Fitch, the credit rating agency, has just downgraded the sovereign debt ratings for the Republic of Ireland from AA+ to AA-.  That is two notches and is proof-positive that the ratings agencies are worried about the hole in Dublin’s finances.

If you read the Irish press this morning, it is all doom and gloom and has a lot to do with the banks and budget deficit.  It is not just about the ratings downgrades.

The EU has just released figures putting in doubt Ireland’s rosy scenario for cutting budget deficits.

The Irish Independent says:

Next month’s Budget may set the economy back further, but without it the country’s national debt could reach 100pc of output (GDP) by 2011, the EU Commission has said in a new analysis.

The Commission is forecasting a decline of 1.4pc in Irish GDP next year. But Brussels is not taking the impact of next month’s Budget into account, because the details are not yet known.

"Depending on the specific measures that are eventually implemented, a dampening effect on consumer demand cannot be excluded," the Commission says in its autumn economic forecast.

Correction

On the other hand, it says that faster correction of the economy’s problems might give more support to consumption and investment by helping confidence.

The Government’s plans include a correction of 4.3pc of GDP — around €8bn — in the Budgets for 2010 and 2011.

Unless there is a compensating boost from confidence, this could also reduce the modest 2.6pc growth forecast for 2011.

These forecasts are higher than those in the Commission’s estimates last May, but it warns of the struggle facing the Irish economy in trying to return to strong growth.

Another top headline in the Irish Independent has the OECD warning that the Irish government should not rule out nationalising banks in addition to its bad bank programme, NAMA.

The Government shouldn’t rule out temporarily nationalising the country’s banks as they may require more capital to cushion against surging bad debts, the Organisation for Economic Cooperation and Development said.

The Government is setting up the so-called bad bank that will buy €77bn of property loans from banks at a discount of 30pc. Losses on those assets may leave the lenders needing extra capital.

“Further recapitalisation may be necessary as assets are being purchased below book value,” the Paris-based OECD said in a report today. “Temporary nationalisation would have a number of drawbacks, but it should not be ruled out altogether.”

The Government has already guaranteed all deposits at banks and some of their debts, pumped €7bn into Allied Irish Banks and Bank of Ireland and seized Anglo Irish Bank.

“Substantial” banking losses are likely to be met by the taxpayer and nationalisation should only be undertaken with the “utmost reluctance,” the OECD said.

The FT’s Stacy-Marie Ishmael has a piece out doubting the maths used in NAMA, which bolsters the OECD view that the bad bank may not be enough.

So you have a trifecta of bad news coming out of Ireland: a two-notch downgrade by a major ratings agency, a warning from the EU that the economy will be weak for sometime to come and that deficits targets will not be met, and another warning from the OECD that the banking situation in Ireland is still very grave.

Quite frankly, it is not looking good for an Irish recovery at this time without the help of the IMF. This all brings me back to my question one year ago: Is Ireland the next Iceland? They will be if the EU, IMF and Irish government do not take today’s bad news seriously and take drastic action to bolster the Irish banks, economy, and government finances.

Who said the financial crisis was over? It is not.

Related posts:

• Ireland: Next stop – IMF
• Ireland guarantees bank deposits at six banks
• Irish government unveils plan to recapitalise banks
• Ireland nationalizes Anglo Irish bank
• Is Ireland the next Iceland?

When it comes to the housing meltdowns in the richest economies, the US has been matched only by Spain, Ireland and the UK. All four countries have seen spectacular losses of wealth in the housing sector over the last two years.

The response by all four governments was to apply as much stimulus as they reasonably could to prevent their economies from descending into free fall. This has opened up gaping holes in each countries’ government accounts. However, in contrast to the United States or the UK, both Spain and Ireland have the Euro as an external constraint which limits their policy choices.  This has resulted in credit downgrades for the sovereign debt in Ireland and Spain.

Looking at Spain, there was massive over-building in the property sector, which attracted a lot of labor to Spain. Now that these jobs have been vaporized, the unemployment rate has soared to near 18%. The problem is quite acute and there are few policy solutions. Reinforcing this point for me was a discussion I had with Spain-expert Edward Hugh, who writes at the blogs Global Economy Matters and A Fistful of Euros, in the wake of some downbeat comments by Paul Krugman about the country.

Edward wrote:

The problem is Spain can only create jobs through exports. The problem is, with Brussels prices we cannot attract investment to build new factories to create high volume unskilled employment. At this stage in the game we are not in competition with Brussels, but with Bratislava. That may not be a pleasant truth, but it is simply like that. We have attracted a large quantity of people here to work in unskilled low-value employment. The industry that gave them work just permanently disappeared out of sight. We need, urgently to find alternatives since we cannot pay them all 420 euros a month for ever. This is more than a simple academic exercise, it is now a question of life and death for the Spanish economy.

Basically we need to go back to 2000 wages and prices and start again. Maybe you don’t like this idea, but can you point me to anyone who has an alternative?"

Obviously, a huge cut in nominal wages is never going to fly in any country because wage prices are sticky. Call it “money illusion” or call it a desire to maintain a decent standard of living, across-the-board nominal wage cuts are a political non-starter. But, this is what is needed in Spain.

Edward does address the standard-of-living problem this presents:

This is not simply about bringing down wages. It is about simulating a devaluation by bringing down prices AND wages together. So you as an employee should be in the same situation as before. The only realistic way to do this is through a pact between employers, unions and political parties, everyone.

The only real problem is with the debts, since they will also need adjusting down, but see another thread here on this.

But OK, I’m not saying this is going to be easy, just that we have no alternative. We shouldn’t have inflated the housing bubble in the first place.

Of course, being able to devalue the currency is one way to achieve this. But, Spain does not have that option. These are the very real policy cul-de-sacs faced in the aftermath of a debt-fueled asset bubble. And since another one seems to be inflating right now, I reckon the U.S. and the U.K. will be joining Ireland and Spain on this dead-end street in due course whether their currencies are weak or not.

Related posts:

• European House Prices are slowing
• Spain and Ireland ‘thrown to the wolves’ after ECB move
• Spain intervenes to save Caja Castilla La Mancha
• UK real wages falling
• Spain gets deflation

Ireland has made heroic strides in trying to deal with its economic problem after a spectacular property bust. But it is looking increasingly like it will not be enough. According to a senior Irish minister, the next stop for Ireland could be the International Monetary Fund (IMF) for a bailout.

The crisis has been building for some time and I have documented some of the milestones here over the last 16-odd months.

• Jun 2008: Ireland: government blew the boom
• Sep 2008: Ireland guarantees bank deposits at six banks
• Nov 2008: Is Ireland the next Iceland?
• Dec 2008: Irish equities suffer largest losses in 215 years
• Feb 2009: Do BRICs (and Germans) Eat PIGS?
• Jul 2009: Depressionary bust in Ireland is echoed in California
• Aug 2009: Government banking Irish edition

Its bad bank – called the National Asset Management Agency (NAMA) – is the most ambitious of its kind and harkens back to the Swedish crisis solution of the early 1990s.  They are truly trying everything they can to revive their economy.  But, a fiscal crisis is looming.

A Fistful of Euros reports:

In April, a supplemental budget that was supposed to settle things for the rest of 2009 forecast a general government balance of -10.75 percent (of GDP) for 2009 and 2010.  Assuming the same package of cuts as the April budget did, the respected Economic and Social Research Institute has just forecast deficits of close to 13 percent for 2009 and 2010.  2 percent of GDP went missing from revenue projections over a few months.  To give credit where it’s due, the IMF never believed the government’s deficit forecasts even at the time they were formulated and forecast deficits of 12 percent in 2009 and 13 percent in 2010.

How big a deal is 2 percent of GDP?  Well, the Irish government has told the European Commission that it will have the deficit down to the Maastricht level of 3 percent of GDP by 2013.   Since the macroeconomic framework for Budget 2010 has already been set, that’s 3 budgets to achieve a fiscal adjustment of 10 percent of GDP, and formulated in the context of inability to reliably forecast tax revenue even 6 months ahead of time.   And the new forecasts allow for a relatively benign global environment relative to the dire projections of earlier in the year, so this is specifically a crisis within the Irish Exchequer.

There is zero chance the Irish are going to be able you make a fiscal adjustment of 10% of GDP in 3 years in a weak economic environment. And we know where this type of policy leads by looking at Latvia.  So, now it seems government officials are finally coming clean and admitting, much as Latvia has done, that the only way out of this fiscal crisis is a bailout plain and simple.

The FT reports:

A senior Irish minister has for the first time warned Ireland could be forced to go to the International Monetary Fund for help if the country cannot implement the necessary cuts in the December budget.

The bleak assessment by Mary Harney, health minister, and former deputy prime minister, was one of several ministerial warnings on Friday choreographed to bolster public opinion for what is set to be harshest budget in the country’s 88-year history.

Mrs Harney, a leading economic reformer, said: “We’re spending €500m a week more than we’re raising. That’s an unsustainable situation.

“If the government hasn’t the capacity to do what’s needed, then others will come in like the IMF and overnight they will make decisions.”

Given the fixed exchange rate into which Ireland is locked via the Euro, there will be no competitive currency devaluation.  So the spectre of banking collapse is still a force with which to reckon. Monies from the IMF will certainly reduce the risk.

Related posts:

• Trouble in Ireland as Fitch cuts debt two notches to AA- and deficits soar
• Ireland guarantees bank deposits at six banks
• Ireland nationalizes Anglo Irish bank
• Irish unemployment gaps up by most in 40 years
• Ireland: government blew the boom

The Irish government today announced that, if necessary, it is prepared to take majority shareholding in ailing Irish banks. However, it has ruled out full-scale nationalisation. But, what is a majority share by government except nationalisation?

This is a duplicitous parsing of words that hides a more sinister interpretation of what is happening in Ireland.

Here’s what Ireland’s Finance Minister Brian Lenihan has to say, according to the Guardian newspaper:

"Some institutions may need capital after they have transferred loans to Nama," Lenihan told a joint Irish parliamentary finance committee this afternoon. But the minister ruled out full-scale nationalisation of the country’s banks. "This will increase the state’s ownership in these banks and in some cases that may result in a majority shareholding," he said.

So, if I could paraphrase Lenihan, he is saying: we are having a temporary problem in Ireland whereby some of the weaker but systemically important institutions need more capital.  We in government are going to give them that capital to maintain the functioning of the financial system.  Technically, this makes us the majority owner, with all the rights, privileges and responsibilities ownership entails.  However, we don’t want to be bank owners and will look to reduce our stake when these firms return to a better capital position or raise more funds from private investors.

