Central Bank predicts 4.7% drop in Irish GDP in 2009

The Central Bank says it expects the economy to contract by 4.7% this year. The country continues to be impacted by global recession and falling demand in what the bank called 'an exceptionally difficult period for the Irish economy.' In its latest economic forecast - the first of 2009 - the Central Bank says the contraction will lead to significant job losses with 100,000 fewer people working at the end of the year. The bank also says that unpalatable short term measures are needed if the economy is to stabilise in 2010. The Central Bank says that GNP will slow by 4.7% in 2009, while GDP will contract by 4%. This compares to estimated figures of negative GNP growth of 2.6% for 2008 and negative GDP growth of 1% for 2008. The figures are a marked slowdown from the GNP growth of 4.1% seen in 2007, while GDP growth registered 6% then. The Central Bank also says that consumer spending will slow by 2.5% this year while inflation will fall to an average rate of -1.9%.

'We are in an exceptionally difficult period for the Irish economy,' commented Central Bank Governor John Hurley as he published today's economic bulletin. 'Our forecasts published today indicate a further serious downturn in the coming year,' he added. He said that to support a return to a more stable economic activity in the medium term, difficult decisions have to be taken and implemented now.

'In particular, it is vital that we move to correct the sizeable deficit in the public finances and that we improve our competitiveness position, which is all the more important in the light of the global downturn,' he said. In the housing market, blamed for many of the country's current ills, the Central Bank says completions could fall to as low as 22,000 units this year compared to 52,000 last year. Last year saw the first drop in employment in many years. The Central Bank says that trend is set to accelerate and assuming some emigration, unemployment is likely to average 9.4% of the labour force this year. However, the bank also believes that Ireland has the potential to grow strongly again if productivity can be improved. But it adds that the potential is not a given and it warns that unpalatable measures are needed. The bank says the largest item of Government expenditure - the public sector pay bill - is 'beyond the scope of current resources'. It says the public sector needs to use its purchasing power to drive hard bargains with the services sector.

How do the unemployed spend their time?

An interesting article written by Daniel Hamermesh appeared on Freakonomics during the week.

Last night Jay Leno joked that only 500,000 people attended Bush’s second inauguration, while 2 million were at Obama’s. The reason, so he claimed, is that we now have so many more unemployed people. Good joke, but is it correct? How do unemployed people spend their time? How does unemployment affect time use in the entire economy? What is the lost output from unemployment, and what is the utility loss?

Several of these questions couldn’t be answered until now due to lack of data. A new paper provides some surprising answers. The unemployed use the time freed up from work for pay almost entirely in leisure and personal maintenance; they do no more household work than employed people. Similarly, in areas where unemployment is perennially high, there is less work for pay, more leisure, but no more household production.

But when unemployment suddenly rises, as in a recession, people shift from work for pay to household production; people don’t take more leisure time than before. So if we would measure output to include production at home, we would infer that a recession doesn’t reduce total output by as much as we thought; and perhaps the utility burden of a short recession is not as severe as one might imagine.

Original article

Pros and cons of nationalising banks

As you know, last week, the Government nationalised Anglo Irish. There is now considerable speculation that they may nationalise the other Irish commercial banks. The Irish Times had an excellent article yesterday examining the pros and cons of nationalising banks from a global perspective.

For
The Swedish example: the blueprint for successful handling of a financial crisis is provided by Sweden’s centre-right government in the early 1990s. It forced banks to write down their bad loans and then injected equity, nationalising the country’s two biggest banks. The banks were detoxified and later re-privatised, with taxpayers getting back much of the money they had contributed.

Bailouts and partial nationalisations don’t work, according to influential economics professor and FT blogger William Buiter. Partial state ownership and the threat of future state control incentivises banks to stop lending. Banks look to pay back government money “as soon as possible” to “get the government out of its hair”, causing them to “hoard liquidity”. This helps them avoid outright nationalisation but cripples the economy. German economics professor Hans-Werner Sinn agrees, saying that government proposals to cap corporate salaries mean most banks would prefer to cut back on business lending and stumble along, zombie-like, rather than accept government interference. AIB CEO Eugene Sheehy, who said in October that “we’d rather die than raise equity”, comes to mind.

