"Morgan Kelly's Hits and Misses"

Brendan Burgess

Brendan Burgess

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Donal O'Donovan analyses Morgan Kelly's record in a very interesting summary manner in today's Irish Independent. (There is also a more general article: Noonan urges Central Bank to heed Kelly's warning on SMEs)


UCD professor Morgan Kelly has a habit of exploding complacency by predicting – often correctly – major economic problems. His track record is the reason why even Michael Noonan does not want to be seen to not take the professor's concerns seriously.


Prof Kelly has had some big hits, but also some misses since he dramatically got involved in public discourse in 2006.


1) "We may be looking at a large and prolonged fall in house prices of the order of 40-50pc"
Prof Kelly was not the only person to say houses were over valued during the boom.
But his 2006 prediction of 50pc house-prices falls, and his evisceration of claims by some "experts" that the economy was heading for a soft landing, were bang on the money.
Verdict: HIT


2) Cash spent saving [broken link removed] "might as well be piled up in St Stephen's Green and incinerated."
Back in 2008 Morgan Kelly was again one of the few voices raised in public against the decision to bail out Anglo with an initial €1.5bn "investment".
He rightly predicted that "attempting to recapitalise Anglo Irish Bank is not only expensive and economically pointless, but futile".
Taxpayers eventually sunk €30bn into the bank, and it still ended up being liquidated.
Verdict: HIT


3) "If you thought the bank bailout was bad, wait til mortgage defaults hit home."
Prof Kelly correctly predicted the scale of the mortgage arrears crisis – rightly forecasting that hundreds of thousands of households would eventually fall behind on their home loans as the economic crisis deepened.
Verdict: HIT


4) "Inchoate rage and despair that will transform Irish politics"
The capacity of the political system to absorb the shock of the economic crisis has so far confounded this 2011 forecast.
There is no sign of the "Irish Tea Party" or other hard right formation that Prof Kelly predicted would convulse the political landscape here by 2015.
Verdict: MISS



5)"Ireland is heading for bankruptcy."
To date the State has avoided a so-called "sovereign default" or national bankruptcy. It has been a close-run thing of course, and we are not entirely out of the woods – but having exited the bailout, default now looks highly unlikely.
That is probably thanks to the radical renegotiation of the original terms of the 2010 bailout. Since he made his prediction, interest rates charged for European rescue loans have been slashed and the State has been given longer to repay both these loans, and the bill for saving Anglo Irish Bank.
Verdict: MISS
 
I think it's worth looking at each of these in turn.

1) House prices will fall by 50% and the banks will go bust - An undeniable hit.

McWilliams identified the bubble in house prices, but did not understand its implications for bank solvency. Kelly got this exactly right.

2) Cash spent saving [broken link removed] "might as well be piled up in St Stephen's Green and incinerated."

Discussed hereHe was right along many others to day that the government should not have guaranteed the bondholders and depositors in Anglo. But having given that guarantee, then the government had no choice to put the €1.5 billion at that time into Anglo.

Most of the money pumped into Anglo went back to Irish depositors. So that was certainly better than burning it in Stephen's Green

3) "If you thought the bank bailout was bad, wait til mortgage defaults hit home."

I am surprised that O'Donovan classifies this as a hit. It's a massive miss.
I wrote a long piece on this at the time about this specific article , but can't find it. The bailout of the banks has cost us around €60 billion. The state owned banks, AIB, EBS and ptsb and had €70 billion in owner occupied and buy to lets at 31 December 2010. Despite the publicity about arrears, the majority are paying in full and there will be no losses on them. I reckon total write-offs will be around €3 billion. He himself estimated it at €4 billion ( 5% of €82 billion book)

So he has made two forecasts on the topic - one was about €4 billion and the other "dwarfs the €60 billion cost of the bank bailout"

So this is a huge miss.

4 "Inchoate rage and despair that will transform Irish politics"
This could have been a self-fulfilling prophecy and as such was very dangerous.

5 "Ireland is heading for bankruptcy."
This should not have been classified as a Miss. This was absolutely correct. We were bankrupt. We probably are bankrupt. We have been bailed out by ridiculously cheap long-term loans. There might not have been a sovereign default, but we certainly were bankrupt.
 
Here are some other comments he made

6. "Ireland will demolish more houses than it will build over the next decade"
January 2009.

I criticised it at the time as "more sensationalist stuff"

Obviously we won't know for another 5 years. Very few houses have been built. But has there been widespread demolition of houses?