I translate this as Lenihan implying the government intends to socialize the losses of the Irish banking system despite the looming fiscal problems in the country.  In my view, this is the worst outcome of potential policy remedies and the least free-market approach.  However, there may be a silver lining in terms of a healthier banking system.

Back in March when everyone was actually talking about solutions, James Kwak categorized three dominant potential banking system solutions. I have bolded the parts I intend to stress:

I think there are three main positions in this debate:

• A1: The banking system is broken. Banks need to get rid of their toxic assets and they need more capital. The solution is for the government to buy their toxic assets at a high price (or insure those assets) and to give them lots of cheap capital.
• A2: The banking system is broken. Banks need to get rid of their toxic assets and they need more capital. The solution is for the government to take them over, transfer off their toxic assets, recapitalize them, and (when possible) sell them back into the private sector.
• B: The banking system is basically sound and will recover if we give it some time. In the meantime, the government should give the banks just enough money and intervene as little as possible to keep them afloat until asset prices recover.

Do you recognize these solutions? A1 is America’s dead-on-arrival PPIP program which was killed by A2, used successfully by the FDIC every Friday night, and A3, otherwise know as the bailout of too-big-to-fail institutions like Citigroup and Bank of America, neither of which has yet to return TARP money.

It sure sounds like Ireland is trying to implement solution B a.k.a. socialization of too big to fail bank losses.  The problem of course is the Iceland scenario i.e. a situation in which the government, now majority owner of several large financial institutions, cannot credibly act as guarantor for those institutions, but has implicitly or explicitly promised to do so. I don’t like the drip-drip-drip approach because it creates the zombie bank problem I just spoke of in my last post on Scandinavia.  This is the same approach taken with RBS and Lloyd’s-HBOS and in the U.S. with Citi and BofA. But, in Ireland, there is even more downside risk as there was in Iceland.

However, at a minimum, the Irish are talking about hiving off bad assets from good and trying to re-insert the cleansed financial entity into the banking system.  This is the approach Sweden took in its early 1990s bank crisis. If one is going to have government banking – and this is what is happening in Ireland no matter how you parse the words – one needs to know that the resulting private financial institutions will be healthy.  Ireland’s National Asset Management Agency gives the country a good chance of getting those healthy banks.

Related posts:

• Irish government unveils plan to recapitalise banks
• Ireland nationalizes Anglo Irish bank
• Ireland guarantees bank deposits at six banks
• Irish equities suffer largest losses in 215 years
• Is Ireland the next Iceland?

The bloggers at bloggers at UMKC’s economics blog have been making the case that California’s IOUs are a currency.  Randy Wray’s entry last Monday was particularly provocative because he suggests a movement to loosen national government power is supporting similar moves in other jurisdictions. Wray writes:

Some commentators have argued that the proposed California "warrants" are similar to local currencies (see, e.g., Mark Thoma). In this piece I discuss experiments with local currencies and continue my argument that if California were to accept its own "warrants" in payment to itself, it could turn these into a functioning currency free of the defects of local currencies.

Interest in local currencies has soared in recent years, with nearly 100 U.S. communities experimenting with them. While proponents offer a variety of arguments in favor of local currencies, they share three common themes. First, there is concern that the use of a national, monopoly, currency creates a variety of economic, social, and environmental problems. Second, local currencies are said to improve regional communities, again across several dimensions including economic, social, political and environmental spheres. Third, many proponents want to reduce the power of national government, recognizing a relation between the monopoly of currency issue and centralization. They believe that decentralized money would shift power back to the communities.

However, previous adventures in local currencies have failed miserably as Wray later attests:

As discussed, most local currencies have failed (of the 82 created between 1991 and 2004, only 17 remained by 2004). Those that succeeded shared some combination of the following characteristics: an exchange rate pegged to a strong national currency by a trusted institution; substantial supplies of unemployed or underemployed workers; businesses operating below capacity; and a strong community spirit, led by liberal, middle class residents. These characteristics are not always easy to replicate nor are they necessarily desirable. If the goal is to displace the national monopoly currency, linking the local currency to it appears inconsistent—especially if one fears national government policy is inflating away the value of the nation’s currency.

So I have another idea, which I got from a knowledgeable reader nicknamed aitrader.  How about a Gold-backed IOU system.  In response to a recent post I wrote on the similarities in the troubles in California and Ireland, he wrote:

Now here’s a curve ball for ya: what would happen if a state or even a private bank were to issue currency redeemable in gold or silver? What would the implications be for the US Federal Reserve? This was the situation for many years in the US. Private banks often issued their own paper currency redeemable in gold and silver. There is nothing illegal about this, though one would assume a new law would be crafted and passed to prevent this from occurring. On that note here is what happened recently to a private currency issuer, http://en.wikipedia.org/wiki/Liberty_Dollar#Fed….
Interesting times…

So, let me explore his idea using Ireland instead of California.  I want to use Ireland as the example here because, in discussing my California-Ireland post, the Economist pointed out that Ireland is the place where true problems lie. The Economist says:

There is a problem with Mr Harrison’s thesis in the fiscal policy department, however. California has faced credit downgrades, but only because it is legally prevented from running deficits—it must default if it cannot make all its payments out of pocket. But California has a relatively small debt load, so far as nations go. If the state were allowed to run annual deficits, it seems highly unlikely that it would face pressure to balance its budget amid recession.

Ireland, on the other hand, is confronted by actual market pressures to prove that it can meet its obligations; it’s in trouble in an absolute sense. Ironically, both have fiscal difficulties that are not rooted in their federal status; Irish borrowing is limited by markets while California’s borrowing is constrained by the state constitution.

Point taken. So Let’s solve this problem.

Say Brian Lenihan is dispatched to consider how to prevent the government from sacking tens of thousands of workers in order to prevent the Irish from defaulting on its debt. 

He suggests that California’s IOUs are a model for Ireland, but he goes one step further adding a redemption in 5 years at a 40% premium to the present spot price for gold, which represents a 7% annual return.  Today, spot gold is trading at $950 an ounce. So, a 40% premium is about $1330 an ounce for gold.  Lenihan would offer this deal to any and all creditors of the State in lieu of cash.  The IOUs would be tradable in standardized amounts of 20, 50, 100, 1000, 10,000 and 1000,000 euros in order to facilitate a secondary market.

I got this idea from the high yield market where often bonds are issued with an embedded option to convert to equity at a premium or with PIK preferred shares thrown in as a kicker.  The point of these options is to provide a sweetener to investors in order to get the deal done.  These are the same kinds of deals that Warren Buffett did with General Electric and Goldman Sachs in 2008, and that he has previously done with USAir (now US Airways) and Salomon Brothers (now a part of Citigroup). If the embedded option increases in value significantly, the debtholder can make a lot of extra money.  For Buffett’s options in Goldman, this has already occurred.

Here’s what the ‘investor’ gets in the case of the Irish IOUs:

1. Bonds backed by the full faith and credit of the State paying a rate of interest that I suggest be a slight premium to the official 5-year bond.
2. A 5-year out of the money European option to buy gold for the full face value of the bond at today’s price.  Obviously,if you think gold is going up you would be willing to pay a lot for this option.
3. An IOU that is not just backed by the full faith and credit of the sovereign like most currencies, but that has a tangible link to a real asset, gold.

What does the sovereign get?

1. Ireland conserves cash without having to issue bonds.  Ostensibly this would mean interest rates on Irish bonds could remain lower. That’s a huge deal, especially since these IOUs would not be considered legal tender.
2. Ireland removes the restriction imposed by the Maastricht treaty as the IOUs are not cash and reduce the budget deficit.  In effect, the government is free to add fiscal stimulus without those restrictions.

Obviously, the Irish government would have to hedge their gold commitment by buying Gold futures. But, the Irish could then legitimately claim that its IOUs were more than just a piece of paper.  And, they would remove some of the constraints now impose upon it by foregoing their own currency.

Related posts:

• Pre-payments are reducing value of mortgage-backed securities
• Ireland: government blew the boom
• Gold hits all-time record high
• Spain and Ireland ‘thrown to the wolves’ after ECB move
• Ireland gets deflation

For quite some time now I have been of the view that there are a number of striking similarities between the goings on in Ireland and those in California, none of them good.  Both locations have seen extraordinary rises in home prices turn to massive busts. As a result, both locales have seen depression-like collapses in consumer demand and the local economy. Unemployment and government deficits are surging in both California and Ireland.  But, both California and Ireland have zero control over monetary policy and this is the crucial connection.

Ireland

Let’s rewind a bit to 1999 when the Euro came into being.  Ireland was a founding member of Euroland. So, on January 1st of that year, the Irish fixed their currency the Punt to the Euro for good at a rate of 0.7876. From that time forward, Ireland effectively had no control of the monetary spigot.  By 2002, Punts ceased to exist as money in Ireland and the Euro was ushered in.

What this change meant for Ireland is that it had the many benefits that go with being part of a large single currency market. Among the many advantages of a single currency are reduced foreign exchange costs, less currency volatility, less chance of a run on the currency, and a greater certainty in business planning that results from those benefits.  And these benefits can be huge in times of crisis – just ask Iceland.

There is a problem though which I mentioned before, namely the Irish have no control over their own money.  To be sure, hard money types probably see this as a good thing as it prevents countries inflating to get out of an economic pickle. But, the alternative for the Irish has been depression.

Back in February, I mentioned this problem in a post called “The European Problem.”

The Eurozone members have decided to forgo independent monetary policies. Individual member nations have free capital movement and a fixed exchange rate but zero control over monetary policy. That rests with the European Central Bank (ECB) in Frankfurt.

The problems mount in recession. Some members are getting devastated. Spain, for instance, is in depression already with unemployment at 14%. Ireland’s national budget is imploding with estimates for deficit reaching 10-12% of GDP. If you are Spain or Greece, you would like to print money– a lot of it. But that’s not happening in the Eurozone yet.

The result is a potential national bankruptcy for the likes of Ireland, one reason their credit rating is suffering. Will Ireland go bankrupt?  Perhaps.  It is unclear how willing other Eurozone members would be to support the country were it to run into that kind of difficulty.  The Germans are furious for having abandoned the Deutsche Mark for the Euro, which they see as a ‘weak’ currency.  Bailing out a Eurozone member would come with many strings attached.

Then, there is the case of Austria.  They too are in the Eurozone.  They have a weak banking system because of excessive lending to Eastern Europe — reaching a full 85% of Austrian GDP.  (Whether the Austrians were mentally re-creating their lost Empire, stripped after World War I, is a case for the Austrian psychologist Freud). If the Eastern Europeans run into problems, Austrian banks will fail en masse, requiring help from other Eurozone members (read France and Germany).

So, Ireland, having no other choice, must cut spending…drastically.  Ambrose Evans-Pritchard reports.

Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15pc of GDP. They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous debt compound trap.

A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12pc and heading for 16pc next year.

Education must be cut 8pc. Scores of rural schools must close, and 6,900 teachers must go. “The attacks outlined in this report would represent an education disaster and light a short fuse on a social timebomb”, said the Teachers Union of Ireland.

Nobody is spared. Social welfare payments must be cut 5pc, child benefit by 20pc. The Garda (police), already smarting from a 7pc pay cut, may have to buy their own uniforms. Hospital visits could cost £107 a day, etc, etc.

California

I hope this sounds familiar to American readers because this is exactly the scenario faced by California.  The state does not have the option of going out to the California Federal Reserve Board’s backyard to pick a few ten billion dollar notes off the money tree. This is a privilege reserved for the U.S. Federal Government, one I would add that has the Chinese worried.  Effectively, California is to Ireland as the United States is to the Eurozone.  And that spells depression for California.  Here are a few headlines:

• California prepares to shut 220 state parks to make up budget shortfall
• California’s Crisis Hits Its Prized Universities
• California closes state offices to save cash

Welcome to Reykjavik on the Pacific.  Don’t think this train wreck happened overnight. It has been building for months.  I first asked in October of 2008 is the State of California bankrupt.  Technically, they are not.  But, when a state refuses to honor its bills by handing out IOUs, that’s bankruptcy to me.

It is going to get worse for California. That is for sure. The problem here again is the depressionary bust that is likely to take hold as California starts firing workers and cutting spending. Remember, people with no jobs have little income. And having little income means foreclosure, which also means a surge in housing inventory and falling prices. That’s a recipe for still more foreclosures, continued house prices declines and a deflationary spiral.  I imagine Wells Fargo and Bank of America would be rendered insolvent by such a scenario.  So why is Obama balking at lending a helping hand?

I anticipated a bust in California and a helping hand from the Obama Administration, because I figured they wanted to mitigate worst-case outcomes. As far back as January 2nd, I was already saying this was the likely scenario.  I asked “Will federal largesse be countered by state and local cutbacks?”

There has been a general outcry for economic stimulus on the part of the North American, U.K. and Eurozone federal governments to counteract the fall in private sector consumption.  In the U.S. and the U.K. in particular, this message is being heard and largesse will be delivered in spades.

But, in the United States, there is a bit of a problem: state and local governments.  They will not, and often cannot, spend.  In fact some will be cutting.  Will local government budget cuts undercut federal fiscal stimulus?

Yes. Yes. Yes.  Doesn’t the Obama administration see this?  I would argue they did not understand this in January or the stimulus bill would have been larger and more front-loaded. But, perhaps they do now, but have chosen not to act because every state and municipality in America would be looking for a handout if they did try to act in California.  So, we’re in bit of a pickle here.

Conclusion

The foregoing analysis can’t leave you feeling like recovery is imminent in Europe or in America.  Certainly, it is not in Ireland or California.  The problem is the Impossible Trinity of a fixed exchange rate, independent monetary policy and free movement of capital. You cannot have all three. And California and Ireland both lack the monetary escape hatch. Depression will set in.

I see only three choices to solve this problem.

1. Bailouts: Of course, we are going to see requests for transfer payments here. Will Obama bite?  Will the Germans block this, afraid that the Austrians and Spanish would be next?  Obviously, transfer payments are part and parcel of a monetary union in order to achieve economic harmonization.  In the U.S., California gets less in federal largesse than it pays in taxes. This is a fact.  However, it is looking ever less likely that this fact will help Schwarzenegger receive the help he wants.
2. Backdoor currency: Marshall Auerback has argued that the IOUs in California are a backdoor currency system. No, they are not legal tender.  But, in a note to me, he said “California can turn its warrants into sovereign currency by agreeing to accept them in payments to the state. Note that I AM NOT arguing that California should make them “legal tender, payable for all debts public and private”—this is something it cannot do. But you could basically reduce the cost of CA’s borrowing substantially via this device and essentially reduce the need for muni bond issuance.  In fact, the implication that flows from my analysis is that you’d want to buy every single muni bond in sight as the IOU, by giving it an intrinsic value to pay state tax, effectively eliminates the need for muni bond issuance.”  Could Ireland do the same?
3. Immigration:   People are just going to have to move.  As jobs disappear in Ireland and California, the Irish and Californians will need to emigrate elsewhere. They have a huge market to chose from in both cases.

None of these are great options. I wish I had something more uplifting to say here. But, that is the situation we face.

Related posts:

• Ireland: the bust after the boom
• Did joining the eurozone bust Ireland?
• Ireland: government blew the boom
• Spain and Ireland ‘thrown to the wolves’ after ECB move
• Ireland: Next stop – IMF

For the time being, I am more worried abut the potential inflationary effects of quantitative easing than about the deflationary impact of deleveraging.  But, the latest news from Ireland shows us that deflation is alive and well. This comes via the Irish Independent:

Consumer prices recorded a second annual drop in April as the cost of energy, clothes and food declined amid a deepening recession.

Prices based on a European Union measure dropped 0.7 percent from a year earlier after falling at the same rate in March, the Cork-based Central Statistics Office said today. The decline in March was the first annual drop since the data were first collected in 1996. Prices rose 0.1 percent in April from the previous month.

Crude oil has dropped around 60 percent since reaching a record $150 a barrel in July. At the same time, waning consumer demand as unemployment rises has prompted stores to cut prices.Tesco this month said it will reduce prices at some Irish stores by as much as 22 percent.

Rising unemployment and tax increases have “heightened consumers’ reluctance to spend,” Lynsey Clemenger, an economist at Ulster Bank in Dublin, said in an e-mailed note today. “Prices have further to fall, as the consumer strike continues.”

The EU measure excludes mortgage interest payments. Based on an Irish gauge, prices fell 3.5 percent in April from a year earlier, the biggest decline since 1933.

In my opinion, the ECB’s recent announcement that it was getting into the covered bond market has a lot more to do with Spain and Ireland than it does with Germany.  Spain and Ireland suffer from their joining the Euro to escape the impossible trinity of free exchange rates, independent monetary policy and free capital movement.  Having sacrificed monetary policy for a fixed exchange rate, the Spanish and Irish are seeing some horrific debt deflation dynamics.  The ECB seems to have awoken to this and is now engaged in quantitative easing via the covered bond market (although Trichet denies this). See Edward Hugh’s take on this from a Spanish perspective.

So, Ireland has joined the deflation camp along with Spain, the U.K., Switzerland and China, to name a few.  If you think this deleveraging cycle is too powerful for the money printers to override, you’ll see the increasing number of countries with deflationary numbers as a bad harbinger.  However, if like me, you are equally concerned about the upturn in commodity prices and the steepness of the yield curve, you will also see inflation as a looming threat.

To be continued.

Related posts:

• Germany gets deflation
• Irish unemployment gaps up by most in 40 years
• Spain gets deflation
• Switzerland gets deflation too
• U.S. CPI: Lowest since 1954 – deflation here we come

Standard and Poors had their hands full today cutting credit ratings.  They cut Ireland. But, they also cut Hungary, putting the country just above a junk credit rating.  I don’t think these will be the last sovereign debt ratings downgrades, especially in emerging markets — economies worldwide are deteriorating.

The Brown Brothers Harriman currency group has released a view that includes South Africa, Poland, Mexico and Korea as well as Hungary.

Here is what Win Thin, a senior currency strategist in the group, had to say about the downgrades:

S&P has been busy today. Besides downgrading Ireland, it also cut Hungary by one notch to BBB- with the negative outlook kept. Just like they missed the mark with regards to subprime, so too did these agencies overrate many of the weaker EM credits (was Iceland really AAA?). Our internal sovereign ratings model (which we just updated for the latest FX quarterly) puts Hungary at a BB- rating vs. BB last quarter and actual ratings of BBB-/A3/BBB actual. Yes, Moody’s still puts Hungary at A3 (equivalent to A-). We think junk status is in the cards shortly for Hungary, and to reiterate our rather frank view, most of these EMEA credits really never deserved to be investment grade in the first place. Our model points to severe downgrade risks in the Baltics and the Balkans. We think Poland and South Africa face modest downgrade risk in 2009, as does Korea and Mexico. Otherwise, we believe the lion’s share of downgrades this year will be in the EMEA region. EUR/HUF likely to retest the 317 high.

Obviously emerging market risk still remains quite elevated and will not diminish for some time to come.

Related posts:

• Baltics: Fitch downgrade and more downgrades to come
• A bearish view on Eastern Europe
• More trouble in the Baltics as S&P downgrades
• Moody’s: Iceland, Latvia and Hungary in “fragile stabilization”
• Greece sees credit rating cut by S&P

Niels Jensen from Absolute Return Partners based in London sent me the following insightful analysis regarding the Euro, the possibility of Eurozone default, the possibility of a Eurozone bust-up and all things European. As Niels is snowed in under 8 inches of snow in wintery London, he obviously has had the opportunity to craft a piece of brilliance.

He has given me permission to publish this piece in full. However, you should also be able to find it at Absolute Return Partners’ website (www.arpllp.com), where there is a wealth of other research and commentaries. For further questions, the contact email is info@arpllp.com.

When the euro was introduced about ten years ago, the pessimists didn’t give it much chance of reaching its tenth anniversary. The euro, or so the argument went, was doomed from the outset because of the wide spread in economic performance and discipline amongst the member countries. At one end you had, and still have, the highly disciplined, but also slow growing, economies of Germany and the Netherlands. At the other end you find the faster growing but poorly disciplined countries such as Spain and Greece. As icing on the cake, you also had, and still have, countries that lack in both departments, such as Italy, making it difficult for the union to ‘gel’ – well, according to sceptics.

There is admittedly an embedded weakness in the way the European currency union is structured. In the United States, arguably that largest currency union in the world, fiscal transfers between member states allow for the federal government to adjust for variances in economic performances. There is no such mechanism within the euro zone, which explains why the member states are subjected to a number of rules¹. These rules require for everyone to exercise a high level of economic discipline. The problem is that there is little or no such discipline.

The best example is the huge spread in the rise of unit labour costs over the past few years. Unit labour costs measure labour (wage) costs adjusted for changes in productivity. It is probably the best measure that exists in terms of tracking the changes in competitiveness between nations. When the Stability and Growth Pact behind the euro was established, there was no reference made to unit labour costs which, with the benefit of hindsight, was a major mistake. Even Jean-Claude Trichet, the Head of the European Central Bank, who rarely admits mistakes, has publicly stated that if he could design the currency union all over again, he would push for a unit labour cost stability pact.

Back to the sceptics. What they failed to realise was that Europe, together with the rest of the world, was about to enter a period of unprecedented prosperity. The good times would not only gloss over the deeper problems, but the euro would actually go from strength to strength to a point where it now threatens to unseat the US dollar as the premier reserve currency of the world. It is therefore perhaps a mystery to some of you, why one should question the longer term viability of the euro. That is nevertheless what I intend to do.

The problem, as I have already alluded to, is poor discipline amongst several of the member states. Ever heard of the four PIGS? This less than flattering acronym stands for Portugal, Italy, Greece and Spain, four members of the euro zone which are all in much deeper trouble than they are prepared to admit. They are often considered the ‘antidote’ to the BRIC countries, the fast growing emerging market economies of Brazil, Russia, India and China. Let’s take a closer look at the unit labour cost index for various countries (see table 1).

Table 1: 2007 Unit Labour Cost Index (2000=100)

Notes: *2006. PIGS countries in bold. Source: http://stats.oecd.org/

Since the introduction of the euro, the PIGS have failed miserably to keep up with Germany on this measure of competitiveness. So has Ireland by the way, hence its current predicament. On the other hand, Brazil (the only BRIC country which the OECD reports unit labour costs on) scores very well on this account, a fact which is not going to make life any easier for the PIGS.

EU countries outside the euro zone, such as the UK, have also lost out to Germany in recent years, but the UK has been able to play a card which is not at the disposal of the euro zone members. That card is called devaluation. Whether by design or otherwise, the UK has received a massive boost to its competitiveness in recent months as a result of the sharp fall in the value of the pound. Italy used to play this card repeatedly back in the days of the Lira. So did countries like Denmark in the dark days of the 1970s.

Back in those days there was less economic integration and recessions were rarely global. Devaluations could therefore be used to stimulate exports. The situation today is fundamentally different. The global nature of the current crisis makes it far more difficult for any country to grow its way out through higher exports. The UK will offer a great case study to test whether devaluations are still a powerful tool.

Another issue, which is potentially even more destabilising for the euro longer term, is the massive liabilities facing Europe as its population ages. We have borrowed table 2 below from Goldman Sachs which makes no secret of the challenges facing a number of European countries. Greece is clearly facing the biggest challenge. Public debt, which currently stands at about 95% of GDP, will grow to a whopping 555% of GDP by 2050 if the current pension and social security programme is left unchanged. The Greek government is painfully aware of this and have been working on several new initiatives. It was the passing of one of those new laws which caused the riots in Athens before Christmas.

Table 2: Actual Debt & Age Related Contingent Liabilities

Source: Goldman Sachs, European Weekly, 22/01/2009

Considering the poor record of fiscal discipline, many euro zone members will probably allow their debt to grow much larger before decisive action is taken. The problems are so massive – and the solutions so painful – that most politicians chicken out and pass the problem to the next generation of politicians.

A third problem facing Europe is the sheer scale of the banking crisis. Although this is not just a European problem, European countries are probably worse off than the US because a larger part of European debt has to be financed externally. As you can see from chart 1, more than $2 trillion of European and U.S. bank debt needs to be re-financed before the end of next year. Unless there is a material improvement in market conditions, re-financing at such a massive scale is simply not doable.

Chart 1: Maturing Bank Securities in 2009/10 (USD)

Source: UBS

The European approach, at least until now, has been to save the banking system at any cost. It is therefore possible that a significant share of the re-financing cost will find its way to the sovereign balance sheets and hence ultimately to the tax payer. This could further destabilise the currency union.

All these challenges are surfacing as the global economy faces the worst year since World War II. I have noted that most economic forecasters are still quite sanguine about the prospects for 2010. Be careful. The models upon which these forecasts are built are based on experience from prior recessions; however, this is no ordinary recession and historical data is therefore largely irrelevant. I am becoming increasingly convinced that most of us are underestimating how long it will take to get the global economy firmly back on its feet again.

Kenneth Rogoff and Carmen Reinhart published a research paper about a month ago which should be mandatory reading for all investors². They have studied every single banking crisis of the past 100 years and reach some rather unsettling conclusions. As they point out: “Broadly speaking, financial crises are protracted affairs”.

Following a banking crisis, asset prices fall more and for longer than most investors realise (see charts 2a and 2b). So do output and unemployment. Most importantly, though, the real value of government debt explodes (see chart 2c) but not for the reasons you might think. Yes, the bailout costs are significant, but the main driver of rising government debt is actually the subsequent collapse of tax income.

Chart 2a: Decline in Real House Prices during Banking Crises

Peak to Trough Decline & Duration

Source: See footnote 2.

Chart 2b: Decline in Real Equity Prices during Banking Crises

Peak to Trough Decline & Duration

Source: See footnote 2.

Chart 2c: Cumulative Increase in Real Public Debt

First 3 Years following the Banking Crisis

Source: See footnote 2.

So when we are told that the bailout cost, although large, is still manageable, it is only half the story. The loss of tax revenue is another nail in the coffin and could lead to a dramatic – and unpredicted – rise in public debt. Have you heard any mention of that from your government?

At this point I need to introduce something as alien as the “flow-of-funds accounting identity”³:

?(G-T) = ?(S – I) + ?NFCI⁴

I rarely throw formulas at you for the simple reason that it scares many readers away. I urge you to stay with me for a bit longer, though, because this formula is critical in order to understand how the government response to the current crisis is likely to impact interest rates longer term. The equation states that any change in fiscal stimulus (?(G-T)) must equal the change in private sector net savings (?(S-I)) plus the change in net foreign capital inflows.

Translation: If our government stimulates the economy through public spending, as it is currently doing in spades, we must either save more or we have to rely on foreigners being prepared to invest in our country. There are no exceptions to this rule.

The key question, as our economic adviser Woody Brock points out, is what will cause this equation to hold true? It is quite simple. We will save more if we get paid more to do so (through higher interest rates) or if we are so scared of the future that we stop spending and start investing instead.

Foreign investors are no different. Now, with the trillions of dollars being spent around the world to shore up our financial system, the fear factor alone is not going to be enough. Higher – possibly much higher – interest rates will be required to ensure sufficient savings.

Obviously, there is another option at the government’s disposal. The central bank can monetize some or all of the deficit by buying the bonds issued by the government. This line of action will keep ?(G-T) down; hence the need for increased private savings (and/or capital inflows) drops accordingly. The problem with this approach, as an old Danish saying states, is that it is like wetting your pants to stay warm. Monetization executed on a big scale is highly inflationary in the long run, inevitably driving bond yields higher.

The good news is that we are very unlikely to loose control of inflation in the short run. The economy is simply too weak for that to happen. In Frankfurt, the ‘eurocrats’ are currently congratulating themselves that they, through strict monetary discipline, killed inflation in the aftermath of last year’s explosion in commodity prices. The reality, however, is that the credit crunch killed inflation – they didn’t – and Europe is now at a junction where even the smallest policy mistake could be very expensive indeed. In my opinion, the ECB has been way too slow in responding to the current crisis and they must act swiftly and reduce the policy rate to near zero levels in order to avoid a deep recession throughout the euro zone.

So, could all this lead to the destruction of the euro? Could the currency union actually break up? It is not that the risk to the PIGS has not been recognised by bond investors. As you can see from chart 3 below, investors in long dated Greek government bonds now earn about 2.5% more than they do by investing in correspondent German bunds.

Chart 3: PIGS Sovereign Debt Spreads over Germany

Source: Goldman Sachs, European Weekly, 22/01/2009

On the other hand, I may disappoint one or two readers (I will certainly disappoint Ambrose Evans-Pritchard of the Daily Telegraph who appears to have declared war on the euro), but I firmly believe that the euro will almost certainly survive the current crisis. I am much more worried about some of the member countries.

There is nothing in the Maastricht treaty which prevents a member country from leaving the euro, yet the decision to join is effectively irreversible. There are a number of reasons for this, the most important being economic costs. Take Italy which has a history of compensating for lost competitiveness through regular devaluations. If Berlusconi did the unthinkable tomorrow (sorry – nothing is unthinkable in Berlusconi’s world), Italy’s borrowing costs would explode. My guess is that bond investors would demand double digit returns on a Lira denominated bond to compensate for the dramatically increased devaluation risk. Already in a precarious fiscal position, Italy could quite simply not afford that.

So, if any country were to leave the euro, it would more likely be from a position of strength, and only one country possesses enough strength to pull that off in the current environment. That country is Germany. And, although the euro is not particularly popular in Germany, I believe it is extremely unlikely for Germany to make such a move unilaterally. There are several reasons for that – Germany’s history in Europe being the most important.

At the same time, the fact that the euro has saved the bacon of more than one country in recent months – Ireland being the most obvious example – should not be ignored. For this very reason, the euro membership is actually far more likely to grow than to shrink as a result of the financial and economic crisis engulfing the world. The issue the EU has to deal with is whether the new applicants should actually be welcomed. Most of those who would want to join will bring plenty of baggage.

Another possible outcome, which you hear almost no mention of, is the possibility of a new Transatlantic currency. When I mention this possibility, everyone laughs, but think about it for a second. The economic crisis on both sides of the Atlantic is enormous. Both are resorting to the same formulas – large fiscal stimulus and quantitative easing (a word invented by central bankers because ‘printing money’ smacks too much of Zimbabwe). There is a real risk that the entire financial and monetary system on either side of the pond needs to be re-designed. If that were to happen, I am pretty confident that the Fed and the ECB would at least sit down and discuss the possibility of a joint currency. That would also allow the UK to join a currency union without too much egg on its battered face.

In the short to medium term, though, there is no such bailout on the horizon. In recent years, the weaker members of the euro, such as Italy, have managed to ‘muddle through’ (to borrow one of John Mauldin’s favourite terms), mostly because the global economy has been strong enough to gloss over any weaknesses. D-day is now firmly on the horizon. As I see things, it is not inconceivable that a member country could be forced to default on its sovereign debt. Interestingly, any euro member country defaulting on its debt could (and probably would) carry on as a full member of the currency union. And I will bet almost anything that the EU would rather have one of its members defaulting on its debt than having to break up the currency union.

