Business Irish

Monday 18 November 2019

Emmet Oliver: Giving the markets a different kind of surprise may be last hope

Former Taoiseach John Bruton used a phrase last month which was inspiring and frightening at the same time.

He said the only way Ireland could break out of its current budgetary malaise was by giving the markets a "good surprise''.

What he meant was that after three years of giving the markets bad surprises -- higher capital costs for the banks, missed growth targets, lower tax receipts, the Croke Park agreement -- Ireland should try to reveal something to the financial markets that surprises investors in a positive way.

Something that makes them re-assess Ireland once again as an investment opportunity, something that makes them look at the problems here with a different perspective and triggers them to alter their models.

"If you can surprise the markets on the upside, your problems remove themselves much quicker,'' said Bruton, a man whose career was forged in the trials of the 1980s when Ireland faced uncannily similar debt problems.

The bond market and share markets have already written the script for Ireland over the next few years.

Debt will keep rising, growth will stall, the banks may need more capital and unemployment will not reduce. While some of these don't worry the bond market too much -- high unemployment is a natural by-product of austerity -- the remorseless rise in the national debt does.

That is where the positive surprise comes into play.

One positive surprise would have been Ireland managing to sell a lot of state assets in a short time for more than anyone thought.

But following the publication of the McCarthy report and the muted reaction to it, that surprise is unlikely to manifest itself.

So the only way Ireland can change outside sentiment now is the debt problem itself.

In other words Ireland can deliver that surprise by reducing its deficit faster than anyone thought was possible and faster than competing peripheral economies.

That would, while hugely painful, shift sentiment massively in favour of the Irish economy. The achievement of a budgetary surplus would transform the prospects for the Irish economy, even if Ireland was left with a residually high level of national debt. As one economist said recently "it is the trajectory of the debt that matters, not the size''.

Clearly the frightening part of Bruton's phrase is the economic (and social) consequences that would flow from such a "surprise'', to effectively front load the front loading.

Nobody with a wit of sense is suggesting the entire €18bn borrowing requirement be eliminated in one year, but a shorter, more truncated, path to capping the debt may have to be found.

Effectively that may be the only action left at this stage which will prompt the markets to look at Ireland afresh.

So far the option of deep and painful front loading has been utterly rejected by public expenditure minister Brendan Howlin. But even he knows that planning for the Budget has yet to start and a lot can change between now and December.

The real reason why Merkel cannot stomach the reality of a Greek default

The European authorities look set next week to apply a sticking plaster on top of a sticking plaster in relation to Greece. Extra cash will be provided to the debt-wracked country and maturities on existing loans extended.

Talk of restructuring a debt burden that comes to €327bn will happen in private of course, but before the Brussels cameras the R word is likely to be barely mentioned.

At this point nobody wants to see Greek bondholders taking haircuts, because the European banks and insurance companies which hold these securities are still not ready -- even after generous capital raisings -- to absorb haircuts that could be as high as 50pc on face value.

With Greece in serious trouble since early last year, one would think key banks that deal with Greece would have written down the value of their Greek holdings already or at least started the process.

For example, German banks have a $34bn exposure to Greece, while French banks have a $57bn exposure. If write downs had already been taken, an eventual controlled default by Greece would be far less painful.

But alas European banks are in most cases holding their Greek assets (not to mention Irish and Portuguese assets) in what are known as their banking books.

This means these assets are not valued according to market prices, as the banks claim they intend to hold them to maturity.

The only assets that get marked to 'market' prices are held in the trading books of the banks, and yes, they have been marked down over recent months, but it has not been enough.

Banks hold about 90pc of their Greek government bonds in their banking books and 10pc in their trading books, a frightening survey by Morgan Stanley suggested last year.

This essentially means that Europe is simply not ready yet to handle the Greek crisis in any other way but to keep the problem at arm's length.

While Angela Merkel and others say a restructuring is not right for now because of more generalised contagion risks, the state of bank balance sheets must also be a key concern for her, though this is rarely voiced in public.

Kelly's early forecasting success might not be repeated

History never repeats itself in quite the same way. Economist Morgan Kelly rightfully diagnosed the Irish banking problem in 2008 during a memorable appearance on RTE's 'Prime Time'.

Kelly, long before establishment Ireland admitted it, said the problem was a lack of capital, not a liquidity crisis.

"Irish banks have made big losses on their loans, they are short of capital,'' Kelly said and within a few months he was proven right when capital injections were ordered for Anglo Irish, and later for AIB and Bank of Ireland.

Kelly's subsequent forecasts have seen him leap into the unknown a lot more. Ireland is "on the cusp of a social conflict on the scale of the Land War'' Kelly told his readers in November, with Ireland about to endure "mass'' mortgage defaults (no definition of mass was given).

Kelly rightfully pointed out then that when interest-only arrangements, mortgage holidays and other arrangements between banks and borrowers are accounted for, the level of mortgages in arrears is far higher than people realise.

But the prediction of mass mortgage defaults remains the contentious one. Even taking account of every single mortgage in arrears, on a mortgage holiday, or on an interest-only arrangement, leaves Ireland sitting on an 'at worst' mortgage default rate of 10pc.

Clearly this figure includes thousands of people who are actually paying their mortgages, but on a lower repayment cycle than originally agreed with their lenders.

For "mass'' mortgage defaults to occur it would presumably require this rate to triple, an extraordinary rate of deterioration even with unemployment hovering around 14pc.

Kelly was right at the outset of this banking problem, but his forecasts are growing riskier with each contribution he makes, giving his opponents (of whom there are many) a late chance to ridicule his predictive powers.

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