November 29, 2010

Ours is not to reason why, ours is but to do or die

UPDATED: Buenos Aires, Argentina: Dec 6, 2010: Does the new 5.8% rescue fund interest rate demonstrate European solidarity with Ireland? Is the European Union abandoning the Irish people? What about the IMF, will they save Ireland? Why are voices in the media mentioning a deal when a budget has yet to be approved?

What follows is a realistic Argentine perspective on this critical phase of debt negotiation. The hindsight offered by historical comparisons with Argentina in 2002 is not 20/20 but Argentina’s experiences may provide some general guid-ance. If only one thing can be made clear it is that the IMF and the ECB are in Dublin for systemic global financial stability (of creditors). They are not there to protect the Irish taxpayer.

Focusing on interest rates, now, in December 2010, is putting the cart before the horse. Creditors set interest rates, and interest rates change. The question faced by the Irish people at this juncture is simple. Their representatives need to negotiate to keep down Ireland’s public external debt? Until Dáil representatives pass a budget, this number is not a done deal. Irish negotiators need to be crystal clear. Unsustainable public external debt is non-negotiable. If the negotiators do not do their jobs they must be replaced till someone does.

Ireland in December 2010 shows many analogies with Argentina in December 2001. This phase of the negotiations cost Argentina dear; riots, deaths, banking collapse and frozen accounts (the notorious “Corralito”). The peso all but destroyed with a 75% depreciation and this lead to the largest sovereign default in the history of modern finance.

There was considerable social unrest. Three presidents were forced to resign between December 2001 and January 2002 because they did not offer solutions acceptable to the public. There were massive riots in the streets. Police shot demonstrators. IMF representatives tried to remain calm, pressing the Argentine congress for changes in national corruption laws and working feverishly in their offices in the Argentine Economics Ministry. They were dark days indeed. Former Minister for Economics and Argentine statesman Aldo Ferrer wrote of this period citing Dante Alighieri, “Abandon hope, all ye who enter here.”

In Dublin this week large sums of money are in play especially in the secondary European and US debt markets where Irish bank debt has been re-packaged (like US sub-prime mortgages) and sold on to foreign derivatives markets. Irish negotiators will be under extreme pressure, their performance now, and the actions of the Dáil in revising, renegotiating and passing a budget, will mark a defining hour in the history of the Irish state.

Seen from the perspective of recent Argentine history some Irish indications seem far from positive. NAMA, a band-aid measure with limited transparency designed to cushion just one industrial sector was ineffective and very expensive. The infinite deposit guarantees on banks were overly generous. Both risk bringing the Irish state dangerously close to sovereign default. Government declarations and interviews with Taoiseach Cowen show a dangerous confusion between the running costs of government and the woes of the private banking sector. Financial analysts do not confuse these matters; they are worried about Ireland’s banking problems. The budget and the banking problems are quite distinct and must be treated as such. The budget gaps can and must be fixed by Ireland alone, the banking woes may be beyond repair by Ireland without systemic instability in Irish state finances.

Banking Instability, an International issue
Financial analysts have been watching the contagion in the global debt derivatives (or asset-backed debt) as they spread causing banking instability. Financial sector risks prompt national financial rescues; a variety of Good-bank / Bad-bank schemes. Few schemes were quite so generous as Ireland’s NAMA.

NAMA was like a giant cushion shoved under defaulting speculator loans from Irish banks. Instigated by Fianna Fáil and the Greens in 2009, NAMA was a critical mistake, a panicky reaction with more than a tinge of corruption. NAMA seems more akin to what one might expect in the 1970’s Latin American Banana republics than a sovereign OECD state.

The Irish banking system faces bankruptcy not the Irish nation. If the bad loans in the Irish bank's cause institutional default, there will be losses internationally for bondholders. These private foreign creditors face ugly losses and torturous lawsuits in bankruptcy courts. If the IMF and the ECB could convince Ireland that saving bondholders with sovereign borrowing of bailout funds is a national priority, much of this pain can be transferred to the Irish taxpayer.

