Sunday, 4 September 2016

Central Bank Lending Rules - Has Nobody learned Anything?

The 2008 financial crisis was supposed to be a "never again" moment in Ireland's financial history and the world's. "Never again" is a dangerous sentiment. It seeks to define the most recent trauma or insult as the gold standard of horror and the measures taken to prevent a repeat must necessarily be taken at the expense of countermeasures against other foreseeable calamities whose occurrence consequently becomes more probable. It's also a substantially insincere sentiment. Nobody in 2008 wanted to talk about the real cause of the 2000s bubble and the Dot.com bubble that preceded it: loose monetary policy and implicit and explicit government bailout guarantees. After all, these self-same measures formed the principal basis behind the policy response to the crash. As the economists and politicians circled the wagons around monetary easing and bailouts, the explanation that emerged was that there simply wasn't enough regulation in the banking system. Hence, the establishment's "never again" admonition was doomed from the get-go: you can't prevent the repeat of an event if you don't even know what the event actually was. 

However, having adopted a false explanation and a flawed regulatory response, all was not lost. Regulators determined to prevent a future disaster could and should have used their powers to sabotage the "business as usual" plans of the central bankers and politicians by hog-tying the rogue banking system with simple regulatory measures designed to block unsound lending. Such policies would, of course, have caused a political crisis, by revealing the fundamental incompatibility of modern central banking and regulatory policy with the needs of a diverse and high-tech 21st century economy. This was a political crisis we needed to have. However, even if they were of a mind to do so, the regulators could not have done what really had to be done without the support of politicians. Unsurprisingly, they didn't get it. While the political class is happy to attack "greed" in the financial sector and use lurid words like "bankster" and "vulture capitalist", they are too addicted to the drug of cheap credit to bring the rogue financial sector to heel. They simply refuse to look the borrowing public in the eye and tell them the unvarnished truth: that they must borrow less and save more. Without a willingness to do this, no financial reform can happen.

In Ireland, we have had two unlikely heroes. One was the last Central Bank governor, Patrick Honohan and the other is his successor Philip Lane. The former brought in a rule which limited banks to lending 80% of the value of any residential property being purchased with a bank loan, meaning that the home buyer needed to stump up the other 20% (albeit that there are limited circumstances in which lenders are permitted to exceed the 80% threshold). As rules go, this was quite a simple and workable one, which has been used to good effect in places like Texas and Hong Kong as an automatic failsafe to prevent bubbles in residential realty. On Professor Honohan's retirement, his successor, Professor Lane has continued with the policy. Nearly two years ago, I published a pessimistic post in which I predicted that the Honohan rule would be kiboshed by the political class. I'm impressed that it's survived as long as it has. Predictably though, the politicians have demonstrated that they've learned nothing. Fianna Fail, Ireland's shadow government party which calls the shots on Enda Kenny's minority administration is calling for the rule to be "relaxed" for first time buyers. Of course, the entire objective of money down requirements is to stop first time buyers, who tend to be younger and have fewer savings and assets, from over-leveraging. By contrast, up-scalers tend to be older and have more savings and home equity built up before entering into a transaction. In effect, if you exempt first-time buyers from the rule, there remains very little purpose to having the rule at all.

Perhaps this is what we would expect from Michael Martin and Michael McGrath. However, it is truly surprising that the Labour Party and its finance spokeswoman, the Passionaria of Big Government, Joan Burton, have joined with them in calling for such relaxation. The argument being advanced by our spineless public representatives is that the 20% requirement makes houses unaffordable to first-time buyers. However, anyone paying attention to the Celtic Tiger years when loan to value ratios ranged between 92% and 100% will know that without the 20% requirement, more money would have been lent into the system and prices would be even higher than they are now: hence no boost in affordability, just more debt collateralised by more (and more dubious) equity. No. The Honohan rule has become a scapegoat for a real problem. However, the real causes have nothing to do with the rule and everything to do with policies which all of the main parties actively support.

Firstly, Ireland is currently experiencing its third period of sustained housing shortage since the commencement of our current planning regime in 1965. However, incumbent homeowners like heavy zoning laws because they raise the value of their properties. Secondly, the more politically controversial NAMA has spent the last seven years warehousing properties on its books in order to prevent a gusher of cheap property onto the market which would exacerbate existing negative equity problems. Thirdly, the ECB has spent the last seven years manipulating interest rates downwards in order to make unsustainable Celtic Tiger-era home loans artificially affordable, thereby keeping repossessions artificially low and the prices of homes artificially high. Fourthly, the government has used such influence as it has to make repossessions (including of buy-to-let properties) as hard as possible, further exacerbating supply issues. Fifthly, the state continues to provide social housing to economically inactive people in expensive housing markets like Dublin instead of sending them to live in (often nicer and more spacious) homes in ghost estates that remain unoccupied across the country. Finally, the ECB has, since the crash, destroyed the interest return on deposit accounts, CDs and high credit quality bonds, thereby driving people looking for fixed income returns into realty.

What is the objective common to all of these policies? They are all designed to bail out existing home owners and property investors and first-time buyers must necessarily be the ones who pay the price. Unless governments and Central Banks are prepared to spread the pain more evenly, the hapless first -time buyer is doomed to remain hopeless and friendless. As of the writing hereof, Professor Lane is standing his ground and deserves full credit for doing so. Let's hope he surprises me by winning the battle that I (incorrectly) predicted his predecessor would lose.