Central Banking Boundaries Post author By Philip Lane Post date October 7, 2014 The UCD Economics Society speech by Patrick Honohan is here. Categories In Uncategorized 36 Comments on Central Banking Boundaries ← Dublin Economics Workshop 2014 → IMF 2014 Triennial Surveillance Review 36 replies on “Central Banking Boundaries” Very interesting speech and I’d be interested on people’s take on it. I think also worth reading: ‘ECB’s treatment of Ireland and Italy is a constitutional scandal, yet nobody held to account’ “So the truth comes out at last. The EU/IMF Troika – actually the ECB – compelled the Irish state to take on the vast liabilities of Anglo-Irish and other banks in the white heat of the financial crisis. “It threatened to pull the plug on ECB support for the Irish banking system, in breach of its own core duty to act as a lender-of-last resort, unless the Irish taxpayer took the full losses. “This protected bondholders from their condign fate, even though these creditors were fully complicit in Ireland’s credit bubble. Indeed, they helped to cause it, along with the ECB’s ultra-loose monetary policy and negative real rates (set for German needs) during the boom. Even the riskiest tranches of junior bank debt were deemed off limits. “Working class youths in Cork, Limerick, and Dublin will have to service a very high public debt — currently 124pc of GDP, up from 25pc in 2007 — for a very long time. “Patrick Honohan, Ireland’s central bank governor, told a group of foreign journalists in Dublin some time ago that this had occurred. We knew, but were sworn to silence, forced to bite our tongues every time we had to listen to the usual pack of lies from certain quarters.” http://www.telegraph.co.uk/finance/economics/11138980/ECBs-treatment-of-Ireland-and-Italy-is-a-constitutional-scandal-yet-nobody-held-to-account.html Patrick Honohan on recent ECB deliberations: ‘From Dublin, we try to bring a distinctive flavour to this difficult policy debate and contribute to influencing the design of novel instruments and programmes”. Prof Honohan recently revisited 2010 in an article on the late Brian Lenihan http://www.independent.ie/irish-news/patrick-honohan-why-i-let-bailout-cat-out-of-the-bag-30621299.html “In terms of market confidence, the die was cast by the Merkel-Sarkozy announcement on October 18 at Deauville to the effect that the holders of European government debt would have to contribute to any bailout. As the financial markets absorbed the implications of this new policy, interest rates on all peripheral government debt, but especially Ireland – now clearly seen as next-in-line for a bailout – jumped to insupportable levels. Now, Irish companies and individuals joined the external investors in removing their funds from the Irish banking system and the need for the protection of official external assistance became acute. Public and semi-public statements and briefings by senior Eurozone officials to that effect added fuel to the fire. ” The key issue is how to burden share- this has still not been addressed satisfactorily. The EZ panjandrums tried at Deauville but the markets sold everything off. Draghi bought the markets off by buying all their stuff but the problem will recur in the next crisis and there will be no sovereign capacity to soak up the mess then. Looking at the debt dynamics, Ireland is still on a very shaky scraw and 2% yields on the 10 y do not reflect the risk of deflation in the EZ and the Fed making the wrong call on interest rates as the US completes another year of 2% growth. It may even reach 2.5% but it’s not exit velocity. Same problem building up as last time – overpriced assets – Ireland should really get out of the line of fire because power always works in the same way . The kids had an experiment the other day. Some sort of box you can put insects into and watch them . They put in 2 spiders. Next day they could only find one. The small one was missing. The big one was busy wrapping something up in web. Guess what it was. ” Bubbles and other sources of financial instability can, as we well know, emerge in the national economy even if not present across the euro area as a whole. Interest rate policy is obviously not available as a tool to inhibit the growth of a country-specific asset price bubble, so what should be done? ” This is the big question. And it’s not clear that CBs have the necessary tools. Central banking is still more art than science. Keynes observed in 1936 that investors care more about what other investors think than they do about fundamentals. That is still valid. QE may or may not be responsible for bubbles, depending on your perspective. It is very tricky. I think Honohan is a good person to have in that position. He’s very keen to share his insight. Dan loose translation…”will ye have a drink Jens” I saw somewhere that joining the EZ meant countries exchanged currency risk for credit risk … @Gavin ““Patrick Honohan, Ireland’s central bank governor, told a group of foreign journalists in Dublin some time ago that this had occurred. We knew, but were sworn to silence, forced to bite our tongues every time we had to listen to the usual pack of lies from certain quarters.” Told precisely what? “Sworn to silence” for precisely what purpose? If