The alternative to the “unfortunate halfway house” prevailing at the moment, Buiter says, is temporary nationalisation.There’s no point trying to nurse banks back to health – it’s a case of “dead men walking”. Nouriel Roubini estimates that US financials will ultimately suffer credit losses of $3.6 trillion. The US banking system, with capital of $1.4 trillion, is “effectively insolvent”. Roubini’s estimate is high, although losses in excess of $2 trillion are commonplace today. In Britain, RBS analysts Ian Smillie and Cormac Leech describe British banks as “technically insolvent” on the basis that they are suffering from a £36 billion shortfall and are facing an additional £143 billion in writedowns.

Opting for more sweetheart deals means throwing good money after bad. In November, the US government injected an amount into Citigroup than exceeded its entire market capitalisation. It also guaranteed the firm’s toxic assets to the tune of $306 billion. Despite that, it ended up with a mere 7.8 per cent equity stake while management was left in place. Recently, Bank of America received $20 billion of government money on top of the $25 billion it received months earlier. It was also given guarantees of $118 billion on potential losses.

It’s not just a waste of money, it’s a case of “moral hazard” – heads you win, tails I lose. Taxpayers are taking all of the risk but none of the reward. Hedge fund manager Whitney Tilson says that current US plans will lead to “the greatest heist in history”. Poor decision making is rewarded if shareholders and debt holders are not wiped out.

Markets are saying that nationalisation is inevitable anyway, as this week’s collapse in Irish and British bank share prices show. Banks cannot receive the monies they need from the private sector, as AIB and Bank of Ireland are finding out. Governments have been behind the curve throughout the crisis – they must grasp the nettle and listen to what the markets are telling them.

“Creeping nationalisation”, as it’s been called, has already set in. Better be done with it sooner rather than later. Ideological hang-ups mean too many see nationalisation as a last resort. In truth, the financial sector has been kept on life support though massive government intervention for over a year now. Recognising that fact through nationalisation and preparing the sector for eventual re-privatisation is a victory for pragmatism, not ideology.

Against:
The Swedish example is simplistic. It nationalised just two banks whereas more than 300 US institutions received TARP money, many of them healthy and solvent. Nationalising en masse is wrong. Also, the Swedish example was local in nature whereas today’s problem is global. Were Britain to nationalise RBS (or others) and follow the Swedish example of writing down assets to nuclear levels, the knock-on effect on other global financial players would be catastrophic.

Governments are not the best people to run banks. A couple of years of crisis in the financial sector does not negate the long-held idea that the private sector manages resources more efficiently. Former RBS chief executive Sir George Matheson said the government should instead guarantee the bank’s deposits and “let it trade out of difficulties”.

Fear of nationalisation has driven financial shares below their true value. For example, AIB is currently valued at around €500 million, even though its has stakes in US bank MT and Poland’s Bank Zachodni WBK valued at €800 million and €1.1 billion respectively. Falling share prices are being used to justify nationalisation, even though the fear of nationalisation has caused the falling share prices. Shareholders have the right to hold on for eventual recovery.

Recent UK measures should help enormously. Besides the £250 billion credit guarantee scheme, regulatory changes mean that banks are being given additional latitude in terms of their capital ratios, with regulators accepting core equity of 4 per cent and Tier 1 capital of 6-7 per cent.

The RBS analysts who said banks were “technically insolvent” added that this is not unusual “at this stage in the economic cycle”, which is why the regulators have given banks breathing space. As Goodbody’s Eamonn Hughes said, similar regulatory moves in Ireland would make nationalisation fears “overstated”.

The cost would be enormous. Despite share price falls, buying up the banks would not be cheap (JP Morgan alone is worth almost $85 billion). Also, the risk of individual states defaulting on their debt is hugely increased by increasing their exposure to the banking system via nationalisation.

The odds of a British debt default hit record levels after it took a 70 per cent stake in RBS. The UK is at risk of losing its AAA credit rating and markets estimate that it stands a one-in-10 chance of debt default in the next five years – something that hasn’t happened since the Middle Ages.

The cost of insuring Ireland’s debt against default also hit record highs in the wake of the Anglo nationalisation, soaring by over 100 basis points to 297bps in little over a week. That’s over twice the cost of insuring Tesco’s debt and more than five times that of Germany’s.

