Author: Karl Whelan

Talk at Irish Taxation Institute Event

I gave a talk last night at “The Big Tax Debate” organised by the Irish Taxation Institute. Here are the slides.

The opening slides do some calculations of where the government is starting from when preparing the next budget. Taking out the €3 billion in adjustments that had been pencilled in last December, the starting deficit would have been 11.8% of GDP. Adjusting for the lower nominal GDP projected in 2011 by the Central Bank, this rises to 12.4%. Subtracting a billion from tax revenue because nominal GDP growth is projected to be €4 billion less than in the December 2009 budget and the projected deficit becomes 13%.

These figures exclude payments on promissory notes because the full cost of the notes issued so far is getting incorporated into this year’s General Government deficit. However, the payments will be real cash flows and international markets will be aware that they increase our borrowing requirements. So, while one can argue that it may not be appropriate to point to our projected 32% deficit for this year as the correct measure, one can’t also keep excluding the banking-related payments as though we are never paying for the banking crisis. Adding on €2 billion a year for promissory note payments (my guess, based on €30 billion in payments spread over 15 years—no I don’t know what the correct figure is because it hasn’t been released) the underlying deficit rises to 14.2%.

One adjustment I didn’t make was for higher borrowing costs than projected in 2009. In any case, you get the picture. You don’t have to be brought into the Department for secret talks to see that the starting position for the deficit is an extremely serious one and that adjustments of €5 billion are probably the minimum required to establish a credible downward path.

I think this point, that we need to credibly get back to sustainable levels of the deficit in the next year or two, is far more important than the other popular debate about whether we should have a four-year plan or a seven-year plan for getting back to 3%. Colm Keena correctly quotes me in today’s Irish Times as saying that I don’t think anyone believes that we are going to reach a 3% deficit in 2014. That’s been my experience, perhaps others know people who do believe this. Either way, the 3% is an arbitrary figure and when we reach it is not the crucial point.

Of course, if the Commission insists that all our plans end up with 3% in 2014, then that’s the way they will be written. However, what’s far more important is that we can convince people that the deficits for 2011 and 2012 are going to be well below the starting point we’re looking at right now.

Finally, as an aside, Keena also quotes me as saying “On efficiencies in the public service, Prof Whelan said there was no need for any more reports. He believed the Government was not serious about the matter.” I’m pretty sure I didn’t say the latter. In fact, I suspect the government are probably more serious on this matter than those who claim enormous savings can be made from efficiency gains in the public sector. The point I was trying to make was that we should try to get some clarity as to how much, or how little, we can save from public sector efficiency improvements. And then we should implement them.

About The €7.5 Billion Cumulative Adjustment Figure

There has been a lot of reporting about how the cumulative adjustment for the next few years is going to be higher than €7.5 billion and how this was the figure that was announced at the time of the last budget.

I was a bit puzzled by this reporting because I had been under the impression that the figure for cumulative adjustments was €8.5 billion. Here’s why. Here’s the Stability Programme Update released at the time of last year’s budget, which is the document provided to the European Commission to illustrate the details of our multiyear plan.

Click on the document and go to page 19. Table 9 describes €3 billion per year in additional measures to be “delivered” in 2011 and 2012 as being made up of €1 billion per year in capital program adjustments that were “already identified and incorporated into the base” and €2 billion per year of additional adjustments.

For this reason, page 20’s description of the adjustments in future years shows €2 billion in 2011, €2 billion in 2012, €1.5 billion in 2013 and €1 billion in 2014, which adds up to €6.5 billion. However, since Table 9 tells us that an additional €1 billion a year in capital adjustments had been identified and incorporated into the base, I had believed the profile for total adjustments planned was €3 billion in 2011, €3 billion in 2012, €1.5 billion in 2013 and €1 billion in 2014, which adds up to €8.5 billion.

However, it turns out that the baseline for capital spending is a continuation at prevailing levels. Table 10 shows Gross Voted Capital falling from €6.445 billion in 2010 to €5.5 billion in 2011 and staying there afterwards. You can add this €1 billion cut in 2011 to the €6.5 billion identified elsewhere in the table to get to the €7.5 billion.

What about the additional €1 billion of capital spending cuts that Table 9 tells us had been identified and incorporated into the base from 2012 onwards? Apparently, the 2012 element of these “identified cuts” doesn’t exist. (It appears that someone in Finance mixed up their levels and changes.)

