Year: 2010

Renewable heat and the cost of capital

Today’s Independent reports that the government is preparing the ground for meeting the renewables target for home heating. Geothermal energy is to play a part in this. Treacy Hogan gets the numbers right, but does draw the obvious inference. Would anyone invest in a project with a payback period of 12-36 years? In a country that is desparately short of capital?

A friend of mine used to sell heat pumps. He had a brilliant marketing ploy: “The payback period is 40 years.” Most of his customers thought you need to maximise the payback period, so he sold loads.

As with most renewables, for geothermal energy, the fuel comes for free, but the capital does not. Compared to fossil fuels, the price risk is gone, but the interest rate risk is higher.

Exposures of Foreign Banks to Euro Periphery

The same BIS Quarterly Review also carries an analysis of the holdings of foreign banks (with a geographical breakdown) in the troubled periphery of the euro area and shows the allocation between claims on the public sector, banks and the non-bank private sector: you can read it here.

As has been pointed out repeatedly on this blog, the claims on Ireland have to be treated with some caution in view of the role played by IFSC-located entities. In its coverage of this new article, the New York Times highlights the probable role of Hypo Real Estate’s subsidiary in Dublin (the former Depfa bank) in contributing to the high claims of Germany on the Irish non-public sector.

Debt Reduction After Crises

The new issue of the BIS Quarterly Review carries some interesting empirical work on debt reduction after crises.  The paper is here and the summary is:

Financial crises tend to be followed by a protracted period of debt reduction in the nonfinancial private sector. We find that a period of debt reduction followed 17 out of 20 systemic banking crises that were preceded by surges in credit. Debt/GDP ratios fell by an average of 38 percentage points, returning to approximately the levels seen before the increase. If history is any guide, we should expect to see a much more significant reduction in private sector debt, particularly of households, than has so far taken place after the recent crisis. The costs of this process in forgone output are difficult to pin down, but there are reasons to believe that they need not be high provided that the banking sector problems that led to the crisis are fixed.

The Costs of Default

Panizza, Sturzenegger, and Zettelmeyer’s influential 2009 Journal of Economic Literature survey on the economics of debt and default has been referenced on different threads over the last few days.   The message has been that the costs of sovereign default in terms debt market access and borrowing costs are relatively low.   While I know that those referencing the paper know these findings provide only part of the picture, I am concerned that some blog readers will come away with too strong a conclusion. 

The puzzle of sovereign debt markets is that they should only be possible if there are costs to default – and especially to voluntary default.   In contrast to corporate borrowers, legal sanctions do not provide much of a deterrent for sovereign governments.   The traditional explanation has instead focused on the value of reputation and thus on future access.   But the finding of low direct capital market punishments for defaulters has put that explanation in doubt. 

Yet sovereign debt markets are alive and well.   From this we can infer that there must be costs of some sort.   Recent attention has focused on domestic costs, such as the costs of severe output losses that have accompanied a number of recent debt crises. 

Here is what Panizza et al. (cautiously) conclude:

If anything, defaults appear to be deterred by the domestic “collateral damage” that tends to accompany debt crises, rather than punishments from outside.   While it is very difficult to empirically disentangle the causes and effects of defaults, there is at least some evidence supporting the idea that defaults may magnify the output drops observed during debt crises.   Once output costs in line with this evidence are assumed in parameterized models of sovereign borrowing, the level of sovereign debt that can be sustained in equilibrium rise to more reasonable levels compared to models in capital market penalties are the only punishment. 

One interesting possibility is that in a world with uncertainty about government/country type, revealing yourself as “non-honest” can have implications for broader dealings both domestically and internationally. 

Even if we take a strict cost-benefit perspective, we should approach “default” cautiously – whether it is debt restructuring or the revocation of guarantees.

Your Country, Your Money

Five finalists have been announced for the Your Country, Your Call competition which, you may recall from the large advertising campaign earlier this year had the modest ambition of finding “two major proposals that, when implemented, will transform our economy – or significant elements of it – by creating jobs and opportunity.”

Competing ideas include installing solar panels on wind farm sites, creating “an Irish Content Industry Association which would then drive the development of a cultural and creative quarter. A media park would be established to attract global content industries” and, my favourite, “Building a world-beating entrepreneurial and innovation ecosystem around digital services aimed at positioning Ireland at the forefront of its associated spin-off industries.”

Two winners will be selected. They will be awarded €100,000 and then be given a development fund of, em, up to €500,000 each to implement the ideas. (Isn’t it great how these transformative ideas are so cheap?)

Obviously, it’s easy to poke fun at this competition. However, there is a serious question. The Times reports

The Department of Enterprise, Trade and Innovation said yesterday it had not provided money to fund the competition but a spokeswoman said formal arrangements were being put in place to allow a payment to be made. Earlier this year, Your Country, Your Call asked the department for €300,000 in funding for the initiative.

The question is whether public money should be used to support this idea. Just to be clear, my answer would be no.