What’s wrong with the “creeping” nationalisation approach? “The good thing about creeping, as opposed to sprinting, is that it’s easier to stop and reverse course if obstacles are in the way,” as Financial Times city editor Andrew Hill put it.

The notion that nationalised banks could be quickly returned to private ownership is facile. Such a process would inevitably be drawn out, during which time all the disadvantages of public ownership would become obvious.

George Matheson said nationalisation would bring “pressure” to do things “according to government practice rather than commercial banking practice”. In particular, politicised lending. “The focus isn’t going to be on the needs of banks,” said Obama economic adviser Larry Summers. “It’s going to be on the needs of the economy for credit,” a point also hammered home by Gordon Brown. The last thing massively indebted societies need, however, is a return to the easy credit that triggered this crisis.

Government demands to increase mortgage lending, even though property values remain at historically elevated levels, are as misguided.

Original article

US banks insolvent?

New York University Professor Nouriel Roubini is someone we at Leavonomics take very seriously because 'Dr. Doom's' economic predictions tend to be very accurate. Yesterday he said US financial losses from the credit crisis may reach $3.6 trillion, suggesting the banking system is "effectively insolvent". "I've found that credit losses could peak at a level of $3.6tn for US institutions, half of them by banks and broker dealers," Roubini said at a conference in Dubai yesterday. "If that's true, it means the US banking system is effectively insolvent because it starts with a capital of $1.4tn. This is a systemic banking crisis."

Losses and writedowns at financial companies worldwide have risen to more than $1tn since the US subprime mortgage market collapsed in 2007, according to data compiled by Bloomberg.

Oil prices will trade between $30 and $40 a barrel all year, Roubini predicted. "I see commodities falling overall another 15-20pc ," Roubini said. "This outlook for commodity prices is beneficial for oil importers, it's going to imply that economic recovery might occur faster, but for oil exporters this will be very negative."

Anglo Irish becomes fully nationalised

Following its plan to inject €1.5 billion into Anglo Irish Bank, and to take 75% of the voting rights in the process, before Christmas, the Government tonight went further and totally nationalised Anglo Irish Bank. It is the first nationalisation of its kind in the history of the state. Since reaching a peak above €17 in mid-2007, shares in Anglo Irish have plummeted, and closed at just 22 cent in Dublin today. It is my opinion that the Irish government took the unprecedented measure in part because of fears that the bank's collapse would have a major impact on the our wider economy. Had Anglo Irish gone out of business a number of sectors of the economy could have found themselves under threat - particularly health insurance. The majority of people here pay insurance to get access to the country's health service. The bank's collapse could possibly have had dire consequences for Sean Quinn, a major shareholder in Anglo Irish, who also has major interests in the insurance industry.

Anglo Irish recently lost top executives over a secret loans fiasco, which the government described as "unacceptable practices" which had played a part in the nationalisation. The bank's chairman , Sean Fitzpatrick, resigned in December after a 87m euros loan controversy where he admitted he had transferred millions of euros out of the Dublin-based bank's accounts. Chief executive David Drumm announced his resignation shortly afterwards. The state tonight took on the bank's liablities which lies probably between €6billion and €20billion.

China becomes world's third largest economy

Ashley Seager reports in Thursday's Guardian that China has overtaken Germany to become the world's third largest economy after revising its figures for output growth. The Chinese economy has grown tenfold in three decades and grew 13% rather than 12% in 2007, Beijing said, putting it behind only the United States and Japan in terms of gross domestic product.

The revision raised the Chinese gross domestic product to 25.7 trillion yuan, the national statistics bureau said, or $3.5tn at 2007 exchange rates. That would be ahead of Germany's 2007 GDP of €2.4tn, or $3.3tn. The fact that China has 1.3 billion people, though, means that GDP per head – a typical measure of individual wealth – remains well behind leading economies. Germany's 85 million people were far ahead of China in this category in 2007 at €28,200 euros per head ($38,800). China's per-person figure was 19,800 yuan ($2,800) in 2007, although many Chinese survive on a lot less than that. The Chinese government says 100 countries in the world enjoy a higher income per head than it does.

