Thursday, 10 December 2009

Municipal bonds can help solve our funding problems

This post has been written by Stephen Kinsella of the University of Limerick and Karl Deeter of Irish Mortgage Brokers

Problem: Cash strapped local authorities, inadequate pension provision within an aging society, and reduced infrastructural development. Solution: Municipal bonds.

Municipal bonds are debt instruments issued by local authorities to finance investment projects. Yesterday’s announcement by government of a Recovery bond is a variant of the municipal bond idea, but on a national level. We have written about municipal bonds before, several times. We are interested in recapitalizing local authorities and regional authorities using these bonds, and we’d like to use this blog post to sound out possible issues with the idea, and compose a plan of action for implementing the idea if people think it is feasible.

Cash-strapped local authorities can use funds generated by municipal bond issues on a yearly basis to reduce their infrastructural deficits in transport, water provision, port equipment, broadband provision, and community initiatives. Ireland’s regions can compete on the quality of our infrastructure, rather than on direct wage competition.

Dealing locally but funded centrally to deal with extremely poor infrastructural provision with broadband, hospitals-both public and private, roads, amenities, playgrounds, local housing, homeless initiatives, and regeneration projects. Individuals can use municipal bonds in order to save and invest, or to fund their pensions, ensuring a guaranteed rate of return on their savings. Local authorities can respond to the needs of citizens directly using these bond issuances.

Ireland's recent flooding has exposed three painful facts. First, increased flooding as a result of climate change is inevitable. This 1 in 800-year event will be probably be seen again inside a decade. It should be remembered the flooding of 2008 broke all previous records in Dublin and Cork. Second, public services were not equipped to stop the flooding from occurring or to deal with the floods once they had occurred. Third, the government cannot pay for the cleanup operation, which may cost a half a billion Euros. In simple terms we need the infrastructure, we cannot go forward with the risk of recurrence unmitigated, and yet we equally can’t afford to pay for the improvements, it is a considerably difficult position to find oneself in nationally.

Municipal bonds can finance important local projects that won’t get funded.
Ireland's local authorities are underfunded, and have been systematically underfunded for decades have been systematically underfunded for decades. The current economic climate means Ireland will reduce its capital spending provision for several years on many crucial projects of long-term national importance, like flood prevention infrastructures, environmental cleanups, broadband provision, roads, port systems, and many more.

According to the Global Competitiveness Report, in the category of 'Quality of Overall Infrastructure' we rank 64th in the world. We will lag further behind as our investment reduces further in the next three to four years. A measure must be found to balance the need for public spending and public saving on a local basis, in order to develop investment strategies that are business-friendly and of long-term economic and social significance.

An aging population requires increased pension provision

By 2050, 1 in four workers will be over 65, 1 in 10 will be over 80. Regardless of the year of retirement of these workers, and the replacement rate of the old by the young, the implications of this demographic shift for our pension and health care system are enormous. Public pension provision may bankrupt the state unless private provision is instituted on a mandatory basis. Private pensions are risky, in particular Defined Benefit schemes, as Waterford Crystal employees found out last year to their dismay.

At present there are 1700 Defined Benefit schemes in Ireland. About 400 schemes are less than 50% funded, a full 1500 are below the 100% threshold, meaning there are only roughly 10% of active and deferred members who have coverage levels of 100% or greater. The scene is set for a social tragedy.

Municipal bonds represent a means to increase private provision of savings and pension entitlements while simultaneously recapitalising local and regional authorities. Authorities can reduce their other minor money-generating schemes such as rates and parking charges, and become more business-friendly, increasing inward investment by private business at the same time as providing world-class infrastructure.

Municipal bonds are working now in the US and Europe.

Municipal bonds are most developed in the US. Build America just increased and re-issued their tax-efficient subsidised debt product to the tune of 56 billion. The bond market in the US is currently thriving.

The State of Oregon is a prime example of municipal bond usage. Municipal bonds are very safe and historically have had a very low default rate. They are appropriate as a pension vehicle and also as a savings and investment vehicle.

How do Municipal Bonds work?

