21/11/2011: Residential Property Prices: October

Sorry to break the bad news, folks, but the latest Residential Property Price Index (RPPI) for October is showing accelerating property prices declines on foot of already substantial rates of contraction registered during 2011 as a whole. the bust is getting bustier.

All properties index fell to 71.2 in october from 72.8 in September, posting a monthly decline of 2.20%. This is the sharpest rate of monthly contraction in prices since March 2009 and the third fastest rate of decline in the history of the series! 3moMA for RPPI is now at 72.63. Year on year prices are now down 15.14% - the highest yoy decline since February 2010. Relative to peak prices are down 45.44%. 12 mo MA is at -1.36% for mom rate of decline and year-to-date rate of prices declines average -1.49%.

When it comes to Nama, relative to its cut-off date of November 30, 2009, property prices are now down 24.17%. When fully set up, Nama called bottoming out of the markets for Q1 2010. Since then, prices are down 20.62%, so those highly paid geniuses employed by Nama to 'value' properties and 'assess' markets are really shining stars. Recall that Nama paid an uplift of LTEV on assets purchased of an average 10%, plus carries a burden-sharing discount / cushion. Factoring these two into the equation, Nama-assessed properties are now held at a loss of 27.79% on their Nama valuations, even with burden sharing cushion 'savings' factored in. Taken across Nama book value, these (for now paper) losses can be assessed at ca €8.3bn.

Let's drill deeper. House prices sub-index is now at 74.3 against 76.0 in September, a decline mom of -2.24% the largest monthly drop since June 2011. 3moMA now stands at 75.77 and year on year change in the sub-index is 14.89% - the steepest annual decline rate since February 2010. relative to peak house prices sub-index is now -43.71% off. 

Apartments prices sub-index fell from 53.2 in September to 52.2 in October, a mom drop of 1.88% shallower than September mom decline of 3.10%. 3moMA is now at 53.43 and year on year sub-index is down 19.81% - the steepest annual decline since April 2010. Relative to peak, apartments prices are now off 57.87%.

Recalling that Nama holds loads of assets written against apartments, Nama cut-off-date valuations, LTEVs and burden sharing cushion included, Nama valuations for apartments-related properties are now off 35.10%.

Chart above shows the price dynamics for Dublin properties. Dublin sub-index stands at 63.1 against September reading of 65.1, a mom decline of 3.07% - steepest since the catastrophic drop of 3.76% in August this year. 3mo MA is now at 64.9 and year on year prices in Dublin are down 17.52% - largest yearly decline since March 2010. Relative to peak, Dublin residential prices are down 53.09%.

Given the above, we can update projections for the core index and sub-indices for 2011 as a whole. These are shown below.

Depressing is the word that comes to mind. The picture is made even less palatable when we recall incessant blabber from our Government reps and stuff-brokers, as well as property 'experts' that inundated the earlier parts of the year with 'property prices will bottom out in H2 2011' noise.

25/10/2011: Residential property prices: September

According to CSO Residential Property Prices index, September 2007 saw the historical peak in prices for overall RPPI at 130.5. Today's data shows that the index now stands at 72.8, implying that property prices have fallen nationwide by 44.2% on average since 4 years ago. Miserable news.

Now, September RPPI for all properties has fallen 1.49% mom and 14.25% yoy, exceeding (in terms of fall) analysts expectations for 13.4% decline. 12mo MA of monthly declines now stands at 1.27% and year-to-date average monthly decline is at 1.41%.

Relative to Nama's cut-off valuation date of November 30, 2009, factoring in average LTEV uplift of 10%, Nama residential properties-linked assets portfolio is now on average 29.52% under water. Factoring 5% burden-sharing (subordinated bonds), the downside is now 26.2% which means that Nama will need a lift-up of 35% on current values to break even.

For Houses, nationwide, RPPI fell to 76 in September from 77 in August a decline of 1.3% mom and 13.93% yoy. The index is now down 42.4% on peak of 132 achieved in September 2007. Apartments sub-index is down to 53.2 in September from 54.9 in August, with mom contraction of 3.1% - the sharpest monthly decline since March. Yoy the sub-index is down 19.03% and relative to the peak of 123.9 (February 2007) the sub-index is down 57.06%.

Nama holds loads of apartments, so applying the earlier assumptions on LTEV, Nama apartments-linked sub-portfolio is under water 36.9%, implying, net of subordinated bonds, a 33.9% decline in valuations to November 2009 cut-off date. This suggests an average required uplift in apartments prices of 55.12% for break-even.

Dublin properties prices are now 51.6% off their peak, with sub-index for Dublin declining to 65.1 in September from 66.5 in August - a drop of 2.11% mom and 15.56% yoy.

Annual forecasts, updated to include September figures, are below

26/09/2011: Irish property prices hit Early Paleozoic layer

Another month, another "Splat, Zap, Squish!" from the Amazing Property Bust Land, Ireland. CSO's RPPI data out for August today is showing continued falls in property markets and accelerating on the July 'performance'. Here are the updated charts and numbers.

Headlines are not pretty, folks:

• RPPI down 13.87% annually in August against a fall of 12.47% in July index now stands at 73.9 down from 85.8 in August last year.
  
• In 12mo through August the decline was 10.8%.
• Mom prices are down 1.6% in August. 3mo MA is at 74.9 down from 76.0 in July.
• Relative to peak, prices are now down 43.4%
• Relative to Nama valuations cut-off date of Nov 30, 2009, prices are down 21.3%. Adding LTEV uplift applied by Nama to purchased loans, state-held residential portoflio is now down in values some 28.5%.
  

