October 5, 2003

Paying a mortgage, not rent, is dead money in today's world

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Are you into cameras? Do you marvel at the quality you can get from the most ordinary models these days?
Or what about the extraordinary technology in normal camcorders? Like me, are you amazed at the quality of images from a bog-standard laser printer?

All these are made possible by Canon, the highly innovative Japanese consumer goods company. Canon, like so many other Japanese companies, was in the doldrums ten years ago, but today it is the market leader again. The man behind the resurgent Canon is a quiet, thoughtful septuagenarian called Michiyo Nakamoto.

Nakamoto is no globalisation-obsessed chief executive warning that, unless people work harder for less, jobs will all disappear to China or Mexico, while at the same time, paying himself a fortune.On the contrary, he believes in keeping as many good jobs as possible in expensive Japan.

His entire board is Japanese, despite 87 per cent of Canon’s sales coming from outside Japan. He is shameless when it comes to putting Japanese workers and interests first. According to Nakamoto, if Japan continues to innovate it has little to worry about. Like any good industrialist, he sees the direct link between productivity, the return on equity and wages.

When asked where did Japan go wrong in the 1990s, he spits out the word “land”. You can hear the contempt in his voice when he remembers the land frenzy that almost bankrupted Japan in the late 1980s and early 1990s.The linkbetween land speculation and future debt problems is so well documented that it is amazing we need to re-examine it.

But with our central bank warning this week about house prices, it’s worth examining the land problem in Ireland and how it devalues the currency in our pockets.

Irish banking operates a land standard. The soaring price of land and houses are intricately linked to the profitability of our banking system and as such, both are part of the problem.

Unfortunately, because rising property prices keep the banks looking profitable, the banks have a vested interest in ensuring that the great Irish land rip-off remains in business. The “land standard” is a useful term to explain why credit in Ireland is rising so quickly.The flip side of credit is always debt.

Historically, banks only lent money against gold, otherwise, loosely printed money would soon become worthless. Here in Ireland, land has replaced gold and banks take land or houses as collateral. So, for example, a house worth €300,000 is used as collateral to borrow €270,000 to buy another apartment for investment. The extra €270,000 goes into the system. The golden rule of monetary economics is that the more money in the system, the greater the upward price pressures on all other things.

Thus, the extra cash sloshing around in the system puts upward price pressure on houses because there is too much money chasing too few houses. This makes the original collateral now increase in “value” to €330,000. The bank extends another loan on the same collateral, failing to distinguish the chicken from the egg.

Back in the real world,the only fundamental reason for house prices to rise is if the income from rent is rising. This is not the case in Ireland. Rents have been falling, according to the Central Statistics Office for over 12 months now. If the income from the asset is falling relative to the value of the asset, then we have a problem.

So why does the price not adjust downwards?

Well for a variety of short-term reasons, but mainly because the cheap credit keeps the whole game in business. Yes, there is demand, but this only explains the direction of prices, not the extent of price increases.

History is replete with examples of accommodation shortages. For example, in post-war Germany demand for accommodation was enormous, yet house prices did not increase dramatically because there was no credit.The key in a credit-driven boom is not to be the last buyer.

As long as credit is cheap,the banks will lend. Indeed, the banks are the main reason land prices remain high and the bank’s future is so tied up in land that if they stop lending now prices would fall. Any fall in prices would lead to bad debts, profit warnings, share price collapses and bank takeovers.

No chief executive of an Irish bank would survive such a scenario, so there are good careerist and personal, as well as corporate, reasons for double digit lending to a workforce whose personal income is only rising by 2 or 3 per cent.

Sometimes,we fail to see that banks are simply selling money. Therefore, instead of being the guardians of prudence, the banks can become the agents of profligacy.

And where does all the borrowed money come from? It is not ours in the first place. It comes largely from other people’s hard-earned savings, from the older savings of continental Europe. European Monetary Union means we borrow their savings on the cheap and our banking system trousers the commission.

But forget the land market for a minute and ask what return does the country get from all of our money going into land and houses. Do bricks and mortar generate innovation? No. Once built, do houses generate wages, employment, Vat, income taxes? No. Does investment in bricks and mortar allow Irish productivity and thus wages to rise? No. Does such investment equip us with the skills to compete with Canon? No way, baby!

