2009
The Irish Property Bubble and its Consequences
January 12, 2009
http://www.irisheconomy.ie/Crisis/KellyCrisis.pdf - PDF
http://www.irishtimes.com/newspaper/opi ... 61333.html
Piling Anglo losses on to national debt risks bankrupting the State
January 20, 2009
ANALYSIS: Anglo
Irish is poisoning the banking system and is of no systemic importance.
It must not be nationalised; it must be allowed to collapse and with it
the developers at the heart of the problem, writes Morgan Kelly
YESTERDAY’S
CATASTROPHIC collapse of Irish bank shares stems directly from the
Government’s proposal to nationalise Anglo Irish Bank. With the
Government’s finances already buckling under the collapse of our bubble
economy, financial markets began to fear that with the added burden of
Anglo’s debt, the Irish State cannot afford to finance itself, let alone
support the remaining national banks.
Facing the imminent
collapse of the national financial system, the Government needs to
perform a ruthless triage. The worthwhile banks need to be maintained by
any means necessary, including nationalisation, while Anglo Irish and
Irish Nationwide must be allowed to collapse.
What began as farce
has turned swiftly to catastrophe. Last September the Government
casually decided to give a small dig-out to some developer pals by
guaranteeing the liabilities of Anglo Irish Bank. This spiralled into a
proposed nationalisation that would saddle Irish taxpayers with Anglo’s
bad debts, which could easily exceed €20,000 per household, and starve
the other, worthwhile, banks of the capital they need to survive.
At
the original crisis meeting on September 29th, Brian Cowen claimed that
the blanket guarantee to all six banks was given “on the basis of the
advice from those who are competent to so advise the Government”.
That does not appear to have been the case.
According
to a source of mine very familiar with what happened at the meeting,
extending the liability guarantee to Anglo Irish and Irish Nationwide
was strongly opposed by representatives of the Central Bank and the
Department of Finance (who reportedly came into the meeting with a draft
Bill to rescue only four institutions). However, I am told they were
overruled by the Taoiseach and the Minister for Finance, who were
supported by the Financial Regulator and the Governor of the Central
Bank on the grounds that a sudden liquidation of Anglo’s assets would
not be in the national interest.
It is still worth asking what
would have happened if Brian Cowen had listened to the Department of
Finance and allowed Anglo Irish to sink? The answer is: very little.
Developers
would have gone bust and commercial property would have become more or
less worthless, but that is going to happen anyway, with or without
Anglo Irish. Depositors of Anglo Irish would have been paid off in full,
and the hit would have been taken by the international financial
institutions that hold around €22 billion of its bonds.
These
bondholders are professional institutional investors who signed up for
higher returns on Anglo debt in the knowledge that they were facing
higher risks. They are, moreover, insured against their losses through
insurance contracts called Credit Default Swaps.
This is the
central point about the bailout of Anglo Irish, and one that has not
received any attention: the only effect of a bailout is that the Irish
taxpayer will make up the losses of Anglo Irish’s bondholders instead of
the insurers who had already been paid to underwrite the risk.
Why
it is necessary to transfer Anglo’s losses from the writers of Credit
Default Swaps to the Irish taxpayer is something that the Government has
not thought to justify.
Indeed, what has been disturbing about
the entire Anglo affair is that at no stage has the Government felt it
necessary to explain why any bailout was needed, beyond inchoate
mutterings about the “systemic importance” of Anglo Irish.
The
reality is that Anglo has no importance in the Irish financial system.
It existed purely as a vehicle for a few politically connected
individuals to place reckless bets on the commercial property market.
These property speculators may be of systemic importance to the finances
of Fianna Fáil, but their significance ends there.
In ordinary
times, piling €30 billion of Anglo Irish losses on to the national debt
would be painful and pointless but not impossible. These however are not
ordinary times. International debt markets are flooded with governments
trying to borrow. The other Irish banks are dangerously short of
capital. Most importantly, the Irish economy and government finances are
collapsing.
Ireland’s growth during the last decade was largely
illusory, generated by a property bubble fuelled by reckless bank
lending. In 2007 an incredible 20 per cent of our national income and
employment came from building houses and commercial property. Next year,
the percentage will be approximately zero.
The only
industrialised economy that has endured a property and banking crash
remotely comparable to what we are beginning to experience was Finland
in 1991, where national income fell in total by 15 per cent and
unemployment rose by 12 percentage points. As the private sector
haemorrhages jobs it is hard to see how Irish national income will fall
by less than 20 to 25 per cent in the next few years. Unemployment will
easily reach 15 per cent by the end of the summer, and 20 per cent by
next year, and will not start to fall until recovery in Britain and
elsewhere permits mass emigration to resume. The economy will not begin
to grow until real wages fall to competitive international levels, a
process that will probably take a decade.
In other words, the
Irish economy is facing a decade of stagnation and mass unemployment of
the same magnitude as the 1980s, with the difference that the unemployed
now have mortgages, car loans and maxed-out credit cards. Faced with an
irreversible contraction on this scale, the Government will have grave
difficulty borrowing to fund its ordinary expenditure, even after
draconian cuts in spending and increases in taxation. In the view of
international investors, piling Anglo Irish’s gambling losses on top of a
spiralling national debt could easily suffice to sink the Irish State
into bankruptcy.
In this national crisis, what should be done?