A simple diagram helps to explain how bonds work.

The bonds are issued by the local authority or a regional authority. They are underwritten, in this case, by the government, and rated if there is the ability to obtain a debt insurance (such as AMBAC in the USA) it reduces the cost to the municipality by ensuring they achieve a top rating. A consultant is required at this stage to manage the process. The bonds are issued to the markets at a fixed coupon and end date, usually 20 years, and their sale frees up funds to be used in the construction of large scale public projects.

Examples of projects funded by municipal bonds include: power plants and distribution systems, public markets, hospitals and health care centers, water supply, sewerage and sanitation, flood protection and prevention systems, schools and day care centres, broadband rollout, telephone and communication systems, toll roads, bridges, ports, airports and public transportation facilities, government housing and regeneration developments, development of industrial estates, tourism and green energy investment and research/development.

Broadly there are two types of bond that tend to issue, one is a ‘General Obligation’ which means that the regional authority/city/municipality are responsible for repayment of the debt out of their general revenue stream, the other is a ‘Revenue Bond’ which pays the debt via revenue from a particular project such as toll bridge/tunnel etc.

Advantages of Municipal Bonds

1. More certain payback for future pensioners, decreased volatility of pension funds, in particular if funds were moved into bonds on a dynamic basis whereby there is greater participation as you near retirement (ie: move away from equities as volatility risk due to retirement age approaching becomes a greater issue); easily transferrable title; increased savings provision for all.
2. Increases funding to local authorities for large capital projects: It would also place the full responsibility for timely and within budget projects upon the areas and taxpayers of the region that benefits from same.
3. Transparent and easily governed structure.
4. Government backed and insured.
5. Solves the 2050 pension provision problem if mandatory. Some form of mandatory participation is required, whether it is under the Singaporean Model (state managed) or Australian Model (individual managed) is a matter of process, but the need for mandatory pension provision is becoming increasingly clear.
6. If funds are never used to finance current expenditure, increased capital provision means the economy can develop in line with local voter's preferences.

Next Steps

1. Get buy in from Central government. Local authorities don't have the ability legally to do this. Yet. The current system is referred to as ‘tax and transfer’ and there are sizeable extraction costs before ground is broken on shovel ready projects.
2. Group spending priorities by region and by location first. Small projects ready to go with 3-5 year time horizon only. Essentially bonds could be part of an overall stimulus package, there is sufficient private wealth seeking low risk yield in this country which remains under utilized in terms of being a part of national recovery, there is no reason for investors not to be part of a coalition of the willing in terms of stimulus, but without the very vehicle to allow this to happen we cannot even bring them to the table.

In the example of infrastructure for floods, perhaps insurance companies would be happy to invest in these bonds as it would reduce liability to their insurance book in the future, they have a vested interest in not seeing the area under water, to the same degree residents do. Municipal projects can therefore bring together disparate groups within a common ideal, whereby profit is far from being a dirty thing, it is an honourable element of necessary infrastructural advancement.

3. Fully cost out a Municipal bond issue for the BMW region: population, prospects for issuances, new types of bonds, and new state pensions model.


Liam Delaney said...

guys - dont see where you are coming from here. it sounds mostly like a national bond with hypothecated spending clauses. you clearly are not proposing that the local authorities themselves would underwrite the repayments, so the analogy to international schemes breaks down on the financing side. Other than a possible behavioural advantage of framing it in terms of local issues, I really cant see how this is different to issuing national bonds to finance local projects through the department of environment. pitching it as a solution to the pension problem is a distraction in my view. are you suggesting that an irish local project scheme would generate a better return than, for example, a safe bond-heavy international investment portfolio?

Liam Delaney said...

Actually, i really object to the idea of mandatory pensions but to mandate what the pensions would actually be spent on is surely a recipe for uproar. to make the case for muni-bonds more squarely, you have to disentangle this issue. We can institute a mandatory pension system in the morning if we want to. Its a separate issue from whether to have muni-bonds. Also, how is this system more transparent. The authorities issue the bonds but the center underwrites them. There are clearly distorted incentives that arise from this.

