Thursday, February 28, 2013

28/2/2013: Boring, Boring Property Prices in January

When one is bored, truly deeply bored, it is hard to muster much strength to go through the twists and turns of the data. And I am bored, folks. Irish property prices data, released by CSO today, is simply equivalent to watching a fish flopping on hot asphalt - it is simply, clearly, obviously, patently... not going anywhere.

That is the story with the stats from Ireland nowadays - the flatline economy, punctuated by the occasional convulsion up or down.

Alas, to stay current we simply have to go through the numbers, don't we?

Let's first do a chart. Annual series for 2012 are finalised and were revised slightly down on the aggregate index compared to the previous release:

The chart clearly shows that despite all the talk about 'bottoming out' house prices, and 'buyers throwing deposits on unfinished homes' is a quasi-2006 frenzy, property prices in Ireland fell over the full year 2012.

Recall the prediction by some economists that property prices are likely to stabilise around -60% mark on peak? I made similar claim, but referencing in the medium term Dublin and larger urban areas, while stating that nationwide prices will be slower to react due to rural and smaller towns' property markets being effectively inactive. Guess what? Dublin prices were down 56.3% on peak in 2012. Not exactly that badly off the mark. Apartments prices - down 61.1% on peak. Exceeding the mark. Nationwide, properties were down 49.5% on peak, still some room to go, but in my view, we are still heading in the direction of 60% decline.

Now, onto monthly series.

Nationwide Property Prices: 

  • All properties RPPI declined from 65.8 in December 2012 to 65.4 in January 2013 (down 0.61% m/m) and is down 3.25% y/y. 
  • Despite all the 'stabilisation claims', overall RPPI has not posted a single month y/y increase since January 2008. 
  • The 'good news' is that RPPI rate of decline (in y/y terms) has slowed down for the 9th consecutive month in January 2013.
  • 3mo MA has been static now over the last 3 months at 65.77, which simply means that half of the gains that were made from the historical trough of 64.8 in June 2012 to the local peak of 66.1 attained in November 2012 were erased when the index fell to 65.8 in December. January rise is a tiny correction back up.
  • Let's put this differently. January 2012 index returned us back exactly to the level of prices recorded in April 2012 and then repeated in October 2012. 
  • The market is... lifeless. Irony has it: 3mo cumulated gains through December 2012 were exactly zero. 3mo cumulated change in the index through January 2012 is exactly zero.
  • 6mo cumulative gains are more 'impressive' at +0.77%.
  • But put this into perspective: this rate of 'growth' implies annualised rate of +0.878%. At this rate of annual expansion, the next time we shall see 2007 peak level prices for properties, expressed in nominal terms, will be 2092. 
  • Prices in Dublin corrected slightly up in January to 59.5 from 59.2 in December 2012. Latest reading is still below 60.0 local peak recorded in November 2012, so the correction is so far very much partial.
  • Y/y prices are now firmer at +2.06% in January, having posted -2.47% decline in December. January marked the first month that we had y/y increases in prices since November 2007.
  • The rate of price increase in January in y/y terms, however, is basically solely correcting for inflation, which means that for anyone with a mortgage payable today, property 'wealth' is continuing to drop in real terms. Obviously, that is too far advanced of an analysis for the Government and its cheerleaders who think 2.06% increase in just one month over 62 months is a firm sign of a 'turnaround' or worse, 'recovery'.
Instead of boring you with the discussion of detailed stats on dynamics, here are the main charts:

All of the above show basic reality of an L-shaped 'recovery' we have been having to-date. May be, one might hope or one might dread, the prices will move up from here in a more robust fashion. Reality is - so far, they are not... When that reality changes, I will let you know.

28/2/2013: Risk-free assets getting thin on the ground

Neat summary of the problem with the 'risk-free' asset class via ECR:

Excluding Germany and the US - both with Negative or Stable/Negative outlook, there isn't much of liquid AAA-rated bonds out there... And Canada and Australia are the only somewhat liquid issuers with Stable AAA ratings (for now). Which, of course, means we are in a zero-beta CAPM territory, implying indeterminate market equilibrium and strong propensity to shift market portfolio on foot of behavioural triggers... ouchy...

Tuesday, February 26, 2013

26/2/2013: 'Italy effect"

Mid-day 'Italy effect' or may be 'democracy effect' or 'No Goldie Sachs Boy in Rome effect'? CDS markets (via CMA) the EU has not banned... yet

Also, note that everyone in the periphery is being clubbed: Ireland and Portugal inclusive (we can safely assume that Tunisia, Sweden, Russia and Bulgaria have been coupled into the group on ad hoc bases).

26/2/2013: The Real Lesson from Italian Elections

The outcome of the Italian elections is the current core driver of the newsflow. Alas, so far, it is for a very wrong reason. The Italian voters have returned a divided Legislature, prompting the claims that Italy is now at a risk of becoming 'ungovernable'. In reality, such statements are confusing one of the symptoms for the entire disease because the original departing assumption of the analysts arguing such a scenario is that the brief period of technocratic governance under Mario Monti administration was:

  1. Effective in enacting / implementing reforms,
  2. Involved reforms needed to address the core problems faced by Italy, and
  3. A sustainable 'new normal' for Italy.

In fact, none of the above three assumptions are valid.

Firstly, the reforms enacted by Mario Monti administration were shallow, not structural and addressed the issue of deficits (which are not the core problem for Italy). These reforms were successfully resisted on the ground - with exception of few tax measures, which were all regressive to growth and were unlikely to survive intact into the future due to their unpopularity as much as due to the fact that Italians evolve very systemic tax evasion responses over time to virtually all attempts to claw tax out of the real economy. There is also a pesky problem that Italian tax burdens are already very high, creating disincentives to entrepreneurs and highly skilled.

Secondly, the reforms enacted by Monti were not addressing the main two problems faced by Italy: the gargantuan Government debt, and the decades-long period of economic stagnation. Structurally, Monti reforms were like a plaster applied to a shark wound, helping to lower the cost of funding the state, but changing little in terms of what is being funded, why it is being funded, and how it is being funded.

Thirdly, technocratic regime is simply incompatible with democratic institutions, and as such cannot be sustained. The result of the latest election actually show the deep disconnect between professional capability of the state / business managerial elites (Monti) and political leadership (ideas-light, and thus forced into rhetorical campaigns juxtapositions) that is emblematic of the proceduralist, bureaucratised European modus operandi since the 1960s. 

Europe's political elite - thin on ideas, experience of real management and knowledge - is incapable of defining leadership beyond populism. Meanwhile, Europe's professional elite - permanently shielded from reality of life by protectionism and bureaucratic licenses - is incapable of capturing hearts & minds of any electorate, let alone emotive electorate found in the periods of crises. Hence, popular leaders turn out to be incompetent managers, while competent managers turn out to be uninspiring as leaders.

This is not an Italian problem - it is a European problem. And the most likely 'European solution' to it will be that Italians will have to vote again, relatively soon, like the Greeks almost  a year ago, in a hope that forcing electorate to face 'explained' or rather 'better marketed' choices can yield the desired outcome, a la Ireland ca 12 June 2008 through 2 October 2009.

Monday, February 25, 2013

25/2/2013: Shifting centre of [economic growth] gravity

Interesting research from McKinsey Institute (link here) on the shifting geography of urban economies growth. Worth a read. And a neat summary of economic trends:

Again, a major theme on my list of big challenges and opportunities coming our way (see presentation on this here).

You can view interactive McKinsey maps and background info here.

25/2/2013: When 8 out of 10 economists agree?

