Archive for March, 2011

Irish Times Needs Better Sources

By Karl Whelan

Thursday, March 31st, 2011

Prior to today’s announcements, the Irish Times were flagging the following:

Mr Noonan will make a “watershed” argument for a EU-wide solution around passing bank losses on to bondholders in response to the tests on Bank of Ireland, AIB, Irish Life and Permanent and EBS building society. Government colleagues last night described it as the first radical policy departure from the previous Fianna Fail-led government.

A few months ago, just prior to the announcement of the EU-IMF agreement, the Times had reported:

The source said there was a “common understanding” between delegations from the EU Commission, the European Central Bank and the IMF that senior and junior bondholders should each pay a share of the rescue costs.

Two conclusions to draw from this. First, people shouldn’t pay much attention to the Irish Times reports on these matters. Second, the Times need better sources.

Anglo 2010 Annual Report

By Karl Whelan

Thursday, March 31st, 2011

Oh, and by the way, Anglo Irish Bank released their annual report for 2010 today. Apparently, they lost €17.7 billion. Don’t worry though, it’s manageable.

ECB Press Releases

By Karl Whelan

Thursday, March 31st, 2011

No announcement today of any new ECB facility for the banks. Three different press statements however, this one and this one welcoming the announcement, and this one possibly a preparation for a more substantive movement in ECB policy.

Department of Finance Presentation

By Philip Lane

Thursday, March 31st, 2011

Some of the economic and fiscal implications of today’s announcements are covered in this presentation.

The 2013 peak in public debt is upwardly revised from 103 percent to 111 percent of GDP  (€10 billion of the €24 billion is funded from NPRF), in the scenario in which all of the extra capital comes from the State.

Central Bank Financial Measures Programme Announcement

By Karl Whelan

Thursday, March 31st, 2011

The Central Bank’s stress test announcements will be available on this webpage at 4.30.  A webcast of the press conference will be available here. The Minister for Finance’s statement is here.

London Event: “Banks, bondholders and risk- Ireland’s call”

By Philip Lane

Thursday, March 31st, 2011

INVITATION
Discussion Forum
Wednesday, 6th April 2011
6.00pm for 6.30pm start – 8.30pm

VENUE

Cass Business School
106 Bunhill Row
London, EC1Y 8TZ

Banks, bondholders and risk- Ireland’s call

Can restructuring/burden-sharing lead to growth, investment, jobs?

Debt looms over every discussion about Ireland. Is public and private debt sustainable? Is it fair? Who pays? Who decides?

The practical question comes down to how to deal with debt so that the real economy – real businesses, real jobs, real livelihoods - have the best outcome, soonest.

No course of action is easy. Timing is critical, too. There are risks in every direction. Which is the best course? What is do-able, what will work?

Business for Ireland is hosting an open discussion forum focused on these practical questions. Key speakers to lead the discussion and stimulate participation will include:

Dermot O’Leary, Goodbody Stockbrokers, author of the influential analysis ‘Irish Debt Dynamics’ February 2011
Donal Donovan, former Deputy Director at the IMF, adjunct professor at the University of Limerick, visiting lecturer at Trinity College Dublin.
Brendan Keenan, Economics Editor, Independent Newspapers, Ireland’s leading economic journalist
The event will be chaired by Margaret Doyle, Columnist, Reuters BreakingViews.

Places are limited. Please RSVP to businessforireland@sky.com

Business For Ireland is a London-based group supporting economic growth in Ireland, bringing together business leaders and opinion shapers doing business in and with Ireland to discuss the prospects for the real economy in Ireland.

A few more thoughts on the stress tests

By John McHale

Wednesday, March 30th, 2011

Following on Kevin’s post, here are a few more thoughts for possible discussion in advance of the stress test results.

1.   I think the criticism of the insufficiently adverse assumptions for 2010 has been overdone.   While it does raise questions about our ability to forecast the future when we have such a hard time estimating the past, getting 2010 wrong really shouldn’t matter.   If BlackRock are taking as hard a look at the balance sheets as we are led to believe, current conditions should already be incorporated in the loan loss estimates.  The value of the baseline and adverse scenarios is in understanding how things might evolve from here.   In other words, it is the delta from 2010 that matters.

