In the 10th century, the King of England, Ethelred the Unready, faced a crisis. Danish longships threatened rape and pillage all along the east coast of England.
Sensing that his armies would be routed, Ethelred conjured up a scheme: instead of facing the enemy head on, he would persuade the tide not to come in, thereby stopping the invaders before they even set foot on land.
He raised a tax, melted down the proceeds into gold coins called Danegeld (Danish money) and flung the coins into the sea in an effort to buy off the waves.
Needless to say, this unique and innovative solution didn’t do the trick. The Danes arrived and had a field day.
The Danegeld episode reminds me of the efforts of the Central Bank to warn against the excesses of the property market. In the absence of any proper economic tools, such as interest rates, the bank is reduced, like Ethelred, to the rather pathetic spectacle of persuasion with no sanction. Last Wednesday, it issued its financial stability warnings, which sounded like a politically-correct social worker trying to discipline an out-of-control juvenile delinquent.
The report was full of pieties, couched in gentle terms such as ‘‘should’’ and ‘‘could’’ and, like any good-thinking liberal sociologist, the bank was keen to pin the blame for the banks’ financial delinquency on anything but personal behaviour. So the credit mania is now a product of the environment, the social conditions, demography or outside influences. This is the economic equivalent of social theories that blame behaviour on mumbo-jumbo like where you come in the family.
For the arch-persuader – the Central Bank – Ireland’s credit bonanza is the result of a financial broken home where the prudential lessons of the middle-class kitchen table have been forgotten. If we could only get back to basics, it would be alright. And is there a threat of the juvenile going completely off the rails? No, not really, although every sign is screaming calamity.
Let’s cut to the chase. The economy is out of control. We dispensed with all our economic tools when we joined the European Monetary Union (EMU). The resulting deluge of cheap credit has propelled all prices upwards. So wages and inflation have taken off, as Junior Cert theory would attest to. When there’s lots of money around, prices go up; in contrast, when there’s not enough cash in circulation, prices fall.
The reason houses prices have gone up six times faster than wages in the past ten years, is that the supply of labour has responded with all this new cash.
Immigrants have kept wages lower than they would otherwise be, had 400,000 of them not arrived in the past five years.
Although it is not their fault, the result of mass immigration has been to stretch the gap between wages and house prices.
This chasm has been filled by borrowing.
Today, the average house price is close to 14 times the average wage, with the result that private sector debt is 205 per cent of GNP – the highest in the world.
The flip-side of all this debt is huge banking profits. Our banks are money-lenders. The more they lend, the more cash they make. This is why the Irish banks make more per customer in Ireland than any other banks in Europe. Equally, the banks are in a market share fight to the death, so it is not in their interest to lose or turn down business.
This means that the banks set extraordinary volume targets each year for their employees to foist money on us, because they need to keep loan growth going. To do otherwise would see their share price falling, and their shareholders wouldn’t like that.
But who are these secretive shareholders – some shadowy off-shore financial Dr Strangelove? Well, not really.
We, the Irish people who contribute monthly to pension funds are the main shareholders of Irish banks. Irish banks are largely owned by Irish pension funds, so we are caught in a financial brace where cash begets mortgages, which begets profit, which increases share prices, which calls for greater loan growth, which drives the entire cycle one more time.
There is little the Central Bank – the financial social worker – can do in these circumstances. If it had control over interest rates, it could send a shot across the bows of the banking system, raising the cost of money and jolting the system into some semblance of sobriety. It’s all a bit like the ‘‘last call’’ at the pub. At the moment, the Central Bank is like a friend trying to persuade a drunk driver not to drive when drunk, but the friend, though staggering, insists he’s grand. The only course of action is to take the keys off him.
But the Central Bank can’t take our keys, so the chances are we will do something silly.
Another dilemma for the Central Bank is that, like all regulators, it is trying to execute a high-wire act. On the one hand it is trying to rein in the banks with gentle advice; on the other hand, it doesn’t want to frighten the horses by shouting too loudly. The last thing the Central Bank wants is a stampede out of the housing market – as has happened in almost every boom/bust cycle in history.
This would cause one of our big homegrown banks to collapse at worse or be taken over by foreigners for a song, at best.
Foreigners owning one of our banks shouldn’t be a problem for us, but the corporate bloodbath at the executive level is something the cosy cartel that is the upper echelons of the Irish banking system banks – and I include the Central Bank – would be loath to witness.
