The Cedar Lounge Revolution

Finally! Someone tells it like it is about the economic crisis and how public opinion is being manipulated. April 17, 2009

Posted by WorldbyStorm in Economics, Economy, Irish Politics.
14 comments

An excellent and thought provoking piece in yesterday’s Irish Times really lays it on the line as regards the issue of NAMA and the current financial crisis. Michael Casey, former chief economist of the Central Bank and a board member of the IMF allows at least some peek behind the mask which a number of us have been attempting to pull aside.

This, incidentally, is not to say that his proscriptions make for pleasant reading, or even that his analysis is correct in detail. But in one startling paragraph he lays bare a basic truth of our current predicament, that the stories we are hearing from media commentators and economists are very much tailored to a specific agenda, one which ignores the egregious inconsistencies between these stories.

First, the forecasting (and budgeting) record has been poor. It is hard to remember many occasions in the last 15 years when the Department of Finance came close to an accurate prediction of revenue. Too many statements made by government and other official bodies about the state of the economy and of the banks have been proved wrong. It is not that long ago when we were told that the boom would continue and that the banks had plenty of capital. When these versions of events were not believed by the public and the markets, the stories began to change.

When the Government sought to cajole the unions into a pay freeze they painted a more downbeat picture of the economy. In the event this made no difference to the unions, and social partnership failed its first real test. Then we were told a depressing story about the public finances and the virtual impossibility of borrowing. This was designed to soften up taxpayers for the pain to come. Much of the uncertainty is caused by inconsistent stories designed to manipulate public opinion.

Let’s be honest. What we’ve been told have gone further than half-truths and yet they’ve also been assimilated as part and parcel of public debate. I was told directly by someone close to government that we were unable to borrow despite the fact that we had already done so earlier that month. And this wasn’t intended as a lie, but rather was the product of – let’s face it – a complete ignorance of economic affairs and a near naive willingness to accept whatever the business pages proposed.

Casey goes on to poke a few holes in the current plans…

Second, the Government takes the view that stabilising the public finances will restore confidence in the economy. This is far from certain. The tax hikes could have the opposite effect. Bear in mind that the marginal tax rate has been raised by nine percentage points. If this does not have serious disincentive effects then everything the Progressive Democrats stood for must have been utterly wrong.

Well, yes. I think we can be a little more nuanced on that. It is possible that lower taxation can be used in a tactical way and that at certain points over the past decade low taxes made sense as driving economic growth. But that doesn’t mean that low tax is in and of itself the solution to all economic woes, as important is to ensure that the tax base is broad, and the fetish made of low tax is in no small way a contributory factor to our current travails. I was re-reading over Easter some of Michael Taft’s thoughts on these matters from last year and was very struck by his proposition that:

If I had a 10 pence piece for every time I heard the statement, ‘we relied far too much on the property market for tax revenue’ I could buy out the national debt. We didn’t ‘rely’ on property-rely taxes. We had so slashed and burned every other tax (income, PRSI, capital and corporate) that the property boom helped disguised the fact that we don’ have the revenue base to maintain current expenditure levels, never mind levels appropriate to a modern European economy. ‘Disguised’ temporarily, that is. Now in its in our face.

Anyhow, Casey continues:

The Budget was equitable – few can deny that – but it bears down heavily on the middle-class which is the economic backbone of the country.

It should be remembered that the middle-class has also suffered a major write-down of personal assets – houses and pension funds – which will undoubtedly produce a negative wealth effect.

This, combined with the prospect of other taxes – including a property tax – will hit consumption and investment.

Now, although Casey is coming from a centre centre/right perspective on this I find little to disagree with his analysis, albeit I’d have some caveats about the middle-class being the economic backbone of the country… define middle class… define economic backbone. I could make an equally good case that the public sector is the economic back-bone too, and one that is best suited for disbursing the elements of a fiscal stimulus package, and it’s a case that ironically many in the US would agree with. From the start the current policies have appeared tailor-made to ensuring that consumption is cut. Does this make sense in the face of mass unemployment and business collapse? It doesn’t to me.

But he continues:

Third, no one knows exactly how the economy will be affected by the Budget.

Budgets in Ireland are rarely more than book-keeping exercises which ignore wider economic effects. There should be a structural model of the economy which can be used to run policy simulations. Without this kind of analytical apparatus there is little possibility of predicting the impact of budget measures.

But we can make some educated guesses. We could posit that cutting expenditure and increasing taxes simply to balance those books is insufficient in the context of a global financial crisis.

He is excoriating about NAMA:

Fourth, Nama which is designed to satisfy the European Commission on the treatment of impaired assets, could work well – or it could be disastrous. It is a blank cheque. We do not know how it will work in practice. Much will depend on the quality and integrity of the people appointed to value assets and negotiate discounts with banks.

There are at least three groups of stakeholder: taxpayers, shareholders, property developers. Until the agency is up and running we have no idea how these groups are going to fare. If there is even the slightest taint of cronyism or political interference the entire exercise could end in disaster. There is also the probability of expensive legal challenges, exorbitant fees and every conceivable form of rent-seeking.

Who, though, is most important in that mix? To my mind it is taxpayers. After all it is us who are carrying the can on this exercise. And yet the benefits to the taxpayer remain nebulous – at best. What precisely does the Irish state get for funding the bank sector? It remains an unknown. And he follows that by a truly worrying statement, particularly considering all the effort and energy expended in telling us how crucial the banking sector as it currently stands is to economic activity on this island.

Fifth, even if banks offload their toxic assets and even if they get fresh capital there’s no certainty that they’ll start lending to enterprises again. Banks lend in boom times; they don’t lend much in recession. And they certainly don’t lend to firms in difficulty.

This is a central problem. Again, drawing on anecdotal experience, I am well aware of companies suffering horrendous cash flow problems. I’m told that these problems are now systemic in various areas of business. But what is the carrot that will push banks to extend credit facilities to such businesses? After all part of the problem we currently face is directly attributable to shoddy lending practices over the past decade and more.

Casey notes this:

Nominal GNP is likely to fall this year by about 10 per cent; why would we expect any growth in lending? Having lost all credibility, banks are likely to be more risk-averse than ever before. If the Budget does lead to a further fall in demand then it is not clear why banks would lend at all. Indeed, we cannot rule out a liquidity trap i.e. a situation where despite low interest rates there is no increase in borrowed funds or in the money supply. The deflation of prices could reinforce this trend.

Which begs the question what precisely are we supporting the current banking structure for? Is it a case that the state and citizenry must fund them because they’re there? I have my account with Bank of Ireland. I’ve no appetite to see it go to the wall, but neither do I want the status quo to be extended into the future if the only goal of exercise is to keep Bank of Ireland in business rather than enquiring as to how business for individuals, commercial enterprises and others can best be accommodated. And that may well mean that I’m banking with some other entity in the near future, albeit I won’t be able to tell the difference.

Casey still harbours hopes for public sector ‘reform’ although tellingly he doesn’t precisely detail what this is. I’d be interested to know his views on the OECD report which detailed Ireland as having too small a civil service for our population size and how our public sector is in European terms underfunded. I also think we could fruitfully marry Tom McGurks statement at the weekend about all the huffing and puffing over taxes and such like garnering a mere (mere!) €3.5bn as against the absurd sums being proposed for NAMA. Motes and beams come to mind.

But to return to the central point, Casey tells it like it is when referring to attempts to shape public opinion. If I have a quibble with his analysis it is that it gifts too much to Government as the main driver of these attempts and ignores the role of the general media and political and economic commentariat. And this is language used to shape that opinion that has quite frankly scared people at a time when events are already scary enough. It’s that simple and that irresponsible.

Beyond that? I’ve said it before. The sheer ignorance, of which I’ll readily confess I’m guilty of as well, with reference to economic affairs amongst those of us who should know better. This is not a highly abstruse area, not just a dismal science. It is something that those of us on the left should be centrally engaged in understanding.

