Tuesday, 14 December 2010

Go ahead, punk. Make my day.

Dirty Harry understood that for a threat to have any effect it had to be credible. He didn't stick a banana in the face of some criminal low life, but a 44 Magnum (the most powerful handgun in the world, that would blow your head clean off).

In all the trivial inanity surrounding the AIB bonus fiasco I have seen all manner of stupid nonsense aired, but the latest "threat" by the minister that AIB will have its future capital funding withheld if the €40 million in bonus from 2008 are paid is up there with the best.

I can only imagine that the Chairman of AIB, or whomever took the call from Brian Lenihan had to restrain himself from the most obvious response - "or what?". Brian Lenihan isn't a fan of the movies. He has confused his Dirty Harry with his Indiana Jones, by bringing a knife to a gun fight.

But on a serious note, Brian (he's not the messiah, he's just very naughty boy), is most certainly penny wise and pound foolish. Hooray!!!! he has saved the taxpayers €40 million. Shame he is and will be (jointly) personally responsible for costing us up to €100 billion. And he stillr efuses to turn off the tap.

But the sad indictment on the country is that electorate cheered!

Thursday, 2 December 2010

Quantitative easing in a monetary union - not as easy as it sounds

The Eurozone is heading gradually off on a path that might require the authorities to consider a large scale QE policy.

If government debt becomes too large to manage, then one way out of the pickle is to create lots of inflation that will erode the stock of debt over time. It is smoke an mirrors or course, as it does not create any wealth, but simply creates a transfer from bond holders to governments. The losers tend to be pensioners, since they are the bond holders in society in the main and receivers of fixed income directly or indirectly from long term government bonds. But that is a distributional issue tangential to the purpose of this post.

This post is to ask a more practical technical queston. How exactly would QE work in the Eurozone? Normally, say in the US or UK, the Central Bank would buy government debt for new money. This increases the amount of money in circulation, which if enough, will create more than enough liquidity which will then, in effect, be given away by banks who in the end won't be able to find any counterparties to deposit it with - because all the banks will have more liquidity than they want or need.

More money in the economy per unit of output produced will mean the ratio of Euros to output (GDP) will increase. The value of money will erode, which is inflation. In a previous post I have described how inflation then leads to a reduced burden on those in debt who have borrowed over a long term. Basically this means governments.

Now what is interesting here from a Eurozone perspective is that there are usually two distinct things going on here. There is the liquidity and eventual inflation that the QE produces. However, just as importantly, the act of buying government bonds for money retires some government debt. The Central Bank is owned by the government, so those bonds purchased can effectively be written off. In other words, what has happened is that the government, via the Central Bank, has called in its bonds and swapped them for an extremely cheap form of liability, or debt, that it will never have to repay - money; Dollars, Pounds etc. which are merely another form of government liability (although sitting on the balance sheet of the central bank).

Do you start to see the question here?

In the US the Fed would buy Federal bonds. These are debts owned by all Americans. They can be retired (swapped) for fresh dollars in the manner I described. The US government debt is both reduced and deflated.

However, what of the Eurozone? Whose government bonds will be purchased? And after that, can we employ the same logic and retire those debts, letting some countries off the hook?

The answer to the first question is that we can and probably would buy the debt of those countries that are prospectively insolvent , that have too much debt. Step forward Ireland. The answer to the second question is that we can, but with the full realisation that the rest of Europe would be bailing our Ireland, Portugal, Greece, etc. by swapping the debt incurred by those nations for liabilities (Euros) owned by all of Europe. The inflation that would ensue would adversely effect all the normal losers in this process (those pensioners in particular that I mentioned), but those losers in Ireland will have benefitted by the reduction in Irish debt that will allow.

Who will like this solution?

  • The Irish, Greek, Portuguese, Spanish governments
  • Irish, Greek, etc. state and civil service pensioners
  • Irish, Greek, etc. taxpayers

Who will not like this solution?

  • German pensioners
  • German taxpayers

Those who might or might not like this solution?

  • Irish, Greek etc. private pensioners (they will have their pensions eroded by inflation, but governments will be better able to afford to maintain higher level of public services - especially health)

It sure makes QE in Europe one hell of a political minefield, something I have not yet seen mentioned in the media.


Just as an aside. Where might a QE program start? Where better than a purchase of the €80bn plus in Irish government debt held by the ECB in Repo. agreements?

Wednesday, 1 December 2010

How much wriggle room do we really have with the banks?

Quite a bit actually.

I just had a perusal of Bank of Ireland data and as at June 2010 they had around €31bn in various bonds on issues. That includes many things like floating rate notes, but technically all ripe for "restructuring".

€31billion would have placed a nice buffer between the banks and us poor taxpayers. It should be used.

Tuesday, 30 November 2010

Waiting for an explanation

What baffles me most about the Irish banking debacle is that I have not yet seen anyone offer an explicit explanation of why banks (plus buidling societies etc.) alone should be exempt from the insolvency laws that govern all other corporate entities?

It seems now to have been enshrined into the law of the land. Talk about moral hazard.

Monday, 29 November 2010

Breaking the piggy bank

So we will be spending another €12.5 billion of our National Pension Reserve Fund as part of the EU/IMF "Bail Out".
This seems to have raised some hackles, but I don't know why. Generally, in your personal finances as well as national one you would always tend to use the cheapest source of funds first.
How much does our NPRF stash cost us? Well, we could retire €18 billion of Irish 6 year government debt for more than 8% per annum. That alternative use makes this expensive money.
We are at the point where we need to do everything possible to stem the growth in our debt. Ideally, we should have been cutting our exposure to bank liabilities. But if we aren't then we have to accept our rainy day has arrived. Time to break the piggy banks.

Friday, 26 November 2010

Scary numbers - debt dynamics in Ireland

I thought I would review some of the debt dynamics for Ireland. It turns out that within a common currency area there is a twist on the normal dynamics that would apply.

Let's start with a little algebra. General government debt as a percentage of GNP will grow as interest accrues (r) and a the government run a deficit before interest (primary deficit) and it will be deflated by the rate of nominal growth in our income (GNP)

Using some mathematical manipulation we can see that the debt to GNP ratio will only stabilise or fall if the government runs a primary balance which is larger than the sum of the difference between Irish real growth and Euro real interest rate, plus the difference between Irish inflation and Euro inflation, all scaled by the ratio of debt to GNP.

When this is normally done for an economy the inflation terms simply cancel one another out - the inflation rate at which the economy grows is the same as the ex post inflation premium paid through interest. For Ireland and indeed any Eurozone country, this is no longer the case. What this is saying is that we are borrowing on terms that reward lenders with an inflation risk premium that relates to the currency of issue, the Euro. However, Ireland will need to service the nominal repayments out of a tax base that will rise only with domestic inflation. A nasty twist for Ireland at this juncture, when one might anticipate a significant ongoing real exchange rate depreciation - in common English; falling Irish prices relative to Euro prices.

So from this relationship we can play with scenarios.

I plug in numbers that would represent a pessimistic scenario relative to official plans.
  • Very weak medium term growth of 1%
  • Real Euro interest rates of 3% (5% minus 2% Euro inflation)
  • Deflation in Ireland relative to the Eurozone (zero inflation here, 2% in Eurozone)
  • All multiplied up by 150% which represent our debt to GNP
Under such assumptions Ireland would need to run a primary balance of 6% of GNP or greater. Our tarting point is a deficit of about 10% of GNP. We would need a fiscal adjustment 16% of GNP or more to stabilise our debt. And the kick is that if we allow the debt to GNP ratio to rise further the surplus we need to run on our primary balance becomes larger - i.e with debt at 200% of GNP that 6% required primary surplus becomes an 8% primary surplus. Ouch.

I think the worry is that the more we deflate (Irish inflation lower than Euro inflation) the bigger the fiscal adjustment needed. And the bigger the fiscal adjustment the more deflation we bring. A viscious cycle that leads to national bankruptcy.

Let's not underestimate what the stakes are with the decisions we will be making over the next weeks.

Wednesday, 24 November 2010

Why did AIB retain its stock exchange listing?

It is a curiosity that AIB will retain its stock exchange listing for stock issued which accounts for one tenth of one percentage of the company's ownership. The obvious question is why??

Initially I thought it was to allow restructure and eventual sale of the company, without going through the hassle of nationalisation and a completely new IPO.

