The Irish Economy

The Irish Times ran a series on water services in Ireland.

The first article is perhaps the most interesting. It leaks the yet-to-be-published report on the water sector by PWC. PWC will apparently be fairly critical of the current system, which nicely fits with the plans by the Minister for a radical overhaul. There will be more investment in water infrastructure. There will be a water regulator. Word on the street has that the Commission for Energy Regulation will have its mandate extended to water (but not to transport). There will be national water utility. Bord Gais, Bord na Mona and the National Roads Authority are bidding to run Irish Water. Only Bord Gais has experience in mass retail.

The piece discusses the transfer of Shannon water to Dublin, but the Minister disappears from the story at that point. I would think that we first want to promote water conservation and fix the leaks.

The piece is silent on the future role of the county councils in water. If Irish Water runs the show, what will happen to the water infrastructure owned by the county councils? What will happen to the civil servants who run this?

Another article wonders what will happen to the private water schemes. Will they be nationalized? Will households with a private well and a septic tank have to pay the water charges? That would be grossly unfair.

The inspection fees for septic tanks are unfair too. Us city folk poo for free — or rather, waste water services are covered from general tax revenues. That is, septic tank owners pay for urban waste water, but city dwellers do not pay for rural waste water.

The second main piece is on drinking water quality, the problems with which are typically overlooked even though they are serious.

The third main article is on water meters. It is summarized in an editorial, and repeats a number of points I made in August. My main concern is the plan for the centralized roll out of water meters. I think that it makes more sense to have people install their own meters and let these meters use the same communication network as the smart electricity and gas meters. See the discussion here.

Conor Pope cites 1000 euro per household per year. I said that. If we maintain the current spending on water (incl. investment), if we keep the business rates for water as they are, and if we exempt those on private schemes from the water charges, then full cost recovery (as required by EU legislation) implies an annual charge of 500 euro per household per year.

If Italy is to be the Euro’s last stand, then a huge amount appears to be riding on hopes that “structural reforms” can get Italian growth going.  This paper from Daniel Gros provides reasons to be sceptical.

I think Daniel’s focus on the link between governance failures and growth is a bit speculative. Still, his conclusion that “it will be difficult to organise a sustained effort to combat corruption, foster adherence to the rule of law and improve the efficiency of the administration in general” might be too negative.

If the worsening of governance and control of corruption is associated with the rule of Berlusconi, then Daniel’s arguments would imply that his departure may have greater economic benefits than currently anticipated. Alternatively, a return to short-lived and unstable coalitions may just make things worse.

Anyway, it’s worth reminding our readers that economists don’t have a good track record at explaining differences across countries in long-run growth rates. Those claiming to have the recipe to produce a spurt in Italian growth while simultaneously imposing fiscal austerity are largely relying on guesswork.

On the afternoon that marks the beginning of the end of the Berlusconi era in Italy,  Gideon Rachman’s piece in today’s FT seems no more than an acknowledgement of the realities now facing us.

I got some flak the other day for this post on the EFSF’s fundraising efforts for Ireland because some people figured there was no problem. At this point, though, there does seem to be an issue. See here and here.

I have posted some thoughts on the potential Greek referendum over at the IIEA’s blog.

Papandreou says

“We have faith in our citizens, we believe in their judgment and therefore in their decision,” Mr Papandreou said after rejecting a call for early elections by some socialist politicians. “All the country’s political forces should support the [bail-out] agreement. The citizens will do the same once they are fully informed.”

Does he believe this? What are the implications for the euro?

This is hardly confidence-inspiring news. EFSF is supposed to save the Eurozone and offer Ireland cheap and long-term funding. What if the markets decide not to play ball and decline to offer the facility sufficient funding at low rates or long maturities?

The eurozone rescue fund has scaled back a planned bond issue designed to finance the bail-out of Ireland amid uncertainty over the level of demand.

The offering will provide a key test of investor sentiment after the announcement last week of new plans to tackle the eurozone debt crisis.

