Euro crisis solutions: An ongoing debate

Tom McDonnell: The Irish body politic and especially its commentariat will no doubt spend the next few weeks obsessing and navel gazing over the fiscal compact and its perceived impact on Ireland. Yet in truth the real debate that matters is the one going on at the Euro zone level. The institutional and policy architecture of the Euro zone is deeply flawed at a structural level. These flaws have been cruelly exposed by the response to the debt crisis and by the failures leading up to the banking and debt crisis. How Europe now decides to respond will decide the future shape of the Euro zone and it is in that intellectual space that Ireland must begin engaging in.

There are a number of useful 'non-official, non-Irish' resources on the Internet for those interested in the debate:

The Eurointelligence feed (newsbriefing@eurointelligence.com) is probably the best free daily resource on the Euro crisis that is out there. It combines news and media reports from around the Euro zone with high quality analysis. See here.

Over at VOX EU there is a lively debate going on about the merits, or otherwise, of austerity. See here.

The Social Europe Journal is another site worth a visit for its analysis of the crisis and for a constructive, albeit damning, critique of current policies.

Well worth a look at from time to time are the CEPS, Project Syndicate and Breugel websites while John McHale helpfully adds a few additional links here. Yanis Varoufakis provides the perspective from Greece here.

Across the atlantic Paul Krugman and the idiosyncratic Brad DeLong regularly provide external and often scathing perspectives on the official response to the Euro crisis.

Finally, the Financial Times and the Guardian usually conduct rolling live blogs whenever the latest Euro zone drama erupts.

This is just a small selection. We are in the midst of a multidimensional crisis with multiple targets. There can be no silver bullet in such a scenario. Nevertheless there are viable solutions out there that can, taken as a package, ensure the viability of the Euro zone over the medium-term. And not just a Euro zone where unemployment and poverty concerns are seemingly always secondary to concerns like narrow price stability.

Some of these solutions will undoubtedly be politically difficult. Ultimately Europe's leaders will need to decide what their vision for the Euro zone is, what is sacrosanct, and what is negotiable. Indeed they should be obliged to articulate their vision. This would bring a degree of much needed clarity to the discussion.

Sailing rudderless into the Anglo storm

Tom McDonnell: The Greek tragedy that is the eurozone debt crisis may soon enter its fourth act. A hard write-down of Greek debt is necessary and there is now a significant probability that Greece will be allowed to default around December. Martin Wolf argues here that:

“the bare minimum the eurozone needs to cope with its crisis is an effective mechanism for writing down the debts of evidently insolvent private and sovereign borrowers, such as Greece; funds large enough to manage the illiquid bond markets of potentially solvent governments; and ways to make the financial system credibly solvent immediately.”

He suggests the sums required will be several times larger than the €440bn of the existing EFSF.

The Dexia crisis is finally forcing the core countries to acknowledge that their banking systems are in serious trouble and this creates an opportunity for Ireland. While the original intent was for the EFSF to be a sovereign bailout fund it is becoming increasingly clear that its future role will likely involve the recapitalisation of failing banks.

If and when Greece is allowed to default the EFSF will be standing by to preserve the solvency of the European banking system through large-scale recapitalization. It is at this point that the Irish Government should request the Anglo/INBS promissory note liabilities be transferred to the EFSF with Ireland then agreeing a negotiated repayment schedule at a low interest rate.

Renegotiating the promissory notes is of huge consequence to Ireland’s future prosperity. Michael Noonan hints here that he has begun the process of renegotiation. We can extrapolate from these new figures that the total cost between 2011 and 2031 will be in the region of €85 billion (assumes a 4.7% interest rate from 2013 onwards). That is €4 billion a year. The infinite spiral of cumulative interest costs is the reason why the figure is larger than the commonly cited €47 billion i.e., we have to pay interest on the €47 billion in borrowings and then pay the interest on the borrowings required for those interest payments and so on and so forth (click on table to enlarge).

