Composition Effects and Loan-to-Value Limits

The Irish Central Bank is scheduled to introduce new macro-prudential risk controls on Irish mortgage lending, with the new regulations taking effect on January 1st or soon thereafter. One of the regulations will limit most new mortgages to an initial loan-to-value ratio of 80% or less. There has been considerable discussion of the effect of loan-to-value limits on potential property purchasers, but the analysis has been very poorly framed.

The budgeting scenario has been described as follows:

“Consider a couple who wish to purchase a €300,000 property. With a LTV limit of 80% this will require that they save €60,000 for the down payment whereas if they were allowed to borrow 85% they would only need savings of €45,000.”

This oft-repeated budgeting scenario misrepresents the nature of market-wide LTV limits imposed by the Central Bank. This budgeting scenario gives the impression that the policy decision is about imposing/not imposing the LTV constraint on only one particular buyer rather than market-wide. It misses the large compositional effects since leveraged property buyers compete with one another for properties. The degree of leverage allowed in the banking system feeds into property prices, and this affects the opportunity set of purchasers. Continue reading “Composition Effects and Loan-to-Value Limits”

Doublespeak of the day

According to the Irish Independent, Minister Noonan was worrying in public last night about the shortage of family homes in the Dublin area. But he also apparently said:

“We need to get property prices up another bit.”

To which the only possible response is: “why”?

If you are stuck in a malfunctioning currency union and can’t devalue, then don’t you want to get all costs down as much as possible, especially if they are going to feed into wage demands? Why interfere with the market in this particular case?

House prices: bubbles versus booms

The end of one quarter and the start of another sees the usual slew of economic reports and the start of Q4 is no exception. Today sees the launch of the Q3 Report. In line with other reports in the last week or so, and indeed with the last few Reports, there is evidence of strong price rises in certain Dublin segments. What is new this quarter is the clarity of the divide between Dublin and elsewhere: all six Dublin regions analysed show year-on-year gains in asking prices (from 1.4% in North County Dublin to 12.7% in South County Dublin), while every other region analysed (29 in total) continues to show year-on-year falls (from 3.1% in Galway city to 19.5% in Laois).

The substantial increases in South Dublin over the last 12 months have led to talk of “yet another bubble” emerging, with internet forums awash with sentiment such as “Not again!” and “Will we never learn?”. To me, this is largely misplaced, mistaking a house price boom for a house price bubble. Let me explain.

Firstly, I should state that, unlike “recession” which is taken to mean two consecutive quarters of negative growth, there is no agreement among economists on what exactly constitutes a bubble, in house prices or in other assets, but the general rule is that prices have to detach from “fundamentals”. For example, the Congressional Budget Office defines an asset bubble as an economic development where the price of an asset class “rises to a level that appears to be unsustainable and well above the assets’ value as determined by economic fundamentals”. Charles Kindleberger wrote the book on bubbles and his take on it is that almost always credit is at the heart of bubbles: it’s hard for prices to detach from fundamentals if people only have their current income to squander. If you give them access to their future income also, through credit, that’s when prices can really detach.

Continue reading “House prices: bubbles versus booms”

Fitch Report: Property Markets Remain Soft, Irish Borrowers on Strike

Namawinelake has a link to the new Fitch report on global property markets, including Ireland which gets considerable attention in the report. The Irish picture is mixed with some positive signals (affordability ratios have become more normal) and other negative signals (continued bank distress limits future mortgage lending).

Fitch also highlights the unusual behaviour of Irish arrears, and connects this to the Irish policy framework.

Irish Borrowers on Strike: Despite economic stabilisation, Irish arrears continue to trend upwards. Fitch believes this to be partially driven by policy framework changes. Lenders are constrained from large-scale repossessions, dis-incentivising borrowers from paying their mortgages. In addition, borrowers in arrears are also likely to benefit from significant debt write-offs when personal insolvency legislation becomes effective.”

We’re different, roysh? The decoupling of the Dublin property market

Today sees the launch of the fiftieth Daft Report, with a commentary by yours truly. To mark the occasion, and to mark five years of Ireland’s property market crash, and the All-Island Research Observatory at NUI Maynooth, have launched a property value heatmap tool. In a companion post to this one, I outline the tool, how it works and what it tells us about Ireland’s property market crash.

