July 11, 2007

Hard to credit we should be grateful to banks for having us in their debt

Posted in Banks · 20 comments ·

1977 was the year the Sex Pistols burst onto the scene, introducing Punk to an astounded public and reinforcing the generation gap by giving two fingers to the establishment.

1977 also looks like being the most unfortunate year to be born in this country because, according to latest figures, if you were born in 1977 you are likely to be an Irish commuter/worker facing the 100pc, 35-year mortgage dilemma.

Figures from the Department of the Environment reveal that one-third of all first-time buyers are now taking out 100pc mortgages over 35 years. This scandal condemns an entire generation to debt. These 30-year-olds are the backbone of our society, they are the engine of the economy and yet, this State has lumbered them with a bill which only enriches our banks and our landowners. So we are witnessing an economy where young workers are financing old landlords through the agency of the Irish banking system.

Were Michael Davitt to come back to Ireland, 140 years after the Land League, he would be astonished to find that we have replaced a British landlord oligarchy with our own home-grown Irish version. The gombeen man in the middle propping up the system today is the Irish bank manager.

The Irish banks that are providing 100pc mortgages are making enormous profits. This is no crime. That’s after all what they are authorised to do by their shareholders. But there is a problem in the financial system which the State has an obligation to analyse and rectify. Otherwise what’s next? 40-year or, why not, 60-year mortgages?

The crux of the issue is that the banks are now out of control – in many cases due to forces beyond the control of any one bank in particular. Someone has to come in and discipline them.

There are three separate forces at work here. The first is the law of insecure middle management. Let’s not forget that behind all the slogans like “working together” or “your partner”, banks are simply moneylenders and the more money they lend the more money they make. So yellow-pack bankers, whose status both within the bank and outside has been dramatically eroded by ATM machines, are at pains to exceed lending targets set by senior bosses.

THE middle manager does not see the borrower as a person in this transaction, but sees his suburban house as collateral. The borrower is simply the conduit to the asset. If the banker can get his hands on a bankable piece of collateral such as the house, he can make an easy sale and hit or exceed his target. After all, if he does not hit the target, there are plenty more suits coming behind who will.

The second force at work is the law of shareholder value. Bank bosses’ salaries are linked to the share price of their outfits. So it is in their interest to get the share price up above the average. The problem, however, is that the people who ultimately own the banks – large pension funds – expect too large a return every year. How can a business like a bank, which is involved in a typically low-growth, mature industry like money-lending, make returns on equity of 20pc-plus as expected by the pension funds and banking stock indices?

The only way they can do this is by working their workers to the bone, capping costs and pay while lending recklessly. Therefore, and ironically, our own pension funds are driving our banks to lend to us with abandon. So the prospects of your pension fund when you retire are indirectly linked to getting you into debt when you are working.

The third and most important factor at work in the lending frenzy is the impact of land on the balance sheet of the bank. If the price of land is rising in tandem with the amount of money gushing into property, the banks will be able to lend more against it. The balance sheet starts to play tricks with them. Counter-intuitively, the more money they lend, the safer it looks in terms of the ratios they use to assess secured lending.

So it becomes a self-reinforcing dynamic where the more money they lend the more they feel they should lend. So credit becomes the crack-cocaine of the financial industry. The initial hit leads to euphoria but it wears off quickly, leaving the junkie needing more. And like the addict, all the economy’s senses have been blurred by credit, so it doesn’t know when to stop.

WE HAVE all become hopelessly addicted to the soothing balm of credit, and the banking system is desperately dependent for its living on the price of land, houses and property. The banks can be regarded as the dealers – the middlemen – who cut up the deals, take a fee and keep the addict hooked. But because of the impact of lending on them, their balance sheets, their bonuses and share price, they are as addicted as their clients.

The State now needs to act because we are impoverishing our young workers in this property scam which is creating a dangerous demographic divide in the society between the young and the middle-aged.

