Funding Versus Capital

If the haemorrhage of deposits is continuing, it is not hard to see why the CB wants early re-capitalisation. They are on the hook for €50 bill, perhaps more, collateralised but perhaps not well, possibly guaranteed by the state but a huge multiple of CB capital.

This has gone to repay wholesale deposits at Anglo and elsewhere which lenders declined to roll over, and these folks now hold claims against the CB which, as Willem Buiter points out, are not claims against the ECB. But what are they? Could banks which hold them not convert at par into claims on the ECB by tendering at the next sterilisation auction? Or could a nervous holder of Irish CB ‘money’ sell these claims below par?

Of course it makes sense to do the stress tests first and then re-capitalise but there must be reasons why knowledgable people want to put carts before horses.

“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”

Isn’t it all hopeless ? The banks seem to be like the legend of the deceased el Cid who went into battle tied to a horse because the Arabs were so in awe of him.

I see from the FT that bond speculators have moved on to Nigeria.

http://www.ft.com/cms/s/0/3f1333a6-2590-11e0-8258-00144feab49a.html#ixzz1C2NnN9M9

“The 10-year bond priced with yields of 7 per cent, higher than other similar bonds from other sub-Saharan nations. Gabon and Ghana 10-year bonds trade at 5.8 per cent and 6.2 per cent respectively.
One investor said: “Ordinarily we would have bought this bond as Africa is a coming market in our view, with potential for strong returns. But we were not impressed by the Nigerians.”Mr Aganga said the pricing was a good result and that if Ghana launched a bond in today’s market it could expect to pay more than 7 per cent.”

7% for Ghana is impressive compared to the Irish 10 year. Or is it insane?

They pour in their money for coupons that ignore the underlying risk. And when things go t*ts up they’ll presumably do the same as they did in Ireland.

John,
Thanks for your comments. You’ve made explicit what my piece only suggested. I suspect you’re right about the funding vs. capital tension, yet I’ve also picked up a sense of institutional inertia from the DOF and, to a lesser extent, the NTMA (although they claim they’re shackled by EU processes). Really, there’s a lack of ideas and confidence around town. Everyone still kind of in shock.

Colm,
You’re point about the CB’s €51bn exposure is right on; I’m embarrassed I didn’t mention it. When you say ‘there must be reasons knowledgeable people want to put carts before horses’, you’re being characteristically deadpan, right?

@Colm McCarthy

Forgive me, Colm (a neophyte, non-economist contributor since just before Christmas from here in Paris) for bouncing around on your excellent “board” but I’m addressing myself to you arising out of your previous, excellent “Bord Snip” attempts to address structural means by/through which Irish government policy can be formulated and executed with a view to optimising our future economic performance particularly as it relates to export-driven growth and the emigration arising out of what looks like being serious unemployment in Ireland for quite some time to come.

Specifically, I contend that Irish “Industrial” policy since TK Whitaker has served us relatively well but that it is now out of date and unsustainable and needs a root and branch review. The MNC-driven export growth that we need to be able to pay our massive debts is NOT creating net increased employment at anything like a rate necessary to soak up our out of work and emigrating citizens. ( No quibbles about the exact numbers please!).

I contend that, Smart/Knowledge Economy, The Irish Mind, The Food Island slogans aside, we do NOT, in fact, have a sustainable “industrial” policy, much less a strategy, in place AND we have no suitable mechanisms for coming up with one.

I have been advised by some well-intentioned and disposed contributors that this board has limited influence on policy.

My reply was that I have already expressed the core of my views to selected future Irish government leaders.

One future minister, for example, has graciously confessed to me his own frustration that strategy for the exports of the employment-critical “indigenous” food and drinks sector currently lies within the remit of the Department of Agriculture!

From my background as former CEO of the primary international food, drinks and consumer goods business federation ( CEOs), it is no insult to the Irish Department of Agriculture to gently point out that its expertise in global fmcg marketing is….zero!

If my comments are more strategic than “economic”, I cite the appointment yesterday by Barack Obama of Jeffrey Immelt, former CEO of General Electric to lead the renamed President’s Economic Advisory Council.