Eurointelligence today published a neat summary of some of the prominent economists' opinions about the Euro area macroeconomic policies:

"Motivated by the recent controversy between Olli Rehn and economic analysists critical of austerity (including from the IMF), El Pais garners the opinions of 10 prominent economists on whether the European Commission is to blame for Europe's poor economic prospects. ... Some quotes:

  • Paul de Grauwe says: "the EU authorities are responsible for the recession … the Eurozone's macroeconomic policy is a disaster"
  • James Galbraith says: "the Commission's leadership seems to work in an alternate reality, indifferent to the consequences of its policies"
  • Luis Garicano says: "Brussels is incomprehensibly dogmatic [and] neglects the probability of a serious accident"
  • José Manuel González-Páramo says: "in a way we're all responsible for the recession … The Commission's proposals are advanced and forward-looking"
  • Paul Krugman blogged "these people have done terrible damage and stll have the power to continue"
  • Desmond Lachman says: "The Commission was very slow to draw the conclusion that the IMF did: excessive austerity with the Euro as straitjacket is counterproductive"
  • Jonathan Portes says: "The optimistic conclusion is that [Rehn] is admitting the justifications for austerity are crumbling"
  • Dani Rodrik says: "The Commission has been fooling itself with the illusion that the structural reforms it spouses can stimulate the economy in the middle of an activity plunge made worse by austerity measures"
  • Guntram Wolff says: "Considering all the constraints the Commission is subject to, it's adopted generally adequate policies, trying to strike a balance between fiscal consolidation and supporting the economy"
  • Charles Wyplosz says: "The Commission makes politically correct forecasts knowing full well they will have to appear surprised when they are not fulfilled."

Paul Krugman also labeled Olli Rehn “the face of denialism”. According to Kurgman, the recent declines in sovereign spreads was due to the LTRO and OMT, and "while unit labour costs have converged a little, they have only converged by a fraction of what needs to be done".

Kevin O’Rourke via the Irish economy blog: “You might have thought that the disastrous but wholly unsurprising eurozone GDP numbers indicate that the bloc is in a bad way, and will continue to be so until the current macroeconomic policy mix is jettisoned. Happily, Olli “Don’t mention the multiplier” Rehn has good news for us: The current situation can be summarised like this: we have disappointing hard data from the end of last year, some more encouraging soft data in the recent past and growing investor confidence in the future. Thank goodness for that.”

I find it very interesting that virtually not a single of the above quotes, save for Krugman's passing reference to labor costs, distinguishes between the necessary structural reforms and pure, brutish, line-across-the-sky cuts that have been adopted by the EU. And even Krugman's references is hardly sufficient - labor costs in and by themselves are not and should not be the target for structural reforms. Instead, market structure, institutional competitiveness, cartel-like structure of some protected sectors, legal systems, moral hazard and other aspects of the crisis should be.

Oh, and lets face it - the drive toward 'austerity' is not only the job of the EU Commission, but also of the EU Parliamentarians (link here), plus all the nation states that adopted the Fiscal Compact.

Olli is nothing more than a mouthpiece for the consensus policies that are continuing to transfer economic crisis burden from the elites to the real economy.

Sunday, February 24, 2013

24/2/2013: EU's Banking Union Plan Can Amplify Moral Hazard It Is Designed to Cure

In a recent note, Germany's Ifo Institute (Viewpoint No. 143 The eurozone’s banking union is deeply flawed February 15, 2013) thoroughly debunked the idea that the European Banking Union is a necessary or sufficient condition for addressing the problem of moral hazard, relating to the future bailouts.

Per note (emphasis is mine), "Largely ignored by public opinion, the European Commission has drafted a new directive on bank resolution which creates the legal basis for future bank bailouts in the EU. While paying lip service to the principle of shareholder liability and creditor burden-sharing, the current draft falls woefully short of protecting European taxpayers and might cost them hundreds of billions of euros."

Instead of directly tackling the mechanism for bailing-in equity and bondholders in future banking crises, "the new banking union plans may... turn out to be another large step towards the transfer of distressed private debt on to public balance sheets..."

Here's the state of play in the euro area banking sector per Ifo: ECB "has already provided extra refinancing credit to the tune of EUR 900 billion to commercial banks in countries worst hit during the crisis... These banks have in turn provided the ECB with low-quality collateral with arguably insufficient risk deductions. The ECB is now ...guaranteeing the survival of banks loaded with toxic real estate loans and government credit. So the tranquillity is artificial."

I wholly agree. And worse, by doing so, the ECB has distorted competition and permanently damaged the process of orderly winding down of insolvent business institutions, as well as disrupted the process of recovery in terms of banking customers' expectations of the future system performance. Per Ifo, "Ultimately, the ECB undermines the allocative function of the capital market by shifting the liability from market agents to governments."

The hope - all along during the crisis - was always that although the present measures are deeply regressive, once the current crisis abates and is reduced from systemic to idiosyncratic, "the European Stability Mechanism (the eurozone’s rescue fund – ESM) and the banking union plan [will impose] more [burden sharing of the costs of future crises on] private creditors".

The problem, according to Ifo is that neither plan goes "anywhere near far enough" to achieve this. "..the “bail-in” proposals suggested by the European Commission as part of a common bank resolution framework [per original claims] “should maximise the value of the creditors’ claims, improve market certainty and reassure counterparties”".

Nothing of the sorts. Per Ifo: "Senior creditor bail-ins are explicitly ruled out until 1 January 2018, “in order to reassure investors”. But if bank creditors are to be protected against the risk of a bail-in, somebody else has to bear the excess loss. This will be the European taxpayer, standing behind the ESM."

"The losses to be covered could be huge. The total debt of banks located in the six countries most damaged by the crisis amounts to EUR 9,400 billion. The combined government debt of these countries stands at EUR 3,500 billion. Even a relatively small fraction of this bank debt would be huge compared to the ESM’s loss-bearing capacity."

Ifo see this four core flaws in "institutional architecture" of the bail-in mechanism:

  • "First, the write-off losses imposed on taxpayers would destabilise the sound countries. The proposal for bank resolution is not a firewall but a “fire channel” that will enable the flames of the debt crisis to burn through to the rest of European government budgets." 
  • "Second, imposing further burdens on taxpayers will stoke existing resentments. Strife between creditors and debtors is usually resolved by civil law. The EU is now proposing to elevate private problems between creditors and debtors to a state level, making them part of a public debate between countries. This will undermine the European consensus and replicate the negative experiences the US had with its early debt mutualisation schemes." 
  • "Third, asset ownership in bank equity and bank debt tends to be extremely concentrated among the richest households in every country. Not bailing-in these households’ amounts to a gigantic negative wealth tax to the benefit of wealthy individuals worldwide, at the expense of Europe’s taxpayers, social transfer recipients and pensioners."
  • "Fourth, the public guarantees will artificially reduce the financing costs for banks. This not only maintains a bloated banking sector but also perpetuates the overly risky activities of these banks. Such a misallocation of capital will slow the recovery and long-run growth."
Note that per fourth point, the EU plans, while intended to address the problem of moral hazard caused by current bailouts, are actually likely to amplify the moral hazard. In brief, "...the proposal for European bank resolution exceeds our worst fears."

Note that the Ifo analysis also exposes the inadequacy of the centralisation-focused approach to regulation that is being put forward as another core pillar of crisis prevention. "A centralised supervision and resolution authority is necessary to address the European banking crisis. But that authority does not need money to carry out its functions. Instead bank resolution should be subject to binding rules for shareholder wipeout and creditor bail-ins if a decline in the market value of a bank’s assets consumes the equity capital or more. If the banking and creditor lobbies are allowed to prevail and the commission proposal passes the European parliament without substantial revision, Europe’s taxpayers and citizens will face an even bigger mountain of public debt – and a decade of economic decline."

