The cloud of delusion in the silver lining of Irish recovery

This is a version of my column in the Irish examiner 11 January 2014 . Every silver lining, they say, has a cloud.  Or is it the other way round? The new year has certainly got off to a bang in terms of the nascent Irish recovery. In the last week we have seen three developments which on the face of it seem to be proof positive that we have moved forward turned the corner to face green shoots and so forth. The NTMA succeeded in getting away a bond issue, so also did Bank of Ireland, and Michael Noonan was voted Best Finance Minister in Europe. While all three are nicer than stories about the impoverished of south Dublin resorting to hunting and eating rats with wings, none of them actually amount to much more than the return of delusion.The question is – who is deluded.

 

deal_with_it_funny_bond_trader_plate-rbd63e395d5a84dfba552f30158567451_ambb0_8byvr_324Lets take the last one . Its ego boosting to Michael Noonan, one can be sure, to be so voted. And in so far as we have a representative democracy we should bask in the wan reflection. For sure the credit goes to the Irish people who have knuckled under (or left) and sorted out the mess of the Ahearn era (for which of course they had voted in majority numbers). Its certainly less embarrassing than the 2009 and 2010 rankings when the then minister , Brian Lenihan, was ranked at or amongst the worst. However, the rankings are really nothing to do with the minister and all to do with the economy. In so far as the finance minister has an influence on the economy and its performance reflects theirs, then there is a relation. But the reality is that Noonan is lucky (as Lenihan was unlucky) in that Ireland has been determined to be the best boy in class, taking its beatings and not complaining. The whining noise from the proles is a mere irritant to the financial markets who applaud (while simultaneously laughing up their sleeves at ) us for paying all our debts and more.
11-landed_on_taxpayerIn the case of bank of Ireland we see the raising of 750m in unsecured unguaranteed bonds by the bank. This cost them approx. the same as the government ten year, and around 1.25% over the government 5 year rate. This again is hailed as being a great harbinger of recovery. It is not. We have seen unsecured unguaranteed senior bonds being repaid not by the issuer but by the taxpayer time and again. There is no doubt in my mind that this would happen again. These are as secure as government debt, in practice, when you are a too big to fail bank, as for us BoI most surely is. So again – why ask for a premium when you know you need none – its either delusion as to the real state of repayment or simple greed. In any case, we need to see banks becoming more reliant on deposit base not on bonds. Irish banks have reduced the percent of assets financed from international bonds from the low teens (at the height of the property boom) to about 3% now but domestic deposits still only account for 1/3 of all funding . This needs to be significantly increased. The paper by Thorsten Beck, the world ranking expert on banking crises and their aftermath, suggests that Irish banks remain in a parlous position. But having created the Two and Half Men of Banking (albeit not remotely as funny) the government cannot now express anything but approval and confidence in anything the banks do, including this. We have exchanged too big to fail banks for really and truly too big to fail banks, and there is no reason why they should not act in as foolish a manner as they have before. Whats the downside?

michael-noonan-fingersIn the Draghi era, where the ECB shows its muscle without having to use it, our bond yields have collapsed – that means prices have risen, gifting massive profits to the holders who calculated that no bond would burn. Combined with the exporting of much of the unemployable youth, a plethora of state activation actions to prepare people for jobs (whenever they happen) and a rise in desperate entrepreneurs we have reversed headline unemployment. To top that we have swallowed the austerity medicine to move to a near primary surplus – that is that we now more or less pay our way on a daily basis so we can slap down hard those that gibber “sure were borrowing billions to pay the <insert public sector/welfare media target de jour>” . Noonan has been lucky and has made his luck – a canny hardened politico he knows how to do that and who can begrudge him this valedictory honour. But its as ephemeral as morning mist.

LoanSharkOn the Markets we are also being lauded. The NTMA had a good week, in that there was massive demand for Irish ten year debt – it could have sold 14b worth of debt when it wanted to get 3b. Irish bonds are now seen as safe, and indeed there is a clear trend for much greater convergence of bond yields across the euro zone. This is strange, not that there is slow convergence but that there is any remaining divergence. There is no prospect, apart from perhaps Greece and Portugal, that sovereign bonds of euro zone countries will be allowed default. None. Therefore these are as risky or not as Germany. That is the logic of the Draghi Era – no sovereign bondholder will be burned. So why is the market not believing that? The premium for these bonds cant be liquidity – there is no problem in moving the majority of these bonds for cash. So why is there a remaining premium? Clearly either the markets are deluded and do not accept that despite all the evidence that European economies will go to the wall to repay debt there remains a risk, or governments are deluded that they can continue to do this into the future. Or both. Markets will continue to lend regardless of the reality of the macro economy so long as they are confident of getting their money back. Being willing to lend is one thing but we should not be willing to borrow regardless.

debtdestroyer_sinkingfundsHistorically governments set aside in the budget a sum of money into what was called a “sinking fund”. That was designed to pay off the principal of monies borrowed. Somewhere in the eighties we got out of that habit. We now are in effect borrowing on an interest only basis and need to get back to the habit of repaying debt without incurring further borrowing. the household as state as household analogy is a really bad one, but it has some power. We are (not really but its an analogy) like a household that has borrowed money; we pay the interest not from earnings (these go to running household expenses more or less in toto) but from further borrowings. When the loans come due we borrow from another source to repay them, and on it goes. We used, as noted, set aside some monies each year to repay the loans in toto, the sinking fund. Such old fashioned fiscal prudence needs to be revisited. Right now we are facing into an era of low nominal GxP growth . In that environment, we can only ensure that we do not increase our debt/ GxP ratio by actively reducing debt. This habit should become ingrained and not be simply a reaction to critically high levels.

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