THIS ARTICLE APPEARED IN THE IRISH EXAMINER AUGUST 8th 2014

In relative terms, the Government is being inundated with good news on the economic and financial front at the moment. Most economic indicators in recent months have been moving in the right direction, and the news from the two main banks for the first half of the year has been more positive than we have seen for quite some time. Given that we are now well into the second half of the electoral cycle this does represent good news for the parties of government, and provided the recent trends are maintained or built upon over the remaining lifetime of the government, there might just be a relatively positive backdrop as they face into what could be a very politically tricky plebiscite.

What the government does or does not do in the remaining budgets could play a key role in influencing voter choices. Taxpayers have obviously taken a serious battering over the past six years, and the payment of the full-year property tax is hurting badly this year. At the moment we are being treated to a very damaging debate about the likely burden of the water charge next year. The sort of speculation and uncertainty that abounds at the moment in relation to the water charge is very destabilising as it is fostering fear and undermining confidence. There is nothing as dangerous as uncertainty, and the Minister with responsibility needs to create certainty as quickly as possible. At least if people have a clear idea of what the cost is likely to be, then they can plan with some level of certainty.

In terms of additional budgetary changes that might be implemented over the likely remaining two budgets of this government, the pressure is clearly starting to ease. Notwithstanding the fact that we are still borrowing too much as a country and that the level of outstanding debt is dangerously high, the public finances are gradually moving into a better place.

The Exchequer returns earlier this week showed that an Exchequer deficit of €5.18 billion was delivered in the first seven months of the year. This is €25 million higher than the equivalent period last year. However, last year’s figure included the proceeds of the sale of Irish Life and Bank of Ireland Contingent Capital Notes. When these non-recurring revenue items are excluded, the underlying deficit this year is almost €2.3 billion lower than the same period last year. Tax revenues are running €548 million ahead of expectations, and are 6.4 per cent up on last year. The three biggest revenue areas are performing very strongly. Income Tax receipts are 7.6 per cent ahead of last year and €54 million ahead of expectations; Excise Duties are 5.6 per cent ahead of last year and €132 million ahead of target; and VAT receipts are running 7.2 per cent higher than last year and €242 million ahead of target. These items are reflecting the improvement in the labour market and stronger consumer spending, particularly on new cars. It just goes to prove that economic growth is good for the public finances.

On the expenditure front, the Government is also maintaining tight control. Net voted expenditure is €172 million lower than last year and is €73 million lower than targeted. The current expenditure component is just €24 million higher than expected, while the capital expenditure component is running €97 million lower than expected.

This all suggests that the government remains well on track to improving upon the Exchequer borrowing target of €9.6 billion for the full year, and a General Government Deficit equivalent to 4.8 per cent of GDP. Granted, there is still five months left in the year with the biggest revenue collection month included, but based on current trends it is certainly possible that the deficit could come in up to a billion euro lower than expected and the deficit could hit 4.3 per cent of GDP.

Should it so desire, this would give the government scope to deliver a total budget adjustment of less than € 1 billion euro in October, which would necessitate marginal changes once the water charge receipts are taken into account. I believe it would be pre-mature for government to contemplate a tax cutting budget. That should be left for Budget 2016, which will likely be the final one before the general election. Assuming the government survives its full term, a relatively generous budget in October 2015 would be likely to give maximum political advantage to the parties of government.

This article appeared in the Sunday Business Post August 3rd 2014

In recent days somebody whose views I deeply respect suggested to me that official data releases and general popular discourse are not fully capturing and reflecting the magnitude of the real upturn in the fortunes of the economy. This view resonates with my sense of what is going on around the country. Whatever about official economic data releases which I believe, have been very positive in recent months, many businesses I deal with and speak to have been suggesting to me in recent times that there is a very noticeable improvement in conditions. Granted, this view tends to be more prevalent in the greater Dublin area than elsewhere, and is very relative, given the low base from which many businesses are now operating.  Be that as it may, there is an inevitability about recovery starting in the capital city and its environs, and  it is very reassuring that the precipitous decline in economy activity from 2008 onwards has stabilised over the past couple of years and there is now a very real recovery starting to build. The perennial pessimists and sceptics, and those who advised us to follow the Argentinian route may find this difficult to stomach, but the recent evidence is pretty compelling.

