The Return of Morgan Kelly and more Bad News

The return of Morgan Kelly to the pages of the Irish Times is most definitely noteworthy, Kelly spent much of the period from 2006-2008 being pilloried as a wonk in an ivory tower who went wrong on the maths somewhere. In 2007 he wrote in a head to head with Austin Hughes (behind paywall, email us for full article):

In Ireland between 2000 and 2006, house prices doubled relative to income and rents. Based on what happened after other European booms we can expect prices here to halve in real terms over the next few years.

Ten per cent of housing units in Irish cities are vacant, and almost none of the 70,000 or so new units built this year have been sold: a Dublin estate agent told me that whereas last year they had sold over 3,000 new units, so far this year they have sold fewer than 100. With Dublin house prices down about 10 per cent already, there is a real risk that panic-selling by investors and builders will spark a price crash.

Eliminating stamp duty will not help: so long as there is a large stock of unsold houses, buyers will stay out of the market for fear of further price falls, and these expectations will be self-fulfilling…

Irish banks are now more exposed to property speculators than Japanese banks were when they imploded in 1989. Banks have lent almost €100 billion to developers, compared with only €80 billion to people to buy their own houses….

The Irish economy is now looking eerily like the Nordic economies in 1992. Norway, Finland and Sweden all had house price and building booms in the late 1980s that encouraged banks to lend heavily to developers. But as house prices fell, developers walked away from their loans and banks collapsed.

Then, as was de rigeur, the political class within Fianna Fail and beyond decided that Kelly was beyond the pale, too mad to be right. Only that he has so far been pretty much on the money. When they couldn’t discredit his previous work they began to work at discrediting any updates – ‘oh he just keeps bragging he was right’ ‘he might have been on to somethign but he is just being extreme now for the sake of it’ (yup, I have heard both those lines) – where Kelly might have been trying to point out where we go.

On the same pages of the Irish Times that day, Austin Hughes wrote:

The broad slowdown we have seen is, in general, a healthy correction, and in the next few months, softer prices could well persist. However, with better news on borrowing costs, a sensible budget, lower levels of building and a resilient Irish economy, I would be confident that a house price collapse will be avoided. Indeed, a modestly improving trend in house prices in a more stable market should become evident during 2008.

I think we all know now who was in the right on that debate. So it is with some clout that Kelly takes up the pen to discuss NAMA in today’s opinion piece for the Irish Times, a day after our Minister for Finance admits he might have to contemplate more nationalisation even once NAMA comes into being.

What Kelly has to say is measured and utterly frightening. Unlike the raw rage of his January article on the Anglo situation this is a piece to chill those who read Mark’s wince-inducing charts. Instead he takes apart the guarantee decision – widely criticised for including bond-holders and also extending to Anglo and Irish Nationwide.He goes on to note that NAMA is the continuation of the logic of the guarantee:

Nama, then, is the latest twist in the Government’s increasingly bizarre efforts to save the Irish banking system while claiming that it does not really need to be saved.

Underlying Nama is the delusion that the collapse of our property bubble is a temporary downturn. In a few years time when the global economy recovers we will be back building houses like it was 2006. All the ghost estates, empty office blocks, guest-less hotels and weed choked fields that Nama has bought on our behalf will once again be worth a fortune.

The reality is that, because of our surfeit of empty housing, there will be almost no construction activity for the next decade…

The taxpayer is likely to lose well over €25 billion on Anglo alone. Among its “assets” are €4 billion lent for Irish hotels, and almost €20 billion for empty fields and building sites. In fact, I suspect that the €20 billion already repaid to the casino that was Anglo represents winners cashing in their chips, while the outstanding €70 billion of loans will turn out to be worthless.

It is the bondholders that Kelly has in his sights in this, they are covered and their coverage will cost us. At the outset he asserts

“By converting a portion of Allies Irish Banks’ approximately €40 billion of bonds, and Bank of Ireland’s €50 billion, into shares, each institution can be recapitalised. Transferring ownership to bond holders will not cost the taxpayer a cent and will avoid interminable legal battles over the transfer of assets to Nama.”

The bondholders instead could cost us up to €50 billion, a tax increase of 10% for the next 10 years. That estimate is ahead of the IMF estimate but no one is working with any hard data, we are taking shots in the dark at the proportion of loans that are not going to be repaid. So what do we do about this?

Irish banks had borrowed heavily from other financial institutions through bonds, and these bondholders originally agreed to take losses if Irish banks got into difficulties.By placing the costs of the banking collapse primarily on existing holders of bank bonds, the State can improve its credit rating and pull back from the edge of bankruptcy. Knowing that taxpayers are not liable for the losses of AIB and Bank of Ireland will make capital markets more willing to lend to the Irish State.

Instead, like a corpulent Tooth Fairy gently slipping billions under the pillows of sleeping bond holders, Brian Lenihan has chosen to extend the liability guarantee and further weaken the bargaining position of the State.

The drift into national bankruptcy looks increasingly unstoppable.

If this is workable then it must be considered, the banks will weigh heavily on national recovery and for many years ahead will determine how much of our young population will have to move abroad. The question would be whether shifting the burden to bondholders would freeze up credit further as banks struggled to get houses in order – but it cannot get much more frozen than it is now.

Kelly has filleted government policy – policy neither the Dept of Taoiseach nor Dept of Finance are rushing to ‘own’ publicly. To get ahead of the problem might require them to cast off too many shakles, burn too many bridges and, importantly, sting too many recently-acquired friends.

For all the cool analysis on how we might manouvere towards some settlement, it is still these sentiments from his earlier article that resonate with most people.

Watching the ineptitude and complacency of Lenihan’s bank bailout, we can understand increasingly how the people of New Orleans must have felt as they watched George Bush rescue their city: “Brianie: you’re doing a heck of a job.”

Particularly galling are the Government’s efforts to feign surprise and indignation at the behaviour of the banks, when the reality is that this is how we have always done business here. All that the Anglo affair has done is to hold up our grubby brand of crony capitalism for international ridicule.

For increasing numbers of ordinary people, the Irish economic miracle has turned out to be as worthwhile as a share in Bernard L Madoff Investments.