Tag Archives: domestic economy

Irish Budget Theatre and the Ghost of 1977

Tuesday sees the budget, a by now largely meaningless piece of set piece theatre.  The old days when ministers were afraid to speak a word for fear of leaking have, thankfully, gone. Yet the setpiece remains, and it is a high point of the political year for the minister for finance to deliver the plans for the coming years.

Our political system favours strokes.  The death of Liam Cosgrave should remind us of the events of 40 years ago. Fianna Fail swept into power on the basis of a massive plan of tax cuts.  Domestic rates were abolished.  Admittedly domestic rates were a very crude mechanism for taxing property values, but they at least existed, and provided the basis for the funding of local council provided services.  40 years on we are still paying the price, politically socially and economically, for that decision.  First-time buyers grant or in economic terms a subsidy to property construction was introduced.  Across a wide range of other taxes, from personal to transport, rates were cut and bases were abolished. Fianna Fail swept into power.  Their successful appeal to the population set the template for Irish political life ever since.  While economically disastrous the 1977 program was politically triumphant, changing the landscape forevermore.

We persist in this country in believing our own myth that we are a uniquely highly taxed nation.  This is not the case.  In comparison with the countries in the northern tier of Europe  the Irish state takes a small percentage of the national wealth, individuals pay a small percentage of earnings, and corporations pay a small percentage of their earnings. We have no effective wealth tax.  Ireland is possibly unique in the western world in that it has hard-left Socialists, the solidarity party, who are against taxing the major form of wealth possessed by most people mainly residential property. Council after Council has reduced the residential property tax, rendering it a bit player in the extreme.  Solidarity, proclaiming to be socialists, have allied with the local populists (whether they are Fianna Fail or Fine Gael or Labour is irrelevant)  in cutting local property taxes and then demanding increased local services. It is entirely politically rational for them to do so.

Nobody likes paying taxes. But we have a political system which is absolutely incapable of telling the people that if they want the kind of services which they consistently demand, they have to pay to provide.  They can either pay at the point of use, a private provision; they can pay through deferred consumption in the form of loans, or they can pay through deferred consumption via taxation. There is no magic money tree.

The budget on Tuesday would be pretty predictable.There is an ambitious  and praiseworthy capital program, and this will be continued. There is an ongoing need to fund the activities of the state. We are earning enough and taxes to pay our way. But the legacy of crisis, and the legacy of the 1977 political earthquake, means that it is extremely unlikely that we will see anything bold or exciting.  We should not expect political vision from the government which was quite happy to yield up hundreds of millions of Euro through not collecting the taxes that are owed to us from multinationals. Whatever the ultimate outcome of the Apple tax case right now apple have a tax bill of €13 billion.  A large chunk of that no doubt will eventually be paid to other countries, if it is ever collected. Before that happens however we’re engaging in reverse Father Tedonomics –  money is not resting in  our account.  1% of €13 billion is €130 million.  That’s a good chunk of the available ”fiscal space”  which the government has to play with. As of its latest quarterly accounts Apple had in excess of 65 billion Euro in cash and short-term securities. They can quite easily pay this bill, Without blinking. There Is no question about them leaving Ireland should they eventually be forced to pay this money. The Irish government has gone to extraordinary lengths, even let us recall not collecting tax legally due to it, to stay on the side of apple.  €130 million, which the government has foregone, is approximately the same amount as is spent by local authorities on social housing. Fitting into a further year of homelessness as a crisis it’s good to know that the government can afford to forego this money.

The government almost certainly won’t announce on Tuesday that is going to collect this money due to it. That will instead spend an equivalent amount of money in ensuring that the optics of tax reduction are maintained.  There will be ritualistic denouncements of the government from the opposition, ritualistic muttering from the silent partners of Fianna Fail, and all sides will compete to demand more services but simultaneously demanding that the government is taking less resources to pay for it.  Continuing to feed the myth of Ireland as a high tax Society, commentator after commentator will breathlessly pore over the entrails of  of minor adjustments, The media will provide infographics showing how three euros here or €4 later will be added and subtracted to various hypothetical taxpayers, and the system will sludge on.  