Seamus Coffey explains the issues here. Turning the notes into a long-term bullet bond owed to the EFSF may offer one plausible solution. Our institutions were unforgivably unprepared for the 2008 earthquake. It would be feckless to sail in to the current storm without a worked out strategy to deal with the promissory note question.

'Understanding what controls us'

Peter Connell: Writing in last Saturday’s Guardian, Ian Jack, bemoaning the irrelevance of the current party conference season in the UK, argued that the media, rather than providing publicity for stage managed political rallies, would better serve society and its citizens by focusing on the powerful institutions and corporations whose decisions shape our society, our economy and our lives. In his piece Jack laments the fact of high levels of economic and financial illiteracy and argues that ‘we don’t understand what controls us’. How can we address what is essentially a democratic deficit? How do we control what we don’t understand?

Given the high level of complexity of the financial system that is an integral part of modern capitalism it is, perhaps, unreasonable to expect that the average citizen will have a good handle on credit default swaps, contracts for difference and ten year bond yields. But that’s not really the problem. The real issue is how is a citizen in a democracy to assess the efficacy of their government’s economic management without some grasp of the context in which decisions are made? The government, naturally enough, have claimed credit, for renegotiating the terms of the EU/IMF bailout that will see a significant reduction in the country’s debt burden on the back of a 2% cut in the interest rate. It’s fair to say that most reasonably well-informed citizens will assess this claim in the context of the Minister for Finance indicating in early June that a 0.6% rate cut might be the best that could be hoped for. Very often, though, it’s much more difficult to make a judgement call.

A good example is the infamous promissory note which, under current arrangements, will cost the Irish taxpayer €65 billion over the next 14 years. Michael Burke, Tom McDonnell and Michael Taft performed a valuable public service when posting on PE on the promissory note and arguing that it should become a major political issue. The nature of the promissory note, the institutions and entities that are party to it and the implications of defaulting on or restructuring it are complex issues on which even professional economists differ. Prompted by the PE posting, a lot of these issues were teased out on irisheconomy.ie. The debate, though, remains one largely between ‘insiders’ when it deserves and demands the widest public audience. Given that the cost of Anglo-Irish/Irish Nationwide debt over the next few years completely dwarfs the gains that will be accrued from the reduced interest rate on the State’s EU/IMF bailout funds, it is an indictment of our mainstream media that it has largely failed to facilitate an informed public debate on this issue.

In assessing how the government deals with the promissory note in the coming weeks the bar needs to be set high. A complete restructuring of the debt, with a rescheduling of payments over a 30 or 50 year period, seems the least we should expect. And the least we should expect from our media is that is that it addresses the democratic deficit and helps us ‘understand what controls us’.

A long, long, long way to go

Michael Taft: A good step; but a very small step: the Finance Minister’s announcement that the Government will seek a substantial write-down of the €3.8 billion in senior unguaranteed unsecured debt in Anglo-Irish and Irish Nationwide will be welcomed. Some will legitimately complain that this should have been done after the Anglo nationalisation, when that debt stood at approximately €16 billion. But that was the fault of the previous government. Most of the debt has been paid off and we are left with the bill – a €31 billion promissory note which will cost the Exchequer €43 billion with interest over the next 15 years. So this first step on senior bondholders is the new government’s initiative. But let’s put it in perspective – the impact will be very small and even if successful we will be left with a staggering bill for winding down, what the Minister has called, this ‘warehouse’.

Currently, the Government is committed to paying off a promissory note of €31 billion (€25.3 billion to Anglo, €5.4 billion to INBS and €0.35 billion to the Educational Building Society). This will entail a cost of €3.060 billion borrowed in each year up to 2023, with a further payment of approximately €2.8 billion in 2024 and 2025.

This is an intolerable burden – equalling 2 percent of 2011 GDP; a burden that would not be accepted in any other EU country; and for a bank that isn’t even a bank. So what difference would it make if the Minister gets his way? Some, but not very much.

In putting forward his suggestion for burden sharing, the Minister referred to the current discount. This, therefore, doesn’t suggest a complete liquidation. The Irish Times reports that Anglo’s November 2011 bonds (€750 million) fell to 70 cents following the Minister’s announcement.

The following calculation, therefore, assesses the impact of writing down the €3.8 billion in senior unguaranteed debt by 50 percent. This would mean a write-down of €1.9 debt, or 6 percent of the current promissory note. This would result in the following difference in annual payments:

• Current Annual Payment: €3.060 billion
• New Annual Payment after Write-down: €2.870 billion

While the new annual payment is my own calculation, any revisions would be trivial.

So after a 50 percent write-down of the senior unguaranteed debt, we would see the annual payments fall by €190 million per year. We would still be pay close to €2.9 billion. This is no less an intolerable burden.

However, we may be into a ‘running-to-stand-still’ situation. The Department of Finance’s projections of the overall cost of the promissory note, including interest, is premised on long-term borrowing costs of 4.7 percent – a technical assumption ‘based on the weighted average cost of funds raised by the NTMA in the bond market in 2010’.

That technical assumption no longer holds. With ESFS borrowing rates at 5.8 percent, we should expect the overall cost of the promissory note to increase. So if we apply that new interest rate and apply it to the promissory note minus the 50 percent write-down of senior unguaranteed debt – we will find the level of payments rise again over the lifetime of the note. In other words, there is little if any net gain.

The Minister for Finance should be supported – as a first step, as an opening of the door. But the fiscal impact will be minimal and the state will still be under an unacceptable and irrational burden.

It is now time for a more radical, thorough-going approach to write-down, if not entirely eliminate, the public exposure to the costs of winding down Anglo and INBS. A starting point comes from the TASC document on banking, ‘The Debt and Banking Crisis’:

‘Insolvent banks should not be further supported by public funds and should be allowed to fail. In Ireland this means that, at the very least, Anglo Irish Bank and INBS should be allowed to fail. No further payments for Anglo Irish Bank’s promissory notes should be made.'

That’s a good starting point.

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.

'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.

Pluck of the Irish?

Jim Stewart: Have they been reading Progressive Economy posts on Anglo Irish Bank? You can read the Financial Times editorial here.

The Honohan and Regling reports

Jim Stewart: There is considerable media coverage and speculation about the contents of the forthcoming Honohan Report on the role of the Central Bank, and the report by the Financial Regulator on the financial and economic crisis (See Simon Carswell, Irish Times 26/5/2010, Emmet Oliver, Irish Independent 25/5/2010, Ian Kehoe, Sunday Business Post 23/5/2010) David Clerkin and Cliff Taylor Sunday Business Post 23/5/2010).

In addition some of the key people involved in financial decision making have also expressed considerable interest in the findings - for example, Michael Somers (interview in the Sunday Independent (23/5/2010). Of the two reports, the Honohan Report is likely to be the more interesting, for example in understanding policy mistakes made by the Central Bank and the Financial Regulator.

It is also of interest that Michael Somers, in giving evidence to the Central Bank Governor (rather than the inquiry team), stated that he was not in any way involved in the decisions to give guarantees to the six covered institutions on 29th September 2008. Michael Somers is quoted as stating :- Patrick Honohan asked me to meet with his team of inquirers and I said I would meet with him, which I duly did. I think his main interest really was what was happening at the time of the guarantee. I said: 'I can't help you because I wasn't here'." (He does not appear to have had a Blackberry!) This statement appears to contradict the view of Eamon Gilmore (Dail Debate April 1) that the terms of reference of the inquiry excluded the government’s decision in respect of the guarantee.

