Ireland’s property market crash has exposed years of reckless lending and has forced the government to nationalise large parts of the banking industry, leaving the taxpayer with a bill of €50bn or more to clean up the mess.
The scale of the disaster is unprecedented in Ireland. By 2008, some 40 percent of Irish banks’ loan books were related to real estate, equivalent to some €160bn. Much was lent at high loan-to-values and when the market crashed, borrowers swiftly saw equity wiped out, leading to breaches of debt terms. The banks, in effect, became the owners of so many billions of euros borrowed against poor quality property and land that their own balance sheets were unlikely to cope.
And that’s not all. Morgan Kelly, a professor of economics at University College Dublin who predicted Ireland’s property collapse, is forecasting that a new wave of toxic debt related to domestic mortgages could sink the country entirely.
He believes that Irish households are stretching themselves to the maximum to pay mortgages they cannot afford because of the stigma attached to default. “That will change,” Professor Kelly wrote in the Irish Times in November. “The perception growing among borrowers is that while they played by the rules, the banks certainly did not, cynically persuading them into mortgages that they had no hope of affording.”
Professor Kelly’s comments have been seized upon as evidence that the country’s financial woes will get worse before they get better. He says the cost of the bank bailout, estimated at €50bn, will be far higher than the government has admitted, with losses at Allied Irish Bank and Bank of Ireland equalling those of toxic bank Anglo, leaving the taxpayer with a €70bn bill – nearly 50 percent higher than estimated. And there are concerns that the wrong banks may have been supported. While Allied Irish and Bank of Ireland have received billions in state aid to cover their dud loans to bankrupt construction tycoons, Irish Life & Permanent has received no bailout help, even though it is the most exposed to Ireland’s depressed market for residential property.
Bleak expectations
The Irish banking crisis has also been compounded by revelations that banks failed to take out insurance to protect themselves against losses on their mortgages, increasing the cost to taxpayers of rescuing them. Irish banks used to ask customers to take out compulsory mortgage insurance but this practice was abandoned at the height of the boom by most lenders. There is about €148bn of mortgages outstanding in the Irish market.
Professor Kelly was vilified when he warned of a property crash in 2007, earning the nickname “Dr Doom” for his gloomy – but accurate – predictions of economic woe. Now he has painted an even bleaker picture of the future and suggests that hundreds of thousands of people will go into mortgage default. “The gathering mortgage crisis puts Ireland on the cusp of a social conflict on the scale of the Land War,” he said, in reference to public defiance
in the 19th century when tenants refused to pay their rents.
Yet the country seems ill-equipped to deal with the problem, and some critics point out that the European Central Bank’s decision to pursue policies that favour Europe’s economic powerhouses like France and Germany, are having a detrimental effect on countries like Portugal, Greece, Spain and Ireland. The interest rates charged on the treasuries of Ireland, as well as fellow indebted eurozone members Portugal and Spain, have been rising ever since German Chancellor Angela Merkel said in October that she expected any future EU bailouts to come with new rules requiring bondholders to absorb some losses.
Economists warn that a rise in ECB base rates, potentially late next year, is the biggest threat to bank mortgage books. A rise in these rates will hit tracker mortgage holders, many of whom took out their loans in the last few years of the boom when prices were at their highest and deposits at their lowest.
The combination of bank bail-outs, government debt, collapsed property prices and a rising ECB interest rate all spell calamity for Ireland’s financial services sector and for its investor attractiveness. By the beginning of November, shares in Ireland’s banks had hit record lows and national borrowing costs had reached new euro-era highs as the government presented its latest plans for financial survival to the EU’s economic commissioner.
Furthermore, investors are shunning Ireland’s government and bank debt in expectation that the country will eventually require a bailout by the EU and International Monetary Fund, as happened to Greece in May.