In this post, though, I’d like to highlight what’s in the report itself. The principal finding from Q2 was that conditions in the Dublin market do indeed look to have improved considerably since the start of the year. This has happened at a time when conditions elsewhere in the country are pretty much unchanged. It seems the decoupling of the Dublin property market from the rest of the country has already begun.

Continue reading “We’re different, roysh? The decoupling of the Dublin property market”

Get them while they’re hot (or cold): Heatmaps of property values in Ireland now available

As I note in the companion post to this one, today sees the launch of the fiftieth Daft Report, with a commentary by yours truly. To mark the occasion, and to mark five years of Ireland’s property market crash, and the All-Island Research Observatory at NUI Maynooth, have launched a property value heatmap tool. In this post, I’ll give an outline of what the tool is and does, and what we can learn from it.

Continue reading “Get them while they’re hot (or cold): Heatmaps of property values in Ireland now available”

Nama Scheme Increases Recorded Property Sales Prices by Approximately 7.5%

In announcing its 80/20 negative equity insurance scheme, Nama management could have, but did not, provide estimates of the implicit cost of the insurance component of the package product. The cost is hidden in the package sales prices, which Nama management describe as “fair value prices” for the property.  With a bit of work, it is possible to reverse-engineer the insurance-component cost from the scanty information provided by Nama. 
Continue reading “Nama Scheme Increases Recorded Property Sales Prices by Approximately 7.5%”

Nama giving away “free” insurance, thereby distorting both its published accounts and Irish property market prices

I have written about this before, twice, but now some more details have emerged and the Nama scheme has gone live.  Nama has announced that it will providing “free” insurance against price falls for selected properties, in order to help sell its Irish residential property portfolio.

From the information provided, it seems Nama will hide the insurance premium in the recorded property sales price, thereby simultaneously distorting Nama’s published accounts, CSO property sales price statistics, and the soon-to-be-released property price sales registry.

Wonkish paragraph: Hiding the insurance premium in this way also has a knock-on effect on the “moneyness” of the embedded option.  Since the actual sales price includes a hidden insurance premium, and the eventual valuation of the property (used to determine the insurance pay-out) does not include any insurance premium, the insurance scheme is immediately “in the red” as soon as the property is sold. Nama has to hope for price increases, not just the absence of decreases, in order to claw back the embedded insurance premium which is hidden in the distorted sales price. This knock-on effect can be quite substantial.

Fire sale prices versus stagnation prices

The concept of “fire sale prices” is a useful one in many contexts – some examples are the October 19th 1987 US stock market crash, the LTCM crisis of 1998, and the 2007-8 US credit-liquidity crisis. In all three of these cases, security prices crashed in a particular sub-market, policymakers stepped in providing extraordinary credit-liquidity support, and eventually (quickly in the first two cases, slowly in the last) the capital market situation normalized. Unfortunately, “fire sale prices” is a useless or even harmful analytical tool for understanding the current Irish financial predicament. A better term for current conditions in Irish asset markets is stagnation prices rather than fire sale prices. Policymakers should look to Japan circa 1991 and the following two decades, rather than the USA, for a useful historical precedent. The fire sale concept gives the wrong policy guidance in the Irish situation; it is metaphorically like trying to use a fire hose to drain a swamp.

Andrei Shleifer and Robert Vishny have a series of papers exploring the use of the fire sale concept in modelling financial markets. There has been a large outpouring of papers by other authors with similar or related models, but the Shleifer and Vishny model is clear and simple and their survey is particularly good. They provide a definition:

“A fire sale is essentially a forced sale of an asset at a dislocated price…. Assets sold in fire sales can trade at prices far below value in best use, causing severe losses to sellers.”

They discuss how fire sales can cause financial and macroeconomic instability via credit and liquidity channels. In a related paper they laud US policymakers for their prompt and correct response in 2007-9 in injecting massive credit and liquidity into the markets for mortgage-related and credit-related securities caught up in the fire sale environment of 2007-9.

