Jim Stewart: The effects of "Trumpolicy" on real investment are difficult to understand. Corporate investment and flows of FDI to Ireland and other countries are extensively influenced by factors other than tax, as revealed by annual investment surveys.
Showing posts with label Jim Stewart. Show all posts
Showing posts with label Jim Stewart. Show all posts
Thursday, 24 November 2016
Thursday, 31 May 2012
The crisis in Greece and arms purchases
Jim Stewart: Recent comments by the Head of the IMF (Christine Lagarde, Guardian Newspaper 26th May) in laying the blame for the crisis in Greece on Greek people (Greek people should help “themselves collectively by all paying their tax”, and that it was now “pay-back time” for Greece) have proved controversial. Overall Lagarde is quoted as stating that “she has more sympathy for children deprived of decent schooling in sub-Sahara Africa than for many of those facing poverty in Athens”.
Hostility to Greece
Taking these views at face value, and ignoring the calculus as to how different levels of deprivation might be compared and the role of the IMF in fostering such deprivation, they are not unique. The head of Deutsche Bank has described Greece as “a failed state ... a corrupt state” (Guardian newspaper May 26, 2012). Der Spiegel (5/10/2012) quotes newspaper coverage citing growing sentiment in Germany that Greece may leave the Euro and that this might be a good thing as a Greek exit could make the euro stronger and could also have a “disciplinary effect on other countries”. At the same Spain and Italy are regarded with sympathy in contrast to Greece. An article in the New York Times states ‘Greece, on the other hand, is roundly criticized for lying about the true state of its finances again and again, before and after joining the euro zone, and its failure to take any of the numerous steps demanded by its creditors to modernize its economy and — a particularly sore point — its tax collections. Its status as a special case is underscored time and again’.
Recent comments by the minister for Finance in Ireland to the effect that Greece leaving the Euro would have little effect in Ireland as “it is very far away” and the only item purchased from Greece is Feta cheese are part of the same pattern. Such comments are far removed from EU declarations on solidarity.
What has changed? In Ireland Greece is the example to be avoided. The Minster for Foreign Affairs in Ireland is quoted as stating a default would “place Ireland in the same situation as Greece” (Irish Times, 27/4/2012).
In the case of Germany, anti-Greek sentiment is partly motivated by economic nationalism. Der Spiegel quotes the head of CSU (Horst Seehofer) as seeing a Greek withdrawal from the Euro as the best option and states “We must preserve Germany’s economic strength. That’s more important than Greece remaining in the euro zone”.
A key feature of much of the comment about Greece and the Euro is its relative lack of analysis. One reason for this is that much of the comment originates from a political position which is closely aligned to the position of the current government in Germany.
Take for example comments by Mr Asmussen (described by the Guardian newspaper as Germany’s representative on the ECB council) who stated: "Greece needs to be aware that there are no alternatives to the agreed bailout program, if it wants to stay in the euro zone" (Reuters May 8 2012). More political still are comments by the President of the Budesbank who is quoted by Reuters as stating "If Athens does not stand by its word, then that's a democratic decision. The result is that there is no more basis for further financial aid" (Reuters, November, 5, 2012).
This lack of analysis is reflected in comments that Greece will be required to leave the Euro. Greece cannot be required to leave the Euro. Greece may itself decide to leave the Euro but again the mechanism for this is unclear, but there is no mechanism by which other countries can require Greece to leave the Euro. Even if Greece were in some sense to leave the Euro, the large black economy is likely to mostly trade in Euros, and elements of Greek banking will move offshore to other Euro area countries.
Military Spending by Greece
A lack of analysis is also reflected in the failure to consider the implications of the size of military expenditures by Greece as indicated by stocks of military equipment (see Table (1).
Greek Military Equipment (In Service)
Source:Wikipedia.
(1) Wikipedia note that military equipment is from German, French, American, British and Russian suppliers
(2) A total of 170 new Leopard (German) tanks were delivered between 2006-2009.
Greece was among the world's top five largest recipients of major conventional weapons for 2005-2009, and was third place for 2000–2004. The transfer of 26 F-16C from the United States and 25 Mirage-2000-9 combat aircraft from France accounted for 38 per cent of the volume of Greek imports for the period 2005-2009 (SIPRI Trends in International Arms Transfer 2009, p. 5). Greece was the largest importer of German conventional weapons in the period 2007-2011 and the second largest importer of French conventional weapons (source: SIPRI Trends in International Arms Transfers 2012). Since Greece joined the Eurozone until 2010 military expenditure has varied between 2.3 and 3.4% of GDP, compared with 1.4 to 1.5% of GDP for Germany and 0.6 to 0.7% for Ireland. Since joining the eurozone cumulative military expenditure for Greece amounts to around €63 billion (Source here). Even in 2011, Greece continued to import arms and has outstanding orders for five German submarines.
Yet it is difficult to find any reference to arms spending as a contributory factor to the fiscal and economic crisis in Greece, by outside commentators or by Greek commentators (see for example Costas Simitis, former Greek Prime Minister, writing in the Guardian 27th April, 2012).
It is also inconceivable that the Minister for Trade in France in 2005-2007 (Christine Lagarde) did not approve of arms exports and it’s likely financing by French Banks. Again it is inconceivable that exports of arms from Germany were not approved at a political level and financing provided by German banks. Expenditures on imported military equipment do not lead to economic growth but rather the growth of international debt. By facilitating such expenditures Germany and France bear some culpability for the predicament now faced by Greece. This should be recognised in terms of bilateral aid to Greece to help achieve genuine economic reform, productive investment and basic levels of affordable health care provision. Lecturing Greeks to pay tax while at the same time offering no positive vision will ensure the Greek crisis continues inside or outside the Euro.
Hostility to Greece
Taking these views at face value, and ignoring the calculus as to how different levels of deprivation might be compared and the role of the IMF in fostering such deprivation, they are not unique. The head of Deutsche Bank has described Greece as “a failed state ... a corrupt state” (Guardian newspaper May 26, 2012). Der Spiegel (5/10/2012) quotes newspaper coverage citing growing sentiment in Germany that Greece may leave the Euro and that this might be a good thing as a Greek exit could make the euro stronger and could also have a “disciplinary effect on other countries”. At the same Spain and Italy are regarded with sympathy in contrast to Greece. An article in the New York Times states ‘Greece, on the other hand, is roundly criticized for lying about the true state of its finances again and again, before and after joining the euro zone, and its failure to take any of the numerous steps demanded by its creditors to modernize its economy and — a particularly sore point — its tax collections. Its status as a special case is underscored time and again’.
Recent comments by the minister for Finance in Ireland to the effect that Greece leaving the Euro would have little effect in Ireland as “it is very far away” and the only item purchased from Greece is Feta cheese are part of the same pattern. Such comments are far removed from EU declarations on solidarity.
What has changed? In Ireland Greece is the example to be avoided. The Minster for Foreign Affairs in Ireland is quoted as stating a default would “place Ireland in the same situation as Greece” (Irish Times, 27/4/2012).
In the case of Germany, anti-Greek sentiment is partly motivated by economic nationalism. Der Spiegel quotes the head of CSU (Horst Seehofer) as seeing a Greek withdrawal from the Euro as the best option and states “We must preserve Germany’s economic strength. That’s more important than Greece remaining in the euro zone”.
A key feature of much of the comment about Greece and the Euro is its relative lack of analysis. One reason for this is that much of the comment originates from a political position which is closely aligned to the position of the current government in Germany.
Take for example comments by Mr Asmussen (described by the Guardian newspaper as Germany’s representative on the ECB council) who stated: "Greece needs to be aware that there are no alternatives to the agreed bailout program, if it wants to stay in the euro zone" (Reuters May 8 2012). More political still are comments by the President of the Budesbank who is quoted by Reuters as stating "If Athens does not stand by its word, then that's a democratic decision. The result is that there is no more basis for further financial aid" (Reuters, November, 5, 2012).
This lack of analysis is reflected in comments that Greece will be required to leave the Euro. Greece cannot be required to leave the Euro. Greece may itself decide to leave the Euro but again the mechanism for this is unclear, but there is no mechanism by which other countries can require Greece to leave the Euro. Even if Greece were in some sense to leave the Euro, the large black economy is likely to mostly trade in Euros, and elements of Greek banking will move offshore to other Euro area countries.
Military Spending by Greece
A lack of analysis is also reflected in the failure to consider the implications of the size of military expenditures by Greece as indicated by stocks of military equipment (see Table (1).
Greek Military Equipment (In Service)
Source:Wikipedia.
(1) Wikipedia note that military equipment is from German, French, American, British and Russian suppliers
(2) A total of 170 new Leopard (German) tanks were delivered between 2006-2009.
Greece was among the world's top five largest recipients of major conventional weapons for 2005-2009, and was third place for 2000–2004. The transfer of 26 F-16C from the United States and 25 Mirage-2000-9 combat aircraft from France accounted for 38 per cent of the volume of Greek imports for the period 2005-2009 (SIPRI Trends in International Arms Transfer 2009, p. 5). Greece was the largest importer of German conventional weapons in the period 2007-2011 and the second largest importer of French conventional weapons (source: SIPRI Trends in International Arms Transfers 2012). Since Greece joined the Eurozone until 2010 military expenditure has varied between 2.3 and 3.4% of GDP, compared with 1.4 to 1.5% of GDP for Germany and 0.6 to 0.7% for Ireland. Since joining the eurozone cumulative military expenditure for Greece amounts to around €63 billion (Source here). Even in 2011, Greece continued to import arms and has outstanding orders for five German submarines.
Yet it is difficult to find any reference to arms spending as a contributory factor to the fiscal and economic crisis in Greece, by outside commentators or by Greek commentators (see for example Costas Simitis, former Greek Prime Minister, writing in the Guardian 27th April, 2012).
It is also inconceivable that the Minister for Trade in France in 2005-2007 (Christine Lagarde) did not approve of arms exports and it’s likely financing by French Banks. Again it is inconceivable that exports of arms from Germany were not approved at a political level and financing provided by German banks. Expenditures on imported military equipment do not lead to economic growth but rather the growth of international debt. By facilitating such expenditures Germany and France bear some culpability for the predicament now faced by Greece. This should be recognised in terms of bilateral aid to Greece to help achieve genuine economic reform, productive investment and basic levels of affordable health care provision. Lecturing Greeks to pay tax while at the same time offering no positive vision will ensure the Greek crisis continues inside or outside the Euro.
Thursday, 26 April 2012
The ECB and the Forthcoming Referendum
Jim Stewart: A recent speech delivered by Mr Asmussen (Executive Director of the ECB) at a seminar organised by the IIEA in Dublin (The Irish Case From An ECB Perspective), gives powerful (though unintended) grounds for a no vote in the forthcoming referendum.
Mr Asmussen emphasised that from an ECB perspective it was of the “utmost importance” that all euro area countries adopt the fiscal compact to regain the confidence of markets. The overall policy can be summarised as austerity (raising taxes cutting expenditure) releases, what Paul Krugman has called the ‘confidence fairy’ and recapitalising banks and repaying senior bond holders, releases the ‘banking fairy’ – banks will once again start lending. Both policies in the absence of policies to encourage growth and investment will simply result in further stagnation. The Fiscal Treaty will make the adoption of policies supporting growth more difficult if not impossible.
Specifically in relation to Ireland, Mr Asmussen clearly outlined ECB thinking on the origins of the crisis and subsequent developments. In summary the view of the ECB is that while the crisis largely originated in Ireland, the solutions devised in conjunction with the Commission and the IMF and set out in the EU/IMF Programme for Ireland are working . The ECB has been particularly generous in its support to Ireland (“working as a true partner”), and because the programme is working there must not be any deviation from it for example in relation to the payment in full of the promissory notes, issued to finance the Irish Bank Resolution Corporation.
The following examines three claims made by Mr. Asmussen:-
1 “The Programme is on track. So far Ireland has delivered” (p.1);
2 The ECB is “a true partner” to Ireland (p.3);
3 “No other institution has provided more help to Ireland than the ECB” (p.7).
“The Programme is on track. So far Ireland has delivered”
Many might query that the EU/IMF Programme is working. Mr Asmussen states Ireland “is the only programme country that has managed to close its deficit and to return to growth last year” and cites growth last year of 0.7% and projected growth of 0.5% in 2012. But we should note projected growth (Table 1) at the time the Memorandum of Understanding was signed (16 December 2010), and on which the programme was predicated, was considerably larger than actual and projected GDP.
Mr Asmussen emphasised that from an ECB perspective it was of the “utmost importance” that all euro area countries adopt the fiscal compact to regain the confidence of markets. The overall policy can be summarised as austerity (raising taxes cutting expenditure) releases, what Paul Krugman has called the ‘confidence fairy’ and recapitalising banks and repaying senior bond holders, releases the ‘banking fairy’ – banks will once again start lending. Both policies in the absence of policies to encourage growth and investment will simply result in further stagnation. The Fiscal Treaty will make the adoption of policies supporting growth more difficult if not impossible.
Specifically in relation to Ireland, Mr Asmussen clearly outlined ECB thinking on the origins of the crisis and subsequent developments. In summary the view of the ECB is that while the crisis largely originated in Ireland, the solutions devised in conjunction with the Commission and the IMF and set out in the EU/IMF Programme for Ireland are working . The ECB has been particularly generous in its support to Ireland (“working as a true partner”), and because the programme is working there must not be any deviation from it for example in relation to the payment in full of the promissory notes, issued to finance the Irish Bank Resolution Corporation.
The following examines three claims made by Mr. Asmussen:-
1 “The Programme is on track. So far Ireland has delivered” (p.1);
2 The ECB is “a true partner” to Ireland (p.3);
3 “No other institution has provided more help to Ireland than the ECB” (p.7).
“The Programme is on track. So far Ireland has delivered”
Many might query that the EU/IMF Programme is working. Mr Asmussen states Ireland “is the only programme country that has managed to close its deficit and to return to growth last year” and cites growth last year of 0.7% and projected growth of 0.5% in 2012. But we should note projected growth (Table 1) at the time the Memorandum of Understanding was signed (16 December 2010), and on which the programme was predicated, was considerably larger than actual and projected GDP.
Table 1:
The ECB does recognise unemployment as an issue. Mr. Asmussen states, (p. 6) “worst of all, perhaps, is the fact that a large portion of the population is currently out of work”. What is not stated is that unemployment in Ireland is the second highest in what the IMF classifies as advanced Europe (IMF World Economic Outlook April 2012, Table 2.1 p. 53) at 14.4% in 2011 and is forecast at 10.5% in 2017. Examples cited by Mr Asmussen such as deregulating the market for legal and medical services (p. 5) are most unlikely (even if implemented), to “expand activity and increase employment” in any meaningful way.
The ECB is “a true partner” to Ireland;
Mr Asmussen describes the ECB “as a true partner”. In fact many of the policies implemented and required by the ECB have magnified the crisis in Ireland. In his address Mr Asmussen clarified that the ECB regarded repayment of Anglo bondholders as a key consideration to prevent negative effects to “banks in other European countries”. This clarification is strangely absent from the written statement (available here). These ‘negative effects’ are uncertain. Bondholders may have held insurance in the form of credit default swaps. Default on senior bank debt by banks in Denmark had no or very little (reported consequences) for banks in other countries (see Denmark Takes Over Second Bank to Trigger Bail-in Resolution, Bloomberg 27 June 2011) and yields on Danish Government debt are close to or below those for Germany. But the main implication of Mr Assussens comments are that the ECB sought to give preferential treatment to banks in other countries at the expense of the Irish State and Irish society. This transfer in wealth (it was a transfer as Anglo-Irish and other banks senior debt was trading far below the value at which it was redeemed before the new government took office) has helped increase the cost to the State of the bank recapitalisation to €62.8 billion by March 2012 approximately 38% of General Government gross debt. Without any bank recapitalisation Irelands Debt/GDP ratio would be approx 65% of GDP (ignoring interest savings)- amongst the lowest in the eurozone.
In February 2011 the five institutions recapitalised, held €35 billion in senior unguaranteed secured and unsecured bank debt (see Senior Debt and Subordinated Debt Issuance by Irish Credit Institutions, Central bank March 2, 2011 available here). If this were written down by 50%, the Debt/GDP ratio (as measured by the IMF), would fall from 105% for 2011 to 94%. (Note this excludes the approximately €71 billion in bonds redeemed at face value prior to February 2011). Any policies that reduce government borrowing and the Debt/GDP ratio, without advesely affecting economic growth will enhance Irelands ability to access market based funding. The ECB belief that negotiating a reduction in the cost of the promissory notes would adversely affect Ireland’s credit rating is delusional. The IMF has recently urged the need to reduce the links between sovereign debt and bank debt. In Ireland the policies of the ECB have the effect of increasing these links.
