Ireland and America, The 2008 Crash - Part 2

What happens when the belief “sure everyone pays their mortgage” no longer holds as happened in 2007. Developers, then and now, are hugely reliant on bank funding in order to build apartments and houses in volume. After the Euro was adopted here in 2002, buckets off cash were available from European banks, especially German banks, and this cash found its way into Irish banks and then Irish developers. We see how all these big movements contributed to a crash in the world economy and depression in Ireland.

Warning: This podcast does not constitute financial or tax advice.  Please contact a financial advisor or tax advisor to discuss your own individual circumstances, taking into account your needs and objectives, knowledge and experience and financial situation.

Transcript

SPEAKER_00 0:01

Welcome to Cash Labs. My name is Paul Malloy from BoxcoverTax.ie and this is Marcus Doyle from Clear Financial. We're here to take the mystery out of money and finance with some history, some stories, and plenty of humor too.

SPEAKER_01 0:20

Hello there everyone. It's good to see you. You may recall, folks, Marcus, we we we were touching on, I suppose, the 2008 crash and where it kind of started.

SPEAKER_02 0:32

18 years ago.

SPEAKER_01 0:33

18 years ago, we're old now. Yeah. But it it uh we we touched on, I suppose, how how the Irish economy got to where it got and what was happening in you know Wall Street with with especially with the um the Wall Street banks buying up mortgages from regional banks or small banks in America uh and making tons of money from uh because the old adage sure everyone pays their mortgage, but we'll see what happened when some people stop paying their mortgage. Okay, so back to back to uh to Ireland, and um I don't know how much familiarity people have with property development or how much thought you've given to it. Um but from a cash flow point of view, this is not a good business because the first thing you've got to do is if you want to build, say, 100 apartments, you've got to buy the side. That's the first thing you've got to do. Then you've got to hire all the professionals like surveyors and engineers and architects. Uh they're all uh crucial. Then you've got to hire the workers who are gonna actually build it. They're not gonna wait for their wages, they want their wages that that week. Um, all the materials, cement, all of that has to be paid for. And generally speaking, it comes from from banks. So a bank will lend to a developer for a two, three, four-year, five-year period, however long that they feel the development's going to take, because without that lending, none of this happens. No, without that credit, none of this happens. So it's it's it's it's it's a it's a tough old business. My father, Chris, was in was a property developer, and you know, he kind of did one site at a time, and and he he would see, you know, contemporaries of his building five, six, seven, eight sites. And they're running around Dublin or wherever it is, all the different sites, and they're being robbed left, right, and centre by people on site. So it's it's it's it's it's a tough business. Um, if you if you do it well, you can make money, but I think there's a perception that it's really, really easy. But ignoring that, um, bank lending is essential. You just it's just very, very difficult to do this, unless you've got a pot of cash. Uh, it's very, very difficult to to do this. So um, you know, up to the time Ireland joined the Euro, say, you know, late 90s or you know, or very early 90s, we joined in January 2002. That's when we started started using the the euro. Um I remember, yeah, we've had to do the convertible change over from the old point. Yeah, yeah, the old point, God.

SPEAKER_02 3:09

You had the little calculator thing. Do you remember the little euro calculator?

SPEAKER_01 3:12

Yeah, yeah, I do. I do, I do, I do. But yeah, I mean, like for particularly our younger listeners, we've only ever known the euro, but there was there was a separate currency. And um, you know, prior to joining the Euro, if banks got their money really from, I suppose, depositors, so you and me putting our savings in there, um, they got their money from uh companies who were also putting savings in there, and then maybe local local property fund local pension funds or life insurance companies would would uh would uh put their mud some money in the bank as well. But there wasn't an awful lot of money going around, and this changed with the euro because the the German banks had the opposite problem to the Irish banks. The Irish banks didn't have enough money. They had loads of people who want to borrow, but not enough. You know, the property market had started to pick up in the 1990s, and in Germany, the opposite problem with um like you were saying, Marcus, they're very good savers. Germans are excellent savers, but they're not they'll only borrow if they really need it. You know, it's not like let's not you know mistake things. It's not like they don't borrow at all, it's just that they won't do so unless it's really necessary. Um, so the German banks realized quite quickly that they could lend to the Irish banks at you know uh making a good return, three, three, three, four percent maybe. Um and then the the Irish banks would then lend to the ordinary individual, to property developers, um, to others, but property was a big, big part of it. And what you start to see is prices beginning to pick up. Because if you, me and Eric are all want to buy a place, you know, and I'm I'm the one with the money, I'm gonna get it. But if the three of us have 500 grand from, you know, AIB, Bank of Ireland, Anglo, whatever it happens to be, then we will we will force each other to pay more than we would would wish. And that's that's that's what started to to to happen. And and whilst the the property sector started to build and build, and there was tax reliefs as well from successive info governments, um the the demand was really outstripping the supply. It was hard for the the the developers to to keep up because the demand was just like what's happening now again. Well, yeah, what I mean I I do think our banks are more careful now than they were.

SPEAKER_02 5:49

They're not just they're not just throwing the money out.

