The Irish Economy

Alan Greenspan is presenting a paper at the BPEA conference today - his draft is here.

[The full programme is here.]

Brian Lucey argues for a different approach to solving the banking crisis in this IT article.

The influential Peter Boone and Simon Johnson have written a critique of the Irish approach to rescuing the banking sector: you can read it here.

The latest edition of the Economic and Social Review has been published. The edition contains two policy papers by staff from the ESRI, one by Tim Callan, Claire Keane and John Walsh on property taxes and the other by David Duffy on negative equity. The Irish Independent have “seen Duffy’s report” presumably because they have access to the Internet. Now you can read it too.

The Central Bank’s new Head of Financial Regulation, Matthew Elderfield, delivered his first public speech today at the Leinster Society of Chartered Accountants (text here.). The speech is an impressive statement of intent and forms a very clear break from the past. I was particularly pleased to read this passage:

High impact firms and those with a poor track record should not expect to receive the benefit of the doubt from me or my staff when the best approach to addressing a risk is a point of contention between us. We will have an open and engaged dialogue with a firm’s senior management. But if we remain unconvinced by management’s plans we will be prepared to substitute our prudential judgement for their commercial one and say: Just do it.

This Nike approach to financial regulation could come as something of a shock to our banks.

Ronan has updated his analysis on property yields and its implications for NAMA and long-term economic value. It doesn’t make for comfortable reading. I wonder does Ronan understand the mystery of the standard discount rate …

In the past couple of weeks, the Oireachtas Committe on Finance and the Public Sector met with the authors of the two forthcoming preliminary banking inquiry reports, Klaus Regling and Governor Honohan (Regling was accompanied by his assistant Max Watson). The transcripts of these meetings are now available online here and here.

Bundesbank president Axel Weber gave a speech on “The Reform of Financial Supervision and Regulation in Europe” today at the Institute for International and European Affairs. The Institute has provided the text of Weber’s speech and an audio podcast here.

Update: Thanks to Michael Hennigan for noting that the impressive Mr. Weber also gave a completely different speech to Financial Services Ireland on the same day, titled “Making the Financial System more Resilient – The Role of Capital Requirements.”  Link here.

Following the approval of NAMA by the European Commission, the Department of Finance has published revised guidelines in relation to NAMA’s pricing of assets. This is a revised version of these regulations released before Christmas. Based on a quick read, there are appear to be a couple of changes, both of which show that the Commission is pushing the government towards paying lower prices.

The first relates to the discount rate used to value cash flows when coming up with long-term economic value.  These had provided for an adjustment of 0.8 percent above the relevant government bond rate. This adjustment is now 1.7 percent.  This change will lower the value of the assets.

Government bond rates are, of course, lower now than they were last September. This is probably what the Minister was referring to when he said “There will, however, be a reduction in the interest rates used for loan discounting purposes” a comment widely (and now it seems incorrectly) reported as being related to the Commission’s recommendations. We see now that the Commission’s recommendations, taken on their own, will imply lower prices paid.

The other change I can spot relates to the (to me) mysterious “Standard Discount Rate”. The regulations for this used to be as follows.

The standard discount rate that NAMA shall apply in the calculation of the long-term economic value of all bank assets shall be 2.75 per cent to provide for enforcement costs, and 0.25 per cent to provide for due diligence costs.

The 2.75 percent is now 5.25 percent. From previous discussions, the prize for best answer as to what the standard discount rate was went to Frank Galton: NAMA LTEV = LTEV*(1-Standard Discount Rate). Assuming that’s correct, then this latest change would also imply lower prices. Anyone who understands the standard discount rate (or can see any other interesting changes) feel free to explain it to us.

Paul Krugman’s NYT column focuses on the new Irish Economy Note by Greg Connor, Tom Flavin and Brian O’Kelly.

Colm McCarthy makes a strong case for a bank resolution regime in today’s Sunday Business Post (article here).   If I understand intent of the argument correctly, however, Colm is proposing the regime as a critical element of a new regulatory system for the long term.  He is not proposing it as a means of imposing loss sharing on existing creditors.    Looking to the longer term, he argues that a resolution regime will make it possible to withdraw the guarantee.  

The wide-ranging guarantee of bank liabilities announced at the end of September 2008 runs out in little more than six months. Assuming that the banks have been recapitalised by then, the government can minimise subsequent risk of exchequer cost through getting out of the guarantee business as quickly as possible.

