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WHEN READING THE history of financial crises, an uncomfortable feeling of deja-vu arises. It’s like the horror movie scene when the expendable character decides to split off the group and descend the steps into a dark cellar alone. You want to shout: “Don’t go down there, you already know what will happen!”
Deregulated banks engaging in financial speculation. Housing prices rising to absurd levels. People leveraging everything to purchase a home with a mortgage they can’t afford. All followed by a financial collapse, a bailout of banks by the public and a long, painful period of recovery. Sound like Ireland and the 2008 financial crisis?
In fact, this is a description of the 1989 Swedish banking crisis. This kind of financial fiasco is neither new, specific to Ireland, nor is it unavoidable. But to avoid it, we first have to understand it.
The average house costs nine times the average annual salary
Right now, average house prices in Ireland have exceeded those at the peak before the last financial crisis. We now stand with the average house costing €338K, nine times the average annual salary. During the last peak average, house prices were €311K. With the market looking sillier with each passing minute, now might be a good time to take stock of where things are headed.
The 2008 crisis involved a big housing bubble, and Ireland was not alone in this. It originated with “subprime” mortgages in the United States: overpriced housing sold to people who could barely afford it or who couldn’t afford it at all.
These dubious (hence the name “subprime”) mortgages were repackaged in such a way that made them appear less risky than they actually were to prospective buyers: sliced, diced and recycled.
Once this financial house of cards collapsed, it caused a domino effect across the world. As the overpriced housing bubble popped, financial institutions were left with assets worth a tiny fraction of their original valuation. Banks immediately began demanding that governments use taxpayer money to back up their shrinking assets to avoid financial armageddon.
Most of us suffer because of these housing crises, both before and after the bubble bursts. Although we’re inundated with stories about how positive it is that property prices are recovering, this has little value to the average person.
An increased price for a house you live in doesn’t mean much unless you sell it, and then, in most cases, you simply have to buy another house in a similarly inflated housing market. New entrants to the market find that they are simply unable to afford a mortgage as prices increase relative to their earnings. For renters, it often means that rents go up as they compete with rising mortgage prices.
In short, rising house prices are largely irrelevant to those lucky enough to have already purchased, but mean a drastic increase in the cost of living for new entrants and renters.
And where does the extra money go?
If we’re investing more of our salary into housing, who gets it? It’s not going into producing more housing. There are very few properties on the market, only 2,700 in Dublin currently. The money is going into the pockets of speculators and landlords.
Financial crises and property bubbles are often linked for precisely this reason. When investors can’t find low-risk, high-return investments, they often decide to store their money in an asset instead. Housing and property is a durable asset that is attractive for this very reason, especially in a growth market.
This helps to produce a vicious cycle. The increase in the cost of housing means a larger percentage of workers’ wages is spent on housing. This puts the squeeze on wages. The profitability of other enterprises declines, and as a result, investors are even more likely to invest in housing, rather than other economic activity.
If you can’t pay your workers enough to live on, you may not find workers, and if paying them enough to live on means you can’t sell your goods then you can’t exist as an enterprise. This effect acts on the wider economy like a brick tied to a swimmer’s leg.
And then, perhaps even more tragically, when the bubble bursts the State is asked to foot the bill to keep the financial institutions afloat. Ultimately “the State” means “us”. We transfer our taxes and future taxes to financial speculators and less of our taxes can be invested in public services: our hospitals, our schools, our public transport.
We might get cheaper housing finally as a consequence of the crash, in the form of falling rents and cheaper mortgages, but we also pay the high price of job losses as the financial fallout takes its toll.
Housing bubbles are not inevitable
One might be excused for thinking housing bubbles are inevitable, like the weather, but this isn’t the case. It is possible to provide housing without going through cycles of boom and bust. The solution can be found by looking to those who lost least during the financial crisis, and that solution is public housing.
Rent prices in Vienna, for example, changed little going into the financial crisis, or coming out of it. They tracked much more closely with the general inflation trends. And the reason for this is that Vienna has 30% of its housing provided by the municipality and a further 30% in various types of not-for-profit housing bodies.
