Carbon Bonds Could Reduce Government Borrowing Costs Too

Published on 2 December, 2009. 0 Comments

After my post a few weeks ago proposing a form of emissions-linked government bond which I called a ‘carbon bond’, I’ve realised an unintended benefit that the carbon bonds would bring to any government that issues them: they would reduce long-term borrowing costs. This actually surprised me when I realised it, as it certainly wasn’t one of the intended consequences of issuing the bonds, but after considering the matter, it’s actually quite clear that borrowing costs would be lower for governments offering carbon bonds, subject to a couple of conditions.

I’m not going to go over a formal mathematical proof here (I like to think my blog hasn’t become quite that nerdy yet), but here’s the reasoning behind my claim:

Assume creditors are buying ten-year government bonds at an interest rate n. Now, if they also have the option of buying a ten-year carbon bond from the government, that carbon bond is going to have a base interest rate m, which would be increased by r if the government goes over its promised allocation of emissions permits by some given amount. We’ll assume that the market of creditors will place a probability p on the government actually having to pay out the higher m + r interest rate. The only reason that p would be zero would be if the markets had absolute and complete confidence that a government would never renege on its promises. We know that’s not true, so we can say that p is nonzero.

The expected interest payment for the carbon bond will be the base rate m plus the increment r times the probability p that the increment will have to actually be paid. That is, expected interest will be m + (p * r). Given the choice between either the regular government bond or the carbon bond, if one has an expected interest rate which is higher than the other, then creditors will simply all buy the one with the higher rate. This means that, in an efficient market, the expected rate for both should be equal, ie n = m + (p * r). Now, we know that both p and r are nonzero (if r was zero, then it would just be a regular bond), and are both positive. This means that m must be less than n for the market for both bonds to operate. That is, the base interest rate on the ten-year carbon bond has to be lower than the interest rate on standard government bonds. Which means that, so long as the government doesn’t actually deviate from its proposed emissions limits, issuing carbon bonds is going to be a definitively cheaper way to raise cash.

Of course, this is a simplified explanation; there would actually be a range of possible rs depending on how far over the emissions schedule the government went, and then a range of possible ps for the expected probabilities of each of those rs being paid out. However, the principle remains the same; markets are going to be willing to accept a lower base interest rate on carbon bonds so long as there is some non-zero probability that a higher interest rate will have to be paid out instead.

Interestingly, what a government would actually be doing with this scheme is betting on its own trustworthiness. The government is assuming with certainty that it will stick to its promises, whereas the markets don’t have the same faith. By issuing carbon bonds, a government can actually leverage this lack of trust in the form of lower interest rates. Of course, to benefit from these lower base rates, the government would actually have to stick to its promises, and can it really be that confident of itself?

Edit (30/03/2010): This post was originally written using the term ‘green bonds’. I’ve since changed all references to ‘carbon bonds’ instead. This is to bring the terminology closer to that used by Michael Mainelli and Jan-Peter Onstwedder in a proposal made last year, where they used the term ‘index-linked carbon bonds’ to describe effectively the same thing. The change should also remove any confusion with other uses of the term ‘green bonds’.

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Want to show the public and the markets that you're taking the economic crisis seriously, Mr Cowen? Then appoint Jim O'Hara to the cabinet.

Published on 10 November, 2009. 0 Comments

While bouncing from economic crises to political crises and back again at an astounding rate, Brian Cowen has stumbled upon a brief opportunity to make a move that would reflect well both upon himself politically, and give a piece of potentially good economic news for the markets to ponder over for once. In a few weeks time, elections will be held to fill two vacant seats in the Seanad. The electorate for both of these seats are current TDs and Senators, and as the government has majorities in each chamber, government nominees are effectively guaranteed to win both seats. This gives Cowen the ability to bring pretty much whoever he likes into the Seanad in time for the new year. What’s more important, though, is that Cowen can, by article 28.7.2 of the constitution, appoint up to two members of the Seanad to the cabinet, which means that he can use these open Seanad positions as a platform to bring expertise into the cabinet that simply can’t be found amongst the ranks of the Dáil.

While such a step would be almost completely unprecedented (the provision to appoint Senators to cabinet has only been used, to my knowledge, once in the history of the state), the situation we’re in is similarly unprecedented. We’re currently in the midst of the greatest fiscal, economic and employment crises to afflict any developed country since the great depression, and there are only three qualified economists sitting in the 166-seat Dáil, two of whom are on the opposition benches. The degree of experience within the business sector in the Oireachtas is similarly underwhelming, which means there is very little the government can do to increase its authority on matters of the economy without bringing in outside help.

Bringing in fresh blood to take over as Finance Minister is not possible, as the position constitutionally has to be held by a TD. However, the second biggest economic portfolio, the Minister for Enterprise, Trade and Employment, is a perfect position to bring outside expertise into. The current Minister, Mary Coughlan, is widely considered to be way out of her depth in the portfolio, and her repeated gaffes are doing the government little help in the popularity stakes. As such, bringing in a suitably qualified person in her place would help show both the electorate and the markets just how seriously the government are taking the current economic crises.

There certainly isn’t a shortage of candidates more qualified than Mary Coughlan for the position, but one that immediately springs to mind is Jim O’Hara. Jim O’Hara is currently Vice President of the Technology Manufacturing Group in Intel, and General Manager of Intel’s Irish operations, where he’s in charge of over 4000 employees. He’s very well respected in the business community, and he represents exactly the kind of high-tech, export-led industry that the government so desperately wants Ireland to become focussed on as we rebuild our economy. Furthermore, he showed during his involvement in the Lisbon Treaty campaign that he’s not only knowledgeable on political affairs, but also that he’s more than capable of presenting himself well in front of the political media.

Bringing him into the cabinet could be done quickly and easily. As it would be best for O’Hara to be seen as apolitical in his appointment, running him as a Fianna Fail candidate for one of the two vacancies directly would not be advisable. However, Cowen could simply call on one of Fianna Fail’s 6 Taoiseach’s appointees in the Seanad to resign from their current seat and run for one of the vacant seats (which they’d be guaranteed to win). O’Hara could then be appointed by Cowen as an independent appointee of the Taoiseach into then-vacant slot. Cowen could perform a mini-reshuffle of the cabinet (most likely giving Coughlan back the Agriculture portfolio she previously held, and pushing Brendan Smith back into a Junior Ministry), and appoint O’Hara as Minister for Enterprise, Trade and Employment before the start of the new year.

Brian Cowen needs to start taking radical steps towards both fixing the economy as well as improving the government’s tattered reputation if he wants to stay in office much longer. Most of the choices available to him would involve substantial opposition from vested interests across the country. He now, however, has the opportunity to make an unprecedented move that would be opposed by virtually no-one but Mary Coughlan. By appointing Jim O’Hara as Minister for Trade, Enterprise and Employment, Cowen could show just how seriously he’s taking the crisis, and that he’s willing to think outside the box in his efforts to do so.

And, as an added bonus for Cowen, the appointment would also be a political jab against Enda Kenny. Kenny decided last month that the Seanad is useless and he’d scrap it if elected Taoiseach, an announcement that was considered rash even by many members of his own party. By using the Seanad as a means to bring extra experience into the cabinet, Cowen could prove to Kenny that it isn’t so useless an institution after all.

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Carbon Bonds: Setting long-term incentives for emission reductions

Published on 8 November, 2009. 2 Comments

With the Copenhagen climate change convention coming up next month, many governments such as ours are looking for ways to demonstrate their commitment to long-term cuts in carbon emissions. Unfortunately, very few of these are anything more than worthless platitudes, and Ireland’s plans certainly fit within this category. Last week, the Joint Oireachtas Committee on Climate Change produced a report making a number of recommendations in advance of the Copenhagen convention. Chief amongst these is a recommendation that legally binding emissions targets be put in place, and that the Taoiseach be held legally responsible for sticking to these targets.

As well meaning as these recommendations are, they simply don’t address the reality of the situation. First off, there’s no constitutional mechanism for the Oireachtas to set such immutable targets. Any bill which the Oireachtas passes to restrict itself and the government in such a manner can simply be amended at a later point, making it an effectively worthless guarantee of future behavior, especially when the composition of the Dáil and cabinet may be radically different by the time the guarantee is meant to take effect. The question also arises of what exactly happens if these “legally binding” targets are exceeded? The state can hardly levy a fine upon itself. The further recommendation of making the Taoiseach legally responsible makes equally little sense. It’s simply unworkable to make a single individual, who may be in office for only a couple of years, legally responsible for the results of a decades-long program which involves the entire economy.

Of course, this begs the question of exactly how a government can make long-term commitments to reduced emissions levels. With the possibility of a new government being elected in a few years with completely different priorities, it’s hard to take seriously any long term plans of this kind. Furthermore, the credibility of the targets, and not just the targets themselves, are vitally important if we want to ensure long term reductions in emissions. This is because the sort of decisions businesses take to reduce emissions often have effects long into the future, even if those decisions can only be made on information available now.
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House Prices – 27% Decline Yet To Come?

Published on 29 October, 2009. 3 Comments

For one reason or another, the housing market has been on my mind recently, and in particular the various guesstimates of how much further house prices have to drop, or if they’ve already bottomed out, as some buyers might like to believe. Hence, as I have a tendency to do in these sort of situations, I decided to throw a load of numbers into an Excel spreadsheet and make my own attempt at empirically forecasting what “stable” house prices might look like, and how far we have to go until we get there. In doing this, I’ve focussed on the ratio of house prices to the country’s per capita GDP, and how this ratio has changed over the years. It would be reasonable to expect this ratio to be quite stable over time; the amount people are willing to pay for a property should be proportional to their earnings at the time.

Using house price data from The Department of The Environment, and indexed with GDP data from the CSO, I’ve put together the following graph of the ratio of house prices to GDP in Ireland since 1976 (click for full size):

House Prices to GDP Ratio

The Department of the Environment provides two separate series of house prices, one for new houses and one for second hand houses. Over the past decade the price of new houses has been quite a lot lower than second hand houses, as new builds have primarily been apartments and small houses which would bring down the average. For this reason I’m going to focus on the prices of second hand houses (red line above), although I’ve included new houses (blue line) in the graph for completeness.

What’s immediately obvious from the graph is the house price bubble over the past decade, reaching a peak of over 9 times per capita GDP in 2006. There was also a similar bubble, although not nearly as pronounced, in the latter years of the 70s. In trying to gauge what a “stable” ratio might look like, it’s the inter-bubble years between these two that we should be looking at. As such, I would propose that a ratio of 6 or below be considered stable for the housing market. The ratio stayed below this level from 1985 to 1997, and, aside from a dip in the mid-90s, was pretty steady throughout. As can be clearly seen in the graph, if a ratio of 6 is stable, we’re still far from stable at the moment.

In order to estimate how much further house prices have to drop to get to a ratio of 6 times per capita GDP, I’ve worked on the assumption that both nominal house prices and GDP will bottom out at the end of 2010. I’ve used the ESRI’s projections of GDP for this year and the next in my calculations. After doing the sums, it seems that nominal second hand house prices will have to fall by a further 27.2% below Q2 2009 levels if they’re to reach a stable ratio to GDP by the end of next year. Of course, I’m using a ratio of 6 as an upper bound for stability; if the ratio was to reach as low as 4.91 (which it got to in 1995), then we could be looking at a drop of 40.4% in nominal prices instead.

This shouldn’t come as pleasant reading for anyone who has a vested interest in high property prices. Unfortunately, with the NAMA legislation now making its way through the Dáil, it won’t be long before we all have such a vested interest, which is becoming more worrying by the day.

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Abolishing the Seanad

Published on 18 October, 2009. 2 Comments

Fine Gael last night announced that, if elected, they’ll hold a referendum to abolish the Seanad. Right now is probably the perfect time to talk about reform of the way our system of government operates, as our Government and Oireachtas are almost completely incapable of dealing with the country’s fiscal and economic collapse, and public confidence in our elected representatives must be reaching an all-time low. Talking about the role the Seanad plays in the running of our country is a vital part of that, and discussions will inevitably come to either reforming the manner in which the Seanad is elected and operates, or getting rid of the Seanad and adopting a reformed unicameral parliamentary system if it’s deemed to make law-making more effective. These sorts of decisions are not to be taken lightly, as the choice of governmental system can have a profound impact on the country for generations to come.

Unfortunately, when Enda Kenny announced the party’s plan to abolish the Seanad, it wasn’t as part of an overarching review of our system of government, with a refashioning of the legislative branch carefully designed to be more effective at devising, amending and passing laws. It wasn’t advertised as a way to allow the country to cope better with the changed circumstances that we’ll have to deal with in the coming decades. Nope, the big headline reason given for abolishing the Seanad was that (along with reducing the Dáil by 20 members) it would save €150 million over the course of a Dáil term. That’s €30 million a year. To put that in perspective, the country’s current annual budget deficit is now approaching €30,000 million. So, Enda wants to make the biggest changes to the constitution in the history of the state, all for the sake of reducing our deficit by 0.1%.

Of course, Enda did hint to more political reforms as part of a “New Politics”, but it doesn’t inspire confidence that the headline reform is so blatantly populist. It also doesn’t inspire confidence that the whole process of devising a new legislative system for the nation has been fobbed off to the party’s environment spokesman, Phil Hogan, who doesn’t even sit on the Joint Oireachtas Committee on the Constitution, the body who’s job it is to discuss electoral reform.

By all means we should start talking about reforming the Oireachtas, in what it consists of, how it operates and how it’s elected. But that debate should be given the importance it deserves, and not simply used as a populist headline-grabbing stunt as Enda Kenny did last night.

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The Healy-Rae Criterion and Reforming Irish Politics

Published on 18 June, 2009. 8 Comments
The Healy-Rae Criterion and Reforming Irish Politics
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Hence, I propose a simple criterion to be applied to all proposals for reform of the Irish political system:
If Jackie Healy-Rae still gets elected to the national legislature under the new system, the reform hasn’t worked.
I don’t mean this to be an attack on Mr Healy-Rae himself, but rather an observation of the way in which his repeated election is symptomatic of wider problems across the political system.
Jackie Healy-Rae, by his own admission, is a Kerry politician, not a national politician. He works for the people of Kerry, makes sure Kerry is pothole-free, fights for funding for Kerry hospitals, amenities and infrastructure, and sorts anything and everything out for his Kerry electorate. Many would agree that this is hard work, and judging by his continued reelection, a lot of his constituents think that he’s doing it well. The problem is that it’s not his job.

Faith in the political system in Ireland is reaching an all-time low. With a government that thinks “legal obstacles” are an excuse for every occasion, and an opposition that believes the best way to deal with a massive budget deficit is to borrow more money, some people have started to call for a complete overhaul in how our leaders are elected. Indeed, I wouldn’t be surprised if these voices grow both in number and in volume over the coming months, as the gravity of our country’s situation begins to sink in. As this debate comes to the fore, I propose that everyone keeps in mind a simple criterion to be applied to all proposals for reform of the Irish political system:

The Healy-Rae Criterion

If Jackie Healy-Rae still gets elected to the national legislature under the new system, the reform hasn’t worked.

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In Defense Of Free Speech

Published on 29 April, 2009. 0 Comments

One of the greatest shames of the modern world is that, despite all our progress, there are still people who would deny the holocaust, there are still groups who preach religious hatred and violence and there are still those for whom racial and ethnic slurs are a part of their common vocabulary. This lack of compassion, lack of tolerance and lack of understanding of the world around us is undoubtedly a great concern, but of even greater significance is that there are governments the world over who think that the best way to deal with these people is to fine them, throw them in jail, or otherwise use the weight of government to silence them. In Minister Ahern’s proposed amendment to the Defamation Bill, he wishes to add Ireland to that group, with a fine of up to €100,000 for “publishing or uttering blasphemous matter”.

The case for restriction of freedom of speech, in any manner, rests upon a fundamental distrust of the populace at large. It assumes that those of us who hear or read such material will be swayed by its very existence. It assumes that we are incapable of reasoned argument, of factual rebuttal and compassionate defense. It attacks the very basis of a liberal democracy, that out of disparate views a society can wield oratory, persuasion and debate to reach a common ground of respect and tolerance.

The appropriate means with which to combat extremism and hatred is not to shut down discussion, but to promote it. It is to allow the great majority of the public to act as defenders of peace and decency; to argue the case of those who have been attacked and offended, and to condemn those arguments which would breach any reasoned morality. Above all, it is the government’s duty to trust its citizens to have these debates and emerge on the side of compassion and sense. If a government ceases to have that trust in its citizens, as ours has indicated with this amendment that it does not, then I would suggest that they are no longer deserving of having our trust in return.

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A New Approach Needed For Alcohol Licensing

Published on 22 April, 2009. 2 Comments

The attitude toward alcohol of many people in Ireland is, unfortunately, an irresponsible, unhealthy and antisocial one. We have some of the highest rates of  binge drinking and alcohol-related violence in Europe, yet perhaps the greater problem is that the entire basis on which our government attempts to ‘tackle’ drinking problems, from the intoxicating liquor bill of 1927 to its most recent amendment last year, has been to forego the carrot in favour of the stick, and ‘crack down’ on excessive drinking rather than encourage people to drink more responsibly. This view is not just held by the government itself, but also by opposition parties who routinely compete to look tougher on binge drinking and alcohol problems, with rarely a whisper on how to deal with them as the social and public health issues which they are. It is this fundamental misunderstanding, and even denial, of the realities of the situation by every political party in the country that has led to increasingly short-sighted and counter-productive attempts to address the problems.

We are in dire need of a new approach to the matter of alcohol licensing and alcohol laws, and how they affect the attitude the public has towards drinking. We must avoid the overly-simple view of young people’s attitudes towards alcohol that dominate current debate and look at the facts as they are to come up with a solution that accepts the realities of our current situation rather than glosses over them. Above all, we have to accept that there is no quick fix for the alcohol-related problems affecting our society and that it could be a generation before any truly progressive reform brings us to where we need to be. Our society and our culture will need a seismic shift, and that can only be achieved by a similar shift in the way in which the government approaches our problems.

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How Haughey Lost The Lisbon Campaign, And What The Government Can Do About It

Published on 14 April, 2009. 0 Comments

The Lisbon Treaty referendum last year could be described in pretty much every way as a complete and utter mess. The government put a long and complicated international treaty to referendum, through an unintelligible constitutional amendment, then completely failed to convey the actual implications in a clear and concise manner. The No campaigners proceeded to engage in scare tactics on a myriad of topics almost completely unrelated to the treaty, while the European institutions themselves showed a shocking lack of understanding of the Irish electorate throughout the campaign. The voters, understandably, refused to vote for something they couldn’t possibly be expected to understand, and the Lisbon Treaty has been in limbo ever since.

Oddly enough, the person most responsible for the whole debacle isn’t in fact any of the above, but rather a man who died before the Lisbon Treaty was ever written; Mr Charles J Haughey.

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An Economic Miracle Cure? The Case For A Negative Income Tax In Ireland

Published on 9 April, 2009. 1 Comment

Ireland is in the middle of what can only be described as a complete economic meltdown, with a recession to the tune of 8% of GDP, unemployment reaching into double digits, and a catastrophic decay in the public finances. Attempts to deal with these problems have unfortunately been limited to tinkering around the edges with marginal changes in the tax rates and limited cuts in public expenditure. The recent mini-budget has continued with this approach, and there have been very few proposals that have gone much further than creative accountancy when it comes to the budget, and little more than platitudes regarding a reduction in the unemployment rate, let alone anything that seriously addresses the collapse in GDP.

There is, however, a little known miracle cure that could do the trick for the Irish economy. It’s a relatively simple idea that could create 300,000 jobs, save the Government €2 billion, bring down the cost of living, dramatically increase Irish competitiveness and turn the corner towards economic growth. Sounds too good to be true? Perhaps it is, because nobody’s ever actually tried it.

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