Now that even last year’s cheerleaders have accepted that the Irish boom was more or less ‘hot air’, inflated by easy credit, there is little point in going over the rights and wrongs of what happened. The case is clear: an economically challenged government, perniciously influenced by the interests of the housing lobby, blew it. The entire Irish episode will be studied internationally in years to come as an example of how not to do things.
Was it a well-orchestrated conspiracy by a few very wealthy people? Was it simply mass plutocratic hysteria or was it appalling governance at every level of the Irish state from the Financial Regulator, the planners and the Department of Finance? Maybe, it was a combination of all three, with a bit of half-assed ideology stitching the fabric together. One other thing is clear: the media -much of them now baying for blood -w ere as culpable as any other influential sector of our society. The media, which should have been critical and alert to the threats to our prosperity, caved in and believed the hype.
We are now seeing the pathetic revisionism of many who are mouthing platitudes such as: ‘‘No one could have foreseen this’’ or ‘‘Everyone knew it couldn’t last’’. Well, hold on, people did foresee it, some people did forecast the crash and warned that it would be so calamitous as to knock the country back a generation, but we were ridiculed at the time -by the political elite, the financial cabal and, more egregiously, by our sycophantic colleagues in the media who are allegedly paid to analyse.
As we head into the new year, is there anything we can do in Ireland to make sure that we are never again beguiled by a portfolio of over-valued council houses, apartments in the Algarve, blacked out Jeeps and self-congratulation?
A good place to start is with the Financial Regulator. Doubtless, the incumbent regulator is on his way out, so what should the new one do to make sure we are not entrapped by property again?
If we examine the real accelerator of the property mania, we can see that the crucial problem was the lending policies of the banks, which stood to gain enormously from property price increases.
The banks allowed their balance sheets to play tricks on them. As property prices rose, the underlying collateral, which underpinned their property lending, became progressively debased. It is this very fragility of collateral that is now hammering them. The fragile collateral, which up until the top of the cycle was driving profits, is now the hazardous waste that is driving up losses.
The crucial mistake made by the banking system was to think that the market price was an accurate reflection of value. During a bubble, this is never the case. Equally in the bust, now that prices are falling over a cliff, the plummeting market forces prices to overshoot on the downside. This price overshoot means that credit will contract further as banks rein in lending. This will cause prices to fall further and ensure that bad loans will be worse than they need to be.
Therefore, we have a systemic problem that is so obviously deleterious to any economic recovery. Are we going to do nothing and become hostage to a flaw in the system or should we make the most obvious change to lending practices that could hasten the recovery and ensure that this boom-bust carry on is consigned to history?
The problem is that picking moments in an economic cycle to gauge the value of collateral either inflates the boom or accelerates the bust. So why pick moments at all? Why not use a moving average of the value of land over a 20-year period to assess the real long-term value of collateral? By using a simple moving average against which to lend, we eliminate the lending madness that leads to a boom/ bust cycle in the first place.
If we had done something like this in Ireland over the past decade, we would never have had our housing boom. Prices would have increased gradually because lending would have increased gradually and ultimately the pace of house price inflation would have been determined by the rate of inflation and developments in the rental market.
If we were to take the long-run average price of houses as collateral as the basis for lending, the property boom would not have happened.
More interestingly, if we instigated such a lending policy now, it would mean that the extent of price falls would be significantly curtailed. As things stand, Irish property prices are likely to fall by another 50 per cent from here, with development land liable to fall by even more.
More worryingly, with the current lending system, these falls will go on for many years, contributing to higher unemployment, emigration and leading to an unprecedented explosion in government debt, with attendant higher taxation. The main reason for this, quite apart from the post-boom adjustment that has to take place in the economy, is that the collateral model that underpins lending and thus monetary policy is not right. The monetary trap has been sprung and Ireland is caught in it.
No matter how low interest rates go, we will still be trapped because deflation is making people postpone their buying decisions as they believe (rightly) that the price of everything, including houses, is falling. Why buy now when you will get the stuff cheaper next month?
Ultimately, deflation corrodes an economy and a society more than inflation ever could, and we in Ireland must avoid this at all costs. At some stage, we need to change things. We might need prices to fall another bit from here to become more competitive, but it’s time to put a stop to this. We need to call a halt.
If the new Financial Regulator has any wit, this idea would be introduced overnight. In fact, it should become part of the global solution to the financial crisis. Unfortunately, in Ireland, the new regulator is likely to be dredged from the same Central Bank/Department of Finance/ IFSR Agene pool, which does not inspire any confidence.
A little bit of hard thinking -rather than the same policies and people who got us into this mess -is what Ireland needs. A 20-year moving average of land prices as the basis for collateral is the way forward. We have no time to waste.