The NAMA system and a bloated budget are both problems faced by the Irish nation but only the budget is a sovereign issue. The budget can be trimmed, and it should be, taking account of the national social priorities. But the banks are another story. Financial assessments by experts suggest unwinding the banking sector in as controlled a manner as possible. Most of the banks are still private enterprises. Shrinking, then removing NAMA should be part of any budget passed. This is not happening, quite the contrary. The Irish Central Bank[1] is citing plans to grow NAMA. If this is what the ECB/IMF advisers are pushing, Irish negotiators need to draw a line in the sand. NAMA in its current form is becoming more and more dangerous to Irish public finances. It should be eliminated quickly. Extending NAMA endangers national financial stability. NAMA is now (and always was) the wrong way to fix the private banking sector. Every cent added to NAMA will be paid by the Irish poor and middle classes for decades to come. NAMA means Ireland risks becoming overwhelmed by debt. Every day that NAMA exists questions the legitimacy of Irish sovereignty.

So how can the imposition of illegitimate debt (to rescue the banking sector) be prevented? Foreign financiers do not have this answer. The IMF and the ECB will fight tooth and nail to load as much debt onto the Irish people as they are willing to bear! This is a political issue. Unlike Argentina and many other South American States where private debt was taken onto the public sector in the 1980’s by dictators; Ireland is a democracy. This would imply that the Irish people can and should refuse to elect any representative, or hire any consultant, unwilling to fight hard on this issue. Politicians and consultants are paid well by the Irish people to represent them.

Any budget passed must be concomitant with national financial stability. If this means forcing the losses of the banking defaults onto the shoulders of the speculators who borrowed from these banks, then so be it. Failing that, they fall to the shoulders of the foreign bondholders who speculated on speculator debt. Irish negotiators need to understand that it is these same foreign bondholders that politely asked their governments to send the IMF and the ECB to Dublin.

In financial terms losses are referred to as “haircuts”; typically a reduction in the value of a bond. The Irish politicians need to learn to cut hair. It is not their job to save foreign bondholders. Bondholders are gamblers, investors in banking derivatives on unregulated markets; gamblers can afford to take losses, the Irish state cannot. The derivatives investors gambled that a corrupt Irish government could be leaned on to protect corrupt Irish speculators. The IMF and the ECB negotiators are leaning on the Irish now. It is time to call their bluff.

A banking crash will cause disruption. In the collapse, the government will have to stand by personal deposits, as any legitimate government would. A reasonable level of coverage might be 50,000 to 100,000 euros per account (similar to FDIC insurance in the USA.) Unlimited and corporate guarantees backing deposits will have to be eliminated. They should never have been put in place. The national economy will wobble and contagion will ripple through the international debt markets forcing losses on CDOs[1], but a sovereign Ireland will make it known that it protects its citizens and not unscrupulous speculators. Other fragile nations like Portugal would benefit indirectly from such a hard-line stance possibly increasing solidarity in the European Parliament groups.

The Euro
The Irish problem is not a budget issue, nor is it a euro-punt issue; it is a debt issue. In Argentina in 2001 the peso was pegged to the US dollar at one peso to one dollar. The devaluation brought relative values to four pesos to one dollar, stabilizing at three-to-one. The Argentine peso today is again worth just 25 US cents. Though similar, this is not analogous to Irelands marriage to the Euro. Membership of the Eurozone is a somewhat more reciprocal relationship. Though divorce is possible, counseling should be sought before any such relationship is terminated.

A new Irish punt will be prone to speculative attacks. It will be hard to convince markets of the stability of a defaulted currency. The resultant devaluation would be severe, pushing up euro-denominated debt obligations. The state would have to maintain high foreign currency reserves. None of this is optimal, but it is possible, and if it proves necessary it may be the least-worse scenario. It should be possible to maintain real public debt obligations close to half of GDP. It will take time before it can get back to the excellent 2007 levels of 25% as GDP drops as a result of adjustments.

The Irish people will need a government that negotiates an effective budget with adjustments that will hurt a little. Deflation will help the poor to bear their part in trimming the fat. Adjustments could begin with politician's salaries and limits to executive and director pay. By accepting a pay cut, Ireland’s new leaders might renew moral legitimacy allowing them to raise taxation in a socially progressive way. Irelands personal and corporate taxation levels are low; sectors best able to pay can contribute more to national recovery.

