Friday, 9 January 2015

Honahan's 20% Rule - A Spanner in the Works

There was a proverb commonly misattributed to the French diplomat Charles Maurice de Talleyrand-PĂ©rigord (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.      

Wednesday, 7 January 2015

#Reboot Ireland: The Open Questions and the Answers that will probably disappoint

The English Leaving Certificate syllabus of 1999 gave teachers the choice between two of Shakespeare's finest: Macbeth and Hamlet. My teacher chose to teach Macbeth. Hamlet, she explained, was an infuriating ditherer, rendering the play, in her view, an almost insufferable read. "Hamlet", she explained, "is best summed up by the line "To be or not to be; that is the question". He can't make a decision and when he finally does, everyone's dead." When I finally read it years later, I came to agree with my teacher. Hamlet is a man characterised by indecision. The wait for Lucinda Creighton's first foray into the formation of a new political force has reminded me of my teacher's verdict on the bard's opus. Almost eighteen months since her expulsion from Fine Gael, the trigger has finally been pulled. The new party is upon us. However, there are two curious features to this new organisation: it has yet to be named (Reboot complete with Hash-tag is only an interim moniker) and it has yet to adopt a distinct set of policies cohering into a recognisable brand. I find both of these facts disturbing.

I myself once knew Lucinda Creighton well - from a chapter in the annals of my misspent youth, during which time my hairs were longer, my wits shorter and my political affiliations more partisan. I knew her before she became a household name and can claim (to a greater degree than most commentators, in any event) to have known the woman that lies (or at least lay) behind the legend. Indeed, I recently found a newspaper cutting from the Sunday Times in 2001, showing a picture of Michael Martin (then the Minister for Health) surrounded by a much larger picture of Lucinda Creighton standing beside your humble narrator, both of us dressed in doctor's white coats protesting against government health policies which were being launched inside the Mansion House. As I remember, the protest made sufficient noise that Bertie Ahern entered the building through the back: "Bertie, Bertie, show your face! Backdoor Bertie, show your face!". I believe Lucinda may have coined that. It certainly wasn't me. My first thought on looking at the picture was the rather churlish observation that she has aged better than I have - my mane of thick brown hair having receded into a shining bald pate. My second was how misleading a snapshot in time that photographer captured. I rose no further in Fine Gael politics. However, within three years of that picture being taken, she was a councillor and within six, a TD. For a third year law student in Trinity (as she then was), to travel such a distance in just six years was beyond stellar - to put it in context, I attended her 21st birthday party in the same year. Our shared experience predisposes me to like her. Her political successes predispose me to respect her.

On arriving onto the front lines of national politics, she has shown courage and conviction of a kind which has set her apart from most of her colleagues. In return for this, she has received the utmost extremes of the commentariat's hatred and loathing. In an era in which the most exiguous insults delivered via social media are treated as forms of oblique violence, the degree of personalised opprobrium heaped on Deputy Creighton is almost unfathomable. As of the writing hereof, there is a page on Facebook named "Lucinda Creighton is a bigoted b*tch". If you have a moment, take a look at the page and you'll see some eye-popping insults - most of which are unfit to print - which have nothing to do with her opinions. And while you're at it, try to imagine the hue and cry that would ensue if such a page were to be set up relating to a PC media darling like Una Mullally or Catherine Zappone. Given the propensity of political and media figures to scream like werewolves when faced with personal invective, Creighton's ability to wear the vitriol with good humour is astounding - it would certainly exceed the defensive capacities of my hide. All this predisposes me to admire her.

Liking, respect and admiration lead me to want any political enterprise that Lucinda Creighton launches to be a worthwhile and formidable project with the potential to shake the nation's rotten political system out of its complacency. This is what has made the Hamlet-style wait of more than a year so frustrating and what makes it so personally distressing to me that I have yet to discern a political philosophy in this new venture which has clear transformative capabilities. We know a few things. There will be no whip on conscience issues such as gay marriage or abortion - good, but hardly a surprise given the circumstances of Creighton's departure from Fine Gael. Property taxes levied on the value of sites not buildings - an excellent proposal. Support in principle for water charges - good. No coalition with Sinn Fein or the Far Left - I should bloody well hope not. No "propping up" of a Fine Gael or Fianna Fail government - what does that mean? Surely, thought I, after hearing the press conference with Eddie Hobbes and John Leahy, the website will tell me something more detailed. Nope. Right above the "Get Involved" and "Become a Candidate" portals is the following mission statement:

"We want to create a new Irish political party, a party that changes the way we do politics. This party will champion human inventiveness."

