Wednesday, 30 January 2013

New CEPR paper on the contribution of IMF recommendations to the ongoing crisis in Europe

The Center for Economic and Policy Research (CEPR) in Washington D.C. has published a paper examining the policy recommendations made by the IMF to European Union Countries for the years 2008-2011.

  Under Article 4 of its Memorandum of Understanding, the IMF is charged with "(i) overseeing the international monetary system to ensure its effective operation and (ii) monitoring each member's compliance with its policy obligations." (IMF) As part of this 'surveillance', the fund continually monitors the economy of member countries, including country visits and consultations with stakeholders. It also makes policy recommendations.

The CEPR paper examines the advice given by the IMF over four years and finds a consistent pattern of policy recommendations, "which indicates (1) a macroeconomic policy that focuses on reducing spending and shrinking the size of government, in many cases regardless of whether this is appropriate or necessary, or may even exacerbate an economic downturn; and (2) a focus on other policy issues that would tend to reduce social protections for broad sectors of the population (including public pensions, healthcare , and employment protections), reduce labor's share of national income, and possibly increase poverty, social exclusion, and economic and social inequality as a result." (CEPR)

  Its is unsurprising, perhaps, that this is the path chosen by the IMF. However, as the paper points out, the IMF is overwhelmingly influenced by European governments through its governance system and these same European governments also subscribe to broader European Union goals, such as those articulated in the Europe 2020 strategy of a sustainable and inclusive economy. The paper points to the tension between these goals of a reduction in social exclusion, an increase in research and development and climate change goals, and the fiscal consolidation and cuts to social expenditure as advocated by the IMF.

The paper recommends that the IMF engage in an Independent Evaluation Office (IEO) review of its policy advice in Europe, which might enable it to "play a constructive role in Europe's recovery" and "demonstrate the IMF's commitment to the goals of accountability and transparency in its role as 'trusted advisor'". (CEPR)

  The paper can be accessed here.

Friday, 25 January 2013

Guest post: Potential of Government Shares held in the ‘Viable’ Banks

Guest post by Gearóid Ó Cosgora: A subject that deserves an airing, if only to tease it out, is the potential of utilising the government’s partial share ownership of the ‘viable’ banks (AIB, BoI & PTSB) to counter the current economic circumstance. I am also suggesting an improvement to the government debt profile, a recommencement of the social economy programme with 150,000 new jobs, and I discuss how the EU bank resolution programme could be self-financing.

A potential benefit of this partial share ownership is the hope (or probability) that the ‘viable’ banks will ‘turn the corner’ in the medium-term and that the eventual gains, when they arise, can be put to good use.

One good use would be to set off these potential gains against the IBRC promissory note upfront. Because the already agreed promissory note timeframe, 2011-31, is substantial, a revised cash-flow within that timeframe could potentially be met in full by directed dividends and capital gains arising from the share ownership in the viable banks.

There are certain values to be met, of course, like ‘none of this was our fault’ and ‘Ireland must be included fairly in the EU’s banking resolution initiative’. Straight off, I’m happy with a break-even, a break-even where the bailout is bailed back with interest included. I’ll even be happy with a ‘nearly’ break-even, as would most other people, I would say, given the bad situation. I’ll be glad to see any combination of actions that brings about the resolution.

As for realigning the promissory note to the government share ownership in the viable banks: If realistically projected to be sufficient, and with measures to deal with an under/over, then the weight of the promissory note would be ended. The costs associated with the ‘viable’ banks would be zeroed as well, i.e. fully recovered. The full banking bailout cost, therefore, of €64.1bn would be lifted and gone (not just deferred); policies for a much quicker economic recovery could be undertaken and issues such as jobs and debt could be addressed seriously and fast. The ‘stressed’ – long-term unemployed, excessively indebted, struggling businesses – could be targeted in an achievable national recovery plan commencing immediately.