I couldn't have said it better myself.

24/2/2013: Absurdity of Human Capital Politicisation in Europe

Much of economic policymaking in Europe is driven by the political objectives of the EU, not by economic rationality or efficiency considerations. Here is an interesting potential example of the same trend toward over-politicisation of decision making happening in another sphere - border controls and immigration:

Most certainly worth a read and a robust discussion.

A note to flag some absurdity of the EU policies. Take a look at this map:

Note that Balkan countries, not members of the EU, all (with exception of Kosovo) have a visa-free travel arrangement with the Schengen area. This means that a resident (both citizen and non-citizen) of these countries has visa-free access to the entire Schengen despite paying not a single cent in taxes in the EU, having no residency in the EU, having no family member with an EU citizenship, maintaining no home in the EU nor any business within the EU.

In contrast, an EU taxpayer with full residency in the UK or Ireland but who is not the national of the EU state cannot freely travel to Schengen countries. Full stop. Only one restrictive exception to this is the case where such travel is undertaken by non-EU citizen accompanying their EU-citizen spouse.

Get the madness? Those non-EU citizens who live, work, maintain homes, have families (including with EU citizens in them), run businesses in EU member states (Ireland & UK) have less rights than non-EU citizens of the countries that are not a part of the EU.

Worse than that. Absurdity goes much deeper. A non-EU citizen who is a long-term resident of Ireland and the UK, with home ownership (1), employment (2), business (3) in these states, cannot gain a long-term multi-entry visa to Schengen countries simply because the issuing authorities (embassies of Schengen countries in the UK and Ireland) cannot coordinate the frequency of travel etc between themselves. Yet, a non-EU citizen with a vacation home in, say Spain or Montenegro, has full unrestricted access to the Schengen.

Saturday, February 23, 2013

23/2/2013: Irish Knowledge Economy: Sources of Funding

In previous two posts, I have covered the broader trends for R&D spending in Ireland over 2007-2012 and more specific trends in terms of R&D-related employment. In this, last, post I will illustrate some trends in relation to R&D spend and activity by nationality of the firm ownership.

First, two charts:

The charts above clearly show that for indigenous firms (Irish-owned):

  • Use of own company funds has declined in overall importance between 2009 and 2011, although the category still plays more important role in 2011 than it did in 2007 in funding R&D activities. This longer-term trend is most likely a result of a combination of factors at work: 1) reduced availability of credit and equity investment as the result of the crisis, 2) reduced emphasis in R&D on tangible IP that can be used to raise equity funding.
  • Meanwhile, public funding (despite the fiscal austerity) rose in overall importance in 2007-2011 period, although 2011 result is showing some moderation in overall reliance on public purse sources for R&D funding. This is also consistent with the points raised above.
  • All other sources funding share accruing to the Irish-owned enterprises is volatile (per second chart above), but overall these sources of funding are becoming less important to the Irish-owned firms (first chart above). It is unclear whether supply (bust financial system in Ireland and collapsed investment) or demand (firms struggling with already massive debt overhang and facing the prospect of multi-annual Government deleveraging) drives this. My gut feeling - both.

The contrast between the Irish-owned and non-Irish-owned enterprises is difficult to interpret outside the simple realisation that the latter are predominantly MNCs and as such have no difficulty in sourcing internal funds for R&D activities. Public funding for these types of enterprises is ca60 percent less important than for Irish-owned enterprises.

Table below summarises the data:

I guess the main lesson here is that we need to more aggressively stimulate the use of 'other' sources of funding for the Irish-owned enterprises. I have been speaking about the need for enhancing Ireland's tax system to increase use of employee equity shares as a major tool for raising funding for indigenous firms, especially medium-sized ones (see presentation here).

23/2/2013: Another 'Competitiveness' Indicator for Government to Cheer About

That price competitiveness thingy is clearly hitting Ireland:

Now, even Dublin 4 can have a competitively priced milk-over-saturated brew with little coffe taste on the side that passes for 'grande latte' in the Starbuck Universe.

23/2/2013: Irish Knowledge Economy and the Labour Market

In a recent post I looked at some troublesome trends in the overall R&D spending in Ireland. As promised, here are some more details, with the employment levels and R&D spend breakdown by nationality of enterprise ownership. This data, unfortunately, only goes as far as 2011.

Here's the chart showing the spending by enterprise type (Small Enterprises (SE) with <50 all="" and="" as="" base="" categories="" category="" employees="" enterprise.="" enterprises="" for="" here="" is="" of="" on="" other="" p="" select="" specific="" spending.="" taken="" the="" total="">

As the chart clearly shows, the bulk of R&D spend is allocated to Labour costs. I wrote about this earlier, so no need to repeat. But time trend is interesting in all costs:

  • The importance of labour costs is falling in 2009-2012 for Small Enterprises (from 61.6% to 53.4%) and is rising for all other enterprises.
  • The importance of Purchases (defined as expenditure on land & buildings, payments for IP licenses, instruments and equipment purchases and purchases of software) is rising for SEs (from 9.7% in 2009 to 24.4% in 2011) and falling for all other enterprises (from 17.5% to 6.8%). 
  • In comparative terms, SEs are spending nearly four times more on purchases than other enterprises.
  • The above is consistent with general theme around the world: SEs require more inward purchasing, while larger enterprises carry out more in-house activities. In turn, this means that SEs must generate more value-added to offset higher costs associated with purchasing.
  • Remarkably, there is much less difference across enterprises types in terms of spending on own in-house software development. This suggests that in-house development is not associated with cost-shifting by enterprises (reallocation of normal business costs to R&D activity category to reduce tax exposures).
In terms of employment generated / supported by the R&D spending, the chart below shows distribution across the core categories of employees:

Despite the fanfares around 'Knowledge Economy' jobs, the chart clearly shows that the numbers of R&D employees with PhD qualification - the basic level in modern science to engage in advanced research - has declined in 2009-2011 period by 8.6%, although it is still ahead of 2007 levels for the Industrial & Selected Services sectors. It also dropped in 2007-2009 and 2009-2011 in the Manufacturing sector, with 2009-2011 decline of 10%.

At the same time, 'Other Research Staff' numbers rose in 2009-2001 by 22.2%. 

This is probably consistent with the R&D activity shifting into ICT services sector, where share of PhD-led research is smaller and much of the research activity conducted is focused not on primary innovation, but adaptation, customisation, other incremental innovation. This is also consistent with much of the R&D activity in Ireland being secondary in nature - not patent-generating or new product development, but incremental improvement. The third potential factor driving these changes is possible expansion of collaborative work between academic institutions and producers.

A very interesting chart plots the sectoral R&D staff employment as a ratio to total R&D staff engaged:

It is very apparent that our flagship exporting sector, the 'Big Hope' for the 'Innovation Ireland' programmes - the agricultural sector is simply not engaged with much of R&D activity. The sector posts lowest share of R&D employment by far. Exactly the same holds for virtually every indigenous sector. The chart is extreme: MNCs-dominated sectors are clear leaders in R&D-related employment, domestically-oriented sectors are clear laggards. Remember renewable energy? We are supposedly filthy rich in inputs in the sector (wind, wave etc). We are also, supposedly, engaging in massive research in the area and have aggressive programmes to drive the alternatives energy sector into exporting electricity to the UK and selling know-how all around the world. However, even with the 'white elephant' project like e-cars from the ESB, sector employment of R&D personnel is simply inconsistent with the grotesque claims made about our alternative energy industry competitiveness or position.

