Monthly Archives: May 2011

Who trusts the ECB?

The last couple of years there’s been a lot of discussion around the role of the European Central bank. It’s very clear from casual conversation that there is a lot of concern, amongst the political commentating classes as well as amongst the general public in relation to how the ECB is perceived to have dealt with the Irish banking crisis.

Although fully accurate recent data are not available there’s an interesting paper recently which analyses trust that the European citizens in general place in the  European Central bank . The paper  is

Roth, Felix, Gros, Daniel and Nowak-Lehmann, Felicitas, Has the Financial Crisis Eroded Citizens’ Trust in the European Central Bank? – Evidence From 1999-2010 (May 20, 2011). Available at SSRN:

It’s an interesting paper as it outlines not just how, but also tries to understand why, different attitudes emerge over time to the ECB. Users the patient from the  Eurobarometer  survey , which are available at . In each of the survey series, which take place twice a year, spring and autumn, a series of questions are asked of a random sample of 1000 persons,  per country.  One of the standard questions asked is whether  people do or do not place trust in a variety of institutions of the European Union.  Since 1999 the ECB has been one of the institutions so evaluated.  The paper   looks at what they call “net trust”, which is defined very simply as the percentage of people expressing that the trust and institution minus  the percentage that say they do not.  Thus if in a  survey  50% of people say they trust  an institution, 40% say they do not, and 10% do not express an opinion  net trust is then defined as 50-40 =10.

The major takeaway from the paper is as follows:   European  citizens  are placing less and less trust  in the ECB, and the reasons for their levels of trust have changed, it appears, over the course of the years.  Prior to the economic crisis the most powerful explanatory variable for levels of trust in the ECB appears to be that of  Unemployment, more so than inflation or economic growth.  With the advent of the economic crisis however the drivers of trust seem to have become firstly economic growth, and secondly inflation.   At a country level the level of  public debt is also an important issue.  The authors conclude “We therefore conclude that European citizens seem to hold the ECB responsible for the overall employment situation at all times, for the economic downturn of growth of GDP per capita in January/February 2009 and to be concerned about inflation and public debt with the start of the Eurozone crisis.”

This is an important finding, as the ECB does not have a mandate in relation to unemployment. In fact its mandate is much more about price stability than it is about growth or employment. It is important for any organization to have trust vested in it by those for whom it is working.  body of the objective which they are pursuing is not one which is likely to engender trust in them they are fighting an uphill battle. We’ve seen the last number of weeks that communication is not a strong point of the ECB. Perhaps this is more evidence of same.

One issue which is not touched on in the paper is the potential differences in levels of net trust between various countries. I went to the Eurobarometer data site and download information on trust levels in the ECB for Portugal, Ireland, Greece, Germany, and the EU as a whole.

The graph below shows some interesting findings.

First, Greece seems to be very distrustful of the ECB. One imagines that when the survey results for Spring 2011 the marriage next trust will have further eroded. Second, and this is worrying given that it is in effect the paymaster for Europe, German trust in the ECB has now dipped to negative net trust. It is striking that Ireland, at least as of November 2011, still retains significant, if small, netted trust in the ECB. However the trajectory of all countries is downwards. People are losing faith, or at least trust, in the ECB.

No organization can continue indefinitely without the active trust of the citizens. It might be a good idea for the ECB to consider a more nuanced and more effective medication strategy. At the very least it would be appropriate that they would consider these results, and one would hope, act upon them.

The OECD on Ireland, Iceland & the rest

So, the OECD have brought out a new set of forecasts. And very interesting they are too. Read them here. there is a nice set of comparative data here in excel format.

What do they say about ireland? “.Despite robust export growth, weak domestic demand and ongoing fiscal consolidation have prevented an economic recovery from unfolding so far. As domestic demand stabilises, a modest upturn of output is expected in the course of 2011, with some acceleration in 2012. The unemployment rate is likely to stay high, and core deflation to continue.” In other words, the slump is ongoing. This is in contrast to the overall OECD situation, where economies seem to be beginning to pull out, with unemployment beginning to fall and growth becoming more self sustaining.

