Analysis: Honohan anxious to avoid past mistakes

It is unlikely that the current state of the Irish economy is giving the Governor of the Central Bank Patrick Honohan too many sleepless nights - he has seen much worse after all - but if anything was to trouble him it seems likely it would be the state of the property market particularly in Dublin.

House prices in Dublin have jumped by well over 20 per cent over the last year as desperate buyers have queued up to buy the precious few properties to be had. According to one set of figures published recently, home owners in Dublin saw the value of their properties increase by € 220 every single day between March and June.

The cause of the spike in prices is easy to identify. There is a chronic shortage of new properties, particularly in the Dublin area. Last year 8,300 new houses were built across the State when three times that number would ordinarily be built to meet demand.

While few people would not welcome a recovery in the property market, price increases of this magnitude have sparked understandable fears that another bubble is inflating so soon after the last cataclysmic one popped.

The banks are still very careful about who they are lending to – and carry out the most forensic of assessments before they will agree to a mortgage – but the problem is as the market heats up their prudence is likely to be relaxed. In recent weeks there have been reports of banks agreeing to lend four times a would-be borrower’s salary - and this at a time when interest rates are at historic lows. The loan-to-value ratios in some institutions are also creeping above the 90 per cent threshold that was once considered prudent.

"Given how badly banks misjudged risk-management in the post-millennial boom in Ireland, it is hard to deny that having a rule constraining loan-to-value and loan-to-income could avoid the re-emergence of this kind of problem in the future," Mr Honohan said last night.

“Even in the absence of a credit-driven bubble, there is much to be said for bringing back some overall rules of this type, limiting the share of their mortgage lending that is at high loan-to-value and loan-to-income rates, especially now that the property market has stopped falling and has indeed turned around with a bit of a bang in Dublin.”

He is probably right. Putting the brakes on rising prices will be unpopular and restricting the banks’ lending practices will mean that some people will struggle to buy their first home.

If the Central Bank imposes a rule stating that banks can not lend more than 80 per cent of the value of a home, then the would-be borrower will need savings of € 60,000 to buy a € 300,000 home.

If banks are only permitted to lend three times a combined household income than a dual income house earning the average industrial wage would only be able to borrow € 210,000 – which would not get them much in most parts of Dublin.

Nevertheless the Central Bank must do something. Increased credit will lead to a bubble and the one thing that Mr Honohan is anxious to avoid will be future accusations that the Central Bank under his watch sat on its hands and watched as another bubble inflated. The bank has already made that mistake once before and we will be paying for it for more than one generation.