Another, and more likely, outcome is the possibility of one or more member countries coming under EU administration. This would almost certainly include the most painful of all cures – mandatory wage reductions in order to get unit labour costs back in line. It would be a lot easier for the government of, say, Greece to get the EU to do the dirty job than to do it itself. Civil unrest will no longer be the privilege of countries such as Indonesia or Thailand. The recent crowd trouble in Greece could very well turn out to be the dry run for much bigger and more organised labour market unrest across Europe as reality begins to bite.

For the time being, though, European governments continue to be in denial. When the IMF recently recommended that Spain implement various structural reforms, the idea was flatly rejected by Prime Minister Zapatero. In the meantime, you can sit back and prepare for the drama to unfold. Very simplistically, it is a choice between Zimbabwe and Japan. Our central bankers can choose to monetize their way out of the current slump and run the risk of much higher interest rates and a rapidly deteriorating currency like Zimbabwe or they can show fiscal discipline and accept perhaps ten years of below par growth a la Japan. Or they can find the delicate balance in between the two and everyone will live happily thereafter. But that requires both skill and luck.

 

---

¹ The Stability and Growth Pact is the main tool to keep economic policies (and hence performance) broadly synchronized within the euro zone. The pact states that no member country’s gross stock of debt must exceed 60% of GDP and that the public deficit in any year must not exceed 3% of GDP. However, the pact allows for these limits to be broken under certain circumstances.      

² “The Aftermath of Financial Crises”, Carmen Reinhart and Kenneth Rogoff, December 2008.

³ This part is taken from Woody Brock’s latest research paper, SED Profile, February 2009. See www.sed.com.

⁴ G = government spending, T = tax revenues, S = private sector savings, I = private sector investments and NFCI = net foreign capital inflows.

Related posts:

• Ireland votes No on Lisbon Treaty
• Iceland fast tracked for EU membership
• The case against the Euro
• Greece sees credit rating cut by S&P
• Denmark wants in on the Euro

The Irish government scrapped a planned recapitalization of Anglo Irish Bank and moved straight to full nationalization.  While some may view this as a necessary move to shore up a troubled institution, I see this as ominous news because the Irish banking system is systemically weak and subject to a potential collapse along the lines of Iceland.

The Irish government is to nationalise the troubled Anglo Irish Bank.

Brian Lenihan, the Finance Minister, said today in a statement that the €1.5 billion plan to recapitalise the bank announced last month will not go ahead, because the funding position of the bank had weakened and given the loan scandal that saw the bank’s top officials quit in December.

“The government has today decided, having consulted with the Board of Anglo Irish Bank Corporation, to take steps that will enable the bank to be taken into public ownership,” Mr Lenihan said.

Anglo Irish’s chairman and former chief executive officer Sean FitzPatrick resigned in mid-December after admitting he had failed to disclose an €87-million loan from the bank. Chief executive David Drum also quit.

“The funding position of the bank has weakened and unacceptable practices that took place within it have caused serious reputational damage to the bank at a time when overall market sentiment towards it was negative,” Mr Lenihan said.

“Accordingly the government believes that the recapitalisation is not now the appropriate and effective means to secure its continued viability. Therefore the government must move to the final and decisive step of public ownership,” he added.

Update 16 Jan 2009: In the interest of even-handedness I am posting this blurb from the FT’s Lex, which appeared after I wrote this article and is more positive about the Anglo Irish nationalization than I am. Their conclusion is that the disappearance of Anglo Irish as a drag on publicly traded Irish banks will bolster the other two big banks. The shares in AIB and BIR give the lie to this view. But, it is still early days.

Anglo Irish Bank, the country’s most reckless commercial property lender – and the most exposed to the Irish and UK property bubble – has at last been committed to the safety of an institution: the Irish government. Dublin procrastinated as the bank gasped its last, the chairman resigned over governance lapses and risks increased of a run on the bank. Full nationalisation became the only option to avert a collapse of the Irish banking system. None of the three largest banks now has a trailing earnings multiple of over one, which says it all.

Ireland’s banks got carried away in the heady years of a property and consumer spending boom that is now a distant memory. The economy could contract 4.5 per cent this year; unemployment is headed for 10 per cent; and with the government deficit zooming towards 10 per cent of gross domestic product, there is even talk of a visit from the International Monetary Fund. The government has been flat-footed from the outset. In September, it tried to steal a march on other countries, by guaranteeing all bank deposits and funding, but did nothing to bolster their capital position, leaving them exposed when, shortly afterwards, the UK government raised capital requirements for HBOS, Lloyds TSB and Royal Bank of Scotland.

Dublin then procrastinated until December, when it launched a €5.5bn bank recapitalisation plan. Bank of Ireland and Allied Irish Banks were offered €2bn a piece in exchange for 75 per cent voting control, and told to raise €1bn each in rights issues. Anglo Irish was in line to receive €1.5bn, but the run on deposits has now intervened. The downturn in Ireland will force Bank of Ireland and Allied Irish Banks to be more realistic in their bad debt projections. Both look safer bets now that the government has removed the sector’s main systemic risk. Ireland’s bankers and politicians can now resume discussion of their golf handicaps in the club bars.

Sources
Ireland nationalises Anglo Irish bank – Times Online
Irish banks – FT Lex

Related posts:

• Ireland guarantees bank deposits at six banks
• Irish government unveils plan to recapitalise banks
• Irish property dam about to burst
• Irish banks have unreported bad debt
• Government banking Irish edition

Today the Irish government has unveiled a 10 billion euro plan to recapitalise its outsized banking sector. I have posted a number of times about the depth of woes in Ireland including the high debt-to-gdp level, the crashing property sector and the steep decline in government revenues. I have also highlighted the fragility of the Irish banking sector. Ireland is a small nation that is heavily dependent on financial services as an economic engine. It’s financial sector is much larger than the government can reasonably support. This makes the country very vulnerable to a loss of confidence in its banking sector.

However, unlike Iceland, Ireland is attached to the Euro, a liquid currency that protects it from a currency attack like the one which helped precipitate the collapse of the Icelandic banking sector. That does not mean the Irish are immune. So it is positive that the government has taken steps to bolster the capital of the Irish banking system. And relative to GDP, this is a bigger package than the one unveiled by the UK, which was widely lauded in the press.

The Irish government is to provide a fund of £9bn (10bn euros) to recapitalise all its listed banks.

The money will be available to AIB, Anglo-Irish, Irish Nationwide, Irish Life & Permanent and Bank of Ireland, which owns the Bristol & West bank.

However before any money is paid out, the banks must await the outcome of the most recent rights issue.

If private investors choose not to step in, then the state will have to provide the money instead using the fund.

Finance Minister Brian Lenihan told RTE News: “Some financial institutions are so embedded in our economy, in terms of their borrowing and in terms of their deposits, that they are of systemic importance to our economy.

“It’s very important that our banking system is seen to sustain our economy and support our economy.”

Bank of Ireland and AIB shares have fallen 92% and 88% respectively this year.

Banking fears

The Irish government said the objective of making the fund available was to ensure the long-term sustainability of the banking sector.

It pledged to secure the interests of the taxpayer through appropriate terms and return on the investment.

The Department of Finance said the state may use money from the National Pension Reserve Fund.

The move would help boost the flow of funds to the country’s struggling economy, it added.

BBC business correspondent Joe Lynam said that, as a proportion of its economy and banking sector compared to the UK, the Irish bailout represents an even bigger capital injection than Britain’s.

Source
Irish banks to be recapitalised – BBC News

Related posts:

• Ireland guarantees bank deposits at six banks
• Government banking Irish edition
• Is Ireland the next Iceland?
• Irish equities suffer largest losses in 215 years
• Ireland nationalizes Anglo Irish bank

You think things are bad where you were.  Well, then, take a look at Ireland.  Irish punters are really taking it on the chin.  Stocks are down 75% from their peak in February 2007.  This makes 2008 the worst year for Irish equities since 1793, according to a report from Bloxham Stockbrokers. Ireland is at the extreme end of this bear market.

And Ireland is suffering for good reason: a massive property bubble and crash, huge debt loads and a bloated financial sector.  Nevertheless, the losses do beg the question whether the worst is behind us.

Bloxham sees five pre-conditions for a rise in equities in Ireland

1. A stabilisation in the bloated financial sector (and this likely means mergers, further recapitalisation and liquidation of some firms)
2. A thaw in credit markets
3. A reduction in market volatility (which Bloxham claims is at its highest level in 80 years)
4. A stabilisation of commodity prices
5. A reduction of corporate credit spreads

These are certainly major obstacles to overcome. But one really needs to look to the underlying causes of asset deflation and market volatility to know when a rebound is in the offing.  The problem is high debt loads, inflated asset prices and an over-sized financial sector.  When these conditions are righted globally, not just in Ireland, we may return to more favorable market conditions.

Source
2008 is worst year for Irish equities since 1793 – Irish Independent

Related posts:

• Irish government unveils plan to recapitalise banks
• Irish unemployment gaps up by most in 40 years
• Irish banks have unreported bad debt
• Irish property dam about to burst
• Irish sovereign debt interest rate spreads

Today’s round-up is going to principally be about the three CCC’s of Countries, Citigroup and Corporates.  But I also have some tidbits on other topics as well.  So let’s jump right in.

Yesterday sucked. Markets fell everywhere from Australia to Hong Kong to France to the U.S.  The U.S. fell to a 11-year low (adjusted for inflation this would be even worse, of course).  Quite frankly, we can’t stand any more of the selling pressure.  Luckily, after an initial fall in Asia, things are looking a heck of a lot better today.  Take a look:

So, let’s hope we can end the week with a bit of a relief rally.  What most concerns me right now are Corporates.  And by that I mean writedown risks, default/bankruptcy risk and corporate bond losses.  Let’s start with default and bankruptcy risks.

General Motors

General Motors ranks right at the top of risk when it comes to defaults.  I pick on GM out of the Big Three because it seems to be in the worst of shape cash flow-wise. According to Forbes, the company ranks number 9 worldwide in the number of employees: 266,000.  A GM bankruptcy would have horrific effects on the employment market, retail sales and the cities that depend on it like Detroit, Gary, Indiana, Windsor, Ontario or Cologne, Germany to name just a few.  Moreover, I believe the knock-on effects could be substantial in terms of losses in the Corporate Bond market, the Credit Default Swaps (CDS) market, the asset-backed securities (ABS) market and the CDO (Collateralized Debt Obligation) market.  GM has $32 billion in corporate debt outstanding. It is a major subject of CDS contracts and its cars are the underlying collateral in many an ABS or CDO.  The loss in retail spending from a GM bankruptcy would have negative repercussions for credit card defaults and, therefore, the ABS and CDO markets for securitized credit card debt.  In short, a GM bankruptcy would not be good.  Pat Buchanan has an interesting take on this – with Washington to blame for Detroits problems.

Yet, the Bush Administration is acting with GM much as it did with Lehman Brothers — assuming that a bankruptcy is best handled by the market without any contingency plan whatsoever for negative consequences.  This is a very ideological approach to governance, and in the midst of a credit crisis, breathtakingly reckless.  In my view, policy regarding General Motors is looking a lot like policy toward Lehman Brothers.  And we know where that led us.  Which brings me to the next Corporation.

Citgroup

Were GM to go under, it would create a difficult situation for other beleaguered companies just as Lehman’s demise did. Citigroup is one of the most beleaguered. This company has really taken a beating of late.  And rumors are circulating everywhere about the company. Much ink has been spilled regarding the goings on at Citi and what to do about this.

• Citi Considers Selling Itself, in Whole or In Parts (And is Barking Up Wrong Tree re Shorts)
• Sheila Bair and seizing Citigroup
• Remember Sheila Bair wanted to sell Wachovia to Citigroup
• Time for the Government to Buy Citigroup

I’ll leave it at that.

China

Then there are the countries.  China is the first to think about.  I got a note just a while ago from a friend published by UBS regarding China.  It reads:

A major announcement is expected by the PBOC at 4.00 local time. Speculation is for a 54bpt rate cut and a 100bpt reduction in the reserve requirement. There is also talk that Hong Kong banks will be given direct access to the PBOC. There has also been talk from the Korean government that they would support the Korean shipbuilders and the Korean car makers. Whilst this all sounds great (and indeed it is), it raises a much bigger question. Given that Hong Kong is pegged to the dollar (and has been intervening aggressively in recent days to stop its currency breaking through the upper band) and given that China and other countries run quassi-pegs, then if the United States is quantitatively easing, then are these guys going to have to follow suit? And what of those free floating currencies; will Europe be left out in the cold, or will they start to print money as well?

The rumors circulating about China are that the country has untold rural poor stalking urban centers for employment and that China needs to continue to grow to meet employment demand or civil unrest will ensue. As the world depends on China as a major source of savings for investment, slowdown in China has disquieting implications both domestically and globally.  See Yves Smith’s “China fears grow over job losses”.

Ireland
And then there’s Ireland. I already wrote a provacative piece pondering whether Ireland was about to go the way of Iceland (strangely enough, if you replace the ‘c’ in Iceland with an ‘r’ – voila: Ireland). But, I find the drumbeat of bad news leaving this country is growing very loud.

• Irish shares slump 75pc from peak as ISEQ hits 13-year low
• Fears of company closures as banks tighten grip on lending
• AIB raises €2bn by tapping the bond market
• Bank of Ireland shares surge on takeover reports
• Jobs fair seeks to lure Lithuanian workers home (the Lithuanians don’t have a lot to go home to right now)

So, those are my worries.  I am heartened by the market’s likely rise but we face some serious hurdles to overcome in the near term.

I have a lot more news to share as always via the news feed.  Below are a few of the stories.  Enjoy.

• Senate sends Bush expanded jobless benefits bill
• Eurozone output hits record low
• Toyota Will Cut 3,000 Jobs in Japan as Car Sales Fall
• Australia, Japan Money Costs Rise; Banks Hoard Amid Bond Risks
• U.S. global dominance ’set to wane’
• Have past crises taught us anything?
• The bailout is turning into a fiasco
• Looking Back Even Further (The Panic of 1873 was the real Great Depression)

Sources
General Motors, Fortune Global 500 – Fortune
GM, Ford, GE debt volumes exceed CDS exposures – Reuters

Related posts:

• GM offers a debt for equity swap to bondholders
• Chrysler: bulls make money, bears make money, pigs get slaughtered
• GM gets the green light on its section 363 bankruptcy
• News round-up: 20 Aug 2008 – financial institutions special edition
• GM Board: Bankruptcy is an option we will consider

Just a few moments ago I caught a very interesting post on Alice Cook’s site UK Bubble. The gist of the post was that things are falling apart in Ireland very quickly. Given what we saw with Iceland, I have to ask: is Ireland next?

I wouldn’t suppose that things are this fragile but we cannot dismiss out of hand talk of Ireland going the way of Iceland. Here is what Alice posted:

Someone left this intriguing comment on one of my posts yesterday:

Alice can you shed any light on what is going on in the Irish Republic?

Last week beef prices collapsed. This week I am unable to sell finished beasts at all.

Last week a police strike in Donegal was narrowly averted when the local authority agreed to stump up accrued overtime.

Bank of Ireland shares are trading for under 90 cents from a one time high of 18 Euro. It looks like the Government’s bluff is about to be called…

Rumour has it that the cashpoint system will stop within 3 days

Can you shed any light?

Is there anyone out there who can help?

Now, Ireland happens to be one of the worst affected bubble economies in Europe. They have seen a massive house price bubble along with huge leverage as their economy leapt forward over the last decade. However, this has all gone pear-shaped in the last year or so and Ireland has a recessionary economy with rising unemployment, collapsing house prices and severe knock-on effects in terms of commercial property. Immigrants, who once flocked to Ireland are no longer coming.

Meanwhile, Ireland was the first country to offer a blanket guarantee to it’s banks’ depositors. I welcomed this move as a necessary step to restore confidence. However, there are two problems associated with it.

1. As Willem Buiter has pointed out, this move was a “beggar thy neighbour” policy which initially sucked deposits out of British institutions. British savers flocked to government-protected Irish institutions in the UK which courted the British savers with higher interest rates — the government had effectively subsidized the banks. Eventually, Europe as a whole got onside, and sweeping deposit guarantees were offered all around.
2. The government must be able to credibly back up its guarantee. And this where Ireland looks a lot like Iceland. The country has an outsized financial sector which could not possibly be guaranteed by the Irish government. Moreover, Ireland is a member of the Eurozone — meaning it can’t print its own money. The UK, which borrows in Sterling can at least print money to finance any guarantees. The Irish are constrained — and, therefore, vulnerable.

It remains to be seen whether there is a sub-current of panic about the fragile Irish banking system that could lead it to Iceland’s fate. In fact, commentators like Wolfgang Munchau have argued that the single currency is a boon to the likes of Ireland because it prevents currency attacks like the one Iceland suffered, leading to its downfall.

However, a run on Irish banks is what would ultimately bring the Irish down. After all, it is the Government bank guarantee which creates the vulnerability. The Irish Government needs to make some contingency planning because an Icelandic fate is not out of the question. It need not worry about a currency run, but a bank run is still possible.

There are two ways to skin a cat.

Sources
Ireland – what is going on? – UK Bubble
Why the British may decide to love the euro – Wolfgang Munchau, FT
The Irish solution: unlawful, beggar-thy-neighbour and short sighted, but apart from that OK – Willem Buiter, FT Mavercon
Iceland, Switzerland, Denmark, Sweden, Jordan and countries with banks that are too big to bail out – Bronte Capital
The first casualty of the crisis: Iceland – VoxEU
Stunned Icelanders Struggle After Economy’s Fall – NYTimes.com

Related posts:

• Ireland guarantees bank deposits at six banks
• Irish government unveils plan to recapitalise banks
• Ireland nationalizes Anglo Irish bank
• Trouble in Ireland as Fitch cuts debt two notches to AA- and deficits soar
• Ireland: Next stop – IMF

When the Euro was formed, bond traders looked askance at Southern European sovereign debt, which trade at a considerable premium to debt from Germany, France and the Netherlands. In those days, the Southern European countries developed the offensive nickname PIGS (for Portgual, Italy, Greece, and Spain). But after EMU, those bonds converged to yield nearly the same as the Germans.

Convergence is over and divergence seems to be the new trend, but this time Ireland has replaced Italy as one of the PIGS. Their bonds are traded at heavy discounts according to the Irish Independent:

Irish Government bonds have widened considerably in recent days amid growing speculation the State may have to invest, or underwrite an equity raising, in the country’s lenders.

Ireland’s 10-year bonds have moved from 4.48pc to 4.66pc within the past week, compared to 3.77pc for the German equivalent. They have become more expensive than the 4.64pc yields of Portugal, though remain below those of Italy (4.97pc) and Greece (5.33pc).
-Irish Independent

Needless to say this is the kind of statistic that has Eurosceptics like Ambrose Evans-Pritchard foaming at the mouth and plotting the demise of the Euro.

Source
Our banks need to be recapitalised at once, says top businessman – Irish Independent

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• Irish equities suffer largest losses in 215 years
• Irish banks have unreported bad debt
• Irish property dam about to burst
• Irish unemployment gaps up by most in 40 years
• Irish government unveils plan to recapitalise banks

Along with American and British banks, Irish banks have been under heavy attack due to the turmoil in the financial services sector. The government has finally had enough and stepped in with a blanket guarantee for six institutions of both deposits and bank debts.

This is a move that is identical to what the Swedes did during their banking crisis and I see this as a necessary position from which to start true banking reform and recapitalization.

The goal is to stop the loss of confidence in banks as deposit institutions and as bank counterparties first. Then, one can move on quickly to the comprehensive solution of merging, liquidating and recapitalizing.

Ireland’s government said it will guarantee Irish banks’ deposits and debts for two years, seeking to calm investor concern after banking shares fell 26pc in Dublin.

The government said it will safeguard all deposits at six financial institutions in response to turmoil in financial markets.

The scheme, which starts immediately and expires in September 2010, applies to Allied Irish Bank, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, Irish Nationwide Building Society and the Educational Building Society, the government said.

“The guarantee is being provided at a charge to the institutions concerned and will be subject to specific terms and conditions so that the taxpayers’ interest can be protected,” it said in a statement.

Anglo Irish Bank, Ireland’s third-biggest lender by market value, plummeted 44pc yesterday – the most in more than 21 years – leading Irish financial stocks lower, as European governments rescued banks hit by funding shortages.

Read the rest of the article at the source below.

