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Damien Kiberd: We recover part of our sovereignty - but banks still losing their senses

The target borrower for banks is often a high net worth individual living overseas: ordinary owner-occupiers can go and whistle.

Damien Kiberd

SEVEN YEARS AGO when the Celtic Tiger’s asset price bubble began to grind to a juddering halt, the government of Ireland owed its creditors €44bn.

Today that number is €206bn, equivalent to 124 per cent of GDP.

Today, December 15, may be the day we recover a part of our lost sovereignty.  It is a good day indeed.

But we are still accountable in many ways to external forces. And the problems we face are bigger than ever before.

Just how sustainable is our programme of debt management? Right now global interest rates are on the floor and, after years of tight management and austerity, the government can borrow long term capital at an interest rate of under 4%. But there is no guarantee that this will remain the case.

Either way the burden of servicing existing debt means that next year we will pay our creditors €8,190m in loan interest. This is more than four times the interest bill of €2,000m which we incurred in 2007.

State revenue earmarked for interest payments

For the foreseeable future a large part of government revenue is going to be earmarked for interest payments even before it is collected. And that ignores the whole question of capital repayments.

Like any sensible borrower the government has been doing its best to string out the process of repaying the sovereign debt.

The ‘average maturity’ of loans provided to us by the European Financial Stability Fund (EFSF) under the bailout programme is 21 years, for example. The NTMA will go on trying to push out the date on which capital repayments are made, rolling the debt forward where possible.

But ultimately our capacity to repay our debts must depend on the extent to which we grow our economy.

The recent growth record is not good.

Ireland’s economy contracted by 2.2% in 2008, by 6.4% in 2009 and by a further 1.1% in 2010.

After growing by 2.2% in 2011, it began to contract again: by 0.2% in 2012 and again by an estimated 0.2% in 2013.

The government hopes that the country will grow again by 2% next year. But there is no guarantee that this will be so. Among our sixteen partners in the Eurozone only the Germans are growing at a respectable pace. And our economy is hugely reliant on exports as a source of growth.

Setting the scene: The early 1990s

In previous periods such as the early 1990s we were lifted out of the mire by a combination of lower taxes and cheap credit. The government brought down the top rate of income tax from 65% to 40% while, for the first time, borrowers had access to a flood of cheap European capital. This created a buoyant local economy in which jobs were plentiful.

Today we are back where we were in tax terms, taxing modest incomes at marginal rates of 52% or even 55%.  And the banking system, which we rescued at a cost of €64bn, has largely shut down as an engine of credit creation for ordinary households and therefore of growth in domestic demand.

Finance Minister Michael Noonan signalled Friday that the tax issue is now his top priority.

Asking single workers on €33k a year gross to pay 52% in PAYE, PRSI and USC is clearly daft. It is also sending out all the wrong signals to overseas investors who will be sending key executives to work in Ireland and seeking to recruit skilled staff from other countries.

So it is vital that he finds the resources to pay for a very big widening of the standard rate income tax band.

Deadbeat banking system

But the real sickener for Noonan and for his cabinet colleagues lies in our deadbeat banking system. Instead of lending more to business and to households, the banks are lending less and less. They don’t think small firms are a good risk. And, apparently, they don’t think that mortgage loans should be given to ordinary people either.

Into the future they may be thinking of a completely different type of banking model.

Consider the following. At some of our biggest banks the rate of default on existing buy-to-let (BTL) mortgages is currently approaching 30%.

You might imagine that this horrific, almost unprecedented, bad debt experience would scare banks away from BTLs altogether. Yet in recent days banks have begun cutting the rate charged for BTL loans as they drum up new business. Simultaneously there are reports that global capital funds are creating new lending vehicles for Ireland which will specialise in BTL lending.

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Have the banks taken leave of their senses? Again?

Vulture funds and global property investors have also been snapping up blocks of apartments in Greater Dublin.

Why is this happening? Have the banks taken leave of their senses, again?

Clearly the banks and the professional investors believe that there is a big future in the rented property market in Dublin and other urban centres. If young people, especially those in fixed contract employment, are not going to get mortgage loans in the future then they must, by definition, become permanent renters.

Already rents are rising sharply in Dublin. The BTL market may actually be the place to be for the banks and capital providers of the future. If the borrower is affluent enough to put up a substantial part of the cost of a property in cash, then the risks in new BTL lending are acceptable.

Similarly, the pillar banks are beginning to offer new five-year interest-only credit to property purchasers provided they can put up half the cost of a property in cash. The target borrower in frequently a high net worth individual living overseas.

‘Professional’ investors v owner-occupiers

The view in the top echelons of banking seems to be as follows. The banks have gone through a terrible time losing pots of money on tracker loans. The 12% default rate on ordinary home loans has pumped up average loan losses. But there has to be a future in lending for bricks and mortar provided you de-risk the lending sufficiently.

This means much lower loan to value (LTV) ratios, completely flexible lending rates and much more rapid methods of dealing with default. This in turn may mean a bank chooses to deal with ‘professional’ investors in property as opposed to owner-occupiers.

If, in the process of changing the lending strategy, you pump up the price of the existing stock of property then so much the better. Ultimately, you may recover some of the capital you thought was lost during the boom.

This may be one of the most important legacies of the boom and the crash. The banks haven’t gone away. They may simply re-invent themselves as property lenders in ways that alter human behaviour quite significantly.

As regards lending to small business, well that’s another day’s work altogether.

Read Damien Kiberd’s columns for TheJournal.ie here>

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Damien Kiberd

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