“No other institution has provided more help to Ireland than the ECB”.
The one area where ECB policy is beneficial to Ireland has been through Eurosytem liquidity provision. Mr Asmussen implies that this liquidity provision was in some sense preferential aid to Ireland. He states “Relative to the size of the economy, no other euro area country has received so much support from the Eurosytem. And no other institution has provided more help to Ireland than the ECB”. However the provision of unlimited liquidity is one of the main functions of a Central Bank and liquidity was provided to banks in Ireland fully in accordance with ECB rules (a point acknowledged by M. Asmussen) and cannot in this sense be preferential. Furthermore the benefit of this liquidity provision accrues not just to Ireland but in a monetary union given large scale interbank borrowing and the presence of a large EU owned bank sector in Ireland, throughout the monetary union. A collapse in Ireland’s banking sector would have been a calamitous event not just for Ireland but for the Eurosystem.
Mr. Asmussen states that the level of this “support” contradicts claims that the ECB “bounced” Ireland into the EU/IMF programme in late 2010. Rather the level of liquidity provision which the ECB erroneously believed was in some sense a gift or aid, exclusively to the benefit of Ireland, and the desire of the ECB to reduce this as quickly as possible were likely to be prime factors in the initiation of the EU/IMF programme. Reducing ECB liquidity provision to Irish banks remains a key policy objective of the ECB. Mr Asmussen states “There can be no doubt that the current amount of liquidity support by the ECB and the Central Bank of Ireland needs to be substantially reduced over time”.
The expressed wish to reduce the amount of eurosystem liquidity provision is not in Ireland’s current interest. A policy objective should be to maximise the amount of liquidity provision from the Eurosystem, given the risks of bank deleveraging as a response to the economic crisis. This risk has been exacerbated in Ireland by the imposition of a higher core Tier 1 capital ratio (equity/risk weighted assets) than that required by the European Banking Authority (10.5% compared with 9%) and at the same time reducing the loan to deposit ratio from 180 to 122.5% (See Central Bank, Financial Measures Support programme, p. 7 and 12).
The crisis in Ireland is largely of our own making involving multiple failures at many institutions (public and private) and at many levels, but ECB policies have magnified the crisis. Policy at the ECB and other EU institutions can and must change to support a pro-growth strategy for Europe as a whole. This is in the interest of all countries in the EU, and in the vital long run interest of Germany. Irish Government policy should be to support the likely new Hollande administration in amending the fiscal treaty and in reforming the ECB (See “Hollande seeks wider EU fiscal pact”, Financial Times April 24, 2012).
| '10 | '11 | '12; | '14 | '15 | |
| Department of Finance forecast of GOP growth, December 20101 | 0.3 | 1.7 | 3.2 | 3.0 | 2.8 |
| Actual 2010-2011 IMF forecast, 2012-2017 | -.04 | 0.7 | 0.5 | 2.0 | 2.5 |
| Department of Finance forecast of unemployment rate, December 2010 | 13.4 | 13.2 | 12.0 | 10.9 | 9.8 |
| Actual Unemployment rate for 2010-11 and IMF forecast April 2012 | 13.6 | 14.4 | 14.5 | 13.8 | 13.0 |
| Department of Finance forecast of change in total numbers at work 10th, December 2010 | -4.0 | -0.2 | 1.3 | 1.6 | 1.8 |
| IMF forecasts for change in numbers at work April 2012 | -4.2 | -2.0 | -1.0 | 0.07 | — |
The ECB does recognise unemployment as an issue. Mr. Asmussen states, (p. 6) “worst of all, perhaps, is the fact that a large portion of the population is currently out of work”. What is not stated is that unemployment in Ireland is the second highest in what the IMF classifies as advanced Europe (IMF World Economic Outlook April 2012, Table 2.1 p. 53) at 14.4% in 2011 and is forecast at 10.5% in 2017. Examples cited by Mr Asmussen such as deregulating the market for legal and medical services (p. 5) are most unlikely (even if implemented), to “expand activity and increase employment” in any meaningful way.
The ECB is “a true partner” to Ireland;
Mr Asmussen describes the ECB “as a true partner”. In fact many of the policies implemented and required by the ECB have magnified the crisis in Ireland. In his address Mr Asmussen clarified that the ECB regarded repayment of Anglo bondholders as a key consideration to prevent negative effects to “banks in other European countries”. This clarification is strangely absent from the written statement (available here). These ‘negative effects’ are uncertain. Bondholders may have held insurance in the form of credit default swaps. Default on senior bank debt by banks in Denmark had no or very little (reported consequences) for banks in other countries (see Denmark Takes Over Second Bank to Trigger Bail-in Resolution, Bloomberg 27 June 2011) and yields on Danish Government debt are close to or below those for Germany. But the main implication of Mr Assussens comments are that the ECB sought to give preferential treatment to banks in other countries at the expense of the Irish State and Irish society. This transfer in wealth (it was a transfer as Anglo-Irish and other banks senior debt was trading far below the value at which it was redeemed before the new government took office) has helped increase the cost to the State of the bank recapitalisation to €62.8 billion by March 2012 approximately 38% of General Government gross debt. Without any bank recapitalisation Irelands Debt/GDP ratio would be approx 65% of GDP (ignoring interest savings)- amongst the lowest in the eurozone.
In February 2011 the five institutions recapitalised, held €35 billion in senior unguaranteed secured and unsecured bank debt (see Senior Debt and Subordinated Debt Issuance by Irish Credit Institutions, Central bank March 2, 2011 available here). If this were written down by 50%, the Debt/GDP ratio (as measured by the IMF), would fall from 105% for 2011 to 94%. (Note this excludes the approximately €71 billion in bonds redeemed at face value prior to February 2011). Any policies that reduce government borrowing and the Debt/GDP ratio, without advesely affecting economic growth will enhance Irelands ability to access market based funding. The ECB belief that negotiating a reduction in the cost of the promissory notes would adversely affect Ireland’s credit rating is delusional. The IMF has recently urged the need to reduce the links between sovereign debt and bank debt. In Ireland the policies of the ECB have the effect of increasing these links.
“No other institution has provided more help to Ireland than the ECB”.
The one area where ECB policy is beneficial to Ireland has been through Eurosytem liquidity provision. Mr Asmussen implies that this liquidity provision was in some sense preferential aid to Ireland. He states “Relative to the size of the economy, no other euro area country has received so much support from the Eurosytem. And no other institution has provided more help to Ireland than the ECB”. However the provision of unlimited liquidity is one of the main functions of a Central Bank and liquidity was provided to banks in Ireland fully in accordance with ECB rules (a point acknowledged by M. Asmussen) and cannot in this sense be preferential. Furthermore the benefit of this liquidity provision accrues not just to Ireland but in a monetary union given large scale interbank borrowing and the presence of a large EU owned bank sector in Ireland, throughout the monetary union. A collapse in Ireland’s banking sector would have been a calamitous event not just for Ireland but for the Eurosystem.
Mr. Asmussen states that the level of this “support” contradicts claims that the ECB “bounced” Ireland into the EU/IMF programme in late 2010. Rather the level of liquidity provision which the ECB erroneously believed was in some sense a gift or aid, exclusively to the benefit of Ireland, and the desire of the ECB to reduce this as quickly as possible were likely to be prime factors in the initiation of the EU/IMF programme. Reducing ECB liquidity provision to Irish banks remains a key policy objective of the ECB. Mr Asmussen states “There can be no doubt that the current amount of liquidity support by the ECB and the Central Bank of Ireland needs to be substantially reduced over time”.
The expressed wish to reduce the amount of eurosystem liquidity provision is not in Ireland’s current interest. A policy objective should be to maximise the amount of liquidity provision from the Eurosystem, given the risks of bank deleveraging as a response to the economic crisis. This risk has been exacerbated in Ireland by the imposition of a higher core Tier 1 capital ratio (equity/risk weighted assets) than that required by the European Banking Authority (10.5% compared with 9%) and at the same time reducing the loan to deposit ratio from 180 to 122.5% (See Central Bank, Financial Measures Support programme, p. 7 and 12).
The crisis in Ireland is largely of our own making involving multiple failures at many institutions (public and private) and at many levels, but ECB policies have magnified the crisis. Policy at the ECB and other EU institutions can and must change to support a pro-growth strategy for Europe as a whole. This is in the interest of all countries in the EU, and in the vital long run interest of Germany. Irish Government policy should be to support the likely new Hollande administration in amending the fiscal treaty and in reforming the ECB (See “Hollande seeks wider EU fiscal pact”, Financial Times April 24, 2012).
Friday, 9 March 2012
The referendum - what to do?
Jim Stewart: The Treaty on Stability, Coordination and Governance is flawed in many respects. Martin Wolf, writing in the Financial Times on 6th March, itemises some of these flaws. The obvious one is the requirement in clause 1b limiting the ‘structural deficit to 0.5% of GDP’. Countries must adjust rapidly to this position as agreed by the European Commission. In addition if the ratio of government debt to GDP is greater than 60%, article 4 requires the excess amount to be reduced over a twenty year period. So that a country where a debt/GDP ratio is currently 100% is required to reduce this amount by 2% per annum. In effect this means running a budget surplus of 1.5%. This is impossible to achieve, without debt writedowns. In the absence of debt writedowns attempting to achieve this target would deepen the current recession in Ireland and other countries, and prevent any economic recovery.
The Treaty states that the rule will be deemed to have been “respected if the annual structural balance of the general government is at its country-specific medium-term objective”. The problem is how can this be known? Both Ireland and Spain would have satisfied this budget criteria before the economic crisis. The key question was whether government finances were stable over time? This means that (1) the financial crisis would have to be forecast, (2) policy responses would have to be forecast, and (3) the effect of both the financial crisis and policy responses on government finances would have to be forecast. Some economists got point (1) right. Official Ireland was spectacularly wrong. No economist forecast all three nor would this be possible. The proposal from Philip Lane (Irish Times Feb. 7) for Ireland to develop a capacity (funded by the State) for “independent, high quality assessments of structural trends in the economy and the public finances” will have the effect of creating jobs for economists but little else.
Further issues arises in relation to the measure of debt. For example, activities transferred to a commercial State owned company, such as the proposed Water Authority, would also have associated debts transferred. Current measures of GDP are favorable to Ireland because GDP is inflated by profit switching transfer pricing by foreign owned firms. This may not always be the case. How can rational economic policy be based on a ratio, in which both the numerator and denominator are subject to revision, especially in the case of GDP?
This does not mean that over a period of time Government expenditure and government revenue, should not be sustainable. Being sustainable does not mean expenditure should be almost identical with revenue. An economy that is growing strongly can have both government deficits and maintain a stable debt/GDP ratio. Successful economies can have widely varying ratios of debt to GDP over long periods of time, for example Japan.
The fiscal treaty can be added to the list of flawed policy making that has helped turn an economic crisis (largely of our own making) into a national catastrophe. It is particularly dangerous because it will be incorporated in the constitution making change very difficult and incorporates the right of another one of the signatories to the treaty to bring a case to the European Court of Justice (article 8.1) and face financial sanctions in the event of non-compliance. It is the same thinking that initially set penal interest rates on Irelands borrowing under the EU/IMF Programme.
Hence the question arises why would rational people vote in favour of a Treaty which has so many flaws. John O’Hagen (Irish Times, 8th March) asks of those opposing ratification to explain “how day-to-day State expenditure will be funded from 2013”. The simple answer is that according to the Government, after the current programme has ended, (that is at the end of 2013, not ‘from 2013’ see EU/IMF Programme, p. 16 ) Ireland will turn to the bond markets for financing (Minister of State Brian Hayes quoted in Irish Times 6 March, 2012), and a point also made by Jean-Claude Juncker, chairman of the Eurozone finance ministers, to the European parliament on Feb 29.
But the point has been made unless the Treaty is ratified financial assistance will not be granted from the European Stability Mechanism at the end of 2013 should it be needed. So the question is how likely is a second bailout and to what extent will it be required? The answer to this question is uncertain. Funding is in place from the existing programme until the end of 2013. While bond redemptions amount to €11 billion in 2014, they will be zero in 2015 (NTMA annual Report 2010, p. 15). In addition, national savings contributed about €4.3 billion in 2011, and could rise further.
A further uncertainty arises from the stated intention of Francois Hollande, the front runner in the French Presidential election to renegotiate the treaty (Hugh Carnegy and Quentin peel, Financial Times, March 4, 2012). At the same time the main architect of the treaty Merkel, has lost credibility in Germany with the resignation of the candidate she supported as President. Because of this and other issues, Der Spiegel (2/21/2012) reports difficulties within the coalition government and states “many are now asking how much longer it can survive”. The second bail out package for Greece required the support of the opposition Social Democrats and Greens (Der Spiegel 2/27/2012). Opposition parties and likely participants in a successor government espouse policies such as emphasising growth rather than austerity to balance budgets, a Eurobond and a Financial Transaction Tax.
Spain recently announced a new higher target for the budget deficit of 5.8% compared with 4.4% agreed with the Commission, some hours after signing the new Treaty. Furthermore the Spanish Prime Minister announced that the budget deficit was a matter for the Spanish Government and not the Commission. It is also interesting to note that there was very little change in yields on Spanish government bonds (benchmark 10 year yields rose from 4.91% to 4.96%) on the first day of trading after this announcement and the signing of the Stability Treaty, indicating, perhaps that markets recognise that increased austerity is bad for economic growth and bad for bond markets. Further budget cutbacks in the Netherlands could result in a general election in which political parties opposed to budgetary cuts would make large gains (Financial Times, March 1, 2012). It is likely that government policy in relation to the financial and economic crisis will change in key EU countries as a result of political change.
The strategy to adopt in the face of this uncertainty is to delay holding a referendum for as long as possible. At government level we in Ireland have ‘world class skills’ in delay. The Department of Justice is especially skilled in this regard. A delay is likely to mean that political change in EU countries, such as France, will result in change to the Stability Treaty. Peripheral countries (Greece, Ireland, Portugal, Italy, Spain) will thus have an opportunity to influence treaty change to their benefit. Writing detailed fiscal stability rules into a constitution is flawed reasoning, and treaty change could remove this threat. Delay will help clarify if and to what extent a second bail out is needed.
What about the promissory notes? If as some have suggested there is an agreement to reduce the cost of the promissory notes, should this influence or decision? On this An Taoiseach is correct: there is no linkage. The cost of the promissory notes can and should be reduced under existing rules and should have no influence on voting intentions on the Treaty for stability.
It is difficult but vital that economic policy is taken from those without any democratic mandate, and without any economic policy other than a dogmatic adherence to the imposition of austerity. It is indeed unfortunate for Ireland and the EU that we have a Commissioner for Economic and Financial Affairs who is bereft of ideas. It is doubly unfortunate for Ireland that those directly responsible for implementing the programme (Mr. Székely, Director and European Commission mission chief to Ireland) are unable to produce a single idea that is growth enhancing (see for example the recently published review of the economic programme for Ireland).
The Treaty states that the rule will be deemed to have been “respected if the annual structural balance of the general government is at its country-specific medium-term objective”. The problem is how can this be known? Both Ireland and Spain would have satisfied this budget criteria before the economic crisis. The key question was whether government finances were stable over time? This means that (1) the financial crisis would have to be forecast, (2) policy responses would have to be forecast, and (3) the effect of both the financial crisis and policy responses on government finances would have to be forecast. Some economists got point (1) right. Official Ireland was spectacularly wrong. No economist forecast all three nor would this be possible. The proposal from Philip Lane (Irish Times Feb. 7) for Ireland to develop a capacity (funded by the State) for “independent, high quality assessments of structural trends in the economy and the public finances” will have the effect of creating jobs for economists but little else.
Further issues arises in relation to the measure of debt. For example, activities transferred to a commercial State owned company, such as the proposed Water Authority, would also have associated debts transferred. Current measures of GDP are favorable to Ireland because GDP is inflated by profit switching transfer pricing by foreign owned firms. This may not always be the case. How can rational economic policy be based on a ratio, in which both the numerator and denominator are subject to revision, especially in the case of GDP?
This does not mean that over a period of time Government expenditure and government revenue, should not be sustainable. Being sustainable does not mean expenditure should be almost identical with revenue. An economy that is growing strongly can have both government deficits and maintain a stable debt/GDP ratio. Successful economies can have widely varying ratios of debt to GDP over long periods of time, for example Japan.
The fiscal treaty can be added to the list of flawed policy making that has helped turn an economic crisis (largely of our own making) into a national catastrophe. It is particularly dangerous because it will be incorporated in the constitution making change very difficult and incorporates the right of another one of the signatories to the treaty to bring a case to the European Court of Justice (article 8.1) and face financial sanctions in the event of non-compliance. It is the same thinking that initially set penal interest rates on Irelands borrowing under the EU/IMF Programme.
