Saturday, July 12, 2008

A Hard Landing

Dr Alan Ahearne, economics lecturer at the National University of Ireland, Galway, puts little stress on who sits behind the finance minister's desk. “I think we have had good policy makers, and the decisions don't depend on one man,” he said. “There are going to be many people involved in the decision making. But you can't make good policy without good analysis, and that is vital over the next few [fiscal] quarters.”

Three years ago, Ahearne warned that an Irish property crash was impending, while others were promising continuing buoyancy and growth. The economist later poured scorn on the forecasts of a soft landing. Bertie Ahern, the former taoiseach, promised one in the course of the last general election, but he was not alone.

In an interview last December with Reuters, the financial news service, John Hurley, the governor of the Central Bank, was still talking about a soft landing for the economy and 3% growth in 2008, down from its October forecast of 3.5%. That same intelligence probably fed into the Department of Finance's budget day calculation that month of 3% growth in GDP.

“We were never going to have a soft landing,” said Ahearne. “This is a crash in the housing market. Look at what is happening to price, to transactions [volume], to building activity.”

Ireland can now be added to the list of classic modern property crashes, from London and Boston through Scandinavia and Japan. The length of time we take to ride it out, though, will depend on the banks' readiness to bankrupt liquidity-challenged developers. Will they choose to flush the bad debts off their books as soon as possible?

Analysts say serious inroads must be made into the overhang of unsold housing stock - estimated to be at least 12 months' supply. There has to be a decline in the value of the euro, and a fall in inflation, before we can start supping skinny lattes with a clear conscience again.

In the meantime, the government is digging in, making retrenchment plans for at least two years of little or no growth, rising welfare bills, and stagnant stamp duty and CGT revenues. Poor forecasting means that the remedial measures required are not in place. This is likely to increase the pain before we get back to what government and the Central Bank like to call “trend growth” of 4-4.5%.

A year ago, forward indicators such as planning permissions suggested the drag on the economy from homebuilding was going to be significant in 2008, yet many forecasters were still calling strong growth in the economy, which Ahearne said defied economic logic and common sense.

Many private sector, rent-a-quote forecasters, he said, appeared to “make up numbers on the way in on the bus” or simply followed the herd. Meanwhile, there was a triumph of hope over realism in some state institutions, where a fear of talking down the economy made them adjust their forecasts down incrementally from quarter to quarter rather than produce a forecast “that was consistent with rigorous analysis”.

Challenged on its December forecast last week, the Central Bank said: “We have emphasised on a number of occasions that there were many downside risks and vulnerabilities in our forecasts that could push growth lower.

“These risks related to the potential for interaction between protracted global financial market turbulence, rising global energy and food prices and the slowing of activity within the economy, which was already under way. In recent months, almost all of these downside risks have materialised and this has led to a greater than expected slowdown in growth and higher than anticipated inflation.”

Dan McLaughlin, Bank of Ireland's chief economist, pointed out that everything that could go wrong for the Irish economy had gone wrong: the credit crunch has lasted a year, oil rose from $100 to $145 per barrel in the three months to July, Irish equities have fallen 30% this year, the European Central Bank (ECB) has raised rates despite slowing activity on the Continent, and sterling and the dollar have remained weak.

As its share price crashed alarmingly last week, Bank of Ireland was again cutting its economic growth forecast for 2008 - forecasting a flat year for GDP, down from the 3% growth previously forecast - and predicting unemployment would reach 6%.

Austin Hughes, the chief economist of IIB Bank, floated ideas such as temporary income tax cuts, Vat reductions or even stamp duty cuts as a balm on bruised consumer confidence. Ahearne is horrified at these notions, and warns government to stay clear of economic advice offered through the media for the coming two years.

“We should not have had tax cuts in the past few budgets - they added fuel to the fire,” said Ahearne. “They increased disposable income and therefore we had more consumer spending which was inflationary.

“It also allowed banks to give bigger loans, since they were doing that on the basis of disposable income. When the economy is overheating, the last thing you should be doing is tax cutting, but most economists were arguing for tax cuts.”

Alan Cooke, chief executive of the Irish Auctioneers and Valuers Institute, is among those who suggest that Irish banks are not helping the situation. “Look at what has happened to property prices and compare it to what has happened with equities as one of the main forms of investment,” he said. “The banks are down 70% on the year, the others are down 40-50%, we are down by 10% - I'd take that any day of the week.

“The only thing stopping much more activity in the market at this point is the banks, because they don't have the money to lend.” They were no longer lending to the buy-to-let market, he said, and they had increased margins on interest rates by 0.25-0.35%, adding to the pressure on domestic buyers already at the mercy of the ECB.

The Sunday Times

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