Have you ever heard the expression ‘Irish pricing’? It is a new term used in banking circles to describe the fact that Irish banks are offering large corporate borrowers money on much better terms than the British or continental banks.
Irish banks are giving away money.
They are undercutting other banks and slashing margins aggressively to get business. So, in big deals of €50 million or more, the Irish banks are offering lower interest rates, longer repayment terms and less onerous covenant demands. This is �Irish pricing’. It is great news for the lender and for the bank that gets the business; it looks good on the balance sheet initially as it boosts the bank’s assets, its projected revenues and its market share.
But it also means that Irish banks are taking more risks than others. To generate the same return, they now have to do bigger deals and lend more money.
So to gain market share, they have to gamble a bit more than they did last year. They are running to stand still and, in the process, the quality of their loan book deteriorates. But when credit is ample, no-one bats an eyelid.
This type of thinking dominated corporate analysis during the tech bubble. Back then, the only thing that mattered was the growth in revenues, rather than the quality, sustainability or, in cases where dodgy accounts were later uncovered, whether the so-called �business’ existed at all. In the late 1990s, nobody really examined what would happen if trading conditions changed.
We are seeing similar carry-on in Irish banking circles, and it is happening across the board. Irish pricing is not limited to the big guys; the little guys are getting in on the act as well.
On Friday, the Bank of Ireland introduced a 100 per cent 35-year mortgage for first-time buyers – the littlest of the little guys. This move follows the First Active 100 per cent mortgage that was announced two weeks ago.
The bank says that this is necessary, and that most little guys will be able to service the higher borrowings. It has put some fairly cosmetic restrictions on who can qualify, but in reality it is throwing money at anyone who comes through the door.
Rather than making houses more affordable, this type of product simply pushes the price of Irish houses up further, forcing the banks to lend even more cash against the same asset this time next year. Friday’s central bank figures showed more than �2 billion was extended in mortgage credit in June, the highest ever monthly total.
Let’s examine how the credit system works, how loose credit reinforces the upward pressure on house prices and how the banks ultimately become the slaves, rather than the masters, of the housing monster. It might also be helpful to entertain what could happen and who might pick up the tab when things go pear shaped.
The key to the system is collateral, and this is also where the systemic fault lies. When it comes to collateral, the Irish banks have always had faith in the housing market. In recent years, this faith has intensified to blind faith, and now, with a 100 per cent mortgage culture, we are observing new levels of Moonie-style devotion.
Moonie economics is quite straightforward and it works as follows. Take an average person, doing what thousands of Irish people have done in the past few years – buying an investment property.
The latest figures suggests that as much as 40 per cent of houses sold in Ireland in the past 12 months were either second homes or investment properties, so this is a fairly hefty chunk of the market, and by extension, of the banking business in Ireland.
So in this example, a house worth �400,000 is used as collateral to borrow �370,000 to buy another apartment for investment. The extra �370,000 goes into the system. The golden rule of monetary economics is that the more money in the system, the greater the upward price pressures on all other things.
Thus, the extra cash sloshing around in the system puts upward price pressure on houses, because there is too much money chasing too few houses.
This makes the original collateral now increase in �value’ to �400,000. The bank extends another loan on the same collateral, failing to distinguish the chicken from the egg. This is the blurred hazy world of Moonie economics.
It is a state of mind characterised by financial back-slapping and corporate high-fiving, where each new loan begets another and the banks and the borrowers waltz blindly up a financial cul-de-sac.
Back in the real world, the only fundamental reason for house prices to rise is if the income from rent is rising. This is not the case in Ireland.
Rents have been falling, according to the Central Statistics Office for over 18 months now. If the income from the asset is falling relative to the value of the asset, then we have a problem. But because of the enormous amount of credit in the system and the way in which the system reinforces the original loan with another one, real world economics is suspended and moony economics takes over.
Moonie economics is the financial equivalent of a confidence trick. When things are going up, Moonie economics accelerates the upswing. When that confidence is punctured, banks pull in their loans, shut up shop and the opposite of Irish pricing occurs – a credit binge is replaced by a credit crunch.
It was interesting last year to hear one of our most senior bankers musing aloud at a conference about the need for Irish banks to remain under Irish management. He made the distinction between ownership and management – which struck me as highly instructive.
He went on to explain why. He suggested that in the event of a property crash we would need a national plan to prevent a credit crunch. It would be the banking equivalent of the countrywide reaction to foot-and-mouth, where everyone would pull together.
In these circumstances, it would be critical that the government could sit down with the country’s main bankers and cut a deal. In the past, countries like New Zealand that allowed its banking system to be taken over by foreigners found that in its property crash of the early 1990s, the foreign owners simply cut lending limits, which had the effect of exacerbating the original downturn.
In the case where the management is Irish, there would be a much greater sense of the impending disaster, because all of us are tied up in the property game in one way or another, whether it is ourselves, our children or our close friends. Laudable and all as these sentiments are, how would such a plan work?
