April 2, 2008
The other day, a friend called by and poured his heart out. He had just had a net worth statement assessed by the bank and was faced with the realisation that not only was he no longer rich, but he was flirting with bankruptcy.
His assets — all property — had fallen in value while some of his initially low interest rate financing was about to ratchet up by close to 1pc, leaving him unable to cover the loans.
Some of his rent had disappeared, because his Polish tenants left just after Christmas. He had three properties empty and not enough cash to meet the mortgages.
He, like thousands of others, began to build his property portfolio in 2003. By 2006, he had half a dozen properties and was “earning” considerably more from the capital appreciation alone per year than he was at work.
About two years ago, when the Irish housing market peaked and property yields began to fall to low levels, he compensated for lower yields by taking larger bets.
As the banks were prepared to release more capital on the “increased” value of his portfolio, he could finance these purchases. Due to the huge leverage, he was still, on paper at least, making enormous profits. After all, if you are borrowing over 90pc and the property is notionally going up, even low initial yields can create impressive “paper” valuations.
Like thousands of other Irish people, he believed the twin fallacies that (1) property always goes up and (2) there will always be cheap money.
No one in a position of responsibility — from the State to the banks that were lending to the (often financially-compromised) commentariat who hogged business pages — questioned these fatal assumptions
The upshot of this collective thinking is that the housing market became, on the way up, more an exercise in mass psychology than individual economics.
The herd took over and very few people sold when the market was going up. Indeed, why sell if the bank was prepared to give you equity release if you needed the cash and, more importantly, why sell if the prices were rising?
Instead of earning our cash, we decided to use our houses as ATM machines, withdrawing cheap cash against the limitless value of our bricks and mortar.
Much of the nation was at the same carry on and that is the reason my friend is important: he is Everyman. This is not one isolated gambler, who recklessly bet his shirt on property. This man is all of us and his dilemma is our dilemma.
Around kitchen tables all over the country, people are asking themselves: why did we buy that third apartment? What were we thinking?
With 200,000 people registered as owning houses abroad and one in six houses in Ireland empty, the property reversal isn’t just an isolated concern, it is a national challenge.
Today, according to the TSB/ESRI index, Irish house prices adjusted for inflation (“real house prices” in an economist’s jargon) are lower than they were in 2004. This is a steep decline. As inflation is likely to move upwards and house prices downwards, the real price of houses is going to fall even further.
One of the great myths peddled in the boom was that the house price boom was all dependent on fundamentals, like demography. Well sorry to have to tell you, but the demographic situation has got better for the housing market in the past two years, yet prices have been falling.
According to the international estate agent Savills, Irish property was the worst performing property market in Europe in 2007.
Figures yesterday confirmed that Irish construction confidence dropped to a fresh five-and-a-half year low in March. Confidence in Ireland is now the weakest of the 27 EU countries surveyed, yet we have the fastest rising population! So this idea of some unique demographic advantage doesn’t wash.
If you want to see what is happening in the Irish housing market, just examine the latest central bank numbers. According to Dame Street, lending to the housing market is the weakest it has been in 14 years. This figure was substantiated by the release of numbers showing that, even at today’s discounted house prices, no one wants to buy — rightly. You would be mad to buy this year when even estate agents and banks are expecting prices to drop. Buying now is tantamount to giving money away.
Like all assets, house prices are determined by credit. People borrow to buy, so the borrowing figure is a plausible leading indicator. If you see this figure moving up, it might be time to reassess the extent of the downturn.
However, as lending to the housing sector has fallen every month for the past 26months, this indicator suggests that there is nothing at all underpinning the market — bar the flatulence of vested interests.
The lesson from the past year is that no one knows much about anything. Just as the surge on the way up caught everyone by surprise and estate agents and banks came up with all classes of flannel to explain why prices were so high and why they could only go higher, now that the market is falling no one has any idea where it will end.
Buyers risk “catching a falling knife” if they take advice from the same “experts” who, this time last year, spoke confidently about a soft landing. These lads are now confidently calling the bottom.
One of the best crutches to lean on in such circumstances is financial history. In the past 40 years, looking at 17 property cycles, we see that typically house price busts see 70pc of the previous price appreciation disappear.
This implies that if real house prices are at their 2004 levels today, they could fall back to 2000 or even 1999 levels.
Hopefully this won’t happen here. No one has any interest in such an outcome. But what do we have other than hope? Our interest rates are controlled in Germany and the rise in inflation there in recent months is likely to keep rate cuts off the agenda for a while.
In contrast, the US authorities are deploying all their resources to keep the economy moving. The Fed has been cutting rates aggressively since August. This week, the government intervened to rein in the banks and change the regulations governing bank lending. Hank Paulson — the Treasury Secretary — also suggested a national bailout of bad housing loans.
This, if followed through, would be a monumental and generational shift in American economic policy. Whatever the upshot, the message is clear: the US government will not allow US prosperity to evaporate with the housing market meltdown.
Bad as it is, our banking system is not anywhere close (yet) to a US-style banking crisis, and therefore such interventions, even if possible, are not warranted.
Furthermore, there is something undemocratic about privatising profits on the upswing while nationalising losses in the downturn — which is in effect, what the White House and Federal Reserve are proposing.
Here in Ireland we have neither the competence nor the reason to follow the US example. We will just have to let financial gravity do its thing as prices fall back to earth.
As for my friend — Mr Everyman — the victim of group psychology, he is left ruing the day he declined to take JP Morgan’s advice that, “Nothing so undermines your financial judgement as the sight of your neighbour getting rich”.