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Financial Analysis of the Prom Note Deal: Where is it?


Volatire

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Feb 25, 2012
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This country is crawling with well-paid economists and financial analysts. Yet not one has produced a financial analysis of the Promissory Note deal so far. The vacuum is being filled with financially illiterate guff and bluster "it's like a mortgage", "inflation will wipe it out", "handing debts to your children" etc.

Why the delay? The details of the deal have been available since yesterday. Promissory Notes/Technical Briefing - Department of Finance - Government of Ireland.

The reason for the delay may be that this is, in effect a derivatives deal. Let's call it a Noonan Swap. Many economic commentators, normally so vocal, are probably out of their depth. They don't know how to price a Noonan Swap which is a derivative in the same sense as an interest rate swap, only more complicated.

The cashflows associated with the Prom Note were penal but certain. We knew exactly what they would be. By design, the initial NPV of the new bonds is identical to that the PN. This allows the PN to be bought back at fair value.

As time goes on, however, the cashflows associated with the new deal become increasingly uncertain. The effective interest associated with the deal starts out as ECB refi rate (which is attractive). But the ecb rate is uncertain and more likely to increase. Also, the bonds have to be sold onto the open market on a pre-determined schedule. This means that the cost crosses over to become long-term Irish bond yields. We don't know where those yields will be. For example, they would be higher in an inflationary environment. Inflation increases the financing cost to the state. ICB even has an option to convert to fixed rate bonds. We don't know how this option might be exercised, but this also affects the eventual cost.

Derivatives deals start out benign. However over time, if left unhedged, their valuation can move drastically.

Noonan's swap starts out with low interest payments. However, the net value of the swap will change radically. In other words, while it is initially cheaper to finance than the PN structure, it is much riskier in the long term. Noonan's Swap may make money relative to the PN, as claimed. Or it may lose money. Depends.

Of course, the goal of this structure was simply to reduce payments over the short-term. That was the only objective. In a sense, they had no choice. The Greek government was doing something like that in 2001 when it entered large cross-currency swaps agreements. Those didn't work out too well.

Let's hope that the Irish government has been well-advised. Looking forward to seeing some analysis from the army of economists who live off the public purse. :rolleyes:
 
Last edited:


ruserious

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When they expect inflation to wipe out the capital costs in 40 years, they have not expanded on the idea that interest will rise to offset that inflation which coupled with austerity could cause a mortgage crisis and a further bailout if the banks are still state owned at that time.

I won't hold my breath for analysis from RTÉ. TV3 have been superior throuhout.
 

Kevin Parlon

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Yes please. Still smarting from the irrevocable transfer of banking debts to sovereign debt, but what does it all mean? Are people who say "it will never be paid" to be believed? Have we simply bought short term relief for longer term deeper pain?
 

Howya

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I posted this on the "other" thread

A calculation might be useful. Based on imperfect information and making the following assumptions;
interest rate on bonds is 3.25%
interest only to 2038
principl paid down in equal instalments from 2038 to 2053

Nominal value is approx 65bn
the nominal value of the old PN was 48bn

So in nominal terms we are paying an extra 17bn. The question is, can the economy grow at a rate greater than before the deal was done so that the extra nominal cost is wiped out?

Edit - this is over simplified.
 

leftsoc

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When they expect inflation to wipe out the capital costs in 40 years, they have not expanded on the idea that interest will rise to offset that inflation which coupled with austerity could cause a mortgage crisis and a further bailout if the banks are still state owned at that time.

I won't hold my breath for analysis from RTÉ. TV3 have been superior throuhout.
Those talking about inflation eroding the value of the repayments are financially illiterate, or as in the case of Michael Noonan with his 1968 house, simply dishonest. We have not the details , but presumably the floating interest rate will ensure that inflation will not erode the value of the repayments due.

The lack of detail is a clue that this is an even worse deal than it appears on the surface. If we would like the details , they would be supplied. That is self-evident in this age of spin.
 

leftsoc

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I posted this on the "other" thread

A calculation might be useful. Based on imperfect information and making the following assumptions;
interest rate on bonds is 3.25%
interest only to 2038
principl paid down in equal instalments from 2038 to 2053

Nominal value is approx 65bn
the nominal value of the old PN was 48bn

So in nominal terms we are paying an extra 17bn. The question is, can the economy grow at a rate greater than before the deal was done so that the extra nominal cost is wiped out?
How does growth wipe out the increase in nominal cost?

Inflation might have, if the interest rate were fixed, but it is not.
 

ruserious

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We are completely depending on externalities to make this a good deal. Would you buy a house under these conditions?
 

Spanner Island

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Feb 22, 2011
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When they expect inflation to wipe out the capital costs in 40 years, they have not expanded on the idea that interest will rise to offset that inflation which coupled with austerity could cause a mortgage crisis and a further bailout if the banks are still state owned at that time.

I won't hold my breath for analysis from RTÉ. TV3 have been superior throuhout.
It's true is that... which is depressing...

RTE have been abysmal and have basically parroted the government line... as feckin' usual...

They've explained what's going on alright, but they certainly haven't challenged it or analysed it in any sort of critical way that I've seen or heard...
 

Cassandra Syndrome

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I posted this on the "other" thread

A calculation might be useful. Based on imperfect information and making the following assumptions;
interest rate on bonds is 3.25%
interest only to 2038
principl paid down in equal instalments from 2038 to 2053

Nominal value is approx 65bn
the nominal value of the old PN was 48bn

So in nominal terms we are paying an extra 17bn. The question is, can the economy grow at a rate greater than before the deal was done so that the extra nominal cost is wiped out?

Edit - this is over simplified.
Unfortunately, I just checked that out. The interest rate is not fixed, which infers that inflation will not eat away at the debt no matter how high the rate is.

It was very dishonest of Noonan to use the analogy of buying a house in the late 60s that could be paid off with a wage check in the 90s. If the house cost €2,000 in the 1960s and non of the principal was paid off to the 1990s, the interest over those 30 years would have been astronomical as they were always higher than the rate of inflation. He would have been worse off.

The more I look at this, the more easier it would have been to simply kill off the debt as it went directly from our own exchequer to our own Central Bank. It is self mutilation.
 

henryhill

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I posted this on the "other" thread

A calculation might be useful. Based on imperfect information and making the following assumptions;
interest rate on bonds is 3.25%
interest only to 2038
principl paid down in equal instalments from 2038 to 2053

Nominal value is approx 65bn
the nominal value of the old PN was 48bn

So in nominal terms we are paying an extra 17bn. The question is, can the economy grow at a rate greater than before the deal was done so that the extra nominal cost is wiped out?

Edit - this is over simplified.
Growth would help, but inflation is what we need to be greater. Culmlative inflation by the 2040's needs to be greater than 35% (the difference between 65bn and 48bn).

An average of 2% inflation over 35 years yields a figure three times the size necessary to break even.
 

Killerbank

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Apr 12, 2011
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This country is crawling with well-paid economists and financial analysts. Yet not one has produced a financial analysis of the Promissory Note deal so far. The vacuum is being filled with financially illiterate guff and bluster "it's like a mortgage", "inflation will wipe it out", "handing debts to your children" etc.


Let's hope that the Irish government has been well-advised. Looking forward to seeing some analysis from the army of economists who live off the public purse. :rolleyes:



I agree. Serious analysis of this deal has been absent and most radio/tv coverage has been at a fairly infantile level.
RTE's Prime Time last night was disgracefully weak with one just economist Colm McCarthy in the studio with personal finance journalist Jill Kirby and the slightly discredited Alan Aherne seen on a backscreen from Cork or Limerick?
Could RTE not find a few more proper economists to discuss the deal and its overall banking context? Colm McCarthy sounded bored with the whole thing and Jill Kirby was the wrong person to have on the programme. Where were the Karl Whelans, the Brian Luceys, the Constantin Gurdievs, the David McWilliams, etc of the world when they were needed?
 

Ribeye

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The deal can't be analysed, cos they won't give us the detailed terms of the bonds, without knowing what the interest rates are nobody can know if it's a good deal or a fckn disaster,

However, for me it's pretty simple, the reason that the ECB would only say that they "noted" the deal is because they know that it IS monetary financing and they are buying time to decide what to do,

Why?

The Anglo bondholders were repaid with printed money from the ICB, that's why the Pro-Note existed, because it was to ensure that the Irish govt canceled out this printed money with money already in circulation, so that the ECB was not in breach of its monetary financing rule,

But now the Irish govt have broken that agreement by repaying the printed money with more printed money from the ICB, tut tut tut,

The get out clause is that the bonds are supposed to be sold to investors who will pay for them with circulating money which the ICB with than destroy, thus neutralising all the printed money, which is in itself pretty spurious,

But it also per-supposes that the bonds will not fall in value prior to their sale,

And anyone who understands how bonds are valued knows that it assumes that interest rates will not rise prior to the sale of the bonds,

Anyone believe that?

It's monetary financing folks, and it's illegal under the ECB rules,

Open unt shut,
 

ChickenBiryani

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Jul 2, 2010
Messages
686
The reason for the delay is best summed up by the inability of our opposition to convincingly refute Noonans patronising and cheap “if I promise to give you €1000 in 40 years time” parlour-trick response to SF’s Doherty in the Dail. You could just sense, aside from the suggestion of alcohol induced befuddlement that they felt on shaky ground talking about the topic. This little nugget was so successful in the Dail I saw Govt Deputies were repeating it ad nauseum on Radio & TV Yesterday.

The bottom line is that people do not understand it. They didn’t understand how in the first place in the face of massive losses money was created out of thin air by essentially the issuing of an IOU and its pledging as collateral. They didn’t understand how it wasn’t included in the national debt. You could sense the nervousness of Radio presenters as they discussed the issue, clearly terrified that someone might ask them what the Promissory notes actually were. They still don’t understand it now it is being extinguished.

This deal boils down to two things when you cut through the crap.
(1) We have converted a standard amortising loan into a longer term interest only loan (gee that really worked out for our new landlord class didn’t it)
(2) We have reduced the interest rate on the principal by approx 5% per annum.

That’s it. Don’t buy any attempts by anyone to suggest it is any more sophisticated or complicated than that, by bringing in NPV concepts etc into the equation. You might be tempted to assume it must be, but it’s not.

Is it a “good deal”? Well it’s certainly “better” and the reduction in the interest rate can only be a good thing.

It still doesn’t get away from two key problems though.
(1) It should not be our debt in the first place
(2) Even at 3% interest rates, the only way this appears insignificant in the future is if, over the term of the loan, we can engineer inflation/growth rates in excess of that interest rate. At present, 3% growth rates look a long way off for the Irish economy, and any underperformance of that target in the short term increases the longer term hurdle for subsequent years.

It should also be said that in trying to win over the electorate, the Government are trying to use various analogies such as household debt to persuade people (and from a glance at these boards, successfully) that this somehow makes this debt insignificant. Of couse, taken individually, I have no doubt that €25bn in 40 years time will be insignificant.
This would however, be to ignore the totality of our debt which I suggest will not be insignificant at the current trajectory of deficits & growth rates.
 

edifice.

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Feb 24, 2005
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Noonan enjoying a bit of a love in with Pat Kenny: and Joe Higgins is in the waiting room. Ouch!
 

sauntersplash

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Feb 3, 2009
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When will people realise that economics is no more a science than politics is? In times to come, people will look back upon our "analyses" as we do on catholic theology. An enormously complex set of rules founded on a complete fantasy.

Blinded by pseudoscience would be the appropriate phrase I t hink.
 

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