This high percentage of public housing has two very important consequences. First, it means the bulk of housing is taken out of the speculation game which financial wizards play. That means you don’t have bubbles and you don’t have pops. Obviously avoiding financial apocalypse should be considered a good thing.
The second is that the cost of living tends to remain stable, and low. This is great news for us, by which I mean people who don’t have millions of euro riding on property investment gambles. This low, stable cost of living is also good for the rest of the economy. It means that we can afford to produce goods at lower costs for export. This knock-on effect has driven even the notoriously pro-business group IBEC to endorse the state getting more involved in keeping the cost of housing low.
We are in the midst of a housing crisis which is creating record numbers of homeless people, putting enormous pressure on renters and making it impossible for most people to buy their own home. And it’s all going to lead to a bad end when the bubble eventually burst. Perhaps it is time to consider not descending those cellar stairs again.
Gavin Mendel-Gleason is the Workers Party representative for Dublin Northwest.
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Moodys, Fitches and S&P… why do we care or listen to them. They triple A rates junk bonds on the sub prime mortgage fiasco… If they for those so wrong why listen to their opinion????
We don’t have to care what they think but when we need money it matters
Because lots of investment funds are only allowed to invest in bonds with a certain rating from those agencies. If you get a better rating, you get more demand, hence higher price, hence lower cost of borrowing new money.
Personally I wouldn’t trust Moodys to tell me what day it is, but that’s not how funds work.
Emily Saul that is no reason to give them more credibility. We have to take it into account, but if I was making decisions I’d want a few other corroborating data points before I’d base any decision off these peoples opinion.
They were more responsible for the crash than nearly any other single factor by mislabeling exploding mortgages as AAA rated investments in a massive fraud.
They should have been wound up and new agencys with new personnel put in their place…but why would we do that, we didn’t bother doing any other serious financial reforms…
The people that countries borrow money off listen to them and use them to set the rates. So we do not have to listen but we certainly are affected by it.
Give them credibility or not it doesn’t really matter. They are what they are and they are going nowhere
It was a rhetorical question…… I know why we do.. We have no choice as a small country… but why does any investor or country on mass do so
They must be doing something right or else investors are losing money……
Warren Buffett called it the lemming effect. While lemmings as a whole have a terrible reputation, no individual lemming has ever been singled out for criticism.
Exactly Brian!!
We know how corrupt the ‘free market’ and powers that be are..thus given how much emphasis is placed on bond status done by these rating agencies, the question is how are they regulated and by who!???
It would be ridiculous in the extreme to believe they were truly impartial and independent!
And Nigel wins the top prize. ….
Our barely above junk paper is trading with below 3% yields! I wouldn’t be so certain the markets still attach the same value to the opinions of these agencies that they once did.
Moody morons. What do they really know?
I would not say they are going nowhere at all Saul, theres another crash coming, anyone familiar with the insane risks currently being taken on the international markets can see that. Were in for a period of sluggish semi-ok but anemic GDP growth (a jobless recovery) followed by another crash and the scale of the risks being taken will mean that no bailouts will be possible this time.
I only hope we get people in charge in the US and UK who can see the writing on the wall in time and go back to pre80s financial regulation.
Also Saul the ‘must be doing something right’ comment is PAINFULLY naive…I used to have people say stuff like that to me in 07 when I was trying to yell ICEBERG ICEBERG back when you could count those of us seeing the thing on one hand, what you got was smug replies about how ”were doing ok so far” and ”soft landings”.
They were making money for people with the sub prime mortgage securitization scam and that ended up getting away from them and crashing the global economy.
Ryan I’m not saying I agree with the system. I’m just saying that it’s not going to change anytime soon. You are properly correct when you say another crash is in the way. I’m not an expert or even close to being one. Are you telling me that nobody (investors) actually listens to ratings agencies? BTW I tried to sell my house in 2006 because I could clearly see the writing was on the wall. Unfortunately I had no idea how bad it was actually going to be or I would have dropped the price a lot more!!!
