BOOM TOWNS: Australian property and the lessons from the Irish experience

In September 2008, a helicopter crashed and burst into flames in the Irish seaside town where I grew up.

It was news to me that there was a helicopter in the neighbourhood, let alone learning that it crashed and exploded. As kids, we’d never seen choppers in the area. It was a village north of Dublin and the most advanced forms of transport we’d known to touch the soil were tractors and buses.

But this happened in Ireland during the now-legendary, and ill-fated, economic boom. The pilot had delivered a property developer client to a meeting. He then moved off the beach nearby because a crowd was gathering around the aircraft. So he decided to try land it in the car park of a small hotel. He clipped a street light in the crowded space, and it all went to cactus.

The hotel he was trying to land next to was being used as a temporary school, a symptom of the strain the boom had put on public infrastructure around Dublin. Looking at the video footage, it’s incredible nobody was killed.

Years later, the incident is still grotesque for its encapsulation of so many problems with the boom: the excess of taking a helicopter to a meeting; the social failure of having school classes in a hotel.

That accident happened three days after Lehman Brothers filed for bankruptcy.

The GFC followed, and with it the implosion of the Ireland’s banking system, leading to a deep recession that Irish taxpayers will now be paying for over generations to come.

As the country recovers from the trauma, nobody’s taking helicopters to meetings much these days. The fallout from the recession – on people’s pockets, careers, and families – is visible everywhere.

I’d left Ireland six years before that chopper crash and the Lehman Brothers blow-up. It was 2002, when Dublin was fully in the thrall of the boom.

Everyone who wanted a job had one, and wages were rising fast. In some industries, you could walk into your boss’s office asking for a pay rise and they’d know your competitor down the road had an offer matching it.

The incredibly generous tax breaks for overseas companies that invested in Ireland – a corporate tax rate of 12% – had drawn huge technology and pharmaceutical multinationals to Ireland for its educated, English-speaking workforce. GlaxoSmithKline, Pfizer, Intel, Dell – they were all there. If you had a Pentium-powered computer back in the early-2000s there’s a good chance it was made in the plant near Dublin. If you were taking Viagra, its active ingredient had been produced in Cork.

People were flooding into Ireland for work. The boom had taken hold less than a decade after the collapse of the Soviet Union and there was a huge influx of migrants from Eastern Europe. There were Vaclavs and Pavels in farms, front-line service jobs, and on construction sites all over the east coast.

The afternoon paper in the city, the Evening Herald, started printing a section of Polish news every Friday. By some estimates in 2006 there were up to 200,000 Poles in Ireland.

But people were coming from all over the world. Dublin exploded with a new cosmopolitanism. Post-Catholic Ireland was enjoying the party, swapping sackcloth and ashes for martinis and holiday homes in Seville.

This did bring visible signs of strain in the workforce. Comprehension of basic orders in restaurant service was an acknowledged industry problem. After one day being at a working lunch and ordering pizza only to be promptly delivered an ice cream sundae, I decided to look into the problems the hospitality industry was having with a lack of English speaking staff. I ended up doing a story for The Sunday Times about the restaurant industry undertaking a trade mission to Canada to try to recruit people. It really was so bad that Ireland was trying to market itself to Canadian bartenders.

The euro had been introduced in January 1999 and, despite the best efforts of the government to avoid price-gouging, it triggered increases in the cost of everything from GP visits to beer to fashion items. Inflation was running at around 5% in the early 2000s.

There was the arrival of the superpubs: giant entire office buildings in central Dublin converted to multi-level bars charging six euros or more for a pint of Guinness. They were always full from Wednesday night on, and packed to the point of a fire hazard on Fridays and Saturdays. Then came the swanky wine bars where people would drop hundreds of euro on a “little drop they tried on my recent trip to Bordeaux”.

It was madness. Any Irish person who lived through it and watched the crash happen will tell you the country should have seen what was coming.

On top of all, there was the total insanity of the property market.

In the late 90s, house prices were surging. It started to look like a good investment. Soon people in their mid-20s were buying second properties.

Between 1997 and 2005, by The Economist’s estimate, property prices in Ireland rose 192%. By some estimates, over the entire life of the boom, Dublin property prices rose 400%. With the overall economic prosperity and full employment came this simple reality that Ireland needed to import labour. The influx of migrants to the booming country created a seemingly insatiable demand for housing. This made second mortgages a seemingly sensible investment for even young people.

The then-prime minister, Bertie Ahern – who was famous for his mangling of English – memorably said in 2006: “The boom just got boomier”. It was a reflection of what many people thought: the good times would not just keep rolling, but the momentum would continue to build.

But of course, that didn’t happen.