SPEAKER_01 5:51

They're not throwing the money out. People people were, you know, there was an an anecdote that there was banks were sending people to bus stops. They were saying to staff, don't come into work until half nine, you know, chat and bus stop with anyone, anyone who's willing to hundred percent mortgages and all that hundred percent mortgages, and then it was like, Well, should you take out a loan to get a new car? So this this all starts uh starts happening, and um and without that kind of euro money, it it doesn't happen. It doesn't happen to the same extent at all. And um, you know, the the as as as the naughtys go on that the Germans are continuing to save money, they're continuing to shove money into German banks, and German banks are going to Spain, Portugal, Ireland, um, Greece in some places, shoving money into effectively from our bank system to to the property developers. And the the next thing we probably need to do is is to is to to go back to uh go back to the US and go back to to what was happening. And we had we had um do you do you have any recollection, Marcus, of of what was going on in the because you were working in finance at that time as a young lad. Do you recall anything about the housing sector or conversations about that in the States?

SPEAKER_02 7:12

I I I don't really No, I think we were so everyone was concentrating on as you as as as we all remember, the Celtic Tiger. We were we were all doing so well, we didn't really care about it. Now I know we knew it all it was all kind of part of the fact that we had all these American multinationals in the co in the country and they were supplying all the jobs, paying loads of well, paying very little tax turned out yet, but still they were boosting up our economy and our still dependent on it. But yeah, we kind of we didn't really know anything about the importance the Americans were. I don't think we did.

SPEAKER_01 7:39

I remember talking to a girl, she worked on uh shorts on Wall Street, um in a in a de different area to to to to this whole area, like and they were aware of what was going on. They felt it sounded a bit mad, but they didn't really look into it too much, you know. And I I think sometimes you could watch a film like The Big Short and think that you know the whole world should have known, you know, but like people are busy with their own lives, you know, and the the ordinary person doesn't have time to worry about an uptick in uh default ratios in in in Ohio, you know.

SPEAKER_02 8:14

Subprime mortgages that they didn't even know about.

SPEAKER_01 8:16

No, so it was very much that'll sort itself out type job. The economy was going very well. The economy was going well. I mean, they they had the dot-com crisis and they had um 9-11, obviously, as well. But you know, the early noughties was it was quite a quite a quite a good time in America. The economy was generally, generally going quite well. And this is you know back to something we touched on in the in the last episode was that um it's not about can you pay your mortgage when things are easy. We know that. We know you can do that, but can you pay it when they're tough? And then that's what starts to happen over the over the mid, you know, from 2005, 2006 onwards. It starts getting um it starts getting a bit a bit trickier, but we're we're back to the uh these mortgage back securities, these things that make make imaginary or you know, amazing money, you know, five, six percent return for its investors. The the banks in local banks are all all delighted, you know. But I mean if you can imagine the you know, I I I think the movie This Big Short does do it very well, the two, the kind of the two young lads that are boasting about all the clones they're making, you know, and they can't lend to people whose credit is bad enough, you know. They they just uh they're just lend lending to anybody, like you know, and how how how how did a system go from where banks are being cautious in America to the point where they're just being ridiculously careless? And these investments, this generated five to six percent a year, these are not well-known uh equities like Microsoft or Amazon or one of these that are really, really well known. These were not those, they were not US Treasuries, these were not uh you know oil or any any of the well-known commodities. These were brand new and they were not well known. And no one was gonna touch these unless the rating agencies gave them a very, very high rating. And what happens with the rating agencies is that let's say you have it one of these one of these funds markets, okay? So you've you've you've you've got money from investors, yeah, you've paid off the banks, and now you own the mortgages and you want to watch the money just just grow. Just grow and grow. Um, but you can't start selling that to investors until I approve it. Okay. And the deal is that if I give you a rating that you're happy with, I'll give you a bit of money. You'll give me money. Um now, naturally enough, we'll talk at the beginning. And if I say I don't think I'm gonna give you a good rating here, then nothing, nothing happens. But I also know from experience that if I don't give you the rating that you want, my competitor down the road, whose morals are even looser than mine.

SPEAKER_02 11:18

Erica.

SPEAKER_01 11:19

Erica. Erica. Erica D. Erica's gonna say yeah, whatever you want. So so this issuer pays model creates a massive incentive. It's it's like it's like the referee asking for money to get the decisions that you want. And but we we would laugh about that.

SPEAKER_02 11:36

Yeah.

SPEAKER_01 11:37

That that that a sport could be so bent uh or so corrupt. But this this was the system, and and this is where it all happened. So these you know, these investments came in, and initially, like we said, they were high, high quality. They were really the best of the best mortgages.

SPEAKER_02 11:58

The people are paying their previous premiums back, never defaulted, never missed the premium, never missed the mortgage pay.

SPEAKER_01 12:04

So these are the ones that could come and land in.

SPEAKER_02 12:08

And then the rating agency obviously value them highly, the triple A's and all that, because they're being paid.

