None so deaf as those that will not hear….(AKA Irish Elites)

There was an interesting book launch last night at the Long Room in TCD. Phillipe Legrain is on a tour of various places, doing local and localized launches of his new book.

He, and Senator Sean Barrett who gave the launch, delivered very strong, impassioned speeches. In his book Legrain lays a large quantum of the blame for the mess on the failure of interlocking European institutions. He backs squarely the Irish need for sovereign debt relief ; he calls for debt-equity swaps for distressed homeowners and SMEs; he castigates the failure of the economics elite to see the crisis, and challenges the policy making apparatus of both local and European governance. He calls for hardball negotiations, and lays out a path for same.

Legrain is no fire breathing radical. He is however from personal and professional background and inclination deeply European. His book has been lauded with positive reviews.  He challenges us.

Given this, and given the importance of the topic on which he speaks, it was frankly astounding to see how widely the launch was ignored. With the exception of Sean Barrett, there was (as far as I could see) not a single faculty member from a single economics department; with three exceptions the same for business school faculties. The Central Bank? The Department of Finance? Taoiseach? Foreign Affairs? Most of the media? Any elected official of state? Nobody that I could see. We could create a list as long as the page of elite institutions (IBEC? IIEA?, ACCI? …..) who were NOT represented at this talk, or if so were very well disguised.  It was to my mind a clear example of how we have  a collective elite who have firmly pulled on the green jersey and decided to press on regardless. Maybe they are right, maybe wrong, but one thing we have learned is that groupthink is bad. We need outsiders to challenge, but we need also to be prepared to be challenged. Seems we aren’t.

 

The ECB experiment

This is a version of my column in the Irish Examiner of 26 April 2014. Macroeconomics is hard. Its hard because there are actually few coherent theories, such internally coherent theories as we have oftent tend to be at odds with reality, data are of fairly low frequency (monthly usually) and we cant run experiments usually. Those of us who are not practicing macroeconomists thus tend to fall back on fairly simple rules of thumb when assessing policies and outcomes, often by reference to the past. Thus in Europe the ECB has in fact run an experiment against the Federal reserve board. While the Fed has taken the lessons of the 1930s on board and expanded its balance sheet, the ECB has taken the lessons of the 1920 on board and done so reluctantly and is now unwinding them. While the USA engages in quantitative easing, the ECB has engaged in quantitative squeezing. And the results are in; look at the comparative unemployment, performance of the two regions which is really the key metric any sentient or ethical policymakers should concern themselves with. Yes, the USA has an advantage in that they cleaned the banks earlier than did the Eurozone, and thus the monetary transmission system, such as it is in the modern world, was able to work. But that aside it is striking how in recent years the two banks have diverged.  It is reasonable to infer that the experiments have had different outcomes.

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The Irish Economy – Out of one wood, into another?

This is a version of my column published in the Irish Examiner 8 Feb 2014. It takes a long time to recover from a banking crisis. If we were unsure of that we need but look around and notice that we still are talking and fretting about ours.

Seven years ago Irish bank shares share prices were at or near all time highs. Lending for house purchases and deposits inflows to Irish banks were also at all time highs. So also were house prices. And then it all began to unravel.  The children born at the bursting of the bubble, who will carry the cost most of their working life, are now in senior infants or first class in school. And still it isn’t fixed. Only this week do we see the first criminal trial arising from the banking shenanigans. This week also we saw a report by the EU which sharply criticized our lethargy in dealing with bringing criminal, especially white collar, trials to justice.  The Cowen government moved neither swiftly nor decisively when the storm hit.

But things may be changing.  At the annual meeting of the Allied Social Sciences, a sort of Woodstock for economists and likeminded folks, a paper was presented on banking crises. The link above is to the paper – there is a longer version but it is firewalled. Reinhart and Rogoff have previously come in for some (more or less justified) stick on account of a missed spreadsheet error in one of their papers. The paper in question was at the heart of the meme propagated that after 90% debt/GDP countries enter a death zone. However, to my mind their more important work by far is in economic history, where in a series of books and papers they have provided comparative data on banking crises and bubbles. Much of the problem with modern macroeconomics is a twin crisis of insufficient data and a lack of a historical perspective. There is no excuse for this in the area of banking crises as we have not only the work of RR but also a comprehensive database from the World Bank.

