Burst housing bubble may mean slow recovery for wider economy - report


HOUSE PRICES have fallen to levels approaching their real value, but the wider economy could face a long, drawn-out recovery due to the bursting of the housing bubble.

These are the key findings of a new European Commission staff report which implicitly criticises the Government for creating a tax system that stoked price increases.

"At the end of 2007, the real prices of secondhand houses had returned to levels that may be explained by the fundamentals, while those of new houses were still overpriced by about 7 per cent in real terms," says the report, which notes there has been an 18 per cent drop in real house prices - adjusted for inflation - since the peak of the boom in 2006.

Ireland's Housing Market: Bubble Troublesays house prices rose by a cumulative 300 per cent in real terms between 1992 and 2006. The unprecedented boom in prices was fuelled by particularly strong housing demand caused by a relatively young and growing population, rapid growth in disposable income and low - at times negligible - interest rates.

It says the tax structure in the Republic played a role in fuelling the housing bubble by creating favourable tax treatment of residential property and house purchases for investment purposes.

"Households are allowed a tax deduction on mortgage interest payments, while there is no tax on property values or imputed rent and only limited taxation of capital gains on residential property . . . Generous tax provisions may have encouraged the spiral in houses prices," says the report, which concludes that the Irish tax structure is one of the most favourable to encourage home ownership across the EU.

Household indebtedness in Ireland, 81 per cent of gross domestic product, is among the highest in the euro area and about 80 per cent of personal credit is secured on property, says the report, which notes speculation in the buy-to-let market also helped fuel the boom.

The report says the collapse of the housing market is acting as a drag on the wider economy and the public finances at a time when exports are also being hit by deteriorating competitiveness and a slowdown in the US and Britain.

It warns that it is too early to tell whether the Irish economy can recover to its previous high levels of growth.

"It remains to be seen whether past structural reforms can help bring about a rapid return to the medium-term growth, or whether the recovery will be more drawn-out, similar to the experience of many industrialised countries that have undergone housing busts in the past 30 years," concludes the report.

It was prepared by Janis Malzubris, an EU official working at the commission's economic and financial affairs directorate.

The report is one of a series of economic staff reports undertaken by commission officials at their own initiative, which means the views expressed by the author do not necessarily correspond to those of the commission.

The reports are considered valuable for providing an insight into particular issues affecting the economies of EU states.