7. "The state will need to provide €5 billion to the banks for the losses on €1m+ home loans" August 2011

This was based on a press release from the Irish Brokers Association which itself was based on anecdotal evidence. Using outlandish assumptions myself, I have estimated the cost at €600m , so he is out by a factor of 10. (The true cost will probably be €200m)
 
1) House prices will fall by 50% and the banks will go bust - An undeniable hit.

McWilliams identified the bubble in house prices, but did not understand its implications for bank solvency. Kelly got this exactly right.


Click to expand...

I stand to be corrected on this, but my recollection of MK's basis for default was that interest rates were going to increase to an unstainable level and this in turn would precipate loan defaults and ultimately effect the collapse in the housing market. If I am correct in my recollection, while his forecast was proved correct, the basis for that forecast was incorrect. I recall an internal bank discussion at that time, rejecting his forecast on the basis that the ECB would not permit such a massive increase in rates as was forecast by MK.
 
44brendan said:
I stand to be corrected on this, but my recollection of MK's basis for default was that interest rates were going to increase to an unstainable level and this in turn would precipate loan defaults and ultimately effect the collapse in the housing market. If I am correct in my recollection, while his forecast was proved correct, the basis for that forecast was incorrect. I recall an internal bank discussion at that time, rejecting his forecast on the basis that the ECB would not permit such a massive increase in rates as was forecast by MK.
Click to expand...

I wouldn't be the biggest fan of Morgan Kelly but I don't think that is accurate. I don't remember him ever linking it to interest rate rises or any other specific event. All Kelly did was look at other property crashes across the world and look to see what would happen in Ireland if or when property crashed. It was remarkably simple but yet was completely accurate. Every country thinks their bubble is different. It isn't. Property bubbles have all behaved the same way. They have all crashed and they have all led to huge losses. Most people and I include myself were deluded to think Ireland was different.
 
Hi 44

An interesting take on it. I enquired here about when he made his first forecast, but we went off on a thread about McWilliams.

He wrote this article in Dec 2006, but you have to pay to read it

How the housing corner stones of our economy could go into a rapid freefall






Here is his ESRI paper from 2007
[broken link removed]

The abstract is pretty clear about the impact of house price falls on the economy. Not sure when he predicted the banking collapse.

Looking at house price cycles across the OECD since 1970, we find a strong relationship between the size of the initial rise in price and its subsequent fall. Were this relationship to hold for Ireland, it would predict falls of real house prices of 40 to 60 per cent over a period of 8 to 9 years. The unusually large size of the Irish house building industry suggest that any significant house price fall that does occur could impose a difficult adjustment on the economy.
Click to expand...
and from the introduction:

Any sudden fall of residential investment to normal international, and national historical, levels, could have a substantial impact on national income, government finances, and unemployment:
Click to expand...
and

Before looking at what these numbers may imply for Ireland, it is necessary to dispose of the idea that Irish house prices merely reflect strong fundamentals: rising income and increased household formation due to the age structure of the population, declining household size, rising employment, and immigration.
This argument is hard to sustain. If the rise in house prices were due to in
creased income and more people needing somewhere to live, we would have observed rents rising alongside house prices. Figure 4 shows how house prices have risen far faster than either rents or income. In fact, while rents doubled relative to income between 1995 and 2000, the ratio has remained unchanged since. The failure of rents to rise, along with the number of recently built units that have been bought but are lying empty (FitzGerald, 2005), suggests that the Irish housing market has left the dull world of fundamental values far behind it.
Click to expand...
Brendan
 
Going back to the source is very interesting

5.2 MACROECONOMIC CONSEQUENCES
House price falls have three effects. First, households feel less wealthy and con sume less. Evidence from the United States points to a final long-run marginal propensity to consume from housing wealth of around 10 per cent: a $100,000 rise in property values, increases household consumption eventually by a total of $10,000 (Carroll, Otsuka and Slacalek, 2006). Second, banks face more bad loans, and become more cautious in their lending, leading to further falls in creditworthiness through the standard financial accelerator. Finally, the value of Tobin's q for residential investment falls, reducing house building. Most countries devote about 5 per cent of national income to building houses and in a typical housing bust, this falls to around 4 per cent of national income.

In most cases then, housing busts are uncomfortable, but not macroeconomically disastrous events. How about Ireland? There is some evidence that the wealth effect on consumption might not be as strong as in the United States: there has been no fall in personal saving in Ireland during the housing bubble, and households have not consumed home equity through second mortgages (Hogan and O'Sullivan, 2006).

Similarly, the larger banks which dominate lending are well capitalised and the banking system has, until recently at least, avoided the worst excesses of the subprime mortgage market, although it is likely that many interest-only and 100 per cent mortgages could go sour, especially given the ease with which delinquent borrowers can relocate to England.