One final point is where you see this money as coming from. These are likely a substitute for national bonds, with resulting issues for debt financing. In fact, if these are to be a runner at all they will have to made more attractive than national level bonds so in essence you are making a transfer to local authorities from other spending priorities.

progressive-economy@tasc said...

With regard to pension reform, TASC's pension reform proposals can be uploaded here:

Stephen Kinsella said...

Hi Liam,

The reason to keep it 'local' or at least regional is to encourage local participation in broadly 'social' initiatives, and to encourage competition between the regions. One can think of Dublin vs Galway, offering different rates on bonds, different returns on pensions, and broadly different investment projects as the locality require, of example, flood protection, parks, broadband provision for investments, etc.

In terms of return, Municipal bonds are very very safe, so I'd say a local bond issue would be comparable in terms of uncertainty reduction to a 'safe' international portfolio.

The pensions idea is related, in my view, because these bonds represent locals 'saving' if they are bought to pay for pensions and paid out later on, and 'investment' for the local authority in the same breath. I know your point about mandatory pensions and paternalism, but spending 13%+ of our GDP by 2050 otherwise is really something to start worrying about now.

The money comes from investors either locally or abroad, we can think of sweetheart clauses built in to encourage 'limerick' people to buy 'limerick' bonds, and so forth, but in principle of course everyone can buy them. The money comes I think from the higher return--4.2% on average over 20 year bonds, which tax-free represents close to 10% return, so I don't think we'd have problems getting buyers for these. They might crowd out other national bonds, but really, what were the other bonds set up to do, but recapitalise the country? This way the saving/investment channel is directed toward infrastructural projects by local people, which to my mind makes sense.

Liam Delaney said...

But the local authority has to make good on these higher rates of interest or the state picks up the tab (either that or lets the authority go bust). Surely, these higher rates of interest end up crippling the local authorities in the long-run. There is not an economic return in the sense of revenue streams from many of the projects one would like to finance at local level.

"but really, what were the other bonds set up to do, but recapitalise the country?" - but steve, not just in the local authority portfolio. also to finance health, education, etc., A mandatory purchase of a bond to finance a subset of spending requirements imposes a big constraint.

with regard to competition, the local authority finance managers don't have the incentive to really compete under the outline you propose. and do you think any national government would allow a local authority to go "bust". how do you stop another NAMA from emerging from the scramble to issue bonds?

i see good sense in a targetted national bond designed to offer broad ranging stimulus. it would be good to compare this against your proposal in a later iteration of this argument.

karl deeter said...

Actually, i really object to the idea of mandatory pensions but to mandate what the pensions would actually be spent on is surely a recipe for uproar. to make the case for muni-bonds more squarely, you have to disentangle this issue. We can institute a mandatory pension system in the morning if we want to. Its a separate issue from whether to have muni-bonds. Also, how is this system more transparent. The authorities issue the bonds but the center underwrites them. There are clearly distorted incentives that arise from this.

One final point is where you see this money as coming from. These are likely a substitute for national bonds, with resulting issues for debt financing. In fact, if these are to be a runner at all they will have to made more attractive than national level bonds so in essence you are making a transfer to local authorities from other spending priorities.

Hi Liam,

The 'national bond' may in effect be a non-specific muni. The core idea being that we have more valid and necessary projects than tax money to fund them. In this respect the collection of taxes and eventual trickle-down to infrastructure is inefficient, it also doesn't allow private investors to willingly take part, relying instead on the state to extract revenue first.

If people in Limerick (for instance) want flood protection they can't actually buy it for themselves and reap any reward, in this case the income would derive from beneficiaries who don't get flooded - likely via a property tax, or perhaps via partial support from insureres who's insurance book isn't marred with claims in flood prone areas. Local authorities would have to underwrite the bonds, obviously a first step is to give them their own revenue raising abilities - but that has started to happen with the NPPR €200 p.a. and now with the impending Site Value Tax mentioned yesterday.

