At the end of last week when optimists might have been hoping for some signs of at least a settling down of the current Euro zone crisis we saw several events which raised its profile yet again. The meeting of Euro zone ministers on the 16th and 17th of December had come and gone without any great disputes but also without any particular new plan. It has been quite some time now since we were first promised a new plan or European Stability Mechanism from 2013. The problem is that we get a new version of it almost every week! Each new version is badged as the solution only to disappear and be replaced by a new one leaving behind an increasing problem of credibility. One obvious problem of grand plans which start in 2013 is what happens in the meantime? Investors posing this question have sometimes not liked the answer and accordingly (loose) talk by Euro zone ministers and officials has contributed to an escalation of this stage of the crisis. I am reminded of the poster campaign in the UK in the Second World War which said “loose talk costs lives”. This time its money rather than lives.
The Ratings Agencies
Over the weekend a comment on here addressed the ratings agencies and I thought I would make my position clear on them. They are conceptually bankrupt organisations which failed in their purpose. Unfortunately a feature of the post credit crunch era is that we have not been good at clearing out failures. So to add to zombie banks we have zombie ratings agencies. We do not have any plan for an improvement as I feel the idea of governments forming them is one example of something which could even make things worse. Could you imagine the Greek ratings agency of say 2 years ago when all her statistics were being dissembled? Or going forwards any ratings agency and the enormous pressure it would come under rating the debt of its own sovereign? An European Union wide one would have the problem of the fact that the organisation setting it up has been unable to get its own accounts past its auditor for 16 years.
Unless anyone has a better idea I would propose simply scrapping them. I doubt the world would end as the financial industry if pressed is often quite innovative.
The European Central Bank and Ireland
We shall receive news later today as to how much money the European Central Bank had to spend in an effort to support the Irish government bond market last week (it is also supporting Portugal and Greece) under its Securities Markets Programme. I wrote on Friday about the planned increase in its capital to address the losses it must be holding on this book. Although as this has been misrepresented in the mainstream media let me make the actual position clear. Some extra money is due on the 29th of December but even then it will have less paid-up capital than many have claimed its capital to be now! Also the next two tranches will be paid one year and two years later so are not much use now. If you are at the ECB you are probably a little edgy on this subject and maybe a little embarrassed. After all it is hard to lecture banks about capital inadequacy with a straight face if you have the same problem.
Just to add to the conceptual issues facing the ECB it is not happy with the details in the bailout deal for Ireland and here is an example from its letter on this subject which summarises its generic view.
The Section needs to clarify this, in particular since the published Bill does not contain an Article 60 which appeared in a previous version of the draft law and which usefully stated that‘nothing in this Act affects any function, right, or entitlement of the [Central] Bank or the European Central Bank’.
You would have thought that all this would have been sorted out. If you remember I first called for Ireland to call for international aid in mid-September so there was plenty of time to prepare paperwork. It would appear however that basic competence is not a Euro zone strength. The problem for the ECB is that it is offering an enormous amount of liquidity to the Irish Banking system and in return for that it receives collateral.
The Bank of England offers a credit line to the ECB
The Bank of England and European Central Bank (ECB) are today announcing a temporary reciprocal swap agreement (swap line). This precautionary measure would enable the ECB to provide sterling liquidity to its counterparties. If requested, the Bank of England will provide the ECB with sterling in exchange for euro up to a limit of £10bn. The agreement expires on 30th September 2011.
I have to confess this arrangement came as something of a surprise. If you look at the liquidity support provided to Ireland by the ECB and add it to IMF/EU/ECB the aid package you can see that an enormous amount of support is being given to what is in effect a very small economy in relative terms. Yet they need a swap line with the Bank of England? If it was me I would only announce such a thing as I was about to use it so I will be monitoring the status of this swap line closely.
The International Monetary Fund
If you were thinking that enough minds seemed to be occupied with Ireland from the news above you would be wrong. The IMF has compiled a staff paper on the subject and it is by no means sugar-coated. Let me give you two excerpts which give plenty of food for thought.
Ireland has faced intense economic and financial pressures in recent months. At the root of its problems is a critically weakened banking sector that has yet to be restored to health and stands at the center of a dynamic that dampens economic recovery while creating pressures on an already serious fiscal challenge.
High program risks reflect uncertain bank losses, a difficult debt outlook despite an unprecedented fiscal adjustment, unclear growth prospects, continued market focus on peripheral Europe countries, and an impending general election.
The issue of uncertain bank losses in Ireland is something I have often written about as a barrier to a solution to her problems. Let me explain why this is important.At this moment in time.
1. If we look at commercial property loans then the Irish bad bank called NAMA is dealing with some of these but this begs the question what about the rest?
2.The Irish banking sector also made loans to companies which must have been affected by the downturn.
3 Residential mortgage lending must have been affected by what has happened and will be affected further as time goes by. What about other personal lending on the books of Irish banks?
4. There remains talk of derivative losses sitting on the books of the Irish banks and this needs to be addressed apart from having echoes of AIG/Lehman Bros from 2008.
So much remains to be done and there is still a danger that problems will mount for Ireland and hinder her recovery. Indeed the IMF was worried about potential contagion for itself from this. But then if you use an organisation designed to deal with balance of payments problems ( Ireland has a surplus on her latest figures) for fiscal problems you shouldn’t be surprised if you hit trouble.
International Problems: contagion?
Theses issues tend to spread and it was the turn of Lloyds Bank via its ownership of Bank of Scotland to declare increased loss provision for Ireland on Friday. Also I notice that Danske Bank announced that it expected bad debts to remain high in 2011 at its National Irish Bank subsidiary. I am sure it is not a coincidence that both countries gave bilateral loans to Ireland as part of the aid package. Put another way its looks as though they were attempting to defend their own banking sectors.
Reviewing events remind me yet again of why I was against the bilateral loan given to Ireland. Firstly the Irish banking sector is by no means fixed and secondly we have given her the money on terms she cannot afford. I do not expect for us to see all of it back.
UK Inflationary trends
One of the problems that the UK faces is that there are quite a few institutions in our economy who faced with problems simply raise prices. These are usually ones which face little or no competition in their main market. In other words with a monopoly or some extent of a monopolistic position. Many of these have been in evidence over the recent period where our inflation rate has been higher than the level one might have expected coming out of a severe recession.
Well now add to the list the Post Office. Next April a first class stamp will rise by 5 pence or 12.2% to 46 pence and a second class stamp will rise by 4 pence or 12.5% to 36 pence. So rather than concentrate on the economics text books with their cost push and demand pull versions of inflation in the UK we have institutionalised inflation as a sub-case.
I was asked over the weekend if consumers and individuals are having more than their share of the burden placed on them in this phase of our economic life. If you add in the effect of inflation (which you can consider as a tax by another name) then the answer is plainly yes.