The RR work provides details of 100 banking crises. Its well worth reading. The main finding is that the effects of the crisis take a long time to peter out. In 50% of the cases real GDP per capita has not recovered to pre crisis levels even after 6 ½ years. On average it takes 7 years.  Ireland has had a really severe banking crisis. RR create a measure of the crisis severity – the data are shown below. In terms of the post WW2 period it ranks in the top ten most severe crises as measured by declines in per capital GDP.  What is however apparent is that we may, based on the real GDP per capita data available, be right on target to be an average recovery. Our GDP figures of course are somewhat distant from the reality of people on the ground, but the fact remains that GDP is what the rest of the world measures as being available for the state to distribute. That we have chosen to in effect shelter a large chunk (the fdi sector) is our own decision. Mind you, with the international moves to make tax arbitrage by MNCs less attractive, how long the GNP/GDP wedge will persist is debatable.

This does not mean we are out of the woods by any means. Entering the crisis with a healthy debt to GDP ratio of 25% in 2007 we are exiting it with one closer to 125%.  Whether high debt causes slow growth, slow growth high debt or more likely both working together, this ratio needs to come down. And herein lies a problem. Europe, and Ireland, are teetering on the brink of deflation. We are used to inflation – rising prices. Deflation however is where prices fall. And while inflation can be bad at high levels deflation at even moderate levels is disastrous. With deflation there is little incentive to spend – prices will fall so why spend now. There is little incentive for firms to invest in new products –demand will be depressed until people consider that prices are likely to stabilize or rise. And for those with debts, that including states with high debt/gdp ratios and households with mortgages and personal debt, it is ruinous as the real level of debt increases over time.

At a wholesale level, the price that companies get, deflation is already a reality. Across a wide swathe of the Irish economy prices have been falling for 6 months or more. This is particularly evident in manufacturing and related areas. Indeed, surprising as it may seem to the consumer, it is also the case in most food areas, save dairy. At the consumer price level of the 12 main categories of goods and services 6 have shown deflation in the last two months. Indeed since 2010 deflation has been the norm in clothing, furniture, communication and recreation.  At a European level overall inflation is now close to zero. What is needed is moderate, 3-6% inflation.

The ECB, again, is in the firing line, as it controls the money supply. However facing  broken banks and close to the zero interest rate bound there is a limit to what monetary policy can do. Eurozone governments cannot pump inflation by fiscal means as they are constrained by the various macroeconomic treaties. We are heading for a decade or more of stagnation unless the ECB can both clean the banks and prime the pumps. What chance that ? Draghi has dismissed deflation as a risk – in his press conference he noted that while there was some deflation (but he didn’t call it that) in the program countries (Ireland, Greece, Spain and Portugal) this simply didn’t matter for the core. We have left the woods of austerity for the darker woods of deflation. And nobody who matters cares.

deflation ireland


Year Country Severity
1857 France 10.9
1857 Germany 4.8
1864 Germany 13.8
1866 Italy 22.8
1866 UK 3.8
1873 Canada 18.7
1873 Germany 15.2
1873 US 7.4
1873 Austria 6.3
1890 Brazil 42.7
1890 Uruguay 40
1890 Argentina 23.3
1890 USA 20.2
1890 Portugal 11.3
1890 UK 10.3
1891 ITALY 15.4
1893 Australia 48
1894 NewZealand 9.8
1907 US 21.5
1907 Italy 6.6
1907 Japan 5.9
1907 Sweden 5.7
1907 France 2.8
1908 India 13
1908 Canada 10.8
1908 Mexico 3.2
1920 UK 29.7
1920 US 10.3
1921 Italy 46.5
1921 Norway 15.8
1921 Denmark 6.2
1922 Sweden 12.4
1923 Canada 40.1
1923 Portugal 8.9
1923 Brazil 7.7
1923 Japan 6.7
1926 Chile 62.6
1927 Japan 13.3
1929 Mexico 47.1
1929 India 39.2
1929 USA 38.6
1929 Austria 33.4
1929 Brazil 21.3
1930 France 25.9
1930 Italy 13
1930 Norway 12.4
1931 Spain 60.6
1931 Uruguay 53.1
1931 Argentina 34.4
1931 Poland 33.9
1931 Germany 24.8
1931 Romania 22.1
1931 Belgium 21.4
1931 Switzerland 18.8
1931 Hungary 18.4
1931 China 13.9
1931 Greece 12.9
1931 UK 11.6
1931 Finland 11.1
1931 Sweden 8.8
1931 Denmark 6.5
1939 Netherlands 37
1980 Argentina 39.8
1980 Chile 26.9
1981 Philippines 39.8
1981 Mexico 31.1
1982 Turkey 0
1983 Peru 57
1983 Thailand 0
1985 Malaysia 8.7
1987 Norway 3.6
1990 Brazil 17.2
1991 Finland 19.8
1991 Sweden 11.2
1992 Japan 8.7
1992 Japan 2.1
1994 Venezuela 38.2
1994 Mexico 10.7
1996 Thailand 19.6
1997 Indonesia 23.1
1997 Malaysia 15.8
1997 Korea 8.4
1997 Philippines 5.7
1998 Colombia 12
1998 Russia 7.2
2001 Argentina 28.9
2001 Turkey 12.3
2002 Uruguay 26.9
2007 Ireland 24.9
2007 Iceland 23.2
2007 UK 18.1
2007 USA 10.8
2008 Greece 36
2008 Italy 23.3
2008 Ukraine 22.4
2008 Spain 20.4
2008 Portugal 19.2
2008 Netherlands 15.8
2008 France 9
2008 Germany 3

