Ship of Fools

by Fintan O'Toole

  The state ended up subsidising - to the tune of around €2 billion in all - the building of houses whose purpose was to provide shelter, not for real people, but for the taxes of their builders. The tax costs to the state of the various ‘renewal’ schemes amounted to a staggering 43 per cent of the cost of the actual developments. Instead of providing real houses for people who desperately needed them, €2 billion of public money was squandered on putting up empty shells in places where no one wanted to live.

  These were, almost without exception, state subsidies for the rich. Indecon, from whom the government eventually commissioned an analysis of the property-based tax incentives, concluded that ‘nearly all of the property tax incentives reviewed have been used primarily by high income earners’. None was introduced as a result of a cost/benefit analysis. None was time-limited, so that incentives that might perhaps make some sense at a particular moment continued to operate long after they were remotely justifiable.

  What the incentives did achieve, however, was to help turn Ireland from a society in which construction serviced the economy into one in which the economy existed to service construction. In May 2009, in a half-hearted excuse for an apology, the Taoiseach Brian Cowen, who had been a pitifully compliant minister for finance during the worst of the bubble years, regretted the ‘reliance on the construction sector, which had grown to 12% of GDP’. This in itself was an interesting example of Freudian repression. The construction sector wasn’t 12 per cent of GDP. It was, at the height of the boom in 2006, almost 24 per cent of GDP. This was twice the average ratio for Western Europe. It directly accounted in 2006 for 19 per cent of the entire workforce. In other words, a quarter of all the economic activity in the state was the manipulation of bricks and mortar, concrete and tarmac. One person in five was employed in building the houses, roads, office blocks and infrastructure for the other four to live in, work in and travel through.

  The height of absurdity was reached in the last years of the boom when Ireland was importing construction workers from Central and Eastern Europe to build the houses in which they themselves would live. In 2006, 13 per cent of the workforce in Irish construction was made up of migrant workers. Many builders were relying on these workers to rent the houses the last wave of migrant workers had built , while they themselves built the houses for the expected next wave of central European builders to rent.

  Faced with this looming disaster, and its implications for the stability of the banking sector, the Central Bank stood on the sidelines wringing its hands. Its own figures, published in its annual stability reports, were terrifying: bank lending for construction and real estate grew from €5.5 billion in 1999 to €96.2 billion in 2007 - an increase of 1,730 per cent. On average, this lending was growing by 18 per cent a month. Even if the Irish regulators didn’t concern themselves with awkward things like ethics and legality, they were supposed to be in the business of risk management and banking stability. That the pace and scale of this rise in lending to one sector of the economy met with no real regulatory response suggests a mass migration to the Republic of Catatonia.

  In May 2009, Brian Cowen claimed that he and the government had been well aware all along that construction and property had become cuckoos in the economic nest and had been planning to tackle the problem. ‘The reliance on the construction sector was something we were in fact going to move down, over time, to get a soft landing’. Apart from the obvious fact that these good intentions were never acted on, one reason to doubt whether Fianna Fáil had the will to act is that the construction and property boom had become essential to the party’s very being.

  Fianna Fáil, in the boom years, had to juggle two ideological imperatives. On the one hand, it had bought into the so-called free market agenda of low taxes for individuals and corporations as the mainstay of economic prosperity. On the other, it remained a populist party with the need to satisfy a large and diverse electoral base that included much of the urban working class and welfare recipients and also many rural and provincial communities who expected their politicians to deliver public goods to the local area. How could it choose between low taxes and the concomitant of poor social services on the one side and the need to keep low-income and regional voters reasonably happy on the other? In order to avoid that choice, it needed to pull off the trick of simultaneously cutting taxes and increasing spending. The magical substance that allowed it to achieve this apparently impossible feat was concrete. The construction boom filled the gap between real, sustainable revenue and spendthrift, careless spending. It meant that Fianna Fáil did not have to do the one thing against which every fibre in its republican being revolted: make a choice.