Far too often we seem instead to default to stances on policy positions and we can see a prime example of that in the current approach of the Labour Party which while its heart is in the right place appears unable, or uncomprehending, of ways to articulate an alternative to the nostrums of economic activity. If we don’t, or won’t understand, the underlying problems, not least in the terms that are used by the centre and centre/right, we certainly won’t have any grasp of the solutions or be able to present them to others.

maNAMAna… doot-doo, doo-doo-doo! April 14, 2009

Posted by WorldbyStorm in Economics, Economy, Irish Politics.
21 comments

It’s been taking me a while to get my head around the National Assets Management Agency aspect of the Budget. In part it is because the figures are so enormous. €90bn is not to be sneezed at. In part because it has that same rather impermeable aspect as matters financial tend to do. How much? For what? Who pays?

Well, the last part if the easiest element to deal with. Us. We’re the who. The citizens of the Irish state.

Even the Irish Times in its editorial yesterday acknowledged this central fact:

The cost of the initiative will be enormous and will be borne by the taxpayer. The problem loans in question amount to somewhere in the region of €90 billion. Even if they were bought by Nama at two-thirds of their face value – to reflect the risk that they may never be repaid – the bill will come to €60 billion. To put this in perspective, Ireland’s national debt is currently €54 billion. Some of the cost will be offset by revenues from the assets held by the new agency and income from the Government’s shareholdings in the banks. The latter are almost certain to increase to levels in excess of 50 per cent as part of the process and it may yet prove expedient to nationalise some banks to reduce the upfront cost.

However it unfolds, the impact of the additional borrowing to fund the agency will be considerable in the initial stages and could push the costs of servicing the national debt from the current projected rate of 19 cent in every euro of tax collected by 2013 to in excess of 27 cent in the euro. That level has not been seen since the late 1980s and 1990s.

Which is why the chorus of voices in the Sunday Business Post on the matter (with one notable exception I will return to momentarily) was so depressingly inevitable. For as one they pulled the bait and switch so beloved of our economic betters.

Let’s start with an unlovely phrase used by Cliff Taylor…

Politically, the initial reaction has been more muted. Does this mean that the PAYE sector is going to sit back and take the medicine? Only time will tell.

Hmmm… take the medicine – eh? It’s the banking and construction sectors that collapsed. The illness is with them. The PAYE sector isn’t ill, it’s the one that’s providing the cure and at no small cost.

He continues that:

But it remains to be seen how taxpayers will react to the major new impositions on their income – and the prospect of more to come.

Somehow, the view of many remains that we are paying to ‘‘bail out the developers’’, rather than to correct a fundamental imbalance in the public finances.

But again, the fundamental imbalance is as one with the collapse of the banking and construction sectors. It is precisely because journals such as the one Cliff Taylor writes in (and as I’ve said before, to my mind it’s the only Irish Sunday newspaper worth buying) championed a low tax economy that we are where we are.

Which lends a certain irony to Taylor bemoaning the fact that:

It marks the final end of the income-tax-cutting era. The top rate famously reached 65 per cent in the mid-1980s, subsequently falling back even before former finance minister Charlie McCreevy slashed tax rates during the 1990s.

While the actual rates of income tax were left as they were in the budget, the marginal rates facing taxpayers – the highest rate at which they are levied on the last bit of their income – will now be above 50 per cent for many. Whatever criticism can be made of Lenihan, he cannot be accused of not hitting the better-off, or certainly the better-off income tax payers.

But the spread is more broad than that. Now, as it happens I fully support higher taxes to pay for better services. But that’s not what is happening here. Nowhere near it. For Taylor also continues:

However, Lenihan did announce plans to save significant amounts in 2010 and 2011 [in public expenditure], through efficiencies and lower numbers. Pushing this through is a huge political challenge now facing the government. It will be fought every step of the way, as we have already seen in areas such as the health service, where plans to reduce spending always seem to affect the patient rather than reduce the bureaucratic overheads.

But our public finances cannot be restored to health unless this work is done. Otherwise we will end up paying more and more tax for services which are still inadequate. It remains to be seen whether a government severely hit by the economic downturn and the public’s reaction to its past mistakes has the bottle and the energy to take this on.

I think this analysis is seriously wrong… and people will know why.

But you think that’s grim? What about the usually more measured Pat Leahy?

The populist sloganeering, that the government is bailing out banks with tax increases, is nonsense – although we will hear a lot of it over the coming months. The tax increases were necessary because the cost of our public services is nowhere near being met by taxation receipts.

