A few more thoughts on the stress tests

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. 

89 replies on “A few more thoughts on the stress tests”

Carol Fallon had the following to say in the Sunday Business Post of 28 March.

“The dissolution of the 30th Dail was undoubtedly a welcome political development for the nation but it comes at an additional cost to would-be home buyers. The fire-fighting by both leaders and opposition, particularly since November 2010, led to the Minister for Justice and Law Reform failing to introduce an amendment to the Property Services Bill to establish a National House Price Register. This failure flies in the face of assurances given to lobbying bodies across all sectors of property industry and frustrates the already cautious market, arguably setting it back further.

In an eleventh hour attempt to stimulate the property market the stamp duty regime was reformed in The Finance Bill 2011, widening the net so that all buyers are now liable, but reducing the rates so that moving is no longer cost prohibitive. While this is a welcome development for those trading up or with cash to invest, it could be argued that this reform might well have been more effective as a stimulus initiative in 2012 or 2013. This is supported by exchequer returns this week showing an increase in stamp duty of 38 per cent in 2010 over the previous year. The market would have been better served by creating the National Property Price Register as a priority and announcing a lead in time for the stamp duty changes. This would have had a more pronounced effect on the market as it would have motivated first-time buyers who were sitting on the fence to make a decision, and it would have allowed that decision to be an informed one. It would also have made sense in terms of access to available credit and dealing with current stock levels around the country as first-time buyers are still the borrowers of choice and buy the so-called ‘starter home’ of the past, freeing up the next wave of buyers, those trading up, in time for 2012 when stamp duty reform would have been effective.
Instead, we are left with a system of property valuation that is laughingly referred to as an art form rather than a science by even the most experienced valuation professionals. This is simply not good enough for buyers”.

Swimming around in a sea of unreliable statistics cannot disguise the reality. There is no reliable guide to house prices in Ireland because those involved do not wish to see such a reliable guide come into existence. Until this mindset is changed, nothing will change.

Being an assiduous follower of daft.ie, I can confirm that, in a particular area in Kerry in which I am interested, there are no houses for sale because the same houses have been on the site for the past three years. Were they genuinely for sale, sellers would have been willing to negotiate. Either there are no buyers whatsoever (the most likely probability) or the owners do not wish to sell.

It is really time to wake up and smell the coffee.

I fail to see what these tests will achieve. I presume the logic is to write down the loan books by a big number and then buttress the equity account with so much extra cash that both depositors and term funding will have confidence that they are not going to suffer loss so that they will provide funding at much more attractive rates.

I cannot see that working. The franchise value of the banks has now been destroyed such that depositors are not coming back any time soon. Moreover, the equity capital is is going onto to the Sovereign’s tab to the point where the debt burden is borderline unservicable-so long term rates will not come down. In addition, with haircuts and bail ins still on the table senior funding will not come back.

So we weillbe left with an extra 20bn on the national debt, no additional market funding and an increassing reliance on the ECB. Markets will also be waiting for the last shoe to drop whic will be the depletion of the equity in the banks associated with deleveraging.

Bloomberg is reporting that ILP needs ‘more than’ 3bn in capital, according to ‘persons familiar with the matter’. That is Bloomberg-speak for a formal briefing from official sources.

You and i have gently crossed swords over what I see as, well, exercises in counting angels dancing on the head of a pin. I’ve tried to make the point that the hole is the hole and it is so big that someone has to write a cheque or we will defualt over simple incapacity to pay.

Imagine one creditor (ECB) and one debtor (us). We have a hole so big that we can’t pay – not that we won’t pay, we simply cannot. The ECB therefore has a bad debt. That is the situation, in my view, today.

The ECB would not pass its own stress test.

So, either Angela wites a cheque to us, so the ECB gets its money back. or she writes it to the ECB, to recapitalise them after we default. Either way, she writes a cheque. It then is a political choice over the reeceiver of Angela’s largesse.

I hope I am wrong. Believe me, I have lots of vested interests in being wrong, none in being right.

If ILP needs ‘more than 3bn’ (we began the week with swoons over rumours of 600m) what’s the read-across? How big is the aggregate hole?

In Cliff Taylor’s memorable metaphor, this is like looking at a spreading ink stain – where does it stop?

We have gone from denial of a problem to the other end of the spectrum where we admit we have a proble and put a really big number out there. This usually involves opening a spreadsheet, assuming really big declines in asset pricies and then outlandish & unverifiable assumptions about probability of default. In all of this one should pay an enormous amount of money to an external consultant (again) to do the work that any inter cert economics student could do.

I adovate a Tribunal under a HC judge to put a seal on matters.


Not always so gently; but always appreciate your candor.

I would just add one thing: I would expect that a significant chunk of the additional required capital will be to bring the CT1 up to 10.5 percent under the adverse scenario. IL&P has roughly €16 billion in RWA, so each percentage point increase in CT1 requires an additional €160 million.

This raises a more general point: We should be careful to distinguish additional expected losses under baseline with additional capital required to hit the new binding capital standard, which is very likely to be the 10.5 under the adverse.


Not sure I understand what you are asking.