SPEAKER_01 12:13

Because they they they genuinely thought they were they were good. And a couple things a couple things start to happen. Firstly, the best mortgages are now gone or dwindling. So if you had a thousand mortgages and you had, you know, nine hundred and ninety-five of them were fine, and and five and five were slow paying, or maybe one or two defaults, you're still making loads of money. Still making loads of money. But what happens now is that 995 starts becoming 975 or 960 or 950. And so the quality starting to drop. So the first thing is if the quality starts to drop, the first thing that should be happening is the rating agencies should be should be reducing the rating. That's that should be happening. Yeah. That doesn't happen. No. Because of the because of the systemic issue of issuer pays, it's we're still back to the point that okay, maybe 25 of them now are a bit bit more risky. But if you don't give me the rating, Erica will. Eric will take it. So that hasn't stopped. That hasn't stopped. We've our percent engineer is getting an awful passion. Yeah. Uh she's she's a highly moral person, uh indeed. But we're just making the example. Um, and another thing that that happens, and it goes back to that um that big short thing, which is the lending standards in the local banks start to drop off because you you know, it's your phone market, you're coming to me, let's say I'm the local bank, and I'm thinking, geez, he's this guy's gonna take any mortgage I give. You know, and then I'm I'm thinking some of the normal checks that I would have made, or some of the normal, you know, are you are you working? Um, well, it's I'm only there six months, whereas previously, if I had a kind of a low level of uh low period of time working with someone, you would say, Well, that would have ruled me out. We need someone who has two, three years working. So now I'm going, well, as long as it's it's a year, it's fine. Yeah. Um, do you have much of a deposit? Well, you know, I don't have the five percent, but I have three percent. Well, that's fine. Because at the back of my mind, I know Marcus doesn't care. Yeah, this big bank on Walls. Is your partner working? Why they had them issue there. No, all of these tests are are are you know our signals, our future signals. If the if you if you can't meet these tests, you are the type of person, once trouble hits, who will send me back the keys and say good luck. You know, there's no like in the States. Now this may have changed, but I'm pretty sure up to 2008, if you were in negative equity, so if your loan was 500 grand, but that the house had fallen to 450, you could just literally give them the keys and say, your problem. Um, whereas in Ireland, you know, uh that that wasn't the case. So um this this dynamic of I don't really care too much if it's risky, Paul, because I'm gonna buy it off you.

SPEAKER_02 15:20

I've got I've my investors. They want this fund.

SPEAKER_01 15:24

So it's just it's just a kind of a creeping, you know, um, a creeping, uh, creeping thing. And you know, these lot the loss of standards and the lack of the reduction in quality mortgages means that these investments should be marked down from triple A to A. But they don't get marked down. And it's it's hard to believe given how how influential these rating agencies were in leading in leading to uh the crash. How did they get away with it? In terms of, you know, back in 2001, there was a company called World, I think I can I can't remember who what the the order was, but there was WorldCom and then there was uh Enron. And Enron were the dodgy, remember the Enron would be the Enron was the companies, yeah, there were dodgy accounts and everything. You know, energy traders or something like that. And their books were just you know, and WorldCom had staff traveling all over the world and they treated it as an asset rather than an expense. And by doing that, their profits looked very, very good. But Arthur Anderson, who's highly respected, the most respected, not the biggest, but the most respected, the best the best students went to Arthur Anderson. They were the auditors of both of those companies. And within those they had those two events happened so shortly. Uh you know, there were such a short gap between the two of them. They were gone. They disappeared. I I met many um Arthur Anderson staff, and they said their heads were spinning like they couldn't believe that their jobs, their jobs were gone. And and so how the the rating agencies have continued uh in there. Now we're not going to talk about uh collateralized uh debt obligations and and stuff like that, but if if things had just progressed the way they were with these investment investment funds that were being rated highly but were increasingly riskier and riskier, the trouble would have just would have would have kept going, you know. Um but what they started to do, and and and I'm just mindful of not trying to blow people's heads off, but what they started to do was they started to come up with all kinds of financial stuff. Like they started to take those investment funds and they started slicing and dicing them up. And then there came a point, particularly towards the end, nobody really knew who owned what. There was no visibility, there was no, it was very opaque, there was no, there was no trail. And then, you know, if if you want to bet uh 250,000 euros on Caldera winning in the All-Ireland markets, which is you know, it's going to be a fur, it's going to be a great time. But here here's what here's when you say to me, you know, Paul, I'm a bit worried about this bet. I think I may have maybe overdone it. We mightn't even make it out of Leinster. But you give me insurance on my bet. So if it doesn't come through, you'll pay it pay me off. That's what happened with this stuff. So they were the um that's just the term which just popped out of my head, but um this this kind of insurance on a burning house um was just hard to believe. So it's it's we we'll come back to that again. We'll we'll come back to the, I suppose, what happened in the last kind of year of 2008, that just you know, with Bear Stearns in March and then Lehman Brothers. But it was just essentially the banks, they all got there towards the end, and they stopped lending to each other because they all knew they were they each knew they were dodgy as whatever. They had loads of bad debt and they weren't going to give it to anybody else because they figured their competitors uh were just as bad. As bad. We'll use the word bad, uh, or as it's in much trouble. So I think we'll we'll leave it to there today. Uh thanks very much. Uh I hope everyone enjoyed listening. See you next time. See ya.