Thursday, December 29, 2011

Mortgages in Irish Banks (and their interest rates)

A previous post looked at loans in Irish banks.  Here will we confine ourselves to mortgages and will start from this graph in the earlier post.

Household Loans for House Purchase

The Central Bank report Private Household Credit and Deposits Statistics which allow us to look at this in a little more detail.  Here is the same graph (going back to 2003) from the Household Credit series.  The data is quarterly and runs to Q3 2011 so does not include the shifts that occurred in October 2011 that guided the previous post.

Total Loans for House Purchase

In general, the series from the two graphs are similar though the securitised series in the latter graph shows a ‘jump’ in the second quarter of 2009 that is not evident in the first graph.  As there is no corresponding decrease in “on balance sheet” loans it is not clear what was securitised (if anything).

It can be seen that banks in Ireland began securitising mortgages in the middle of 2006 and stopped by the end of 2009 (apart from €17 billion that was “derecognised” in October 2011 of course!)

The benefit of the household statistics is that we can look a little deeper into this although most of the data series only start from the fourth quarter of 2010.  We can, however, get the breakdown of the “on balance sheet” loans for house purchase back to 2003.

On Balance Sheet Loans for House Purchase

Most of the significant step decreases can be explained by increases in securitised loans although the drop that can be seen at the end of 2010 is as a result of Bank of Scotland (Ireland) leaving the Irish market.

The more detailed series are only available for four quarters.  There has been little movement in the series over this period so there is little value in graphing the series.  Here is the most recent data for September 2011 in tabular form. 

First, the total amount of loans for house purchases.

Loans for House Purchase

The €102 billion total of residential mortgages in September 2011 is significantly lower than the €114 billion reported in the Financial Regulator’s Residential Mortgage Arrears Statistics for the same time.  The primary reason for the difference is the absence of Bank Scotland (Ireland)’s mortgage loan book from the above figures.  

We are also provided with a breakdown of the €132 billion of mortgages by interest rate type: standard variable, tracker and fixed for different periods.

Mortgages by Interest Rate

More than half of mortgages in Ireland are tracker-rate loans linked directly to the ECB base rate.  With the ECB rate now back to 1% the repayments on these loans are now much lower than when these loans were taken out in the 2006 to 2008 period.  Finally, we can get a breakdown by interest type for residential, buy-to-let and holiday home mortgages.

Here is a breakdown of the €102 billion of residential mortgages by interest rate type.

Principal Dwelling Loans by Interest Rate

Just over half of residential mortgages on are on tracker rates.  If the €10 billion or so of mortgages in the former Bank of Scotland (Ireland) were included this proportion would be even higher as most of its mortgage book comprised tracker-rate loans. 

The proportion of buy-to-let mortgages that are on tracker rates is even higher.

Buy to Lets by Interest RateAlthough they make up a very minor part of the overall market here is the same data for holiday home and second home mortgages.

Holiday and Second Homes by Interest Rate

Loans in Irish Banks

Here we will give a look at the asset side of the balance sheets of Irish banks, looking specifically at loans and in particular at some large changes that seemed to have occurred in October based on the most recent release of the Central Bank’s Money, Credit and Banking Statistics.

First up, is the total amount of loans on the balance sheets of the domestic banks, broken into the covered group (AIB, BOI, IBRC and PTSB) and the non-covered group (Ulster Bank, National Irish Bank, etc. and also credit unions).

Total Loans in Domestic Banks

There has been a fall in the amount of loans on the balance sheets of the covered banks.  Some of this is due to repayments on existing loans exceeding the amount of new loans issued but most of the drop from a peak of €513 billion in July 2009 can be explained by the transfer of over €70 billion of developer loans to the National Asset Management Agency (NAMA) and the sale of loans to other banks.

The total amount of loans the covered banks had was steady at around €400 billion from May of this year but there was another sharp drop to €377 billion in October.  It would be possible to explain this drop in a chart or two but we will use the drop as a reason to have a fuller look at the loans on the balance sheets of the banks.

Tuesday, December 20, 2011

Investment, Depreciation and the Capital Stock

Last Friday’s release of the Q3 Quarterly National Accounts contained some interesting figures but the standout one was the 20% drop in Investment that occurred in the quarter.  Investment is now down more than two thirds on its peak and is the main reason for the fall in the Irish economy over the past four years.

In fact, if we do an unusual dichotomy for the national accounts and break it into expenditure on “Goods and Services” and expenditure on “Capital Formation” we see that the former has held up while the latter is down nearly 70%.

Current and Capital GDP Expenditure

The distinction is a little crude but “Goods and Services” is made up of C + G + NX:

  • C – Personal Consumption of Goods and Services
  • G – Net Expenditure by Central and Local Government on Current Goods and Services
  • NX – Net Exports of Goods and Service (Exports minus Imports)

In the third quarter of 2007 these summed to:

€22.8 billion + €7.5 billion + (€37.9 billion – €33.4 billion) = €34.7 billion

The most recent figures for the third quarter of 2011 the figures were:

€20.0 billion + €6.4 billion + (€40.5 billion - €29.7 billion) = €37.3 billion

There have been reductions in expenditure by households (-12%) and government (-15%) but these have been offset by an increase in net exports (+70%).  For the period 2007 to 2009 this was as a result of falling imports rather than rising exports but for the past 18 months or so the improvement in net exports has been as a result of increased demand abroad for goods and services produced in Ireland.  Overall demand for goods and services is up €2.6 billion over the four years.

“Capital Formation” is just I from the National Accounts: Gross Domestic Fixed Capital Formation.  Over the period used above quarterly investment fell €5.6 billion from €9.1 billion to €3.5 billion. 

Quarterly GDP fell 7.6% from €43.5 billion in the third quarter of 2007 to €40.2 billion in the third quarter of 2011.  Using the dichotomy we have applied here this is largely explained by the collapse in capital expenditure.  To explore further the nature of the fall in investment see this post on patterns of investment over on  The general idea is fairly clear  - it is mainly a story of households and housing.

Two weeks ago the CSO released the 2010 update of the Estimates of the Capital Stock of Fixed Assets.  Here is a graph of the value of the stock of fixed capital (excluding land) in 2009 prices.

Net Capital Stock

The capital stock increased consistently from 1995 to 2008 and this is true for the overall capital stock and the capital stock excluding dwellings (other buildings, roads, transport equipment, other machinery and equipment, cultivated assets, computer software).

Of course, it is not that there was no investment in 2009 and 2010.  There was €25.3 billion of gross capital formation in 2009 and €19.0 billion in 2010, but this was just enough to cover the amount the consumption of the existing stock of fixed capital (depreciation) so the increase in the net capital stock was much less.

[The investment figure here is form the National Income and Expenditure Accounts and the depreciation figure is from the Estimates of the Capital Stock of Fixed Assets.  There may be some non-overlapping between the definition of fixed capital/assets used in each but it is unlikely to change the overall conclusion.]

Investment and Depreciation

The fall in investment has continued and in real terms 2011 is 15% behind 2010 so it is clear that investment this year will not be sufficient to cover depreciation.  For the first time since the series began the real value of the capital stock in Ireland will fall.  The picture is equally bleak if we exclude dwellings (with land excluded in all of the analysis here).

