Five years after crash, what have we learned?

Five years. It has been five years of continuous economic crisis this month.

August 2007 was the month that the growth of world economy began falter and fail, exposing the weakness of Ireland’s banks, bursting the construction bubble, hammering the State’s finances, escalating unemployment and bad debt levels, and undoing a generation’s worth of economic growth and development in a country just starting to believe that the bad days of the 1980s were well behind it.

Five years. It is a good moment to look back on the last five years and ask: just what happened, and what, if anything, can we learn?

What happened? The years following the 9/11 attacks saw a wave of financial expansion as low interest rates allowed many households and firms to cheaply increase their debt levels relative to their incomes and assets. Profit-seeking banks and their shareholders, who lent long at ultra-low rates because they could borrow short at even lower rates, facilitated this increase in ‘leverage’. The Irish government encouraged speculation on land prices by allowing rezoning on land. The government change the composition of its taxation revenue, reducing income taxes, and relying more heavily on property-based taxes, exposing the State’s coffers to a huge downside risk if the property market went down. The banking regulator was off somewhere playing golf. The media, making money from property supplements, stayed silent, as did most economists who weren’t being paid by banks to cheerlead the boom.

There is an oversupply of shocking statistics to emphasize just how unstable this situation was. Here are two: At the end of 2008, the total stock of foreign borrowing by Irish banks was around 110 billion euros. Only four years earlier, in 2004, Ireland’s banks had only borrowed more than 15 billion euros from abroad.

At the end of 2007, Irish banks were lending 40 percent more to property developers alone than they had to the entire Irish population a mere seven years earlier.

An unstable process of accumulating foreign debt so that Irish people could sell other Irish people property had begun. As I said already: It would end much more quickly than it started. Bubbles rarely burst slowly.

Note that the bubble wasn’t confined to Ireland, although we were surely the most extreme example. Across the developed and developing world asset prices were rising, people were happy, investor confidence was high. Everyone was spending. Because at the level of the macroeconomy someone’s spending is always someone else’s income, the economies of the world all grew.

It was all a mirage.

The growth was based on an over extension of credit.  Worse: the mirage had real effects. More than a fifth of the Irish workforce was employed building houses, contributing to an oversupply that will take decades to reduce.

Once the mirage began to fade and ordinary people realized that four hundred thousand euros for a two-bedroom apartment in the southern suburbs of Dublin was insane, everything came crashing down rather quickly.

The proximate cause of Ireland’s economic crisis was the subprime mortgage crisis and the subsequent collapse of the bank Lehman Brothers. On August 6^th, 2007, the American Home Mortgage Investment Corporation (AMICO) filed for bankruptcy.  At the time it was the 10th largest retail mortgage lender in the US. AMICO was not a subprime lender, but it had been forced to close because of the difficulty. The AMICO filing sent shockwaves throughout the financial system. Credit between banks began to dry up, meaning banks wouldn’t lend to one another at previous levels. The system began to collapse.

Despite the best efforts of the US authorities, a credit crunch happened where banks became unwilling to lend to one another. The main Irish banks, with some of the most over extended balance sheets in the world, were extremely vulnerable to this credit crunch.

By February 2008, when UK bank Northern Rock is nationalized, it is clear Ireland’s banks are in deep trouble. Ireland’s unemployment rate begins to climb in early January 2008, as the construction bubble finally bursts. By 2010 the unemployment rate will have jumped from 6% to 14%. The Irish authorities claim nothing is particularly wrong. The economists of major banks bombard the airwaves throughout 2007 and 2008 with talk of soft landings. Very few economists shouted stop. David McWilliams and UCD’s Morgan Kelly were perhaps the most notable exception.

By September 2008, as a result of the international economic and financial turmoil, there was a run on Irish deposits and a collapse of Irish bank shares. The Irish government stepped in to guarantee the assets and liabilities of the banking sector. It was a bold move. It was the wrong move. The State (and by implication the taxpayer) was on the hook for the catastrophic losses of the banking sector.

The State’s overreliance on stamp duty and capital gains taxes was exposed when these funds no longer came in once the property boom collapsed. Coupled with the increasing cost of rising unemployment level and a drop in domestic demand, for the first time in years Ireland needed to borrow seriously from the international bond markets to plug the hole between government expenditure on goods and services and its income from taxation. Realising that the State, with an annual national output of around 130 billions euros per year was on the hook for a banking system worth over 400 billion euros, the bond markets who lent to the State got worried we wouldn’t be able to repay our debts. Relative to the cost of buying German government debt, the cost of Irish borrowing skyrocketed.