The safety of the scheme is unfounded as it is untested, but a comparison of such bonds in other countries show they are an preferred and logical option for the private buyer, the municipal bond market (as least in the US) is the only market that isn't dominated by institutional investors, it is predominantly bought by the general public.

On the pension front it gets tricky, pensions tend to come with tax entitlements so the lower yield of Muni's actually deters using them in a pension, normally people talk about the TEY (taxable equivalent yield), if you get 4% on a muni and you are paying say 33% then you'd need to get about 5.6% on a corporate bond to earn the equivalent. However, if there was the option of getting tax relief on the lump sum but obtaining the coupon tax free you could be onto a real winner, people start to save and fund important projects while securing an small cashflow to retirement.

In this respect you don't channel people into the bond, but there is a perfectly reasonable reason for an allocation of a portion of ones retirement portfolio in the muni because of the tax free extractable coupon and avoidance of CGT if the bond rises in value. Naturally you could invest without pension provision but then there would be taxable gain on the bond.

The advantage over national level bonds or sov. debt is the tax free element of the coupon along with the local aspect of the benefit of the bond. It is no surprise that the biggest buyers for munis are often the very people who stand to gain from the project. It could also be bought by insurance companies who have a vested interest in fast tracking projects (such as the previously mentioned flood protection).

All in all, we need a method to get local governments to have actual powers with budgets based upon their encatchment area revenue with the ability for private investors to participate in public programmes. This is one such method of getting that result.

Paul Hunt said...

"All in all, we need a method to get local governments to have actual powers with budgets based upon their encatchment area revenue with the ability for private investors to participate in public programmes."

The intention is good, but given the shambolic balkanisation, inadequacies and lack of effective accountability in local government it's not the place to start. FG's NewEra proposals are probably a better place to start in relation to infrastructure and utilities, but I would opt for wholesale privatisation and an effective regulatory revenue model which would allow pension funds (or whoever) to include some of this equity in balanced portfolios and allow the businesses to issue their own paper. There might be some scope for regionalisation (similar, perhaps, to the Euro constituencies), but I would be inclined to pull out as much as possible of the activities that can be commercialised and leave the rest (taxation-funded) in restructured regional LAs.

Stephen Kinsella said...

Hi Paul,

Privatisation just doesn't work for utilities, as my colleague Donal Palcic has shown. But yes, the FG policies are a good place to start!

Paul Hunt said...

Thank you, Stephen. Donal and I have argued to a standstill on privatisation. What amazes me is the belief that it is impossible to establish effective regulation of private sector businesses but that public officials will be better able to finance, direct and manage the same activities. It is also puzzling that privatisation automatically equals IPO. There is no reason why a consortium of pension/insurance funds could not buy out existing semi-states and hire the existing management. And there is no reason why something similar could not be done for restructured water and waste water services. This could be expanded to address transport and other services. There is no question that there is a demand for regulated, relatively low-risk, stable returns. It makes sense to use appropriate regulated revenue models to take these off the state balance sheet (and remove them from the associated requirement for tax funding).

Stephen Kinsella said...

Hi Paul,

If I understand it correctly, Donal's point is that there are certain utility-class services, like power, water, broadband networks, that need to be provided by the State on public goods grounds as well as efficiency grounds. Other services, say the selling of services over those networks, should and could be run privately. Are there any figures on what kind of benefits we migth see from such a privatisation? I think we can all agree the Eircom privatisation has been a disaster for all but a select few.

Paul Hunt said...


Many thanks for the response. I realise I am dragging this thread away from the orginal post, but I think its primary intention was to secure necessary infrastructure financing off the central government balance sheet. Given the current EBR anything that assists in this respect is worth exploring. I understand Donal's point about network ownership; FG is adopting the same approach - public network ownership and private/privatised network users. And it's precisely where I disagree with both.

If there are benefits, they arise in the complete ownership separation of the network and supply businesses. This will help to ensure efficient financing of the network businesses. Standard & Poor have downgraded BGE because it is perceived as having over-payed for wind-farm assets and is relying on regulated network revenues to subsidise its non-core, more risky empire-building. Gas consumers are paying through the nose for this.