Investment and Depreciation excluding Dwellings

For most categories investment in 2010 exceeded the level of depreciation estimated by the CSO, but the gap has gotten substantially narrower and for 2011 will be negative in many cases.

Investment by Use

The depreciation for Dwellings and Other buildings includes the costs associated with the transfer of land and buildings but a breakdown under gross investment or depreciation is not included.  The Net Investment under Dwellings and Other Buildings could be larger if conveyancing costs were included in the gross investment figure (as they are in the depreciation figure).  It should also be noted that the gross investment figure for Other Buildings and Construction includes land rehabilitation but land is not included in the depreciation figure.

The negative net investment figure for other machinery and equipment is large but a lot of this could be explained by the almost stalling of activity in the construction sector.  It be argued that a lot of the machinery and equipment here is out of use rather than depreciating and will never be replaced.

For 2011, it is likely that gross fixed capital investment will struggle to get much over €16 billion (in 2009 prices).  It is €12.6 billion for the first three quarter of the year.  The 2010 depreciation figure of €16.2 billion is unlikely to the much changed for 2011.   An increase in the capital stock for 2011 is unlikely and the prospects are that a similar outcome will occur in 2012.

Finally here’s net investment as a percent of GDP.

Net Investment

Friday, December 16, 2011

Wealth (and Taxing Wealth) in Ireland

Wealth has been getting a lot of attention in Ireland recently particularly in relation to the claim that it would be possible to raise €10 billion per annum from a 5% wealth tax on the wealthiest 5% of the population as detailed in the Budget Submission of the United Left Alliance and repeated on an almost nightly basis on television and radio.

The adult population of Ireland is around 3,400,000 so the 5% that are liable for this tax would be 170,000 people.  In order for the €10 billion total to be achieved these people would have to be pay an average of an additional €60,000 in tax every year.

The ULA’s budget submission also envisages an additional €5 billion of income tax to be raised from those earning in excess of €100,000.  According to data from the Revenue Commissioners in 2009 there were 110,000 tax cases reporting an income in excess of €100,000.  The average income in this category is €180,000, but two-thirds of those who earned more than €100,000 earned less than €150,000.  In order for the €5 billion target to be achieved those earning more than €100,000 will be required to pay an average of an additional €45,000 of income tax. 

This is an addition to the €60,000 average income tax that this group paid.  In 2009, this excludes payments made because of the Health Levy and also PRSI contributions.  Anyway, the focus here is on the potential to raise €10 billion from a wealth tax.

Tuesday, December 13, 2011

Do we want miss the budgetary targets?

The measures put together for last week’s budget(s) has the stated aim of getting the General Government Deficit down to 8.6% of GDP.  Although we know neither the final deficit nor the nominal GDP figure it is currently forecast that the deficit will be around 10.1% of GDP this year. 

The original Four-Year Plan published last November targeted a 2012 deficit of 7.0% of GDP but this was based on very optimistic assumptions which had the deficit falling to below 3% of GDP by 2014.  When the EU/IMF deal was brokered a few weeks later the timeframe for getting the deficit under 3% was pushed out to 2015 and at the ECOFIN meeting of 7 December 2010 a deficit limit of 8.6% of GDP for 2012 was set.

The 2011 Budget was announced the same day and still forecast a deficit for 2012 of 7.3% of GDP.  It wasn’t until the Stability Programme Update in April of this year that the 8.6% deficit figure for 2012 made an appearance in Irish documents.

Much has been made of the fact that at 10.1% of GDP the deficit for this year has come in “below target”.  This was not so much below target as below the 10.6% limit set by the ECOFIN meeting last December.  The target from last year’s budget was that this year’s deficit would be 9.4% of GDP.  The deficit is very much larger than the target.

This year the deficit limit was 10.6% of GDP, the target was 9.4% of GDP and the outcome will likely be somewhere in the middle.  Next year the limit is 8.6% of GDP and the target is also 8.6% of GDP.  While there was room for significant slippage this year (and the GGD is almost €800 million larger than forecast in last year’s Budget) there is absolutely no room for slippage next year.

If growth is slightly lower than expected or the measures introduced don’t have the anticipated impact than it is very likely that the deficit will come in above 8.6% of GDP.  This year we had the capacity to absorb such downward developments; next year we have none.

The reduction in the EU interest rates agreed last July will make reaching the 8.6% target a little easier.  These are estimated to save around €900 million in 2012.  If these were applied statically to the projections from the April SPU then the deficit target for 2012 would be around 8.0% of GDP.  This would have been a better target for 2012 but slippages elsewhere have fully absorbed the interest rate gains. Even with €900 million of savings announced in July the deficit target for 2012 is still at the 8.6% of GDP it was last April.

As a result of the interest rate savings we might be able to get fairly close to the 8.6% of GDP limit set by the EC.  How we will fare on the IMF targets are less clear.  The IMF does not make targets based on the overall general government balance and does not make them very far in advance.

The IMF budgetary targets are in terms of the primary exchequer deficit.  This is the deficit on the Exchequer Account excluding interest payments.  The IMF’s Third Quarterly Review (table 2, page 54) sets an indicative target for the end-June 2012 primary exchequer balance of €7.4 billion.  Up the the end of June 2011 the primary exchequer balance was €8.4 billion (exchequer deficit of €10.8 billion less €2.4 billion of exchequer interest payments).

The IMF targets are not affected by the interest rate reductions announced last July.  The primary exchequer deficit has to improve by €1 billion in June 2012 relative to its performance 12 months previously.

In last December’s budget tax revenue was forecast to be €34.9 billion for 2011.  It is now clear that tax revenue of around €34.2 billion will be achieved. And this was only possible with the addition of €0.5 billion from the private sector pension levy announced in the May Jobs Initiative.  On a ‘like-for-like’ basis, tax revenue for 2011 is around €1.2 billion behind last December’s target.

Just like the EC limit there was significant room for slippage when it came to the IMF target.  Last June when the primary exchequer balance was €8.4 billion, the limit set by the IMF was €10.1 billion.  We were well within the limit and had enough room to absorb the deterioration seen in tax revenues in the final quarter.  Once again we have decided to eliminate this capacity and made the limit our target.  The margin for error on the downside is zero.

Some of the numbers in last week’s budget do not stack up.  The Minister for Finance admitted that the 2% VAT increase would not bring in €670 million over a full year because the estimate did not account for a fall in demand.  The is an extra €160 million forecast to be brought in as a result of changes to CGT and CAT.  This is equally unlikely.  The €200 million gain from increases in Excise Duty also seems optimistic.  These make up the bulk of the €1,000 million of new tax measures announced last week.  

Many of the expenditure measures are equally woolly.  Here is a list of “savings” included in the €1,400 million of current expenditure cuts from the Summary of Budget Measures.