Then I read this:

http://ntma.ie/Publications/2010/SubDebtBurdenSharing.pdf


Thursday, 7 October 2010: Following the Statement on Banking made by the Minister for Finance on 30 September 2010 there has been some uncertainty among market observers and participants about the intended treatment of subordinated debt in issue from Irish banks.

In order to clarify the position the Minister has advised that prospective resolution and reorganisation legislation, insofar as it affects subordinated debt in issue, will apply only to such debt in issue from institutions which are not listed on a recognised stock exchange, are in 100 per cent State control and cannot survive in the absence of total State support.

My bold.

Note that AIB isn't going to be delisted from a recognised stock exchange, nor pass into 100% state ownership.

Comfort for AIB subordinated bond holders then. Thanks for that Brian.


Yours sincerely,

Taxpayer Bled-Dry Esq.



Oh, forgot to add. Can anybody name a bank that is not listed on a recognised stock exchange, is 100% owned by the Irish government and cannot survive without State support?

Anyone?

Closed to new borrowing!!!!!

More tripe being spouted from government circles about why we need to stay committed to pouring more and more of taxpayers' money into Irish banks in order to prevent them going into insolvency and default on their liabilities.

The cry goes out "if there is a default on bank bondholders now, nobody will lend to us in the future".

OK, let's put aside the obvious point that nobody has been willing to lend to either Irish banks and now the Irish government at an affordable rate of interest for some time now and think about that alarmist statement. It is nonsense of course.

The fact is that default on bondholders today will not in itself mean lenders or potential buyers of bonds will be scared off in the future. In fact, the result could be expected to be quite the opposite if we finally manage to do the right thing policy wise.

Why would that be?

It is pretty obvious. Nobody will lend now at anything less than completely unacceptable (unaffordable) interest rates because they believe that the massive financial burden of the current and prospective size of Ireland's debt (government + bank losses assumed by government) will make it increasingly unlikely that they will get repaid.

However, if we quickly and it needs to be quickly stop the rot now we might have one last chance to write down a mass of bank assets and liabilities (which will mean bond holders), restructure them, likely with debt to equity swaps, and emerge with smaller banks with little concern over potential additional assets and liability write downs and a cap on the additional government borrowing that would be needed to fund the banks.

In effect draw a line right now under any potential future capital demands on taxpayers from the banks by putting them into nationalised administration (which I have mentioned before) and forcing the risk capital lenders to those banks to take the losses.

If we do that we then only (only!!) need to address the smaller (smaller!!) issue of general government finances in order to put a lid on government debt at a high, but not disastrous level - something around 130-140% of GNP.

And do you know what? People will lend to us again. They won't be looking back and thinking "well, they burned those bondholders last year", they will be looking forward and thinking "the losses have clearly been taken now and Irish banks and the Irish government are much better risks now". That is how markets work. Yesterday's loss is gone and irrecoverable. Markets look forward.

It still isn't too late, but it nearly is for Ireland.

Our banks need to be put under nationalised administration using special emergency legislation and restructured by defaulting on enough of the tier 1 and tier 2 capital (that includes senior bondholders) as required to make them unambiguously well capitalised with impairment free balance sheets.

End game approaching for Ireland - what to do?

Does anyone have a plan to get Ireland out of this financial quicksand that is sucking the country under as we try and stop anybody (except taxpayers) losing money on our failed banks?

Well, yes. Here is one I made earlier - over one year earlier:

http://geckkosworld.blogspot.com/2009/08/more-nama-debate.html

But it doesn't have to be that way. The guarantee expires next year. The government can effectively renege by threatening to string out affairs until its expiry. This can be used as leverage to force the reconstitution of the banks balance sheets by wiping out current shareholders and doing debt-equity swaps on some bond holders to reestablish the banks.

If the shortfalls are too large the government could then force the banks to be declared insolvent and nationalise them on the basis that they tale only those liabilities they are required to - effectively deposits and secured creditors/bondholders. Then use taxpayers' funds if necessary to restore tier 1 capital. Only that way could you ensure that the burden on the taxpayer is kept to a minimum.

Tuesday, 23 November 2010

Keynes has a lot to answer for

Well, that might be a bit unfair. John Maynard Keynes was an exceptionally clever person. It is hardly his fault that people get all confused by what he was saying.

It is an almost undeniable fact that probably more than 90% of the population (maybe more) believe that macroeconomics can be understood by reference to what is nothing more than a basic accounting identity - a banal statement of equivalence:

Y = C + G + I + X - M

Economics begins and ends there for an alarming proportion of the populous and an even more alarming proportion of opinion formers and decision makers (especially my bugbear, "successful businessmen").

Let's get one thing straight. All that little identity tells us is that everything we produce must by definition be bought and/or added to inventories. That is it. There is nothing else in there of use to understand economics, or formulate economic policy.

For example, it does not:
  • mean that not buying foreign (imported) goods will increase our output or incomes
  • mean that increasing government expenditure will increase our output or incomes
  • mean exporting a lot will increase our output or incomes
I could go on, but I think you get the picture. This national accounting identity is just a simplified algebraic description of how we deploy our income. Economics is really (really) about how we create that income in the first place.

So what made me blog this rant today? Believe it or not it was our new IMF overlords in a tangental way. A news report this morning that an IMF paper has floated the idea of a lower income tax rate for women on the basis that they "tend to put more back into the economy than men". And we had a couple of accountants (christ!) and other economic ignoramuses proclaiming what a clever idea. If I had to appraise this argument for its intellectual efficacy I would tend to the technical. Ughhh!! What a load of tosh.

The premise, as presented by the media, is that women will spend more of their income - increasing the "C" in our accounting identity above - hence leading to more output and hence incomes. Output and hence income, we were told, would increase. Huzzah!! We've found the magic formula!!!

Now, it is entirely possible that the IMF report does not make such an argument but that is exactly what was presented and commented upon.

So why is this stupid? It is stupid because if (if) such claims about propensity to consume by the female gender were true, giving them lower taxes than men would reduce growth in our output and incomes. Yes, reduce it not just in one year, but by a small amount every year forever.

To understand why this is so you have to forsake your beloved accounting identity and accept the power of the supply side (mwwaahaahhaaahaahaa).

We create output and hence income by combining labour with capital to create stuff that is greater than the sum of its raw material parts. There are three parts to this process; capital (income we don't consume), labour (blood sweat and tears), productivity (the ingenuity possessed to make stuff out of other stuff).

In market based economies we become wealthier each year because we experience increases in two of those three areas (the amount of labour we have is limited at 24-sleep-eat-etc.). Productivity rises because humans, despite our clear collective stupidity are strangely collectively clever. We become more ingenious as time goes by and can make more stuff and more useful stuff out of less stuff every year.

Then there is capital. This tends to rise over time because we will save some of our income, preferring to defer some of our consumption to later years rather than simply live hand to mouth. That means we have an increasing pot of capital (per head) available to use to produce output and income.

And that is where these spendthrift women come in. If we tip the incidence of taxation towards men and away from women and they do indeed consume more of their income each year, we will reduce the rate at which we accumulate capital. Lower growth in our capital stock means slower growth in our output and hence incomes.

Sure, there will be a lot more bling bling about and we might feel richer, but we will be poorer and the opportunity cost will rise over time as we forsake investment for lipstick.

Do you doubt it? Ireland has just completed a nation wide experiment of this very theory. We consumed and consumed until we made ourselves the poorest country in Europe. We have no capital, that is why the IMF is filling up our hotel rooms.

Today's fun number fact - 125%

125%


The total net foreign debt of Ireland expressed as a percentage of our annual income.

To give a point of reference, Australia is considered one of the most heavily indebted economies in the developed world due to running a substantial current account deficit for decades and has a total net foreign debt of 67% of annual national income.

The UK is 22%

Monday, 22 November 2010

Another fun number fact

Time for another fun number fact.


100%


The value of Irish domestic banking assets (equivalently liabilities) accounted for by lending to one another, expressed as a percentage of annual national income.

For point of reference, the number for the UK - another over-banked country is 30%.



Rearrange for the following words to make a coherent sentence:


as, cards, as, of, house, strong, a



....

Thursday, 18 November 2010

Fun with numbers - today's fun fact

Want a fun number fact?



64%






The current amount of "Repo" lending to Irish credit instutions as a percentage of our annual GNP. For those who don't understand jargon, that is probably a bit like going down to the pawn shop to borrow over half your annual income in order to buy this week's groceries down at Dunnes.



Stay tuned for another fun number fact tomorrow.

Friday, 12 November 2010

Mortgage forgiveness - an alternative

The "mortgage forgiveness" proposal is a bad idea. Firstly it does threaten to introduce as well as exacerbate moral hazard problems (these have been quite transparently glossed over by some of the scheme's proponents), but worst of all is that it will not have any material macroeconomic benefit. To suggest it will is absurd, to borrow a phrase.

The reason is because this scheme will only transfer wealth between parts of Irish society, when the problem is our complete lack of wealth in total, or more accurately our now massive net indebtedness as a country.

The proponents say it will address the "mortgage default overhang", which is essentially to say that it will allow further required contraction in the balance sheets of the Irish banking system by writing down those banks' assets. However, it will do so in exactly the same way that the hair brained NAMA scheme has and will. It will create a capital hole in the Irish financial system which will be filled by government borrowing. It didn't work for NAMA I and that was when Ireland was far less grossly indebted than it is now. This mortgage forgiveness will be NAMA II, where taxpayers are forced to pile even more of their money into those same banks from a far far more indebted starting point. It is a really really bad idea, especially because we have only just tried this stupid idea, it didn't work.

So what should we do? This is what we should do:

  1. Modernise Ireland's bankruptcy laws. There are many models in the UK, US etc., but they have similar features in that the force a crystallisation of loss on the debtor and creditor, the debtor is required to make as realistic reparation and there is a clear finite term (say 5-10 years).
  2. Repeal the bank guarantees - yes I have said it countless times since I declared it hair brained upon its introduction. Of course that leads to bank collapse, so you take them into nationalised administration under some properly drafted legislation (what they should have done in the first place) and begin capital restructuring talks with creditors while allowing them to continue business.
  3. End the political coercion that is stopping forclosure on mortgage holders who are defaulting on their loans.
  4. Let markets get at it.
What would this do? Well it would do the following that the "Times 12" proposal will never do:

  • It will have a beneficial macroeconomic effect. As banks begin to write down bad mortgages as they deal with them on a case by case basis, capital losses will be taken by the banks risk capital investors - mostly foreign - and not Irish residents. There will be a positive net wealth outcome for the Irish economy.
  • It will be much more efficient. The lenders themselves are best positioned to determined what mortgages will or will not ever provide an economic return and they can foreclose and take the write down under the modernised bankruptcy laws. Simply having "negative equity" won't be enough - nor should it.
  • Banks balance sheets will contract in a relatively orderly and proper way, with liabilities falling as well. Smaller balance sheet less encumbered by non performing loans.
  • This will be far more equitable. This won't represent the arbitrary transfer of wealth being proposed by the Times 12. Those who lose will be those who lent the risk capital to the banks, not Irish taxpayers who managed their financial affairs sensibly.
  • Reduced likelihood that we promote moral hazard. Although modernised bankruptcy procedures would allow a clear exit path for borrowers beyond the point of no return, it would still be onerous and clearly punishing. Effectively, having to work for your creditors and your creditors alone for 5 years or more isn't an attractive option.
  • It won't treat the existance of "negative equity" as a problem. It isn't People in negative equity have exactly the same fixed cash flow burden they anticipated when they borrowed the money. They still have their property and as long as they continue to pay off their mortgage there is no problem to try and "solve".

Wednesday, 10 November 2010

Mortgage forgiveness and moral hazard

Stephen Kinsella of Limerick University popped up on Newstalk this morning to tell the country that concerns that the floated mortgage debt forgiveness might cause increased problems of moral hazard as absurd, or somesuch dismissive noun. His argument is put here.

It wasn't a complete or particularly coherent argument, which is forgiveable given the live radio context, but I feel a need to point out that Stephen's performance leaves me feeling that his is the absurd position on this issue. And he can't be given the same forbearance for his blog posting.
It is worth parsing his argument to see how poor it is, riddled with omission, straw men and simple appeal to emotion.

Stephen makes three supposed points referring to moral hazard, conveniently labelled one, two and three in his post. Let's look at them:

"First...the Irish economy has already been
 pumped full of moral hazard because of the bailout of Ireland’s banks
and bankers"

Well, I don't disagree with this, but point out that the bank bailout was stupid and most likely has increased moral hazard, but for lenders of risk capital. What is at issue here is whether to compound one immeasurable level of stupidity (the bank guarantee/bailout) with another (mortgage debt forgiveness) which would extend the exacerbation of moral hazard from risk capital lenders to the borrowers as well - a type of "why stop now?" type of argument. Strange indeed. Stephen's argument might also seem to imply that we should all be allowed our share of moral hazard, that it simply isn't fair or that households should not miss out on this fun. I would characterise that as a rather strange type of analysis of welfare economics.

"Second, the moral hazard existed at the point of sale–the bank
 selling the mortgage had more information about the likely evolution 
of the market...

...Recent research has shown that rising house prices were driven predominantly by increases in the size of mortgages that banks were willing to give, meaning the banks were the engine of the housing bubble, not interest rates or population. The average person just wanted a house to live in."

I don't know how to interpret this. He makes a claim and doesn't support it. To state that "the moral hazard existed at the point of sale" and was manifested through the lender, suggests that the lender had strong belief when they made the loan that they would not be made to bear the cost of any default, over and above their contracted security. Does Stephen have any proof of that? I am not aware of anything that suggests that banks believed they could rely on anything more than the ability of the borrower to repay and the strength of the backing collateral (the house). So this claim is just absurd.

But Stephen then confuses this non-argument by going on to claim that house prices were being driven by the size of mortgages (well, d'uh Stephen, it was a monetary and credit bubble), but doesn't make it clear how that matters for his argument. It is simply a well accepted fact; people wanted/needed larger mortgages to buy property and took increasing personal risk (gearing) to do so, banks wanted/needed to make larger mortgages available and took increasing risk (gearing) to do so. If Stephen has evidence that either side had some information that led them to believe they had some "get out of jail free" card in the event that something went wrong he should actually state it. Otherwise he has not pointed out any moral hazard.

And Stephen then descends into something which is pretty deplorable for an academic economist. He resorts to argument from emotion: "The average person just wanted a house to live in". But I don't give Stephen full credit here. This is even worse than an argument from emotion, it is just plain stupid. There was and is plenty of housing available. People could have rented a house or apartment. Would that have sated this desire of the "average person"??? Moreover, this average person could have found "a house to live in" at a rental yield so low that it made the very idea of buying over renting totally irrational - in fact it was.

So to number three:
"Third, the worry is that these bailed out homeowners would start
 taking out more debt, thinking they’d be bailed out again. Think about
 this for a second from your own point of view. Say a bailout happens 
for you and your wife with a 600,000 euro mortgage on your home. Say through some mechanism the bank forgives 200,000 euros of the mortgage, you keep your home, and you continue to pay a reduced amount to the banks. You and your wife have spent probably two years getting letters and phone calls from banks and solicitors, you’ve gone through the stress of nearly losing your home. A note about the debt forgiveness exists on your credit record. You are not going to start running up debt again, and
even if you’d like to, you’ll be stopped. The moral hazard argument is flawed and useless. We should discard it."

This is flawed by not properly identifying where the issue of moral hazard is really concentrated. Increasing problems with moral hazard will come from all those people who will try to manage their financial affairs in order to qualify for a bailout. For example, we are probably talking large sums here, potentially multiples of gross annual earnings for individuals. People will be incentivised to make their financial position appear worse than it is, or heaven forbid actually deliberately make their financial position worse than it is (why bother with this saving lark, lets blow some cash on holidays etc.) as they reorder their priorities away from paying off their mortgage. Just like a lot of people tried to distort their financial position during the bubble in order to qualify for a larger mortgage, a lot of people will certainly try to distort their financial position in order to qualify for debt forgiveness.

And there is more. The moral hazard will in fact be most likely to affect the children of those people who get the bailouts, or those people who won't get the benefit of this bailout. They will be the ones watching risk being absolved and factor that explicitly or implicitly into their future decisions.

After that series of non-points Stephen then makes some intellectual doodles before signing off. They are all pretty specious, but I find this one probably the most unforgiveable for a supposed Economics professor:

"Fully cleansed, functioning banks, homeowners taken out of substantial negative equity and consuming and investing again, and a clear signal to the markets that Ireland has put its house–no pun intended–in order, may be worth it"

There is a serious ommission of fact that mortgage debt forgiveness will spark increased solvency problems for the banks - they are writing off yet more assets, OK - and not help to "cleanse" them, but require us to put more taxpayers capital into them under the current polices.