Another worrisome fact is that for all the successes of the IFSC and international financial services in general in Ireland, the sector - a major source of innovation (good and bad) worldwide - is yet to put forward appreciable levels of R&D-related employment in Ireland. What is worse, while employment in the IFSC held up relatively well during the recent years, employment of R&D staff in financial services shrunk, relative to the levels of employment if research staff across the economy.

I will post on the breakdown of R&D activity by the company ownership (Irish v Non-Irish owned enterprises) later, so stay tuned.

Friday, February 22, 2013

22/02.2013: A small cloud over German economy's silver lining

Released today, the Ifo Business Climate Index for German industry and trade "rose significantly by over three points in February. This represents its greatest increase since July 2010. Satisfaction with the current business situation continued to grow. Survey participants also expressed greater optimism about their future business perspectives. The German economy is regaining momentum."

These are positive news for the German economy and it needed some cheer up. But, alas, good news, like every proverbial silver lining, do come with small clouds attached. Since I am not in the business of spinning the same story as everyone else, I will focus on some of these clouds in the note. You can read the actual press release and see data here:

Good stuff: "In manufacturing the business climate indicator rose sharply. This was specifically due to a considerably more optimistic business outlook. Manufacturers also expressed greater satisfaction with their current business situation. Export expectations increased and are now above their long-term average once again."

"In construction the business climate index continued to rise sharply, primarily due to a far more optimistic business outlook. The business outlook reached its highest level since German reunification. Satis-faction with the current business situation also continued to grow."

Truth be told, in the industrial sectors, the entire rise in the index can be explained by the above two sectors, with wholesale and retail sectors staying at and below the zero mark (respectively). Internal economy seems to be still in poor shape, although the rate of decline clearly dropped in wholesale sector, whilst accelerating in the retail sector.

In services, business climate also rose impressively, but the entire increase was due to business expectations, while the current situation assessment deteriorated.

What worries me more is the headline indices for all sectors.

  • Business Climate index rose to 107.4 in February 2013 - up +3.0% m/m, but it was down 1.9% y/y. 3mo average through February 2013 is at 104.7, up on 101.0 3mo average through November 2012, but down 3.4% on the 3mo average through February 2012.
  • Business Situation improved much less dramatically and is lagging well behind overall climate reading. The sub-index on current situation rose to 110.2 in February 2012 (+1.9% m/m), but is down 6.1% y/y. 3mo MA through February 2012 is down 7.2% y/y.
  • As the result, most of the gains in the overall Climate reading were due to, yep, expectations of future changes. Expectations rose to 104.6 in February, up 4.0% m/m and up 2.3% y/y. Expectations were also up on 3mo average reading +0.6% y/y. 

The latter point is problematic. You see, expectations surveys of businesses are often more indicative of the direction, rather than of the magnitude, of future changes. And so is the case with the Ifo index.

Per chart above, whilst current conditions are strongly correlated with the business climate in the same period, it turns out that future expectations are much more strongly linked with current climate (and conditions) than with what they are supposed to predict - namely, future conditions. In fact, the same result holds regardless of whether we choose a forward lag on expectations 6mo out or 12mo out. There is simply no connection between m/m changes in reported expectations and the future business climate realisations.

So, while we sound victory trumpets around the headline 'strong rise' in the Ifo index, we should be aware of the fact that most of this rise is indeed being driven by highly suspect expectations.

But wait, things are even worse than that. Take a look at historical volatility in indices. Based on two standard deviations metrics (sample and population), m/m changes in sub-indices post historical standard deviations of 1.4 for Business Climate, 1.7-1.8 for Business Conditions and 1.7 for Expectations. Which, basically, means that 3% rise in headline index was basically statistically indifferent from zero change, and likewise was 1.9% rise in Business Conditions index. Only the 4.0% hike in Business Expectations was possibly statistically significant.

So here wi have it - the most questionable in quality indicator was the most influential driver of the February gains and was also the most likely candidate for being statistically distinct from zero in terms of its m/m expansion.

Wednesday, February 20, 2013

20/2/2013: Irish R&D Spend 2011/2012 - Concerns >> Fanfares

CSO has recently published data on R&D spending in Ireland for 2011/2012. That's right: in the days of Big Data, Open Data, etc our 'Knowledge Economy' is operating in the environment where evidence is more than 13 months old. In fact, the reality is even more bleak: CSO data for 2012 covers only actual data on current spending, with capital spending covered by estimates. In brief, Ireland's pro-Knowledge Economy policy formation is backed by old and hardly impressive in scope data.

However, given we have nothing better to go, let's take a look at what the latest stats tell us about the Irish economy's R&D intensities. In what follows, I reference combined time series with both actual and estimated data points.

Overall, Total R&D Expenditure by all enterprises rose 5.49% y/y in 2012 to EUR1.96 billion. That's right, Irish economy is investing just 1.53% of its GNP on R&D activities. In 2009 that number stood at EUR1.87bn amounting to 1.41% of GNP. The miracle of the 'knowledge economy' or 'Innovation Ireland' is really quite feeble. In 2009-2012, therefore, the R&D spending rose 4.99% cumulatively.

However, the above growth is distributed unequally across a number of items of expenditure and types of enterprises:

  1. 2009-2012 Labour Costs associated with R&D activities went up 15.18% (+8.45% in 2012 y/y alone), while total Current Costs rose 12.28% (+7.81% y/y in 2012).
  2. 2009-2012 costs associated with Payments for Licenses on IP rose 356.84% (+0.51% y/y in 2012), while software purchases costs shrunk 47.3% (up 18.22% y/y in 2012). Meanwhile own Software Development costs incurred by all enterprises rose 148.01% in 2009-2012 period (up 0.03% y/y in 2012).
  3. Total Capital Spending on R&D activities has declined in 2009-2012 period by 29.55% and was down 9.24% in 2012 in y/y terms.
In other words, there is some evidence of potential cost shifting via R&D credits onto workforce, away from physical investment, as well as evidence of re-orientation of our exports away from manufacturing toward services.

In terms of enterprises types (Small enterprises, SEs at <50 at="" employees="" enterprises="" large="" medium="" mles="" to="">50 employees):
  1. SEs saw rapid growth in 2009-2012 in Licenses for IP costs (+3,997% and only up 0.87% y/y in 2012), followed by Software purchases (+112% on 2009 and up 29% y/y in 2012) and Software development by the company (+87% on 2009, but down 5.1% y/y in 2012).
  2. SEs overall current spending rose 44.75% on 2009 in 2012 and 9.9% y/y, while their total capital spending rose 328.4% on 2009 in 2012 and was down 8% y/y.
  3. Total R&D spending by the SEs rose 73.0% on 2009 and was up 4.9% y/y in 2012.
  4. In contrast, for MLEs, the largest growth was recorded in Software development by the company (+174% on 2009 and up 1.65% y/y in 2012). There were significant declines recorded in all other categories, with a 86.5% drop on 2009 in payments made for licenses to use IP (also down 11.2% y/y in 2012), 64.9% decline on 2009 and 4.3% decline y/y in 2012 for Instruments & Equipment spending, and a 57% drop (on 2009) in Software purchases, although here there was a rise of 15.3% y/y in 2012. Total Capital spending on R&D by firms with more than 50 employees declined 65.8% on 2009 in 2012 and there was a drop of 10.8% y/y.
The above is consistent with the view that in 2011/2012 there was re-orientation in expenditure to either reduce labour costs and / or support services-focused sectors, away from traditional R&D spend on equipment, software and IP.

Table below summarises relative allocations to specific lines of expenditure by the types of companies:

For SEs I highlighted in color the areas of strength in the new data (green) and weaknesses (red). As can be clearly seen, Irish smaller enterprises are not at the races when it comes to overall investment and spending relating to R&D activities, with 26.5% of the total nationwide expenditure captured by SEa, although the good news is that this number has risen compared to 2007-2008 period. In particular, weak dynamics are present on the labour costs side. At the same time, Irish small enterprises tend to purchase more IP from outside (97.2% of total expenditure nationwide on IP purchases is by SEs) and  tend to develop less software in-house.

The above results show just how much more needs to be done at the SEs levels to drive forward knowledge intensification of the economy. At the same time, overall headline figure of 1.53% of GNP being spent on R&D related investment and expenditures is also a major, system-wide problem. It is even more egregious when one considers the fact that Ireland is the base for European operations of many major multinationals.

I will be blogging more on the analysis of the 2011/2012 figures in coming days, so stay tuned.

20/2/2013: Hungary's 'Return' to Bond Markets

Week ago, Friday, Hungary was downgrade to junk. This Tuesday, despite its newly-minted junk bond status from all three core agencies (Ba1/BB/BB+) Hungary went to the market with a plan to raise USD3bn worth of US Dollar-denominated bonds. 

Now, unlike Ireland, Hungary is NOT in the 'best-of-class' league in Europe when it comes to compliance with the Troika demands and in general. After all, Hungary went on to aggressively interfere with its Central Bank independence, broke off negotiations with the IMF on second 'rescue' package back in November 2012, and basically replaced the Governor of the Central Bank with dovish Monetary Council. The country economy is still in a tailspin based on IMF figures*, although its fiscal performance, external balance and unemployment are healthier than those of the 'best-in-class' country - Ireland: 
-- Hungarian GDP is estimated by the IMF to have fallen by -1.021% in 2012 (against Ireland's estimated increase of +0.353%), with 2013 forecast for a rise in Hungarian GDP of just 0.797% in real terms (Ireland's same period forecast is for a rise of 1.394%).
-- Hungary's unemployment rate is barely budging off the crisis high (11.243% in 2010 to 10.925% in 2012). Ireland's unemployment rate is at the crisis period high with 2012 estimate at 14.7-14.8% and expected to decline marginally to 14.41% in 2014.
-- Hungary's General Government Revenues are shrinking faster than the economy. In 2011, Hungary's Government collected 52.864% of GDP in revenues, which has fallen to 45.787 in 2012 and is expected to shrink to 45.054% in 2013. In the mean time, Ireland's Government Revenues are marginally up from 34.118% in 2011 to expected 34.542% in 2013.
-- General Government Total Expenditure in Hungary is slowly inching up: from 48.672% in 2011 to forecast 48.761% in 2013, against Ireland's contraction from 46.869% in 2011 to 42.065% projected for 2013.
-- General government net lending/borrowing in Hungary stood at a deficit of -2.909% of GDP in 2012 and is forecast to rise to -3.707% in 2013. This compares with the completely abysmal Irish performance at 8.301% GDP in 2012 to 7.523% in 2013 forecast.
-- Hungary's primary deficits are expected to be less than 1/2 of those of Ireland in 2013.
-- Hungary's Government debt is sitting at 74.2% of GDP forecast for 2013, down from 80.6% in 2011, while Ireland's debt is up from 106.5% in 2011 to 119.3% projected for 2013.
-- The Government is aiming to repay the IMF and EU of €3.65bn and €2.31bn in 2013, against Ireland's nil repayments.
-- Hungary's current account balances have been in excess of that for Ireland since 2009, although 2013 forecast is for the current account surplus of 2.69% in Hungary vs 2.71% in Ireland.

*Note: I am using WEO data for the comparatives, instead of individual countries assessments, so some of the data cited is slightly off the latests projections, although the actual comparatives are hardly off by much

In other words, Hungary is clearly more of a sovereign policy, economic environment and monetary policy risk to the investors than Ireland. And despite this, Hungarian Government 10-year bonds have fallen in terms of yields from 5.8% in August 2012 to around 4.7% currently.

And last Tuesday, Hungary has managed to place USD3.25billion worth of new 5- and 10-year bonds with the cover ratio at 12.5-to-3.25. Overall, Hungary had offers for USD5.5bn worth of 4.25% 2018 bond with USD1.25bn allocated, these were priced at 335bps over US Treasuries and 320bps over mid-swap bang on with where the 10-years (2011s) were traded in the secondary market. Last time it sold 10-year bonds back in 2011, these were priced at coupon of 6.375% or full 100bps above the current deal. It also booked USD7 billion book for 5.375% 2023 bond with USD2bn allocated, priced at 345bps over US Treasuries and 336bps over mid-swaps.

Hungarian Government planned to raise some USD4bn worth of bonds in 2013 in total and is now 81% at its target for the year. Geographic allocation of the placement was even more encouraging: US investors took 55% of the 10-year paper, UK and Europe investors took 21% each. Funds took 81%, hedge funds took 9% and banks and retail investors only 5%. The 5-year allocation was similarly spread.

All of this suggests that the markets have little interest, currently, in the underlying risk fundamentals. Instead, pretty much anything offering a yield above the G7 average is simply seen as a target worthy of consideration. While Governments are quick to show up at the sales announcements with proclamations of their policies successes, the reality of the market awash in liquidity and nothing to chase in terms of yield means that investors are rushing into the issues pushed through by the economies that hardly in rude health today or can be expected to return to such a state any time soon. 

Tuesday, February 19, 2013

19/2/2013: Japan's Woes: 3 recent posts

Some excellent blogposts on Japan's problems via Economonitor:

1) All exports and money printing can't offset Japan's debt, ageing and domestic demand woes:

2) Does end of growth (Japan's example) spell end of high quality of life?

3) Japan's forgotten (but not fully unwound) debt bubble:

All worth a read.

I can add that in 2011 Quality of Life Index by International Living magazine, ranking 191 countries around the world, Japan was in 7th place (rank range is between 7th and 10th), whilst Ireland was in 20th (rank range between 20th and 26th) in terms of overall quality of life, with Japan outperforming Ireland in 4 out of 9 categories of parameters on which the rankings were based and tying Ireland in one category. (link to full rankings)

Note: the above rankings did throw some strange results, so careful reading into them.

Monday, February 18, 2013

18/2/2013: OECD on Corpo Tax Havens for G20

Just as G20 was starting to make noises about corporate tax havens at their meeting in Moscow (here) the OECD produced a convenient paper on the topic of tax avoidance. The paper is rather 'neutered' when it comes to language, but nonetheless offers couple fascinating insights, especially when it comes to Ireland. The report is titled "Addressing Base Erosion and Profit Shifting"

Per OECD: looking "specifically at the effects of income-shifting practices of United States based MNEs [Clausing, 2011],  …finds large discrepancies between the physical operations of affiliates abroad and the locations in which they report their profits for tax purposes: the top ten locations for affiliate employment (in order: the United Kingdom, Canada, Mexico, China, Germany, France, Brazil, India, Japan, Australia) barely match with the top ten locations for gross profits reporting (in order: the Netherlands, Luxembourg, Ireland, Canada, Bermuda, Switzerland, Singapore, Germany, Norway and Australia)."

And then:

"A report of the United States Congressional Research Service (Gravelle, 2010) concludes that there is ample and clear evidence that profits appear in countries inconsistent with an economic motivation. The report analysed the profits of United States controlled foreign corporations as a percentage of the GDP of the countries in which they are located. It finds that for the G-7 countries the ratio ranges from 0.2% to 2.6% (in the case of Canada). The ratio is equal to 4.6% for the Netherlands, 7.6% for Ireland, 9.8% for Cyprus, 18.2% for Luxembourg. Finally, the study notes that the ratio increases dramatically for no-tax jurisdictions with for example, 35.3% for Jersey, 43.3% for Bahamas, 61.1% for Liberia, 354.6% for British Virgin Islands, 546.7% for the Cayman Islands and 645.7% for Bermuda."

