Irish Mortgage Brokers Blog

We touched on this topic over on MyHome.ie last Friday in our weekly blog contribution to their site.

It is important to look at this from a few perspectives

1. Regulation and the role of the Regulator
2. Past decisions by the Regulator
3. Politics and policy

1. Regulation and the role of the Regulator: The idea of regulation is not for price control, rather it is about prudential control. As galling as it seems to everybody, the Financial Regulator is not (nor should they be) empowered to tell banks what prices they can charge. This is sickening given that we have spent €10,000,000,000 this year alone via the NPRF in supporting our banks (€8.8bn to AIB and €1.2bn to Bank of Ireland).

Readers, if you know of other jurisdictions where regulators set prices please let us know! The idea of a Regulator is that you pay for them in return you get the avoidance of systemic risk, that is the fundamental reason for their existence and for bearing the cost of having them. The same way that we pay for police in order to have a safer society where there is consequence of actions.

That our regulator has failed and was unfit for purpose is a given, however, placing new powers in them that can force banks to charge certain prices is utilitarian - where the end justifies the means - rather than fair and prudent. If we are to sell our banks they must be profitable, higher rates are one route to that (the others are dropping deposit rates and firing staff).

No investor will want to buy an Irish bank if they cannot control their own pricing, even if pricing is controlled and certain promises given or undertaken not to meddle in the future, the first time you do so it destroys your credibility. And that is where Government erred. They thought that the warning of a stern telling off would make banks change their ways.

It failed, leaving the Taoiseach with egg on his face and the banks with a reputation as bad as ever, while the ball is now in the Regulators hands as they were asked to ‘let the Government know if they need extra powers’.

[Irish Times] “Mr Elderfield has previously stated that his powers of intervention are limited when it comes to forcing the banks to pass on mortgage rate cuts. The Government’s legal advice is that the roles of the regulator and of the Central Bank are independent and the Government cannot direct him to take action.

A source said it has instead “invited” him to consider the outcome of the meeting and, if necessary, make a request to Government for additional powers.

Mr Gilmore denied the Government was powerless in the matter. “No, this has some way to run yet . . . we will take further action if necessary,” he said.”

2. Past decisions by the Regulator: It is interesting to note that the argument about rate setting has already been raised with the Regulator, only it didn’t make headlines the last time. The complaint was via the Professional Insurance Brokers Association and the basics were that ‘dual pricing’ (where prices vary according to distribution channel) was wrong and should be prevented.

The regulator said and did nothing about this, their return comment was that ‘The Regulator has no input into pricing by banks’. So if that precedent is anything to go by then they will not intervene this time either. And that is the key issue- Kenny has passed the ball to the Regulator and now they will be the ones to be made to look bad by appearing impotent. Or worse yet they will seek powers that will make the financial services vista even worse in Ireland.

If the Regulator does get involved in pricing issues it will open a larger can of worms than presently expected, next of all people will dispute their TVR’s based on LTV’s, brokers can bemoan dual pricing etc. etc. It is a downward vortex when you make a Regulator responsible for pricing.

3. Politics and Policy: It is not disputed that people are unhappy, upset and morally outraged at banks getting a cut in cost and not passing it on. However, this is primarily perceived rather than real, because banks are paying more for money than they have existing loans out at (for the most part, and largely due to the 400,000 tracker loans out there).

The question we are asking though is ‘what part of politics requires price intervention?’. The natural byline is ‘well we had bank intervention?’, that that is true (we made a mistake in how we did it, a big one), but mistake ‘A’ is not a justification or foundation for Mistake B if you operate on a rational case by case basis. Furthermore, the likes of AIB who are ‘the bad guys’ are still more than 2% cheaper than PTsb who did pass the rate cut on! So should politicians risk any political collateral they have on diving into this?

Why instead are they not fighting the most expensive providers and asking them to come in line with more competitive banks, this ‘pass the rate cut’ is all about the appearance of power, and the flexing of muscle rather than about genuine leadership and policy, sadly it would seem that our leaders are willing to spend considerable equity in optics when the results are unlikely to be forthcoming.