Fire sale mitigation policies are unusual as economic policies in that, as a rule, they should result in a net profit for the policymaker. This follows from the theory of the limits to arbitrage. This certainly seems to apply in the US case – the Federal Reserve made a trading profit of $79.3 billion in 2010 and $76.9 billion in 2011. The Fed vastly outperformed the best-performing hedge fund both years, at U.S. civil service pay rates, and without actually trying to make a profit. TARP was also profitable or near profitable, after an adjustment for the expensive but necessary bail-out of the US automobile industry. This is the nature of fire sale mitigation policies – they are about buying securities slightly below fair value and holding them temporarily on government account while injecting liquidity and credit.

The bad news is that this has near-zero relevance for Ireland. Irish asset markets are not suffering from a fire sale problem but rather from a long-horizon stagnation problem. The appropriate comparison case is not from the USA but rather Japan circa 1990. Japanese policymakers and financial institutions worked endlessly to slow the pace of adjustment, leading to an almost twenty year period of stagnation, suppressing growth and business innovation, and leaving a massive overhang of government debt. Irish asset markets need to be forced to adjust quickly and reach their new (much lower) equilibrium values with un-frozen free trading and clear, public pricing. This applies to banks, collateralized pools of debt, commercial leases, and commercial and residential property. Preventing this from happening is not preventing a “fire sale” rather it is guaranteeing a long stagnation. It could even last twenty years, as in Japan.

Another question – what is it about the US environment that gives rise to fire-sale-induced financial crises of typically short duration? Part of the answer lies in the USA lead in financial innovation. New financial innovations were key to all three fire-sale market crashes mentioned in the first paragraph of this post (portfolio insurance, statistical arbitrage, and numerous CDO innovations, respectively). High-frequency trading (the most recent big innovation) will be the likely cause of the next fire-sale-related crash, if one comes in the USA.* Ireland seems to avoid these fire-sale crashes, but is plagued instead by long-lasting periods of stagnation. Let us hope the current one is not dragged out for a decade.


*A post-script on HFT and the Tobin tax. After my last blogpost, Frank Barry asked me to give more details about Tobin’s use of the term “sand in the wheels” and its application in old-fashioned engineering. I do not know that much about the engineering use of sand in the wheels – I only heard Tobin discussing it in an interview. I now know that historically the sand in the wheels technique was used in the case of a metal (steel or iron) wheel aligned on a track and needing better grip, such as an old-fashioned railway wheel on a wet track. It is used for wheel-type mechanisms and not for gears with teeth. See Wikipedia for some details for those with an interest. I remember Tobin saying he was annoyed that many commentators mistook him as suggesting sabotage, and I remembered that key idea correctly. Sand in the wheels is a technique to improve, not hinder, performance.

Nama’s Property Price Insurance Scheme

A little bit more detail has emerged (via press interviews rather than detailed technical documents) about the Nama property price insurance scheme as it is currently proposed. The basic design was leaked to the press in early July, and was discussed in my earlier thread. The emerging details of the scheme as announced so far are not reassuring. The scheme has considerable potential to manipulate recorded property sales prices, to damage confidence in Irish property market openness, and to build up a hidden future cash flow liability for Irish taxpayers. The motivation given by Nama for implementing the scheme is not entirely convincing.

Continue reading “Nama’s Property Price Insurance Scheme”

Forbearance and Frontrunning in Irish Property Markets

The most recent Financial Stability Report from the Bank of England warns about the danger to U.K. economic stability from excessive debt forbearance by U.K. domestic banks. The governor of the Bank of England, Mervyn King, put stress on this risk in his speech introducing the report (although he also noted that this does not mean that forbearance is always a bad thing). In the report, only the potential UK fallout from the Euro crisis ranks more highly than excessive debt forbearance on the list of risks to the UK banking system. This should ring alarm bells in Ireland, since the level of debt forbearance in Ireland at present is much higher than in the U.K.  Encouraging debt forbearance is a deliberate Irish government policy, and the extreme level of forbearance by domestic Irish institutions is storing up potential problems for the future.

