I read an article this week about a group of four teenagers from Co. Wicklow in Ireland, who were crowned world champions in a global science competition. The "Koni Kats" team from St. David's Secondary School in Greystones took the top honours at the fifth Formula One Schools Technology Challenge World Championships in London. At an awards ceremony attended by Lewis Hamilton and a large VIP entourage from Formula One, the students were presented with the Bernie Ecclestone World Championship Trophy and Automotive and Motorsport Engineering scholarships to the University of London. Thirty one teams from 20 countries were vying for the title, with students using generic software to design, build and test a model compressed air-powered balsa wood F1 car of the future.
Two things struck me about this, beyond being mildly pleased that Irish intellects were to the fore - firstly: these young kids are representative of the quality and focus of the Irish education system, but they will take their scholarships at university in London and will likely end up employed in great jobs somewhere other than Ireland, which is a concern. The second thing that struck me was that having gone through a large part of secondary school education in the UK, it's hard to believe that I would have been reading about a group of four British students accepting such a prize. The lack of focus on engineering or scientific education in the UK just isn't going to produce the contenders.
I mention this article because it's symptomatic of some bigger picture problems in both Ireland and the UK. For Ireland there has always been a pressure from the so-called "brain-drain" - well educated talent leaving the country for bigger opportunities. Over the past 15-20 years, opportunities within Ireland have seen many would be leavers stay, and many past leavers return. Employers like Intel, Pfizer and Dell have allowed the best and brightest scientists and engineers opportunities at home through their large investments within Ireland - and these companies have chosen to base themselves in Ireland not least because of the access to a high quality pool of talent provided by a generally well focused third level education system. It's a healthy working relationship.
A cause for concern, naturally, during tough economic times is diminished foreign investment by these companies and others as they retreat to their bases in the US. Regardless of the economic times, though, it is critical for Ireland to have a good looking "shop window" to attract whatever FDI is going, and to continue to focus on fostering the talent pool that will form that shop window. The Lisbon Treaty vote that's imminent will have important consequences for the look of the Irish shop window.
In the case of the UK, I firmly believe that there are far greater structural problems. The recent nose-dive of sterling in the currency markets, while driven to some extent by the short term effects of "quantitive easing", is grounded in some significant long term problems that the currency markets are becoming more and more aware of. Britain has, since 1990, run a deficit on its balance of payments' current account averaging 2% of gross domestic product - which for the layman means that the UK is consistently buying more stuff from abroad than it's selling. This was fine as long as capital flowed into Britain from other countries - which it did. Britain's banks borrowed from the international markets and lent into the UK economy. That process, however, looks like it has ended - and therefore the sustainable long-run exchange rate against the rest of the world's currencies is perceived to be lower.
A weak pound, isn't necessarily problematic - it's good for exporters, and bad for holiday-makers - swings and roundabouts and all that. What is significant, however is that it may be indicative of the view that the UK isn't capable of producing companies and products that will be competitive in the world. If that's the case it's questionable where the tax revenues are going to come from to fund the huge budget deficit that the government is running. The Adventure Capitalist Jim Rogers said in January of this year, that "the UK has nothing to sell... There's two big holes developing in the UK's balance of payments - North Sea oil drying up and the financial industry. I don't see anything replacing those two big holes". While his view is somewhat prejudiced by his whopping personal short position on the currency, the gist of what he's saying has some truth.
Some countries can justify a higher budget deficit than others - on the basis of their ability to produce successful companies that can provide the tax revenues to pay for these debts. It's really no different to the choice of what size house to buy and what size mortgage to finance it with. If your income growth prospects are good and secure, a higher amount of borrowing might be justified. If on the other hand, you're not too sure, then a 2 bedroom semi in East Ham might be more appropriate than the penthouse in Knightsbridge.
The prospects for the income growth to fund the penthouse just don't seem to be there in the UK - second and third level education is poorly directed, and underfunded. The prospects for a Silicon Valley to appear out of such a poorly directed system are quite bleak, but will be crucial to the ability of the government to justify such a significant mortgage on the country. It's not going to be easy - global competition is getting tougher in this regard with both India and China graduating more than 500,000 engineers per year. In Ireland's case, I hope that the Koni Kats return to Ireland in the future and create a world beating automotive company for the 21st century, which employs thousands of people and creates local wealth, and local tax revenues. Such endeavour will be critical for the country as a whole in the years ahead. In the case of the UK, something needs to change quickly, not least to justify the international capital markets continuing to finance the ever growing supply of UK gilts.
Sunday 27 September 2009
Monday 21 September 2009
All things tend to entropy...
Entropy - A thermodynamic quantity representing the unavailability of a system's thermal energy for conversion into mechanical work, often interpreted as the degree of disorder or randomness in the system.
A year has passed since Lehman Brothers, my former employer, passed into the annals of the has-beens. This week has seen plenty of media commentary looking into the lasting impact of that moment on 15th September 2008 when all the avenues of potential rescue had been exhausted, including a final desperate phone call from a relative of George W. Bush who worked for the bank, and Lehman declared itself bankrupt.
I'm currently reading a book called "A Colossal Failure of Common Sense", written by a former Lehman trader which looks at the whys and wherefores of the the bank's collapse. The basic gist seems to be that a long serving CEO, with a gigantic ego, lost the plot and either stopped listening to his subordinates or removed those that disagreed with him. There is an amazing sense of inevitability about the implosion - the hugely successful mortgage group at Lehman printed money for the bank in the boom times in the early 2000s, and more success gave them more and more power and more and more capacity for risk. In the end, the strongest part of the Lehman artillery became the weakest link, as they took some massive risks sanctioned by a management team that has lost all grounding in common sense.
Lehman's demise it seems was representative of the 2nd Law of Thermodynamics - that even the most orderly process will tend to disorder over time - that all things tend to "entropy".
I vaguely knew the guy who wrote the book - Larry McDonald. He was a trader in the distressed debt group in New York - a group that traded the bank's capital in companies with a "complicated" past or future. He and his cohorts would look deep into the balance sheets of distressed companies, or even bankrupted companies and buy and sell their debts on the basis of whether the market price of the debt undervalued or overvalued them. For example, when Delta airlines went bust, his group became the market in the bankrupted debt. The Atlanta based carrier was assailed by $18bn worth of debts. In addition they had significant pension obligations and every time jet fuel went up by a cent it cost Delta $25mm annually. Basically the airline didn't work. Nevertheless it did have lots of valuable assets - lots of grounded planes, which if they were all sold would give a "recovery rate" on Delta's bonds of over 50%. So when the less well-researched members of the investment community saw that Delta had gone bankrupt, they rushed to sell - on the first day the Lehman group acquired around $200mm worth of Delta bonds at prices between 15-20% of par, and over time pocketed significant profits as the wider market started to understand what the real price should be for this debt.
I tell this story to demonstrate that these guys were pretty astute - they worked very hard to understand the intrinsic value of these complicated situations, which gave them the edge on the rest of the market, which tended to be either lazier or less competent. As the property market reached fever pitch in 2007 these guys started to turn their attention to some of the US home builders as more and more reports suggested that things had become "toppy" or overdone. Tales of "NINJA" mortgage loans (no income, no job and no assets) struck all but the daftest as odd and worthy of further investigation. As this group started to investigate some of the companies involved in the process of subprime mortgage lending - they were struck by the fact that a lot of the dangerous lending led back to Wall Street, and a significant part of the market to their own front door. Brokers with mortgage companies like New Century, Ameriquest, BNC and Aurora Loan would "originate" mortgages in faraway states, and wholesale flog them to Wall Street banks who would sit on them for a short period of time before selling them off in bits to investors around the world - so called securitisations. The distressed debt group that Larry McDonald was part of had started to take an interest in this market as they thought there might be a way to profit from the potential doom that they saw might be coming, but in the end found themselves more concerned about their own institution's bigger picture situation.
The mortgage group within Lehman had been hugely successful in the few years previously, basically minting it in a market of endless liquidity and asset price inflation. Their gameplan as it turned out, wasn't all that complicated - acquire as much capacity as possible in the US and European mortgage markets, and then repackage and ship the risk to institutional clients from Dublin to Tokyo.
Where I sat in all this was a seller of the these securitisations - trying to offload these risks. I recall in a meeting in early 2006, a group of senior guys from the mortgages group in New York had despatched themselves to London with the intent of educating the European salesforce on the the US mortgage platform, with the ultimate aim of selling more of their product through our channels. The standard investment banking type pitch-books were handed around, outlining the strengths of the US housing market, the quality of the Lehman platform and the madness that we should accuse our clients of if they did not choose to buy into the subprime dream.
One of the pages in the pitch book had a summary of the expected performance of different types of securitised bonds on the basis of US HPA (House Price Appreciation). I noticed that the axis on which HPA had been plotted began at zero - as in there was no conceivable scenario in which house prices would fall. I put my hand up cautiously (as always in these meetings) and inquired as to what would happen if there was a situation where house prices fell - as surely my clients to whom I would be pitching these deals would be inclined to want to know. I don't remember the guy's name who was running the presentation, but he very publicly balled me out and suggested that such a notion would be ridiculous, and quoted what seemed to be the mantra - that the worst single year fall in house prices since the Great Depression had been 5%, but even in that scenario the following year had been positive. I didn't pursue this any further, more concerned about being publicly embarassed and not thinking that there was any upside for me. I did leave Lehman in the few months afterwards, and would like to think in hindsight that this meeting played a part in that decision.
Interestingly on reading Larry McDonald's account, it turns out the same mantra was being peddled in the US - and while the profits were rolling in senior management was more than happy to listen to it. Nevertheless his group were starting to form a cabal of non-believers - who were beginning to push the idea quietly that the US property market was "pumped up like an athlete on steroids, rippling with a set of muscles that did not naturally belong there." Mike Gelband, who was the global head of fixed income, held a semi-secretive meeting as early as June 2005, outlining his contrarian point of view on the US property market. In this meeting he had cited the "shadow banks", the vast complex network of mortgage brokers that were not really banks at all but had somehow managed to insert themselves into the lending process, making an enormous number of mortgages available while having to borrow money themselves to do so. He cited the interest only loans, the no down-payments, the no-docs, the negative amortization loans (the one where the mortgage gets bigger as you pay), and the option ARMs (Adjustable Rate Mortgages) which gave you a cheap initial interest rate on your mortgage for the first couple of years and then hammered you with a massive rate rise. At that point in mid-2005 most of the option ARMs had yet to reset to their higher rates, which meant that defaults on mortgage payments would surely spike in the coming year or so.
He raised the issue of the securitisation market, that was being used by Wall Street to repackage and distribute these mortgages - Lehman for one was buying up $300k mortgages, in pools of 10,000 a time, parceling them into collateralized bonds, getting them highly rated by the rating agencies, and selling them into the market. A standard 1% commission on a $3bn bundle of collateralized debt added $30mm to the Lehman coffers, and multiples of that were being done on a monthly basis. The problem being that the $3bn worth of assets were sitting on Lehman's books until they were sold - he foretold of the situation where the market for this securitised debt caves in and Lehman gets caught with many billions of these unsellable assets - and that happens at a time where every other Wall Street bank is rushing to the door to sell.
Through the end of 2005 Mike Gelband started to push harder on this point of view - taking it directly to the CEO Dick Fuld, and also to the heads of the mortgage group. While his views were latched onto amongst his own people on the Fixed Income trading floor, he was perceived to have developed something of an attitude problem elsewhere. On taking his presentation to the mortgage group he was viewed as way too conservative, and clearly unappreciative of the fact that the they were carrying Lehman's balance sheet quarter by quarter.
Basically, it seems he had formed a view, that with hindsight was an entirely accurate perception of how the world would play out, but his view was falling largely on deaf ears. The past successes of the mortgage business had stopped senior management from separating the wood from the trees. It didn't help that the rest of Wall Street was up to the same activity, but just not quite the same extent of risk. In the end Mike Gelband quit Lehman in early May 2007, unable to continue to accept the direction the bank was being taken. While it's easy to point to the person who was right in hindsight, what was evident was that senior management had lost the ability to reasonably debate a contrarian point of view - something for which there always has to be a place. The inevitable process towards entropy was hastened by a basic loss of common sense.
A year has passed since Lehman Brothers, my former employer, passed into the annals of the has-beens. This week has seen plenty of media commentary looking into the lasting impact of that moment on 15th September 2008 when all the avenues of potential rescue had been exhausted, including a final desperate phone call from a relative of George W. Bush who worked for the bank, and Lehman declared itself bankrupt.
I'm currently reading a book called "A Colossal Failure of Common Sense", written by a former Lehman trader which looks at the whys and wherefores of the the bank's collapse. The basic gist seems to be that a long serving CEO, with a gigantic ego, lost the plot and either stopped listening to his subordinates or removed those that disagreed with him. There is an amazing sense of inevitability about the implosion - the hugely successful mortgage group at Lehman printed money for the bank in the boom times in the early 2000s, and more success gave them more and more power and more and more capacity for risk. In the end, the strongest part of the Lehman artillery became the weakest link, as they took some massive risks sanctioned by a management team that has lost all grounding in common sense.
Lehman's demise it seems was representative of the 2nd Law of Thermodynamics - that even the most orderly process will tend to disorder over time - that all things tend to "entropy".
I vaguely knew the guy who wrote the book - Larry McDonald. He was a trader in the distressed debt group in New York - a group that traded the bank's capital in companies with a "complicated" past or future. He and his cohorts would look deep into the balance sheets of distressed companies, or even bankrupted companies and buy and sell their debts on the basis of whether the market price of the debt undervalued or overvalued them. For example, when Delta airlines went bust, his group became the market in the bankrupted debt. The Atlanta based carrier was assailed by $18bn worth of debts. In addition they had significant pension obligations and every time jet fuel went up by a cent it cost Delta $25mm annually. Basically the airline didn't work. Nevertheless it did have lots of valuable assets - lots of grounded planes, which if they were all sold would give a "recovery rate" on Delta's bonds of over 50%. So when the less well-researched members of the investment community saw that Delta had gone bankrupt, they rushed to sell - on the first day the Lehman group acquired around $200mm worth of Delta bonds at prices between 15-20% of par, and over time pocketed significant profits as the wider market started to understand what the real price should be for this debt.
I tell this story to demonstrate that these guys were pretty astute - they worked very hard to understand the intrinsic value of these complicated situations, which gave them the edge on the rest of the market, which tended to be either lazier or less competent. As the property market reached fever pitch in 2007 these guys started to turn their attention to some of the US home builders as more and more reports suggested that things had become "toppy" or overdone. Tales of "NINJA" mortgage loans (no income, no job and no assets) struck all but the daftest as odd and worthy of further investigation. As this group started to investigate some of the companies involved in the process of subprime mortgage lending - they were struck by the fact that a lot of the dangerous lending led back to Wall Street, and a significant part of the market to their own front door. Brokers with mortgage companies like New Century, Ameriquest, BNC and Aurora Loan would "originate" mortgages in faraway states, and wholesale flog them to Wall Street banks who would sit on them for a short period of time before selling them off in bits to investors around the world - so called securitisations. The distressed debt group that Larry McDonald was part of had started to take an interest in this market as they thought there might be a way to profit from the potential doom that they saw might be coming, but in the end found themselves more concerned about their own institution's bigger picture situation.
The mortgage group within Lehman had been hugely successful in the few years previously, basically minting it in a market of endless liquidity and asset price inflation. Their gameplan as it turned out, wasn't all that complicated - acquire as much capacity as possible in the US and European mortgage markets, and then repackage and ship the risk to institutional clients from Dublin to Tokyo.
Where I sat in all this was a seller of the these securitisations - trying to offload these risks. I recall in a meeting in early 2006, a group of senior guys from the mortgages group in New York had despatched themselves to London with the intent of educating the European salesforce on the the US mortgage platform, with the ultimate aim of selling more of their product through our channels. The standard investment banking type pitch-books were handed around, outlining the strengths of the US housing market, the quality of the Lehman platform and the madness that we should accuse our clients of if they did not choose to buy into the subprime dream.
One of the pages in the pitch book had a summary of the expected performance of different types of securitised bonds on the basis of US HPA (House Price Appreciation). I noticed that the axis on which HPA had been plotted began at zero - as in there was no conceivable scenario in which house prices would fall. I put my hand up cautiously (as always in these meetings) and inquired as to what would happen if there was a situation where house prices fell - as surely my clients to whom I would be pitching these deals would be inclined to want to know. I don't remember the guy's name who was running the presentation, but he very publicly balled me out and suggested that such a notion would be ridiculous, and quoted what seemed to be the mantra - that the worst single year fall in house prices since the Great Depression had been 5%, but even in that scenario the following year had been positive. I didn't pursue this any further, more concerned about being publicly embarassed and not thinking that there was any upside for me. I did leave Lehman in the few months afterwards, and would like to think in hindsight that this meeting played a part in that decision.
Interestingly on reading Larry McDonald's account, it turns out the same mantra was being peddled in the US - and while the profits were rolling in senior management was more than happy to listen to it. Nevertheless his group were starting to form a cabal of non-believers - who were beginning to push the idea quietly that the US property market was "pumped up like an athlete on steroids, rippling with a set of muscles that did not naturally belong there." Mike Gelband, who was the global head of fixed income, held a semi-secretive meeting as early as June 2005, outlining his contrarian point of view on the US property market. In this meeting he had cited the "shadow banks", the vast complex network of mortgage brokers that were not really banks at all but had somehow managed to insert themselves into the lending process, making an enormous number of mortgages available while having to borrow money themselves to do so. He cited the interest only loans, the no down-payments, the no-docs, the negative amortization loans (the one where the mortgage gets bigger as you pay), and the option ARMs (Adjustable Rate Mortgages) which gave you a cheap initial interest rate on your mortgage for the first couple of years and then hammered you with a massive rate rise. At that point in mid-2005 most of the option ARMs had yet to reset to their higher rates, which meant that defaults on mortgage payments would surely spike in the coming year or so.
He raised the issue of the securitisation market, that was being used by Wall Street to repackage and distribute these mortgages - Lehman for one was buying up $300k mortgages, in pools of 10,000 a time, parceling them into collateralized bonds, getting them highly rated by the rating agencies, and selling them into the market. A standard 1% commission on a $3bn bundle of collateralized debt added $30mm to the Lehman coffers, and multiples of that were being done on a monthly basis. The problem being that the $3bn worth of assets were sitting on Lehman's books until they were sold - he foretold of the situation where the market for this securitised debt caves in and Lehman gets caught with many billions of these unsellable assets - and that happens at a time where every other Wall Street bank is rushing to the door to sell.
Through the end of 2005 Mike Gelband started to push harder on this point of view - taking it directly to the CEO Dick Fuld, and also to the heads of the mortgage group. While his views were latched onto amongst his own people on the Fixed Income trading floor, he was perceived to have developed something of an attitude problem elsewhere. On taking his presentation to the mortgage group he was viewed as way too conservative, and clearly unappreciative of the fact that the they were carrying Lehman's balance sheet quarter by quarter.
Basically, it seems he had formed a view, that with hindsight was an entirely accurate perception of how the world would play out, but his view was falling largely on deaf ears. The past successes of the mortgage business had stopped senior management from separating the wood from the trees. It didn't help that the rest of Wall Street was up to the same activity, but just not quite the same extent of risk. In the end Mike Gelband quit Lehman in early May 2007, unable to continue to accept the direction the bank was being taken. While it's easy to point to the person who was right in hindsight, what was evident was that senior management had lost the ability to reasonably debate a contrarian point of view - something for which there always has to be a place. The inevitable process towards entropy was hastened by a basic loss of common sense.
Sunday 13 September 2009
Taking the rough with the smooth...
Barack Obama reportedly brought five books on his recent holiday in Martha's Vineyard - a careful mix of fiction and nonfiction, a dose of urban crime and rural tranquility, with a dash of global economic thought and some American history. An ambitious list I would think, as I tend to battle my way through just the one Dan Brown book at a push on my holidays. The global economic insight on Obama's reading list was provided by the NY Time journalist/ author Thomas Friedman in "The World is Flat". Friedman has been a regular commentator on the trials and tribulations that the process of economic globalisation produces for those who choose to participate in it freely.
One of Friedman's theses is that individual countries must sacrifice some degree of economic sovereignty to global institutions (such as capital markets and international corporations), a situation he has termed the "golden straitjacket". The main implication of giving up some sovereignty is that bridging the gap between the attitudes of the voting population of a country and these global institutions can be increasingly difficult - particularly when economic times are tough. Inevitably, though, when it comes to the crunch, local governments will tend to pander more towards their electorates than these global institutions for the obvious reason that political survival depends on votes. Obama himself has a current trade off between trying to protect the domestic job market in the US, and maintaining a strong relationship with the biggest funder of the US budget deficit - China. If he needs to print money to save jobs, but in doing so erodes the value of the dollar to the detriment of the Chinese, he will invariably opt to do that regardless. With the tough global economic backdrop, these sorts of domestic versus international trade-offs are appearing around the world more and more.
This coming Wednesday the Irish Finance Minister, Brian Lenihan, is set to announce the specifics of Ireland's version of the bank bailout plan - NAMA. The specifics he's going to clarify are the average discounts that will be applied to the banks' loan portfolios upon their transfer into this new government agency. The level of discount will be critical in determining how much fresh capital each bank will need - and what level of state ownership they can expect in the future. The larger the discount, the larger the upfront loss that will be triggered in each bank on the transfer of their loans - and the greater the damage to their already stretched capital bases.
Whatever numbers he comes up with he's likely to upset almost everyone - basically it's a lose-lose situation. If he pays too much for the loans then there is a perceived moral hazard that the banks' shareholders and creditors will not have taken a sufficient hit for the risks that they chose to take, and if he pays too little then this will only clarify for the international financial community that currently funds these banks that they are basically insolvent, and will make it very difficult to raise private capital going forward.
It's a very big few months coming up for Ireland. Aside from the NAMA debate, there is a critical second go at the Lisbon treaty referendum (the first answer wasn't the right one). While the terms of the Lisbon treaty in and of themselves are not that significant, the referendum is seen as a symbolic indication of the direction Irish people want to be going with regard to Europe - is it a continued concession of power to Brussels, or is it now the time to say this is far enough, thanks. In practice if both NAMA and the Lisbon Treaty issues go the wrong way, the implications for Ireland could be substantial - to the extent that some commentators think the IMF (at the request of the European Central Bank) may have to be called in by Christmas.
The stakeholders in Ireland Inc. are manifold - but the two biggest are the electorate, who are in control over who is in power, and the multitude of international investors who provide financing into Ireland. The "golden straitjacket" of globalisation have left these two parties running on entirely different tracks it would seem. On the one hand the government is reliant on the electorate for its capacity to govern, but on the other hand the government is reliant on the international capital markets to allow it to manage its finances, and for investment into the Irish companies that will create growth, jobs and tax revenues. Intel, for example, which employs thousands of people in Ireland have a strong interest in Ireland being fully committed to further European integration - they are putting 1mm Euros into the "Yes" campaign for the Lisbon treaty referendum, and the consequences of a "No" vote may result in serious repercussions for Intel's long-term desire to invest in Ireland. There is a very serious trade-off here.
Ireland plotted it's economic path over the past 20 years as a "small, open country" - small in the sense of geographic size and population, and open in the sense that it had realised the benefits of international trade, particularly the benefits of a full participation in the ever extending European Union. During the good times this costume suited quite nicely. Ireland focused on high margin pharmaceutical and information technology businesses, attracting inward investment on the back of a well-educated, English speaking workforce. Lower margin work, was "traded away" in the comparative advantage stakes, and instead of mass producing cheap clothing and the like these were imported from Taiwan and China at mind-blowingly cheap prices. For quite a time this worked well, and Ireland was the poster-child for the high margin export led growth model. Domestically, tax revenues were substantial, credit flowed, asset prices soared and the living was easy.
In the space of alarmingly few years, however, Ireland has fallen from the top of the world economy beauty parade. The evidence shows that Ireland's most respected institutions including the Central Bank, the major Irish banks, the Department of Finance, and others failed to grasp the massive danger to the economy posed by the property bubble.
Whatever happens in Ireland over the next few months, what is increasingly clear is that there is a growing divide between what the electorate want their government to do and what it actually can do. Ireland is running a substantial budget deficit, like most of the rest of the Western world, and unemployment is pushing 13%. Domestically, the bankers are apparently to blame for the situation, and the prospect of further concessions to a European Union that Ireland is now a net contributor towards are a difficult proposition to swallow. The "golden straitjacket" is not going to provide the government with much room to manoeuvre, but there is a serious risk that favouring the views of the electorate too heavily versus international stakeholders will leave Ireland in a worse position over the long run. A no vote to the Lisbon Treaty and a overly harsh approach to NAMA will put Ireland in a very tricky position with Europe and the international capital markets. Having plotted it's economic course and benefitted heavily from economic integration it's now Irelands responsibility to take the rough with the smooth.
One of Friedman's theses is that individual countries must sacrifice some degree of economic sovereignty to global institutions (such as capital markets and international corporations), a situation he has termed the "golden straitjacket". The main implication of giving up some sovereignty is that bridging the gap between the attitudes of the voting population of a country and these global institutions can be increasingly difficult - particularly when economic times are tough. Inevitably, though, when it comes to the crunch, local governments will tend to pander more towards their electorates than these global institutions for the obvious reason that political survival depends on votes. Obama himself has a current trade off between trying to protect the domestic job market in the US, and maintaining a strong relationship with the biggest funder of the US budget deficit - China. If he needs to print money to save jobs, but in doing so erodes the value of the dollar to the detriment of the Chinese, he will invariably opt to do that regardless. With the tough global economic backdrop, these sorts of domestic versus international trade-offs are appearing around the world more and more.
This coming Wednesday the Irish Finance Minister, Brian Lenihan, is set to announce the specifics of Ireland's version of the bank bailout plan - NAMA. The specifics he's going to clarify are the average discounts that will be applied to the banks' loan portfolios upon their transfer into this new government agency. The level of discount will be critical in determining how much fresh capital each bank will need - and what level of state ownership they can expect in the future. The larger the discount, the larger the upfront loss that will be triggered in each bank on the transfer of their loans - and the greater the damage to their already stretched capital bases.
Whatever numbers he comes up with he's likely to upset almost everyone - basically it's a lose-lose situation. If he pays too much for the loans then there is a perceived moral hazard that the banks' shareholders and creditors will not have taken a sufficient hit for the risks that they chose to take, and if he pays too little then this will only clarify for the international financial community that currently funds these banks that they are basically insolvent, and will make it very difficult to raise private capital going forward.
It's a very big few months coming up for Ireland. Aside from the NAMA debate, there is a critical second go at the Lisbon treaty referendum (the first answer wasn't the right one). While the terms of the Lisbon treaty in and of themselves are not that significant, the referendum is seen as a symbolic indication of the direction Irish people want to be going with regard to Europe - is it a continued concession of power to Brussels, or is it now the time to say this is far enough, thanks. In practice if both NAMA and the Lisbon Treaty issues go the wrong way, the implications for Ireland could be substantial - to the extent that some commentators think the IMF (at the request of the European Central Bank) may have to be called in by Christmas.
The stakeholders in Ireland Inc. are manifold - but the two biggest are the electorate, who are in control over who is in power, and the multitude of international investors who provide financing into Ireland. The "golden straitjacket" of globalisation have left these two parties running on entirely different tracks it would seem. On the one hand the government is reliant on the electorate for its capacity to govern, but on the other hand the government is reliant on the international capital markets to allow it to manage its finances, and for investment into the Irish companies that will create growth, jobs and tax revenues. Intel, for example, which employs thousands of people in Ireland have a strong interest in Ireland being fully committed to further European integration - they are putting 1mm Euros into the "Yes" campaign for the Lisbon treaty referendum, and the consequences of a "No" vote may result in serious repercussions for Intel's long-term desire to invest in Ireland. There is a very serious trade-off here.
Ireland plotted it's economic path over the past 20 years as a "small, open country" - small in the sense of geographic size and population, and open in the sense that it had realised the benefits of international trade, particularly the benefits of a full participation in the ever extending European Union. During the good times this costume suited quite nicely. Ireland focused on high margin pharmaceutical and information technology businesses, attracting inward investment on the back of a well-educated, English speaking workforce. Lower margin work, was "traded away" in the comparative advantage stakes, and instead of mass producing cheap clothing and the like these were imported from Taiwan and China at mind-blowingly cheap prices. For quite a time this worked well, and Ireland was the poster-child for the high margin export led growth model. Domestically, tax revenues were substantial, credit flowed, asset prices soared and the living was easy.
In the space of alarmingly few years, however, Ireland has fallen from the top of the world economy beauty parade. The evidence shows that Ireland's most respected institutions including the Central Bank, the major Irish banks, the Department of Finance, and others failed to grasp the massive danger to the economy posed by the property bubble.
Whatever happens in Ireland over the next few months, what is increasingly clear is that there is a growing divide between what the electorate want their government to do and what it actually can do. Ireland is running a substantial budget deficit, like most of the rest of the Western world, and unemployment is pushing 13%. Domestically, the bankers are apparently to blame for the situation, and the prospect of further concessions to a European Union that Ireland is now a net contributor towards are a difficult proposition to swallow. The "golden straitjacket" is not going to provide the government with much room to manoeuvre, but there is a serious risk that favouring the views of the electorate too heavily versus international stakeholders will leave Ireland in a worse position over the long run. A no vote to the Lisbon Treaty and a overly harsh approach to NAMA will put Ireland in a very tricky position with Europe and the international capital markets. Having plotted it's economic course and benefitted heavily from economic integration it's now Irelands responsibility to take the rough with the smooth.
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