Hence the question arises why would rational people vote in favour of a Treaty which has so many flaws. John O’Hagen (Irish Times, 8th March) asks of those opposing ratification to explain “how day-to-day State expenditure will be funded from 2013”. The simple answer is that according to the Government, after the current programme has ended, (that is at the end of 2013, not ‘from 2013’ see EU/IMF Programme, p. 16 ) Ireland will turn to the bond markets for financing (Minister of State Brian Hayes quoted in Irish Times 6 March, 2012), and a point also made by Jean-Claude Juncker, chairman of the Eurozone finance ministers, to the European parliament on Feb 29.
But the point has been made unless the Treaty is ratified financial assistance will not be granted from the European Stability Mechanism at the end of 2013 should it be needed. So the question is how likely is a second bailout and to what extent will it be required? The answer to this question is uncertain. Funding is in place from the existing programme until the end of 2013. While bond redemptions amount to €11 billion in 2014, they will be zero in 2015 (NTMA annual Report 2010, p. 15). In addition, national savings contributed about €4.3 billion in 2011, and could rise further.
A further uncertainty arises from the stated intention of Francois Hollande, the front runner in the French Presidential election to renegotiate the treaty (Hugh Carnegy and Quentin peel, Financial Times, March 4, 2012). At the same time the main architect of the treaty Merkel, has lost credibility in Germany with the resignation of the candidate she supported as President. Because of this and other issues, Der Spiegel (2/21/2012) reports difficulties within the coalition government and states “many are now asking how much longer it can survive”. The second bail out package for Greece required the support of the opposition Social Democrats and Greens (Der Spiegel 2/27/2012). Opposition parties and likely participants in a successor government espouse policies such as emphasising growth rather than austerity to balance budgets, a Eurobond and a Financial Transaction Tax.
Spain recently announced a new higher target for the budget deficit of 5.8% compared with 4.4% agreed with the Commission, some hours after signing the new Treaty. Furthermore the Spanish Prime Minister announced that the budget deficit was a matter for the Spanish Government and not the Commission. It is also interesting to note that there was very little change in yields on Spanish government bonds (benchmark 10 year yields rose from 4.91% to 4.96%) on the first day of trading after this announcement and the signing of the Stability Treaty, indicating, perhaps that markets recognise that increased austerity is bad for economic growth and bad for bond markets. Further budget cutbacks in the Netherlands could result in a general election in which political parties opposed to budgetary cuts would make large gains (Financial Times, March 1, 2012). It is likely that government policy in relation to the financial and economic crisis will change in key EU countries as a result of political change.
The strategy to adopt in the face of this uncertainty is to delay holding a referendum for as long as possible. At government level we in Ireland have ‘world class skills’ in delay. The Department of Justice is especially skilled in this regard. A delay is likely to mean that political change in EU countries, such as France, will result in change to the Stability Treaty. Peripheral countries (Greece, Ireland, Portugal, Italy, Spain) will thus have an opportunity to influence treaty change to their benefit. Writing detailed fiscal stability rules into a constitution is flawed reasoning, and treaty change could remove this threat. Delay will help clarify if and to what extent a second bail out is needed.
What about the promissory notes? If as some have suggested there is an agreement to reduce the cost of the promissory notes, should this influence or decision? On this An Taoiseach is correct: there is no linkage. The cost of the promissory notes can and should be reduced under existing rules and should have no influence on voting intentions on the Treaty for stability.
It is difficult but vital that economic policy is taken from those without any democratic mandate, and without any economic policy other than a dogmatic adherence to the imposition of austerity. It is indeed unfortunate for Ireland and the EU that we have a Commissioner for Economic and Financial Affairs who is bereft of ideas. It is doubly unfortunate for Ireland that those directly responsible for implementing the programme (Mr. Székely, Director and European Commission mission chief to Ireland) are unable to produce a single idea that is growth enhancing (see for example the recently published review of the economic programme for Ireland).
Wednesday, 21 December 2011
The Pension System in Ireland: Current Issues and Reform
Sinéad Pentony: The TCD Pension Policy Research Group has recently published a Working Paper written by Jim Stewart called The Pension System in Ireland: Current Issues and Reform.
The paper provides a very useful overview of the key features of the Irish pension system and it examines five key issues:
• The sources of income of retired persons.
• The value of pension fund assets.
• The National Pension Reserve Fund.
• Implications for pension funds of the rise in long bond yields.
• Policy responses and reform.
The paper highlights the inadequacy of recent policy responses and reforms in dealing with the structural problems in our pension system which have been brought into sharp focus by the financial and economic crises. The need for fundamental reform of our pension system and the development of a new model of pension provision has been highlighted by TASC and the TCD Pension Policy Research Group.
The paper provides a very useful overview of the key features of the Irish pension system and it examines five key issues:
• The sources of income of retired persons.
• The value of pension fund assets.
• The National Pension Reserve Fund.
• Implications for pension funds of the rise in long bond yields.
• Policy responses and reform.
The paper highlights the inadequacy of recent policy responses and reforms in dealing with the structural problems in our pension system which have been brought into sharp focus by the financial and economic crises. The need for fundamental reform of our pension system and the development of a new model of pension provision has been highlighted by TASC and the TCD Pension Policy Research Group.
Friday, 25 November 2011
The Euro Crisis: is history repeating itself?
Jim Stewart: It is a “common view ... that the world was headed for a massive payments crisis in which several European countries would default on their debts, setting the stage for a general restructuring of all international commitments”.
So writes Liaquat Ahamed in his book ‘Lords of Finance’ (p. 326) in describing the prelude to a conference in 1929 called to reach a final settlement to the German Reparations issue. The conference succeeded in reaching agreement but on terms which eventually lead to financial chaos in Germany and helped precipitate the great depression of the 1930s. Policies that are now regarded as disastrous, were held widely by key decision makers and dogmatically argued. The analogy with policy making and events in the period preceding the great depression of the 1930s and today are striking.
Personal animosities, then as now, are widespread. In 1929 the Governor of the Federal Bank of New York and in effective control of The US central banking system described his German opposite number as an “.. ..exceedingly vain man. This does not take the form of boastfulness as it does a certain naive self assurance” (Ahamed, p. 281). For recent 2011 examples, see Lord Myner's comments on Michael Barnier, the Commissioner for internal regulation. Media reports often cite German annoyance with French Government policies and proposals, see for example here. At an EU summit in October, President Sarkozy is widely reported as telling The Prime Minister of the UK "You have lost a good opportunity to shut up.". Kauder (a leading member of the CDU) has described UK policy as irresponsible and self interested.
But the main problem is the prevailing consensus (held for example by the President of the ECB, the new Prime Minister of Italy, the Governor of the Irish Central Bank etc) that the solution to current economic problems is austerity plus maintaining the solvency of the banking sector at any cost. For short hand this can be termed the Goldman Sachs consensus. The increasing irrationality of such a policy is becoming obvious even to some former supporters. Some examples:-
(1) Ireland, even though it is dependent on IMF and EU loans, and has suffered a hugh recession and economic collapse, was required to pay bondholders in a failed bank even though these bondholders were not covered by any guarantee;
(2) The ECB intervenes in the sovereign bond market while at the same time stating such support will be limited and undesirable. The net effect is that those who wish to sell government bonds such as banks have been able to do so without any medium term effect on bond yields. In effect, such intervention is another support to the banking system.
(3) Where default is both desirable and certain, as in the case of Greece, policy makers perform numerous contortions to try to ensure such a default does not trigger an ‘event’ resulting in the payout on a Credit Default Swap Contract. A Credit Default Swap is similar to insurance on a bond. If the bond defaults the insurance is paid. Such contracts would appear to be one of the greatest financial frauds perpetrated in recent history. Given that policies to ensure debt write downs are not technically a default, buying a CDS contract on government debt, means that the contract will not pay up in the event of default. In any case, in the highly desirable event of a write down of Government debt generally in indebted countries (where Government debt was greater than 60% of GDP, as in the case of Belgium, Ireland, Italy and Portugal), CDS contracts would also not pay out because the counterparty would become insolvent. This is because it is most unlikely that, following the bailouts due to the subprime crisis of AIG and other financial firms, there could be a second massive transfer of resources from the state to the banking sector.
As in earlier periods of financial crisis, commentators assume rationality by decision makers. However key decision makers should be judged by what they say, as distinct from what we hope they think. Take the case of the recently appointed President of the Bundesbank . In a recent interview with the Financial Times, the Bundesbank President stated that the correct response to Greece is “implement what has been decided”. The problem is what has been decided cannot be implemented. Greece does not have the necessary administrative or technical skills, never mind the political will, to implement IMF/EU proposals. The problems with Italy are seen as a problem of “confidence”. Italy has many problems, both political and economic. These reforms will take many years to implement. The lack of confidence in Italian Government bonds is immediate. The Bundesbank President considers the key competitive strength of Germany results from labour market reform. The key strength of Germany relates to its innovative, high productive economy, with a skilled labour force, extensive infrastructure and success in tax compliance (for example using leaked information on deposits held in Swiss bank accounts by German nationals to ensure tax compliance).
There is widespread support for issuing Eurobonds. There are arguments for and against such a proposal (see for example the recent Green Paper on Stability Bonds (Annex 2). Issuing eurobonds could help in the current crisis if applied only to new bond issues, and if existing bonds were not converted into new bonds. Instead they could be transferred to a debt management agency for all or some of the most heavily indebted countries. These bonds could then be written down in value and held until redemption. This is in contrast to the proposals in the EU Green Paper on Stability Bonds, which does not envisage or discuss writing down the value of existing bonds. In addition, the Green Paper does not refer to or discuss the very different economic policies pursued by central banks in the US, UK and Japan, that is large scale intervention in the bond market referred to as ‘quantitative easing’, and the consequent effect on bond yields.
But comments by key decision makers on such a vital topic have been meaningless. For example, the President of the Bundesbank has dismissed arguments in favour of Eurobonds by stating such a policy would be “like drinking sea water to kill thirst”. These and other comments do not give any confidence that key economic policy makers are intellectually equipped to deal with the current crisis.
There is no modern equivalent to Keynes. As in the 1930s, we may have to wait until current policies have demonstrably failed, and are widely recognised to have failed, before there is a change in policy. The cost and problems created could be enormous.
The forthcoming Budget in Ireland is given much media attention. The forthcoming EU summit on 9th December could take decisions that will influence our economic destiny for the next decade.
So writes Liaquat Ahamed in his book ‘Lords of Finance’ (p. 326) in describing the prelude to a conference in 1929 called to reach a final settlement to the German Reparations issue. The conference succeeded in reaching agreement but on terms which eventually lead to financial chaos in Germany and helped precipitate the great depression of the 1930s. Policies that are now regarded as disastrous, were held widely by key decision makers and dogmatically argued. The analogy with policy making and events in the period preceding the great depression of the 1930s and today are striking.
Personal animosities, then as now, are widespread. In 1929 the Governor of the Federal Bank of New York and in effective control of The US central banking system described his German opposite number as an “.. ..exceedingly vain man. This does not take the form of boastfulness as it does a certain naive self assurance” (Ahamed, p. 281). For recent 2011 examples, see Lord Myner's comments on Michael Barnier, the Commissioner for internal regulation. Media reports often cite German annoyance with French Government policies and proposals, see for example here. At an EU summit in October, President Sarkozy is widely reported as telling The Prime Minister of the UK "You have lost a good opportunity to shut up.". Kauder (a leading member of the CDU) has described UK policy as irresponsible and self interested.
But the main problem is the prevailing consensus (held for example by the President of the ECB, the new Prime Minister of Italy, the Governor of the Irish Central Bank etc) that the solution to current economic problems is austerity plus maintaining the solvency of the banking sector at any cost. For short hand this can be termed the Goldman Sachs consensus. The increasing irrationality of such a policy is becoming obvious even to some former supporters. Some examples:-
(1) Ireland, even though it is dependent on IMF and EU loans, and has suffered a hugh recession and economic collapse, was required to pay bondholders in a failed bank even though these bondholders were not covered by any guarantee;
(2) The ECB intervenes in the sovereign bond market while at the same time stating such support will be limited and undesirable. The net effect is that those who wish to sell government bonds such as banks have been able to do so without any medium term effect on bond yields. In effect, such intervention is another support to the banking system.
(3) Where default is both desirable and certain, as in the case of Greece, policy makers perform numerous contortions to try to ensure such a default does not trigger an ‘event’ resulting in the payout on a Credit Default Swap Contract. A Credit Default Swap is similar to insurance on a bond. If the bond defaults the insurance is paid. Such contracts would appear to be one of the greatest financial frauds perpetrated in recent history. Given that policies to ensure debt write downs are not technically a default, buying a CDS contract on government debt, means that the contract will not pay up in the event of default. In any case, in the highly desirable event of a write down of Government debt generally in indebted countries (where Government debt was greater than 60% of GDP, as in the case of Belgium, Ireland, Italy and Portugal), CDS contracts would also not pay out because the counterparty would become insolvent. This is because it is most unlikely that, following the bailouts due to the subprime crisis of AIG and other financial firms, there could be a second massive transfer of resources from the state to the banking sector.
As in earlier periods of financial crisis, commentators assume rationality by decision makers. However key decision makers should be judged by what they say, as distinct from what we hope they think. Take the case of the recently appointed President of the Bundesbank . In a recent interview with the Financial Times, the Bundesbank President stated that the correct response to Greece is “implement what has been decided”. The problem is what has been decided cannot be implemented. Greece does not have the necessary administrative or technical skills, never mind the political will, to implement IMF/EU proposals. The problems with Italy are seen as a problem of “confidence”. Italy has many problems, both political and economic. These reforms will take many years to implement. The lack of confidence in Italian Government bonds is immediate. The Bundesbank President considers the key competitive strength of Germany results from labour market reform. The key strength of Germany relates to its innovative, high productive economy, with a skilled labour force, extensive infrastructure and success in tax compliance (for example using leaked information on deposits held in Swiss bank accounts by German nationals to ensure tax compliance).
There is widespread support for issuing Eurobonds. There are arguments for and against such a proposal (see for example the recent Green Paper on Stability Bonds (Annex 2). Issuing eurobonds could help in the current crisis if applied only to new bond issues, and if existing bonds were not converted into new bonds. Instead they could be transferred to a debt management agency for all or some of the most heavily indebted countries. These bonds could then be written down in value and held until redemption. This is in contrast to the proposals in the EU Green Paper on Stability Bonds, which does not envisage or discuss writing down the value of existing bonds. In addition, the Green Paper does not refer to or discuss the very different economic policies pursued by central banks in the US, UK and Japan, that is large scale intervention in the bond market referred to as ‘quantitative easing’, and the consequent effect on bond yields.
But comments by key decision makers on such a vital topic have been meaningless. For example, the President of the Bundesbank has dismissed arguments in favour of Eurobonds by stating such a policy would be “like drinking sea water to kill thirst”. These and other comments do not give any confidence that key economic policy makers are intellectually equipped to deal with the current crisis.
There is no modern equivalent to Keynes. As in the 1930s, we may have to wait until current policies have demonstrably failed, and are widely recognised to have failed, before there is a change in policy. The cost and problems created could be enormous.
The forthcoming Budget in Ireland is given much media attention. The forthcoming EU summit on 9th December could take decisions that will influence our economic destiny for the next decade.
Tuesday, 4 October 2011
The case for a Financial Transaction Tax is compelling
Jim Stewart: The reaction to the proposal from the European Commission, France and Germany, for a financial transaction tax (FTT) has produced a predictably hostile reaction from the financial sector and its apologists. This is disappointing, but not wholly unexpected. It reflects an inability or unwillingness to learn from the Global Financial Crisis (GFC). The FTT concept is not new: as pointed out by Philippe Doustte-Blazy, there are over 40 such taxes already in place. What is new is that such taxes would be imposed on all financial transactions rather than, as in the current position, on a small number, such as the cash market for equities.
There are compelling reasons for the introduction of an FTT, regardless of the revenue generating potential of such a tax. We know from the GFC that those jurisdictions with a bloated financial sector suffered greatly in comparison to those with more balanced and hence more sustainable economies. Insofar as FTT would serve to restrict and reduce the size of the financial sector and the associated ‘crowding out’ of the productive wealth generating sectors, economic growth is more likely to resume and to be more stable through time.
We also know that those jurisdictions in which short-termism does not have primacy do better than those in which short-termism is the prevailing strategy. Insofar as an FTT would serve to act as a disincentive to short-termism, economic growth prospects would improve. Economies would be on a sounder footing for long-term sustainable progress.