But the overall exercise should achieve two things, both valuable in my view: (i) a substantial reduction in the range of uncertainty about the size of the bank losses; and (ii) very well capitalised banks. It is unfortunate that the latter is necessary, but clearly it is if the banks are to have any chance of regaining creditworthiness. I do understand that you see all this as so much wheel spinning if you — like simpleton — have already accepted the worst.

@John McHale
“But again the current state of the housing market should be reflected in the current state of the loan book.”
Eh, right. You do know how many loans PTSB gave out last year? And for how much? And what proportion of the mortgage market they now constitute?
(I’ll give you a clue – they are a rounding error in all categories).

If that is not what you mean, I am confused as to how price information can be gleaned from existing debt information?

The whole raison d’être of both domestic policy and IMF/EU policy was to generate growth to be able to service the existing and increasing public debt and to prevent a collapse in asset prices from holing the balance sheets of the commercial banks whilst at the same time imposing one of the greatest austerity packages on personal disposable incomes. Until that circle is squared (it didn’t work in 1926 USA) you may as well stress anything you like.


I can see I overstated it, but my point is that knowing the current value of house prices is not so important in gleaning the current state of the loan book. At least under the Irish non-recourse system, metrics such as arrears, etc. are more informative. The value of the scenarios is to see how things could evolve from here, with the income/employment-related variables probably more important than the house price variable.

“outlandish & unverifiable assumptions about probability of default”
Well, no.

That they are looking at using UK and US default and loss figures suggests that they are looking at something like UK or US style personal bankruptcy. If so, figures are available.

In any case, a standard high-end loss rate on residential mortgages when a bursting bubble is accompanied by a financial crisis is about 12% IIRC (with 5% being a normal bubble burst loss rate, can’t remember where I read it. Some of it here http://www.bankofengland.co.uk/publications/fsr/2003/fsr15art6.pdf More on the rest of the BoE site. Note that a blanket guarantee significantly worsens the outcomes…).

Apologies if the sword crossing has been on the robust side. This is no place for lack of courtesy; there is enough of that out there.
I am intrigued by your use of the word ‘acceptance’. The Kubler-Ross five stages of grief (denial, anger, negotiation, depression, acceptance) ends in preciously that state. Her definition of mental ill-health focussed on getting stuck at a prior stage or, in the case of psychosis, looping around from, say, denial to anger and back to anger, in a vicious circle.

I am most definitely not ponting the finger at you here but at the banks: if they had behaved properly, they would have moved on from denial and we would all be in a better place, one of acceptance. If they had fessed up earlier we would be accepting a better situation than the one we are about to enter. The authorities have deferred to the bankers who have probably have believed the rubbish they have been telling everyone. Looks like this phase of denial/negotiation/denial is about to end.

@ John McHale

Sorry if I’m being dim, but a question for you.

You kindly posted the Central Bank’s criteria for the tests, and I link again here:


These suggest a % fall in property prices, baseline and adverse. I understand your point about absolute prices not being the be all and end all, but I still don’t get what these % falls are based on. From what to what? Is the CB using the ESRI/TSB house price index or some other source of information?

@John McHale
“my point is that knowing the current value of house prices is not so important in gleaning the current state of the loan book. At least under the Irish non-recourse system, metrics such as arrears, etc. are more informative.”
Ah, I see. See my response to Tull above – this is, I believe, what is driving the use of the particular loss metrics. As it is a small market, while they take averages from the UK and the US, they really do need to leave overcapitalised banks – there is a danger that the country as a whole could end up like Detroit.

@ Simpleton

‘We have a hole so big that we can’t pay – not that we won’t pay, we simply cannot. The ECB therefore has a bad debt. That is the situation, in my view, today’

That is clearly not Jurgen Stark’s view, or the view which @ Ciaran O’Hagan tends to reflect, if I understand his posts correctly. The troika reserves the absolute right to impose on us whatever terms are required to recover as much as possible of that debt.

a) Liquidation of state and bank assets is expected, as well as
b) alterations in i) tax ii) spend iii) mortgage rates

The ‘core’, as creditor, does not care too much, I suspect, which combination of a),b) i) or ii)or iv) are employed as long as the funds are extracted somehow from Ireland.

The ulitmate fate of our nation and its people is probably of little concern. If that really is the direction European politics is headed, it is a retrograde one, but we need to adapt and survive until a more enlightened view takes hold.

On the above logic, the debt collection process will be slowed only in circumstances where the political or other costs are seen to outweigh the benefits. There a variety of peaceful and democratic ways to achieve such a ‘holding’ objective. It would be useful for the MoF to verify, as a preliminary, that Herr Stark is not simply winding us all up.

@Paul Q
You raise good points, exposing the subtleties of what happens next. I suspect that Stark & Co are far more probablistic than i am, although pointing in the same direction: they would probably agree that the probability of default is high, but not 1. There is also the extent of the default. In their world, which does not embrace doing us any favours (too many bridges burnt over too many years), they need to get as much debt recovey done in case default probabaility moves to one, and the need to minimise the scale of any default. They don’t seem to have figured out that the more they screw us now, the more likely that probability does hit one. And increases the size of the bust.