Published as a column in Irish Examiner, 9/10/17

Taxes, bull and the Irish economy

bull-023Another week  another inversion. This time, passing almost unnoticed in the august torpor, one of the worlds largest meat companies, JBS, signalled that it would relocate its HQ to Ireland. It also noted that this HQ company would be controlled from an office park in Herefordshire.  The reasons for this have nothing whatsoever to do with anything real, all to do with favorable tax and legal reasons. This is unlikely to have any effect on GDP, unless of course JBS decide to start using intellectual property and patents to start to shuffle money around, thus creating “exports” from Ireland.
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Irish Banks : Arrears, Deposits, Bail-in and Interest Rate Editon

This is an edited and extended version of a column in The Irish Examiner 26 October 2013

There is a great book on marketing titled “the long tail” , which stresses that instead of trying to hit millions of customers at once its perhaps better to do millions of niches. Replete with examples it was and remains a deserved hit. The long tail refers to the distribution of something – a large bulk at one end quickly trailing off to smaller numbers but which go on for a long time. Another word for this is skewness. In very many skewed distributions it is common for the total amount in the long tail to be equal to or greater than the amount in the bulk. Another way of thinking of this is a power law. Many many things have been found to follow power laws – terrorism, population of cities, bibliometrics, income distribution… theres no reason to think Irish bank losses are different.

download (1)The long tail approach is worth considering as we move into the sixth year of this crisis.  Having dealt with the massive mess of the commercial property and developers loans via hiving them off to NAMA (which has yet to “get credit flowing” as its cheerleaders in the then government and some still prominent stockbrokers trumpeted) , the long tail of the mortgage and SME loans continue to erode the banks. We are moving down the tail with the average loss getting smaller but there are an awful lot of them. Today I spoke to a SME owner who runs a small distribution business. He had settled with a bank for a loan taken out in 2006 which resulted in the bank taking a loss of just under €1m. The business is still going, much reduced but “ticking over nicely”. This is as good as it gets – a viable business remains. Many many SME loans are for larger amounts and the banks will take a larger hit as there is nothing left. I think of someone  I know who purchased a house in 2006 for €450k, interest only of course, in a  not very fashionable holiday area, where similar homes are selling at €150k on a good day. These are the long tail and they are wagging the dogs of our banks as the banks chase them round in a circle.

Basel-IIIAt present Irish banks are well capitalized. Some might say that in a classic overreaction to the lack of adequate capital buffers in the past they are over capitalized. Bank capital is a two edged sword. On the one hand the more capital they have the greater a buffer exists to absorb losses. On the other, as capital is measured as a percentage of assets the more capital is required then all things considered the smaller will be the assets. A bank that has a 10% capital ratio will be able to make more loans (assets) than one that is required to hold a 15% ratio. The ECB has recently announced that it will conduct another round of stress tests. These are required, in essence, so that the final set of capital injections will be made prior to the ECB taking over full control of regulation. The political reality is that this step, a necessary requirement for a proper banking union, will require that individual states make or supervise any capital injections. In a banking union this will be the responsibility of the union, and thus the German taxpayer might be on the hook. But not this last time.

gpyugoWe have known for some time that the Irish banks will require additional capital. The state of the mortgage book is bad but the state of the SME loan book is also dire. Earlier this year we found out that  50% of the SME loan book was in distress.  There is a total of €70b in SME lending, of which an astounding €30b is still outstanding to real estate. A multibillion loss is an absolute certainty.   On the mortgages we have similar. The question that should raise its head is : who bears these losses. Traditionally the order of losses was deemed to be shareholders -> junior bondholders -> deposits and senior bonds. The taxpayer might then step in and recapitalize if the bank was deemed to be needed.  So in the Irish case 2008 saw some but not all junior bondholders and almost all equity destroyed, but the system balked at that and so in stepped Paddy with his chequebook. And we know how that ended. We saw in Cyrpus, and indeed have seen in the liquidation of IBRC that depositors can and in future will be “bailed in”. This is fine and dandy if all other sources of capital have been burned through. The problem is that recent statements by Mario Draghi suggest that bondholders might be spared in future, for fear that once burned they might not return. In other words the sovereign would be required to make a decision as to whether they would absorb losses or instead force bailins on depositors. There is zero willingness for the Irish state to add more taxpayer money into the banks. Thus the question becomes: do the banks hae sufficient buffers in place to absorb losses before the question of depositors comes into play?

