Month: September 2011

Irish Government Debt and Implied Debt Dynamics: 2011-2015

This detailed analysis of Ireland’s public finances by John Fitzgerald and Ide Kearney is available here.

Summary:

This article examines the debt dynamics facing the Irish State over the period 2011 to 2015. Using medium-term official forecasts on the growth rate and assuming that the official target primary surplus will be achieved, it examines the likely path of the debt out to 2015. It takes account of the reduction in interest rates on EU borrowing agreed at the EU Council meeting on 21st July. However, it makes very conservative assumptions on the interest rate available after 2013, which could well be significantly lower than we have assumed, with consequential beneficial effects on debt sustainability. In addition, the analysis uses the official projections for holdings of liquid assets, which seem very high.

Using these assumptions, the base case estimates suggest that the net debt to GDP ratio will peak at between 100 and 105 per cent of GDP in 2013 and that it could fall back to 98 per cent by 2015. The related gross debt to GDP ratio would peak in 2012 at between 110 and 115 per cent of GDP before falling back to between 105 and 110 per cent of GDP by 2015.

There are no easy options in tackling the current levels of debt facing the Irish government. The current programme of austerity, with an agreed package of cuts totalling €30 billion over the period 2008-2014, will, on these assumptions, be sufficient to all but eliminate the primary deficit by 2013. However, the very high current levels of debt mean that if growth were to prove less than assumed in the Department of Finance estimates, it would not be sufficient to stabilise the debt to GDP ratio before 2015. On the other hand, a more robust recovery would both improve the primary balance more rapidly than in the base case and it would also ensure that the debt to GDP ratio would begin to fall at an earlier date.

In planning for recovery a critical additional strategic hurdle faces Irish policy makers – the need to return to the financial markets in 2013 in order to fund substantial debt repayments in 2014. If this can be satisfactorily accomplished then the position of the government will be facilitated by the prospective lower funding needs in 2015. To prepare for this return it will be important to implement fully the prospective adjustment in the public finances agreed with the Troika. If this is successfully accomplished and growth picks up in 2013 it will be clear that most of the new borrowing from 2013 onwards will be to fund debt repayments, not to pay for an unsustainable gap between public expenditure and revenue.

September 2008: The European Option

In Friday’s testimony before the Oireachtas Committee, Patrick Honohan encapsulated the European option that might have been pursued in September 2008:

Professor Patrick Honohan: I draw the attention of members to the report I prepared in May 2010, which lays out in considerable detail, though perhaps in not in headline grabbing language, the regulatory experience and the policy on regulation and financial stability in the Central Bank and the Financial Regulator’s office in the years running up to the crisis and the night of the guarantee. It lays out what the people thought, what preparatory work they had done, the way in which the banks were supervised, the style and approach adopted then and the quality of the information. Information was not of high quality, which led to the situation in September 2008 when neither the Central Bank nor the Regulator had anything like enough information about the condition of the banks and, furthermore, to a large extent, they did not realise the degree to which they did not have the information. They did not realise, therefore, the risks that were involved and the huge risks being presented by the policy action.

The Senator has put his finger on an important point. The decision taken at that time was to say “We are a triple A rated country; we can take this on our books no problem with everything guaranteed”. The decision could have been to say, “This is quite a big and unknown risk; it may be too big to take on our books. We need to get the European tie in”, which would not have been easy. We know that the message from Europe at that time was that everybody had to solve their own banking issues because each country had problems. However, our problems were much larger proportionately than those in any other eurozone state. If that had been brought to the European table with an acknowledgement and a sharing of the risks involved, we would not be in the position we are today. The information was not there and the decisions taken by the Government at the time were based on a quality of information that should have been better.

Wolfgang Schäuble: Why austerity is only cure for the eurozone

You read the FT op-ed here.

Household Debt Restructuring Post Number 4012

The household debt restructuring (I’m not going to use the ‘f’ word) debate rumbles on. From the blanket coverage in the Sunday papers, Colm McCarthy’s Sindo post and Stephen Donnelly’s pieces were, I think, the best. For context, earlier in the week Seamus Coffey looked at the numbers in arrears from the Central Bank. From Colm’s article:

It would be wrong to dismiss the ‘forgiveness’ campaign as just a silly season space-filler revved up by a woolly-minded media. There is a real problem for many people and some mortgage debt will have to be written down. You cannot get blood out of a stone.