So, €7.5 billion is indeed the correct figure. However, those of you who, like me, had thought that the government had been planning €3 billion in adjustments in 2012 haven’t had it right.

Honohan-Supported-Guarantee Talking Point Still Going Strong

Stephen Collins writes in today’s Irish Times that “Fine Gael also had the courage to support the bank guarantee which, despite the Anglo shambles, was in principle the right thing to do as the governor of the Central Bank, Patrick Honohan, has repeatedly said.”

The guarantee was perhaps the most momentous policy decision in the history of the state. Unfortunately, the standard of commentary on this decision from prominent media columnists has, in general, been pretty lamentable. Here, Mr. Collins repeats a talking point that has been rolled out repeatedly by government TDs. Well, repetition of a talking point doesn’t make it true.

As I’ve noted here and elsewhere, there is a world of difference between Honohan’s support for a guarantee and the idea that he supported the guarantee that was actually put in place.

And again contrary to a widely repeated talking point, Honohan’s primary objection to the form of the guarantee was not the inclusion of subordinated debt but rather the inclusion of almost all existing long-term bonds. He argued that this inclusion “complicated eventual loss allocation and resolution options” and that it “pre-judged that all losses in any bank becoming insolvent during the guarantee period – beyond those absorbed by some of the providers of capital – would fall on the State.” In other words, it worsened the cost of what Collins calls “the Anglo shambles.”

These comments were consistent with Honohan’s previously-expressed opinions on this issue, as shown for example in this article published in the Economic and Social Review in 2009, published a few months before he was appointed Governor.

No public indication has been given that the authorities gave serious consideration to less systemically scene-shifting – and less costly – solutions. For example, they might have provided specific state guarantees for new borrowings or injections of preference or ordinary shares – approaches that were widely adopted across Europe and the US in the following weeks.

Footnote 15, placed after the word “costly” in the above paragraph, reads as follows:

Blanket guarantees are among the “accommodating” approaches to crisis policy shown by Honohan and Klingebiel (2003) to have added considerably to the fiscal costs of banking crises around the world.

The working paper version of this 2003 publication is available here.

We also know now from the documents released by the PAC, that the form of the guarantee that was given was not recommended by the government’s own advisors Merrill Lynch, nor is there evidence that senior civil servants were recommending this approach either. So, at this point, the last refuge for those who want to argue that the government’s approach on September 30 was the right decision is this misleading Honohan-supports-it talking point.

For what it’s worth, also, I think one could argue just as strongly that it was Labour who showed more courage in objecting to the guarantee: Indeed, to this day, Labour are still getting flak from government politicians and commentators like Collins for failing to fall in line with the consensus to support the guarantee. Moreover, my understanding of Fine Gael’s position at this point is that they consider themselves to have been essentially misled by the government into supporting the guarantee.

Borrowing Rates from The EFSF

Today I re-read this piece that Wolfgang Munchau published in the FT on September 28th. Titled “The Truth Behind the EFSF” at Eurointelligence and “Could Any Country Risk a Eurozone Bail-Out?” at the FT, it concludes that countries that tap the facility will have to pay interest rates of about 8 percent. If this were true, then countries like Ireland could face very substantial financing costs even after seeking help from this fund, which would make successful stabilisation all the harder.

Looking into this issue, it seems to me that Munchau’s assertions about borrowing rates from the EFSF are not correct. By my calculations (see below) the EFSF borrowing rate would be a bit below 6 percent. Now this is still very high but given the large sums that would be involved if the facility swings into action (financing budget deficits and bond redemptions for three years) this difference is likely represent a significant amount of money.

Munchau calculates his 8 percent figure as a 4 percent cost of fundraising for the EFSF plus 350 basis points for administration charges and lending margins and an additional 50 basis points related to the fact that the EFSF will be holding back some of the funds raised as a “cash buffer.” While fundraising costs, administration charges and lending margins and the cash buffer do all come into calculating the correct borrowing rate, my read of it is that Munchau’s calculation isn’t accurate on any of these three figures.

I’ll admit, of course, that this stuff is pretty complicated, so let me start with providing the official sources and then people can tell me if I’ve got it wrong.

