There was a proverb commonly misattributed to the French diplomat Charles Maurice de Talleyrand-Périgord (better known as Talleyrand) to the effect that the Bourbons forgot nothing and learned nothing. Depressingly, the same can now be said of most public institutions, both here and abroad. The global response to the 2008 financial crisis, which was caused by the monetary machinations of a rogue central banking system has been to give yet more power to that same rogue central banking system to engage in further machinations. The response to the accumulation of excessive risk concentrations in the financial sector has been to further concentrate such systemic risk by combining institutional mergers and buyouts with new regulatory structures which make the likelihood of new entrants coming into the system more remote. The response to the moral hazards which have proliferated in finance since the rescue of Continental Illinois in 1984 has been to double down on bank bailouts, with an unprecedentedly deep linkage between sovereign and financial sector debt. The world's response to peak debt - with accumulated public, private and household sector debt averaging between 300% and 400% of GDP throughout the western world has been to dramatically increase government debt and deficits further in the name of "stimulus". Meanwhile, globally, the response to an economic meltdown precipitated by the massive overvaluation of assets has been to try to re-inflate the very asset bubbles whose collapse brought the world economy to its knees in the first place. Yes, - just when you think you can't dig yourself any deeper, some idiot hands you a bigger shovel.
In Ireland, the precipitants behind our own version of the 2008 collapse were land and buildings, whose rising value, catalysed by vast ECB-fuelled over-lending, collateralised yet more lending, which caused the value of the said collateral to rise even more etc. When the merry-go-round stopped, it revealed a broken real estate and banking sector, with contracted lending incapable of keeping grossly inflated prices at their peak and the resulting meltdown in asset values vaporising the collateral securing the existing portfolios of (now delinquent) loans. The survey of devastation went far beyond banking and property into a rotten (and now collapsing) economy which had been grossly deformed by the bubble, the principal manifestations of which were massive dubiously secured household debt, a sputtering export sector and a bloated public sector. Years have been spent trying to (ineptly) clean up the resulting mess, and when it comes to international influence on our policy, we have been given depressingly few examples that could possibly guide us in the right direction. In relation to real estate, the asset at the centre of the bubble and the ensuing crash, our government has been at the apex of an international response whose principal aim has been to re-inflate - a policy which has flowed interminably from the ECB on downwards and spans the full gamut of monetary, fiscal and financial stabilisation policy.
It is thus a supreme irony that while the media and political complex has spent the last six years convulsed with rage about greedy bankers and developers and "never again" allowing a repeat of the 2000s property bubble, the business of politicians and central bankers has been business as usual - and often an even more pathological version thereof. Stated differently, while the rhetoric of our politicians has been anti-bubble and some expensive (and probably useless) prosecutions have commenced or taken place, the grim fact remains that our government's whole strategy for dealing with the mortgage debt crisis, restoring the health of the banking system and bringing tax revenue and spending back into line has been to return our dysfunctional property market to the same unsustainable trajectory off which it was unceremoniously thrown in 2008. This saga has hitherto had an unlikely hero pitted against its numerous villains, namely the Irish Central Bank's impeccably left-of-centre governor, a former adviser to Garret FitzGerald and vocal admirer of Thomas Picketty, Professor Patrick Honohan. While a predictable regurgitator of the conventional wisdom of "Super Mario" Draghi at the ECB and "Calamity Janet" Yellen at the Fed, Professor Honahan's disdain for markets has constituted an unlikely break on the machinations of the political class.
While the political and central banking establishments on both sides of the Atlantic have waxed lyrical about the need for reform, their complete refusal to examine the role of monetary policy in incubating the last crisis has led to an ultimately futile and counterproductive focus on macro-prudential regulation as the route through which the prevention of future 2008-style eruptions must travel. However, even bearing this folly in mind, a much better job could have been done in managing the regulatory reform process. Thus far, regulatory reform has taken the form of increased quantitative bank capital standards (an expensive and slow process which does little to address the real problem in the banking system, which is counterparty and collateral quality), the increased regulation of derivatives trading (which does nothing to address the cardinal issue of derivative exposure to deposit-guaranteed institutions), the regulation of bankers' bonuses (a piece of gimmicky lowest-common-denominator demagoguery that treats a symptom of the underlying problem as if it were the problem itself) and the licensing of rating agencies (which creates an obvious conflict of interest for those whose job it is to rate the creditworthiness of the very governments which are regulating their activities).
Completely missing from this soup of reforms is the key ingredient of politically unpopular restructuring of public expectation. Banker bashing means nothing in the absence of a firm and vigorous emphasis on the household and business habits which have deteriorated alongside banking practice in the decades since the collapse of the Bretton Woods exchange rate system in the early 1970s. Bluntly, we have been borrowing too much and saving too little. Too many of the expenditures that used to be financed with savings have slowly migrated onto bank balance sheets through car loans, student loans, payday loans, credit card loans, lifestyle loans and other forms of consumer financial intermediation. Meanwhile, traditional areas of consumer borrowing such as the crucial residential mortgage market have suffered from continuous over-leveraging, with the 2000s being years characterised by rising Loan to Value Ratios and lending to higher and higher multiples of borrower incomes. While the 2000s brought plenty of complaints about housing affordability dropping, no political movement was prepared to grasp the nettle of telling home buyers that they needed to save more for their new homes in order to pay less. This genus of mistake has been repeated. While politicians have been happy to pick low-hanging fruit like the aforementioned bankers' bonuses, they have been unwilling to allow their financial reforms to stray into areas that might modify the behaviour of large numbers of voters. The former is easy and popular. The latter is controversial.
