08 October 2010

Too big to fail? Ireland v Iceland

Yes I’ve neglected my blog for a while.

No I don’t have a decent excuse.

However, on the up side, the passage of time has allowed the greatest social experiment of the GFC to develop. Iceland and Ireland have generously lent their entire economies to answering the question: Can a bank be too big to fail?

You will recall when we left the story back in March the two countries had shattered banking systems, crushed economies and severe downturns in their property markets. Both had massive private sector banks either on the verge of falling over or already collapsed. The issue was whether the governments of those nations would step in to guarantee the banks' liabilities?

The Irish chose to nationalise their banks and all the toxic assets that they contained, while the Icers rejected paying for the excesses of Icesave and others despite threats from creditors.

When the British and Dutch investors demanded the Iceland government guarantee the banks’ debts, the Iceland government put the question to the people. Asked whether the government should pay €3.8 billion to cover British and Dutch investor losses following the collapse of their Icesave accounts, 93% of Iceland said “just as soon as Satan rides to work in a snow plow” and the debt remained stubbornly private (at least in Iceland, in the UK and the Netherlands their own governments covered the losses).

The world is finally getting to see a side by side comparison of the two strategies. Would the pain of saving the banks be worth the price to the citizens of Ireland, or would it have been better to let them fail and pick up the pieces Iceland style?

The cost of the Irish bailout was staggering. In 2009 the Irish government injected €54 billion into its largest banks to protect them from collapse. The only way to pay for this was to smashed its local population.

Public sector wages were slashed by 1 billion euros and welfare reduced by €760 million (about 20% and 4% respectively in real terms).

The removal of that much public spending increased the contraction pressue in the economy and helped send unemployment to its current 13.7%.

This month, the other shoe dropped: Anglo Irish Bank just hit the wall with massive unserviceable debts.

The Irish government has agreed to save the bank at a cost of up to an additional €35 billion (if you’re doing the maths, that’s about 20 times the savings from wage restraint and welfare cuts).

Even after this, the bank's bonds are rated as junk.

Once again, the Irish taxpayers have been advised that they will be paying the bill to protect investor confidence and save the Irish economy.

The net effect? Ireland’s current account deficit is projected to increase from 14% to 32% of GDP as a direct result of swallowing all that toxic debt. That will put government debt up from the current 77% to 115% of GDP in the next years.

The only way to pay for this will be further cuts to services and wages from a people already on their knees. If you’re of a keynesian school, you know this will lead to further contractions in the economy, more unemployment and still further reductions in public services.

On the other side of the experiment, the Iceland government is still talking with the Brits and the Dutch about someday looking at the real possibility of considering kicking the can for some of the bad loans. So far they haven’t paid a single euro towards those debts.

While they are at it, the Icers declared a moratorium on house repossession to give households a bit of breathing space without forgiving debt.

They also defiantly refused to strip what has become the hallmark of Nordic countries, a strong social safety net.

People predicted it was the end of Iceland, it would be frozen out of the world economy, their children would starve, the country would come to resemble an arctic version of Mad Max II.

So how are the Icers doing beyond Thunderdome? Well, not good, to be sure, but not Irish bad.

Contrary to threats made, the IMF has continued to provide a “Stand by Arrangement” to provide $2.1 billion in loans. The third tranche was paid on 29 September.

While their public debt is currently 115% of GDP, Iceland's 2010 budget will actually produce a surplus. The IMF itself believes Iceland will get back to a national debt of 80% GDP by 2015. This is more or less the exact reverse of the Irish trajectory.

Unemployment is at 7.3% which sucks if you’re in that group, but better than the 13.7% in Ireland.

Real wages, which were put to the sword in 2008, remain depressed but have been growing in the last three months.

It’s a tough long road for the Icers, but they seem to be climbing back.

On the flipside, the Irish are crushed and look like getting more crushed as their deficit continues to spiral, their economy shrinks and those that can leave, get on a plane out of there.

Its still too early to decide if the Irish were fools to listen to the "too big to fail" mantra; this experiment still has quite a way to run. Iceland has not resolved its dispute over the Icesave accounts, nor does a projection of reigning in nation debt by 2015 automatically mean that it will happen.

However at this stage it looks like Iceland has its nose in front.

27 June 2010

The Mining Tax and the PM's Downfall

I’ve been neglecting my blog, focusing on the fortunes of Australia, Germany and Brazil at the World Cup.

However, events in Canberra this week inspired me to post.

I woke up on Thursday morning intending to watch the last roar of the defiant Soccerroos as they fought for a desperate and ultimately pointless victory against Serbia.

There is something sublime about fighting for a lost cause, but I’ll leave that for another day to dissect.

Instead I woke to a leadership spill in the Australian Federal Government that was executed with brutal speed and efficiency and which left a former loyal deputy standing over the political corpse of her former leader. Indeed the numbers so lopsided, the move so irresistible Rudd didn’t even contest the ballot.

Looking back, Rudd might reflect on the fact that his downfall was caused in part by the backlash against his proposed Resources Super Profits Tax.

He was so confident about this being popular, he was prepared to take it to an election.

He must have viewed this as a way that the government could collect more revenue without increasing tax on the ordinary people of Australia, thinking “Surely voters will see that a tax on very rich miners will benefit them”?

Instead of being viewed positively, the proposal sent his popularity plummeting to the point where his own team dumped him.

In my view, this reaction is a predictable outcome if you think in terms of Public Choice Theory.

Public Choice Theory is one of my personal favourite tools for explaining democratic politics. It posits that political decisions are marketable commodities that can be bought and sold with money, influence and lobbying.

In such an environment small well funded groups competing for concentrated gains will triumph over large disparate groups where the gains to any member are relatively small.

RSPT pitted a very small, very powerful group of mining magnates defending a huge amount of personal wealth against the entire nation fighting for at best a very small amount of personal gain should the tax go ahead. Whether in practice the tax would have benefitted the majority of Australians or not, I’ll leave for others to debate, however, the one thing it was certain do was reduce the profits of the big miners like BHP Billiton, Rio Tinto and Fortescue Metals Group

Their reaction was predictable: They fought it with all the power and strength their considerable resources and influence could bring.

If Rudd predicted this, he might have comforted himself with the notion that voters vote with their hip pockets and would reward his policy because, it would not involve a tax on the ordinary person. However, his timing was lousy. You don’t pick a fight with powerful interest groups in the run up to an election. It means you have to defend a policy rather than a detailed plan.

A policy lacks detail, which allows your enemies to create hypothetical detail and then attack it. In the US they saw this with their recent health care debates, with Republicans predicting that the legislation would create death panels and that people would be allocated doctors rather than seeing their own GPs.

What US President Obama understood (and Rudd didn't) was that if you are going to face entrenched opposition from powerful groups, you need to have time to get out a structured plan. Even then, his health reform bill went right down to the wire.

RSPT suffered from the same problem. Without a clearly detailed explanation of the tax, those opposed were free to predict disastrous consequences to whip up pubic fear.

So we saw little old men on television saying “you know, I’m just an ordinary street sweeper, but this mining tax will kill my superannuation and wreck my life”. A little fear goes a long way in the public’s mind.

The miners' relentless ad campaign successfully reframed the debate from a discussion as to where the tax burden should fall in Australia, to whether the RSPT would destroy the prosperity of Australia.

With the public offside, the polls falling and the Prime Minister unsupported, it was a quick and easy hatchet job for the power brokers in the party.

I don’t think in their wildest dreams that Twiggy Forrest and Marius Kloppers thought they would bring down the Prime Minister in their campaign or even wanted to, however, the response from the miners to the RSPT was a key factor in pushing the ALP down in the polls to the point where an internal coup was possible.

23 May 2010

The General takes a bullet, the Toad eats crow

Well there’s no denying it. However the Thailand situation resolves itself, the Toad was wrong: The Thai government managed to clear the Red Shirts from their Bangkok fortress and hold on to power.

While I don’t deny my prediction was incorrect, I’m trying to understand the shift in the battle that permitted this end game.

The government’s actions on 19 May don’t seem to be any more ruthless than their efforts of 10 April. So why did the Red Shirts send the troops packing a month ago, but were flushed out with only six causalities this time?

Obviously there are lots of things happening with the power structures in Bangkok that your humble blogger isn’t privy to. However, from the known facts, its possible to speculate a little.

Back in April, when the army went in for round one, it was far from clear that the Thai army was a united force. There was plenty of speculation that the loyalty of certain key units was with the Red Shirts.

The informal leader of the Red Shirts defences was Major General Khattiya Sawasdipol, formerly part of Thai Internal Security Operations Command, but demoted and suspended for pro Red Shirt statements.

A hard man by any definition with experience in counter insurgency operations, he had the personal loyalty of troops within elite units such as the Rangers and enjoyed celebrity status. I expect he maintained close ties with fellow officers still serving who provided intelligence on the government’s plans and orders even after he was kicked out.

We can be pretty sure that one or more senior officers were feeding intelligence to General Khattiya, as its really the only way to explain how the Red Shirt leaders could have escaped the raid on their hotel back on 16 April.

It seems logical to me that General Khattiya would have been making deals with old buddies advising them that he would be generous to those who sabotaged the efforts of the government once the Red Shirts came to power and would punish those who stood against them

With real prospects of the Red Shirts forcing the government out, field officers would be forgiven for hedging their bets so that, whichever side won, they wouldn’t be purged.

This would explain the disconnect between the Prime Minister’s order on 10 April to clear the street by any means necessary and the army’s inability to push out unarmed civilians.

However, everything changed on 13 May 2010, when a sniper took out General Khattiya with a single shot to the head. It had three immediate and significant consequences:

1. It ended the relationship between the Red Shirts command and the army making informal communication between them impossible;

2. It made any deals between General Khattiya and army commanders in a post election world null and void; and

3. It served notice on commanders that the government was prepared to liquidate its enemies.

The change in the government, Red Shirts and army was immediate and profound. On 19 May the government was so confident the army would clear the streets, it could afford to ignore any further calls for negotiation or discussion from the Red Shirts. The army seemed more determined, moving confidently to clear the protest site with troops and APCs. The Red Shirts seemed sure the army would use all the force necessary to clear the streets and the protesters melted away rather than face the troops.

Perhaps with a single bullet the government undermined a popular protest movement that had held the centre of Bangkok for two months and, at least for now, has succeeded in holding power.

But Thais should ponder that what goes around, comes around. Once you authorise targeted killing of your political opponents, you open Pandora’s box. General Anupong Paochinda and Prime Minister Abhisit Vejjajiva should carefully consider all trips past tall buildings and book repositories for the foreseeable future.