Whether the guarantee is included or excluded from the scope of the inquiry is of great interest, because it is seen by some (for example, Morgan Kelly Irish Times 22/5/2010) as being disastrous for the stability of exchequer finances and any possible recovery. The guarantee helped the survival of all the covered institutions, but the issue is whether two of those institutions should not have been supported with a consequent reduction in the cost to the State. The ending of the guarantee gives an opportunity to revisit this decision. The guarantee also had a cost in terms of increasing the overall borrowing rate estimated at 0.15 -0.3% (Department of Finance Banking Statement Supplementary Documentation), recouped from the covered institutions via charges.

The decision to implement the guarantee may lie in an important Ecofin (Economic and Financial Affairs Council) decision one year earlier, that responsibility for managing any crisis effectively rested with national authorities (Ecofin meeting October 9, 2007). In late September 2008, following the Lehman collapse, a loss in confidence in banks raised the real possibility of bank runs. In response, individual countries competed for deposits via more and more generous insurance schemes. As Fonteyne et al state (available here) “Starting in early October 2008, EU member countries effectively raced one another to extend deposit and other bank guarantees”. Ireland was one of the first countries “out of the trap” to start this race, and this led to considerable criticism at the time (See for example, Charlie Weston, Irish Independent, October 1, 2008).

Fonteyne at al also note that bank failures “have been very rare in the EU and have usually been limited to small banks”. Restructuring via injections of public funds has been common, and exit via arranged mergers. This was attempted in the case of Anglo Irish and Irish Nationwide. The rarity of decisions to allow banks to fail within the EU is also likely to have influenced decision-making in implementing the guarantee.

The ending of the bank guarantee provides* an opportunity to ‘close’ both Anglo Irish and Irish Nationwide by withdrawing State support, which is very likely to cause them to move into liquidation. Alternative options between liquidation and continuing State support are also possible and deserve extensive analysis. In any event the liquidation of both institutions now, would not (unfortunately) remove all liabilities for the Irish State, central bank deposits would have to be repaid, ordinary depositors and perhaps commercial bank depositors (should there be any) are likely to be repaid in full.

Given the international nature of Anglo Irish’s assets and liabilities, allowing this bank to fail in view of the absence of an EU-wide special resolution regime is likely to be resisted by EU bodies such as the ECB.

The forthcoming reports are important. Given the public interest nature of the issues involved, including as much detail as possible would add enormously to their value.


* The guarantee has been extended for certain debt instruments and the main scheme may be extended until December according to Cliff Taylor, Sunday Business post 23/5/2010).

Can we have some more transparency please?

Slí Eile: In regard to Anglo-Irish Bank claims have been made that: (i) winding up would cost Ireland €70bn and (ii) defaulting on some €15bn in 'senior bond debt' for Anglo-Irish would have systemic and negative impact across the entire financial system. It would help if someone could guide the taxpayers of Ireland to (a) a full set of meaningful and informative accounts of the 'state owned' Bank and (b) a breakdown of lenders and investors as distinct from deposit holders and others with the claimed total liability of near €70bn. A search of the Annual Report of Anglo for 2009 shows an Annual Report here. On page 38 of the Annual Report a total liability of €97bn is reported. This breaks into €51bn in 'customer accounts' (of the great, the good and the humble), €20.5bn in deposits from banks and €17.3bn in 'debt securities in issue'. A further €5bn is in subordinated liabilities and 'other capital instruments'. How much of these liabilities are, ultimately, to the Irish Government, other Irish banks, investors and lenders from outside the State? What concentration of liability rests with a small circle of high-wealth individuals?
Could the people who have to pick up the bill please have a full, transparent and detailed account of who owns what to who. If we are to gamble with €20bn plus in capital transfers and thereby add to EU-measured Government debt, could we have a full cost-benefit analysis accesible to the Oireachtas and civil society? Too much to ask?