  • Enhance fraud and control activity.
  • Continued focus on delivering reductions in the price and volume of goods and services procured by the health services.
  • Savings from anticipated lower disease incidence and operational changes.
  • Miscellaneous Savings on the Vote
  • Achieve a reduction in non-pay administration costs through increased efficiencies.
  • Reduce costs associated with operation of the Mahon Tribunal.
  • Efficiencies and changes to business processes.
  • Streamlining the State’s employment rights bodies.
  • Rigorously review of every area of expenditure.
  • Introduce new efficiencies mainly through the use of IT.
  • Programme savings through efficiencies.
  • A range of measures to improve programme efficiency are being considered.
  • Introduction of efficiencies.
  • Efficiency measures in Revenue, Office of Public Works and savings in legal fees in Law Offices.
  • General savings in Departments of Arts, Heritage & the Gaeltacht and Communications, Energy & Natural Resources.

The arithmetic might add up to a budget with €3.8 billion of “adjustments” but the reality is likely to be somewhat different.

After a year of being “the best in the bailout class” are we actually looking to exceed the deficit limits set down by our external funding partners?  Is there political capital to be gained from missing these targets?

Thursday, December 8, 2011

Inflation edges higher

Today’s CPI release from the CSO reports that the headline rate of annual inflation rose from 2.8% in October to 2.9% in November.  As has been the case since inflation returned to positive territory in the middle of 2010 this continues to be mainly driven by just two categories; energy products and mortgage interest. 

The price of energy products are up 13.7% in the year, while the price of mortgage interest is up 17.8% in the year.  These make up 15% of the index and removing them gives a measure of ‘core’ inflation.  Core annual inflation in November was 0.66%, up from 0.55% in October.

Core Inflation November 2011

On mortgage interest, it is important to realise that the CPI measures the price of mortgage interest and not necessarily the cost.  The price of mortgage interest change but the cost to most households may not change if this change is not also applied to existing mortgages.  This has happened in Ireland for the past 18 months or so.  Mortgage variable rates have been increasing far more than tracker rates and these form most of the mortgage interest price in the CPI. 

The mortgage inflation rate in the CPI overstates the average increase in mortgage rates as it reflects mainly the rates that have been rising by more(standard variable rates) and largely omits the rates which rose only slightly (tracker rates).  Almost half of all mortgages are on tracker rates.  This is explained in a Information Note to the CPI release.

In line with normal practice for a fixed base price index, the current approach to measuring mortgage interest in the CPI reflects the situation in the base reference period December 2006 when the standard variable rate was dominant. Subsequently, tracker mortgages have become more popular. This did not give rise to any difficulties while the standard variable and tracker mortgage interest rates moved broadly in line with one another, which would be the normal expectation. However, the decoupling that has taken place since August 2009 has resulted in dramatically different trends emerging. For example, between September 2009 and September 2010 the standard variable rate increased from 2.93% to 3.66% whereas the tracker rate did not change. The Mortgage Interest component of the CPI, which is largely determined by the trend in the standard variable rate, increased by 25.1% as a result and contributed +1.25% to the overall change in the All Items index. It is crudely estimated that the latter impact would have been reduced by between 0.2% and 0.5% had the Mortgage Interest component been calculated on a current weighting basis. Users should take this “weighting effect” into account in interpreting the mortgage interest related movements in the index.

Tuesday, December 6, 2011

Social welfare expenditure to fall by €88 million

Today seems like an appropriate time to update this.  The 2012 expenditure of the Department of Social Protection was subjected to €475 million of “savings measures” today.  It is projected that the full effect of the measures announced today but which will come into effect over the next three years will be €811 million.

In 2011 it is estimated that expenditure on social welfare payments from either the Department of Social Protection or the Social Insurance Fund will be €20,030 million.  With the measures announced today the forecast for 2012 is €19,942 million – a fall of €88 million. 

Here are the expenditures by six main headings for 2011 and 2012.

Social Welfare Expenditure

The actual payments under each heading were detailed in the previous post on this issue.  It can be seen that most of the expenditure increases are for pensions and in particular the contributory pensions paid from the Social Insurance Fund.

Around €45 million of the 2012 savings announced today are as a result of reduction in Child Benefit for third and subsequent children.  Even with this the aggregate amount of Child Benefit is forecast to increase (albeit by just €8 million) from €2,067 million to €2,075 million.

The large drop is income support payments from the Social Insurance Fund is evenly split between a fall in Jobseeker’s Benefit and Redundancy and Insolvency Payments.  The fall in Jobseeker’s Benefit is because entitlements expire after 12 months. Recipients can switch to the means tested Jobseeker’s Allowance paid by the Department of Social Protection where expenditure is forecast to increase by more than €150 million.

In 2009, the outturn for social welfare payments was €19,959 million.  As shown above it is forecast to be €19,942 million in 2012.  This is a drop of 0.08%.  Next year, social welfare payments will be 99.92% of what they were in 2009. 

It is clear there have been significant adjustments to social welfare expenditure and these cuts continued today.  However, there has been no reduction in overall expenditure.  Rather, the same amount of money is being spent but it is going to more people (more children, more pensioners, more unemployed) so, on average, people are getting less.

Thursday, November 24, 2011

Back to ten percent?

Here is the one-day performance of the Irish government bond nine-year yield as calculated by Bloomberg.

Bond Yields 1D 24-11-11

So much for bond yield tranquillity!  And this is not too different to what was happening on November 24th 2010 only this time we’re going one percentage point higher.

How much austerity have we had?

Here is an exchange from last week’s meeting of the Joint Committee on Finance, Public Expenditure and Reform Debate which was attended by members of the Independent Fiscal Advisory Council.

Deputy Mary Lou McDonald: Far from viewing Professor McHale as cautious or conservative, my reaction to his contention that the austerity should be greater and quicker is that it is reckless. I would like him to give us the rationale for his commitment to austerity. Where is the evidence it is working? We have not seen a dramatic reduction in the underlying deficit despite €20 billion having been sucked out of the economy.

Professor John McHale: Deputy McDonald asked if the austerity is working. By that I understand her to mean if it is succeeding in bringing down the deficit. The question is sometimes asked whether attempts at deficit reduction is self-defeating in that the deficit does not come down. In my view it is working. Our assessment of the numbers is that it is working. The overall general government deficit fell from 11.7% of GDP in 2009, and the most recent projection is that it will be 10.3% of GDP for this year, so that is a reduction. The Exchequer deficit for the first ten months-----

Deputy Mary Lou McDonald: Is that a satisfactory rate of decrease?

Professor John McHale: That is a good question. It looks like the Exchequer deficit for the first ten months of this year will be €1.8 billion lower than it was for the first ten months of last year.

In making an assessment, we have to recognise that austerity is not the only factor slowing down the economy. There are significant forces pushing the Irish economy down and this refers to the earlier discussion of the balance sheet recession. There are significant issues of confidence and issues of credit access. This economy has been hit with a number of very severe shocks that have been slowing growth and particularly slowing the growth of domestic demand, which is critical to the fiscal position.

The Deputy is correct that these numbers as regards improvement in the deficit are not startling in the sense that the deficit is on this incredibly slow downward path but the fact that this has been achieved in the face of such headwinds shows that it is actually working. It is hopefully a question of when we get back to growth and the measures taken, such as the new tax and expenditure structures, will yield much more. When we get back to growth and, particularly and crucially, growth in domestic demand which is affected by much more than just the austerity measures themselves, the expectation and the hope is that the deficit will improve more rapidly.

