Tuesday, September 29, 2009

No Consensus

I was looking at Pat Kenny's "Frontline" Programme last night.

It was dealing with the forthcoming budget and the need to achieve dramatic cuts with respect to Government expenditure. As things stand the deficit will be about €20 bl. with revenue set to exceed €60 bl. and tax revenue not much more than €40 bl. So this gross excess of expenditure over income is clearly not sustainable and therefore needs to be controlled.

The audience was largely made up of public and private sector workers arranged in two separate groups. However it quickly became apparent that they were simply unable to address the overall financial issue. Everyone seemed completely locked into their own particular perspectives made even more rigid by a perceived sense of injustice with respect to the present situation.

Therefore there was no appetite anywhere for either a reduction in Government expenditure or alternatively for further increased taxation (as a means of closing the gap).

Based on the evidence of such reactions there is little scope for the Government to introduce major spending cuts in the budget through reducing public sector pay (which is the major component). So what is most likely to happen is that most of the cuts in practice will fall on capital expenditure.

This of course makes very little sense from an economics perspective where potentially the most productive expenditure is cut whilst the least productive - due to sectional pressures - remains largely untouched.

In the circumstances there would seem to be no likelihood of the Government's meeting its target of reducing the budget deficit back to 3% by 2013 (as required by EU rules).

On the contrary we are likely to see once again - as in the 1980's - a steep rise in the National Debt. Though the cost of financing this debt may not seem unduly prohibitive at present (due to the low climate of interest rates) this is not likely to remain with rates set to rise in coming years. On top of this - though technically the Government may be allowed to treat it as an off balance sheet item - we will face further increases in debt due to the NAMA proposals.

Due to the excesses of the Celtic Tiger, Ireland has become a very uncompetitive economy. We fooled ourselves into believing that there was an inherent strength to what was unfolding when in actual fact it was largely due to strongly artificial factors. One of these has now collapsed i.e. the property bubble. However the other artificial factor is perhaps of even more significance relating to the use of Ireland by multinational companies for tax diversion purposes. We are in fact - along with the Bahamas - the top tax haven for US multinational investment. It is no accident therefore that we have such strong company representation in the IT and chemicals sector (as these sectors can especially benefit from tax diversion through locating here).

At a deeper level we are seeing the futility now of trying to detach economic decisions from the moral behaviour of those making them. The present crisis is indeed revealing huge social injustices in the way our economic business is carried out and this in turn makes any attempted efficient mechanism to deal with such problems impractical.

Ultimately we cannot deal with economic without genuinely addressing moral issues for they are inseparable. Much of the injustice that festers throughout the system has arisen through ignoring this simple fact.

Sunday, September 20, 2009

More on NAMA

As I write, more information has been provided by the Government on the proposed NAMA rescue plan.
For example we now know that the total value of loans transferred to the Agency will be €77bl. (including €9bl. rolled up in interest). Against an estimated current market value of €47bl., NAMA will be offering €54bl. So on the face of it this would represent a premium to the banks of €7bl.

However much of these calculations are very questionable. If we exclude the interest the remaining value of the loans would be €68bl. To then suggest that these loans would have a current market value of €47bl. seems to me far too high. (The Government claims that the actual value of property against which these loans were issued is in fact €88bl. due to developers commiting the remaining €11bl. of their own funds. However I would remain highly sceptical that this actually is the case!) Therefore the true premium in payment to the banks is likely to much higher than €7bl. So as many critics suggested, this does look very much like a bail out plan for the banks. No wonder therefore that their share prices surged the following day!

In addition one cannot feel reassured by the utter nonsense being used to sell the plan whereby the Minister for Finance tries to convince taxpayers that if property prices rise by just 10% over the next 10 years that they will be actually profiting from the deal. Apart from the fact that this ignores the time value of money (with interest rates likely to rise again in future years) it represents an unacceptable way of assessing value. If one is buying a house for example during a boom one does not calculate the price with reference to some estimated future value in 10 years time (which could conceivably be double or treble present value). Likewise one should not try and calculate the price of property in a recession with respect to an estimated future value (which given the present unprecedented situation cannot be calculated with any accuracy).