With that in mind I hope readers of this blog will immediately understand why I find this statement completely unconscionable. We are talking about a redistribution of wealth here. Ireland's economic problem is a hangover from a massive savings/investment imbalance. A mortgage debt forgiveness program will simply take capital from members of society and give it to some others - completely arbitrarily. Note that the capital might be "taken" via even more borrowing by government, which of course has to be repaid by taxpayers.

Back to Econ 101 for you Stephen. How does such a redistribution of capital either:

  • increase the total amount of capital available, or
  • increase gross saving in Ireland

It doesn't, unless the capital is coming from foreigners, say in the form of default on (foreign)bank bondlholders - but Stephen doesn't say that, nor does he show any indication that he understands that only with such an inward foreign transfer of wealth, would his argument hold water. That is a shocking, shocking piece of supposed analysis from an Economics lecturer.

No, our big mistake was the bank guarantee and subsequent bailout, as I have stated many times over. We should have taken AIB and Bank of Ireland under national administration at the earliest possible sign that they might fail (for "liquidity" or solvency reasons) and then recapitalised at minimum possible cost to the taxpayer, leaving shareholders and then bondholders progressively down the capital structure to take the losses. Thinking we can make debt somehow evaporate (when as I stated it is merely an act of transferring wealth) is seductive, but flawed and dangerous in equal measure. We risk merely compounding our problems and mistakes.

Monday, 8 November 2010

Let them eat cheese

If proof was needed that we have truly descended into the rabbit's hole, the Irish Government has helpfully announced their program to give away cheese to the masses. Of course, when I say masses I mean that elusive body of the population variously labelled as "the most vulnerable", "the poor", "those in need". In other words, that politically useful rhetorical devise; "the third person".

Once we all stop laughing and crying in equal measure, let's just turn to some economics to make some interesting observations and some random predictions.


  • The cost of this scheme in terms of packaging and distribution, verifying that the recipients as indeed "the most vulnerable" etc. most likely rivals the costs of handing everyone who qualifies a €20 bonus in the welfare payment.

If the reports are to be believed, vis:

The cheese is available in 12 x 1kg boxes from stores in Clondalkin, Portlaoise, Kilmacthomas Waterford, Cobh and Togher Co Cork from November 15th with a “minimum of one box per collection”.


(a minimum of 12kg of cheese each!!) we will have a nice little arbitrage opportunity opening up. Prepare to see markets do their stuff. So:

  • This could mean cheap cheese for everyone, as enough clever clogs see the opportunity to take a few boxes of their free cheese and sell it on. There may be attempts to restrict the sale of this cheese, but that is likely to futile as either nothing will be illegal about it, or a black market will simply develop.

And when this secondary, or black market for cheese develops, the demand for cheese via regular outlets, like supermarkets will fall. In order to prevent wastage, the price is likely to be discounted, potentially below cost in order to clear purchased stock.

Or, an alternative scenario:

  • Clever supermarkets recognising this potential cheese glut curtail significantly their cheese purchases over the next month. That might lead to a shortage of cheese in supermarkets. Riots in the dairy aisle shopping mums and toddlers battle it out for the last 500 gram block of red cheddar.

And of course the medium term consequences:

  • Cholesterol levels sour and heart disease takes off. The strain on the national health budget increases and our cheese binge starts to look like a big mistake.

Oh, how much fun it is to live in Ireland today. The comedy rolls on every day.

Tuesday, 26 October 2010

The Frankfurt dilemna - Ireland, hold on to your hat

So you think Ireland has some significant economic difficulties? Trying to manage our way off an explosive debt and deficit path for both the public sector specifically and the entire country generally is a painful adjustment.

Well, don't look now because things might get worse in the not too distant future. The reason is because short term interest rates might be on the way up before too long if recent trends continue, which if it comes to pass will make our adjustment even more painful and more difficult because the interest charge on the country's massive debt stock will rise too. Note that most of Ireland's total debt is subject to a variable, or short-term interest rate largely due to the concentration in variable rate mortgages of some description or another.

But why would interest rates increase? Surely it doesn't make sense. Well, tell that to those humourless suits at the Bundesbank who watch monetary aggregates like hawks. Those influential central bankers know that money supply figures have passed a clear turning point that means we should be ready to tighten monetary policy from its current sluice gates open mode.

Exhibit #1 - Monetary aggregates















M1 is narrow money, mostly notes and coins in circulation. M3 represents wider demand and interest bearing deposits in banks. Note what has happened to both in recent years. Before the full onset of the Global Financial Crisis (GFC) M3 was rising at a generous pace. People were borrowing from banks, that borrowing circulated back via economic transactions into deposits in banks. The Lehman Bros happened, at the point indicated in the chart. Initially it led to people putting wealth into cash (so M1 increased with an immediate spike) and then the ECB began cutting interest rates, promoting further growth in narrow money. M3 virtually stalled, as people didn't want to leave wealth on deposit with banks and the borrowing and deposit (known as money creation) cycle collapsed.

So this state of affairs continued. Until earlier this year. While M1 is still rising as monetary policy remains lax and interest rates remain low, M3 has started rising. The money creation process appears to have been rekindled. That is good news, because a continued downward money supply (M3) spiral would be a harbinger of deflation. However, it is also ominous in the sense that it indicates that the type of emergency low interest rates and lax monetary policy (including generous ECB repo lending and open market operations - e.g. Irish government bond purchase) may not be deemed appropriate any longer. That means higher ECB reference rates (the Refi. rate), which in turn will push up interbank rates and hence lead to higher retail rates, especially (say it softly) tracker and variable mortgage interest rates in Ireland.

Exhibit #2 - Euro monetary aggregates recent rates of growth
















This chart shows the most recent rates of growth, annualised rolling quarterly growth rates. M3 is now growing for the first time in over a year and not much below 5%, which would be within a range considered to be consistent with the long term inflation target of the ECB - 2%.

Exhibit #3 - Euro monetary aggregates annual growth rates















Even the annual (year on year) rate of change of M3 has turn positive, while M1 is growing at rates that would only be acceptable for short periods of time.

Ireland had better watch out, because nobody seems to be talking about this big smelly elephant at the moment.

Thursday, 21 October 2010

Ireland versus Greece - the fiscal comparison

Budget silly season is now in full swing in Ireland. There are two gigantic myths that appear to be circulating generally, fed to the media who chew and the regurgitate without so much as thinking. The two I had in mind are:
  1. The much trumpetted and imminent 4 year fiscal plan is the initiative of the current coalition government to somehow rescue the economy, and

  2. Ireland has been and will continue to lead the way on fiscal austerity programs, in particular putting Greece in the shade.
Both are pure unadulterated fiction.

Yesterday there was a pow wow between the most important political parties in the Dail (plus the Green Party) to discuss an advance copy of a much trumpetted 4 year plan. The claim made by the government of the day is that this is of national importance and that some form of cross party consensus is needed on its content. I won't comment on that (it is complete political bollocks), but just note that the requirement for this medium term fiscal plan is enshrined in the Maastricht Treaty under Stability and Growth Pact. Ireland, like Greece needs to submit for approval by the European Commission a "Stability Program" that explains how the general government deficit will be trimmed to less than 3% of GDP by 2014.

Point 1. This is a legal requirement, not some admirable piece of national governance.

Next to how we mighty Irish are showing up those lazy Greeks. The general government deficit in 2009 was estimated at 11.7% of GDP (output), or in my preferred numeraire for Ireland 14.2% of GNP (income) - it makes a difference, doesn't it. For Greece the number was 13.8% of GDP and essentially the same as a proportion of GNP.

The first myth running around Ireland and sold to the rest of the world (as only the Irish can) was that Ireland had already introduced the most massive fiscal adjustments, while the Greek government had been sitting on its lazy bum.


Exhibit 1. - Comparable primary deficits


















Source: European Commission, Greek Ministry of Finance


The primary deficit excludes debt interest, so it is a measure of budget items under the direct control of government. Well, knock me down with a smoked kipper. It looks like those lazy, profligate Greeks have been significantly more masochistic than our own bunch assorted teachers and country solicitors.