Despite having large cash balances, global firms are not investing. The volatility that prevails in current financial markets helps create an environment of massive uncertainty for managers. Furthermore modern financial strategies, for example by hedge funds, thrive and depend on the creation of uncertainty. Thus managerial decisions dedicated to wealth generating activities are restricted, and indeed made to appear irrational. Insofar as an FTT would serve to curb volatility, uncertainty would be reduced and investment would be more likely in the wealth generating sectors.
Finally there are those who incredibly claim that an FTT would impair the operation of “efficient” markets. The belief that markets were “efficient”, held especially by regulators, was a key part of the development of the GFC (see Turner Report pp. 39-40). It is generally agreed that an FTT would reduce volumes traded in financial markets. While the relationship between volume traded and volatility in financial markets is mixed, there is much stronger evidence for a positive relationship between speculative bubbles and volumes. Recent financial history has shown that the growth in volumes and values of derivatives was a central part of the GFC (see Fig. 3.1 Financial Crisis Inquiry Report). Thus, irrespective of revenues raised, the introduction of a FTT would have beneficial effects on the stability of financial markets.
It is time financial markets returned to becoming the servant of wealth creators rather than their inhibitors.
There are compelling reasons for the introduction of an FTT, regardless of the revenue generating potential of such a tax. We know from the GFC that those jurisdictions with a bloated financial sector suffered greatly in comparison to those with more balanced and hence more sustainable economies. Insofar as FTT would serve to restrict and reduce the size of the financial sector and the associated ‘crowding out’ of the productive wealth generating sectors, economic growth is more likely to resume and to be more stable through time.
We also know that those jurisdictions in which short-termism does not have primacy do better than those in which short-termism is the prevailing strategy. Insofar as an FTT would serve to act as a disincentive to short-termism, economic growth prospects would improve. Economies would be on a sounder footing for long-term sustainable progress.
Despite having large cash balances, global firms are not investing. The volatility that prevails in current financial markets helps create an environment of massive uncertainty for managers. Furthermore modern financial strategies, for example by hedge funds, thrive and depend on the creation of uncertainty. Thus managerial decisions dedicated to wealth generating activities are restricted, and indeed made to appear irrational. Insofar as an FTT would serve to curb volatility, uncertainty would be reduced and investment would be more likely in the wealth generating sectors.
Finally there are those who incredibly claim that an FTT would impair the operation of “efficient” markets. The belief that markets were “efficient”, held especially by regulators, was a key part of the development of the GFC (see Turner Report pp. 39-40). It is generally agreed that an FTT would reduce volumes traded in financial markets. While the relationship between volume traded and volatility in financial markets is mixed, there is much stronger evidence for a positive relationship between speculative bubbles and volumes. Recent financial history has shown that the growth in volumes and values of derivatives was a central part of the GFC (see Fig. 3.1 Financial Crisis Inquiry Report). Thus, irrespective of revenues raised, the introduction of a FTT would have beneficial effects on the stability of financial markets.
It is time financial markets returned to becoming the servant of wealth creators rather than their inhibitors.
Saturday, 14 May 2011
The proposed levy on pension funds
Jim Stewart: The levy on pension funds makes economic sense, but it has been very poorly presented, and it is inequitable in its proposed from.
The levy makes economic sense because the State has a large budget deficit (forecast at 10% of GDP for 2011), reducing this deficit without steps to improve economic growth would exacerbate the problem. At the same time the State cannot borrow on capital markets and borrowing from the ECB/EU is expensive.
The household savings rate for 2009 was estimated by the CSO to be 12% of income in 2009. The household sector held €105 billion in net financial assets in 2009, and an estimated €240 billion in housing (excluding land). It is likely that net financial assets have increased since then, and the value of the housing stock has fallen.
Thus the household sector in Ireland in aggregate, is not ‘bankrupt’ and cannot become ‘bankrupt’ in the context of a monetary union and integrated financial markets with no capital controls. The prediction by Morgan Kelly of ‘a prolonged and chaotic national bankruptcy’ is thus misleading. The analogy would be Orange County in the US which became bankrupt or insolvent in the sense that State employees, interest on debt etc. could not be paid, but the citizens of Orange County did not become bankrupt/insolvent.
Recent publicity given to the view that Ireland is bankrupt, and that a policy option is to leave the Euro causes further outflows, and helps bring about one aspect of that which has been predicted - the insolvency of the State.
An important economic issue is that most savings are held outside Ireland in the form of pension funds, and increasingly deposits. A solution to the budget deficit is to use these savings, by borrowing or by taxation. This is what has been proposed in relation to pension funds. It is in effect a form of wealth tax but it is a partial wealth tax which it is proposed to levy on some forms of pension assets (those pension assets that have benefited from tax relief), while ignoring those who have chosen to provide for their pension, via conventional savings or by property, and the implicit value of public sector pensions The partial nature of this levy is one of the reasons, as argued later, why it is inequitable.
But the case has been poorly presented. The vital jobs initiative is dependent on funding from this source. Yet some of the information issued is misleading, for example in relation to the decision not to impose the proposed tax on ARFs because it is argued that they were ‘closest in nature and an alternative to an annuity’. They are in fact closest in nature to a pension fund as that fund is operated in Ireland. But more important there is poor data on the value of pension fund assets. The former Minister for Finance stated in answer to a PQ (16th December) that there ‘was no data on the value of individual pension schemes’. There is also no recent data on the value of ARFs. The most recent estimate is for 2005 and the figure then was 6600 schemes held €1.1 billion in assets (Budget 2006, Internal Review of Certain Tax Schemes, G, p. 21).
The proposal as currently envisaged is inequitable. Employees in the public sector are more likely to have a pension than those in the private sector, and this pension is also likely to be larger. Yet the proposal envisages legislation which will enable funded schemes to ‘reduce the pension payable’ (Pension Fund Levy Q and A. Department of Finance). Some of those who are currently retired have extremely generous pensions, and will bear no extra tax burden, while a majority of the population aged over 65 have no occupational pension.
It is proposed not to impose a levy on ARFs yet the tax treatment of ARFs under certain circumstances is far more generous than pensions in payment.
A more equitable and hence acceptable proposal would be to extend the levy to all pension fund assets that have not been annuitised.
The proposed funding of the vital jobs initiative appears to have been poorly thought out. This may be partly explained by complications introduced into government policy making by negotiations with the EU/ECB/IMF. These bodies have conflicting views on policy, some policies proposed are incoherent. Key decision makers appear at times to be both ill informed and arrogant.
The Minister for Finance has given a commitment to ‘examine’ the issue of tax reliefs on pensions contained in the EU/IMF programme and any ‘scope for fiscally neutral changes’. The implication being that the levy on assets may result in a proposal for smaller reductions in announced tax reliefs. The implications of such changes need to be carefully considered so that existing inequities in the tax treatment of pensions are not exacerbated. Such an examination may show that further reducing tax reliefs for pension provision, increasing the pension contribution of high earners in the public sector and reducing tax allowances for those retired persons with large pensions is a more equitable and effective means of funding the vital jobs initiative .
The issue of the taxation of pension funds has been confused by the issue of high charges by pension funds. Tasc/TCD Pension Policy Research Group has long argued that pension fund charges are excessive and should be reduced. This should happen irrespective of the tax treatment of pension funds.
The levy makes economic sense because the State has a large budget deficit (forecast at 10% of GDP for 2011), reducing this deficit without steps to improve economic growth would exacerbate the problem. At the same time the State cannot borrow on capital markets and borrowing from the ECB/EU is expensive.
The household savings rate for 2009 was estimated by the CSO to be 12% of income in 2009. The household sector held €105 billion in net financial assets in 2009, and an estimated €240 billion in housing (excluding land). It is likely that net financial assets have increased since then, and the value of the housing stock has fallen.
Thus the household sector in Ireland in aggregate, is not ‘bankrupt’ and cannot become ‘bankrupt’ in the context of a monetary union and integrated financial markets with no capital controls. The prediction by Morgan Kelly of ‘a prolonged and chaotic national bankruptcy’ is thus misleading. The analogy would be Orange County in the US which became bankrupt or insolvent in the sense that State employees, interest on debt etc. could not be paid, but the citizens of Orange County did not become bankrupt/insolvent.
Recent publicity given to the view that Ireland is bankrupt, and that a policy option is to leave the Euro causes further outflows, and helps bring about one aspect of that which has been predicted - the insolvency of the State.
An important economic issue is that most savings are held outside Ireland in the form of pension funds, and increasingly deposits. A solution to the budget deficit is to use these savings, by borrowing or by taxation. This is what has been proposed in relation to pension funds. It is in effect a form of wealth tax but it is a partial wealth tax which it is proposed to levy on some forms of pension assets (those pension assets that have benefited from tax relief), while ignoring those who have chosen to provide for their pension, via conventional savings or by property, and the implicit value of public sector pensions The partial nature of this levy is one of the reasons, as argued later, why it is inequitable.
But the case has been poorly presented. The vital jobs initiative is dependent on funding from this source. Yet some of the information issued is misleading, for example in relation to the decision not to impose the proposed tax on ARFs because it is argued that they were ‘closest in nature and an alternative to an annuity’. They are in fact closest in nature to a pension fund as that fund is operated in Ireland. But more important there is poor data on the value of pension fund assets. The former Minister for Finance stated in answer to a PQ (16th December) that there ‘was no data on the value of individual pension schemes’. There is also no recent data on the value of ARFs. The most recent estimate is for 2005 and the figure then was 6600 schemes held €1.1 billion in assets (Budget 2006, Internal Review of Certain Tax Schemes, G, p. 21).
The proposal as currently envisaged is inequitable. Employees in the public sector are more likely to have a pension than those in the private sector, and this pension is also likely to be larger. Yet the proposal envisages legislation which will enable funded schemes to ‘reduce the pension payable’ (Pension Fund Levy Q and A. Department of Finance). Some of those who are currently retired have extremely generous pensions, and will bear no extra tax burden, while a majority of the population aged over 65 have no occupational pension.
It is proposed not to impose a levy on ARFs yet the tax treatment of ARFs under certain circumstances is far more generous than pensions in payment.
A more equitable and hence acceptable proposal would be to extend the levy to all pension fund assets that have not been annuitised.
The proposed funding of the vital jobs initiative appears to have been poorly thought out. This may be partly explained by complications introduced into government policy making by negotiations with the EU/ECB/IMF. These bodies have conflicting views on policy, some policies proposed are incoherent. Key decision makers appear at times to be both ill informed and arrogant.
The Minister for Finance has given a commitment to ‘examine’ the issue of tax reliefs on pensions contained in the EU/IMF programme and any ‘scope for fiscally neutral changes’. The implication being that the levy on assets may result in a proposal for smaller reductions in announced tax reliefs. The implications of such changes need to be carefully considered so that existing inequities in the tax treatment of pensions are not exacerbated. Such an examination may show that further reducing tax reliefs for pension provision, increasing the pension contribution of high earners in the public sector and reducing tax allowances for those retired persons with large pensions is a more equitable and effective means of funding the vital jobs initiative .
The issue of the taxation of pension funds has been confused by the issue of high charges by pension funds. Tasc/TCD Pension Policy Research Group has long argued that pension fund charges are excessive and should be reduced. This should happen irrespective of the tax treatment of pension funds.
Tuesday, 22 February 2011
The manifestos and economic policy
Jim Stewart: The publication of the various party manifestos has not been accompanied by detailed scrutiny of many of the policies proposed. There are exceptions (see, for example,the analysis of Parties' proposals for pension reform by Gerard Hughes and Jim Stewart here). One reason for this may be that without expected electoral success, a party manifesto is irrelevant. It may also be because control over the budgetary process and much of economic policy is prescribed by the EU/IMF Memorandum of Economic and Financial Policies which is subject to extensive monitoring (weekly, monthly and quarterly reports). Nevertheless, in some areas there is discretion.
All parties propose renegotiating the terms of the EU/IMF agreement. Electoral change in Germany may make this more likely as the German Governments hard line stance is to some degree determined by electoral strategy (see Quentin Peel, Financial Times, February 21, 2011). As regional elections take place in Germany with defeats for the ruling government, electoral strategy may also lead to a change in economic strategy in relation to EU policies towards peripheral countries, and the role of the European Financial Stability Facility.
The Fine Gael manifesto is of particular interest, as Fine Gael is likely to form the largest party in the next Dail and may even have an outright majority.
Fine Gael Policy Areas/Statements that Require Analysis
The decision to sell state assets (Less Waste, Lower Taxes, Stronger Growth, p. 4) deserves considerable analysis. The assets to be privatised are listed as Bord Gais, ESB Power Generation, ESB Customer Supply Companies, and RTE Transmission Network (Working for Our Future p. 21). Fine Gael criticise (and rightly) the forced fire sale of bank assets (Credit Where Credit is Due, p. 6), yet any sale of Sate owned assets would amount to just that. The economic justification for privatising assets is poorly developed. In addition, the EU/IMF Memorandum of Understanding states “under the period of this financial assistance programme, any additional unplanned revenues must be allocated to debt reduction”. This means selling State assets will be used for debt reduction as in the case of Greece (see Guardian Newspaper 18/11/2019 ‘Greek PM denies plans to sell off national treasures’);
The statement that our effective corporate tax rate is actually higher than that of most EU countries (p. 7) is not supported by the most reliable data available, that is US Bureau of Economic Analysis data;
It is proposed to replace the HSE by new systems by 2016 (Less Waste, Lower Taxes, Stronger Growth, p. 13). In another document it is stated “that the big top down bureaucracies like FAS and the HSE will have been replaced by new systems” (Less Waste Lower taxes Stronger Growth, p. 13). The Manifesto (p. 47) states that the ‘dysfunctional HSE will be dismantled’. Is the fixation with structures really the solution? Are we facing into another five years of chaos while the health system is restructured at the expense of services? It is not clear what institutional structures would replace the HSE, how the new social insurance model will work and how budgets would be allocated.
The Department of Finance is criticised because “it failed to deliver good value for money for taxpayers through public service modernisation and because of the excessive breath of its responsibilities and its culture of centralised control and distrust of the front line” p. 20, See also Reinventing Government, p. 26)).
The Department of Finance can be criticised on many points, but the main failure in economic policy was the destructive policies pursued by McCreevy (decentralisation, deregulation, etc.). Avoiding the pursuit of catastrophic policies in future requires change at many levels, including the near ‘monopoly of the consensus’ in discussions/writing about economic policy, and the consequent silencing of alternative voices.
The formation of an ‘independent’, unelected, fiscal council to which the Minister for Finance will be obliged to either “comply or explain (p. 20) poses many questions. Are we not voting with the intention that those candidates with a majority will have a democratic mandate to form the next Government and be responsible for fiscal policy? Who will be appointed to this independent Council? Many ‘experts’ are not independent of vested interests and especially not independent of an outdated and failed ideology (see blog by Paul Sweeney, A Code of Ethics for Economists). How will such a body avoid being captured by the cosy consensus?
There are welcome proposals, such as the proposed introduction of a loan guarantee scheme. (Working for Our Future p. 265) - but why is it being introduced as a ‘temporary’ measure?
The proposal to use existing banks to administer such this scheme will largely neutralise the scheme and end up subsidising banks as existing loans will be displaced by loans issued under the guarantee scheme.
Note
(1) For example, there is an analysis of Fine Gael and other Parties proposals for pension reform by Gerard Hughes and Jim Stewart at http://www.tcd.ie/business/assets/pdfs/Pensions-Reform_&__Party_Manifestos%5B1%5D.pdf
All parties propose renegotiating the terms of the EU/IMF agreement. Electoral change in Germany may make this more likely as the German Governments hard line stance is to some degree determined by electoral strategy (see Quentin Peel, Financial Times, February 21, 2011). As regional elections take place in Germany with defeats for the ruling government, electoral strategy may also lead to a change in economic strategy in relation to EU policies towards peripheral countries, and the role of the European Financial Stability Facility.
The Fine Gael manifesto is of particular interest, as Fine Gael is likely to form the largest party in the next Dail and may even have an outright majority.
Fine Gael Policy Areas/Statements that Require Analysis
The decision to sell state assets (Less Waste, Lower Taxes, Stronger Growth, p. 4) deserves considerable analysis. The assets to be privatised are listed as Bord Gais, ESB Power Generation, ESB Customer Supply Companies, and RTE Transmission Network (Working for Our Future p. 21). Fine Gael criticise (and rightly) the forced fire sale of bank assets (Credit Where Credit is Due, p. 6), yet any sale of Sate owned assets would amount to just that. The economic justification for privatising assets is poorly developed. In addition, the EU/IMF Memorandum of Understanding states “under the period of this financial assistance programme, any additional unplanned revenues must be allocated to debt reduction”. This means selling State assets will be used for debt reduction as in the case of Greece (see Guardian Newspaper 18/11/2019 ‘Greek PM denies plans to sell off national treasures’);
The statement that our effective corporate tax rate is actually higher than that of most EU countries (p. 7) is not supported by the most reliable data available, that is US Bureau of Economic Analysis data;
It is proposed to replace the HSE by new systems by 2016 (Less Waste, Lower Taxes, Stronger Growth, p. 13). In another document it is stated “that the big top down bureaucracies like FAS and the HSE will have been replaced by new systems” (Less Waste Lower taxes Stronger Growth, p. 13). The Manifesto (p. 47) states that the ‘dysfunctional HSE will be dismantled’. Is the fixation with structures really the solution? Are we facing into another five years of chaos while the health system is restructured at the expense of services? It is not clear what institutional structures would replace the HSE, how the new social insurance model will work and how budgets would be allocated.
The Department of Finance is criticised because “it failed to deliver good value for money for taxpayers through public service modernisation and because of the excessive breath of its responsibilities and its culture of centralised control and distrust of the front line” p. 20, See also Reinventing Government, p. 26)).
The Department of Finance can be criticised on many points, but the main failure in economic policy was the destructive policies pursued by McCreevy (decentralisation, deregulation, etc.). Avoiding the pursuit of catastrophic policies in future requires change at many levels, including the near ‘monopoly of the consensus’ in discussions/writing about economic policy, and the consequent silencing of alternative voices.
The formation of an ‘independent’, unelected, fiscal council to which the Minister for Finance will be obliged to either “comply or explain (p. 20) poses many questions. Are we not voting with the intention that those candidates with a majority will have a democratic mandate to form the next Government and be responsible for fiscal policy? Who will be appointed to this independent Council? Many ‘experts’ are not independent of vested interests and especially not independent of an outdated and failed ideology (see blog by Paul Sweeney, A Code of Ethics for Economists). How will such a body avoid being captured by the cosy consensus?
There are welcome proposals, such as the proposed introduction of a loan guarantee scheme. (Working for Our Future p. 265) - but why is it being introduced as a ‘temporary’ measure?
The proposal to use existing banks to administer such this scheme will largely neutralise the scheme and end up subsidising banks as existing loans will be displaced by loans issued under the guarantee scheme.
Note
(1) For example, there is an analysis of Fine Gael and other Parties proposals for pension reform by Gerard Hughes and Jim Stewart at http://www.tcd.ie/business/assets/pdfs/Pensions-Reform_&__Party_Manifestos%5B1%5D.pdf
Thursday, 2 December 2010
The €67.5 (not €85) billion bailout
Jim Stewart: Whatever the Taoiseach thought he was doing at the press conference last Sunday) in announcing the EU/IMF net loans to Ireland of €67.5 billion, he was not as he claimed, addressing ‘the Irish People’. At least the Secretary General of the Department of Finance adopted the right tone by wearing a black tie. Nevertheless in the rather rambling responses there are some nuggets of information.
The Official Announcements
There are a number of very disappointing features in the Government statement about the receipt of EU/IMF Funds for Ireland. The most is the failure to ensure that the debt of all bank bondholders is written down. This follows the poorly thought-out “National Recovery Plan 2011 - 2014”. One feature of this plan is, in places, its simple reflection of narrow sectional interest. For example (p. 94), the view is expressed, as argued by the pensions industry, that tax deferred on accumulated funds for pension provision is not a cost as it is in effect ‘deferred income tax’, and the open invitation to the pensions industry to lobby for ‘alternatives’.
There are some surprises :- Why is the contribution from the UK €3.4 billion rather than the much-publicised €8 billion? Could it be related to the proposed interest rate on UK borrowing? (A direct question on this subject was asked but not answered at the press conference announcing the rescue fund). Or was it reduced to ensure that State discretionary funds were reduced?
There are some perfectly reasonable proposals: we will no longer have to contribute to the Greek rescue fund, although the two documents together repeat the same mistakes that started with the September 2008 guarantee (see endnote)
The Bond Holders
Yetm in dismissing the write-down of the value of bonds to senior debt holders, one argument has been dropped, and that is that Senior Debt cannot be restructured (writen down in value, extending maturity etc.) because it ranks ‘parri passu’ with depositors, meaning senior debt and depositors have the same rights. Other legal issues have been hinted at.
In answer to a question regarding whether the ECB ‘vetoed’ debt write downs by banks, the Taoiseach stated that there was no ‘agreement from the EU for such a policy and, to a second question on the same issue he answered that there was no political or institutional ‘support’ for such a move. Ajai Chopra, the leader of the IMF mission, again in answer to a question refused to categorically say that bond holder write downs might not be an option in a future period (Morning Ireland 28/11/2010). The reported lack of support at EU level for such a policy is surprising, given recently enacted German banking laws which the Financial Times state will ensure that “creditors take losses rather than the State” (Jennifer Hughes and James Wilson, Financial Times November 11).
The Financial Times (November 30) quotes the Central Bank governor as stating that ‘Dublin’ had refrained from taking action against [bond] investors in return for a “liberal attitude” by the ECB – in another article this is explained in terms of funding of Irish banks. This funding is likely to have increased from the reported figure of €130 billion (Irish banks borrowing from the ECB is likely to be less than this) on 29th October, because of liquidity strains on Irish Banks due to large deposit outflows. Similar outflows are likely to be taking place in other countries where government bond prices have fallen such as Portugal, Spain and more recently Italy. In providing such liquidity, the ECB is acting as a normal Central Bank. The ECB has been reported as opposing senior debt restructuring by insolvent banks. As a result, it is in effect imposing private sector liabilities on a sovereign State in the case of those bonds not subject to a government guarantee. There cannot be any legal basis for such a position. There is certainly no economic basis.
It is likely that, in the event of liquidation or wind down in the case of Anglo Irish bank and the Irish Nationwide, any competent insolvency practitioner could reorganise assets so that depositors and bond holders were in separate legal entities. The one with depositors' funds could be rescued. The other not. This is unlikely to require any legislative changes or the introduction of a Special Resolution Regime, as it could be performed under existing law. Bonds with a government guarantee could be written down at the expiration of the guarantee.
As in the case of junior bond holders, no legislation is required to ensure bond holders suffer losses through falling market values. Policy should be to drive down the value of this debt and then negotiate with senior bond holders. The Anglo Irish subordinated debt write down did not require legislation. Nevertheless various statements that legislation to require restructuring is in preparation pose a threat, even though it is currently proposed that this should relate to subordinated bondholders. This action coupled with refusals to categorically rule out such a policy will help achieve the desired objective. More is needed. Some bond traders have been reported as already anticipating such a policy. Many bond holders may have covered potential losses via credit default swaps, passing the ultimate liability to counterparties.
Writing down senior unsecured debt issued by Anglo alone, and not covered by a guarantee, by 80% would reduce required State funds by €3.2 billion. Writing down senior unsecured debt covered by the guarantee would reduce State funding by €2.1 billion (See Parliamentary Answers to Joan Burton, 27 October, 2010). Current actions to write down subordinated debt by 80% will reduce required State funding by €1.88 billion
Some argue a debt for equity swap could be instituted. This is only likely in one case. The Bank of Ireland is in the best-placed bank to raise additional capital and may be able to do so in conjunction with a debt for equity swap. Bond holders would convert debt into equity and subscribe for new shares. A debt for equity swap where bank capital requirements and access to capital from markets are uncertain, would introduce additional complications and cost to bank financing. As in the case of debt write downs, debt for equity swaps are unlikely to result in sufficient additional capital. Any shortfall is most likely to come from the State.
The Austerity Programme: What Options Remain?
One effect of the ‘austerity package’ in the National Recovery Plan and the EU/IMF “Programme of Financial Support for Ireland” (http://www.finance.gov.ie/) (not entitled Memorandum of Understanding as in the case of Greece) is to lock any incoming administration into existing policies, by extensive prescription of budget balances and monitoring, but especially by removing options relating to the use of National Pension Reserve Fund, Options still remain - not all the fund will be used. There are possibilities for utilising the exceptionally high savings rate to partially fund the exchequer borrowing, as noted in the National Recovery Plan, but this could be extended to fund skill enhancing programmes such as placement schemes, work experience and employment creation. The government has control over aspects of tax policy and social welfare policy; initiatives can be introduced to create and sustain jobs; further efficiencies can be derived from the public sector; our state owned enterprises could be used to rebuild our economy, as their assets and liabilities are not subject to EU/IMF approval. This could be particularly important as the EU/IMF document, in contrast to the National Recovery Plan, specifically states that “any additional unplanned revenues must be allocated to debt reduction” (p. 13). This assumes that State-owned companies are not privatised - an option discussed in the National Recovery Plan but not in the EU/IMF programme.
An incoming administration will have many problems. One that receives little or no attention in the National Recovery Plan or the EU/IMF Programme is how change may be achieved in the attitudes and outlook of ‘official Ireland’. One symptom of this is the failure to recognise how far out of line pay and conditions of senior personnel in the public sector (academics, hospital consultants, judges, politicians, regulators, senior civil servants, etc) are in comparison with other countries in absolute levels, and as a multiple of average earnings. At at the same time the minimum wage will be reduced and the scope of the “inability to pay clause” widened (EU/IMF Programme pp. 10-11). There are even greater pay disparities in the private sector between those at the top of organisations and those on average earnings. These disparities have been an essential ingredient in creating our economic problems.
An incoming administration will have to work with the existing civil service, the IDA, etc. Some of these have contributed directly to the problems we face, some have a strong economic ideology, disguised as ‘economic science’, but there are many who would welcome change, and would also welcome debate about the policies that have led to the collapse of modern Ireland.
Endnote: some Issues with current Policy
(1) The belief in the austerity fairy’, that is cutting expenditure and raising taxes will lead to an economic recovery, without any other policies; and that recapitalising the banks will lead to economic recovery;
(2) The absence of proposals to create and sustain jobs, or proposals to develop and sustain indigenous firms such as a Loan Guarantee Scheme. Labour market reforms (much loved by the IMF, OECD and other institutions), such as cutting the minimum wage will have little impact on job creation. Wage costs have fallen considerably as acknowledged by IBEC (See Irish Times, 27/11/2010). This is partly due to the growing prevalence of short week contracts (particularly in retailing).
(3) The State is now a major owner of property (hotels, office blocks, houses) yet there is no statement as to how economic value might be obtained from these assets. Where are the plans to vastly expand the tourism sector and visitor numbers?
The Official Announcements
There are a number of very disappointing features in the Government statement about the receipt of EU/IMF Funds for Ireland. The most is the failure to ensure that the debt of all bank bondholders is written down. This follows the poorly thought-out “National Recovery Plan 2011 - 2014”. One feature of this plan is, in places, its simple reflection of narrow sectional interest. For example (p. 94), the view is expressed, as argued by the pensions industry, that tax deferred on accumulated funds for pension provision is not a cost as it is in effect ‘deferred income tax’, and the open invitation to the pensions industry to lobby for ‘alternatives’.
There are some surprises :- Why is the contribution from the UK €3.4 billion rather than the much-publicised €8 billion? Could it be related to the proposed interest rate on UK borrowing? (A direct question on this subject was asked but not answered at the press conference announcing the rescue fund). Or was it reduced to ensure that State discretionary funds were reduced?
There are some perfectly reasonable proposals: we will no longer have to contribute to the Greek rescue fund, although the two documents together repeat the same mistakes that started with the September 2008 guarantee (see endnote)
The Bond Holders
Yetm in dismissing the write-down of the value of bonds to senior debt holders, one argument has been dropped, and that is that Senior Debt cannot be restructured (writen down in value, extending maturity etc.) because it ranks ‘parri passu’ with depositors, meaning senior debt and depositors have the same rights. Other legal issues have been hinted at.
In answer to a question regarding whether the ECB ‘vetoed’ debt write downs by banks, the Taoiseach stated that there was no ‘agreement from the EU for such a policy and, to a second question on the same issue he answered that there was no political or institutional ‘support’ for such a move. Ajai Chopra, the leader of the IMF mission, again in answer to a question refused to categorically say that bond holder write downs might not be an option in a future period (Morning Ireland 28/11/2010). The reported lack of support at EU level for such a policy is surprising, given recently enacted German banking laws which the Financial Times state will ensure that “creditors take losses rather than the State” (Jennifer Hughes and James Wilson, Financial Times November 11).
The Financial Times (November 30) quotes the Central Bank governor as stating that ‘Dublin’ had refrained from taking action against [bond] investors in return for a “liberal attitude” by the ECB – in another article this is explained in terms of funding of Irish banks. This funding is likely to have increased from the reported figure of €130 billion (Irish banks borrowing from the ECB is likely to be less than this) on 29th October, because of liquidity strains on Irish Banks due to large deposit outflows. Similar outflows are likely to be taking place in other countries where government bond prices have fallen such as Portugal, Spain and more recently Italy. In providing such liquidity, the ECB is acting as a normal Central Bank. The ECB has been reported as opposing senior debt restructuring by insolvent banks. As a result, it is in effect imposing private sector liabilities on a sovereign State in the case of those bonds not subject to a government guarantee. There cannot be any legal basis for such a position. There is certainly no economic basis.
It is likely that, in the event of liquidation or wind down in the case of Anglo Irish bank and the Irish Nationwide, any competent insolvency practitioner could reorganise assets so that depositors and bond holders were in separate legal entities. The one with depositors' funds could be rescued. The other not. This is unlikely to require any legislative changes or the introduction of a Special Resolution Regime, as it could be performed under existing law. Bonds with a government guarantee could be written down at the expiration of the guarantee.
As in the case of junior bond holders, no legislation is required to ensure bond holders suffer losses through falling market values. Policy should be to drive down the value of this debt and then negotiate with senior bond holders. The Anglo Irish subordinated debt write down did not require legislation. Nevertheless various statements that legislation to require restructuring is in preparation pose a threat, even though it is currently proposed that this should relate to subordinated bondholders. This action coupled with refusals to categorically rule out such a policy will help achieve the desired objective. More is needed. Some bond traders have been reported as already anticipating such a policy. Many bond holders may have covered potential losses via credit default swaps, passing the ultimate liability to counterparties.
Writing down senior unsecured debt issued by Anglo alone, and not covered by a guarantee, by 80% would reduce required State funds by €3.2 billion. Writing down senior unsecured debt covered by the guarantee would reduce State funding by €2.1 billion (See Parliamentary Answers to Joan Burton, 27 October, 2010). Current actions to write down subordinated debt by 80% will reduce required State funding by €1.88 billion
Some argue a debt for equity swap could be instituted. This is only likely in one case. The Bank of Ireland is in the best-placed bank to raise additional capital and may be able to do so in conjunction with a debt for equity swap. Bond holders would convert debt into equity and subscribe for new shares. A debt for equity swap where bank capital requirements and access to capital from markets are uncertain, would introduce additional complications and cost to bank financing. As in the case of debt write downs, debt for equity swaps are unlikely to result in sufficient additional capital. Any shortfall is most likely to come from the State.
The Austerity Programme: What Options Remain?
One effect of the ‘austerity package’ in the National Recovery Plan and the EU/IMF “Programme of Financial Support for Ireland” (http://www.finance.gov.ie/) (not entitled Memorandum of Understanding as in the case of Greece) is to lock any incoming administration into existing policies, by extensive prescription of budget balances and monitoring, but especially by removing options relating to the use of National Pension Reserve Fund, Options still remain - not all the fund will be used. There are possibilities for utilising the exceptionally high savings rate to partially fund the exchequer borrowing, as noted in the National Recovery Plan, but this could be extended to fund skill enhancing programmes such as placement schemes, work experience and employment creation. The government has control over aspects of tax policy and social welfare policy; initiatives can be introduced to create and sustain jobs; further efficiencies can be derived from the public sector; our state owned enterprises could be used to rebuild our economy, as their assets and liabilities are not subject to EU/IMF approval. This could be particularly important as the EU/IMF document, in contrast to the National Recovery Plan, specifically states that “any additional unplanned revenues must be allocated to debt reduction” (p. 13). This assumes that State-owned companies are not privatised - an option discussed in the National Recovery Plan but not in the EU/IMF programme.
An incoming administration will have many problems. One that receives little or no attention in the National Recovery Plan or the EU/IMF Programme is how change may be achieved in the attitudes and outlook of ‘official Ireland’. One symptom of this is the failure to recognise how far out of line pay and conditions of senior personnel in the public sector (academics, hospital consultants, judges, politicians, regulators, senior civil servants, etc) are in comparison with other countries in absolute levels, and as a multiple of average earnings. At at the same time the minimum wage will be reduced and the scope of the “inability to pay clause” widened (EU/IMF Programme pp. 10-11). There are even greater pay disparities in the private sector between those at the top of organisations and those on average earnings. These disparities have been an essential ingredient in creating our economic problems.
