Time for some home truths as residential wealth plummets
Published 14/11/2011 | 05:00
AS a result of the expected 60pc peak-to-trough decline in residential property prices, Irish households are enduring an unprecedented collapse in wealth levels.
Although we don't have the data to detail its composition, it can be safely assumed that first-time buyers who purchased property close to the peak will bear the brunt of this collapse.
As a result, households have now switched to "debt deleveraging" mode. While this is the correct decision from an individual household's point of view, paying down debt en masse is resulting in what can be described as a "balance sheet recession", which will continue to affect household spending and investment levels for some time to come.
There is little by way of historical precedent for the scale of collapse in asset prices, but the performance of the Japanese economy following its collapse in asset prices in 1990 is instructive. The circa 90pc collapse in commercial property prices there created an imbalance between Japanese corporation's assets and liabilities that could only be closed by paying down debt. This created contractionary forces which were the root cause of the weak economic growth that persisted for over a decade. In contrast, Ireland is not in the midst of a corporate balance-sheet recession, but a household one.
The troika largely dictates the policies that Ireland must implement in the coming years. Internally, fiscal consolidation, banking sector deleveraging and private deleveraging are all contractionary forces. For example; banking sector deleveraging/restructuring has already heaped enormous losses on to the Irish taxpayer because private sector creditors have, by and large, been repaid in full. Fiscal consolidation also increases the difficulty for household deleveraging due to hits to disposable income. While Ireland has returned to growth, it is heavily dependent on exports. However, this is now very much under threat as the international economy, particularly the eurozone, heads towards recession in 2012. Ireland has received many plaudits recently, but growth may well fall short of expectations over the coming years, throwing plans off course.
The question, therefore, is whether the current policy direction is the right one and should it change to give Ireland a better chance to grow over the coming years? Given that Ireland continues to have one of the largest budget deficits in the euro area, it would be politically impossible to argue that fiscal consolidation should be slowed. In the case of household deleveraging, the process is largely wealth driven, which is difficult to influence.
Given that the majority of the banking system is still in government control, policies can be implemented to slow the process of deleveraging in this sector. The current policy states that the banking system must reduce its loan-to-deposit ratio (LDR) to 122pc by the end of 2013, through a process of asset sales and deleveraging.
The fact that much of the developed world's banking system is in deleveraging mode means it will be difficult to achieve competitive prices on Irish bank assets. Deleveraging is supposed to focus on "non-core" activities within the Irish economy, but the LDR targets provide perverse incentives for the banks to reduce the size of their loan books. An easing of the LDR targets would remove this incentive but this would require further assistance from the ECB.
Were it not for the insistence of the ECB, costs associated with the banking system would probably have been shared with private sector creditors by way of deeper burden sharing. The Irish Government did not, however, attempt to put the wider European banking system at risk by going down this route. This is particularly frustrating in the context of the proposals to cut Greek sovereign debt by 50pc and the recent payment of Anglo Irish bonds.
Given the continued downward momentum in domestic spending and the international threat of slowdown, that is unlikely to remain the case. Further European assistance in relation to the restructuring of the banking sector is required.
Dermot O'Leary is chief economist with Goodbody Stockbrokers. Maeve Dineen is away.