Hopefully more people will note this and not wonder why the streets of Athens were turned into a type of European Beirut, while the Irish electorate were characterised by the local media as being "docile in the face of much more draconian fiscal measure". Let's agree right here and right now that this type of statement was and still is a bare faced lie. Regardless of the economic merits of such a fiscal contraction being implemented by Greece, there is no case that Ireland was making more significant budget adjustments. I know that a new raft of expenditure cuts and tax increases are about to be announced in Ireland, but even €5 billion in measures will amount to about 4% of GNP would only, at best, represent catch up with the measures already being implemented in Greece.

Of course these are primary deficits and they do not include interest on the stock of government debt. In the case of Greece , such interest costs amount to more than 7% of GNP and mean that they won't have completed the necessary fiscal adjustment until the primary balance is in significant surplus (that 7% of GNP deficit including debt interest would keep Greece on debt death spiral). However, that is irrelevant to the point being addressed here. The Greek government has been far more courageous (or stupid, depending on your point of view) than the Irish government to date.

Monday, 18 October 2010

Damien Kiberd ... aaaahhhhh!!!!!

Another Sunday, another self inflicted hair loss. To be honest, it is my own stupid fault. Why can't I resist passing over Damien Kiberd's weekly rantings of ignorance in the Sunday Times.

How this man, who by all appearances is just some chancing journo, equally qualified to be writing about this season's womens' Autumn fashions as economics or finance continues to get access to national media is the comic indictment of ongoing economic failings of Ireland. Idiots in charge at all levels.

In his latest rantings Kiberd keeps beating his drum about "confidence" and "consumer spending". He goes so far to advocate an extension of the car scrappage scheme because it would "increase tax revenues". Words fail me how stupid and dangerous this man is with regard to issues concerning the economy and our future welfare.

Ireland as an entity - that means Irish people in aggregate - has consumed far far far too much. We have consumed everything we have and everything we will manage to earn over the next couple of decades. This goes for the government who has done the same on our (taxpayers) behalf. Kiberd is saying that we should build an even larger stock of personal debt and/or spend savings in order to hand money over to a government who needs to cut spending.

I imagine Kiberd would probably retort something along the lines of "well, at least everyone will have a nice shiny car in the driveway". Yeah, brilliant Damien. We can park them in one of the numerous shiny new housing estates that lie empty around the country. Don't think for a moment Damo that we forget your enthusiasm for the property boom, right up to the point the bubble imploded. Why, I believe you are in print claiming Ireland would be suffering a severe housing supply shortage in 2008. Unbelievable.

This man is worse than a fool (someone who speaks beyond their capacity), his media prominence on both radio and print make him a dangerous one.

Sunday, 17 October 2010

"Capitalism" to the rescue

I really shake my head at the persistence of failed Socialist views of the world. The supposed values that leftist thinking is supposed to bring is almost universally trumped by market-based solutions, which come from allowing personal and economic freedoms combined with just the right amount of regulation and law where it is needed (and no more)

One of the last places you would look for evidence of the massive benefits of this wonderful system might be the recent Chilean mining rescue. Have a read, it is revealing stuff.

Thursday, 14 October 2010

So you want to become an internet squillionaire...

The first thing to do is to learn some economics. Alternatively you might be naturally endowed with all the right sort of intuitive skills to help you make the correct commercial decisions.

Have a look at this review of the new Facebook movie that documents (to greater or lesser historical accuracy) Mark Zuckerberg's development of the ubiquitous social networking site. How did this not only become so successful, but also something of such commercial value? Here is a clue in the movie, if it is indeed true:

He resisted bombarding users with advertising, believing it best to let the service reach its natural market size without offending them. This is accurately portrayed in the movie; his early business partner Eduardo Saverin insists the company has to immediately "monetize" and Zuckerberg refuses. He still believes that growth is more important than short-term monetization.

A nice exposition of two important concepts; "switching costs" and "network externalities". Take the second first. The phrase network externalities refers to positive indirect effects that accrue to third parties. Elsewhere I have blogged on the more talked about negative externalities, but here is a case of positive ones.

A Facebook with two users provides very little "utility" or value for either of its users. If two more people join then instantly the value to the existing users increases. Why? Because of the additional connections, contributions etc. that those additional people bring. Let's say that the users find the larger Facebook network with twice as many contributors twice as interesting/useful/fun and that feeling is shared by the other users. The size of the network has doubled (from 2 to 4 users) but the value of the network has increased from 2 x 1 = 2 to 4 x 2 = 8; a multiple of 4!! That is network externalities at work; a network gains its value from the number of connections.

Zuckerberg was perfectly correct to resist those urging an early commercialisation of his network, realising (supposedly) that its value would grow exponentially relative to its size. The return to being patient was potentially - and subsequently proven to be - enormous.

What about the other concept - "switching costs". Not only did Zuckerberg appear to realise the need to wait and let the implications of network externalities run their profitable course, but he was reputed to have been concerned about "offending his users". Again, wise to the economics of his website. What is implicitly recognised here is that regardless of how much value the users of Facebook (customers) personally derived from being a member of the network, the only amount that he as owner of Facebook could extract from these same users was the cost any user would bear from leaving - that is each user's "switching costs". And when Facebook was smaller, before the Network externalities had really kicked in and there were other similarly sized and even larger networks around, the switching costs of Facebook users was probably very small. Any actual or perceived cost imposed on Facebook users at that time - for example a user fee or even annoying advertising, could have led to mass desertion of Facebook users to one of the other popular networking sites of the time. Imagine how easy it is to jump ship from a Facebook with 10,000 members, compared to jumping from one with 500,000,000 members. For one thing, there is no alternative...

But Zuckerberg held his nerve and allowed Facebook to grow to the point that it was big enough that:
  1. The exponential growth via network externalities made Facebook very valuable to it users and
  2. That same size and associated network effect increased the switching costs of users to something meaningful; users would now be willing to tolerate some advertising or funnel some money into their use of Facebook.
These are two simple concepts that have been exploit knowlingly or otherwise by Internet winners (Microsoft, Google, Facebook etc.) and not understood by a myriad of losers.

Just a final note. Again something that the astute reader should have picked up. These two concepts together mean that network type industries or businesses will tend to be "winner take all", or natural monopolies. It is no accident that technological, informational or network industries are more commonly dominated by a small number of large participants compared with production or cost driven industries like manufacturing.

For the astute and most likely wealthy readers, there is a lesson for investing here also. Don't try and pick winners in this space. Simply try and cover the field so that you will have some money on the eventual winner.

Wednesday, 13 October 2010

"Equality"? Give me a break

The World Economic Forum is probably the most absurd "economic" organisations in the world. Famed for its ludicrous "competitiveness reports", it also produces other useless and complete harebrained "reports, like the "gender gap index".

The complete absurdity and nonsense of this type of work is apparent in its own methodology.

For example, Ireland demonstrates comparable "inequality" because men have a life expectancy of only 96% of that of women. The longer women live relative to men the more "equal society is apparently. So imagine if we could produce some "gender equality" policies that shifted this 96% figure to 90% or even 50% - hey that would probably generate a boost to the aggregate "equality" ranking.

The same absurdity appears in all the other comparable scores the boost the supposed "gender" equality as women increasingly dominate outcomes for men in education, representation in professional classes etc.

Next look at the male/female birth ratio. As pure statistical indicator, a low female to male birth ratio is in fact a boon to women - as China is now finding out. Women have complete control of the partner selection process. Men are increasingly left into the middle ages at the fringes of society. Perversely, this supposed "inequality" towards women is in fact leaving men not women disadvantaged in Chinese society.

I don't think I will bother with this report.

Tuesday, 12 October 2010

Tricks of the trade

One of my favourite, non-moralist based, parables against protectionism or mecantilism comes via Brad de Long (I can no, longer find the link).

In a fictional country that exported grain and imported cars, a protectionist movement developed that demanded imports of cars stop in favour of domestically produced cars.

As this movement built political momentum (”protect the jobs”, "buy local") a billionaire announced that he had discovered a technology that would allow for the transformation of grain, of which the country produced plenty, into cars, which the country at present imported. On the back of a substantial government grant (!), the billionaire built a sprawling site on the coast, protected by massive security. He employed a workforce that was sworn to secrecy and then began buying up large amounts of the locally produced grain.

The grain was shipped into the secretive site in trainloads and amazingly cars were shipped out to be sold to customers. The billionaire was a national hero, lauded by politicians for single handedly ending the need to import cars. No longer were imports needed. In addition, he was also a big buyer from domestic farmers (buying "local"). And of course he employed people and made huge profits which provided corporate tax revenues.