Housing prices will drop further making them again accessible to a new middle class, this is inevitable under any scenario. Eventually housing prices will stabilize and the government could optionally choose to take measures to help certain people in danger of losing their home. This was done in the US with rental options or mechanisms for handing back the keys for those holding underwater mortgages. It is important to note that such costly policy options might not be possible if mistakes are made now.

The critical issue in December 2010 is that the new budget bring less public money to the banks, not more! The crisis will be over by Spring, the World will keep on spinning, the Euro will survive, and the EU experiment (which in general is a good thing for Ireland) will also continue. It will be necessary to apply significant pressure on the ECB to democratize the euro and there will have to be more Central bank coordination. Most important, from an Irish perspective, this return to stability can happen without loading decades of misery onto the Irish people.

So first things first! Have your voices heard in those snowy streets and prevent a bad budget! If the current government or future governments show any signs of corruption, change them. Their mismanagement to date should make such political changes not just necessary but popular. Elect a government who can be trusted to represent national interests against global financial power and capable of cooperating with European allies.

The remit of the IMF and the ECB includes the protection private financial interests abroad. They will make the Irish pay till they scream. Learn a lesson from Argentina, scream early and scream loud. It will mean less pain in the long run. Ireland needs to take back control of its public finances and play hardball with foreign financial interests now. Argentina is watching you. Sovereign debt is a sovereignty issue; time to prove your mettle.

[1] A CDO is a Collateralized Debt Obligation, bundles of debt, re-bundled and sold on to other banks (often internationally), in this case with the backing (collateral) of Irish and Irish-owned assets such as NAMA properties.

[2] Financial times, nov 29, "Alphaville" blog entry analyses new capital requirements for Ireland's banks mentioning (new) "Loans eligible to transfer to NAMA with value less than €5m, and between €5m and €20m" Download: Prudential Capital Assessment Review ("PCAR") from Central Bank of Ireland Web page"

Posted by Tony Phillips at 03:36 PM | Comments (1)

November 26, 2010

Bailout, Intervention and Political Collapse

loan-to-deposit-ratios.jpg150 protestors shouting "Cowen, Cowen, Cowen, Out, Out, Out" pushed open the gates of Government Buildings in Dublin on Nov. 22nd after a €100Bn.[1] bailout and IMF intervention the day before.

Avoiding answering allegations of his own involvement, Brian Cowen, Prime Minister (Taoiseach) declared he would dissolve parliament (calling elections) but only after "passing the budget" (a statesman to the last). One has to suppose that the Taoiseach still believes that he shall be able to pass the proposed budget. Financial times commentator, John Authers, in an interview with Vincent Browne has his doubts.

Cowen was finance minister 2004 to 2008 when loan-to-deposit ratios rose above 200%[2]. In 2006, 70% of all new loans in some Irish banks were for speculative property deals. When the property property bubble collapsed Ireland's debt to GDP ratio rose from 25% to 66% in two years.
very-bad-banks.jpg Earlier that day Green Party alliance leader John Gormley was first to call for elections. The Greens were criticised for their support for the "National Asset Management Agency”. NAMA absorbed bad property loans using public funds. In a New York Times opinion piece 26/11/2010 entitled "Eating the Irish", the Nobel Prize winning economist Paul Krugman clarifies the anomaly of the logic of NAMA:

"[an Irish] genuine economic miracle ... eventually gave way to a speculative frenzy driven by runaway banks and real estate developers, all in a cozy relationship with leading politicians. The frenzy was financed with huge borrowing on the part of Irish banks, largely from banks in other European nations [particularly the UK... NAMA hung Irish] taxpayers suddenly on the hook for gigantic bank losses, even as revenues plunged, the nation’s creditworthiness was put in doubt. So Ireland tried to reassure the markets with a harsh program of spending cuts. Step back for a minute and think about that. These debts were incurred, not to pay for public programs, but by private wheeler-dealers seeking nothing but their own profit. Yet ordinary Irish citizens are now bearing the burden of those debts."