As regards the practical working of the plan - which is vital in terms of its appraisal - I still find it very difficult to envisage how it will operate.

As I understand it, NAMA has very few staff at present (though more will be hired before it commences work). However there are many thousands of loans out there which have to be investigated. Many of these are cross collateralised relating to property companies who have deliberated designed their company structures so as to cause the maximum amount of confusion.

Who will exactly be dealing with these loans? Will NAMA officials attempt to directly negotiate with such developers or - as is more likely - delegate them largely back to the bank personnel already involved? In the latter case one can then validly query as to whether there would then be any urgency to resolve the loans. After all the banks will have received a generous payout from NAMA for such loans thus relieving them of immediate pressure. Meanwhile the developers will be only too happy to sit and wait for the property market to pick up (which could take a long time).

So on the face of it therefore NAMA looks like a giant warehouse for storing largely dormant property loans while giving the impression that it is designed to actively resolve the problem.


I will attempt here to address just some of the issues that I feel have been overlooked in discussion.
One of these relates to the fact that there has been a tendency to treat bank shareholders and taxpayers as two distinct groups (with shareholders assumed to benefit and taxpayers, by comparison, likely to suffer a cost).


However a high proportion of these shares are held directly or indirectly by domestic taxpayers. Some will have purchased bank shares outright and be well aware of the value of their holdings. However many more will have contributed to management and pension funds containing Irish bank shares. Such taxpayers therefore stand to benefit through investment and pension fund values rising. However we have very little detail as to the precise composition of bank share holdings. Though some anecdotal evidence suggests that there has been an increase in privately held shares (purchased towards the bottom of the slump) detailed information is not available.
So clearly a significant number of taxpayers stand to gain from any rise in share prices that is directly attributable to NAMA.

Another issue that causes me considerable concern, likewise has received surprisingly little attention. This relates to the fact that not all loans have been transferred to NAMA. The question then arises as to well the non-transferred loans - which are of considerable value - will actually perform. For example I understand that only loans in excess of €5 ml. have been transferred. However it stands to reason that many of these smaller valued loans will also be somewhat toxic relating to speculative property deals. Here, the attitude of the banks is likely to be very different with an incentive to squeeze the borrowers as strongly as possible while the really big defaulters enjoy comparatively a free ride inside NAMA!

A worrying indication is given by the news that Anglo Irish Bank is set to require further billions in capitalisation by the government with respect to expected losses on such non-transferred loans. It is truly a shocking indictment on the supervisory system that this bank, which was of no strategic importance to the economy, already accounts for €28 bl. of the total loans transferred to NAMA. On top of that it had already requested an additional €3bl. - €4bl. for capitalisation purposes. But apparently this is by no means the end of the matter. So the ultimate losses that this one “upstart” bank will entail can only be described as truly horrendous.

As for the supervisory regime, it was already readily apparent that it was operating in a largely ineffective manner and - worse still - deliberately designed to act that way. Since the Financial Services Centre was set up, Ireland has been trying to attract the international institutions with the promise of “light touch “ regulation very much part of the overall incentive package. In addition we have been turning a blind eye for years on the financial activities of multinational companies based here (who form a disproportionately large part of the Irish economy). For example in 2005 it was reported in the Wall Street journal that Microsoft had two subsidiary companies based in a Dublin legal office reporting gross profits of $9bl. and $1bl dollars (approx)respectively!

It seems that these companies were simply set up for tax diversion purposes (due to Ireland’s low corporation profits tax). This begs several questions. What tax diversion activities are being carried on by other multinational companies based here in Ireland? How big a role do such activities play in the decision to locate here? Does the supervisory regime enquire regarding such activities or is there in fact an unspoken practice to simply ignore everything so that firms will continue to invest here?

The point therefore that I am making is that financial regulation does not take place in a vacuum and the very reason why it has been so weak is that it has perhaps suited Ireland to have it this way (to facilitate multinational firms and international financial institutions locating here).

Therefore, I see grave problems in now genuinely moving to a stricter environment. True reform would require a very different ethos to the loose practices that historically have been seen to favour Ireland. And as I see no appetite to openly discuss the key underlying issue as yet, I do not expect the supervisory regime to change in any fundamental respect.


