Irish banks are lending at 5% interest when they have to pay at least 8% to borrow funds. This would appear to be a recipe for disaster. Carleton University economist Nick Rowe tries to make sense of this.
Here’s [University College Dublin economist] Morgan [Kelly]:
“The other crumbling dam against mass mortgage default is house prices. House prices are driven by the size of mortgages that banks give out. That is why, even though Irish banks face long-run funding costs of at least 8 per cent (if they could find anyone to lend to them), they are still giving out mortgages at 5 per cent, to maintain an artificial floor on house prices. Without this trickle of new mortgages, prices would collapse and mass defaults ensue.”
Why are banks willing to lend at 5% when they can only borrow at 8%? Morgan says it’s because all the banks are colluding to try to support house prices. Might it instead be that they are all trying to internalise the externality of the common resource problem? And they are aided in this by the fact that there is only one, large, ultimate lender, the ECB [European Central Bank]? And the Irish government is holding the bag (sort of, maybe) for the existing loans?
I can’t work it out.
Nick Rowe, “Bad Irish banks and the Tragedy of the Commons”, Worthwhile Canadian Initiative, 8 November 2010.
Don’t overlook the subsequent interchange between Nick and commenters. It contains many useful ideas.
Tags: Nick Rowe