Perhaps the most pertinent question is ‘what are they hoping to achieve?’.

I hope you enjoyed the first round of economic history from 2008 to 2011, I think it is time for round 2.

Alan Greenspan was on CNBC last week and his interview is a very interesting take on Europe - which happens to be the first thing he looks at every day (European Bond Markets). Meanwhile Lloyds are reporting that the risk of a 2nd recession in the UK are higher at c. 25-30%.

Greece is the crisis that just keeps giving, The Telegraph has the usual Eurosceptic line but it isn’t about being smug any more. The Greek referendum call of recent days came out of left field and while it may never actually occur the political optics show that the Aegean issues are far from solved, along with the replacement of military officials (the interpretation being the fear of a coup).

And German joblessness is higher for the first time in 2 years, standing now at 7%. The rate of inflation in Germany is currently 2.6% (HICP at 2.86%), having remained over 2% since January 2011. The issue with that (and unemployment that wasn’t growing) is that it lead to a ‘Goldilocks delusion’ where not cutting rates and fiscally conservative policy was considered best. It seems now that Germany has not decoupled from the rest of Europe.

Growing resentment about profligate EU members along with some fear inducing inflation as well as rising unemployment make for a very grumpy Germany, it does not bide well for negotiations. Perhaps hindsight will equally not bide well for the Germany that handled the Great Recession so well (from an employment perspective) either?

Of course at home here in Ireland we are about to pay €700,000,000.00 to speculative/junk rated bond holders who in any normal circumstances would be jumping for joy at a 50% haircut. Politicians are walking out of the Dail due to the lack of discussion, and bingo halls being raided by cops [irrelevant but a sign of the times!].

The Central Bank of Italy (Banca d’Italia) €-Coin ‘one figure for all European GDP’ statistic is also showing a sharp down-trend at present, negative for the first time since September 2009. Italy, with the worlds 3rd largest debtor at €1.9 trillion Euro, and winner of ’scary chart of the day’ almost every day regarding their bond spreads v.s Germany.

I don’t know of any model that can capture and create metrics out of the information flying around at present. There are interesting twitter based investment tools that use crowd sourced information to imply the trajectory of the markets, but I’m not privy to being under the hood on those.

What I am trying to say is that all of this news doesn’t paint a pretty vista, and in this analysts opinion the October/November 2011 period will be another big turning point or cusp. I last made a call like this in January of 2008 (and while it seemed grim at the time it was understated in retrospect), and during that time I went entirely to cash and advised all of our private clients to do the same until late 08′ early 09′.

Today I am repeating that call - to stay out of the markets for a while and see what comes of this all. You might miss out on the Spring 09′ moment, but you won’t face the burn on the road that gets you there. The news flow is simply too negative at present for confidence to go any other way than down, capital preservation remains key.

Until Central Banks step up to the plate (and it our long held belief that they must and will -they are already our lifeline) with the multi-trillion multi-lateral approach there is no reason to do anything other than earn interest.

Don’t watch this if you want to sleep well tonight.

Feasta and the Smart Taxes Network are holding a conference on the 22nd & 23rd of September in the Mont Clare Hotel in Dublin 2. The people who work in Feasta are ideologically diverse (that is one of the things I really like about them!) and a bright bunch, the delivery, debate and data are all sure to be excellent. Hopefully we’ll see some of our readers there! (details below)

It is sure to be a treat, there are great speakers from around the world, to name a few:

Marshall Auerback (Roosevelt Institute Fellow & global portfolio strategist for Madison Street Partners, LLC)
Prof. Charles Goodhart (member of the Financial Markets Group at the London School of Economics & former monetary adviser to the Bank of England)
Bernard Lietaer (author of ‘The Future of Money’ & international expert in currency systems)

And of course we have our home-side team of heavyweights too! Fergal O’Brien (Chief Economist – IBEC), Richard Douthwaite (Sustainability Economist and Author), Dan O’Brien (Economic Editor- Irish Times), Paul Sweeney (economist with ICTU), Prof Ray Kinsella (UCD, Michael Smurfit Business School.), Constantin Gurdjiev (Adjunct Prof. of Economics TCD) and David Korowicz (Physicist and Human Systems Ecologist