2.  A related criticism is that the ESRI/TSB house price index is underestimating the true decline in house prices (the index has house prices down by 38 percent from peak by Q4 of 2010).    But again the current state of the housing market should be reflected in the current state of the loan book.   If house prices are really down 50 to 60 percent, then the declines under the adverse — or even the baseline — scenario truly get us into Morgan country.

3.   There appears to be a “my (preferred) stress tests are more stressful than yours” attitude to the choice of the adverse scenario in the stress-testing exercise.   But I think this sometimes reflects a misplaced view of the purpose of the adverse scenario.   In addition to seeing what bank losses would be under an adverse (but somewhat arbitrary) scenario, the adverse scenario plays an important role in triggering recapitalisation.   In the current exercise, my understanding is that recapitalisation will be triggered if the Core Tier 1 falls below 10.5 percent (please do correct me if this is not correct as the documentation is not that clear).  Thus the toughness of the test must be judged by looking at the combination of the adverse scenario and the target ratio under that scenario.   A 10.5 percent target is an extremely tough target by any measure.    Under the last round of tests, the baseline target was 8 percent and the stress (adverse) scenario was 4 percent.   The former has been raised by 4 percentage points to 12 percent; the latter has been raised by 6.5 percentage points to 10.5 percent.   

It is noteworthy that IL&P was the only one of the tested banks to fall foul of the 4 percent stress scenario last time round (see here).   It is not really surprising that they are in deep trouble with a stressed target of 10.5 percent.   This sensitivity to the stress scenario must reflect the importance of mortgages (and in particular buy-to-let mortgages) on the balance sheet of IL&P, and also the large additional assumed declines in house prices under this scenario. 

The Sentinel

By Philip Lane

Wednesday, March 30th, 2011

Ross Levine advocates the creation of an independent agency (’The Sentinel’) to monitor the conduct of financial regulation in this paper.

The Risk Map

By Philip Lane

Wednesday, March 30th, 2011

The assessment of portfolio risk is on everyone’s mind at the moment.

In timely fashion, UCD host a seminar tomorrow on this topic.   The details are below:

The next seminar hosted by the Centre for Financial Markets (CFM) will take place tomorow, March 31 between 2-3.15pm at the Smurfit School of Business, Carysfort Avenue, UCD. The venue for the paper is Room C302.

The paper is to be given by Christophe Perignon (HEC) (www.hec.fr/perignon):
The Risk Map: A new Tool for Backtesting Value-at-Risk Models

Details of the seminar series and the paper are available here.

Live register figures

By Kevin O’Rourke

Wednesday, March 30th, 2011

The Live Register figures for March are out.

The standardised unemployment rate in March was 14.7%, unchanged from February. This compares with the latest seasonally adjusted unemployment rate of 14.7% from the Quarterly National Household Survey in the fourth quarter of 2010, and an annual average of 13.6% for 2010.

By way of comparison, the baseline forecast for 2011 unemployment in the Central Bank’s PCAR macroeconomic scenario is 13.4%. In the adverse scenario, this rises to 14.9%. We are almost there, and it is only March.

At least the Central Bank scenarios got the 2010 unemployment numbers right! This contrasts with their 2010 GDP numbers, as Dan O’Brien pointed out earlier in the week.

(And I admit that I am baffled by an adverse house price scenario that is not robust to the ‘What if Morgan Kelly is right?’ objection.)

Financial Defeasance Structures

By Philip Lane

Wednesday, March 30th, 2011

This morning’s WSJ notes that Portugal’s 2010 fiscal deficit will likely be revised upwards due to a shift in Eurostat’s rules concerning the accounting treatment of problematic assets. The March 16 Eurostat guidance note is here.