On the basis that in the US at least, they believe they are no longer in mid financial crisis but that growth is not lifting employment, Obama has fired former Fed. Chairman Volcker and named Immelt to lead the “new” “President’s Council on Jobs and Competitiveness.”

Shouldn’t we be voting for the party that proposes the immediate appointment of an equivalent Irish body, headed up by ONE, accountable, former private sector Irish ( OR non-Irish) business executive who REALLY knows something about exporting?

@ Paul Hunt

” Just as the politics is going into meltdown mode, it seems the banks are heading in the same direction”

Is it not all part of the same process that has been going on since 2007 ?
An incredibly complex financial system based around the assumption that property prices will rise forever breaks down.

@Seafoid,

Agree. The ability to sustain this characteristic Irish ability to supend disbelief has been remarkable; but, inevitably, it collapses in a trice.

@Richard Fedigan,

I don’t doubt the sincerity or validity of the case you are making, but the immediate priorities are fiscal sustainability and a functioning banking system. And these must be accompanied by a removal of the deadweight costs on the tradable sectors (I suspect this is part of the coshing Colm McCarthy has in mind). Remove these burdens and much potential will be realised. It will be time then for a thorough strategic review of industrial policy.

@John McHale
re: 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).

I hope that you are correct in your view of the delineation of solvency requirements and liquidity requirements with the State being on the hook for bank losses ‘only’.

However, I take it from Colm McCarthy’s remarks and the CB’s own borrowings that the CB and therefore the State is on the hook for all borrowings whether for solvency/ratio issues or indeed for liquidity to cover the loss of deposits.

What is the truth of this matter or has the truth been defined or established?

This issue is at the kernal of the bank support issue. Initially, I approached this from the perhaps naieve view which equates with your own statement above but as of now I am more unclear. Indeed I fear that the ECB has disowned the Irish banks and the CB is now having to provide funding for both solvency and liquidity.

I would welcome clarification on this issue.

@Paul Hunt

“It will be time then for a thorough strategic review of industrial policy”… after… “the immediate priorities of ..fiscal sustainability and a functioning banking system.

You’re right, Paul, and I’m not disputing what you say. Leaving aside quibbles about “manufacturing and “tradeables” definitions in Colm’s comment, I intuit, I hope without immodesty, that he agrees that employment generated by our “legacy” industrial strategy is just that ( a legacy, out of date, call it what you like) an employment effect that has been “over” ( he uses the term “peaked”) since 2002.

That is what is causing the understandable sustained unemployment consternation (NOT only in Ireland) but in Ireland this is translating into the emotive “emigration” wailing, at least as we in Ireland have historically seen and defined it. (Chinese, Indians, Pakistanis, Africans and Latinos, of course, see “emigration” very differently).

So, I agree that fiscal sustainability and resolving the banking crisis are priorities but please don’t lose sight of the underlying structural and strategic weaknesses that can only be addressed by a recognition that our existing “industrial strategy” is bust.

Finally, from my experience of running relatively large international enterprises, leaders MUST recognise the immediate need to put appropriate mechanisms in place early to deal with fundamental threats that are looming even while we deal with the “immediate priorities”.

If we don’t, these threats will become the next “immediate priority” FAR sooner than we would wish and could be decisive for even more generations than the current fiscal and banking threats.

Right now, perhaps understandably due to the present chaos, we’re in denial about these underlying threats.

Let me assure you (from “out here”), however, that planners of global strategic “industrial” investment are very much aware of how the leaders of Ireland Inc. face up to these threats. NOW. And smart (arse) innovation, cloud computer and R&D slogans are not going to convince them.

I’ve come to realise academic types like citations, so to quote Harvey Norman – “Once it’s gone, it’s gone”

Any prudent plans should assume that the deposits/snr debt fleeing the Irish banks isn’t coming back any time soon. ‘Overcapitalisation’ of banks will help stem the flow of deposits, but I don’t see it attracting new deposits. Attracting new funds would require some form of European guarantee and the offer of higher interest rates. This seems remote. Overcapitalisation should assist interbank lending, but over-reliance on very short term funds isn’t exactly a solution.