China expects to keep on growing in spite of the current economic turmoil. But economists have slashed 2009 growth forecasts to as low as 6%. That would be the highest for any major economy but is worrying for the country's leaders, who are concerned about public anger over recent job losses. Nevertheless, economists think it will take only three to four years for China, which recently overtook Britain, to surpass Japan ($4.4tn GDP) to become the world's number two economy. The United States is the world's biggest economy, at $13.8tn in 2007.

Pawnbrokers far from broke

The Guardian has an article this morning about one of the winners in the recession - pawnbrokers.

Britain's biggest pawnbroker has cheered the City by predicting it will comfortably beat profit expectations after enjoying a surge in business last year. H&T Group reported this morning that its chain of 105 UK stores experienced strong growth during the last six months of 2008, a time when many families began to suffer from the downturn in the economy. With like-for-like sales up by 3% in December, H&T is confident that its pre-tax profits for the year will beat consensus forecasts of £10m by at least 10%.

H&T, whose website's slogan reads "Helping you get your hands on cash", opened 16 new stores last year. Much of its business involves making loans guaranteed against personal possessions such as gold jewellery, though the company, founded in 1897, also provides cheque-cashing services. Chief executive John Nichols said H&T was planning to open more stores and hire more staff in 2009. So far, H&T has not seen an increase in the number of customers failing to repay their loans. Nichols said this could change, though, if consumers were hit by rising prices and bills this year. The average loan made by H&T is £120, typically repaid after three months. H&T reported last summer that gross profit in its pawnbroking business grew by almost 36% in the first half of the year. The soaring gold price has also helped the company, as it buys broken jewellery which is sold on as for scrap metal.

Analysts at Daniel Stewart tipped pawnbrokers as likely winners of the financial crisis. Shares in H&T jumped by 13%, gaining 19.5p to close at 172p.

Deflation Q&A

The London Times is running regular briefings to coincide with 'Target Two Point Zero', the Bank of England contest for English sixth-formers run in conjunction with the newspaper. The competition challenges students to play the role of the Bank's Monetary Policy Committee (MPC) and recommend the best level for interest rates. This week's topic is one we have already written a lot about - deflation. Unfortunately, we cannot enter the competition but the article is a good one and deals with an issue I mentioned in class to the Fourth and Fifth years last week.

What is deflation?
The dreaded “D” word, one of the most feared economic blights, refers to sustained falls in prices in the economy for goods and services.

Don't we already have falling prices for some products?
Yes. For goods such as many types of clothing, Britain has got used to steadily cheaper prices as a result of intense high street competition and cheap imports from Asia. But deflation is different, meaning falls in prices more or less across the board.

But that sounds good. What's the problem?
The trend can sound like a money-saving bonanza. A short-lived burst of deflation for only a few months might end up like that and need not be a disaster. Problems start when consumers collectively curb spending, constantly waiting for ever-cheaper prices. In turn, this sucks the lifeblood of demand from the economy. With spending falling sharply, businesses sell less and less and are forced to cut wages and lay off staff - leading to even less spending, lower demand and sharper falls in prices. A vicious, downward spiral takes hold that can spell deep and prolonged recession. Once deflation sets in, it can be tough to reverse it, as negative effects feed on themselves. For example, if interest rates have been cut sharply to try to rekindle spending, then once they fall to zero it is impossible to cut them further and, after factoring in falling prices, this means that real interest rates are still higher than zero.

Are there any other effects?
Unfortunately, yes. Debt is a headache. Where prices and incomes generally are falling in a bout of deflation, this means that the real value of peoples' debts, relative to falling incomes, is rising. So debts become an ever bigger burden, stretching the time that is needed to pay them off to longer periods. This is known as “debt deflation”. In an economy such as Britain's, where households have the highest burden of debt of any leading economy, it poses a particularly severe danger.

How can economies escape?
With great difficulty. Deflation is like quicksand. Once in it, it is very hard to escape the mire. Solutions to “reflate” the economy are found in flooding the financial system with ultra-cheap money. This can be done by governments printing money to give away in tax cuts, although this risks irreversible damage to a country's finances, or by a central bank buying up assets from banks, effectively handing them extremely cheap cash.

Is deflation likely to take hold now?
There is a significant danger. Headline inflation in the United States could turn negative as soon as this week, after a huge reversal of last year's surge in fuel prices. In Britain, the Bank has said that it expects inflation on some measures to fall into negative territory for at least a few months. This may fall short of full-blown deflation, but will magnify the danger of it.

www.bankofengland.co.uk/education/targettwopointzero www.timesonline.co.uk/targettwopointzero

Dell poleaxes us!

* Sorry about the lack of posts in recent days. We had a new exam system in the school over Christmas which seems to have increased the scale of corrections substantially - for me at least! But leavonomists, rest assured, normal service resumes from today. *

Well, this week brought us one of the worst pieces of news since the recession hit when Dell in Limerick announced 1900 job losses over the next 12 months. The manufacturing plant is moving to Poland. 450 people will lose their jobs by the end of April, with the remainder gone by next Christmas. About 1,000 high-value jobs will remain in Limerick, but for the workers who were losing their jobs, the decision was final and would not be reversed.

The job losses are a huge blow for the mid-west region, but the knock-on effects may be far worse. Dell confirmed that 1,500 jobs in other locally based companies supplying it would be directly affected by the downsizing. Local business leaders have estimated that as many as 5,000 people could lose their jobs by the end of the year, as the shockwave from the announcement hit the city. With unemployment rates in Limerick among the highest in the country, and jobs going by the day across a range of industries, the chances of re-employment for many are slim, at best. In all, the events of this week are yet another reminder that the country's largest employers no matter what sector they're in - Waterford Crystal, Tara Mines and now Dell - are vulnerable to the vicissitudes of a wildly turbulent global economy.

Russian/Ukrainian gas crisis deepens

Exports of Russian gas to Europe via Ukraine appear to have completely stopped amid a dispute over gas supplies between the two countries. Heating systems shut down in some parts of central Europe, as outdoor temperatures plunged to -10C or lower. Russia and Ukraine have blamed each other. Russia's gas company Gazprom has accused Ukraine of shutting off the final pipeline carrying gas to Europe, but Ukraine's Naftogaz said that would be impossible, since the taps are in Russia. The EU says it wants its own monitors to check the flow of gas. The EU depends on Russia for about a quarter of its total gas supplies, some 80% of which is pumped through Ukraine.

The list of countries that have reported a total halt of Russian supplies via Ukraine includes Romania, the Czech Republic, Slovakia, Bosnia-Hercegovina, Bulgaria, Croatia, Greece, Hungary, Macedonia, Serbia, and Austria. Italy said it had received only 10% of its expected supply. The row comes amid a cold snap across Europe that is likely to push up demand for gas. Bulgaria says it has sufficient supplies for just a few more days.

Europe's need for gas is likely to increase. Economic growth, when it resumes after the current recession, will mean more demand for electricity. Gas accounts for about a fifth of the EU's electricity and the share is likely to grow, partly because gas produces less by way of greenhouse gas emissions than coal or oil. The EU does have other suppliers, including Norway and Algeria by pipeline, and Qatar and Algeria, again, by ship. But Russia, with the world's largest gas reserves and an extensive network of pipelines to Europe, is likely to be increasingly dominant.

Where to invest now?

The Sunday Independent has an interesting article by Dan White this morning asking which shares we should buy in a recession.

ISEQ Challenge Results December 2008

The ISEQ finished up for the month and the year yesterday morning at 11. Here is the latest table for the ISEQ Challenge amongst the Fourth Years. Once again, our initial investments are being whittled away generally so well done to those whose companies improved in December (positive % in green). As for the big risers and fallers, much was a consequence of the pork crisis in December. Both the Kerry Group and Donegal suffered badly whereas Glanbia's decision to sell its pigmeat business in a management buy-out to Rosderra Meats last March helped it avoid any hit. However, more importantly, it was named as the Business & Finance Company of Year for 2008 before Christmas so its sudden increase is understandable. Aryzta's almost 10% jump follows an earlier drop in their December price, due to a downgrade to "sell" from "neutral" by Goldman Sachs which pointed to its over-reliance on the US market and on premium goods. Needless to say, the banks are the biggest fallers, which is to be expected in the current climate. At least nobody bought shares in Anglo-Irish!

We will add The FTSE Challenge when we return next Wednesday.