Panels will be moderated by David McWilliams (Economist), Peter Matthews TD (Banker and Fine Gael TD), Prof. Terrence McDonough (Economics Dept. NUIG), Karl Deeter (Irish Mortgage Brokers), Graham Barnes (IT Currency Consultant), Deirdre de Burca (Former Green Party Spokesperson on EU affairs) and Emer O’Siochru (Architect and Renewable Energy Developer)

Date:                Thurs & Friday September 22nd & 23rd
Registration:     1.00pm Thursday 22nd Sept.
Conference:     Thurs 2.00—5.30 p.m
Friday 10am – 4pm
Venue:              Mont Clare Hotel, Merrion Square, Dublin 2.
Conference Fee:  €80 full conference, €60 one day,
€250 Corporate Fee,
concessions for Feasta and IEN members.

Please submit enquiries to conference [AT] feasta.org. Advance booking is essential.

David McWilliams hit an interesting point in today’s piece in the Independent about having ‘too much regulation’, and how it may repel new banks from coming here.

in late 2009 I was picked as part of a team that approached PostBank with a view to turning it into an SME business bank - our proposal never even made it as far as board meetings because they were determined to close down rather than continue, we found the whole process perverse at best.

Instead the same investor group will be setting up in the UK, meaning SME’s in Ireland lose out on funding.

It isn’t that new banks don’t want to come here, it is that they are routinely put off from doing so via the Central Bank and the way in which we grant banking licences in this country.

The other regulatory issue is Basel III.

Asking a bank during a time like this to hold more capital makes sense from a risk perspective, but from every other angle it is a noose.

Banks are being asked to deleverage (have fewer loans versus deposits), market forces are making them pay more for deposits than is healthy, they have huge tracker mortgage books that even when they perform create a loss and at the same time we want them to lend.

Simply put, these are not compatible objectives.

Banks HAVE to become zombies in order to continue because it is only with huge liquidity & capital injections at low prices that they could hope to work normally again - and we have already spent all of the money we have on saving them; so their alternative is to grind along trying to make whatever money they can and in a very very long time they will eventually be breaking even (think Japan)

That is the true tragedy of the crisis, if we had let Anglo close (I argued for this here) and only tried to save a few good banks (even though AIB is a banger it is still the owner of half of the payments system that the likes of EBS sit on top of) then we could have had a chance - it would have also required going right down the order of liabilities as follows:

Sharholders - wiped out
Preference Shares - wiped out
Mezz & SubOrd - wiped out
Senior bonds - turned into new equity
Depositors - saved (in order to maintain confidence)

Then we could have given 25bn in low cost money to the banks to make them healthy. Naturally hindsight is 20:20, we are never so prepared for anythin we are for yesterday!

But the new point is clear - regulation in itself is actually a risk, and a systemic one. Regulatory Risk will be a common word in banking vernacular of the future.

The entire justification of regulation and the bearing of its cost on the financial system (which ultimately gets built into consumer prices) is the avoidance of the systemic risk it is meant to mitigate. It didn’t and it won’t in the future so why is more of it now the solution?

Mainly because it sounds good…

If you look at the dynamic of the crisis to date you see the following flow (broadly but not exactly)

1. Sub-prime mortgages in the USA started to go under
2. Interbank lending froze as banks liabilities were unknown & collateral was of unknown quality
3. Interbank rates shot up
4. The crisis was not contained, culminating in the fall of Lehman which triggered a series of world events
the most substantial aspect of which was a loss in confidence.
5. Markets fell rates were dropped to record lows in the EU, USA and Britain.
6. Recovery began with several bailouts in the majority of nations affected.

and then….

7. This is critical - bank and private debt effectively became public debt, in Ireland’s example this was via our banks, in other countries it was in the same manner or via quantitative easing. Across Europe the ECB was a key facilitator of liquidity.