The bad bank
Economists say that Ireland is experiencing by far the greatest scepticism from would-be lenders, who look with horror at the country’s projected deficit of 32 percent of GDP – a modern European record. While Ireland says it has sufficient cash until mid-2011 and has announced plans to resume bond auctions in January, its bank stocks and bonds have been dropping since Finance Minister Brian Lenihan announced plans at the beginning of November to slash £5.16bn from its 2011 deficit – double his previous target. Lenihan said he wants to cut the 2011 deficit to 9.5 percent and reach the EU’s limit of three percent by 2014. The European Commission thinks it can be done, but few others are so sure.
The government has made efforts to try to stem the crisis and to increase the flow of credit through the Irish economy. The National Asset Management Agency (NAMA) was created in late 2009 and will function as a “bad bank,” acquiring property development loans from Irish banks in return for government bonds – which may lead to a significant increase in Ireland’s gross national debt.
There are five participating institutions in NAMA – Allied Irish Banks, Anglo Irish Bank, Bank of Ireland, Irish Nationwide and EBS. The original book value of these loans is €77bn (comprising €68bn for the original loans and €9bn rolled up interest), though the current market value is estimated at €47bn as many of the loans are now non-performing due to debtors experiencing “acute financial difficulties.”
NAMA is buying the loans at an average of 52 percent discount to November 2009 values, paying an estimated €35bn for the €73bn of loans. Initial discount estimates were 32 percent.
There are up to 10 years to work out the loans, although there are goals of repayment of 25 percent by 2013 and 80 percent by 2017. It is hoped to make a profit of at least £1bn by the end of NAMA’s life.
Lenihan said the banks would have to assume significant losses when the loans, largely made to property developers, are removed from their books. If such losses resulted in the banks needing more capital, then the government would insist on taking an equity stake in the lenders. Economist Peter Bacon, who was appointed by the government to advise on solutions to the banking crisis, said the new agency has the potential to bring a better economic solution to the banking crisis and is preferable to nationalising the banks.
NAMA has caused equal measures of anger and worry in Ireland – anger that taxpayers could be saddled for years to come with debts on ill-timed investments made by property tycoons who have evaded the fallout and are still living in mansions, while there is a worry that these property loans could capsize the economy. The agency also has its critics: Nobel Prize-winning economist Joseph Stiglitz has said that the plan amounts to “squandering” public money to bail out the banks.
The agency is also likely to face criticism when deciding which schemes should be supported through new capital.
Many development sites, particularly on un-zoned land, will not be viable, and also offer no income to service interest, which means that they will be unlikely ever to cover the associated debt – not exactly the news that taxpayers and investors have wanted to hear. As much as €33bn of the land and development schemes are expected in Ireland, with another €10bn in Great Britain and €3bn in Northern Ireland. Some will be partially complete; others simply unwanted farmland standing fallow. Some observers point out that the political aspects of what stays and what goes may be heightened by the fact that many loans have personal guarantees from borrowers.
Potential opportunities
Yet besides the political sensibilities that the agency has to navigate, it is the operational side of the organisation that is causing most concern at the moment. Investors who have come to Ireland to carry out commercial property deals looking for a return over five or seven-year investment periods have given up due to the length of time it takes to complete transactions – or even get them started. One fund manager said, “We have put real estate investment in Ireland on indefinite hold.” Instead, fund managers may look at markets like France and Poland to pick up bargains.
There is little doubt that there are bargains to be had for investors who stayed out of Ireland during the boom. For example, in upmarket Booterstown in south Dublin, Irish Nationwide is selling two-bedroom apartments at €289,000 – 50 percent below prices in the same neighbourhood three years ago. Meanwhile, receiver Martin Ferris & Associates is behind a plan to sell 30 apartments at Blakes Road in Mulhuddart, west Dublin, for less than €1.9m – or €63,000 each. The Construction Industry Federation (CIF) reckons that such sales are at or below build cost, even reckoning land values at zero.
Domestic property professionals are unwilling to talk down NAMA but this is hardly surprising as the €81bn property vehicle will be by far the biggest user of professional services for a decade. But off the record, many say that NAMA is, at best, slow moving. “People are saying that NAMA is a white elephant, and like an elephant, it is proving difficult to shift in a hurry,” said one source.