Thus while the government has been happy to make popular noises about making banks behave more prudently, there has been a continued clamour for banks to expand mortgage lending and lending to small and medium enterprises - regardless of the dangers associated with such lending into such a fragile and over-leveraged economy. Stated differently, while the 1998-2007 lending binge ended, the mindset that generated it - a belief in pumping cheap credit into the economy and making consumers and small business people happy - has endured. Such political cowardice has ensured that the already hugely suboptimal approach of ramping up regulations has been completely defanged in terms of its ability to bring finance to heel. Put simply, where policy makers are themselves wedded to irrational lending practices, their attempts to reform finance will be futile. This is where Professor Honohan has stood out from his peers. Late last year, as talk of a new property bubble emerged onto the media's radar, he announced his intention to introduce a simple lending restriction to pop this emerging bubble before it took on a life of its own. The new rules, which were to be introduced this year, would have mandated a minimum down payment by home purchasers amounting to 20% of the purchase price of the property - effectively a maximum gearing of 4:1 and a maximum loan to borrower income ratio of 3.5:1. These ratios are broadly reflective of pre-bubble mortgage lending norms, whereunder the average house price in 1996 was five times the average income, compared to ten times by 2006.
Professor Honohan's proposed reforms were immeasurably modest, in light of the fact that the peak to trough collapse in property values between 2008 and 2012 exceeded 40% and in some cases 50% - remember that even with a 20% down payment, a borrower who had bought a house at peak would still have been thrown into the hell fires of negative equity. However, what they did represent was an intention to structurally alter consumer behaviour and to put it back onto its historic pre-bubble path. Hence the unlikely heroism. Unlike those who excoriated “light touch regulation” and the “principles based approach” but were shown to be all hat and no cattle when it came to imposing order on our errant property markets, Honohan showed an admirable willingness to place onto the table a measure which would upset the apple carts of consumers who were all too willing to accept the loans that they subsequently excoriated the banks for giving them once the tide went out.
However, the lemmings in the political establishment could not wear such a regime. With tens of thousands of people in negative equity due to 92-100% mortgages written during the boom, with NAMA books chock full of development land portfolios on which the government is eager to profit, with the politically powerful buy-to-let investor lobby screaming for relief (often with the ironic support of anti-landlord far left politicians) and with establishment economists demanding more spending to increase “aggregate demand”, it was perhaps inevitable that Honohan’s attempt to sabotage his own government’s macroeconomic policy would fail. As Charlie Weston put it in yesterday’s Irish Independent:
“The proposal by Professor Honohan to tighten mortgage lending has merit and has been done for the best of reasons – to forestall the banks all over again from bad lending…
But the plan has been attacked from all quarters. Taoiseach Enda Kenny, Tanaiste Joan Burton and Minister for Finance Michael Noonan are among those who have questioned the blunt proposal to require most borrowers to have a 20pc deposit and have borrowings limited to three-and-a-half times income.
Mr. Kenny has even threatened to introduce a mortgage indemnity scheme that would effectively override the plans to set minimum deposit levels.
Now the prestigious [his word not mine] International Monetary Fund (IMF) has joined the chorus of those complaining that the initial proposal for a 20pc deposit for the majority of borrowers is too severe…
All of this pressure to ease up on the original tough measures to restrict lending means that Prof Honohan will be left with little choice but to water down his proposals.”
Weston’s five paragraphs represent an excellent summation of the state of play. The government has recognised that Professor Honohan’s decision not to merely pay lip service to the objective of rationalising mortgage lending represents a sabotage of the government’s national policy agenda. Hence, the government and the IMF have coalesced around a plan to throw a spanner in Honohan’s works. Sadly, the government will not stand up to commercial and household interests who wish to be bailed out of their losses and hence the decision to sabotage the sabotage, so to speak.
So it would appear that Enda Kenny and his government have crossed the Rubicon. There are only two means by which affordability to first time buyers can be restored while allowing the losers of the 2008 crash to avoid the worst extremes of their losses. The first is to establish a state compensation scheme for borrowers - which would be politically unacceptable to those who were too old, too young, too poor, too prudent or just too plain lucky to take advantage of the 1998-2007 borrowing bonanza. The second is to loosen lending standards and allow prices to rise – and all those who have lived through the last six years should know how that ends. This is the great tragedy of our times. Cumbersome, inflexible, centralist, intrusive, blunt and illiberal as the Honohan proposals were, they at least took into account the structural dysfunctionality of the real estate market, in which Central Bank subsidised loans have turned banks into de facto (and often de jure) wards of the state and destroying all honest systems of free market price discovery. The point is not that it is desirable for Central Banks to decide on the price of a house – it plainly isn’t. It is that where ordinary free market failsafes have been disabled and cannot impose discipline on markets, someone or something must and this is why the social democratic Professor Honohan deserved support from across the political spectrum (left and right) in attempting to step in as he did. He didn’t get that support and one hopes that the consequences will not be as bad this time as they were the last time that prudential warnings weren’t heeded.