Fire-sales of Irish loans will be extremely expensive – way more than expected losses. Banks’ foreign loans might achieve better prices, though we’d need to figure out how much non-nama/non-securitised stuff there is. A knock-on problem of getting ‘reasonable’ discounts is that they inevitably end up selling the higher quality assets.

So, at present, I don’t see any option other than continued support. It would be helpful to get this formalised and reduce the uncertainty.

@Michael,

The annual figures I calculate, as published by NIB/FDI Intelligence, remove the retail sector from the figures (as well as other obvious stuff, e.g. mining, oil exploration etc, where choice of location of investment is not mobile). Our figures show that, per capita, we are one of the most attractive countries in the world for FDI. Further, Irish exports have outperformed the Eurozone average by a large margin over the last 2 years.

Where you are right is that employment has largely stagnated over the last decade or more, as we shift from medium-skill, more labour intensive production to higher productivity. However standard analysis would suggest you examine peak-to-peak or trough-to-trough shifts. The employment experience as of 2009 (your figures) are after the largest collapse in world trade since the depression. Concluding that we have to change our industrial policy (you aren’t in your post I know) based on this would be flawed. Data from 2008 (before the great collapse in workld trade) suggests that aggregate manu employment in virtually all other European countries are far below 1997 levels.

@ Ronnie O’Toole

It’s good to have services export growth.

However, data from for example the aircraft leasing industry can distort the picture.

Goodbody estimated in 2007 that the aircraft leasing companies based in Ireland were managing a combined fleet of 1,600 across global markets.

Nearly 500 jobs are anticipated to be created over the next three years in the aircraft leasing industry in Ireland, according to the Irish Aviation Authority (IAA). In 2010, about 1,000 people were employed in the leasing industry and the authority predicted a growth of around 45% – – that may well be the usual bs from a state agency!

Avolon, the aircraft leasing group headquartered in Dublin, today announced an additional capital raising of US$465m, bringing the total value of funds raised since it was established in May 2010, to in excess of US$2.5 billion.

@ All

It seems that we will be in big league company in the debt stakes in coming years.
The IMF said today that US public debt will exceed 110% of GDP by 2016.

@Richard

I would tell you that the export sector in a developed economy must compete in high productivity employment. This will create a lot of income, tax receipts etc, but won’t create a huge number of jobs. Thats not to say that there is anything ‘wrong’. Most employment in a modern, developed economy is domestically facing, and therefore the cure to high unemployment is the savings rate falling to more normal levels, not Ireland diving into employment intensive industries where we have no hope of outcompeting India, China etc.

@ Ronnie O’Toole

Net jobs growth in the tradeable goods/services sector in 1998-2007 was 11,000. Even in 2006, when 83,000 jobs were addded in the economy, 3,000 were added in the FDI sector.

Andy Grove, the cofounder of Intel asks what kind of a society are we going to have if it consists of highly paid people doing high-value-added work — and masses of unemployed?

http://bloom.bg/ePcsNA

Globalization is no longer low manufacturing jobs in Asia and high-paid knowlege jobs in the West.

@Richard,

Please don’t take offence. ‘The words that I spoke, shure, were only in jest.’

I would like to see one of our learned contributors kick off a separate thread on this topic. I just sense a naive optimism that we can wind the clock back to the early 2000s before we took off on the ‘Twin Bubble’ detour and pick up where we left off.

@ Paul Hunt

Absolutely no offence taken, Paul. I meant it that I’m learning from you guys.

From Ronnie’s reply ( though he didn’t need to imply I was advocating employment-intensive industries to compete with India and China!), I learned that an industrial policy may not be ‘wrong’ if it doesn’t create a “huge number of jobs” but creates lots of income, tax receipts etc. And, as I sorta knew, that most employment in an advanced economy is domestically facing.