Likewise, in the great offshore accounts scandal engineered by the banking system against the state, did the Central Bank act as an agent of the state -which is what it is?
Not at all, it acted in the interests of the banking system, not those of the citizenry.
So when we hear the bank’s warnings about the property market, you are hearing a sanitised version of the conversation it is having behind closed doors.
But it matters not a jot, because without control over interest rates, the Central Bank is about as useful against the tsunami of credit crashing down around us, as ancient Ethelred’s Danegeld was against the Danes.
David mcWilliams may well be rights, having just returned from the US after a short visit – what I noticed was the good returns on property investment there compared to Ireland and given that the us have accepted that they are in decline
I think every rational ,non-economist citizen is reading from the same hymn sheet David for some time now.Its not rocket science.
However,the landing-soft or hard can not be far away-despite Fianna Fails (and the banks) determination to maintain the feeding frenzy for their principal backers the developer/speculator lobby..
Considering approximately 40% of our housing stock is reputedly in the hands of speculators/investors, we will likely see a new landlord class arise in Ireland during the coming years.An unhappy legacy from the most corrupt and inept of our two principal, mirror image, political parties.
The problem about pointing out that the Emperor is starck bo—ck naked, is that those who make the observation will be blamed when his majesty catches his death.
With the average price of property now 14 times of average industrial wages you would want to be an idiot to say that property is not over-valued.
When it drops we will then here the idiots crying and moaning and I will be laughing at them because I will be buying there property at rock bottom prices. HAHAHAHA
Come on property crash, bring it on.
BANG
I have listened to David talking and warning the irish people about the property overinflation for a long time and the crash now seems very close and inevitable. I feel very sorry for all irish people who are trying to start in life, to make an honest living under a government whose house is built on sand. Shame on irish banks, property developers and government.
When the Great Irish Property Scam of the early 21st century ( as economic historians will call it) unfolds, Bertie will be seen as a Nero type figure who fiddled..(ahem) while the young generation mortgaged their lives away. Fianna FAIL (rhymes with pale, Friendly Association of Irish Landlords) and their PooDle partners could have used a myriad of tools to cool the property market but did nothing. A government are supposed to behave with the best interests of its citizens at heart. But through lack of basic lending regulations and lack of property planning have allowed the older generation and… Read more »
The loss of control of monetary policy certainly meant that the Cental Bank could do nothing about demand fuelled inflation, but what it could have done, with the resources and influence available to it, was to have researched supply side measures that might have taken some of the steam out of the upward pressures. There are planning and infrastructural options that might have been explored, ensuring an adequate and affordable housing stock within reasonable distance of work.
There an olding saying “you get the government you deserve” and its as relevant here now as ever. Us blaming the government is a pathetic moan – we voted them in, after all. The RTE headline a few months back ‘immigrants cause rising house prices’ was as ignorant as it was inflammatory. The major ‘choice’ foible we made over the last decade was the joining of the euro. It was (and is) obvious that we were out of sink economically with mainland europe. Taking the UK/Sweden route would have been a far wiser choice. Losing control over our interest rates… Read more »
Very interesting article; Mr. McWilliams makes an admirable attempt to interpret the latest arcane declarations from the esoteric world of Central Banking. What I found most interesting about Governor Hurley’s comment was that it coincided with hawkish statements from the ECB. Commentators from the Commission had expressed the view that inflation was under control and many had felt that new rate rises were increasingly unlikely. As Ireland’s ear in the Governing Council of the ECB, Governor Hurley is the man with the clearest idea where interest rates will be in six months. He is obviously worried. Perhaps what Governor Hurley… Read more »
Why the Irish property ‘market’ won’t fall? A possibly unique characteristic of the Irish property market is that it may actually be so small in comparison to the high number of super-rich who continue to buy into it. As a result, the market is not ruled by the borrowing behaviour of Joe Average, the market is unable to fall because property magnates have no need/desire to sell their holdings at this time.