The trouble was, Irish people were borrowing money from Irish banks for property speculation and selling the houses on to other Irish people. And the banks were pretty happy to lend the money. To a certain extent, this pattern required sustained demand from migrants – either Irish people returning home or people from overseas needing to come to Ireland and needing houses. Property developers were buying huge tracts of land and building huge numbers of houses on them, which in turn would be bought as the population continued to expand.

Around 2007 the spectacular rate of economic growth started to slow. House price growth eased off. The eastern expansion of the EU in 2005 to include many of the former Soviet republics had a hand in an important demographic shift: after working abroad for years to support their families, migrants started to return home.

Then the GFC arrived, crushing the global credit markets and leaving Irish banks to answer for all the money they had borrowed offshore to fuel the boom.

Irish banks could get no more money to lend to Irish people to buy Irish houses. The market for all those investment properties dried up quickly. Rental demand, and rental yields, disappeared.

In hindsight, the unwinding of everything looks like a Hindenberg-level economic cataclysm. But the bubble didn’t so much pop as exhale.

The post-GFC collapse of the Irish property market and the nation’s economy was not complicated. People had believed property prices would continue to rally for ever, and had bet on it by borrowing up.

The bets failed.

BOOM TOWNS

Naturally many Irish people – not just expats but also in Ireland itself – are now watching what’s happening in Australia – Sydney in particular – with house prices with some interest.

A mate and I who left Ireland at the same time now joke we were leaving the insanity to move somewhere that people would surely have enough common sense to resist getting caught up in credit-fuelled property and lifestyle bubble. And we chose Sydney.

Much of the conversation has not been light, though, as the property boom has taken hold about the similarities between Ireland during the doomed boom and modern-day Sydney. The outrageous house price rises. The $10 beers. The high cost of doing business, especially in wages.
A range of articles in The Irish Independent, the country’s biggest-selling newspaper, have drawn connections between what’s happening in Sydney and, to a lesser extent, Melbourne, and the warning signs of excess that preceded Ireland turning into a basket case after the GFC.

Here’s an excerpt from one recent story:

Brian Whelan, a Perth-based estate agent, believes the Australian property market is an accident waiting to happen.
Originally from Beaumont, Dublin, Whelan (30), gave up his job as a financial consultant in 2011 and moved to the southern hemisphere with his wife Zarrin.

“The average house price is now AUS$1m in Sydney and Melbourne is also too hot. There are tonnes of apartments on the market in Perth. There are warning signs everywhere,” he said.

“The cost of living is also high while unemployment levels are also growing.

“I predict that the Australian property market will crash next year or in 2017 and I will be ready to buy property when it does,” he added.
Property issues aside, then there’s the commodities market. With Australia at the end of a 24-year growth cycle, some investors believe recession is inevitable given the cyclical nature of economies.

David McWilliams, the economic commentator who coined the phrase “the Celtic Tiger” to describe the Irish boom that gathered in the 1990s, recently examined the threats to Australia’s property market from the apparent slowdown in China. He wrote:

Up to now, most people saw the past 30 years’ economic miracle and concluded that China would find a way again. In recent months that view is being reassessed. This reassessment focuses of countries whose dependence is significant and of course, China’s quarry, Australia comes to mind.

Right now, the Aussie housing market looks to be madly overvalued.

Without commodity wealth, Australia looks like a large leveraged bubble.

But as we know in Ireland, these bubbles can inflate for a long time before they burst…

When it comes to the fallout from housing booms, Aussies would be well advised to heed the wisdom of John Stuart Mill, the 19th century English economist and philosopher, who said of market booms and busts that “the bust doesn’t destroy wealth, it merely reflects the extent to which wealth has already been destroyed by stupid investment decisions taken in the so-called boom”.

When we see average house prices hit one million dollars, we can’t say we weren’t warned.

Tell us what you really think, mate.

Now sure, there are plenty of comparisons to make between Ireland in the mid-2000s and Sydney today. Not even bullish investors believe the kind of price growth in housing we’ve seen can be sustained. When John Fraser, the secretary of the federal Treasury, is prepared to say that Sydney is “unequivocally” experiencing a housing bubble, you can’t say, to borrow from McWilliams, you weren’t warned.

After everything fell in a heap in Ireland, it became clear the banks had engaged in obscene levels of risky lending, especially to those large-scale property developers building huge residential projects. They put enormous liabilities on banks’ books and bankers were confident the money would come back. These lending practices were the cause of the true disaster that will now haunt Irish taxpayers for decades. The bailouts have now cost around €40 billion, or some $A60 billion on current exchange rates.

I should be clear: there is no chance, on the current facts available, that anything similar will happen in Australia. But here are a few themes worth thinking about.