The country was universally in awe of this national miracle of economics, except for one curious journalist who managed to infiltrate the secretive site, into which the grain went and cars emerged.

This journalist discovered that the site, hidden from outside eyes, consisted of little more than a massive rail freight and dock facility. The grain was being transferred from the incoming trains on to bulk transports sailing off to foreign countries. At a different point, car transports were arriving, unloading their cargo onto trains heading off to be sold across the country.

Friday, 8 October 2010

Green investor update

With the end of the third quarter it is time to get an update on our green investments courtesy of HSBC.

It looks like another bad quarter, underperforming the broad equity market index by about 0.5%. On the bright side, performance is consistent. Consistently under performing the equity market, as I predicted but certainly not what HSBC or our friendly reporter at the Financial Times, Kate MacKenzie, predicted.

Since 2008 an investor in this HSBC green fund would have lost more than 20% against a standard global equity benchmark. Ouch. That is what I call suffering for your principles.

But then, maybe it isn't all about principles. Maybe some people do buy into the "green is the future" malarkey. There is an apt investment lesson in that case. Don't let your emotions bias your use of and interpretation of data. In this case, the data and facts pointed to subsidy reliant "green" industries and companies being poorly positioned to improve their profitability or grow their businesses. The clear message was sell.

Wednesday, 29 September 2010

More quantitative easing for the UK?

Now here is an interesting news article in the Telegraph:

Bank of England's Adam Posen calls for more quantitative easing
The Bank of England should restart the printing presses and pump more money into the economy to prevent a "lost decade" of low growth and high unemployment, one of its senior policymakers Adam Posen has said.
So called "quantitative easing", or QE, accomplishes one thing and one thing only; it produces inflation. So how is that any use as a policy instrument to be used to "prevent a 'lost decade' of low growth and high unemployment"? Well, it does two major things:
  1. It deflates real wages, on the premise that real wages are flexible. A fair enough assumption at the moment given that unemployment is high generally there won't be too much resistance from or bargaining power with sellers of labour who might see the true value of their time fall.
  2. It deflates the stock of debt. Governments in particular borrow over long terms at fixed rates of interest. Inflation which is higher than expected at the time of issue will mean that the amount these governments will need to repay will be smaller in real terms (they will be paying back in the future using devalued money). In fact, if inflation is high enough they might end up paying back less than they borrowed.
Now think about that second point for a moment. Astute readers understand instantly that debt is a two sided coin. One person's debt is another person's asset. So, if higher than expected inflation means that borrowers might not have to pay back as much as they thought, or even as much as they borrowed, then the person who lent them the money is losing out by exactly the same amount. All we are witnessing is a transfer of wealth, not a creation of wealth or indeed a "destruction of debt" (which in fact is impossible for the reasons noted).

So what is the benefit? Is there any benefit? Well, I'm glad you asked, because the answer is yes/probably/sometimes.

Yes, in that for an economy facing the opposite case where inflation is unexpectedly negative and large (deflation) currently extended borrowers can easily find themselves in a debt death spiral. Instead of paying back less than they planned in case of higher than expected inflation, they might find themselves paying back much much more than they expected if prices fall over time. At the moment we certainly have over extended borrowers aplenty. An extremely widespread occurrence of such a debt death spiral (debt deflation) would indeed be a potential threat I for one would prefer to not test. Think of Greek, or Irish public finances for example. What if the debt stock which looks worryingly large and is increasing turned out to be a multiple of what we currently estimate it to be because every €100 that needs to be paid back in 20 or 30 years time turns out to be a massive €150 or €200 in today's money due to deflation? Can you imagine the crippling debt effect?

So inflation is probably a benefit in these circumstance, but not unequivocally so. Consider what happens if QE is successful. Debtors avoid the debt spiral and the €100 that, say, the Irish government needs to pay back lender in 20 years time turns out unexpectedly to be more like €50 or even €20 in today's money. Huzzah, the taxpayer is saved!!! Well, hold your horses there pilgrim. Who is on the receiving end of the now devalued €50 or €20. Look no further than yourself in retirement. Yep, pensions are funded predominantly by bond assets. The unexpected inflation has robbed you of the expected value of your savings in retirement. It isn't without reason that inflation is referred to as a tax on savers. In this case it is a tax, because the benefit mostly accrues via government accounts in reduced public debt repayment.

So that is the choice that we are looking at with Posen's policy suggestion. There is no outright economic gain here, but a potential aid to adjustment (reducing the price of labour), plus a potential redistribution of wealth, as noted from government bond holders to governments (and possibly from foreign holder of those bonds to your domestic government - which is a local benefit as a type of tax on foreign lenders) and from today's savers to today's debtors. If you fear the debt spiral scenario enough (and perhaps if many of your creditors are foreigners) it becomes a policy worth considering.

Tuesday, 28 September 2010

Implied default rates and compounding probabilities

I nice little primer on calculating implied default rates over at irisheconomy.ie. These are calculated under the assumption of no arbitrage, in that the expected value of the security with (implied or assumed) zero risk must be equal to or in excess of (under risk aversion) the expected value (probability weighted value) of the risky security.

The example there comes out for Ireland at about a 40% implied probability of default at some point over ten years. Sounds high, but think about this; a 40% probability of default in any of the next 10 years is equivalent to 5% probability of default in any single year.

Risk compounds just like interest rates.

Thursday, 23 September 2010

Irish politicians handy policy check list

I thought I would post a handy reference guide to some of the things I think will range from being simply useless to downright dangerous as the government and assorted politicians strive to save their skins and make people believe the fantasy that they "manage the economy" (of course "the economy" just is - they can only meddle with it for better or worse).

A starter list of things for politicians not to do (as the verbiage continues this might build):

  • boost consumer confidence
  • restore foreign confidence
  • just about anything to do with "confidence" basically
  • training schemes
  • job "creation" schemes
  • just about any hairbrained scheme where the objective is to "create" jobs
  • "knowledge economy" strategy
  • "innovation hub" strategy
  • "global education centre" strategy
  • just about any type of "strategy" - meaning in truth industrial policy

When does a recession become a depression?

About now in the case of Ireland I would reckon.

There is no formal description of what a "depression" is. Even the term "recession" is subjective and can vary in its definition.

I am using it to refer to a significant and persistant decline in real national income per capita. For Ireland, that means roughly looking at GNP (not GDP). And with the CSO release of national accounts data for the second quarter we find that Ireland has now moved into its third year of falling quarterly GNP:

















It is also pretty meaningful, in that our real income (in aggregate) is 17% lower than immediately prior to the onset of this depression.

I would fully expect this to continue a bit longer yet. The economy is trying to deflate itself (i.e. Irish prices need to fall relative to other countries) and we have to repay a lot of debt owed to foreigners, which means no available capital to invest (it isn't the banks' fault) and a need to cut back on consumption to repay these foreigners.

These are pretty drawn out adjustments occurring. This is one drawn out depression we are in the midst of.

Friday, 17 September 2010

Thoughts on sovereign bonds #2

The yield to maturity on sovereign bonds has generally represented the "risk free rate" for financial markets. No other financial asset could provide for less risk that a fixed stream of cash flows emanating from the government of a sovereign country.

What is the risk free rate in the Eurozone now, say from an Irish perspective.

It can't be Irish government bonds. In the past the domestic sovereign bond issuer was seen as "risk free" because in the event of difficulty in making repayments the government could either levy higher taxes or print some more money. Not so any more on either count.

It can't be a market basket Eurozone bonds - generally weighted by amounts on issue. You could hold German government bonds alone at a lower yield, but presumably lower risk than a basket that includes Greek, Irish and Portuguese bonds for example.

Can it be German bonds? They are issued in the same currency. Within the Euro is Germany able to meet all potential fiscal demands on it via taxes or money supply? Probably not, as the German people clearly fear - Germans look obliged to help bail out the financial troubles of other and again, they no longer have their own currency to print. Outside the Euro, a different story might apply perhaps - a renewed German fiscal and monetary autonomy, which could allow it an increased capacity and backstops to repay any debt it occurs (and to accrue less debt int he first place). Unfortunately, new bond issues in Euro would be forsaken for NeuDeutschmark. The amount of German issued "risk free" Euro bonds would wain.