A topic likely to be raised is whether government ownership into the post-medium-term period will hamper economic recovery. I don’t think so; two pillar banks and one ‘smaller’ bank, neither wishing to be outdone; public-v-private. I think they would be nicely set up, with an incentive to get the better of each other. As for the requirement of maintaining market share, there is nothing obvious on the horizon that suggests otherwise.

The backdrop is summarized as follows: Firstly, the level of annual profits in the ‘viable’ banks in 2007 was €4.2 billion. Secondly, this figure is allied to the averaged weighted level of government ownership in these banks, around 60%. Thirdly, the Balance Sheet equity ‘net worth’ as reported in the most recent accounts, June 2012, is €19.9bn (with government capital loans & preference shares shown as liabilities). Fourthly, the downsizing of the loan book has been mostly completed – from €318bn in 2007 to €210bn in June 2012 and to around €203bn currently (noting bank management statements issued in November), with a target of €190bn, but probably leveling out at above that, say €195bn.

EU Negotiations: This strategy would augment whatever partial write-off is achieved in the current negotiations with the ECB on the promissory note. Although it is currently suggested that no write-off will be achieved, merely a deferral, it should be noted that the ECB could agree to transfer part of the loan to the ESM where a partial write-off could be agreed as part of an EU-wide bank resolution policy. I wouldn’t throw in the towel yet. If achieved, this would make the above suggestion even more viable. The case for similar treatment for all banking resolution issues, from 2008 onwards, is solid. Also, the bank resolution process as cash-flowed over time will likely be of a break-even nature. Although times are difficult now for parts of EU banking, there will be better times. Things will likely balance out over time, so a break-even is achievable.

If the bank resolution programme is self-financing over time, the programme will attract political agreement more easily.

The income side of that cash-flow will likely include gains on bank shares, as well as bank levies and probably smallish government contributions directed from other areas. It may be possible for the ECB to channel gains from its Securities Market Programme to the banking resolution effort, a fact that was referred to at the recent Joint Oireachtas Committee on Finance (Jan 16) in discussion with Professor Patrick Honohan, Governor of the Central Bank of Ireland. It is thought that around €19bn of Irish Government bonds were purchased by the ECB at distressed prices well below par. The ECB profit on this transaction has been estimated (Barclays Capital Report) at between €3-5bn. It is within that ‘cash-flowed over time’ structure that the promissory note write-off could be included, bearing in mind that the Irish government would be left with the balance of the promissory note. All in all, there would be greater fairness across the EU or Euro area. The ECB can play a huge role also as provider of finance at negligible interest rates.

So what are the ‘viable bank’ figures that are relevant to a projection of future equity net worth? The ratio of after-tax profits to loan book in 2007 (the basis figures are above) was 1.32% (4.2/318). I project a marginal improvement in this ratio, if only because of the newly-found caution of bank regulators, bank management, governments and shareholders. Say 1.5%. If we project the loan book upwards at a cautious 2.75% cumulatively from its €195bn start-point at the beginning of 2014, we reach €266.7bn by 2025, yielding an after-tax profit of €4bn for the year, based on a 1.5% net profit rate. This is a very moderate suggestion, based on an 18-year cycle (2007-25) of market correction, surely erring on the side of caution. Leaving dividends out of the calculation, for the moment, the Balance Sheet ‘net worth’ would have increased by (say) an average of €3bn per annum for the years 2014-25, that’s €36bn, but less further losses during 2012/13 of (say) €5.9bn. The new figure is €50bn (19.9 + 36 - 5.9).