Headlines on property prices by type are even less pretty:

• RPPI for houses is at 77.0 in August, down 1.41% on 78.1 reading in July. 3moMA is now 77.9, down from 79.0 in July. Year on year prices are down 13.58% from index reading of 89.1 in August 2010. Relative to peak prices are down 41.7% (September 2007). This is the steepest rate of decline since March 2011.
  
• RPPI for apartments is at 54.9, down 4.7% on July reading of 57.6. August 2010 reading was 67.2, so we are now 18.3% down yoy. 3moMA is now at 57.3, down from 59.0 in July. Monthly rate of declines is now accelerating for the 3rd month in a row. August rate of decline is the steepest monthly decline in the history of the series. Relative to peak (February 2007), apartments prices are now down 55.69%.
  

Geographical distribution of price changes:

• Dublin residential property prices fell by 3.76% in August and were 14.85% lower than a year ago. Dublin house prices decreased by 3.4% in the month and were 14.7% lower compared to a year earlier. Dublin apartment prices fell by 6% in the month of August and were 17.4% lower when compared with the same month of 2010. 3mo MA for Dublin properties is now at 68.23, down from 69.7 in July. Relative to peak (February 2007) Dublin prices are down 50.56%. House prices in Dublin are 48% lower than at their highest level in early 2007. Apartments in Dublin are now 57% lower than they were in February 2007.
• The price of residential properties in the Rest of Ireland (ex-Dublin) fell 0.3% in August compared with an increase of 0.2% recorded in August 2010. Prices were 13.2% lower than in August 2010. The fall in the price of residential properties in the Rest of Ireland relative to peak is at 40%.

My forecast for the annual results is below. In summary - we've gone from the penthouse to the ground floor, through the parking levels and still going - services levels, sewer, imaginary metro tunnel.... next "Splat" is due at around middle Paleozoic layer... see you in October's Early Mammals exhibit...

29/08/2011: Residential Property Price Index: July 2011

Residential Property Price Index for Ireland for July 2011 was released earlier today by the CSO, showing continued deterioration in property prices across the board.

Per CSO: "In the year to July, residential property prices at a national level, fell by 12.5%. This
compares with an annual rate of decline of 12.9% in June and a decline of 12% recorded in the twelve months to July 2010." Chart below illustrates:
Residential property prices fell by 0.8% in the month of July. This compares with a
decline of 2.1% recorded in June and a decline of 1.3% in July of last year. To give a bit more granularity to the data:

• RPPRI now stands at 75.1, down from 75.7 in June, and 3mo MA is 76.03, against June 3mo MA of 77.07.
  
• Relative to peak property prices have no declined 42.45% against June to-peak decline of 42%.
  

Using 7 months of 2011 data, we can forecast expected declines in the index for 2011 as a whole:
Please note: this is a crude forecast. The result suggests that prices can decline to 75.3% of 2005 levels by the end of 2011 for all properties, with corresponding declines in House prices to 78.41%, Apartments to 57.47% and Dublin prices declining to 69.02%.

Let us make another set of important calculations. Recall that section 73 of the NAMA Act 2009 established the definition of the cut-off date for NAMA valuations. This date was later set at 30 November 2009. NAMA then applied an LTEV uplift on properties valued to that date. According to NAMA own business projections, the agency will require 10% increase in property values referenced to LTEV and November 30th 2009 cut-0ff-date to break even. In addition, NAMA claimed that its valuations are based on the consulting report they received from London Economics that timed property markets bottoming out to the latest Q1 2010.

Well, since the cut-off date, Irish residential property has now fallen a whooping 20.02% and relative to the end of Q1 2010, when NAMA expected the bottoming of the property cycle, the property values are down 16.28%. Ooops...

Back to the data:

• Index for House prices stood at 78.1 in July, down from 78.6 in June (-0.64% mom) and down 12.25% yoy
• House prices 3mo average index is now 79.03, down from 80.1 a month ago.
• House prices are down 40.83% to peak
• Apartments continued falling at precipitous rates, with Price Index for Apartments down to 57.6 in July from 59.4 in June. A decline of 3.03% mom and 15.67% yoy.
  
• Apartments prices 3mo MA is now at 59, down from 59.93 in June.
• Apartments prices are down 52.59% to the peak.
  

Having posted a bizarre increase from 70.5 in April to 70.8 in May, Dublin prices have fallen off the small cliff in June settling at the index reading of 69.1. July data shows Dublin prices flat at 69.1. This means that 3mo MA is now at 69.67, down from 70.13 in June. Relative to peak, prices in Dublin are down 48.62%. Year on year, July Dublin prices are down 11.86%, an improvement on annualized rate of decline of 12.64% in June, but worse than yoy change attained in May (-11.5%).

22/06/11: Residential Property Index - May 2011

The CSO released their latest data for the new Residential Property Price Index (RPPI) for May 2011. Here are the highlights and updates, including forecast for 2011 (see last chart).

• Year on year May 2011 residential property prices nationally are down 12.16% with RPPI standing at 77.3 in May down from 78.2 in April. The 6mo average rate of decline is now at 1.2% per month and 12mo average rate of decline is now 1.07% monthly.
• Relative to peak prices across the nation are down 40.77%.
• 3mo MA RPPI is at 78.17 in may, down from 79.2 in April.
• RPPI is now down consecutively month on month since its peak in September 2007 with exception for August 2010 when it posted no change mom relative to July. Last time the index posted increase in yoy terms was January 2008.
  

So per chart above, the crunch is getting crunchier (note accelerated average rate of decline for 6mo relative to the average for 12mo), and mom changes are also posting acceleration downward from -1.01% in April to -1.15% in May.

Breaking down across two property types:

• RPPI for houses fell to 80.4 in May from 81.3 in April, down 1.11% mom. This marks consecutive monthly contraction since August 2010 when it rose statistically insignificant 0.11%. Relative to peak the series now down 39.1%. the 6mo average monthly rate of decline is 1.21% well ahead of 12mo average of 1.03%
• RPPI for apartments is down at 60 in may from 60.4 in April (-0.66%). Apartments prices index is down 51.57% on peak and 6mo average at -1.19% per month is signaling slower rate of decline compared to 12mo average of 1.41%

As a signal of stronger regional economy, Dublin presents a slightly divergent picture to May national level data:

• Dublin RPPI rose from 70.5 in April to 70.8 in May (+0.43%mom), marking the first monthly increase since April 2008. This increase is statistically insignificant, however. In addition, 6mo average decrease rate of 1.06% monthly is still ahead of 12mo average of 1.01%, suggesting the latest move is unlikely to be a trend-breaker to the upside.
• Dublin prices index is now 47.4% below the peak.

Now, using 5 months data for 2011 we can attempt a very crude forecast for the entire 2011, as shown in the figure below.
So far, all indications are - we are looking at another brutal year when it comes to property prices here. then, again, with zombie banks not lending and continuously hiking the cost of mortgages for existent clients, with Nama still hell-bent on derailing any sort of market bottoming-out dynamic, with all fundamentals signalling decreasing demand for property and reduced ability to pay for mortgages, it is hard to imagine the upside trend establishing in Irish property markets any time soon.

07/06/2011: Residential property prices

An impressively decent dataset from CSO on residential property prices has been released for the second monthly installment, so here are the charts and some high level analysis.

• Overall Residential Property Price Index (RPPI) for April was 78.2 or 0.8 points below March levels. Hence, mom the index has fallen 1.013% and is now 1 point below its 3mo MA. Year on year the index has fallen 12.233% and relative to peak of 130.5 reached in September 2007 it is now down 40.077%.
• Overall RPPI has recorded its 8th month of consecutive declines having risen statistically and economically insignificant 0.11%mom in August 2010. Year on year, April marked 38th consecutive month of declines.
  
• April index for houses fell 0.9 points to 81.3, down 1.095% mom, or 1 point below 3mo MA. Year on year index has fallen 12.013%. The peak for this sub-index was reached in September 2007 at 132.0.
• April index for apartments fell to 60.4, down 0.6 points - a mom decline of 0.984% and a yoy decline of 15.288%. April reading was 1.233 points below 3mo MA. This sub-index peaked at 123.9 in February 2007.
• Dublin properties sub-index has fallen 0.5 points in April to 70.5, a decline of 0.704%mom or 12.963% yoy. The sub-index now stands 0.77 points below 3mo MA and 47.584% below the peak of 134.5 in February 2007

Charts to illustrate:
To summarize - the deflation of house prices continues, although the monthly rate of decline has now fallen below both 6mo and 12mo average. This, however, might be due to seasonality, since April marks a relatively moderate month in terms of price movements in every year since 2008. house prices have now fallen 38.41% since their peak, while apartments prices have declined 51.25% from their peak.

It is worth noting - not as a criticism of the CSO, since it cannot do anything about the data - that the index is computed based on mortgages drawdowns, hence excluding any share of transactions that might take place on the 'gray market' (tax evading payments, swaps etc), as well as cash-only purchases and mortgages issued by lenders other than the 8 largest lending institutions from which the data is available.

Another issue, again - little that CSO can do for this - relates to hedonic adjustments undertaken in index computation. Hedonic characteristics used by CSO exclude a number of relevant parameters, such as number of bathrooms and the site size, as well as existence of garage and/or off-street parking. This, alongside with the tendency - due to planning permissions restrictions - to under-report actual floor area and number of bedrooms - means that the hedonic model might be relatively weak.

Finally, CSO employes a Laspeyers-type indexation method, which is "calculated by updating the previous month’s weights by the estimated monthly changes in their average prices". However, like all types of indices, Laspeyers indices suffer from some specific drawbacks. In particular, these indices are weaker in periods of adjustment in the markets. Here's a quick non-technical discussion:

Laspeyers index is designed to answer the question: "How much is the sales price today for the house that is of the same quality as in the base year (2005)?" Quality is compared using the hedonic model mentioned above, based on specific size of the house (floor area), its amenities (number of bedrooms, house type) and location (note - we do not know the granularity of such 'location' adjustment, which can be critical. For example, I live in Dublin 4, but not the "fashionable" part of it. This means that if location code used is D4 for my house, it will receive signficantly higher locational weight relative to true value of my location than a house in a "fashionable" D4 locale.

One key objection to Laspeyers index is that it is computed while assuming that the base year (2005) house remains unchanged over time. Hence, quality is assumed to be constant for referencing, implying the index over-states inflation and under-states deflation.

In addition, index does not capture the effects of substitution in housing. In other words, Laspeyers index does not reflect conversions of house features to substitute away from more expensive options, etc, or purchases shifting in favour of smaller properties.

Index also assumes that geographical distribution of house sales does not change over time - a feature that introduces significant biases into the index when locational markets are not uniform (when there are significant differences within the markets).

Finally, the index overstates price appreciation at the peak of the bubble, since at that point, less desirable properties were disproportionately represented in the market as buyers chased any home available for sale. This is known on the basis of the US data where at the top of the markets 'gentrification' of lower quality locations in many states has led to Laspeyers indices understating price inflation.

For thes reasons, Laspeyers indices are known as 'constant quality' indices.

Chain-linked indexation, employed by CSO, helps addressing some of these issues, but it does not eliminate them. Of course, that too has its drawbacks, namely the more substantial data requirement, plus the lack of index additivity (you can see this indirectly in the first chart above by the gravitational pull of the houses index on overall index.

Economics 29/7/10: PTSB house prices

PTSB/ESRI house price index is in for Q2 2010. The core result: house prices were down, again, by 1.7% qoq in Q2 2010 - a lower rate of change on Q1 2010 contraction of 4.8% qoq. Thus, prices are now off-peak by 35% to an average of €201,364.

Dublin prices are down 3.5% qoq in Q2 2010 and are off 44% relative to peak. This gap between nation average and Dublin, assuming (as seems to be reasonable) that capital prices appreciation prior to the current crisis were significantly affected by underlying demand, should be erased over the next 12 months plus. Which means we can expect at some point that Dublin will lead the recovery across the country, while other regions continue to contract toward the 45-50% nationwide average off-peak pricing.

NCB stockbrokers gave a good comparison to fundamentals-determined prices. Per their analysis,

• Rental yield model implies house prices equilibrium at between €118,000 and €157,000, or a mid-range house price of €137,500;
• Earnings multiples model implies €170,000;
• Present value model (although not detailed as to the assumptions built in) implies the range of €158,000 to €236,000 for an mid-range of €197,000

You can see where these valuations are heading, don't you? Take a full range of estimates mid-range point of €177,000 - that would be a decline of 43% off the peak prices. Take the simple average price of all mid-range points to get 46% decline.

Now, recall - these are equilibrium prices. In normal price adjustments, there is a relatively pronounced undershooting in prices - in other words, we can expect prices to fall below equilibrium levels before reverting toward longer term values over time.

The depth of this undershooting and its duration depend on some external factors, such as the ease of getting mortgages approvals, mortgage conditions etc - none of which are currently helping the housing markets. So there is a very strong possibility for prices to hit the floor at around -55-60% off the peak.

Lastly, there is a question to be asked as to the validity of PTSB's data - the country largest mortgages holder might no longer be the country largest mortgages issuer. And the sample size globally has shrunk substantially. In other words, if a desperate homeowner in the distant province sells a house for, say, €120,000 while a dozen of his neighbors are not braving the market, does this really tell us anything about the market clearing price? Not really. Imagine what the said homeowner would have got for his dwelling if 12 more identical dwellings in the neighborhood had a 'For Sale' sign.

So a grain of salt is due - the size of an orange...

Economics 20/04/2010: IMF report on global financial stability

IMF's GFSR report for Q1 2010 is out today, and makes a fantastic, albeit technical reading of the global financial system health. Ireland features prominently.

First, Ireland, alongside with Austria, the Netherlands and Belgium are the four leading countries responsible for contagion of markets shocks to the rest of the Euro area. Own fundamentals drove, per IMF team, Irish sovereign bond spreads more than those for any other country in the common currency area, dispelling the Government-propagated myth that our crisis was caused by the US and the global financial markets collapse. Chart below - from the report - illustrates:
Between October 2008 and March 2009, Ireland's contribution to cross-Euro contagion was 12.3% of the total Euro area distress probability - second highest after Austria (16.7%). For the period of October 2009 - February 2010, the picture changed. Greece came in first in terms of distress contagion risk - at 21.4%, Portugal second with 18.0%. Ireland's role declined to 8.1% - placing us 6th in the list of the worst contagion risk countries. A positive achievement, beyond any doubt. But again, IMF attributes the entire probability of the risk of contagion from Ireland to the Euro zone down to domestic fundamentals, not external crisis conditions.

This progression has not been all that rosy for the sovereign bonds:
Notice that Ireland's term structure of CDS rates has barely changed in Q4 2009-Q1 2010. Why is that so? Despite the Budget 2010 being unveiled in between, the markets still perceive the probability of Ireland defaulting on sovereign debt in 5 years times relative to 1 year from now as pretty much unchanged. This would suggest that the markets do not buy into the Government promise to deliver a significantly (dramatically and radically) improved debt and deficit positions by 2015! In other words, the Budget 2010 has not swayed the markets away from their previous position, leaving Ireland CDS's term structure curve much less improved than that of the other PIIGS.

Here is another nice piece of evidence. Guess who's been hoovering up ECB lending?
And if you want to see just why Irish banks will be raising mortgage rates regardless of what ECB is doing, look no further than this:
The chart above, of course, covers 2008 - the year when Anglo posted spectacular results and AIB raised dividend. Imagine what this would look like if we are to update the figure to today. Also notice that in terms of return on equity, Irish banks were doing just fine with low margins back in 2008 and before. The reason for this is that our lending model allowed for that anomaly: banks were literally sucking out tens of billions of Euro area cheap interbank loans and hosing down a tiny economy with cash. As long as the boom went on, it didn't matter whether the bankers actually had any idea why and to whom they were lending. Now, the tide has gone out, and guess who's been swimming naked?

Interesting note on the equity markets. looking at historic P/E ratios, the IMF staff concludes that back in February 2010 "For advanced economies, equity valuations are within historical norms". Except for Ireland, which deserves its own note: "Forward-looking price-to-earnings ratios of Ireland appear elevated due largely to sharp downward revisions in earnings projections."

So, read this carefully: Irish stocks were overvalued - based on forecast forward P/Es - back in the time of the paper preparation. Using z-scores (deviation of the latest measure from either the historical average or the forward forecast based on IMF model) for Irish equities are: +2.1 for shorter horizon (a simplified 96% chance of a downward correction) and +0.9 for longer term forecasts (roughly 63% chance of downward adjustment). In other words, the market is overpriced both in the short term and in the long run. Worse than that, we have the highest short and long term horizon over pricing in the world!

