A credit-less recovery

 

After the financial crisis and the property crash, few would have then predicted that by 2014 the Irish economy would once again be the fastest growing in the euro area. The Economic and Social Research Institute (ESRI) now regards this as likely. In its latest quarterly commentary, the institute has forecast strong growth (over 3.5 per cent of GNP) this year and for 2015. Both predictions are well ahead of the Government’s more conservative estimates. Certainly, the pace and strength of the recovery has taken many by surprise. However, it is marked by one worrying feature: strong growth has occurred despite a lack of credit. The ESRI describes it as a “credit-less recovery”. And that raises concerns about its sustainability.

Nowhere is the credit shortage more apparent than in housing. Banks are both reluctant to provide mortgage finance for house buyers, and unwilling to extend sufficient credit to developers for house building. Instead the big banks, which will soon face stress tests set by the European Central Bank, have been bolstering rather than risking capital, as they repair balance sheets. The result is a weak housing market, largely confined to cash buyers, where little new construction has begun. Tom Parlon, chairman of the Construction Industry Federation, estimates only 2,000 homes will be built in Dublin this year. As demand has exceeded limited supply, house prices have soared in Dublin, rising by 16 per cent in 2013 – almost three times the national rate.

House prices have, from peak to trough, declined by more than half. The recovery now under way, as the ESRI points out in a detailed analysis of the Irish housing market over three decades, does not – as yet – constitute a property bubble. The ESRI estimates that house prices, nationally, are between 12 and 27 per cent below real value, but are less undervalued in Dublin. In the capital, strong demand and limited supply have boosted prices. In the past, too little attention was paid to independent analysis of property prices by professional research bodies. In 2005, when the OECD indicated that average house prices were then up to 20 per cent overvalued, its warning was ignored.

Price excesses, whether in property or financial markets, are rarely recognised and checked in time. For now, a property bubble is clearly not a threat. Of greater concern is the imbalance between supply and demand in the housing market. For this, unless rectified, could serve to inflate house prices and erode some of the competitive advantage the economy has gained in recent years. The ESRI estimates that 15,000 houses will be built next year when 25,000 will be needed. That gap must be closed. And the banks, after the stress tests, should be best placed to so, and willing to extend adequate credit to the housing market.

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