Residential property prices shot through the roof until 2007. Now the Central Bank is worried that they are going the other way. The banks won't lend money.
Only those with cash and speculators are buying. Prices are reported to have fallen by as much as 70 per cent following the recent property auctions, spearheaded by Nama. They may be too low. But only an elite few can buy them. The market is not efficient and things will get a whole lot worse if left unchecked.
Economists tell us that the market will find the right price if we leave it to the forces of supply and demand. Eventually an equilibrium price will be found. But as Warren Buffet said of financial markets, he would be a beggar in the street if markets were efficient. There are always winners and losers. On this occasion the market is not efficient because too few people can raise cash.
When prices peaked more than five years ago, they overshot the mark. Since the collapse they have continued to fall. Some have fallen below what they should be. An efficient market would pick up on this and demand would increase until prices stabilised. But with most of the population strapped for cash the market is out of control. For those with cash there might be bargains to be had.
The banks were recapitalised to fund new mortgages, but they are not lending. Nama is offloading property in a market where those who need it most have no access to cash. So prices fall, adding to the mayhem in an already volatile market.
On the other hand Nama attempts to control prices, by guaranteeing mortgages for those who are willing to buy at higher prices. When government agencies interfere they make things worse. Not only are the sellers losing out, but anyone who owns residential property is losing too. The extent of their negative equity is getting worse.
The banks clearly don't have the money to lend. Everything we had was used to pay off unsecured bondholders and foreign banks because that's what the EU demanded. To fool an unsuspecting public, Michael Noonan took €3bn out of circulation when he got Bank of Ireland to fund the repayment of the Anglo promissory notes in March.
In a free market economy government intervention can be a bad thing, especially when they don't know what they are doing. When the market gets out of control some intervention is needed. We should have learned from the global downturn that the financial regulator must intervene when faced by crisis. If the banks won't lend and the Government won't take decisive action to get things back on track, the watchdogs should resign unless they can force the necessary changes through. Otherwise they are not doing his job.
The speculators should be discouraged from making things worse too. If they faced 80 per cent capital gains tax they might act more prudently. Michael Noonan introduced a special capital gains tax exemption for those who buy property and keep it for seven years.
If only an elite few can benefit from the initiative the market will not recover and more tax revenue will be lost as it was on countless bungled property schemes in the past. If the tax initiative has merit, it was introduced prematurely. Those who need it cannot get the money to buy property. The most vulnerable are being encouraged to buy at artificially high prices. As other prices go through the floor, the mortgages guaranteed by Nama are already coming under pressure.
When the market peaked in 2006, more than 110,000 loans were granted. Only 11,000 loans were granted for property in 2011. There was nearly €28bn in new lending in 2006. It was little more than €2bn in 2011. Is it any wonder that the property market is not efficient and prices are unreliable? The prices we had were too high, now nobody knows what price is right. With so few players in the market information is not flowing as freely as it should. And even when the information gets to the right people they cannot get the funds. Based on a report by Kennedy and McQuinn for the Central Bank, Irish property prices may have over-corrected by 12 to 26 per cent. If it's true the speculators stand to gain.
We are in the fifth year of one of the most protracted and severe property slumps in the OECD. It's not over and it could get worse. When it happened in Japan it lasted for more than 20 years. In Sweden and Denmark it lasted for only two years. It took four years for Irish property prices to fall by 40 per cent. On average a slump continues for six or seven years.
If that's the case, we are not there yet but we should begin to see recovery soon. While Government agencies interfere and banks withhold funds, recovery will be protracted. If we are unlucky, like Japan, we could be in this for another 15 years. If the banks don't provide the funds the market will collapse. Then negative equity will be everyone's problem and default will be the norm.
In spite of the fall in prices the public believes this trend will continue. Just as they thought they would go on rising in the boom, they don't think the fall will ever stop. Kennedy and McQuinn reveal in their report that even though prices have fallen so much in such a short space of time, many people feel it is not good value.
Banks have tightened their credit controls. The income multiple that determines the level of the loan is lower and incomes have fallen too. With the exception of the public sector, most jobs are less secure than they were four years ago. Not only does it influence the banks' willingness to lend, it also affects the borrowers' own sense of security. The lack of funding for SMEs is having a knock-on effect. It is creating greater uncertainty in the market.
If the Government was less influenced by those holding the purse strings, it might address our own problems. We urgently need an injection of emergency aid from the European Investment Bank to get the banks lending and to improve consumer confidence. Meanwhile, if you have the stomach for it and you can raise the cash there may be bargains out there.
Sooner or later, supply will dry up. In 2006, 93,000 units were completed, but only 10,500 were finished in 2011. If someone doesn't intervene soon, there will be nothing left worth buying and vacant units will have to be demolished. Demand is there for first-time buyers and those trading up. They just need to be confident the supports afforded to bankers and builders will be there when they need them. Is that too much to ask for the people who have stayed on to rebuild the country?
James Fitzsimons is an independent financial adviser specialising in tax and financial planning