However, the ‘value’ of the equity increases to a level above that because the value of its sustainable profits is added, bringing the ‘value’, as distinct from its ‘net worth’, to a higher figure. Take the following example: Balance sheet net worth, steady at 10% of loan book, sustainably earning 15% after-tax per annum (100% of loan book @ 1.5% net after-tax profit), and where the cost of the purchasing capital is 5% per annum: The balance sheet net worth is attributed the first 5% of after-tax profit to match up with purchaser’s cost of capital. An additional purchase cost above balance sheet net worth is factored in. This represents the value to the purchaser arising from the extra 10% annual contribution (over cost of capital) plus any projected growth in that contribution. The purchaser might anticipate recovery of this extra purchase cost within (say) 5, 7 or 10 years. In the case of Allied Irish Bank (AIB) in 2007 the market value at €21bn was around €12bn over balance sheet net worth, i.e. close to 6-times after-tax profits. This ratio was replicated elsewhere before the banking crisis.

I am applying a figure of 5 times profits (€4bn), equal to €20bn. This is added to the balance sheet net worth after the dividend pay-out is factored in. If the balance sheet ‘net worth’ is pared back to bank capitalisation requirements, around €26.7bn (10%), with a dividend pay-out of €23.3bn, then the ‘value’ is projected at €46.7bn. The dividend contribution at 60% of €23.3bn is €14bn.

The equity cost, including the non-recoverable special capital contribution of €6.054bn to AIB, is €19.8bn. When deducted from the sale contribution, €28bn (@ 60% of €46.7bn), a capital gain of €8.2bn is shown, giving a total gain (with the dividend) of €22.2bn. To which we can add the gain from the government’s bank guarantee scheme plus part of the surplus earned by the Central Bank from the banking crises (excluding the promissory note interest cycle). This should be circa €7bn. (Alternatively, we could set off the special capital contribution of €6.054bn to AIB against these gains and be done with it.)

Significantly, the remainder of the bank recapitalisation of the ‘viable banks’, now at €7.3bn (following a recent €1bn sale), can be recovered from within their asset/liabilities, i.e. without recourse to the revenue reserves. The €1.3bn purchase cost of Irish Life can also be recovered. That completes the non-AngloNationwide banking bailout.

If we factor in a partial write-off from the ECB/ESM, (say €11.6bn, one/third of AngloNationwide principal cost) and if we elect to continue ownership until the promissory note end-date, 2031, then a decent kitty could be anticipated which could be targeted upfront to fund strategic capital projects and to augment a very major jobs programme, such as via a very substantial social economy programme (see below) in conjunction with the Dept of Social Affairs. Continued equity-holding in the ‘viable banks’ for 2026-31 could yield a further €16bn, allowing for inflation. Capital projects that could be undertaken include the Spirit of Ireland energy project, which could underpin our quest for a comfortable time into the future.

By these projections the full cost of the AngloNationwide bailout plus net interest is exceeded. Such projections are of no importance when compared to the principal of a proper buy-in by the EU in the resolution of AngloNationwide debt as part of its amendment, effectively, of the EU Euro Treaty. The ‘successful’ projections shown here are important as part of good solid democratic debate, and as part of the ‘glass half-full’ approach. The NPRF is an obvious recipient of surplus.

Resetting the Promissory Note: So how could we turn the potential of the government equity in the ‘viable banks’ against the cost of the promissory note. We could do this by coming to an agreement to reset the promissory note within its timeline, 2011-2031, with a revised cash-flow. A special share would be issued, linked to the reset promissory note, directing dividends & net capital gain from the equity held by the government in the ‘viable banks’, instead of the payments from the exchequer. This would be a new fully legal agreed alternative to the current method of funding the promissory note, a method that removes it from the general government debt.

What to do with government debt: We could agree on a realisable working assumption that the equity held in the ‘viable banks’ would hold par value in the medium term. When the promissory note debt and the unused borrowing amount is removed from the General Government Debt, the amount at 2012 year-end is thought to be around €138.1bn. When the AngloNationwide bailout contributed directly by government (€7.1bn) is excluded, the figure is reduced to €131bn or 80% of GDP.

