March 30, 2005

Middle classes are hung out to dry

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Forget working-class, middle-class, rural, urban, blue-collar or white-collar – the Irish workforce is now divided into two distinct tribes: the ‘nailed’ and the ‘non-nailed’. The nailed have clean, healthy, neatly-shaped nails with well defined half-moon cuticles. The non-nailed have chipped, broken, grubby stubs on the ends of their fingers, typically moderately deformed or covered with plasters.

The nailed work in offices, banks and the page-shuffled, memo-obsessed, paper-trail world. The non-nailed toil away (usually on higher incomes) in the real world, making, breaking, fixing, putting together and overseeing.

In contrast with the 1970s or 1980s, there are now few more secure or prosperous positions than that of the non-nailed craftsman. He who can create, weld, craft and sketch is in the ascendancy again. At the same time, the position of the nailed has declined both in terms of overall status and security.

Nowhere is this uncertainty more evident than in the banking sector.

Bank of Ireland’s announcement of 2,100 job cuts this week is the opening salvo in the first great industrial relations battle of the 21st century – the shake-out of the nailed sector. Across banking, insurance and the rest of the nailed sector, thousands of workers are about to lose their jobs.

The reasons for this are complex and go far beyond the typical �technological change’� stuff thrown around at times like these. BoI’s announcement is the beginning of a process which, when it is over, will have totally changed the Irish suburban landscape.

For the first time in many years, the solid car-washing, hedge-trimming, kitchen-extended, rugby-shirt-wearing middle classes will be affected.

Ironically, the new class war will pit two distinct middle class groups against each other. It will go to the heart of the dilemma for modern wealthy societies that have made old left/right politics irrelevant.

This is a battle where neither of the protagonists actually knows that another might be the enemy. In fact, they might play golf together, drink together, compete in Brown Thomas with each other for limited this or first-edition that.

This is a battle where the reasonably rich non-nailed Irish pension-holder squares up to the reasonably rich nailed Irish bank worker.

To understand this, we have to understand who owns the banks, who demands that they cut costs and who has become drunk on the greedy expectation of yet another year of bumper profits.

Let’s take some altitude in order to better understand this shift.

Banks lend money. The price of this money is called the rate of interest. Today the rate of interest is just above 2 per cent.

This means that people are prepared to pay a bank just above 2 per cent for the pleasure of doing business. This constitutes the natural rate of return that one should expect for the risk of being involved in the money-making game.

If you are in the long-term lending game, the rate of return rises to above 4 per cent, to take into account that you are risking your money with some lender for longer. (This interest rate is called the long bond rate.)

It seems cheap, doesn’t it? Well, the reason that money is cheap is because it is actually free to print. There is lots of it around. Banks are creating money at a rapid rate, because their balance sheets allow them to, and because they are using land as collateral.

In Ireland, we operate a land standard, where all lending is backed by property.

So banks lend, and house prices go up.

This creates the impression of a stronger balance, against which they can create more money. They lend this new money to the housing market, and house prices go up again. This allows the banks to create more cash and lend more again.

In most countries all this demand for new cash would force the interest rate up, because there is typically only a limited pool of savings from which the banks can borrow/create money.

Because we can borrow in euro currency from any of 200million odd EU savers, the four-million-strong Irish market can borrow all it wants at rock-bottom interest rates. Thus the banks and the housing market become indistinguishable.

Because the banks and the property market are so interdependent, it is hard to know what is driving what. Is the price of property being driven by bank credit, or is bank credit being driven by property prices?

Either way, the financial system and the Irish property gluttony are umbilically linked. As long as credit is cheap, the banks will lend. Arguably, the behaviour of the banks is the main reason that house prices remain high, and the banks’ future is so tied up in land that if they stopped lending now, prices would fall.

Any fall in prices would lead to bad debts, profit warnings, share price collapses and bank takeovers.

Therefore, instead of being the guardians of prudence, the banks can become the agents of profligacy.

But all this rebounds on the bank workers, because the inflated expectations of what can be achieved in the housing market (fuelled by bank policy) has also inflated the expectations of how much money and profits should be made in a bog-standard industry like banking.

Remember, they are not lending something scarce or precious. They are lending money for which we are only prepared to pay 2 per cent a year.

Despite the low-rent nature of this business, investors expect that Irish banks should make a rate of return on equity of close to 20 per cent a year.