A lot of other blogs are saying that BOI will be nationalised tomorrow, as a result of the stress tests.

What do ye reckon ?!?


The whole system will be effectively state controlled by tomorrow night. We will have the highest capital ratios in the world therafter but there will still be deposit outflows and lack of access to term funding. Who would want to be exposed to a banking system which in an economy facing continued contraction, rising debt burdens and quixotic regulation.

BoI should have been majority owned by the state with the last recapitalisation (I reckon about 70% based on the share price at the time). That it wasn’t was, IMO, corrupt. Will we see more corruption? Well, what do you guess?

@ simpleton

‘The authorities have deferred to the bankers who have probably have believed the rubbish they have been telling everyone’

+ 1 Addicts are truly the most convincing liars. They genuinely believe their own BS. Were Irish bankers so utterly different from bankers everywhere else ? I notice there is a B in ECB.

Spot on. I could never understand that deal. It was not in the best interests of the State or the unfortunate shareholders who were induced to buy at a supposedly knockdown price (55c). Not sure about corrupt but definitely incompetent.


In an eleventh hour attempt to stimulate the property market the stamp duty regime was reformed in The Finance Bill 2011, widening the net so that all buyers are now liable, but reducing the rates so that moving is no longer cost prohibitive.

The reduction in stamp duty of approx 8% was a straightforward attempt to put a floor under the falling property values and by extension under further bank losses. It also would have had the ‘welcome’ ? side effect of saving the remains of the property owning class.

It failed absolutely on all counts.

@ simpleton

We owe the ECB a lotta dosh. It is secured on assets, some very good but most of those assets are dependent on the Irish economy. When you say we won’t pay because we can’t pay you are in effect saying the assets are dud i.e. the Irish Economy, even after having been written down, is doomed.

Note then that your point is not really about the debt (you say we won’t pay it, so it is irrelevant), your point is that we will soon have no economy.

You might be right.

Is ignorance of our position (bent over the table with a stick between our teeth) a possibility? I doubt it. Do ‘they’ care? Yes, but about themselves (politically speaking). So, what is our option?

We default on all bank guarantees. This will bring the required ‘restructuring’ to the entire euro banking area – and most likely beyond. Its not like dropping a stone into a pond and watching the ripples expand out. Its like hurling a huge log – you get a pretty big wave. In effect, we achieve with prejudice what financial folk opposed, politicians dismissed, but the citizens (taxpayers) needed for their protection and economic wellbeing.

Its (money) only virtual stuff anyway, you can fiat-up all you need anytime you need it, just don’t allow it to go into bubble stuff. The proposed increase in ECB interest rate may have more to do with oil prices (paid for with dollar), not increases in consumer prices which are (mostly) directly related to oil price changes. We’ll see.

Res property prices? Please go to 1990 – 1994 era.


@cet. par.

I could never understand that deal.

I think it’s readily understood (though not easily justified) if you put it in context. Any Western country would want to avoid the embarrassment of seeing its banking sector fully nationalised. Worse, in this country the dream of BoI and AIB as national champions – privately-owned by Our Own but government-protected and set to conquer the world – dies hard.

All this is down to a high-level political decision that will be made in the corridors of power in Brussels, Frankfurt, Paris and Berlin as to how much liability for cleaning up the Irish bank blow-out may be imposed on the Irish Government, economy and people – and how much will have to be shared in some form. Within broad ranges the numbers don’t really matter as they will have been tweaked to provide cover for whatever political decision will be made.

It seems to me that that dream came from the much-revered Whitaker/Lemass “golden age” just as much as the push for FDI did, and it was just as much of a sacred cow to the Irish policy/political/business establishment as FDI was too, no matter that no-one felt the need to openly recommend it to the voters. (I’m not aware of any reason to think that Whitaker was responsible for the banking policy, but that’s certainly not the case for other sages of the era – check out the biography of Paddy Lynch.)
Good riddance to it! Of course the last efforts to keep at least BoI private sector were pretty obviously futile, but the Irish authorities consistently been a day late and a few dollars short when it comes to the banking crisis. I think that one of the most significant things in the Ireland First document was the call for BoI and AIB to be sold to foreign investors – not because no-one had thought of the idea before, but because it indicates that Dermot Desmond and other members of the Irish business world have now come around to it.


At the very least, one hopes that the outcomes of this round of stress tests will place the upcoming vichy_bank/sovereign default on a more understandable footing. It is EZ policy to postpone this event to 2013, by which time it is hoped that the BIGBIG Black Hole in EZ Banking Kore will have been filled in somehow: peripheral collateral damage has been deemed to be acceptable in the Kore; imho, this is a flawed policy for the EZ Kore – and devastating for the periphery – and potentially fatal for the Euro and the European Project.

@Jurgen Stark
Unlike your colleague Lorenzo, whose logic is far too profound for fools such as the Irish to understand, it is a pleasure to witness your understanding of heterogeneity in the EZone. I agree on the sterling work that you and your colleagues have achieved in fulfilling your mandate on keeping a close eye on galloperin_inflation. Well done.

