Ireland is contrasted with Greece: Is there a reward for virtue?

After this weeks action in Ireland where her “bad bank” the National Asset Management Agency (NAMA) began its task of clearing up the debris from the implosion of her property sector I thought that it would be useful to look at the implications of this move and to compare her situation with Greece. Of the two Euro zone countries these were the two whose fiscal deficits looked most likely to get out of control. However their responses to the problems were quite different with Ireland acting decisively in an austerity budget last year and ending up looking to make cuts equivalent to 6% of her Gross Domestic Product (GDP) whilst Greece had to have several bites at the cherry before eventually planning to make cuts this year of around 4% of GDP.So has virtue had its reward?

NAMA

As the week has gone on more details have come out on the initial stage of NAMA’s operations where she paid 8.5 billion Euros for assets with a face value of 16 billion Euros. The plan is for her to take on bad property based loans so that Ireland’s banking sector can resume normal lending (although after the boom and bust we have been through that may be easier said than done). The average haircut on the first tranche at 47% was higher than expected reflecting the poor quality of the loans made. As I have commented before Anglo-Irish bank appears to have been the lender with the worst quality loan book and now to add to this she is mired in corruption allegations. In total some 81 billion Euros of loans will join NAMA.

A consequence of this and the fact that Ireland’s financial regulator has given guidance on the amount of Tier one capital the banks will require means that her banking sector will require around 32 billion Euros of extra finance. The bank in the worst situation is the nationalised Anglo-Irish bank and the bank in the best is Bank of Ireland. The painful truth is that Bank of Ireland is the only one where state ownership looks likely to be a minority partner.

Also the size of the haircuts at 47% was worse than expected and some analysts now feel that for the rest of the 81 billion Euros the haircuts may be even higher. This is based on the fact that so far investments have mostly been transferred into NAMA rather than land itself and commercial and residential property developments have barely begun to be switched in at all. It will come as no surprise to hear that the Governor of Ireland’s Central Bank is more bullish. But the fact that there is a debate does not sound a good omen.

Ireland

Numbers on this scale are significant for Ireland which is only a small economy. For example the capital requirements for Anglo-Irish bank are almost the same as how many government bonds Ireland planned to issue this year.So a banking sector implosion has turned into a big burden on the Irish state and will ripple out for years to come.

Ireland now has a delicate balancing act to perform she needs economic growth to get going but she also needs austerity in her public finances, and these are uneasy bedfellows.

Greece

Having been forced by various outside influences to start an austerity programme and facing something of a backlash over her previous governments misrepresentation over her economic statistics means that Greece finds it much harder to claim she has been virtuous. Added to this is the fact that her problems came mostly from a bloated public-sector.

This week saw her get away a new 7 year bond issue and so 5 billion Euros found its way into her coffers. As you will have read on here I feel that this was a mistaken strategy. You will have a sense of my surprise when I heard that Greece was very soon afterwards trying to issue 1 billion Euros of an existing 12 year bond. This was compounding a mistake particularly when they were trying to insist on a yield cap of 6% and ended up punishing those who had bought the seven-year bond. In case anybody is wondering how you issue debt, in my view this is how not to do it. Only a third of the requested funds made their way into the new bond. If you were not sure by now that Greece’s authorities were showing signs of desperation, talk of issuing some government debt in US dollars should convince you. Some may wonder if they are trying to trigger an aid package,

Just to show that problems tend to come together Moody’s also downgraded five of Greece’s banks  this week and left them on negative watch. A curious move in some ways after the change in European Central Bank collateral rules which is likely to benefit the Greek banking sector but it is also true that the challenges facing Greece as a nation and hence her banking sector are not getting smaller.

A Market Comparison

If we look at comparable government bond yields we see the following. In terms of ten-year yields then Greece is now at 6.53% whilst Ireland is at 4.47%. I wrote earlier this week that Greek yields were double those of Germany’s on this measure well now they are at +3.44% which is more than double. Ireland by contrast is at +1.39% which is within what you might call her recent trading range.

Shorter dated bond yields also give one a clue to see if authorities control of overnight money ripples out through such maturites. Ireland has a 2 3/4 year bond which is yielding 2.78% whilst Greece has a two-year bond yielding 5.79%. The difference is very stark.

Conclusions

1. I am pleased to report that there has been a reward for virtue from the financial markets if you compare Ireland with Greece. That is not the message many (politicians in trouble) want to hear.

2.The best review of the Euro zones rescue package is that ten-year bond yield for Greece are more than a quarter of a point higher than they were the day before the plan. Those who are supporters of global warming theory will be disppointed that so much hot air was expended for so little economic effect.

3. Greece’s debt management agency is either following a rather bizarre strategy or it is trying to deliberately trigger an aid package for Greece.

4. As I have pointed out before what are called successful bond issues can cause indigestion afterwards and it takes time for their full impact to be felt.

5. It would be best to call in the International Monetary Fund now.

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16 thoughts on “Ireland is contrasted with Greece: Is there a reward for virtue?

  1. Agree entirely – this is getting beyond embarrassing. With European partners like these as friends, who needs enemies ………….

  2. But what of the virtuous UK?

    (i) faced with a difficult funding scenario the Bank of England printed £200,000,000,000 and used it to buy pretty much all the gilts issued to teh market.Enabling the banks to hoover up up gilts issued on tap and flip them into the BoE for a nice turn.

    (ii) Recognising that the UK faces a structural spending deficit that would take 5 years to bring under control the govt plans this year to spend 2% more in real terms.Oh yes and assume a return to growth based on a policy of wishful thinking and prayer.

    (iii) Meanwhile as part of a root and branch approach to reform spending plans a white paper on home care is introduced akin to when Homer Simpson was made Garbage Commissioner for Springfield.

    Get rich quick Short Gilts

  3. Shaun,

    Thank you for your thoughtful posts.
    Perhaps I am missing something, but what do you see IMF being able to do in Greece? The total available package (EU + IMF) is supposed to be in the order of 20 billion euros (IMF by itself would be about 10 billion). Per Greek press reports, in the last couple of days the director of the Greek Debt Management Agency gave the following approximate borrowing needs for the coming years
    2010: 55 billion euros (total)
    2011: 60-65 billion euros
    2012: 65 billion euros
    These numbers are 15-20 billion euros more than the maturing debt plus interest for each of these years. Perhaps I am missing something, perhaps he was looking at the wrong set of books, or maybe he is indeed following an obscure strategy. But it appears that the government cannot meet its domestic obligations (i.e., salaries, pensions, health care, etc) without borrowing. After all, there are several months behind in payments to doctors (for on call duties), to pharmacists, to construction companies, and even to recent retirees (people have been waiting for close to 2 years for the lump sum they receive upon retirement), to mention a few.

    To ask my question more directly. Does the involvement of IMF presuppose the existence of any particular administrative infrastructure? Or is IMF supposed to (re)organize this infrastructure? And how much legal latitude do they have? IMF can require budget cuts, but how would they be implemented?

    js

    • Hi John
      In essence the IMF provides two things cash and experience/credibility. Breaking them up you could argue that the latter is more important than the former. So in that sense numbers are not the answer because the power of the IMF comes with its credibility. So a rescue would involve some IMF cash. If we took the Euro zones example and look at a 21 billion Euro rescue plan then the IMF would provide 7 billion Euros if they stick to the percentages they hinted at.
      1. In itself plainly this would not even get Greece to the end of May.
      2. However other lending always comes in with it, for example the bilateral loans of 14 billion talked about in the Euro zone plan.
      3. Both amounts in an extreme example could run out by the end of this year but I would imagine that the other Euro zone countries would add to their loans in extremis.
      4. The IMF will impose conditions for the lending and this will be an austerity programme which may be tougher than Greece’s existing plan (which remember is likely to see Greece’s GDP fall this year by 3/4%). However in the past markets have trusted the IMF and backed its plans as it has credibility and so if Greece follows them she is then likely to be abe to borrow from world markets and this is likely to be at a cheaper price than now. So this answers your questions at the end, the IMF will impose terms in return for its help, no commitment no lending. Greece will have to sign up at the beginning to this. So the problems you highlight will begin to be tidied up by the IMF. As an aside one of Europe’s Finance Minsters complained that the IMF faxed him a conditions form which plainly had been used elsewhere,hinting at a one solution fixes all approach.
      5. The IMF money will save Greece 2/3% per annum in interest costs so this helps too. However the Eurozone plan is so poorly specified it is impossible to say what they will charge.

      However IMF involvement is no panacea for an example of how tough it can get please read my article on Latvia’s experience. For the world as a whole I expect 2010/11 to be tough anyway as many countries are withdrawing fiscal and monetary stimulus programmes and for Greece the danger is that the austerity programme she needs really bites down hard on her economy. Frankly for Greece it is coming down to a bilateral choice the IMF or leave the Euro and devalue. My first article on Greece suggested that it would be illogical and expensive for Greece to leave the Euro but events have moved on and in particular whilst I expected Euro zone politicians to be incompetent it turns out I did not know the half of it! As numbers have emerged for how much of Greece’s debt is in overseas hands can one really say that if things get tough one could rule out the installation of a new revolutionary government which blamed foreigners for Greece’s ills?

      • Shaun,

        thank you for taking the time for the extensive reply. Your clarification that the importance of the IMF input is expertise and credibilty and not so much additional funds is helpful. It is interesting that the Greek government has been requesting cheap loans and not IMF involvement, which could be interpreted as them being interested more in the loans than in solving the problem.
        I am rather pessimistic whether IMF could make a difference. The reasons are the extensive corruption in the Greek public sector (including the tax collectors) and the unfriendly business environment (it is extremely difficult to start a business in Greece among other problems — and the black market economy is 25-30% of the GDP). Another difficulty is a clogged up legal system (with 1,500,000 cases currently pending, and with a lot of cases taking more than 10 years to resolve).
        Foreigners will definitely be blamed for Greece’s ills — the EU/IMF surely, but also the immigrant workers and refugees who have already become the target of attacks.
        js

  4. Is this a mis-print or have things just gone very wrong for Greece this evening (20:44hrs). I am refering to the following… http://markets.ft.com/markets/bonds.asp
    According to this the Greek 10yr yeild has just gone through 350% Yes you read it right and I didnt mis-type… THREE HUNDRED AND FIFTY PERCENT. But I cant see anything else on the newswires. Anyone know anything??