Now, well aware of the GNP/GDP issue, and also well aware that Iceland had the (perhaps dubious) advantage of being able to devalue as well as having taken the choice NOT to fling its national treasure at the black hole of the banks, some pictures. Portugal, Ireland, Iceland, Greece and Spain

First, the headline GDP growth figures

then the unemployment figures

and finally General Gov Balance (borrowing/ saving by govt) again as a % GDP.

Remember all that talk in 2009 and 2010 from Brian Lenihan, that Ireland was not Iceland…? Yeah, right Brian.

INFINITI Conference TCD 2011: Update

For all your lovers of conferences on international finance, heres one coming up. Its eligible for CFA and ACA continual professional education credits. Thanks to Pioneer , IBM Institute for Business Value and Eventus for sponsorship. Here is a link to the latest draft.

Main highlights :

Monday 13 June 1115-1230 Keynote ” Downsizing financial safety nets: missing elements in crisis driven financial reform” Ed Kane, Boston College. 

Financial reform in Europe and the US is being led by macro economists and industry leaders who turn a blind eye both a regulatory capture and to the deleterious distribution effects it engenders. Although everyone agrees that regulators should control systemic risk, official definitions of systemic risk either the role that government officials play in generating it. Policymakers support of creative forms of risk-taking and their proclivity for absorbing losses in crisis situations encourages opportunist firms to foster and exploit incentive conflicts within the supervisory sector. To restore faith in the diligence, competence and integrity of officials responsible for managing financial safety net, reforms need to rework Information Systems and incentives in the government and financial sectors. The goal should be to align the incentives of private risk managers, accountants, credit rating firms, and government supervisors with those of ordinary citizens. Emphasising the ease of arbitrageur reforms that focus only on strengthening capital requirements, this paper proposes a program of complimentary ways of advancing towards the goal. The most important steps would be to measure regulatory performance in terms of its effect on taxpayer risk exposures and require insured institutions to develop information to support this effort. This entails estimating the explicit and implicit safety net benefits they receive and issuing extended liability securities designed to improve the accuracy of these estimates

Monday 13 June 1600-1800 Industry Roundtable: “The Future of Financial Services” Moderator: Constantin Gurdgiev, Institute for Business Value, IBM; St Columanus AG  & Trinity College Dublin. Speakers include senior thought leaders from IBM Global Banking and Financial Markets Services, Citibank, Bank of New York Mellon, and other leading international financial institutions.

As the global financial system continues to reform and rebuild, the industry is faced with a number of opportunities and challenges. More than ever before, the winners will be those organisations that find the ways to create competitive differentiation, deal with operational complexity and raise their risk and client management capabilities. The roundtable will discuss some of the core future themes for the financial services providers, including:• Where is value being added versus destroyed? • What will financial markets and leading financial institutions look like in 2020? • How will financial institutions compete in the new economic environment? • How will financial institutions regain the trust and mind-share of their clients? • What are the roles that academic and industry partnerships can play in the areas of thought leadership and analytics research in shaping the future of financial services?

Tuesday 14 June 1130-1300  Plenary Session “Alternative Views of the Crisis” Andrei Shleifer, Harvard University, USA

Three broad views of the crisis will be discussed, in particular how financial institutions got themselves into so much trouble. The three views are “too big to fail”, “distorted compensation arrangements”, and “neglect of tail risk”. In particular, it will be argued that the third view provides the most coherent explanation of the various aspects of the crisis.

Plus over 150 papers in all areas of international finance.