the idea was that selecting a tiny number of people on whom to bestow this information would result in such an influence on the conversation at polite (overseas) dinner parties that a whip-round for the 30 bil would follow, then it was a misjudgement. Perhaps airing things in front of the great unwashed rather than a few foreign hacks was the thing to do. ..or is AEP just exaggerating again? From PH: “Some people think that the Central Bank should mandate specific debt relief or forgiveness for borrowers. In fact this is not within the Central Bank’s power, nor could it be. Intervention into the property rights of creditors is a matter for legislation under the Constitution (or Government fiscal action – the latter remaining highly unlikely given overall fiscal pressures).” One assumes this also applied in 2008 and in 2010. (see “property rights” and “bank guarantee”). “So, should there be a ceiling on interest spreads?” Honohan says no, even though he frankly admits that ECB rate reductions are not being passed on to new borrowers. The only rationale he provides for saying no, ie that new banks may enter the market, is very weak. New borrowers may benefit a little, but the large margins that existing banks have on new lending will be cut, thereby reducing their profitability. The real fundamental issue of tracker subsidisation is not addressed at all. “The persistence of chronic arrears cases inhibits the ability of Government to attract buyers for the banks that have been nationalised..” The government still wants to flog the banks-with no attaching liability-back into the private sector. What an ideologically driven but spineless government. These banks should stay in public ownership until every cent of the ‘bail-out’ money is returned to the State. If it takes a thousand years. IMF reckon there is a 40 % chance that the EZ goes into recession for the third time since Lehman http://www.ft.com/intl/cms/s/0/aef2e36a-4e04-11e4-bfda-00144feab7de.html It could get awfully messy The markets with their dark pools and algorithmic trading of mispriced bonds : http://www.youtube.com/watch?v=6mNCzSqdKZo versus the EZ policy wallahs https://www.youtube.com/watch?v=ES32UFlPOUA Go bhfóire Dia orainn FT article on Apple, tax and Ireland http://www.ft.com/intl/cms/s/0/bde702e4-4d5e-11e4-bf60-00144feab7de.html UFC: “Intervention into the property rights of creditors is a matter for legislation under the Constitution.” Creditors, by definition, have lent what? Borrowed money? In other words – it was not even their’s to start with? But what if some of the money they ‘lent’ was actually leveraged? Had no prior existence? Had no prior owner? Does this fiat money not then belong to the State (or even the ECB) – and not the lender who created it ex niliho? I think this “creditors have property rights over fiat money” needs to be seriously challenged. The ‘right’ to create your own money is one mad, bad and dangerous economic idea. The lenders might have ‘property rights’ if they were Gods – or maybe they ARE Gods, and I missed the introduction! That LTV and LTI proposal. Might get the Mr Enda short shrift? Lets see what to-day brings. The most dangerous WMD (weapon of mass destruction) on the planet: The Financial System @The Guv’nor Keep an eye onit! @ BWS The Fiat punter 2010 Martin Wolf But the real catastrophe, as I argued last week, is the risk taken on by the gamblers working legally inside the machine. The role of big institutions is obviously problematic: they are, at one and the same time, the house, the biggest players at the gambling tables, agents for the other players and, if all goes wrong, beneficiaries of limited liability and implicit and explicit government bail-outs. This is a guarantee of repeated catastrophe. Under the gold standard, the scale of bail-outs was constrained. In a fiat system, there is no such limit, until the value of money collapses. @ Seafóid: “IMF reckon there is a 40% chance that the EZ goes into recession for the third time since Lehman.” Has it even ’emerged’? Looks a tad dodgy to me. Global oil demand is … like, kinda depressed. So, who’s doing all this the ‘growing’ then? Like its an incoming tide that will float the craft* anchored in the harbours? Is this what they call ‘hydroponics’? Or am I being confused, again. * The ones without the gaping holes in their hulls, that is! Enough of ‘Capital’ … back to ‘Labour’ or Human Capital Emigration as a high price to pay … The labour market effects of immigration and emigration in OECD countries http://www.voxeu.org/article/labour-market-effects-migration-oecd-countries @Brian Woods Snr Metaphorical update: Randy Wray: Rising Tides Lift All Yachts – Why the 1% Grabs all the Gains From Growth Posted on October 2, 2014 by Yves Smith http://www.nakedcapitalism.com/2014/10/randy-wray-rising-tides-lift-yachts-1-grabs-gains-growth.html contd. The Lower Unemployment Rate is a Recovery – for the Top 10% Economist Pavlina Tcherneva of Bard College explains why monetary policy that is directed at finance and not job creation has this effect – October 5, 14 http://therealnews.com/t2/index.php?option=com_content&task=view&id=31&Itemid=74&jumival=12479&updaterx=2014-10-05+16%3A15%3A06 @ David: Thanks for that. Quite depressing. Not sure if