  Money flowed into the state coffers from the construction boom through stamp duty, VAT on construction materials, capital-related taxes and income taxes on building workers, including those who came into the country from Central Europe. VAT on house building alone accounted for 8 per cent of Irish tax revenue in 2006. Overall, property-related taxes, which had contributed 4 per cent of government revenue in 1996, made up at least 17 per cent in 2006.

  In real terms, taking out these unsustainable factors, the Irish public finances were in the red: the IMF calculated this ‘structural deficit’ at 9 per cent of GDP in 2007 and 12.5 per cent in 2008. But the construction-related revenues turned this deficit into a budget surplus, creating both the illusion that there was plenty of money to spend and a lack of concern with how well it was spent.

  The government turned itself into a junkie, injecting itself every day with the narcotic of easy money from the property bubble. Like every addict, its main interest was in making sure the supply of the drug didn’t dry up. In these circumstances, two things were inevitable. One was that the bubble of debt and inflated property values would burst with, as Slattery had predicted, ‘traumatic’ consequences for those who had bought houses at the top of the market. The other was that this first inevitability would be denied, ignored and, if possible, obliterated from the public mind.

  Thus, in late 2006, when Morgan Kelly, professor of economics at University College Dublin, wrote an extensive piece in the Irish Times, and followed it up with an academic paper with the phlegmatically chilling title ‘On The Likely Extent of Falls in Irish House Prices’, he might as well have broken wind in an airtight room. Kelly made the point that he had studied forty booms and busts in property markets in OECD countries since 1970. The overall pattern is remarkably stable: property loses 70 per cent of the value it gained during the bubble years. There is a simple law: the more house prices rise relative to average incomes, the harder they will fall. On this basis, Irish house prices were due to fall by between 40 and 60 per cent.

  This was not a wild jeremiad. This kind of fall had happened in Holland in the 1980s, in Switzerland and Norway in the late 1980s, and in Finland in the early 1990s. These slumps, and the others that Kelly detailed, were typically quite long in duration: five to seven years was the norm, but the markets in Switzerland, Japan and Holland had taken at least a decade to recover.

  Kelly cut through the favoured phrase of government, cheerleader economists, banks and property companies - ‘soft landing’ - like a scalpel through silk: . . . a soft landing is not so much unlikely as contradictory. Suppose that house prices really were expected to level off, then the owners of the tens of thousands of empty houses and apartments can expect no further capital gains and should cash in their investments. Why pay a mortgage on an empty apartment that has stopped rising in value? As speculators rush for the exit, prices will crash.

  Second, if prices stop rising, it makes no sense to buy a house. Compared with mortgages, rents are ridiculously low. For €2,000 a month you can pay a mortgage on something in a muddy field on the wrong side of Celbridge [in the commuter belt south of Dublin], without nearby shops or schools and a two-hour commute to Dublin. For the same amount you can rent a €1 million house in southeast Dublin, close to the Dart [rapid rail] line and surrounded by good schools. Once people p
ut off buying in favour of renting, prices will not stabilise, they will crash.

  The effects on an economy dangerously dependent on construction would, he warned, be catastrophic: ‘We could see a collapse of government revenue and unemployment back above 15 per cent.’

  Bertie Ahern’s response to Kelly’s (entirely accurate) predictions was to urge him and his ilk to kill themselves. ‘Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don’t know how people who engage in that don’t commit suicide.’ Ahern got strong support from his main media cheerleader, the bestselling Sunday newspaper the Sunday Independent, whose deputy editor Liam Collins wrote that ‘Bertie Ahern got it absolutely right’ and attacked the Economic and Social Research Institute for having the bad taste even to publish Kelly’s paper: ‘The state-funded Economic & Social Research Institute set the stalled ball rolling again last week when it regurgitated a hysterical rant from an academic who had the audacity to accuse those in the property business of “wishful thinking” because they remained optimistic about the future of house prices. Professor Morgan Kelly, from the bloated campus of University College Dublin, first jumped on the property bandwagon on December 21, 2006, with his paper, Irish House Prices: Gliding into the Abyss? When not too many people paid much attention to his thesis, the state “think tank” reissued his gloom-laden forecast under the new guise of academic research. It came with complicated formulae, big words and long, hard-to-read paragraphs - but the same dismal conclusions. ’ Collins accused Kelly of ‘tabloid scholarship’.