Now, of course, Ireland is a conduit via which profits of MNCs are off shored to zero tax jurisdictions, so one wonders, how much of Cayman's and BVI or Bahamas' 'profits' are really coming via Ireland.

The whole report addresses the issue of 'base erosion' in tax systems - the topic also close to heart to Ireland, as CCCTB proposals at the EU level are attempting to deal exactly with that problem and represent a massive threat to Ireland's tax optimisation industry.

Based on the data in the report, here are some revealing charts:

It is first worth noting that in absolute terms, corporate tax revenues overall are not that spectacular in the case of Ireland, contributing at an OECD average levels to the Exchequer. And these revenues have been falling, not rising, in importance despite a severe decline in GDP during the crisis:

Three interesting aspects per above are:

  1. It is pretty clear that Irish Exchequer has opted to transfer lower corporate tax burden onto the shoulders of individual Irish taxpayers, and that this process has started well before the onset of the crisis, but became dramatically pronounced in 2007-2009.
  2. It is also pretty clear that overall corporation tax is not an important source of Exchequer funding in recent years despite the Government numerous claims that the Corporation Tax receipts are robust and vital to the Exchequer.
  3. Domestic boom period was associated with a massive (relative) uplift in tax revenues from the corporation tax, while the MNCs/exports boom during the crisis did nothing of the sorts, showing clearly that the effect of MNCs activities on Irish economy (as instrumented by the Exchequer) is weak.
However, the trend toward deterioration in revenues importance to the Exchequer during the crisis (driving down the 2000-2011 average) stands in contrast with rising importance of the corporation tax in the decade of the 1990s:

It is illustrative to highlight the change in relative importance of the corporation tax revenues over the last decade:
Ireland stands out as the the country with the third largest decline in corporation tax importance in 2011 compared to 2000-2005 average. In contrast, in Switzerland, the corporation tax contribution in 2011 stood at a premium on 2000-2005 average.

Here are some links on the topic of the Irish corporate tax haven from the blog:


18/2/2013: Short-selling and Markets Volatility

A large number of analysts and policy makers tend to believe that highly leveraged trading activity, especially that linked to HFT, is a significant, even if only partial, driver of markets volatility. The channel through this logic usually works is that in the presence of leverage, speed of positions unwinding in response to unforeseen events increases, thus amplifying volatility.

An interesting study by Harrison Hong, Jeffrey D. Kubik and Tal Fishman, titled "Do arbitrageurs amplify economic shocks?" (Journal of Financial Economics, vol 103 number 3, March 2012, pages 454-470) examined the impact of arbitrageurs' activity on stock performance. Based on quarterly data from 1994 through 2007 for NYSE, Amex, and Nasdaq, share prices were examined over two distinct sub-periods: one day before earnings announcement and one day after the announcement. Medium-term performance was analysed for two days before earnings announcement and 126 days after earnings announcement.

The authors find that:

  1. Stock price reaction to earnings news is more severe in heavily shorted stocks than in stock with fewer short positions;
  2. Changes in the short ratio and earnings surprises counter-move;
  3. Share turnover as a result of large earnings surprises is higher for heavily shorted stocks as consistent with (1) above;
  4. Positive earnings surprises push up the valu of heavily shorted shares (as consistent with (1) and (2) above)
  5. Following positive earnings announcement, returns are higher (in general) for stocks with heavy shorting positions prior to the announcement since price appreciation post-announcement forces covering of short positions and triggers more demand for shares;
  6. Consistent with (5) above, post-positive earnings announcement, previously heavily shorted stocks become better targets for further shorting;
Overall, the study finds that:
  • Any earnings surprise in any direction (either positive or negative) leads to a corrective action by (either long or short) investors;
  • The above increases price sensitivity to newsflow and thus volatility;
  • Trading volume and stock price increase abnormally for heavily shorted stocks;
  • The abnormal volatility and volume & price effects are temporary and in the medium terms, prices revert to the mean.

18/2/2013: G20 & Currency Wars

Amidst continued rapid devaluation of the Yen, predictably, and per usual, the G20 summit in Moscow has ended with a useless and unenforceable statement. This time around, as was signalled in the days ahead of the meeting, the 'focus' of transnational vacuousness was on the topic de jour: the Currency Wars.

But the background to it was much less economic than political. G20's sole obsession is to drive forward the idea that to survive, the world needs more coordination of top-level policies. This invariably requires (a) finding a convenient newsflow-worthy boggy, (b) making a statement to the effect that greater coordination is needed and that cooperation can cure all ills, and © proceeding to do absolutely nothing about it post-statement. The latests communique went on to conclude that “ambitious reforms and coordinated policies” were the key to achieving strong sustainable growth. Just like that: coordinate and magic shall happen.

Thus, the meeting of G20 has issued a statement rallying against competitive currency devaluations - or in more common parlance, a “currency war”.

In reality, G20 has no power to abate, let alone reverse, the process of currencies debasement. Quantitative easing - in its now fully evolved multitude of forms will go on, with central banks and governments across the OECD continuing to print their ways out of the slump. If G20 communique were to achieve anything, it will be just to push the whole affair under the proverbial rug, with devaluations not explicitly targeted in public pronouncements.

The communique states that G20 states "will refrain from competitive devaluation. [and] will not target our exchange rates for competitive purposes, will resist all forms of protectionism and keep our markets open.” The devil, of course, is in the slight turn of phrase. The G20 committed to not drive down their currencies values for 'competitive purposes'. But as long as money printing is 'necessary' to sustain domestic financial stability or deliver a monetary stimulus or both - then all is ok.

Just how feeble the whole statement is was illustrated immediately, with the worst offender - the Japanese Yen, down 7% in value already in 2013 - posting a slide against major currencies. In many ways, the communique makes it even more likely that sustained devaluation of the yen will be even more damaging now. Prior to G20 statement, the Japanese Government could have simply continued pushing down yen values by focusing on aggressive statements about the need for monetary stimulus and forex rate targeting. Now, it will have to print hard cash silently.

And the Fed is still sitting on a massive bonds purchasing programme that so far has been running at ca USD80bn per month. At G20 meeting this programme has been squarely defended by Bernanke.

Senior Bank of England, Martin Weale went on, during the G20 summit, to praise Sterling debasement, saying that a 25% devaluation of the pound over 2007-2008 period was not enough to boost exports and that more devaluation should be targeted.

In short, the entire G20 summit was a joke. It neither signaled any real policy shift, nor mapped a single tangible policy response to the crises still impacting advanced economies. If anything, via reducing potential rhetorical impact of monetary policy stance, it pushed the G7 countries into a more aggressive real monetary policies responses space. This promises to accelerate the currencies wars, while reducing overall ability of the monetary authorities to quickly unwind the decisions taken in years to come.

Sunday, February 17, 2013

17/1/2013: 'Brown' Republicans v 'Green' Democrats?

Farzin, Y. Hossein and Bond, C. A., in their paper "Are Democrats Greener than Republicans? The Case of California Air Quality" (January 16, 2013. FEEM Working Paper No. 97.2012. or ask an interesting question: "When it comes to environmental quality preferences, it is popularly believed that Democrats (and more generally, liberals) are “green” while Republicans (conservatives) are “brown”. Does empirical evidence support this popular belief?"

The paper tests the hypothesis that "regional political identification leads to differences in concentration outcomes for several measures of California air pollution indicators, including CO, NO2, SO2, O3, PM10, and PM2.5 concentrations." The authors control for "political party preferences of the local populace, as well as …the political party affiliations at the state-level legislative and executive branches".