Using our fiscal feedback model, we have also conducted simulations of what would have happened if there had been no adjustment at all. The Deputy referred to the €21 billion adjustment which has taken place so far. On conservative assumptions, the deficit in 2011 would have been 20% of GDP instead of the projected 10.3% if there had been no measures taken. We would be heading for a debt to GDP ratio in 2014 to 2015 of approximately 180% of GDP. We would be fast becoming like Greece. We would probably never get there because we would probably have ended up in default before then.

The question here is not so much on whether austerity is working but on what exactly entails the “€21 billion adjustment” which is referred to in the exchange. The McCarthy Report on State Assets provides a useful summary of the measures that have been introduced up to this year.

Budgetary Adjustments

The sum of measure introduced is indeed €21 billion, but has €21 billion been “sucked out of the economy” over the last three years?  The €21 billion was the projected full-year impact of the measures introduced.  Maybe we should look at what actually happened to see how close reality is to this €21 billion.  I think the answer is closer to €10 billion than it is to €20 billion.

Monday, November 21, 2011

Public Sector Pay Once Again

This is old ground but somehow we keep having to go over it.  Yesterday’s Sunday Independent features an incredible article from James Fitzsimons, who “is an independent financial adviser specialising in tax and financial planning”.  It is incredible because it contains so many errors.  It is nearly difficult to know where to begin.

THE Government that lives in La-La Land has just created Disneyland for 300,000 public servants.

There are around 350,000 public servants in Ireland.  The breakdown of these is provided in Table A2 of the Earnings and Labour Costs Survey from the CSO (see page 15).

The 300,000 number that is commonly used is the number of full-time equivalent public servants.  Staff employed on a part-time basis and those engaged in job-sharing are only included on a pro-rata basis to get to the 300,000 figure.  The latest figure from the Department of Public Expenditure and Reform is that there were 302,769.7 full-time equivalents in the public sector in Q2 2011.

It is proposed to cut 37,500 jobs by 2015. This is 11.72 per cent of the 2008 figures when they were at their peak. Mr Howlin claims the gross public sector pay bill will fall by €2.5bn.

Based on CSO figures, the average earnings are €901.07 per week in the public sector. The savings for a cut of 37,500 jobs would be about €1.76bn a year. If 10 per cent of earnings constituted tax, the real saving would be less than €1.6bn.

When working out the reduction in the gross public sector pay bill compared to 2008, Fitzsimons focuses solely on the 37,500 reduction in headcount and completely overlooks  the average 7% pay cut for all public servants that was announced in the December 2009 Budget.  The reduction in the gross pay bill from this measure was almost €750 million.  Once this is included it is clear the the €2.5 billion claim from Brendan Howlin is not that wide of the mark.

Fitzsimons then goes on to calculate some measure of “net savings”.  This time he seems to omit the impact of the Public Sector Pension Levy introduced in April 2009.  This levy had no impact on gross pay but did reduce net pay (by around €1 billion).

It is incredible that someone “specialising in tax” would suggest that 10% of earnings constitute tax.  The average earnings figure he uses (which we will return to) is equivalent to an annual income of just under €47,000.  Using a fairly simple tax calculator it can be seen that the net pay for a public sector worker is €30,600.  Of the €16,400 of deductions €2,200 is a pension contribution so the tax on this average worker is €14,200.  That is 30% of gross pay.  Why is a figure of 10% used in the article?

According to the CSO average pay in the public sector is €901.07 compared to €611.88 in the private sector.  We have previously considered the impact our progressive tax system has on the 47% differential.

It is also important to note that the average of €901.07 provided by the CSO is based on around 400,000 public sector workers.  This is because it includes just over 50,000 employees in semi-state companies.  These are not paid from government resources and have not been subject to the pay cuts, levies and other changes introduced in the public sector.

I have asked the CSO to provide a breakdown of average wages in the public sector under the same headings used in Table A2 in the Earnings and Labour Costs release.  I have been told that this figure is not available.  The €901.07 average is likely higher because of pay in the semi-states.

The McCarthy Report on state assets reports (Table 4.4, page 23) that average pay in December 2009 for the 40,000 employees in the semi-states considered under the terms of reference of the report was €54,600 or €1,050 per week.  If we apply this to the CSO data it means that average weekly pay for the public servants in the total is around €880.

A 2% difference may not seem that significant it would be useful if the correct figure was available.  I have made further requests to the CSO but nothing has been forthcoming.

If the average pay in the public service were brought in line with the private sector, it would be cut by 30 per cent. This is without taking account of the cost of public sector pensions. It would achieve annual savings of €5bn to €6bn. We need this now, not in 2015 or 2020.

We can get some crude measures using The Analysis of Exchequer Pay and Pensions 2006-2011 which gives total pay and employment numbers across a number of categories.  The measure of gross pay given here includes salaries, employers’ PRSI and employers’ pension contributions.  The figures given here are for 270,000 public servants paid from the Exchequer.  The table excludes about 30,000 local authority employees.  The total public sector pay bill will be around 10% higher than the figures given here.

Exchequer Pay

In 2008 the gross Exchequer pay bill was €17.7 billion.  In 2011 it will be €16.2 billion.  There has been a drop of €1.5 billion or 8%.  Brendan Howlin is projecting a  further fall of €1 billion and a total drop of 14% on the 2008 level.

Exchequer net pay is calculated by subtracting employee pension contributions (€534 million in 2010), the public sector pension levy (€916 million) and some other minor appropriations-in-aid (€59 million).  Exchequer net pay has fallen from €17.1 billion in 2008 to €14.8 billion in 2011, a drop of 14%.  The projected fall to 2015 will be around 20%.

If a measure of net pay was provided to account for Income Tax, the changes to income tax would mean that the fall in net pay from the employees’ perspective would be greater than the 14% shown above.  We previously estimated this to be 17% for a public sector worker earning the average wage published by the CSO.

Fitzsimons argues that public sector pay should be cut by 30% now.  There is no evidence to support the claim that this will bring it “in line with the private sector”.  A 30% reduction in the 2011 gross pay bill would be €4.9 billion (or around €5.5 billion if local authorities are included).  It is claimed that this would “achieve annual savings of €5bn to €6bn”.

The actual saving would be much lower.  When questioning Howlin’s €2.5 billion figure at the start of the article Fitzsimons argues that the actual saving  would be lower because of lower tax revenue.  However when it comes to his own figure of €5-€6 billion he makes no such adjustments.

The cut in gross pay would reduce employee pension contributions (estimated c. €0.3 billion) , pension levy receipts (c. €0.3 billion) and income tax receipts (c. €1.25 billion).  Of course, there would also be loss of VAT and Excise Duty receipts as the pay reduction reduces consumption expenditure. 

The actual saving from a 30% cut in average pay in the public sector would actually be closer to €3 billion and not the €5-€6 billion claimed in the article.  If we went the whole hog and cut public sector pay by 100% the actual saving would be around €10 billion.  The deficit in 2011 will be €16 billion.  Public sector pay is not the only reason for the deficit so cannot be expected to be the only solution.

