Monday, December 10, 2007

If only we could airbrush the 2006 blip from history

Let's just pretend that 2006 never happened. Certainly, it shouldn't have happened.

The Stalinesque idea of airbrushing last year from the economic history books came from Ulster Bank economist Pat McArdle. It was, he argues, a blip which muddied the waters -- or whatever blips do -- and made it hard to see clearly what is going on.

The word "blip" is mine, not his. It has tended to be used when things turn down but, according to my dictionary, the actual meaning refers only to a temporary upturn. Downturns don't qualify. (It is also another word for a nickel).

I'm not sure I agree with this dictionary definition. What is sure is that, in the year of 2006, things unexpectedly did turn up, and very temporary it proved to be. Whatever one's views on dictionaries, that was a blip, and a rather damaging one.

As to the unexpected nature of the blip, it can be seen in the Budgetary arithmetic from the Department of Finance over the past two years. This gives the department's forecasts for the coming three years. In 2005, they expected that, in 2008, the public finances would show a deficit equivalent to 0.8 per cent of economic activity (GDP).

But then along came 2006, when the economy defied expectations by producing another year of growth close to 6 per cent. The public finances surged into a surplus of 2.9 per cent of GDP. In those circumstances, the department was obliged to up its forecasts. By last December, the projection for 2008 had gone from the 0.8 per cent deficit to a 0.9 per cent surplus. That is a not inconsiderable difference of €2 billion.

Little did we know, as those figures appeared and the Christmas tills of 2006 rang, that the blip was over. Well, some people expected it, but it was well into this year before the facts became incontrovertible.

The blip was caused by the housing market, and ended because of it. Until now anyway, the rest of the economy has performed very well, and very steadily. The surge was produced by the enormous construction of 90,000 dwelling units and the public finances were further swollen by a totally inexplicable 12 per cent rise in house prices.

Transactions plus price rises are a finance minister's dream. One suspects that the surge in building was partly the fault of finance ministers. Developers were mad keen to get stuff up and sold before the lucrative tax breaks ran out. The price rises are harder to explain.

Interest rates began rising in November 2005. The European Central Bank kept ratcheting them up all during 2006, but Irish property buyers ignored them, even as houses became wildly unaffordable, whether for first-time buyers unable to get a big enough loan, or investors unable to get a reasonable return.

One suspects that the tax breaks played a malevolent role here too. They increased the apparent poor yield from rental investment. One sometimes feels that the aversion to paying tax is so strong in many people that they would prefer to lose money rather than give it to the Exchequer.

Whatever the reasons, last year's peculiarities interrupted an orderly slowdown. House construction has plunged from 90,000 to probably less than 55,000 next year instead of declining from the previous 70,000 figure. Once people finally got it into their heads that house prices were too high, they stopped buying. So few sales are taking place that figures for current prices are largely meaningless.

In a rational world, the 12per cent rise would not have taken place and prices would have fallen as rates rose. A drop of 5-10 per cent might have maintained affordability at its historically stable figure of around 28 per cent of disposable income. Now, even allowing for rising incomes, they will have to fall by 15-20 per cent. This has probably happened already, but few are willing to sell. Until now.

The world is not rational and there are few things as irrational as a market in the grip of manic optimism or terror. It is remarkable, though, how they tend to exhibit the same characteristics. The US market turned down some months before ours, and is worth watching. For the first 15 months or so, sellers maintained their asking prices. Then they cracked.

Lo and behold, some 15 months after the Irish downturn comes news that apartments in Ashtown, Co Dublin, have had their prices cut by 20 per cent. The danger, as other developers well know, is that once this starts, it can go beyond what is rational.

In the early Nineties, Irish houses were so cheap they could be bought with little more than 20 per cent of disposable income.

If nothing improves, Brian Cowen will be excoriated for not abolishing stamp duty altogether. But it is hard to get buyers to commit until they believe that prices will fall no further, stamp duty or no stamp duty. From the point of view of the economy and the public finances, a bigger risk is that builders will not return on site until they believe the same. Probably the best way to convince them would be cuts in interest rates. As of last Thursday, though, the ECB was not for turning.

The Indo

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