Does An Irish Solution loom for European Banks (one way or the other) ?

brokenbankThis is a version of my column in the Irish Examiner of 25 Jan 2014 .Europe’s banks are broken. Very broken. We have always suspected that, but recent evidence in indications suggest that nearly six after the crisis first began to manifest itself seriously they are still grossly impaired. The drive towards meaningful banking union has stalled again amidst squabbling about whether or not there should be and if so how much of a common pot for resolution.  German banking giant Deutsche unveiled a billion euro loss just this week, underscoring how fragile both the banking system and the economy remain, even at the core. Without a working banking system the economy cannot prosper.

Recall what it is that banks do – despite the mystique and the bluster, its actually pretty simple. Some people have money and others need it. Banks act as a middleman to facilitate those that want it to get it from those that have it, in return for them taking a cut of the interest charged. This can be across space (savings flow from region to region) and/or time (mortgages and longer term loans) . Lending money out is risky. That is why banks charge an interest rate on loans that is greater than that which they pay on deposits – apart from needing to make a profit and cover costs, they need to put some money aside for the inevitable defaults and bad loans.  These retained profits, plus some other ‘safe’ assets, are the banks reserves, or its capital

There is a persistent fallacy that banks lend out reserves. They don’t. People such as Frances Coppola have been banging on about this fallacy for some time now (see here and here)  Its more complicated than that and revolves around the fact that banks can create credit (money) by issuing loans. However,  banks  do need, under prudential regulation, to hold a certain amount of capital, a proportion of the assets they have (loans made).  If banks have more capital they are in a position to expand. The problem for  European banks is that they are stymied by the fact that they have written down bad loans to an extent sufficient to impair their capital base but by no means enough to clean their balance sheet of the these bad loans. Caught in a double bind, they are unable to efficiently do their job as intermediaries and as credit creators.

As part of the ongoing efforts to get to the root of the problem the ECB have initiated an asset quality review. This is in effect yet another stress test. Previous not-terribly-stressful tests have been greeted with derision as they in effect claimed that all was well when it was manifestly not. Thus this stress test, to be credible, needs to fail some banks – any banks.  It is reminiscent of Admiral Byng, who was shot not for failing at his task of taking Minorca, more or less impregnable and a rock on which others had foundered, but ‘pour encourage les autres’.  European banks all stand in danger of being the financial Admiral Byng of 2014. One or more large banks needs to fail to show the virility of the tests.

Recent research has looked at what holes might be lurking in the capital. As has been the case throughout this crisis while high level public data cannot give a precise amount it has been remarkable how using such data the gross magnitude and nature of the money sink de jure has been accurately estimated. Looking at the 109 largest banks with €22 tr in assets a hole of between 5b and 66b is found even assuming no further deterioration of any assets – an unstressed situation.  The biggest holes are in the core – French and German banks and the smallest in the periphery. Ireland, if things don’t get any worse, does not need any more capital in its banks.

