Friday, 26 April 2013

Housing problems - lessons from Ireland (3)

What caused the Irish housing boom and bust crisis, and could it happen here?

The biggest element in the Irish event was a grossly inappropriate monetary policy. After Ireland joined  the Eurozone, it got the monetary policy of the European Central Bank - it got low interest rates, reflecting the slow growth conditions in the major Eurozone economies. Ireland, on the other hand, was 'the Celtic tiger', with strong growth in output, incomes, and prices. The 'one size fits all' Eurozone interest rates were way, way too low for an economy growing at a gangbusters rate.

The other important element was the 'me too' behaviour of both borrowers and lenders. On the borrowers' side, people saw their neighbours making pots of money by taking out mortgages at the low Eurozone interest rates, and buying houses that trebled in value in a decade. The house buying took on a self-fulfilling frenzy. On the lending side, banks, even if they saw a problem lurking down the track, and they may not have, did not want to lose out to their competitors when it came to getting their fair share of this booming mortgage market, so they accommodated the boom as well.

It didn't help that neither borrowers nor lenders were able to sort out, in real time, the speculative excesses from the increases that would have happened perfectly naturally anyway. There was strong net inward migration to Ireland (70,000 people a year at its peak), and strong growth in employment and incomes. House prices would have risen by some amount - perhaps by a substantial amount - in any event. Who, in the midst of very robust economic conditions, is able to figure out that the first 10% of price appreciation is in line with the strong economic fundamentals, but that the next 5% or 10% or 20% isn't?

Could it happen here? To some extent, we've got the Irish problem of importing too-easy monetary policy: we've had to match, or at least get within spitting distance of, the zero or near zero short term interest rates of the major OECD economies, to prevent our currency being driven up to even more insane levels. We've certainly got the same household and bank behaviour. And we've got some modest level of genuinely higher demand for housing, from immigration and from net increase of the domestic population, coupled with some degree of constraint on supply responding quickly to the increased demand. Increased demand and constrained supply make for higher prices, and can seed a subsequent expectations-driven bubble.

You can see why the Reserve Bank is worried. And you can also see why it won't be a surprise if the Bank tries to stop the arms dealers supplying the ammunition for this campaign - or in other words, looking to do something about the banks providing easy finance for a housing debacle.

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