The answer is simple. The State must do everything to rescue AIB, Bank
of Ireland and Permanent TSB, and let Anglo Irish and Irish Nationwide
sink.
The Government must continue to guarantee all deposits at
Anglo Irish while announcing that, in the light of continuing
revelations of misconduct in the bank and shortcomings in its auditing
procedures, it will enter into negotiations with senior and unsecured
bondholders.
The proposed Anglo nationalisation marks a decisive
watershed in Irish democracy. With it, an Irish government has coolly
looked its citizens in the eye and said: “Sorry, but your priorities are
not ours.”
It is to be hoped that the collapse of other bank
shares will serve as a warning to deter the Government from this
catastrophic course. I would therefore urge any TDs and Senators who
still believe that the Irish State exists to act in the interests of its
people to vote against the nationalisation of Anglo Irish and do
everything to protect the other banks.
Morgan Kelly is professor of economics at University College Dublin.
Corrections & Clarifications - Published January 22nd
In
this article, it was stated that the Minister for Finance Brian Lenihan
had failed to follow advice received from representatives of the
Central Bank and the Department of Finance at a meeting on September
29th 2008 at which the Government decided to guarantee the deposits and
certain identified liabilities of six named financial institutions.
It
was also stated that a Bill to rescue only four institutions was before
the Government on that occasion. In fact, the Bill was the same as that
passed by the Oireachtas this week, being a Nationalisation Bill. The
Irish Times notes the unequivocal statement by the Minister for Finance
in the Dáil on Tuesday confirming the correct factual position and we
are happy to set the record straight and withdraw any suggestion of
corrupt motives on the part of the Minister.
http://www.irishtimes.com/newspaper/opi ... 78003.html
Bank guarantee likely to deal a crippling blow to the economy
February 17, 2009
ANALYSIS: Government borrowing is not an immediate problem, but the extent of banks’ bad debts may prove catastrophic, writes MORGAN KELLY
BETWEEN
COLLAPSING house prices, bankrupt banks and spiralling unemployment,
you might be forgiven for thinking that fate has already dealt Ireland
every misfortune in its hand. However, there may be one more unpleasant
surprise in store for us, the prospect that international investors
unexpectedly stop lending to the Government.
Economists call this
a “sudden stop”. The original sudden stop occurred in 1998 when a
default by Russia panicked lenders away from Latin America and plunged
their economies into prolonged crisis.
The consensus among Irish
economists is that government borrowing is not an immediate problem.
Ireland has a low level of public debt by international standards, and
even a few years of heavy borrowing will still leave it below Greek and
Italian levels.
To understand why this view is too complacent,
imagine that you are a bank manager and somebody that we will call Brian
(not his real name) comes in looking for a loan.
Brian’s income
is €30,000 and he would like to borrow €20,000 to cover living expenses.
This sounds like a lot in these nervous times but, because Brian is not
carrying much debt, you think you might lend to him.
However,
Brian then lets it slip that, because his income is falling sharply, he
will need to borrow at least as much each year for the foreseeable
future. He also admits that, late one night and for what seemed like
good reasons at the time, he somehow agreed to insure the gambling
losses of some “banks”.
Brian has no idea how large these losses
might be, but is starting to fear that they might be substantial. At
this stage, you realise that Brian is on a trajectory into bankruptcy
and show him the door.
Multiply the numbers in this story by a
million and you begin to understand why Ireland makes bond markets
nervous. First, the Irish economy is heading into a severe and prolonged
slump that will force the Government to borrow heavily at a time when
markets are increasingly reluctant to lend heavily.
Secondly, the
Government’s delay in revealing how much its bank liability guarantee
is likely to cost is making markets suspect that the final bill will be
crushing.
After a decade of a credit-fuelled property bubble, the
economy is not so much crumbling as vaporising: were we the size of
Britain, January’s rise in unemployment would have been over half a
million.
As the economy collapses, so does the Government’s tax
revenue. This year the Government will have to borrow about €20 billion –
everything it spends on wages or on social welfare – or about 15 per
cent of a falling national income.
With no chance that the
hopelessly uncompetitive economy will recover in the next five years and
little sign that the Government has any appetite for serious cuts in
spending or increases in taxation, borrowing looks set to continue at
around this level for the foreseeable future.
If this borrowing
was the limit of the Government’s liabilities, Ireland would probably
just about weather the storm in the bond markets. Unfortunately, an
elephant is lurking in the corner in the form of the bank liability
guarantee, and this looks increasingly certain to sink the economy.
In
my view, the Government has made insufficient effort to estimate how
much its banks have lost. We have therefore had the bizarre experience
of nationalising Anglo Irish Bank and recapitalising Allied Irish Banks
and Bank of Ireland without knowing precisely the extent of their bad
debts.
The Government has not updated its estimate of losses
since Brian Lenihan’s boast that the liability guarantee was “the
cheapest bailout in the world so far”, an assurance that already ranks
in the annals of supreme political irony alongside Neville Chamberlain’s
“peace in our time”.
The ability of the State to continue
funding itself ultimately depends on the size of these bad debts. If
they are of the order of €10–€20 billion, we will survive. If they are
of the order of €50-€60 billion, we are sunk.
Irish banks could
easily lose this much. If we suppose that most of the €20 billion lent
to builders will not reappear this side of Judgment Day, along with 20
per cent of the €90 billion lent to developers, and 10 per cent of the
€120 billion in mortgages, then we are already up to €50 billion.
