The Irish Economy

In an Irish Times article that must have much of the country talking, Morgan Kelly calls for a Special Resolution authority to force bank creditors to swap €65 billion of debt for equity (link in Greg’s post below).     The number is €50 billion less than called for in his V0X article earlier in the week, and critically calls for the losses to be imposed after the original guarantee expires in September.   He is thus, as far as I understand, not calling for default on the “quasi-sovereign” guarantee. 

I am sympathetic to the idea of forcing the funders of Ireland’s banking binge to bear a fair share of the resulting losses (some thoughts here).   But if Morgan’s policy suggestion is not to be dismissed, we need more specificity on the source of the €65 billion.   The Anglo accounts revealed that roughly €7 billion of bonds will mature post September.   He must have the big two in his sights. 

Even with Special Resolution authority in place, the proposed debt-equity swap could only be triggered if capital adequacy falls below some critical threshold.   But the two “technocrats” Morgan lauds appear to believe that Bank of Ireland and AIB are on course to reach the new capital adequacy requirements.   Patrick Honohan had this to say in a recent speech:

Over the previous few months, we at the Central Bank have been making a careful assessment of the likely bank loan-losses that are in prospect over the next few years. This is over and above the valuation work being carried out by NAMA, and which gives us a good fix on the likely recoverable value of the larger property loans.  We have been working on the non-NAMA loans and figuring out their likely performance as they suffer from the impact of the overall economic downturn – part of it of course attributable to the global crisis, and not just to the bursting of our own bubble.  This exercise involved working with the banks, but challenging their estimates of loan-loss based on our own more realistic – some may say pessimistic – credit analysis. (I am over-simplifying the exercise, as it also looked at other elements of the profit and loss account over the coming years).  The conclusions of this exercise are worth emphasizing. 

To my relief, and slight surprise, it turns out that most of the banks started the boom with such a comfortable cushion of shareholders’ funds that they would be able to repay their debts on the basis of their own resources.  This includes the two big banks.  It is because of this fact – that their shareholders’ funds will remain positive through the cycle – that one of them, Bank of Ireland, has already been able to tap the private market for an additional equity injection.  Of course they do need additional capital to move forward, but, as has happened in the US and elsewhere, the Government’s capital injections of last year into these two institutions looks like being well-remunerated.

The €65 billion number needs more explanation. 

Update (Sunday, May 23)

In correspondence, Karl Whelan has provided maturity information for the outstanding bonds of the major banks.   The information is drawn from the 2009 accounts, and is based on bonds that mature more than one year after December 31, 2009.   Thus, it does not include bonds that mature in the last quarter of this year.   (It is not clear what fraction of the bonds were issued based on the extended guarantee.)

The numbers are as follows (billions of euro):

BOI:       Senior, 18.5;  Subordinated, 5.3;    Total, 23.8

AIB:       Senior, 8.5;    Subordinated, 4.6;    Total, 13.1

Anglo:    Senior, 4.1;    Subordinated, 2.7;    Total, 6.8

INBS:     Senior, 1.2;    Subordinated, 0.2;    Total, 1.4

ILP:       Senior, 5.1;    Subordinated, 1.6;    Total, 6.7

Totals:   Senior, 37.4;  Subordinated, 14.4;   Total, 51.8

These numbers suggest that Morgan’s €65 billion is in the right ballpark.   But they also highlight the extent to which the money relates to the big two, and especially Bank of Ireland.   The most natural sequence for implementing the loss imposition strategy that Morgan proposes would be: (1) legislate a resolution regime; (2) apply comprehensive stress tests to determine capital adequacy; and (3) trigger resolution tools as required.  Based on the stress tests that have been done so far, which we are told have been quite comprehensive and conservative, the big two would not be put into resolution.   Of course, it is evident that Morgan does not believe these tests were comprehensive or conservative enough, with AIB probably being more suspect than BOI.   Even so, I think it is important not to expect too much in the way of loss imposition on creditors from a resolution regime.  Yet it is still worthwhile to pursue a regime even if the savings to the taxpayer are just a fraction of the €65 billion. 

Morgan Kelly has published a downbeat assessment of Ireland’s prospects for debt stabilisation in today’s Irish Times. As part of this, he provides a very powerful indictment of the Irish bank loan guarantee and Anglo bailout.

Peter Boone and Simon Johnson turn their attention to the Irish economy in this Baseline Scenario article (also published in an edited form as “Irish Miracle - or Mirage?” on the NYT Economix blog).

Frank McDonald at last admits that all is not well in climate land, but fails to find fault with the advocates of climate policy. Anne Jolis is more strident.

The largest finance conference in Ireland returns for its eight year; The INFINITI Conference on International Finance will be held at TCD from 14th-15th June.

In addition to the keynote and special sessions, there are over 166 papers being presented. Full details including registration are available here.

Highlights of the conference include

• Opening address by Professor Patrick Honohan, Governor of the Central Bank of Ireland (Monday 14 June)
• Roundtable on Property and Real Estate Investment, Monday 14 June, afternoon with lead speaker Professor Simon Stevenson, Director of Center for Real Estate Studies, City University Business School, London, and panel members Derek Brawn, Constantin Gurdgiev, and Peter Matthews.

• Roundtable on Investment in a Post Crisis World, Tuesday 15 June, Afternoon. Sponsored by the CFA Institute Ireland, this roundtable features: “An Update on Latest Trends in Fund Offerings” by David Hammond, CFA, Bridge Consulting,  “Major Challenges in Allocations to Irish and Emerging Markets’ Equities, Liquidity Risk and Product Innovation: The Perspective of a Pension Fund Trust” by Stephanie Condra, CFA,  Invesco Pension Consultants,   “An Update on Current Issues in the EU Government Bond Market” by Catherine McLaughlin, CFA, Irish Life and “Role of the CFA Institute and CFA Ireland in the Changing World” by Oliver McClure, CFA
• Roundtable on The Structure of the Emerging Bond Market, organized by the OECD Development Centre in collaboration with the Pontifical Catholic University of Argentina Graduate Business School. It will bring together three recent papers on the micro-structure and pricing of emerging bond markets.