Putting your faith in those in charge in the US and UK to “see the writing on the wall” and act is a bit naive too Ryan. The ones in charge are the ones orchestrating the crashes – doesn’t take a professor to work out the ultimate consequences of pumping upwards of $40bn in new liquidity every month into capital markets.
No no quite the opposite Saul…sadly…to my eternal horror they listen to them as if they never had any history of fraud whatsoever. Talking to people in the financial sector today and I’m talking about traders investors not bank tellers the smugness is shocking, and I feel kinda bad saying that cos some of them are friends, we’ve generally agreed to avoid this topic in our conversation, but they act as if the 08 crash had nothing to do with them, and no mistakes were made, that it was all govt policy mistakes or people ”dumb enough” to buy houses above their grade.
I don’t beleive crashes are orchestrated I’ve seen too much of the inside of the top of the political and financial systems to beleive that, the more scary (imo) reality is they are unplanned and people are bumbling through oblivious to the consequences of their actions (politicans)..or just not caring (in the case of the financial sector)
Even in the best most ideal financial reform we’d still need ratings agencys…I’m not saying lets stop being capitalists and bring on the central planning, just that these particular actors should have been swept away and new people and organizations put in their place, we could still do that and should.
Short of that, I’m saying we should take what they say with a grain of salt and look to corroboration for everything they say.
Is it worth pointing our none of the triple A bonds defaulted. They were a lot riskier than people thought but if held to maturity none defaulted.
I think we need to be clear about what the rating agencies’ fraud was, because usually it is trotted out by crusties who don’t know what they are talking about.
The obvious type of fraud they could commit would be to overstate the prospects of investments in which they already had a stake. People buy in and they cash out. There’s absolutely no evidence of this type of fraud whatsoever. So whenever it gets trotted out, it is easily dismissed.
At the other end of the scale is incompetence. Getting it wrong, even getting it spectacularly wrong as the rating agencies did, is hugely damaging. But it is not fraud.
That is the distinction which the agencies have been able to draw so far. But it is a false dichotomy. In between those two extremes is an area which in my opinion isn’t grey at all.
The way the subprime loans worked was that junk was bundled up with apparently good stuff, so that overall the investment was seen as fairly safe and graded accordingly. These were then themselves mixed up, repeatedly, on the insane theory that if risk was spread around far enough, it effectively disappeared.
By the end of this chain, the instruments which were being sold to Norwegian pension funds and Canadian cities were based on an incredibly complicated basket of assets. By some estimates, in order to conduct a due diligence exercise on any one of those instruments, you would have had to read one billion pages of documents. This is of course impossible.
And it is the very fact that it is impossible which makes the rating agencies fraudulent. They were giving a rating to securities when they had absolutely no idea whether or not they were good investments – and must have known that they couldn’t possibly have any basis to rate them.
The theory is that the agencies have escaped prosecution because they have threatened to destroy the credit rating of any country which tries. This at least has the whiff of credibility. It cuts down the number of countries who would be in a position to give it a go, and certainly rules out the US.
Subprime was never mixed up with prime mortgages in CDO’s. You fundamentally misunderstand what a CDO is…
6 year old video but explains the problem well.
https://www.youtube.com/watch?v=eb_R1-PqRrw
An upgrade would upset the Whingers. They should leave announcement until after weekend.
This will drive the Sinn Fein shills mad.
Good news under this Government puts them into a dark rage, verbal diarrhea and lashing out insults at everyone. Their economic think tank had been hoping for a second bailout.
As a measure of current market sentiment, this is fine; as a measure of economic and financial reality, it is delusional.
Given the Agencies’ rating of US sovereign debt, their indebtedness and the state of their economy, this upgrade for Ireland is relatively realistic if not too little.
” likely to upgrade Irish debt to Baa2 from Baa3 ”
This company run by sheep or something?
Well, the deficit is heading towards 3% of GDP?
the only thing its confirming is the abality of Baldie and Givememore to bitch slap a capitve population
fock moodys vankers
It’s just another euphemism for” your still trash lads” . Long ways from the heady days of triple A
Heading the right way though
Baa2 is a long way from Caa1/2/3. Anything but trash.
have your say