  • Banking
  • Banks & Bank Capital
  • Bank Competition & Globalisation & Bailouts
  • Bank Lending
  • Asset Pricing
  • Capital Flows
  • Systemic Risk and Tail Risks
  • BRIC Countries and investments
  • Commodities
  • Cross listings
  • Finance and the macroeconomy
  • International Financial Integration
  • Real Estate
  • International Personal Finance
  • Ratings agencies
  • Modelling contagion
  • EU Sovereign Rates
  • Mergers and Acquisitions
  • Bankruptcy
  • Cross Border Banking
  • Emerging markets
  • Information and trading
  • Credit Default Swaps
  • Development and Finance
  • Precious metals
  • Institutions and culture
  • Portfolio allocation
  • and more!

Financial Repression?

This is a longer version of a piece published 18 May in the Irish Examiner. I cant find a link as of yet but…

The jobs initiative, revealed last week, is something that I have previously welcomed. It’s not so much that the jobs initiative is in and of itself going  to create hundreds of thousands of jobs per se, it’s rather that it indicates that the government are fully aware of the seriousness of the unemployment situation, and that unlike the late unlamented predecessors are willing to actually begin the process of public engagement.

For all the good things that are in the jobs initiative, it rests upon a foundation, which I cannot but think is an extraordinarily retrograde step.  To fund the VAT cut which is at the heart of the jobs initiative in terms of its most costly element, the government have decided to impose a levy of 0.6% upon the assets of individual pension funds.  Its curious to read the reaction of the proponents of the plan  to the reaction of the population to the plan. It appears to me to revolve around the arguments  that pension plans got “too much” tax relief and that we need to start taxing this disgusting foreign wealth which the wealthy pension fund holders have squirreled away overseas. . A further wrinkle is the argument that  sure the pension fund industry has been taking too much in fee income anyhow so this will (how?) incentivise them to buck up.  This revolves to : we are doing this for your own good.  Quiet…

Much of this is tosh. There is no doubt that over the years pension funds in Ireland have been given very generous, some might say over generous, tax treatment. But there is already in place (writ in the stone of the IMF Memorandum of Agreement , section on fiscal consolidation ) that these provisions will be scaled back. In any case one can think of lots of areas that got overly generous tax treatment that are not being so targeted. Racehorses anyone?

There is also no doubt that for the majority of people who hold private pension funds they do not have a pot of gold. The average amount of money invested in pension funds is somewhere in the region of €154,000.   This represents the savings of some 500,000 persons, money that they were encouraged to put aside in order to ensure that the state would not be liable for the entirety of the burden of supporting them in their old age.  But here is the rub : the most wealthy have not been availing of the pension funds which will be hit. They instead have been availing of special creatures called Approved Retirement Plans, and these billions will NOT be hit. One can only wonder why, but perhaps not where lawyers can hear. In any case, there are arguments for a wealth tax , and at one stage even Donald Trump was arguing in favour of one. However, a wealth tax would tax all forms of wealth, while this taxes one small form mainly held by the middle classes

As to the argument on fees, this has superficial attraction. Its certain that like most other things in Ireland over the last while the costs of managing ones retirement fund soared. And to be fair the government has agreed to investigate this. However, the government itself has, as is often the case, been a cause of this , so it is alleged, via their fees structure for Personal Retirement Savings Accounts. In any case we have a long way to go before people “shop around” for pension fund management, and this levy is being laid not on the profits of management of the assets but on the actual level of the assets.

Finally we have the argument about overseas. One of the very few undoubted things we know about finance is that, for most investors, it makes sense to be somewhat diversified. In the case of IRish pension funds one of the main problems they have faced over the years is their relative lack of diversificaton. As of the latest Mercer Asset Allocation Survey in 2010 Irish funds held 20% of their holdings in Irish equities and 34% in Irish government bonds.  There is if anything too little overseas diversification evident there, not too much.

As Talleyrand stated about the murder of a prominent member of the French royal family, the decision to begin to expropriate private savings, no matter for what reason, was worse than a crime, it was a blunder.   Their is a long and inglorious history of governments using what has become known as “financial repression” to enable them to close, surreptitiously, the gap between government spending and government revenue.  The academic and research literature on financial repression mostly lives in the area of development, and for the most part was, we thought, an interesting if somewhat historical curiosity.

