Thursday 23 October 2014

Viva Las Vegas, where mortgage defaulters have a chance to learn from their mistakes and move on

Published 27/02/2013 | 17:00

THIS week the column comes to you from Las Vegas. It may not be the ideal place to gauge the pulse of the American recovery but Nevada had one of the most violent boom/bust housing cycles in American history, so it constitutes a ground zero of sorts. The last time I was here in 2009, there were foreclosure tours of cut-price housing. There were buyers at discounted prices.

Prices kept falling until 2012 but since then, they have begun to stabilise and rise modestly. The market has cleared, or at least much of the process of clearing is already behind them.

When you compare Nevada and Ireland, one of the key differences between both housing busts is the non-recourse mortgage. In America, banks can't come after the person and chase them for the rest of their lives for a mistake made in a property boom. The American hands the keys back to the bank, the bank sells the property and the new owner moves in. The bank takes the loss on its balance sheet and everyone moves on, older and hopefully a little wiser.

It is called co-responsibility. The creditors and debtors both pay a price and we start again. Both parties are adults and both make sacrifices to clean up the mess. That's how it works in the US. It is called capitalism. And the process whereby debts are worked through is called deleveraging – both by the banks and by the people.

The situation in Ireland is different because, despite new legislation, the debtors are harassed by the banks and the creditors still hold most of the aces. Things are improving a little bit, but not half quick enough. I have been told that the banks are now gearing up to come after debtors in a way that they haven't done so far. This will be the next phase of the bursting of the Irish debt bubble.

As long as this is going on, the prices of houses are likely to continue to grind downwards and with such a large overhang of debtors who can't pay, there is likely to be downward pressure for some time still.

For the banks, which want to lend because that is how banks make money, the situation is disastrous too. Their problem is having been recapitalised last year, amid claims that Irish banks were the "best capitalised in Europe", and having claimed that they had more than enough capital to cover the losses they will make on their mortgage book, there is a real fear deep within the banks at board level that they mightn't have enough capital after all.

The economy can't recover in such an environment and it patently isn't.

When the problem is deflation, as it is in Ireland with asset prices and wages falling, the solution is inflation, not yet more deflation.

This simple lesson appears to be totally lost on our rulers. But it is not just our rulers. All across Europe, the political elite is embracing deflation, and this is driving up unemployment. Then these guys are surprised when the Italians vote them and their proconsuls such as Mario Monti out. There is shock in polite circles when people like Berlusconi re-emerge. Yet what the elite fail to remember is that they deposed Berlusconi and whether you like him or not, he was the democratically elected prime minister. That has got to count for something, no?

Anyway he is back and the austerity policies followed by the eurozone are again under the spotlight. When there is mass deleveraging going on, unless demand is created from somewhere, the economies will continue to shrink.

This is why this part of the US is so interesting because just up the road from Vegas is a fine example of what a government can do in a recession that will add real long-term value to the economy, while at the same time provide a boost to demand in the short term.

For someone with vertigo, looking down at the Hoover Dam on the Nevada/Arizona border was not the most relaxing experience for me. However, in terms of understanding what has to be done by governments in recessions, there can be few better examples.

The Hoover Dam is a marvel of engineering and political will power. The dam was largely built by Irish-American workers, under the supervision of Frank Crowe, another Irish- American. It was constructed in the middle of the Great Depression.

President Roosevelt combatted rising unemployment and deflation with a huge rollout of public infrastructure projects from highways to dams to housing and schools. In the 1930s, America built and built.

Not only did the Americans build and build but during the Depression they also tore down old ideas that were inhibiting the growth of the country. The most significant of these was abolishing the gold standard.

The gold standard was a creditors' charter, a policy that limited the ability of the central bank to print money by linking the dollar to gold and ensured that the real cost of debt was gold so the debtors hadn't a hope of paying back old legacy debts. So, for example, when prices, wages and asset prices were falling, the debtor had to come up with more and more of his resources to pay old debt he took out in the pre-1929 boom.

As long as America was on gold, the amount of dollars in circulation was limited and deflation in prices, commodities prices and food prices, continued. As food prices fell, farmers had no incentive to increase production and deflation gripped the economy, begetting more and yet more deflation.

Before Roosevelt abandoned the gold standard, most serious people said that if America came off gold its credibility would be smashed and chaos would ensue because creditors wouldn't be repaid in gold but in paper dollars and this would constitute a default. Surprise, surprise, these people were usually rich and were owed money!

In the event, the Americans orchestrated the biggest default in history and guess what happened? The economy took off rather than faltered because, unshackled from gold, the dollar could fall in value, be printed, allowing cash-starved companies get credit.

This loosening of monetary policy combined with massive public works programmes like the Hoover Dam jolted the American economy back to life.

The euro is Europe's gold standard. It is rising now in value just as debts in a country like Ireland strangle the average homeowner. The Italians have given their response. If we keep going down this road, political gridlock, chaos and radicalism beckon across the continent.

www.davidmcwilliams.ie

Irish Independent

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