Source
Irish government guarantees bank deposits – Telegraph

Other sources
Ireland gives savers guarantees for two years – Times Online

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• Australia guarantees bank deposits for three years
• Ireland nationalizes Anglo Irish bank
• Irish government unveils plan to recapitalise banks
• Is Ireland the next Iceland?
• Trouble in Ireland as Fitch cuts debt two notches to AA- and deficits soar

Further evidence that the housing slump has spilled over into the real economy in Ireland comes from Irish unemployment numbers today, up the most in 41 years of data. Ireland looks to be one of the hardest hit countries in Europe. In all likelihood, Ireland already is in recession with data like this.

Irish unemployment rose in July to the highest in a decade as the country’s housing slump deepened, prompting builders to cut jobs.

Benefit applications, adjusted for seasonal swings, increased to 226,000, the highest since July 1998, from 215,400 in June, the Cork-based Central Statistics Office said today. The claimant count has increased by 63,600 in the last 12 months, the biggest annual increase since the data was first collected in 1967.

The unemployment rate rose to 5.9 percent in July from 5.6 percent in June, according to the report. Irish monthly jobless figures include part-time and seasonal workers who claim unemployment benefits. Based on the Quarterly National Household Survey, the seasonally adjusted unemployment rate was 4.8 percent in the first quarter.

-Irish Independent, 30 Jul 2008

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According to the Irish Independent, the recent fall in Irish bank shares is due to a loss of faith in their bad debt provisions. On Tuesday, Bank of Ireland fell 14%, the largest amount in 20 years.

After last week’s dive in their share prices, the Irish banks are under pressure as never before. It is now abundantly clear that investors no longer believe the bad debt numbers being published by the Irish banks. Until they do, bank share prices will keep on falling.

Tuesday was a defining moment for the Irish banks. With their share prices already down by between 63 per cent and 76 per cent since their peaks in the first half of 2007, banks shares tumbled by a further 5 per cent on Tuesday morning.

Events in the UK, especially the implosion of Bradford & Bingley, have been weighing on Irish shares as similar previously hidden losses are expected there soon as well. Moreover, Irish banks are also heavily exposed to the UK, where there has been a steep drop in house pries.

Overseas investors are looking at the Irish and UK property markets, to which all of the Irish banks are heavily exposed, and not liking what they see. Irish house prices are down by almost 12 per cent since March 2007, while commercial property values are down by an estimated 20 per cent. Across the water, house prices are falling at their fastest rate since 1992.

The numbers are startling. At the end of 1997, total Irish private sector credit stood at just €56bn. By the end of 2007, just 10 years later, it had risen almost seven-fold to €375bn. However, it was not just the scale of the Irish credit explosion with average annual credit growth running at over 21 per cent a year for a decade, which spooked overseas investors, but the changing composition of Irish bank lending.

A decade ago mortgage and other property-related lending, such as loans to builders and real estate developers, made up 38 per cent of all bank lending or about €21bn. By the end of 1997, the volume of such property-related lending had increased more than eleven-fold to €236bn and made up over 61 per cent of all bank lending.

In other words, property-related lending increased from just over a third of all Irish bank lending to almost two-thirds in a decade. Over the same period, average Irish house prices rose by 208 per cent.

Overseas investors take one look at those numbers and head for the hills. It is their perfectly legitimate fears — that such a huge increase in property-related lending and property prices will be followed by a price collapse, resulting in massive bad debts, and not the activities of the largely mythical short-sellers, which have caused the collapse in Irish bank share prices.

So just how massively exposed are all four quoted Irish banks to the property market?

Least exposed is AIB which has 59 per cent of its loan book tied up in bricks and mortar. Next up is Bank of Ireland where property-related lending makes up 71 per cent of all the loans on its books. IL&P’s banking subsidiary Permanent TSB is even more exposed with over 90 per cent of its loans being property-related.

Unfortunately the other Irish quoted bank, Anglo Irish, doesn’t produce a meaningful sectoral breakdown of its lending.

However, we have it from the horse’s mouth. Actually from finance director Willie McAteer, in Anglo’s recent interim results conference, that: “All lending [is] secured, cross collateralised with personal recourse”. Translated from bankerspeak that certainly means that most — if not all — Anglo’s €69bn loan book is directly or indirectly property-related.

Add it all up, and the four major Irish banks have a total exposure of about €280bn to property-related lending. Most of it to the falling Irish and British property markets. With that sort of an exposure, the only question is not if bad debts will increase but by how much. One possible answer is provided by the fall in the combined value of the Irish banks.

At their peak AIB, Bank of Ireland, IL&P and Anglo were worth a combined €58bn. By the end of this week this had fallen to just €17bn. That’s a total reduction in value of almost €41bn.

A combined bad debt charge of €41bn would be catastrophic for the four main banks. In practice, things probably aren’t quite that bad. Just as the Irish banks were overvalued in the first half of 2007 they are now probably oversold. However, bad debts of even half that amount would still condemn the Irish banks, and with them the Irish economy, to years of grinding retrenchment.

After last week’s events, there is no longer anywhere left for the Irish banks to hide. The most recent bad debt figures published by the banks, which show annual bad debt charges of between 0.09 per cent and 0.26 per cent of their loan books belong to another era and are no longer credible.

The Irish banks are going to have come clean on the real level of their bad debts. We are now entering a much more difficult period during which bank lending will at best stall and probably contract while property prices will continue to fall. This will mean much higher levels of bad debts. Unless and until the Irish banks respond to this new reality, their share prices will continue to fall.

-Irish Independent, 13 Jul 2008

All of that said, recent events in the US, like the bankruptcy of IndyMac can only serve to make investors in Irish financial service companies that much more nervous.

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This is a story about how the ECB move affects individuals. As much as I support the ECB rate hike, one has to remember that real people are very much affected by these policy decisions. This is what makes these decisions difficult.

From the Independent Ireland:

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As I have said in prior posts, I am a bit of a eurosceptic. It is my view that the Euro is a political construct just as the expanded European Union has been and just as the reunification of East and West Germany on a 1 for 1 currency basis was. When politics come before economics, bad things happen.

And so it is for Ireland. But is the bust actually the Euro’s fault? And if so, is that a bad thing?

The EU is too big
One reason the Irish rejected the Lisbon Treaty is that the European Union is becoming an unwieldy bureaucracy of 27 countries. What started as a union of the six members of France, West Germany, Italy, the Netherlands, and Luxembourg, all with compatible economies, has become a free for all that includes countries as dissimilar as Bulgaria and Sweden. The last time the EU added a group of roughly similar economies was in 1995 when Sweden, Austria and Finland joined.

Since then, purely for political purposes, and creating great enmity in Russia, a barrage of former eastern bloc nations has joined the EU. While the eurocrats might think all is well with enlargement because the ‘United States of Europe’ is a good counterbalance to the United States of America, in truth, the EU is like putting together Canada, the US, Mexico, Guatemala, El Salvador, Honduras, Belize, Nicaragua, Panama and Costa Rica. That would never fly.

No wonder the Irish said no.

The eurozone is also too big
Then you have the eurozone. As with everything in the EU: EU membership itself and the Maastricht treaty in particular, eventually any- and everyone could join. The Eurozone now comprises 15 countries: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia, and Spain.

This union gives bond markets liquidity and obviates the need for foreign currency exchange, reducing costs. However, high growth Ireland and Spain are very different from Germany and France. Harmonizing these 15 economies will take decades, if it ever happens.

The politicians said they would harmonize through forcing fiscal discipline. You remember the Germans, in their arrogance, talking about strict adherence to a 3% deficit rule and penalties for slackers? They chided the Italians until they themselves broke their own rule and now no one talks about it anymore. Since then, it has been an orgy of deficit spending across Europe.

Interest Rates
And yet, when the European Central Bank sets interest rate policy. It has been fairly hawkish (at least as compared to the Fed) with Wim Duisenberg and Jean-Claude Trichet following well in the path of the Bundesbank. But, they have not been hawkish enough.

When the Germans and the French were struggling after the tech bubble crashed, the EU started to print money and lower interest rates. Unfortunately for the Irish and the Spanish, where things were just fine, this meant overheating and bubble economies. Now that inflation is spiraling out of control, the ECB wants to slam on the brakes again, just when Ireland and Spain might want relief.

The ECB will never run its monetary policy for the Irish or the Spanish and that’s the problem.

In an article entitled, “Why a recession is exactly what the Irish economy needs,” Money Week spells this out very well:

The Irish economy, as we’ve pointed out before in MoneyWeek, was ticking along just fine before Ireland joined the euro. In 1998, GDP growth stood at 8.7% and inflation at a dreamy low of 2.2%. Interest rates meanwhile, were at over 6.2% and on the rise. Then, as if fourth gear wasn’t enough for the economy, the Irish government strapped a super charger to the engine and whacked it into sixth. Ireland joined the Euro.

On joining the euro, interest rates dropped, and by 2000 stood at 4.5%. House prices soared, the building sector boomed and emboldened by the strength of the economy, the Irish binged on the cheap credit made available by the mandarins at the European Central Bank in Frankfurt. Timber decking was slapped onto the back of new build houses in the suburbs and wide screen plasma TVs became a feature in living rooms up and down the country. All of it fuelled by the housing bubble.

Had Ireland had an independent monetary policy, it could have set its own rates, and stopped the madness before it began – though judging by what happened in Britain, perhaps not. In any case, what actually happened was that Irish people borrowed enthusiastically against their homes, as the ECB looked to waken the sleeping German economy from its prolonged slowdown. The slumbering factories of the Ruhr Valley, were more important to the ECB than the booming car sales showrooms that ring the outskirts of Dublin city.

Now, Ireland is facing a jump in unemployment form 4.5% to 7% as high interest rates dampen the construction industries prospects and 20,000 people are expected to emigrate this year.

But is the recession such a bad thing? As John Stepek, Deputy Editor at MoneyWeek pointed out on Newstalk Radio, the Irish radio news station on Tuesday, not at all. In fact, it’s probably exactly what Ireland needs right now.

Recessions, as the economist Joseph Schumpeter pointed out, are a necessary evil in a capitalist economy. They clear out the unnecessary fat that’s built up over years of prolonged economic growth, and are thus the price we must pay for that growth. That’s not to say it won’t be painful. The bust which follows a particularly wasteful and overblown boom like this one will hurt badly. Plenty of people will lose their jobs.

But gradually, the saving rate will go up and consumers will repair their balance sheets. First-time buyers will relearn the habit of building up deposits rather than stretching themselves on 100% mortgages, and will be able to buy houses at reasonable multiples of their income.

And with national debt standing at 30% of GDP, compared to 130% in 1986, the Irish public finances are in much better shape than they were back then. Unemployment might rise above 7%, but in 1986 it stood at a jaw dropping 17%. The Irish economy is slowing, like the rest of its western counterparts. But overall, it’s far from being the European country in the worst position to weather a downturn.

The Euro is flawed because it subjects countries like Ireland to inappropriate monetary regimes that causes their economy to overheat and bust. However, one cannot say the Irish economy would have maintained an even keel had they not given up the Punt. Just look a the mess in the UK, where the British have their own currency. So, don’t blame the Euro for a housing bubble.

However, at a minimum, interest rate policy could adjust more closely to the needs of the Irish economy with their own currency. This is the price paid in order to be part of the Euro.

That said, a recession may well be what the Irish economy needs right now anyway, as recessions are where economies purge the excesses of the previous boom in order to set off again on the path of economic growth. Ireland needs to purge a tremendous amount of debt and leverage before moving forward again. They should use the recession to do so.

Related posts:

• The case against the Euro
• Ireland faces two-year recession
• Spain and Ireland ‘thrown to the wolves’ after ECB move
• Is Ireland the next Iceland?
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In Ireland, the papers are very much focused on how to deal with the bust after the boom. In the wake of the big fat no on the Lisbon Treaty and after 15 long years of upswing, it is readily apparent to anyone that the bust is happening. The question everyone is asking is how will Ireland survive this downturn. In three articles today, the Irish Independent gives us a good sense of the angst.

First, there is the scathing attack on government. The article, “If we blew the boom, let’s see how we handle bust” recalls the story I wrote about yesterday on Ireland claiming government have been irresponsible in squandering the money of the good years and were caught out by the bust. This time the article wonders where the Irish economy is headed, accompanied by a suggestive picture from Oliver Twist.

Interests groups will be lining up soon, like Oliver in Oliver Twist, pleading ‘Please sir, can we have more’ but Finance Minister Brian Lenihan will find the cupboard getting barer by the day

“We Blew the boom” proclaimed the headline in this newspaper on Tuesday. The economic case against the Government seems to be gathering pace and they can expect little sympathy from the electorate.

After spending years claiming undue credit every time the sun rose in the sky, the flipside now is that the politicians will get blasted for events that they can do little to control.

In much the same way as we seem to have “No Plan B” to deal with the rejection of Lisbon, the ruling administration has yet to produce a Plan B to protect the lifestyle and wealth that the people have become used to.

The bottom line is that we have become a bit spoilt and while Brian Cowen might be itching to point this out, I would advise against it.

He is still fresh in the chair and what must be done now is to make a bold statement on what type of economy will carry us through the next 20 years.

The 1990s were characterised by massive tax breaks on property which are now about as out of touch as an avocado bathroom suite.

Favour

The VCs did well out of the boom, the Government should call in a favour by getting them on board to identify the emerging hot areas of the IT and Biotech industry.

And no, I’m not calling for yet another quango. Their services should be given free reign. Tax breaks should then be given to those who invest in companies operating in these areas.

These are capital intensive businesses and flinging a couple of hundred grand in grant support is about as useful as the Kerry hurling team.

The premium is now on vision.
- Daire O’Brien

I don’t see things in quite as dire a way. Ireland still has a low tax, dynamic free market economy with unemployment much lower than the likes of France, Germany , Spain and Italy. The bust will change none of that. Sure, there will be pain, but the core advantages of the economy remain in tact.

In Public services face crunch time, the second of the three articles, Brendan Keenan puts the spotlight on public services and its massive growth during the boom.

“The size and cost of the Irish public service have risen rapidly in the past 12 years. But the economy has grown even faster, so the relative cost of the public service — as a proportion of national income — has not increased.

Now, growth in national income (GNP) has stalled. It is not expected to return to the levels of recent years even when the economy recovers. The problem is whether the growth in public spending can also be cut, in line with economic growth, while still delivering better public service.

Again, the article is quite downbeat about the Irish economy and where the money is going to come from for better public services. Keenan suggest government have no clue how to provide the improvements needed in healthcare, education and transport with a collapsing economy. One can feel the anger in his words.

The last article gets to the heart of matters, the housing bust. Price of average home has dropped by €30,000 in year is a title that says it all.

The property market is falling faster, and more than half of mortgage brokers expect the home loans market to weaken further in the next few months.

On a day when the bad news for the property market piled up, the head of the European Central Bank also indicated yesterday that interest rates were likely to rise next Thursday.

New figures out yesterday showed that the price of a house nationally was now down by almost €30,000, after prices fell by 9.5pc in the past year.

And the fall in house prices accelerated in May, according to the Permanent TSB/ESRI house price index.

This is the core of the problem in Ireland. The housing bust. Prices are falling and will continue to fall for some time. Ireland has seen the fastest housing growth in the developed economy over the past 10 years. Their housing sector will fall more than others.

And with the fall in house prices in Ireland, the pride in its ‘Tiger Economy’ has turned to anger as jobs are lost and Ireland slips into recession. This anger is a large part of the ‘no’ vote on the Lisbon Treaty. It also stems from the fact that people were under the illusion that the good times were going to last forever. And now that its gone a bit pear shaped, people are in disbelief.

In the end, all of this will pass. Ireland will go through its own lost decade much as Japan and Germany did after their own property bubbles in the 1980s and 1990s. However, the underlying dynamism of the Irish economy will help to pull Ireland out of its funk sooner than either Japan or Germany with their statist-lite economic paradigms.

What would be a cause for concern is if Ireland began to intervene in the unwind process, propping up zombie companies and bailing out the financial sector. The U.S. seems on this road as we speak. Hopefully, Ireland will not follow its example. If the calls for government to do something, anything, lead to a statist model of dealing with the bust, expect a very long and difficult decade.

Related articles
Public sector pay leaves Cowen between a rock and a hard place, The Irish Independent, 26 Jun 2008

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As Ireland faces a recession after a fifteen-year property boom, it has come to light that the government have been caught out and doesn’t have the enough funds to support the economy now that the boom has gone bust. The Irish Independent chronicles a research piece from the Economic and Social Research Institute, which is somewhat downbeat about the Irish economy over the near-term.

In a devastating economic analysis, the Economic and Social Research Institute (ESRI) forecast the first recession in the Irish economy since 1983. Outlining gloomy prospects for the economy over the next few years, the ESRI said output of goods and services will fall this year — an Irish definition of recession.

Emigration will return, with a 20,000 outflow next year needed to stop unemployment going through 8pc, it said.

Meanwhile, public finances will plunge into the red, and next year will burst through EU limits on borrowing, sparking potential sanctions, according to the influential ESRI analysis.

The main culprit is still the collapse in house construction, which has plunged from 75,000 units last year to just 30,000 next year. This fall is so serious, it wipes out all the growth in the rest of the economy.

-The Irish Independent, 24 Jun 2008

The analysis of the Irish government’s being caught unawares is not particularly unique. If you look at any central government or state or local government in former boom locales, the problem is the same. That’s not to say that the government should have been prepared for the next downturn.

But, I do expect many governments to go deeply into the red as they deal with the revenue shortfalls associated with their residential property busts. Some local government in the U.S. will undoubetdly go bust, due to the same circumstances — Vallejo, California being the first to declare bankruptcy.

In Spain, I wrote last month that:

Spanish municipalities are being hit hard due to the tax revenue shortfalls emanating from the effects of the Spanish property market crash. The two local governments most affected have been Madrid and Catalonia.
-Credit Writedowns, 19 May 2008

The situations in Ireland, Vallejo, Madrid and Catalonia demonstrate how hooked on the property boom we all had become. It’s not specific to one city or country.

Now that the boom has come to an end, it all seems very suddden and we are unprepared for the retrenchment required.

Related posts:

• Spanish local governments struggling with bust
• Ireland: the bust after the boom
• State and local government weighed down by housing
• Ireland: Next stop – IMF
• State and local governments: budget cuts likely

From the Telegraph:

Irish right to craic the whip over EU treaty

By Liam Halligan

Against the advice of the major political parties and most of the media, Irish voters have rejected the Lisbon Treaty. Good for them.

That’s a perfectly reasonable response to an agreement which is not only absurdly complex, but also replicates the problems inherent in the ghastly EU constitution spurned by the French and Dutch in 2005.

Amid the acres of commentary on this issue, as an economist of Irish stock, allow me to add my two penn’orth.

First, this vote is not “ungrateful, seeing how the Irish have benefited from Europe”.

Related posts:

• Ireland votes No on Lisbon Treaty
• The Euro crisis is beginning
• Did joining the eurozone bust Ireland?
• Ireland faces two-year recession
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That’s what Sir Howard Davies, a former deputy governor of the Bank of England (BoE), has to say. Davies adds the usual list of suspects to suffer in the housing meltdown to Ireland: the UK, the U.S. and Spain. He believes the BoE and other central banks have moved the focus away from housing toward inflation and that means interest rates won’t come to the rescue in Ireland or the other bubble economies anytime soon.

Source
Ireland faces two-year recession, ex-central banker says, The Irish Independent, 13 Jun 2008

Related posts:

• Ireland: government blew the boom
• Irish unemployment gaps up by most in 40 years
• Ireland gets deflation
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The Lisbon Treaty, which was to give the European Union more say over matters in EU member states received a vote of no confidence from Ireland. The result was 52% against and 48% for. Just as with the EU constitution, there is great resistance from member states to the bureaucratic control of the EU over political and social affairs.

What this will mean for Europe’s economy is still unclear but it has overtones that will reflect negatively on the Euro, another EU construct that is not viewed favourably by all who a part.

“Ireland has voted No to the Lisbon Treaty, plunging the European Union into a new crisis.

With results coming in from across the country, a final result of 52 per cent against and 48 per cent in favour of the treaty was rapidly hardening. A final declaration is not expected until after 4 pm.

The Lisbon Treaty, the reworked successor to the formal constitutional pact dumped by voters in France and the Netherlands in 2005, officially needs the approval of all 27 EU member states. But only in Ireland has it been put to a popular vote, meaning today’s result may have far-reaching consequences for the entire bloc.

Barely two hours after the count began today, the No camp had already started celebrating, while senior Fianna Fail strategists privately and glumly conceded their defeat.”
-The Times of London, 13 Jun 2008

Update: EU referendum: Czech president says Lisbon Treaty project is over, The Telegraph, 14 Jun 2008

Related posts:

• Ireland No to Europe: Commentary
• Did joining the eurozone bust Ireland?
• Ireland: the bust after the boom
• The Euro crisis is beginning
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