Ironically, when looked at from the general economic standpoint, money invested in bricks and mortar is actually “dead money” – a term usually reserved by estate agents to describe renting.

If those billions of borrowed euro were diverted into productive rather than unproductive capacity what would happen? First, investment in humans, rather than bricks, would increase our productivity.This raises the return on equity in the country. The greater the return on equity, the more profits and wages that can be paid.

Thus both wages and profits could rise simultaneously.This, surely, is the point of the exercise, is it not? If Irish workers get paid more per hour of work because we are producing more, then we can have more free cash to spend in our free time.

But no, we do precisely the opposite. We invest all we can in land and houses.The opportunity cost of this is lower productivity per worker. This means relatively lower wages than our German neighbours. Lower wages and a much higher proportion of our after-tax take home wage going to rents and mortgages (historically, low interest rates notwithstanding), means less disposable income.

Equally, the huge rise in land prices causes a huge transfer of cash from workers to landlords, for doing nothing and, more egregiously, from the young, who shoulder the debts to the old and middle-aged who own the land. This is not how a modern, sophisticated economy works; it is demographic feudalism.

Mr Nakamoto must be sitting back laughing, because at least he knows there is one country that will never challenge the livelihood of his Japanese workers. “The Irish,” he might say, “we used to worry about them, but they’ve been seduced by the mirage of land, and they will impoverish themselves before they realise that the Emperor is in the raw.”     

  1. Ruairi Newman

    You certainly raise some very interesting points. I’d be
    interested to know in light of this article, have you bought
    a house or are you renting?

  2. Donal Flynn

    Worth noting that if 36% of the cost of a house is tax,
    then the people who raise long term loans to pay for houses
    are in fact transferring long term borrowed money to the
    Government for it to use on its immediate consumption. So
    your long term loan, and the interest you pay on it,
    together constitute interest free national loan given to
    the State.

  3. Henry Barth

    House prices are driven by demand. When there is more
    housing, prices will drop. But of course, the government
    and local councils do not want more housing being built and
    use “planning” and taxation to keep them from construction.

    There are approximately 50,000 housing units per year being
    built in Ireland, but the demand is for 60,000 or more,
    especially near Dublin.

    Perhaps when we run out of hotels to house asylum-seekers,
    they will be forced to allow housing for the rest of us.

  4. David Burke


    I have just read you article “Paying A Mortgage, not

    Very Very Very good, I enjoyed it.

    I believed that house prices had moved beyond an economic
    footing in 1998. They are still rising!. You are right the
    root, cause is the Irish Banking System.

    Perhaps you should write an article to let us know what
    will happen when the crash comes. Myself and my friends
    (some employed by those very Banks) often run through
    scenarios of what the crash will be like.

    1) Will there be repossessions ( no way ), will the Banks
    try to possess the properties and then rent them back
    through the Councils to the original occupants. This would
    be a nice little earner and they could just sellout later
    on a rising market and with rent/fees the Banks would own
    the entire house having eaten up and residual equity in
    charges/fees. Very Nice. This is what I vote they’ll do.

    2) Will there be a Japan style meltdown and the Banks
    actually go bust, ( our Government stepped in twice to save
    AIB). No Way.

    3) Will emigration resume and the heat be removed allowing
    a soft landing with prices becoming realistic over 10 years.

    4) Will the refugees continue to prop up the system through
    the council guarantee rent system. I can still buy a house
    and rent it to the council for refugees. Or will this
    trigger the crash, when the numbers of poor from overseas

    5) What will be the trigger, a very visible failed auction
    perhaps, or the time which it takes to sell a house getting
    longer and longer. ??, until every road seems to have 20%
    of it’s houses for sale.

    6) Everybody, Banks, auctioneers, Government , Papers and
    even TV3 will rush to the defence of the house prices, “no
    they’re not going down”, “it’s a slight readjustment”.
    Surely the FF Government will prop up the prices ( through
    refugee rentings, or other means ) until their term is up.

    DAVID !!!!!!!

    Please write this article, myself and my mates need to know
    what you think.

    So write the article and let us know :

    1) When the bust will come
    2) What will be the first signs
    3) What will occur when the crash first it happens.
    4) What will be the long term effects.

  5. Kevin Hewett


    Land purchase is a great investment for the progeny set as
    they can continue to “live” forever when their sons and
    daughters faithfully enshrine the house they finally paid
    off as a temple to hard work and family values.

