More lessons from the Irish experience

Ireland is a financial basket case.  Yet only a few short years ago they were the envy of Europe.  Ireland was dubbed the ‘Celtic Tiger’.  Strong economic growth had much of Europe caught in awe and envy.  Ireland enjoyed budget surpluses.  The good times were projected to continue indefinitely.

In late November they received a bailout: An EU lifeline to protect them from creditors who increasingly viewed them as a default risk.

It’s a marvelous tale of riches-to-rags.  I would never suggest that we will follow in their footsteps, as many of the excesses seen in their boom times make us look like prudes.  Nevertheless, we would be remiss to gloss over their story without gleaning the relevant applications to our current Canadian economy…particularly their over-reliance on real estate, consumer spending, and debt to generate economic growth.  I examined this in an earlier post:

Lessons from the now toothless Celtic Tiger

Now we see that Vanity Fair has written a fantastic (and lengthy) article on the Irish real estate experience….hat tip to NDG for the link:

When Irish Eyes Are Crying

There are too many good quotes to recap in one post without rehashing the bulk of the article.  But I will re-post a few that caught the attention of some of our readers who posted them in the comment section of another post.  As you read them, consider our current situation in Canada.  The parallels will jump off the page at you:

“…And they were all saying the same thing: ‘We’re going to have a soft landing’.”

“The statement struck him as absurd: real-estate bubbles never end with soft landings. A bubble is inflated by nothing firmer than expectations. The moment people cease to believe that house prices will rise forever, they will notice what a terrible long-term investment real estate has become and flee the market, and the market will crash. It was in the nature of real-estate booms to end with crashes—just as it was perhaps in Morgan Kelly’s nature to assume that, if his former students were cast on Irish TV as financial experts, something was amiss.”

“The comparisons that sprung to Morgan Kelly’s mind were with the housing bubbles in the Netherlands in the 1970s and Finland in the 1980s, but it almost didn’t matter which examples he picked: the mere idea that Ireland was not sui generis was the panic-making thought. “There is an iron law of house prices,” he wrote. “The more house prices rise relative to income and rents, the more they subsequently fall.”

“There’s no such thing as a non-recourse home mortgage in Ireland. The guy who pays too much for his house is not allowed to simply hand the keys to the bank and walk away. He’s on the hook, personally, for whatever he borrowed. Across Ireland, people are unable to extract themselves from their houses or their bank loans. Irish people will tell you that, because of their sad history of dispossession, owning a home is not just a way to avoid paying rent but a mark of freedom. In their rush to freedom, the Irish built their own prisons. And their leaders helped them to do it.”

I’d encourage everyone to read the VF article as well as my previous post on the Irish experience.  History may not repeat itself, but it certainly rhymes.  We’ve witnessed numerous countries succumb to the excesses of consumer indebtedness and misallocation of capital into the ponzi-dynamic that has become the housing market in most Western countries.  How far down that path we’ve already traveled may be up for debate, but the end destination is well mapped.

Cheers,

Ben


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23 Responses to More lessons from the Irish experience

  1. pricedoutfornow says:

    This was a good article, though very long. They also commented on who the Irish thought would buy their expensive houses. The Poles, they said. Sound familiar, Vancouver?
    Interestingly, I was in Ireland in 2000 when the economy was just beginning its ascent. Things were great, the economy was roaring ahead, the unemployment rate was 4%, anyone who wanted a job, got a job (and a good paying one at that!). People from all over Europe began moving to Ireland to work, head offices were being set up there because of a tax holiday. It certainly did seem that things were great. I had several friends who also went to Ireland in the years after I went, got good jobs there, and made friends with people from all over the world (my brother worked in a kitchen with guys from Sri Lanka). No wonder it was an economic miracle, Ireland had been poor for so long.
    Then, from what I can tell, the Irish went and wrecked their success with a housing bubble. It’s too bad.

    • UnagiDon says:

      The Poles were economic migrants. This is true for a certain fraction of the immigrants to Vancouver, but it is not true for the wealthy immigrants that are driving up the price of SFH on the west side and in Richmond.