In housing markets, our price/rent ratio z-score is +1.1 (74% probability of deterioration), which means we are somewhat close to the bottoming out but are not quite there. How big is the 'somewhat' the IMF wont tell, but it looks like we are still 1.1 standard deviations above the equilibrium price. Price to income ratio - the affordability metric is at +0.8 stdevs, so prices might still have to fall further to catch up with fallen incomes (57% probability).

Economics 03/10/2009: IMF GFSR: partII

To continue with IMF’s World Outlook (from the earlier post here for GFSR and here for WO Part I):

Remember we left WO Part I on that table estimating expected future contraction in house prices. The table is:
Some interesting estimates of the ‘left to contract’ distance in house prices by countries and by measures of long-term equilibrium pricing, as of Q1 2009, taking into account the contractions achieved to date. As with the analysis of the last table, based on the historical averages Ireland has some room left for downgrades. Loads of room.

As we all know, Ireland is experiencing a perfect storm – a confluence of several simultaneous crises: housing bust, general property bust, general economic recession with global demand contractions, an unprecedented fiscal crisis and a financial sector meltdown. Clearly, these factors warrant much deeper contractions on the long-term adjustment path than what simple averages suggest.
The second chart above shows that indeed, this might be the case – Ireland is distinguished as the country with the greatest remaining room for further downward adjustments in house prices than any other country in the sample. This reflects Ireland’s economic, assets markets and property markets fundamentals comparative to other countries in the sample. So 15% to go still? And that is assuming only property crash has happened…

Chart below actually confirms the above, once we realize that the income measure used by IMF is our GDP. Of course, we are familiar with the following tow facts:

1. GDP in Ireland is currently 18.5% above GNP, and
2. GNP is a closer measure of our income in the country.
   

Thus, adjusting the above figure for GDP/GNP gap implies that instead of roughly 0.2 forward expected adjustment expressed in GDP terms as the income base, we are facing a 0.24 level of adjustment. Furthermore, given that Ireland is currently experiencing deeper income collapse than any of the charted peers, plus, given substantial declines in after-tax income following Budgets 2009 and 2009.II, the real extent of the remaining room to compression for Price-to-Income ratios comparisons is of the magnitude closer to 0.3 – in line with all of our peers. 24-30% still to move down for Irish house prices then?
Lastly, the chart above once again reinforces the conclusions reached by IMF in the second chart above and by my own recalibration of the IMF’s duration-to-amplitude model in the table above. Price to rent ratio still has a room for some contraction of the magnitude of ca 40%. This, of course will be reached through further declines in prices relative to rents and this process is currently being delayed by rents falling off at a faster rate than asking prices in recent months. In rental yield terms, some 40% left to cover for Irish prices. Hmmm… me recalls some stockbrokers recently were saying yields are at 6-8% already and the crisis is nearly over…

Is that really a case? Not per IMF:
So IMF is saying that Irish commercial rents have much further to fall – 30 plus percent more! Say yields also compress – if not by more than that, but at least that much. Ronan Lyons estimated recently that commercial yields in Ireland are around 3% pa. Bringing these to historical average will require prices falling dramatically more from current levels – as chart above implies.

Good prospects for Nama, then, which is overpaying for underlying real assets at today’s prices, let alone at where IMF would expect the prices to be in equilibrium… Will it be -40% from current levels or -30%, or -20% - no one can know for sure. But then again, Nama is a bet on prices actually rising from current levels, not falling.

Economics 27/07/2009: NAMA, ILandP rate hike, US home sales and redemptions

So NAMA failed the first day of Cabinet debate. We know this much - even RTE managed to issue a post, although the Montrose boys lacking anything real to report managed to produce a cheerful note on the debacle. Oh, how much they want the State to succeed in soaking the private sector...

But what really hides behind the Cabinet in-decision? Well, it is rumored that not the (allegedly) ethical Greens, but Mr Cowen's own troops are unhappy about NAMA. Some senior ministers, as I hear, are saying 'Hold on, we'll have to face constituency out there one day and you are about to load an average person (25 yo+) in this country with some €20K in fresh debt from the bankers and developers alone'. Good for them. And I certainly hope the Greens also stand up and tell Mr Cowen where to pack that NAMA idea.

Oh, and apparently, the DofF men are saying that the 'long term economic' value under the NAMA formula will be based on, well, more than 5 and less than 9 years. Hmmm... What does this mean? It means that NAMA should be expected to break even (at the very least) were we to price the property assets to be purchased into NAMA on this 'long term' valuation basis. Ok... but...

First there is one majour issue here - in real world of economics, long-term market value usually means a long-term past average or trend. What it means for NAMAphiles is thatwe will be forecasting the values forward over some long-term horizon. Anyone familiar with forecasting knows that this, in reality, means that we will be in a completely arbitrary forecasting territory. In other words, for DofF to say we want to take current discounts based on future values projected 5, 7, or 9 years ahead is like saying 'we'll name the price and then justify it afterward'.

But wait, there is also a problem with the way the DofF is allegedly timing the cycle.

Calculated Risk blog (see below) - the top forecaster for US housing market shows expected time to the bottom in price in the US residential market of 5-7 years. Do you think we gonna get there in this time here in Ireland? No. We have had worse correction in the market to date than Japan, who are 20 years into the downturn in their property markets and still not seeing the light at the end of the tunnel.

And NBER research paper 8966 (BOOM-BUSTS IN ASSET PRICES, ECONOMIC INSTABILITY, AND MONETARY POLICY by Michael D. Bordo and Olivier Jeanne) has a handy set of charts at the end, showing the most recent busts in property markets in the OECD economies. Ratios of boom length to bust duration are (defining as boom - trough to peak prices, bust - peak to trough):

• Australia 1980s: 3 years of boom, 7 years of bust: ratio of 3:7;
• Denmark 1980s: 4 years of boom 7 years of bust: ratio of 4:7;
  
• Finland 1990s: 4 years of boom, 6 years of bust ratio of 2:3;
• Germany 1980s: 4 years of boom, 7 years of bust: ratio of 4:7;
• Ireland 1970s-1980s: 3 years of boom, 7 years of bust: ratio of 3:7;
• Italy 1970s-1980s: 3 years of boom, 6 years of bust: ratio of 1:2;
• Italy 1990s: 4 years of boom, 6 years of bust: ratio of 2:3;
• Japan 1970s: 2 years of boom, 4 years of bust: ratio of 3:4;
• Japan 1985-today: 6 years of boom and 19 years of bust: ratio of 6:19;
  
• Netherlands, 1970s-1980s: 4 years of boom, 8 years of bust: ratio 1:2;
• Norway 1980s-1990s: 4 years of boom, 6 years of bust: ratio 2:3;
• Spain 1970s-1980s: 2 years of boom, 5 years of bust: ratio 2:5;
• Sweden 1970s-1980s: 4 years of boom, 7 years of bust: ratio 4:7;
• Sweden 1980s-1990s: 3 years of boom, 7 years of bust: ratio 3:7;
• UK 1970s: 2 years of boom, 4 years of bust: ratio 1:2;
• UK 1990s: 4 years of boom, 7 years of bust: ratio 4:7

So average ratio is 1.874 years of bust per year of boom... and that means that, given we had 5 years of a boom that the historical data suggests a bust of 9.4 years duration at an average. That is 9.4 years to a trough in Irish property prices! Not to a realization of some miraculous 'long term economic value', but to a trough.

Well, let's take a look at the same data from the point of view of time to full return to pre-crisis property prices, or peak to trough (nominal prices):

• Australia 1980s: 18 years from 1981 through 1998;
• Denmark 1980s-1990s: 8 years (1979-1986) and 13 years (1986-1998);
  
• Finland 1990s: 1989-2004 or 16 years;
• Germany 1970s: 1973- today... oh yeah, right - some 36 years;
• Ireland 1979 to 1995 or 17 years;
• Italy 1981- through today... right, so that's about 29 years;
• Japan: 1973 through 1986: 14 years;
• Japan 1990- today: 20 years;
• Netherlands, 1978 through 1998: 21 years;
• Norway 1987 through 2003: 17 years;
• Spain 1978-1987: 10 years;
• Spain 1991-1998: 8 years;
  
• Sweden 1979-today or 31 years;
• UK 1973-1987: 15 years;
• UK 1989-2000: 12 years.
  

So average peak to trough for 'long term nominal economic value' is 17.8 years. Again, given our peak at 2007 we have to look forward to NAMA recovering peak valuations at around, hmmm... 2026... But wait - not all corrections were steep enough to match ours... so let's isolate those that were:

• Australia 1980s: 18 years;
• Finland 1990s: 16 years;
• Germany 1970s: 36 years;
• Italy 1981: 29 years;
• Japan 1990: 20 years;
• Netherlands, 1978: 21 years;
• Norway 1987: 17 years;
• Sweden 1979: 31 years;
• UK 1973: 15 years

Which yields an average of 22.6 years, pushing our recovery to beyond 2030. By this standard, a break even value for NAMA should be based on something closer to 15-16 years, if we are to take a 20-25% haircut on current book values of the loans.

So DofF is talking about under 9 years then... I see... ah, the poverty of expectations...

The Government has time to get it right - they have the entire month of August to sort the new piece of legislation on NAMA, outlining in details:

• Provisions for taxpayer protection;
• Complete and comprehensive balance sheet and cost/benefit analysis of the undertaking;
  
• Exact amount of equity the taxpayers will receive in return for NAMA funds (hmmm, 100% would be a good starting point);
• The exact procedures for divesting out of the banks shares in 3-5 years time with exact legal obligation to disburse any and all surplus funds (over and above the costs) directly to the taxpayers in a form of either banks shares or cash;
  
• The formula for imposing a serious haircut (60%+) on banks bond holders, possibly with some sort of a debt for equity swap;
• A recourse to all developers' own assets - applied retroactively to July 2008 when the first noises of a rescue plan started;
• The list of qualifications for any bank to participate in NAMA, including, but not limited to, the caps on executive compensation at the banks and the requirement to set up a truly independent, veto-wielding risk assessment committee at each bank with a mandatory requirement for a position of a taxpayers' representative on the board that cannot be occupied by a civil servant or anyone who has worked in the industry in the last 10 years;
• Provision for a taxpayers' board, electable directly by people, to oversee the functioning of NAMA;
• A condition that the banks must undergo loan book evaluation prior to transfer of any loans to NAMA, the results of which will be made public - on the web - instantaneously - and will impose a requirement on the banks to write down their assets, again before NAMA purchases any of them, by the requisite amounts to balance their own books in line with valuations;
• A condition that any loan purchased by NAMA be placed on the open market for the period of 2 weeks and that NAMA will not pay any amount in excess of the bids received (if any), with a prohibition for the participating banks to bid on these loans;
• A condition that every NAMA loan should be publicly disclosed, including its valuations and bids it receives in the auction stage of the process;
  
• A stipulation that all and any regulatory authorities (and their senior level employees) that were involved in regulating the banking and housing sector in this country take a mandatory pension cut of 50% and return any and all lump sum funds they collected upon their retirement;
• A provision for dealing with the speculatively zoned land to be acquired by NAMA, i.e orderly de-zoning of this land and transfer of this land to either public (if no bidders arise) or private use consistent with sustainable agricultural development, environmental improvements, public use or forestry;
  
• The measures to prevent banks from beefing up their profit margins through squeezing their preforming customers;
• The measures to force the banks to reduce their cost bases by laying off surplus workers;
• The measures for accounting (in a transparent and fully publicly accessible fashion) on a quarterly basis for NAMA operations and the performance of the state-supported banks.