There is a considerable overhang of unwanted or distressed (in some cases unfinished) property assets in Ireland (see Ronan Lyons and Namawinelake for discussion). The smart-money players (foreign-owned banks with Irish property assets) might front-run the slower-footed players (domestic, taxpayer-owned banks and Nama) by selling relatively quickly, leaving the Irish taxpayer to fund any eventual shortfall. (I am including the IBRC, the vestiges of Anglo Irish and Irish Nationwide, in my definition of domestic banks.) So loan forbearance and front-running in Irish property markets could interact to the detriment of taxpayers.   


Continue reading “Forbearance and Frontrunning in Irish Property Markets”

Nama’s Mortgage Enhancement Scheme

In today’s Irish Times, Fiona Reddan has an interesting short article about Nama’s planned mortgage-enhancement scheme. The scheme is intended to unload some of Nama’s large inventory of houses and flats without unduly lowering property prices.  The scheme, at least as it has been described so far, will work as follows.  Suppose that Nama wants to sell a particular flat for 100,000.  It will offer a buyer the following deal. The purchaser must put down 10,000 in cash, and take out a mortgage from a bank for 72,000.  Nama will pay (itself) the remaining 18,000 and record the flat as sold at 10,000+72,000+18,000 = 100,000.  If after an initial period, say five years, the fair market value of  the house is more than 82,000 (the amount already paid by the homeowner) than the homeowner must “top up” the difference to a maximum of 18,000.  If the fair-market value of the house is 82,000 or less at this date, the homeowner has no need to pay the remainder. Continue reading “Nama’s Mortgage Enhancement Scheme”

Martin Walsh on Residential House Prices

This article by Martin Walsh in the Irish Times has some convincing analysis (unfortunately the graphics are not shown in the on-line version), and some thought-provoking comments on the Irish government policy conundrum regarding residential house prices.  As Martin Walsh notes, to minimize expected future (state-owned) bank losses and Nama losses, policymakers must hope that prices have now fallen to their steady-state equilibrium level.  But for the purposes of restoring competitiveness, continued house price decreases would be better. 

“… it seems that there is a real dilemma at the heart of national policy. Do we prioritise competitiveness by bringing house prices back into line with incomes or keep them inflated in the hope of reducing further losses to the banks and Nama (National Asset Management Agency), as well as containing the extent of negative equity?”

Most importantly, by most long-term metrics, current house prices in Ireland still seem to be above sustainable levels.  

What actions (if any) should Irish policymakers pursue regarding stabilizing the residential housing market, and to what ends?    

National Consumer Agency report on grocery prices

Details of the latest NCA report on grocery prices here. Highlights include the fact that the prices of branded grocery products fell by 14% between between January 2009 and July 2010, the fact that there is almost no difference in the cost of a basket of branded grocery goods between the four main retailers (including SuperValu) and the fact that price competition in the Irish grocery market mainly takes the form of promotions and special offers and by juggling small price changes on specific items.

Six stores were visited, but because the multiples (though not SuperValu) operate a policy of national pricing, prices in any one store are representative for the group as a whole. The data collected is made available in an accompanying spreadsheet, although the link did not appear to be working when I accessed it this morning. The discounters Aldi and Lidl were not included in the survey. Conor Pope in his analysis piece on the survey in the Irish Times today suggests that retailers may be able to `play´ the survey by keeping prices low on the items likely to be included while giving prices free rein on less common items.

The NCA Chief Executive Ann Fitzgerald says that the findings suggest that competitive pricing is still not a feature of the Irish grocery market and to address this there is a real need for a new entrant to the market to offer consumers a real alternative. According to Paul Cullen’s report in the Irish Times, she called for a removal of the cap on the size of retail units under planning regulations, claiming this would stimulate competition by encouraging a big overseas retailer to come to Ireland.

In a variant of the glass half-full argument, one might argue that similar prices are actually a sign of a very competitive market and emphasise more the fall of 14% in prices of branded goods over the past 18 months. However, the previous discussion on this blog regarding Ireland’s high food prices in an  EU context suggests that Ann Fitzgerald has a point.