The State is not helpless. Remember that banks operate here under license. This license, like all permits, is conditional on good behaviour; it is issued by the Central Bank – an agent of the State. What about using the penalty points system to discipline the banks in the same way as we are all policed on the roads? Bad financial behaviour – such as issuing irresponsible, 100pc mortgages over 35 years – should carry two penalty points.

Ten penalty points and the bank’s license would be withdrawn for a period like a delinquent driver. This would focus Irish bank managers. Like the rating agencies who rate the credit-worthiness of banks, the penalty points system would give shareholders clarity and would minimise the risk of unwelcome profit warnings taking the market by surprise. House prices, which are only being maintained by too much credit being extended, would fall quickly to a level where buyers are not encumbered with huge debts.

So shareholders, first-time buyers and the State would be in a better position. Everyone needs discipline. Sometimes, even in this era of high-faluting finance, the old rules are still the best ones.

  1. Tony D

    Finally! somebody has pointed the finger at the real crooks.
    Bertie complains about talk downers?, is it any wonder?
    I’ve been tracking the recklessness of the banks for several years and in the USA where subprime lending has met its faith which is just the beginning for them.
    I was born in 1979 (not 77) as were most of my friends and they dont even contemplate buying anymore. We just see it as the train we were to young to take advantage of.

  2. Ciarán Mc

    I’m not sure if the answer simply lies with the banks. The banks are simply selling a product. It just happens to be money they are selling. We assume that as profit maximising firms they are going to make prudent lending decisions in terms of people’s ability to pay. It doesn’t suit banks to be chasing people for money or repossessing homes. Anyway, even before 100% mortgages became widespread, people were borrowing 92%. And with sky high prices that still leaves people with vast mortgages.

    The answer then has got to lie in the supply of land. This would require a massive and sustained effort to provide large amounts of zoned, serviced , and as far as possible, affordable land. It may even require some element of price interferance. And a long term program to tackle the problem where a handful of developers own almost all future development land around Dublin. It probably also requires changes to only sanction higher density development in some urban areas – to reduce future need for land. These units should all be required to be family friendly. In short, the government needs to do far more than slap the bankers on the wrist and set a few regulations. Alas, none of this is going to happen for the simple reason that FF would never confront their powerful backers even if they know that doing nothing will lead to the nightmare you descrbe. :-(

  3. Aidan

    I disagree with the last comment, i think too much land has already gone into housing loo look at the sprawl of dublin into kildare and meath, and thev one off mansions which have consumed big tracts of valuable agricutural land, land that we will need in the future, the answer lies in high density housing in the big cities, if that involves demolishing low density housing then so be it.

  4. Ciarán Mc

    I agree that we should build higher density housing. Which is why I wrote that we need to “only sanction higher density development in some urban areas”. Though I don’t think there will be much scope for demolishing low density housing. How could the government tell a whole estate, sorry lads, we’re building appartments, you’re out? In fact, that approach would be wrong and is the sort of thing seen in communist China. No, we need all future development to be higher density to some extent, and far higher density in the large urban centres. Even in rural areas, there is huge scope for improvement. Today ribbon development has littered many roads out of villages and small towns. Apart from being unsustainable, it’s plain ugly! We need to end this notion that you can build on your 1/2 acre site, and have your neighbour build on another 1/2 acre site down the road. There are many other ideas I’m sure, but any of them which can be meaningful will require a level of political vision and above all, courage, which are all but absent from our body politic. Sadly then, I can only see minor tweaking around the edges for the forseeable future.

  5. Jimmy

    Hi David,

    Regarding your comment … “The State now needs to act because we are impoverishing our young workers in this property scam which is creating a dangerous demographic divide in the society between the young and the middle-aged.”

    Sadly, this government and most democratically elected governments are incapable of acting on issues like this. One reason is that any measure that will bring the price of property back to historical norms will make a lot of voters poorer. Such an outcome would be political suicide. I think this train is going to crash, just as it is happening in the US today, and in the aftermath government might act to stop the next crash. Everybody will agree that 100% mortgages were a bad idea and we will see a return to more traditional mortgages. Perhaps there will be a tribunal for ten years.

  6. Donall Garvin

    I think that the generation gap is something that we are not fully appreciative of.
    Those born before ’77 are more likely to have final salary pensions, acquired property when prices were low and due to the low availability of credit have a different attitude to money.
    Those born after ’77 have worse pensions, more expensive property and have been brought up with the knowledge that credit is easy to get a hold of. In fact, I’d say that (in the North and UK) student loans get people into thinking that debt is nothing to worry about.

    The good news for those young people who aren’t on the housing ladder (and saddled with debt) is that they have the freedom to leave the country if/when the economy goes cold turkey.
    Those that have huge mortgages are going to be slaves to debt for the rest of their lives.

  7. Ciarán Mc

    But to be fair, it’s not all bad for those born since ’77. Their generation found it easier to get a place in college (swell in places); found it easier to get through college (no shortage of part time work); found it easier to get jobs thereafter (so much so they became the S.E Asia/Autralia generation). It’s not all gloom. (I accept that there is a debt problem).

    There is another dimension to the debt problem: people are obsessed with larger houses to the extent that they take on serious debt when they might have settled for less. I know several people who could have afforded a smallish house without too much pressure, but absolutely maxed out. They willingly decided to take on as much debt as they could get in order to increase their floorspace. That was their decision – completely unforced. Same goes for people who trade their precious minutes for square yards when they move to the Kildare commuter belt for bigger homes. I accept that some people move out because they cannot afford _anything_ in Dublin, but many make a rational trade between time and space.
    These factors that I mention are a little more complicated and no raft of regulation is going to fix them. My point is: the issue of house prices and high debt is far more involved than first meets the eye and there simply is no quick fix.

  8. David McWilliams

    Thanks for all the comments. I think Donal’s point about the generation gap is the crucial factor here. Yes Ciaran, people do chose to move out for more land but i can’t blame them really and yes there is a zoning scam at play, no doubt. However, my feeling is that it is credit and the primacy of bank profits above all, that is driving up the price of land and that any solution has to target this monetary delinquency. Thanks for all the comments, best David

  9. John O'Brien

    I agree with your comments regarding the Banks.
    They simply lend money for profit.They are not policy makers or guardians of the economy.
    They have found themselves in a country where, apparently, the government has abandoned all thoughts of prudent managment in the pusuit of positive ecomonic statistics.
    it would have been possible for the government to restrict the rates of lending by the banks by the impostion of a simple multple of the net income(s) available to discharge the intended loan.
    Instead they allowed the banks , who, as you say, are licenced by the State to adopt a reckless lending policy which introduced a concept of ” stress testing” the borrowers. What does this mean?
    In addition the continuation of the property based Tax reliefs has added greatly to the potential for disaster.
    The developers path was made even easier when the government introduced a special rate of Income tax for trading in Residential property.Developers now pay 20% not 41%+ as they would have if S 644a had not been intrduced.
    There was never any need for this other than presumably the distaste by Developers at paying the same rate of tax as every other trader.
    As a first step to cooling the property market the Government should abolish s644a and end allother remaining property based tax reliefs immediately

  10. Conor

    The European Central Bank has been printing money (low interest rates) and this money needs a home. The governments approach to the house market means this money is finding a home there – a combination of mortgage interest relief and no property taxes means that there is actually a positive pressure on people to put money into houses. This has caused the price of houses, or more specifically the plot of land underneath them to rise.
    It’s easy to complain about the banks but they’re really just doing what they do within the fiscal environment in which they find themselves.

  11. Ciarán Mc

    There is no doubt that the stamp duty regime should be reformed – to be more fair (progressive but each rate levelled on the amount over the cut-off as opposed to on the full price) and to reduce the restraint on trading down. I agree too that lending criteria should be more sensible. But these demand management measures need to be phased in with a long term view, and not designed to tweak current market conditions. The various bacon reports were an attempt to intervene that done nothing more than confuse matters and introduce instability. The supply side measures that I mentioned above – higher density, agressive government intervention in land bank/green belt usage and provision – are long term measures which make sense not just to deal with inflated house prices, but for other equally compelling reasons. Chief among them are the need to create accommodation patterns that can be serviced efficiently over the next few generations. I’m thinking here of everything from the provision of transport, to refuse collection, to sewage treatment, to provision of assistance to the elderly, to infrastructure for children and teenagers. I’m not saying we need to replicate manhattan all over the country, but clearly our low housing density and urban sprawl are at currently sitting at levels that will be far too costly in future – economically, socially, and environmentally.

  12. If you ask me, the lack of supply in the market is a complete red herring. We’ve been churning out record levels of housing for years now, despite this, prices have shot up.

    Last year for example, our little nation of 4.2 million people built 93,500 (1) new dewellings in 2006.

    The United Kingdom on the otherhand a nation of 60 million, produced 185,000 (2) new dwellings in 2006.

    Obviously, you can’t compare apples with oranges, but I feel David is on the mark here. The abnormally low interests rates we have/had for this country and the loosening of lending criteria (Bertie and co. were complicit in letting this happen) are the key factors in these financial milestones that young people are carrying around their necks.


    1. http://www.cso.ie/statistics/newdwellings.htm
    2. http://www.nhbc.co.uk/NHBCpublications/LiteratureLibrary/AnnualReviews/filedownload,27376,en.pdf

  13. Aidan

    It was also this generation that voted fianna fail back in. The generation that are up to their eyes in debt voted them back in. They must know deep down that this government was complicit in creating the bubble.

  14. Mark

    It’s not just the banks that are at fault here. The government itself incentivises buying over renting with all the financial aid it gives in the form of reliefs etc. And here we are with exactly the reason for NOT joining the euro – great and all as it is, the one-size-fits-all thing is typical euro logic. And what about the individual? If people are so stupid then they get what they deserve. I know that’s harsh but it’s true. Anyway, people don’t live forever. The old will eventually die and then the “young” will then be rich!

    ps I was born in ’77

  15. Jim Tipperary

    In May 1989 I was in Blackpool on vacation.Looking in Estate Agents windows I remember seeing 100% financing and said to myself that’s dangerous.This was at the height of the property boom in England.Council flats were selling at stg£100,000 and expats returning to Ireland buying 4 bed bungalows at ir£45,000.Stg being much at par with the punt at that time,with loads left over to put on deposit and supplement their pension.By September of that same year people were left with negative equity in their homes and throwing back the keys to the building societies and banks as the crash hit.As a “talker downer” I fear the same is around the corner for us if not already with us.David of course has been predicting this for some time back now.

  16. Ted

    The real issue is that the ordinary house buyer doesn’t understand how mortgages and lending work – as a result the banks are in an incredibly powerful position. When I ask people do then know how to calculate compound interest you would be surprised at how many don’t even know what this means.

    The average person will probably expect to at least 2 housing transaction in their lifetime. What people don’t appear to realise is that if you are paying a 35-year mortgage you are not making any significant dent into the principal of the loan in the first 5 years. If you have a loan of 300k in the first 5 years of a 35 year mortgage you have paid only approx. 20k – having paid down around 90k to the bank. (10 years is less the 50k paid off the principal.)

    I think that people will start to realise the folly of the 35-year mortgage when they look to move from their apartments to more appropriate family orientated houses. People will have very little equity built up over the lifespan of their initial mortgage and assuming that house prices stay relatively static would have to make a larger outlay for their new home. It is unlikely that the banks will give them a 35-year term as they are 5 years older – as a result they will have significantly higher monthly repayments. To be honest allot of people are financially trapped but they just don’t realise it – which is what the banks wanted to engineer over the last couple of years and were allowed to do by the state.

    The next 5 years in Ireland will be very interesting.

