David McWilliams on middle class debt

January 27, 2010

McWilliams is always a good read, and worth reprinting in full.

How FF put middle class deep into ‘debtor’s prison’

Has Fianna Fail destroyed the Irish middle class? If the answer is yes, then this recession will have considerably more dramatic lasting effects than even some of the most realistic observers suggest. The reason for asking this question is that the huge debts incurred by the broad middle class in the property boom can’t be paid. And with no coherent mechanism for individual mortgage default, the Government is putting bondholders before mortgage holders.

Fianna Fail has placed the middle classes in a ‘debtor’s prison’ and, what is more egregious, it has given the middle classes the bill for the mistakes of Fianna Fail’s developer mates because it is obsessed with keeping the banks afloat in their present crippled state.

This ‘debtor prison’ approach to financial mistakes will bankrupt the middle classes. Today the average Irish family owes €132,000 to the banks. This huge debt overhang, taken together with tax increases and cuts in real wages plus the prospect of families supporting their unemployed children who are living at home, and what we are looking at is nothing less than the shattering of the Irish Dream.

The Irish Dream, like the American Dream, is based on the notion of a progressive conveyor belt of prosperity whereby each generation becomes better off than the generation that came before them. It is an idea rooted in the expectation of progress and the hope that aspirations can be translated into real results, traditionally with the help of increased family investment in education.

As Irish families moved from being predominantly single breadwinner to two income households, we didn’t get richer, we got more indebted and this debt made us feel rich. Feeling rich, we borrowed more and more, cheer-led by Fianna Fail.

This was the Ahern/Cowen conveyor belt. The deal was simple: we Fianna Fail, will keep the house party going and you will feel richer, safe in the knowledge that the next generation will be able to afford the silly prices because the unregulated banks will make the cash available to them. You just vote for us and take the cream. The banks will get the cash because we are in EMU and we will never again face a credit constraint.

This is how the middle classes started to become enfeebled. It began in 2001/2 and went into overdrive in 2004. The Irish Dream of prosperity was a sham and worse still there was no Plan B. No one thought about how we would react when or if the money stopped flowing. Would we have provisions for the inevitable default? Who would come first in the crisis, the people or the banks’ creditors? Without a coherent plan, the same Fianna Fail Government just stumbles from crisis to crisis, hoping the middle class who voted it in has infinite resources to pay for the mess.

But we don’t. We are broke. The middle aged, middle classes are rocked by the sudden unemployment of their children (30pc of our under-25s are unemployed) and the collapse in value of their second home. On top of that, their pension funds — which were invested by charlatans in the shares of Irish banks — are now worthless (and after the nationalisation of the big two, they will be wiped out altogether).

So the “two income”, middle class family in Ireland — as in the US — ends up on a knife-edge. The only way it can maintain its status and ensure that its children have a better opportunity is if Ireland finds a new economic blueprint to kickstart employment. But we are stagnant at best, going backwards at worse.

Without significant job opportunity and income opportunity, the middle class has only two other avenues to maintain its living standards. The first is to sell its assets and the second is to borrow more. But it can’t sell its assets because its assets are houses and these will continue to fall for a few years.

Selling now, even if it saves money over the longer term, will crystallise the losses and leave the average family with a huge debt to the banks. So the natural tendency is to hope that something will turn up. But what if it doesn’t?

The other option is to go back to the Ahern/Cowen model of borrowing to get rich. We know that doesn’t work and anyway it has been supplanted by the Cowen/Lenihan model of the State borrowing in order to try to protect the already decimated shareholders of the banks. This leads to NAMA and the errant folly of betting the country yet again on the hope that the property market will recover to make the bad balance sheet of the banks good again.

But even looked at from first economic principles, for the Fianna Fail plan to happen, the banks have to lend out money. But the middle classes don’t want their money (even if the banks had it) because they are stuffed with debt anyway. In short, the broad middle classes still think that if we do the right thing, things will turn around.

But what if they don’t? What if the middle classes of the likes of Korea, Malaysia and Poland compete with us in a way they they didn’t in the 1990s? What if they are as educated as us and are half the price, hungrier and, most crucially, without the useless debts we have built up?

What happens to the Irish middle class then? It shrinks is what happens. It gets weighed down by unpayable debts, living in a “never-never land” of an overvalued currency and insurmountable debts, tied to worthless assets (houses) in a place where the working population is falling. Given that the middle class provides ballast to society, this is a dangerous thing.

Fianna Fail is well on the way to destroying the very class that put it in power in the past three elections. Extraordinary times demand extraordinary solutions but more of the same has been advocated. Like the Irish Home Rule Party in 1916, denial abounds and a vacuum emerges.

Introducing FreeState51

January 26, 2010