The Grand Bargain

By John McHale

Tuesday, March 29th, 2011

Having been a bit tough on the FT yesterday morning, I would like to echo commenter DOMC in drawing attention to a very good article by David Oakley (see here; related piece here).   While our attention has naturally been on the Ireland-specific aspects of negotiations over the crisis-resolution mechanisms, the Grand Bargain on the ESM is probably far more significant for our creditworthiness.  

David Oakley notes that market conditions are improving for Italy and Spain.   This is consistent with the idea of a self-fulfilling equilibrium: if you look like your will need a bailout no one wants to lend to you (and get caught up in a later “bail-in”), and so you end up losing market access and forced into a bailout.   This is what seems to be happening to Portugal at the moment; Italy and Spain have been able to stay out of the critical region – at least for now.   A problem for Ireland is that improving your fundamentals looks less effective once already in the bailout mechanisms.   Can it make sense to have this “black hole” (potentially) spreading from the periphery?   Hardly a Grand Bargain.

Speculation on New ECB Lending Programme

By Karl Whelan

Tuesday, March 29th, 2011

There has been a lot of focus in the past few days on stories based on leaks of Thursday’s stress tests results. Perhaps more important, however, is the question of what the plans are for the €150 billion in central bank funding that the Irish banks are currently receiving.

Two interest stories here and here suggest there is lot to be negotiated on this issue. While less visible than the question of the interest rate on Ireland’s EU loans to the sovereign, the questions of how long the Irish banks will have to pay back these loans, and at what interest rate, are perhaps more important.

Were global imbalances a once off adjustment, and will they now come to an end?

By Kevin O’Rourke

Tuesday, March 29th, 2011

These are some of the issues raised in this provocative piece by Pradhan and Taylor.

Lex — Ireland: sharing the debt burden

By John McHale

Tuesday, March 29th, 2011

The FT’s Lex renews its call for bondholder burden sharing in today’s column (see here).   I know many readers are fans of the FT’s stance on dealing with the Irish banks.   A consistent feature of this stance, however, has been to throw out strong recommendations for burden sharing, but with little discussion of the practical challenges involved.   Today, the suggestion is to put losses partly on unguaranteed but secured senior bondholders; and, true to form, there is no discussion of the practicalities of imposing losses on the subset of banks that will be well-capitalised after the stress tests.   I know space is tight, but I think we have reason to expect better from the FT.   The closing couple of paragraphs:

Some €21bn of that total consists of senior bonds issued and guaranteed since January 2010, and, therefore, probably untouchable. Another €7bn is subordinated debt on which holders are already taking a haircut. The rest is senior bonds, of which €16.4bn are unguaranteed and unsecured, and €19bn are unguaranteed but are secured on bank assets.

It is here that burden sharing should be concentrated, and the government needs to start the bidding as high as possible. Only if both classes of unguaranteed bonds, amounting to 23 per cent of GDP, are included can the resulting savings make a real difference to Ireland’s otherwise ballooning debt/GDP ratio, which could hit 120 per cent without burden sharing. Thursday’s stress test results on Irish banks will indicate how much extra capital they need. The taxpayer’s contribution must be as little as possible. Irish senior bank bonds trade at prices that discount some burden sharing. The case for it is compelling.

Jeff Sachs: Stop this Race to the Bottom on Corporate Tax

By John McHale

Tuesday, March 29th, 2011

Jeff Sachs weighs in on the corporate tax rate question in a Financial Times op-ed.

A four-part banking support plan

By John McHale

Saturday, March 26th, 2011

Arthur Beesley provides a helpful report on the government’s emerging four-part support request for the banking system (see article here; related front-page article here).   I think the plan is based on a broadly correct diagnosis of the challenge of restoring the creditworthiness of both the banks and the State; it is also realistic in not demanding policies that involve large expected net transfers.

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Some thoughts on the QNA release

By John McHale

Saturday, March 26th, 2011

With all that was going on in Brussels, the fourth-quarter QNA release got less attention than might have been expected.  As usual, the numbers don’t all point in one direction.  And also as usual, the quarterly numbers must be treated with caution given their volatility and propensity for revision. 