  2. mac says:

    Housing bubble. Plus LOTS of corruption, unfortunately.

  3. UnagiDon says:

    Ben, this is nothing to do with your post, but something just occurred to me. Isn’t it rational to take on high levels of debt when the interest rate roughly equals inflation?

    For example, suppose the interest rate is 2%, and the inflation rate is 2%. You want to buy an item whose present price is $1000, but you expect to have $1000 cash available next year. There are two possible courses of action.

    Scenario 1: Borrow $1000 from the bank and buy the item now. 1 year later you will have your item and be in debt for $1020, due to the interest. Then you receive your $1000 cash, pay down your debt, which stands at $20.

    Scenario 2: Wait 1 year. You receive $1000 cash. But the item now costs $1020, due to inflation. So you go into debt for $20, and buy the item.

    In both cases you end up with the item, and $20 worth of debt. But in the first scenario, you have had usage of the item for a whole extra year. So, I would think it’s rational to prefer Scenario 1 to Scenario 2.

    Although these scenarios are a bit limited, it suggests that having high debt levels during times of low interest rates is not an undesirable consequences, it’s actually the rational thing to do.

    What are your thoughts?

    • Get Real says:

      This is assuming that the value of item increases by $ 20 each year.

      What if the value decreased by $ 20 (likely for RE), then you would be $ 40 debt!!!

      Why is there always an assumption that RE always goes up

      • UnagiDon says:

        I agree with your point, but I was more about buying items using a line of credit. For example, perhaps I have no mortgage, and I’ve always wanted to buy granite countertops. (Or go on an expensive vacation.) If so, why wait to save up for them? I could just buy them now and start enjoying them sooner.

        In this case I’m not speculating on RE going up, I’m just hoping that interest rates don’t rise too suddenly. (Although looking at historical charts, it seems that interest rates did rise suddenly in the past.)

    • Dmitri says:

      Well, you are assuming that inflation will increase your income. This is not necessarily true.

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  5. Anonymous says:

    This is also assuming the item can be paid off in one year.

    If you have to amortize that payment over many years where the interest rate can rise and screw you — things look different.

    • UnagiDon says:

      Yes, I guess the decisions become more complicated for longer time periods. I would also guess that economists have a principled way of deciding exactly how much is rational to borrow given certain beliefs of possible interest rates. (These beliefs would necessarily become less accurate over longer time periods.)

      But I don’t know enough economics to know the right way to make such a decision.

      • rp1 says:

        Funding consumer spending with long term debt is a recipe for financial disaster. Think of how easy it would be to charge it and forget it. If you didn’t keep a tight lid on spending, you could really dig yourself into a financial hole!

  6. Out_sider says:

    Precisely the same as happended to us in Iceland. And here too, the people cannot hand in their keys and walk away from their depts. Can you in Canada? It’s good to think about it for people who havent invested in houses that a man in dept is not a free man.

  7. Mango says:

    I would look at this way – and maybe Ben will do a post on this. The Saver is being robbed by Carney! is how it should be titled. While the saver is basically scrambling to get barely 1%, the banks are borrowing from governments and deposits from Canadians only to turn around take the benefits of lending at higher rates and taking risk. This generosity via the Bank of Canada and the people of Canada is a gift to institutions. Well I am not going to be robbed by anyone. No one is pick pocket me.

    You have people on your blog coming to you with questions about what do with cash/savings, rather then should I hit eject on my home? What are we learning from this? The fact is that the Bank of Canada is forcing me and you to take risk. They are pushing you into equity, high div stocks (they are not bonds remember that please), real estate and into crappy high risk Sprott funds.

    So what has happened? If you took the nudge, you made money since the recovery and in fact were given an amazing entry point into risk assets. Now the people with cash are looking at this (upset they missed) and looking for reasons to say that the system is broken, corrupt, etc. “I am getting zero on my money and asset prices are booming, hell with you” they scream. Blame Carney, not the risk takers, they are just taking marching orders and are not going to watch him rob the Canadian people. We look for anything in the media to help sooth our pain from watching others being rewarded from taking risk.