An incoming administration will have to work with the existing civil service, the IDA, etc. Some of these have contributed directly to the problems we face, some have a strong economic ideology, disguised as ‘economic science’, but there are many who would welcome change, and would also welcome debate about the policies that have led to the collapse of modern Ireland.
Endnote: some Issues with current Policy
(1) The belief in the austerity fairy’, that is cutting expenditure and raising taxes will lead to an economic recovery, without any other policies; and that recapitalising the banks will lead to economic recovery;
(2) The absence of proposals to create and sustain jobs, or proposals to develop and sustain indigenous firms such as a Loan Guarantee Scheme. Labour market reforms (much loved by the IMF, OECD and other institutions), such as cutting the minimum wage will have little impact on job creation. Wage costs have fallen considerably as acknowledged by IBEC (See Irish Times, 27/11/2010). This is partly due to the growing prevalence of short week contracts (particularly in retailing).
(3) The State is now a major owner of property (hotels, office blocks, houses) yet there is no statement as to how economic value might be obtained from these assets. Where are the plans to vastly expand the tourism sector and visitor numbers?
Friday, 12 November 2010
Is Mr (Bond) Market in Charge?
Jim Stewart: (The Governor of the Central Bank, Patrick Honohan is quoted as stating to the Oireachtas Committee on Economic Regulatory Affairs :- “though we may not like it, we have to jump to what the lenders expect and convince lenders we can get to the situation where debt is not spiralling out of control”).
The interest paid or yields on Irish Government debt have soared in the past two weeks. The yield on ten year debt is nearly 9%, below that of Greece at 11.6% and above that of Portugal at 7.2%. The economic problems of Ireland, Greece, Portugal and Spain are regularly discussed as being at the centre of ‘investor concerns’ (New York Times, November 7). There is renewed speculation about the break up of the Euro, re-adoption of national currencies and devaluation (Victor Mallet and Peter Wise, Financial Times November 8). The rise in bond yields in the peripheral countries of Europe caused the Euro to fall against the dollar and stock markets to fall on Monday, Tuesday and Wednesday of this week according to the Financial Times (Financial Times, November 9,10,11).
Yet at the same time, bond prices in many other countries are at historic highs, yields are at historic lows. The real yield on inflation-linked 5 Year UK bonds is -0.44%. Despite low interest rates, falling yields and rising prices have meant that returns on, for example, German and US government debt have been over 8% so far this year (Keith Jenkins, Bloomberg, November 8) This has led to considerable debate as to whether there is a bubble in bond markets. (See for example:- Financial Times, October 31). Much media attention focuses on the price of gold - up over 30% in the past year - but commodity prices have risen even more:- sugar is up 40%, corn 55%, cotton 76%. These prices, if sustained, will result in higher inflation. Hence it is likely that long term bond yields in countries such as Germany will rise.
Why have interest rates on government debt in peripheral countries risen so high so quickly? In the case of Ireland, the cost of the bank bailout and resulting Government borrowing requirement has been roughly known for some time, and yet the markets are only reacting now.
One factor is undoubtedly due to German Government policy which led to what Der Spiegel (8 November) has referred to as the ‘Merkel crash’. That is the proposal, apparently agreed to by the European Council at the instigation of the German Government, that bond holders would suffer losses in the event of a country borrowing from the European Financial stability Facility. The Financial Times recently reported this decision as agreement on “an automatic” default by borrowing countries (David Oakley and Richard Milne, November 9). However the European Council press release of conclusions at its meeting merely agreed to ‘endorse’ the Van Rompuy report. The Van Rumpuy proposals are however aspirational. The only phrase include the word automatic is in par. 26, as in ‘increasing the automaticity’ of decision making.
Much more serious was Merkel’s statement that a new bankruptcy mechanism will be established which will ensure private investors bear some of the costs in any future crisis. The German finance minister recently stated in relation to the crisis mechanism, “we are working out the details within the German Government and at the European level. Its already clear today that the new mechanism will not apply to old debt but only to new debt” (Der Spiegel 11/8/2010). These policy statements are more likely to be driven by domestic German concerns (politicians cannot be seen to be bailing out the feckless Greeks and Irish by the virtuous Germans with ‘Swabian’ housewife values) than by broader issues relating to financial and economic crisis in eurozone and other countries.
Partly as a result, it is not clear what rules will emerge and how bondholders both new and old might be affected. Commentators have conflicting versions of what the German Government proposes and what might be implemented at EU level.
German Government proposals have created uncertainty and bond yields have risen as a result. This was indeed forecast at the meeting of the Council of Ministers (29 October) by the President of the ECB (See Jack Farchy, Financial Times November 9).
But the sudden rise in bond yields is also due to other factors. The President of the ECB is also quoted as stating that, by encouraging short selling of bonds of those countries with large deficits, they are facilitating ‘US speculators’. The relationship between rising debt costs and hedge funds/speculators has also been made by others. Speculation against eurozone bonds may be linked with beliefs in relation to the break-up of the eurozone.
The Trading Strategy of Hedge Funds
Credit Default Swaps (CDS) may be an integral part of the trading strategy of hedge funds (very large investment funds, for example Soros Fund Managers with assets of €27 billion, which are typically highly leveraged, lightly regulated, and limited to a small number of large investors). CDS provide insurance on the underlying debt asset but also allow speculative trading because CDS contracts do not require any insurable interest (an analogy is with rival criminal gang members taking out life insurance on their opponents).
There is a positive correlation between yield on debt and Credit Default Swaps. For example the yield on Irish government debt will approximately equal the cost of a CDS plus the risk free rate that is the yield on German Government debt of the same maturity.
Y on Irish debt = CDS cost + risk free yield (German Bund yield) or
CDS cost = Y – risk free yield.
If the cost of a CDS rises, the yield on government debt rises. The market for CDS and Irish Government bonds is narrow (New York Times 10 November) and the market for Government debt has become more illiquid. The collateral requirements of those trading Irish Government debt increased on 10th November, meaning those trading Irish Government debt had to post higher margins or sell debt. The Financial Times (11/11/2010) reports the Bank of Ireland chose to post higher margins requiring extra cash of €250 million. The net effect is that liquidity and trading in Irish government debt will be further reduced. In addition most bonds are held to maturity. A sudden demand for CDS will drive up the price and drive down the price of bonds. Holders of CDS swaps on Irish Government debt purchased some weeks ago have now large gains. Holders of Irish Government debt have large losses. This has implications for example for banks, pension funds, etc., to the extent that they have suffered and realised losses on their holdings of Irish Government debt.
Implications
Irish and other countries’ bond yields are a function of hedge fund trading strategies. Hedge funds thrive on uncertainty. Part of their strategy is to create uncertainty by media reports, ‘research’, etc. One widely cited report on Bloomberg asserted that Ireland was going bankrupt, would run out of cash in 60 days, and that debt restructuring of peripheral countries as proposed by Germany would mean “the whole thing is gone”. In contrast, the NTMA state they have sufficient cash reserves to fund the projected government deficit until June/July 2011 and furthermore do not need to refinance debt until November 2011.
Strategies pursued by hedge funds have driven up yields. High yields means the Irish and other Governments are in effect shut out of the bond market. The recently announced extension of the guarantee on bank debt is meaningless, as bank debt guaranteed by the State is unlikely to have a lower cost than the cost of debt issued by the State. The Irish State is currently the only possible source of long term funds.
An election would reduce uncertainty, but other uncertainties remain. For example, a continuing decline in property values, failure to obtain economic value from the large stock of existing housing, hotel and other assets will mean further capital losses by banks, company insolvencies, negative equity, etc.
Yields once driven up are likely to be ‘sticky’. Even if they fall likely to a large premium over German Government bonds is likely to remain.
Use of the Economic Financial Stability Facility (ESFF) by any country is likely to be conditional on rules for this fund. Rules that exempt existing bond holders, but seek to impose losses on new bond holders (debt restructuring and write downs), may simply ensure that the interest cost of debt in peripheral countries remains high and countries such as Ireland may cease to be able to borrow. Hence the only source of debt will be from the ESFF.
The loss of control by the Irish Government of policy decisions, while predictable, has suddenly arrived. But it is not inevitable that bond markets determine policy. EU rules in relation to the use of the ESFF have yet to be determined. Policies that equate macroeconomic management with the economics of households (the ‘Swabian’ housewife) can and should be countered. Restrictions should be imposed on the use of Credit Default Swaps. Earlier this year, the French Economy Minister was quoted as being in favour of restrictions on the use of Credit Default Swaps. One effect of ECB policies of providing liquidity at low cost to the banking sector is that such liquidity can be used to speculate against sovereign debt, but the ECB is prohibited from lending directly to sovereign states.
Ireland would not be alone in making these arguments.
The interest paid or yields on Irish Government debt have soared in the past two weeks. The yield on ten year debt is nearly 9%, below that of Greece at 11.6% and above that of Portugal at 7.2%. The economic problems of Ireland, Greece, Portugal and Spain are regularly discussed as being at the centre of ‘investor concerns’ (New York Times, November 7). There is renewed speculation about the break up of the Euro, re-adoption of national currencies and devaluation (Victor Mallet and Peter Wise, Financial Times November 8). The rise in bond yields in the peripheral countries of Europe caused the Euro to fall against the dollar and stock markets to fall on Monday, Tuesday and Wednesday of this week according to the Financial Times (Financial Times, November 9,10,11).
Yet at the same time, bond prices in many other countries are at historic highs, yields are at historic lows. The real yield on inflation-linked 5 Year UK bonds is -0.44%. Despite low interest rates, falling yields and rising prices have meant that returns on, for example, German and US government debt have been over 8% so far this year (Keith Jenkins, Bloomberg, November 8) This has led to considerable debate as to whether there is a bubble in bond markets. (See for example:- Financial Times, October 31). Much media attention focuses on the price of gold - up over 30% in the past year - but commodity prices have risen even more:- sugar is up 40%, corn 55%, cotton 76%. These prices, if sustained, will result in higher inflation. Hence it is likely that long term bond yields in countries such as Germany will rise.
Why have interest rates on government debt in peripheral countries risen so high so quickly? In the case of Ireland, the cost of the bank bailout and resulting Government borrowing requirement has been roughly known for some time, and yet the markets are only reacting now.
One factor is undoubtedly due to German Government policy which led to what Der Spiegel (8 November) has referred to as the ‘Merkel crash’. That is the proposal, apparently agreed to by the European Council at the instigation of the German Government, that bond holders would suffer losses in the event of a country borrowing from the European Financial stability Facility. The Financial Times recently reported this decision as agreement on “an automatic” default by borrowing countries (David Oakley and Richard Milne, November 9). However the European Council press release of conclusions at its meeting merely agreed to ‘endorse’ the Van Rompuy report. The Van Rumpuy proposals are however aspirational. The only phrase include the word automatic is in par. 26, as in ‘increasing the automaticity’ of decision making.
Much more serious was Merkel’s statement that a new bankruptcy mechanism will be established which will ensure private investors bear some of the costs in any future crisis. The German finance minister recently stated in relation to the crisis mechanism, “we are working out the details within the German Government and at the European level. Its already clear today that the new mechanism will not apply to old debt but only to new debt” (Der Spiegel 11/8/2010). These policy statements are more likely to be driven by domestic German concerns (politicians cannot be seen to be bailing out the feckless Greeks and Irish by the virtuous Germans with ‘Swabian’ housewife values) than by broader issues relating to financial and economic crisis in eurozone and other countries.
Partly as a result, it is not clear what rules will emerge and how bondholders both new and old might be affected. Commentators have conflicting versions of what the German Government proposes and what might be implemented at EU level.
German Government proposals have created uncertainty and bond yields have risen as a result. This was indeed forecast at the meeting of the Council of Ministers (29 October) by the President of the ECB (See Jack Farchy, Financial Times November 9).
But the sudden rise in bond yields is also due to other factors. The President of the ECB is also quoted as stating that, by encouraging short selling of bonds of those countries with large deficits, they are facilitating ‘US speculators’. The relationship between rising debt costs and hedge funds/speculators has also been made by others. Speculation against eurozone bonds may be linked with beliefs in relation to the break-up of the eurozone.
The Trading Strategy of Hedge Funds
Credit Default Swaps (CDS) may be an integral part of the trading strategy of hedge funds (very large investment funds, for example Soros Fund Managers with assets of €27 billion, which are typically highly leveraged, lightly regulated, and limited to a small number of large investors). CDS provide insurance on the underlying debt asset but also allow speculative trading because CDS contracts do not require any insurable interest (an analogy is with rival criminal gang members taking out life insurance on their opponents).
There is a positive correlation between yield on debt and Credit Default Swaps. For example the yield on Irish government debt will approximately equal the cost of a CDS plus the risk free rate that is the yield on German Government debt of the same maturity.
Y on Irish debt = CDS cost + risk free yield (German Bund yield) or
CDS cost = Y – risk free yield.
If the cost of a CDS rises, the yield on government debt rises. The market for CDS and Irish Government bonds is narrow (New York Times 10 November) and the market for Government debt has become more illiquid. The collateral requirements of those trading Irish Government debt increased on 10th November, meaning those trading Irish Government debt had to post higher margins or sell debt. The Financial Times (11/11/2010) reports the Bank of Ireland chose to post higher margins requiring extra cash of €250 million. The net effect is that liquidity and trading in Irish government debt will be further reduced. In addition most bonds are held to maturity. A sudden demand for CDS will drive up the price and drive down the price of bonds. Holders of CDS swaps on Irish Government debt purchased some weeks ago have now large gains. Holders of Irish Government debt have large losses. This has implications for example for banks, pension funds, etc., to the extent that they have suffered and realised losses on their holdings of Irish Government debt.
Implications
Irish and other countries’ bond yields are a function of hedge fund trading strategies. Hedge funds thrive on uncertainty. Part of their strategy is to create uncertainty by media reports, ‘research’, etc. One widely cited report on Bloomberg asserted that Ireland was going bankrupt, would run out of cash in 60 days, and that debt restructuring of peripheral countries as proposed by Germany would mean “the whole thing is gone”. In contrast, the NTMA state they have sufficient cash reserves to fund the projected government deficit until June/July 2011 and furthermore do not need to refinance debt until November 2011.
Strategies pursued by hedge funds have driven up yields. High yields means the Irish and other Governments are in effect shut out of the bond market. The recently announced extension of the guarantee on bank debt is meaningless, as bank debt guaranteed by the State is unlikely to have a lower cost than the cost of debt issued by the State. The Irish State is currently the only possible source of long term funds.
An election would reduce uncertainty, but other uncertainties remain. For example, a continuing decline in property values, failure to obtain economic value from the large stock of existing housing, hotel and other assets will mean further capital losses by banks, company insolvencies, negative equity, etc.
Yields once driven up are likely to be ‘sticky’. Even if they fall likely to a large premium over German Government bonds is likely to remain.
Use of the Economic Financial Stability Facility (ESFF) by any country is likely to be conditional on rules for this fund. Rules that exempt existing bond holders, but seek to impose losses on new bond holders (debt restructuring and write downs), may simply ensure that the interest cost of debt in peripheral countries remains high and countries such as Ireland may cease to be able to borrow. Hence the only source of debt will be from the ESFF.
The loss of control by the Irish Government of policy decisions, while predictable, has suddenly arrived. But it is not inevitable that bond markets determine policy. EU rules in relation to the use of the ESFF have yet to be determined. Policies that equate macroeconomic management with the economics of households (the ‘Swabian’ housewife) can and should be countered. Restrictions should be imposed on the use of Credit Default Swaps. Earlier this year, the French Economy Minister was quoted as being in favour of restrictions on the use of Credit Default Swaps. One effect of ECB policies of providing liquidity at low cost to the banking sector is that such liquidity can be used to speculate against sovereign debt, but the ECB is prohibited from lending directly to sovereign states.
Ireland would not be alone in making these arguments.
Friday, 15 October 2010
How to deal with the bond markets
Jim Stewart: Recent Government policy decisions (postponing the monthly bond auction, recapitalisation of banks, etc. and other announcements) have been evaluated in terms of changes in Irish Government bond yields - a rise indicating poor policy and a fall good policy. The problem with such analysis is that bond yields are determined by forces that may be only loosely connected to economic policy. Trading in Government debt is once again dominated by hedge funds (Financial Times, 15 September 2010). This may partly explain volatility in the prices and hence yields on government debt. Greek bonds although yields are the highest in the eurozone, provided the highest eurozone bond returns over the entire month of September.
The Minister for Finance stated on September 30 that subordinated bond holders will suffer losses in both Anglo-Irish and INBS via resolution and reorganisation legislation. At the same time, he specifically stated that there would be no ‘legislative’ changes in relation to senior bond holders. However, negotiation with bond holders does not require legislation or permission from any other body, and the Regulator, Matthew Elderfield, on October 6th raised the possibility of negotiating with senior bond holders.