The great fiscal shell game

Michael Taft: The only enjoyable aspect of Eurostat’s decision today to reclassify the Anglo-Irish Bank subsidy as a liability on the General Government Balance/Debt is to watch the Government’s hands move even faster in an increasingly vain attempt to prevent us from seeing under which shell the real deficit is hidden. But they must be getting tired; and eventually we’ll glimpse it

In short, the Government keeps two sets of books: one for the EU which determines our General Government Balance (GGB or annual deficit) and our General Government Debt (GGD or overall debt) for the purposes of the Maastricht guidelines; GGB must be kept below -3 percent and our GGD must be kept below 60 percent of GDP). That’s one set of books – the other is for us. There’s nothing shady about this – there are a number of expenditure items that don’t appear on the EU books (e.g. payments into the Pension Fund), while there is revenue that appears on the EU books but not on our own (e.g. Social Insurance Fund surplus).

As a rule, expenditures in the form of bank recapitalisations don’t count in the EU books as they are considered equity investments. For instance, recapping Bank of Ireland through equity purchases should, in theory, be recouped. The Government had hoped that recapping Anglo-Irish would also be considered as an equity purchase and, therefore, not appear on the books they keep for the EU. Eurostat put paid to that. The money flowing into Anglo-Irish, according to Eurostat, could not realistically be considered an equity investment. Instead, it is now considered a straight-forward capital transfer. This transfer now appears on both sets of books.

Does this make any difference to the bottom-line? In one sense it is merely re-aligning statistical methodology with economic reality. At the end of the day, regardless of whether the capital transfer to Anglo-Irish appears on the EU books or not, it certainly will weigh down the economy’s books. This is money that has to be borrowed on the bond market. These borrowings will have to be serviced. For every €1 billion we borrow, we increase our debt servicing costs by €45 million at current rates. If the Government transfers the maximum amount - €22 billion – this debt servicing cost will rise to nearly €1 billion a year. It doesn’t matter whether the debt appears on this book or that; it will be a very real item on the current budget.

How will Eurostat’s reclassification impact on the Maastricht guidelines and the Government’s target of reducing the annual deficit to below -3 percent by 2014? Be prepared to receive two new words into the popular economic debate: the ‘headline’ deficit and the ‘underlying’ deficit. The Government will make this distinction to downplay the official (for EU purposes) GGB, or annual deficit, level.

For instance, prior to the reclassification, the Government estimated the GGB to be -11.7 percent. After today, it is 14.3 percent. The Government will claim that the former is the true, or ‘underlying’ figure; while the latter, the ‘headline’ figure, is merely the product of a one-off – in this case, the one-off capital transfer to Anglo-Irish.

The problem with this is that there may be considerably more one-offs in regards to Anglo-Irish. Philip Lane points out that such transfers will count on the EU books at the time of the commitment. While the Government may drip-feed the capital transfers into Anglo-Irish over a number of years through promissory notes, it will nonetheless be recorded in the year the decision is made. So if the Government commits €8 billion, it will be recorded immediately.

Still, the Government will hope to have done with these commitments so that by 2014, no such liability for the purpose of determining that year’s GGB, or annual deficit will arise. In that sense, they hope the ‘underlying’ reading will prevail.

But there is no such distinction when it comes to calculating our GGD, or overall debt. This will be a permanent feature. The Government had hoped to keep the GGD below 80 percent of GDP. If they have to hand over the full €22 billion to Anglo-Irish, the GGD will balloon to over 91 percent. Both the optics and the reality of that ballooning debt will not be good.

And here is where the Government is on a slippery slope. This reclassification will invite further scrutiny and this kind of scrutiny rarely has a favourable conclusion. Regardless of Eurostat rules, investors into our debt will start examining NAMA’s impact and may start their own mental reclassifications.

Further scrutiny may be made of the Government’s credibility in regard to their strategy. Already, the EU Commission has recently given a thumbs-down in its update on their excessive deficit procedure against Ireland. They have concluded that (a) the Government’s growth projections are too optimistic (and if this is the case, unemployment, tax revenue and the deficit will all go south); (b) the Government’s future fiscal consolidation plans are too vague; and (c) even if the Government somehow manages to hit their targets, they will still have to make more fiscal adjustments than planned for.