These
are only guesses. However, the continuing stream of revelations from
Anglo Irish – which bear out the old investment dictum that there is
never just one cockroach in a kitchen – suggest that they could be
optimistic guesses.
To see what would happen to Ireland if
foreign lenders suddenly pull the plug, we only need to look at what
happened in Latvia last December. We would be forced to seek an
international bailout, with the International Monetary Fund and European
Union playing bad cop and good cop. We could expect cuts of one-quarter
to one-third in public sector wages and social welfare benefits, and
draconian tax rises to bring the deficit back to around 5 per cent of
national income in two years.
There is actually a worse scenario
where international bond markets suffer a general panic, like 1998. Not
only does Ireland gets torpedoed, but also Portugal, Italy, Greece,
Spain and Austria. The IMF and EU simply would not have the resources to
bail out so many economies and we would be entirely on our own.
In
circumstances where the Government could not even pay public sector
salaries, the bank guarantee would immediately become worthless and we
would see an uncontrollable run on all the Irish banks.
Watching
the ineptitude and complacency of Lenihan’s bank bailout, we can
understand increasingly how the people of New Orleans must have felt as
they watched George Bush rescue their city: “Brianie: you’re doing a
heck of a job.”
Particularly galling are the Government’s efforts
to feign surprise and indignation at the behaviour of the banks, when
the reality is that this is how we have always done business here. All
that the Anglo affair has done is to hold up our grubby brand of crony
capitalism for international ridicule.
For increasing numbers of
ordinary people, the Irish economic miracle has turned out to be as
worthwhile as a share in Bernard L Madoff Investments.
In return
for working hard and paying their taxes, the lucky ones who keep their
jobs can now look forward to pay cuts, negative equity and savage tax
rises; while the unlucky ones face prolonged unemployment and losing
their homes, their cars and everything for which they have worked.
If,
on top of this, we suffer a sudden stop, people will see their pensions
and Government spending slashed to pay off the gambling losses of Seán
FitzPatrick and his pals. The Irish social fabric would certainly rip
and unprecedented civil disorder ensue.
Bill Clinton’s feared
enforcer James Carville once said that he would like to be reincarnated
as the bond market, because that way you get to intimidate everyone.
Without
decisive and intelligent Government action in the next few weeks, by
the end of this year we will understand exactly what he meant.
http://www.irishtimes.com/newspaper/opi ... 65637.html
Brought to our knees by bankers and developers
July 3, 2009
OPINION: Nama
is in effect Fianna Fáil’s shrine to the property bubble for which the
party still yearns. Prepare to pay 10 per cent more in income tax for
the next 10 years to pay for it all . . . we are headed for national
bankruptcy, argues MORGAN KELLY
WRITING
HERE two years ago, I pointed out that the exuberant lending of Irish
banks to builders and property developers would sink them if the
property bubble burst. Since then, the bubble has burst, the banks have
sunk, and we are all left wondering how to salvage them.
Two
ideas for fixing the banks have been suggested: a bad bank or National
Asset Management Agency (Nama) and nationalisation. While these
proposals differ in detail, their impact will be identical. Irish
taxpayers will be stuck with a large bill, and in return will get an
undercapitalised and politically controlled banking system.
A far
more efficient and cheaper alternative to Nama is to copy what Barack
Obama did with General Motors, and transfer ownership of Irish banks to
their bond holders. In this way we can achieve well capitalised banks,
run without political interference, at minimal cost to taxpayers.
By
converting a portion of Allies Irish Banks’ approximately €40 billion
of bonds, and Bank of Ireland’s €50 billion, into shares, each
institution can be recapitalised. Transferring ownership to bond holders
will not cost the taxpayer a cent and will avoid interminable legal
battles over the transfer of assets to Nama.
While the shaky
state of Irish banks had been worrying investors since early 2007, when
the crisis finally broke in late September the Government was taken
completely by surprise and reacted with blind panic. Faced with a run on
Anglo Irish Bank by institutional depositors on September 29th, the
Government was stampeded into guaranteeing virtually all liabilities,
except shares, of the six Irish banks.
This guarantee contained
two obvious but fundamental flaws. Everything that has happened since –
the proposed recapitalisation of Anglo, the nationalisation of Anglo,
the establishment of Nama – can be understood as the Government
scrambling to catch up with the consequences of these two errors.
The
first mistake was to guarantee not only deposits – which had to be
guaranteed – but also most of the existing bonds issued by banks to
other financial institutions. Bond holders receive higher returns in the
knowledge that they are accepting the risk of losses on their
investment. In addition, unlike depositors who can scarper, existing
bond holders are effectively stuck.
It made no sense for the
Government to insist that taxpayers would take the hit on any bank
losses instead of the financial institutions that had already entered
legal contracts to do so.
The second mistake was to extend the
guarantee to Anglo Irish and Irish Nationwide. As specialised property
development lenders with incompetent management, they were at risk of
heavy losses as their market collapsed, and fulfilled no role in the
wider economy.
In making the guarantee on September 29th, I do
not doubt that the Government believed that the difficulties of Irish
banks ran no deeper than temporary liquidity problems stemming from the
international crisis. However, as it has become apparent that Anglo was a
mismanaged wreck, with AIB and Bank of Ireland scarcely better, the
Government has stuck with the mantra that all banks are equally
important and equally worth saving at any cost to the taxpayer.
