• ‘You know you’ve a bubble when second rate developers are earning billions,’ says Swiss-Swedish banker
• Developers and politicians trying to roll back borrowing regulations introduced last year
• Last time it cost Ireland €60 billion and 40 per cent of its GDP
By Bernard Purcell
The former deputy governor of Ireland’s Central Bank, Stefan Gerlich was at Ireland’s Central Bank between from 2011 until last year has warned that Ireland is at risk of another housing market crash – because ‘bandwagon jumping’ Irish politicians want to loosen new lending rules.
He says restrictions are tough on Irish home-hunters but not as tough as another crash. Stefan Gerlach left Ireland’s Central Bank earlier this year to take up a job as chief economist at BSI Bank in Zurich.
The dual Swiss-Swedish citizen joined the Irish Central Bank as one of two deputy governors in 2011 and oversaw the introduction of regulations intended to prevent a repeat of the property bubble and collapse which crashed Ireland’s economy.
Ireland was forced to borrow to repay the losses of unsecured speculators and investors in Germany, France, the US and many other countries.
In an article, The Return of Ireland’s Housing Bubble, published over a month ago but which has received wider circulation in Ireland in the past week, he expresses concerns that the country’s politicians are setting it up “for another devastating crash”.
The article was written for an international digital newsletter published by the Project Syndicate Think Tank. The newsletter has wide and varied contributors on a range of subjects, including, in the current issue, an article by former Goldman Sachs and BP boss Peter Sutherland on the refugee crisis.
In the article Mr Gerlach, an international banker who has also worked in Hong Kong, writes: “Having endured the collapse of its housing market less than a decade ago, Ireland has lately been experiencing a blistering recovery in prices, which already have risen in Dublin by some 50 per cent from the trough in 2010, is Ireland setting itself up for another devastating crash?”
To a deafening silence from leading Irish politicians – and free from the constraints imposed on his former colleagues – Mr Gerlach says Ireland’s Central Bank here is coming under undue pressure from the construction industry and politicians to relax the loan to value and loan to income ratios on mortgage lending it introduced last year. He says housing bubbles are easy to spot but various conflicts of interest make it hard to act before the market is out of control.
“The obvious question is why nobody stepped in before it was too late. The answer is simple: while the bubbles are inflating, many people benefit. With the construction sector thriving, unemployment falling, and banks lending freely, people are happy – and politicians like it that way.
“The process is simple. Rising prices trigger a surge in building activity, which creates job opportunities for young, low-skill workers, whose employment options are otherwise limited, and generates large profits for property developers and builders. In fact, a telltale sign of a bubble is that second- rate developers suddenly are able to earn billions.”
The private sector will always seek to maximize advantage and profits but Ireland’s Central Bank and the country’s financial regulator must make sure that the same mistakes – fundamental market flaws – are not made again.
“Many in Ireland might find that conclusion overly pessimistic. Maybe they are simply hoping that, this time, the luck of the Irish will hold. Perhaps it will, and this time really is different. But there isn’t much evidence of that,” he warns.
He points out that only a year and a half ago while he was still at the Bank it took specific measures to stop irresponsible lending and borrowing – but developers and builders working with politicians have sought to roll back those rules.
“In January 2015, the Central Bank sought to protect financial institutions from another catastrophic bubble by restricting their lending to high-risk borrowers. As a result, annual growth in property prices fell from a little over 20 per cent to just below 5 per cent.
“But the construction industry, worried about its profits, has been harshly critical of the rules, as have ordinary people who have been denied credit, and thus must struggle to find suitable housing in a small rental market. Politicians, no surprise, have jumped on the bandwagon, to capitalise on the popular mood.
“As the pressure on Irish regulators to relax lending rules intensifies, so do concerns that they will succumb to it. One hopes that they will continue to resist. Would-be borrowers do indeed face genuine challenges as a result of these regulations; but that is nothing compared to the pain that a collapsing bubble would cause,” he said. “It’s no secret that the collapse of asset bubbles carries massive financial and social costs.
“With construction activity and investment spending grinding to a halt, sharp recessions – which cause tax revenues to fall, even as surging unemployment demands increased social spending – are unavoidable.
“Taxpayers may even be asked to shore up financial institutions’ capital base. The last time that happened in Ireland, it cost more than €60bn, or about 40 per cent of GDP.”
“The obvious question is why nobody stepped in before it was too late. The answer is simple: while the bubbles are inflating, many people benefit. With the construction sector thriving, unemployment falling, and banks lending freely, people are happy – and politicians like it that way.”
In a damning analysis of property bubbles such as the one that hit Ireland in 2008, he says: “The process is simple. Rising prices trigger a surge in building activity, which creates job opportunities for young, low-skill workers, whose employment options are otherwise limited, and generates large profits for property developers and builders.
“Banks’ profits rise too, because there is plenty of demand for mortgage lending, which is viewed as almost risk-free. After all, steadily rising property prices mean that, if a borrower defaults, the property can be resold at a profit. (The inevitable market correction remains too remote to be taken seriously at the height of the boom.)
“Taking advantage of this lending, ordinary people, from taxi drivers to hairdressers, can become millionaires by playing the market on the side.
“All of this benefits elected leaders, who win the support of voters who feel wealthier, the formerly unemployed who find jobs, and the homeowners whose houses are rising in value.
“Endearing politicians to voters further are new spending increases and tax cuts that can be undertaken, as accelerating economic growth causes the debt-to-GDP ratio to fall.”