However, against this it is possible to allocate the task of loan interest payment to the available government assets. The National Pension Reserve Fund (NPRF), with its bank ‘investments’ now valued at par, and with all the remaining exchequer funding of banks (€6.5bn) assigned to it, would have a value of €28.5bn, (i.e. €6.5bn less allowance for the €3,771m contributed by the NPRF as part of the €6,054m non-recoverable special capital consideration allocated to AIB, and less allowance (€1.05bn) for previous sale of Bank of Ireland equity shares, July 2011, which were paid directly to exchequer).

The remaining exchequer funding of banks are listed as follows: €2bn Contingent Capital, €1,3bn Irish Life, €2.3bn PTSB, €0.875bn EBS; the revised NPRF value is €26.8bn (current) + €1.7bn = €28.5bn.

The remaining commercial state assets plus the Central Bank – with a combined value of €10.4bn – would complete this loan interest assignment government asset. Combined, the asset group would undertake to meet the loan interest costs of a selection of debt, matching the asset group value, €38.9bn (say €40bn). The loan portfolio selected would be taken mainly from the low interest end of the loan book. The interest paid by this asset group would be approximately €1.5bn, based on an average rate of 3.75%.

Two difficulties arise requiring a solution. 1) The Central Bank payment would be channeled via the exchequer as normal, and 2) the income forgone by the exchequer would be recovered by means of tax buoyancy and interest savings. The government debt would now stand at €93bn, or 57% of GDP. The government asset group would continue to fund the loan interest until 2025 when the NPRF becomes operative, or earlier if the gross national debt had fully stabilised.

The net government debt, the banking crisis aside, has moved from around 13.5% of GDP to a little over 63.5% of GDP in the 5-years, 2008-12, i.e. 10 percentage points per year on average. It has cushioned the crisis somewhat. But now is the time, with the banking debt off our backs, to steady it to not more than what it is at.

Social Economy Programme: The improved economic circumstance arising could be directed to quickly develop a voluntary social economy programme with 150,000 places, thereby countering the very high unemployment rate. I don’t see any difficulty in rolling out this programme, based on the 2000-2002 model. A leaner model, perhaps, with management from within the participants, with strong voluntary involvement undertaking tasks such as financial management, support for management, marketing and training. A leaner model would better sustain the roll out. It would require a ‘GRAND’ plan, big and brash, closer to full-time than the one week on, one week off of earlier times. And funding: Premises funded by local authorities (funded directly from property tax) but utilising empty space; Materials & consumables budget funded by savings re above suggestions; Labour costs funded by current unemployment assistance/benefit and other linked funding; Social Economy project earnings contribution averaging 25% of costs. Pay: Social welfare payment + €50 per week. Some working from home factored in.

Mortgage debt: The figures seem to be roughly as follows: Households with no mortgage, a low mortgage or who are paying a social housing economic rent: equal to 50% of households. Renting by young or mobile: equal to 10% of households. Long-term renting: equal to 10% of households (mostly small units). Renting by ‘settling down’ households: equal to 10% of households. High mortgaged households: equal to 20% of households. Some of the high mortgaged households have mortgage-security extended to non-household funding, including struggling or lapsed businesses; many high mortgages are on temporary interest-only payment systems.

I mention mortgage debt because, as these rough figures suggest, the issue can be solved and the above measures would undoubtedly hasten that solution.

Household debt: At €178bn (3rd Quarter, 2012), it is a serious drag on the economy. If the portion of it that is ‘business balance-sheeted’, i.e. that is part of a business balance sheet that ‘could’ be earning some return (perhaps not in the immediate short-term) – such as buy-to-let property, some of, and secured business loans – was being repaid from business activity, or at least where there might be repayments in the medium-term, then that would reduce the severity of the overall figure.

Also, as a measure of the problem, some account should be taken of the cost of an alternative to mortgages, i.e. controlled or uncontrolled rents. The aggregate cost of housing in Ireland may still be less costly than in countries with a practice of mainly letting.