Despite the collapse in our banking system and its’ still pretty dysfunctional characteristics, the results from our two biggest banks over the past week have been relatively positive.

In the first half of this year AIB returned to profit for the first time in six years. It delivered a pre-tax profit of €437 million, which was well ahead of any analyst forecasts that I am aware of. The bad debt provisioning has been reduced considerably; operating expenses continue to fall; and total income rose by 36 per cent. Furthermore, its Chief Executive David Duffy has reassured the taxpayers of   Ireland that his bank will return all bailout funding of €20.8 billion received from the state since 2009. For a bank that is 99.8 per cent owned by the state, this is good news. Meanwhile over at Bank of Ireland, a first-half pre-tax profit of €399 million was announced.

This week’s news from the banks is unambiguously positive. Whatever we may think about banks and bankers, it is an irrefutable fact that for an economy to function properly, its banking system must be functioning properly. The role of a bank is primarily to act as a trustworthy intermediary to attract deposits and channel credit into the real economy. Since 2008, the Irish banks have not been meeting these criteria, but with a return to profitability, this looks set to change over the next couple of years. A functioning banking system will help accelerate the return to a properly functioning economy.

On the real economic data front, the news is also generally positive.

Earlier in July, national accounts data for the first quarter showed that GDP expanded by 2.7 per cent during the quarter, and was 4.1 per cent higher than the same quarter in 2013. Real GNP increased by 0.5 per cent during the quarter and was 3.1 per cent higher than the first quarter of 2013. This represented a very positive start to the year, and the good news is that the recovery has subsequently gathered pace.

Consumer confidence is at more than seven-year highs, but consumer spending is also gradually gaining traction. In the first six months of the year the value of retail sales was 4.4 per cent higher than the same period in 2013, and the volume of sales increased by 6.5 per cent.  However, when the motor trade is excluded, the retail sales performance was less strong, although more vibrant than in previous months. Excluding cars the value of retail sales increased by 1.5 per cent and the volume of sales increased by 3.4 per cent. We know that the number of new cars registered was 23.4 per cent higher than the first half of 2013. Indeed after 9 days of July, car sales for the year to date surpassed total sales for 2013.

On the export front, the news is also positive. In the first 5 months the value of merchandise exports was 0.3 per cent higher than last year.  Exports of Chemicals & Related Products declined by just 1 per cent (the patent issue), but exports of Food & Live Animals increased by 10.7 per cent. The volume of manufacturing output is 21.8 per cent higher than last year. Irish industry is clearly moving again.

 

The labour market also continues to improve. In July, the number of people signing on the live register was 37,461 lower than a year earlier and has fallen by 55,800 over the past two years. Most recruitment consultants will tell you that there is a marked pick-up in demand for labour. The IDA also continues to deliver.  In the first six months of this year, over 100 investments were secured, which represents an increase of over 40 per cent on the first half of last year. Over 40 per cent of the investments secured are from companies investing here for the first time, with the remainder coming from existing companies. It is estimated that those investments will lead to more than 8,000 extra direct jobs in the economy.

The final piece of the jigsaw is in the housing market. According to the CSO, national average property prices have increased by 12.5 per cent in the year to June and are now 13.9 per cent off the low point seen in March 2013; Dublin prices have increased by 23.9 per cent over the past year and are now 30.2 per cent off the low point in August 2012; and Outside of Dublin, property prices have increased by 3.4 and are now 5.6 per cent off the low point in March 2013. While this strong pick up in house prices will not please all, it does help remove thousands from a negative equity situation and does indicate a greater level of confidence out there.

 

All in all, I find the evidence of economic recovery very compelling, and hopefully it should continue to build from here. This is not to suggest that it will be plain sailing. It most definitely will not. There are still many obstacles to overcome, including the continued pressure on discretionary incomes; public and private debt; credit availability; housing market issues; and the fragile nature of the banking system. However, economic growth will make all of these problems more manageable, and it is very clear that this is starting to happen.  Hopefully, Michael Noonan will deliver a modest budget correction in October, and this should reinforce the more positive vibes in the economy and in business.

This article appeared in Businesspost.ie July 17th 2014

WOULD MORTGAGE INSURANCE BE SUITABLE FOR IRISH MARKET

By Jim Power

Most sensible people would recognise that a functioning economy needs a functioning property and construction sector. After a dramatic collapse since 2008, Ireland’s property and construction sector has been decimated and although slightly better than in recent times, it is still in a very perilous state. Consequently, it is imperative that measures are taken to re-build a sector that has been decimated and stripped of a vital skills base. The government launched its latest blueprint for the sector in recent weeks, titled Construction 2020. This report contains 75 action points for the sector, but underlying it all is a clear recognition that it is essential to re-build the sector as quickly as possible.

Action point No. 51 recommends that consideration be given to the concept of a universal mortgage insurance scheme, which would allow banks share the risk of mortgage lending, either with the public sector or with private insurance companies. The key aim of the proposal would be to increase bank lending in general or increase lending to specific target groups. However, it is essential that if demand is to be given a boost, there must be sufficient supply to meet that demand. If not, any demand-side measures would just lead to undesirable house price inflation.

The Department of Finance is currently finalising its thoughts on the topic of universal mortgage insurance. It remains to be seen what it will advise the Government, but there is reasonably compelling international evidence that it has a key role to play in a functioning mortgage market. Canada is a good example.

Mortgage lenders here in Ireland are under significant pressure to re-build profitability, reduce the size of the balance sheet and hold adequate levels of prudential capital. High LTV mortgages are in theory more risky than low LTV mortgages, and so they may require higher capital provisioning or may creation the perception of a more risky loan book, which could influence the ability of banks to raise capital. It is in this context that mortgage insurance could play a significant role.

At the moment there is some evidence that worthy borrowers with strong repayment capacity based on actual and potential earnings are having difficulty raising a deposit of sufficient size to bridge the gap between the mortgage they are being offered and the price of the house they want to purchase. However, there is not a strong incentive for lenders to engage in such high LTV lending, so some aspiring home owners may be prevented from getting on the property ladder.

Mortgage insurance could play a role here. Mortgage Insurance is a risk mitigation product that is used to protect mortgage lenders (originators, and/or underwriters) by transferring mortgage risk, and notably tail risk, from lenders to insurers.

The creation of a universal mortgage insurance model would impose a mandatory requirement for all lenders providing high LTV mortgages to put mortgage insurance in place. This would oblige the financial institutions to insure the portion of the high LTV mortgage above a certain level, such as 75 per cent. This would mean that the financial institution would not have to hold expensive capital and thereby would be in a position to offer lower interest rates to borrowers over the lifetime of the mortgage.

Under such a model, the insurer would have an external role in assessing the mortgage transaction, thereby creating better oversight; lenders would not have to hold expensive prudential capital and could offer lower interest costs; higher lending standards would be enforced through the higher level of oversight; the solvency of the financial system would be helped through greater risk diversification; and most importantly first-time buyers in particular would be helped on to the housing ladder, which is important from a social cohesion perspective.

It would not make sense for the State to guarantee any component of the mortgage as this would just serve to increase contingent liabilities on the banks’ balance sheet. This should be left to the private sector through a mortgage insurance model. There are arguments for state intervention in the market in order to help that who cannot get housing, but not in guaranteeing lending where the private sector is already prepared to do so.

It would not be prudent to introduce mandatory mortgage insurance for first-time buyers only who are buying a new house. The reality is that not all first-time buyers want to buy a new house. By concentrating only on first-time buyers, important segments of the market would be ignored. The mortgage insurance model should ideally be applied to all high LTV lending. This more holistic approach would help get the overall market functioning more efficiently and more effectively.

Arguably in mortgage insurance had been in place over the past decade, mortgage lending would have been more prudent and the dramatic losses in the financial sector might have been avoided. However, mortgage insurance is not a panacea for all ills. Rather, it should be part of a mortgage model that is characterised by sustainable debt service coverage ratios, effectively reviewed at regular intervals of time; appropriate LTV ratios combined with a prudent approach to property appraisals; prudent loan to income ratios; effective verification of the borrower’s underlying income capacity; comprehensive file documentation of all loan originations kept over time; and effective collateral management and sound appraisal standards.

Rebuilding a functioning property, construction and mortgage sector would pay huge dividends in terms of economic activity, employment, labour market mobility, financial stability & sustainability, and social cohesion.

THIS IS A SUMMARY OF A PAPER PRESENTED BY THE AUTHOR AT A BREAKFAST BRIEFING ORGANISED BY GENWORTH FINANCIAL.

 

 

This article appeared in the Examiner July 4th 2014

Following the disastrous election results in May, the Government is now under considerable pressure with less than two years to go to a general election. The most immediate issue to be faced up to is the budget this October and whether an adjustment of €2 billion will be required or not. The next big issue to be then faced is seeking to ensure that the general economy and particularly the labour market are in a better place in the months leading up to the election. These are difficult questions to answer because the one thing we should have learned from recent experience is that the economic future is nigh on impossible to predict with any degree of confidence, and is always potentially vulnerable to shocks that we not yet have thought about.

Be that as it may, economic data releases over the past week will provide the beleaguered government with hope. The labour market is continuing to gradually move in the right direction; the public finances are better than expected; and the growth numbers for the first quarter of the year are certainly suggesting an improving picture.

Yesterday the Central Statistics Office (CSO) published revised historical data on the economy. This is normal because as the CSO gathers additional information from different sources on the millions of transactions that occur in the economy over the course of a quarter or a year, it will have to revise previous estimates. However, this time the CSO in line with new international standards, has sought to measure illicit activities such as drugs and prostitution, and also to change the manner in which it accounts for expenditure carried out by companies on Research & Development (R&D).

One of the many criticisms of GDP as a real measure of what is going on in the economy is that is does not capture the informal or ‘black’ economy, as it has traditionally been called. Whatever we may think about activities such as drug dealing and prostitution, they do represent economic transactions and should be measured for economic activity purposes. By definition, this is very hard to do, but the CSO yesterday sought to do so and this has added to gross domestic product (GDP), albeit in a modest fashion. However, the change to the treatment of R&D is more significant. Previously it was regarded as a business expense and formed part of intermediate consumption in the economy and did not really constitute GDP. Now based on international best practice, such spending is regarded as business investment, and hence contributes directly to GDP. In 2013 for example, illegal economic activities added 0.72 per cent to GDP, but the capitalisation of R&D added 4.1 per cent. As a consequence of these changes and other revisions, GDP actually expanded by 0.2 per cent last rather, rather than contracting by 0.3 per cent as had been previously suggested.

This is now of historical interest in the main, but the data for the first three months of this year are of more immediate interest. The good news is that all of the components of economic activity showed decent year-on-year growth in the first quarter. In real terms, consumer expenditure increased by 0.2 per cent, investment increased by 2.9 per cent; exports expanded by a strong 7.4 per cent; and imports increased by 5.9 per cent. This resulted in an increase of 4.1 per cent in GDP and 3.1 per cent in the more important measure of economic activity, gross national product (GNP).

Obviously these data are provisional and are subject to later revision, and quarterly data do tend to be very volatile from quarter to quarter, but the clear picture emerging is that the recovery which commenced in a very gradual and modest fashion during 2013, is now gathering some momentum.

The upward revision to historical GDP and the stronger than expected growth in the first quarter, when combined with the public finances for the first half of the year, are suggesting  that Michael Noonan could actually bring in borrowing close to 4 per cent of GDP rather than 4.8 per cent this year. This in turn would suggest that a budget adjustment of less than €1 billion would be more than adequate to hit a borrowing target of less than 3 per cent of GDP in 2015. It is still too early to be too definitive about this, but the omens are getting better. How to translate this into political popularity is a different matter, however. Who would be in politics?