Oh yeah? Well, we’ll come back to that too…

The second reason for the budget’s relatively comfortable passage was that it was constructed with politics in mind, as much as economics. Lenihan avoided large cuts to public spending, and the bulk of the budget package was made up of tax increases and cuts to the capital budget.

…

This is particularly the case when the tax increases are targeted at middle and higher earners, as last Tuesday’s package was. There was as much critical media comment about taking €200 from social welfare recipients by cutting the Christmas welfare bonus as there was about taking several thousand euro from middle-income families.

Why was this? Part of the reason is that media and public debate in Ireland is dominated, to an unusual degree, by special interests and individual pleading. How many of the ‘budget reactions’ in the media coverage were from interest groups assessing the impact on their members?

Come again? Ireland is dominate to an ‘unusual’ degree by special interests?

I think that’s a pretty sweeping generalisation. Anyone who follows US or European politics, let alone the remarkable adventures taking place in Greece, would know that the sort of deal making we see here is far from sui generis.

And he too continues:

There is nothing wrong or unusual in such groups being asked for their opinion, or for a summary of how the budget will affect them. But what is odd – and a bit incomplete – is that the responses of these special interests are rarely put in the context of the broader national interest. They’re not just part of the budget reaction – collectively, they are the budget reaction.

Part of it is just human nature; cutting back on services in health and education is perceived to be hitting those who are most vulnerable, to which people have a natural reaction. Never mind that most increases in the budgets for these services pay for those who provide them- the nurses, doctors and teachers -whose representatives are especially able to portray any cuts in their areas as uniquely cruel. Perception is everything, and much of the public perceives cuts in government spending as especially harsh. For the government, cuts are just tougher to justify.

Now, I like Pat Leahy’s analyses, but that’s plain simplistic. The cervical vaccine furore wasn’t caused by the idea of increased payment to public sector workers. The pension levy debacle wasn’t a response to some notional or real wage hikes for civil servants and equally the idea that cuts somehow equate with cuts in payment to public service workers is close to risible. Cuts equal cuts in services. No less. No more. Services which the public has, as the phrase goes, a ‘reasonable expectation’. It’s nothing to do with cruelty or, really, wages in the public sector. That train has moved on.

But Leahy is still wedded to the idea that only cuts will save us from ourselves. And he suggests that coming up to 2010:

Preparing the ground for cutbacks may lessen the backlash, but it won’t avoid it. The pressure on the public finances will not go away. Ireland will still run an eye-watering deficit of more than €20 billion this year, or nearly 11 per cent of GNP.

Well, eye-watering only for those who ignore the €90bn outlay on the banks. Or who ignore the European Commission Directorate-General for Economic and Financial Affairs Interim Forecast which notes that the Irish Government gross debt as a % of GDP will be 54.8% this year, a shocking 17.9% below the EU average of 72.7%, a figure – incidentally – supported by the Macroeconomic and Fiscal Framework 2009-2013 document issued by the Government on foot of the Budget this last week which in 2010 sees the ratio increase to 73%, still just shy of the 75% average of the EU area. And we could, should we so choose, take heart from a Research Report by Davy from this January which argued that:

Low initial debt means ability to pay not an imminent issue
• Note that the state started from a good position: the debt
to GDP ratio was 41% at end-2008 (or 32% excluding
the assets of the NPRF). Nominal yields are still low. As a
result, the share of tax revenue required to meet debt
repayments will be way lower than in the 1980s, taking
into account massive deficits in 2009 and 2010.

And that €21bn figure Leahy quotes? Davy seem surprisingly calm about it all…

Total long-term funding needs (excluding funds for bank
recapitalisation) for 2009 total about €20bn after successful fiveyear
bond auction
Ireland is going to run a significant fiscal deficit in 2009 and 2010.
From the EU’s perspective, it is the General Government deficit that
matters. It is likely to reach at least €21bn both this year and next. A
five-year government bond is also due to be redeemed in April. In total,
therefore, long-term funding needs heading into 2009 totalled about
€26bn for the calendar year – excluding any funds needed for bank
recapitalisation.
Importantly, the National Treasury Management Agency (NTMA, the
Irish government’s debt manager) successfully raised €6bn in five-year
money on January 8th. It was the biggest auction in the history of the
euro area. The yield was low in absolute terms at 4.06%.
The salient point is that almost 25% of the year’s long-term funding was
sorted within the first week of the year. That was an important
achievement, considering a failed German bund auction the previous
day and in the context of unprecedented government bond issuance in
the euro area slated for 2009.

Bear in mind that all this was written before the Budget and the various activities of the last three months. Now, I may take issue with the entire thrust of macro-economic policy of this state, may gaze aghast at the so minimal one can barely see it nature of the fiscal stimulus, look slack-jaw at the funding of the banking sector (as it happens there me and Constantin Gurdgiev are nearly of like minds) and so on. But from reading the figures the froth being whipped up in the media is simply incorrect. Things are serious, but let’s not ignore the agendas being set.

And so to NAMA…

While much of the domestic reaction was as negative as could be expected in a climate where the government has just made everyone poorer, the international reaction was cautiously positive.

The politics of it are horrendous, of course: bailing out bankers while raising taxes and cutting services. And yet there is little choice – without a banking sector, there is no economy.

Which is true, but perhaps this particular approach isn’t the correct one. We’re hearing a lot about the Swedish model, indeed I was told last week by someone close enough to government that the Irish policies being developed, more or less on the trot, are reaching towards ‘best practice’ in the area.

I wish I were convinced of that. Because if I read the features pages of the SBP I come across a rather disturbing piece by Patrick Honohan, professor of international financial economics and development in TCD. And writing about NAMA he starts:

Breathtaking is the word that came to mind when considering the ambitious asset purchase scheme for the banks. Big problems require big solutions, and the scale of NAMA, taking over responsibility for managing and recovering up to €90 billion of bank loans, is certainly big.

And then he details some of the hurdles that NAMA must face, not least that asset recovery across national borders is a hell of a challenge in itself, that it may raise difficult contradictions, as when he notes:

The mandate of NAMA will also have to be unambiguous: if its recovery actions threaten employment, will it be asked to stay its hand? Like state-owned banks all over the world, it would be very easy for an asset management company to morph into an off budget grant agency incurring hidden additional costs to the taxpayer.

Sure, I know where I stand on that point, and it isn’t with him… then he writes:

The Swedish case is often mentioned – though, at less than 8 per cent of GDP, it was managing a much smaller portfolio than the one NAMA is likely to have to deal with (50 per cent of GDP).

What’s this? The Swedish model that we’ve had held up as the epitome of excellence dealt with a problem 1/5th as large as ours? And other forerunners are no less cheering:

The American and Spanish schemes of the 1980s also did well, but they were even smaller. The jury is still out on others, including the massive scheme in China, now into its second decade of operation. Some did not fare so well, including those of Mexico, Indonesia, Philippines and Senegal, all of which were contaminated by politicisation.

And then he makes some interesting points, very very interesting points indeed.

For example, he notes that the Irish Government appears loathe to simply do the obvious and nationalise. He accepts that ‘this emotive word needs to be parsed and analysed’ but continues:

When the assets are being priced for transfer, the banks will have to reduce (write down) their assets to the new value represented by the bonds that they will receive. This will likely reveal insufficient capital (essentially the excess of assets over liabilities) and require them to raise additional capital.

Despite the reduced risk of the banks’ balance sheets, given the world crisis, the state is likely to be the only source of such capital, and will accordingly acquire an ownership stake – quite possibly a very large percentage stake in each of the banks. The case regarding temporary 100 per cent ownership can then be argued – there is something to be said on both sides.

Sure is. So why the hesitation. We must turn to Richard Curran’s piece on the €90bn property loan that our children’s children will potentially still be paying off (incidentally entitled “A loan again, naturally’… the sub editors down the SBP have a penchant for such things…)…

The government has nationalised Anglo Irish Bank, and Irish Nationwide will probably be next. Meanwhile, it is heading for a majority stake in AIB and a significant minority stake in Bank of Ireland. There is an argument that, having followed the Swedish ‘‘bad bank’’ model, the government should just follow the Swedes and take full ownership and control of the banks. This would enable it to transfer the stressed loans over, and eventually refloat the banks on the stock market in a few years’ time.

