Author: Colm McCarthy

It is being reported (by eg Simon Carswell on the Irish Times website) that, in addition to the four-year fiscal framework, there will be an early resolution of the banking issues as part of the IMF/European deal.

De-leveraging the banks further through private sector deals for bank assets, including non-NAMA impaired assets, has long been an option, as argued here before. The tracker mortgages constitute an impaired (though performing) asset which can no longer be marked at par (as appears to have been the case) in computing the balance sheet hole if market disposal is contemplated. Carswell uses the phrase ‘heavy discounts’ and on the face of it the cost of funds, minus the c. 2% return on these mortgages, put them well under water. There are moving parts – the ECB funds are cheap, for example, and the replacement liabilities, and their cost, is unknown.

The banks wrote a very large piece of derivative business when they extended these mortgages and did not (or could not) hedge, so far as I can see. The risk is in the form of an uncovered exposure to an interest rate spread beyond their control. It looks as if this is about to be marked to market.

The front-page lead in yesterday’s Sunday Independent consisted of a souped-up summary by a journalist of an article I wrote for the same edition. The souped-up version has got some coverage today on Alphaville, Bloomberg etc. Here’s the full version: 

http://www.independent.ie/opinion/analysis/in-keeping-with-halloween-heres-a-scary-one-2401299.html

The post hoc attribution of market movements to specific events is always a bit speculative. But Thursday’s release of weak Q2 national accounts (Economy Shrinks Shock!) was headlined in Irish and international media and appears to have unsettled the secondary market in Irish government bonds. The 10-year closed around 6.65 on Friday, the worst close of the crisis to date and cue panic stations.

This makes sense if

(i) The prospective growth rate in 2011 and later is critical for fiscal sustanability, which is reasonable, and

(ii) A sensible person would have revised their expectations on the basis of Thursday’s release, which I think is not reasonable at all.

So far as I know, there have been just three technical studies of the Irish quarterly data since the CSO commenced publication in 1997 and which are relevant to this discussion.

In this paper, the conclusion here is that the Irish quarterly GDP and GNP numbers are very volatile, and considerably more so than is the case in other OECD countries, including smaller ones.

This study concludes that the seasonal adjustment procedure used by CSO is (probably) not the best, and that this can make a difference, in the sense that an alternative, and preferable, procedure can give results which sometimes alter the qoq % changes quite a lot.

The final study shows that revisions to the first-shot estimates, while no greater than elsewhere, can be substantial.

The economy sank like a stone through 2008 and 2009. The last three qoq % changes in real GNP, using the CSO’s seasonal adjustment, were -1.9, then -1.2 and just -0.3 for the most recent Q2 number. Using the alternative (indirect) seasonal adjustment, the most recent number was -0.1. A reasonable headline in either case would have been ‘Economy Now Flat’.

The reason for the Shrinking! headlines was the GDP numbers. The last three qoq changes read -2.5, +2.2 and -1.2. These are the qoq changes, not annualised. At seasonally adjusted annual rates (saar) the decline in real output in Q4 was -9.6%. It then grew at a saar of +9.1% in Q1 of 2010, relapsing to a saar of -4.7 in Q2. If you really believe this, maybe you could make it as a bond dealer.

The gyrations in the quarterly numbers are just not credible. Various people including Garret FitzGerald and Robbie Kelleher have speculated that real output measurement in the MNC sector is mainly responsible for the extreme volatility. There may be a bit of informal smoothing practiced by other countries too.

Forecasts of GDP growth for 2011 seem to be mostly in the 2% to 3% range. My point is not that these forecasts are likely or plausible. The point is this: given what we know about the behaviour of the Irish quarterly macro aggregates, whatever your figure was on Wednesday, there was no good reason for changing it on Thursday morning.

The President of the High Court, Justice Nicholas Kearns, has established a working group to explore the alternatives to Ireland’s system of lump-sum compensation for accident victims. The group is headed by another judge of the High Court, Justice John Quirke, and has been asked to report by end-year.

The lump-sum system has been modified across the water, where the courts can award recurring payments, in practice index-linked annuities, with or without the agreement of the parties. I argue in the paper below that we should consider following suit in this country.

 http://www.ucd.ie/t4cms/wp10_23.pdf

Karl Whelan has posted on this question, querying the non-removal of Anglo management after the guarantee at end-September 2008. One rather strange manouevre has been commented on by Cliff Taylor in the Sunday Business Post (I can’t locate the piece: Cliff writes a lot, for an editor).

What appears to have happened is this. In May 2008, Anglo borrowed in Yen to finance an asset position in £ Sterling, and ran the position uncovered. There was some tax angle. Yen interest rates were well below sterling rates. By end-September, the Yen/Sterling exchange rate had moved adversely but not disastrously. But the movement accelerated and the deal was unwound at substantial cost a few months later. The following is from Anglo’s 2009 accounts, page 62.

Included within foreign exchange contracts is the impact of a non-trading Japanese Yen financing arrangement, which was first

entered into in May 2008 and ended during December 2008 and January 2009. The financing arrangement was intended to

reduce the Group’s overall net cost of funding and was structured in a manner which was anticipated to result in no net after

tax loss for the Group arising from currency fluctuations. In the six months to 31 March 2009 the arrangement resulted in a pretax

loss of €181m but an after tax benefit of €17m. However, due to the significant operating losses incurred by the Group in

the nine months to 31 December 2009, €97m of taxation benefit has not been recognised resulting in a pre-tax loss for the

fifteen month period to 31 December 2009 of €181m (30 September 2008: €31m) and an after tax cost of €80m

(30 September 2008: gain of €6m). The potential benefit of these losses carried forward is a component of unrecognised

deferred tax assets in note 35.

Not being an accountant, I am unable to translate this into English, but it looks like an uncovered foreign exchange carry-trade punt that went wrong. Of the €181m hit, €150m occurred after end-September 2008, at which point there could have been no plausible expectation of profits to shelter, assuming that the tax angle is, or was, serious. Thus Anglo would appear to have run a naked forex position post the guarantee, and dropped €150 m in the process. No doubt there is a more detailed explanation to be given, but it sure looks like gambling for redemption. On October 5th. 2008, I wrote the following in a piece in the SBP:

  ‘All six of the domestic banks have been given an identical vote of confidence and none has been allowed to fail. This is both unjust and potentially costly, since any bank close to insolvency now has an incentive to throw more dice, without capital at risk’.

The Commission of Inquiry will have a long agenda, but this costly Anglo forex manouevre deserves a slot somewhere.