Continue reading “Borrowing Rates from The EFSF”

The Irish Banks and the ECB

On Friday, the Central Bank reported (in Table A.2 of its Credit, Money and Banking statistics) that its lending to euro area credit institutions as part of the ECB’s monetary policy operations jumped from €95 billion in August to €119 billion in September. This represents one-fifth of the total amount of ECB lending that took place in September.

I have put together some charts here that illustrate what is going on with Irish bank borrowing from the ECB. First, some technicalities. The release reports (on Table A.2) how much ECB-related lending the Irish Central Bank did. It also reports (on Table A.4) how much ECB-related borrowing our banks did but these tables are a month behind. The first chart, however, shows that the two series are pretty much the same most of the time and they have been very similar lately. (I’m not sure what makes up the difference. It may be a statistical discrepancy or it may be due to different reporting periods.)

The second chart shows ECB borrowing by Irish banks broken down into the Domestic Banking Group (taken from Table A.4.1.) and the rest (essentially meaning IFSC institutions.) Non-domestic bank borrowing from the ECB has been pretty stable lately. Also, there’s little secret as to why the domestic banks needed to borrow more from the ECB during September: Many of the bonds issued under the September 2008 guarantee matured last month when the original guarantee expired. The banks were not able to issue new bonds to roll over the maturing bonds and so much of the funding to pay off September’s maturing bonds came from ECB borrowing.

The final chart shows the total share of Eurosystem lending accounted for by the Irish Central Bank and also shows the fraction of Eurosystem borrowing accounted for by the domestic banks. I have assumed in this chart that the €24 billion increase in September’s ECB lending from the Irish Central Bank all went to the domestic banks, so I’m issuing a health warning about the last point on the green line: This is not data, but rather my guess as to what this series will show when released next month. Health warning issued, it looks as though the fraction of Eurosystem borrowing accounted for by the Irish banks probably reached about 14% as of September. This would be the highest fraction yet accounted for by these banks.

What happens now? Unfortunately for the Irish banks, there are signs that the ECB is considering taking steps to end the dependence on its liquidity operations of banks that can’t get bond market funding. The last month has seen a plethora of newspaper articles prompted by the ECB insiders briefing journalists using the phrase “addict banks” to describe those banks still dependent on Eurosystem operations.

Now, this weekend, the ECB has issued a statement that would be barely understandable to most people but that the Financial Times have interpreted, probably correctly and based on briefings, as opening up the possibility of taking action against the “addict banks.”

Digging into the announcement, one can see why there may be cause for concern among the ECB-dependent banks. The relevant document that has been approved is Guideline ECB/2010/13, which is amending Guideline ECB/2000/7. Checking out what exactly is being changed requires a tedious checking over and back between the two documents and I can’t claim to have spent all of my Sunday on this. However, a couple of changes stand out as being potentially very serious for ECB-dependent banks.

Section 2.4 of the original 2000 guidelines could already be invoked as a reason to cut off funding for certain banks because it says that “the Eurosystem may suspend or exclude counterparties’ access to monetary policy instruments on the grounds of prudence.” (Counterparties means banks borrowing from the ECB.) The new guidelines supplement this with the potentially ominous “Finally, on the grounds of prudence, the Eurosystem may also reject assets, limit the use of assets or apply supplementary haircuts to assets submitted as collateral in Eurosystem credit operations by specific counterparties.”

A bit more clarity about the prudence business is provided later on in the new guidelines. Box 7, under the heading “Risk Control Measures” previously contained the line “The Eurosystem may exclude certain assets from use in its monetary policy operations.” This has now been augmented to include “Such exclusion may also be applied to specific counterparties, in particular if the credit quality of the counterparties appears to exhibit a high correlation with the credit quality of the collateral submitted by the counterparty.”

Since the Irish banks are submitting NAMA bonds as collateral to the ECB, as well as securitised loan books formed from turning large amounts of Irish loans into marketable securities, it could be argued that they fit the bill for being counterparties who are offering up collateral whose credit risk is highly correlated with the credit risk of the counterparty itself. As such, they could be forced to reduce their borrowings from ECB if it is decided to exclude some of the collateral that they are offering up to get access to ECB funds.

This may just be tough talk from the ECB. But if it’s not, then it raises the very serious question of what exactly needs to be done to allow the Irish banks to access funds on the international bond markets.