Can Special Purpose Vehicles help alleviate the Housing Crisis?

Tom Healy: A Special Purpose Vehicle (SPV) is a technical term that refers to a wide variety of arrangements where a financial entity is established for a ‘special purpose’ as the title suggests.  The National Asset Management Agency is a type of SPV set up to buy distressed assets from bust banks and seek to work off these loans over time and recoup some of the loss for the state.  In this case, the vehicle established is said to be ‘off the books’ (of the state.

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.

Table 1:

	'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).

The Fiscal Compact, or: where will we be in 2018?

Tom McDonnell: The debate about the fiscal compact is likely to continue for some time. Much has been made of the 'one twentieth' rule but in practice it is adherence to the rules around the structural balance which will really matter in terms of the fiscal stance post 2015.

Ireland is currently working its way through an Excessive Deficit Procedure (EDP) which requires the general government deficit to be no worse than 3% of GDP in 2015. At that point Ireland will be expected to improve its structural budget balance by converging to a medium term objective of a deficit no larger than 0.5% of GDP. The Department of Finance estimates that the structural deficit will be 3.7% in 2015. If one generously accepts this figure as accurate then the government will be obliged to adopt a fiscal stance consistent with 'correcting' the remaining gap. This will trigger additional discretionary fiscal consolidation equivalent to circa 3.2% of GDP - about €5 billion in 2012 terms (though not necessarily all in the same year). This suggests that the programme of continuous austerity will continue out to 2017/2018. A bleak prospect.

This continuous fiscal tightening combined with the huge private debt overhang will drag on the economy's capacity to generate increases in real GDP. Debt sustainability in the absence of higher inflation (anathema to the ECB) or low interest rates on government borrowings (perhaps by extending the official programme past 2013) will be challenging. The Treaty does refer to an ability to deviate from the medium term objective under 'exceptional circumstances'. It will be interesting to see how this is interpreted in practice and it is possible there may be scope for wriggle room.

The fiscal compact is certainly no panacea for the current crisis though it might ameliorate the severity of the next one. The answers to the current crisis lie elsewhere.

“…all of the adjustments are being done to impress the rating agencies and international capital markets….”

Slí Eile: So writes Michael Casey, former chief economist with the Central Bank and currently board member of the International Monetary Fund. He then makes the extraordinary claim that (‘The reputations sent up in smoke’)

“..Our Government and the EU Commission have sold out to the rating agencies, none of whom cares about unemployment or emigration.”

Whatever one may think of our Government or parts of the current EU Commission it has to be pointed out that we owe much to the European Union not least because of the excesses and poverty of ambition of our native gombeen classes. (Where would gender equality be, today, were it not for the EU)
Take these statements in conjunction with what another economist, Pat McArdle, wrote recently Irish Times (‘Effective measures are needed to stop the rot from spreading’)

‘With hindsight, we were fortunate to have gone down the road we did. The alternative of job creation schemes or expansionary measures would have been disastrous.’

‘Job creation schemes’ and ‘expansionary measures’. What a terrible vista.
The single-minded focus on correcting Ireland’s fiscal stance, reducing the public sector deficit and competitive devaluation (i.e. cutting wages) is now the only moral narrative in town. Jobs, migration, living standards of the poor – are secondary to the One Policy Target = reduce the fiscal deficit to a much lower level. But, how much lower? At least two interesting facts seem to be emerging in the current debate and debacle over Greece and associated ‘high debt’ countries:

1. The Stability and Growth Pact targets are dead, long live the SGP
2. There is a very widely shared consensus that all roads must lead to fiscal rectitude and all roads to poverty reduction, sustainable growth and full employment (if people care about these things) lead from a balanced or near balanced budget – in the long-run.

But, will this single-minded focus on correcting the fiscal deficit work? I think not. If continuing deflation and wage and price devaluation is the only way then we run into at least two constraints:

• The degree of unemployment and wage reductions needed to ‘clear markets’ and balance the public sector books may be too much for people to take. We still live in a democracy.
• The world recovery may be a lot slower and lot more jobless in a way that offer little solace to a small open economy stuck with a dysfunctional banking system and a low-tax regime.

In other words, cutting wages and cutting public spending may compound the problem not only through reducing domestic consumer demand and investment but also in undermining social cohesion itself – a necessary ingredient to sustainable social and economic progress in the long-run.

But, suddenly, the spin is turning to the following type of meta-narrative:

“…in the year of 2008 the world economy collapsed and plucky Ireland went down fast as output and tax receipts went into free fall…but while other countries in a similar situation dithered the brace Irish and their unpopular Government took brave (and painful – everything must be painful) decisions ….and hey presto from 2011 onwards Ireland was rewarded with a reducing deficit, increased exports and stabilisation in unemployment…too bad many had to emigrate and other indices of social strife, poverty and ill-health went up for a while…that’s life”

Time will tell. However, missing from the debate up to now:

• A comprehensive, progressive, convincing, numbers-backed Alternative Economic Strategy
• A political movement with the backing of more than 40% of the population and with enough electoral backing positioned to implement such a Strategy not in some distant future election but at the next one which has to be within the next 27 months.

Some argue that in the course of the last half-century the left have won many of the cultural wars in Europe but have lost, decisively, the political struggle. However, the time has presented itself for a fundamental re-evaluation of policy because too much is at stake from the very real possibility that unregulated capitalism has wrecked the global eco-system to the unacceptable pain inflicted on the working poor and the unemployed in order to bail out capitalism against itself. If every fiscally troubled country plays competitive devaluation then we are looking at beggar-thy-neighbour.

What can be learned from the fiscal debacle of the noughties?
In a paper presented by Philip Lane at the Statistical and Social Inquiry Society of Ireland, recently (A New Fiscal Framework for Ireland) a case is made for

1. New Fiscal rules
2. A Fiscal Policy Council to monitor and manage fiscal adjustments (the never-again agenda)

There is some merit in these suggestions. However, what rules or what monitoring are needed here to rescue an economy and society from itself? Is our political system so decrepit that existing parliamentary and governmental institutions are not up to the task? Moreover, if such machinery were to be put in place (supported by a research department of economists of course!) who would select the membership and what types of conflicting interests would be brought on the board? Would it resemble Bord Snip Nua or the Commission on Taxation in terms of membership and ideological composition? Lane argues that such a Council or set of rules would be political neutral (it would judge on how much of a deficit or surplus is warranted rather than prescribing a level of taxes or spending). However, this is hardly convincing given the unavoidable interaction between the size of the deficit/surplus on the one hand, and the level of spending and taxes on the other (e.g. a popular claim is that cutting spending is a more effective way to cut deficits than raising taxes – a dubious claim not backed by enough case studies I suggest).

Would such a mechanism assess the wider social and economic benefits and costs of spending and taxes as a necessary corollary to judging the appropriate level of borrowing, spending and taxes taking into account, in so far as data permit, the likely monetary and non-monetary value of adjustments to societal assets and liabilities. Reducing current state liabilities through public sector downsizing as advocated by most mainstream economists may very well corrode valuable public assets not to mention social solidarity and cooperation – which are assets in themselves.