Property Investor

Welcome back to the good old days, when loans were only given to those who didn't need them and getting a mortgage depended on who you knew, writes JACK FAGAN

WITH no end in sight to the banking crisis, and the property market on the floor, it seems odd that no one has suggested that we need to return to the wholesome, old-fashioned banking practices of the past. After all, it was our departure from the tried and tested banking procedures of the 1960s and 1970s that landed us in deep trouble.

The basis of old-fashioned banking, particularly where property was concerned, was the acceptance of deposits by building societies, which then lent out to would-be home buyers at a higher interest rate than they paid their depositors. Thus the volume of savings in a bank restricted the amount it could lend. This led to banks increasing saving rates in the hope of generating extra investment finance – a tactic of prime concern to policy makers in the mid-20th century as it inhibited consumption, without which there was nothing in which to invest.

Two major factors affecting mortgages in the last 20 years have been the decision to join the euro and the securitisation of mortgages. The first meant that our interest rates were no longer linked to sterling (effectively the sterling rate plus an added per cent or two). Instead they began to drift towards the deutschmark rates which formed the basis of the euro.

Securitisation of mortgages meant lenders could sell on their existing mortgages to other investors and, effectively, re-lend the same money again to property buyers. The result was, as we all know now, a huge credit bubble. It became easy to borrow. Property prices were pushed up through increased affordability because of lower interest rates and more competition between lenders. The whole machine clanked to a stop when one small cog – the sub-prime mortgages in securitised packages – snapped.

In the chaos that followed, banks stopped lending to each other: nobody knew who was a good or a bad risk anymore because of what might be hidden in their supposed assets. The flow of available funds stopped, banks stopped lending, the property market – always dependent on lending – crashed, and the banks found themselves with billions in toxic loans lent on the strength of property nobody wanted.

A common response has been to bemoan the sequence of events which led to this and, rightly, to blame those – including the regulators – who allowed it to happen.

In doing so, however, it is useful to remember what old-fashioned banking actually means in the Irish context. Essentially, it means lending to those who do not really need it – the rich, the secure and comfortable. It is no wonder that one of the old definitions of a banker is one who will give you an umbrella when the sun is shining and demand it back when it rains. In other words, you can borrow easily if you can back up the loans with deposits or other acceptable assets, but not if you present a marginal credit risk. And those who are a marginal credit risk now probably include the vast majority of the population.

In the past, policy makers had two common complaints: that interest rates in Ireland were too high (because they were always above the frequently high sterling rate) and that there was no real competition between banks to narrow their margins, bring down lending rates and encourage more lending generally.

The interest rate issue was solved by entering the euro in the early 1990s. Attempts to address the competition problem in the early 1990s included much talk about a “third banking force” which was never created. Instead, the boom triggered more competition with the arrival of foreign lenders, notably Bank of Scotland, offering new products including 100 per cent mortgages and cheaper rates.

It all went too far, of course. We are now back to talking, sporadically, about a “third banking force”, as the old banking cartel is once again in place.

What reason is there to assume that the resulting situation will be different to that which pertained in the past, when mortgages were difficult to obtain – frequently a matter of grace and favour, and dependent on who you knew? Welcome back to the old-fashioned banking values.