Negative Interest Rates - How They Came About

Negative interest rates are well and truly with us here in Ireland with the news that Bank of Ireland are to begin imposing negative interest rates on pension funds that deposit cash with them. This means pension funds holding cash will be hit on the double (also inflation).

Here is a quick summary of how negative interest rates came about. Many articles that you will have read in the media about negative rates don't fully explain how we have got here, so this could be the first such article.

The ECB gave the game away here : 

Meanwhile, the first-order and tangible effect of Negative Interest Rates Policy on financial stability has been that it has enhanced it by improving the sustainability of outstanding debt.

There is nothing sustainable about the mountains of debt piled up, it is not possible to improve the sustainability of colossal amounts of debt except by eradicating it and preventing it from happening again by implementing high interest rates . Negative interest rates are actually doing the opposite - they help create new debt by making it so cheap. 

So, the main reason why negative interest rates are here is because spending is out of control in the EU and in Ireland and we are more reliant on debt than ever before.

The other main reason is because of Quantitative Easing (QE), or money printing. As you can see in the figure below, after QE, the commercial bank such as Bank of Ireland or AIB, holds more reserves with the central bank. The central bank has been charging negative interest rates for holding these reserves, so the commercial bank has no choice but to pass this on to consumers.   

 

So as economies in Europe become increasingly dependent on QE, the central bank will come under pressure to charge for holding these higher reserves, and the commercial banks will have no choice but to pass on these costs to consumers. 

This process of never ending debt and continuous QE is a feedback cycle, whereby more QE allows governments to borrow even more by offloading longer term bonds into the market. As you can see from the above, the pension fund sells their government bonds to the central bank to get the QE process going.

Negative interest rates are the direct consequence of this continuous cycle of QE and debt that has been the central policy of the ECB since 2014. Only recently are customers feeling the pinch from negative rates so we are in uncharted territory as to what will happen. But my prediction is that they are the harbinger of a very bad recession and widespread poverty. As it becomes clear that no real production is taking place and the high consumption levels are a mirage.

There is also a calamity coming when people retire, as savings are no longer being encouraged  and the alternative of investing in pensions are now being hit. The days of high interest rates are over but that also means prudence is over and that can only end one way. 

  

ECB Policy Keeps Afloat Economically Unviable Companies and Creates Market Bubbles - German Court Rules

The Supreme Court in Germany this week ruled that the European Central Bank's monetary policy, called the PSPP (Public Sector Asset Purchase Program) led to "the keeping afloat of economically unviable companies" due to the effect it had on maintaining low interest rates. 

As the PSPP lowers general interest rates, it allows economically unviable companies to stay on the market since they gain access to cheap credit.

Since 2015, the ECB have been buying up large quantities of government bonds, including high risk ones, distorting the EU market and propping up unsustainable debt and spending in the process. Contrary to what you may have read on some media outlets, this ruling has nothing to do with the emergency stimulus program initiated in response to the coronavirus crisis which I would argue was justified.  The PSPP program has been going on for five years. 

This blog was the first to reveal the shaky financial situation of many wind farms in Ireland. The ECB bond buying program we now learn was required to keep companies like these, aswell as banks, afloat. 

ECB bond buying is the sticky plaster of the EU. And it promotes unsustainable economic practices in direct contradiction with the EU's pledges to sustainability. 

The German court said this about the effects of the ECB program on banks :

Moreover, the effects of the PSPP on the banking sector must be taken into account. The programme affects balance sheets in the commercial banking sector by transferring large quantities of government bonds, including high-risk ones, to the balance sheets of the Eurosystem, which significantly improves the economic situation of the relevant banks and increases their credit rating. At the same time, it creates an incentive for banks to increase lending despite the low level of interest rates

The German Court also warned about the effects of the program on real estate and stock market bubbles :

Relevant economic policy effects of the PSPP furthermore include the risk of creating real estate and stock market bubbles as well as the economic and social impact on virtually all citizens, who are at least indirectly affected inter alia as shareholders, tenants, real estate owners, savers or insurance policy holders. For instance, there is a considerable risk of losses for private savings. This has direct consequences for (private) pension schemes and the returns they generate [...]. Both factors lead to, in part excessive, portfolio shifts [...], while risk premiums are in decline.

Artificial low interest rates was one of the main factors that led to the catastrophic building boom in Ireland. The EU and the European central banks clearly have not learned from these mistakes as history is repeating itself once again :

Real estate prices are on the rise with trends of sometimes particularly sharp increases – especially regarding residential property in major cities – [...], which possibly already come close to creating a “market bubble”, as the oral hearing confirmed. It is not for the Federal Constitutional Court to decide in the current proceedings how such concerns are to be weighed exactly in the context of a monetary policy decision; rather, the point is that such effects, which are created or at least amplified by the PSPP, must not be completely ignored. 

It then warns about the risky juggling act that the ECB is trying to keep up :

In addition, the longer the programme continues and the more its total volume increases, the greater the risk that the ESCB becomes dependent on Member State politics as it can no longer simply terminate and undo the programme without jeopardising the stability of the monetary union. 

The legal conclusions from all this are set out below, namely that the ECB never considered any negative effects from their policy and therefore acted disproportionately and ultra vires :

(2) In view of the considerable economic policy effects resulting from the PSPP – not all of which are discussed here –, it would have been incumbent upon the ECB to weigh these effects and balance them, based on proportionality considerations, against the expected positive contributions to achieving the monetary policy objective the ECB itself has set. It is not ascertainable that any such balancing was conducted, neither when the programme was first launched nor at a any point during its implementation; it is therefore not possible to review whether it was still proportionate to tolerate the economic and social policy effects of the PSPP, problematic as they may be in respect of the order of competences, or, possibly, at what point they have become disproportionate.

Neither the ECB’s press releases nor other public statements by ECB officials hint at any such balancing having taken place. For this lack of balancing and lack of stating the reasons informing such balancing, the ECB decisions at issue violate Art. 5(1) second sentence and Art. 5(4) TEU and, in consequence, exceed the monetary policy mandate of the ECB deriving from Art. 127(1) first sentence TFEU. cc)

The violation of the principle of proportionality is structurally significant. In this regard, the considerations set out above in relation to the Judgment of the CJEU in Weiss apply accordingly (cf. para. 124 et seq.). Therefore, the ECB’s actions amount to an ultra vires act.

Brookfield Renewables Sale Part 2

Canadian company Brookfield Renewables sold two wind farms to Greencoat Renewables last week - Knockacummer and Killhill. I took a look at Knockacummer in my last post. This time I will examine Killhill.  Things don't look any better from a financial point of view.

Killhill is outside Cashel in Co.Tipperary. It has sixteen Enercon 2.0 MW turbines and was commissioned in 2014. The latest accounts show operating profits for 2015 and 2016 but a net loss for both years after interest is accounted for. In fact, since it came into operation, it made a loss every single year  and now has accumulated losses of nearly € 900,000. It had net current liabilities of €3.2m and was completely dependent on financial support from Brookfield, the parent company, to meet it's debts. There were about €37m of loans outstanding by the end of 2016. 

Im speculating, but it could be that the banks will be paid out of the sale proceeds leaving the company completely financed by equity under Greencoat. This could account for the apparently large, but undisclosed, sale price of both wind farms. 

Canadian Company Sell a Loss Making Wind Farm for a Profit to State Backed Investors

A wind farm sold for a profit in the region of €7 million last year made a net loss of € 4 million in the latest accounts filed with the companies office for 2016.

The wind farm, Knockacummer, in Cork, has a capacity of 87.5MW, was commissioned in 2013 and has thirty five 2.5MW turbines. It was sold by Canadian company Brookfield Renewables.

It paid interest of € 12m (at 7.5%) in 2016, which was 54% of it's turnover. The interest was higher than it's operating profit which turned the profit into a net loss. It also made a net loss in 2015. 

At 31st December 2016, it was carrying Accumulated Losses of € 5.7m.

It's outstanding loans stood at €145m at end of 2016. €3.8m of which was written off by Brookfield during the year. The company was financed by loans from Brookfield, which in turn was financed by external loans. 

The buyer was Greencoat Renewables. Last year, the Irish State, through ISIF and AIB, acquired a 33% stake in the company. Which could potentially rise to 49%. 

Greencoat also bought another loss making wind farm, Lisdowney, last month. 

One has to question as to why the Irish State is helping to purchase loss making wind farms. Are we looking at another NAMA in the making ?

Are wind farms financially viable into the future ?

Loss making wind farm sells for € 22 million

Lisdowney wind farm in Co.Kilkenny is quite small at 9MW but it sold for a whopping 22.5 million last week to Greencoat Renewables. Although the company is solvent, the published accounts show it made a loss in 2017 of € 262,000 and € 59,000 the previous year. The accumulated losses now stand at €374,000. “This acquisition is in line with our strategy of acquiring high-quality wind farms in the Republic of Ireland, ” said Greencoat Capital.

There are signs that the days of lucrative profits for wind farm companies may be over. Gaelectric, one of the largest renewable companies in the country, are winding down and laying off staff. Windfarms owned by SSE Airtricity are also in financial difficulties. According to published accounts, Gartnaneane wind farm in Cavan and Meentycat in Donegal are both insolvent i.e. unable to pay their debts as they fall due. The financial statements state that both companies "are dependent on ongoing financial support from a fellow group company". Airtricity claims to provide 100% green energy to Irish homes, although quite how it separates the green electrons from the gas and coal generated electrons in the grid remains a mystery. 

The National Development Plan for 2040 states that ESB, Bord na Mona and Coillte are currently planning to invest in renewable energy technologies. These companies have about 15% of the overall operational wind farm fleet in the State. They plan to continue to invest, predominantly in wind generation, over the coming years.  

Derrybrien wind farm, one of the largest in Ireland, and owned by ESB made losses last year. Should these state run companies still be investing in unprofitable ventures ?

Liam Halligan points out in the Spectator that the era of easy money may be over and that it's no bad thing. Is there a big crunch on the way for wind farm companies ?

Ultra-low rates have also kept thousands of ‘zombie’ companies alive, so we have firms able only to pay debt-interest rather than clear actual debts. Around a quarter of a million struggling UK firms are in this situation, kept on life support by unnaturally low rates. Unable to invest and expand, they tie up resources that should be channelled into healthier firms. This helps to explain the low productivity and wages that have cursed the UK economy in the past ten years.