Michael Lewis on the Irish Collapse

I already recommended Michael Lewis' marvelous essay on the Greek financial collapse, and now let me recommend his equally fine piece on the collapse in Ireland. After roughly a thousand years as a poor country, Ireland in the 1990s rather suddenly started getting rich. Lewis:

How did any of this happen? There are many theories: the elimination of trade barriers, the decision to grant free public higher education, the persistent lowering of the corporate tax rate, beginning in the 1980s, which turned Ireland into a tax haven for foreign corporations. Maybe the most intriguing was offered by a pair of demographers at Harvard, David E. Bloom and David Canning, in a 2003 paper called “Contraception and the Celtic Tiger.” Bloom and Canning argued that a major cause of the Irish boom was a dramatic increase in the ratio of working-age to non-working-age Irish brought about by a crash in the Irish birthrate. This had been driven mainly by Ireland’s decision, in 1979, to legalize birth control. That is, a nation’s fidelity to the Vatican’s edicts was inversely proportional to its ability to climb out of poverty: out of the slow death of the Catholic Church arose an economic miracle.

The Harvard demographers admitted their theory explained only part of what had happened. At the bottom of the success of the Irish there remains, even now, some mystery. “It appeared like a miraculous beast materializing in a forest clearing,” writes the pre-eminent Irish historian R. F. Foster, “and economists are still not entirely sure why.” Not knowing why they were so suddenly so successful, the Irish can perhaps be forgiven for not knowing exactly how successful they were meant to be. They had gone from being abnormally poor to being abnormally rich, without pausing to experience normality. When, in the early 2000s, the financial markets began to offer virtually unlimited credit to all comers—when nations were let into the dark room with the pile of money and asked what they would like to do with it—the Irish were already in a peculiarly vulnerable state of mind. They’d spent the better part of a decade under something very like a magic spell.

Love that description of the lending mentality of the early 2000s, on which more later.

In 2008, after 20 years of boom times, Ireland's biggest banks all collapsed and now the country is looking at decades of austerity to pay the bills. To find out why, Lewis spoke with an obscure Irish economist named Morgan Kelly:

Morgan Kelly is a professor of economics at University College Dublin, but he did not, until recently, view it as his business to think much about the economy under his nose. He had written a handful of highly regarded academic papers on topics (such as “The Economic Impact of the Little Ice Age”) considered abstruse even by academic economists. “I only stumbled on this catastrophe by accident,” he says. “I had never been interested in the Irish economy. The Irish economy is tiny and boring.” Kelly saw house prices rising madly and heard young men in Irish finance to whom he had recently taught economics try to explain why the boom didn’t trouble them. And they troubled him. “Around the middle of 2006 all these former students of ours working for the banks started to appear on TV!” he says. “They were now all bank economists, and they were nice guys and all that. And they were all saying the same thing: ‘We’re going to have a soft landing.’ ”

The statement struck him as absurd: real-estate bubbles never end with soft landings. A bubble is inflated by nothing firmer than expectations. The moment people cease to believe that house prices will rise forever, they will notice what a terrible long-term investment real estate has become and flee the market, and the market will crash. It was in the nature of real-estate booms to end with crashes—just as it was perhaps in Morgan Kelly’s nature to assume that, if his former students were cast on Irish TV as financial experts, something was amiss. “I just started Googling things,” he says.

Googling things, Kelly learned that more than a fifth of the Irish workforce was employed building houses. The Irish construction industry had swollen to become nearly a quarter of the country’s G.D.P.—compared with less than 10 percent in a normal economy—and Ireland was building half as many new houses a year as the United Kingdom, which had almost 15 times as many people to house. He learned that since 1994 the average price for a Dublin home had risen more than 500 percent. In parts of the city, rents had fallen to less than 1 percent of the purchase price—that is, you could rent a million-dollar home for less than $833 a month. The investment returns on Irish land were ridiculously low: it made no sense for capital to flow into Ireland to develop more of it. Irish home prices implied an economic growth rate that would leave Ireland, in 25 years, three times as rich as the United States. (“A price/earning ratio above Google’s,” as Kelly put it.) Where would this growth come from? Since 2000, Irish exports had stalled, and the economy had been consumed with building houses and offices and hotels. “Competitiveness didn’t matter,” says Kelly. “From now on we were going to get rich building houses for each other.”

Which brings me back to the thing that still bothers me about the financial crisis. In the early 2000s there was so much money sloshing around world financial markets that investors could not think of anything better to do with it than to lend it to people who couldn't pay it back. The countryside of Ireland is now scattered with completely empty housing projects -- more than 180,000 vacant dwellings, newly built or unfinished, in a nation of 6 million, not to mention dozens of abandoned office buildings, shopping malls, and so on. Even in the gung ho world of early 2000s banking there were plenty of insiders rolling their eyes at the behavior of Irish banks. Yet investors still snapped up their bonds. Meanwhile in America we put a trillion or so dollars into sub-prime mortgages, and there were real estate bubbles in Chile, Australia, Spain, and sundry other places, all this at a time when most of the world's governments are running deficits, which is supposed to "crowd out" private investment. Even now, after trillions have been wiped out by the collapse, the real interest rate on US government bonds is negative.

I was always taught that the economic growth rate is limited by the amount of capital available to invest, so that more savings leads to more growth in the long term. I see no sign that this is true now. Instead we have trillions of dollars sloshing around the globe looking for any sort of return, and what we are short of it good ideas about how to invest it.