Think about it. In the event of a crash, Irish banks would see their loan books decimated. This would affect their ratings, their share prices, and ultimately their ability to raise new funds.
We, the public, would be in negative equity territory, so would be both unwilling and unable to borrow.
Traditionally, in such cases, the central bank of the afflicted country would slash interest rates dramatically to kick start borrowing. But we could not do this, as our interest rates are set in Frankfurt and might actually be rising.
Do you think the ECB would cut rates to bail out Ireland -1 per cent of the EU’s population? No, I don’t think so either!
The only thing that we could do is let the state borrow enormously by issuing Irish banking bonds to international investors. This cash could then be given to the crippled banks in the form of a 30-year swap, on the condition that the increased liquidity be squeezed into the system, preventing a credit crunch from taking hold.
But who would pay for this? Well, we would, because a special tax would have to be levied initially to pay the repayments of the bonds until the banks’ balance sheets recovered. It is a scary prospect and one that the 100 per cent 35-year mortgage brokers or the guys involved in �Irish pricing’ dare not contemplate.
Awhile back I heard one of our most successful bankers musing about national plans, financial war cabinets and credit crunches. And if you know he is worried about the ramifications of Moonie economics, you should be too.
Sounds like the banks are involved in very sophisticated
pyramid selling…
I am one who has resisted buying an over inflated house in this country. Howevever, if the banks’ scheme of lending hand over foot comes back to bite them where it hurts, I shalln’t be staying around to pay tax to bail out those who created the conditions for the property bubble, that goes for banks & investors. I see RTE news did a story on the slowing down on house prices in Dublin. As usual they got their expert commentary from a bank official who predicted a 5% rise in house prices. I thought we had enough of Baghdad… Read more »
I heard on the radio this morning from an economist talking about the proportions of tax being taken in by the government and how they compare with 1997 when this government came to power. In 1997 Corporation tax comprised 12% of government receipts, I think it rose to 14% in 2000, today it is less than 10%. In contrast stamp duty has risen from 2% in 1997 to 7% today. VAT receipts as a proportion of total taxation are also up a lot. This clearly shows that corporations which in Ireland’s case comprise mainly of foreign multinationals are not doing… Read more »
Clearly the house price issue is heading to a crunch. We would have massive excess capacity this year were it not for the unprecendented number of immigrants – a number which will have to continue to repeat at 100K+ a year to guarantee the smallish rise in house prices. The whole thing stands on a pin. Ireland needs immigrants to stock retail outlets which are booming due to a massive 25% per year increase in non-mortgage private spending, most of which is people borrowing on the assumption that they have equity in their houses: The houses increase in equity, despite… Read more »
Good article, Aidans comments are spot on But you’ve been a skeptic of the housing market for a long time. So far you’re analysis, while it sounds rational has been wrong. Anyone who refrained from buying a couple of years ago and is renting has just seen themselves priced out of the market, and lost a good few thousand in rent.. Short of an absolutely massive property crash in the next year or so, buying has proven to be the right decision. I’ll cheerfully admit to being wrong also, I dont have your knowledge but thought housing prices were at… Read more »
you’ve been on about this for years now, and the house
prices have not dropped.
I think it’s unfair to criticise david on his long term predictions of gloom and doom for the irish housing market. The fact is the situation has been out of control for a number of years now, but there are tendencies in the irish market (and the global economy) that have meant the credit bubble has continued to grow despite the dangers of over- indebtedness. Something will have to give. The downturn will come, it’s just a matter of when. Capitalism is inherently prone to these cyclical movements. Normally (as is the case in the US and GB) counter-cyclical “keynesian”… Read more »
A recent Economist issue (June 18th – 24th) can provide some facts on the scale of the global housing bubble. Some highlights include: 1. The total value of residential property in developed countries increased from $40 trillion to over $70 trillion over the past 5 years – an increase equivalent to 100% of those countries’ combined GDPs. This is the biggest bubble in history (1990s dot com bubble was equivalent to 80% of combined GDPs; US stockmarket bubble in late 1920s was equivalent to 55% of GDP). 2. Some housing booms have already started to fizzle out, e.g. prices have… Read more »
Where most american s will be homeless if they can get a loan at all. i am disabled ,with a grandchild who is disabled also we cant live so where do you think fwe will be when credit runs out
Clearly this is all nonsense – our banks are, er, rock solid and house prices can only ever go up. I think everyone now knows enough to understand that building an economy based on swapping three bed semis between each other at ever inflating prices is clearly the way to go. Why waste time on creating new businesses that actually produce products and services that people might want?
(please wake me up when this nightmare is over)
[…] group’s thoughts were coloured by the Irish experience — recently converted as we were to the McWilliams school of naysaying — we recognised many correlations between the market performance and the stakeholder behaviour […]