Public servants might have to suffer the same increases in VAT as the rest of us, but they have 50 per cent more income to cover the cost.

People pay VAT from net pay not gross pay.  Public servants have a higher gross pay than private sector workers but the effect of a progressive tax system and the Public Sector Pension Levy substantially narrow the gap.  The Pension Levy is not a pension contribution but is just a pay deduction.  This was made clear by Brendan Howlin in the Dail a few weeks ago.

The Trident report assumes that the pension related deduction, commonly called the public service pension levy, is a pension contribution. This is mistaken and the law could not be clearer. Section 7(2) of the Financial Emergency Measures in the Public Interest Act 2009 states: “(2) A deduction under section 2 is not a pension contribution for the purposes of the Pensions Act 1990”. The pension levy contribution is a misnomer. It was called that by the previous Government, but it is a levy on pay.

I hope it will not be a permanent feature, as I said to the unions when I met them. In my judgment, it is mistake for unions to characterise it as a pension contribution because the fear will be at a future date that it will be subsumed into the calculation of pension contributions. Under the auspices of the Financial Measures in the Public Interest Act 2009, it is not, by definition, a permanent measure. I hope it will not be a permanent measure, but, obviously for the foreseeable future, it is required.

Maybe it is too much to expect a tax specialist to know the difference between gross pay and net pay.  To finish here is the conclusion to my previous post on public sector pay.

This doesn’t mean that public sector pay should not continue to fall by more than private sector pay. A staggered wage cut from 0% for those at the bottom (with possibly even some increases) rising to maybe a cut of 12.5% through to the top of payscale (and maybe even more targeted than that), along with forthcoming general changes in income tax could bring the average fall in net pay in the public sector to 25% (with most of the latter burden shared by those above the average wage). 

A 25% cut in net pay would be a huge contribution from the public sector but what needs to be remembered is that with a 17% cut in net pay we are already two-thirds of the way there.  At times this seems to get forgotten in the ongoing pay debate.

And that is a 25% reduction in average net pay for those who are in the public sector.  By 2015 there will also have been a 10% reduction in the number of full-time equivalent employees in the public sector.

Thursday, November 17, 2011

Bond yield tranquillity

There has hardly been a day in the past fortnight when bond yields have been outside the top three stories in the news.  However, it is been Greece, Italy and Spain and latterly Belgium and France that has been attracting the attention.  Our bond yields have already caused a peep.  Here is the nine-year Irish government bond yield as calculated by Bloomberg for the past month.

Bond Yields 1M to 17-11-11

For the past month yields have been in a range between 8.1% and 8.6% and are at the lower end of that range now.  It could be that attention is directed elsewhere but it is noteworthy nonetheless.

Also interesting is following graph which gives the relative performance of Irish nine-year yields and German ten-year yields for the past year.  A reading of 0 means the yield is unchanged relative to the yield on the starting day of the graph.  A reading of 100 means the yield is twice as high.

Irish v German Yields 1Y to 17-11-11

Irish bond yields are at almost the exact level they were at 12 months ago (8.1%).  The surge in the summer ahead of the July 21 summit is clearly visible and that quickly dissipated which these gains largely maintained.  German yields are about 33% lower than they were this time last year (2.6% down to 1.8%).

How are Irish yields relative to those of France?

Irish v French Bond Yield 1Y to 17-11-11

French yields took the same downward pattern as those of Germany during August and September but have been rising since the start of October and are now about 20% higher than they were this time last year.

On a pure price basis compared to this time last year:

  • a German bond is worth more
  • an Irish bond is worth about the same, and
  • a French bond is worth a bit less

What does this mean? Not a whole lot.  It does suggest that we have gotten most the uncertainty surrounding the solvency of the State into the open, in particular in relation to the banks.  Clearly there are doubts that remain (reflected in the yield above 8%) but in a period of European volatility the relative tranquillity in the Irish setting is interesting.

Thursday, November 10, 2011

Core inflation stays low

The headline rate of inflation from today’s Consumer Price Index release is 2.8%.  However 2.33 percentage points of that are accounted for by just two categories: energy products and mortgage interest.  These make up about 15% of the index.   Mortgage interest is up 18.1% on the year and energy products are up 13.4% on the year.

The remaining 85% of the index, which we are using as a measure of ‘core’ inflation, contributes just 0.47 percentage points to the overall inflation rate and is showing annual inflation of 0.55%.

Core Inflation October 2011

The headline rate is inflation is nearly 3% but outside of mortgage interest (and it is only standard variable rates that are picked up in the index) and energy products inflation remains low.

The deficit and “the banks”

The Medium Term Fiscal Statement released last Friday projects that the general government deficit in 2012 will be €13.6 billion or 8.6% of GDP.  This is the number we have to reduce to less than 3% of GDP by 2015, which is what measures to be introduced over the next few Budgets will be targeting.

The simple question here is: how much of the €13.6 billion deficit is due to the banks?

So far we have poured about €62.5 billion into AIB, BOI, EBS, PTSB, Anglo and INBS and all of this has been accounted for in the general government deficits of the last three years.  No further payments are planned so there are no direct payments to the banks in the €13.6 billion deficit for 2012.

What about providing this €62.5 billion?  Surely there are huge interest costs associated with providing this money to the banks.

Of this money €17 billion came from the destruction of the savings we had built up in the National Pension Reserve Fund.  This money was not borrowed so there are no interest costs.  There is the loss of income that this money could have earned but this loss has no bearing on the general government balance.

Of the remaining €45.5 billion almost two-thirds is accounted for by the Promissory Notes given to Anglo and INBS in 2010.  This €30.6 billion was included in full in the €49 billion general government deficit in 2010 and due to some complications in their construction there will be no interest paid on these notes in 2012. 

In 2011, a cash payment of €3.1 billion was made on the Promissory Notes.  This will not affect the debt as the €3.1 billion simply changes from being a Promissory Note debt to a cash debt.  There is now around €28 billion of Promissory Notes outstanding but this will have no impact on the €13.6 billion general government deficit for 2012.

That means we are down to the final €18 billion.  This is split between €11 billion paid from the Exchequer and €7 billion taken as part of the EU/IMF programme.  The money from the Exchequer includes €4 billion given to Anglo in 2009 and €3 billion paid into the NPRF in the same year to help fund the initial recapitalisation of AIB and BOI.  It also includes the €3 billion payment made on the Promissory Notes this year.  It is safe to assume that all of this money was borrowed (or at least increased our borrowing by the same total which amounts to the same thing).

The €7 billion from the EU/IMF was used to fund the State’s  €17 billion contribution to the  €24 billion recapitalisation of the banks this year.  The other €7 billion came from haircuts to subordinated bondholders, some minor asset disposals and some private sector investment in BOI.

We will assume that the average interest rate on this €18 billion is around 4.5%.  At this interest rate, borrowings of €18 billion would require an annual interest payment of around €800 million.  This interest cost does form part of the general government balance for 2012.