With respect to developers I can see many potential problems in the operation of NAMA that are unlikely to be resolved.

Though I accept that we must move on to an effective resolution of the mess that has been caused by the development mania that overtook the Celtic Tiger, social justice requires that some penalty should be imposed on those who rashly squandered enormous sums of money.

Firstly, I see no reason why they should be granted strict confidentiality - as NAMA proposes - regarding their dealings. Taxpayers, who are now paying for their excesses are entitled to know the identity of the major culprits, the amounts that are owned and the extent to which they are cooperating with the Agency.

Secondly, an open investigation - perhaps starting through Dail committees - into the practices and dealings of developers leading up to this crisis should be promised. I expect that in many cases - apart from merely unwise - downright fraudulent behaviour will have been involved (perhaps in many cases also involving bankers). And where such is the case developers and bankers should be prosecuted in accordance with the law. Apart from requiring these developers (and bankers) to answer in some manner for their actions we could learn a great deal from the process that could help perhaps prevent a similar scenario unfolding in future.

Thirdly, we need to end this ridiculous practice of allowing a labyrinth of perhaps hundreds of companies under one developer ownership being set up (deliberately designed to make it extremely difficult for investigators to follow any paper trail). Indeed this could all form part of that necessary investigation of the development crisis.

As I said in a previous offering on the topic, I expect that many developers have already hidden away large amounts of money e.g. through companies registered in other countries that NAMA will never be able to tap.

So I expect that these will just hold tight and plead inability to pay when approached by NAMA officials. Indeed - with money safely hidden - it may well suit some developers to declare bankruptcy if necessary, walk away and get ready for the next property upturn (whenever it occurs).

There is an even more frightening scenario that may unfold when NAMA does eventually seize such assets, in that it may then feel obliged to sell them at low cost to other developers already on their books (with the banks once again rowing in to provide the finance).

One hopeful suggestion here that I would make is that we now have a great opportunity for the State to seize a great deal of land. By carefully controlling its future use the state would then be in a position to prevent a speculative land bubble in a future recovery of the property market.


As for the banks, we must of course strive to move forward and restore confidence in the system. However justice - and thereby acceptance of NAMA proposals - requires again that the bank officials responsible for such appalling lending decisions in recent years face some penalty. Just as with the developers, a detailed investigation into the whole affair should be promised. Indeed perhaps the two proposed investigations (into the developers and bankers) should be combined in one as the issues are very much interrelated. Once again I would expect that many fraudulent practices would be uncovered in the process. And where officials are found guilty the full rigours of the law should be brought to bear.

However people have a right to feel cynical about the present Government’s intentions in this matter. We have already had a clear example where 10 leading business men were invited by Anglo Irish in what appeared as an obvious share price rigging exercise to protect the large investment there of the wealthiest businessman in the land i.e. Sean Quinn. The Director of Corporate Enforcement , we are told, is dealing with this matter with a view to criminal prosecutions taking place. However with nearly a year gone by, nothing has happened. Indeed the same man who is supposed to be the centre of the investigation has since become the sponsor (through Quinn Insurance) to the flagship programme of the national broadcaster. Surely if a genuine criminal investigation is indeed pending the acceptance of such sponsorship is then highly inappropriate!

So there is a huge credibility gap to be bridged by this government in demonstrating that it is genuinely concerned with social justice and this I believe is the greatest barrier to acceptance of their NAMA proposals.

Much more could be done to deal with this overriding issue and the need for those who are most responsible to make reparation in some appropriate way.
This would then make it much easier for people to address practical proposals for moving the situation forward.


Now the government will claim - and I don’t doubt them on this point - that the NAMA proposals are designed most of all in an attempt to restore liquidity to the banking system. They are offering the banks €47bl. in low interest bonds. These can then be placed with the ECB for money. So with the expectation that the banks will now receive a large amount of cash through the Euro system, it is believed that they will be free to lend more to business.

However I would be very doubtful regarding this. The banks will still want to improve their capital base by preserving - rather than lending out - money. Also having had their fingers so badly burnt through lending out for risky purposes they are likely in the near future to move in the opposite direction and act extremely conservatively in assessing risk. And with the economy in recession not many businesses will seem like good options for receiving loans.