its ‘old age’ or what – but I am getting a tad tetchy with folk who witter on about ‘growth’ (ie. the economic stuff, not the garden stuff). I believe that the majority (politicians, economists and useful idiot journalists and commentators) have not the slightest clue what they are talking about. They just mouth ‘growth’ and believe themselves to be ‘smart’. Actually they are just dumbskulls. And that also goes for those who totally misuse what Lord Keynes actually proposed – a temporary injection of fiat money to kick-start consumer demand, which had fallen away. Without an increase in consumer demand there can be no supply. Does it work in reverse? Sure it does -if’n your Mr Guiney and you have a pile of ladies interlock knickers and you intend to sell ’em cheap! The Great Financial Crisis was, at base, brought on by the major oil producers reducing their forward (3 – 5 year) investments in additional or renewed production capacity such that in 2005 they passed the key 95% capacity utilization mark, and crude oil prices rose exponentially. Global economic rate-of-growth went CRASH! Its not been fixed. And the producers are at it again – crude is sub-$90 bbl. and forward investment is almost at a standstill. Sure they are digging like crazy in the sand – but those wells have a 2 year half-life. That should signal the next big global CRASH for 2018 – 2020, but given the increasing rate of decline in the legacy land-producers nett crude output for export, it might be earlier. Very dodgy. Do you think some folk might need to visit SpecSavers? Central Banking boundaries presumably should work in both directions. CBI today announced LTI and LTV policy. Is there a possibility an Irish politician might suggest offering “a government guarantee” to the banks, to make up any deposit shortfall, on behalf of certain electorally active potential purchasers? How about ring-fencing some tax revenue – say VAT on new houses – to label and, temporarily you understand, park as “government deposit contribution”… Am I being too cynical? I note that BTL investors will be subject to less restrictive LTI and LTV rules than owner occupiers. “Buy-to-let borrowers will also be exempt from the income restrictions. ” http://www.irishtimes.com/business/personal-finance/new-mortgage-loan-rules-mean-most-house-buyers-to-need-20-deposit-1.1954732 I have read that LTV will be 90% for investors ( Ir Times, Fiona Reddan, I think) but cannot find source. So Mr Gerlach, what is you justification for what appears to be outright discrimination in favour of investors, especially when considering that the most egregious defaulters in recent times have bee investors. Martin Wolf says we are trapped in a cycle of credit booms http://www.ft.com/intl/cms/s/0/1a9f058e-4d43-11e4-bf60-00144feab7de.html As EL-P says in Deep Space 9mm “It’s all bad timing” Private Eye on Tesco “While earnings per share – “the Number” that drives all things, especially management pay, had marched on upwards in the Leahy years, return on capital employed “ROCE” had declined. Tesco was generating insufficient free cash to invest and pay its dividend- the gap being filled by debt. And its definition of ROCE had changed eight times” Dividends are real money. Accounting values often aren’t. We need a system reset. Too many prices are fake and will fall as soon as volatility re-emerges. The Banking Inquiry will discuss the role of the media in generating unrealistic expectations about the prices of things. Journalists will push bank saying the role of journalism is to hold power to account. And the system will roll on. Take one Sindo , 28 September, and read all about the glorious economic future if only Inda can scaoil amach an bobailín. Arra go on . http://www.independent.ie/opinion/columnists/brendan-oconnor/is-it-the-return-of-greed-or-the-return-of-hope-30621288.html http://www.independent.ie/irish-news/politics/big-phil-and-the-dark-art-of-cronyism-30621240.html http://www.independent.ie/opinion/cut-taxes-in-budget-by-2bn-to-get-us-spending-30621238.html http://www.independent.ie/life/could-someone-listen-to-michael-d-30618095.html @Gavin Kostick http://www.telegraph.co.uk/finance/economics/11138980/ECBs-treatment-of-Ireland-and-Italy-is-a-constitutional-scandal-yet-nobody-held-to-account.html Here’s an idea for your next play. A picture of Sinn Fein activists heading a Daily Torygraph article. And being given very sympathetic treatment in the article itself. For someone who lived through The Troubles in Northern Ireland, this is incredible – or maybe not. Let’s think, what do the Daily Torygraph and Sinn Fein have in common? Not much, but one thing is that they both want to see the Euro collapse. As Scotland’s referendum showed: successful Euro = end of UK And, as Steakknife and many others showed, by the end of The Troubles Sinn Fein was stuffed with people who were being ‘guided’ (a euphemism) by MI5. One wonders if they are still being ‘guided’. @ Joseph LTV for BTL will be 70% The timing of the Central Bank’s macro-prudential proposals is curious. Residential prices ex Dublin have risen by 8% from the cycle low and are still 45% below the previous peak, the CB’s own research points to prices still well below fundamental value and net mortgage credit is still