If we do a simple counterfactual and magic away the €62.5 billion we have pumped into the banks, the projected deficit for 2012 would fall from €13.6 billion to €12.8 billion or 8.0% of GDP.  Eliminating the effect of the bank payments would knock 5% off the deficit; 95% of next year’s deficit is not related to the bank payments.

There are many claims that the expenditure cuts and tax increases are being introduced to “bail out the banks”, “repay bondholders” and the like.  The changes are being introduced to bring about the necessary reduction in the budget deficit.  There may be disagreements about the make-up of the changes but 95% of the problem there are trying to address is not as a result of the money we have handed over to the banks.

Saturday, November 5, 2011

Ireland and Iceland

As Greek fatigue threatens to overcome us all, it may be useful to draw comparisons between Ireland and a country other than Greece.  There have many occasions when comparisons have been made between the differing approaches of Ireland and Iceland to their respective banking crises.  One indicator that is frequently used to aid the comparison is the unemployment rate in both countries. 

The IMF put unemployment in Iceland at 7.5% in contrast to 14.5% in Ireland – a rate that is almost twice as large.  This formed part of a recent presentation from Paul Krugman.  You can watch a 15-minute video of Krugman deliver the presentation here (go to 52:00 of the Session II: Road to Recovery video).

However, this unemployment snapshot only paints a partial picture.

Ire Ice Unemployment

Icelandic unemployment is significantly lower, but it also started from a much lower level.  The unemployment rate in Iceland was 7.5 times larger in 2010 than it was in 2007 (1.0% to 7.5%).  In Ireland the increase was 3.1 times (4.6% to 14.5%).  In Iceland, the unemployment rate increased by 6.5 percentage points, here it rose by 9.9 percentage points.  There is no doubt that unemployment in Ireland is higher and has risen by more than unemployment in Iceland.

As Krugman does, we can account for migration by looking at changes in employment.  Since 2007, the number of people employed in Ireland has fallen further, but the Icelandic figures is somewhat invariant because of the units used by the IMF (tens of thousands with Icelandic employment forecast to be completely unchanged at 150,000 over the four years from 2009 to 2010).

Ire Ice Employment

Since 2007, employment in Iceland has fallen 6% while in Ireland the fall has been over 14%.  However, it is hard to argue that this is as a result of the response to the crisis given the huge collapse that has occurred in construction employment in Ireland.  Since 2007, there have been more job losses in the construction sector in Ireland than there are people working in Iceland.

What happens if we move on from unemployment and employment and look at other macroeconomic indicators.  Krugman doesn’t seem to be a fan of using GDP for small open economies but it seems a reasonable place to start.

Ire Ice Total Real GDP

Judging by the IMF forecasts the “roads to recovery” of Ireland and Iceland are almost side-by-side.  There are also graphs of an index of real GDP per capita and GDP per capita at PPP by clicking the links.

An interesting picture begins to emerge if we look at the relative performances of nominal GDP.

Ire Ice Total Nominal GDP

There is a huge break from the onset of the crises in both countries in 2007/08.  Clearly, with the real GDP indices of both countries tracking each other over the same period there must be some significant price effects.  This can be seen if we look at an index of consumer prices.

Ire Ice Price Index

Annual inflation in Iceland has been higher than in Ireland since 2004 but this gap ballooned in 2008 when Icelandic inflation was 18% compared to just over 1% in Ireland.  The annual inflation rates can be seen here.

Next is the gross government debt to GDP ratios for both countries.

Ire Ice Gross Government Debt

Spot the difference!  In 2007, both countries had a gross debt to GDP ratio of just under 30%.  By 2010 both had ballooned to around 95%.  And note that the Ireland ratio was pulled up with the price deflation in the denominator, while Iceland was experiencing inflation of almost 20% in its denominator.  The Icelandic debt level rose faster and is forecast to moderate at a lower level.  The same can be seen for government net debt.

Ire Ice Net Government Debt

Iceland does better when the comparison is based on unemployment.  The comparison is not so positive if GDP, inflation and government debt are included.  The same is true if we look at the current account of the Balance of Payments.

Ire Ice Current Account

The Icelandic current account has been improving but this is more to do with a collapse in imports rather than a rise in exports.  Finally here is the investment share of GDP in both countries.

Ire Ice Investment Share of GDP

All in all, there does not seem to be a lot to separate the two countries.  Both have had banking collapses.  Both have struggled to deal with them.  Iceland is perceived as being in a better position but that is not really borne out in the IMF data.

Wednesday, November 2, 2011

Some general government debt developments

Back in May, Morgan Kelly snapped us out of a Saturday morning stupor with another thought-provoking article in The Irish Times.  Among many topics the issue of Ireland’s public got an airing.

Irish insolvency is now less a matter of economics than of arithmetic. If everything goes according to plan, as it always does, Ireland’s government debt will top €190 billion by 2014, with another €45 billion in Nama and €35 billion in bank recapitalisation, for a total of €270 billion, plus whatever losses the Irish Central Bank has made on its emergency lending. Subtracting off the likely value of the banks and Nama assets, Namawinelake (by far the best source on the Irish economy) reckons our final debt will be about €220 billion, and I think it will be closer to €250 billion, but these differences are immaterial: either way we are talking of a Government debt that is more than €120,000 per worker, or 60 per cent larger than GNP.

This €250 billion projection was immediately latched onto and generated some articles in response from Murphy and Leddin & Walsh.  In both cases the €250 billion estimate was said to be the result of “double-counting” and other errors.

However, I think the Kelly analysis is technically correct but is inflated by some overly pessimistic assumptions.   It may seem like this is going over old ground but it does give a starting point to summarise the debt developments that have occurred since May.

Up to today it was believed that the general government debt at the end of 2010 was €148 billion.  From the four-year National Recovery Plan (page 110) the planned general government deficits for the years 2011 to 2014 were forecast to be €15 billion, €12 billion, €10 billion and €5 billion.  These are exclusive of any banking costs.  Adding these deficits for 2011-2014 to the 2010 debt of €148 billion brings us to the €190 billion starting point of Morgan Kelly.  There is no double counting of bank-related sovereign debt.

These deficits were revised up in April’s Stability Programme Update (page 50) by a cumulative €8 billion to a total of €50 billion.  The reduction in the interest rates on our EU loans will have brought this down again and this is likely to be reflected in the revised macroeconomic projections to be released by the Department of Finance on Friday.  Of course the starting point in 2010 was reduced by just under €4 billion as a result of a real double counting error in the Department of Finance.  Between the ups and downs it looks we are looking at a 2014 debt of around €190 billion before we start adding bank-related debt.

Thus far, this is equally as  pessimistic as Morgan Kelly so we better inject some optimism into proceedings.  From €190 billion he adds €35 billion for bank recapitalisation and €45 billion for NAMA.  While these figures have an actual basis (and were used in the original Namawinelake estimate) it is now commonly accepted that they will not be simple additions to our government debt.

The €35 billion figure was the “worst-case” contingency amount set aside to recapitalise the banks as part of the EU/IMF programme.  As we know the actual recapitalisation amount was €24 billion as revealed in the March PCAR announcement.  As a result of haircuts to junior bondholders in the banks and some private sector involvement the portion to be covered by the State was around €17 billion.