hqdefaultOn a macro level they are good. AIB has shareholders funds of c 10b, BOI of 8b and PTSB 2.4b.  In the case of PTSB and AIB much of these shareholder funds are in fact state funds, so any erosion of these is an erosion of taxpayer funds. The problem is that as we noted they are required to hold funds at a certain level. This level is higher than the European requirements. Thus as losses get booked the banks will have to either raise additional funds. This, in sufficient amounts, is I submit unlikely. While they have had some success in raising limited amounts these have either been expensive or have required significant security. In addition, the banks face rollovers of existing issued debt. Bank of Ireland will need to roll over or pay off bonds of 9.5b in 2014-2015, AIB 7.5b and PTSB 5b n the same period. This will tax them significantly. If they face a requirement to otherwise increase capital from losses that will make the job that much more difficult. A large part of the outstanding bonds are senior notes, some 7b. A large part of the remaining is covered or asset backed. Only some 5b or so across the banks, mainly in Bank of Ireland, are unsecured or subordinated. Bank of Ireland has the largest “burnable” buffer but is the one least likely to require it. AIB has very little unsecured debt and less than 4b senior debt. We have seen that even the mention of senior debt being burned, where legally possible, has caused significant negative market reaction. Thus where there is no taxpayer backstop and either no bondholders or no willingness to burn them, inevitably deposits must come into play. In that context depositors should seek a higher rate than they are at present getting.

browseChartThe chart shows the deposit rate on new deposits for an agreed maturity, Ireland v Germany. Deposits that were ten years ago seen as close to riskless as it is possible to be are no longer so perceived. The difference between Irish and German deposits is not, I suggest, sufficient to reward for the relative risk differential. Although small, the risk of depositor bailin in Ireland is many many times larger than that in Germany. These risks are the worst sort- small probability large outcome risk. It is time that the banks begun to remunerate depositors  appropriately for the risk, small that it is, that they are being asked to bear.  We need to move away from a banking system that is dependent in large part on loan capital towards one that is dependent on deposits. In fact, in the last week we have seen the situation worsen. The increase in DIRT means that deposits are now paying less than the already paltry levels. Combined with the loss of ACC , closing after 86 years, this further erodes competition, even if ACC was a small player. Expect pressure on interest rates to be downward, relatively speaking, on deposits. Which are now risk capital and in the firing line.

Irish Banks failure to deal with BTL mortgage arrears gives scant hope for the future.

austeritycornerThis is a expanded version of my column with the Irish Examiner of October 12 2013. With the budget around the corner we are hearing soothing noises all round about the economy. Apparently things are grand, or about to be. We are to be grateful that in an inversion of 1 Kings 12:11 we are not to be beaten with the scorpion of 3.1b but merely with the whip of 2.5b in cuts.  Hooray… Although the Fiscal Council still suggests exemplary discipline, the government has decided to show some mercy. We also see the ESRI coming out very bullish on the economy, particularly with regard to employment, which is rising. This, and they are right, represents an improvement in the domestic economy. How much of this is a dead cat bounce and how much a sustained improvement we will see, but one thing is clear, we are by no means out of the woods. At best we have worked out on what side of the dead tree we should look for the lichen to aid us in getting out. The real domestic economy remains mired in deep recession and persistent questions remain about the reality of the export figures especially for services, which are subject to the vagaries of international tax arbitrage.