The Financial Times, in an interview with the Minister for Finance (October 12), reported that, typically, a voluntary negotiation with bond holders is done to ensure that it does not constitute a default as regards credit default swaps - instruments which apart from enabling speculation in bond values may also provide insurance in the event of default . This raises the issue of why holders of such bonds who have also purchased Credit Default Swaps on those bonds, would enter into negotiations which would result in a diminution of the value of their investment without recourse to the guarantees given by the counterparties of credit default swaps. In this case, in the event of ‘default’, the counterparties of credit default swaps would make large losses. Who are they? Most likely Goldman Sachs, Merrill Lynch, etc. Hence we can expect representatives of such institutions to be vociferous in their condemnation of burden-sharing policies with owners of bank bonds, and rather emphasise ‘austerity' (see reports of speech by Peter Sutherland http://www.independent.ie, September 25). Yet such policies must be pursued. The greater the loss faced by existing bondholders, the lower the required capital contribution to banks by the State, and the lower government borrowing. As a result, the greater the likelihood that the cost of future state borrowing will fall. There is a clear distinction between the existing debts of the nationalized banks and State debt. What is bad for the former is good for the latter.
In the coming months, the State should pursue strategies that drive down the market price of existing debt of the now nationalized banks. This can only be done in the context of the removal of guarantees on existing debt.
Will Ireland be ‘Shut Out’ of the Bond Markets?
Given the high cost and volatility, the decision ‘not to proceed’ with bond auctions scheduled for October and November is rational. The minister stated, that “as the NTMA is fully funded until late June 2011 the Agency has decided not to proceed with bond auctions” until early 2011.
The NTMA has a policy of prefunding, so that cash balances at the end of June amounted to €20 billion (NTMA). This is explained by the NTMA, who state that “maintaining large cash balances has underpinned investor confidence and provided valuable flexibility in the timing of its borrowing”. The NTMA are also quoted as stating that, if they do not issue debt, the market will interpret this as a signal that the Government cannot issue debt.
Policy pursued up to September 30 appeared to be that new debt must be issued every month to ensure the overfunding position remains. So, even though interest rates on Irish government debt rose throughout 2010, the NTMA continued to issue debt. Rather than signalling that the government cannot issue debt, this policy may have signalled that the NTMA held non-public information which would be adverse for bond prices.
The NTMA should suspend bond auctions until there is greater certainty (for example in relation to future government policies). This may mean suspending auctions until March next year or later. Reduced uncertainty will result in some convergence of Irish bond yields with eurozone bond yields. It is also possible that speculative forces in the bond market will diminish and will result in greater convergence in eurozone bond yields. This means rising German yields and falls in the yields of peripheral countries such as Ireland and Portugal.
An issue that may arise is that uncertainty rather than diminishing may continue to exist, for example in relation to the formation of a new government, or the policies of a new Government. Hence it is desirable that financing the deficit is less dependent on external investors (international investors hold 85% of long term debt). One solution is to use the remaining funds (€14 billion) in the National Pension Reserve Fund after providing for bank funding, to provide support for the Irish bond market.
Establishing the National Pension Reserve Fund was misguided (although hailed by some such as the current Governor of the Central Bank, as the most important policy decision for a decade). Transfers of resources (bread, haircuts, etc.) to future retirees can only come from future output. The best way to safeguard current and future pensions is to ensure that the current and future economy is as productive as possible.
Borrowing to invest in equities and other risky assets is equivalent to the State behaving like a hedge fund. There is a national crisis. In this crisis the National Pension Reserve Fund should be utilised. One way is to announce that the investment policy will change, so that from the New Year the National Pension Reserve Fund will be used to purchase new Government debt if prospective yields are above some stated figure (say 5%). If Ireland remains part of the Euro system (which is highly likely), such returns would be much higher than those achieved to date. Volatility and risk would be reduced.
In the longer term the State is likely to have high levels of borrowing for some time. Current policies to reduce borrowing by cutting expenditure will perversely have the effect of increasing the need for borrowing and may depress property prices further, as well as bank capital. Even if policies change, the legacy of the banking and economic crisis will still ensure high future levels of borrowing. At the same time, it is likely that the extra premium payable on Irish Government debt will remain.
To finance this deficit a greater proportion of government borrowing should and can be sourced internally. For example, investment choice in the proposed new auto-enrolment pension scheme should be limited to the purchase of Irish Government debt. Apart from financing the exchequer deficit until pension payments must be made (10-15 years), this would also have the effect of reducing costs and risk. In effect this new proposed supplementary scheme would then become a type of PAYG system, but with pension payments more closely tied to contributions and returns.
Some commentators, and no doubt some (Department of Finance) officials, would welcome IMF/EU intervention, as cuts could be presented as being externally imposed. The difficult task of increasing efficiency in the public sector by negotiating and implementing necessary change, would be seen as no longer necessary. The existing Department of Finance/McCarthy report on Public Sector Numbers and Expenditures and the forthcoming Department of Finance/McCarthy report on privatization would form a major part of any imposed IMF/EU intervention.
But IMF/EU intervention similar to that in Greece is unlikely. However closer monitoring by the ECB, and EU bodies is certain. This will lead to policy changes but in addition considerable negotiating skills are required to try to ensure that external policies, encourage rather than hinder the prospects for economic success. There needs to be careful monitoring of policies and economic data in other EU countries, in particular those in the eurozone so that Ireland can be presented as ‘average’ rather than an outlier.
The issues discussed above are holding policies. What is needed is a fundamental change in economic policy.
The Minister for Finance stated on September 30 that subordinated bond holders will suffer losses in both Anglo-Irish and INBS via resolution and reorganisation legislation. At the same time, he specifically stated that there would be no ‘legislative’ changes in relation to senior bond holders. However, negotiation with bond holders does not require legislation or permission from any other body, and the Regulator, Matthew Elderfield, on October 6th raised the possibility of negotiating with senior bond holders.
The Financial Times, in an interview with the Minister for Finance (October 12), reported that, typically, a voluntary negotiation with bond holders is done to ensure that it does not constitute a default as regards credit default swaps - instruments which apart from enabling speculation in bond values may also provide insurance in the event of default . This raises the issue of why holders of such bonds who have also purchased Credit Default Swaps on those bonds, would enter into negotiations which would result in a diminution of the value of their investment without recourse to the guarantees given by the counterparties of credit default swaps. In this case, in the event of ‘default’, the counterparties of credit default swaps would make large losses. Who are they? Most likely Goldman Sachs, Merrill Lynch, etc. Hence we can expect representatives of such institutions to be vociferous in their condemnation of burden-sharing policies with owners of bank bonds, and rather emphasise ‘austerity' (see reports of speech by Peter Sutherland http://www.independent.ie, September 25). Yet such policies must be pursued. The greater the loss faced by existing bondholders, the lower the required capital contribution to banks by the State, and the lower government borrowing. As a result, the greater the likelihood that the cost of future state borrowing will fall. There is a clear distinction between the existing debts of the nationalized banks and State debt. What is bad for the former is good for the latter.
In the coming months, the State should pursue strategies that drive down the market price of existing debt of the now nationalized banks. This can only be done in the context of the removal of guarantees on existing debt.
Will Ireland be ‘Shut Out’ of the Bond Markets?
Given the high cost and volatility, the decision ‘not to proceed’ with bond auctions scheduled for October and November is rational. The minister stated, that “as the NTMA is fully funded until late June 2011 the Agency has decided not to proceed with bond auctions” until early 2011.
The NTMA has a policy of prefunding, so that cash balances at the end of June amounted to €20 billion (NTMA). This is explained by the NTMA, who state that “maintaining large cash balances has underpinned investor confidence and provided valuable flexibility in the timing of its borrowing”. The NTMA are also quoted as stating that, if they do not issue debt, the market will interpret this as a signal that the Government cannot issue debt.
Policy pursued up to September 30 appeared to be that new debt must be issued every month to ensure the overfunding position remains. So, even though interest rates on Irish government debt rose throughout 2010, the NTMA continued to issue debt. Rather than signalling that the government cannot issue debt, this policy may have signalled that the NTMA held non-public information which would be adverse for bond prices.
The NTMA should suspend bond auctions until there is greater certainty (for example in relation to future government policies). This may mean suspending auctions until March next year or later. Reduced uncertainty will result in some convergence of Irish bond yields with eurozone bond yields. It is also possible that speculative forces in the bond market will diminish and will result in greater convergence in eurozone bond yields. This means rising German yields and falls in the yields of peripheral countries such as Ireland and Portugal.
An issue that may arise is that uncertainty rather than diminishing may continue to exist, for example in relation to the formation of a new government, or the policies of a new Government. Hence it is desirable that financing the deficit is less dependent on external investors (international investors hold 85% of long term debt). One solution is to use the remaining funds (€14 billion) in the National Pension Reserve Fund after providing for bank funding, to provide support for the Irish bond market.
Establishing the National Pension Reserve Fund was misguided (although hailed by some such as the current Governor of the Central Bank, as the most important policy decision for a decade). Transfers of resources (bread, haircuts, etc.) to future retirees can only come from future output. The best way to safeguard current and future pensions is to ensure that the current and future economy is as productive as possible.
Borrowing to invest in equities and other risky assets is equivalent to the State behaving like a hedge fund. There is a national crisis. In this crisis the National Pension Reserve Fund should be utilised. One way is to announce that the investment policy will change, so that from the New Year the National Pension Reserve Fund will be used to purchase new Government debt if prospective yields are above some stated figure (say 5%). If Ireland remains part of the Euro system (which is highly likely), such returns would be much higher than those achieved to date. Volatility and risk would be reduced.
In the longer term the State is likely to have high levels of borrowing for some time. Current policies to reduce borrowing by cutting expenditure will perversely have the effect of increasing the need for borrowing and may depress property prices further, as well as bank capital. Even if policies change, the legacy of the banking and economic crisis will still ensure high future levels of borrowing. At the same time, it is likely that the extra premium payable on Irish Government debt will remain.
To finance this deficit a greater proportion of government borrowing should and can be sourced internally. For example, investment choice in the proposed new auto-enrolment pension scheme should be limited to the purchase of Irish Government debt. Apart from financing the exchequer deficit until pension payments must be made (10-15 years), this would also have the effect of reducing costs and risk. In effect this new proposed supplementary scheme would then become a type of PAYG system, but with pension payments more closely tied to contributions and returns.
Some commentators, and no doubt some (Department of Finance) officials, would welcome IMF/EU intervention, as cuts could be presented as being externally imposed. The difficult task of increasing efficiency in the public sector by negotiating and implementing necessary change, would be seen as no longer necessary. The existing Department of Finance/McCarthy report on Public Sector Numbers and Expenditures and the forthcoming Department of Finance/McCarthy report on privatization would form a major part of any imposed IMF/EU intervention.
But IMF/EU intervention similar to that in Greece is unlikely. However closer monitoring by the ECB, and EU bodies is certain. This will lead to policy changes but in addition considerable negotiating skills are required to try to ensure that external policies, encourage rather than hinder the prospects for economic success. There needs to be careful monitoring of policies and economic data in other EU countries, in particular those in the eurozone so that Ireland can be presented as ‘average’ rather than an outlier.
The issues discussed above are holding policies. What is needed is a fundamental change in economic policy.
Monday, 6 September 2010
IFSC shadow of its intended self
In an opinion piece for the Irish Times today, Jim Stewart concludes that "In the short term, changes in tax regimes raise issues for economies dependent on financial centres or low-tax regimes as a key component of economic strategy. But longer term, tax-haven type activities are unlikely to provide a basis for a diverse, skill-based economy. Such activities may attract an increasing share of resources in terms of talented individuals working on tax and regulation avoidance activities and in terms of State agencies and legislators ensuring tax and other legislation facilitates the operation of low-tax, low-regulation type activities. Such legislation may in turn unintentionally diffuse to the wider economy.
As a result of the economic and financial crisis, a new political economy is emerging within the EU. Competition for investment via low tax rates and light touch regulation may no longer be an option." You can read Jim's full article here.
As a result of the economic and financial crisis, a new political economy is emerging within the EU. Competition for investment via low tax rates and light touch regulation may no longer be an option." You can read Jim's full article here.
Thursday, 2 September 2010
Jim's equation
Michael Taft: ‘The bank is something more than men, I tell you. They breathe profits; they eat the interest on money. It's the monster. Men made it, but they can't control it.’
So wrote John Steinbeck in The Grapes of Wrath. It could easily be applied here (except for the profits part – but the Government is doing everything possible to get them back into the black with our money).
So how do we slay, or at least cripple, the biggest monster of them all – Anglo Irish? Jim Stewart has put forward an incredibly simple, practical and far-reaching proposal that can save the taxpayers’ billions (this was followed up by Brian Lucey).
In its Recovery Scenario the ESRI estimated that the bail-out of Anglo-Irish and Irish Nationwide would cost a combined €25 billion. We have moved on a bit, but let’s take the ESRI’s calculations as a proxy for Anglo alone (it will serve the purposes of this analysis). It will cost, when the bail-out is fully paid over, approximately €1.25 billion a year in interest payments.
But there is an additional, even more substantial, drain. The ESRI estimates that the banking crisis could contribute up to 15 to 20 percent of the permanent loss of output due to the recession. We won’t factor this in (partially because it will only be permanent if we persist with current policies) but the ESRI warns us that this indirect cost could be substantially higher than the direct costs in terms of lost revenue and higher unemployment costs.
Now, let’s take up what I call ‘Jim’s Equation’. Simply put, Jim argues that we should:
‘ . . negotiate with all bond holders and purchase bonds, not at face value but at some fraction of face value. Writing down the 2009 balance sheet value of Anglo Irish debt by 50% would reduce balance sheet liabilities by €8.7 billion. Writing debt down to 10% of face value (a generous value in the event of liquidation) would reduce balance sheet liabilities by €15.6 billion.’
Jim, along with Professor Louis Brennan, makes the same point in the Financial Times:
‘A more effective approach from the perspective of Ireland’s taxpayers and economy is to negotiate the purchase (at a fraction of face value) of the bonds from the reckless lenders that funded the banks’ foolishness.’
At the very minimum, what would this save the taxpayer? A write down between 50 and 90 percent would:
• Save between €435 million and €780 million per year on interest payments– not an insignificant sum.
• Reduce our debt/GDP ratio by between 4.3 and 7.6 percent
So, we make a real public expenditure savings and reduce our overall debt. Not a bad day’s work for a simple renegotiation.
But we can do so much more. What if we took the money saved through Jim’s Equation and reinvested it back into the economy. Spreading out the savings over five years, here is the result using the Lane-Benetrix multipliers.
If we were to discount 50 percent of the debt and redirected it to investment spread over five years, economic growth would climb – by up to €7 billion by 2015 (an increase of nearly 3.5 percent in nominal GDP). What’s more, tax revenue would increase by nearly €8 billion over the five year period – a significant return on the initial investment.
If we were to discount 90 percent of the debt and redirected it, economic growth would climb by over €12 billion by 2015 (an increase of nearly 6 percent nominally). And naturally, tax revenue would yield a greater amount over that 5 year period - €14 billion.
But the fiscal and economic benefits don’t stop there. Using the ESRI fiscal multipliers, we’d find that employment would increase:
• Under the 50 percent discount into investment, 32,000 jobs would be created, of which 20,000 would be potentially permanent.
• Under the 90 percent discount, 70,000 jobs could be created, of which 43,000 would be potentially permanent.
Then we have to count the savings from reduced unemployment costs (in 2010, the Government estimates that it pays out approximately €15,000 on average for each person in receipt of Jobseekers’ Benefit/Allowance.
And then there’s the supply side benefit – the economic benefit that persists long after the ‘building phase’ is completed. This can be measured as anything between 5 and 10 percent of the original outlay, depending on the particular project. But it can be better understood by looking at what we could have on our asset sheet:
• IBEC estimates the cost of installing Next Generation Broadband to be approximately €2.5 billion (for 90 percent business/household coverage). Imagine the productivity gains at enterprise level.
• Fine Gael has estimated the cost of fitting out a modern water, waste & sewage system to, again, be in the order of €2.5 billion. Imagine the annual savings to local authorities in reduced maintenance costs on our current Victorian-age system.
• Comhar estimates that for €4 billion, approximately 500,000 energy deficient buildings could be retrofitted. Imagine the savings on fossil-fuel consumption and the redirection of those savings into business investment and consumer spending.
And here’s the real knee-slapper: by adopting this approach, we’d bring the fiscal deficit into Maastricht compliance within a few years while substantially reducing our debt/GDP ratio. This is in contrast to the ESRI’s estimate that the current Government policy won’t be able to do that at all.