I understand that your mandate does not explicitly include reference to monitoring dodgy-dodgy capital flows – source of Irish and EZcore banking system problems – but with your know-how on the heterogeneous nature of EMU across the EZ it is somewhat surprising that you advocate halting the basic laws of capitalism and placing private debt on the shoulders of mere citizens. Eyes off the ball …. I won’t mention the relevance of Kant’s categorical imperative here, or Apel’s or Habermas’ more refined approach to the mutuality of discourse ethics …. but

As you know, outcomes of stress tests are to be outlined today in Ireland; like being knocked out by Heidegger’s hammer, and not only in Dublin, but in Frankfurt as well. From a glance at these, it appears that the ECB exposure to Ireland, for which we are grateful, makes it impossible for the ECB itself, as pointed out by commenter ‘simpleton’ above, to pass such a stress test itself as suspending the laws of capitalism makes it inevitable that Ireland will default – and ECB is now major creditor.

We need to discuss, at your convenience, a mutual resolution to this situation which demands write off or substantial capital injection or other pragmatic solution that may emerge. As your compatriot, Max Weber, once put it: ‘one messes with the basic laws of capitalism at one’s peril’. But I’m sure you and Axel are more than familiar with Max.

@Paul Hunt

Within broad ranges the numbers don’t really matter as they will have been tweaked to provide cover for whatever political decision will be made.

Assuming (not unreasonably) that this is true, what will happen if and when the Irish numbers are found out again? Who will receive the blame for choosing the numbers which (we are assuming) the EU demanded should be chosen? We’ve seen how this one works a few times by now.

This is the 5th attempt to stabilise the banks. It is hardly likely to be the last.

The process keeps moving on and the measures taken are always behind the action on the ground.

Frau Merkel’s goose is cooked. Her CDU/CSU lost Baden Württemberg for the first time in 2 generations. For the first time ever the Greens are going to lead a coalition in BW.

I was in Munich yesterday. The ZDF channel news showed how much Chernobyl cost( €160bn) and how much a nuclear disaster in Germany (€5 tn) would cost. Spiegel says Nuclear energy is “unelectable”.
How about Noonan speaking to the German people in nuclear terms? The financial radioactivity from the banks is worse than Chernobyl. Or else Ireland needs to get the economy growing again so we can move to renewable energy.


I’ve mentioned this previously. I see a clear line being drawn between the smaller peripherals (Ireland, Greece and Portugal – its entry into the treatment room is a given once the current political difficulties will have been finessed) and the vulnerable core and extended core players (Spain, Italy and Belgium). I think the Irish numbers will be tweaked to make sure they come in under the bank contingency financing (€35 bn ?) in the EU/IMF package. And we’re getting hints that this seems to be the case.

Given that the enormous ECB/ICB liquidity support has been built up to compensate for the redemption of senior bonds as they fell due and for whoesale market deposit flight, the big challenge now, under the usual flummery of the EU’s existing laws, rules and procedures, is to craft some mechanisms to unwind, re-assign, reallocate, whatever this liquidity support. And this will require some sharing of risk by our EU partners with some implicit fiscal support and implications.

The main task of avoiding the burning of senior bank bondholders (and preventing the resulting contagion) has been largely achieved. The next task is to conceal whatever burden-sharing is required from core EZ voters (don’t frighten the horses). But some burden-sharing will be required as the small peripherals won’t be able to shoulder the entire burden on their own. But the view in the core now seems to be that it is necessary, possible and manageable to keep them in the treatment room for an extended period without damaging the rest of the EZ.

À la recherche du temps perdu

The Irish Times – Wednesday, May 12, 2010
Crisis almost resolved, says Lenihan’s adviser
HARRY McGEE Political Correspondent
IRELAND IS in the ultimate phase in the resolution of its financial crisis, the chief adviser to the Minister for Finance has contended. In two presentations last night, economist Dr Alan Ahearne said he expected growth to return to the economy even sooner than the forecasts of the second half of the year. He predicted that job creation will also return, beginning in 2011. He said there would be a net job creation of 20,000 next year and 45,000 per annum in succeeding years.
A specialist in banking crises, Dr Ahearne said the National Asset Management Agency (Nama) had got its valuation of the loans of the five covered financial institutions right.
“Nama has determined the price for the first tranche of loans, after rigorous loan-by-loan analysis,” he wrote in his presentation.
“There is a 50 per cent average discount [which shows] aggressive valuations. Nama has forced the banks to acknowledge reality and recognise their losses.”

He also said the capital requirements set by the new Financial Regulator and by the Central Bank were prudent.
He said the overall budget targets were being met, that the unemployment rate had steadied, and the new homebuilding market was “near to bottoming out”.

He said the State would benefit significantly from the bank recapitalisation schemes. The Bank of Ireland deal would give the State a 36 per cent share of the bank. It would own about €1.8 billion worth of preference shares with a coupon of over 10 per cent.

In addition, the State would make almost €500 million in profits for the warrants it has given to the bank, he said, along with €51 million in fees for conducting the deal.

@ Joseph Ryan

I posted the comment by Carol Fallon because it is the only one, in the flood of commentary, that made any sense to me. I may be missing something, but the market level for housing can only be established for ALL housing whether the owners have mortgages or not.

