Head To Head

Head to Head Mon, Oct 08, 2007 Are we heading for a property crash? Morgan Kelly says we can expect prices to halve in real terms over the next few years while Austin Hughes disagrees, saying we are seeing a healthy, short-term correction in property prices. Yes Morgan Kelly : As the Bertie Bubble of 2000 to 2006 fades into the distance, the question is no longer whether the Irish property market will have a soft or hard landing, but what kind of hard landing it will have. Will prices fall gradually over a decade, or rapidly over two or three years? And as the building industry sinks, will it drag the banks under as well? Property bubbles are nothing unusual: sudden affluence invariably leads to a collective lapse of rationality where people start to believe the utterances of estate agents, developers and other spivs. House prices boom for a while and then, as common sense gradually filters back, fall back to their previous level. In Ireland between 2000 and 2006, house prices doubled relative to income and rents. Based on what happened after other European booms we can expect prices here to halve in real terms over the next few years. Ten per cent of housing units in Irish cities are vacant, and almost none of the 70,000 or so new units built this year have been sold: a Dublin estate agent told me that whereas last year they had sold over 3,000 new units, so far this year they have sold fewer than 100. With Dublin house prices down about 10 per cent already, there is a real risk that panic-selling by investors and builders will spark a price crash. Eliminating stamp duty will not help: so long as there is a large stock of unsold houses, buyers will stay out of the market for fear of further price falls, and these expectations will be self-fulfilling. Commercial property also looks shaky: investors are now borrowing at 7 per cent interest to buy offices and warehouses that yield rents of 4 per cent. With rising vacancy rates and increasing supply, we can expect sharp price falls. On the face of it, a fall in house prices should not be a disaster. The value of mortgages to buy your own home is only 50 per cent of national income here, compared with 75 per cent in Britain and the US, and 125 per cent in Switzerland. Massive transfers of wealth from the young to the old in Ireland are a figment of journalistic fantasy. (Admittedly, mortgages to buy investment apartments and join commercial property syndicates equal another quarter of national income, but the gambling losses of the rich and greedy should not be near anyone's conscience.) But a large minority of borrowers have crushing, unsustainable mortgages and large negative equity will force many borrowers into bankruptcy As competitiveness has fallen, the prosperity of the Irish economy has come to be based on selling houses to each other. Nearly 15 per cent of our national income comes directly from building houses, three times as much as other industrialised economies. Large falls in employment are inevitable as building slows to a saner level, and do not forget that only 15 per cent of building workers are foreign born. With spending on house building 10 times as large as spending on roads, no conceivable increase in infrastructural spending can compensate for job losses in residential construction. While housing starts have halved since last year, the surprising thing is that any new houses are being started at all given that few, if any, are going to sell. The reason is that banks are

owed so much by large developers that they cannot allow them to fail, and are allowing them to go on borrowing as if nothing is wrong. Irish banks are now more exposed to property speculators than Japanese banks were when they imploded in 1989. Banks have lent almost €100 billion to developers, compared with only €80 billion to people to buy their own houses. With no new houses being sold, it is unclear how developers are coming up with annual interest payments of around €6 billion (or 4 per cent of national income). Were one large developer to be allowed to go bankrupt, the value of the land used as collateral by other developers would collapse in value, setting off a spiral of bankruptcies. The Irish economy is now looking eerily like the Nordic economies in 1992. Norway, Finland and Sweden all had house price and building booms in the late 1980s that encouraged banks to lend heavily to developers. But as house prices fell, developers walked away from their loans and banks collapsed. The Finnish collapse was particularly spectacular, with unemployment going from 3 per cent to 20 per cent, national income falling by 15 per cent, house prices and share values down 50 per cent, and land prices falling by over 75 per cent. Recapitalising its banks cost the Finnish government over 20 per cent of national income. While our football and rugby teams have disappointed lately, our builders and bankers may yet do us proud and effortlessly clear the bar for catastrophic avarice and stupidity raised by the Finns nearly 20 years ago. Morgan Kelly is professor of economics at University College Dublin No Austin Hughes: We are now seeing a marked slowdown in the Irish housing market. For many, familiar only with the exceptional buoyancy of recent years, this is a strange and scary experience. However, it doesn't mean we face a collapse in house prices. We live in a world where every reversal seems to threaten a major calamity. But not every shower brings with it a flood. Not every cough threatens a fatal ailment. Not every sporting defeat spells catastrophe for the nation. In spite of headlines and hysterics, life usually goes on. Although this is a testing time for the housing market, the risks of a collapse shouldn't be exaggerated. The main reason why a house price collapse is unlikely is that the key driver of the current slowdown - a sequence of interest rate increases every two or three months since December 2005 - now appears to be at an end. Although the European Central Bank may continue to threaten further increases, falling US interest rates, record highs for the euro against a faltering dollar and weaker business sentiment in continental Europe combine forcefully to argue that the next substantive ECB policy change is more likely to be downwards rather than upwards. Before long, interest rate changes should support rather than soften Irish house prices. Another reason why Irish house prices should not collapse is a surprisingly sharp and speedy response by builders to softer sales. A substantial drop in housing starts means that the bulk of the current correction in the housing market is likely to occur through weaker activity levels rather than markedly lower prices. If house building falls to around 65,000 units next year, it will keep Irish house prices roughly 10 per cent higher than would have been the case if building remained at last year's levels. It is sometimes suggested that, even if building is curtailed, the market still faces a problem of too much supply. Without doubt, there are mismatches in terms of location and/or type of accommodation that make for excess supply in some areas. In the near term, this will keep prices soft. However, double-digit rent increases suggest that underlying demand for

