterns, highlighting which countries engage in financial trade with small financial centers.
Patrick Honohan and Gavin Murphy
Institute for International Integration Studies, Trinity College Dublin
IIIS Discussion Paper No. 317
Ireland had been considering a break in the long-standing currency link with sterling for some time when the ideal opportunity of a new exchange rate regime – potentially retaining the sterling link while stabilizing other exchange rates – seemed to offer itself in the form of the “zone of monetary stability in Europe” proposed by France and Germany in April 1978. Based on newly released archives, this paper reviews the evolving attitude of Irish officials and the Irish Government over the following months as the decision gradually shifted to one of breaking the sterling link and rejoining what was little more than an expanded “Snake” arrangement; the UK having decided to stay out. While financial issues were to the fore in the discussions, the final decision to join was based on a strategic vision that Ireland’s economic and political future lay with Europe rather than with the former colonial power.
This topic has found its way onto another thread, and given that it has occupied lots of newspaper space and airtime over the last few days it is probably useful to discuss it here in terms of the economic issues. This has been a bit like a tennis match with the ball going back and forth for some time so it is hard to keep track of all the points.
On the one side we have Michael O’Leary who claims he wants to (re)create 300 jobs, but needs Hangar 6. On the other side we have Mary Coughlan and the DAA who say Hangar 6 is not available, as Aer Lingus has a lease on it.
While Michael O’Leary appears happy for other airports to build a facility for him, he does not seem to want the DAA or, given that he appears to prefers not to deal with them, the IDA to build a new hangar for him at Dublin airport. It would appear that the reason for this is cost – he claimed on radio that hangar 6 would be available at a low cost. No doubt Aer Lingus is also getting it at a low cost. In the debate some have argued that Ryanair is pursuing a different agenda – to open Hangar 6 as a terminal. Ryanair say they would be happy to sign a legal agreement preventing them from doing so. So what is this all about??
In a letter to the Irish Times the chairman of Aer Lingus, Colm Barrignton, makes the point that hangar 6 is the only hangar at Dublin airport capable of accommodating wide bodied planes, and that it is extensively used. Could the ability to accommodate wide bodied planes be the key to this scrap? At the moment Ryanair do not have any such aircraft, but might Ryanair have plans to get into the medium- and long-haul business? Aquiring hangar 6 would allow them to build a base in Dublin while at the same time discommoding Aer Lingus, which would be a competitor in that market?
This FT article reports on two letters it publishes today (the article provides links to the letters) which argue against a more aggressive approach to fiscal consolidation.
As many of you may have heard, Fine Gael’s Senator Eugene Regan (who’s been having a busy few weeks) submitted a formal complaint about NAMA to the European Commission in January. Last week, Regan followed this up by submitting a detailed discussion of how the NAMA legislation is inconsistent with the EU’s guidelines on impaired asset schemes. The detailed document is here and the summary is here.
The European Commission continues to instruct Bank of Ireland to stop paying coupon payments on lower tiered bonds unless the payments are legally binding. Which brings us back again to the €280 million that is due to the Irish state from Bank of Ireland this Saturday.
The Commission’s request that the bond coupons not be paid triggers a “dividend stopper” clause for the government’s preference shares: These bonds have a claim that is senior to the preference shares, so this clause ensures that the holders of preference shares can’t get paid before them. This means we won’t be getting €280 million in cash from BoI this weekend.
The Economist website features an interesting graph that shows the correlation of a father’s educational status on the probability that a son will obtain a university degree – together with Luxembourg, this correlation is strongest for Ireland.
Not wanting to be outdone by Martin Feldstein, Laurence Kotlikoff (recently based known for his Limited Purpose Banking proposals) is the latest US-based economist to bring his analytical skills to bear on the Greece’s problems to diagnose an instant solution:
Is there some way that Greece can devalue without devaluing?
There is, indeed. The government can implement wage and price controls for, say, the next three months, with these controls covering not just the growth in wages and prices over the next three months, but also their initial levels. Specifically, the Greek government would decree that all firms must lower their nominal wages and prices by 30 per cent, effective immediately, and not change them for three months. After three months, everyone would be free to put prices and wages back up.
This is an interesting proposal. Indeed, if this decree-based approach proves to be successful, it could then be applied to other areas. For instance, in the sphere of justice, the Greek government could decree that people should obey the ten commandments. And, if it works in Greece, we should try the decree approach here. After all, we’re all in favour of evidence-based policy formulation.
Readers of this blog may be interested in an event taking place tomorrow at the Dublin Writers Museum. José Manuel González-Páramo, Member of the Executive Board of the European Central Bank since 2004, will be delivering an address entitled “Globalisation, international financial integration and the financial crisis: The future of European and international financial market regulation and supervision.”
More information can be found here
To register for this event call Shane on 01 874 67 56
There is a new CEPR report on this topic – this VOX column provides a summary.
A reader has pointed me towards this nice post by Michael Pettis, which strays from his usual Chinese turf to take a look at Europe. It makes the same points as the ones Martin Wolf has been making about the need for the large countries with ‘fiscal room’ in the Eurozone, particularly Germany, to do everything they can to maintain aggregate demand in the Eurozone.
This should be obvious to anyone with an understanding of intermediate macroeconomics, so I won’t comment on it. But Pettis also cites Barry Eichengreen’s classic Golden Fetters, which readers may not be familiar with, and in particular Barry’s views on the implications of democracy for the maintenance of the gold standard. That system required adjustment through deflation for countries suffering negative shocks. This was not necessarily a problem in the 19th century, when wages and prices were flexible, and universal suffrage was rare. By the 20th century, however, rigidities in the economy were such that deflation implied unemployment; and democracy meant that this economic cost translated into a direct political cost for policy makers. The gold standard, inevitably, broke down when confronted with the pressures of the Great Depression.
I don’t think it’s fair to compare the euro to the gold standard, as Pettis does. The ECB has lowered interest rates, not raised them, although not by as much as other central banks; and both the French and the Germans have applied fiscal stimulus to their economies. On the other hand, it is true that adjustment in the PIIGS now implies deflation there (unless, as the FT points out today, inflation in the Eurozone as a whole is increased). This is going to be both economically and politically costly, and will have unpredictable effects, especially if the Eurozone as a whole experiences a double dip recession.
I suspect that Ireland will find these adjustments easier to bear than most, since emigration gives us both an economic and a political safety valve. (That was a positive rather than a normative statement by the way.)
In today’s FT, Feldstein has spotted the obvious easy way out. Briefly, Greece should be allowed to leave the Eurozone temporarily, devalue, and rejoin. The drachma would start at one-for-one to the €, then fall (quickly!) to 1.3, at which point it would re-adopt the €. Greece would be competitive again. The only snag is that, as he puts it, ‘…other Eurozone members might object to giving Greece this improved competitiveness.’
In fairness therefore, everyone else would have to be given the same option.
Perhaps there could be an appointed day, once a year, when everybody could step out, as in Lanigan’s Ball, and then step in again, as soon as the competitiveness gain seemed adequate.
In the dollar zone, the lack of competitiveness in eg Michigan could be dealt with in the same way.
And thus the whole world could participate, with confidence, in sub-optimal currency areas, without fiscal discipline. I so wish I had thought of this.
With one brave bound…..
The Greek situation is regularly discussed as being “a threat to the Euro” and, on this blog and elsewhere in Irish commentary, it has revived the idea that the solution to our economic problems is to leave the Euro and re-establish our own currency.
This idea is often discussed as though membership of the Euro simply involves being locked into a disadvantageous fixed exchange rate, which we can address by getting out of the Euro. In fact, the process of leaving the Euro would be far more complex than that and could have many downsides that would offset the benefit of a more competitive exchange rate. Perhaps it’s been linked to on this blog before but this paper by Barry Eichengreen provides plenty of food for thought on this issue.
Update: Thanks to Philip for pointing out that Eichengreen has a new column on Greece and the Euro. Link here.