  What was remarkable, however, was how few mainstream economists came to Kelly’s defence. Every historically literate economist knew for sure that the Irish property boom was going to crash. As early as August 2000, the International Monetary Fund put the Irish bubble in the context of all known modern property booms and concluded that ‘there has not been a single experience of price inflation on the scale of Ireland’s which did not end in prices falling’. Given that prices actually doubled in the six years after that warning, the scale of the crash was even more predictable. Yet the overwhelming majority of Irish economists either contented themselves with timid and carefully couched murmurs of unease or, in the case of most of those who worked for stockbrokers, banks and building societies and who dominated media discussions of the issue, joined in the reassurances about soft landings.

  In effect, the cheerleaders for the Celtic Tiger had constructed an impregnable but entirely fictional reality. It was an unquestionable certainty as secure as the Tsar’s conviction that there could be no revolution in Russia or Donald Rumsfeld’s conviction that there were weapons of mass destruction in Iraq. In a country that was losing its religion, the indestructibility of the property market was the remaining one true faith. Were it not for the unfortunate restrictions of modern civility, heretics like Kelly would have been burned at the stake in O’Connell Street. Unreality was now the place where Ireland lived.

  6

  Kings of the Wild Frontier

  ‘Don’t try to protect everyone from every possible accident’

  - Charlie McCreevy

  If, at the height of the Irish boom, you stopped virtually anyone in the street in Dublin and asked them the following questions, you could be pretty sure of the answers they would give:a. Where does most of the foreign investment in Ireland come from?

  b. What sectors of the economy does it go into?

  c. What is Ireland’s largest bank?

  The answers were common knowledge. Most of the investment came from the United States of America. Most of it went into either information technology (Intel, Microsoft, IBM) or pharmaceuticals (Pfizer, Eli Lilly, Merck). And Ireland’s largest bank was Allied Irish.

  In fact, these obvious answers were all wrong. From 2002 onwards, the largest source of foreign direct investment into Ireland was the Netherlands (€10.7 billion that year, compared to €7.9 billion from the USA). In 2003, €8.6 billion came from the Netherlands, while flows from the US were actually negative, with more going out in repatriated profits than came in through investment. Even in 2007, when North American investment doubled to €31 billion, it was still less than the €33 billion that came from the Netherlands.

  Where was this vast Dutch investment coming from? Was Shell oil buying up the entire country? Were the Dutch rat-race refuseniks who set up smallholdings in rural Ireland in the 1970s planning an unimaginable expansion of their organic cheese-making operations? In fact the money was mostly connected to high-level financial juggling by American-owned transnational corporations, with their Dutch-based treasury-management subsidiaries routing capital flows through Dublin.

  The answer to the second question was equally surprising. The largest single component of the stock of foreign-owned assets in Ireland was not in either information technology or pharmaceuticals, it was in the International Financial Services Centre (IFSC) in Dublin, which is essentially a tax haven for global finance. The prominence of world-leading transnational firms like Intel or Pfizer may have defined the Irish economic landscape. Their presence was solid and reassuring - whatever anyone thought of them, however much we knew about their repatriation of vast profits every year, they were global industrial titans, producing real products for real export markets. But they were dwarfed by the sheer scale of money that was pumped through the IFSC. In 2005, for example, the IFSC accounted for approximately 75 per cent of all foreign investment in Ireland. Yet it was not particularly surprising that most Irish people would not have known this, for it was not easy to understand exactly what many of the companies in the IFSC were up to.

  And, to answer the third question, the largest Irish bank was not AIB, but the giant German operation Depfa (short for Deutsche Pfandbriefanstalt), a specialist lender to governments and municipalities that transferred its global headquarters to the IFSC in Dublin in 2002. Its global centre at Harbourmaster Place on the River Liffey had just 319 employees, but claimed assets in 2003 of $218 billion. Depfa had been as German as sauerkraut - it was founded by the Prussian government in 1922 and it was still listed on the Frankfurt stock exchange. But it was now as Irish as bacon and cabbage.

  The IFSC was established in 1987 by Charles Haughey, at the suggestion of one his financial backers, Dermot Desmond, specifically to persuade international finance companies to set up offices in a new, American-designed development at Custom House Docks on the Liffey, just a few minutes east of Dublin’s city centre. The incentive was simple: a 10 per cent rate of corporation tax. (The IFSC moved in 2005 to a 12.5 per cent tax rate and companies were allowed to locate themselves outside the Custom House Docks centre.)

  The IFSC worked. It attracted half of the world’s top fifty banks and top twenty insurance companies, alongside another 1,200 operations of various sizes. By 2003, Ireland was the main global location for money market mutual funds (a total of $125 billion in these funds was domiciled in Dublin), overtaking its old spiritual hinterland of the Cayman Islands. In the same year, Dublin’s investment funds industry (valued at $480 billion) surpassed London’s. Hedge fund managers liked the place: by 2004, over $200 billion in hedge fund assets were being serviced in Dublin.

  The IFSC eventually employed 25,000 people, many of them on high salaries. In spite of the low tax rate, it contributed, at its height in 2006, €1.2 billion in taxes to the government. But there was a price to pay for these blessings. The attraction of the IFSC for the global finance industry was not just low taxation. It was also lax, and in some cases virtually non-existent, regulation. The Irish state acquired an incentive to keep banking supervision to a minimum.

  Any urge to beef up regulation after the DIRT and Ansbacher scandals was outweighed by the belief that the Irish tradition of looking the other way while banks passed funny money around was actually an economic asset. Ethitical banking went global. While the embodiment of Irish banking culture had been the bogus non-resident, now it became the bogus resident. The unreality of Irish people pretending to be elsewhere was replac
ed by the unreality of foreign people pretending to be in Ireland.

  In February 2009, the Guardian newspaper sent reporters to Dublin to check out the ‘head offices’ of British companies that were now ‘domiciled’ in Ireland: ‘One such “headquarters” turned out to be merely the premises of the company’s accountants. Other multi-nationals had just a handful of staff at work, no nameplates outside, or occupied the premises only sporadically . . . Tarsus, a business media group, says its new Irish headquarters is in a redeveloped Dublin dock by the river Liffey. But when we went there, it appeared to be merely the premises of their tax advisers, PWC [Price Waterhouse Coopers]. Henderson Global Investors has only three staff at its Dublin suite of off-the-shelf rental offices, compared with 550 who continue to work at its main London office. A receptionist in Ireland said: ‘They are not here a lot of the time.’ Charter Engineers has no nameplate on its temporary offices, and the company secretary - one of only five staff - flies in on Monday and home again on Friday.’

  Under Irish tax law, a corporation can pay its entire tax bill in Ireland if ‘its central management and control are located in the state’. The ghostly presences traced by the Guardian are the ciphers of ‘central management and control’ that allow companies to pay tax at generous Irish rates rather than more stringent British ones. The Guardian revelations prompted the Treasury spokesman of the Liberal Democrats to call Dublin ‘Lichtenstein on the Liffey’.

  If the Irish had a right to be insulted by this description, it was only because we tended to prefer warmer, Caribbean climes. The Cayman Islands, as we have seen, was a virtual fifth province in the 1980s. And in fact, the official equivalent that the IFSC was seeking was also West Indian: in 2003, referring to the IFSC, the state’s Industrial Development Agency (IDA) actually boasted that ‘There has been rapid growth in the Irish insurance and reinsurance industries in recent years, with Dublin fast becoming the Bermuda of Europe.’