I found this quite depressing. He doesn’t want to cut interest rates further for fear of falling into a liquidity trap???
In addition to harming the overall Eurozone economy, this sort of attitude, if it prevails, will be particularly damaging to Ireland because of its implications for exchange rates. And it will I think set in motion serious protectionist forces in this continent, with the potential to do great damage to the international economy in the years ahead.
Alan Ahearne is today’s contributor to the Irish Times series: “Income Tax Rates Will Need to Rise.” (As usual, headline does not give full flavour of the article.)
The fiscal plan of Fintan O’Toole is also worth reading: “Government Reaction to Crisis Needs to be Credible.” A longer version of this article would have been even more interesting, in which the economic consequences of the pay element of his plan might be explained in more detail.
I am pleased that Dan Donovan (a highly-experienced trader in the financial markets) has taken the time to write an explanatory note on some of the most important features of the sovereign CDS market. See his contribution below.
From Dan Donovan:
As the current malaise in the credit markets unfolds one of the rapidly emerging issues has been the markets concern about various sovereign solvency issues, most particularly with regard to the ability or otherwise of countries to be able to pay for the varying forms of bank guarantee’s they have proffered.
Most agents seeking to express views that sovereigns would be unable to meet their commitments and or that the cost of doing so will escalate have been doing so via the Credit Default Swap market; buying “insurance” against the default of the named sovereign. It is note worthy how quickly and dramatically the cost of this insurance has escalated.. Ireland as can be seen below (ex Iceland) has borne the brunt of this position taking.
Port 134/144 130/150
Ital 177/187 172/182
Gree 260/290 255/285
Spa 148/158 145/160
Irel 260/300 240/290
UK 140/150 137/147
Denk 109/119 108/120
Swe 110/125 115/130
Aust 145/155 145/145
Ger 56/66 56/66
Fran 63/73 64/74
Finl 55/65 57/67
Belg 115/135 113/133
Neth 105/125 105/120
Iceland 925/975 800/1000
Source JP Morgan.
It is tempting to dismiss such moves as merely a thin market overreacting to the current zeitgeist, for instance it now costs roughly 3 times as much to insure against a default of the UK government as it does to insure against the default of Cadburys! There are however some important issues to consider regarding the implications of such moves.
Price Setting: Many participants in the market are able to switch between writing CDS insurance and buying Government bonds. As such the CDS market which is more active than the underlying market can have the effect of defining the cost of borrowing for sovereigns despite the fact that there is very little in the way of transparency regarding who the agents in this market are and what volumes have been traded. Governments could be forced by virtue of this market to pay unnecessarily high (perhaps punitively high) borrowing costs.
Agency Issues: The existence of the Sovereign CDS market may change, considerably, the motivation of traditional suppliers of credit extension to sovereigns.
Whilst the CDS market is a zero sum game, it is however conceivable that certain groups can accumulate considerable positions in the CDS (buying insurance) of a given Sovereign without holding any underlying positions in the securities referenced by such a CDS. It would then be optimal for such agents to fail to support the issuance programmes of the country in question. The reason being that this will benefit the CDS they own via the spread moving wider or in the extreme technical default of the Sovereign triggering the CDS contract. Under normal circumstances this issue would be so remote as to be irrelevant, but these are far from normal times and as such these issues need consideration.
Possible Solutions: It is certainly arguable that CDS contracts have been far from a force for good in these times and have done more damage than good and should be outlawed. It would be difficult to “put the Genie back in the bottle” however and as is the case in banning short selling may have severe unintended consequences. One simple strategy would be to enforce disclosure of all agents Sovereign CDS positions. Such transparency could be delivered in a very short time frame and would enable Issuers and the market in general to understand and interpret the actions of the varying market constituents more clearly.
I wrote a short piece in yesterday’s Sunday Independent that illustrates why bank regulators must think beyond International Financial Reporting Standards in judging the health of the banking system. The link is here.
Today’s installment in the Irish Times is written by John McHale: Minimising the Pain.
In response to my earlier post on the nationalisation of Anglo Irish, Enrique DeLucas writes that “as Anglo was also an active syndicator with the other Irish commercial banks, any impact of large scale writedowns of their loan books would have a collosal impact on the remaining listed Irish banks”. In response to a further comment from Alan Ahearne he writes that “under IAS39, if a fire sale of Anglo’s assets gives specific evidence of a diminution in value of these assets, they must be marked down accordingly. As a result, this creates a requirement under Balse II to increase the capital adequacy reserve by this amount, thus impinging on the banks liquidity position and tier one capital ratios further”.
Do we know the extent of Anglo’s syndication with the other Irish banks, so that the importance of this effect could be assessed?
By the way, some info on who is advising the government: http://www.irishtimes.com/newspaper/finance/2009/0124/1232474679313.html
The CSO Index of Retail Sales had been rising to mid-Summer 2007, flattened for a few months and has been falling since October 2007, which was (just marginally) the sa peak. November 2008 was 8.1% off the peak, and October plus November combined down just under 8% on the same two months of 07. Today’s Sunday Business Post reports a survey by Retail Excellence Ireland and CBRE for the full fourth quarter. They believe that value of sales was down 10.7% over Q4 2007, and that the figure would have been even worse (14%) if the DIY and electrical sectors had been included in their survey, which seems to have a somewhat narrower coverage than the CSO’s inquiry. Nonetheless, the survey confirms anecdotal evidence that December was dire, and that Q4 volumes could be down anything up to 10% on Q4 2007. Some sales were brought forward into December, and the January figures could well be pretty poor too.
Notwithstanding the diversion of trade into NI retailers, consumer spending must be falling faster than household disposable income. There will have been a hit to income in Q4 from job losses, but not yet from tax increases. Pay rates (outside the construction sector) were still rising in Q4 so far as I can see, although they may fall in the private economy overall in Q1 2009. The implication is that the household savings rate rose sharply in Q4 08, and that the marginal propensity to save must be high. This is also consistent with the historic lows in the consumer confidence indices.
If the consumer has decided that it’s time to repair the balance sheet, the case for fiscal stimulus is even weaker than normal, which in Ireland is pretty weak to begin with. The corrolary is that fiscal tightening has even less output cost than the macro models indicate.
(Cliff, an SBP headline today contains the coinage ‘oversaturated’. Is this overexaggerated? When will the slaughter cease?).