WHAT’S ON YOUR MIND? Steering the Ship of Fools, U.S. Paradox of Attitudes, World’s Most Secret Real Estate Bubble: Thoughts from EconoMonitor’s Hugh, Dolan and Deliveli

Steering the Ship of Fools
-Edward Hugh (Don’t Shoot the Messenger)

Ship of Fools is a renowned painting by Dutch artist Hieronymus Bosch. The work is considered to be an exemplification of the human condition. The ship depicted in the painting sets off from Basel, of all places, setting sail towards the Paradise of Fools. On board are a group of passengers who appear deranged, frivolous, oblivious to the fact the ship has no captain, and seemingly ignorant of their appointed destination.

Looking this weekend at the documentation associated with the latest set of Spanish stress tests I must confess to having experienced a similar feeling to the one aroused in me by gazing at copies of the Bosch painting.

What surprised me most of all was the role of the “so called” steering committee in the test process, since it was this committee which decided the make-up of the two tested scenarios. The committee’s brief included taking into account (but not, please note, following to the letter) the advice of an Advisory Panel, composed of ECB, IMF, national central bank and EBA representatives.

So just who was on this key Steering Committee? Well, the Chairman was the Secretary of State for Economic Affairs and Support for Business, Ministry of Economy and Competitiveness, the Vice Chairman was Deputy Governor of the Banco de España (Fernando Restoy), and the Secretary was a representative from the Banco de España. In addition there were two more representatives from the Banco de España, and two more from the Ministry of Economy and Competitiveness. Do you get the picture? These were all either representatives of the Bank of Spain or the Spanish government.

What am I getting at with all this rigmarole? Well, basically, my central point would be that the stress tests are not quite as independent as they are being made out to be.

Basically, the point is this, since all the models and assumptions (for things like probability of default, or loss given default) used by analysts in these kinds of tests are really very similar, you don’t need to be an Einstein to set the scenario parameters to fit them to the results you want to come out.  As one friend put by e-mail, “Once these main variables were decided they were passed on to the “independent” advisors and they plugged them into excel to derive the new capitalisation numbers.”

Let’s take an example. In the adverse scenario Oliver Wyman and Rolland Berger were asked to test for a 51% fall in the stock market. Such a fall sounds incredibly dire and would naturally be an important event, one which would have a substantial impact on the value of the banks own company shareholdings, but the effect would probably be slight on the key areas of developer loan or residential mortgage default. Even the wealth effect would be substantially different from the one to be expected in, say, the US, due to the much smaller relative importance of the Spanish stock market.

The unemployment assumptions, on the other hand, are not especially drastic – 25% for 2012, and 26% for 2013 – numbers not far from what are likely to be the actual values. Why might this be? Well unemployment levels are a key variable in all test models, since non-performing loan rates rise in tandem with unemployment levels. And this was on the strongly adverse scenario. On the baseline scenario unemployment was 23.8% in 2012 and 23.5% in 2013 (i.e. the rate improves) even though the economy is expected to contract 0.3% in 2013 under the scenario. How does the economy contract more and the unemployment rate go down?

Just to give us a feel for all this, the Spanish unemployment rate in March this year was 24.3%, i.e. already above the anticipated level for this year. So there is no way that these tests were truly “independent”, Oliver Wyman and Roland Berger did the best job they could with the inputs they were given, but they were given the inputs. I don’t think I have any doubt about the technical ability of Bank of Spain staff to run the models themselves. It is not their technical ability I doubt, it is what they are trying to achieve that puzzles me, hence the analogy with the Bosch painting made at the outset.

My opinion is that an important opportunity has been missed with these tests, the opportunity to use European support to do some really rigorous tests which would enable a major clean up of the Spanish banking system to take place, one which would ready it to for a return to its true function which is to provide credit, using normal risk criteria, to the private sector. The recapitalisation process currently being undertaken will not enable such credit to flow, and the big losers here will be ordinary Spanish citizens who will find their economy frozen for at least a couple of years more.

This is now the third such test to have been sponsored by the Bank of Spain, and while it clearly is a question of “if at first you don’t succeed….” I think it is already clear it won’t be a case of third time lucky.


Greeks with the Euro, Americans with healthcare – a Paradox of Attitudes
-Ed Dolan (Ed Dolan’s Econ Blog)

We in the United States can be a little condescending at times when discussing the paradox of Greek attitudes toward the euro: A strong majority of Greeks want to stay in the common currency, but few endorse the painful policies that would be necessary do so. For a dose of humility, we should contemplate the equally self-contradictory attitudes of our own electorate toward health care policy.

As the Supreme Court gets ready to announce its decision, a strong majority of Americans oppose the Affordable Care Act, especially the individual mandate, which provides an incentive for healthy people to buy insurance. At the same time, they favor other central provisions of the act, especially those that allow children to stay on their parents’ policies into their mid-20s and those that require private carriers to insure people with pre-existing health conditions. Economists’ repeated warnings that the private insurance system would collapse with a mandate to cover but no individual mandate to buy fall on deaf ears.

So far all of this has been a political problem mainly for Democrats, but House Speaker John Boehner is right to warn his Republican colleagues not to gloat if the court does overturn the law. The paradoxical attitudes of voters will then become a political problem for the Republicans. They have been promising “repeal and replace,” but if Obamacare goes by the wayside, they will be forced to answer the question, Replace with what?

Many Republicans say that they would like something more market oriented, some kind of system in which health care consumers would share enough of the costs to become wise shoppers. What they don’t always realize is how radically the existing fee-for-service system would have to be reformed to make that possible. An article by Tara Siegel Bernard in Saturday’s New York Times brings home just how far we are now from such a system. Bernard provides graphic examples of how capricious and opaque the pricing policies of health care providers now are. She quotes Princeton economists Uwe Reinhart, who says, “I have always found a bit cruel the much-mouthed suggestion that patients should have ‘more skin in the game’ and ‘shop around for cost-effective health care’ in the health care market, when patients have so little information easily available on prices and quality to do those things.”

The reforms necessary to bring transparency to pricing will bring would-be GOP reformers up against another core paradox of the U.S. health care system that Reinhart has emphasized: The total cost of health care is, by definition, equal to the total revenue of health care providers. Anything that makes it easier for consumers to avoid overpriced or ineffective services will necessarily reduce that revenue and will meet fierce resistance from the army of lobbyists that providers are able to mobilize.

Yet, if “repeal and replace” would bring Republicans under fire by forces that have in past been friendly to them, “repeal and ignore” won’t fly either. GOP and independent voters won’t be any happier than Democrats when their college-age, diabetic children are left without the health care coverage the Affordable Care Act has given them, or when the failed employer-based insurance system continues its slow-motion collapse. It is indeed a paradox.


The World’s Most Secret Real Estate Bubble
-Emre Deliveli (The Kapalı Çarşı: Emre Deliveli’s blog on the Turkish economy)

It is tough to argue that there is a real estate bubble in Turkey, especially if your definition of bubble is based on what happened in Spain and the U.S. Home prices have not really increased a lot in the last couple of years.

However, as I argue in my latest Hürriyet Daily News column, prices are subdued exactly because there is a flush of new housing hitting markets every month. This residential supply boom partly reflects the country’s good growth prospects and comparatively sound macronomic fundamentals. But as I detail in the column, it is also the result of the major contractors’ and banks’ unsound business practices.

There is no reason to panic: The difference between residence and occupancy permits, a gauge for the supply-demand gap, has fallen significantly since the IMF rang alarm bells one and a half years ago, and is only slightly positive, according to the latest statistics from March. Besides, Turks are very loyal to their debts: Many people would do everything not to default on their mortgages. And mortgages and construction lending, as a share of GDP, are very small.

Click to enlarge

However, the official statistics are lagging behind 3 months or so, and the head of the Association of Real Estate Investment Companies, who obviously has access to real-time data, recently said that home sales are currently down 20-25 percent. Therefore, it is best to watch the Turkish residential property market closely, me thinks…




3 Responses to "WHAT’S ON YOUR MIND? Steering the Ship of Fools, U.S. Paradox of Attitudes, World’s Most Secret Real Estate Bubble: Thoughts from EconoMonitor’s Hugh, Dolan and Deliveli"

  1. John Tepper Marlin   June 25, 2012 at 10:13 pm

    Is Istanbul going to look at property taxes as a future source of revenue to meet rising needs? My impression was that a large part of land is government owned but privately occupied. Housing went up overnight and then by law the residents can't be evicted.

  2. Blake   June 25, 2012 at 10:26 pm

    "The total cost of health care is, by definition, equal to the total revenue of health care providers."

    This is not correct. A great deal (perhaps $100 b) of expenditures go to profits for private insurance, hospital chains, and device and drug manufacturers and their investors… it's hard to call them "providers." But you are correct that if you try to reduce costs many many powerful, wealthy interests will raise hell.

  3. Frank Youell   June 26, 2012 at 2:44 pm


    Turkey is heading for a harsh fall. See "Turkey posts record current account deficit " (http://www.hurriyetdailynews.com/turkey-posts-record-current-account-deficit.aspx?pageID=238&nID=13690&NewsCatID=344)

    “The current account deficit is still close to 10 percent of gross domestic product (GDP) […] but with the expected slowdown in the economy in 2012, we expect to see a slight narrowing in the deficit,” said Oyak Investment’s economists Mehmet Besimoğlu and Gülay Girgin in a written note. They predict the current account deficit to narrow to $55 billion, roughly 7.5 percent of GDP in 2012."

    Large CA deficits strongly predict future problems. See Greece, Spain, Ireland, etc. Actually, see the USA (6%+ under Bush before the crash).