As noted in an excellent column in this paper on Monday by Stephen Kinsella, it is five years since the Irish economy began to concertina under the twin pressures of too much debts and collapsing growth. As we head towards six years, the question most reasonable people want to know is, “when is it all going to end”. Maybe the question should be not when, but “how is this all going to end”.
Using history as our guide and the recent episodes of debt-related boom followed by bust, we can safely say that as night follows day, massive borrowing splurges, huge mortgages and house-price booms lead to a protracted period of massive retrenchment, house price falls and a certain amount of defaults. It is not a matter of if, but when.
If a housing bubble can bust with collapsing prices, so too can a debt bubble with mass default.
For those looking for an end to all this, the default period signals the beginning of the end of the slump because this is the moment of realisation for both debtors and creditors that the world has changed irrevocably and in order to go forward, we can’t go back to the past. Contracts signed then, in good faith, simply can’t be delivered on because the new environment of falling prices and diminished income and wealth simply make this impossible.
The more new capital is used now to pay these old debts, the more fresh capital is wasted trying to make legitimate poor investment decisions, which were based on nothing more than “hot air” in the first place. It is throwing good money after bad, the ultimate expression of “dead money”.
A recent report by the stockbrokers Davy indicated that one-in-seven residential mortgages is in arrears.
The number is twice that in buy-to-let mortgages and overall, 50pc of all mortgages are in negative equity. We are now entering that zone where the reality of there being too much debt and not enough incomes, is beginning to dawn on most people.
The endgame is that someone has to lose — either the debtor or the creditor. The best solution is co-responsibility, where both debtor and creditor take a hit.
In Ireland, up to now the debtors — ordinary people with huge mortgages — are being asked to shoulder everything, while the creditors — the banks — are still behaving as if they expect to be paid in full. They won’t be, nor should they be.
The endgame starts with isolated defaults and then this process accelerates.
Bear in mind that 400,000 tracker mortgages are at historically low subsidised interest rates, which can only go up over the lifetime of the loan. The tracker phenomenon is a ticking time bomb because it gives an unrealistic picture as to the real cost of borrowing in this country.
But before we look at interest rates, let’s just briefly see what happens to the other key component that drives mortgage defaults — income — in the downturn,
The collapse in house prices leads to falls in consumer wealth and demand, which in turn, causes incomes to fall. As unemployment rises, the fall in income for those who lose their jobs is direct and immediate. But the collapse in demand also leads to lower general tax revenue and increases in welfare spending. The government budget deficit increases. Eurozone nations lack a sovereign currency and have great difficulty following the counter-cyclical fiscal policies that would allow a faster recovery from the recession. The decision to extend what was originally a temporary guarantee that was designed only to prevent an evident bank run, into an open-ended bondholder bailout of what turned out to be massively insolvent Irish banks, blew up the budget deficit to levels that a nation lacking a sovereign currency could not repay.
Bond vigilantes target nations that are in economic trouble and lack a freely floating sovereign currency because these countries have to pay back debt which is effectively in a foreign currency. Irish sovereign debt became far more expensive to refinance and would have become impossible to refinance without EU support. The great increase in sovereign debt costs makes the budget deficit surge. Credit rating agencies then downgrade Irish sovereign bonds, exacerbating the death spiral.
The EU’s Stability and Growth Pact then compounds the problem — demanding that Ireland embrace austerity at the worst possible time. The EU and ECB demand that Ireland increase taxes, reduce spending, and cut ordinary people’s incomes (to spur exports) in order to close the budget gap.
Tax increases and wage reductions reduce private sector monthly income, leaving less cash to pay the huge mortgage. This reduces private sector demand, which is already inadequate in a recession. The reduction in public spending reduces public sector demand. The recession deepens, unemployment increases, and incomes fall. Housing values fall even further. Tax revenues fall and unemployment expenses rise.
Austerity can increase not only unemployment, but the very deficit it is promised to end. The terrible truth is that a nation mired in a deep recession cannot ensure that austerity will reduce a budget deficit. Remember, while consumer income goes down, housing debt is fixed.
Over the course of the next year, as the economy continues to deteriorate or at best bump along the bottom, many thousands of people trapped in too much debt on houses that are worth half of what they paid for, will ask themselves:”what’s this all for?”
Will they chose to default, not because they are financial delinquents who always intended to abscond from their economic responsibilities, but because the sums don’t add up? And if they do, will this process become viral where each default gives the permission for the next guy to do something similar?
Remember, house prices rose and fell in a similarly viral manner, going up together and crashing back in tandem.
This is possibly the major economic dilemma facing Ireland’s political class in the years ahead.