accommodation remains strong and supply is not excessive. Indeed, compared to most European countries, Ireland's housing stock is still low relative to our population. While alarmist noises are often made about the number of "empty" houses, last month's IMF report on Ireland shows the proportion of unoccupied dwellings here is slightly below the EU average. A surge in spending power that made ownership of holiday homes and accommodation for children at college almost commonplace is one element in this rise in socalled "empty" homes. The scale of house price increases Ireland has seen may make some readers nervous. However, the Irish economy has undergone a transformation that is extreme in many ways. If it seems crazy that new house prices are now nearly 50 times higher than they were in 1970, it is even more astonishing that the money value of activity in the Irish economy is more than 70 times greater. Increased prosperity has naturally translated into more expensive property. A surge in population in the past decade associated with a virtual doubling of employment, a halving of borrowing costs and dramatic gains in after-tax incomes have contributed forcefully to higher house prices. The unique transformation experienced by the Irish economy also means that many simple cross-country comparisons of house price changes can be dangerously misleading. The slowdown is sharper than I expected. Softer house prices owe a great deal to higher interest rates. However, the fiasco surrounding stamp duties and some doom-laden predictions have also had a significant impact. As a result, there is a strong case for confidence-enhancing measures in the upcoming budget, not to avoid a normal correction in the market, but to prevent unnecessarily nervous conditions persisting through early 2008. On average, Irish house prices are now around 2 per cent below the levels of a year ago. This conceals a range of circumstances. It is sometimes suggested that a definition of a downturn is when someone else loses their job, whereas a depression is when you lose yours. In the case of the Irish housing market, the personal experience of some would-be sellers may now be approaching what they would describe as a "collapse", but across the market as a whole, the softening is more limited. The broad slowdown we have seen is, in general, a healthy correction, and in the next few months, softer prices could well persist. However, with better news on borrowing costs, a sensible budget, lower levels of building and a resilient Irish economy, I would be confident that a house price collapse will be avoided. Indeed, a modestly improving trend in house prices in a more stable market should become evident during 2008. Austin Hughes is chief economist with IIB Bank Online: join the debate @ www.ireland.com/head2head Last week, Declan Purcell and Michael Faherty debated the question, Should city bus services be opened to private competition? Here is an edited selection of your comments Yes. Dublin Bus and Bus Éireann have had a monopoly for decades. Yet despite this, most bus stops don't even display accurate timetables (if any), have bus shelters or even real-time displays. In addition, there is no sign of "smart ticketing". Paul R, Ireland It never ceases to amaze me the amount of people who seem to believe, with almost evangelical zeal, that the privatisation of publicly provided services is always a good idea. Is Dublin Bus a net cost to the taxpayer? Yes. Has that cost been increasing of late? Yes. Is the service in need of some changes? Yes. But just because service has slipped does not mean that privatisation would make the situation better. What most people seem to forget is that public services are not temporary solutions but longterm institutions. We create them to insulate ourselves from the wild swings of the market

economy, while also assisting opening up the market economy to as many people as possible. Imagine what would happen if Dublin Bus was replaced by private competitors, one day gas prices skyrocket, and every company pulls out?... Remember, while a key job of government is to promote economic growth and liberalisation, there are times when the overall stability of the economy and welfare of the people are better served by a public enterprise over a privatised system. Brendan Hood, United States Dublin Bus obviously cannot provide the service a modern city and its commuters require. That may not be entirely their fault but their entrenched unionised work practices, such as the insistence of most of their drivers of driving their buses to and parking them in the city centre in order that they can take their break in their canteen behind O'Connell Street, hardly helps the traffic congestion that affects us all and for which they take no responsibility. They've got to go - modern working practices are required as a minimum for any public transport system, be it public or private. D McGeown, Ireland Let's not follow the complications and mess that has happened in the UK's transport network since the 1980s. The current scenario isn't perfect but we will be guaranteed fragmented chaos if bus and other internal commuter routes are tendered for private acquisition. This scenario has also happened in many developing cities around the world leading to further disparities between the "haves" and "have-nots", or in Ireland's case those communities with or without suitable access. Conor Flavin, Kenya Of course not. Profit making and providing services do not mix. We would end up with buses on profitable routes only. But something tells me that that will not deter the privatisation fanatics in the present Government. We've five more years of their antics to face, so buy a pair of hardy boots is the best advice. Jim O'Sullivan, Ireland We need a private service to keep the other on its toes. I well remember the terrible service from Dublin airport in the 1990s, with the last bus at 21.20 almost always leaving at about 21.10, forcing passengers to get taxis. CIE's response? "We cannot keep an eye on all our drivers." Fintan, Ireland There is nothing like a bit of competition to reduce prices and improve customer services, and there is a particular need for this in emerging cities all around the country. And why not use the State regulatory authorities already in place to monitor the changing price schemes and work to prevent the possible formation of a cartel among the new companies? Iain McGurgan, Ireland No. They should improve the service that currently exists and go for a more integrated transport system. Conor, Ireland No, don't. But Dublin Bus must improve now. The service is the worst in Europe. The timetables are a joke. You always have to guess when the next bus is coming if you are somewhere in the middle of a route. Their website is a joke as well. I want to see the routes and not only that there is a bus going somewhere. I have mailed them many times but they never respond. Nick, Ireland © 2007 The Irish Times