Deleveraging and next years GDP

Justin Collery

I have a question relating to GDP, debt and deleveraging.

The banks have various deposit to loan ratios ranging from about 150% to about 250%. One would expect them to want to get these to somewhere between 100 and 150% (assumption correct?). The latest figures from the central bank appear to show this in action, with loan repayments outstripping new loans in September by €2.3bn. I guess it could take 12 to 24 months to complete this deleveraging.

Annualising this September figure you get about €25bn taken out of the economy over 12 months. This equates to about 15% of GDP. Is that a fair correlation? If over the next 12 months €25bn more of loans are paid off than is borrowed, thats €25bn less in the economy, which should lead to a contraction of about 15% in GDP?

If that is a fair correlation, my second question is this. We are told that the economy is expected to contract by about 4% next year. Thats 11% less than whats calculated above. By implication some part of the economy must be expanding at a great rate to make up the 11%. I don't see it.

The government is attempting to stabalise its finances by reducing spending by 2% of GDP. It the economy continues to contract at the rates indicated above, thats not nearly enough. Due to the contraction in the rest of the economy, the governments numbers could look much worse in 12 months time that they do today. In any case, I don't want to open a debate about the solution, what I really want to know is this - is deleveraging likely to continue for the next year or two, and how much of a drag will it put on the economy.

JC

Dannyboy83

jcollery wrote: »

I have a question relating to GDP, debt and deleveraging.

The banks have various deposit to loan ratios ranging from about 150% to about 250%. One would expect them to want to get these to somewhere between 100 and 150% (assumption correct?). The latest figures from the central bank appear to show this in action, with loan repayments outstripping new loans in September by €2.3bn. I guess it could take 12 to 24 months to complete this deleveraging.

I think that depends on who is reporting it.
For example, RTE reported it not as a massive jump in people paying loans (although the trend is UP), but as part of the continuing downtrend of Banks to refuse new loans/mortgages.
http://www.rte.ie/news/2009/1130/economy.html

It looks to me like the banks are expecting an even bigger property crash next year.

Dannyboy83

Dannyboy83

Dannyboy83

http://www.rte.ie/news/2009/1130/banks.html

NAMA fears send bank shares tumbling

Monday, 30 November 2009 16:11
Shares in AIB and Bank of Ireland have fallen sharply today over fears regarding the impact from NAMA.
AIB and Bank of Ireland both issued statements this morning confirming they will hold extraordinary general meetings at which shareholders will vote on participating in the National Asset Management Agency process.
Bank of Ireland said it will hold an Extraordinary General Meeting of shareholders early in 2010, with a recommendation from the Bank's board to approve its participation in the National Assets Management Agency.
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The bank warns that failing to vote through NAMA would increase the risk of further state investment in the bank and could lead to nationalisation.
Bank of Ireland said it expects that the discount applied to up to €16 billion in loans it will transfer to NAMA will not be above the expected 30% average. However, it had previously anticipated a discount of significantly less than 30% with markets actually forecasting a discount of about 20%.
If the discount was 30%, Bank of Ireland said it would receive about €11.2bn for the assets and would take a pre-tax loss of about €3.4 billion on the portfolio.
'This potential loss on disposal represents the maximum loss likely to be incurred on the sale of loans to NAMA,' it said.
The Bank's new guidance on the level of discount follows an internal valuation analysis of a sample of loans that may be eligible for NAMA. The sample valuation has been reviewed by NAMA and the Department of Finance.
Bank of Ireland said that participation in NAMA should result in greater market certainty, by removing certain assets from its balance sheet about which the market has concerns regarding their absolute value. It will also allow the bank focus its liquidity and capital on its core profitable assets and improves the prospect of it raising new capital from private sources.
'The court believes the non-participation of the bank in NAMA may have material adverse consequences for the bank's business, operating results, financial condition and prospects,' the statement says.
After this morning's statement, stockbrokers Davy said Bank of Ireland would need €1bn more in capital.
Meanwhile, AIB said it will hold an EGM on 23 December where shareholders will vote on the bank's participation in the NAMA.
AIB said it estimates that NAMA will buy land and development loans worth about €24.2bn on a gross loan basis.
The bank said there is no reason to believe that the average discount applicable to the transferred loans will fall significantly outside of the 30% discount guided by the Minister for Finance.
AIB said that taking part in NAMA will enable it to sell certain land and development loans and associated loans, which will result in it being able to determine the losses associated with these loans.
'It is expected that this will increase market certainty because the NAMA assets in general are perceived to carry a higher risk than other classes of assets on the group's balance sheet,' the statement said.

And judging by the above, the downward trend in bank lending and property crash look like it will be a self fulfilling prophecy until NAMA comes through at least.

Dannyboy83

jcollery wrote: »

If that is a fair correlation, my second question is this. We are told that the economy is expected to contract by about 4% next year. Thats 11% less than whats calculated above. By implication some part of the economy must be expanding at a great rate to make up the 11%. I don't see it.



JC

I'm not qualified to answer, but here is my best guess.
That banks being taken care of by the ECB via NAMA, means that we stop contracting in 2011, with 1% growth (seen in Scofflaw's table below), as the bank starts lending again and the economy starts to recover.




IMF figures courtesy of Vinylbomb
Table Couresty of Scofflaw

Year|GDP(PPP)|Change
2007|188.03|
2008|182.32|-3.04%
2009|168.65|-7.5%
2010|164.43|-2.5%
2011|166.12|1.03%
2012|170|2.34%
2013|174.4|2.59%
2014|178.94|2.6%
2015|183.41|2.5%
2016|188|2.5%
2017|192.7|2.5%
2018|197.51|2.5%
2019|202.45|2.5%
2020|207.51|2.5%
2021|212.7|2.5%
2022|218.02|2.5%

The government is attempting to stabalise its finances by reducing spending by 2% of GDP. It the economy continues to contract at the rates indicated above, thats not nearly enough. Due to the contraction in the rest of the economy, the governments numbers could look much worse in 12 months time that they do today. In any case, I don't want to open a debate about the solution, what I really want to know is this - is deleveraging likely to continue for the next year or two, and how much of a drag will it put on the economy.

The government will look much worse, see my debt to GDP chart above.
I don't think they can do it all at once, its too much of a shock to the system. I think deleveraging will continue indefinitely until NAMA comes in at least.
The deflationary impact is unavoidable and reduction in government spending is a necessary deflationary evil to control debt.
Post 1 & 2 by NESF explaining more about that.

So I think there has to be a meeting in the middle somewhere.


Sorry if my answer was crap, I'm just guessing

nesf

Dannyboy83 wrote: »

One thing I would strongly caution is that the second graph is highly idealised and involves some quite questionable ideas of lack of memory in the system (i.e. the long run growth path is not affected by the bubble).

nesf

Thread moved as the technical nature of the question is better suited to the Economics forum and its tighter restrictions on people requiring to back up their statements.

nesf

Dannyboy83 wrote: »

Post 1 & 2 by NESF explaining more about that.

I'd caution that both posts above are very simplistic analogies of what's going on and should be taken with a grain of salt.

Économiste Monétaire

CBFSAI wrote:

Headline PSC [Private Sector Credit] declined by 3.7 per cent, or €13.5 billion in the year ending October 2009. Approximately 90 per cent this annual decline is a result of valuation effects, such as write-downs of loans and increased bad-debt provisions given broader economic conditions, and exchange rate effects as the euro has strengthened in recent months, particularly against the US dollar. The balance, which is marginal in overall terms, reflects a decline in the underlying stock of credit on a year-to-year basis in October. Non-mortgage credit (Table A2.2), which also excludes lending to non-bank IFSC companies, was unchanged over the year ending October 2009.

The €2.3bn move isn't due to negative net flows on new business. It's a good idea to look beyond RTÉ when extrapolating forward.

Dannyboy83

Économiste Monétaire wrote: »

The €2.3bn move isn't due to negative net flows on new business. It's a good idea to look beyond RTÉ when extrapolating forward.

I'm a willing student, if you're a willing teacher.:)

Dannyboy83

nesf wrote: »

One thing I would strongly caution is that the second graph is highly idealised and involves some quite questionable ideas of lack of memory in the system (i.e. the long run growth path is not affected by the bubble).

Thanks.
Given all the other factors, don't you agree that chart in not inaccurate?
I would have thought questionable ideas of lack of memory could be equally as likely to propel the losses as to deter them.

a) A sustained period of strong global economic contraction over a number of quarters.
b) A sustained period of strong negative Irish economic growth over a number of quarters (GNP & GDP).
c) The collapse in interbank lending.
d) The Irish banks being considered bad risks to lend money to by their international counterparts, considering bond interest rates.
e) The Irish banks considering home buyers as bad risks to lend money to.
f) No significant reduction in the overhang of empty and un-sold properties in the national inventory.
g) A prolonged period of growing unemployment
h) Population decline driven by net emigration.
i) Sustained decreases in average incomes.
j) short to medium term rising ECB interest rates
k) massive deviation from historical norms
l) sustained increases in taxes
m) sustained decreases in rents
n) credit rating downgrade from AA+ to AA-
o) public expenditure reform/cross border shopping/increased saving/smuggling & contraband= deflation
p) property tax/local authority charges
q) OECD recommendations : Mortgage interest tax relief should be reduced, full individualisation in the tax system, abolition of higher standard rate bands for single-income married couples, personal allowances cut, widen the tax base, Tax reliefs should be limited to the standard rate of tax and capped, some reliefs should be eliminated.
q) fear of negative equity/ speculation on collapse


(Thought I could get up to z)

I don't see how any of the above suggests that the market will go anywhere but down until 2011 at the earliest.

Edit: I realise this is a more scientific based/less opinion based forum compared to than those I usually post in, so for anyone reading this, I'm a complete amateur and trying to learn myself, so don't run off believing any of this.

Justin Collery

Thanks Danny Boy for the great info. Ecomoniste Monétaire's post got me thinking and I think I figured it out. Here it is in very round figures.

- Government Guarantee = total debts + total deposits = €450bn

- Assuming debt to deposit ratio of 2:1 that leaves debts = €300bn, deposits = €150bn

- NAMA takes €100bn off the banks at a discount

- Banks now have debts = €200bn, deposits = €150bn. Problem nearly solved.

This leaves a €50bn hole. It's still a big number. Do the banks need to get to 1:1 debt:deposit ratio?

JC

Dannyboy83

jcollery wrote: »

Thanks Danny Boy for the great info. Ecomoniste Monétaire's post got me thinking and I think I figured it out. Here it is in very round figures.

- Government Guarantee = total debts + total deposits = €450bn

- Assuming debt to deposit ratio of 2:1 that leaves debts = €300bn, deposits = €150bn

- NAMA takes €100bn off the banks at a discount

- Banks now have debts = €200bn, deposits = €150bn. Problem nearly solved.

This leaves a €50bn hole. It's still a big number. Do the banks need to get to 1:1 debt:deposit ratio?

JC

http://www.finfacts.ie/irishfinancenews/article_1017917.shtml
Goodbody says post-NAMA, the Loan to Deposit ratio for the financial system drops from an estimated 164% to 130% - - still too high, in its view.

From: http://www.finfacts.ie/irishfinancenews/article_1017917.shtml

Justin Collery

Good article. The question stands then.

Nama takes €77bn off the banks which reduces the ratio from 166% to 130%. International norms indicate a requirement to get to about 110%.

This will require an increase in deposits, or reduction in outstanding loans of €42bn (if 77bn = 36% reduction, 42bn = 20% reduction). Either way, it's money that is not in circulation.

Forget about the government taking €4bn out of the economy, the banking system could take €20bn out of the economy in the next 12 months. Surely this would result in a reduction in GDP in the order of 10%, with the same likely the following year?

JC