In short, this reclassification by Eurostat could prompt an opening up of Pandora’s deflationary box. Independent forecasters are already predicting lower growth and higher debt than the Government is doing – and that’s without today’s decision.

So the Government has no choice but to keep up this glorified shell game – continually reassuring all of us that nothing has changed. But it has. It is. It will.

And don’t forget – shell games are just a confidence trick. If you buy into it, you will lose.

Shock News: The entire €4bn fiscal adjustment goes to just one Zombie Bank

Slí Eile: The next time you hear a politician or economist saying that our current public borrowing deficit ‘has nothing to do with NAMA’ show them the Red Card as follows:
Department of Finance Press Release 2 October 2009
It reads:

At end-September 2009, the Exchequer deficit is €20,158 million, compared to €9,404 million at end-September last year. The year-on-year deterioration in the deficit of some €10.8 billion is primarily explained by a decline in tax receipts of €4.8 billion, the €4 billion payment to Anglo Irish Bank and €1.7 billion in respect of the frontloading of the annual contribution to the National Pensions Reserve Fund (NPRF).

Non-voted capital expenditure at end-September was €7,026 million. This compares to €1,270 million in the same period of last year. The year-on-year increase is due to the payment of €4 billion to Anglo Irish Bank in 2009 and the increase of €1.7 billion in the payment to the NPRF (a total of €3 billion has been paid to the NPRF in 2009 as part of the bank recapitalisation programme, at this stage last year some €1.3 billion had been transferred to the NPRF).

In plain English what this means is that the infamous €400m a week that we are borrowing is associated with payments to Anglo-Irish and the collapse in tax receipts (which in turn is greatly exacerbated by the bursting of the banks-induced property bubble over the decade to 2008).
The astonishing conclusion to be drawn is that the €4bn payment to the zombie Anglo – a bank that is very unlikely to serve a useful social role by way of lending ever again – earlier this year matches exactly the estimated ‘fiscal adjustment’ proposed in the December 2010. So, welfare recipients, children waiting for CF treatment, public sector workers etc are directly paying money to a zombie bank. And that’s not all. We have another major bank or two waiting in the wings for fresh recapitalistion and possible State takeover if that doesn’t work (which it probably will not in the case of AIB).

The other interesting twist to this sorry tale is that Eurostat have just ruled that money borrowed by the commercial banks from the European Central Bank will not be counted as national debt. This is off-balance sheet borrowing on a massive scale (up to €54bn in bond issues used as collateral by the commercial banks in exchange for capital from the ECB) which will not be counted in that terrifying figure of €400 million a week paraded, daily, in the media.

So, there is one solution for the banks (borrow up to 33% of annual GDP and divert €4bn of precious tax payer money as ‘cash for trash’) and one solution for the rest of us who use public services (must cut back to level of taxes available we are told).

There are three fundamental problems with this strategy and mindset:
1 It is completely unethical to condemn this generation and the next to a massive bail out of bankers, some developers (more than we thought judging by the proposed seed of repayment in the NAMA business plan) and a few politicians who would rather face the electorate later rather than sooner.
2 The clumsy and reckless NAMA solution (described less charitably by Joseph Stiglitz) is very unlikely to achieve its aim of cleaning bank sheets and freeing up credit
3 Deflation won’t work – with an additional deflationary shock in store this December – retail sales in the domestic market together with tax receipts from income and consumption are likely to continue falling and pressure on welfare payments will mount (even if rates are cut) because more and more people will require medical cards, ‘back-to-school’ allowances and other services.
For every person made unemployed as a result of fiscal contraction there is a direct financial cost of some €20,000 per annum in addition to other costs associated with health, housing and education public spending. Not to mention the profound impact on personal and community health and well-being – especially for a new generation that expected more than the Celtic Tiger could promise.