    • Hi Zak.. that’s got to be a error of some sort.
      But I agree with Notay.. the IMF needs to be called in. My understanding is that the IMF can only provide $15 billion of the $50 billion needed to get Greece thru summer. Then what ??

      Kowalski’s guess.. the EU coughs up a chunk this summer. After that.. who knows. Anything resembling a breakup of the Euro will cause that currency to tank badly, causing deflation here as traders rush to trade their Euros for USD. I think Ben Bernanke steps in forcefully before Xmas.

      http://themeanoldinvestor.blogspot.com/2010/03/update-326.html

      Kudos to the Irish for staring reality in the face and dealing with it upfront. I honestly think they are the only nation doing so; their PM should be awarded the Victoria Cross.

    • Yes that page has gone rather AWOL.If you look at the spreads it also implies German bond/bund yields are 100%. The spreads often do need checking as they sometimes do not add up but this is plainly someone having trouble with their decimal places. The FT service overall is good but nothing is perfect. The Greek yield was 1/100th of what they say in this instance if you then add 3%!Ooops, just to be clear 6.53%.

  5. I wonder how long Greece herself will put up with the prevarications of her euro partners? Once again lack of decisive leadership seems to be the key element. She needs to,
    1. Get out of the euro but ‘charge’ other euro members for the privilege of protecting their currency.
    2. Call in the IMF and take 30% devaluation. This should make her resort of choice in the Med and stimulate economic activity in that sector and also bring in foreign exchange.
    3. Invigorate, reskill and refocus her workforce attracting international private sector investment.
    4. Slash public sector costs.
    I can’t see what long term benefits Greece will have is she does just accept whatever the current ECB/IMF package is now? With the abject lack of any swift coordinated EU action why stay in the club?

    • Mac: “I can’t see what long term benefits Greece will have is she does just accept whatever the current ECB/IMF package is now? With the abject lack of any swift coordinated EU action why stay in the club?”

      Precisely.. at some point, when things get bad enough, an enterprising politician will get on the podium and say “Why not simply go bankrupt.. how much worse can it really get, and at least our kids will have a better future. Piss on those German banks” to the howls of the mob. It’s then that the REAL party starts for the EU.. first there’s Greece’s $400B debt, then the debts owed by crumbling Greek banks, then the credit default swaps written on them both.

  6. Yes the Quantum offered in IMF support would not be enough to cover maturing and new debt issuance.It would however provide sufficient confidence in the markets to buy time. Beyond this year the IMF would have to bring in other sources and economic concessions (Looking at you Germany) to deal with the deficit.So any ‘rescue’ would come in Phases.

    I,m driven to the conclusion that default is in the Greek interest and IMF intervention is in the interests of everyone else.

    Unless Europe finally relents with a total guarantee!

    Advantage Greece methinks

    • Andy,

      the only way the greek state is functioning now is with borrowed money. If they default, how is the government going to pay its employees? Let alone funding the public and private pension funds, which appear to be broke.
      The already implemented measures (public sector salary/salary supplement cuts, increase in VAT, and extra taxes on fuel and alcohol) are expected to yield savings of about 4 billion euros per year. It is definitely not enough.

      The greek government needs to borrow more and more to keep running, the EU realizes where any new loans will go. Disadvantage everyone.

      js

  7. If I was a Greek politician I would be asking for an agreed default on EU held Greek debt as part of the cost of withdrawing from the Euro and accepting total IMF involvement.
    Once the Greeks sit down and think about it and realise where some of the blame lies for their predicament I can see Mr K’s scenario playing out and that might make the first sentence more palatable!
    As Andy says ‘Advantage Greece methinks’, if they have the bottle for the fundamental changes needed.

  8. Mac: “who holds the bulk of the Californian debt ?”

    I honestly don’t know; my guess is hedge & mutual funds like PIMCO head the list; other municipalities and states probably hold a decent chunk, with the rest being held by mom & pop investors. Ultimately in California, unless they change their state’s constitution which states that the debt must be the absolute first budget priority, the problem will get solved thru whatever tax/rate hikes they can enact in combination with state wage cuts, prison closings & cuts in other areas like the Univ of Calif system. Honestly.. this is as it really should be. Accounting tricks should also be thrown into the mix. The upcoming election will be key; if Jerry “moonbeam” Brown returns to the Big Chair with a Democratic majority in both state houses (a distinct possibility) look for taxes of all kinds to go sky high and for businesses to shut down in response.

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