Month: November 2010

In August 2009 I wrote a blog post that sparked a little debate about where Ireland was headed. Having read it again, it is interesting that absolutely nothing has changed in the intervening 15 months.

I am reproducing it again here in full:

Countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Ireland grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise.

In Ireland, for instance, the private sector is now in serious trouble because, over the past seven years or so, it borrowed at least $130 billion from banks and investors on the assumption that the country’s property sector could support a permanent increase in consumption throughout the economy. As Ireland’s oligarchs spent this capital, acquiring other companies and embarking on ambitious investment plans that generated jobs, their importance to the political elite increased. Growing political support meant better access to lucrative contracts, tax breaks, and subsidies. And foreign investors could not have been more pleased; all other things being equal, they prefer to lend money to people who have the implicit backing of their national governments, even if that backing gives off the faint whiff of corruption.

But inevitably, oligarchs get carried away; they waste money and build massive business empires on a mountain of debt. Local banks, sometimes pressured by the government, become too willing to extend credit to the elite and to those who depend on them. Overborrowing always ends badly, whether for an individual, a company, or a country. Sooner or later, credit conditions become tighter and no one will lend you money on anything close to affordable terms.

The downward spiral that follows is remarkably steep. Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse. Yesterday’s “public-private partnerships” are relabeled “crony capitalism.” With credit unavailable, economic paralysis ensues, and conditions just get worse and worse. The government is forced to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah. The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions—now hemorrhaging cash—and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.

Squeezing the oligarchs, though, is seldom the strategy of choice among governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or—here’s a classic Dublin bailout technique—the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk—at least until the riots grow too large.

Eventually, as the oligarchs in Cowen’s Ireland now realize, some within the elite have to lose out before recovery can begin. It’s a game of musical chairs: there just isn’t enough cash to take care of everyone, and the government cannot afford to take over private-sector debt completely.

First, an admission. The above is a quote from Simon Johnson’s excellent essay in the Atlantic in May of this year, The Quiet Coup. But I have modified it ever so slightly. I simply replaced the word ‘Russia’ with ‘Ireland’, and other slight edits to take into account energy versus property. You can see the original here.

Why the modification? Well it demonstrates at exactly the level Ireland is at.

We are a two-bit emerging market economy, dominated by political and business elites. I think it’s an open and shut case. Every word Johnson intended for Russia accurately applies to Ireland. We are almost the definition of a banana republic.

The only difference is in the last paragraph. “Some within the elite have to lose out before recovery can begin.” No. In Ireland, no oligarch property developer will lose out if the government can help it – thanks to the €90 billion NAMA, what will be the largest property ‘firm’ in the world.

The only people who will end up paying are you and me, our children, and our grandchildren. If people think our political leaders are acting out of the interest of the taxpayer they are dead wrong. Our political leaders are acting only in the interests of themselves and their paymaster developers.

Let us examine some of Johnson’s indicators that we are an emerging market, dominated by oligarchs. We could make a checklist:

* “Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders.”
Check.

* “As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise.”
Check.

* “As Ireland’s oligarchs spent this capital, acquiring other companies and embarking on ambitious investment plans that generated jobs, their importance to the political elite increased.”
Check.

* “Growing political support meant better access to lucrative contracts, tax breaks, and subsidies.”
Check.

* “Oligarchs get carried away; they waste money and build massive business empires on a mountain of debt.” Check.

* “Local banks, sometimes pressured by the government, become too willing to extend credit to the elite and to those who depend on them.”
Check.

* “Overborrowing always ends badly, whether for an individual, a company, or a country. Sooner or later, credit conditions become tighter and no one will lend you money on anything close to affordable terms.”
Check.

* “Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse.”
Check.

* “If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah.”
Check.

* “The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions—now hemorrhaging cash—and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.”
Check.

* “Squeezing the oligarchs, though, is seldom the strategy of choice among governments.”
Check.

* “At the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or—here’s a classic Dublin bailout technique—the assumption of private debt obligations by the government“.
Check. NAMA.

* “Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk—at least until the riots grow too large.”
Check, minus the riots. Yet.

* “Some within the elite have to lose out before recovery can begin. It’s a game of musical chairs: there just isn’t enough cash to take care of everyone, and the government cannot afford to take over private-sector debt completely.”
Except in Ireland, where we are trying to assume €90bn in private sector debt. Liam Carroll as the elite one losing out? Check.

And so we return to the original question posed: What is wrong with Ireland? My answer is this: We believe we are something we are not.

We believe we have a more mature regulatory environment, a mature, transparent and accountable political system, we believe the media holds our government to account, and we believe that our elected leaders will act in the best interests of citizens. Even the media believes it holds the government to account.

These assumptions are all wrong.