Eugene the super-rich people buying property are Ireland will be the first to leave as the market slows and will instead exacerbate any slump. Many of them have already moved into other, more profitable markets. 40 year (or more) mortgages are not sustainable. The only rational people who would buy one are either people so desperate to get on the ever rising bottom rung property ladder that they don’t think they have a choice or are betting high stakes on major rises in property prices AND relatively low interest rates for years to come. I’m only 28 and a 40… Read more »
Another interesting article David. I see that there is quiet a mixed view of the whole situation from your various comments posted. The best one I think relates to the possible call to drop the Euro! Citing it as the problem????? The Central Bank and the Government had a wide range of tools to cool or prevent housing from spiralling out of control but they chose to ignore! Possibily due to vested interests! Why would they do anything to stop it! The majority of people with the ability to do something in the system are middle-aged individuals with probably more… Read more »
The term ‘favourable demographics’ is coming into widespread usage as bulls scramble for even the flimsiest of arguments to support the largest property bubble in European History. 15% of the housing stock is empty rents are lower now than they were in 2002, the supply of homes for sale is rocketing; so the demographics don’t seem to support the current market. But realtors in the US were using the demographics argument back in 1926 prior to the Great Florida Real Estate Bust. Come to think of it realtors were using the same demographics argument prior to the current collapse in… Read more »
The only way i could afford a house is if there is a crash.Every cloud has a silver lining! David,haven’t you being predicting a crash for years now? Even a blind squirrel finds a nut now and again.You have to be right sometime I suppose.
Declan Carolan said,
The best one I think relates to the possible call to drop the Euro! Citing it as the problem?????
I actually dont know if you’re being sarcastic here Declan as you neither support nor rebuke the argument?
Please tell me how the Irish economy has beneffited from adopting the euro (unlike the UK)?
note to eugene,
you strayed a little from david’s article but you did make a valid point:
“the market is unable to fall because property magnates have no need/desire to sell their holdings at this time” …..
but what happens when they feel they must test the market or convert paper money into real money ??? this is when the bubble birsts !!!
First of all it’s Consumer consumption that leads the market. If consumers consumption falls then every other market will fall including the stockmarket and housing market. The likes of inflation,interest rates, stock market, jobs (unemployment figures) all lag behind consumer consumption. The average house price of a property should be no greater that 5 times average earnings (According to the bank of England and the old central bank of Ireland). Average Industrial wage = 32,000 euros and therefore house price = 32,000 * 5 house price = 160,000 euros. Average house price in Dublin say 400,000 euros this means that… Read more »
Note to Glen: “The likes of inflation,interest rates, stock market, jobs (unemployment figures) all lag behind consumer consumption”. Truth: Irish inflation & jobs are irrelevant for the setting of Irish interest rates. THATS WHY WE HAVE A BUBBLE IN HOUSE PRICES. The stock market will reflect european (or perhaps world) global growth expectations not singularly Irish growth expectations. “Also markets are called mean reverting” – this is an absurdism. Real assets – stocks included display very little, if any, mean reversion. There is a huge +ve mean to returns on these assets, linked to global growth expectations and inflation. A… Read more »
Note to R byrne You missed the point completly. Consumer spending controls the housing market, stock market, inflation which in turn sets interest rates. When an economy is doing well then people gets hired and when an economy is doing bad then people start to loose there jobs. The causes of employment and unemployment comes after the state of the economy. The problem with Ireland is that if our inflation gets out of hand then we cannot correct it by raising interest rates however it is still up to consumers to buy or not to buy. If consumers stopped buying… Read more »
Glen, Ref: Mean Reversion You’re embarrassing yourself here. Please stop, admit you’re wrong and take the shame. “Also anyone with a financial mathematics degree would also tell you this. It is very complicated and maybe I should have kept it to myself.” Tell me you’re kidding? Mean reversion implies a negative autocorrelation in returns. There is no oscillation about a mean by the stock market. Anyone who has seen a chart of any stock index can see that. There is an upward trend and positive autocorrelation at medium and long term frequencies. It is painfully obvious that stock markets and… Read more »
To r byrne,
The discussion of this article is not about the stock market but about the housing market and it seems that you agree with me, that the housing market is run by consumer spending.
Just a note have a look at the Q ratio (or Tobins q). Tobin won the Nobel Memorial Prize in economics in 1981. The whole point of Tobin’s q is and he proves it that the stock market exhibs a mean reversion.
http://en.wikipedia.org/wiki/Tobin%27s-q
As you can see the graph clearly exhibs mean reversion.
Personally I have been looking aghast at what has been happening here in the last few years. In my opinion housing prices is not the only problem. If we have to import approx. 90000 extra people a year to achieve the levels of economic growth we have here, why do we need all this extra growth? Given the infrastructure bottlenecks, would it not be better if Ireland was let settle into its own skin (economically speaking) for a few years. Then again maybe this is the only way the vested interests can keep the necessary support under the housing pyramid.