The EU expressed 'satisfaction' at the four-year budget plan. But healthy doubts remain over NAMA and the budget. The Irish corporate tax rate, the lowest in the Eurozone, is also on the table but political instability is mounting and seems likely to explode in Saturday's march for a better way called by trade union movements opposed to austerity measures. A major march is planned in Dublin on Saturday to protest "austerity" measures.

[1]: About 90 Billion Euros from the Eurozone rescue fund and 7 Billion pounds from the British. One wonders if this British largesse is to save the Euro (or could it be to save themselves) The British Chancellor, when asked, claims that Britain is simply being (laughable as it may seem to anyone who reads their history) a "good neighbour".

[2]: Yes this is high and grew when other countries kept their levels stable (see chart), more importantly it was recognised by experts as lacking.

The document "Irish banking crisis and regulatory stability policy 2003-2008" states the following on page 23: "At the systemic level, a far greater increase in capital requirements on risky loans, if implemented several years earlier, would have made a major difference. A ceiling or penalty on very high loan-to-deposit ratios for banks would also have been effective."

That same report also adds: "At the micro-prudential level, a cap on property-related lending would have curbed the worst excesses, as would have increased, accompanied by a more aggressive stance on governance in the case of one or more specific institutions."

Posted by Tony Phillips at 02:28 PM | Comments (0)

November 19, 2010

Speaking Truthiness to the Irish Times

The Irish Times "Opinion" section has spoken. It welcomes the IMF to Ireland. Maybe the Irish Times should ask Latin America why they decided to pay back all of their debt to the IMF so as to kick their consultants out of their national Ministries of Economics, and then again, maybe not. The IMF is a fait acompli for now, I beg a moment of your time to point out a true flaw in the Times analysis.

To do that it is necessary to focus on the problem (foreign bond exposure) behind the problem (the banking crisis) behind the problem (speculative investments)?

Donal Donovan writes that a "Firm hand of the IMF will keep [Ireland] steering in right direction" His analysis is that:

"While psychologically [the Irish taxpayers] may feel put upon, the arrival of the International Monetary Fund is really not all that bad"

Is that so Mr. Donovan?

As an Irishman living in Buenos Aires I would rather avoid the topic of psychology, and that of the IMF too, for that matter. Psychologically speaking feeling "put upon" is the least of the Irish taxpayer's problems. Ireland's financial woes will not be cured on the couch of the IMF. Rather than quote a flawed analysis, I would prefer to highlight the real problem causing the Irish crisis. The problem is the banking sector, it is not the deficit, these problems will not be solved by austerity measures, neither are the banking sectors woes fixed by NAMA. In fact the problems are made worse and transferred to the Irish taxpayer.

The original "mistake" was that Irish Banks make loans for bad speculation. When their client's investments went bad, this risked a collapse the Irish banks. If the banks do, in fact, collapse, the risk falls on the shoulders of powerful financial interests abroad. It is they that face a real problem. They would be left holding the problem behind the problem behind the problem. But the Irish government gave them a get out of jail free card, NAMA. They love NAMA, for them it is the solution. For the Irish taxpayer it is not.

Mr. Donovan says: "Incidentally, whether the [IMF] money is “for the banks” or “for the State” is a red herring. It will all be signed for by the Irish Government, which owns most of the banks anyway."

Euro 81Bn.[1] is a very big red herring, in fact what smells "off" about this has nothing to do fish. The problem is, in fact, this very 81Bn of public NAMA exposure; two problems really: 1. it isn't enough money and 2. it isn't (or shouldn't be) public debt.

Donovan is simply parroting the commonly agreed fallacy that Ireland's two big private banks and their clients should be completely rescued by the Irish taxpayer. The implication is that it is the government's job to fix the problem of the private financial center, absorbing all of the pain that it can (onto its public tax base).

Why not stick the rest of the bank's problems in NAMA too?
In for a penny in for a pound...
Or is it in this case "In for a euro, in for a cent?"

