Brian Gaynor: Ireland feels terrible toll of boom and bust

The transformation of the Irish economy from prosperity to boom and now bust is an important lesson for small countries, including New Zealand.

Ireland's economic collapse has been primarily due to reckless lending by the three major banks. We are fortunate, at least from a macro perspective, because most of our high risk lending was confined to the finance company sector.

In other words the major Irish banks behaved more like Hanover Finance, Bridgecorp Finance and Strategic Finance than the four major domestic banks, ANZ National, ASB, BNZ and Westpac.

The other big difference between Ireland and New Zealand is that the investors in Hanover, Bridgecorp and Strategic have lost most of their money whereas the Irish Government guaranteed all bank deposits. This has been a huge drain on Government finances and is a major reason for this week's massive bailout.

The Irish economy was characterised by low growth, poor productivity and high emigration until the 1990s. A dramatic turnaround occurred as the country began to attract a large number of new manufacturing operations, mainly US multinational-owned.

Ireland also benefited from membership of the European Union.

Productivity and exports rose dramatically during the 1990s.

The Central Statistics Office Ireland began measuring productivity in 1996 and in the following four years the Output per Person in Manufacturing Index surged from 58.2 to 100.

Export growth was even more spectacular with total exports exploding from €14.3 billion ($25 billion) in 1990 to €65.6 billion in 2000.

There was a dramatic turnaround in Ireland's traditional migration patterns, with total migration going from a net loss of 22,800 in 1990 to a net gain of 26,000 in 2000.

This net gain accelerated in the 2000s.

Thus the Celtic Tiger economy was initially soundly based as it was driven by massive increases in productivity, exports and a reversal of the traditional brain drain.

However, there was a dramatic shift in the 2000-2005 period when the productivity and export-driven economy was transformed into one dominated by reckless bank lending, a construction boom and a massive increase in the price of land and property.

The two major Irish banks have traditionally dominated the domestic financial sector, including the stock exchange, and at the end of 2000 Allied Irish Bank had a sharemarket value of €10.9 billion and Bank of Ireland, €10.5 billion.

The third listed bank was Anglo Irish Bank, which had a market value of only €800 million, and was run by Sean Fitzpatrick, an ambitious chief executive.

Anglo Irish Bank grew rapidly, mainly through aggressive lending to the property sector, and the two major banks began to copy Anglo's strategy.

In the 1996 to 2006 period, particularly the latter few years, Ireland had a huge property bubble as Allied Irish Bank and Bank of Ireland followed the lead of their smaller competitor and dramatically increased their property lending books.

This is illustrated by the following statistics:

* Irish house prices increased 3.9 times during the 10 years ended December 2006 compared with a 2.1 times increase in New Zealand house prices over the same period.

* House prices surged 4.7 times in Dublin over the 10-year period, compared with only 1.9 times in Auckland.

* Ireland built 80,960 new houses in 2005, 93,420 the following year and 78,030 in 2007. In comparison New Zealand, which has the same population as Ireland, built no more than 31,900 homes in any one year over the past few decades.

The property boom extended far beyond the Irish residential sector as the banks encouraged investors to borrow more and more. Irish residents bought investment properties in England, Poland, Bulgaria, Romania, Turkey, Dubai, Spain, Portugal and the Americas while there was also a commercial property development boom at home.

Sean Dunne, one of Ireland's more infamous property developers, bought Dublin's Jurys and Berkeley Court hotels, plus a next-door property, for €380 million.

The site is well known to New Zealanders as the hotels, where the All Blacks and many of their supporters have stayed, are only a block away from the old Lansdowne Rd rugby ground.

The site, which cost an amazing €115 million per hectare, has never been developed while Lansdowne Rd has been transformed into the plush Aviva Stadium.

The Irish property bubble, like all property bubbles, couldn't last and the global financial crisis brought it to a sorry end.

The impact has been dramatic as Irish house prices have slumped 36.1 per cent from the peak, with Dublin experiencing a 44.5 per cent plunge. The Irish city and countryside is littered with empty housing estates and unfinished property developments.

The three major banks, which had a huge exposure to the property sector, reported combined losses of €18.1 billion in 2009, compared with aggregate net earnings of €4.6 billion in 2007.

The total sharemarket value of the three banks has taken a hammering, as shown by the accompanying table. Their combined sharemarket value has slumped from €48.8 billion at the end of 2006 to just €2.1 billion this week, even though the two largest banks have had major capital raisings (Anglo Irish Bank was nationalised and delisted last year).

This destruction in shareholder value has had a devastating impact on elderly investors as the banks were considered to be blue chip investments and their dividends were an important source of retiree income.

The loss in sharemarket value of the three large Irish banks has been far, far greater than the losses experienced by finance company investors in this country.

Not surprisingly, bank directors and executives are subjected to even more media criticism in Ireland than Mark Hotchin, Rod Petricevic and other finance company directors and executives are in this country.

Meanwhile, the Irish economy has collapsed with the property sector. The country's GDP has slumped 13.5 per cent since its peak in the December 2007 quarter while the unemployment rate has rocketed from 4.8 per cent to 13.5 per cent.

Although the overall economic picture is gloomy there are pockets of positive activity, with Pumpkin Patch and Delegat's both reporting positive sales growth in Ireland at recent annual meetings.

Government tax revenue contracted and expenditure increased, with the Irish Exchequer reporting a deficit of €13.3 billion for the first 11 months this year.

This huge deficit is prior to money spent propping up the banks through the purchase of bad loans.

As the crisis worsened the yield on Irish Government debt surged up towards 10 per cent, making it very expensive for the Government to fund its deficit.

In addition, the Irish banks were finding it increasingly difficult to attract wholesale funding on international markets and there were fears of a run on the Irish banks.

The €85 billion ($148 billion) bailout announced this week will stabilise the Irish financial sector and reduces the Government's cost of borrowing as it is paying between 5.7 per cent and 6.1 per cent per annum on the bailout money compared with the nearly 10 per cent on international markets.

The property boom and bust has been a terrible experience for the Irish economy, particularly as it should have been avoided.

The Irish economy was soundly based until Anglo Irish Bank led the headless charge into the property sector.

The lesson for New Zealand is that we must maintain control of our financial system and have an efficient oversight regime.

The problem with Ireland, as well as Spain, Portugal and Greece, was that they had inadequate oversight of their major financial institutions and the low interest rate policies of the European Central Bank were totally inappropriate for countries experiencing full-blooded property bubbles.

Brian Gaynor is an executive director of Milford Asset Management.