But what if things do go south? They stress the banks rerunning a severe financial crisis, and further suggest that any residual bad loans are written off. Writing off bad loans of capital weak banks is the only way to kill zombie banks who crowd out and hinder the banking system.  In this stress situation the banks are woeful. Assuming reasonable levels of reserves to be held, European banks may need between 500b and 750b. Again the worst holes are in the core banks  especially French German and Belgian banks. Top of the list are the giant french banks – Credit Agricole, BNP and SocGen, and Deutsche Bank. Bank of Ireland and AIB are not immune, possibly requiring 6-13b euro more. But sure were good for that, havent we turned the corner and exited the bailout to a land of green shoots…

So what to do? Senior bondholders are sacrosanct and while depositors of unimportant nations such as Cyrus (whose banks are still bunched beyond reasonable hope of redemption) might be bailed-in that wont happen to real depositors, those of the core. So banks will limp along. But there is a potential solution – promissory notes. The notes were created to shore up the capital base of Anglo Irish Bank, and allowed it to access liquidity from the Central Bank of Ireland. Which it did. Ok, Anglo was a hopeless case but the principle is good. The problem with the notes was not per se their existence  – it was that they were required to be extinguished over a fairly swift timetable, placing unbearable strain on an already  strained exchequer and that it was done to put a figleaf on the notion that Anglo was a going concern.

Were these or national equivalents to be created by the national authorities of the core, we could well imagine much longer periods for extinguishing being placed in play.  If the Anglo ProNotes had been repaid over 300 years instead of 30 they would not have been an issue, except morally. While the numbers seem large, in the context of the (shrinking ) ECB balance sheet of 2.2b even the largest amount required is not unbearable. Part of the ECB objection to the notes was that the liquidity created was done so “outside its control”. A system of central banks cannot have individuals pursuing their own monetary policy in an uncoordinated and national focused way – that is what brought down the Rouble zone. But as a once off final fix for the banks? Its worth a shot.  In all probability the 750b would not be required in full. While the 40% fall over 6 months in equity values is high, this does not happen very often – but it does happen about 1 time in 25.   Doing this would ‘cure’ the banks, in so far as it would allow, in fact would have to be accompanied by,  a full write-down of impaired loans and thus position them for regrowth. It would allow a clean start to be made. Clean the mess up once and for all, and restart.

Alas, the inflation hawks and their fears  dominate the ECB, fears never more imaginary than now with deflation staring the Eurozone in the face, will not allow this. The consequence is that we flirt with a further crisis not merely knocking out the periphery but the core. As we have throughout the crisis we face a choice of unpalatable alternatives.  European banks will follow the irish lead – either via partial or full zombification with the odd twitch of life now and again while hoping that the economy does nothing remotely scary all the time barely functioning and taking a decade or more to get back to any health, or by the solution which worked, in that it allowed a bank to be cleansed and to br resolved.

Enough, already, just pull the plug on Anglo before its too late ; September 2 2010

Id had it with the arguments that Anglo could be saved. Here is my oped in the Irish Times on 2 September 2010. Enough already…

OPINION:Ordinary folk have paid enough. Subordinated and senior debt holders should cover the rest

THE HORRENDOUS losses of Anglo Irish Bank come as no great surprise to informed analysts of the banking catastrophe. The Government s solutions amount to no more than insisting the taxpayer must, under all circumstances, bear all the losses Anglo will continue to create. This cannot be borne.

That there are significant additional losses to come from Anglo is undoubted. The Government and its proxies continue to assert, without placing in the public domain any detailed analyses, that the losses will be capped at EUR 25 billion. This is the same process that has successively asserted that the losses will be EUR 4.5 billion, EUR 12 billion, etc. Why are we expected to believe them now, when they have proven to be wildly inaccurate in the past? Analysts inside and outside Ireland believe Anglo s losses will be at least EUR 35 billion with potential for EUR 40 billion-plus.

Anglo, like all banks, is funded in five ways: deposits; borrowings /deposits of a short-term nature from other banks and central banks; longer-term borrowing (senior debt); longer-term borrowing with less protection (subordinated debt), and by shareholders. The question that arises is simple: which of these should be protected in full, and which in part? It is startling that, as of now, only the most junior party, the shareholders, have been asked to take the full consequences.

Some subordinated debt has been (voluntarily) renegotiated, but there remains some EUR 2.5 billion of subordinated debt in Anglo. This should now absorb the next EUR 2.5 billion of losses. It is unfortunate that the Government has guaranteed some of this, but this is a legislative act and can be unwound.