Unbundling and financially ring-fencing the ESB and BGE network businesses and debt-financing them up to the proportions generally considered appropriate for regulated network businesses internationally would release up to €3 billion in equity back to the Government and allow a reduction in network tariffs that could final electricity and gas prices down by as much as 10%. A subsequent privatisation of the networks could generate €2 - 3 billion. The CER has the power to compel investment in required gas transmission and supply infrastructure; it would be easy to extend its powers in a similar manner for the electricity system.

It is often argued that networks should be kept in public ownership because governments and state-owned enterprises can borrow more cheaply than private network owners, but this is nonsense. This is the case because tax-payers are on the hook for government and government-supported debt, but credit spreads widen if there is too much of this debt. There is a compelling requirement to reduce this debt and privatisation is an appropriate approach.

Donal Palcic said...

Hi Paul,
We have definitely argued ourselves to a standstill and agreed to disagree on the topic of utility privatisation over on irisheconomy so I’ll try not to go back over those points!

In relation to your point that there is a "belief that it is impossible to establish effective regulation of private sector businesses", I would argue that it is hard to believe that effective regulation will be established if we privatise our energy/water/transport networks based on the Irish experience to date. We have all seen just how ineffectively ComReg has dealt with Eircom over the past decade. You yourself have often criticised the CER’s regulation of the electricity and gas industries. If we are not regulating our energy companies effectively now, why must we assume that this will change if they are privately owned? This would require policymakers to enact the necessary legislation to create an effective regulator with the appropriate powers. Again, based on the experience to date, I would not be overly optimistic that this will happen. I think these points were already made by Alan Matthews and Eoin Reeves in response to your guest post on the benefits of increased investment and efficiency in public infrastructure and utilities over on irisheconomy last November.

In relation to your point about privatising water and waste water services, again I would ask why you believe this would lead to an improvement in these services and where is the evidence to support this? Eoin Reeves already pointed to the failure of the privatisation of the water industry in the UK in his comments on your irisheconomy guest post that I referred to above.

I would like to state that I am not completely anti-privatisation and I also acknowledge that state ownership of network industries can be inefficient. I also acknowledge that effectively regulated private network business can provide services in certain industries more efficiently. However, as you yourself have said previously, effective regulation isn’t easy to develop and apply. In the absence of effective regulation I cannot see any reason why we should sell our remaining state-owned network utilities, thereby transferring considerable economic power to the private sector in the hope that they will prove to be more efficient.

Paul Hunt said...

Hi, Donal,

I agree that there's no point re-hashing previous points, so let's start with FG's proposals which Stephen seems to consider as a useful point of departure - and I assume you are not in fundamental disagreement. Its proposed restructuring, for electricity and gas, focuses on the complete separation of the network and supply businesses with the former remaining in public ownership and the latter being prepared for privatisation "when appropriate". My principal criticism of the CER is that it extracts additional revenue from consumers to finance the continued intgeration of the ESB and BGE and their empire-building ambitions. (I have every confidence that it would be as effective in grinding down private sector owners as it has been in gouging consumers in the interests of the ESB and BGE.)

Since this thread is about financing much needed investment, a re-financing of the publicly-owned, stand-alone network businesses (off the state balance sheet) would release up to €3 billion in equity back to the state and the required network revenues would fall (as a result of more efficient financing and the removal of the obligation on the CER to help finance the ESB's and BGE's empire-building) leading to lower final prices.

With sufficient political will it should not prove difficult to enforce the necessary separation of the network and supply businesses. These businesses are supposed to be operationally separate to comply with EU directives and the separation will have to be enforced more stringently following the enactment of the latest directives in July.

The released equity would reduce the net indebtedness of the State. (I would go further and privatise the networks generating up to another €3 billion, but let that pass.) But it would also provide a "war chest" to leverage the financing of further investment in other infrastructure areas - but only of restructured activities governed by an appropriate regulatory revenue model.

All of this would be opposed tooth and nail by the ESB and BGE (and their unions) and by the LAs if water and waste were restructured. I expect most of the posts on this - progressive site - would support their opposition.

Sean said...

Fine Gael's position, as per NewERA, is very clear.

We believe that the State has a key role to play in helping roll-out a 21st C infrastructure to improve competitiveness. We further believe that strategic networks such as the grid should remain in State ownership.

While NewERA includes a National Recovery Bond, it will also be necessary to finance some of the investment in strategic State infrastructure by the sale of non-strategic State assets. In addition, we are convinced that the semi-state companies, as part of NewERA, need to be radically reformed to increase efficiency and effectiveness.

We fully accept that Local Govt. generally, and Local Govt. finance in particular, is in a mess and this is something we are looking at in the context of our "New Politics" initiaitve. Generally, we are of the view that the centralised model of politics and governance in Ireland has failed in many key ways.

Stephen Kinsella said...

One very constructive belief that's come out of the crisis is the acceptance of institutional failures in Irish society- ComReg and our local authorities are excellent examples of institutions with poor governance and accountability, as well as a definite misalignment of incentives across these institutions.

The use of municipal bonds as a carrot to encourage institutional reform does make sense in that regard, and has historical precedent--the state of Oregon (pun intended) was altered by the introduction of Muncipal bond funding. Bond funding exercises necessarily come with strict oversight conditions, precisely because of the 'local' nature of the funding. So this could be one part of the carrot and stick exercise in encouraging reform.

Sean said...

@Stephen. Why would local bond funding exercies come with any more oversight than bond funding exercies, on a commercial basis, through NewERA for instance? Not a criticism of your position - genuinely interested in understanding your approach.

Paul Hunt said...


Very few US states have a population less than that of Ireland. US States have a fiercely defended degree of autonomy (see that goes back to Federalist Papers of Madison, Hamilton and Jay. And the US is always keen to distinguish its system of governance from that in the UK (the direct or indirect origin of most of the Founding Fathers) and in France (the source of many of the ideas they put into practice). For better or worse we have an adaption of the UK centralised system; the task is to make it work better in the interests of all citizens - and not the few. Copying the US is unlikely to lead us very far.

The key issue here, in the context of grossly overstretched public finances relying on external financing, of gross citizen-damaging inefficiencies in regulation and financing of semi-state bodies and of the requirement to build the platform for growth and prosperity, is the exercise of political and economic power.

It is good that FG's proposals in these areas are being given some consideration as the likely reality is that it will either form - or be the major partner in - the next government. It would sense for the Labour Party - and those on the so-called "progressive left" - to begin to engage in an open-minded, non-tribal and non-ideological manner.

For far too long semi-states, such as the ESB and Bord Gais, have been cosseted and allowed to set the policy agenda at the expense of all citizens. This is not an attack on the terms and conditions employment of ESB or BGE employees. As I have mentioned previously BGE is one of the most efficient semi-states in operational terms; it is the policy/regulatory decisions on investment and financing that impose the burden on consumers.

Tackling these inefficiencies will have major economic benefits - not least in reducing the cost of living for recipients of SW benefits and those on low income who are bearing the brunt of the current budgetary adjustments.

Michael Burke said...

Problem: cash-strapped financial services firms, large swathes of private sector now bankrupt. Answer: find new ways to milk the public to bail them out.

Unless the local authority or the private sector company can borrow at rates below the government, there is a new, addtional cost to the public from their higher interest rates.

Local authorties will only be able to borrow at higher rates than the government, which are already too high. No private agency in Ireland is likely to be able to borrow at rates below government either. Only foreign capital could currently, meaning privatisation is the exchange of a stock of capital (the sold bus company or energy provider, for example) for a permanent outflow of capital in the form of repatriated profits.

In addition, any private capital, foreign or domestic, exists for profits, which the public sector does not. This can only be achieved either by increasing prices and/or driving down wages, or both.

Not sure what is 'progressive' about any of this.

Damian said...

Stephen - interesting proposals (as always) but this type of initiative is no substitute for local government financial reform. To say local government finance is in a mess is an understatement. However a municipal bond on a local government that does not have the authority to generate its own tax revenue is simply a claim on central government. In this regard I think a more suitable comparison might be South Korea where I believe central government had to bail out local governments hit by the recent crisis. Ireland certainly doesn’t have the deep and liquid financial markets or fiscal federalism of the US. And we certainly don’t need any more claims on central government!

gabriel said...

@ Damian,

Thanks for the South Korea reference, I'll check it out asap.

I think we're talking about something more radical than a local authority borrowing money--the law would have to be changed to allow them raise revenues in a US-style way.

The notion of oversight and transparency is key here--the Municipal bond markets have heavy oversight, moreso than other types of issuances. I think an even more drastic form of oversight could be applied to local authorities in the Irish case.

@ Michael,

I take your point, but I think you're being a bit too 'general equilibrium' about it. Private savings have increased in Ireland, a market does exist for tax efficient government backed securities, and these direct the funds from those issuances toward infrastructural projects which may be revenue -generating. I'd argue this type of financing is very progressive if well applied. The issue of who buys the bonds is largely immaterial from my point of view at least.

@paul, cheers for the links, will check them out and comment back later

gabriel said...


The real issue with municipal bond oversight comes from their history: the first Muni issuers did a runner back in the 1800's, and people have been wary of local authorities ever since!

Stephen Kinsella said...

Woops! The 'gabriel' above is me, folks--must have logged in as my dad for some reason!

karl deeter said...

re: privatisation.

I think it is important to realise that privatisation is not an inherently good or bad thing, rather it boils down to implementation.

Eircom is a great example, for instance - they cannot drop their prices to drive down consumer costs because they have an unfair advantage over other providers, if the infrastructure had remained in the ownership of the state but users were private companies then it would ensure a better market place exists, the 'irish' version of privatisation is where you IPO then keep the state meddling away in the background. Own the infrastructure and control the contributors, it can work, I know because it already does in many countries - in particular look at Gas distribution in the US, during the 30's there was a push toward making gas a federal issue, electricity on the other hand was local only, in the end both systems work, one had govt. ownership of infrastructure the othere was free market only.

@michale burke @Liam the idea of borrowing below the national rate is due to the taxation treatment of the coupon, on a Taxable Equivalent Yield it may be over national borrowing rates but strip that out and it could easily trade below.

@damian we could consider a bond insurance scheme, or go to a product producer (eg: lloyds) and have them underwrite the bonds. If a core principle is to decentralise reveneu then you can't centralise losses!

Paul Hunt said...

@Michael Burke,

Your diagnosis, as usual, is sharp and to the point. But the logical conclusion of your post is more, and much more, central government borrowing. Even if it generates returns through faciliating economic growth it imposes an increasing burden on current and future taxpayers. At the moment the marginal cost is increasing and the future supply is uncertain.

Colm McCarthy may be a bete noire on this site, but his piece in yesterday's SBP could not be more clear and reasoned on this issue. And I can't believe that you view the buyers of sovereign bonds as being less interested in profit maximisation than buyers of corporate bonds and investors in equity.

At the moment the ESB and BGE are sitting on €6 billion of equity that has been contributed largely by consumers. Encashing this would reduce the State's net indebtednes immediately and reduce the State's cost of funds. I have seen no evidence to suggest that pension and insurance funds generated in Ireland would not welcome the opportunity to invest (both equity and bonds)in regulated infrastructure and utility businesses - energy, water, transport.

They are likely to look for slightly higher average returns than the Government's cost of funds, but the overall cost of capital would fall. In addition the asscociated restructuring of the ESB and BGE would result in lower final prices which would have a signifciant impact on the cost of living and the cost of doing business.

This would be a "win-win" outcome and fundamentally progressive.

Paul Hunt said...


I think you may have misunderstood the import of the major restructuring that has taken place in the US gas and electricity industries in the last 30 years. Apart from some notable exceptions both industries are almost entirely in private sector ownership. The gas industry there is an excellent example of a fully functioning competitive market that generates benefits, ultimately, for consumers.

