Belfast Telegraph

Finding answers to debt crisis is a taxing matter

By Brendan Keenan

No, it wasn't Lehman Bros. The foibles of Dick Fuld and his merry band have been cited by the politicians involved as the cause of much of our troubles, from the collapse of Anglo to the bailout itself.

That was never plausible, but it seems reasonable to think that the global financial conflagration, for which Lehman's lit the spark, has much to do with the appalling severity of the Great Recession.

Well, maybe even that is wrong. The term 'Great Recession' is now next to official, given its use by the International Monetary Fund, no less, to describe the global crisis.

Ireland might qualify for 'Greater Recession', given the record-breaking character of its downfall. But, according to the said IMF, things might have been just as bad in Ireland even if there had been no Lehmans and no global pandemonium.

As the Economics and Social Research Institute (ESRI) pointed out towards the end of the boom, the Irish economy was heading for the rocks anyway.

On the IMF's figures, debt recessions seem even more severe than the worst-case scenarios postulated back then. Ordinary recessions, about which we fulminated so much in the past, look mere bagatelles compared with these household busts.

The difference is not even all due to collapsing house prices - as again one might expect. The IMF study covers only recessions involving house price crashes.

It identified no fewer than 99 examples among 24 IMF member states.

The analysts then compared those house price busts which had a prior large increase in household debt with those which had not.

The differences are stark. Household spending falls by more than four times the amount when the property crash is accompanied by a large debt burden.

"It seems to be the combination of house price declines and pre-bust leverage that explains the severity of the contraction," the authors say.

The combinations vary widely. In particular, the behaviour of Irish house prices was unusual - also in an unexpected way. Despite what is commonly said, the rise in Irish house prices was not that extraordinary, but the subsequent fall certainly is.

Measured from 2002, the real increase in Irish prices was less than that of Denmark, Spain and Iceland. The UK and US were not far behind Ireland.

Ireland does stand out in terms of the rise in the household debt burden and it is the combination which proved lethal. Debt rose by 90% from 2002-08.

In Ireland's case, we know that households have reduced debt quicker than anyone else, but falling incomes and rising taxes mean only a few points have been knocked off the debt/income ratio.

Perhaps this helps explain the startling graph in the study, which shows the percentage of mortgages in arrears. The 6% figure for Ireland (which has doubled since), and 9% for the US (which has fallen since) compare with 2.5% in arrears in Britain and Spain.

Problems may have been deferred in those countries too, but the financial stress indicated by the huge Irish arrears must be part of the explanation for the extraordinary collapse in house prices.

It is also partly explained by the fact that those high levels of household debt are so concentrated in mortgages - mortgages taken out mostly by young people during the bubble years. This creates the curious situation where net household wealth - €600bn (£491bn) of assets minus €200bn (£164bn) of debt - is still greater than it was when the boom/bust cycle began in 2003, but is most unevenly spread.

Most people approve, in theory at least, of equalising income differences between richer and poorer. Equalising wealth to any degree, by taxing assets and relieving debt, is an entirely different matter.

Finding solutions is a taxing question in both senses of the word but, before we start, we must at least be sure that we understand the nature of the problem.