This brings us to Andy Groves’ depiction of an Irish society of highly paid, high value workers and masses of unemployed which I, believe, could at least be partially held at bay by a radical change in the way we view “emigration” as part of, you guessed it, a new “industrial” strategy.

A bientôt, on another thread peut-être!

@ grumpy

I think we making broadly the same point.

BW2

Don’t forget that if CB Irl looked the other way and held its nose in the repos for these “othere assets” then the issued “liquidity” is a euro liability on the Irish state only – no the ECB. It is an addition to national debt.

@Brian J Goggin,

Oops, will try harder 🙂

@ grumpy

Yes it is sovereign debt albeit “asset” backed

@ seafoid

They’ve started now so they will finish. Nothing will get in the way of stopping a bank collapse. First ECB exhausts all possible repo support and this ain’t normal repo – it won’t be unwound for a very long time. Next they allow the CBI to “print” money even though that was not really the way it was meant to be. Next they will allow the government borrow from the EFSF to recapitalise the banks.

At this stage it is not just wholesale and foreign money which has taken flight. The run on the banks has spread big time to the ordinary depositor. Will 12% capital ratios entice them back?

How is software licenses classified when calculating the value of exports? Is it a separate item or grouped with other items?

Previously when working where I had to know I knew that a software license was for VAT purposes classified as a remotely provided service. I don’t know if this has changed.

The CB is simply “magic”ing these 51 billion into existence and these Euro denomiated credits are going into the banks in order to defend against an on-going run. The Irish tax payer is on the hook alright but at a rate that is likely to very favorable and over a term that is likely to be interminable.

The ECB is effectively turning a blind eye in order that it does not have to fork out. These funds will eventually find their way into the Eurozone proper and will dilute the currency. This is a form of QE through the back door. It is a cheap way for the ECB to get money into the Irish banks without upsetting the Germans in the short term.

Or maybe I am missing something here and this turns out to be the only way that our banks get readies? Wither ECB/IMF funding?

The precedent being set here is very interesting. It would be possible for a National bank owned by the State to generate issuance sufficient too restore considerable amounts of lost liquidity in the economy. Its been done in other countries in the past and even in Ireland ( wasn’t the ACC such a lender?). Since the CB seems to have the program up and running, why not do it now in Ireland. There will be no inflation problems if done correctly. The economy is instantly re-configured. Hey presto!

We need people to save as hard as they possibly can in order to restore investment funding for our entrepreneurs. We do not need ways to discourage saving. We can stimulate the economy, but not through the banking system as currently exists. This is like giving a blood transfusion to a corpse. Better that a national bank funds major projects top down. If there are healthy banks around they too can obviously participate but only after the law has been changed to outlaw fractional reserve lending. In other words the only organ that will create new money in the economy is State owned and does so without borrowing at interest.

Mokabaybob

“Maybe they will be sanitized as ColmMcCarthy says and end up expanding the money supply in the Eurozone. Keep going like this and everyone will be doing it. What then interest rates?”

Unless the ECB does the mopping up I don’t see how this doesn’t expand monetary base.

Worth remembering though – and bond vigilantes just don’t get this – that it is the private sector banks that “print” money via the fractional system. There was excessive money supply during the boom because of this. Recently it has been the banking system that has been “anti-printing” during the credit crunch. Expanding monetary base really is pushing on the proverbial string.

If you want to get words of wisdom in this country you do not listen to economists or even Irish people but Dutch with South Kerry accents.

Rebuilding Cahirciveen Power station was the topic of conversation –

There was once a thing known as the physical economy – even at a micro level multiplied many times this place could kind of work – it will never be Holland but.
The problem is that money is feeding interest , not capital development – its as simple as that.
The banks have no interest or understanding of wealth creation – they exist to feed , they do this via credit/debt creation which by definition extracts capital.
We were always under the Kosh of Banks in this bog hole but since 1987 there has only been the voice of the banks with predictable results.

The first thing we should do is create a Industrial bank and use its interest free currency to both build infrastructure and hide the fiscal debt withen its walls – the ECB can have its 3% deficit prison if we can game them.