There is no market because there is no credible National House Price Register to enable buyers to make an informed decision, other than in certain limited urban areas where a reasonable comparison can be made on the basis of asking prices. (“The day you buy is the day you sell”).

The reduction in stamp duty, if it had been implemented in the manner and context outlined by Carol Fallon, could have worked and can still work if the new government can demonstrate that it is not just a marginally different version of the previous one in the matter of policy implementation.

I fear, however, as in the case of property tax and water charges, that the Irish still view themselves as somehow exceptional and can defy the laws of economic gravity, a bit like Road Runner until he crashes into the desert.

Reading some other commentary this morning, I am reminding of the joke of the captain of a very large vessel mistaking a lighthouse for another smaller vessel and refusing to give way.

Klaus Regling, incidentally, is also of the view that the risk of contagion is now no longer what it was, that Spain has the means to rescue its own banks and that the package agreed for Ireland is sufficient to cover the bank losses. Only Reuters Deutschland has a comprehensive summary of an interview that he gave to Sueddeutcshen Zeitung today. It is a lighthouse.


@ PH: “But the view in the core now seems to be that it is necessary, possible and manageable to keep them in the treatment room for an extended period without damaging the rest of the EZ.”

Modern medical (aka financial and political chicanery) is so technologically advanced, that the patient – um, corpse, can be preserved in such a state that it not only appears to be, but virtually is, alive. Look what those pesky Egyptians did with their mummies!

Could anyone please recommend a good line in cerebral anesthesia (purely temporary, you understand).


@ Paul Hunt

I did not see your post until after I had posted above. As you know from previous contributions by me, I agree with your general analysis, in particular the following (although I would not go so far as to use the word conceal as liquidity assistance is one of the core functions of any central bank).

“The next task is to conceal whatever burden-sharing is required from core EZ voters (don’t frighten the horses). But some burden-sharing will be required as the small peripherals won’t be able to shoulder the entire burden on their own”.

What the French call disparagingly the “Anglo-Saxon financial press” will do its best to hype up the situation. But it all boils down to a judgement by the markets. The jury is still out.


Eh, Axel Weber with a stunning conversion…


Thanks, B. EB. Sez Reuters:

“It will take some time before markets stop overshooting risks in periphery sovereign bond market,” Weber, who also heads the German Bundesbank, said during a panel discussion at German Banking Day.

Weber also said governments should no longer write blank cheques to save banks, adding it would be better for Irish creditors to participate in losses.

Are we about to witness an outbreak of sanity? Is the unthinkable becoming the inevitable?

@Bond. Eoin Bond

We do need someone to act as CEO of the Nationalized Irish Banking System (NIBS); Methinks Axel is ideal – and a much more challenging and interesting post for Axel than the mundane DeutscheBank offer. Think a five year contract is in order …

The Fundamental Problem with Efforts to Save the Euro

An Essay by Michael Sauga [Spiegel Online International]

‘… it’s a known fact in economic life that both a bankruptcy and the postponement of a bankruptcy can generate costs. When applied to the euro crisis, this means that there is a point at which delaying the bankruptcy of the European community of nations becomes more costly than an orderly insolvency of its most delinquent borrowers. There are reasons to suggest that this point could soon be reached …’


@Mr. Bond,

There doesn’t seem to be any text/speech supporting this Damascene moment. I suspect this signals the end of the extraordinary liquidity support to redeem senior Irish bank bonds as they fell due and that he reckons that anyone left holding such bonds bought them at a discount and can cope with a bit of a haircut without generating contagion – and that any initial purchasers holding out for full redemption deserve the same.

We definitely seem to be at the end of the beginning. The bondholders that matter have escaped unscathed (or marginally cut); those that remain or bought in took their chances. We’re now into the unwinding of this extraordinary liquidity support.

If the strategy of having the sovereigns default, but only in 2013, is coming unstuck for reasons that have been widely discussed, then this would seem to be a logical response.

@DOCM etc al

I’ll wager Anglos crisp €23.5bn promissory note the figures in relation to house prices will be out by the preverbal mile – and we’re virtually guaranteed to have round 6 and possibly 7 of this nonsense.

I’ve indicated here before that mean reversion in risk asset pricing is alive an well and it matters – it matters hugely to the PTT (peak to trough) estimates with regards to house prices – and to my mind has been largely absent from the lexicon of the CBI/the Regulator and if the scenarios as presented are to be believed it seems also absent from Blackrock/Boston Consulting as well.

Given that residential property is a risky illiquid asset class and prone (as we all know) to severe price corrections albeit at a slower pace than listed equities the asset class itself still exhibits virtually all the characteristics of an equity investment and this needs to be considered in the context of the long term assessment of the likely PTT falls.

Basing the analysis on the Daft.ie surveys for house prices and rental yields the adverse scenario assumed by the PCAR has at the end of 2012 house prices yielding 5.6% under the long run yield assumptions.

This result is after applying the PCAR assumed rates of decline against the Daft.ie average house price falls to q4 2010 – the Daft.ie survey indicate the highest decline levels amongst any of the surveys and as a result my net yield result should look rather more flattering than similar assessments.