If I forget something, please, let me know...


Oh and on the topic of IL&P predatory rate hike for adjustable rate mortgages, here is a brilliant argument as to why Minister Lenihan must intervene to stop the practice of soaking the ordinary consumers to pay for past banks follies. Read it and think - can any government, acting in the interest of the broader economy and taxpayers and voters be so reckless in its attempts to hide behind 'protecting the markets' arguments as to willingly sacrifice its own people on the altar of cronyism. And do remember - I am a free marketeer, and a proud one, yet I see no moral strength in Lenihan's arguments.


US data is now showing more serious signs of an uplift... or does it? Sales of new homes rose 11% in June is a sign that some decided to interpret as a return to growth. I wouldn't be so trigger happy myself - this is the largest rise in new homes sales since... oh you'd think like somewhere in 2006? no - since November 2008. This is volatile series and the seasonally adjusted rate of 384,000 new homes sales in a month is, while impressive, way off the old highs. Thus sales are still down 21.3% on already abysmal levels of 2008 so far this year.

Here is what my favourite US housing guys - http://www.calculatedriskblog.com - had to say about the latest rise: a W-shaped bottoming out is coming. And a superb chart from the source:
Or, in the words of the blog author:"There will probably be two bottoms for Residential Real Estate. The first will be for new home sales, housing starts and residential investment. The second bottom will be for prices. Sometimes these bottoms can happen years apart. I think it is likely that we've seen the bottom for new home sales and single family starts, but not for prices. It is way too early to try to call the bottom in prices. House prices will probably fall for another year or more. My original prediction (a few years ago) was that real house prices would fall for 5 to 7 years (after 2005), and we could start looking for a bottom in the 2010 to 2012 time frame for the bubble areas. That still seems reasonable to me."

And to me too. But what I would caution against is the optimism for the overall property markets. Here are two tidy little reasons:

One: US equitable redemptions are the lags between the property being reported as a non-performing on the loan book of a bank and the time it hits the foreclosure market. Now, these vary by state, with some states having no er provision at all, while others having 9 months plus. The US average is about 4 months. This is what is yet to be reflected in the 'distressed' sales gap - the gap between new home sales and existing homes sales. Chart below illustrates:
Again, the distressed gap is not closing, but both series are pointing up. Now, notice that around November 2008-February 2009, the days of the most fierce destruction of income and wealth worldwide, the number of existent properties on the markets did not rise. Why? The ER lags are kicking in. So take the average of 4 months and get June 2009 to start showing an increase in existent homesales rising - foreclosures are feeding in. This process is likely to continue through months to come.

Two: I would watch the maturity of securitized commercial loans... these are still looming on the horizon for the roll-over (and they are also a problem in Ireland, where most of commercial property lending was securitized)... Comes autumn, expect things to get tough once again... Oh, and then NAMA will coincide with the already tightening credit markets and will take a large chunk of liquidity our of the market... Gotta love that Lenihan/Cowen timing - like two elephants trying to dance polka at a Jewish wedding - loads of broken glass, but not to the delight of the newlyweds...

Economic 20/07/2009: Property Tax

And by request from one of you, an earlier Sunday Times article (July 12, 2009) on property tax:

A specter of a new tax is haunting Ireland. Since last October, the Government has been pre-occupied with finding increasingly less subtle ways to raise revenue out of the shrinking economy. The latest Department of Finance estimates put new ‘committed’ tax measures envisioned for 2010-2011 at €4.6bn – one and a half times more than is planned in expenditure cuts.

Per latest rumours from the Commission for Taxation, the most favoured new scheme being discussed in the corridors of power is a property tax. A source close to the Commission has indicated to me last week that this month’s report will recommend replacing the stamp duty with a levy on residential and commercial properties. Another source – this time from the Upper Merrion Street – voiced a serious concern that the Government is leaning in favour of “a quick and regressive property tax grab”. When civil servants start labelling a new tax prospect as a “regressive” policy”, one has to be concerned.

The problem is that a property tax is an economically inefficient way for addressing our long-term tax reforms objectives. To see this, consider the reasons as to why our existent structure of taxation in Ireland has to be overhauled.


To date, our taxation system has relied excessively on pro-cyclical tax sources: stamp and excise duties, VAT and assets-linked levies. This has contributed (alongside with gross over-expansion of the public sector) to a full-blown crisis of insolvency in this state.

In H1 2009 total returns from capital gains and acquisition taxes (CGT and CAT) were 74% down on their peak in H1 2007. Stamps fell 80%, VAT - 23.5%, while excise duties were off 26%. Of the €5bn shortfall in total tax revenue in the first six months of 2009 relative to the peak year of 2007, €4.7bn was accounted for by the property, capital and consumption taxes.

Assuming the property tax replaces the two-three year average revenue from stamps – in order to compensate the Exchequer at least in part for some revenue declines – the amount of tax to be raised would equal to €2.4-2.9bn against the current revenue of €680-700mln. In other words, property taxes simply cannot resolve the problem of financing the Exchequer deficit until at least there is a dramatic improvement in the economy.

