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Marc Coleman: Stressed market means prices have fallen too far

It was my first and best economics lecturer John O'Hagan who told me that of all the other sciences, economics was closest to medicine. Economies are, like human beings, highly complex and thinking of troubled economies as sick patients is a useful way of grasping that complexity.

One of the most threatening disorders facing our domestic economy and chances of recovery right now is the condition of our property market and the closest medical analogy I can think of to describe the problem is bipolar disorder.

As loved ones of those who suffer from it know, the swing from exhilarated highs to depressive lows is exhausting and distressing. Likewise the property market's swing from the highs of early 2007 to its current lows has taken its toll in the form of reckless personal borrowing, an illusory surge in tax revenues and a resultant wasteful spending binge.

Now we are left with the lows: a depleted exchequer, ruined banks and the millstone of negative equity forcing over a third of a million households to slash consumer spending as they face a lifetime of debt.

As with bipolar disorder, the proper diagnosis is not to exacerbate the swings, but stabilise them. Between extreme highs and lows is a sustainable middle to be reached using the right medication: this week economist Peter Bacon suggested doing for property buyers nationally what Nama does for buyers of its properties; assuming the risk of future price falls. Only then can buyers be enticed back into the market, he reckons. The €1.25bn payment of taxpayers' money to holders of unsecured bonds in Anglo Irish Bank will this month remind us just how willing the State is to assume risks for bondholders. And that is a fraction of the amount guaranteed by the promissory note. Yet it is enough to greatly help refloat the market in the form of a stamp duty rebate that would wipe out much of the negative equity for those who paid a fortune in property taxes during the boom, and who face double property taxation in the future.

As the latest Central Statistic Office house price index shows, average property prices are now 46 per cent below peak 2007 levels and roughly back to 2002 levels. Have they fallen enough? Could they fall further? Have they fallen too far?

The distressed state of the property market strongly suggests the latter to be the case. In its latest survey, the Irish Banking Federation puts the mortgages drawdown total at just 3,607 for the third quarter of last year. When compared to the 53,543 drawdowns in the same period of 2005 -- and even allowing for 2005 being a boom year -- this is a traumatic low. One source -- Rachel Doyle of the Professional Insurance Brokers Association -- suggested that between 60 and 80 per cent of mortgage applications are being refused.

While we need a thorough report to be sure, several indicators suggest that price levels prevailing in the year 2004 -- while overvalued in that particular year -- are probably now a good benchmark of where the market should settle: even if government forecasts are optimistic, Gross National Product and Gross Domestic Product should this year settle at 2004 and 2005 levels, respectively.

Despite widening spreads with base rates, European Central Bank rate cuts mean that retail mortgage interest rates are broadly similar to 2004 levels. Despite higher unemployment, the level of employment, 1,805,500 persons, is consistent with 2004 levels. And despite significant tax hikes, gross income -- which remains the basis for approving a mortgage -- remains above 2004 levels. And despite recession, population growth since 2005 -- a rise of one-third of a million from 4.2 million in 2006 to nearly 4.6 million last year -- has been stunning.

But three factors are hampering the market besides the absence of bank lending: supply, fiscal policy

and negative equity. The supply issue is significant but has been exaggerated. Far from 300,000 properties being vacant the National Institute for Spatial and Regional Analysis estimates that the number of vacant properties is in the region of 100,000. Mr Bacon agrees that the demolition of ghost estates is one way to restore the balance between supply and demand. Against the backdrop of a third of a million population increase -- and with statistics indicating about 2.6 persons per household -- there is no shortage of demand to mop up this excess.

Fiscal policy and bank lending are the more serious obstacles to recovery and here we are witnessing a spectacle out of the Madness of King George, with bewigged doctors applying the quack solutions of bleeding the patient by overtaxation.

In last Thursday's Irish Times one writer asserted that "a lack of property taxes also contributed greatly to the property bubble ... A property tax is therefore essential". But far from there being a "lack" of a property tax around 40 per cent of the €3bn paid in stamp duty between 2004 and 2007 -- around €1.25bn -- was paid by homeowners (the same amount, interestingly, as will be paid this month to Anglo bondholders). So the real cause of the boom-bust cycle was not the absence of any tax but the explosion of credit caused by negative interest rates and poor bank regulation. Planning factors -- a myriad of failures that limited housing supply -- also contributed. The idea that a property tax would have stopped a relentless tidal wave of credit from producing a boom is misguided. The idea that a distressed market can suffer the imposition of a property tax that, according to the ESRI, could amount to €1,000, and have any chance of recovery is misdiagnosis.

So what does the market need? Between 2007 highs and current lows there is a sensible mid-point that can be achieved if bank lending resumes and two more policy changes occur: a decisive shift away from tax increases and towards real spending reductions: having risen by 55 per cent between 2004 and 2009 gross current spending needs to fall now by much more than the mere seven per cent envisaged in the Government's expenditure and reform plans.

The issue of the promissory note must also be revisited: spending billions to guarantee the risk of profit-seeking banks while doing nothing to tackle the negative equity crisis faced by those who merely invested in a family home is neither economically nor politically sound: property will never drive the economy again, nor should it. But by effecting a one-off injection into the market to alleviate negative equity it could be decisive in allowing spending, confidence and household finances to return to normal.

Follow @marcpcoleman on Twitter and listen to Marc on 'Coleman at Large' Tuesday and Wednesday from 10pm, Newstalk 106-108fm

Sunday Independent