And the findings are very much against the grain with the common 'wisdom':  "In general, we do not find a consistent and statistically significant relationship between pollution outcomes and political variables for California. The popular belief is empirically supported only for NO2 and O3, but not for any of the other pollutants, and even in these two cases the relationship only holds at the local regulatory level and not at the state policymaking level. At the state level, for most of the pollutants no significant effect of party affiliation is identified, and in the rare cases where such an effect exists, it is either too weak to be conclusive or is even counter to popular belief."

17/2/2013: Why do economists use models with false assumptions?

An interesting new paper from the PIER on the currently quite acute divergence between academic economics and the general understanding of economic inquiry outside the field of academic economics, namely the divergence in the value attached to theoretical models in analysis. Especially models, that are based on patently false assumptions.

Gilboa, Itzhak, Postlewaite, Andrew, Samuelson, Larry and Schmeidler, David, paper "Economic Models as Analogies, Third Version" (January 27, 2013, PIER Working Paper No. 13-007. or argues that although "people often wonder why economists analyze models whose assumptions are known to be false", "economists feel that they learn a great deal from such exercises. We suggest that part of the knowledge generated by academic economists is case-based rather than rule-based. That is, instead of offering general rules or theories that should be contrasted with data, economists often analyze models that are "theoretical cases", which help understand economic problems by drawing analogies between the model and the problem. According to this view, economic models, empirical data, experimental results and other sources of knowledge are all on equal footing, that is, they all provide cases to which a given problem can be compared. We offer complexity arguments that explain why case-based reasoning may sometimes be the method of choice and why economists prefer simple cases."

Saturday, February 16, 2013

16/2/2013: Minister Noonan Talks International Finance, briefly

This week, Calgary Herald reported some fascinating remarks made by Irish Minister for Finance, Michael Noonan at the EU Finance Ministers meeting. Quoting from the paper (full link here), with mine emphasis added:

"Arriving Tuesday for a meeting of the 27 EU finance ministers, Irish Finance Minister Michael Noonan said: "I think all this debate about the relative value of currencies is going to be an issue at the G-20 but we're coming through a period where the concern was the volatility of the euro". "It's a bit soon to argue that it's too strong." Noonan said he wouldn't support any proposals that the ECB should intervene in the markets to get the value of the euro down."

This statement bound to raise eyebrows of anyone even remotely familiar with economics and / or international finance.

Minister Noonan - in charge of the Finance portfolio in a Euro area country - seemingly has trouble formulating exactly what the Euro crisis is / was about. Volatility of the euro he cites was never a problem during the crisis. In fact, in major exchange pairs, Euro has not been the driver of the volatility, but the subject to periodically, short-term elevated volatility induced by the changes in policies and fundamentals in non-Euro area countries. And volatility of the EUR relative to any other major currency was actually lower than for exchange rates ex-EUR.

The confusion in his mind seems to arise from the lack of basic grasp of the currency markets.

  1. Minister Noonan seems to have no idea that "volatility of the Euro" as a phrase is fundamentally imprecise. Euro (and any other currency) can be volatile only in terms of a bilateral (or in more complicated setting - triangular) exchange rate. He mentions no such pairs. We can talk about EUR/USD exchange rate volatility, or EUR/JPY volatility, etc, but not about 'Euro volatility' in pure terms, unless we want to say that EUR is the driver of volatility in the bilateral exchange rates vis-a-vis all major currencies.
  2. Minister Noonan seems to be confusing 'volatility' (definable by a number of statistically objective metrics) and 'uncertainty' (definable only imperfectly by a risk transform approximation). This is more than an innocent failure to understand philosophical differences between risk and uncertainty. By confusing 'volatility' for 'uncertainty', Minister Noonan anchors his analysis of potential and preferred solutions to the crisis solely to policies that can reduce volatility of the exchange rate. By this metric, the crisis was not even worth a footnote in a newspaper.
But then comes a logical step that defies any comprehension. Having stated that the crisis was 'volatility of the Euro', Minister Noonan goes on to say that he opposes ECB intervention to alter the value of the euro. Surely, intervention would be consistent with policy management to reduce the exchange rate volatility that Minister Noonan is so concerned about?

Let's set aside the apparent lack of logic in the statements above. And let's focus on Minister Noonan's longer-term position vis-a-vis the Euro. 

Minister Noonan and his Government have actively pursued policies of extending Irish Government debt maturity. The latest instalment of this strategy was the 'deal' on the IBRC Promissory Notes. In other words, Irish Government entire economic policy (with exception of 'exports-led recovery') can be summed up as a hope for future inflation wiping out real value of Irish Government debt. Forget the fact that such an outcome will destroy the other side of our economy where debt overhang is also present: the households (higher inflation = higher interest rates = higher burden of debt). But what on earth is Minister Noonan doing talking against his own Government policy?

This bizarre combination of 'swinging' focus in policy goes deeper. Irish Government second (and last) pillar for economic policy - other than inflation - is 'exports-led recovery'. 2010-2012 data on Irish exports shows rapidly contracting rate of growth in exports. Monthly and quarterly data show even more reasons for concern. Foreign demand weaknesses and structural issues in the Irish exporting sectors are clearly major drivers. But higher valuation of the Euro are not helping. Yet, Minister Noonan is concerned with preventing devaluation!

Should Enda, perhaps have a chat with Minister Noonan, rather than send troops out after his party backbenchers whenever they are slightly critical about the Government position? Afterall, in the above few words, Minister Noonan has managed to mis-state the source of the Euro problem, derive an implicit but deeply flawed policy conclusion out of this mis-statement, and contradict his Government's two cornerstone policies. 

Friday, February 15, 2013

15/2/2013: Euro Area Banks: Staff & Admin Costs 2008-2011

Brilliant data set on Staff and Admin costs in domestic banking sectors across the Euro Area (H/T to Lorcan Roche Kelly aka @LorcanRK via twitter), via ECB (link) :

So run through these. Over 2008-2001, Admin & Staff costs in banks:

  • Declined by 7.84% across the entire Euro Area;
  • Went up in Cyprus by a massive 21.9% (banks are now bust), in Spain by 12.16% (banks are largely bust), in Portugal by +4.26% (many banks are zombified)
  • Fell marginally by  -0.05% in Italy (some larger banks in pretty dire shape), -3.2% in Greece (banks are bust).
  • Fell significantly in Ireland by -26.4% (banks are bust), Luxembourg by 36.5% (brassplates operations), and by 31.3% in shaken Estonia (banks are operating in high risk, low growth environment). Fell consistently in line with overall state of the crisis across the banks-related sectors of the economy in the Netherlands (-10.81%) and overshooting economy's woes in Belgium (-23.2%).
  • Fell massively in Germany, where overall banking sector was not as badly mangled (-59.6%).
Go figure...

15/2/2013: Irish CDS mid-day

Mid-day CMA update on CDS markets: Ireland slipping slightly after good rally and so are other peripherals:

Not a game-changer, but then again, Sovereign CDS are hardly a 'game' anymore, given thin trading and other constraints. Still, pleasant to see 167.01 5-year spread.

15/2/2013: Loose Lips of Brendan Howlin & Jens Weidmann's Bother

Strong words today on the Irish Promo Notes deal from ECB's Jens Weidmann via Bloomberg (link to full interview here):

"It’s important that we draw a clear line between monetary and fiscal issues. The transaction in Ireland demonstrates how difficult it is for monetary policy to free itself from the embrace of fiscal policy once you’re engaged. The Irish government in its very own statements underscored the fiscal elements in this transaction.

