Ship of Fools (15 page)

Especially in the last four years of the boom, Ireland became the owe-zone of Europe. The housing boom fuelled a vertiginous growth in private sector credit. This was already very high by the end of the 1990s - around 110 per cent of GNP in 1999, which was higher than the proportion in Scandinavian countries when their banking systems had collapsed earlier in the decade. Especially after 2001, when the European Central Bank made sharp cuts in interest rates, things got far worse. In 2004, private credit stood at €190 billion - 145 per cent of GNP. In 2006, it was €305 billion - more than double the size of GNP. By 2008, it had hit the €400 billion mark - two and a half times GNP. Property-related lending amounted to about two-thirds of this vast swamp of credit.

The annual rate of growth of private sector credit in Ireland in 2006 (€65 billion in one year alone) is probably the highest in any country anywhere, ever. A big part of this was created by people taking out mortgages. The level of personal mortgage debt in Ireland increased by €2 billion
a month
during 2006, a year in which the average price of a new house in Dublin rose by €55,000 in 12 months. Both personal debt and mortgage debt doubled in the five years between 2004 and 2008.

Much of this debt was essentially a transfer of wealth from the putative future incomes of ordinary workers to the bank accounts of those who had gained control of the property development industry. But it was also creating an obvious
instability in the Irish economy as a whole. As early as 22 December 1999, Standard and Poor's
Credit Week
mentioned Ireland as one of seven countries with a financial system vulnerable to a credit bust.

In an article in the February 2000 edition of
Finance
magazine, the former Central Bank regulator William Slattery pointed to the unsustainable nature of the growth in private sector credit. Sooner or later, he argued, borrowing would have to come back to a rational level, and when it did so, this would ‘result in the removal of the source of a large volume of expenditure in the economy. When this happens I believe it is likely that the supply of property will substantially exceed demand . . . In that event, a substantial decline in property prices is inevitable.' How much would prices fall? Given the inflated prices being charged for houses and land, Slattery's educated guess was that ‘A return to more normal levels for each of these elements would mean a substantial drop in house prices, perhaps as much as 30 to 50 per cent.' Unless the government made it a priority to ensure that house prices did not continue to rise, Slattery warned, it would simply ‘exacerbate what I believe is likely to be ultimately a quite traumatic situation for many current house buyers'. This is pretty much what happened: the government did not try to stop house prices rising, prices ultimately dropped by 30 to 50 per cent and it was indeed pretty traumatic for people who had bought homes during the boom years.

To be fair, it is something of a misrepresentation to say that the government did not try to control the property boom. Bertie Ahern remarked in 2006 that ‘the boom is getting more boomier', and making booms boomier was what Fianna Fáil did. Faced with a rapidly inflating balloon it took the
advice that Lauren Bacall gave to Humphrey Bogart in
To Have and Have Not
: ‘Just pucker up your lips and blow.'

The Bacallian (or should that be Bacchanalian?) school of economics, as perfected by Ahern, McCreevy and Harney, dictated that the way to make sure that a property crash did not destroy the economy was to force-feed property developers and investors with tax incentives. The government created a bewildering array of property-based tax breaks to encourage more building, higher land prices, and a diversion of potentially productive investment into yet more bricks and mortar. There were incentives for the developers of hotels and holiday camps, of private hospitals and nursing homes, of holiday cottage schemes, of third-level educational buildings and student accommodation blocks, of childcare and park-and-ride facilities, of multi-storey car parks and refurbished flats. Most of this was stark stupidity: the number of hotel rooms, for example, increased by 150 per cent in the Celtic Tiger years, while the number of tourists increased by 70 per cent. Developers were building hotels, not to meet a market demand, but simply to get the tax subsidies from the government. Fianna Fáil ended up spending €330 million of public money to subsidise the building of hotels. The only effect was to make the hotel trade unviable. With so many of them sprouting up all over the place, there were simply not enough paying guests to go round. By the summer of 2009, Irish hotels, with an occupancy rate of 53 per cent, were officially half-empty - a towering achievement for Bacallian economics.

One of the most popular tax incentives was the so-called Section 23 relief, under which most of the cost of building rental accommodation (generally apartment blocks) in designated areas could be set against tax. The original intention
was that the relief would encourage development in specific, neglected urban areas. It was rapidly seized on as a broad tax-avoidance measure. Ruairi Quinn, then the outgoing Finance minister in the Rainbow Coalition government defeated by Bertie Ahern in 1997, told a story of that year's election. He was canvassing in Carrick-on-Shannon in County Leitrim for the local Labour Party candidate. Leitrim is one of the least urbanised areas in Western Europe. Quinn was approached by members of the Carrick-on-Shannon Chamber of Commerce. ‘They said, “We want section 23” and I asked what part of Carrick-on-Shannon they wanted it for, to which they replied, “Oh no, we don't want to make a selection.” I asked what other places they wanted and was told: “We don't want to be competitive between one town or one village and another.” I asked them what exactly they would like and they said, “We want you to give section 23 to the whole of County Leitrim.”'

This helps to explain why Leitrim ended up with almost one in three of its houses empty and with hundreds of houses built in villages like Dromod or Leitrim village that recorded only a very small increase in their actual population. It is a strange housing boom that leaves such places literally emptier than they were before.

The state ended up subsidising - to the tune of around €2 billion in all - the building of houses whose purpose was to provide shelter, not for real people, but for the taxes of their builders. The tax costs to the state of the various ‘renewal' schemes amounted to a staggering 43 per cent of the cost of the actual developments. Instead of providing real houses for people who desperately needed them, €2 billion of public money was squandered on putting up empty shells in places where no one wanted to live.