This is a general problem that is being experienced worldwide. It reminds me very much of conditions during the Great Depression and the contribution of Keynes who clearly saw that the state had to take the lead in spending where private confidence is very low.

I would consider therefore that the Government should propose its own capital spending injection in a manner that would be economically desirable and also politically popular. For example they could aim to dramatically solve the problem of inadequate school buildings by greatly accelerating this programme over the next couple of years. However this proposal should only be offered on condition that genuine efficiency improvements are agreed to in the public sector.

Of course this would mean even more being added to the national debt. However it would greatly assist a depressed building sector, create many new jobs and through the multiplier effect give a much needed boost to other economic activity. This would also help to arrest the collapse in property prices thus making the whole task of NAMA more plausible.
Above all it would offer much needed hope at a very difficult time.

However it should be made clear that this would be in the nature of a once off gesture designed, not to replace, but rather facilitate recovery in the private sector.

Ireland has ignored a growing loss of competitiveness for some considerable time which urgently needs to be addressed for long term growth to be sustained.
So any temporary injection of government spending must be viewed pragmatically as a short term fillip that cannot be permanently continued.

Monday, September 14, 2009

The Lisbon Treaty

Here in Ireland we are preparing for a second vote on the Lisbon Treaty and as we are the only country in the EU required to hold a referendum on the issue its outcome may exercise a considerable effect on the overall development of Europe.

The background to this Treaty (also referred to as the Reform Treaty) is quite complex.
The European Union has been rapidly growing in recent years with 12 new members (from Central and Eastern Europe) joining since 2004. Obviously this poses new difficulties with respect to effective administration. So several changes with respect to key institutions e.g. Council of Europe, the Commission and EU Parliament are proposed. Also it has been deemed timely to now collate and also amend the growing legislation that has been accumulated since the founding of the Union. So in many ways the Reform Treaty is designed to act as a statement of what has already been achieved in the EU whilst providing the framework for effective progress in the future.

Stated in this fashion the proposed Treaty might appear quite reasonable and indeed desirable. However in practice it has proven divisive.
The Reform Treaty in many ways represents a slightly watered down version of the EU Constitution. When this constitution was put before the electorate in 2005 it was rejected in both France and the Netherlands.

Then using tactics worthy of Machiavelli the Lisbon Treaty was reformulated in such a manner that it did not legally require referenda to be held in any of the member countries (with the sole exception of Ireland) for it to be passed. Rather a vote in Parliament (secured by the majority vote of parties in power) is enough to signal the assent of each member country to the Treaty. Though difficulties still remain it looks like this will be achieved for the 26 members (not holding a referendum). However one sticky problem remains. Due to a decision of the Supreme Court taken here with respect to a previous case, Ireland is obliged to hold a referendum on the issue. And as it requires the unanimous agreement of all 27 members for the Treaty to become law, the decision of the Irish electorate assumes significant importance.

This in fact is the second time that the Lisbon Treaty has been put before the Irish electorate who voted NO first time around last year.
However following certain concessions and assurances it is now hoped that a YES can now be obtained thus paving the way for overall acceptance of the Treaty.

Perhaps the main argument against acceptance of the Treaty is that in the very way in which it has been handled it demonstrates a growing democratic deficit in the manner in which the EU operates.
Many people now feel alienated from European decision making believing that important decisions are being taken by unelected bureaucrats “in Brussels” significantly affecting their lives but over which they have no effective control.

Though democratic elections are held for the EU Parliament, people do not see how this has immediate relevance. Despite all assurances to the contrary the Parliament is still seen as little more than a “glorified talking shop” for an elite group who are richly rewarded for their membership of this political club. In truth most citizens would have great difficulty in naming their EU parliamentarians who momentarily surface every five years and then quickly disappear off the radar when elected.

Many citizens feel that as the EU becomes larger and more complex that power moves to the centre gradually superseding national, regional and local concerns.
Though of course it may well be argued that in an increasingly globalised world such a shift is necessary it does not help when citizens no longer feel involved in any meaningful fashion with the process.