contracting. A counter-cyclical approach might have made better sense, with higher LTV’s and LTI’s allowed after a large price correction, but falling when credit and prices are rising rapidly. A broader issue relates to boundaries. The Central Bank and the ECB are effectively unaccountable, unlike politicians (at least very 5 years anyway) and macro-prudential measures are likely to have far-reaching effects on Irish life Mario Monti on the crying need to change the rules on public investment in the EZ . Fair play to him. http://www.ft.com/intl/cms/s/0/ba9cd208-4d5e-11e4-bf60-00144feab7de.html @dan AQR? The central bank will be aware of rapidly rising house prices in Dublin – in some places they have increases by around 60% since early 2014 – and the return of a mid-naughties, panicky, one-way-bet psychology. They don’t want the snowball rolling again, at least not without making people aware that credit availability will be limited. Given that it wasn’t limited last time, and the punters tend to rely on their own experiences rather than technical notes about ECB oversight, it seems appropriate. Also, the AQR will be viewed in the context of the banks’ inability or cultural unwillingness to enforce their supposed security. Even in the BTL sector several times more mortgages drop into the 2yrs+ arrears category each quarter than are taken into the lenders’ possession. the runniing total is around 14,000. Foreigners find this rather odd. @UFC fair enough but 72% of the population do not live in Dublin … @BEB Thanks for that. Nevertheless why don’t LTI limits apply to investors. The person who wrote this in the Central Bank document, needs to look again at the BTL default stats. “Buy-to-let mortgages: These are not covered by the proposed regime inasmuch as the loan-to- income ratio is a less relevant metric for such lending. However, the more demanding LTV ceiling that is proposed will contribute to limiting the risk for both borrower and lender. ” Why the distinction in LTI? Why are investors being favoured over owner occupiers? This now seems to be an unwritten code within banks and the Central Bank. Equally, why are the limits variable, in the sense that some people (favoured people?) will be able, with the central bank’s blessing, to avoid the rules. 15% in the case of OO and 10% in the case of BTL (on an overall basis). Who are these exemptions designed to benefit? Why, in Ireland, are there always rules for the majority ( 85% in this case) that need not be applied to a favoured minority (15% in this case)? The Central Bank needs to explain why it is proposing to retain this old-school-tie system in relation to the design of its rules. @Dan McLaughlin “Residential prices ex Dublin have risen by 8% from the cycle low and are still 45% below the previous peak, the CB’s own research points to prices still well below fundamental value” I’m sure you would agree that everybody needs to forget about the previous peak. Nothing, except insanity, should be measured from that pinnacle. Not everybody would agree with the CB research on house prices, and the timing of its release begged some questions. One need to look at what two people (at most) on the average wage can afford in terms of housing and then measure current house prices against that benchmark. [Unless of course there is a probability of a 50%-100% increase in the average wage.] @ JRyan Re LTI BTL is much more like a leveraged equity investment – if the income from the asset (ie rent) doesn’t pay off the interest, the loan probably goes into default regardless of the borrowers income levels. An LTI would be of little use, as the current wave of employed professionals defaulting on BTL proves. OO mortgages tend to be much more reliant on ability rather than willingness to pay, strategic defaults notwithstanding. I note from the Sindo that many banks are now offering loans up to 5* salary and that banks are gagging to lend. So 5* salary, up to 90% of purchase and max 50% of salary as repayments with terms stretched out to 35 years where necessary. WTF. @ seafóid: Arrogance knows no boundaries. They took a residential mortgage lending system which was in statistical control for at least 4 decades and trashed it. Mortgage defaults rose 40 fold! And they call that what? Successful failure on a truly heroic scale? So, reprise it? “Right on!” Sentiment will always triumph over rationality. And the suckers get shafted. “Long live the suckers!” @ BWS It’s not just arrogance. It’s also recklessness. And it’s happening again, same as the last time. Media driving the herd. Giving someone a loan of 5 times salary over 35 years because 20 years is “too expensive” is a dereliction of duty. The global macro context is extremely fragile. -QE has more or less wiped out risk premiums -There is no agreement on how to measure value -There has been massive explosion in financial assets over the last 25 years http://www.ft.com/cms/s/0/4df99d28-4590-11e4-ab10-00144feabdc0.html And there isn’t enough real world activity to give it sustainable rent. House prices are going to be very volatile for the foreseeable. And 5x a stagnant salary is a very thin reed against which to lean. When the salary multiples were 2.5 to 3 at least people got pay rises. Comments are closed.