Bank resolution legislation – clarifying the power of the authorities to ensure that all providers of risk capital share quickly and appropriately the losses incurred by failed banks – is an important component in the state’s exit strategy from the banking collapse.

I believe the more pressing issue is to have a resolution regime in place for the period after the current guarantee expires and before existing subordinated bonds mature.  If the banks are insolvent, or at least incapable of reaching minimum capital adequacy requirements on their own, there should be a willingness to impose these losses on creditors, most likely as part of the debt-equity swap long advocated by Karl Whelan.  (more…)

Here’s a new report from UCD’s Urban Institute by Brendan Williams, Brian Hughes and Declan Redmond titled “Managing an Unstable Housing Market” (summary here.)  It supports earlier calculations from NIRSA (see this post from the Ireland After NAMA blog) suggesting a very large stock of empty houses.

Gregory Connor, Thomas Flavin and Brian Kelly write on this topic in Irish Economy Note No. 10.

The Icesave talks have collapsed (Update: Elaine Byrne is right. They didn’t collapse, they just didn’t come to an agreement prior to the referendum.)  Most likely, negotiations will resume after the referendum gets a resounding no. More positively, Iceland’s economy grew by 3.3% in the last quarter of 2009. This is good news. If indeed it is the case that the difference between Ireland and Iceland is one letter and six months, then we should see an economic recovery here during the summer.

The February ECB bulletin carries an interesting article on commercial property markets across the euro area; it is striking to compare the boom-bust cycle in Ireland relative to other countries: you can download the bulletin here.

Sarah Carey’s column in today’s Irish Times does a good job of introducing the public to the Department of Finance’s thinking about the banks as articulated in Slide 11 of the slides from the Minister’s presentation last week. However, I think it will take a lot more than a few op-ed columns to slay the beast that is the Iceland! talking point.

As an aside, for those who can’t get enough of the Iceland!ic banking crisis, here are two reports co-authored by eminent economists written prior to the crisis endorsing Iceland’s fabulous banks. Here’s one from 2006 co-authored by Columbia University’s Rick Mishkin, a former Fed Governor (Best section - “Could Bank Refinancing Be a Problem?”). And here’s one from 2007 co-authored by Richard Portes of the London Business School. (Best section - “The banks:successful and resilient”.)

As another aside, I note that some people were poking fun at the slides. However, it is very unusual for a politician to usual visual aids like this to illustrate their arguments and, based on my observation of his talk at the McGill Summer School, Minister Lenihan uses this material very effectively. So politicians using slides is a good thing: Don’t encourage those who’d recommend the minister keep his head down and deliver a monologue without charts and tables!

The opening statement by Governor Honohan can be read here.

AIB’s preliminary results for 2009 are here. There’s some new NAMA-related information but not much. The bank is transferring loans with previous book value of €23.2 billion to NAMA, down from earlier estimates of €24.1 billion. The provisions of €4.2 billion against these loans, corresponding to an 18 percent writedown, are presumably a holding operation until the actual transfer involving a larger writedown.

In relation to stories about AIB shrinking credit, I heard references on the radio this morning to the bank shrinking its loans to customers from €129.5 billion in 2008 to €103 billion in 2009. This is only correct if one accepts the accounting treatment of the €19 billion the banks expect to receive from NAMA as “financial assets held for sale to NAMA” rather than “dodgy property-related loans that have been written down a bit.” I’m sure the bank is restricting lending but it’s not as easy to get loan books down as fast as the “loans to customers” line suggests.

There are many aspects of the government’s handling of the Anglo Irish Bank fiasco that are open to criticism. However, this doesn’t mean that every Anglo-related criticism of the government is accurate. Today’s Irish Times column by Fintan O’Toole has an appealingly simple argument that I suspect will get repeated a lot in the coming weeks:

Yesterday, Postbank, jointly owned by An Post and BNP Paribas, stopped taking new business. It will close by the end of the year. Its name would suggest that Postbank is actually a bank, but this must be an illusion.

If it were a bank, Postbank would not be allowed to fail. And Brian Lenihan’s reaction to its closure was merely to say that he is “disappointed [his favourite word] but not surprised”.Why does the closure of Postbank get a c’est la vie shrug of the shoulders while the closure of Anglo is so unthinkable that at least €30 billion of public money is being used to keep it, if not actually alive, then apparently undead?

The answer Brian Lenihan would give is that Anglo is of “systemic importance” to the Irish economy, while Postbank is not.

O’Toole then correctly points out that Postbank has lots of branches and customers.

The problem with this argument is that it is based on a confusion of the meaning of the words “close” and “fail” in the context of the banking sector. Postbank is a subsidiary of BNP Paribas Fortis and that bank is not going out of business. Every one of Postbank’s depositors will get their money back and BNP’s withdrawal from Ireland has no implications for its bondholders.

In contrast, when we discuss letting Anglo fail, we aren’t talking about shutting down its nonexistent branch network. What we mean is acknowledging that the bank is insolvent (and Fintan is correct that claims in January 2009 that Anglo was solvent were indeed ludicrous) and then having it declare bankruptcy. Normally, such a decision would lead to Anglo’s creditors not getting all their money back. However, if we did that now, we would face the problem that the Irish government has guaranteed essentially all of Anglo’s liabilities, so no money would be saved for the taxpayer.

My point here isn’t to defend the scale of the September 2008 guarantee or its extension to Anglo but merely to acknowledge that the issues related to Anglo are completely different to those related to Postbank.

Elaine Byrne’s column today also focuses on Anglo with reference to Iceland! She discusses whether, if the Iceland!ic referendum passes, we should follow suit and not pay off Anglo debts. There will be more discussion of this question in the coming months.

There are major decisions still to be taken in relation to reducing the costs to the taxpayer of resolving Anglo and other banks that appear to be only NAMA over-payment away from insolvency. We could decide to just remove the guarantee and let all the banks declare bankruptcy. But this would have, let’s say, some short- to medium-term implications for the functioning the Irish banking sector.

With the September 2008 guarantee set to expire later this year, there is the opportunity in the coming months to arrive at an orderly resolution process in which insolvency is recognised, bad property assets are cleared off the bank balance sheets, providers of risk capital lose money in a way the reduces cost for the taxpayer, and the banks are placed back on a sound footing.

These are very important decisions and the sooner our more influential journalists recognise what the real issues are, the better the public debate will be.

A number of prominent academics testified before the US FCIC last week  - you can download the background papers here.

Here are the slides from a talk the Minister for Finance gave at the Irish Taxation Institute on Friday. Lots of useful material in it, most of which I agree with. Slide 11 is great. It actually says Iceland! (Less fun is the repetition of the de-listing argument as a serious point.)

I guess the news that the Commission has approved NAMA (statement here) will get some attention over the next few days but it’s hardly too surprising. EU guidelines allow governments to introduce an asset management agency of this type and it’s very hard to imagine that the Department of Finance had designed something that wasn’t guaranteed to get approved. However, as I’ve noted before, if you read those guidelines closely, they also suggest that the Commission isn’t in favour of packages that are overly friendly to providers of risk capital.  For instance, the guidelines state

(21) As a general principle, banks ought to bear the losses associated with impaired assets to the maximum extent …

(22) Once assets have been properly evaluated and losses are correctly identified, and if this would lead to a situation of technical insolvency without State intervention, the bank should be put either into administration or be orderly wound up, according to Community and national law. In such a situation, with a view to preserving financial stability and confidence, protection or guarantees to bondholders may be appropriate.

(23) Where putting a bank into administration or its orderly winding up appears unadvisable for reasons of financial stability, aid in the form of guarantee or asset purchase, limited to the strict minimum, could be awarded to banks so that they may continue to operate for the period necessary to allow to devise a plan for either restructuring or orderly winding-up. In such cases, shareholders should also be expected to bear losses at least until the regulatory limits of capital adequacy are reached. Nationalisation options may also be considered.

The relatively tough line suggested by these statements has been evident in the Commission’s rulings on payments to subordinated bonds and on various restructuring plans. This approach undoubtedly limits the government’s ability to overpay for the assets going into NAMA and with the assets falling in price with every passing month, the opportunity to keep the banks from actual or near insolvency via overpayment seems to be slipping away.

In my exchanges with our old friend John the Optimist, I have regularly pointed out economists shouldn’t necessarily be judged on their forecasts and I certainly have made calls here that have turned out to be incorrect. However, I will take this opportunity to point out that tomorrow is the one year anniversary of this column that I wrote for the Irish Times. Among other things which I’d still stand by, the column pointed out the following:

In addition to being unfair, it is questionable whether the bad bank proposal could achieve its goal of properly re-capitalising private sector banks. There may be limits on the price the Government can pay for impaired property loans under EU state aid rules. Banks may still have to write down their assets. It is easy to imagine a scenario where banks struggled with weak capital bases even after a bad bank scheme has been put in place.