It is the scale of the Irish house building industry that makes a fall in house prices potentially troubling. While most economies derive only 5 per cent of their income directly from residential construction, in Ireland house building accounts for around 15 per cent of national income.

Effectively, the recent growth of the Irish economy looks similar to the unstable case of an old-fashioned multiplier-accelerator model. The employment growth in the Celtic Tiger period of the 1990s led to increased demand for housing, reflected in rising real house prices and rent to income ratios. This stimulated house building, which generated more employment, leading to more demand for housing, and so on. Effectively, the Irish economy has come to be driven by building houses for all the people whose jobs have come, directly or indirectly, from building houses.

It is hard to envisage how a fall in house building from 15 per cent to 5 per cent of national income might be achieved without considerable macroeconomic dislocation. Building booms, moreover, tend to end suddenly: the example of Arizona in the summer of 2006 shows how a housing market can move in the space of a few months from buyers queuing overnight to buy, to empty tracts of new houses being priced below construction cost and still failing to sell.
Click to expand...

So I was wrong. In July 2007 he was not forecasting that the fall in house prices would wipe out the banks. I wonder when he first forecast this?
 
It's on TV rather than in print, but on the day of the bank guarantee, while other commentators were still assuming a temporary liquidity problem, Kelly was confidently asserting that they were insolvent and would suffer "horrific" losses on developer loans.

http://www.youtube.com/watch?v=11CCxv2ueiQ

I believe he also envisaged an Irish sovereign default with consequent enforced austerity, which he explains in the Q&A to his latest talk was the backdrop to his prediction about a lurch to the far right in politics. He claims the reason that hasn't come to pass is because of Draghi's subsequent ECB policies -- basically we haven't had any austerity in the proper sense of the word but have continued to pile up debt (which makes it still premature to pronounce on his bankruptcy prediction).
 
Very interesting links thanks. It would be interesting to chart his predictions and their changes

Dec 2006 - Irish Times
house prices will fall by 50% - I don't have access to this article

July 2007 - ESRI
House prices will fall by 50%
This will disrupt the Irish economy and Irish public finances as we are so dependent on construction
The larger Irish banks are well capitalised

September 2008 - Prime Time
The banks are bust

Post guarantee - 2008 -
Putting money into Anglo is the same as burning it in St Stephen's Green

2009 (?)
The country will go bankrupt
Irish government debt will be €250 billion in 2014 ( Net debt was €185 billion at end 2013)

January 2009
The country will demolish more houses than we will build over the next decade

30 December 2010 - date on his Excel spreadsheet
(This could be the date which I saved it though, and not the date he created it)
Losses due to mortgage default - €4 billion to €8 billion

?
If you thought that the bank bailout was bad, wait until mortgage defaults hit home
Implies losses on mortgages in excess of €60 billion - 10 times his previous estimate


August 2011
The state will need another €5 billion for the banks for losses on 10,000 mega mortgages of between €1m and €2m.


March 2013
The ECB will tell the banks to move in on the SME sector in Ireland which will destroy the economy
 
FROM RTE Morning Ireland 'To The Editor':


"I listened to the UCD lecture given by Professor Morgan Kelly with great interest and the subsequent discussions. Economists make assumptions - hence taking what Prof Kelly says out of context is where you get the insane headlines. A few examples might help. Low interest rates courtesy of ECB was the most important factor keeping SMEs afloat. Then he went on to say we knew nothing about the SME sector. Then he seemed to say that there were huge volumes of property loans hanging out of SMEs. Then he said that extending term of loans was not a solution. All very well except as we know business people seem to not understand economics very well. So any businessman that bought Government Bonds at 40c became rich. In fact had we any confidence at that time we could probably have written off a lot of debt by buying it back at 40c - a proper bonfire of bondholders versus what we actually got. Morgan's strategy is simply to say there is a collapse and then slowly let slip into the conversation the conditions that would need to exist for that situation. For the SMEs - it's low interest rates ending. It's the non-recovery of property markets. But he never said the banks were actually falsifying their figures. What he said was the defaults would come when the interest rates went up. With virtually zero construction, do people seriously believe that the rise in property prices is an illusion? Flick through the press at the start of the last boom. Denials that it was a boom. It was temporary. The famous Bacon Report. The reality was a sustained increase in demand; restricted supply (US can double housing output in 2 years); incomes up; taxes down etc. He went on to say a lot more on many topics which you did not cover - just look at his comments on Health."
 
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