Using peak average Daft.ie yields (3.2% in q2 2007) against PTT Daft.ie prices falls to q4 2010 + PCAR losses to end 2012 in the adverse scenario reveals average residential yields of 5.6% and the end of 2012. This also assumes no further average monthly rental price falls over 2011 and 2012, which at the market level seems akin to boundless optimism – but we’ll run with it for now.

If one believes in mean reversion then a 5.6% adverse scenario yield result simply does not stack up.

It compares with a long run average net Irish residential property yield of 7% calculated since the Govt started to keep stats back in the mid 1970s and it quite clearly suggests that the CBI et al are already understating the PTT falls to end 2012 by c25% – based on the mean reverting assumption. Given that by this evening all of the Irish banks will be state control a 7% yield seems somewhat quaint versus the sovereign long yields and what’s likely to come as a result. So resi yields will in all probability push out beyond 7% given the country risk and the fact that c150,000 additional units remain on the market unoccupied.

Just in case one doesn’t believe in the mean reverting model then a quick glance of the Credit Suisse Global Investment return yearbook which looks to data back to 1900 and indicates a long run average equity risk premium in Ireland of 2.9% over bonds since 1900.

Now I appreciate that using the current 10year Irish bond yield as a ‘risk free’ benchmark is stretching credulity however using today’s German 10 year bund equivalent at 3.34% would suggest an equivalent equity market required return of 6.24% as a minimum.

As indicated the Irish residential property market is in virtually every aspect equivalent to an equity type investment aside from the obvious illiquidity (which would likely increase the return requirement) and equally even in the best of times the Irish 10 year always traded at a yield premium above its German equivalent so my 3.24% is every respect too low. Net net to move from a 6.24% equity required returns the long run 7% as indicated in the actual looks very reasonable so empirically the long run numbers stack up meaning the PCAR assessments don’t.

I don’t accept for one moment that the lack of country wide house price index prohibits accurate pricing. In pricing property on its actual fundamentals (which should always be the case) one actually doesn’t require a pricing index at all – what one really needs is an accurate assessment of market rents and using a 7% capitalisation method the true price of most properties can easily be established.

The level of market rents can be gleaned off the Evening Herald and local newspapers with little of no effort and even less cost than employing the same Real Estate agents and banking ‘property experts’ which brought to us great works of fiction such as ‘Soft Landings’ and the like.

If anyone is attending this evening announcement by the CBI and Regulator I’d ask one very simple question? Does the Regulator know the net long run yield on Irish residential property – a reply in the negative will I believe tell you all you need to know – ding, ding round 6.


“This is the 5th attempt to stabilise the banks. It is hardly likely to be the last.”

Perhaps, the Irish fondness for the ‘ah, sure it will do’ methodology has finally become its epitaph. Reading the figures today on continuing deposit flight/drop, unfaltering unemployment and rising mortgage arrears is truly worrying.

There was been some media commentary regarding a medium term lending facility from the ECB to ease the Irish banks’ funding needs. I was struck by the suggestion that a state guarantee would be required.

This suggests the ECB is not confident that the stress tests are sufficient. Further contingent liabilities will weigh on our sovereign strength. It’s time for the ECB to stand behind these stress tests and drop any demands for a guarantee.


I can find nothing to back up this headline in subsequent reports. Did he say it or not?

@Paul Hunt

You passed over my question

Who will receive the blame for choosing the numbers which (we are assuming) the EU demanded should be chosen?

It’s quite evident that the EU core, ECB, etc. want to contain the crisis in the “outer periphery”. It’s pretty probable that their opposition to senior bank haircuts is as strong as ever. What is less evident is that they’re significantly closer to the point when they start granting EU taxpayer money to the Irish banks. Which brings me back to my question. Is a second failure by the Irish authorities to correctly estimate the banks’ losses going to smooth the way politically for EU rather than Irish money to be spent on them? It seems more likely it will do the opposite.


It is no part of the ECB’s functions to provide “liquidity” funding to clearly insolvent banks.

@ Yields or Bust

I cannot say that I can follow the technical aspects of your presentation but I think it boils down to saying that officialdom are understating the peak to trough for the Irish property market, a view with which I would wholeheartedly agree.

On two other points, I would most vehemently disagree

“As indicated the Irish residential property market is in virtually every aspect equivalent to an equity type investment aside from the obvious illiquidity (which would likely increase the return requirement)..”

Comparing property to equity is the source of the downfall of the Irish economy. When coupled with low or non-existent deposit requirements and variable rate mortgages of whatever length the lenders could dream up, it has given rise to a sequence of boom and bust not just here but also in the UK.

“I don’t accept for one moment that the lack of country wide house price index prohibits accurate pricing. In pricing property on its actual fundamentals (which should always be the case) one actually doesn’t require a pricing index at all – what one really needs is an accurate assessment of market rents and using a 7% capitalisation method the true price of most properties can easily be established”.

This would be true if rents were an accurate guide but they often bear no relationship to the capital value of an apartment or house because renting is very seldom a lifestyle choice but viewed as an interim stage before purchasing a property. Choice is often limited and the rental and the purchase markets, when coupled with social rent assistance etc., are divorced from one another. There can be no other explanation for the divergence between the presumed capital value and actual rents received.

This is the direct opposite of the situation on the Continent. Once again, the Irish exception comes into play. In property markets such as the French, one of the most solid in Europe, they do not think that they can dispense with solid price information. We do. cf.


Hmmm, that rally may have to wait a while….


I see Brian Lucey being quoted by Bloomberg as saying a realistic number would be 40b but that they will come in at 25-30b as anYthing more would be hard to sell.

Now what does that tell us?

@Kevin Donoghue

It’s not insignificant, but when it comes to the Troika and the EU core governments I think that Weber is now on the outside pissing in. A lot of people assumed that he dropped his bid for the ECB presidency because he’d concluded that he couldn’t win, but my assumption (I haven’t been following closely) is that he decided he didn’t want to win. I guess that he took a good look at the situation of the ECB and the EU and world economy, and at the sort of pressures the next president will face from EU governments, and decided to pass. Now that he’s no longer running for president, he’s free to (take your pick) bravely follow his conscience in opposing Troika policy/position himself politically so that he’s still employable when the current policy hits the iceberg.

@ CP

that Lucey loves being controversial and no upper limit will ever exist so long as he draws a media-seeking breath?


In relation to the property v equity equivalence I’m referring to the pricing methodology i.e. the fundamental aspects of the pricing of an equity would according to most analysts revolve around a dividend discount model or its near equivalent and in relation to property the equivalent is a rental discount model where the discount rate (capitalisation rate) is the long run rental yield.

If property was priced off this method (as it should only ever be) i.e. a discounted rental method the boom bust scenario would simply not arise as property prices would simply move with rents which we know over the long term track CPI inflation +/-1% on average. So perhaps a pause on the ‘vehemently’ disagreement and think about what I’m actually suggesting for a while.

A question which therefore arises in relation to your other rental criticism. What is buying a house in any case? Surely it is the opportunity cost of not renting. An owner-occupier/investor is buying a discounted stream of rents for as long as he/she wishes to hold on to the asset. And vice-versa: a renter pays a monthly sum to a landlord rather than interest to a bank. The opportunity cost of not owning a home is presumably forsaking the chance for a return on that investment. If rents are relatively static (in line with inflation more or less), not only is the potential for capital appreciation reduced, it is also more attractive in cash-flow terms to pay rent rather than interest.

So the problem is therefore the banks model in pricing property – given that today they are all going into public ownership – only a fool would suggest that their previous methodology has worked well. As I’ve indicated here before it’s an absolute proven loser in every respect. Pricing property as the banks have done off someone’s ability to repay a loan where the size of the loan bears no relationship to the underlying property value has us where we are today. What’s the property value so? back to my argument that the ONLY sustainable long term method is to price property values off rents – nothing at all to do with number of times a persons salary etc nothing to do with ‘well the banks lent x thousand against #4 therefore #5 has to be worth at least the same’ – all complete fairy tales.

What’s more than crazy is the following situation which I’m sure is replicated up and down the country by the thousand: a couple seeks to buy #5 ordinary street, ordinary town, Ireland and approaches a lending bank where the asking price is €300k (local estate agent) but the same bank has already lent money against #4 which is rented and bring in c€10,500 p.a. i.e. €875 a month and yet goes ahead and lends against the €300k valuation – with a 90% mortgage over 25 years at starting rate of 3.5% which costs the couple €1,347 per month – now whose at fault, the bank? the couple? the estate agent? Rent @ €875 v Mortgage cost @ €1,347.

There can only be one answer and that’s the bank – they have the power to disregard the ‘valuation’ and say no and suggest to the couple that in fact the ‘correct’ valuation is in fact €150k not €300k priced off a long run yield of 7% on known rents (which they see being lodged to the landlords account each month). Crazy I know but this was Ireland from about 2000 to date sadly however the banks assumed the ‘valuation’ was correct and now hide behind its ‘independence’ and claim the couple owe them the full €270k. One may claim that the couple should have known – but normal folk transact in the property market once or twice in their adult lifetime (that’s the average) so hence the reason for reliance on ‘experts’ to guide. How many ordinary folk know that the long run net yield on Irish residential property is 7%?

So ask yourself again who actually prices property – again the answer can only be the bank and who should in theory bear the responsibility of this mispricing error – again the only answer has to be the bank – they ought to and should have known better.

Pricing off long run yields cuts through all of the above nonsense so to suggest that ‘rents …bear no relationship to the capital value..’ is akin to misunderstanding the Irish economic collapse of the past number of years. The facts are that the banks FORGOT that the capital values are absolutely tied to the rent on the property and hence the announcements at 4.30pm today.

@cet. par.

Did they take the opportunity to express their confidence in the robustness of Chinese economic growth, I wonder? Anyhow, Reuters is apparently reporting that “There has been disagreement in ECB governing council over new liquidity facility” so it seems it’s not just an administrative delay.

Consider prices in a firesale marketplace – Nevada 2011. House prices down 60%+ from peak with repos selling at 20% to 40% discount to current prices at auction. If this experience is factored into stress testing mortgage books here with 36k ready to go repossessions and another 40-50k in the red zone what’s the possible outcome? 4.30pm may shed some light.

@yields or bust

What role would international comparisons of residential rents play here?

Is one of the lessons of the boom that there can be a bubble in rents too so that prices are even more overvalued than they appear? If you accept that must it not follow that you need an external anchor for rents in order to get prices?

More generally, rents and prices are both influenced by macro conditions and both also influence macro conditions.

A partial equilibrium of, or the requirements imposed by arbitrage opportunities in, the housing market can never tell the whole picture

Bondholder Haircut by Ireland May Shut Italy, Spain Funding


@Eoin Bond

Is there a spot of selling on French, Italian, Spanish bonds going on?

Delay in ECB prob due to fact that they can’t find Lorenzo …. his logic of dumping all on the serfs and screw1n em with Silvio appears to be shattered by the comment from Axel … poor lorenzo …. as for poor Nicky, well he can drink all the tea in China for all I care …


It was flagged earlier that legal problems arose regarding ECB funding Gov. debts -cannot remember Article number- so delays are inevitable when the lawyers get involved. It does not look like the final solution will emerge today.
It’s very stressful waiting for stress tests.


Examiner reporting Noonan to burn bondholders-
“Once the figures are revealed by the Central Bank, the Finance Minister Michael Noonan will unveil plans to restructure the banks, including proposals for some form of burden-sharing with bondholders.


Most property markets are influenced at the micro level by the local factors so I’m not sure that international factors really play that big a role as local lending banks ultimately price local property or at least they should.

That said where direct or near direct comparisons can be drawn in relation to size, transportation, large city proximity etc etc then obviously international comparisons are very useful for instance in economic competitive comparisons but at the pricing level its a bit like trying to compare the share price of CRH and Holcim – the underlying factors are similar but they not the same and hence long run returns and risk premiums will probably differ.

In relation to rents the long run average is that rental growth has typically tracked CPI -1%. Of course there has to be a starting point and that point like any other price is the price at which investors/owners can achieve a return which exceeds alternative risk free investments plus a risk element. That additional risk element is investor dependant however on average the rate in Ireland has settled at 7% of the value of the underlying for residential property investments.

I don’t subscribe to the view that for instance in Ireland we actually had a bubble in rental prices. From early 2001 to mid 2006 house prices were up c50% on average nationwide but rents were actually down c2% over the same period. Hence the irrationality in banks pricing housing off inflated salaries – these were not being reflected in the rental market at the time so should not (on my model) have been reflected in the underlying prices.

Rents if anything are less affected by macro issues as the local supply and demand of suitable properties generally dictates where prices tend to settle.

@cet. par.

That would be Article 123 TFEU – Articles 124 and 125 are also highly relevant. But the ECB and the EU member states have been cheerfully micturating on these articles since before the Greek bailout, so it’s not as if anyone was startled to just now discover that the BURP might be against Lisbon.

How none of these knaves, liars and fools in the banks and regulators have not been trailed infront of a court for the economic terrorism they have committed to this country is beyond belief and comprehension.

@ceteris paribus

Local rumour that The Neu Minister has seconded the Munster Scrum into the Department of Finance for 36 hours; to be released in time to tear into Leinster on Saturday – at least he has his priorities in order (-;


speechless … 30 months later we have NIBZ Nationalized Irish Banking System …. get that contract to Axel …. hear he is still in Berlin.

what can be said except that civil, democratic society is clearly very, very strong. Or very, very, stupid. Or both. I mean in the broader, big picture of history, we do have just about enough evidence and cause to lynch a few culprits… And if not now, when?


Why not just play the in the DoF and send for the ambulances to pick up the ‘collateral’?

Enough with the half measures (-:


Should have read – sorry

Why not just play the match in the DoF and send for the ambulances to pick up the ‘collateral’?

Enough with the half measures (-:


Sorry should have read.

‘Why not just play the match in the DoF and send for the ambulances to pick up the ‘collateral’? ‘


Neue Irische Besatzung Zone

The new Irish occupation zone.
Maybe we will have to cede Donegal, Cavan and Monaghan to Norn Irn as reparations.

@ Yield or Bust

Having read your second post, I concede that I misunderstood what you were getting at. I do not question the absolute link that should exist in terms of analysis between rent and capital value. I was simply pointing out that it did not work in Ireland, a fact which you have confirmed in a later post.(“I don’t subscribe to the view that for instance in Ireland we actually had a bubble in rental prices. From early 2001 to mid 2006 house prices were up c50% on average nationwide but rents were actually down c2% over the same period”).

I have not changed my view that transparent pricing information which allows for comparison right across the country – as in France – is a sine qua non (unless the country that has had the biggest bust in history has made an unheard of discovery).

This radical restructuring is designed to break the bonds with our toxic banking past – Noonan

It may break bonds alright- 10yr 10.223%

Lenihan queries lack of liquidity scheme from ECB (as reported by IT last Saturday). ECB have to be dealt with with kid gloves and not with megaphone diplomacy-BL

This is the crux of the matter.

The whole thing is very unimpressive, just more of the same- truckloads of money into banks and ILP left in limbo. They don’t do radical.

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