The danger is that the campaign will encourage everyone in negative equity to disguise themselves as stones and to lobby politicians for relief from debts that they are able to service. The politicians need to understand that debt relief, beyond the minimum necessary to acknowledge that some people simply cannot pay, comes at the expense of a bankrupt Exchequer. Do they really want to go to the IMF/EU looking for a further loan to recapitalise the banks yet again?

The best way to proceed is for all banks to be treated equally, regardless of ownership, and encouraged to write down mortgage debt that cannot realistically be serviced. The process will not be left entirely to the bankers, in whom public confidence remains weak, and it makes sense to have active oversight from the Financial Regulator to ensure, for example, that there is no preferential treatment for favoured borrowers, such as bank staff.

Debt write-downs should be expedited where these are unavoidable and extra staff assigned to the task. A modernised personal bankruptcy code would help and legislation has been promised.

I agree with Colm’s assessment of the situation. With the date of the expert group’s report hurtling towards us, it might be useful to consider a few worked examples of debt restructuring as and when they become important to us. Here is a google spreadsheet considering those cases.

I chose just one restructuring instrument, a debt/equity swop, although there are many others. See appendix 2 of the MARP report for worked examples internationally. The headings of the spreadsheet should take you through the logic of the examples.

First off, these are archetypal cases made up to make some points about types of mortgages in difficulty, so they are subject to a series of assumptions I detail in the spreadsheet. They are not meant to be anything other than exemplars, though they are driven by real life cases I’m familiar with. Anybody wishing to improve the ‘reality’ of the examples, by including interest and arrears for example, or another debt restructuring mechanism, please have a go on google docs and I’ll link to your examples in the comments.

Second off, it’s pretty clear from the spreadsheet that very few cases actually qualify for some kind of restructuring. Of the 6 cases, only 2 mortgages are deemed ‘sustainable’ when the bank takes a 45% equity stake, and only 1 is sustainable when the bank takes a 35% stake. So, under the present set of arrangements, the rest of these mortgages would most likely end up becoming court cases, with the attendant stresses on household and society, and the possibility of the bank recouping only the secured asset. If, and it’s a big if, these examples are any guide to reality at all, an efficient personal insolvency mechanism is clearly the first step towards resolving the debt crisis, with a subset receiving some form of restructuring.

It’s clear there is a need for an efficient filter to decide, based on individual circumstances, which mortgages aren’t sustainable, which are, and which might be, given other considerations.

In practice, here’s how I see such a filter working.

1. The process is done through the banks but supervised by the regulator. Another quango or NAMA we really don’t need. Banks are best placed to work things out with their borrowers, but they should be supervised–especially the uncovered banks and subprimes but most importantly the ‘pillars’. A metric agreed by both sides on the debt profile of the individual lender and borrower should be constructed.
2. The implementation should be a menu of options available to the bank, one of which *must* be used depending on the outcome of a series of tests for income, etc., applied in stage 1. The penalty for misrepresenting yourself to the bank should be fraud charges. Cute hoors need not apply in other words. This will reduce the moral hazard element enormously.
3. This menu will include: straight out bankruptcy, debt/equity swops, repayment rescheduling, debt writedowns in cases where the banks have clearly acted inappropriately, giving the house back to bank in full and final settlement but renting the same house again, and more.

The principle, I feel, should be means tested income streams plus arrears rather than negative equity. Each menu item (a, b, c, etc.,) will come from an individual pot of money in the banks (e, f, g, etc.), all overseen by the regulator in a monthly report to them.
4. The objective is to be fair to both parties (lender and borrower) while allowing people to get on with their lives. The perspective, in some sense, is social welfare rather than letting banks or borrowers off the hook. Understanding you’ll never get this just right is key.
5. The guidelines should have the force of a directive on the banks from the regulator, eg it should remove a lot of the discretion from the banks and add clarity to the process while differentiating between ‘can’t pay’ and ‘won’t pay’ and ‘might pay’ and ‘will never pay’.

Update: Karl’s Business and Finance piece this month is excellent on this issue.

Oireachtas Committee Transcripts: September 1 and 2

The transcripts from last week’s meetings of the Joint Committee on Finance, Public Expenditure and Reform are now online. The transcript for Michael Noonan’s appearance is here. The Honohan-Elderfield transcript is here. I’m happy to say the website has improved since the last Dail and you can now read the transcript for a full meeting without having to hit lots of arrow buttons.