What is more problematic, however, is that our tax system yields are highly volatile and unpredictable. This is linked to stamps and consumption taxes, with the former having by far the largest impact on revenue deviations from the long-term trend. Stamps are transaction taxes that normally act to reduce overall variance of asset prices and thus dampen down market bubbles – the so-called Tobin tax effect. Normally is the operative word here, for when the underlying assets is infrequently traded, like housing, transactions taxes have the exactly opposite effect, contributing to bubble inflation, rampant speculation and producing extreme peak-to-trough deviations in revenue. This makes future changes in tax receipts less predictable and thus hinders expenditure planning.

A property tax will only partially address the issues of predictability and volatility as it will be directly linked to collapsing property prices. And it will not reduce the propensity for speculative investment in real estate, thereby doing nothing to prevent bubbles in property markets. International experience shows this to be the case, as are the simulations for a property tax in Ireland.

Instead, a site value tax can be used more efficiently to smooth real estate price cycles and to introduce a system of revenue falloff warnings, because land values tend to move change slower over time in functional real estate markets than property prices. For example a simple site value tax, along the lines of the one used in Denmark and Hong Kong, can provide up to 10-12 months delay in decline in revenue relative to other tax heads in a recessionary cycle. Such a tax would apply to all land, including residential property, and can be set at rates that would encourage more efficient and environmentally and spatially more sustainable development in the long run.

In the case of Ireland, my simulations show that a land value tax, raising equivalent of the stamp duties revenue at the peak of the growth cycle in 2006-2007, would have reduced Government revenue shortfall by approximately 35-40% until roughly the end of Q4 2008 – delaying the onset of the fiscal crisis by some 9-10 months. The same tax would have fully smoothed out tax revenue volatility in previous two downturns.

In the long run, our reliance on income and consumption-related taxation is starting to adversely impact Ireland’s ability to attract highly educated and young labour force. This imperils our ambitions to develop a knowledge-intensive high value-added trading economy. In H1 2007, income tax and VAT accounted for 64% of all revenue. By 2009 this figure stood at 70%. Property and capital taxes have seen their share of overall tax burden collapse from 14% to 4% over the same period of time. In other words, thanks to our economically illiterate system of taxation, we are now subsidising property speculators while destroying more productive households. Some 83% of all taxes collected since the beginning of the current downturn accounted for by income tax, excise duties and VAT (up from 76% in 2007).

Shifting more tax burden from physical capital stock onto our incomes and consumption – as a property tax would do relative to the site value tax – will lead to two long-term damaging developments. An increased tax burden will disproportionately befall those amongst us who possess greater human capital and destroy the savings and investment capacity of our younger generations.

A property tax, applicable to the value of one’s residence or office will also act to increase the cost of more efficiently used facilities, putting further pressures on income of the more productive segments of our population. A land value tax, in contrast, will raise more funds out of the under-utilized speculative land and property holdings, increasing relative returns to more efficient, sustainable and demand-driven development, thus in the long run improving housing and commercial real estate markets and costs.

A property tax will hinder any realistic chances of us transitioning to a more environmentally and economically sustainable development model, incentivise further sub-urban sprawl and destruction of community social capital. It will also reward, in relative terms, those who let their property fall into disuse or disrepair. For example, for two neighbours residing in otherwise identical residences, higher taxation will apply to the one who adds an extension to her dwelling or improves insulation on the house, thus allowing for a more efficient use of our housing stock resources.

Should the city or a local authority provide new infrastructure to the neighbourhood, thus increasing the value of the land in the area, once again a property tax will hit the hardest those of the neighbours who put most effort into their property, leaving brown sites and underutilised property owners largely unaffected.

A comprehensive research study into the optimal infrastructure-financing tax systems, published this week by the University of Minnesota found conclusively that a land value tax is a unique measure for directly linking private returns to public investment and the Exchequer tax revenue. A property tax, in contrast, will yield higher private gains to less economically and environmentally sustainable forms of development and property ownership, preventing proper payment for the private benefits of public investment by property owners.

In short, introducing a property tax in place of a more progressive land value tax will be an opportunity lost to create a more equitable, economically sustainable and efficient system of taxation in Ireland.



Box-out: In response to my note on June 14 here, a recent editorial in the Irish Times (Friday, July 3) by Cathal O’Loughlin claimed that if the €10 per passenger travel tax passed into Budget in April were to induce some Irish households to stay away from vacationing abroad, there will be net gains for Irish economy.

Mr O’Loughlin’s arguments fail in terms of simple data analysis. Current data shows that in Q1 2009 relative to Q1 2008, Irish economy has lost 148,000 visitors travelling here from abroad for more than one day, it might have gained some share of the 231,000 Irish residents who decided not undertake a trip abroad. Given seasonality in travel demand, the split between business and other travellers, the latter share is likely to be in the range of 30-40%, as at least some of our potential travellers would opt to take discretionary breaks in their second homes or staying with friends and relatives instead of surrendering to the rip-off prices in our hospitality sector. Do the math: 140,000 foreigners gone, about 70-90,000 domestic travellers holidaying at home. Net gains for the travel sector?

Mr O’Loughlin further confuses the effects of imports and exports of services on the domestic economy, when he simplisticly claims that any Euro ‘saved’ from travelling out of Ireland is a Euro spent in Ireland and when he asserts that such a spending turn-about has the identical net economic effect to every Euro in spending by the foreign visitors here.


The sheer economic illiteracy of Mr O’Loughlin’s argument in favour of a tariff protection of an internationally traded domestic sector is stunning and has been refuted by the entire body of international trade literature. Not surprisingly, every developed country in the world has resisted raising such charges on travel in the current downturn, and many have lowered them.