These were, almost without exception, state subsidies for the rich. Indecon, from whom the government eventually commissioned an analysis of the property-based tax incentives, concluded that ‘nearly all of the property tax incentives reviewed have been used primarily by high income earners'. None was introduced as a result of a cost/benefit analysis. None was time-limited, so that incentives that might perhaps make some sense at a particular moment continued to operate long after they were remotely justifiable.

What the incentives did achieve, however, was to help turn Ireland from a society in which construction serviced the economy into one in which the economy existed to service construction. In May 2009, in a half-hearted excuse for an apology, the Taoiseach Brian Cowen, who had been a pitifully compliant minister for finance during the worst of the bubble years, regretted the ‘reliance on the construction sector, which had grown to 12% of GDP'. This in itself was an interesting example of Freudian repression. The construction sector wasn't 12 per cent of GDP. It was, at the height of the boom in 2006, almost 24 per cent of GDP. This was twice the average ratio for Western Europe. It directly accounted in 2006 for 19 per cent of the entire workforce. In other words, a quarter of all the economic activity in the state was the manipulation of bricks and mortar, concrete and tarmac. One person in five was employed in building the houses, roads, office blocks and infrastructure for the other four to live in, work in and travel through.

The height of absurdity was reached in the last years of the boom when Ireland was importing construction workers from Central and Eastern Europe to build the houses in which they themselves would live. In 2006, 13 per cent of the workforce in Irish construction was made up of migrant
workers. Many builders were relying on these workers to rent the houses the last wave of migrant workers had built , while they themselves built the houses for the expected next wave of central European builders to rent.

Faced with this looming disaster, and its implications for the stability of the banking sector, the Central Bank stood on the sidelines wringing its hands. Its own figures, published in its annual stability reports, were terrifying: bank lending for construction and real estate grew from €5.5 billion in 1999 to €96.2 billion in 2007 - an increase of 1,730 per cent. On average, this lending was growing by 18 per cent
a month
. Even if the Irish regulators didn't concern themselves with awkward things like ethics and legality, they were supposed to be in the business of risk management and banking stability. That the pace and scale of this rise in lending to one sector of the economy met with no real regulatory response suggests a mass migration to the Republic of Catatonia.

In May 2009, Brian Cowen claimed that he and the government had been well aware all along that construction and property had become cuckoos in the economic nest and had been planning to tackle the problem. ‘The reliance on the construction sector was something we were in fact going to move down, over time, to get a soft landing'. Apart from the obvious fact that these good intentions were never acted on, one reason to doubt whether Fianna Fáil had the will to act is that the construction and property boom had become essential to the party's very being.

Fianna Fáil, in the boom years, had to juggle two ideological imperatives. On the one hand, it had bought into the so-called free market agenda of low taxes for individuals and corporations as the mainstay of economic prosperity. On the other, it remained a populist party with the need to satisfy a
large and diverse electoral base that included much of the urban working class and welfare recipients and also many rural and provincial communities who expected their politicians to deliver public goods to the local area. How could it choose between low taxes and the concomitant of poor social services on the one side and the need to keep low-income and regional voters reasonably happy on the other? In order to avoid that choice, it needed to pull off the trick of simultaneously cutting taxes and increasing spending. The magical substance that allowed it to achieve this apparently impossible feat was concrete. The construction boom filled the gap between real, sustainable revenue and spendthrift, careless spending. It meant that Fianna Fáil did not have to do the one thing against which every fibre in its republican being revolted: make a choice.

Money flowed into the state coffers from the construction boom through stamp duty, VAT on construction materials, capital-related taxes and income taxes on building workers, including those who came into the country from Central Europe. VAT on house building alone accounted for 8 per cent of Irish tax revenue in 2006. Overall, property-related taxes, which had contributed 4 per cent of government revenue in 1996, made up at least 17 per cent in 2006.

In real terms, taking out these unsustainable factors, the Irish public finances were in the red: the IMF calculated this ‘structural deficit' at 9 per cent of GDP in 2007 and 12.5 per cent in 2008. But the construction-related revenues turned this deficit into a budget surplus, creating both the illusion that there was plenty of money to spend and a lack of concern with how well it was spent.

The government turned itself into a junkie, injecting itself every day with the narcotic of easy money from the property
bubble. Like every addict, its main interest was in making sure the supply of the drug didn't dry up. In these circumstances, two things were inevitable. One was that the bubble of debt and inflated property values would burst with, as Slattery had predicted, ‘traumatic' consequences for those who had bought houses at the top of the market. The other was that this first inevitability would be denied, ignored and, if possible, obliterated from the public mind.

Thus, in late 2006, when Morgan Kelly, professor of economics at University College Dublin, wrote an extensive piece in the
Irish Times
, and followed it up with an academic paper with the phlegmatically chilling title ‘On The Likely Extent of Falls in Irish House Prices', he might as well have broken wind in an airtight room. Kelly made the point that he had studied forty booms and busts in property markets in OECD countries since 1970. The overall pattern is remarkably stable: property loses 70 per cent of the value it gained during the bubble years. There is a simple law: the more house prices rise relative to average incomes, the harder they will fall. On this basis, Irish house prices were due to fall by between 40 and 60 per cent.

This was not a wild jeremiad. This kind of fall had happened in Holland in the 1980s, in Switzerland and Norway in the late 1980s, and in Finland in the early 1990s. These slumps, and the others that Kelly detailed, were typically quite long in duration: five to seven years was the norm, but the markets in Switzerland, Japan and Holland had taken at least a decade to recover.

Kelly cut through the favoured phrase of government, cheerleader economists, banks and property companies - ‘soft landing' - like a scalpel through silk: