The report of the US Financial Crisis Inquiry Commission was released last week to controversy and criticism.   The report contains a wealth of information and is interesting reading even for those whose interest is mainly in our own financial crisis.  Much of the story has been about the partisan squabbling since the report’s release, with the Commission failing to agree on the final product.   Republican commissioners issued two separate dissents to the “majority” report (see here for the dissent of Hennessy et al.).    This just underlines how politicised the narrative of the crisis has become.   Strangely enough, though, I find the duelling perspectives actually add a useful analytical edge – otherwise lacking – to the report.  (Update: See here for an interesting discussion at the NYT.)

Anger at our government is probably too raw to have a much of a productive debate until after the election.  But to draw the proper institutional and policy reform lessons, it will be useful to similarly consider the competing extremes of the “rotten institutions” and “blameless bubble” explanations for the crisis, and to explore where the truth lies.  

Some short extracts follow after the break to give a flavour of both the majority report and the dissent. (more…)

The new Central Bank Quarterly Bulletin is available here.  In addition to the new economic forecasts, the Bulletin carries some very interesting special articles on:

• Large-Value Payment System Design and Risk Management
• Firms’ Financing During the Crisis: A Regional Analysis
• Irish Money and Banking Statistics: A New Approach

The recent Ernst and Young report commissioned by the Department of Finance on the economic and budgetary impact of the proposed CCCTB is available here.

Anousha Sakoui has written a very interesting Analysis article in today’s FT on the experiences of some top European officials during various Emerging Market debt crises during the last 30 years: you can read it here.

Tommaso Padoa-Schioppa was a major figure in the creation of the euro; he died just before Christmas.

Lorenzo Bini-Smaghi provides a very interesting overview of his career in this speech.

Here is a link to the article by Gary O’Callaghan that Colm McCarthy referred to in a previous post but for which there was a problem with the link.

Failures by the Irish fiscal authorities have been blamed, in recent newspaper and TV interviews, by ECB Executuve Board member Bini-Smaghi for precipitating the October crisis and Ireland’s resort to bail-out.

Gary O’Callaghan of Dubrovnik International University thinks the culprits were ECB Executive Board members.  

https://imap.ucd.ie/uwc/webmail/attach/Did%20the%20ECB%20Cause%20a%20Run%20on%20Irish%20Banks.doc?sid=&mbox=INBOX&charset=escaped_unicode&uid=22418&number=4&filename=Did%20the%20ECB%20Cause%20a%20Run%20on%20Irish%20Banks.doc

There have been some comments on this blog this morning on the popular subject of bank bonds.

Let me point out some facts and then some questions for debate.

The facts:  On Monday, January 31^st, Anglo Irish Bank are going to pay out on a maturing bond worth €750 million. (For reference, the total cut in this year’s welfare budget will be €873 million.) The investors who purchased this bond invested their money with Anglo on the 17^th of January 2006. The bond is senior unsecured debt and is not covered by a state guarantee.

The questions: Should the government have passed legislation this month to allow the Minister for Finance to intervene so that the bank did not pay this bond back? And if so, should the next government pass such a bill in relation to the remaining €4 billion or so in outstanding unguaranteed bonds owed by Anglo and INBS?

In answering the question, it’s worth noting that the logic of the section of the recent Credit Institutions (Stabilisation) Bill relating to subordinated debt suggests that a government can change the terms and conditions of bonds to apply haircuts if the bank owes its continued existence to significant amounts of public money being injected.

It is unclear whether this power can simply be extended to senior bonds but it seems to me that it can. Another issue is whether such changes in terms and conditions can legally work to allow a bank to distinguish between different types of unsecured creditors that start out with equal claims, by haircutting bond holders but not deposits. Mechanically, of course, one could achieve the same outcome by haircutting both senior bonds and depositors and then compensating depositors via a separate piece of legislation, but this would be more complicated.

The other issue is the implications of a default on a senior bond for the Irish and European banking sectors. My belief is that how this plays depends on what investors believe is the precedent being set. If the precedent is that investors can lose out if they place their money with banks with flawed business models, who engaged in shady business practices and then become grossly insolvent—then surely this is a precedent that must form part of new proposals for dealing with failed institutions?

On the other hand, one could argue that at such a sensitive time for the Irish banking sector, defaults of this type would send the wrong message and worsen an already extremely serious liquidity problem. This is the argument put forward by our new best friend, Mr. Bini-Smaghi.

I’m open to considering all sides of this argument. On balance, however, I’m inclined to the position that it is in the interests of both Irish citizens and those in the wider EU to set a precedent with the Anglo and INBS bonds that there need to be limits on how much support European taxpayers will provide to insolvent banks.

A useful explanation of QE is available here.

A reader has written to me about an important item missing from my briefing paper on the IMF-EU loans. I noted in the report that the amount of money that Ireland can borrow at cheap rates is three times our IMF quota and that this quota was about to increase. However, I did not mention that a much larger increase in Ireland’s quota is likely to occur over the next year or so.

On November 5^th, the IMF concluded its 14th General Review of Quotas with the Executive Board recommending that the Fund’s Board of Governors adopt the proposed quotas. The proposals include a doubling of the total amount of quotas and review of each county’s share of the total. Ireland’s share is proposed to increase further from 0.528% to 0.724%). This means that Ireland’s IMF quota will increase to around SDR 3.45 billion, which at current exchange rates would translate to a quota for almost €4 billion.

If implemented, these proposals would allow Ireland to borrow almost €12 billion at IMF’s low interest rate (currently 1.38%) with the remaining €10.5 billion at the higher rate (3.38% for the first three years, 4.38% thereafter). Over a seven and a half year period, this would translate into a loan that had an average margin over the variable SDR base rate of 228 basis points, down from the 326 basis point margin associated with the IMF lending terms that prevailed at the time the bailout deal was increased.

To come into effect, the proposals must be approved by 85% of the IMF’s voting share and 113 member countries. It’s unclear how long this will take but it may take a year or so.

I think this adjustment of the IMF lending terms is an important point to keep in mind when considering the lending terms on the EU loans. The EU lending authorities have been keen to point out that, once compared in the appropriate fashion, their loans can be viewed as having equivalent cost to the loan that the IMF offered the Irish government in November. This is true. However, when compared against the terms that the IMF is going to offer Ireland in the near future, the European loans are a good deal more expensive.

Last night’s Prime Time contained some interesting material.  A reader has provided a summary of some of  the main points, reproduced below:

Transcripts below of  remarkable comments by the ECB’s Executive Board
member, Lorenzo Bini-Smaghi, and  Fine Gael’s Leo Varadkar.

The stark contrast in the two viewpoints is a good summary of today’s
difficulties in Europe… Something has got to give, will give. And
probably in favour of the governments generally, not the ECB.

Leo Varadkar was asked on Prime Time what Ireland’s opposition Fine Gael
will be saying to the European Commission at their meeting today in
Brussels.

Leo Varadkar  - “They will be saying that Ireland does want to pay, that
we do want to take responsibility for our sovereign debt. They are going to
be saying that is a European problem, not just an Irish problem, that there
are flaws in the system in Europe. We are making it very clear to them,
which is very important, that at the current rate of 6%, we won’t be able
to pay. If they insist on this deal, on this interest rate, there will come
a point when Ireland won’t be able to honour its debts. And the money that
has been lent to us, we will be unable to pay, you know”.

Lorenzo Bini-Smaghi was interviewed by Prime Time -
“The amount of senior bonds is so small compared to the overall amount that
if you give a haircut to the bonds, immediately you would have a run on the
banks, by the Irish themselves by the way, because they would not trust
anymore their liabilities, their assets held in the banks are safe. So you
would have immediately a run on the bank, a collapse of the banking system
so the banks would not lend anymore to corporations. They would have to
restructure their own liabilities with the Irish citizens. So the Irish
people in the end would pay, pay for it, in the same way as the Americans
paid for the collapse of Lehman”.
“The government engages a country when it signs a agreement. .. The
programme is there has been signed and has to be implemented”

(more…)

Arthur Beesley has an interesting article in today’s Irish Times which reports on the views of Nouriel Roubini and Ken Rogoff in relation to Ireland’s debt situation.  One element in the article is a passing reference by  Rogoff to Romania’s determination to pay off its external debt under the Ceausescu regime.

Readers may interested in more details on this case.

(more…)

It is obviously true that a lower interest rate on the EU loans to Ireland would help debt sustainability. As written by Karl and highlighted in the FT today:

The overall cost of funding from the EU sources appears likely to be over 6% per year. If this is the rate that the Irish state will be paying in coming years, the national debt will grow by 6% each year even if the state is running a zero primary deficit (the headline deficit minus interest payments.) This would require a 6% growth rate in nominal GDP to stabilise our debt-GDP ratio even when we are not running a primary deficit. In other words, an interest rate of 6% will make debt stabilisation far more difficult in the coming years than an interest rate that doesn’t carry a large profit or risk margin.

This is an important point to make and is a standard way to illustrate the impact of the interest rate on debt sustainability.

However, for the 2011-2015 period, it is important to appreciate that the impact of a lower interest rate on this source of funds would be limited:

• There is a lot of Irish government debt outstanding, much of it funded at substantially lower interest rates.  There is about €81 billion outstanding, maturing at various dates between 2011 and 2025 (see the interest rates and maturity dates at the NTMA website).
• Also, there is short-term debt outstanding and John Fitzgerald has pointed out that the NTMA could do more short-term debt financing under the ‘umbrella’ of the EU/IMF deal
• A substantial amount of the new borrowing needs of the Irish sovereign will be met by drawing down cash balances and the assets of the NPRF

Putting these factors together means that the projected average interest rate on Irish sovereign debt over 2011-2015 will be 3.9%, 4.0%, 5.3%, 5.3%, 5.4%  (according to the IMF’s December 2010 Ireland report) so that the near-term impact of shifts in the marginal cost of funds from the EU will be limited. (Still nice to have a lower rate, however!)

In addition, Karl’s illustrative example focuses on a zero primary deficit.  The IMF projections are that Ireland will run primary surpluses of 1.2% in 2014 and 1.5% in 2015 - of course, this assumes that the fiscal plan is implemented and that nominal output growth meets the IMF’s projections. A different way to express the same point is that, for a given path for nominal GDP growth, the higher the average interest rate, the higher the primary surplus that will be required to stabilise or reduce the debt/GDP ratio.

John Bruton has written an open letter to José Manuel Barroso, available here.

I appeared today before the Oireachtas Committee on European Affairs to discuss the interest rates on the EU-IMF loans. I provided the committee with a briefing paper (available here) and a short presentation (available here). I will edit this post later to include the transcript of my opening statement and the questions and answer session when these materials are posted on the Oireachtas website.

There’s a lot of material in the briefing note and I’m not going to repeat it here. One point I would briefly point to, however, is that the note discusses how recent movements in market interest rates and the pricing of EFSM’s initial bond issue on January 5th (EU Commission press release here) meant that, by my estimates, the cost of funding from the EFSF and EFSM would be 40 basis points higher than had been estimated in the December note released by the NTMA.

These materials were prepared prior to today’s €5 billion bond auction the EFSF. Press stories have been very positive about how this bond auction went (e.g. here and here). However, the material I prepared discussed the pricing of the EFSM bond yield relative to swap rates. The January 5th bond was priced at mid-swaps +12 basis points while this bond mid-swaps +6 basis points, so the interest rate on today’s bond would not change my judgment on this issue by much.

Update: As promised here’s the transcript of my appearance

The estimate for Q4 GDP in the UK has come in at negative 0.5 percent (well below expectations of mildly positive growth), with the deviation ascribed to the terrible December weather.

Ireland’s Q4 GDP number does not come out until March but we should not be too surprised if a similar undershoot happens here, in view of the similar weather in December.

