The Irish Real Estate Bubble: An Emotional Finance Perspective

Clare Branigan (UCD), Paul Ryan (UCD) and Richard Taffler (WBS)

ERES June, 2015

Abstract

Between the mid- 1990’s and the mid- 2000’s, in a period characterized as the Celtic Tiger, the Irish residential real estate market experienced a boom. During the 13 years from 1994 to 2007 house prices rose in excess of 500% and then after March 2007 they started to collapse with a sustained decline continuing for almost six years eventually stabilising in March 2013. From peak to trough this fall was in excess of 50% and in modern times is second only to Japan in terms of magnitude. This series of years of steady price rises accompanied by sustained price declines constitutes a classic speculative bubble which, when it finally burst, had disastrous consequences not only for the housing market, but also for the banking system and the entire Irish economy triggering eventually triggering a bailout from the IMF, European Commission and European Central Bank.

This paper explores the role that individual’s emotions potentially played in firstly escalating and eventually pricking this bubble. To do this we conduct a textual analysis on official reports (including IMF and OECD reports) as well as commentary on the real estate market as reported in the media as prices firstly escalated and eventually declined. We also perform a textual analysis of the official reports that were commissioned after the collapse to investigate their analysis of the causes of the bubble. Our findings are consistent with Kindleberger and Aliber (2011) who couch their model of market bubbles in terms of human emotions, though the official reports into the causes of the crisis were largely silent on emotions as a primary driver. Our results have implications for the effectiveness of official policy responses to prevent a similar bubble emerging in the future.

Motivation

• Irish property bubble and its economywide ramifications

• Irish property bubble second only to Japan in terms of magnitude

• Continuing search for explanations (Commission of Inquiry into the Banking Crisis November 2014- ?)

• Competing hypotheses- Rational economic man (homo oeconomicus)- Behavioural finance (biases and heuristics in decision making leading to sub-

optimal decision making)- Housing as an emotional asset (emotional finance)

Presentation Outline• Overview of tenets of emotional finance and the Kindleberger

and Aliber (2005) model of market bubbles

• Overview of Irish economic data

• Official explanations to date - Honohan Report (May 2010)- Regling and Watson Report (July 2010)- Nyberg Report (March 2011)

• Preliminary Data analysis

• Next steps

Emotional Finance• Critical role of the unconscious

• Investing results in an emotional attachment and ambivalence (emotional conflict) (Tuckett and Taffler, 2012)

• Inherent uncertainty in predictability of future outcomes generating powerful feelings of excitement and anxiety

• Drawing on psychoanalytic understanding of the human mind

• Wish fulfillment and distortion of reality (Auchinloss and Samberg, 2012)Þ feeling what wants to be true rather than what is true

Emotional Finance (cont’d)

• Psychic reality vs external reality

• Pleasure principle vs reality principle (Freud, 1908)

• Consequences are splitting, repression, idealisation, denial

• Results in the emergence of the phantastic object (unconscious wish fullfilment)

Þ Possession leads to unconscious feeling of omnipotence

• Groupthink and work groups vs basic assumption groups (Bion, 1952)

Kindleberger and Aliber- 5 Stages of a Bubble

• Stages- Displacement- Boom- Euphoria- Denial- Blame

• K&A describe rather than explain why!

Graph of House Prices, Price/Income and Price/Rent 1994-2014

. 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

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nominal house pricesprice/incomeprice/rent

Property Lending Vs. GNP (€m) 2000 to 2007

2000 2001 2002 2003 2004 2005 2006 20070

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total property lendingnominal GDP

Proportion of Total Bank Lending attributable to Property Lending 2000-2007

2000 2001 2002 2003 2004 2005 2006 20070

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Chart Title

Index of Private Irish Debt (2000=100)

2000 2001 2002 2003 2004 2005 2006 20070

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constructionreal estatepersonal mortgagestotal lendingnominal GDP

Property- related Tax Revenue

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100

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% of total tax revenue

Irish Stock Market Indices 2000-2014

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

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ISEQ OverallISEQ Financial ISEQ GeneralISEQ Small Cap

Official Reports- Summary Findings

• A key word search for “emotion, “fantasy”, “illusion”, “mania”, “panic”, “unconscious” was undertaken with only a total of 11 hits across the three reports being 9 mentions of “mania” in the Nyberg Report and 2 mentions of “panic” in the Honohan Report. There were no mentions of these words in the Regling Report.

• Official reports only describe and don’t actually ask why!

Summary Findings: Regling Report

Regling Report lay the blame at low interest rate, favourable taxation regime,, breaches of corporate governance and a breakdown in the implementation of risk management processes and only indirectly mentions groupthink on page 41 of the Report:“the response of supervisors to the build- up of macrofinancial risks wain Ireland banking system was the opposite of hands- on or pre-emptive. There was a socio-political context it which it would have taken some courage to seem to prick the Irish property bubble.”

Summary Findings: Honohan Report

• Blame for the crisis are attributed to macroeconomic imbalances, governance structures in the banks and Central Bank and a mistaken belief in the “principles- based” approach to regulation on the part of the Central Bank

• Again only an indirect mention of groupthink on page 16 of the Report:

“... an unwillingness on the part of the CBFSAI to take on board sufficiently the real risk of a looming problem… Rocking the boat and swimming against the tide of public opinion would have required a particularly strong sense of the independent role of the central bank in being prepared to “spoil the party and withstand strong adverse public reaction.” (p.16)

Summary Findings: Nyberg Report

Blame is assigned in a similar fashion to the other two reports but interestingly there are 23 mentions of “herding”, 28 mentions of “groupthink” and 4 mentions of the “bandwagon effect” mostly occurring in a 4 page section termed “Herding and Group Think in Financial Markets” (pp. 7-9) and lays the blame at the belief in efficient markets!

“ … the Commission frequently found behaviour exhibiting bandwagon effects both between institutions (“herding”) and within them (“groupthink”), reinforced by a widespread international belief in the efficiency of financial markets” (page i)

Significant News Events in the Irish Property Bubble and Consequent National Economic

Crisis

• Table 1 distributed!

• Matching to K&A Stages of a Bubble- Displacement: January 1994- December 2000- Boom: January 2000- June 2003- Euphoria: July 2003- June 2007- Denial: July 2007- December 2010- Blame: January 2011- December 2012

Significant News Categories

• Objective is to explore whether the articles published are consistent with K&A model

• Table distributed!

Significant News Events : Key Findings

Overall• Articles on views are consistently high in all phases• Renovations category also consistent

Euphoria phase• Dramatic increase in articles on foreign properties• Greater proportion of articles with positive tone• Greater average number of articles per quarter

Denial phase• Proportion of articles with positive tone declines • Average number of articles published per quarter declines• Substantially less articles on sales transactions consistent with denial• Evidence of ambivalence in articles • Articles on foreign properties decline but is greater than boom phase!• Banks and Politicans categories go up

Significant News Events : Key Findings (cont’d)

Blame• Banks continue to be negative whilst politicians have been

seen to be dealing with the situation• Big increase in the negatively towards property developers• View on property have turned positive!

Next Steps

• News commentary surrounding IMF, OECD reports etc

• Articles mentioning bubble• Articles adulating property developers• Collusion of parties (media, economists,

politicians, banks, property developers etc (Group think)

• Commentary around significant events e.g. Futureshock programme