The combined effect of all these measures in unison would be to speed up the needed resolution to the crisis effecting the economy, jobs and debt. It would be like handing the economy a €64.1bn boost or stimulus. But unlike a Keynesian multiplier stimulus, there is no cost, no borrowing and no circling of the multiplier effect.

The loan balances across the six banks bailed out by the government in September 2008 are now down by around a half, €403-203bn (plus the NAMA/IBRC balance of around €42bn, now not in the system); the suggestion above, if successful, would show the government debt at very manageable levels; but the household debt would remain an issue, except that the improved economic outcome would facilitate a substantial easing. The social economy initiative, if successful, would put a far better shape on the unemployment rate and restore work dignity to a considerable number of people.

It is a proposal of speeded-up economic recovery directed at the ‘stressed’ – long-term unemployed, excessively indebted, struggling businesses. A slow-crawl recovery, as per Japan (since the nineties), would serve most of the population well, but not the stressed.

Gearóid Ó Cosgora is proprietor of Salthill Bookkeeping and Accountancy. He held management roles in community initiatives such as Leader, ADM Partnership, and community cooperatives and was involved in both the pre-development and operational stages of the social economy programme, 2000-02.

Wednesday, 16 January 2013


The most recent issue of the Economic and Social Review has a symposium on the politics of financialisation, including papers on the US, a comparative analysis of financialisation and inequality in the OECD and my own paper on”The Crisis of Financialisation in Ireland”.

The table of contents, with links to papers, is here:

The abstract of the Ireland paper is below:

Comparison of EU Bank Bailouts

Michael Taft uses Eurostat data here to compare the 'direct' impacts on General Government Deficits caused by the EU's numerous bank bailouts. In some cases these figures dont even capture the full cost of the bailouts as, for example, in the case of Ireland the €20 billion taken from the National Pension Reserve Fund is not included in the Eurostat figures.

Monday, 14 January 2013

Promissory Notes: Any old deal won't do

Tom McDonnell: There is a real risk that any old deal in advance of the 31 March payment will be hailed as a victory after the failure to get a deal on the promissory notes last year. No matter how bad the deal actually is.

In that context Nama Wine Lake provides a quick overview here of what would and wouldn't constitute a deal. Just eleven weeks to go.

Wednesday, 9 January 2013

Launch of NERI Quarterly Economic Observer/Facts

The NERI has published, today, its fourth Quarterly Economic Observer (QEO) along with the latest Quarterly Economic Facts (QEF). A link to the full QEO together with a short summary of key points is contained here.

The QEF may be accessed here.

Later today staff of the NERI will present these publications at a special seminar at 3pm (earlier time than normal NERI seminars) in Dublin. All are very welcome to attend. Details are here.

The next (Spring 2013) QEO will be focussed primarily on the Northern Ireland economy while retaining the NERI's all-island mandate in the publication itself.

Friday, 4 January 2013

What is the matter with Europe?

Tom Healy: It is time to think deeply about the European project especially as Ireland assumes the Presidency for the coming six months. While I don't necessarily share all of the premises and conclusions in this article(written in mid-2012) by Prof Ray Kinsella and Maurice Kinsella the reader has reason to pause and think and think again. The authors assert that there is an alternative to current economic orthodoxy with a 'new economics based on solidarity'. They are trenchantly critical of the move away from the founding principles of European solidarity, subsidiarity and respect for fundamental human rights including economic and social. I was particularly struck by the following:
"The policies offend against justice in that in Spain, to take one example, almost 50 per cent of those under twenty-five are now unemployed. No amount of economic sophistry based on 'flexible labour markets' can detract from the reality that this generation has been cut off from the right to work, and to give expression to their talents and their capacity to support a family. Whole new segments of society have been cast into poverty and this offends against justice and the shared values which once animated the European ideal."
Incidentally, the same edition of Working Notes (produced by the Jesuit Centre for faith and Justice) has very interesting articles by economist historian Kevin O'Rourke, TASC economist Tom McDonnell and Robin Hanan of the European Anti-Poverty Network