We should have known of course that this time is never different. And indeed the author of that eponymous and magnificent book, Carmen Reinhardt, has recently produced an extremely interesting research paper on the issue of financial repression.  Financial repression in general refers to situations where the government and the financial system become very much more closely entwined.  The objective of this close intertwining is that the government can reduce its debt not only through prudent fiscal housekeeping but also through in some way directing or expropriating private savings, replacing other forms of investment with government debt.

This intertwining of course has been going on, a macro level in Ireland, ever since the disastrous events of the first bank guarantee. On a more operational level a number of different strands of financial repression can be identified. Perhaps the most common and indeed historically the most effective way in which financial repression occurs is through the government inducing or permitting negative real interest rates, via a combination of artificially low nominal interest rates combined with a slow but steady dose of inflation, inducing or permitting negative real interest rates. We should be aware that the ECB have an explicit anti-inflation mandate and this therefore is likely to play only a small part if any in any repression. Another form of financial repression is through capital controls, forcing investors to invest monies domestically, again not possible (or perhaps it is, if you listen to this clip from Junker )  within the Eurozone context, but a necessary precursor if anybody was to consider leaving the Eurozone.   A third form of financial repression is where the government directs private saving towards its own use. This is usually done via the government directing large pools of private savings, such as bank deposits pension funds, to invest all or a large part of the investment in government debt. The 0.6% pension levy is, in my opinion, a move towards that kind of approach. It forces the private sector investor to underpin the cutting of a tax rate, which would otherwise have had to be met by reduced expenditure elsewhere or by borrowing.

We should also notice that respected analysts suggest financial repression as an explicit means.  The director of the Centre for European Policy Studies has recently suggested that the Irish government should direct the pension and life investment community to invest all of their overseas bond holdings into government bonds. One wonders why he didnt suggest they convert their forein equity holdings as well and be done with it…This would be a direct and explicit form of financial repression. It also be flying in the face of 60 years of financial wisdom, that investors should diversify. Irish pension and life insurance investors are already very “long” Ireland as i have noted above. Forcing them, through their pension funds, to have an even longer position in Ireland would make no sense.  Nonetheless savers and advisors should be aware of this kind of discussion and would be wise to make such musings part of their decisions. Deposits have been flowing out of irish banks for years now and it would be a worrisome development if people were to fear that they have to contemplate similar flight for their remaining assets

While it is an exaggeration to say that the small levy is a smash and grab, it is in my view the first element of a new phase, one that hopefully will not continue. It is essential that the government make it extremely plain that they will not go down the road of recent countries. In Bolivia the government has nationalized pension funds, following the same path as Argentina. In Hungary the state has directed that the in effect mandatory payments into the private pension funds be directed instead to state funds, and a partial version of the same has taken place in PolandBulgaria planned to move in a similar direction but union pressure put paid to that plan. A Peruvian presidential candidate has placed nationalizing private pension funds as part of his campaign, although this plan changes reasonably rapidly depending on the strength of perceived opposition to it.

These are all desperate measures, and ones that we need to see the government here ruling out. Of course, the converse of this is that the state needs to get its finances in order, sharpish. This will require very sharp reductions in state expenditure, moving as much as possible to close totally the funding gap over two to three years.  Doing that will require that all bear the brunt of sacrifice, and in an environment where judges and the top layer civil servants avoided the cuts in pay that others took state leadership will require that not only will these burdens be shared but will be seen to be shared.

Robbing future Peter to pay putative present Paul

This is an expanded version of an opinion piece published in the Irish Examiner on 11 May 2011

The last week has seen an enormous outpouring of national introspection in relation to how we will get Out of the mess.  At the heart of this has been the as ever controversial, polemical, and pungent Prof Morgan Kelly, whose proposal at the weekend that we ditch the bailout and simultaneously close the gap in the national finances in the course of one year has been at one and the same time reviled and welcomed. Kelly deserves enormous kudos for being a (almost) lone voice in the wilderness, calling the property bubble for what it was and in doing so dropping the scales from many of our eyes, and more latterly for holding up a stark mirror to the folly that has been the banking rescues.

