Monthly Archives: November 2010

Graduate gilts

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Iain Pears on the proposed changes to university funding in Britain:

Another thing to note is the extraordinary nature of the loans system being proposed, which is that students will be charged at 3 per cent plus inflation for a very long period of time once they hit a certain level of income. This is sheer profiteering disguised as fairness. Essentially, the government will be requiring individuals to issue 30-year index-linked bonds on their own balance sheets, rather than do it itself. A few sums shows what this might mean. For the government will raise the money to advance the loans on a flat rate basis. It will, in other words, borrow the money at about 2.5 per cent, and lend it out at 6.1 per cent, more if inflation increases. While it will enjoy the benefit of seeing its real debt eroded by inflation, the student will not be permitted the same escape route. If only half the total number of students take out a loan of £7000 every year, then that would amount to a transfer from the state’s balance sheet to those of individuals which stabilises over 30 years at about £110 billion. The government would pay a peak £2.75 billion a year in interest for this, and receive peak income of £6.75 billion back, as wage inflation will ensure within 12 years that most graduates earn over the £41,000 benchmark which triggers the maximum levy, and there seems to be no provision for this to be index-linked.

Even Barclaycard would applaud such audacity, not least because there are measures to guarantee this income stream by imposing financial penalties on anyone who wishes to pay off their debts early – a unique and almost feudal arrangement, where individuals are going to be forced to remain in debt, effectively to provide the government with cash flow, for most of their working lives. I know of no other case of a government requiring its citizens to be in permanent debt. The argument that this is just like a mortgage is specious, as mortgages are not index-linked, there are a wide variety of different time periods available, individuals have a choice of which ones to take, and they are secured on hard assets which have traditionally risen in value over time. None of these conditions apply to student loans.

Even if you think it right for students to carry all or most of the cost of their degrees, you surely have to do extra work to demonstrate why a student should pay a graduate tax on top, in the form of an interest rate set three points higher than inflation. And once graduated, why shouldn’t the student loan recipient be allowed to refinance his or her new debt?

Another Lesson In How Not To Go About Things From The EU Commission

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The present generation of European leaders will doubtless be remembered for many things, but somewhere high up there on the list will be the appauling sense of bad-timing they seem to have when making critical announcements. The confusion caused by certain ill-considered remarks from Angela Merkel about how private sectors bondholders would need to participate in future EU bailout processes is evidently one good example. Another, without doubt is going to be the decision by EU Commissioner Olli Rehn to appear before the world’s press today (yes, today of all days, one day after the sensitive announcement of the Irish Bank Bail-out plan and the decision to create the European Financial Mechanism), and inform the assembled throngs that as far as the EU Commission could see Spain will not be sticking to its 6% of GDP fiscal deficit committment next year, simply because according to EU calculations the deficit is going to be 6.4% – unless, of course – there is another round of fiscal reduction measures. Continue reading →

EU to Ireland: Do you want your pensions or your banks?

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In assessing the effectiveness of the EU/IMF emergency lending package to Ireland, it’s important to distinguish the financial market impact from the political impact.  In terms of market impact, the package is surely a success.  All talk of restructuring, for sovereign debt let alone senior debt in banks, is off the table.  Through IMF and bilateral involvement, the call on EU lending has been kept in the low range: note the heavy use of the EU-budget backed stability mechanism relative to the use of the financial stability fund — the EFSF’s powder has been kept dry in case it’s needed elsewhere.  Furthermore, the lender of last resort checklist is looking good: if not quite lending freely at high rates against good collateral, all the EU money comes in at a large headline amount, with a fairly high rate (above IMF and Greece program), and the collateral coming from conditions to which the Irish government had already agreed.  This money will get paid back.

In terms of domestic politics — and therefore with broader implications for the EU as political project — the package is much more problematic.

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Greece Is Almost Certainly “On Track” – But Towards Which Destination Is It Headed?

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“There is a difficulty that is widely recognized that the amount [of debt] to be repaid is high in 2014 and 2015,” Giorgios Papaconstantinou (the Greek Finance Minister).

“We are confident that Greece will be able to return to the markets. But whether it will be able to return to the markets on a scale that allows Greece to pay off its European partners and the IMF, that is a question.”…”We have a number of options. If paying off the €110 billion loan proves to be a question, we stand ready to exercise some of those options” – Poul Thomsen, head of the IMF team in the ECB-EU-IMF troika delegation.

“In the rushed last-minute deal to forestall certain bankruptcy, everyone missed one very important fact. That the memorandum created an unrealistic and immense borrowing squeeze on the feckless Greek state for the next five years.”
Nick Skrekas – Refusing Greek Loan Extensions Defies Financial Reality, Wall Street Journal

Get On The Right Track Baby!

According to the latest IMF-EU report Greece’s reform programme remians “broadly on track” even if the international lenders do acknowledge that this years fiscal deficit target will now not be met and that a fresh round of structural measures is needed if the country is to generate a sustained recovery. My difficulty here must be with my understanding of the English lexemes “remains” and “sustainable”, since for something to remain on track it should have been running along it previously (rather than never having gotten on it), and for something – in this case a recovery – to be sustained, it first needs to get started, and with an economy looking set to contract by nearly 4% this year, and the IMF forecasting a further shrinkage of 2.6% next year, many Greeks could be forgiven for thinking that talk of recovery at this point is, at the very least, premature. A more useful question might be “what kind of medicine is this that we are being given”, and “what are the realistic chances that it actually works”. Unfortunately, in the weird and wonderful world of Macro Economics, witch doctors are not in short supply. Continue reading →

Can Irish saving save Irish banks?

