If our capacity to make credit based consumerism work is based on our willingness to borrow to spend when does the party stop?
If globalisation means that states become increasingly dependent on producing goods and services that others value – should others stop valuing those goods or be restricted in buying them what happens next?
Market analysts are worried global growth will not be strong enough to finance repayments on about $150 trillion of debt-based financial assets; many fear a double dip recession is taking hold.
Consequently last week's flight to cash, downgrading of the US
Nearer to home, political leadership failure has been taken to new heights with bickering between euro partners exposing the failure of any co-ordinated policy response to recognising that non-repayable losses will have to be borne by both public (taxpayers) and risk taking private investors (banks and institutional investors).
One hundred years ago, similar leadership failings caused first a collapse in bond market confidence and then the First World War. Should any state and thus the ordinary person on the street be expected to act as insurers-of-last resort when free-market capitalism fails?
A dogmatic insistence on socialising bank debts to protect privately held wealth is backfiring as investors realise the resultant burden of public debt has undermined all but the strongest of national balance sheets. A sovereign’s balance sheet is now seen as only as strong as its banking systems financial stability or in our case, its continuing fragility.
With the slow motion train wreck of the euro project reaching its predictable crisis laden destination, we have experienced the destruction of about €230bn in household wealth, much of which is tied up in property assets.
Suffering from the same loss aversion that has plagued European policy decision making, we are equally incapable of coming to terms with what the outcome must be. Well understood, loss aversion means we fight doggedly to protect ourselves against losses even when they are absolutely inevitable. How many people are sitting on losses they will never recover and are unwilling to act to sell up now? How many are trying to sell at prices too high to attract buyers?
Our human predilection to prefer avoiding losses about as twice as much as we prefer acquiring gains, means that will forebear; we will refuse to realise losses.
In a recent financial stability report, the Bank of England warned of the dangers of banker’s forbearance, wherein, gambling for resurrection, banks act to hide the true extent of losses by cutting deals with their borrowers. It’s by no means certain that our Central Bank’s short-circuiting of this flaw in forcing banks to overcapitalise will work given two important issues.
The first is that losses were figured after economic assumptions that now appear to be optimistic and the second relates to the risk of a double dip property bubble.
Today the average sales price of a home is €196,000 down peak price of €366,000. Prices have reached 2001 levels. Predictions are prices having dropped beneath the €200,000 level may drop as low as €150,000. Attended by cash buyers, recent fire-sale auctions achieved prices as low as 60-70% off peak. Commercial and real estate property values are languishing at 1999 levels. With an estimated overhang of about 170,000 residential units and failed credit market it’s a market primed for the extend and pray approach, in others words forbearance. With about 10,000 professional investor loans of upwards of €2m each, the extent of bank and investor loss aversion can only be guessed at.
NAMA is floating a negative equity insurance scheme it intends packaging with the two pillar banks to encourage buying activity. It may provide upwards of €18,000 in negative equity insurance on the price of a house for five years. Its plan to shift its mountain of vacant residential units, including developer incentives, could distort the property market. Some say its actions may be anti-competitive as it offers what amounts to state backed insurance on its portfolio of properties.
Whatever of NAMA’s market power to distort property prices, there’s another marketplace phenomenon raised on the influential irisheconomy.ie blog. It could well be the case that more agile, non-state owned or directed banks may act as “frontrunners” and grab first mover advantage. Should they switch from “extend and pray” forbearance to getting out for what they can get now, they might sell off their controlled properties leaving domestic state controlled banks and NAMA to essentially suck on the hind tit. More so as international market tensions and herding flight-to-cash behaviour could trigger foreign controlled banks to cut losses.
A version of this article appeared in the Irish Examiner, Business Section, Monday 8th August 2011.
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