It’s probably no exaggeration to say that millions of words have been written about the Irish banking collapse, and about the consequential economic disaster.

Curiously muted has been the discussion around jobs. At start of 2007 unemployment was just over 4%, while now it is now at 14.6% at last count.  While this is not by any means the worst in the European Union is a very very serious and rapid deterioration.

This tripling of unemployment has of course occurred against a background of massive emigration, and the headline unemployment rate masks startling discrepancies. Overall male unemployment is now just under 18%, while for men between the ages of 20 and 24 is nearly 33%. A very useful recent post on the Irish economy blog discusses the issue of male unemployment.

Nobel prizes and economics have been awarded for people who have worked on the issues of unemployment, unemployment solutions, and the issues of the effect of unemployment, particularly when young, on long-term work prospects.

It against this background that one cannot but welcome the focus that this government has now shown in trying to begin the process of reducing unemployment. Under the watch of Brian Cowan we saw not only the collapse of the Irish banking system, not only the collapse of the Irish fiscal system but also the collapse of the Irish employment system.  When Hercules had but one Augean stable to clear out this government has three, any one of which would   daunt the staunchest.

The initiatives themselves are worthy, but will hardly reduce the unemployment level by much. At most they can best be seen as an opportunity to ensure that certain categories of industries are favored, that certain types of jobseekers are favoured, and that the government is seen to be doing something. Being seen to do something as important, as it might well give people a degree of confidence, that somebody somewhere is trying…we have a small reduction in the   lower rate of value-added tax, which will almost certainly not on past experience translate to a reduction of prices for the Irish tourist product, prices tending to be sticky downwards; we have some additional expenditure on minor roads; we have a reduction in PRS I at the lower level but only for a time limited period; we have some incentivization for universities to seek additional  non—Exchequer  funds and to be then allowed to employ people;  and we have the introduction of common tourist Visa between Ireland and UK,  in hope of cashing in on large numbers of non EU residents visiting the Olympics  one assumes. The largest single amount of jobs noted will be training and internships, worthy but not self evidently sustainable in the long-term.   No mention is made of serious reform of FAS, there is no serious evidence given to a concentration on youth unemployment, other than the assumption that persons going back into training and education will be young, there is little evidence that the national obsession with the construction industry has finally been purged. Commenting on the jobs initiative the entrepreneur Jerry Kennelly of welcomed it, insofar as it went, but pointed out that the government really need to get serious with telling people who had worked in the construction industry that their jobs were irretrievably gone. He suggested that the need to be given much more significant incentives to reskill, or, and this is characteristic of the frank way in which she speaks, beautiful to emigrate. No politician is going to tell people to emigrate… that would smack far too much have Brian Lenihan senior and his statement about a small island.  Examining the jobs initiative one sees that the largest single amount of money being spent is in the reduction of the value-added tax.  The assumption appears to be that if prices fall more people will spend money and more people spend money domestic demand increasing will result in increased employment in the retail hospitality and other industries.  In addition, while I don’t believe necessarily that the minimum wage, which is in any real sense pretty paltry, is a serious disincentive to employment, it does also seems somewhat perverse that in an environment where we should be taking every opportunity to enhance the competitiveness of the nation we increase, at least relative to where it has been for the first couple of months, the cost of employing persons.