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The government of Ireland released its 4 year plan for fiscal consolidation and structural reform earlier today.  Finance Minister Brian Lenihan gives the optimistic version in the Financial Times.  Speaking of optimism, here’s an interesting bit of the underlying economic analysis (page 28) —

This combination of current account surpluses and substantial (though declining) budget deficits implies the continuation of a large private sector financial surplus throughout the period of the Plan.   Much of this accumulation of financial surplus by the private sector will take the form of increased deposits with and reduced borrowing from domestic banks. The result will be a very substantial fall in the loan-to-deposit ratio of the domestic banking system and a corresponding reduction in the domestic banks’ reliance on external sources of funding.

So the expenditure compression coming from continued austerity will form part of a slow-motion solution to Ireland’s banking crisis, because deposits will go up and loans go down.  With Bank of Ireland and Allied Irish Banks currently on loan-to-deposit ratios of about 160 percent, this effect certainly goes in the right direction.  But it takes a long time to work relative to the speed with which wholesale funding can disappear.  And it’s a very fine balancing act.  In the section on risks, the same 4 year plan says —

… domestic risks are tilted towards the downside. The most significant of these risks is that households maintain savings rates at current very high levels which would represent a continued constraint on personal consumption.

So the same saving that might help the banks could undermine expenditure growth in the economy.   But most of all, the optimistic scenario regarding banks’ funding needs assumes that these Irish household savings flow into Irish banks.   Whether the traditional home bias of Irish savers — as is true for savers in most EU countries — can be assumed to continue is an open question.  Without confidence in domestic banks, the assumptions in the four year plan look heroic.

An End to Conscription in Germany

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Germany’s Defense Minister, Karl-Theodor zu Guttenberg, announced on Monday that conscription for the country’s armed forces will come to an end in the summer of 2011. The all-volunteer Bundeswehr will have approximately 185,000 persons, down from the current 240,000. That is roughly in line with the current number of volunteers serving.

I wonder whether anyone will say that the change has come too soon, or that preparations have been rushed. That’s because I flagged it as on its way, oh, more than six and a half years ago. Embarrassingly enough, I used the phrase “sooner rather than later” in the previous post, and this qualifies as “sooner” only by the very generous standard usually reserved for EU institutions. Nevertheless, it is a welcome and necessary change, for all the reasons I outlined in January 2004.

Ireland: Lead us not into temptation

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Wall Street Journal Europe editorial —

Ireland’s plight is not the result of collecting too little tax. The country is a victim of the global credit bubble, which tended to hit hardest the countries that had the largest and most innovative financial industries: Ireland, the U.K., Spain, the U.S. and, in its especially perverse way, Iceland.

From the report of Klaus Regling (yes, that Mr Regling) and Max Watson into the macroeconomic and global sources of the Irish crisis (page 29) —

Concerning credit growth …. what occurred in Ireland over the past decade was simply and squarely a massive financial sector and property boom. Moreover, this boom was not marked by the esoteric complexity of financial instrument design that proved the downfall of nstitutions elsewhere. The problems lay in plain vanilla property lending (especially to commercial real estate), facilitated by heavy non-deposit funding, and in governance weaknesses of an easily recognisable kind. Together, these factors led to acute vulnerabilities and then to deep economic and social costs.

To spell it out, although you can use various words about Irish banks, “innovative” is not going to be one of them.  Yes there was cheap money but bad lending practices (including investment loans payable on demand and non-recourse loans to developers) are at the root of the crisis.  However, it remains a Eurozone article of faith that bondholders who lent money to banks to engage in such dodgy lending practices shouldn’t lose a cent.

The EU’s crowning achievement

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As relief from the gloom this weekend, it struck me recently that there was literally nothing that would shock me about Silvio Berlusconi. Really, I couldn’t imagine a revelation that I hadn’t already mentally priced-in. And then, I realised that this is one of the achievements of the European Union, NATO, and the post-war settlement of Europe. Possibly the most important one. Someone like him has been the leader of a significant power, a country that owns its own reconnaissance satellites and builds aircraft carriers and Eurofighters, for years on end, and what has he managed to do? What evil has he done that will last beyond him? Of course, in many ways he’s been lucky, but then that’s rather my point. The system was stronger than the man, as Kevin Drum put it. You could say the same about Italy.

Ireland: The timidity of the lawyers

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Perhaps the biggest puzzle of Ireland’s 2+ years of economic crisis is the lack of progress on restructuring the banking sector, and in particular the reluctance to follow through on the implications of having guaranteed the liabilities of insolvent financial institutions. As with many of Ireland’s problems, there is no single explanation so in this post we focus on just one — a mindset in the Irish government that springs from the legal background of several of the principals in it.

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DSK on QE2

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IMF Managing Director Dominique Strauss-Kahn gave an interesting interview to Stern magazine.  The transcript on the IMF website seems more comprehensive than the story based on the interview in Stern.   DSK covered a lot of ground but his comments on the US Fed quantitative easing were especially interesting.  In addition to offering the standard pro-QE2 position that what’s good for the US economy is good for the world, he had this exchange —
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