    Risk is something everyone has to take to get the reward. If you sit on your bum and complain about other risk takers, what is that doing for you? Zippo. Who cares if HAM pays more than ask? Who cares if society will eventually pay the cost for the insured mortgages? You know the end game right? Over levered folks jump ship and the banks and Carney come in with a printing press and clean up the mess – the free put as I call it.

    So if risk reward always holds true, are we not all in the best situation ever presented. Take the nudge, take smart risk. If society fails in a big way, it’s going to be ok, so our downside is limited in someway or another. At least you are in the game and playing and have a chance for upside.

    You can never have a shot from the sidelines and if everything worries you, you will be on the sidelines forever. From Oil Sands to RIMM, this country has amazing people doing amazing things. Why can’t everyone be proud of that and invest in your future, rather than painting a messed up society. Even if you complain, it is not going to stop, if your worst outcomes is actually realized. YOU WILL PAY THE BILL. that is not going change because you knew it would come one day.

    Ben, you follow me I hope. Happy to open a discussion on the topic.

    • Mango says:

      By the way, this doesn’t imply just be long and strong, you can also go short, the point is risk taking has to be done until rates are high enough to pay savers. Five years swaps have moved very quickly from 1.90 to 2.90, so I imagine you that five year will start to kiss 4% very soon…

    • ATP says:

      “Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don’t know how people who engage in that don’t commit suicide.”
      – Bertie Ahern, Irish prime minister June 1997 to May 2008

  8. Anonymous says:

    This sounds like Canada or at least Ontario. Internal economy out of balance with external economy. We need to pick up the export side with finished manufactured goods. Shorting ourselves with commodities exported only. Our housing demand has been exhausted by lowering downpayments along with stretching out principle. Drove demand up and prices. The game is pretty well over in Ontario. Some speculation in Condo’s but for the most part we stole from the future. A readjustment is going to take place.
    Googling things, Kelly learned that more than a fifth of the Irish workforce was employed building houses. The Irish construction industry had swollen to become nearly a quarter of the country’s G.D.P.—compared with less than 10 percent in a normal economy—and Ireland was building half as many new houses a year as the United Kingdom, which had almost 15 times as many people to house. He learned that since 1994 the average price for a Dublin home had risen more than 500 percent. In parts of the city, rents had fallen to less than 1 percent of the purchase price—that is, you could rent a million-dollar home for less than $833 a month. The investment returns on Irish land were ridiculously low: it made no sense for capital to flow into Ireland to develop more of it. Irish home prices implied an economic growth rate that would leave Ireland, in 25 years, three times as rich as the United States. (“A price/earning ratio above Google’s,” as Kelly put it.) Where would this growth come from? Since 2000, Irish exports had stalled, and the economy had been consumed with building houses and offices and hotels. “Competitiveness didn’t matter,” says Kelly. “From now on we were going to get rich building houses for each other.”

    • Mango says:

      Give me a break dude, we don’t have empty starbucks and towers.

      • Maybe not, but we do have an economy that is 20% reliant on housing…..

      • ATP says:

        Following your logic, since we see plenty of empty apartments, office buildings and malls in China, should we worry about a crash there? If that happens, what will happen to the hot Chinese money now flooding Canada?

    • Mango says:

      and what does mean, what has been historically? What do you think that will shrink towards in your doom and gloom world? Dynamic economy.

      • Dmitri says:

        You can’t have 20% of your economy based on mal investment and low skill/productivity labor. Not for the developed economy.

  9. mac says:

    Mango,

    You seem to be advocating market timing? Must take risk… just don’t take it for too long? Am I reading you right? Is that what your house purchase is? You’re holding but hoping to get out before something happens?

  10. Mango says:

    Hello Mr Mac

    I believe in long term risk with RE, I want to own these income producing assets to give my children as did my dad with me. The upside is just gravy, if I don’t sell them, I don’t realize the gains, so price movements in the short term don’t excite or upset me. The long term non-negotiable trend is up..

    Also, if I sell, what am I going to invest in that produces levered returned risk with no chance of a margin call? Day trading for timers, not me.

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