Gabriel Fagan looks like the quintessential central bank economist. Grey-haired, serious, sober and well-informed. He’s the kind of guy you trust. You’d leave your money with him.
Fagan, the chief economist of the Irish Central Bank, appeared before the Oireachtas committee on budget oversight last week, and left parliamentarians’ jaws on tables when he mentioned a figure of €300 billion the Central Bank wasn’t quite sure about.
The bank is examining more than €300 billion in assets here owned by investment funds. What kinds of assets? Property.
To give you a sense of scale, the total debt owed by all the households in Ireland is about €160 billion. The national debt is around €200 billion. To have over €300 billion floating around in the assets of investment companies is big, big news.
The Central Bank is doing its job – keeping Ireland’s balance sheet safe – but the scale of asset ownership by foreign-owned investment funds was clearly way, way higher than people expected. The bank discussed this in its most recent macro-financial review, but it was certainly news to our TDs.
We know Ireland’s national accounts are distorted by huge companies like Apple when their assets being reclassified as resident in Ireland, and we know foreign-owned ‘vulture’ funds have been ploughing money into the Irish property market, sometimes using dubious tax loopholes to inflate their returns by paying next to no tax on these investments, facilitated by Irish law firms.
Thanks to revelations in this newspaper and work by parliamentarians like Stephen Donnelly and minister Katherine Zappone, Michael Noonan is to close the loophole allowing investment funds to claim charitable status for their special purpose vehicles in order to pay almost no tax. The Revenue Commissioners are currently conducting an investigation into their activities. The scale of the tax avoidance has the potential to dwarf the €13 billion Apple ruling, and this time we can be sure the money is owed to us and only us, as these are properties located in Ireland.
How did this happen? How did so much money find its way into the country, and what does this mean for ordinary people paying rent and trying to save for deposits for houses?
To answer that question, we have to think about yields. A yield is a percentage return on my investment. If I invest €100 and I get back €105, the yield is 5 per cent.
Across the developed world, yields on every kind of financial asset have been falling since the crisis. They are now negative across a large swathe of asset classes like sovereign and corporate bonds, equities, and so forth. A negative yield means that if I invest €100, I get back €98. As a measure of just how weird the market is right now, consider this: there’s an estimated $12 trillion worth of bonds giving negative yields.
Investors, in particular pension funds and insurance companies, get hurt when the assets they hold don’t earn a sufficient return. The money managers still charge their fees, of course, but the average punter cashing out of a pension today is not in a great position, and nor is the money manager looking for a bonus to buy the new Jag.
The current low growth, low interest rate, low inflation condition of much of the developed world means savers everywhere are being hurt. People who make money hunting for yield have had to look in some really strange places for yields above even 1 per cent. Assets like the bonds backed by the legal settlement of the tobacco companies with US states, companies dealing in arms manufacturing, junk bond debt, and purchasing property in nearly-broke tiny islands on the edge of Europe.
It may seem like a long time ago, but there was a time when international investors were sucking money out of Ireland with hoovers. They were worried Ireland would default on its enormous debts. I was fairly worried about that at the time too. The National Treasury Management Agency was flying around the world selling Ireland to people who normally buy the debt of developing nations. The Department of Finance was thinking up ways to entice foreign capital back into the country. Real estate investment trusts – Reits – and other investment schemes were introduced to try and restart a damaged domestic market. Ireland actively courted the business of prominent vulture funds.
These and other funds saw a chance to earn yields far in excess of those they’d earn investing in bonds or anything else, and so once our policy makers had created the channels for them to do so, money flooded into Irish assets – mostly property – as our yield hunters did their jobs.
Back down to earth. How does someone investing in Irish property make money from it? First, they bought the properties in big baskets from Nama at knock-down prices. Second, some of them set up special purpose investment vehicles demarcated as charities to reduce taxes. Third, if their newly-owned asset came with a revenue stream – say, an apartment block stuffed with people paying rent – they just jacked up the rents, waited a year or two for the property market to come up a bit, and if they sold, then the €100 they put in turned into €120, a yield far in excess of anything they would have made anywhere else in the world.
So that’s why there’s more than €300 billion in investment company assets floating around in special purpose vehicles and financial vehicle corporations, and that’s the challenge facing Fagan and his team: to figure out what all this stuff is doing, and whether some of these activities are kosher, or not.
The broader pattern is now clear. Apple, and companies like it, use Ireland to help them pay less tax. Their sheer size distorts everything about the Irish economy, including how we measure its progress. We make up 1 per cent of Europe’s economy, so we should expect to get 1 per cent of its foreign direct investment. We have 4 per cent of the FDI share. That’s good for jobs, and has been our model for development since the 1950s, but arguments about low-tax, business-friendly policies don’t wash in 2016 when you’re one of the richest countries in Europe helping some of the largest companies on earth pay very, very little tax.
The International Financial Services Centre is a world leader in brass plaques for shadow banks. Ireland was recently ranked with China as the joint third-largest hub for non-bank finance firms (the technical term for shadow banks). We’re only behind the US and Britain with €2.3 trillion of assets. That’s well over 1,000 per cent of even our Apple-inflated GDP. See the pattern yet?
Our property market in the capital is severely distorted by the presence of over 800 tax-shy investment compaies hunting for yields in a low inflation, low interest rate, low growth world. Our political system is scrambling to close the gates which previous administrations opened to allow all of this to happen.
There is more to come, as repeated investigations into Nama’s conduct in some of these deals show, but this is the big picture and the small picture: Ireland is an island devoted to servicing the needs of global financial capital. There are benefits for us, of course. There are costs, one of which is the ability to say: “We didn’t know it was happening.” We have people like Gabriel Fagan to thank for that. The question is: what are we going to do about these behaviours, now that we do know?