When you examine, even to a minor degree, any aspect of Irish society, you will invariably find a distinct lack of all the above factors. For example captured regulators: The Financial Regulator, the Irish Stock Exchange, the ODCE, ComReg, the Financial Ombudsman.

Whenever and wherever corruption is discovered, nothing happens. Whenever and wherever whistles are blown, nothing happens. We live in a country where the very idea of accountability, or that our politicians are our servants, simply does not exist.

As a nation state, we are a failure. As a democracy, we have failed. As a country we are bankrupt, both morally and financially. We are the emerging market, banana republic of the European Union. Our political system is broken. It is beyond redemption.

Some will reply that I am a socialist, or other such attacks. I am actually right of centre economically, I just recognise what is standing in front of me for what it is. An almost incalculable political and financial mess – generations are being saddled with the debts of the oligarchs, and the taxpayer is being lied to by its own government.

The only hope is this: That the people, in whose hands all power rests, will realise the appalling vista of a broken Ireland – a country in need of radical political reform – and demand that it is changed.

If it is not, everything that has happened, will continue to happen, and we, the citizens, will continue to pay the price.

We have warned time and time again that Ireland was facing a massive fiscal crisis, both on here and on Twitter. We took a look back through the archives to see what we might have called right over the last number of months:

September 11, 2009: ‘A floor in the market’

We questioned just how much nonsense Finance Minister Brian Lenihan spoke in September 2009, where he argued that Ireland had neared the floor in the housing market. Of course, NAMA set its floor in November 2009, and prices have fallen ever since – leading to yet more losses for the taxpayer. We quoted him:

“If a flood of property is dumped on the market, it will be utterly unsustainable. That is one of the reasons we must establish NAMA and try to establish a floor in the market. We are very near it on the basis of the figures and data we have about the yield from property. The yield is at an all time high relative to the assets, which is a clear objective economic indicator that we are approaching the trough. We must banish our devils, the suggestion that we have further to go. That is part of the problem and the reason for the illiquidity in the housing market.”

And posted the video:

There is no doubt that everything said there was a fiction, and it was patently obvious at the time.

December 24, 2009: Morgan Kelly on how we got here

Morgan Kelly published a paper at Christmas 2009, in which he outlined the looming bank crisis and the coming massive mortgage crisis. It was universally ignored. We highlighted it at the time:

I can’t really add much to Mr Kelly’s excellent analysis. What it says to me is that the next 12 to 18 months are going to be among the most difficult, if not the most difficult, time this country has faced. I encourage everyone to read the entire document.

I will emphasise his conclusion:

Despite having pushed the Irish state close to, and quite possibly beyond, the limits ofits fiscal capacity with the NAMA scheme, the Irish banks remain as zombies whose only priority is to reduce their debt, and who face complete destruction from mortgage losses. The issue therefore is not whether the Irish bank bailout will restore the Irish banks sothat they can function as independent commercial entities: it cannot. Rather it is whether the Irish government’s commitments to bank bond holders when added to its existing spend-ing commitments, will overwhelm the fiscal capacity of the Irish state, forcing outside entities such as the IMF and EU to intervene and impose a resolution on the Irish banking system.

February 4, 2010: The Coming Crisis?

It might be news to some people, but the purchasing of Irish bonds by Irish banks was highlighted a long time ago. We highlighted along with many others that Irish banks were buying Irish sovereign bonds and using them as collateral at the ECB. We also emphasised that Ireland was in as worse, if not a worse state than Greece – just that the markets had yet to pay attention to Ireland:

If you thought all of the problems had been sorted, then think again. There are really big problems coming down the road, and very few people seem to be talking about them. So let’s look a little closer at the potential fiscal problems Ireland, and our banks, face.

Everyone is talking about Greece right now, but to me Ireland is no different. It is probably worse. So with these deadlines looming, what is happening? Over the past number of weeks you might have noticed various headlines to do with NAMA delays. Why is this important? Could it be that unless the banks can transfer these junk ‘assets’ from their books, they could face funding difficulties on non-ECB markets?

I could well be wrong, or even cynical, but my feeling is that banks are desperate to get this stuff off their books, in order to be better able to fund themselves after the ECB shuts the discount window. If they don’t get them off their books, and onto the backs of the taxpayer, the banks could simply end up going to the wall, or simply being nationalised.

If you’ve read Morgan Kelly’s excellent analysis of the Irish credit bubble you will be aware of the Irish banking system’s over reliance on international money markets for funding. When the financial crisis hit in September 2008, these money markets froze and Irish banks struggled to get day to day funding. This is what ultimately led to the bank guarantee, and to the opening of what’s called the ECB discount window.