166 research papers on a vast array of international financial topics. Highlights include (more…)

Floyd Norris in the New York Times last weekend put together some interesting comparative charts for twelve countries including Ireland showing trends in their trade up to the beginning of this year. The relatively small dip in Irish exports during the recession comes through clearly. He draws attention to the welcome rebound in trade globally, but classes Ireland among the four Euro laggards including Greece, Portugal and Spain. However, the data for Ireland only go to the end of 2009, whereas for other countries the data includes the first three months of 2010. As all of the rebound in the other countries has occurred in this first quarter of 2010, the charts give an unfavourable, but misleading, impression of Ireland’s comparative trade performance.

At VoxEU, Anne Sibert writes on “… how Icelandic banks issued “love letters” to each other – swapping their debt securities and using the other bank’s debt as collateral. This ruse ensnared not just the Icelandic Central Bank, but also the ECB – a fact that has only recently come to light. The ECB’s lack of transparency on this is a serious problem.”

The article is here.

Mrs Merkel has been speaking in the German parliament about her latest financial proposals. In addition to defending the CDS and short-selling proposals, the Germans are apparently preparing proposals for an “orderly insolvency of euro-region states”.  In a separate story this morning, I see that former Fed Governor Rick Mishkin has been reported as follows: 

“What they should have done was to let Greece go and say we are going to ringfence the rest of the system,” Mishkin said. “Ringfence the banks, protect the other countries that have problems such as Portugal, Italy and Spain, which have not been fiscally irresponsible the way the Greeks have been.”

It’s interesting to see how far the consensus has moved. We’ve gone from the idea that no Eurozone country can be let default and the IMF can’t possibly be allowed to help to getting ready for orderly defaults.

Coming hot on the heels of the EU’s restriction on hedge funds because of the role they played in the financial crisis (though this role was in fact pretty minimal) comes the latest European attempt to deal with nasty financial market participants. The German government has released the following statement, translation thanks to the FT’s Alphaville column:

The Federal Financial Supervisory Authority has on Tuesday temporarily banned naked short sales of debt securities issued by eurozone countries for trading on domestic stock exchanges in the regulated market. It has also temporarily banned so-called credit default swaps (CDS) where the reference bond and liability are from a eurozone country, and which does not serve to hedge against default risk (naked CDS).

In addition, BaFin has banned naked short sales in the following financial sector companies: 

AAREAL BANK AG

ALLIANZ SE

COMMERZBANK AG

DEUTSCHE BANK AG

DEUTSCHE BÖRSE AG

DEUTSCHE POSTBANK AG

GENERALI Deutschland HOLDING AG

HANNOVER RÜCKVERSICHERUNG AG

MLP AG

MÜNCHENER RÜCKVERSICHERUNGS-GESELLSCHAFT AG

These bans apply from 19 May 2010, 00:00, until 31 March 2011, 24:00, and will be reviewed.

BaFin justifies these steps given extraordinary volatility in debt securities issued by eurozone countries. Furthermore, credit default swaps on the credit default risk of several countries in the eurozone has increased significantly. Against this background, massive short sales of the affected debt securities and the conclusion of naked credit default risk on eurozone countries had led to excessive price shifts, which could have led to significant disadvantages for financial markets and have threatened the stability of the entire financial system.

Faced with these circumstances, BaFin has also banned naked short sales within the selected financial institutions.

The FT notes that “BaFin had previously introduced a ‘transparency system for net short selling positions‘, and found ‘no evidence of massive speculation against Greek bonds‘ in the CDS market.”

Let’s be clear about this. Short sellers are not the cause of the European sovereign debt crisis anymore than they were the cause of the Irish banking crisis.

As an aside, it’s worth noting that this announcement appears to have triggered a pretty serious downward run on the euro. Now I happen to think that this is a good thing in our current economic circumstances but perhaps the “ve must protect ze currency” crowd might remember that much of the demand for the currency comes from people who use it to purchase financial assets. If you keep mucking around with the rules of the games for financial assets denominated in euro, eventually investors pack it in and your currency loses value.

This shouldn’t be too complicated a point to understand. For example, I teach my undergraduates about how a currency’s value depends on the supply and demand for the assets denominated in that currency.

Germany has been one of the main drivers of international and EU policy on climate change, and hence one of the key drivers of Irish climate policy.

Until recently, there was political disagreement about whether draconian greenhouse gas emissions where needed, or drastic cuts would be enough.

In the last few months, two documents have appeared that suggest that this is changing. Both are available in German only.

The first paper, by a relatively junior researcher at think tank close to the Chancellery, suggest that (whisper it) the sacred two degrees target is perhaps infeasible, that (a few odd but not entirely crazy people have argued that) there is nothing special about two degrees anyway, and that we should perhaps keep in the back of our minds that one day we may need to consider whether a Plan B might be required. The extremely cautious tone of the paper is indicative of the scale of the heresy.

The second paper does not mince words. It is by the Scientific Advisory Council of the Federal Ministry for Finance, a body of 29 professors. The Council argues that climate change is not as big a problem it is made out to be, but that it can be solved at a relatively low cost with clever policy intervention. It further argues that the first-mover advantage in technological progress is a myth (the second mover is often better off) and that Germany should stop taking the lead as nobody else is prepared to follow.

Harbingers of change to come? Time will tell.