Despite two hair shirt budgets in 2009, by the autumn of 2010 Ireland could not borrow on the markets. Ireland applied for a programme of assistance in November.

Everything, every policy decision, and every major action the Irish State has taken since the night of the banking guarantee has been geared toward relieving the burden of this debt. Nothing, not the immolation of Fianna Fail and the Green party at the last election, not the frequent flights to Europe by the new government, not the many summits, not the burgeoning long term unemployment problem, not the NAMA architecture for bad commercial debt instituted by the old government; not the increase in sovereign debt to pay off private bondholders in banks, not the curtailing of credit into the economy by the banks Ireland’s taxpayers helped save, nothing has helped to alleviate the debt burden imposed since 2008’s banking guarantee.

It is from this point that the modern Irish economy must start. September 30^th, 2008 was our singularity, the point at which it all began. Everything prior to 2008 is, honestly, a footnote.

The parameters from the night of the guarantee were quite simple. First, Ireland must avoid any default on its debt of any kind because we were sure we would need to borrow from the international markets sooner rather than later. This constraint held above all others. Ireland would not default. Second, relations with Europe must be restored at all costs. Everything, including the various Treaty referenda, has proceeded from the position of needing to be within the good graces of those whose largesse we rely upon.

Ireland has a banking problem, a fiscal problem, a debt problem, an unemployment problem, and a political problem. The ordering is important. Ireland tried to solve its banking problem first, and has ended up with several zombie banks—banks that look alive but don’t lend into the real economy. The fiscal problem is in the process of being solved, through austerity. Essentially spending on government services has to drop and taxes of all kinds have to rise to make government expenditure coincide roughly with taxation revenue. Long term, austerity is a good thing because it will reduce our reliance on external borrowing. Short term, it will increase the suffering of the innocent in our society who rely on these services, and decrease the level of demand in the economy, which is key to helping to reduce unemployment. Austerity combined with sluggish growth means that unemployment over 10% will continue for the foreseeable future.

Ireland’s debt problem has had a few passes at it. I’ve already mentioned NAMA, the National Asset Management Agency, designed in 2009 to purge the banks of their bad commercial debts (over 71 billion euros worth). NAMA is currently working to recover as much money as it can for the taxpayer. It will be a decade or more before we can judge NAMA a success or a failure. Another aspect of the debt problem is the household mortgage problem. Many of the households who borrowed during the boom cannot repay. A new personal insolvency bill is attempting to address the stress this causes the people in debt, as well as the impact their default might have on the already weakened banks. Again it is far too early to tell whether this legislation will succeed or fail, but my opinion is the legislation won’t be sufficient, as I argued in the Irish Independent on the 3^rd of July.

Ireland’s unemployment problem is monstrous. We have over 309,000 people unemployed in Ireland today, almost 15% of the workforce, enough to fill the Aviva stadium more than six times over. More than 200,000 of those unemployed have been unemployed for more than a year. There are no certainties in economic research, but when it comes to long term unemployment—those unemployed for more than a year–almost all the research we have done shows that it damages the life time earnings of those who experience it, as well as damaging those around them.

Where is our retraining apparatus? Some of those construction workers made unemployed in 2007 could have Masters degrees by now. The ordering of our masters’ priorities when it comes to solving our problems lets us understand our own priorities when electing them. Remember that we elected the current coalition on a platform of no default and European solidarity.

Our political problem is that those in power are in fact powerless. Ireland’s political system will not change, despite the valiant efforts of a few to do so. The stakes, now, are just too small. Ireland’s politicians are constrained in every way. Only a solution to our debt problems at the European level will result in a recovery of the Irish economy. But a recovery to what? Our best hope is for a solid return to the bond markets, already underway, to continue.

What have we learned?

We have learned that those in power who fail will be rewarded but dismissed. The corrosive effect on our society of the impunity of those who helped cause the collapse cannot be estimated.

We have learned that even an existential crisis cannot unseat official Ireland.

We have learned that change is treacle-slow, but that it does come.

We have learned that no pain is too great for the Irish people to bear without protest.

We have learned that we can recover and move on from the property crash, but that it may take five more years with modest growth and high unemployment to do so.

The cost will be incalculable.

Published in the Independent.