The debt has now, in many countries become a public debt issue, in Europe specifically it is a Sovereign debt issue, the like of which the US is not immune to having been downgraded by Standard & Poors rating agency.

This means that there is only one fall-back left… namely Central Banks.

We are at a cross roads in which about four outcomes are available

1. Default
2. Inflate (default via the back-door)
3. Extreme austerity - which hurts the poor/middle class the most
4. Grow your way out

In Ireland the fourth option is not available as it would mean getting growth above the rate of interest we pay on debt (because otherwise the trajectory of debt does not change). While we may run a current account surplus the issue here is of a Fiscal deficit that is still weighing down on the country.

The second option is unavailable because we don’t control our currency as do any of the PIIGS.

Austerity in the absence of growth has a negative growth affect on a nation, this may or may not be in our future - while it doesn’t make sense, it is also not an option that is or isn’t within our control so it may be the road we find ourselves on; it may make our Debt/GDP ratio worse, but it may also solve our debt/revenue ratio which could in time service the former.

While we often look at the macro-picture, it is worth considering the micro. Households are the ultimate economic unit and if we examine total private sector debt over private sector income we can get a picture of the ability of the private sector to endure…

If total private sector credit is c. €335Bn and there are about 2m people in the work force earning €35,000 per year then your average person is leveraged almost 4.8 times. Using mortgage criteria - you would be hard pressed to get a loan. Then strip out the unemployed and the situation looks worse.

The clean-up is only part of the greater ongoing issue, now the developed world will have to increase living standards at a time when growth prospects are low and governments are looking to cut deficits and spending.

There is a book called ‘great waves’ by John Fisher Hackett and points out long super cycles, normally inflation is followed by deflation then price stability, if history is to repeat itself we may be looking at a 20yr run of general deflation leading to price stability.

The ‘muddle through’ solutions that will be the likely political outcome, where definitive solution after definitive solution fail to work fully will be the order of the day unless we get the ‘big bang’ solution.

What?

It can’t just be Eurobonds because Europe is one of several key world players that are interlocked with everybody else, it would have to be Europe, the USA, Japan, China, Australia, Britain and Canada and c. 20+ other countries with strong reserve positions.

The USA is the engine of the world, while that may change in the future, it is the case in the here and now - and on a Gross debt basis if you factor in all state and local government debt the US is over 100% debt to GDP. Like all debt this must be balanced against the borrowers ability to service the debt.

Thus it is our belief that only a massive multi-lateral approach by several central banks might work - this is the ‘big bang’ we mentioned earlier. This would involve a multi-trillion swap line with all participants bailing in (lead by BIS/IMF with everybody else taking part - Fed&Treasury/BOE/ECB/BOJ etc.)

In a nutshell, there is too much debt in the world, the only viable players left are central banks, and unless we are going to explore options 1 & 3 listed above (or perhaps worse option 2?) then the massive wall of funding is the only way to do it, stop the panic once and for all, put out every potential fire by flooding the entire land.

Or we can just sit back and watch?

Once a month we head over to TV3’s ‘The Morning Show’ to talk with Sybil and Martin about the property and finance markets in an easy to understand manner, this month the topic was NAMA mortgages and household charges.

Credit Default Swaps (CDS’s) are an over the counter (not bought or sold through an exchange) product which gives the buyer insurance in the case of a credit event (default) of the underlying (reference entity: often a bond). Effectively this brings together a long and short. The video below does a good job of explaining much of this, well worth watching.

bank run as defined by Barron’s dictionary of banking terminology as follows: ‘A series of unexpected cash withdrawals caused by a sudden decline of depositor confidence or the fear that a bank will be closed by the chartering agency. Today the ’silent run’ is much more prevalent than bank runs in the past where customers lined up in front of the tellers window and demanded their cash. Today depositors simply transfer interest rate sensitive funds - called ‘hot money’ to other institutions, also called ‘a run on the bank’.

Several things have been happening in Ireland that feed into this, firstly is that some banks are leaving the country, that partly helps to make the €40bn that left in December make sense (the figure for all of 2010 is about €110bn). Then there are confidence issues with downgrades and the like.

