There has been much favourable comment on the entry of Bank of Scotland into the mortgage market, competing on price for the benefit of consumers.
Bank of Scotland says it has £200 million (€254 million) in loan approvals so far. By June 30th this year, mortgage loans made to Irish residents by Irish banks and building societies totalled £20.5 billion, according to Central Bank statistics. Bank of Scotland's new mortgage approvals represent about 1 per cent of mortgage lending before it entered the market. The pricing of this 1 per cent has affected a lot more than its own slice of the market.
More importantly, Bank of Scotland's actions represent a very public judgment that the Irish property market is not a bubble or even a potential bubble. The welcome extended to Bank of Scotland should also be a welcome for betting some part of its capital on this view.
By their actions, neither Bank of Scotland nor any of the other Irish mortgage lenders seem to agree with the Central Bank's comment in its Autumn Bulletin that "there remains a real danger of overshooting and the emergence of an asset price bubble". The ESRI, too, is worried about a "potential bubble" in the house market. The economist and consultant, David McWilliams, has written passionately a number of times about a coming apocalypse for Ireland and its house prices, and has had two episodes of RTE's The Open Mind devoted to his thoughts.
Bernard Connolly, the former EU official who penned a "J'Accuse" style book about the single currency project, sounded similar dire warnings in the Sun- day Business Post. Contrarian views are important, but they should be well grounded.
By using the term "bubble", economists are not alone misapplying a metaphor, they are also appealing to memories and myth about speculative investment bubbles of history.
The Irish property market is nothing like a real speculative bubble. It is not even like the UK property market in the late 1980s. The rate of increase in house prices is now slowing. According to Irish Life and Permanent, prices increased by 12.8 per cent in the first nine months of this year, compared to 23.2 per cent in the same period last year.
Follow the money trail. Another indicator is Irish Life and Permanent's recent repackaging and sale of £473 million of its mortgage loans. In this process, called securitisation, investors buy bonds issued by a special purpose company to which the mortgage assets are transferred. The mortgage payments as a whole pay for the principal and interest on the bonds. The bonds are rated for credit risk by international rating agencies. Now if the Irish market were seriously judged to be bubbly, these bonds would be very difficult to sell. Rating agencies would give them poor ratings. Most of the bonds issued by Irish Life & Permanent received a top AAA rating.
This cannot be done unless the credit risk is acceptably low or, if not, someone insures the bonds to a high level. If the Irish market were dicey, then the insurance premium would have made the transaction uncommercial.
The rating agency, Fitch IBCA, recently developed a special model for these type of transactions in Irish mortgages, and it sounded no alarm bells about the conditions of the Irish market. Fitch IBCA noted the fall-off in house purchases for investment, following the implementation of the Bacon Report's recommendations on removing tax deductibility of mortgage interest for investment purchases.
The model assumed in a deliberately conservative way that a substantial proportion of the gains in market value in Dublin prices from 1996 to 1998 would be lost in possible distress scenarios. Dublin, it was assumed, could lose 49 per cent of value, Cork 35 per cent and Limerick 27 per cent.
The Fitch IBCA model distinguishes between regions, types of houses, investment properties and first mortgages, among other factors, in calculating the severity of any loss of market value and the probabilities of default.
A key conclusion from the Fitch IBCA model is that it is entirely possible to issue triple-A bonds from Irish mortgages.
Of course, bookies can lose and so can banks. Investors and bankers can run in herds foolishly and often have. But it is hard to find anyone betting any capital on a sudden bursting of the putative property bubble. Someone recently asked me if I won the Lotto, would I invest the money in residential property? I hesitated, mainly because I haven't much practice at investing. But I know for sure that I don't want to sell up what property I do have, put the proceeds in the Post Office, rent a house, and buy back cheap when the bubble bursts. I challenge any bubble theorist to do so.
Oliver O'Connor is editor of Finance magazine; e-mail: ooconnor@irish-times.ie