Deflated-balloonThe budget will act as a drag on the economy. There is no doubt about that. We have long since passed the point of no return for the myth of expansionary fiscal contraction, in fact that was exploded in the Irish case by Karl Whelan in 1997. What remains to be done however on the fiscal side is, by comparison to what has been done, small (but still painful).  We are  still however looking at a structural deficit – that is to say that abstracting from interest payments on debt we are still running a deficit. Until we are in structural balance we are still liable to fall into fiscal wardship. So the domestic economy will struggle on.

For many persons with mortgages, particularly buy to let mortgages on investment properties the next few years are likely to be the most difficult of all.  Having taken cuts and tax rises, incomes are  tight. We now know that the buy to let market is in the horrors. Of the 150,000 mortgages outstanding 40,000 are in arrears. That is an astounding figure – one in four loans in distress. Arrears are rising by 3% every quarter with arrears over two years rising by 15% every quarter. The sector is bust.

Anchor,_England_-_scan01Typically buy to let mortgages in the boom were on a interest only basis. Thus the mortgagee repaid interest and expected that in 20 or 25 years time the capital value of the property when sold would meet or exceed the initial sum borrowed. Fully 50% of a sample of recent BTL investors noted that they were not getting rental income sufficient to cover the interest. Thus in addition to these mortgages slipping further into arrears there is a growing cohort of investors who are building up further arrears on capital. The same investors do not see the property market recovering, in the sense of outperforming for its level of risk, in the short or medium term. Despite all that a large percentage of these investors refuse to sell for less than the price at which they purchased. In the face of a 50% fall in capital values where there is likely to be at best modest nominal increases in value in the medium term, this is while understandable from a psychological perspective simple delusion from an economic perspective. Not selling in hope of nominal prices returning is called Anchoring. While it may be stable something anchored can also have its guts ripped out if the anchor is overly strong, and of course being tied to an anchor  is a wonderful way to drown. Tying oneself to something while underwater is generally contraindicated.

house-of-cards-550x550The banks refuse to engage with this problem . With 150000 mortgages of which 40000 are in arrears we have a paltry 500 in repossession. There are 10000 buy to let mortgages in arrears of over 2 years. These are never going to be repaid.  The 700m of accumulated arrears of these defaulters are gone. The €3.3b of mortgage value represented by these two year defaulters  is impaired by at least €1-2b. The banks refuse to move to write down these loans, repossess and move on.  They too are anchored to unrealistic expectations. This is down to their petrification that when they start to do this, to repossess investment properties, they will cause a cascade.  Part of that cascade will be that as repossessed houses come onto the market this will further depress the prices which, Dublin aside, remain in decline. A more worrying element for some is that there are an unknown, but presumably non-trivial, number of these which are cross secured on residential properties. While there is some faint appetite for repossessing investment property there is much less for principal private dwellings. More worryingly, a large percentage of these property investments seem to have been secured on other property investments. Kicking away the props from a shaky house rarely results in a neat outcome. So despite rents beginning to rise, which would make these properties more attractive for banks in their capacity as landlords, there remains a massive blockage. At the bottom of an interest rate cycle, with a depressed economy at best recovering very haltingly, with little prospect of fiscal loosening in the medium term, the outlook for these BTL investors is bleak as it is for the banks.

billboard-stuck_1116867iSitting on the  problem and hoping that it will go away will not work for the BTL investors. Nor will it for banks. While individuals may be excused for anchoring to past prices and for displaying psychological traits such as cognitive dissonance (wanting to sell, not seeing the asset as attractive but not wanting to sell for less than purchase) there is no real excuse for a large commercial organization to do so. These are investments. People took them for such. If the Irish banks refuse to deal with these then there is scant hope that they will deal with the  larger problem of residential mortgage arrears. The residential mortgage market is 4x the size of the buy to let but has ‘only’ 2x the arrears. Together however the banks are sitting on mortgages in arrears totalling a stunning €35b, with €4b in total arrears. Looking at the over two year arrears  we have mortgages of €10b with accumulated arrears of just under €2b. These are for the most part lost. But the banks refuse to move on them.The result is that the banks will be crippled for decades. We need functioning banks and right now they are dysfunctional.