Home ownership is the most emotive policy issue in the state. Not water charges, not public sector pay, not Travellers’ rights, not reproductive rights, not even the status of Ireland’s so-called military neutrality. Nothing evinces emotion like housing.
The tip of the spear is, of course, homelessness. We are one of the richest countries on planet Earth, and we have thousands of families living in hotel rooms, hostels and on the streets while vulture funds buy properties and jack up rents only to pay no tax on their gains.
We have a generation of young people for whom owning a house is not a dream but a fantasy. We have a banking system still stuffed with non-performing loans nearly nine years after those loans stopped performing.
We have a minority government incapable of action, hamstrung by domestic politics and fiscal and monetary rules.
None of what I’ve written above is wrong. It’s just not very helpful. The words you’ve just read is not analysis so much as emotive language, aimed at identifying a problem and sympathising with sufferers of that problem without trying to fix it. It’s virtue-signalling, which is just whinging, basically, and it’s what much of the commentariat has been doing since the Central Bank introduced its rules on loan to income and loan to value for homeowners in February 2015.
Blamed for doing nothing before the crisis, the Central Bank was blamed for doing something to avoid the next one. Regulators shouldn’t be popular. That’s why they aren’t elected, they are independent, and they get paid lots of money.
I was a fan of the prudential rules when they were introduced because I listened to the entire banking inquiry online. As each banker came in to be roasted (consequence-free, of course), it was clear they hadn’t a clue of the damage they were doing while they handed out the loans to grateful (and greedy) homeowners.
Unfettered access to credit via a loan to value ratio that was much, much too high was the true cause of the housing bubble from 2002 to 2007. It is the Central Bank’s job to safeguard the stability of the entire financial system. It didn’t do that before 2007. We know this because there was a peak-to-trough fall of over 50 per cent in residential property between 2007 and 2012.
A build-up of credit on the household sector’s balance sheet made this sector much less resilient to the 2007 downturn.
Flawless logic of the rules
The logic of the rules on households and banks to restrict the supply of credit is flawless. Requiring those borrowing a mortgage to put up a minimum percentage as a deposit and then capping the amount they can borrow at 3.5 times their own incomes means the borrower is much more resilient to any change in the value of their house.
This is exactly what the rules are there to do, and new research by John Joyce and Fergal McCann shows that newer mortgages given out since 2009 are much more resilient. The probability of these homes defaulting is much, much less than the homes borrowed for in 2005 and 2006 with 100 per cent (and more) mortgages, but this is probably because banks had reverted to their historical role of gatekeepers of credit rather than being dispensing machines for it, a role they had assumed from 2002 to 2007.
Good economics tells us why. The economist Hyman Minsky described a financial cycle where banks, stung badly in a previous crisis, are extremely reticent to lend. Only the best projects get funded. So for example only two senior civil servants married for 20 years with no other debts get a mortgage. These people are safe as houses (pun intended). Then as the economy recovers, more and more loans repay, and so banks make credit more freely available. The process moves from careful extension of credit to euphoria and collapse with remarkable regularity.
It is clear we are at the start of yet another cycle of credit extension, over extension, and property mania. The end is a collapse. The Central Bank is doing its job in guarding against the Minsky cycle, but has bowed to pressure to change its rules.
Rental sector is the problem
The problem is the damaged and poorly regulated rental sector, which is unable to accommodate all these people, stuffed full of accidental landlords who need rents to go up to heal their own damaged balance sheets. Fergal McCann’s research on Irish rents shows that they increase where the population is higher, unemployment rates lower, house prices higher, and rental supply lower. Dublin, in other words. The locus of the problem is the supply of available rental accommodation in Dublin.
The residential property price index for Dublin was almost 9 per cent above the rest of the country in September 2016. Since mid-2013, all residential property prices have been rising, but Dublin has done all the running. Many people think that apartment prices are rising faster than house prices, but this isn’t the case. The recovery in Dublin house prices is the real story since 2013.
The loan to income rule is there to stop banks over-extending themselves across the household sector. It is a crude measure which penalises people who have costs other than buying the house: for example, those who have to commute long distances to and from work. Banks can only lend 3.5 times the value of the house, capping the exposure they previously had to households with relatively low incomes who, once made unemployed, were unable to service any portion of the pre-crisis debts they were allowed to run up.
The loan to income rule isn’t changing. If any rule was to change, this one would make the most sense in my view. It is in the loan to value area that everything went really wrong before 2007. Research by Gerard Kennedy, Eoin O’Brien and Maria Woods showed using the ratio of prices-to-income and the ratio of prices-to-rent that house prices fell below their long-run values during the crisis - meaning they were undervalued - and today they are slightly above these long-run averages, meaning they are slightly overvalued.
The loan to value rule is there to make sure households have an equity buffer. Today, if you are a first-time buyer, you can only borrow 90 per cent of the value of the property up to €220,000 and 8o per cent for the remaining balance. In 2017, you’ll be able to borrow 90 per cent of the entire value. Combined with the mortgage relief and tax credits introduced in Budget 2017, and the fact that banks can make ‘proportionate allowances’, the effective deposit will be reduced from slightly under 20 per cent to 5 per cent.
A concrete example: first-time buyers purchasing a property worth €400,000 need €58,000 today. By January 2017, the same buyer will need a deposit of €40,000, and they can avail of tax rebates of €20,000. The effective deposit has gone from €58,000 to €20,000.
It is very difficult to see how this will not result in price increases, especially where the supply, reasonably, of housing is fixed.
With credit now more easily available, with a much smaller equity buffer, households will also be that bit less resilient to downturns.
It is very interesting to see where the unpopularity of the rules came from. Of course, the populists hated them. Of course, the tabloids hated them. Stories of young families struggling to raise a large deposit while paying rising rents shot through the media. Most interestingly, the strongest critics were the mandarins of the Department of Finance, which lobbied intensively behind the scenes to get the loan to value and loan to income rules relaxed. In its August 16 submission to the Central Bank, the department argued for exactly the changes the Central Bank has brought forward.
Anyone who bought in 2016 might feel like a sucker today, but they shouldn’t. They are much more resilient to any downturn. They owe less, and the Central Bank’s changes mean they can expect to see rises in the price of their property, especially if they are in Dublin. The rental market may see an easing of price increases as first time buyers who now need a far smaller deposit can exit the rent market in favour of ‘getting on the ladder’. Those who are looking today are in a better position, but their expectations have been changed, and they don’t know what risks exactly the Central Bank thinks might be worth changing the rules again.
Say we see a huge spike in house price increases in Dublin as first-time buyers run out in January and bid up the price of every three-bed semi inside the M50. Will the Central Bank act? How and when, and in what measure? People don’t know. The Central Bank is stuffed with smart people whose job it is to keep tabs on price movements, but how it communicates its future policy moves matters a lot when people are considering what will likely be the largest purchase of their lives.
The role of the Central Bank is to dispassionately and independently analyse and regulate an important and highly emotive asset class. It has tweaked the rules once. The question is now: when will the rules change again? Will Minsky be proven right, once again?