Is that it then? While the Euro remains in its status quo there is no traditional "risk free haven"? Is a German departure from the Euro the event that would bring a return of a proper risk free rate, but in doing so kill the Euro risk free rate off?

Sounds bizarre, but no different really to US, Australian or Canadian state or provincially issued debt. In those countries we see a Federal issuer with fiscal and monetary primacy fill the role of "risk free" lending. Should the Euro survive, do you doubt where the constitutional structure of the EU is headed?

Thoughts on sovereign bonds #1

Under pensions regulation derived from the European Commission, Irish pension schemes are restricted in the amount of financial interest they may hold in either the employing company or its wider group.

Is holding Irish government bonds now effectively a holding against the scheme sponsor for Irish banks? Let'e push that from the sublime to the ridiculous. Is holding German government bonds now the same as holding a financial interest in the parent of the sponsoring company of the pension scheme of an Irish Bank?

It's an interestnig philosophical question.

Wednesday, 18 August 2010

The Parable of Anglo Irish Bank

A man is walking down the street. A massive and apparently bottomless fissure opens up in the ground before him.

He is panicked and instantly motivated to do something about this dangerous development.

Without wasting another moment, he rushes home and collects everything he possesses and packs it into his car and a trailer that he rented for the task.

On his way back to the hole he sees an old friend. He stops and gives him a ride, simply telling him that he is going to fill a dangerous hole.

He drives the car into the bottomless fissure in his valiant effort to fill the dangerous hole. His friend disappears with him into the void.

Saturday, 10 July 2010

Home truths for Charlie Weston

Charlie Weston is the Personal Finance Editor of the Irish Independent. The Irish Independent in turn is probably the greatest receptacle of garbage posturing as journalism in Ireland. It is match made in heaven.

Friday is the day refuse is collected up my street. Friday was the day Charlie wrote this "opinion" piece:
http://www.independent.ie/opinion/columnists/charlie-weston/charlie-weston-lenders-ignoring-home-truths-with-rate-hikes-2252146.html

This gives the gist of the column:
IT makes little sense, and it was probably never meant to. At a time when record numbers of homeowners are at the pin of their collars trying to repay their mortgages, lenders are piling on the pressure by hiking interest rates.
In the past year alone, mortgage interest costs have shot up by 16.5pc, according to the Central Statistics Office.
The CSO only looks at standard variable rates when it examines mortgage costs, so the statisticians are reflecting the pain being borne by those with these variable mortgages.
Lenders are free to push up variable rates whenever they want -- something households with these types of mortgages have learned to their costs in the past year.
It is hard to get your head around the 16.5pc figure, but what it means is that a family with a not-untypical mortgage of €250,000 has seen the annual cost of repaying it jump by €1,300 in the past 12 months.
In monthly repayment terms the original payment of €954 a year ago has now zoomed up to €1,110, based on two separate 0.5pc increases in the past year.

...

This is at a time when the European Central Bank has not moved its main rate off it record low of 1pc since May last year

Such drivel perpetuates ignorance of financial matters. That would seem to me to be at odds with the general job description of a "Personal Finance Editor", even at a newspaper that chooses to inhabit the lower reaches of the newsprint media.

The ECB rate Weston refers to is of course the "refi" rate. This is the rate at which banks can secure short term liquidity (but increasingly long term over the financial crisis and beyond) by handing over assets like government bonds as collateral. It is a bit like going to the pawn broker. Of course, at the moment the pawnbroker is acting like Saint Vincent de Paul, charging banks little in interest and allowing more freedom in terms of collateral and term. Nevertheless this is short term and requires assets to be handed over.
What this refi does not do is determine the total cost of money bank have available to lend at all times, because that is determined by the major sources of their capital which includes:
  • What banks need to pay to attract deposits
  • What banks need to pay as interest in short and long term bonds to investors
  • What banks need to pay other banks for short term borrowings (interbank funds)

All these are determined by a number of factors that are determined by the market in general and the specific bank concerned. Needless to say that the agents listed above (depositors, other banks, investors) have been and continue to be far less interested in giving charity to Irish banks - which is what the 1% ECB refi rate effectively is.

So the point good old Charlie should be making plain is that mortgages have gone up because that is the true cost of the money borrowed by Irish households. It is now better reflecting what they should be paying given what a risky proposition they are. In fact, what a risky proposition they always were, but haven't had to pay over the bubble times.

Of course I get the feeling that the intention of the piece is to make people think that banks are profiteering. As an unwilling shareholder in Irish banks, like every other Irish taxpayer, I only wish that was the case.

And just to put things into proper perspective, despite these shocking increases that Charlie is up in arms about standard variable rates range from a low of less than 3% for the most attractive customers up to the more typical 4%. To claim this is usury borders on outright lie. Strange how Charlie never specifically mentions these rates. I wonder why.

What figures Charlie does throw around includes the €1,300 annual increase in mortgage repayments for a hypothetical €250,000 mortgage. This is apparently beyond the pale according to Charlie, although remember this is price charged for something borrowers voluntarily agreed with the bank.

Here is something that is also putting "hard pressed homeowners" under pressure. It is also something that is dumped on homeowners with no choice on their part. Tax. Yes, if we imagine that this hypothetical €250,000 mortgage is held by a homeowner with a €65,000 salary (€250,000 is too much to borrow on that level of income, but it is a realistic scenario in Ireland - hence the problems) we would note that the tax burden of such a person has increased by about €2,600 over the last couple of years. And you can bet that homeowner didn't voluntarily enter into an agreement to set up one of the most over inflated, wasteful, inefficient and in far too many areas completely pointless public sector.

No the politicians decide that and simply send the bill.

But the following is the kickker as far as Charlie is concerned. This is what he wrote around a year ago, when the problem wasn't rising variable rates, but falling rates, which those people who had fixed their mortgage could not participate in and would need to pay some recompense to the bank if they wanted to welch on their deal.

Some people on fixed rates are paying up to €600 more a month more than those on variable home loan deals.

But to get out of these deals lenders impose a penalty, called a redemption fee. This is the cost difference between the rate the customer is on (which can be as high as 6pc) and the rate presently charged on its variable rate.

...

Granted, people locked into bad value fixed rates should have been aware of what they were getting into.

But as enormous flexibility has been shown towards our banks by the State, it is not unreasonable to expect banks to be flexible towards those stuck on fixed rates.


I would hate to enter into any type of wager with Charlie. Could you imagine the rules; "heads I win tails you lose".



Wednesday, 7 July 2010

"Unprecedented" warming (or, how certain are you of that trend?)

Global temperatures have been rising for the last 50 years right? That is not to controversial. Look at most data that attempts to produce some average temperature for the earth over time (whatever that actually means) and there is a self evident increase. It has been warmer in recent decades that it was in earlier decades.

Ignoring potential sources of error over time (including unsatisfactory adjustments for urban heat affects, areas that haven't had sufficient measurement coverage in the past or even now, such as oceans and the poles) and just taking data as given, the increase over the last 50 years appears to be around 0.8 degrees. People get hold of this data, plot a line through it, proclaim that there is a positive trend. It is from that observational position that the hypothesis of the enhanced greenhouse effect is employed to explain the trend and then extrapolate into the future.
Think carefully about this. There are two distinct points here.
  • Historical observations.
  • Hypothesised causes.
The first is just acting as witness to what we can measure. The latter is an application of an hypothesis.

I make this point because, in this post, I want to deal solely with the former. What exactly does the historical data tell us with any certainty in terms of behaviour? Simply saying "it has gone up" hides a multitude of sins. What I am trying to investigate is whether the data we have witnessed is indeed extraordinary. Is it so unusual that we need to search for some, or even any, explanation or cause?

I am going to do this, like all statisticians by employing a model. I am going to start with a basic naive one the explains any monthly temperature anomaly as being zero plus or minus some random element. This random element will be described by a Gaussian (or normal) distribution, be centred around zero and have a variance of about 0.01 (which means a standard deviation of 0.1).

This would be written as Tt = N(0,0.01) ; Tt= temperature anomaly at time t.

Such a model would lead to a history of temperature anomalies over say 30 years that looks something like this:




















No need for fancy statistics. There is no trend here. Just stable temperature about some constant average over time, affected by some random noise from month to month. This doesn't look anything like the actual record for global temperature anomalies, which everyone agrees seems to have risen over time. And therein lies a weakness. When people look at the actual temperature series and think "this is definitely going up", they are implicitly comparing it with the model above. Because it is clearly different, an intuitive reaction from most people is that:

"there must be something going on to push up temperatures"

And from that point a leap is made to try and find some hypothesis, possibly any hypothesis, that will "explain" the cause of the obvious positive trend. But what if this model is wrong. What if the nature of temperatures is better described by an alternative model that has different characteristics. Well, you might not be surprised to find out I think that is the case.