That drives the price/earnings ratio – which is a fancy way of measuring corporate profitability. But how can the financial markets logically expect that a low-rent business such as lending cash at 2 or 3 per cent could generate 20 per cent profit a year? Because they are deluded.

Deluded or not, this is the return that Bank of Ireland chief executive Brian Goggin is expected to generate. How could he do this when he is selling a product for which the market is only prepared to pay 2 per cent?

Well, he can either charge hefty fees from the public or squeeze more workout of fewer workers. In the past, Bank of Ireland and AIB have extracted more money (a total of more than �350 million a year) from customers than any other bank in Europe.

This cannot last. Last week, Bank of Scotland (Ireland) said it would move into the retail banking market, by buying ESB’s shops for �120million. Mark Duffy, the chief executive of Bank of Scotland (Ireland), wants part of this lucrative action.

So Bank of Ireland knows the fee gravy train is coming to an end. Therefore it has to squeeze more workout of fewer workers. This is why it is firing 2,100 people.

But let’s get back to the nailed-sector civil war. Who is forcing Brian Goggin’s hand? His board? His management team?

His workers? His missus?

No, the owners of Bank of Ireland are putting the gun to his well-paid head.

But who owns Bank of Ireland? Well surprise, surprise, you do!

Yes, you – the average Irish pension fund owner who has a policy with Bank of Ireland Asset Managers or AIB, or Hibernian, or Irish Life, or New Ireland.

Irish pension funds own the Irish banks, and it is we, the pension fund holders, who have inadvertently sacked the 2,100 workers.

Our old age pensions will be paid by the money saved by sacking our neighbour, the father of our daughter’s friend, our golf partner or our drinking buddy.

So the enemy of our future prosperity is our present neighbour, whose job has to go for the pension funds to generate cash for us in the future. In this way, the opening salvoes of this middle class civil war have been fired.


  1. Paul

    Great article!

  2. Eoin

    Stephen,

    My feeling is that the external shock will probably have to be an interest rate
    rise, which we can’t rule out. Even a small rise in basis points will push the
    mortgage repayments higher. It is clear, that the latest round of house prices
    , are being caused by inward migration of a scale absolutely unprecedented.
    An article in the Irish times today talks of 50,000 extra Poles since Accession
    last May, other Eastern Europe’s probably bring that number to 80,000 plus.
    Then there are the non-Europeans. In total that gives one hundred thousand
    or more extra migrants last year, which explains why 80K houses wont make
    a difference to prices . If – as i suspect – a lot of these people are being
    employed in construction we have a circular loop of people migrating to take
    jobs in construction, jobs needed because of demand for housing caused in
    large part by migration.

    So lets say there is an external shock which would affect house prices. To
    pick one: the ECB raise rates, and indicates it is on an upward trend. House
    prices begin to fall in Ireland, and else where. However, in Ireland, the shock
    caused by a house price fall will reduce the massive employment in
    construction as they curtail; and since that employment is 30% of the private
    sector ( about 400,000 people) you can see the effect that a collapse to 50%
    of present day construction would do (and that figure of 40K house
    completions would still be large by world standards. It could be worse).

    what would happen would be a 200,000 increase in unemployment. If most of
    these new unemployed were external and left the country, house prices
    would tumble even more. People would have higher mortgage payments, and
    reduced spending anyway, but the wealth effect of having equity in houses
    would be diminished, and debtors would realise they have actual real credit
    card debt, and their home equity will not cover it. This would reduce
    spending more across the economy, reducing the need for non-European
    immigrant employment visa – there is, in fact, no justification for such visas
    in a recession. So no one would come in in that year of recession, and plenty
    would leave.

    The result could be a mass reduction in the population in one year, with
    apartments lying empty all over the place. I think this scenario is more than
    likely.

  3. adrian

    Perfectly explained Eoin,
    It seems odd that the shareholders arent selling bank
    shares which are exposed to the irish housing market. Maybe
    the banks are very safely diversified into foreign markets.
    I hope they are.

  4. Christian

    Who owns Ireland?

    Well not the Irish thts for sure… cause the BANKS DO!!

    Who ever owns the banks, owns Ireland.