So who would be rescued exactly by such Irish taxpayer generosity? Not the AIB & BOI shareholders. They are now pretty much wiped out. I should know my family owned class A shares in these banks, their values dropped from about $94 US Dollars to about $2 (see for yourself). Long term shareholders hardly care now if the banks are nationalised though this may not be true of the bank's management. It is the bondholders behind the soon-to-default debt on the books of AIB & BOI who are sweating. Indeed it is probably them that are feeding this misinformation to the Irish Times.

The crux of the governance "mistake" is making the Irish people accept that their government is "responsible" to save the foreign bondholders who stand to lose a lot more than 81Bn. euros if the Irish banks default.

The Irish state is not responsible! For the Irish state to save the banks, if indeed this is either necessary or possible, is to commit financial suicide.

Why not take a leaf out of the Icelandic book on this? The bondholders are not Irish and hence should not be rescued by the Irish government. NAMA should never have existed. The Irish government should have stuck to guaranteeing what governments do; bank deposits up to 100K or 200K, i.e. personal savings and nothing more.

Instead Ireland played nice to their bondholders, they invented the National Asset Management Agency (NAMA), the planet's most fiscally conservative "bad bank". A "system" that prompted Nobel Prize-winning economist Joseph Stiglitz to remark that the Irish government was squandering state money to rescue banks.

Why would the government do that to their own people? Who were they protecting? Could this be why the IMF are forcing their attentions on Ireland and why British bankers are coming to Dublin? “Our engagement in this is because we are good neighbors of Ireland and not because we have particular concerns about any particular U.K. bank,” says George Osborne, the British chancellor of the Exchequer in the New York Times but can we really believe him? Why is it exactly, in a time when credit is extremely hard to find, that suddenly everyone is insisting on lending to the Irish government to give the Irish government money to rescue their banking sector? Could it be that by doing so they rescue their own nation's private banking sector who have outstanding loans to Ireland? Of course they are happy to make the loan! They stand to lose a fortune if the Irish banks default. Their loans transfer the risk to the Irish taxpayer :)

IT boils down to the question as to whether Ireland is really willing to make this crucial mistake; one that may result in decades of austerity for its people? Look at what happened here in Argentina, it has taken a decade to recover from a debt crisis and much less of it is as a result of corrupt loaning practices.

But we have to save the Euro? Right? Right!

If the British bankers are coming to Dublin to patch things up this has very little to do with the stability of the euro. Watch this FT video if you don't believe me. I warn you it is both doctrinal and bleak (but watch the bankers squirm when they are asked direct questions.)

There is one solution for Ireland's woes and it is a just solution, this is to roll back NAMA, not add to it, as was the Lex FT column on "Irish banks" suggested today. The international financial sector and the corrupt borrowers love NAMA! They can't get enough of it. NAMA is the best (read worst if you pay Irish taxes) "bad bank" plan ever invented.

Allowing loans or banks to default is the haircut needed to smarten up in the Irish financial sector! It is a smart alternative to forcing the Irish population to don NAMA hairshirts to rescue speculators with their assets hidden abroad in complex trusts.

A similar "rescue" happened in Greece; same solution different problem. Greece had a chronic deficit problem which lead to chronic debt-to-GDP ratios. Ireland didn't until NAMA. Since then Ireland's public debt to GDP ratio has almost tripled. Yet the fix is the same, governments of exposed nations like France or Germany (or in the case of Ireland, Britain) pledge bailout monies to a fund to loan to the Greek (now Irish) taxpayer to avoid default to the lender's private banks. Hey presto, they rescued (their own) private financial sector using public tax money but indirectly transferring the burden to Greek/Irish taxpayers.

In fact they didn't fix anything, they simply postponed Greece's (and if it goes through Ireland's) problems to calm the financial markets are calmed for a while. The problem, in the press at least, is "solved!"

Might it be that it is the city of London, Frankfurt and New York that is really driving this rescue? Why else are British bankers in Dublin? If you (like British bans) had a $22,000,000,000 Irish exposure problem to solve, maybe you too might might buy a few first class tickets London to Dublin. However it is a bit of a stretch to expense the tickets to "save the euro."

[1]: NAMA's initial size

Posted by Tony Phillips at 01:16 PM | Comments (2)