JUST WHY DOES Finance Minister Michael Noonan think that it would be good if house prices continued to rise?
Cynics claim it’s a matter of simple arithmetic, fiscal and political.
Firstly, the higher the price of houses, the more he’ll collect in Local Property Tax. Secondly, the recent strong recovery in house prices has been confined largely to The Pale. It has not yet permeated the districts where Fine Gael returns the greatest number of Dáil deputies. There’s a way to go.
Noonan is a very intelligent man. It’s not conceivable that his thinking on house prices is driven by such venal concerns. No, what he’s really interested in is the ability of licensed banks and of households to repair their balance sheets and get the country back to normal trading again.
The problem is clear. Despite an injection of €64bn into the main Irish banks by the Exchequer, along with other substantial amounts of rescue finance from RBS, Lloyds and others in the UK, the task of normalising the banking system still eludes us.
The banks are going to need more capital. Noonan/the State owns two of the biggest banks. A rise in house prices will reduce the potential bill by curbing the level of bad and doubtful debts.
An important book published in recent days – ‘Plan B’ by finance expert Cormac Lucey* – highlights some remarkable numbers.
Buried within the 2012 results from AIB, Bank of Ireland and PTSB are two sets of figures. These reveal, in each case, the book value of the assets as set out in the balance sheet of each bank (net of provisions) together with the banks’ own estimates of the ‘fair value’ of these same assets. The latter value is the best estimate of the commercial value of these loans if they were sold today to a third party.
The difference between the two values is €9bn for AIB, €12bn for Bank of Ireland and €7.5bn for PTSB. That’s a hole of almost €30bn – equivalent to about 15 per cent of the book.
Worse still, seven years into the recession the big banks are still losing vast amounts, before provisions for bad debts. That hole in the balance sheets is getting worse, not better.
Rotten at the core
At the heart of this problem is the impossibility of recovering a proportion of the money the banks have already lent in home mortgages and in working capital and property loans to SMEs.
Official Ireland routinely claims that 12 per cent of the mortgages held by owner occupiers are toxic. These are the home loans that are in arrears for more than 90 days. A more brutal analysis of the numbers would show that the true figure for toxic debt is much higher.
If you include loans in arrears for less than 90 days and buy-to-let loans (BTLs) then the number in arrears exceeds 145,000.
Furthermore, almost half of the loans made to SMEs are in some type of difficulty. This chronic incapacity to repay exists despite the fact that base rates in the Eurozone – currently 0.25% – are on the floor.
The results of these realities are rapidly becoming quite ugly.
When the bosses of four big banks were brought before the Oireachtas Finance Committee this past week they revealed that their banks have taken or are threatening to take legal action against 31,000 mortgage holders. A legal bloodbath is coming: many of those with loans in default will have to decide between losing their property altogether or selling at a loss into a somewhat improved market.
On Thursday, the Department of Finance issued some new numbers for end-February. Some 80,000 mortgages held by owner occupiers had been restructured, along with 21,500 BTLs. That is over 100,000 restructured mortgages.
The ‘restructuring’ is often quite crude. These borrowers have most frequently been put on ‘interest only’, had their arrears added to the capital balance outstanding or else been given longer repayment terms. The rate at which problem loans are ‘restructured’ is accelerating.
Many of the restructured loans are not technically categorised as being ‘in arrears’. It’s not possible to be completely precise but if you eliminate double counting there are well in excess of 200,000 mortgages in trouble. And that’s more than a quarter of the mortgage book.
Balancing the books at home
Just as the big banks are struggling to restore order to their balance sheets, the average Irish family is doing exactly the same thing.
Consumer confidence has not recovered in the wake of the 2007 recession. The net wealth of Irish households has dropped by €200bn, mainly due to lower house prices, and they are being salted by super-taxation with marginal tax rates of 52 per cent and 55 per cent. Noonan knows that the economy contracted again last year instead of growing by the 3-4 per cent predicted when the austerity programme began .
The economy is showing all the signs of Japanese-style debt deflation: prolonged decline in output, falling prices, contracting credit. We are legally prevented from either devaluing our currency or arranging a Keynesian fiscal stimulus. The Germans will probable prevent the European Central Bank from engaging in Quantitative Easing. We are in a complete cul-de-sac.
Pumping up house prices might be the only way to lift the mood among consumers, supporting more jobs in services. That may explain the official tolerance for greater house price inflation. If you feel you may inflate your way out of arrears, out of negative equity, you might start to spend again.
It’s a forlorn hope but it may be the only hope available. Absurd house prices-and the related credit bubble- got us into this problem: the paradox today is that higher house prices are now seen as the possible trigger for recovery.
Is this all a delusion?
Getting the economy to grow again seems hugely difficult, despite Friday’s optimistic noises from the ESRI.
There’s no wall of credit coming into the market. Anglo and Irish Nationwide have been closed down in stages, while Bank of Scotland and Danske Bank are running off their books. Despite the hype about the remaining banks being ‘open for business’ net lending for mortgages and SMEs is still dropping relentlessly by 5 per cent a year.
The banks themselves don’t have the staff with experience of how to assess business risk. The current workforce spent years shovelling cash into an overheated property sector followed by years acting as amateur receivers. There’s no conventional lending skill base left.
At national level we’ve pledged to continue the austerity programme until the end of 2015. After that we’ve agreed to cut the national debt to 60 per cent of GDP compared to 120 per cent today and to take the annual deficit down from 3 per cent of GDP to 0.5 per cent. The national debt exceeds €200bn, the interest bill is heading for €11bn a year.
Even though deposit rates are tiny, households are still saving 10 per cent of net income each year. They are still scared and ‘de-leveraging’ like hell.
A lot of Irish assets are being sold to overseas buyers for big numbers. But that money will be used to pay off the debts of both NAMA and IBRC (in special liquidation), not to stimulate growth.
We’ve restored order to our budget and stemmed the cash bleed at the banks. But we have not created a functioning economy.
We may need something more dramatic to do just that. In his new book Cormac Lucey advocates an exit from the Euro followed by a likely devaluation along with a restructuring of the government debt (a coded expression meaning controlled default), though not necessarily in that order.
*’Plan B: How leaving the Euro can save Ireland’ by Cormac Lucey is published by Gill & Macmillan (€12.99).