A wealth of confidence threw the country completely off balance
ANALYSIS: Ireland is in a balance sheet recession of the worst kind, pumped by optimism that crashed to pessimism
IRELAND IS in what economists call a balance-sheet recession. Such recessions tend to be the longest and deepest kind.
Because the balance sheet of Ireland Inc ballooned so spectacularly in the years up to 2007, and its asset side has since crashed so violently, the recession being experienced is severe even by the standards of balance-sheet recessions elsewhere, now or in the past.
At the root of it all is property. Huge amounts were borrowed to invest in property.
As long as property prices continued to rise, it all looked perfectly manageable. Indeed, as the growth in the number and value of properties raced ahead, the asset side of balance sheets expanded more rapidly than the liabilities side.
That meant that wealth in the economy grew, and it did so at a more rapid pace even than income, as measured by gross domestic product.
This all became self-reinforcing. As people felt richer they spent and borrowed more – a phenomenon know as the “wealth effect”.
But once the bubble burst and property prices began falling, the asset side of balance sheets began to contract.
That triggered a process whereby the self-reinforcing boom became self-reinforcing recession.
One reason why balance sheet recessions tend to be so long is because the wealth effect turns negative.
As people, including those whose incomes have not been affected by recession, see their net worth declining they react by reining in spending.
Irish households’ net worth (assets minus liabilities) continued to fall in the first quarter of this year. This is overwhelmingly because of property.
When economists and statisticians at the Central Bank tot up the value of every property owned by every household in Ireland, they arrive at a figure of €328 billion.
That, to give some context, is equivalent to more than twice the wealth created in the economy each year as measured by GDP.
And while this is an enormous figure, it is down from more than €600 billion in 2007, and back to 2003 levels.
Household debt levels have declined, but total liabilities are still at 2007 levels, not 2003 levels, when they stood at just €184 billion. Reducing household debt to manageable levels will take many more years.
If household deleveraging will go on into the foreseeable future, at least a start has been made. The Government, by contrast, is still leveraging up.
The Government has a ballooning balance sheet. Despite all the budgetary consolidation measures imposed to date, its gross and net liabilities positions continue to worsen.