Glen, I dont agree with very much you say. Specifically, i reiterate that your ‘mean reversion’ argument is an absurdism. What Tobin shows and what you mis-interpret is that certain properties of a stock (or stock market) exhibit some mean reversion tendencies. The stock price itself does not. A stock, overvalued by Tobins Q measure, could mean revert on Tobins chart and yet still produce positive returns. There are two ways of returning to a fair value: through price or through asset value. Asset value will increase with inflation and GDP growth (and other variables). As i said above –… Read more »
To r byrne, I did not say absolute mean reversion and it looks like that I am correct. Frankly I don’t care what you have to say either and you are really showing very limited intellegence. First of all Tobin won a nobel prize for his proof on proving the stock market is mean reverting. If he was wrong then he would not have got the Nobel prize. I’m not going to argue with an idiot any more on basic economics. If you can’t grasp the basics then you are in trouble. Also all investment banks in London and the… Read more »
Glen, your attempts to defend yourself are only losing you more and more credibility. I admit i may have come across as patronising on this mean-revresion issue but let me assure you that i have very many years of experience on this topic. Stock markets do not display mean reversion and Tobin did not prove that they do. You are mis-interpreting the results of your wiki search. From your dictum so far i guess you are either still in college or a year or 2 out. Ask an expert at your bank/college what the correct interpretation of Tobin-Q is and… Read more »
Actally kid you are wrong. I work for JP Morgan in the city of London and since you questioned my experience I have been doing investment banking for 20 years. If you look at my recent comments you will notice that I never mentioned mean reversion of stock prices. I did say the stock market as a whole illustrates mean reversion. Here is one of the many investment banks in London who uses Tobin’s Q: http://www.smithers.co.uk/about.php It’s good to see that you are slowly coming around to my way of thinking now and it’s good to see that you are… Read more »
Glen, Honestly, drop it. You are wrong on so many counts it’s unbelievable. its natural that you would try to defend yourslf on an anonymous website but there are now also bare faced lies in your comments. Here’s a lie: Most recently you wrote … “you will notice that I never mentioned mean reversion of stock prices” while earlier you wrote… ” (if) the stock is below it’s mean then this stock is said to be undervalued, knowing that the stock will rise above it’s mean when market conditions come back into play”. Here’s an error. you wrote… “(Smithers) is… Read more »
David wrote an atricle a while ago concerning “the great con of irish inflation statistics”.David suspected and argued that true irish consumer inflation was far higher than official statistics showed. I argued at the time that i didnt believe there was any great (disguised) inflation in Ireland. I still believe this is the case. why resurrect the issue? because, in my opinion, we have enjoyed the spoils of cheap credit without the backlash of more expensive goods. Supermarket prices have not increased much in the past 5 years becasue of tougher competition from european names (Aldi, Lidl). The days of… Read more »
Please R byrne, My original comment that started this off is: First of all it’s Consumer consumption that leads the market. If consumers consumption falls then every other market will fall including the stockmarket and housing market. The likes of inflation,interest rates, stock market, jobs (unemployment figures) all lag behind consumer consumption. The average house price of a property should be no greater that 5 times average earnings (According to the bank of England and the old central bank of Ireland). Average Industrial wage = 32,000 euros and therefore house price = 32,000 * 5 house price = 160,000 euros.… Read more »
Actually, if you look at the UK data you will see that house price increases did ease consideribly in 2005H2 and 2006H1 as a direct consequence of interest rate increases during 2004. In that 12month period house prices rose no more than 3-4% on average. This is less than official interest rates and less than all mortgage fixings. Owning property was a negative carry trade during that period. In recent quarters prices have picked up again as expectations of a dramatic increase in interest rates has recinded. The UK market is a very mature market in the sense that it… Read more »
Hi No Inflation That is correct in what you have said about the UK and we are expecting another interest rates rise in January 2007 but this did not stop house price inflation rising too 8%. http://news.bbc.co.uk/1/hi/business/6142986.stm?ls People were saving during the period of 2005H2 – 2006 H1 (Nobody was buying property and so the prices were going down). People now are buying property even though they know that they are not going to be able to pay there mortgage if interest rates keep rising that is why we are now seeing a dramatic rise in house inflation. People today… Read more »
Thanks for replies to my post above. I still maintain that the Irish property market is distorted by the large holdings of the small number of super-rich who are non-sellers. As an anecdote, I asked one of these why they don’t sell or move into something more liquid and the answer was ‘….because I’m so wealthy already that Irish property is just a part of my portfolio, a good thing to hold onto, it may dip or fall, but its a good longterm asset’. It may be incorrect to assume that the Masters of the Universe are motivated to increase… Read more »
eugene – i dont know. i’m not sure about your ‘few super rich’ theory. i know about as many people (average age 30) who can’t afford anything as i know with 3 houses. i know idiots with 3 houses who think they’r gordon gecko becasue they got lucky. some of the smartest people i know cant afford anything because they ‘were right at the wrong time’. most young people who bought in the mid 90s have leveraged up either by buying more or buying bigger. they are all loathe to sell – property just doesnt lose value they cry. they’ve… Read more »
I’m not a grammer snob, heaven knows I have a limited grasp for punctuation and spelling. The pronoun to use is “their” and not “there”. Please don’t post comments without editing the; too/two/to, and there/their mistakes out or I will be forced to stop reading the rantings on this site.