  17. Well , it seems that I am one of those poor unfortunates born in 1977.
    Great article David, this is exactly what I have been thinking and feeling for a long time. It’s nice to see someone is keeping check on the reality of what has happened to my generation. My generation has been shafted. Plain and simple. As far as buying a house in concerned. I haven’t a hope. At the moment I can’t even leave home and enter the rental market as I am a 30 year old mature student who can’t find a place in Dublin which takes rent allowance. This is due to the current climate of “rent allowance discrimination” which pervades the current rental market like a xenophobic plague made of snobbery, prejudice, bigotry and ignorance. Over one third of the rental market is in receipt of rent allowance. And for many of them it is certainly not by choice. It is difficult enough finding a half decent place within a tight budget, without the added burden and struggle of rent allowance discrimination. Why are Irish landlords and letting agents allowed to advocate and perpetrate this blatant prejudice? Why are landlords allowed to judge a tenant on their socio-ecenomic situation and not on their character? What kind of society is Ireland becoming ? It seems that rent allowance discrimination is in breech of equality laws, yet even the “daft.ie property web site” allows landlords to state “rent allowance not accepted” on their ads. For those that are interested in this issue , please check out my blog about it. ( also I would love to know your views and opinion on this issue David)


    And keep writing David
    I think one day your words will be seen as prophetic.

  18. Kieran

    Hi David,

    Thank you! for once again highlighting the property madness of this country for what it is. I have always seen you and your articles as one of the few voices of reason in a sea of vested interests in this banana republic. Undoubtedly the banks have their hands dirty on this property scandal along with the other vested interest accomplices such as the wealthy land-hoarders, developers, estate agents, sections of the media and so called economic experts on the payroll of the before mentioned, but above all I hold the FF/PD government responsible. I feel Bertie Ahearn’s recent remarks on doomongers and naysayers is very telling of the motivations and loyalties of our government. Bertie his government and the other VI’s have become financially fat though their ravenous feeding at the property trough filled with the younger generation. I truly feel that this period will be looked back on in years to come as a monumental failure and lost opportunity for sustained prosperity in this country. Moreover Ireland inc will be held up around the world as an example of what happens when government through gombeenism sit on their hands and allow private interests free reign in markets.

    Mind yourself David, because the thought police are alive and well in good old Ireland at present.

  19. Some things never change:

    “I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs”.

    Thomas Jefferson in 1802

  20. MB

    I was born in 1977 as well and I see a lot of my contemporaries mortgaging the rest of their lives away to the banks while up to their eyes in credit card debt. It has become a way of life and if you question the wisdom of it and point out that a grand cabal of middle-aged people is profiting from their misery, they just smirk and say that they’re “on the ladder” and can’t wait to buy more furniture at IKEA as they just got a great 0% balance transfer deal…

    It’s sad because, as Ted points out, most of this is down to bad advice and ignorance of how banks work. They think the bank is being helpful and obliging by offering them 7 times their income or self-certification or a mortgage based on rental income from two of the bedrooms in their home. They also think that the 1500 euro / month that they’re paying into the mortgage is actually paying it off when in fact if they did the financials they’d see that the first 10 years of a 35 year mortgage are basically interest payments i.e. rent paid to the bank. Unless the property goes up in value in those 10 years, they’ll have nothing to show for it when they sell.

    I’m living abroad and the mortgage I pay is small – even then I can still see that the first 10 years of our 20 year mortgage is only making a tiny dent in the capital repayments. Our lender is a German bank and they lay out the financials for you when you take out the deal, clearly showing what you’re paying off in Years 1, 2, 3 etc until the end of the mortgage. Irish banks should be forced to do the same. They’ve been getting away with murder for the last 5 years and I’m sure there’ll be a tribunal before too long now that prices are dropping. It’s a mad pyramid scheme and unfortunately it’s damaging the life chances of a whole generation as David points out. The government are the worst culprits as they could have acted to regulate lending much more quickly before now and reined in self-certification, BTL mortgages and interest-only deals. They’ve chosen not to and now there is a real implosion on the way. Once the credit crunch in the USA starts rolling across the Atlantic (as it soon will), things will get nasty in Ireland. The young will suffer and Bertie and his cronies will still be laughing all the way to the bank (until they’re FINALLY voted out of office.)

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