Brian
Lenihan and Brian Cowen are happier to dice with national bankruptcy
than lose face by admitting that they were misled about the state of
Irish banks last September.
Nama, then, is the latest twist in
the Government’s increasingly bizarre efforts to save the Irish banking
system while claiming that it does not really need to be saved.
Underlying
Nama is the delusion that the collapse of our property bubble is a
temporary downturn. In a few years time when the global economy recovers
we will be back building houses like it was 2006. All the ghost
estates, empty office blocks, guest-less hotels and weed choked fields
that Nama has bought on our behalf will once again be worth a fortune.
The
reality is that, because of our surfeit of empty housing, there will be
almost no construction activity for the next decade. Empty apartment
blocks in Dublin will eventually be rented, albeit at rates so low that
many will decay into slums. However, most of the unfinished estates that
litter rural Ireland – where the only economic activity was building
houses – will never be occupied.
Nama is a variant on the “Cash
for Trash” scheme briefly floated in the United States last year where
the government would recapitalise banks by overpaying for their bad
loans. Our Government is proposing to buy €90 billion of loans and will
reportedly pay €75 billion for them.
The International Monetary
Fund (IMF) guesses that Nama will cost us €35 billion, and this is
probably optimistic. The narrowness of the Irish property market meant
that banks effectively operated a pyramid scheme, bidding up prices
against each other. Now that banks cannot lend, development assets are
effectively worthless.
The taxpayer is likely to lose well over
€25 billion on Anglo alone. Among its “assets” are €4 billion lent for
Irish hotels, and almost €20 billion for empty fields and building
sites. In fact, I suspect that the €20 billion already repaid to the
casino that was Anglo represents winners cashing in their chips, while
the outstanding €70 billion of loans will turn out to be worthless. And
it is well to remember, as the architects of Nama have not, that
although the problems of Irish banks begin with developers, they do not
end there.
The same recklessness that impelled banks to lend
hundreds of millions to builders to whom most of us would hesitate to
lend a bucket; also led them to fling tens of billions in mortgages, car
loans, and credit cards at people with little ability to repay. Even
without the bad debts of developers, the losses on these household loans
over the next few years will probably be sufficient to drain most of
the capital out of AIB and Bank of Ireland.
Brian Lenihan’s largesse to bond holders could cost you and me €50 to €70 billion. What do numbers like these mean?
The
easiest way to put numbers of this magnitude into perspective is to
remember that in 2008 the Government generated €13 billion in income
tax. Every time you hear €10 billion, then, think of paying 10 per cent
more income tax annually for the next decade.
In other words, the
fiscal capacity of a state with only two million taxpayers, and falling
fast, is frighteningly thin. Ten billion here, and ten billion there
and, before you know it, you are talking national bankrutcy. Even
without bankrupty, Nama will ensure a crushing tax burden for everyone
in Ireland for decades.
The tragedy is that, were it not for the
Government’s botched efforts to save financiers from the predictable
consequences of their own greed, the Irish economy would have recovered
far more quickly than most people, including the IMF, expect.
Recovery
for the Irish economy will not be easy – there is no painless way for
an economy to move from getting about 20 per cent of its national income
from construction to getting about zero – but the flexibility of the
Irish labour market would have ensured that our incomes and share of
global trade would have rapidly recovered. Now, however, any fruits of
recovery will be squandered on Nama.
Aside from the fact that
Nama will spend huge sums to achieve little, its governance is
problematic. Here, the fog of secrecy that has quietly settled over
Anglo Irish since nationalisation sets an unsettling precedent.
After
revelations of financial irregularities forced the resignation of three
executive directors, Anglo moved decisively to replace them with . . .
Anglo insiders. Most astonishing, in the light of the scandal over Irish
Nationwide deposits, was the decision to replace Anglo’s disgraced
financial director with his immediate subordinate, Anglo’s chief
financial officer.
It is hard not to conclude that a deliberate
decision has been made at the highest level of Government that what
happened in Anglo, stays in Anglo. And we can expect Nama to be run in
the same tight manner.
While there has been considerable
speculation about dark motives for bailing out developers and banks, I
do not believe that the Government’s behaviour has been corrupt: it has
been far worse. At least corruption implies a sense that you are doing
wrong, and need to be paid in return. Our Government actually thought it
was doing the right thing in risking everything to safeguard the
interests of developers who had given us an economy that was the envy of
Europe.
Instead of recognising bankers and developers as
parasites on our national prosperity, the Government came to see them as
its source. While everyone else in Ireland has come to see the past
decade as an embarrassing episode of collective insanity to be put
behind us as soon as possible, the Government still sees it as the high
point of our nation’s history. Nama is effectively Fianna Fáil’s shrine
to the bubble, and likely to be an expensive and enduring one.
What
should be done instead of Nama? First, we need to understand how the
idea of Nama follows from a mistaken analogy with the Swedish banking
crisis and bad bank of the early 1990s. The Swedish banks differed in
one fundamental way from ours: they only had deposits as liabilities. If
their government had not taken over their bad debts, ordinary
depositors would have suffered. By contrast, Irish banks had borrowed
heavily from other financial institutions through bonds, and these
bondholders originally agreed to take losses if Irish banks got into
difficulties.
By placing the costs of the banking collapse
primarily on existing holders of bank bonds, the State can improve its
credit rating and pull back from the edge of bankruptcy. Knowing that
taxpayers are not liable for the losses of AIB and Bank of Ireland will
make capital markets more willing to lend to the Irish State.
Instead,
like a corpulent Tooth Fairy gently slipping billions under the pillows
of sleeping bond holders, Brian Lenihan has chosen to extend the
liability guarantee and further weaken the bargaining position of the
State.
The drift into national bankruptcy looks increasingly unstoppable.
http://www.irishtimes.com/newspaper/opi ... 55311.html
Overpaying for Nama may hit taxpayer for €30bn
September 15, 2009
MORGAN KELLY
ANALYSIS:
Government estimates of Nama valuations appear implausible, are out of
line with other property collapses and may impose massive losses on the
taxpayer
WHAT HAS been dismaying about the recent acrimonious
exchanges over Nama is that neither side seems to feel it necessary to
produce any evidence to support its assertions about its likely cost to
the taxpayer. Like most discussions in Irish public life, the Nama
debate seems set to generate more heat than light.
If we want to
make sensible predictions on the likely course of Irish property prices
over the next decade, we need to see what has happened historically in
the aftermath of similar booms. In other words, we need to find property
booms where sharp increases in bank lending caused real prices to more
than double.
In Ireland, between 1995 and the peak of the boom in
2007, the average price of housing and commercial property roughly
tripled, adjusting for inflation, while disposable incomes increased by
one half.
Two previous booms fit this pattern closely: Japanese urban land in the 1980s, and Irish agricultural land in the late 1970s.
In
Japan between 1985 and 1990, the real price of commercial land in major
cities tripled, while the price of residential land doubled. What makes
the Japanese case particularly relevant to Ireland, as I pointed out
here two years ago, is that at the peak of their bubble, Japanese banks
had the same extreme exposure to development and construction loans – 30
per cent of their lending – as Irish banks did in 2007.
As
Japanese banks buckled under bad property debts, lending fell sharply
and prices with it. By 2005 – 15 years after the peak – residential land
had fallen back to its pre-bubble level, while commercial land had
fallen by nearly 90 per cent. Given that many people are claiming that
Irish property prices will recover once the economy starts to grow
again, it is interesting to note that Japanese property prices collapsed
while the economy continued slowly to expand: real output in Japan rose
20 per cent between 1990 and 2007 and did not fall in any year during
this period.
The next case is much closer to home but almost
forgotten: the boom and bust in Irish farmland prices in the late 1970s.
After joining the EEC in 1973, Irish banks began to lend heavily to
farmers. As a result, the inflation adjusted price of agricultural land
tripled between 1975 and 1977, reaching a peak equivalent to €14,000 per
acre in 2009 prices. Real Irish GNP in 1977 was about one third of its
present level, so this price is roughly equivalent to €50,000 per acre
in current purchasing power for land with no development potential. For
comparison, during the recent boom, when agricultural land prices were
driven by demand for potential development, prices peaked in 2006 at an
average of €21,000 per acre nationally.
The bubble quickly burst
as farmers ran into difficulties servicing loans: between 1977 and 1980
real prices fell by around 75 per cent, and remained at this level, more
or less where it had started in 1973, until 1995, 18 years after the
peak.
These examples illustrate a general principle: property
bubbles are the consequence of abnormal levels of bank lending. Once the
bank lending that fuelled the boom returns to its usual levels, prices
return roughly to where they started before the boom.
In ordinary
times, property prices grow at the same rate as national income: people
in industrialised economies spend much the same fraction of their
income on housing as they did a century ago.
However, a surge in
prosperity, which drives property prices higher and encourages banks to
lend more on appreciating assets, can lead to a self-reinforcing cycle
of rising prices and rising lending.
Eventually, banks get a
fright and return to levels of lending they used to regard as prudent,
causing prices to fall back to where they were before the bubble. Just
like Irish farmland in the 1970s, and Japanese property in the 1980s,
our recent property boom was the product of unsustainable bank lending.
Between
2000 and 2007, while nominal GNP rose by 77 per cent, mortgage lending
rose from €24 billion to €115 billion, lending to builders from €2.4
billion to to €25 billion, and to developers from €5 billion to €80
billion. Should the usual post-bubble correction occur in Ireland, it
would suggest that real prices of residential and commercial property
would return to their levels of the mid-to-late 1990s, two thirds below
peak values.
Already the Irish property market has seen unusually
sharp falls by international historical standards. The Sherry
FitzGerald house price index is down 35 per cent nationally, and 42 per
cent for Dublin; while the Society of Chartered Surveyors estimate that
commercial property prices have fallen 48.6 per cent from their peak;
and Knight Frank estimate that farmland prices, which were driven by
their development potential, are down 45 per cent from their peak but
are still twice those of comparable UK land.
Despite these large
falls, which already exceed the one third haircut on Nama assets
rumoured to be proposed by the Government, the property market remains
moribund. Property transactions, measured by stamp duty receipts, are
two thirds down on this time last year, and 80 per cent lower than two
years ago.
In other words, if nobody is buying despite large
falls in price, then price needs to fall considerably further to reach
its long-run equilibrium.
The impression that Irish property
prices are still considerably above long-term value is reinforced by
rental yields: the ratio of the rent you get from a property to the
price you paid for it. As many of you have discovered to your cost,
property is a risky asset that performs particularly badly during
economic downturns. To compensate for this fundamental risk, property
should earn a long run rental return of at least 8 per cent.
Despite
some of the highest rents in the world at the peak of the bubble
(according to Lisney, Dublin ranked as the second most expensive
location for industrial property and ninth for offices, with Grafton
Street coming in as the fifth most expensive retail street on earth),
new residential and commercial property was earning a paltry rental
yield of 3-4 per cent.
This means that, to restore long-run equilibrium, prices needed to halve from peak levels, or rents to double.
Suppose
for a moment that the Government’s assertions are correct, and the
long-run value of Irish property is two thirds of its peak value. In
order for rental yields to rise from an unsustainable 4 per cent to a
long-run equilibrium of 8 per cent, the Government needs rents to rise
one third from their already extreme peak values.
In fact,
instead of rising, rents have fallen, and nearly as sharply as prices.
The Irish Property Watch website estimates that residential rents have
fallen by 32 per cent since May 2008; while Lisney estimate that
commercial rents have fallen 24 per cent from peak, with office rents
down 35 per cent and now lower than they were a decade ago.
Again,
these large falls have not been sufficient to restore equilibrium. The
number of rental properties listed on Daft.ie has risen from 5,000 at
the start of 2007 to nearly 25,000 now, while the average time to rent a
property is now 76 days.
For offices, HWBC estimate that
lettings are running at one fifth of their rate last year; while Lisney
calculates that one fifth of Dublin offices are now empty (something
they describe as “startling”) and one third in west Dublin.
The
usual post-bubble correction in property prices is likely to be
aggravated in Ireland’s case by large falls in national income, and the
dislocation in the banking system and Government finances, caused by the
collapse of our unusually large construction boom.
The effective
ending of new construction activity, collapsing consumption, rising
taxes and cuts in Government spending all make the 15 per cent
contraction in GNP forecast by the ESRI and others look optimistic. The
fall in national competitiveness and likely continuing difficulties in
the banking sector make the prospect of a swift national recovery seem
problematic.
What we have seen then is that as the abnormal
lending that fuelled the property boom returns to its normal level,
Irish property prices should fall back to their pre-bubble values, at
around one third of their peak values.
In the absence of evidence
to support it, the Government’s claim that €90 billion in developer
loans are backed by €120 billion in assets appears implausible. While
five-year developer loans were the norm, properties were usually flipped
on after two years, meaning that existing loans were mostly taken out
at peak prices.
In addition, while loans were supposedly 70 per
cent of property value, the collateral supplied was usually equity in
other property or personal guarantees, both now worthless.
It
appears, therefore, that, by paying an average of two thirds of the face
value for Nama assets, the Government is likely to impose severe losses
on taxpayers of the order of €30 billion, or one fifth of national
income.
Morgan Kelly is professor of economics at University
College Dublin. During the recent High Court case involving the Zoe
group of companies and ACCBank, he gave property valuation estimate
evidence on behalf of the bank
http://www.irishtimes.com/newspaper/opi ... 08947.html
Turning bank debt into equity will save us from Nama ruin
October 13, 2009
MORGAN KELLY
History
shows Nama-style bad banks are profoundly corrupt and corrupting
institutions. If Nama didn’t happen, the alternative would involve
minimal cost to the taxpayer and banks would manage their business
without political interference
WHILE MOST economists by now
simply dismiss Brian Lenihan’s utterances on the economy as “not even
wrong”, this is to miss the Minister’s almost eerie ability to predict
exactly the opposite of what is going to happen. Merely to contradict
Brian Lenihan is virtually to guarantee that you will later be credited
with supernatural prescience.
Who else, as Irish bank shares
plunged 13 months ago, could conclude: “Our banks uniquely have
weathered this storm . . . We are in a zone of financial stability in a
very troubled financial world.”? Two weeks later, having been panicked
into his catastrophic bank liability guarantee, the Minister assured us
that we had “the cheapest bailout in the world so far”, and six weeks
later averred that: “It is not the function of the Government to fund or
bail out the banks.”
The effortless miscalculations, the assured
non sequiturs, the lofty indifference to facts: all reveal Brian
Lenihan as a master of what Princeton philosopher Harry Frankfurt
defined succinctly in his 1986 paper, On Bullshit .
The Nama
legislation, as expected, piles up this material on an Augean scale.
Prices have fallen 47 per cent; the long-term economic value of property
is 30 per cent below its peak value; the loan-to-value ratio is 77 per
cent; prices only need to rise by 10 per cent in 10 years for the State
to break even.
To subject these almost poetic flights of
ministerial imagination to any sort of rational analysis will seem to
many like vandalism, but that is what God made economists for.
First,
the estimate that prices have fallen 47 per cent. The reality is that
prices can only exist when there is a market, and the market for
commercial property and development land has disappeared.
A less
futile exercise is to ask how much Nama would have cost at the end of
similar credit-fuelled price bubbles. A decade after their peaks, Tokyo
land prices had fallen by five-sixths, while Irish farmland, adjusted
for inflation, had fallen by three-quarters. Had Brian Lenihan bought
€77 billion of either, applying the proposed Nama discount of 30 per
cent, he would have lost €35 billion-€40 billion on our behalf, or
roughly €20,000 per taxpayer, and that is before adding interest.
At
a quarter of national income, Nama would dwarf the cost of previous
bank bailouts, which varied from about 3 per cent of GDP in Sweden to 14
per cent in Finland and Japan.
Most baffling of all the Nama
numbers is the proposed discount of 30 per cent, implying that the
“long-term economic value” of property is at 2004 prices. Not one shred
of evidence is offered for this assertion, the keystone of the
Government’s strategy.
At first, I thought that this mystical 30
per cent number embodied Fianna Fáil nostalgia for a vanished era of
innocent greed; a hope that we would wake up one morning and find
ourselves back in 2004 forever, basking in the benevolent gaze of Bertie
Ahern and Seán FitzPatrick. The reality turns out to be a lot more
mundane. The EU simply forbade Lenihan to pay any more. This is not
through any dismay at seeing Irish taxpayers fleeced by their
Government, but for fear that they will be stiffed into carrying out an
Iceland-style rescue here.
The figure of a 77 per cent
loan-to-value ratio is equally fanciful. It will take years for the
courts and Fraud Squad to disentangle multiple personal guarantees and
imaginary collateral. The situation in Anglo Irish Bank appears
particularly grave.
Finally, there is the assumption that the
Irish Government can continue to borrow forever at low rates from the
European Central Bank. However, the ECB is making no secret of its
dismay at being turned into a credit union for feckless Micks, and is
anxious to end such emergency lending facilities within the next year.
Once
the ECB slams the window on its fingers, the Government will be forced
to borrow at market rates of 5 per cent or more. In the next decade,
this will add another €25 billion or so to taxpayers’ losses from Nama.
Property
speculation was a mania that swept every level of Irish society, from
hairdressers buying apartments in Bulgaria to dentists taking out second
mortgages to join commercial property syndicates. Business owners were
not immune to the lure of effortless wealth, and many borrowed heavily
to gamble in property.
As one banker put it: “We are happy to
restore their credit line as soon as they repay us the €15 million they
borrowed to buy that land bank on the edge of town.” The destruction of
the Irish commercial class, who we might have hoped to be an engine of
export led recovery as they were in the 1990s, is likely to prove one of
the most enduring and costly legacies of the property bubble.
Forcing
banks to lend to SMEs will only compound our problems. One condition of
the Japanese bank recapitalisation in 1999 was that they lend to small
firms, but the effect was to heap a second layer of non-performing loans
onto existing property losses.
As well as being expensive,
history shows Nama-style bad banks to be profoundly corrupt and
corrupting institutions. After the financial crisis in 1931, the US,
Germany and Austria all set up bad banks which turned into conduits for
directing funds to politically connected enterprises.
Bad banks
are the means for governments to choose which oligarchs will survive to
emerge even stronger than before. They do not just happen to behave in a
corrupt and anti-democratic manner: it is what they are designed to do.
And
do not forget that, even after the crushing expense of Nama, Irish
banks will still be seriously short of capital. Under the current,
deliberately lax, international bank regulations, AIB and Bank of
Ireland need capital of around €8.5 billion.
Financial markets,
which assume that Nama will go through, value their existing capital at
around €3 billion, and adding Government preference shares of €3.5
billion leaves them short about €2 billion each. Once stricter capital
requirements are imposed next year (the so-called Basel 3 process), this
shortfall will probably rise to €6 billion.
Nama then, will turn
out to be expensive, corrupting, and inadequate. While the abject,
almost endearing, eagerness of the Greens to please their Fianna Fáil
masters means Nama is almost certain to go ahead, it is perhaps worth
asking what would happen if it did not.
All that needs to be done
is for ownership of Irish banks to be transferred to their bondholders.
This process of converting debt into equity occurs sufficiently often
in banking to have a name: resolution. Resolution offers a way for Irish
banks to be adequately recapitalised at no cost to the taxpayer, and
able to manage their business without political interference.
Under
existing Irish corporate law, this transfer would be a recipe for
centuries of litigation. That is why most other industrialised economies
have, or are introducing, special legislation to resolve failing banks
with limited judicial review. Particularly impressive is the UK’s
Special Resolution Regime introduced last February, which could easily
serve as a template for similar legistlation here.
Instead we
will get Nama. Brian Lenihan assures us that Fianna Fáil’s monument to a
decade of waste, corruption, and ultimate ruin will not be wasteful,
corrupt, and ultimately ruinous.
Let us hope that, for once, he is not wrong.
December 2009
The Irish Credit Bubble
http://www.ucd.ie/t4cms/wp09.32.pdf
http://www.irishtimes.com/newspaper/opi ... 54227.html
Ghosts of debt and jobs will haunt economy
December 29, 2009
MORGAN KELLY
OPINION : By 2015, Iceland will almost certainly be a lot better off than Ireland because it dealt decisively with its banks
WHILE
THINGS are hard to predict, the future, especially the situation of the
Irish economy, is so stark that even an economist can make some
predictions that stand a chance of being right.
Two ghosts of Christmas will haunt Ireland in 2015: jobs and debt.
For
20 years, the Irish economy experienced extraordinary growth.
Unfortunately, this growth came from two separate booms that merged
imperceptibly into each other. First we had real growth in the 1990s,
driven by rising competitiveness and exports. However, after 2000
competitiveness collapsed, and growth came to be driven by a lending
bubble without equal in the euro zone.
As Michael Hennigan of Finfacts (
http://www.finfacts.ie)
has pointed out, of the half million jobs created in the last decade,
only 4,000 were in exporting firms; and fewer people now work in
IDA-supported companies than in 2000. The Irish economy has been faking
it for a decade.
Now that the property bubble has burst, people
hope that exports will once again become the engine of our salvation.
The problem is that, back when we were becoming rich by selling houses
to each other, we priced ourselves out of world markets. Wages have
risen by one-third here compared with Germany since 2000. Restoring
competitiveness will be an arduous task where nobody, outside the banks
and ESB, will see a pay rise for a decade, and many will take pay cuts.
Whether
desirable or otherwise, leaving the euro is not possible for a mundane
reason. Changing currencies takes a lot of organisation, as we saw when
the euro was introduced. If the Government announced that a New Irish
Pound will be introduced in 12 months, everyone would rush out to
withdraw their savings in euro and wipe out the banks.
Prolonged
mass unemployment is a disaster not only for its victims, but for all
society. The great Harvard sociologist William Julius Wilson showed how
the disappearance of low-skilled jobs in the US during the 1970s led to
the social collapse of black ghettos.
In Ireland for the last 20
years we saw this process working in reverse, as rising employment
turned what had been sink estates into decent, if not wonderful, places
to live. Finding a job does more for the disadvantaged than a legion of
social workers: people’s sense of self-worth is transformed by being
able to earn the money to do ordinary things like own a car, buy toys
for their kids at Christmas, and take their family on holiday.
While
many commentators argue that the benefits of the Celtic Tiger flowed
exclusively to the wealthy and connected, this is nonsense. The benefits
went overwhelmingly to ordinary people in the form of something that
Ireland had never seen before: abundant jobs. By 2015 we will have seen
what happens when jobs disappear forever, particularly from less
educated men who were able to earn a good living in construction. In
effect, Ireland is at the start of an enormous, unplanned social
experiment on how rising unemployment affects crime, domestic violence,
drug abuse, suicide and a litany of other social pathologies.
We
will be forced to discover the consequences when people, who had worked
hard to make decent lives for themselves and their children, find
themselves reduced to nothing. Less than nothing in fact because, unlike
the unemployed in the past, people now losing jobs are weighed down
with debt and facing the terrifying prospect of losing their homes.
Debt
will be the second ghost of Christmas 2015. Back in 1997, when exports
drove real growth, Irish banks lent little by international standards.
By 2008, Ireland had twice as much debt for its size as the average
industrial economy: banks were lending a third more to property
developers alone than they had been lending to everyone in Ireland in
2000.
It was this tidal wave of credit that inflated house prices
and launched the construction boom that drove wages and government
spending to unsustainable levels.
To fund this suicidal lending,
Irish banks borrowed heavily internationally, and now must pay it back
fast as the world realises that our recent economic miracle was less in
the spirit of Adam Smith than of Bernard Madoff. As Irish bank lending
returns to ordinary international levels, property prices will fall by
at least two-thirds from their peaks.
However, five years from
now, property prices could have been driven far lower than that by a
deluge of sales of unsold, foreclosed and abandoned homes.
Mass
mortgage defaults caused by unemployment and falling house prices are
the next act of the Irish economic tragedy. As well as bankrupting our
worthless banks all over again, the human cost of tens of thousands of
families losing their homes will be enormous but, because the Government
has already exhausted the State’s resources taking care of developers
with Nama (National Asset Management Agency), there is very little that
can be done to help these people.
Most people, of course, will
not lose their jobs and homes. However, even they will be forced
painfully to relearn something our parents already knew: beyond a small
mortgage, debt swiftly turns into pure poison that will eat away your
prosperity and happiness.
One response to large-scale home
repossessions that will be attempted is to buy ghost estates for public
housing to accommodate evicted home owners, providing ample
opportunities for good old fashioned petty corruption.
For grand
corruption, though, we will have to look to Nama. By allowing the banks
to dictate the terms of their bailout, the bank rescue was turned into
the most lucrative and audacious Tiger Kidnapping in the history of the
State, with the difference that, like the sheriff in Blazing Saddles ,
the bankers held themselves hostage.
Bad banks like Nama were
tried on a large scale in the early 1930s in the US, Austria and
Germany; and proved to be profoundly corrupt and corrupting
institutions, whose primary purpose was to funnel money to politically
connected businesses. The German bank is best remembered for setting up
what we would now call a special purpose vehicle to fund the
presidential election campaign of the odious Paul Hindenberg.
Bad
banks do not just happen to be corrupt and anti-democratic
institutions, it is what they are designed to be. Effectively, bad banks
give governments the power to choose which of a country’s most powerful
oligarchs will be forced into bankruptcy, and which will be
resuscitated to emerge even more powerful than before.
Nama will
get to pick which of the fattest hogs of Irish development will be
sliced up and fed, at taxpayer expense, to better connected hogs
(remember that Nama has been allocated at least €6.5 billion,
considerably more than the Government saved by draconian budget cuts, to
“lend” to favoured clients).
While Nama may have momentous
political consequences, it has already failed economically: the Irish
banks are still zombies, reliant on transfusions of European Central
Bank funding to survive until losses on mortgages and business loans
finally wipe them out. In the next few months we will discover if the
State bankrupts itself by nationalising the banks; or if it has the
intelligence to free itself from bank losses by turning the foreign
creditors of banks into their owners, as Iceland has just done with
Kaupthing bank.
It is ironic that by 2015, having devalued its
currency and dealt decisively with its banks, Iceland will almost
certainly be a lot better off than Ireland.