Attached are the four conclusions of the IMF’s Financial Stability Update just released, in so far as they concern the Eurozone, with my comments:

‘In the European Union, the steps listed below are needed to reduce uncertainty and help restore confidence in markets.

• Further rigorous and credible bank stress testing is required along with time-bound follow-up plans for recapitalization and restructuring of viable, undercapitalized institutions and closure of nonviable ones.’

Comment: The IMF is suggesting new stress tests and ‘follow-up’ recapitalisation and re-structuring of banks. In that order, not in the reverse order.

• ‘The effective size of the European Financial Stability Facility should be increased and it should have a more flexible mandate. For countries where the banking system represents a large proportion of the economy, it is now even more essential to ensure access to sufficient funds, going beyond national backstops whenever necessary.’

Comment: Means the EFSF is inadequate in size and function, particularly for countries with large banking systems, such as Ireland. 

• ‘Euro area-wide resolution mechanisms need to be deployed and strengthened as needed. The introduction of a pan-European bank resolution framework with an EU-wide fiscal backstop would help decouple sovereign and banking risks.’

Comment: Means the IMF wants to share bank losses with bank creditors and re-capitalise banks with EU-wide, and not just national, fiscal support. 

• ‘The European Central Bank will need to continue to supply liquidity to banks that need it and keep its Securities Markets Program active, while also recognizing that this is a temporary set of measures and will not solve the underlying problems.’

Comment: Means that ECB has been overly restrictive on both counts.

Does anyone still believe that the IMF was happy with the design of the Irish bail-out?

The debate about the banks has gone off the boil.   But, as John Ihle argues in yesterday’s Sunday Tribune, the next six months will be a very active period in the restructuring of the Irish banking system (article here).    

Fixing the credit system and minimising the cost of the rescue to the State have been the focus of the debate.    The first has strangely faded from view.   The second has acquired an ominous twist: tension between the ECB (which bears increasing risk as funder of last resort of the banking system) and the State (which is effectively on the hook for bank losses given limits on creditor loss imposition).  The ECB wants to shrink the balance sheets of Irish banks to minimise its exposure, even at the cost of “fire sales”; the State wants to minimise bank losses to give it a fighting chance of regaining its creditworthiness.    Like the ECB, the Central Bank of Ireland is increasingly on the hook for funding the banks through its Emergency Liquidity Assistance, although things are complicated by the fact that first on hook for losses on this assistance will be the State itself.  

This basic funding versus capital tension is most likely behind the conflict pointed to by John Ihle between the Central Bank/Financial Regulator on one side and the NTMA/Department of Finance on the other.   How this conflict plays out will have a significant impact on how the restructuring unfolds. 

Some of my students today complained - softly - about the workings of the Back to Education Allowance.    Like many such schemes globally it allows for some mechanism to maintain welfare payments whilst returning to full time education at both second and third level.   Laudable enough, although  I haven’t seen this evaluated in terms of impact but then again what is new for Irish policy.

(more…)

Even as we are distracted by political upheavals at home, the debate on how best to reorient the euro zone’s bailout mechanisms continues.   The proposal gaining most traction, with at least a degree of German support, is to allow countries in difficulty to use EFSF funds to buyback their own debt on the secondary market.   The initial focus is on Greece, but any new mechanism should be available in time to Ireland.   (Wolfgang Munchau provides a critical analysis here.)

The attraction of buybacks is that they allow a country to reduce the face value of outstanding debt without a formal default.   A disadvantage is that they can be gamed by bondholders: it makes sense for bondholders to hold out for a higher price if a buyback is really expected to improve creditworthiness.   One partial solution that I mentioned previously is for countries to buy back the debt accumulated by the ECB through its Securities Markets Programme (see here).  

Writing on Friday before the latest developments, Arthur Beesley reminds us of the stakes:

[T]he debate merits serious attention across the political spectrum in Dublin. Political activity for the next . . . weeks will centre on the election, but neither the Government nor the Opposition can afford to lie low on this front.

The debate on Greek debt takes place amid an intensive negotiation of key reforms to the European Financial Stability Facility (EFSF) rescue fund, including lower interest rates. Any inattention here would hamper Ireland’s argument for a rate cut, which is already difficult. But the Irish dimension does not end there, far from it.

.  .  .

[S]etting the election date brings clarity as to when a new government is likely to take office. From the perspective of European talks, the timing is tricky enough. Polling day is March 11th. EU leaders are working to make final decisions on EFSF reforms and a new permanent bailout fund at a summit only 13 days later.

There will be time – just about – to install a new taoiseach. By then, however, the really tough talking may well be done.

For those who haven’t heard the sad news, Denis died on January 20. He worked for many years in the ESRI and then, in his ‘retirement’, in NUI Maynooth and UCD. He was a brilliant statistician and a real giant of the Irish Economics world. He was always generous in sharing his knowledge with colleagues, particularly the PhD students with whom he worked. He was also encyclopaedic on local and military history, and an avid hill-walker. He will be greatly missed.

This presentation can be found on the Department of Finance website.

The ESRI’s new emigration forecasts are sobering (see here for QEC Press Release).    For the year to April 2011, net emigration is forecast to be 60,000, falling to 40,000 for the year to April 2012.  The gross emigration forecasts are 75,000 for 2011 and 60,000 for 2012.   The numbers are consistent with anecdotal evidence of a resurgence of interest in the emigration option.   It is also worrying that significant outflows are forecast in the context of a relatively depressed UK labour market, and despite quite restrictive and skill-biased immigration policies in the destinations of choice: Australia, Canada and the US. 

The numbers are a reflection of how limited opportunities are at home for young people, though it would be even worse for those who leave if outside opportunities were not available.   The unemployment rate for those aged 20-24 is 25.5 percent.   And this is despite a fall in the participation rate from roughly two-thirds in 2008Q3 to half in 2010Q3.  

We must also worry about the implications of large-scale emigration for economic recovery.    In a thought-provoking post back in November, Kevin O’Rourke drew attention to the danger of an adverse fiscal feedback loop given the large fixed cost of the national debt.   We get a form of fiscal increasing returns: the more people leave the greater the tax burden (and indeed the poorer provision of State services) for those who stay, further increasing the incentive to leave.  (more…)

Over the past week, there have been repeated references during the Fianna Fail heave\confidence vote to the government’s achievement in securing funding for the state for a number of years.

The plan was originally presented as funding the state for three years. However, yesterday on Morning Ireland, Brian Cowen claimed that “funding for the state for the next four years had been organised” while on the Vincent Browne show on Monday night, junior minister Tony Killeen swung for the stars and claimed that we had secured “financing for the state for the next ten years or so”. (15.40 in).

Given the hyperbole\confusion on this matter, I thought it might be worth pointing out a few figures that suggest that the maximum length of time that the deal allows the state to stay out of the bond market is three years and that a more realistic assessment would suggest about two and a half years.

(more…)

Colm McCarthy has some trenchant remarks on Mr Sarkozy’s recent populist speech:

As Fianna Fail deputies and the media debate the performance of Brian Cowen as Taoiseach over the next few days, the question of the September 2008 guarantee will come up time and again. The Taoiseach has defended himself strongly against accusations that any relationships he had with bankers led to his government’s decision to offer a near-blanket guarantee to the liabilities of the Irish banks. He has repeatedly argued that this decision was taken in the national interest.

This still leaves open the question of why it was considered in the national interest to offer such an extensive guarantee. On this subject, Mister Cowen has tended to answer that they took this decision based on the best advice available. The next few days would be a good time to provide evidence for this statement. As it stands, there is a lot of evidence that plenty of contrary advice was given. For example, as has been noted here on a number of occasions, the government’s expensively-hired outside advisers, Merrill Lynch, were not enthusiastic about such a guarantee.

In relation to the Department of Finance’s policy advice on this issue, a useful example of the Department’s stance is document 36 from the PAC collection. The document is a slide presentation from February 2008 titled “Overview of Financial Stability Resolution Issues”.  Page 11 states in bold:

As a matter of public policy to protect the interests of taxpayers any requirement to provide open-ended/legally binding State guarantees which would expose the Exchequer to the risk of very significant costs are not regarded as part of the toolkit for successful crisis management and resolution.

In bold and with “not” underlined. It certainly seems as though the Department officials were on the record as being against the form of guarantee provided. Evidence on who exactly proposed the form of guarantee that was provided would be welcome.

I also think it’s worth keeping in mind when government politicians condemn those who opposed the guarantee (i.e. the Labour Party) as having been irresponsible, as Peter Power did on the The Week in Politics last night, that this opposition was shared by the government’s own advisers.

The Sunday Business Post yesterday published an op-ed by me. It’s a shortened and updated version of last week’s blog, and it sketches emission reduction options in transport:

“There is already a carbon tax on fuel, while motor tax and vehicle registration tax favour low emission cars. There are strict European rules about the fuel efficiency of new cars. Fuels are blended with biofuels. Public transport is subsidised. If the economy returns to modest growth and policies continue as they are, but the carbon tax rises, then emissions from transport in 2020 would be roughly the same as they are today. (Transport emissions doubled between 1990 and 2000, and another 20 per cent was added between 2000 and 2010.) According to the climate bill, however, transport emissions should fall by 20 per cent.

How can this be achieved?  If we ignore all the evidence that biofuels are bad for the environment and bad for poor people, and we increase the mandatory blend from 3 per cent to 10 per cent (in energy terms), emissions fall by 7 per cent. If 10 per cent of cars were all-electric, emissions would fall by 2 per cent. (This is small because electric vehicles appeal primarily to urban households with two cars.)  Some 60 per cent of commutes by car are less than 10 km long. If half cycled to work instead, emissions would fall by 7 per cent. If the sale of two-litre cars is banned from 2012, emissions would fall by 2 per cent.

These four measures together reduce emissions by 18 per cent. Even this is not enough to meet the new targets.”

The SBP dropped a paragraph: “The climate bill would also establish a National Climate Change Expert Advisory Body, which would oversee the measures to reduce emissions taken by the various departments. This is welcome in principle. Like monetary policy, climate policy is best removed from day-to-day politics. The Expert Body would be like the Central Bank. Unfortunately, the Expert Body as foreseen in the climate bill is different. Any civil servant can be declared an expert, but others are excluded. Experts can be removed at will by the minister. And the government can block any publication by the Expert Body. The Expert Body would not have the required expertise or independence to do its job.”

The same edition carried another article on the climate bill, which cites the IFA and Teagasc. The IFA’s 4 billion euro is an estimate of the loss of export revenue; the cost would of course be much lower. It’s not clear where the number comes from. A 40% reduction in the herd size is probably much more than is needed to meet the 2020 target (although it is hard to imagine that the herd size would not be cut). I could not find a source for that number.

The IFA used to be firmly opposed to climate policy.  Over the last couple of years, their position has become milder as they realised that climate policy would bring new opportunities (carbon storage, bioenergy). In fact, Irish dairy is among the most climate-friendly in Europe, so EU policy might improve our competitive advantage. The publication of the climate bill seems to have reversed a positive trend.

Michael Noonan puts forward some ideas for amending the bailout deal in an opinion piece for the Sunday Independent.   His focus is on ways to reduce the expected cost/risk to the State of cleaning up the banking mess.  

He suggests four main options: (i) have the EFSF put capital directly into systemically important European banks; (ii) have the EU provide insurance against bank losses beyond some specified level (an idea already suggested by Patrick Honohan); (iii) the fast-tracking of an EU-wide of a bank resolution regime (that presumably would not be limited to future bank creditors); and (iv) an ECB-funded special purpose vehicle for bank assets to avoid the alternative of firesales with losses rebounding on the State.

If you are already fed up with the albums you got for Christmas, I did an interview for Vox about the Irish situation which you can download here.

Over at VoxEU, a bunch of economists challenge the current consensus in climate policy circles and suggest a range of policies that may actually reduce emissions.

In the forthcoming ESRI Research Bulletin, David Anthoff and I offer some thoughts on how a country may set a carbon tax.