Let's think a little more deeply about (monthly) temperature anomalies. Our naive model above assumes that the temperature in one month is unrelated in any way to the temperature in any other month. But it is reasonable to postulate that maybe temperatures are related between months. The global temperature should reflect the transfer of energy around the world. It should operate with lags and so we might expect that the temperature anomaly witnessed in any month is in part affected by the anomaly witnessed in previous months. If it was unseasonally hot in January, then it should be more likely to be unseasonally hot in February. What this describes is an auto regressive process. We can investigate the data to see if there is any reasonable sign of such a phenomenon and to try and estimate the size of it.

So that is what I did. And a simple piece of statistics indicates that there seems to about two months months of inertia. In fact it tends to indicate our model should be more like this (the 0.65 and 0.25 drop out of the analysis:

Tt = 0.65*Tt-1 + 0.25* Tt-2 + N(0,0.01) ; Tt= temperature anomaly at time t.


So, let's now see what sort of series of temperature anomalies this type of model might be expected to produce. Here is simply one example, but note that this model will produce a much greater range of apparently different results:






















Compare this with the first chart. There appears to be a clear trend (I have drawn the linear trend). In fact there is a trend that equates to 1.4 degrees per century - or about 0.7 degrees over 50 years. This is pretty much exactly what we have witnessed from actual temperature measurements over the same sorts of periods. Compare it with an actual temperature series over a similar period (this is from the University of Alabama Huntsville):




















So what is going on? I have created this series of data using a very basic and naive model that reflects the actual measured characteristics and contains in it absolutely nothing that might cause warming. The trick of course is that this is but one potential outcome. I could generate another series and it might have a cooling trend, or no trend. But the salient point remains. Simple random data over time can generate what appears to be a material trend caused by something, when it is in fact simply an random outcome well within the range of what one might expect.

If you conducted some proper statistical tests on that series and the computed trend, you would find that the trend is not statistically significant. It would confirm what I have just said, that such an apparently significant trend - as high as that which is estimated from actual temperatures - is within the range of what might be randomly generated without any physical cause.

So, when I am asked to consider whether we are at risk of producing dangerous climate change, I have trouble getting past even the first obstacle. What does the data show us. Up until now, nothing that doesn't appear within the expected range of outcomes given the characteristics of the data involved. A trend that isn't particularly special.

Now this doesn't rule out human influence on the climate, in the form of CO2 forcing, or other localised influences (such as land use change). However, it does nothing to support the argument that we are definitely experiencing dangerous rates of warming that can only be explained by physical causes over time.

Monday, 5 July 2010

How regulation kills our quality of life

I enjoy listening to music on the bus on the way to work. So I bought myself a new iPod. A great little piece of technology (except for Apple's anti-competitive business model). I have found out after buying it is is useless for listening to music on the bus because you can't hear over the ambient noise of engine, wind, tyres etc.

I initially thought there might be a fault with it, but to my dismay I found out that those useless drains of the taxpayers' pocket, the European Commissioners and Parliament, decreed regulations that set the maximum volume output for such devices.

What a piece of life diminishing regulation, proposed and decreed by buffoons looking for things to do. iPods have always had a volume limiter you could set so that you didn't inadvertently turn the thing up too loud. But apparently, the people eating the cake are to be directed and told what to do, so a permanent limit needs to be set by the manufacturer.

Thank you, stupid, idiotic, moronic, manipulating, parasitic, tax stealing politician and bureaucratic apparatchik. You have wasted €150 of my money, which I have blown on a device that can't do what I, reasonably, want it to do - let me listen to music on the bus.

The industrialised world is truly killing itself cut by cut.

Friday, 2 July 2010

Recession? What recession?

Ireland's recession is over!!! Hurrah!!!!

After removing regular season influences, GDP increased by 2.7% in the three months to March, compared with the three months to December 2009. That must mean the recession is over, right? Growth has resumed right?

Wrong.

The Irish economy is a curiosity in that its underlying structure is badly distorted by government industry policy (read meddling) and the statistics we might use to measure it are tainted by accounting fiddles to the point they are almost as useful as measures of Bernie Madoff's investment performance.

Because the crux of the matter is that the amount of value added created in Ireland by Irish entities has continued to fall. While GDP increased, GNP fell by 0.7% in the quarter. As a nation we have continued to suffer a fall in our income and that is the only thing that matters.

Let's explore this in a little more detail. There is some useful background reading in this topic here and here.


The difference between GDP and GNP will be net foreign income. If you deduct that component of GDP (net output) that represent is effectively owned by foreigners and add net output created created overseas and owned by Irish residents you get GNP. Examples of the former would be profits generated (more accurately reported) by Microsoft or Dell operations in Ireland. The latter would be profits of CRH in the US.


Add to that the accounting shenanigans practiced by companies resident in Ireland and you have a recipe for a complete distortion of the true state of health of the Irish economy as you do here.

Exports may have increased and pushed up Irish output (GDP), but there is no way to know if that simply isn't the result of an accountant's pen. What we do witness is that the supposed rise in output in the economy, had absolutely no apparent positive affect on the income of Irish residents (GNP).

This tells us nothing new. As I noted in the blogs I link above, Ireland is not a "small open economy". Exports provide relatively little feedback into the economy. If Dell exports more (or records in its accounts that it exports more), that simply means that they are importing more parts from abroad to then crudely bang together and sell on, or they are just writing up their profits by claiming more revenues from abroad.

What appears to be happening here? I reckon it is most likely the latter, for two reasons. The import response to the rise in exports was muted (for any merchandised exports like pharmaceuticals, chemicals, IT equipment etc. companies need to import more to export more). Secondly, with some modest improvement in foreign European markets, there is increased incentive to record revenues in Ireland - over 2008 and 2009 Google or Microsoft for example would have recorded less in profit or even loss in higher tax jurisdiction. Once demand stabilises to the point that they are no longer loss making, they start to transfer more in way of revenue to Ireland in order to bring any profits within their low tax jurisdiction.

It all amounts to smoke and mirrors basically. Keep watching the GNP figures before GDP. The state of the labour market gives the best cues - unemployment is still on the rise the latest figures show.

Monday, 28 June 2010

A NAMA for the people

RTE 1 on the weekend had a panel with David McWilliams and some other members of the Irish social firmament bandying around yet more blah blah blah (excuse my sudden inability to articulate intelligently) about the Irish economy and our mess.

Yet again the cry for a "Peoples' NAMA", under the now common belief that NAMA was designed as a type of debt forgiveness program. Well, it may appear to be run that way, but the cold hard facts are that a "NAMA for the People" would do this:

  • Transfer all the outstanding mortgages of those people deemed to be in "negative equity" to a special purpose vehicle - that just means a new company of some sort.
  • Call in the mortgages of all those people.
  • Begin to foreclose on those people who can't repay and plan for an orderly disposal of the houses.
  • Pursue the outstanding amounts (the amount of the mortgage shortfall following the sale of the house) out of any other asset these people might have to the point of bankruptcy.

In theory, that is what a "NAMA for the People" would be. I was surprised that David MacWilliams failed to point that out to the journalist, lawyer, politician and broadcaster present and the many people listening.

I wish people with their hands on the microphones to the nation would stop perpetuating this fallacy that NAMA is a bailout. It is certainly the case that people who had command of tens or hundreds of millions of Euros - albeit borrowed - can legally squirrel a nice wedge away protected from future creditors. But it doesn't mean the process to recover as much money as possible from them and their companies is a "bailout" simply because it is frustrated by legal financial shenanigans and the underlying fact that there simply isn't enough money to repay all the debt.

So let's stop the cute hoor nonsense about "NAMA for the People" and start being honest. How about a "Money Grab for the Stupid People". Sound harsh? Well, not harsh enough for those who would insist I and other prudent savers in Ireland now pay to give them a fresh financial start. This isn't a diatribe against those people who are now in negative equity -mistakes are made. Many of those people will quietly and diligently save their way out of their predicament and as a nation we should hold them up as admirable. But I reserve disdain for those who would demand the government expropriate the savings or income of others so that they get a free ride.