    Look at this a poll! Oh my GOD its contrary to the consumers
    “5% growth optimisim” translates infactually as opinion ->
    converts to => reality => converts to => relative =>
    converts to =>rubbish

    All this was trumpted aobut in the media by all the vested
    intrests(BANKS) and agents blah balh balh … just look see
    the poor dog-o-de-street, they know the big lie, oh and its
    a BIGGY.

    http://www.unison.ie/polls/index.php3?ident=Irish%
    20Independent&mypollid=930

    How about “Do you think the Price of a Head Of Cabbage is
    going to Appreciate in Value this Year”

    or how about this

    “Would you prefer a good nights sleep or a jam sponge cake..
    . la la lalalal ”

    Hmmm maybe then we’ll get some real answers!

    ANY CHANCE OF POLLS ON THIS WEBSITE THAT WOULD BE FUN!

  5. adrian

    Nice one David. good article!

    Its funny to notice that men with the rough hands and no
    nonsense attitudes are creaming it in comparison with us
    the supposedly educated bunch.

    The brickie who’s throwing up our house is on more money
    than Roy Keane.

    I liken the rise of house prices to that of a Jenga tower.
    (you know that game we play at christmas where you
    carefully slide out the wooden bricks and put them on the
    top.)
    The vested interests are putting up the tower, they’re
    cheating here and there, and the tower keeps rising.

    As Dougal says to Ted:’Ah sure Ted, if they put more bricks
    on the top and if they put more fresh air on the bottom it
    can only keep going up.’

    When you’re playing jenga you always believe that you’ll
    get another brick on top and its always a wee surprise when
    it collapses.
    Its putting the pieces back together afterwards that is the
    pain.

    The Bank of Ireland dont want to be staff heavy when things
    come crashing down and in shedding staff they’re the first
    bank to run from the game…. but look I think they’ve
    shook the table… JENGAAAAAAH !

  6. Natalie

    It has been a long time since I agreed wholeheartedly with
    your article.

    Shareholders are asking stupid returns, and institutional
    shareholders particularly are the most predatory,
    undercover and ruthless kind of them all. Overall the
    process of corporate governance (management, director,
    shareholder triad) is a right shamble. Corporate governance
    worked in the past as directors used to be the main
    shareholders and would have the long term protection of
    their investment at heart, but today’s directors are merely
    puppets in front of obsenely paid CEOs and shareholders
    behave like absentee owners, there is no system of balance
    and check anymore.

    But I do have a problem with accepting that shareholders
    MUST rule the show. They only provide the capital when
    buying stock off the issuing corp, after that it is pure
    gamble between individuals extracting dividend out of that
    same corp. It is purely about wealth extraction rather than
    the original wealth generation.
    But in the process, the only entity knowing who the
    shareholders are remains the corporation. I question
    whether it is not the corporation responsibility to sell
    its stock to the right “owner”. After all, alcohol sale is
    controlled, why not share.

    I also question whether the shareholders are truly the
    owners. Ownership comes with rights and responsibility.
    Among others:
    - the right to use a property as wished (in this case, only
    selling or buying since shareholders cannot directly
    influence how a company is managed)
    - the right to regulate anyone else uses of the property
    (shareholding is too diluted to even have a inkling of who
    else in the game, control and regulation is not possible)
    - the right to transfer property on terms he/she wishes
    (today shareholder sell at a given price, no choice there)
    - the responsibility for making sure that his use of
    property does not damage other (shareholders do not have a
    say in this – other than by selection criteria such as
    passive screening for SRIs).

    So the theoritical right and responsibility of the
    shareholder and the reality are totally at odd with each
    other. The shareholder is NOT the owner of the company, it
    merely owns a piece of paper. It should be referred as a
    gambler.

    Instead of blaming the gambler, corp could either try to
    manage its shareholder portfolio better (since it has this
    visibility) or ask itself what is the point of sitting on
    billion profit in exsanguinous society.

    The fundamental question is whether businesses are there to
    support society or society to support businesses.

  7. Stephen

    David,

    Without a real interest rate shock, as distinct from an
    gradual rate increase, what do you believe will be the
    trigger to upset confidence in property? With so many
    apartments coming onto the market in Dublin and so high a
    proportion of our inward immigration involved in
    construction of yet further property, the forces for some
    market change seem very clear, but there is no apparent
    prospect of a sudden jolt to affect confidence. Maybe
    mainstream media reports of some change will do it, but for
    the time being they are all singing the same song. What do
    you and your readers think?

    Stephen

  8. John Bennett

    excellent article. I think people are finally starting to
    realise what globalisation really means. It is interesting
    to note that in the week following the announcement by the
    bank of ireland there was unprecedented uproar in the media
    about how dare the bank get rid of 2000 workers. However
    there was hardly anny comment about the 500 manufacturing
    jobs lost in clondalkin in january or the textile jobs lost
    in donegal. It was as if these jobs didn’t matter because
    they were just manufacting and anyway wasn’t
    ireland “moving up the value chain”. However the bank
    themselves described the jobs they were cutting as being
    from “manufacturing”. So I think in modern
    ireland “manufacturing” is a dirty word. However it proves
    that globalisation is now reaching into previously safe
    careers and it won’t stop with banking.

  9. antod

    Banks are like middle men
    They give out deposits, and they take the interest.
    But what interests me is I couldnt care who owns the bank
    because when the economy does contract led by
    the stockmarket everyone will lose. The bank, the
    depositors and the lenders.
    The banks will deserve it, you could argue if the
    depositors do as is true for the lenders.
    Its catch 22. Only real banks in the World are in
    Switzerland and Singapore. Some of them dont even lend
    money out.
    Which is why I guess they have the oldest banks in the
    World.( Switzerland 350yrs!) Singapore is relatively new
    however.
    Dont end up like the Argentinians,or the Japanese soon to
    be. get liquid, get safe.)

  10. londonreader

    …but on the bright side

    when the bubbles pops:

    save your pennies for the WONDERFUL assets that will be on
    sale when the blood is really flowing on the streets

    all those lovely assets at pennies on the pound….
    mmmm, allied irish at EUR 2…mmmmmm !

    take note : HK property and Jap property has been DECLINING
    for over a decade…hang on, it’s now 2005, make that 15
    years……now how many people in Ireland could possibly
    comprehend a situation where property doesn’t go up but DOWN
    over a multi-year time frame ??? name two !! go on !

    To address the point about funding costs being a necessary
    precursor for this bubble to pop…..what if now the US has
    stopped raising rates and may start moving them lower…what
    if DEFLATION is on it’s way back (remember that in
    2003…not so long ago but deflation was a fear back then)

    What if then EUR zone competes in lowering rates because it
    suits the French and Germans (to hell with the rest of them)?

    but what if in that scenario, the psychology
    changes….check out such an example in late 99 to late
    2000…”what a difference a year makes”
    “i can’t get enough” to “i can’t get far away enough”
    When the crowd’s psychology changes and runs for the
    door…wow ! just you watch them go

  11. Brian

    The rapid rise in house prices is, as you say, directly
    related to the cost of borrowing.The Banks are screwing
    every penny out of their customers that they can possibly
    get,one reason this is happening is because there is no
    real competition in the banking industry.Not much room for
    manouvre at low intrest rates they say while earning two
    million euros profit per day,every day of the
    year.Something rotten here.
    However there is another side to the rapid rise in house
    prices that is not highlighted nearly enough.It is the
    fact that the government now force the local authorities
    to provide the infrastructural costs involved in
    housebuilding.Put simply,when you buy a house you are
    paying for the water supply, drains, roads, electricity,
    phone lines and additional charges required of the
    developer by the local authority before planning
    permission is given. We know that charity is not a
    characteristic widely practised among building developers
    and so..all these additional costs are pushed straight
    onto the house price.Hey presto..higher prices for houses.
    The FF/PD policy of reducing income tax from the cruelly
    high levels of the 1980s was introduced to kick start a
    consumer economy and it has worked.The result was a
    booming economy and high prices.The income-tax return was
    lowered but the income had to achieved directly from the
    consumer economy.The government are thus equally
    responsible for the high price of housing.
    Here is another angle, the value of property is rising
    quicker than the value of money, i.e. intrest rates on
    savings are now averaging 0.1% p.a. so if you have money
    it is naturally wiser to invest in property, a second or
    third home perhaps.As you can only live in one house you
    will rent out your surplus property.Who will rent from you
    at a price that will cover the mortgage?Who can afford it?
    Step in the immigrant worker.He or she will probably be
    earning the minimum wage or perhaps 10 euro an hour,not
    enough to pay the rent required. Step in the government
    agency to assist with half the rent on orders from the
    gov. to assist the manpower shortage in our burgeoning
    economy.Who pays the rent allowance,you do,its taxpayers
    money,but its not really a rent allowance its now a
    mortgage allowance for the property owner.The taxpayer,
    remember him, if he/she is PAYE then he is paying over 80%
    of all tax raised by the Exchequer,is now paying for the
    house which/she cannot afford to buy for himself and his
    family.
    Marie Antoinette would be outraged as she lost her life
    for lesser crimes against the people.

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