The contractual and regulatory arrangements for the relatively low-risk recovery of long term investments has encouraged signifciant investment in, and supply from, "unconventional" - tight gas formations and coal bed methane - reserves. This has resulted in lower prices and a reduced demand for LNG which, along with the recession-induced fall in energy demand, has resulted in a global supply overhang that is reducing gas prices internationally. Gas consumers in Ireland will have to wait until next February before they benefit from this reduction.

The EU is a long way from creating similar market arrangements that would benefit consumers and it is unlikely it ever will. Ireland - for its own perverse reasons - is even further away.

Michael Burke said...

@ Paul Hunt

No, in the short run my proposal leads to less, much less government borrowing.

On this site I showed, using DoF data in the Budget, that an increase in GDP arising from public spending would reduce the level General Government Borrowing.

The only assumption I was obliged to make was that increased government spending was at least as effective as lowering interest rates, which is an assumption shared by most econometric models. More importantly, it is logical, since government spending is a direct increase in activity, while lower interest rates are merely an inducement to increase activity. The DoF did not model government spending itself, for whatever reason.

Everyone else in Europe has chosen this path and seen the projections for their growth improve and for their deficits to fall (the exception is Italy, and even Berlusconi has not chosen to copy Ireland's unique contractionary experiment).

Ireland, with fiscal contraction, keeps on seeing higher deficit forecasts, as also shown in the Budget (Table 7).

The verdict is clear. You can spend your way to growth and deficit-reduction but you can't cut your way to it.

Paul Hunt said...

@Michael Burke,

I don't think there is any fundamental disagreement on objective; we seem to be diagreeing on the means. In line with the thrust of this thread, my focus is on financing of productive and necessary investment. Similar to Liam Delaney, I have my doubts about the benefits of "municipal bonds" in the Irish context, but I fully agree there is scope and a requirement for signficiant investment in infrastructure and utility services.

We may have to agree to disagree as I see limited scope for increased Government borrowing in the short to medium term; therefore other sources have to be tapped. And the adjustment required is broader. Despite the recent deflation the general Irish price level for consumer expenditure is more than 15% above the Eurozone average. This is fuelling the demand to keep nominal wage rates and SW rates at current nominal levels - and makes the budget provisions so harsh and unfair. One need only look at the CPI detailed sub-indices and the positive changes over the last year to see what areas need to be attacked. These inefficiencies and unjustified costs exist across the state, semi-state and private sectors.

gabriel said...

Michael makes an important point regarding rates of return in domestic investment.

I believe infrastructural investment is lacking in Ireland. We disagree about how to fund more investment into the future it seems.

Surely the benefits of a bond issuance which funds, say, a broadband network that attracts world class businesses to Ireland and enables more 'smart' economy products and jobs to be created in a locale outweighs the cost?

Stephen Kinsella said...

Jaysus. This is getting Oedipal folks, apologies!

Michael Burke said...

@ Paul Hunt
"I see limited scope for increased Government borrowing in the short to medium term".

But we keep seeing increased scope for government borrowing, because the deficit keeps overshooting the target. And an additional €54bn is on the way soon.

Foresaking investment now while the deficits keep going higher and with NAMA bonds in the pipeline is like an alcoholic borrowing to finance his addiction, but saying he can't afford the bus fare to an AA meeting.

Investment is not an attractive optional extra. It's the only remedy.

Paul Hunt said...

@Michael Burke,

I should have specified "increased Government borrowing for investment". The Government is seeking to reduce the increase in borrowing to finance current expenditure in its usual ham-fisted way and this line of credit must be secured and not overburdened. The intention is to push NAMA liabilities out for a decade, but major bank recap - or nationalisation - is getting closer by the day and the Government has gotten itself into a position where it will need to secure some external finance for this as well.

I agree that "investment is not an attractive optional extra" - even if the Government has painted itself into a corner where for them it is. All I'm highlighting is the need to explore alternative sources of finance while the cost of Government borrowing is high (and could increase) and the supply is uncertain. Stephen and Karl kicked off one option in the original post. I simply believe there's a need to explore others. And not because I have an ideological preference for options such as privatisation - I simply think we've run out of road.

sarah said...
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