    For the rest of us, buying experiences is about all we can
    usefully do with our money–the cryogenic freeze whackos

    It’s another olden days value set that’s being beaten off
    the sides of the modern ship of culture like a barnacle and
    it’s going certainly the way of racism or religiosity in
    the face of secular humanism. There’ll be the inevitable
    50 to 150 year overlap during which some still promote the
    old value while more, many, and finally most adhere to the
    modern reality.

    Attention all home-”buyers”, would-be home-”buyers”,
    erstwhile home-”buyers” and their kith: You will be on the
    Earth for about sixty to ninety years. This is factually
    supportable by scientific evidence. You will need housing
    during that time; it is a common option pursued by most. A
    price will exist to be paid. Pay it. Shut up about it.
    Then die. The amount you paid for your housing (rent,
    taxes, improvements, lease-closure, down-payment, renter’s
    insurance, mortgage, left arm, security deposits, home
    owner’s insurance–every dime of it) while living was
    your “rent”.

    If you chose to call it your “investment” or your “equity”
    or your “capital” then die in full appreciation of your
    delusion. It was rent. You paid it. Now you’re dead. If
    they gave you a fancy “deed” then have that tucked into
    your coffin with you or sign it over to that ingrate you
    spent 22 years raising, but you didn’t “buy” anything,
    because land cannot be “sold”, it can only be controlled
    for periods of time. Such is the way of land, sad to say;
    (it’s a complicated geological reality having to do with
    all the bits of land being connected to all the other bits
    of it and being very heavy and difficult to move around).

    All men and women are renters and will forever be so–
    length of “lease(s)” being variable from 6 months to fifty
    years or even seventy years.

  6. Conor Desmond

    A recent story has broken on the headlines of the irish
    independant re local govt levy on new houses to drive up
    house prices by 10000 to 28000 euros per house.

    Opposition parties are up in arms that house purchasers
    will be footing the benchmarking payments – the article

    Surely the effect of such a levy is to discourage house
    builders to supply houses at such times when there are only
    low profits to be made i.e after a substantial fall in
    house prices.
    The levy will not put money in the pockets of potential
    purchasers to bid against one another to drive up prices.
    The article on the front of the independant misleads and
    only serves to scare unwary house hunters into the wobbling
    market. ESRI figures show a fall in Dublin house prices in
    October with a typical house falling by a couple of
    thousand euros over the four weeks or so of October. Not a
    bad saving!
    Opposition politicians would be giving better advice if
    they advised potential house purchasers to stay well clear
    of the market for now and refrained from clumsy

  7. Paul Moore


    Many thanks for the thought-provoking article. Makes me
    think about the statement about Bangladesh being the
    country with the highest rate of home ownership in the
    world, and Switzerland being the lowest.

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  9. Spinsta Sista

    It’s now 2006, and there are still no signs of house
    prices falling. Estate agents are jumping up and down with
    glee while people in their 20s and 30s are moving out of
    Dublin in droves to buy houses in places like Mullingar. A
    couple I know recently bought a house in Enfield with a
    99% mortgage. They face hours of commuting every day and
    we don’t see much of them any more. Prior to this they
    were renting near the city centre and walked to work. They
    were thinner, healthier, less stressed and had a better
    social life when they were renting, but has home ownership
    made them any better off?

    People who take out 99% mortgages are effectively renting
    their homes from the bank. It makes no sense for these
    people to live 40 miles from work and spend hours
    commuting when they can rent a place within walking
    distance of work. Unless they intend getting work in the
    town where they live (which is unlikely given the rate of
    businesses relocating from Ireland to the Far East) they
    are burning themselves out for the trumped-up illusion of
    home ownership. We are deluding ourselves that our house
    is our pension because if there is a rash of houses on the
    market in 30 years time it is likely that the value of
    houses will fall. Urban landlords, D4s and people who own
    their houses outright will be fine but what about the rest
    of us?

    If emigration resumes the scenario could be even worse –
    remember the 80s anyone? Are the buyers of these houses
    likely to get back what they put into them? In 30 years
    time the Far East will be a superpower, and Europe will be
    in even more decline than it is now.

    If you pay a huge mortgage to “own” your home or you rent
    it from the bank in years to come, the bank is still your
    landlord. Remember, whatever happens in the property
    market, the banks cannot lose.

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