Ireland Facing House Price Collapse?

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Via Tyler Cowen, Ireland is not nearly done with its mortgage crisis.  Another tsunami is headed for the Emerald Isle:


In the last year, America has seen a rising number of "strategic defaults". People choose to stop repaying their mortgages, realising they can live rent-free in their house for several years before eviction, and then rent a better house for less than the interest on their current mortgage. The prospect of being sued by banks is not credible - the State of Florida allows banks full recourse to the assets of delinquent borrowers just like here, but it has the highest default rate in the US - because there is no point pursuing someone who has no assets. 
 If one family defaults on its mortgage, they are pariahs: if 200,000 default they are a powerful political constituency. There is no shame in admitting that you too were mauled by the Celtic Tiger after being conned into taking out an unaffordable mortgage, when everyone around you is admitting the same. 
 The gathering mortgage crisis puts Ireland on the cusp of a social conflict on the scale of the Land War, but with one crucial difference. Whereas the Land War faced tenant farmers against a relative handful of mostly foreign landlords, the looming Mortgage War will pit recent house buyers against the majority of families who feel they worked hard and made sacrifices to pay off their mortgages, or else decided not to buy during the bubble, and who think those with mortgages should be made to pay them off. Any relief to struggling mortgage-holders will come not out of bank profits - there is no longer any such thing - but from the pockets of other taxpayers. 
 The other crumbling dam against mass mortgage default is house prices. House prices are driven by the size of mortgages that banks give out. That is why, even though Irish banks face long-run funding costs of at least 8 per cent (if they could find anyone to lend to them), they are still giving out mortgages at 5 per cent, to maintain an artificial floor on house prices. Without this trickle of new mortgages, prices would collapse and mass defaults ensue. 
 However, once Irish banks pass under direct ECB control next year, they will be forced to stop lending in order to shrink their balance sheets back to a level that can be funded from customer deposits. With no new mortgage lending, the housing market will be driven by cash transactions, and prices will collapse accordingly. 
 While the current priority of Irish banks is to conceal their mortgage losses, which requires them to go easy on borrowers, their new priority will be to get the ECB's money back by whatever means necessary. The resulting wave of foreclosures will cause prices to collapse further.

It's terrifying to contemplate that the federal government is now, for all intents and purposes, the source of nearly all the mortgage origination in the United States.  Doubly so for a libertarian, of course--but it's also terrifying to contemplate what the market would look like without those interventions.  Would other sources of mortgage finance exist? And if not, what's the value of a house in a market that has suddenly gone to all-cash deals?  


It's tempting to say 20%, a standard downpayment.  Probably more than that, but I doubt too much more.  In actuality, I doubt that prices would drop that low--except on foreclosures.  Rather, the market would simply freeze.  Foreclosures would be sold at deep discounts to buyers entering the market for the first time, while most homeowners would be simply unable to sell for anything that would clear their mortgage.  Meanwhile, the banking system would be hammered again, as the value of their collateral plummeted.

In Kelly's telling, this is what Ireland is actually facing.  This is what the folks who simply want the government to get out of the way and let housing prices fall to whatever level--call them the "economic naturalists" of the Mellonist school--have been advocating.  It looks like we may get to see how that works out in practice.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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