The bond from the European Financial Stability Facility will only target €3bn, instead of €5bn, and will be in 10-year bonds rather than a 15-year maturity because of worries over demand. A 10-year bond is more likely to attract interest from Asian central banks than a longer maturity …

Already delayed from last week, EFSF officials decided to price this week because market conditions could deteriorate if they held off any longer.

The bond is expected to price at yields of about 3.30 per cent, and about 130 basis points over Germany, the European market benchmark. This is a big mark-up since the middle of September when existing 10-year EFSF bonds were trading around 2.60 per cent and only 70bp over Germany.

Not good.

Update: Eoin points us to an Oct 13 statement indicating they intended a €3 billion issue. Thanks Eoin. It appears the FT over-egged this one. They’re probably right about the delay, the reduced maturity and the higher yield

Here’s the official statement from last night’s summit. Other materials are here.

Someone asked me today how a Greek-style haircut for private bondholders would impact on the Irish debt situation if applied here. Without any claim that this is a prediction for what could happen to Ireland, or a policy recommendation, here are the calculations.

While the figure grabbing the headlines is the 50%-60% haircut for private holders of Greek sovereign bonds, it appears that the bonds bought by the ECB will not be written down, nor will the IMF loans. FT Alphaville discuss a UBS report that calculates that a 50% haircut for private bondholders actually implies a 22% reduction in total debt.

In Ireland’s case, the latest EU Commission report estimates (page eight) that our year-end general government debt will be €172.5 billion or about 110 percent of GDP. The report also estimates that by the end of this year, we will owe €38.2 billion to the EU and IMF.  (Table 4 on page 23).

We don’t know how much Irish sovereign debt the ECB own but it’s believed to be a large amount. I do remember a report from Barclay’s claiming they owned €18 billion by June 2010. Let’s say ECB owns €22 billion of Irish debt (that’s just a guess, I really don’t know). Combine that with €38 billion from EU-IMF and you have €60 billion in debt that wouldn’t be getting a haircut. Better guesses of ECB holdings of Irish sovereign debt are welcome.

Now apply a 50% haircut to the remaining €92.5 billion of our debt and you reduce the debt by €46.25 billion, or 29 percent of GDP, getting the debt ratio down to 81 percent. (Of course, we’d still be running large deficits, so it would start increasing again.)

So that’s the answer. Perhaps worth noting, however, is that an alternative method of writing down Ireland’s debt by close to 30 percent of GDP without haircutting private bondholders at all would be to have Anglo’s ELA debt to the Central Bank of Ireland written off.

According to its interim report Anglo owed €28.1 billion in ELA at the end of 2010 but this had risen to €38.1 billion by the end of June. This is because Anglo transferred €12.2 billion in NAMA senior bonds to AIB in February to back the deposits that were being moved out of the bank.

On July 1, Anglo was merged with Irish Nationwide Building Society (INBS) to form what is now called the Irish Bank Resolution Corporation (IBRC). As of the end of 2010, INBS had €7.3 billion in loans from the ECB. However, €3.7 billion of this was backed by NAMA bonds and other assets that were transferred to Irish Life and Permanent. INBS has been in receipt of ELA since February to replace this lost funding. While this has been admitted by a Department of Finance official (see this story) the exact figure has not been released. I assume it is about €4 billion.

So my estimate is that the IBRC now owes about €42 billion in Emergency Liquidity Assistance to the Central Bank of Ireland. If the European authorities ever decide they like the idea of haircuts for Irish debt, it would be fair to ask which of a fifty percent haircut or a write-off of ELA would be more likely to damage Ireland’s reputation or cause financial market contagion.

New mortgage lending in Ireland in 2011 is on course to set record lows, with the number of new mortgages lower than any year back to the early 1970s. The conventional wisdom is that this is due to a temporary reluctance on the part of Irish domestic banks to issue normal amounts of normal-quality residential mortgages. Under this conventional view, Irish domestic banks must currently pass up otherwise profitable mortgage opportunities because of the banks’ temporary shortage of liquidity and the need to shrink their balance sheets. They are operating under a liquidity constraint. They cannot issue many residential mortgages even though they would profit from doing so. In the circumstances they are rationing their constrained liquidity, only issuing unusually high-quality (that is, super-safe) “gold-plated” residential mortgages to the first tier of very-low-risk applicants. Under this conventional view, once liquidity in the Irish domestic banks is back to normal, the banks will return to issuing normal amounts of normal quality mortgages, servicing a much broader range of customers.