Yeah. But remember, the Swedes had a smaller problem than us. Although that works both ways:

The advantage of leaving Bank of Ireland and AIB with some private ownership and stock market listings is that it sends out a signal to the international community that Ireland did not have to nationalise, and that it still has a functioning private sector banking system. Keeping the listings also gives a ready market for the state’s shares, should it decide to sell them. Finally, it also means the banks will have greater transparency through analysts, results briefings and so on.

Think about that… the signal sent out is that “Ireland did not have to nationalise”… even though our bail-out is five times greater than the Swedish one. And that ‘we still have a functioning private sector banking system’. Check out the machinations around the elite of our banking sector, most of whom appear to be hanging on by their fingernails as the Government attempts to defenestrate them en masse and we can the see the absurdity of that statement. Or… talk to anyone you know working in the private sector who will tell you that credit has dried up and that companies with jobs on their books are unable to get payment for them. And then think about the workers in said companies.

Not that Curran ignores that point:

The counter-arguments are that it means the state does not cleanly have full control of all the banks. Look at the ridiculous goings-on between Brian Lenihan and Gillian Bowler of Irish Life & Permanent over the resignation of chief executive Denis Casey, or the crazy conundrum over Michael Fingleton’s position at Irish Natwionwide.

But going back to the Swedish situation for a second. What is being attempted here, is – to my mind – yet another tentative attempt to stand halfway between two points. Too big to be allowed to fail… to big to be nationalised.. our state, our Government hesitates once more.

And the overall impact of this situation? Well, I think for once Tom McGurk, who has been criticised in his time on this site, gets it more or less right:

I’m sure there were times last week when Brian Cowen felt like taking his revolver into the banks. Seemingly, nowadays, – as in the past – the unbreakable rule is that the banks must be preserved, irrespective of the fortunes of the state.

Perhaps, even more fantastically, were you to gather together all of the senior principals in the six banks and building societies that approved this outrageous behaviour, and joined them to the property speculators to whom they loaned the billions, they would hardly fill a good sized bus.

And cogently argues that:

Last week, it emerged that the banks have sunk us into levels of debt that I suspect few alive now will see repaid in their own lifetimes. You can get some idea of the size of the black hole in our economy if you consider that all of last Tuesday’s budget day of painful huffing and puffing will raise just over €3 billion, and the loans that bankers and property speculators have run up between them apparently totals €90 billion. (Nobody seems to know the exact figure – I wonder why?) That’s about 30 budgets, so to speak.

It’s strange how this simple arithmetic, both social and financial, is ignored by other commentators (again with another honourable exception, Vincent Browne who for good measure quotes Eugene McCartan of the Communist Party).

And McGurk happily asks a few hard questions about NAMA, not the least being:

For example, how is a state agency going to repossess property from all across the world, much of it owned by a multitude of different people or institutions, and much of its ownership carefully hidden in off-shore shelters or tax-free areas?

How is it to be valued? One even wonders – given the panic the government was in to give some answers last Tuesday in the Dáil – has this process even been properly examined legally.

And he doesn’t ignore the ramifications of this in the world where both citizens and those citizens who are politicians must live and work:

…whatever about how NAMA does or doesn’t work, there is potentially an even more serious problem looming that could have unforeseen social implications for our society.

Not only is there the very real chance that thousands will sink into debts they will be unable to meet in their lifetime, but thousands may be faced with credit-rating crises and even eviction from their homes.
…

That the same system of loan and interest, and of eviction or even imprisonment for debt, should be allowed to continue into the future in the aftermath of what the banks and the builders have done to our society, now seems unimaginable. Yet, seemingly, this is what is proposed.

Imagine, the banks responsible for this debt might, a few years down the road, toss you and your family out onto the pavement. If the government believes the debt crisis affecting ordinary citizens is any less important to society than the debt crisis the banks are in, they will be making an enormous mistake.

Taylor, Leahy and others may be sanguine about such matters, believing that they can easily disentangle the banks from other aspects of the financial health of the nation, but McGurk at least points to a central truth…

The country’s political and financial classes – who have foisted this disaster on us – should now ponder carefully where we are headed. If they think that financial collateral is our only problem in the coming years, they are mistaken.