The annual declines in real GDP (1 percent) and real GNP (2.1 percent) received the most coverage.   But the annual numbers can give a misleading picture when the economy is at a turning point.   A better measure is the percentage change over the same quarter of the previous year.   I linked to these graphs on the thread following the release.   The noticeable turnaround in real GNP is encouraging (up 2.7 percent on quarter four of 2009); less encouraging is the 0.6 percent decline in real GDP, with the overall performance dragged down by a poor final quarter.    

The final graph in the set shows again the “two economies” reality of recent Irish growth performance.   The only thing that I would add is that the underlying potential growth of the economy is a critical factor for our capacity to pull out of the debt crisis without default.   Recognising the likely impact of the austerity measures on domestic demand, I think the picture is consistent with the (ESRI) view of solid underlying export-driven growth potential.

The main bad news in the release relates to the performance of nominal GDP.    The Budget 2011 forecast for nominal GDP in 2010 was €157.3 billion.   The actual nominal GDP turned out to be €153.9 billion – a 2.1 percent shortfall over the budget day forecast.   Readers might recall that the €157.3 billion was itself the result of an earlier downward revision (see Philip Lane’s explanation here).  

If that nominal shortfall carried over to 2014, the deficit would have to be reduced by an additional €94.1 million to meet the 2.8 percent of GDP deficit target for that year.   This back-of-the-envelope calculation ignores the impact of any additional deficit reduction on GDP.   Of course, there are even more severe implications if we are required to hit the higher intermediate targets along the way (for these targets see Table 6, p. D19 here; see p. D9 for the Budget 2011 nominal GDP projections).   For example, an extra €316 million would have to be taken off the deficit to meet the 9.4 percent deficit target for 2011.  It should be noted, however, that the poor performance for nominal GDP mainly reflects an eyebrow-raising quarter-on-quarter drop in the final quarter (down 6.6 percent, seasonally adjusted), and could be even more than usually subject to revision. 

Why bother investing in Ireland?

By Michael Moore

Friday, March 25th, 2011

I have been disappointed but not surprised by the lack of comment on Edgar Morgenroth’s  blog about the threat to introduce a low rate of corporation tax in Northern Ireland.

We are all well used to IDA shibboleths about the Republic of Ireland’s advantages other than the low Corporate Tax rate.  We are told about the modern infrastructure, the well educated labour force (sic), EU membership and the fact that the Republic of Ireland is English- speaking.  Northern Ireland has all of these as well as a dramatically lower cost base: we’ve even stopped killing each other in large numbers. 

The UK already has generous R&D incentives and intellectual property incentives are already trumped by other European countries such as the Netherlands. The Republic’s only remaining advantages may be its sovereign ability to skate close to the wind of tax haven status: relaxed rules on transfer pricing, absence of controlled foreign company laws, limited rules on thin capitalisation and its skill at negotiating double tax treaties.

Is that all the Republic has?  Surely, I’ve missed something!

Upcoming Investment Opportunity

By Karl Whelan

Friday, March 25th, 2011

I had missed this yesterday but it’s worth flagging for our readers in search of an investment bargain.

PENSION funds will be able to buy 30-year bonds at an interest rate of around 5pc, in a move that could ease funding difficulties for schemes. To be known as sovereign annuities, the new bonds may also lessen the liabilities in pension funds … Buying the likes of “safe” German 10-year bonds yields only 3pc, which does little to ease the funding difficulties in pensions … Director of funding at the National Treasury Management Agency Oliver Whelan told a conference yesterday there will also be an inflation-linked version of these bonds … Mr Whelan insisted that there was no default risk for pension funds buying Irish sovereign bonds, despite repeated questions from a number of trustees about such a risk … Mr Whelan insisted that no western country had defaulted since West Germany in 1948.

In a related development, Irish pension funds are soon to be offered shares in a well-known New York bridge. Apparently, it’s a tremendous investment opportunity.