Of this, €10 billion came from the further destruction of the savings built up in the National Pension Reserve Fund so will not add to our debt.  Although we poured €17 billion into the banks this year, only €7 billion of this is to be added to our debt as €10 billion came from our existing resources.

Some of the money not used will be diverted to the credit union sector where it is anticipated that up to €1 billion could be used to prop up ailing credit unions.  This will add to the general government debt.

The official general government debt (GGD) measure excludes NAMA so we are now looking at a 2014 GGD of around €198 billion.  Using the IMF’s nominal GDP forecast for 2014 of €174 billion this would put the debt-to-GDP ratio at 114%, and it is projected to fall from that point on.  This does not account for three assets that will also be on the balance sheet:

  1. €15 billion of cash we had on deposit at the end of September
  2. €5 billion in the remaining portion of the NPRF
  3. €3 billion of contingent capital provided to the banks to be returned in 2014.
  4. Possible resale value of the banks (AIB, PTSB and 15% share in BOI)

It is hard to put a value on the banks and hopefully the view that they have “moved from being a liability to an asset on Ireland’s balance sheet” will gain a greater foothold.  It is easy to suggest that the above four items would reduce Ireland’s net debt to GDP ratio to below 100%.  If you prefer GNP as the appropriate measure of the Irish economy we are probably looked at a net debt to GNP ratio in 2014 that will be less than 125%.  Large but not terminal.

The €45 billion figure for NAMA was the estimated total if all property and construction loans of more than €5 million in the participating banks (AIB, BOI, EBS, Anglo and INBS) were transferred to NAMA.  As we know the transfer of developer loans above €20 million was completed.  In total NAMA bought about €72 billion of these loans and paid €31 billion for them.  The loans of less than €20 million were never transferred to NAMA and the expected losses on these were included in the PCAR analysis undertaken by BlackRock Consultants as part of the stress tests so have been accounted for.

It is impossible to know what the final outcome of the NAMA process will be.  NAMA did create €31 billion of bonds to buy the developer debt, but it bought assets which also had a notional value of €31 billion as valued in November 2009.  If these levels were to be maintained beyond the November 2009 valuation date, NAMA would have no effect on our net debt position.

Of course, property prices have not been unchanged since November 2009 and they have tumbled onward ever downward.  The excellent Namawinelake (the “best source on the Irish economy” remember!) estimates that the value of property backing the loans has fallen by a further €6 billion since the NAMA valuation date. 

It is impossible to use this as a projection of possible NAMA losses.  In most cases NAMA has control over the loans and not the assets.  NAMA has been making substantial disposals for the past few months but we are not told if the agency is making a loss or even possibly a profit on these transactions. 

NAMA has the potential to make a call on the State’s resources to cover a shortfall on its operations.  Unless there is almost complete collapse in asset values it is hard to see how this shortfall could be more than €10 billion, and it is likely to be substantially less than that. 

It is not clear that there will be losses on the Emergency Liquidity Assistance (ELA) provided by the Central Bank of Ireland.  The banks have been provided with sufficient capital to absorb the losses on their loan books so they should be able to repay the central bank liquidity.   In fact the chief executive of the biggest user of ELA has said that the State is providing them with €1 billion to €4 billion more than is required to meet all their liabilities.

Even with the net value of NAMA included, the 2014 debt level will not be more than €210 billion and may be closer to €200 billion.  This is truly massive, but the difference between a debt of €200 billion and a debt of  €250 billion is material.  We could not survive a debt of €250 billion. If we have to carry a debt that large we would be in a similar crisis to one that Greece is now having to face up to. 

A €200 billion government debt is massive but it can be carried and does not make default inevitable.  Just like in the domestic mortgage market, it is important to distinguish between a borrower who simply can’t pay and one that just won’t pay.  Of course, unlike most mortgages we have little intention of ever repaying this debt.  We need to get into a position where we can sustainably service the interest costs of the debt.

Greece is bust and cannot carry it’s debt which even in the EC’s baseline scenario is forecast to be close to 190% of GDP by 2014.  In Greece the news has been consistently bad.  In Ireland we have some positive debt developments since the Morgan Kelly piece in May:

  • lower bank recapitalisation costs,
  • lower interest rates on EU loans,
  • and even a lower 2010 debt because of a DoF accounting error.

By 2014 our debt to GGD ratio will be 114%.  Even if we went through the equivalent of the banking crisis again and had to borrow an additional €63 billion for some reason this would bring our debt to around €270 billion which would be 155% of GDP.  We would still not be even within touching distance of Greece if the equivalent of the banking catastrophe was to the hit us again.

Greece is bust and their economy is broken.  The EU deal on the table does not go far enough and cannot rescue Greece.  We can fix the mess we find ourselves in without resorting to the tyranny of default.  It will require hard choices but it can be done.

Tuesday, November 1, 2011

Now you see it, now you don’t

Just two days ago we asked “where is our money?” when discussing the €24.8 billion of cash we are supposed to have at the end of the year as indicated at the top of page 3 in the Maastricht Letter released a little over a week ago.

Today we learned that €3.6 billion of this cash never even existed in the first place.  The error has to do with the treatment of the Housing Finance Agency (HFA) in the general government accounts.  Prior to 2010 the HFA was a standalone entity whose assets and liabilities formed part of the general government accounts. 

For 2010 the HFA’s financial transactions were assumed into the National Treasury Management Agency so the assets and liabilities of the HFA should no longer be individually included in the general government accounts as the figures are incorporated into the NTMA’s accounts.  To include the HFA’s assets and liabilities again is just double counting and that is just what happened.

The NTMA issued €3.6 billion of government notes on behalf of the HFA and this €3.6 billion of debt was included in both the liabilities of the NTMA and the HFA.  However, the State only owes the €3.6 billion once so the debt of both agencies should not be included in the general government accounts.  Similarly the €3.6 billion appeared on the asset side of both agencies’ balance sheets and also should only be counted once.

The NTMA raised €3.6 billion and placed it “on deposit” with the HFA.  The NTMA counted this as a market deposit even though the money was actually not available for use.  This is usefully explained in this note from the CSO.

As the changes affect both our asset and liabilities positions there is nothing “saved” from the discovery of this error.  The final sentence from the CSO note sums it up nicely.

“Overall, the State is no better or worse off as a result of the correction.”

But at least know we know where some of that €25 billion is.  Let’s hope the remaining €21 billion doesn’t do a similar disappearing trick.

Bond Yields

Last week’s announcements from the latest EU emergency summit did not result in much of a change in the nine-year government bond yield as calculated by Bloomberg.  There has been a slight drop over the past couple of weeks and yesterday’s close at 8.15% was the lowest since the 13th of October.

Bond Yields 6M to 01-11-2011

Last week’s agreement might have had little effect but Greek Prime Minister George Papandreou’s announcement last night of a referendum on the deal has had an effect.

Bond Yields 1D 01-01-2011

This isn’t a big jump and does not have much significance.  It is not significant because yields are still lower than they were last Wednesday (and of course the significance is reduced because we do not plan to borrow from these markets for at least another year). 

Sunday, October 30, 2011

Where is our money?

The recent Maastricht Letter on Ireland’s financial position released by the Department of Finance shows that the government expects to have €24.8 billion of cash in working balances at the end of 2011, up from €18.7 billion at the end of 2010.  The increase is our cash balances is largely the result of frontloading of our borrowing from the EU/IMF package and the reduced cost to the State of this year’s bank recapitalisation programme.

The ESRI have recommended that “significant interest savings could be achieved by reducing the holdings of cash”.  This is on the basis that the interest cost of our debt is greater than the interest gain from our deposits.

So where are we keeping close to €25 billion of cash?  Here are deposits from Irish residents in all banks operating in Ireland.

Irish Resident Deposits in All Banks

Deposits from government in banks operating in Ireland were €2.8 billion in September 2011.  Of this, €2.4 billion was in the covered banks (AIB, BOI, PTSB), while €0.4 billion was in non-covered domestic banks (Ulster Bank etc.).  There were no deposits in other (IFSC) banks.

Deposits from government did rise to over €20 billion from April to June of this year, but that was the money set aside for the recapitalisation of the banks as we discussed here.  Since July, government deposits have returned to less than €3 billion.

So, if we are supposed to have almost €25 billion of cash at the end of the year where (or what) is it?  Do the NTMA have it?  Are they then included in the Financial Institutions or Private Sector deposits in the banks? Is the increase in cash balances of the State giving the false impression that deposits in Irish banks have stabilised?

As suggested by the ESRI it does seem costly to have a debt of €170 billion, while at the same time having  €25 billion in cash.

Monday, October 24, 2011

Presentation to UCC MBA Class

Last Friday I gave a session to UCC’s MBA class which looked at some recent data on the Irish Economy.  The session was built around the Y = C + I + G + (X – M) representation of the economy.  Here are the slides.


New Beginning Mortgage Proposal

We have previously looked at the mortgage proposal from the New Beginning group (here and here).  Revised details of the proposal have been circulated.  Following our previous analysis the key peace of information is that the interest rate on the example we worked through is 3.55% rather than the 4.29% that was assumed in the previous posts.

“Compound interest” is the answer attributed to Albert Einstein when apparently asked what he thought mankind’s greatest invention was.  Just three-quarters of a percentage point may seem like a small change but in a mortgage such a difference can have a massive effect.

Our initial assumption came from the fact that Ken’s repayment was given as €1,450 per month and that he had borrowed €315,000 over 35 years.  If you plug these into a mortgage calculator the required interest rate is 4.29%.  This was further supported when the starting payment of €840 was the interest-only payment on the non-shelved mortgage of €215,000 at 4.29%  but this appears to have been nothing more than a remarkable coincidence.

The updated information indicated that Ken’s actual mortgage payment is €1,387.61 per month rather than €1,450, that the interest rate is 3.55%.  It is still assumed the case that the €315,000 is to be paid off over 31 years.

If the interest rate was 4.29% it would take total payments of €570,000 to repay the full amount over 31 years under the conditions of a typical mortgage.  If the interest rate is 3.55% the same mortgage can be repaid with €520,000.

The New Beginning proposal is that Ken’s monthly payment be immediately reduced to €840 and that this is applied to a mortgage of €235,000.  Ken monthly payment increases by 3% per year and the €80,000 of the mortgage that is “shelved” is repaid in instalments beginning in year 10.

First up here is what happens to the €235,000 loan using the New Beginning figures.  The actual annual payment increase is 3.0595% rather than just 3% and this continues until the payments reach €1,135.48 from the start of year 11.

The €235,000 is paid off over the 31 year term of the loan (with eight months to spare).  This requires payments of just over €402,000.  Again it should be remembered that the loan can be paid off for less if a standard mortgage repayment schedule is applied.  However, in this case a typical mortgage of €235,000 at 3.55% over 31 years would require €388,000 of repayments.  The difference is only €14,000 and the benefit of the reduced payments early in the term is likely to be useful to someone who is having temporary difficulty in meeting their mortgage commitments now.

What about the €80,000 that was put on the shelf?

This is repaid in four short-term loans beginning from year ten.  These are five-year loans where some of the €80,000 is taken off the shelf and repaid at 3.55%.  The rest of the money stays on the shelf and no interest is charged.  The proposed repayment schedule is

Shelf Loans

Essentially Ken the borrower gets €80,000 interest free for ten years (cost €34,034 at 3.55%), €97,778  (equal to €80,000 + €34,034 – €16,256) interest free for a further five years (cost €18,961), €98,207 interest free for a further five years (cost €19,044), €96,124 interest free for a another five years (cost €18,640) and €90,679 interest free for ever more but the cost for the final six years of the mortgage is €17,584.

All told the bank has foregone €108,263 of payments over the 31 years of the mortgage.  The interest costs of this will continue into perpetuity.

All told the borrower will have made €402,000 of payments on the mortgage and €87,000 of payments on the shelved loans over the 31 years of the plan.  If this €489,000 had been used to repay a standard mortgage over the same time it would repay a mortgage of €296,000 at 3.55%, just €19,000 below the original loan of €315,000.

How much of the €315,000 if the New Beginning repayment schedule was applied to the full amount of the loan?   In this instance the repayments will be around €103,000 short of repaying the mortgage in full.

The benefit of the New Beginning scheme to the borrower is just over €100,000.  This can be shown as either the benefit of having borrowed money put “on the shelf” at no interest cost or the amount that would be left on the mortgage if the New Beginning repayment schedule was applied to the original loan.

It should also be remember that most of the benefit accrues to the borrower from having money borrowed from the bank for longer.  The total amount of repayments are very similar: €520,000 to repay a standard €315,000 mortgage at 3.55% over 31 years versus €489,000 to repay under the New Beginning split mortgage scheme.

The borrower gains around €30,000 from making lower repayments, but because more of the payments are made later the actual benefit is north of €100,000.  The power of interest rates is shown when compared to our previous analysis.  With an interest rate of 4.29% the benefit of the scheme was estimated at around €280,000 for Ken.

A truer measure of the benefit of the scheme to the borrower (and hence the cost to the bank) is just over €100,000.  The overall cost of implementing such a scheme depends on how many “Ken’s” there are.  For every 10,000 that enter the scheme the cost to be covered is €1 billion.

The scheme is not as off the wall as the original analysis indicated.  €100,000 is a lot of money but it may be a price worth paying as a solution to the current crisis.  The scheme has some merit and it could be adapted so that some of the costs incurred early in the term can be recouped with higher payments later in the term of the loan – 31 years is a long time.

Still, though if we are going to reduce the mortgage burden on some people why make it so complicated?   If we want to save someone €100,000 on their mortgage why not just reduce the balance upfront.  Ken would save €100,000 on repayments over 31 years if his current mortgage was simply reduced from €315,000 to €255,000 – it’s just debt forgiveness.

As we said above the borrower also benefits from the reduced payments early in the term so the reduction will be less, probably to around €275,000.  So we could follow the New Beginning repayment scheme or just knock €40,000 off the mortgage now.  There is no difference.