This week, people are asking whether the Central Bank’s new restricted credit regime will stop house prices from rising. To answer that question, we have to know what drives house prices in Ireland.
Is it the “fundamentals” that you hear certain people talking about, such as people’s wages, people’s ages and the amount of accommodation available? Or is it the amount of credit sloshing around in the economy, and how much we think house prices are going to increase in the year ahead?
In other words: do Irish people buy houses because they need them, or because other people are buying them?
The evidence from the last cycle is that Irish people bought houses because other people bought houses. As people looked around and saw others buying houses, they thought house prices would continue going up. Panicking, they jumped on the ladder for fear that they would be left behind, thinking they would otherwise have to pay more in the next year.
These inflationary expectations, fuelled by lots and lots of bank credit, resulted in the banking sector being mortgaged to the housing market, and vice versa.
This self-reinforcing process is a classic bank/credit/asset bubble that we see time and again when that most fragile of things, human nature with all its idiosyncracies, meets an unregulated banking sector whose objective is to extend as much credit into the system, book as much short-term profit and drive up the share price. Not surprisingly, as the share price determines the top dogs’ bonuses, there is an inherent flaw in the system of light-touch regulation, which leads to massive over-lending.
In the ensuing melée, first-time buyers were pitted against buy-to-let investors; the latter hoping the former would become their tenants and the former trying desperately to leap from being a tenant to being an owner. And in the end, Irish people bought and sold Ireland to each other using other people’s money.
Of course, it’s also true that the population rose – as did income and employment – but not by anything like the rise in the price of houses. Unfortunately, much of the mainstream of the economic profession bleated about supply and demand and soft landings when we were in the middle of a bubble.
Credit, not demand, drives up house prices. Ultimately the cure for high house prices is high house prices. The problem is when they fall, the expectations plunge the other way. If the credit part of the equation is controlled (by the Central Bank), surely this will prevent the wild swings in prices and something like the fairytale world of supply and demand might reinstate itself?
So, this time round, with its latest moves to tighten credit, has the Central Bank done enough? I’m not too sure, and would have preferred to see a backward-looking loan-to-value (LTV) arrangement, which ties the banks to only lending against the “average” house price of the past 20 years. This would break the line between credit and valuations, but it didn’t happen.
From the outset, it has to be appreciated that doing something is always better than doing nothing, mainly because of the impact it has on the crucial part of the housing conundrum: expectations. Anything that reins in expectations of house price rises is good news.
As more than half of all mortgages are taken out by first-time buyers, the Central Bank focused on this sector. For properties up to €220,000, the maximum LTV for the first time buyer is 90 per cent. Above that, the LTV will be 80 per cent. In the past, the figure was an LTV of 92 per cent.
As the average house in Dublin costs €270,000, this means that the first time buyer aiming to buy this house has to come up with €32,000 (a deposit of 10 per cent on the first €220,000, plus a deposit of 20 per cent on the remaining €50,000), as opposed to €21,600. This is a massive change for the potential buyer.
How are they supposed to find this type of cash, when the top income tax rate is kicking in below €40,000? Income taxes are simply too high, and take-home pay is simply too low. We would need to see falls in house prices for a number of years, increases in wages and decreases in taxes for the average first-time buyer to be able to save anything like this amount. Remember, the majority of first-time buyers are having (or planning to have) children, and everyone knows that this is when weekly spending goes through the roof.
Therefore, I have no doubt that it will impact on activity and prices at average house level in Dublin. But maybe not as much as people think.
First, the kids of rich parents will be fine, because the parents will pony up. There is some €90 billion on deposit here, so there are plenty of wealthy parents. A move which results in the social endgame of only the relatively rich getting a look in seems to be a bit odd, don’t you think?
The Central Bank has done a good job in the past few months in introducing uncertainty into the market, and we have seen a significant cooling-off in the last three months ahead of the announcement of the new rules. But will this last?
Just because the first-time buyers may be locked out from buying doesn’t mean they automatically emigrate. They are still here, for the most part, and they still need a place to live.
The fact that many first-time buyers are locked out of buying means they will have to rent for longer. So we will see a spike in demand for rental properties, pushing up rents and therefore yields for investors.
Thus, young workers will be tenants for old landlords, again providing an income to the already wealthy and topping up their pensions.
The impact of eurozone quantitative easing on Irish deposit rates means that money that is now on deposit, earning nothing, will flood back into the housing market because yields in the housing market will rise in tandem with the demand from the renters.
In time, price expectations will resume their upward trajectory – though maybe not at such a giddy rate – and the only significant change will be one that reinforces the supremacy of the already wealthy. We will have the same dynamics in the market for accommodation, just with different owners. The middle-aged have been handed a tax-efficient pension vehicle and the young pay for it.
Remember, Irish people buy houses because other people buy houses. This move doesn’t change this fact. It simply changes the type and age of people doing the buying.
Many years ago, I interviewed Tony Benn. He said to me: “The young and the old have one thing in common: they get bullied by the middle-aged.” Rings true, doesn’t it?