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Us and Them

I notice that the private sector have now decided they’re supporting the public sector who are being described as “parasites” or “wastrels” by some commentators.
The whole private sector supporting the public sector thing is a bit of a crock. In effect both private and public sectors getting loans they couldn’t afford to buy houses that were over-priced and giving the government over a billion in stamp duty a year was a huge part of the problem.We’ve been living on an overdraft often provided by Arab and Chinese investors for the past 15 years.Our public sector didn’t look disastrously expensive to the exchequer when everybody was all spending like there was no tomorrow. Unfortunately, tomorrow came.
So now we’re figuring out who to blame when nobody is spending in an economy reliant on spending and extravagance for tax revenue. Spending has decreased much more than unemployment so it’s not that everyone is on the dole. Are we so much poorer on a monthly income basis than in 2007, excluding asset value from houses? I don’t think so. Spending is depressed as people have actually started to think about saving based on a panic and an inability to get more debt to fund more things they don’t need. This isn’t the fault of public or private sectors. In particular a big chunk of the shortfall is a collapse in the housing market, the biggest sign of our extravagant tiger years. It’s not that nobody can afford to buy houses anymore, it’s that the prices haven’t dropped far enough. The only people who don’t publicly admit this are auctioneers and/or politicians. There’s a lot of overlap between the two 🙂
I’d contend that there’s something worse than mere deflation, it’s long term consistent deflation. It’s depressing and discourages all sorts of investment. David McWilliams suggestion regarding a 20 year moving average for property valuations is one mechanism of drawing a line in the sand regarding the current house prices versus their actual value. Helping developers to cling on to delusional notions of a recovery in property value is actually only harming the situation. Everyone is waiting for the collapse so nobody will buy now. The end result is that the property chain is frozen and stamp duty revenue is being lost.
Now that the builder bank is nationalised, the government could call in NPL’s and put the resulting already developed properties to auction to find their true market value. We’re better off to get people buying at knock down prices now than to perpetuate a bluffing game that’s already gone on for more than 12 months. At worst we’d confirm what the markets believe, that our banks face a huge asset write-down. Remember that perpetuating this is now costing every taxpayer in the state as we’ve guaranteed the interbank loans of these banks. Whatever our investments are used for it shouldn’t be kicking out maturities or allowing interest holidays for breakfast roll men while they wait for pigs to fly and the market to recover.

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thought for the day

As crisis seems to be the word of the year (along with meltdown) here’s an old Chinese proverb.

“A crisis is an opportunity riding the dangerous wind”

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The debt black-hole

I read a report recently that suggested the US credit derivatives market is worth at least 50 trillion with CDS’s making up the majority. These are estimates obviously but the bottom line is a figure so large that it could collapse a country never mind a bank. Admittedly that figure is believed to be the total amount of credit derivatives swaps outstanding in the US.
Because of the good old US belief in minimally regulated market freedom a reasonable sounding mechanism to transfer risk became the spring board for a range of financially engineered derivatives which multiplied both the number of parties involved and the net effect of any individual default. CDS’s require low capital backing so they’re risk that appears “cheap” to play with and potentially very lucrative. On the way up, this creates liquidity. However, the multiplying affect is probably 10 or more as the commercial loan market in the US is supposed to be worth around 5 trillion dollars.
So one bank fails and, simplistically, brings down another 10 financial services companies with it. As banks of differing sizes tend to buy credit from banks up the food-chain, Credit is almost like a commodity that can be manufactured and productised into other packages suitable for smaller financial services companies with different capitalisation, risk profile, timeframes etc. Therefore, it’s possible that a large failure, causes a catastrophe for a few smaller banks. If their problems are resolved, the effects are felt by even smaller banks etc. It’s a ripple effect that we can’t insulate ourselves from, even with an unlimited governmental guarantee.
This won’t “balance out” as they say due to the multiplying affect and the scale. There’s simply more risk-based derivatives out there than assets to protect. Even more so when you consider those assets are inflated. We already know European banks have participated in this market so even if no Irish bank has partaken in the CDS market directly, it is reducing and will further reduce the ability of Irish banks to get credit. It could also devalue their other foreign investments. No bank is an island 🙂
I think the size of this black hole of risk is what’s terrifying world governments into producing these massive bail out packages. As it’s cheaper to nationalise or recapitalise one bank than it is 10. Better to protect defaults at source than wait for the meltdown.
Essentially, this is the goal of the 700 Billion dollar bailout package that was passed recently in US Congress. Purchase the debt that’s in default or most likely to become “toxic” ASAP before the “ripple effect”. Now consider, the multiplier effect and you have 7 trillion of associated CDS’s sitting out there. Some has possibly been triggered already due to the events at Lehman Brothers. Although there are differences of opinion regarding exposure, the multiplier factor and the Net effect. Also, it’s worth remembering that you actually have to be able to get the money from the CDS counter-party. They could simply refuse to pay.
How to mitigate the risk of this happening again? Bubble-expert Yale professor Robert Shiller makes a few suggestions which are discussed over the at the freakonomis website. These focus on improving the information available between institutions and public so risk profile is less opaque. He also proposes the solution of creating derivatives on city-level real estate prices. I don’t like this solution as by his own admission markets are subject to mass delusion regarding prices going onwards and upwards. The ability to short these markets may limit control, but with leverage it IMO provides another mechanism for ordinary joe (popular guy recently) to see one of his life’s major investments exploited by profit-hungry hedgers. Reducing leverage capacities of both banks and individuals is an excellent idea. It’s tough love and many commentators suggest it damages liquidity but that’s arguably adopting a catastrophist attitude towards tighter regulation. What good is all that liquidity if it’s going to be channelled into trading timebomb credit derivatives? What’s wrong with telling someone who can’t afford to buy a house that they can’t have it? The only reason they wanted to buy was because of the mass delusion of the ever-ascending property ladder. If sub-prime buyers had been encouraged to wait it out the prices wouldn’t have overheated.
Or to use another(‘s) metaphor we could do worse than remember the world of John Maynard Keynes:

“A general bonfire is so great a necessity that unless we can make of it an orderly and good-tempered affair in which no serious injustice is done to anyone, it will, when it comes at last, grow into a conflagration that may destroy much else as well.”

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The Euro project

I stumbled across this article on David McWilliams blog in relation to exting the Euro. It’s sparked a lot of intense debate and got me thinking.
There will always be as many arguments against as for leaving the Euro. It’s essentially one of those arguments of perspective and potential that’s irreconcilable until a decision is reached and history unfolds. It’s funny but I don’t remember much debate about the negative effects of joining the Euro when we made the decision. This is probably more poor recollection on my part but I’m sure someone here remembers 🙂 Are we economically more sophisticated now or is it a small pocket of people sharing their thoughts over the net? I’d like to think that, based on the results of the lisbon treaty referendum, the Irish are looking more critically at the advice from our politicos than in the past. (accepting political trust is a cyclical thing). On some of the specifics of this debate. I’m not against the idea, in principle, of Tobin Tax or similar levies on national currency speculation. I quite liked the Sterling Stamp Duty idea, however, it’s likely that this damages liquidity unless implemented as a “braking function” on speculation through application on higher volumes of speculation alone. i.e. financial regulations should be utilitarian and when they don’t work it’s possible to fix them! I’d reject comparisons between an unpegged and reconsituted Irish punt and Sterling. Given our well publicised economic woes and small scale it appears unlikely a new Irish currency would, initially, be in sufficient demand to trade so strongly against the dollar. There’s the question of the dollar’s weakness. Some analysts will suggest this is inevitable as the result of a balance of power shift from the West to the East. A long and expensive war isn’t helping either. This is not the first time an eclipse of the US has been suggested and arises from an unhealthy IMHO obsession with trade balances. Many felt Japan would eclipse the US during the 80s and for a short period of time it worked. What are the Chinese accepting as payment for their goods? Billions of dollars, many of which are being invested in US companies, real estate etc. The strategy of beating a country into economic submission by accepting all the fiat currency they can print for your manufactured goods tends not to work. In a way, the gold standard continues in the minds of anyone who associates economic prestige with a particular country. What was the gold standard about but perceived security? The US is the prime example and as long as its economic competitors continue to accept payment in dollars and commit their profits to dollar investments then the US economy looks secure for the long term. As secure as anyone else’s anyway. So a pegged currency against the dollar or even the euro isn’t necessarily an awful idea in the short term. The HK dollar is pegged and the rate has been judiciously adjusted several times. Arguably more important than the currency debate is the corporate and personal tax debate that incentivises people and organisations to bring their wealth to Ireland. For our small size we can arguably make ourselves even more attractive.