Regards
Des
I do property repossessions in England, and the system is barmy. House prices keep rising along with interest rates, and people who can’t afford their existing mortgages are remortgaging or securing extra money on the property. They’re just running faster to stand still. Then they end up in court, babbling like demented chickens, and nine times out of ten the judges give them another chance, and another, and another … Legions of people are entering bankruptcy or IVAs, and then the selling process starts all over again, to buyers who will be even less able to afford the monthly instalments.… Read more »
Hi
Surely a bubble has to have at its base a shortage. There has been a shortage of houses in Ireland because of restrictive planning practices.
Next, the Central Bank does have some powers. It sets the reserves. When lending was exploding why didn’t it up the reserve requirement?
I distinctly disagree with the fundamentals of David’s argument: The resulting deluge of cheap credit has not propelled prices upwards. It is internal economic conditions that have propelled prices upwards in the phenomenal form of inflation. In other words the source of price rises is caused by the economic conditions obtaining. To claim that credit increases lead to price increases is merely to assert that price increases cause price increases. This is a circular argument that goes nowhere. Clearly the economic conditions in Ireland have not developed in such a way as to prevent the occurance of inflation. The problem… Read more »
You mean the party is not going to last forever.
Anyone remember the famine.
Hi Paddy, Communism does not work for single countries. It would work if the entire World was at the same level of progression both socially and economically. Also the Communism that Russia, China and North Korea have is not the Communism that Karl Marx’s envisioned. I agree with the rest of what you said. The way we look at the economy was that having a job alone meant that you were rich regardless of the salary that you were on because during the 80’s it was impossible to work in Ireland. If having cheap credit is meant to be a… Read more »
“If having cheap credit is meant to be a cause of a bubble then how come Sweden does not have a bubble and they have cheap credit (Swedish Interest rates are currently at 2.5%)” Swedish house price went up 12% in 2005. Is that a bubble? Heres some reasosn why it might not be as expensive as ireland… …the 2.75% (and rising) official rates suit their lower inflation and steady work force participation …they have had lower growth over the past few years …the banks are stricter on credit lending …they dont have the same wage inflation as ireland and… Read more »
Hi Krona, I believe Sweden does not have a bubble economy because of a number of reasons. 1. There inflation rate is very low. It is at 1.3% 2. The average house price in Sweden is about 75,000 euros (Small increases in price would appear big in percentages. If the average house price rose to 80,000 euros that would mean that house prices rose 6.67%) I agree with the rest of what you said and you missed out that Sweds have to put down a 20% deposit in order to get a mortgage out. I do not see the Euro… Read more »
Hi all, WRT the availability of credit I get a laugh each month when offers of credit cards and pre-approved loans come tumbling through my door. Why? Because I’m a student (researching for my PhD) and live off a stipend which in the context of “Celtic Tiger”, big spender Ireland makes me relatively poor. Before anybody starts on about students and being supported by rich parents, I’m not and haven’t been for a long, long time. In anycase it’s doubtless in my mind that the banks are giddy about handing the money out to people who can hardly afford to… Read more »
Well, it’s started in America. Subprime feeds into Alt-A into prime. Repossessions rise and rise. Bubble pops, housing industry goes wallop. Consumer spending plummets. Dollar collapses. Bush declares war on Iran. Oil price rockets. Greenspan is de-canonised and Bloomberg TV taken off air!
I knew this was going to happen when I saw a starving, bikini clad contestant on the US version of Survivor seven years ago greet the fortnightly supply boat with the question, “How’s the stock market doing?”
Seriously, what effect is this going to have on Ireland, Britain, Europe?