Committee on European Affairs Report on EMU

The Joint Oireachtas Committee on European Affairs has produced a report titled “European Monetary Union: Challenges and Options”. The report is available here and the executive summary is hereSenator Paschal Donohoe acted as Rapporteur on the Report, which was drafted in association with my former UCD colleague, Rodney Thom

The State of the Public Finances

Much of this morning’s media coverage of the latest ESRI Quarterly Economic Commentary (summary here) has focused on the ESRI’s projection that the 2010 general government balance will be a deficit of 19.75 percent of GDP, which is the sum of the ‘underlying’ deficit of 11.5 percent of GDP and the capital transfer into Anglo/INBS of 8.25 percent of GDP.  (Based on the reasonable assumption that Eurostat will adjudicate that the infusions into these banks indeed are capital transfers rather than financial investments.)

This is not really a surprise –  the scale of the bank bailout was announced back in April and the accounting issues were dealt with on this site at that time (see here and here).  In terms of investor sentiment, the bad news should have been incorporated at that time.  Sophisticated investors will understand the distinction between non-recurrent capital transfers and the underlying deficit and also the distinction between accrued liabilities and this year’s funding needs (the use of promissory notes limits the extra funds required this year).

However, beyond the accounting issues, the increase in the government’s liabilities remains a substantial economic and financial cost.  In terms of the trajectory for the public finances,  debt sustainability requires that an increase in liabilities is met over time with a higher primary surplus  – the government will need to raise more taxes and/or cut spending to service the extra liabilities (unless serendipity means that the extra liabilities coincide with a matching upward revision in the forecast for GDP growth).

The next version of the government’s multi-year fiscal framework will need to specify how the opposing forces of the improvement in GDP forecasts and the increase in debt liabilities feed into plans for taxes and spending.

SME Lending Announcements

The government has announced lending plans to SMEs from Bank of Ireland and AIB. It has also released the quarterly report of its Credit Reviewer, John Trethowen. Mr. Trethowen has concluded that he has “found no evidence of bank lending policies which constrained the supply of credit to viable businesses in either of the banks.” If this is correct, then the two banks have formulated plans to deal with a problem that apparently does not exist.

In judging these plans, it would be nice if we were provided with information that distinguished stocks and flows. Of the two plans, AIB’s strikes me as slightly more useful in stating that it has “total lending of over €13bn to SMEs at year-end 2009”. This puts the commitment to €3 billion per year in 2010 and 2011 in “new or additional credit” in some context. One would like to believe that this is a commitment to have total SME lending from the bank at €16 billion by the end of the year but I’m guessing this doesn’t have to be the case: Expiry of old loan agreements could, for all we know, match the €3 billion in new and additional credit.

What would be really useful here would be comprehensive statistics on SME lending in Ireland. It is my understanding the Central Bank are preparing to publish such statistics. Hopefully, these will be more useful in assessing the situation than the assurances of the banks or, with respect, Mr. Trethowen.

ECB Bond Purchase Program Almost Done?

Though as I write the official release has yet to appear here, the FT is already reporting that the ECB only acquired about €1 billion in sovereign bonds last week, down from the €4 billion or so seen in previous weeks and the €16 billion that occured during its first week. The winding down of the program was quasi-predicted here a few weeks ago.

One interpretation of what has happened with this program is that the ECB reluctantly launched the program despite some internal disagreement to ease tensions in sovereign debt markets, and that once the Stabilisation Mechanism funds were put in place, they have been quick to head for the exit.

Increasingly, it seems unlikely that the ECB will at any point engage in large-scale purchases on the secondary market aimed at keeping access to the primary market open for a specific country such as Ireland. Rather, a closing primary market will instead lead to a country to tapping the Stabilisation Mechanism funds.

Of course, one cannot completely rule out the ECB will re-activate the program on a larger scale if tensions start to mount again. But I wouldn’t bet on it.

Update: Official announcement confirms the figure at 796.5 million.

Daft House Price Report: 2010:Q2

The latest Daft house price report is now available here. Ronan Lyons discusses the report here and also discusses the need for a property tax.

The report shows asking prices down 36% from peak. Since asking prices during the boom tended to be less than purchase prices while the opposite seems to be the case now, I reckon it’s fair to view this figure as consistent with an actual decline in prices of over 40% since peak.

Are we near bottom? Nothing ever stops real estate vested interests from assuring everyone that things are stabilising and it’s a great time to buy. However, I reckon we still have further to go. The recent Honohan report informed us on page 83 that the (quite sensible) McQuinn-O’Reilly model indicated that house prices were 33% over-valued in 2007:Q2 relative to what could be justified by disposable income and mortgage rates.

This would justify a decline of one-third in house prices even if incomes hadn’t changed. However, nominal GNP has dropped by about 17% since house prices peaked while income tax rates have been increased. Headline mortgage rates are lower now for those on tracker mortgages but the more relevant measure is probably the cost of financing for the marginal new buyer and these are a good bit higher. One also has to factor in that people will need to make allowance for rate hikes to come.

Taken together, I think a peak-to-trough decline of about 60% wouldn’t be too surprising.

Update: John the Optimist reminds me that an overvaluation of 33% corresponds to 25% decline (100/133) which is fair enough. However, to be honest, I was being deliberately understated in the original post. Add in 17% for the decline in GDP, 10% for the effect of increased tax rates, and who knows what for tight mortgage credit and rate hikes to come and one can easily justify greater than 60%.

Innovation Fund Announced

There have been a number of media stories about the government’s latest Smart Economy initative: a new innovation fund featuring public money matched by money from venture capitalists. The Taoiseach was quite bullish about this program on RTE’s The Week in Politics on Sunday night and he has announced it in a speech in New York (press release here.)  The details say that it is a €500 million fund. As I understand it, this is €250 million from the Irish government spread over five years (€50 million per year) matched by private venture capital funds.

The press release tells us that this is a “major boost for enterprise development and job creation.” Well, with GDP for this year projected at €161 billion, venture capital investments of €100 million per year corresponds to six tenths of one percent of GDP. Government initiatives to develop a venture capital industry in Ireland are probably a good idea (I say probably because these initatives are often poorly implemented, in which case they’re a waste of money.)  However, in the grand scheme of things, this cannot be considered a major boost to enterprise. It’s certainly not a major boost to job creation.

Taxes postponed

It now looks as if neither property taxes nor water charges will feature in the next budget. Shifting the tax burden from income to property and resource use would provide a welcome stimulus to the economy. That said, water charges need water meters and property taxes need a valuation database — and the government does not appear to have put much thought into these matters since the Commission on Taxation released its recommendations.

The upshot, of course, is that spending will need to be cut further and that income taxes will stay high for longer.

It Depends on What the Meaning of “Cashflow Generating” Is

Here‘s an interesting article from the Irish Times by Simon Carswell in which NAMA’s senior officials squirm about their changed assessment of the quality of their loan portfolio, blaming most of it on the fragile psychological state of our bankers last Autumn (poor dears). The highlight:

Mr McDonagh said some loans – on top of the 25 per cent that were generating income – were yielding some, if not all interest due, but Nama was still assessing this.

“Twenty-five per cent is cashflow generating – the rest has some cashflow generating,” he said.

It brings to mind our friend Maurice O’Leary’s favourite quote:

“When I use a word,” Humpty Dumpty said in rather a scornful tone, “it means just what I choose it to mean — neither more nor less.”

Update on Current-Year Macroeconomic Projections

The Department of Finance has released an interim update of its macroeconomic projections: you can find it here.   While the upgrade to the real GDP forecast has been well publicised, this release also notes that the decline in the GDP deflator is sharper than expected –  but it does not provide a number for nominal GDP growth.

A more elaborate revision of its forecasts will be published in the Autumn.

NAMA Profit Projection Due to Faulty Haircut Calculation

I had thought there was something a bit odd about how the NAMA business plan extrapolated from the 50% discount applied to the first tranche to come up with its figure for the amount it would be paying for its full portfolio. After all, the fraction of Anglo loans in the first tranche was higher than for the total portfolio and these are likely to be worse in quality than the average loans from AIB or BoI.  Surely, the correct approach would have been to calculate this figure applying the institution-by-institution discount from the first tranche to the total consideration, assuming for example that the first tranche haircut for AIB is the appropriate figure to apply to the rest of AIB’s NAMA portfolio.

So, I did the calculation (here‘s the spreadsheet) and, lo and behold, it projects that NAMA will pay €41.7 billion for the portfolio, not the €40.5 billion they published in the business plan based on extrapolating from the first tranche aggregate discount.

It turns out that Jagdip had done the same calculations before me and discussed them here.  I agree with his comments there and believe this implies some pretty serious questions about the thinking that went into the production of this business plan.

Suffice to say, from here on, I will be assuming that NAMA are going to spend €41.7 billion, not €40.5 billion, and that the baseline case in which full long-term economic value is recovered actually implies a small loss rather than a profit.

Update: As Jagdip points out below, if the base case now becomes a loss of €200 million, this can be made up by not honouring €200 million of subordinated bonds. So the outcome is neither profit or loss. Of course, the “realise ten percent less than LTEV” scenario (known to some as the worst-case scenario) would now be a loss of €2 billion because the original €800 million loss in the business plan already accounted for the sub bonds not being honoured.

Why Larger Losses on NAMA are Likely

Day 2 of the new NAMA business plan and I’m sure people are already a little tired of it as tolerance for all things NAMA has dwindled for most of us. For those still interested, Constantin Gurdgiev has a number of useful calculations in this post.

I’ll conclude on this issue for now by making a few simple points as to why I think the outcome for the taxpayer is likely to be worse than indicated by the plan’s “worst-case scenario’’ of an €800 million loss to be recouped via a levy. Continue reading “Why Larger Losses on NAMA are Likely”

NAMA Business Plan

NAMA have now published their business plan (announcement here). I haven’t looked at it in full detail but a few comments are worth making at this point.

First, it’s not much of a plan. It doesn’t bother trying to update the draft plan‘s year by year analysis of cashflows. As such, the scenario analysis, such as it is, seems like it will be pretty useless to those of trying to assess its credibility.

Second, in relation to Monday’s leaks, the prize for accuracy goes to the Indo’s John Mulligan who correctly reported the new information on cash flows was that NAMA now estimate that 25% of the loans are cash flow producing, which was more accurate than the Times report of about 20 per cent. To be specific, the plan says:

the draft Plan assumption was that 40% of acquired loans would be income-producing; however, the level of debtor impairment evident from the first tranche loan transfers suggests that 25% may be a more reasonable estimate. Similarly, the actual LTV ratios that have become evident during the Tranche 1 due diligence process have been higher than those indicated by institutions last autumn.

There are two possibilities in relation to the difference between the current and draft business plans in relation to their assessment of loan quality. Either the information provided to the government by the banks last year prior to the passing of the NAMA bill was highly inaccurate (speculate yourself as to why this might have been) or the loan portfolio is deteriorating rapidly.   It would be useful for NAMA to clarify the relative contributions of these two factors.

Third, I find it interesting that when NAMA CEO Brendan McDonagh appeared before the Oireachtas Finance Committee on April 13, NAMA had already paid for most of the first tranche of loans. And yet, at the time, McDonagh said that “we estimate the figure is probably closer to one third, that 33% of the loans are cashflow producing.”

It might be possible that the discrepancy between this estimate and the current estimate is accounted for by new information about Anglo’s loans, which were still being analysed when McDonagh gave his one-third estimate. That said, why it should be difficult for a government to find out how many people are repaying the NAMA-bound loans beats me (a point that applies doubly when the bank in case has been nationalised bank.) Less palatable is the idea that we are finding new nasty surprises about loans after we have already paid for them.

Irish economy and climate change

Climate policy in Ireland and Europe is important to the economy of Ireland, and I will continue to blog on that. I have not posted much lately, which is because nothing much has happened (except for a series of non-conclusive international and European meetings).

Most aspects of climate change are not particularly relevant to the Irish economy. Although some frequent visitors to this site share my interest in these matters, the discussion is better placed elsewhere. My adventures in IPCC land are discussed here, but I’ll also use VOX, Klimazwiebel and Pielke Jr for issues on climate change economics, science, and policy, respectively.

Are One Third of NAMA’s Loans Producing Cash? No.

You might remember that a few months ago, NAMA CEO Brendan McDonagh appeared before the Oireachtas Finance Committee and told them that one third of NAMA’s assets are cashflow producing. I noted at the time (based on the information in bank annual reports) that this didn’t seem to me to be correct, with the likely figure being a good bit lower. Now, the media are leaking details of NAMA’s new and improved business plan and we are being told that “only about 20 per cent of the loans are generating any income, that is repayments or interest payments.”

This raises an interesting question: Was Mister McDonagh misinformed in April when he said that one-third of the loans were cashflow producing or have 13 percent of the loans stopped producing income between April and July? Neither answer is particularly palatable.

As for “In a worst-case scenario, Nama could end up losing several hundred million euro” one really has to wonder do the people who put this plan together know what a worst-case scenario means.  However, coming from the folks who brought us the 80% full recovery scenario, I suppose we shouldn’t be surprised.

The OECD Innovation Strategy

The OECD Innovation Strategy brings together the results of a three-year analysis of innovation and innovation policies.

The Executive Summary of the analytical study can be found here and the Key Findings here. A Compendium of Indicators to measure innovation and monitor the implementation of the strategy can be found here.

 An Expert Advisory Group including experts nominated by the governments of member states and other selected governments has provided advice and feedback on the project. As far as I can see in this Expert Advisory Group Ireland is not represented.

Incineration (part N+1)

More on PoolBeg in today’s Indo.

The article repeats some of the arguments I have been making for a while.

Worryingly, Covanta’s shareholders have began to take notice that Ireland no longer seems so business-friendly. Presumably, Covanta’s shareholders also hold shares in other companies that consider investing in Ireland.

UPDATE: Minister’s behaviour to be investigated by SIPO