Beyond that, we are into the realm of senior debt holders. Anglo has borrowed some EUR 14 billion from such investors, of which some EUR 7 billion is repayable in September. It is now beyond time that these investors be informed that their investment is not fully payable. There is more than enough in the subordinated and senior bondholders to absorb even the most pessimistic estimates of losses to emerge from Anglo. We can, and I say we should, consider this.

We are told by the Government that to do so would be a sovereign default. This is palpable nonsense. Anglo Irish is a private institution, which has some elements of its capital structure guaranteed by the Government. It is not the State. The reason the guarantee was given was the fear that allowing Anglo to be wound down in 2008 would have precipitated a cascade of Irish bank failures. While this is debatable, we are now in 2010. The taxpayer has paid enough.

Governments have a genuine concern that if a state defaults, it may not be able to re-access bond markets. But even if we allow the fantasy that Anglo is the same as the State, assertions that this chimera would be locked out of the international bond markets are false, and are pedalled as a scare story to frighten the taxpayers and citizens into ponying up sovereign money to bail out private investors.

Bond investors look forward what they are interested in is the risk that they will not be repaid. A history of default will of course impact on the amount of money they will lend, and the price they will charge. But the evidence is that even serial defaulters can gain funds on an ongoing basis.

Academic evidence, including papers from the International Monetary Fund, indicates absolutely no evidence that sovereign investors are permanently excluded from the international capital markets after a default. Even in the rare cases of temporary exclusions, in the sense of not being able to issue bonds, this rarely lasts for more than two years. In addition, the evidence is that any increase in sovereign debt costs is short-lived and transitory. We have to decide: is the price for the taxpayer of any increased cost of lending if we discontinue support to Anglo, less than the cost of continued support?

There is in my mind no question now but that there is a moral, political, economic and social need for the subordinated and senior debt holders of Anglo Irish Bank to bear the remaining costs. There is a timing problem, however any announcement of the intention to force these losses on the senior bondholders would have to come prior to the renewal of the guarantee at the end of September. Thus, the next three weeks are critical.

There is an argument that this decision to withdraw the guarantee should be taken in conjunction with another. The State is now paying more for money than it would if it were to access the EU stability fund. The judgment of the bond markets is that the combined banking and fiscal crises are such that Ireland is no longer a sound bet. A very large part of this is the increasing concern that there is not the political will to deal with either of these problems, never mind both.

Pulling the plug on further taxpayer involvement in Anglo may best be done at the same time as announcing that we are to seek the assistance of the EU in restructuring our fiscal position.

It is time to seek to place ourselves in the hands of people who can run the State effectively and in the long-term interests of the citizens. Political or indeed national pride should not stand in the way of this.

Brian Lucey is associate professor of finance at Trinity College Dublin

Ban this Filth NOW (that’d be €500 notes…)

500-eurosFighting crime is a tough job. And so, shortcuts are often proposed. The latest is to : ban €500 notes. These dastardly beasts (introduced to not annoy Germans who used DM1000 bills) are it seems uniquely the provenance of criminals. So, if we recall them, and ask people to explain where they got them it might fight crime. Because criminals now keep all their money under the bed dontcha know. Curiously and worryingly the author, a well respected financial journalist, thinks that a) reducing euro area money supply is good and b) it will somehow alleviate sovereign debt. Its a bonkers article, frankly. And not even internally consistent.

There are about €290b worth of euro 500 notes in circulation. In terms of numbers of notes these are about 580k of the 14m odd euro notes in circulation.

Of course, the ‘bin laden’ (so called because although every one has heard of it nobody has seen it) is not now nor in history the largest denomination note. Leaving aside hyper inflationary episodes, we have seen large denomination notes. The USA issued a $10,000 note in the 1930s. These are now withdrawn and the $100 the largest. Try using these to pay for anything…one expects a SWAT team to cap your ass. Switzerland has a CHF1000 note in circulation. Singapore has S$1000 and S$10000. Even latvia has LV500 note. Presumably these should  be banned also?

More seriously this is part of a common fallacy – that money is the note in your pocket. Its not. Its much much wider than that. M3, a broad (but not nearly the broadest) measure of money, is about €10,000b. So the dastardly binLaden is less than 3% of the whole. While its conceivable that this is all in the hands of crime its unlikely. Serious criminals have their money laundered into clean assets. Amateur ones have wads of fifties. I have no idea who uses these notes. I can’t see a need for them personally but….