November 18, 2009
Did you know that our country’s housing wealth has shrunk at a rate of â‚¬142.8m per day since the peak of the boom in 2007? This is a catastrophic figure because housing wealth was one of the key drivers of spending, and domestic spending is what kept the dole queues so low in the boom years.
Without this housing “feel-good factor” we will continue to spend less. And the housing situation is getting more alarming. In January 2007, the total value of all our houses and apartments was â‚¬550.64bn and today that figure is â‚¬411.69bn. According to the latest report from daft.ie, rents are collapsing back to 1999 levels. Many people believed that, even in the worst case scenario, the housing market would bottom at 2003/4 levels. This now looks optimistic.
The more rents fall, the more house prices fall too and this is because the rents are a leading indicator of what is happening to real housing demand. There is such an overhang of houses in the system and such a lack of demand that house prices will continue to tumble.
The problem is that it is getting worse by the day. Not only is the housing market not stabilising, it is getting weaker. This fundamental weakness in our balance sheet is one of the main reasons that we have to be cautious about the positive spin we are hearing this week from some stockbrokers and the spectacularly useless forecasts from the Department of Finance.
Like almost every economic problem of the past two years, all roads lead to the banks. In a situation where house prices are falling, the banks will not lend because the banks’ balance sheets are mortgaged to the very houses and properties that are now falling in value. As this process leads to defaults, the bad debts of the banks will rise, reducing their capital base and causing money to leave the banks. With investors unwilling to plug the gap until the full extent of the bad loans becomes apparent, the forced nationalisation of one of the big banks is clearly a distinct possibility.
Yesterday, we heard that the serial delinquent Irish Life and Permanent — an outfit whose loan to deposit ratio reached a ludicrous 260pc — is now trying to gain deposits again. But if it gets its deposits up, then to get the loans to deposit ratio down it has to lend less. Here again is evidence that credit in the economy is drying up.
Shrinking housing wealth brings into focus what is happening around the country and explains why hundreds of thousands of us have stopped spending and borrowing. Why would you borrow when prices are falling by 6pc and the banks are charging 5.5pc at least in interest? This is a real interest rate of 11.5pc. What company or individual, when faced with falling incomes, will contemplate borrowing at these rates? More crucially, when faced with real rates of interest of this magnitude, banks will not lend to businesses because these levels of interest rates increase the risk of bankruptcy.
This is the monetary environment we are faced with. In economics this situation is called a liquidity trap. It describes a situation where the banks are unwilling to lend to risky businesses, so business gets starved of cash and people are unwilling to borrow because they are crippled by the servicing costs of debts they took out in the boom.
This credit crunch is felt most drastically in much higher unemployment than is necessary. Unemployment, for anyone who has experienced it in a family, is a most destructive force. The shock is not only financial, but the psychological and emotional cost as well as the stress associated with unemployment is enormous. If you want to see this, ask your local doctor; doctors are seeing people presenting to them who never visited a surgery before.
The only way out of this liquidity trap and the rise in unemployment — according to mainstream economics — is now to bypass the banks. If the banks are not lending the money which the European Central Bank is giving them, then bypass the existing ones. This means one of two things. Either the State sets up a new bank, deals with the creditors of the old banks and gives these creditors some equity in the new bank; only a new bank will start to lend again and this is how our system works.
Or, more radically, the State could follow the moves of every country that has found itself in this dilemma in the past — it could print its own money free of any constraints to get things moving again.
This idea of pumping new money into the system seems radical until you examine history and see that extraordinary times demand extraordinary responses. This is how the US, for example, got out of the Great Depression following the collapse of the economy and the banking system in 1931.
On April 18, 1932, within weeks of coming into power Franklin D Roosevelt, ignoring the advice of his economic advisers, took the US off the gold standard and allowed the Federal Reserve to print as much of these “new dollars” as was necessary to get the economy going. The effect was almost miraculous. The financial markets jumped 15pc on the announcement and in a matter of months the US economy rebounded, with industrial production rebounding.
We need the same sort of political courage now to do something radical because if we leave the economy to its own devices and continue to cut spending when the people are petrified and the present banking system is in tatters, the wealth of the country will just keep on shrinking.