TOO MUCH ECONOMIC EXPOSURE TO HOUSING DEBT AND THE BANKS THAT CARRY IT IS A VERY BAD THING…

Young couples buying second properties in a hot market might be a colourful warning sign that things are getting out of hand, but the real seeds of the crisis were sown by enormous levels of borrowing by developers building houses which, as it would turn out, were not needed. When this was combined with the willingness of banks to lend, and the wilful misrepresentation of the amount of money that the bank had out in loans, catastrophe became inevitable. (The head of Anglo was hiding €87 million in loans from directors and auditors.)

The worst-case scenario for an Australian bank right now is that a severe correction in property prices that will expose, first, some over-eager property speculators and, within a bank, a large pile of risky loans.

… BUT IT LOOKS LIKE AUSTRALIANS ARE GETTING ON TOP OF IT

One of the great uncelebrated achievements of the Australian community since the GFC has been people’s responsibility with money. Household borrowing was a concerning trajectory in the run-up to the GFC but since then, Australians have been doing a very good job of paying off their bills. In the three months to June, household debt in Australia was reduced by $25 billion.

This effect of this is that it is the build-up in the ability of households to withstand future stresses, such as a global economic shock or the eventual, but inevitable, return of interest rate rises in the future. Perhaps part of this is driven by an increasing realisation that the government, with the budget position having crumbled from its mining-boom strength, will not be able to provide as strong a buffer against shocks as it once may have been.

THE EXPOSURE OF THE BANKS TO RESIDENTIAL PROPERTY DEBT IS RIDICULOUS BY GLOBAL STANDARDS…

There are plenty of commentators around the traps – I don’t need to name them, because you can find them easily – who will say there is a bubble in Australian property that’s going to pop, that there’s a huge structural issue with the Australian banks that means the nation will be plunged into recession because of our housing debt.

Now the argument on whether this is the case could go on forever, but this simple chart which shows how much of the Australian banking system’s loans comprise of residential mortgages – and how that compares to other countries around the world – will give anyone pause for thought.

This was not rolled out by some harbinger of doom. It was presented by Wayne Byers, head of the banking regulator, APRA, to a gathering of economists last month.

In his accompanying speech, Byers said: “With such a concentration in a single business line, we are all banking on housing lending remaining ‘as safe as houses’.”

Quite.

… BUT SOMETHING’S BEING DONE ABOUT THAT, TOO

Byers and his team have been crawling all over the loan books of Australian banks for the past year and the results of that exercise are now being seen. The major banks have been cranking up the prices of loans to investors, and they are also drastically reducing the amount of money that people can borrow to buy homes, signalling that money is not going to be easy to come by, despite the historic lows of interest rates.

Some would argue that APRA should have stepped in earlier. The fact that Byers has been so determined and vocal in his rhetoric about the need to contain the banking system’s exposure to property debt is, by itself, a sign that there is probably too much risk in the system.

But at the same time, the activity of the regulator is clearly having an impact. The Australian stock market has had a nasty year but bank stocks have undergone a drastic re-rating as investors reconsider the outlook for bank profitability given the crackdown on housing investment.

This “tap on the brakes” is, in the estimation of some analysts, effectively as good as an increase in interest rates, which will basically take some of the heat out of the property market.

WITH ALL THIS HAPPENING, ATTRACTING PEOPLE TO LIVE IN AUSTRALIA IS VITAL

With this backdrop, sustained demand for residential property is arguably the most important force in this economy. It’s the lifeblood of the banking system, not to mention the retirement plan and investment of choice for millions of families.

If the Irish experience tells you anything, it’s that people being prepared to choose somewhere else to live because of a force beyond your control can be the start of something very difficult.

So the importance of migration intake – and the desire and willingness of people to come live in Australia – becomes clear.

This year, the Reserve Bank of Australia made an adjustment to its economic outlook because data had shown that migration into Australia was not as strong as expected. Here’s the RBA in its Statement on Monetary Policy last month:

Lower population growth has important implications for the economy. It lowers the growth in demand for goods and services, as well as the economy’s capacity to supply those goods and services. On the demand side, lower population growth would, all else being equal, be associated with less growth in consumption. Over time, it may also reduce the need to expand the capital stock through investment in residential housing, non-residential buildings, machinery & equipment and so forth. At the same time, lower population growth implies that there are fewer individuals available to be employed in producing goods and providing services.

So overall, clearly, it’s not a desirable situation.

When we talk about “Australia’s competitiveness”, real policy settings matter, especially tax settings. Having high rates of personal income tax and corporate tax rates can make a difference to people’s decisions to come live and work here.

With taxation reform now high on the political agenda and likely to be a central issue in the next federal election, the debate about these policy settings really should understand that the migration intake is not just about bringing in skills, but about sustaining some pretty important parts of the domestic economy, too.

On the facts available, there is no indication Australia is at risk of going through anything like what happened to Ireland. But there’s no harm in understanding the lessons about debt buildup, speculating, and the importance of risk levels in banking loans that it offers.

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