Tuesday’s FT has a long piece on the Spanish banking system: you can read it here. An interesting difference relative to Ireland is that the Bank of Spain insisted on banks building up reserves against general future risks. However, these provisions are not formally counted as part of its capital base and the general push towards higher measured capital ratios means that the Spanish banks are also looking to raise capital. This may reduce the chances of these banks getting involved in acquisitions in Ireland, at least in the near term.
Garrett had an article in the Irish Times on Saturday which I thought made an important point: the scale of the deficit is so large, that to claim it can be fixed by expenditure cuts alone is inherently implausible. (Although a pay cut for people like us would certainly help.) Presumably (?) the government understands this, and doesn’t really mean it when it claims there will be no more tax rises.
So: what tax increases will do the least damage to the economy? Like expenditure cuts, all tax hikes will obviously drive the economy further into recession, but given that we have no choice here, the question as to what is the least-worst strategy seems worth posing.
The latest round of international negotiations under the United Nations Framework Convention on Climate Change in Poznan reached its conclusion last week. The parties to this convention meet twice a year. The latest talks were a preparation for the Copenhagen negotiations scheduled for late 2009. Nothing much happened in Poznan. These were talks about talks. Should one pity the civil servant who attends these boring meetings, or envy her for all the foreign travel at the taxpayers’ expense?
By the way, the Irish taxpayer need not worry about such expense: The Irish delegation to the climate negotiations travels on account of official development aid. Poor foreigners foot the bill.
The irrelevance of Poznan is best illustrated with the fact that the European Council met during the “crucial” end-phase of the Poznan conference — and made decisions about European climate policy. The decisions are bizarre from an economic viewpoint.
The main target of European climate policy was unchanged. We will reduce greenhouse gas emissions in 2020 to 20% below their 2005 levels. A number of countries expressed concern about the costs of meeting such a strict target. These worries were placated by grandparenting more emission permits, and auctioning fewer. This is exactly wrong. Cap-and-trade with grandparented emission permits is roughly equivalent to a carbon tax with lump-sum recycling. Cap-and-trade with auctioned permits allows for a smarter recycling of revenue. In fact, almost any recycling scheme is smarter than lump-sum. In this particular case, the revenue is essentially a capital subsidy to energy-intensive industries (but long after credit will be uncrunched), although it can also be interpreted as a windfall profit. The agreed compromise is not bad for the environment as some environmentalists have claimed because emission targets are the same. The agreed compromise is not good for the economy either, contrary to the claims of the politicians involved. It is bad for the economy, but good for shareholders in energy-intensive industries.
The government has announced the launch of its recapitalisation process. The official statement is here.
It is up to each bank to decide its recap strategy. It will be interesting to observe the extent to which the major shareholders of each bank become actively involved, relative to leaving it to the management teams to develop these strategies.
Another instalment of miserable analysis to help maintain the festive spirit! This time, on cross-border shopping, patriotism and the real exchange rate.
Also, a paper by Olivier Blanchard on Portugal that got me thinking along these lines:
It all suggests that, as far as public sector pay is concerned, the commentariat is focused on quite the wrong question. It’s not whether there should be a public sector pay freeze, it’s how big the pay cut should be.
Responding to Labour leader Eamon Gilmore’s suggestion of a fiscal stimulus at his party’s recent conference in Kilkenny, Jim O’Leary argued in yesterday’s Irish Times that the option is unattractive. I would like to expand on some of Jim’s points and offer a few more.
The first is that the Government’s fiscal targets for 2008-2011 will in all likelihood be over-shot significantly in 2008 and 2009, and will be hard to hit in the terminal year of 2011. The targets are (as per the Budget Stability Update), GGB deficits for the years 2008 to 2011 at 5.5%, 6.5%, 4.7% and 2.9%. The gross debt grows from 36% through 43.4%, 47.5% to 47.8%, while net debt starts at 25% and grows through 31% to stabilise at 34% for both 2010 and 2011.
To begin with, the out-turn for 2008 will be a GGB deficit of maybe 6.5%: the NPRF vauation was 10% of GDP at end-June, but can only be 9% at best now; and GDP for 2008 will probably come in under the figure assumed in this table. At end 2008, gross and net debt ratios will likely be 2 to 3 points higher for these reasons. But borrowing in 2009 could be in the 8 to 9% zone, rather than the 6.5% target, and the assumed growth in NPRF value in 2009 may not happen. There could be bank bail-out costs not included in the budgetary arithmetic. At end 2009, gross debt will likely breach 50% (of nominal GDP below the 2008 outcome), and the net debt ratio could approach 40%. These would be the numbers before the fiscal consolidation begins!
There is a casual assumption being made by some commentators, and possibly some Governments, that the sovereign debt markets will pony up whatever is required, at least for developed countries and certainly for Eurozone members. But Germany struggled with a bond issue during the week, secondary markets are illiquid, spreads have widened and the weakest Eurozone member (Greece) trades 1.65% above bunds at ten years. The second-weakest is Ireland at 1.35%, and some Eurozone countries with worse debt ratios are trading on narrower spreads than us.
Martin Wolf argued in the FT during the week that a weaker Eurozone member could, in principle, default. There cannot be a currency crisis, but there can be a credit crisis instead. Greece is the current bookie’s favourite, but Wolf described Ireland as ‘…a dramatic case’, noting the speed of the fiscal deterioration and the over-leveraged private sector. The system as a whole needs to de-leverage, and there is no point offsetting a necessary balance-sheet improvement in the private sector with a public borrowing explosion. Indeed, de-leveraging the public sector through liquidation of the NPRF at some stage, and crystalising the painful losses, will need to be addressed. If you can’t easily sell debt, you may have to sell equities, as many hedge fund managers have discovered.
Any attempt by Government to stimulate will run up against Ricardian Equivalence anyway, even more so in the UK version, where the tax reductions are accompanied by specific commitments to increase taxes later. If the private sector is determined to improve its balance sheet through cutting consumption and investment spending, fiscal easing will either fail, in which case it is pointless, or ‘succeed’ at the cost of frustrating the unavoidable private sector adjustment.
Finally, Mr. Gilmore proposed specific capital spending initiatives, such as school building. These may be better projects than some other components of the capital programme, but it is notoriously difficult to fine-tune with capital spending.
Sheltering under the Irish Government’s guarantee, the Irish banks have survived massive falls in their share prices.
In each case the current market price is less than 10 per cent of its peak — 2 per cent in the case of Anglo Irish Bank. Value to book ratio (using the last annual accounts) varies between one fifth and one sixteenth.
Time to recapitalize, then, I would guess. When the regulator finally decides to require them to increase their capital (not least to reflect the large foreseen losses of the “incurred but not reported” type), the Government will have to be ready to participate. But how?
For some ideas and a cautionary comment by an academic scribbler, see today’s Irish Times: http://www.irishtimes.com/newspaper/opinion/2008/1211/1228864660643.html