Instead of wage cuts we need to hold the real value of wages for most workers – to do otherwise is to add to the deflationary spiral;
Instead of cuts in welfare to the old, the sick and those not in the labour force we need cuts in welfare to those big cats who played – recklessly – by the rules of capitalism only to be compensated, rewarded and bailed out by Government in a massive exercise of risk-socialisation (essentially Government has nationalised risk in the banking sector and privitised most of the gains to be had from any partial recovery in asset prices in the future).
Instead of cuts in public expenditure we need redirection of spending from unfair subsidies and waste to areas of greatest need (early childhood, social housing and community health services)
Instead of retrenchment in public services we need to expansion to prepare Ireland for the eventual upswing
Instead of no hope and no-other-way mindsets we need to let loose a new wave of entrepreneurs, thinkers and leaders in the public, private and voluntary sectors less oriented to short-term gain, position or income/profit maximisation.

When is spam not spam? When it's As Gaeilge ...

Last Thursday morning, shortly after The Report had been released and our bloggers were preparing to comment, we received the following message from Blogger:

"Your blog at: http://www.progressive-economy.ie/ has been identified as a potential spam blog. To correct this, please request a review by filling out this form. Your blog will be deleted in 20 days if it isn't reviewed, and your readers will see a warning page during this time. After we receive your request, we'll review your blog and unlock it within two business days."

The e-mail included a link to a page informing us that:

"spam blogs [...] can be recognized by their irrelevant, repetitive, or nonsensical text, along with a large number of links, usually all pointing to a single site"

After some head-scratching - not to mention several frantic e-mails requesting that the site be unlocked so we could continue blogging The Report - we realised what the problem was: Sli Eile's first post on The Report was entitled Bord Snip Nua = Gearr siar-agus-doigh. And Blogger's robots, not programmed to recognise Irish, immediately flagged PE as spam ....

Thankfully, Blogger responded to our pleas and unlocked the site within a couple of hours ...

The root cause of the recession

Paul Sweeney: Too much competition can be bad. It is heresy to most liberal economists, but the low interest rate and liberalisation of markets did generate intense competition between financial institutions which led to this crisis. It happened in the US and it happened in Ireland. In Ireland Seanie Fitzpatrick and his boys in Anglo Irish were so aggressive on lending that the big boys in AIB and BOI got really angry with the loss of market share to this upstart. So the Big Boys decided to loosen the rules on lending to compete with Anglo Irish. So the contagion spread in this fair isle!

In the US, it was even worse. Competition led to some banks inventing new financial products. Is not that what competition is about? It generates innovation and new ideas. Yes… up to a point. Here they created the famous toxic debt and wrapped it up as something really nice with a big bow on it and a “triple A” stamp from the also compromised Rating Agencies.

Part of this story is told in a new book, "Fools' Gold" , by Financial Times writer Gillian Tett.
Tett is an excellent writer and this extract in last Saturdays Financial Times magazine is really worth reading if you want to know what went on the big US finance houses. She tells us what financial derivatives are and much more. Such as why the lack of regulation was so important of the innovators:-

“But within AIG, an upstart entrepreneurial subsidiary was booming. In the late 1980s the company hired a group of traders who had previously worked for Drexel Burnham Lambert, the infamous – and now defunct – champion of the junk-bond business under Michael Milken in the mid-1980s. These traders had developed a capital markets business, known as AIG Financial Products and based in London, where the regulatory regime was less restrictive. It was run by Joseph Cassano, a tough-talking trader from Brooklyn. Cassano was creative, bold and highly ambitious. More important, he knew that, as an insurance company, AIG was not subject to the same burdensome rules on capital reserves as banks.”

Click here to read on……

Meanwhile, in America ....

Check out Paul Krugman's blog for a progressive perspective on what's happening in the United States.