Banks all over Europe were struggling with funding, so the ECB essentially enacted emergency measures to help fund the banks. Irish banks were one of the biggest beneficiaries of the discount (the interest rate charged by the ECB is sometimes called the discount or repo rate). Ireland’s banks have effectively been kept on life support by the ECB since 2008, as McWilliams also noted last year. Essentially Irish banks were buying NTMA-issued sovereign bonds with short-term lending, presenting that as collateral to the ECB and then borrowing cheaply from the ECB. Summed up here – 25% of our deficit in most of 2009 was indirectly funded by the ECB.

When you combine the shutting of the discount window, with the delays in NAMA transfers and ultimately our own State borrowing (indeed we have already borrowed €6.5bn so far this year – 33% of our bond issuance for this year was done in January) and with the likely writedowns of not 30% but 50% on the loanbooks, we are facing a serious crisis. And of course the other factor is the ECB raising interest rates at a time we need them to stay low.

My questions is this: how are we going to pay for all of this?

February 22, 2010: Delay and Pray

This actually sums up how the Irish banks, especially Anglo, have been dealing with our property developers. Rolling over interest, not writing down the loans, not crystalising the losses, doing repayment deals with developers – to drag it out – extending and pretending.

Here it is in a nutshell: NAMA is one massive “Delay and Pray”.

Given that our banks are insolvent, that they are facing massive liquidity issues with the imminent closure of the ECB discount window, they cannot keep the pretence of extending and pretending up forever – and NAMA is, or was supposed to be, the answer to their prayers. You could also argue that Bank of Ireland recently changing its fiscal year was part of this tactic.

The Government would take the crappy loans from the banks (rather a lot), and through some financial voodoo, the losses would still not be crystalised, and rather ingeniously – the debt would not appear as sovereign debt for Ireland, or as debt for the banks, but would instead be dumped into this NAMA bad bank.

And NAMA has one sole purpose – keep the pretence going that someday, somehow, the value of the underlying assets will return to peak prices. Delay and pray. Do not write down the loans. Do not accept the reality of the losses. Do not pass go.

Not only is it unlikely that this will happen, it is almost impossible. Morgan Kelly wrote in December that it could take 50 years for the underlying assets to return to 2006 prices. Last week, in the High Court, we saw development lands being written down by 60% to 98% (in terms of valuation, not borrowing). These figures are the reality of the lands that NAMA is taking charge of. And we are overpaying already. How long do you think it will take rezoned agricultural land bought for €13m at peak, revalued at €600,000 in 2010, to return to €13m? The answer is: it won’t. So much land was rezoned that there is no necessity for rezoning for a further 70 years in many counties. Add to that the 300,000 vacant properties. Add to that little demand. Add to that zombie banks unable or unwilling to lend.

This is the reality of NAMA. Delay and pray.

It logically follows that where the banks lent money with no obvious collateral to back the loan, and where the supposed value of derivative is now zero, the bank sustains a massive capital loss.

However the banks are simply delaying and praying until NAMA takes over the loans, and then NAMA continues the praying.

We are in for one hell of a fiscal mess.

If you hear spin that no one saw this coming, don’t listen. There were plenty of commentators and plenty of warning signs. Unfortunately many people chose not to listen.

Been a while since I linked to a Boone and Johnson piece around these parts. This one is required reading…

[..] For Ireland, too, sovereign debt, including bridge financing, will rise close to 150% of GNP by 2014, and is mostly external. But a sovereign default would require a much larger bank bailout than in Greece, potentially leaving private debt almost worthless if official debt has seniority. Total haircuts don’t happen historically – except in the wake of communist takeovers – but it is hard to imagine that private creditors won’t suffer huge losses in net present value.

Given this, we should expect Greek debt yields to rise further, despite the current IMF program. Likewise, an IMF program for Ireland – which seems increasingly likely – will not bring down domestic bond yields and reopen credit markets to any kind of Irish borrower.

If people start to think this way, Portugal, whose already high and growing debt is held largely by non-residents, becomes a candidate for default as well. In that case, it makes little sense to hold Spanish debt, either, which is also mostly external. Spain’s financial exposure to Portugal and its housing-led recession don’t help matters.

And, if Spain is at serious risk of default, government solvency is at risk throughout the eurozone – except in Germany. Perhaps Italy can survive, because most of its debt is held domestically, which makes default less likely. But the size of Italy’s debt – and of Belgium’s – is worrisome.

Given the vulnerability of so many eurozone countries, it appears that Merkel does not understand the immediate implications of her plan. The Germans and other Europeans insist that they will provide new official financing to insolvent countries, thus keeping current bondholders whole, while simultaneously creating a new regime after 2013 under which all this debt could be easily restructured. But, as European Central Bank President Jean-Claude Trichet likes to point out, market participants are good at thinking backwards: if they can see where a Ponzi-type scheme ends, everything unravels.

Word has it that a few media outlets have picked up on Gav and Lorcan’s latest post. Welcome aboard if you’re a first-time reader. Make sure you’ve your spinshield at hand, Government ministers are already out talking nonsense. 