The conventional view may be correct, but I wonder? Is it possible instead that the “normal” Irish residential mortgage is gone forever? Might the “gold-plated” mortgages of 2011 become the only ones available? If so, there are many policy implications, hence it is advisable to consider the possibility. I will give three reasons for speculating that “normal” Irish mortgage contracts might not come back until after Godot.
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There are a lot of reasons why attention has turned to the idea of leveraging EFSF via one of a number of possible methods. If this can be done, it takes a big step towards solving both the solvency and liquidity issues plaguing Euro area sovereigns and banks – on the liquidity front, a €2 trillion or €3 trillion fund is big enough to buy up Spanish and Italian bonds for a number of years, while €440 billion is big enough to absorb a lot of the potential losses.

The financial press are abuzz with various mechanisms that could be used to leverage up the EFSF. However, I was surprised today to twice read that Gros and Meyer’s proposal to have EFSF (or some vehicle funded by EFSF) register as a credit institution and borrow from ECB is likely to be illegal.

The Wall Street Journal reports

Klaus Regling, chief executive of the European Financial Stability Facility, told a podium discussion that “there are serious concerns” that such a scheme wouldn’t be allowed under the EU Treaty, which forbids the ECB from financing governments directly.

And at the FT’s Money Supply blog, Ralph Atkins writes

But Jens Weidmann, Germany’s Bundesbank president and ECB governing council member, has already made clear his opposition. Giving the EFSF access to ECB funding, Mr Weidmann argues, would be “monetary financing” – central bank funding of governments – which is banned under European Union treaties …

More crucially, an ECB legal opinion issued in March made clear that the European Stability Mechanism – a permanent fund expected to replace the temporary EFSF from 2013 – would not be allowed access to its liquidity because of the ban on monetary financing. “The ECB recalls that the monetary financing prohibition…is one of the basic pillars of the legal architecture of economic and monetary union,” its lawyers wrote then. I am not a lawyer, but to me that would also rule out giving the EFSF access.

The ECB legal opinion states

Article 123 TFEU would not allow the ESM to become a counterparty of the Eurosystem under Article 18 of the Statute of the ESCB. On this latter element, the ECB recalls that the monetary financing prohibition in Article 123 TFEU is one of the basic pillars of the legal architecture of EMU

Of course, we in Ireland have been here before. Back in 2009, a number of very serious people assured us that nationalising any banks would be inadvisable because the ECB was prohibited under the monetary financing clause from lending to nationalised banks. (That Anglo were at the time borrowing in a big way from the ECB didn’t seem to get in the way of what seemed like a great argument).

As I pointed out back then on a few occasions (e.g. here and here) this wasn’t true because while Article 123 of the current consolidated Treaty on the Functioning of the European Union states

1. Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

This is immediately followed by

2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions.

So while the ECB may recall the monetary financing prohibition, you could argue that they don’t recall it very well.  One could quibble that EFSF is not currently not a “publicly owned credit institution” but it’s hardly high octane financial engineering to create a vehicle funded by EFSF that counts as such.

To Paul Krugman’s recent posts on Ireland and the Baltics, I would add two points.

1. Ireland’s quarterly GDP data are notoriously volatile.

2. Ireland is a small, open economy, and it is by common consent a relatively flexible economy. It is also an economy in which labour is both inwardly and outwardly mobile. And yet unemployment here is now running at 14.5%. So do we really think that the Irish experience can be used to argue that the austerity/internal devaluation medicine is appropriate for countries like Greece or Italy?

The latest collection of briefing papers for the European Parliament’s Monetary Dialogue with the ECB are available here (click on 4.10.2011). There are nine papers (including one by me) discussing Jean-Claude Trichet’s term as ECB President and the challenges facing his successor.

Feasta (The Foundation for the Economics of Sustainability) are holding an interesting conference on Thursday and Friday of this week titled National Strategies for Dealing with Ireland’s Debt Crisis: Exploring the Options. The webpage for the conference is here and the conference programme is here.

Many will have heard Alan Ahearne on Morning Ireland explain why we should try to work our way out of the crisis by ’sticking to the plan’.  He clearly believes that the Eurozone will survive in its present form and that the costs of Ireland defaulting and/or unilaterally leaving the currency union would far outweigh the benefits.

In their recent ESRI publication, John FitzGerald  and Ide Kearney set out in some detail why they believe the Irish debt problem is manageable and why we should should stick to the plan.  This was already posted by Philip Lane and has been discussed here.

Nouriel Roubini, on the other hand, believes that ’sticking to the plan’ has no chance of working in Greece, so it should organize an orderly default and re-introduce the drachma. Some of the arguments he makes are compelling and many of them apply with some force to Ireland, especially the difficulty of restoring competitiveness and growth through a deflationary internal devaluation.

We need to evaluate the prospects for the Eurozone and our place in it.

It would be wrong not to have a thread on the latest unemployment and emigration data.

Together with the recent data on our consumer price level, relative to the rest of the EU, they show (as if there were any doubt on the matter) that even in small, open, flexible Ireland, the current poster boy for the EU’s preferred austerity/internal devaluation strategy, wage and price flexibility — while impressive — isn’t what certain macro theories assume it to be.

Here’s the latest from Willem Buiter and Ebrahim Rahbari on the future of the Eurozone.

Here is the latest from Barry Eichengreen, who is a busy man since he will be giving his Presidential Address to the Economic History Association this evening. Congratulations Barry.

But do be careful Barry, go too far down this road and you’ll have the Irish Times accusing you of being on the far left or far right.

This excellent post by Karl deserves a thread of its own.

Karl is quoted here as saying that the Franco-German proposal that we insert borrowing limits into the Irish constitution will not solve our current debt problems. This is obviously correct, as is the point that such an amendment would not have made a blind bit of difference during the bubble years.

There is also the point that a constitutional amendment is a much bigger deal in Ireland than in some other countries, since it can only be changed by means of a new referendum.

Here are two questions:

As per Derek Scally in the Irish Times, is this a taste of things to come, or much ado about nothing?

What are the chances of the Irish government winning such a referendum?

No.

In the drive to fiscal policy coordination, the potential of fiscal spillovers should feature more heavily, especially for small open economies like Ireland. Sadly they don’t, as this new research shows. Other models hold out more hope (but in a static setting), but the principal findings are that small open economies can’t rely on larger trading partners to help them overcome large cyclical slumps in output.

Money quote from the first linked piece:

“Even under very high multipliers, a 1% of GDP fiscal expenditure stimulus in Germany would raise the GDP growth in Ireland by only 0.3 percentage points after 2 years, in Portugal by 0.1 percentage points, and have virtually no effect on growth in Greece. Similarly, fiscal policy changes in Germany alone have only a small impact on the trade balance of the peripheral countries, and are thus unlikely to contribute to the reduction in peripheral countries’ imbalances.”

This is worth considering in the context of monetary, and perhaps fiscal, union in the EU. The source document for the spillover calculations is this IMF report.

Nick Cohen is gloomy here.

Roger Bootle gives a market perspective on potential endgames, one of which echoes Paul Krugman, here.

And here is Kantoos, echoing Olivier Blanchard, Ken Rogoff, and many others.

To those who think that an inflation rate of 5%, say, for a few years, would mean the end of the world, one has to ask: is this really the worst potential scenario that you can envisage us facing in the years ahead?

This report from the Guardian is consistent with Thomas Klau’s argument that current eurozone governance arrangements are pushing “democratic debate and voters’ choices to the margins”. It also suggests that in the long run the present way of doing things will prove politically unsustainable, in a union of democratic states. Whether Klau’s preferred solution is likely to come about is another question entirely.

Kantoos is a German blogger who occasionally posts in English; he has a thoughtful response to an earlier piece by Ryan Avent here.

(I would add two comments. First, that when people talk about fiscal union they can mean many different things. And second, that we already have the politically noxious conditionality which Kantoos is worried about.)

Here’s the official statement of the heads of state of the Euro area governments from today’s meeting.

European politicians are engaged in frantic negotiations to deal with both the Greek debt problem and the wider question of the EU’s approach to the problems of peripheral countries.

On the approach to the Greece, I’m not encouraged by the reporting from the financial press which has focused on a bank tax and debt buybacks.

First, we’re being told that the idea of a tax on European banks to raise about €30 billion is emerging as a “popular consensus” approach to getting private creditors to “help pay for the estimated €115bn bail-out”.  As reported, it’s pretty unclear what happens with the €30 billion. Is it loaned to Greece and then later paid back to the banks that paid the tax? If so, it’s not really a tax in the usual sense of the word.  Anyone who understands this is welcome to explain it in comments.

However it’s structured, this seems to be the wrong approach to the wrong problem.  The goal seems to be to keep Greece’s debt burden exactly where it is (thus not solving the key problem) but to reduce the headline number for the size of a second EU-IMF loan (which solves a political problem in some countries).  In relation to private sector “burden sharing”, the approach still seems to view a Greek default as unthinkable (despite almost everyone viewing it as inevitable) while adopting a very strange approach to the demand for “private sector involvement”: Why should banks that don’t own any Greek debt have to pay a tax to contribute to a second bailout?

Maybe there’s a good idea hiding under this reporting: If so, I’m happy to have it explained to me.

Then there’s the increased focus on debt buybacks. The idea of debt buybacks is popular with both politicians and holders of debt. The politicians get to claim that there was no coercive default on the outstanding debt, thus saving face. The creditors usually manage to get the debt bought back at a nice premium to the current market value, so many of them make a tidy profit.

Academics that have looked at this issue generally don’t like debt buybacks. Here’s a short article from VoxEU by some IMF staff. And here and here are two classic older articles written in the context of the 1980s Latin American debt crisis.

To briefly explain why buybacks are not as great an idea as they appear, consider the case of a country with debt and GDP of €100 billion, so the debt ratio is 100%. The market doubts this debt burden is sustainable and so prices the debt at 60 percent of its face value.

Now a programme is announced whereby funds are provided to allow the country to buy back all its debt. Those behind the plan imagine they can go into the market and start purchasing debt at 60c and get the debt ratio down to 60%.  However, because the debt ratio would be sustainable at 60% and at that point the government would be able to pay back all of its debts, there would be no need in such a situation for there to be a market discount on the price of the debt.

So, as the programme is announced and the government intervenes to start repurchasing its debt, the price of the debt would jump above 60c.  The final price of the debt would depend upon a number of factors including the terms on the money being provided externally to fund the programme. But the end result would probably be significantly less debt relief than obtained, for example, by a straight swap of new for old bonds involving a forty percent reduction in net present value.

In relation to the wider Euro area problems, I’m somewhat optimistic that Thursday will see a harmonisation and reduction of EU programme interest rates, extension of maturities, as well approval of EFSF loans for debt buybacks. Personally, I would like to see the remit of EFSF extended to allow it to lend directly to banks, replacing excessive ECB funding as well as Emergency Liquidity Assistance. Of course, I doubt if this is even being considered.

We’ll see what happens but my prediction is that political face saving will take precedence over economically efficient solutions.

Update: The FT has an answer to my question about the bank tax which mixes it together with the buyback plan: “According to officials, it would amount to a 0.0025 per cent levy on all assets held by eurozone banks and would raise €10bn per year for five years. The cash would go to the bail-out fund, which would then use the money to conduct a Greek bond buy-back.”

Colm is at his best in this Sindo column. Best bits:

Plan A has failed to create circumstances in which the three ‘rescued’ countries can return to the markets, the over-riding objective of any programme of official support. Their traded debt has collapsed in price and all three are rated junk by at least one of the bond-rating agencies. They will not be graduating from the programmes of official support anytime soon and the verdict of the markets, the only verdict that matters, is that Plan A is also junk.

The essence of Europe’s Plan A, as first applied to Greece, is to pretend that the problem is less serious than is actually the case, avoid any element of debt relief and insist that budgetary stringency alone will do the trick.

…

Persistence with Plan A and blaming the markets and ratings agencies is not a viable option should Spain and Italy go under. The game is up. Plan A is being quietly abandoned. In this sense, this has been a good week for Ireland.

..

Minister Noonan should now be seeking European support for an end to payments to holders of bonds, guaranteed or unguaranteed, in the Irish banks. Every cent paid to them is at the expense of the holders of Ireland’s sovereign debt, who have been treated in quite cavalier fashion at the behest of the European Central Bank and apparently in response to threats from this unique organisation.

ECB officials come and go but sovereign states need sovereign credit forever. It would be an unmitigated disaster if Ireland’s act of faith in Europe were to result in the first-ever default on the sovereign obligations of the State.

Here’s a link to the Eurogroup statement from last night. This is promising

To this end, Ministers stand ready to adopt further measures that will improve the euro area’s systemic capacity to resist contagion risk, including enhancing the flexibility and the scope of the EFSF, lengthening the maturities of the loans and lowering the interest rates, including through a collateral arrangement where appropriate. Proposals to this effect will be presented to Ministers shortly.

But I’m not holding my breath waiting for an impressive intervention.

The pre-2007 Irishman abroad in Europe had a little swagger to him. He thought his economy was a Tiger. When abroad in Europe, he spent like crazy, and generally annoyed his European counterparts with his brash ways. (Of course I’m not thinking of anyone in particular). The reverse is happening at the moment. We’re humble little chappies. My French and German friends are sending me emails with pictures of the Book of Kells saying ‘please take care of our investment’ and ‘are you enjoying your bailout?’ and ‘we’re still waiting for the thank you card’.

They’ll be waiting a while longer. When I say our European friends should be thanking us, they assume it’s a throwback to the hubris of pre-2007 Ireland or something to do with keeping eyes off the balance sheets of German and French banks. It’s not, and here’s just one reason why.

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I know this is getting silly now and everyone knows what’s going on with the Target 2 debate. Still, it’s entertaining to see Professor Sinn doubling down on his false claims about the operation of the Eurosystem.

By the end of 2010, ECB loans, which originated primarily from Germany’s Bundesbank, amounted to €340 billion.

Em, no. I don’t know how to explain this any better than here. But, like I say, really, honestly, no.

But, he’s on a roll now is Professor Sinn, so now we get a new nonsensical talking point:

If this continues for two more years as it has for the past three, the stock of refinancing loans in Germany will disappear altogether.

Indeed, Deutsche Bank has already stopped participating in refinancing operations. If German banks drop out of the refinancing business, the European Central Bank will lose the direct control over the German economy that it used to have via its interest-rate policy. The main refinancing rate would then only be the rate at which the peripheral EU countries draw ECB money for purchases in the center of Europe, which ultimately would be the source of all the money circulating in the euro area.

I literally laughed out loud when I read this. So Deutsche Bank don’t borrow from the ECB? Who cares? There have always been banks with surplus liquidity and banks that are short of liquidity. That’s why interbank money markets exist.

The fact that the ECB stands willing to make unlimited amounts of short-term loans to all Euro area banks at 1.25% is clearly the key influence on short-term rates throughout the Euro area.  Deutsche Bank may not be borrowing from the ECB but they certainly won’t be able to lend their funds out on a short-term basis at rates that are much higher than the ECB’s.

So ECB rates are clearly setting German short-term interest rates just as they set them elsewhere in the Euro area. (Note also the resemblance between ECB rates and short-term German government bond yields.)

So another scary sounding but ultimately baseless claim from Professor Sinn.