It has been calculated that over the very long term house prices perform marginally better than inflation, somewhere up to 1% per annum better. The two main analyses that have been done to reach this conclusion are Robert Schiller’s analysis of the US housing market in the twentieth century and the analysis of the housing market in Amsterdam dating back to the seventeenth century (The Herengracht index).

If your house goes up markedly in price, above the rate of core inflation, it is going to come back down in price. This will either take place through higher core inflation than house price increases for a number of years or a decline in house prices. Declines can be of long duration, like the Japanese ‘lost decade’ (which is into it’s eighteenth year!) or short and sharp like the crash in Sweden in the 1990s.
What will happen, though, is that prices will reach a level. That level depends on a number of factors:

• The availability of credit
• Affordability
• Change in the number of purchasers

The availability of credit
Prices can be increased by easy money policies from central banks where the general level purchasers indebtedness is low. The housing market in Ireland was cooling in 2001 when the US Federal Reserve and the ECB in turn lowered interest rates to below core inflation rate. This made credit cheap and encouraged a credit-fuelled spending binge.

Affordability
It makes no sense in Ireland that our parents could afford to buy a house on one income, where the price of that house was only three or four times the income, but we cannot. Price levels in Dublin reached ten times income in 2006 and are still far above levels that prevailed as recently as 1998 (a time when the country could not be said to have been poor).
Simply put, you cannot afford to buy a house if you have to:

• Lie about your income, bonuses, commission, saving ability or debts.
• Borrow a deposit, either as an extra from the bank or from a credit union.
• Get a parent to go guarantor.
• Buy with a friend that you are not in a long-term relationship with.
• Take out a loan to furnish the property or kit-out on credit.
• Rent a room to a stranger.
• Take out a 100% mortgage.

Change in the number of purchasers
It is often said that Ireland ‘needs’ to build 60,000 properties a year to cope with the natural increase in demand through growth in the indigenous population and immigration. This is based on the experience of the last few years, a time when the construction industry was a huge chunk of the economy and the majority of immigration was to satisfy construction demands for workers. 90,000 houses were built in 2006 as a result.

If we are not building that many houses, we do not need that many workers. If we don’t have that many workers we don’t need to build as many houses.  The vicious cycle of building to house builders that drove us to to 90,000 completions a year, is now in full reverse.  Housing completions dropped below 30,000 in 2009 and are expected to be less than 10,000 in 2010.  Immigration has turned to emigration.

Immigrants leaving and returning home doesn’t directly reduce the number of purchasers.  Immigrants in general tend to rent.  However the massive drop in demand for rental accommodation feeds through into rental properties being offered for sale, or being offered at lower rents as landlords try to undercut the market to get tenants.

The simple point is that at the peak of the boom Ireland had too many houses, and too few people to live in them.  Since then we have built more houses and lost people. 

Booms and Busts

To some extend, booms and busts are inevitable.  The notion of a perpetually growing economy, steadily adding jobs and improving quality of life is a myth.  That doesn’t stop politicians promising such an economy.  It also doesn’t stop politicians who happen to string together a few years for growth from claiming that they have achieved the dream.  Phrases like “New Paradigm” or “This time it’s different” will litter the media.  Every boom from perhaps the second one onwards has been greeted with promises that “This time it’s different”.

At best a government which behaves prudently and wisely can smooth out some of the ups and downs.  It can prevent an economy from reaching the extreme highs and lows that we have and are witnessing in Ireland.  The primary reason why Ireland has seen such incredible extremes is that the last couple of government have done the exact opposite of the correct course of action.

The correct approach to managing an economy is to hold back when the economy is growing.  This controls the growth, slowing it’s climb so unsustainable levels.  As the economy grows it will produce a windfall for the government.  Taxes will increase as more jobs are created, and one of taxes such as those house and car sales will increase rapidly.  At the same time unemployment will fall reducing the spending burden.

When this happens a government needs to make a decision about what to do with the windfall.  One approach is called a counter cyclical fiscal policy which in short means that when the money is pouring in we hold back perhaps even cutting certain types of spending, in an attempt to control the growth.  The benefit of this is that when the inevitable turn occurs in the economy (a turn will come no matter what we do), the windfall money that we put aside during the boom can be used to stimulate the economy.

By working against the natural cycle of the economy we seek to prevent the extreme highs, and subsequent catastrophic lows.

Fianna Fail, particularly during Charlie McCreevy’s tenure as minister for finance took the opposite approach to the counter cyclical policy.  McCreevy even summed up his approach to managing the economy when he said “when I have money I’ll spend it, when I don’t I won’t”.

We need as a nation to understand why the property bubble reached such spectacular heights, and more importantly why when the boom ended the bust was so deep and so damaging.

The economic crisis didn’t “Just happen” as Dermot Ahern claimed in February 2009.  The economic crisis wasn’t “unforeseen, unpredictable or caused by external factors”.  The extreme highs could only have been achieved through the feeding of the boom by the last three governments.  Our massive deficit and mushrooming national debt was caused by massive spending increases which both fed the boom and left us without the resources the stimulate the economy. 

We are where we are

One of the common responses by governments when they make huge mistakes is to say “We are where we are, there’s no point trying to see what caused this”.  In fact our current Taoiseach and one time minister for finance said precisely that.

There is of course a need to find out what caused this.  If we don’t learn from our mistakes we are doomed to repeat them.  Fianna Fail seems to be repeating it’s mistakes about every 20 to 30 years.  They didn’t learn from their mistakes of the late 70’s and the 80’s, and those have been repeated and surpassed in spectacular fashion.

It’s easy to be critical of Fianna Fail for failing to learn from history, however the voters are hardly innocent.  Following the disaster of the 19977 election, and the lost decade that followed, the voters have voted Fianna Fail back into government for all but 2 years since 1987.