It looks likely to be a wild ride over the next few days. We should know a little more following a meeting of EU finance ministers in Brussels tomorrow evening.

Eyes-peeled for a bail-out involving Ireland and An Other which will be spun as a broader European ‘restructuring’ (possibly of the banking system, not the State, as if it’s still possible to seperate the two) by our Government and thus no fault of their own.

Sure, all the correct decisions have been made and all the right corners turned, remember. Cheapest bank bail-out in the world, lads.

Last week we showed how the most recent Irish Central Bank financial statement showed a large jump in the ‘other assets’ of the bank. We’ve been trying to figure out what exactly is going on. Over the weekend, Lorcan noticed that the data we used last week has since been updated to include the October data. It makes for eye-watering reading – hold onto your hats.

The ‘Other Assets’ of the Central Bank are now at €34.606bn, having jumped from €14.378bn in August and from the €21.195bn in September (which we reported last week). That’s a rise of over 140% from August to October. But what, on the face of it, is going on, and what does it mean?

Here is a chart of the ‘Other Assets’ of the Central Bank from the peak of the property bubble in September 2006 to October 2010:

Here is the table:

When previously contacted, the Central Bank of Ireland gave this description of what is captured by the ‘Other Assets’ column of the Irish Central bank balance sheet:

“The ‘Lending to euro area credit institutions in euro’ columns [including “main refinancing operations” and “longer term refinancing operations”] are Eurosystem operations.

Any other lending undertaken by the Central Bank is captured under the ‘Other Assets’ column, also in Table C2. It should be noted that this column is not exclusively lending, but also captures other certain assets of the Bank.

There is no further detailed information we can provide.

[The sheet being referred to is here, note the columns referred to (f) and (g), while other assets is column (r).]

So, what does this mean?

Well, the total amount of ‘assets’ in the Irish Central Bank has risen by a total of €55.3bn from August to October, from €130.310bn to €185.815bn . But only €35bn of that has been captured by the ECB-related columns in (f) and (g) referred to by the Central Bank above.

The other €20bn has been added to the ‘Other Assets’ column.

All of which seems to point to some euro quantitative easing happening on Dame Street in Dublin. How long will the ECB allow this situation continue?

Something to muse on. Here is a timeline chart. I wonder what it represents…

Most insightful press release of the day goes to… drumroll please… Shell to Sea.

Today marks the 4^th year anniversary of the baton charge and violence by Gardaí against protestors opposed to the Corrib Gas Project.

The 10^th of November 2006 was chosen by the Shell to Sea campaign, as a suitable day of action as it marked the anniversary of the hanging of Ken Saro Wiwa and 8 other Ogoni activists who opposed Shell. Over 200 Gardaí were drafted in under the direction of Superintendent Joe Gannon (then Superintendent in Belmullet).

Ironically Superintendent Joe Gannon is now Superintendent at Pearse Street Garda Station, which today will be the focus of a protest march in opposition to Garda brutality against protestors. This protest was called in light of the violence that was dealt out to students in Dublin last week. Supt. Joe Gannon was present and personally involved in the scene at the Dept of Finance when students were violently removed from the building.

Shell to Sea spokesperson Terence Conway stated “In a investigation into Supt. Joe Gannon’s handling of a protest at Pollathomais Pier in which 20 people were injured, the Garda Ombudsman recommended to Garda Headquarters that disciplinary action be taken against him. However nothing happened and instead Supt Joe Gannon was promoted and has continued to police protests in the same manner that characterised his time down here in Mayo”.

Irish Times report on the Garda Siochana’s decision to reject the recommendation by the Garda Ombudsman is here.

Shady’s back. Back again.

The gathering mortgage crisis puts Ireland on the cusp of a social conflict on the scale of the Land War, but with one crucial difference. Whereas the Land War faced tenant farmers against a relative handful of mostly foreign landlords, the looming Mortgage War will pit recent house buyers against the majority of families who feel they worked hard and made sacrifices to pay off their mortgages, or else decided not to buy during the bubble, and who think those with mortgages should be made to pay them off. Any relief to struggling mortgage-holders will come not out of bank profits – there is no longer any such thing – but from the pockets of other taxpayers.

The other crumbling dam against mass mortgage default is house prices. House prices are driven by the size of mortgages that banks give out. That is why, even though Irish banks face long-run funding costs of at least 8 per cent (if they could find anyone to lend to them), they are still giving out mortgages at 5 per cent, to maintain an artificial floor on house prices. Without this trickle of new mortgages, prices would collapse and mass defaults ensue.

However, once Irish banks pass under direct ECB control next year, they will be forced to stop lending in order to shrink their balance sheets back to a level that can be funded from customer deposits. With no new mortgage lending, the housing market will be driven by cash transactions, and prices will collapse accordingly.