On any metric, writing down Anglo debt and redirecting into investment is win, win, won.
Of course, some will point out that we’d still have to borrow the money. But we can be comforted by the Central Bank Governor’s assurance that borrowing this money is ‘affordable and manageable’. Now, if it's ‘affordable and manageable’ to borrow money in order to burn it in Anglo’s balance sheet, then how much more ‘affordable and manageable’ would it be if we used that money for investment – with all those benefits mentioned above accruing to the economy and society.
And, yes, we’d still have to fork up billions for Anglo-Irish – there’s no escaping that. But using the ESRI’s baseline projections in its Recovery Scenario, we can measure the significant and long-lasting gains from this simple, yet far-reaching proposal in relation to Anglo-Irish debt.
We are stuck in a corner with little room for manoeuvre. The main benefit of ‘Jim’s Equation’ is that it gives us more space and more options – something we desperately need. Even if you don’t buy into all that investment lark, writing down Anglo-Irish debt will save us billions on the debt and hundreds of millions a year on interest payments at a minimum.
‘Jim’s Equation’ should be taught to every Government Minister, starting with the Minister for Finance.
So wrote John Steinbeck in The Grapes of Wrath. It could easily be applied here (except for the profits part – but the Government is doing everything possible to get them back into the black with our money).
So how do we slay, or at least cripple, the biggest monster of them all – Anglo Irish? Jim Stewart has put forward an incredibly simple, practical and far-reaching proposal that can save the taxpayers’ billions (this was followed up by Brian Lucey).
In its Recovery Scenario the ESRI estimated that the bail-out of Anglo-Irish and Irish Nationwide would cost a combined €25 billion. We have moved on a bit, but let’s take the ESRI’s calculations as a proxy for Anglo alone (it will serve the purposes of this analysis). It will cost, when the bail-out is fully paid over, approximately €1.25 billion a year in interest payments.
But there is an additional, even more substantial, drain. The ESRI estimates that the banking crisis could contribute up to 15 to 20 percent of the permanent loss of output due to the recession. We won’t factor this in (partially because it will only be permanent if we persist with current policies) but the ESRI warns us that this indirect cost could be substantially higher than the direct costs in terms of lost revenue and higher unemployment costs.
Now, let’s take up what I call ‘Jim’s Equation’. Simply put, Jim argues that we should:
‘ . . negotiate with all bond holders and purchase bonds, not at face value but at some fraction of face value. Writing down the 2009 balance sheet value of Anglo Irish debt by 50% would reduce balance sheet liabilities by €8.7 billion. Writing debt down to 10% of face value (a generous value in the event of liquidation) would reduce balance sheet liabilities by €15.6 billion.’
Jim, along with Professor Louis Brennan, makes the same point in the Financial Times:
‘A more effective approach from the perspective of Ireland’s taxpayers and economy is to negotiate the purchase (at a fraction of face value) of the bonds from the reckless lenders that funded the banks’ foolishness.’
At the very minimum, what would this save the taxpayer? A write down between 50 and 90 percent would:
• Save between €435 million and €780 million per year on interest payments– not an insignificant sum.
• Reduce our debt/GDP ratio by between 4.3 and 7.6 percent
So, we make a real public expenditure savings and reduce our overall debt. Not a bad day’s work for a simple renegotiation.
But we can do so much more. What if we took the money saved through Jim’s Equation and reinvested it back into the economy. Spreading out the savings over five years, here is the result using the Lane-Benetrix multipliers.
If we were to discount 50 percent of the debt and redirected it to investment spread over five years, economic growth would climb – by up to €7 billion by 2015 (an increase of nearly 3.5 percent in nominal GDP). What’s more, tax revenue would increase by nearly €8 billion over the five year period – a significant return on the initial investment.
If we were to discount 90 percent of the debt and redirected it, economic growth would climb by over €12 billion by 2015 (an increase of nearly 6 percent nominally). And naturally, tax revenue would yield a greater amount over that 5 year period - €14 billion.
But the fiscal and economic benefits don’t stop there. Using the ESRI fiscal multipliers, we’d find that employment would increase:
• Under the 50 percent discount into investment, 32,000 jobs would be created, of which 20,000 would be potentially permanent.
• Under the 90 percent discount, 70,000 jobs could be created, of which 43,000 would be potentially permanent.
Then we have to count the savings from reduced unemployment costs (in 2010, the Government estimates that it pays out approximately €15,000 on average for each person in receipt of Jobseekers’ Benefit/Allowance.
And then there’s the supply side benefit – the economic benefit that persists long after the ‘building phase’ is completed. This can be measured as anything between 5 and 10 percent of the original outlay, depending on the particular project. But it can be better understood by looking at what we could have on our asset sheet:
• IBEC estimates the cost of installing Next Generation Broadband to be approximately €2.5 billion (for 90 percent business/household coverage). Imagine the productivity gains at enterprise level.
• Fine Gael has estimated the cost of fitting out a modern water, waste & sewage system to, again, be in the order of €2.5 billion. Imagine the annual savings to local authorities in reduced maintenance costs on our current Victorian-age system.
• Comhar estimates that for €4 billion, approximately 500,000 energy deficient buildings could be retrofitted. Imagine the savings on fossil-fuel consumption and the redirection of those savings into business investment and consumer spending.
And here’s the real knee-slapper: by adopting this approach, we’d bring the fiscal deficit into Maastricht compliance within a few years while substantially reducing our debt/GDP ratio. This is in contrast to the ESRI’s estimate that the current Government policy won’t be able to do that at all.
On any metric, writing down Anglo debt and redirecting into investment is win, win, won.
Of course, some will point out that we’d still have to borrow the money. But we can be comforted by the Central Bank Governor’s assurance that borrowing this money is ‘affordable and manageable’. Now, if it's ‘affordable and manageable’ to borrow money in order to burn it in Anglo’s balance sheet, then how much more ‘affordable and manageable’ would it be if we used that money for investment – with all those benefits mentioned above accruing to the economy and society.
And, yes, we’d still have to fork up billions for Anglo-Irish – there’s no escaping that. But using the ESRI’s baseline projections in its Recovery Scenario, we can measure the significant and long-lasting gains from this simple, yet far-reaching proposal in relation to Anglo-Irish debt.
We are stuck in a corner with little room for manoeuvre. The main benefit of ‘Jim’s Equation’ is that it gives us more space and more options – something we desperately need. Even if you don’t buy into all that investment lark, writing down Anglo-Irish debt will save us billions on the debt and hundreds of millions a year on interest payments at a minimum.
‘Jim’s Equation’ should be taught to every Government Minister, starting with the Minister for Finance.
Wednesday, 1 September 2010
'Pluck' and reckless banks
Paul Sweeney: Regular Progressive Economy blogger on Finance, Dr Jim Stewart, has a letter in today’s Financial Times - co-authored by his TCD colleague Prof Louis Brennan - on the Anglo Irish bailout.
Commenting on that newspaper's Editorial last Friday on the debacle that is the foolish and costly Government bailout of Anglo Irish Bank, they suggest “negotiating the purchase (at a fraction of face value) of the bonds from the reckless lenders that funded the banks’ foolishness.”
Another alternative, they suggest, is that “as proposed in a recent BIS document, is that debt instruments could be written off entirely.”
Stewart and Brennan rightly warn of the “inevitable self-serving noise from the usual suspects, continuing to indulge at any cost the lenders that engaged in wholesale recklessness is a luxury that Ireland’s taxpayers and economy can ill afford.”
Is it not time to call a halt to this disastrous Government decision and for it to negotiate, hard, with the “reckless” bondholders? Or are our leaders so incompetent that they multiple every error they make. At our immense and growing cost.
Commenting on that newspaper's Editorial last Friday on the debacle that is the foolish and costly Government bailout of Anglo Irish Bank, they suggest “negotiating the purchase (at a fraction of face value) of the bonds from the reckless lenders that funded the banks’ foolishness.”
Another alternative, they suggest, is that “as proposed in a recent BIS document, is that debt instruments could be written off entirely.”
Stewart and Brennan rightly warn of the “inevitable self-serving noise from the usual suspects, continuing to indulge at any cost the lenders that engaged in wholesale recklessness is a luxury that Ireland’s taxpayers and economy can ill afford.”
Is it not time to call a halt to this disastrous Government decision and for it to negotiate, hard, with the “reckless” bondholders? Or are our leaders so incompetent that they multiple every error they make. At our immense and growing cost.
Monday, 30 August 2010
Pluck of the Irish?
Tuesday, 24 August 2010
What to do about Anglo Irish Bank?
Jim Stewart: Much comment argues that the increasing cost of Irish Government borrowing (the second/third highest in the eurozone and over twice the cost of German Government borrowing) is a direct consequence of Government economic policies in relation to the banking system. Other policies are also likely to be a factor, such as the emphasis on fiscal austerity in the belief that this will restore confidence and lead to economic success - what Paul Krugman has called the ‘confidence fairy’.
Removing the blanket guarantee on all bank liabilities, rather than extending it, is very likely to reduce the cost of Government borrowing (on August 19th, the Minister was quoted in the Irish Times as saying that "Elements of the guarantee will not be continued from September”).
However, amending the guarantee also gives an opportunity for a much more radical intervention.
In his Beal na mBlath speech, the Minister recently restated the Government’s policy of supporting the existing debt of Anglo Irish.
“...we must stand behind our banks in order to ensure that a sustainable financial system is established and, in the case of Anglo, to ensure that the resolution of its debts does not damage Ireland’s international credit-worthiness and end up costing us even more than we must now pay”.
It is false analysis to present the options in relation to Anglo Irish Bank as allowing it to fail (liquidation) or continuing to support it. Those who advocate continued support may justify this position by calling for a type of Special Resolution regime in Ireland for failing banks, to reduce the risk of bank failures in the future. As has been pointed out by others – most recently the Bank for International Settlements, p.3 – a Special Resolution regime within one country is unlikely to work for a large institution whose operations straddle a number of different countries. Assets in other countries cannot be seized unilaterally. Legal systems have differing requirements for creditor protection in the event of a firm being forced into liquidation, further complicating the efforts of any single regulator.
A third and less costly option is to negotiate with all bond holders and purchase bonds, not at face value but at some fraction of face value. Writing down the 2009 balance sheet value of Anglo Irish debt by 50% would reduce balance sheet liabilities by €8.7 billion. Writing debt down to 10% of face value (a generous value in the event of liquidation) would reduce balance sheet liabilities by €15.6 billion.
There are some implications: Anglo Irish must not be allowed redeem any existing bonds, as it has done in the past, and then declare the difference as profit.
Such a solution is consistent with proposals for reform in the consultative document recently published by the BIS, which addresses the issue of banks which received public sector funds but most of whose long term capital did not suffer any losses.
What are the costs?
It is important to note that it is normal commercial practice to renegotiate with debt holders in the event of a corporate financial crisis. A well known example is Eurotunnel.
It has been argued that the costs in terms of reputational damage to the State would be large, the credit rating on existing Government debt would fall, and government debt yields would rise. The fact that Anglo Irish is State-owned gives some credence to these views. However, continuing with current policy to undertake to redeem most long-term debt at face value will ensure continued risk and uncertainty in relation to State finances.
These costs are likely to be exaggerated. Those firms who advise bond holders, and who may have a financial interest in maintaining the value of bank debt, are likely to complain the loudest.
Issues might arise in relation to increased risk to depositors and deposit withdrawals. The largest single source of deposits in the most recent accounts consisted of bank deposits (€33 billion), of which the largest single component is likely to be Irish Central Bank/ECB, whose deposits are automatically guaranteed. However, a risk of deposit withdrawal could be met with an extension of the guarantee to all depositors in Anglo Irish alone. The risk of not being able to issue new debt would be covered by specific guarantees.
There are fundamental changes taking place in the structure of Irish banking (the closure of Bank of Scotland, Halifax, Post Bank; the re-emergence of a banking system dominated by two banks). Government policy in recent years has been far too quick to allow – and even encourage – abandonment of the mutual form of ownership/control. This policy is continuing in the case of the EBS (see Irish Times 4/8/10 and Financial Times 4/8/2010).
Mutuals and credit unions play a key role in the financial architecture of all EU states (and for very good reasons). The largest and best-known is Rabo Bank in the Netherlands. With appropriate policies, these benefits could also accrue to Ireland (See here).
The costs associated with, and the excessive focus on, Anglo-Irish means that there has been little analysis of, or comment on, the important changes taking place in the structure of Irish banking and the implications for the sector’s likely future conduct and performance. Coupled with the absence of specific policies to provide finance to indigenous firms (a loan guarantee scheme as in the UK and other countries; a State Development Bank) these changes are unlikely to be conducive to economic success.
The rising cost of supporting Anglo Irish bank has at least clarified one issue – nationalizing this bank did not reduce the cost to the tax payer.
Removing the blanket guarantee on all bank liabilities, rather than extending it, is very likely to reduce the cost of Government borrowing (on August 19th, the Minister was quoted in the Irish Times as saying that "Elements of the guarantee will not be continued from September”).
However, amending the guarantee also gives an opportunity for a much more radical intervention.
In his Beal na mBlath speech, the Minister recently restated the Government’s policy of supporting the existing debt of Anglo Irish.
“...we must stand behind our banks in order to ensure that a sustainable financial system is established and, in the case of Anglo, to ensure that the resolution of its debts does not damage Ireland’s international credit-worthiness and end up costing us even more than we must now pay”.
It is false analysis to present the options in relation to Anglo Irish Bank as allowing it to fail (liquidation) or continuing to support it. Those who advocate continued support may justify this position by calling for a type of Special Resolution regime in Ireland for failing banks, to reduce the risk of bank failures in the future. As has been pointed out by others – most recently the Bank for International Settlements, p.3 – a Special Resolution regime within one country is unlikely to work for a large institution whose operations straddle a number of different countries. Assets in other countries cannot be seized unilaterally. Legal systems have differing requirements for creditor protection in the event of a firm being forced into liquidation, further complicating the efforts of any single regulator.
A third and less costly option is to negotiate with all bond holders and purchase bonds, not at face value but at some fraction of face value. Writing down the 2009 balance sheet value of Anglo Irish debt by 50% would reduce balance sheet liabilities by €8.7 billion. Writing debt down to 10% of face value (a generous value in the event of liquidation) would reduce balance sheet liabilities by €15.6 billion.
There are some implications: Anglo Irish must not be allowed redeem any existing bonds, as it has done in the past, and then declare the difference as profit.
Such a solution is consistent with proposals for reform in the consultative document recently published by the BIS, which addresses the issue of banks which received public sector funds but most of whose long term capital did not suffer any losses.
What are the costs?
It is important to note that it is normal commercial practice to renegotiate with debt holders in the event of a corporate financial crisis. A well known example is Eurotunnel.
It has been argued that the costs in terms of reputational damage to the State would be large, the credit rating on existing Government debt would fall, and government debt yields would rise. The fact that Anglo Irish is State-owned gives some credence to these views. However, continuing with current policy to undertake to redeem most long-term debt at face value will ensure continued risk and uncertainty in relation to State finances.
These costs are likely to be exaggerated. Those firms who advise bond holders, and who may have a financial interest in maintaining the value of bank debt, are likely to complain the loudest.
Issues might arise in relation to increased risk to depositors and deposit withdrawals. The largest single source of deposits in the most recent accounts consisted of bank deposits (€33 billion), of which the largest single component is likely to be Irish Central Bank/ECB, whose deposits are automatically guaranteed. However, a risk of deposit withdrawal could be met with an extension of the guarantee to all depositors in Anglo Irish alone. The risk of not being able to issue new debt would be covered by specific guarantees.
There are fundamental changes taking place in the structure of Irish banking (the closure of Bank of Scotland, Halifax, Post Bank; the re-emergence of a banking system dominated by two banks). Government policy in recent years has been far too quick to allow – and even encourage – abandonment of the mutual form of ownership/control. This policy is continuing in the case of the EBS (see Irish Times 4/8/10 and Financial Times 4/8/2010).
Mutuals and credit unions play a key role in the financial architecture of all EU states (and for very good reasons). The largest and best-known is Rabo Bank in the Netherlands. With appropriate policies, these benefits could also accrue to Ireland (See here).
The costs associated with, and the excessive focus on, Anglo-Irish means that there has been little analysis of, or comment on, the important changes taking place in the structure of Irish banking and the implications for the sector’s likely future conduct and performance. Coupled with the absence of specific policies to provide finance to indigenous firms (a loan guarantee scheme as in the UK and other countries; a State Development Bank) these changes are unlikely to be conducive to economic success.
The rising cost of supporting Anglo Irish bank has at least clarified one issue – nationalizing this bank did not reduce the cost to the tax payer.
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