And here we are.

The government has appointed an expert group to advise on this important issue (press release here).

What are the suggestions from the readership of this blog for this new initiative?

Today’s media coverage of the Bank of Ireland share issuance contained a number of inaccuracies, which to be fair, probably isn’t too surprising given the complexities of the issues.

On RTE’s Drivetime show, its reporter said that the share issuance occurred because the European Commission was preventing banks from paying dividends on the preference shares. Technically, this isn’t correct. The Commission is preventing banks from paying coupons on subordinated bonds. These bonds, in turn, have dividend stopper clauses and it is these clauses that prevented the payment of the cash dividends.

This is perhaps a technical distinction and it may be difficult to get across the true picture in a short space of time. More misleadingly, however, when I appeared on The Last Word today, I heard Fianna Fail TD Frank Fahey state that the Commission had merely put a hold on cash dividend payments to the government while it is assessing BoI and AIB’s restructuring plans. Fahey thus asserted that in a few months time, AIB’s business plan would have been approved and the government would be receiving the cash dividend from AIB in May.

However, as I noted last week, the coupon stopper is in place “to prevent the reduction of own funds by financial institutions which are still reliant on State aid to fulfil regulatory capital requirements.” It seems likely that AIB will still be reliant on state support in May so by that reasoning the coupon stopper is likely to still be in place.

I’ve been a little surprised that there has been no coverage of the fact that the shares were paid out despite the NTMA CEO John Corrigan and the Minister for Finance both stating in public last week that they could wait to collect the cash dividend. It appears, however, that Bank of Ireland’s own bylaws required it to pay out the shares on the deadline day (see this report by the Independent’s Emmet Oliver). It seems a little strange that Mister Corrigan and the Minister were not aware that the shares were going to be issued.

Governor Honohan’s characterisation of the whole affair as “untidy” seems about right (comments reported on the Six-One TV news). He is, of course, also correct that this payment is small beer compared with the amount of recapitalisation that the banks are going to need after the NAMA transfers. With AIB transferring €24 billion to NAMA, and BoI transferring €15.5 and mooted discounts of about a third, recapitalisation requirements will be a lot more than €250 million. But the fact that €250 million acquires 15.7% of BoI tells us that a far more serious dilution of ownership is on its way.

You can read the latest speech from Governor Honohan here.

Despite NTMA chief John Corrigan’s position last week that the state expected to receive its cash dividend of €250 million from Bank of Ireland at some point soon and so would not be getting ordinary shares in lieu, the Bank has today announced that they will be issuing ordinary shares for this amount to the government on Monday February 22. Announcement here. The Department of Finance response to is here. Hat tip to commenter Frank Galton.

As many of you may have heard, Fine Gael’s Senator Eugene Regan (who’s been having a busy few weeks) submitted a formal complaint about NAMA to the European Commission in January. Last week, Regan followed this up by submitting a detailed discussion of how the NAMA legislation is inconsistent with the EU’s guidelines on impaired asset schemes. The detailed document is here and the summary is here.

The European Commission continues to instruct Bank of Ireland to stop paying coupon payments on lower tiered bonds unless the payments are legally binding. Which brings us back again to the €280 million that is due to the Irish state from Bank of Ireland this Saturday.

The Commission’s request that the bond coupons not be paid triggers a “dividend stopper” clause for the government’s preference shares: These bonds have a claim that is senior to the preference shares, so this clause ensures that the holders of preference shares can’t get paid before them. This means we won’t be getting €280 million in cash from BoI this weekend.

(more…)

There is a new CEPR report on this topic -  this VOX column provides a summary.

The Central Bank have released a new paper by Yvonne McCarthy and Kieran McQuinn (link here) that uses data from the 2007 Survey of Income and Living Conditions (SILC) to describe how various types of households were coping with their mortgage burdens on the eve of the economic crisis. The paper also applies various techniques to estimate how these burdens may have changed since 2007.

I think this type of work is vital for gaining a better understanding of the extent of the upcoming mortgage default problem. It would also be crucial that data of this type be utilised if the government do wish to design a mortgage modification program, as discussed earlier here and here.