In The Days of Bulls, Bears and Tigers, Do The Elephants Know Best?

Previous discussions on this blog have addressed the issue of whether the economy is being talked down, and this is something that has been getting a lot of media attention lately. Obviously, the most desirable course of action is for commentators to simply "tell it like it is", rather than talking the economy down, or up, for that matter. Another concern is that homo psychologus should not over-react to news, be it good or bad. Writing this weekend about the Irish property market, Lisney economist John McCartney says that "despite all the changes of the last century, one weakness of the human condition - our tendency to overreact to both good and bad news - remains intact". ('Gloom merchants endanger property market'). One thing that worries me, though doesn't bear cause for outright panic is the news that the average cost of mortgage repayments has doubled since this time last year (Department of Environment). I am however quite cautious, and if my macroeconomics is worth any salt, its a case of considering whether there's more interest rate hikes on the way, rather than wondering if there'll be any reprieve. Today's generation of first-time buyers should be grateful for the current weakness of the US dollar.

An article by David McWilliams in the current edition of the Sunday Business Post is titled "A Country in Denial". McWilliams suggests "if it is possible to talk the economy down, it must be equally possible to talk it up. But who was talking it up, panicking thousands of young workers to buy commuter homes for 14 times their salaries? Who terrified thousands to get into life-long debts with their 100 per cent mortgages over 35 years? The people responsible for this are those who ''talked up'' the economy precisely when it was overheating three or four years ago".

McWilliams finishes the article by using the theories of psychiatrists to give a new twist to the behavioural economics of the property market. He describes the five stages of dealing with death in the observations of bereavement discusssed by Elizabeth Kubler Ross in her 1967 book 'On Death and Dying'. The five stages are denial, anger, bargaining, depression and acceptance. McWilliams suggests that "the five stages also provide an interesting framework to analyse how societies react when they experience a significant fall in house prices and the consequent loss of wealth". He contends that we are in the denial phase, and I suspect he is right given some quite worrying news-stories that also feature in the current edition of the Sunday Business Post.

Kathleen Barrington, in the same edition as McWilliams, says that "Most analysts have agreed that the intensifying of competition (in the mortgage market) has driven down the price of mortgages, and resulted in margin attrition for banks selling mortgages. That should be great news for consumers. The problem, however, is that the cheaper and more available mortgages become, the greater the supply of money in the market. And the greater the supply of money being made available to buy houses, the higher that house prices go". ('How Competition in the Mortgage Market Pushed Up House Prices'). Also: "The fact that first-time buyers were seizing on 100 per cent mortgages in large numbers goes some way towards explaining the anomaly that house prices rose by 9 per cent last year, even though many observers had expected house prices would fall as interest rates rose. Commenting on the figures, housing minister Batt O'Keeffe made the very good point that 'mortgage lending is essential to the housing market, but recent experience shows how lending can add to market cycles'. The pity is that his warning has come too late for many of the country's young borrowers". And: "The scale of the contribution made by lenders to the housing bubble can be gleaned from a revealing analysis by Goodbody Stockbrokers, published last month. Economist Dermot O'Leary hinted that financial innovation was responsible for some of the sharp rise in house prices over the last ten years. He found that house prices rose by 21 per cent a year in the period from 1997 to 2007, a mounting to a total increase of 211.3 per cent over the decade.
A significant part of the increase - 3.5 per cent a year, or 35 per cent over the decade - could be attributed to the extension of the average mortgage term from 25 to 35 years".

An interesting debate might emerge as to whether the 35 per cent increase in house prices attributed to financial innovation is what the market needs to lose in order to return to equilibrium. Some folks would make the reasonable argument that innovation is to be welcomed, but some innovations are quite dangerous, say the atom bomb, or bio-chemical weapons. It could very well be the case that the government has allowed the financial institutions to provide too much access to the punchbowl. The ECB sets our interest rates, but IFSRA still has a strong influence over various aspects of liquidity in the Irish housing market. If the government believes so strongly about the wanton attention-seeking of the 'down-talkers', why don't they put money into schemes that would demonstrate their convictions? For example, what about a government-sponsored scheme that would compensate any first-time buyer for any fall in the value of a mortgage-financed house purchase? The Department of Finance should bear the risk if Bertie wants to rebuke the doomsayers.

I wonder what the Department will make of the news this weekend that the 10,000 first-time buyers who bought homes over the past year are now experiencing negative equity. ('Negative Equity Affects 10,000'). This is certainly bad news and it does ehance my proclivities to consider that there might be panic at the disco. "Fears that the house price index has yet to reflect the full extent of house price falls were exacerbated recently when one of the country's top mortgage lenders, Permanent TSB, said it would lend 20 per cent less to new borrowers this year than last... AIB chief economist John Beggs said recently that house prices were likely to fall further over the remainder of this year". (Barrington, SBP). What worries me most is that a financial institution is now looking less favourably on the use of a house as collateral for a long-term mortgage. So surely there is at least a risk that property faces a substantial drop in value? The days of the 100 per cent mortgage might be numbered, but the damage may already be done if the effect of financial innovation has been to create artificial market liquidity - the sorcerer's artifice, perhaps?

In terms of trying to tell this situation like it is, I think that some insight might come from observing what behaviour ia actually taking place, and subsequently attempting a sensible interpretation. In the days of bulls, bears and tigers, it might be the elephants who know best. While the market doesn't always get it right, I'm very conscious of developments in the ISEQ over the last week. "Last week saw the Iseq take a fresh hit as heavyweight institutional investors, most of them based overseas, decided once again it was time to offload holdings in Irish banks and construction companies with most to lose from the incipient property slowdown". ('ISEQ In The Firing Line'). The market for stocks is much more liquid than the market for properties and no-one can ignore the fact that all of the major Irish stocks in the financial sector lost between 3 and 4 per cent last week.

Furthermore, DIY and building materials group Grafton fell 5 per cent, despite an upbeat trading statement that had good news on the six months to June. "But the most significant damage was done to those closest to the Irish housing market, where investors offloaded as they continued to worry about future sentiment towards property. Cavan building materials group Kingspan was punished for its exposure to housing through its insulated panels and timber-framed homes. Its share price tumbled 10 per cent on the week at one point. The market had equally bad news for house builder McInerney, whose share price continued a dismal run by falling 10 per cent since the start of last week". Nor was last week just a blip. All of the companies mentioned above are, on average, down 20 per cent in terms of stock market value, since last February. McInerney is 39 per cent lower than its level of five months ago and the combined fall in the value of Grafton and Kingspan alone has been in the region of €1.5 billion.

It used to be a case of working the 'nine-to-five', but in the words of McWilliams, many will now work the "100pc, 35-year mortgage dilemma. This scandal condemns an entire generation to debt. These 30-year-olds are the backbone of our society, they are the engine of the economy and yet, this State has lumbered them with a bill which only enriches our banks and our landowners... The crux of the issue is that the banks are now out of control - in many cases due to forces beyond the control of any one bank in particular. Someone has to come in and discipline them... Everyone needs discipline. Sometimes, even in this era of high-faluting finance, the old rules are still the best ones" ('Having Us In Their Debt'). Well, this disco might certainly be more enjoyable if they would now take the punchbowl away. Or maybe... its come to the stage where nobody wants the punchbowl anymore - are the newest kids on the block causing all that noise in the rental market?