NI Corporation Tax

By Edgar Morgenroth

Thursday, March 24th, 2011

The UK Budget was published yesterday. One of the noteworthy changes announced as part of this is a reduction in corporation tax:

“a reduction in the main rate of corporation tax by a further one per cent. From April 2011, the rate will be reduced to 26 per cent with further yearly reductions of one per cent until 2014 when it will reach 23 per cent”.

In addition the UK Treasury has published a consultation document entitled Rebalancing the Northern Ireland Economy, which specifically considers the potential for, and costs and benefits of devolving the power to vary the corporate tax rate in Northern Ireland, potentially reducing the rate in Northern Ireland to the 12.5% that applies in the republic of Ireland.

In the context of the pressure from France and Germany for the Republic of Ireland to raise its corporation tax rate, both the reduction in corporation tax rates in the UK and the potential harmonisation of the corporation tax rate to 12.5% on the island of Ireland are an interesting development.

Latest GDP/BOP data

By Philip Lane

Thursday, March 24th, 2011

The GDP release is here.

The BOP release is here.

2010 Q4 GDP

By Philip Lane

Wednesday, March 23rd, 2011

The CSO will release the initial estimate of 2010 Q4 GDP tomorrow at 11am.  The last quarter of 2010 saw the arrival of the troika, plus bad weather in December.  Any guesses for the numbers?

ESM Details

By Karl Whelan

Wednesday, March 23rd, 2011

Details of the proposed structure of the new European Stabilisation Mechanism can be found in various parts of the World Wide Web thingy, e.g. here and here.

Two things jump out to me. First, the agreed margin on a 7.5 year fixed rate loan from the EFM would be 260 basis points, about 60 points lower than the current rates on offer from the EFSF. Perhaps someone will insert a clause making the margin dependent on a country’s corporate tax rate but somehow I doubt it.

Second, despite a lot of previous focus on the idea that only bonds issued after 2013 would be eligible for restructuring, the proposal does not contain such a commitment. As expected, there is a commitment that government bonds with a maturity greater than one year issued after the introduction of the ESM will have to have collective action clauses facilitating restructuring. But rather than adopt a position that existing bonds cannot be haircut, the proposal seems to essentially take the opposite strategy. A country that fails a “sustainability analysis”

will be required to to engage in active negotiations in good faith with its creditors to secure their direct involvement in restoring debt sustainability. The granting of the financial assistance will be contingent on the Member State having a credible plan and demonstrating sufficient commitment to ensure adequate and proportionate private sector involvement.

I’m all in favour of this, having argued at various times (e.g. here and here) that a proposal to only haircut bonds issued after the introduction of ESM was unworkable. However, this does help to explain the market jitters of the past few days. The Irish two-year bond yield was up another 40 points or so today and stands at 10.25% as I write, having reached as high as 10.7% earlier today.

IIEA Blog Post: No Deal Is Better than the Wrong Deal

By Karl Whelan

Wednesday, March 23rd, 2011

Over at the IIEA blog, I have written a new post arguing that it would be better for Ireland and for Europe to have no deal on the interest rates on the EU loans to Ireland than to have a deal that linked an interest rate change to adjusting Ireland’s corporate tax rate.

The European Banking Problem

By Philip Lane

Wednesday, March 23rd, 2011

This WSJ article by Kashyap, Schoenholtz and Shin provides a good summary of the  situation.

The Black Hole Grows

By John McHale

Tuesday, March 22nd, 2011

It has been apparent for some time that proposed design of the post-2013 ESM — notably preferred official creditor status and arrangements for creditor bail-ins — is undermining peripheral country creditworthiness. The so-called bailout mechanisms have the rather grotesque feature that they can suck a country in once it begins to show enough vulnerability.  

At the moment, markets do not want to lend to Portugal in large part because markets expect Portugal will enter the bailout mechanisms, increasing the risk they will be caught up as junior creditors in later accelerated bail-ins.  This could end up happening well before 2013; hence the surge in our 2-year yields. These fears are likely to be self-fulfilling, despite the resistance of the Portuguese government (no doubt informed by watching what happened to Ireland).  As we are learning more by the day, once in, it is damn hard to get out.   Peripheral yields have shot up every time the ESM became that bit more certain (latest news on the agreement here).   With the evidence so clear, it is hard to understand how European leaders persist with a solution that could end up destroying the Eurozone.   The interest rate issue appears a sideshow by comparison.