Though this trend was already well in place before the Lisbon Treaty, perhaps in a certain way it acts to highlight the very nature of the problem involved.
What adds weight to such concerns is the manner in which this latest political process has been handled by our political masters. When it became apparent that the EU Constitution had become dead in the water, rather than significantly address the key problem i.e. the growing sense of a democratic deficit, they decided to change the procedure by which the Treaty would be accepted (with the direct assent of citizens no longer required).

This only acts to strengthen the sense that the interests of the politicians and public servants who comprise the EU power group perhaps differs in fundamental respects from any genuine concern with enhancing democratic accountability.

Then when a NO vote was delivered in the first Irish Referendum on the Treaty, rather than accepting this decision, this “power group” immediately sought to place pressure on its Irish members (e.g. Taoiseach and Minister for Foreign Affairs) to ensure that a YES would be delivered at a further referendum.

So from one perspective one could argue that the forthcoming referendum offers a unique opportunity for the Irish to speak on behalf of the wider electorate of Europe whose voice is not being heard. In this way a NO vote could be seen as a fine exercise of genuine democracy in practice.

Unfortunately it is not as easy as this!
It is naïve I believe to think that democracy can ever work in a pure disinterested fashion. Also despite its failings it could be validly argued that the Lisbon Treaty represents the best compromise - as between member country interests - that can be achieved at this time and that it only emerged after years of painstaking discussion and negotiation.

So from this perspective if the Lisbon Treaty was to be rejected life would of course still continue in the EU but at the risk of growing disagreement and fragmentation on various issues. Also this could send out the wrong signals at a very difficult time. With key challenges facing the world relating to trade, the environment, financial markets etc. the ability of the EU to operate on an agreed unified basis is desirable.
I think it is fanciful to believe - as some apparently do - that if this Treaty is defeated that we can simply go back and negotiate a better one. Given that the overall economic climate is much more difficult now that it was when negotiations originally took place, another agreement would be highly unlikely in the present climate.

There is also a strategic argument for Ireland which is very important to consider. Historically EU membership has proven beneficial for the country. Also as a small country we have been successful in accumulating over the years a significant amount of good will among other member countries (largely because of our positive commitment to EU ideals). To be seen to turn now in the opposite direction would not spell the end of the world. However being practical it could significantly erode that fund of good will which could then adversely affect our interests in various ways.

And given our present economic difficulties we can do with as much assistance from the EU as possible. I do not wish to overstate this point however for it is mainly at the margins that the difference would be felt!

Many of the arguments that are put up by both the YES and NO sides have little to do with the Lisbon Treaty. For example the Treaty has no direct relevance for issues such as abortion, neutrality and taxation. Also I do not believe that it directly impinges on worker rights. Admittedly, a significant issue has been raised by the membership of the new Eastern and Central European countries where wage rates are significantly lower than in the older established members. Thus applying traditional rights such as free movement of workers and free establishment of businesses does pose a threat to local workers (who have enjoyed higher wages). However this problem – though very real - is not caused by the Lisbon Treaty. Likewise a workable resolution will have to take place outside it in a pragmatic manner.

In general the EU has proven very responsive to social legislation protecting worker’s rights and this commitment is enshrined in the Charter on Human Rights which is part of the new Treaty. Though individual decisions on specific work related issues will necessarily be taken through the Courts (and cannot be readily predicted) the Charter does at least provide a social oriented backdrop from which such decisions will emanate.

I feel that the quality of debate in Ireland has been greatly marred by a polarisation of attitudes on both sides of the divide. YES proponents in debate seem committed to the untenable position that there is nothing questionable in the Treaty and that it effectively answers all the NO objections. Equally the NO side seem very trenchant in dismissing any of the positives that are put forward on the YES side.

Realistically anyone who attempts to look dispassionately at the issues will see that there are valid arguments to be made from both perspectives.
Ultimately the decision that one takes depends on the way one attempts to balance these arguments against each other (which in turn is greatly influenced by the particular standpoint that one adopts on the issue). In my own case I believe that agreement on a new Treaty is desirable for Europe at this point in time. Also Ireland’s strategic position in Europe can be better protected through a positive approach to the Treaty. This therefore will result in my case - as it did on the first occasion - in a YES vote.