It would thus appear that the fine people at the party soon to be formerly known as #Reboot Ireland are inviting me to put myself forward as a candidate before I know what policies my putative party is to have. I suppose I do like human inventiveness - that and apple pie - and therein lies the problem. If I can't oppose it, then it's rather difficult to see how a political identity can be built around it. With no constitution, statement of principles and aims, track record, position papers, policy documents or even details of a support base upon which it is to rely, we are left looking at the tea leaves that the initial press conference has left in its wake, as a means of deciphering what the party's actual policies are going to look like - a bad sign in and of itself.

First, it is clear that the party will be typecast by its enemies as socially conservative, leaving social conservatives as its most obvious principal support base - look no further than Fintan O'Toole dubbing the new movement "Foetus First" and the "Progressive Theocrats". The (necessary) objective of moving beyond this support base needs to take into account that the media establishment and the left have already written the script on the party's social conservative roots. Creighton's first salvo ought to have established the intention to form an alliance of social conservatives and economic liberals. Instead of splitting the difference between the two sides, Creighton needed to unambiguously align herself with one camp (the social conservatives) and make a pitch to liberals based upon a mutually respectful identification of common ground. This should not have been hard. Irish politics is dominated by pseudo-liberals who believe that people of the same sex should be able to marry but believe that they shouldn't be able to enjoy a €2.50 pint at their wedding reception, should be forced to fund government radio and television broadcasting when they get home and who wish to levy nanny state taxes on them every time they drink a can of Coke. This rather hollow vision of lifestyle freedom - "No government in the bedroom but more government in every other room in the house" - could easily be exposed by a skillful campaigning organisation. However, for now, the opportunity has been fluffed. Instead, Creighton has sought to triangulate. She has stood by her 2013 opposition to abortion liberalisation but said she'd "probably" support gay marriage.

As triangulations go, this is as about as inept as they come. Social conservatives have already been identified by the political and media establishment as the Antichrist du jour and progressives and egalitarians are riding high enough that they are applying a "one drop" rule to group loyalty. Gone are the days when they needed to show gratitude to the pro-life, anti-gay marriage John Bruton for supporting the introduction of divorce. Today, the campaigning base of left wing and politically correct orthodoxy will not tolerate a single deviation from the party line. As long as Creighton (presumably) still opposes gay adoption, her support for gay marriage (presuming she sticks to it) won't attract a single progressive vote. What it will do is to encourage rural, socially conservative voters who have been demonised by the left, spurned by Fine Gael and disappointed by Reboot to vote for Fianna Fail candidates, leaving the vacuous but canny Michael Martin (who wisely allows free votes to his conscientious dissenters) obtaining establishment credibility for toeing the line whilst his socially conservative Councillors and TDs quietly hoover up socially conservative support in the countryside.

Then there's the rhetoric. Again, the party has been typecast as right wing and will not discard this taint. Likewise, it has been typecast as "neoliberal" - another label from which it can't escape. Much like its social conservatism, its presumed economic liberalism guarantees it all the enemies that such ideological positioning entails. What it will not necessarily deliver, is the support such an ideology can muster. Unfortunately, another test has been fluffed. Creighton peppered her launch with the usual invocations to voluntarism and civic society - straight out of the FF/FG playbook - and sought to reach out to trade union officials - a group representing the symbol (and indeed the quintessence) of Ireland's fetid culture of incumbency protection and insider-ism - as potential allies. The real danger is that having been typecast as an economic liberal, Creighton will fail to enthuse those of an economically liberal mindset by presenting herself as the leader of yet another Fianna Gael party. This impression is only cemented further by John Leahy's references to protecting and subsidising farmers - another classic feature of Ireland's incumbency protection culture.

Likewise, there has been no articulation of a specific vision which could move support away from other parties towards the new vehicle. UKIP in Britain and AfD in Germany are showing how serious attacks can be mounted on establishment parties. However, we do not have either a classically liberal free market vision (tax cuts, balanced budgets, radical deregulation of our red tape strangled labour market) which could appeal to entrepreneurs or a national conservative one (immigration restriction, trade protection, withdrawal from the EU) that could appeal to working class voters. Instead, we seem to be getting another Europhile offering of watered down social democracy of the type that parties in the EPP and ELDR groups have been pedalling for decades, the only substantial modification of which is a brand which has already been rendered toxic in the eyes of the media and institutional overseers who seek to dispense and deny access to the political system.

For all of the above reasons, I think the odds on #Reboot making a hash (forgive the pun) of its historic opportunity seem to be shorter than those on success. However, there's a further problem. Politicians define success electorally. The rest of us don't get to enjoy the salaries and perks - no matter how we vote, a government will be elected. This means that success must be defined more substantively. In this regard, we have a disturbing historical parallel. In 1983 Des O'Malley was expelled from Fianna Fail for breaking his party's whip on contraception legalisation. Two years later, he formed a party designed to sit to the right of Fianna Fail and Fine Gael economically and to their left socially. What was the result?

The Progressive Democrats were effectively defined by the catalyst for it's founder's expulsion from Fianna Fail. It immediately become a liberal party of the right, at a time when social conservatives were in a majority. This narrowed its appeal. Likewise, today, Creighton's public identification with the pro-life position looks like it could seriously narrow the appeal that her vehicle should have to the now dominant liberal cohort of the right. Once in existence, the PDs caused a schism on the right, which isolated socially liberal right-of-centre voters from the rest of right. Likewise, if Reboot succeeds, it may do so by isolating social conservatives into a niche vehicle of limited electoral appeal. Secondly, the departure of many free market elements in Fine Gael and Fianna Fail for the PDs left anti-market politicians like Charles Haughey and Garrett FitzGerald more powerful than ever within their parties. With the remains of Fine Gael too small to form the FG-PD alliance of which O'Malley dreamed, Fine Gael's reliance on the dirigiste Labour Party to form coalitions increased, with the PDs increasingly left adrift. By 1987, Ray McSharry in Fianna Fail was beginning to steal the PDs' free market clothes and by 1989, Des O'Malley was lining up with Fine Gael, Labour and the Workers' Party in opposing Charles Haughey's Pauline conversion to spending cuts. Meanwhile, the party's desire to evade the "right wing" label led it to emphasise its social liberalism over its economic liberalism. This never stopped the Labour Party and the unions from labelling them as "Thatcherite" but it did result in the party attracting left-of-centre figures like Liz O'Donnell (who entered politics through the feminist movement and whose principal concern was increasing government spending on foreign aid) and Helena McAuliffe Ennis (a Labour Party Senator). The dilution of the PDs' core message did nothing to make them more acceptable to the commentariat, but it did result in many free market oriented politicians like Charlie McCreevy staying in their existing parties and keeping their voters with them. It was ultimately the undignified fate of the PDs to serve in a government which more than doubled public spending, enacted thousands of pages of job destroying red tape, heedlessly joined the euro despite the manifest unsuitability of the Irish economy for membership and ended with just two TDs before folding up its tent.

Reboot Ireland appears not to have learned any of the PD lessons. Their base is too narrow and their policy positions are too vague. In short, like the PDs before them, they seem to be falling into a trap of giving themselves all of the disadvantages of being a big "catch-all" centrist party with none of the advantages and like the PDs, their electoral success may simply result in the weakening of Fianna Fail and Fine Gael in ways which make both parties more reliant on the left and Sinn Fein. The latter is a particularly appalling vista.

It is, of course, not too late to give this movement proper underpinnings, but Creighton must act now. Like Hamlet, she has dithered too long and with numerous political and media figures queuing up to reprise the parts of Claudius, Polonius and Laertes, she must stop dithering now.