Before we get too carried away with congratulations however we need to be cognizant of the fact that this is a jobs initiative built upon an extremely unfortunate foundation. The proposal to levy not the premiums but the actual asset values of pension funds is entirely regrettable in my view. Irish pension underfunding is a massive problem not just for the public sector because of the private sector. At least in principle in the public sector all employees who are members of the defined benefit scheme can hope there would be tax revenue to pay their pensions. In the private sector people have to put aside funds, and while there are very generous tax breaks for doing so the long-term argument in favour of encouraging private sector pension provision is indisputable. Make no mistake; this is a levy, a tax, on thrift. For every multimillionaire who has put aside vast sums of money as tax shelters there are a dozen or more small to medium business owners who have put aside a modest amount of money to try and ensured they will not be reliant simply and solely understating their old age.  It is astonishing that the pensions board has not been up in arms about this, in particular the consumer and pension representatives.  What we have here is a retrospective tax on saved income, and if constitutional there is no reason why such a tax cannot be applied to bank deposits or other forms of wealth. Taxes on income from such savings are one thing but this is a new departure. And it’s an unwelcome one. If the government can levy on the wealth, the savings, of persons accumulated in pension funds why can they not so similarly lengthy on other forms of saving? Could the government, using the same justification is here, put in place a 0.6% levy on the level of deposits in Irish banks? The fig leaf that has been used here is that there has been very generous provision for tax relief and pensions investments over the years, and that it’s appropriate that this be retrieved.   2 problems arise with this: first will we see this logic applied to the recouping of what ought by the government’s logic be “excess” wealth accumulated through other areas where there has been overgenerous tax provision such as the bubble wealth accumulated by developers and speculators in land   or to the very large bonuses paid by failed banks to the executives who led them into failure, and secondly the government is already committed to the IMF deal which involves a reduction in the future of the tax incentives for investment into pensions.

One has to reluctantly conclude that having given a public, electoral, commitment to the idea of a jobs budget that then became a jobs initiative the government felt it had no choice but to continue to do something.  The Financial Times has suggested that some government election policies, this amongst them, are best left unfulfilled.

As I have said doing something is a good idea, the individual ideas are not themselves bad, it gives a strong signal that the government is at least thinking about the unemployment issue, and they have to start somewhere. However there are other places than the pensions funds of private savers that could have been used to fund the reduction in value-added tax, which is at the center of this initiative.

One obvious place would have been the largest single tax break (above the individual tax credits), which the state gives, namely the exemption of the principal private residence from capital gains tax. Important research on the cost of various tax incentives was undertaken by Dr. Michael Collins of TCD.  He finds that the total amount of tax foregone by the exemption of the principal family residence from capital gains tax was something of the order of €2.4 billion per annum, albeit based on 2006 Data.  The total sum estimated to be raised in a year from the pensions assets levy is some  €470 million.  Even allowing for the collapse in property values from their bubble prices it should be entirely possible to raise a goodly chunk of this by the exemption being removed.

Morgan Kelly and academic salaries

Is Morgan Kelly right when he says that he should, by reference to European norms, take a pay cut to 50% salary?

A quick look at one of the leading websites for jobs in academia, gives a good idea of what’s happening, particularly for jobs in the United Kingdom.

There are a  number of chairs in economics advertised . Take for example Coventry University… The maximum of the scale there is £71,000, which translates to just over €81,000.  Another being advertised as in Germany, , where salary appears to be just under €47,000. Brunel are also looking for a chair in economics,, and the salary is not specified.  The University of Essex is also offering a chair in economics, Essex being one of the top schools in economics. Its details are here and if one goes to the University of Essex website its human resource Department links the salary scale, where the maximum salary scale for professors is £58,000, although the job does say that the salary will be “commensurate with experience”, so one might imagine that would be closer to at least the Coventry level. Let’s say £75,000, should translate to about €85,000.  There is a full chair in public economics going in the Vienna University of economics and business, , and a chair in Hull The professorial salary at Hull appears to be just under £61,000, or €70,000, but I can’t find information on salary for Vienna.

Ireland? gives information on the pay scales for UCD academics. The top of the professorial salary is €138,655. That’s 1.7 times Coventry,  2.95 times the German, and 2.3 times that of Hull.

( one point, usefully pointed out to me… in a number of cases in the UK, and elsewhere, at the top of the tree professors can negotiate fairly considerable amounts of salary above the posted maxim. Now of course we don’t have data  on that, so we can’t actually  take it into account here.  So these figures should of course be taken as indicative.)