One of the most common personal finance questions I get is about deposits being safe in the bank here, and on sums below €100,000 I hand on heart believe that to be the case.

Efforts to save banks don’t always work, but they are often more successful than efforts to save yourself -if you look at Argentina in the start of the last decade the system was falling apart, Argentinians, desperate to put their cash somewhere safe moved all of their money into Uruguay the so called ‘Switzerland of South America’.

The Uruguayans fearing contagion equally took out all of their money and again, ATM’s stopped working, everybody lost money, Argentinians looking for a safe haven having taken the majority of the damage, a friend in PWC there told me that in effect, Argentinians ensured that fewer Uruguayans took ‘the hit’. Even today, nearly a decade later there is a fundamental mistrust of banks in both of those countries.

In fact, Banc do Brasil in the heart of Montevideo still lies empty as testament to this period. When GMAC fell apart in the US people with more than $100,000 were left wondering for months whether they would get any of the balance over that amount back, and I trust the FDIC far more than the ECB!

I don’t think we will see that in Ireland, a blog post by Lorcan Roche Kelly adequately sums this up. The thing that isn’t being mentioned though is the role of corporate and banking treasury departments in the way that they manage their money and how it is causing the flight of deposits.

Take a pension fund in Arizona, they wanted Euro deposit exposure and they are happy with leaving it in Ireland, but part of their policy is that they can’t keep money on deposit with any institution that is less than A3 or A- (quoting Moody’s & S&P respectively), an upper medium grade rating.

We have passed from upper medium grade last year to lower medium grade, but in 2011 we crossed the Rubicon into the Ba1/BB+ territory which is non-investment grade speculative.

Commonly referred to as ‘junk’, Irish banks earned this esteemed rating on the 11th of February.

What I can say is that any depositors who were holding out before on the corporate deposit side will now be giving up the ghost. The big damage wasn’t done in Q3 or Q4 of last year, it is happening right now. As you read this there is quietly money flowing out of our banks into other banks.

The fact is that even people on the street are afraid, fear doesn’t mean that banks go under, it just exacerbates an existing problem. Banks are a confidence game, I mean that in strict adherence to the nature of the word ‘confidence’ as opposed to implying a ‘con’.

Fractional reserve banking means that they never have the actual cash to hand that is necessary if all liabilities are called in at once; while deposits are ‘capital’ on the balance sheet they constitute a liability to the bank.

To get over this loss of depositor cash banks are increasingly using repurchase markets, often called ‘repos’, currently the main market maker is Goldman Sachs in London and haircuts are in the region of 30% on high quality assets. To address liquidity the banks are leasing out their remaining good assets, but that is different than the issue that is occurring with solvency. The repurchases that could be placed with the ECB or Irish Central Bank are already being done, as was a further €17bn of ’self sold’ or ‘own bond’ issuances under the ELG, effectively any usable asset is on lease.

The tricky situation is that while deposits fly away that banks in fact have fewer liabilities, but at the same time it affects their capital position. That is what the updated PCAR and PLAR reviews are for.

Suffice to say, that somebody somewhere just clocked into work and sat down to their treasury workstation, and the alert came up with an allocation order for part of their assets under management. That alert is saying to move x amount of money away from an Irish bank to another place.

It is mechanical in nature, yes, confidence and news about Ireland plays a part, but with many other funds it is just a domino effect of ratings versus allocation. That is part of the role that treasury managers work with, Irish banks are doing the exact same thing with other banks in other jurisdictions that get similar downgrades.

So the next time you hear that we are downgraded and people say ‘ah sure it doesn’t matter, sure we aren’t out in the market looking for money so it doesn’t affect bond pricing’, be sure to remind them that a corporate can’t list above the credit rating of the sovereign and that mechanical trades will be occurring that make our banks weaker as a result of it. We might not be ‘looking to the markets’ for money, but it doesn’t mean we won’t be looking anywhere for money fairly soon, the biggest damage to deposits to date is likely being done as we speak.