The FT has a couple of good articles that nicely capture that damage being done to our and others’ creditworthiness (see here and here).  A flavour:

Investors warned they could boycott peripheral eurozone bond markets as reform of the region’s bail-out fund sparked fears of a sovereign default in Europe.

Irish three-year bond yields leapt close to a full percentage point at one point on Tuesday, while the cost of borrowing for Portugal and Greece also shot up on worries that one of these countries would have to restructure their bonds.

European finance ministers finally drew up plans to make investors share the burden of potential sovereign defaults beyond the summer of 2013 in a deal hammered out on Monday night. Concerns centre on the preferred creditor status given to European Stability Mechanism, the permanent eurozone rescue fund, which takes up the reins from the temporary fund, in the middle of 2013.

Investors warn that this will mean they will be the last in the queue for the recovery of money in the event of a default. One fund manager said: “We will definitely not buy peripheral bonds now, not with the uncertainty this has created.”

Tamara Burnell, head of sovereign and financials analysis, M&G Investments, said: “This agreement will not do anything further to encourage investors to buy peripheral bonds.

Frank Daly on Residential House Prices

By Karl Whelan

Tuesday, March 22nd, 2011

The complications caused by the absence of a properly representative national house price index have been illustrated again via a speech given by NAMA’s Chairman Frank Daly (see NAMAWinelake here). Frank discusses NAMA’s assessment of the residential sector as follows:

On the residential sector the Central Bank is forecasting falls of 60% from peak (end 2006) to end 2012 under its adverse scenario or 55% under its baseline scenario - based we understand on the PTSB\ESRI index. At NAMA we are not surprised by this and it is not as alarming as one would first think. We do not believe that the PTSB\ESRI index currently showing close to 40% fall from peak is realistic and reflective of where the market is. NAMA’s base valuation date was November 2009 and at this date we were already taking account of on average 50% falls in residential property values from the peak.

So while the residential market may have some little more to fall and no one can be certain that an average fall of 60% from peak may not occur in residential house prices, we would believe that the bulk of this has happened already.

Based on my own anecdotal sample, I’m inclined to agree with Daly that residential prices have fallen more than shown by the PTSB\ESRI index. However, the implications for the Central Bank stress testing exercise strike me as a little more serious than Daly suggests. Daly indicates that most of the peak-to-trough decline envisaged in the Central Bank stress scenarios has already happened.

But this raises the question as to whether the stress scenarios should be based on a peak-to-trough calculations or should they be based on an assumption about a current level of prices and an additional assumption about further declines. It’s not clear why the scenarios should be based on a peak-to-trough assumption. And if, for example, the valuation of residential mortgage portfolios is based on an inaccurate assessment of current levels of house prices, then this may undermine the credibility of the calculations. I would hope that the report accompanying the stress test results would discuss this issue.

Brookings Papers are now freely available for all

By Kevin O’Rourke

Tuesday, March 22nd, 2011

The Brookings Papers on Economic Activity are now freely available on the web. This is a really terrific resource which I hope will be of interest to lots of our readers. For example, you can read what some of the top economists in the world were saying at the time about the Latin American debt crisis of the 1980s, the EMS crisis of 1992/3, and the East Asian crisis of the late 1990s, to name just three examples.

Inversion: Two-Year Bond Rate Moves Above Ten-Year

By Karl Whelan

Tuesday, March 22nd, 2011

As I write, the two-year Irish bond yield has risen from 9.3% to above 10% and is now higher than the ten-year bond yield. I suspect this may be a reaction to yesterday’s meeting of Euro area finance ministers and the prospect that Ireland will not get a reduction in its interest rate. But I’d be interested in hearing if people can point to other reasons.