"I’m rather strict when it comes to the definition of monetary financing. It’s important to draw a clear dividing line and accept the limitations of Article 123 for our actions. It’s not difficult from that to guess what my position is. [I would guess he is 'troubled' by the deal]

"The Irish government liquidated the IBRC. That has repercussions on net financial assets and has to be assessed against the background of Article 123. Of course the Eurosystem has to make sure that its actions are in conformity with its rules and statutes. [Widemann here clearly links NPV from the deal (small but positive by my estimates at EUR4.3-6.5bn, with some other analysts getting their estimates out to EUR8bn or roughly 25% of the original Promo Notes issuance or 30% of the remaining outstanding amounts) to the issue of whether the deal is legitimate.]

"I’m not passing a legal judgment on a particular transaction, but I think it is clear from what I said that I’m very concerned about monetary policy being too closely intertwined with fiscal policy and crossing the line to monetary financing. That’s why I was very skeptical about some of the decisions in the past, and you can be sure that I apply the same benchmark to this transaction.

"Once you cross a certain line, setting a precedent, it’s very difficult to come back and argue against the next similar transaction. That’s why it is important to define our mandate narrowly, so we’re not drawn into fiscal policy matters. There is a reputational issue, there’s a credibility issue. It might make it more difficult to focus on our main objective credibly. If governments had wanted to provide additional funding to Ireland, they could have tapped the ESM.

"We took note of this issue in the Governing Council. Our deliberations aren’t public. Apart from that, the transaction is out there, it’s known, it’s very transparent. Everybody has his own judgment on this -- I have mine.

"The transaction as such is technically a bit complex but it has a fiscal nature as stated by the Irish government. That’s clear enough." [Oh, here we come: Irish Government and senior Ministers have gone out talking about the 'social' dividend on the deal 'savings' etc. This might just bite the Government back. Rhetoric about Government spending (in any way) at least a share of the deal short-term cash flow savings will clearly signal that the Irish Government has pulled ECB into monetary financing and thus opens up the whole affair of the deal to legal challenge in Germany. As they used to say in WWII: 'Loose Lips Sink Ships'... care to listen, Minister Howlin?]

Thursday, February 14, 2013

14/2/2013: New Compensation Model for Rating Agencies

I wrote yesterday about two studies on the effectiveness of the rating agencies (link here). Another interesting study on the agencies and their performance was published in Spring 2012 issue of the Journal of Structured Finance (vol 81 number 1, pages 71-75). Authored by Malesh Kotecha, Sharon Ryan, Roy Weinberger and Michael DiGiacomo and titled Proposed Reform of the Rating Agency Compensation Model, the study looks at the current model of rating agencies compensation - the so-called issuer-pay model whereby issuer of securities being rated paying for the rating delivery - in light of the apparent conflicts of interest implicit in the model. The authors propose an alternative model based on fee levied on new issues and secondary markets trade. Fees would be deposited in a dedicated fund which will pay these out to the rating agencies. The agencies will be rotated on a performance basis, taking into account accuracy of their ratings over time.

The criticism of such an approach to compensation model - as noted by the authors - stems from 
-- the disincentive to rating agencies under the proposed changed model to innovate in ratings models development (higher potential errors etc)
-- the fact that the US bonds market is global in coverage and thus requires competitive pricing systems, 
-- difficulty of devising a merit-based rotating system and setting appropriate levels of fees; and
-- the new model introducing a transactions tax.

Overall, the weakest point of this proposal is undoubtedly its failure to consider the US markets role as global issuance platform with any transaction tax eroding cost competitiveness and the failure in recognising that global scope of rating agencies and the US markets also implies severe limits on new compensation model ability to capture the activities of these agencies.

Wednesday, February 13, 2013

13/2/2013: Rating Agencies Role & Effectiveness: 2 recent studies

In light of all the cases being filed against the rating agencies and in light of the general controversy surrounding them, here are two recent papers dealing with the topic of rating agencies performance and the links between their ratings and investors' decisions.

One interesting paper was published in the Journal of Banking & Finance )vol 36, number 5, May 2012, pages 1478-1491) by Thomas Mahlmann titled "Did Investors Outsource Their Risk Analysis to Rating Agencies? Evidence from ABS-CDOs".

The paper looks at the floating-rate tranches from collateralised debt obligations (CDO) backed by asset-backed securities to test whether yield spreads at the point of issuance (origination) act as good predictors of future performance. The paper found that, once we control for rating at issuance and other deal-specific data, yield spreads do indeed indicate future performance. However, this result is primarily due to tranches that were initially rated below AAA.

The study concludes that at the issuance / origination, investors did not rely only on ratings, when pricing the CDOs studied. The study econometric evidence also indicates that ratings were inadequate for CDOs because these instruments are much riskier than corporate bonds.

Another paper, published in the International Journal of Finance and Economics (March 2012) by Eduardo Cavallo, Andrew Powell and Roberto Rigobon, titled "Do Credit Rating Agencies Add Value? Evidence from the Sovereign Rating Business" look at the credit downgrades made during and after the financial crises asking whether rating agencies opinions provide any incremental information to the market.

The answer to the question is yes. Rating agencies opinions on sovereign risks do explain a portion of variation in three macroeconomic variables, relevant to the market: exchange rates, stock market indices and future sovereign bond spreads, once the authors control for observed bond spreads.

The study also found that rating agencies upgrades (downgrades) are correlated with:

  1. decreases (increases) in the spreads one day forward;
  2. increases (decreases) in the stock market;
  3. nominal exchange rate appreciation (depreciation) relative to the USD.
Top level conclusion: the ratings do contain information about specific credit and the rating's informational content is in addition to other publicly available market data, such as credit spreads.

13/2/2013: BlackRock panel economic outlook for H1 2013

Not surprisingly - and in line with the likes of CESIfo Index measuring global economic conditions (see link here) - BlackRock Institute report on global economic outlook also signaled that analysts' expectations are turning positive.

Here are two key charts for North American and Western Europe:

I like the cautious, but overall improving outlook for Ireland: still significant proportion of experts expecting continued recession, but crucially, Ireland is (at least in expectations) well-decoupled from the peripheral euro area countries.

Do note Spain's position as the worst expectations performer in the group - must I remind you, Mario Draghi recently praised Spain as the country that serves as an example of how to 'stabilise' crisis-hit banking sector... right...

13/2/2013: CESIfo Index shows improvements in Global Economy

CESIfo institute has issued its analysis of the global economy and... some good news: per CESIfo index tracking global growth, world economic climate indicator finally is up after two consecutive declines.

The increase in the index "was mainly driven by significantly more positive assessments of the 6-month [forward] economic outlook." At the same time, "assessments of the current economic situation improved only slightly. After 6 months of stagnation, the prospects for the world economy seem to be brightening."

  • Asia led the global index rise, with region index "now higher than its long-term average once again. Both assessments of the current economic situation, and especially expectations, have brightened considerably." 
  • In the case of North America "the rise in the economic climate indicator was mainly due to improved assessments of the current economic situation. Despite the improvement, the current economic situation is not completely satisfactory in this region." 
  • Per CESIfo release: "The current economic situation is also unfavourable in Western Europe. Assessments of the 6-month [forward] economic outlook, on the other hand, were significantly more positive, which led to a moderate overall improvement in the economic climate." 

CESIfo Index panel "on average expect short-term interest rates to remain largely unchanged over the next six months. However, they believe that long-term interest rates are set to increase slightly. On worldwide average, economic experts expect moderate growth in the value of the US dollar over the next six months."

Tuesday, February 12, 2013

12/2/2013: Small step down, but doesn't hurt either...

Nice move in CDS markets for Ireland earlier today - not large, but good positive. Also, note relative distance in implied probabilities of default between Ireland and Portugal: