Not so much looking down as across..

Monday, December 20, 2010

Where has all the money gone?

Where has all the money gone?

A fellow blogger asked this simple question some weeks ago.
It is a reasonable question to ask.
We were told a mere three years ago that we Irish were the wealthiest people in Europe if not the whole wide world. How can it be that we have been reduced, seemingly, to being the beggars of Europe?
Did we blow it all? Where did we spend those billions we now owe and how did we manage to spend it so effortlessly?

Here’s my Ladybird approach to economics.

Filthy lucre or money has two functions – it allows for the payment of goods and services and also tries to put a value on a specific good or service.

The first function is much easier to follow. I work as a teacher. I get my wages at the end of the month. I buy a litre of milk in the shop and hand over a euro. The shop takes a little profit and pays the dairy, which after taking a little profit pays the farmer. We can follow the money splendidly.

During my working life I was always fascinated by how that one farmer supported the Co op who bought from him and the retailer who bought from the co op, and the insurance salesman which insured the cow and the banker who lent for the cow. The only person, it seemed to me, who was creating anything of value was the farmer, the rest were simply living off him. We might go a little further if we believe in animal rights and give the full credit to the cow, but that is for an udder day.

The second function is to put a value on an object - say my house. It is an anticipated value, because I won’t know how much it is really worth until I sell it. The same holds true of the stock market where values are assigned to shares. Because shares trade daily we can much surer of the value from a day to day to basis(unfortunately).

Let’s look at an imaginary comfortable upper middle class family. Let’s call them Black, (they were once in the black) whose family balance sheet looked like this at the end of 2007
Family home Cost 750k Value 2,000k Debt 600k
Investment property Cost 500k Value 700k Debt 400k
Bank Shares Cost 500k Value 700k Debt 400k
Holiday Home Cost 350k Value 400k Debt 300k

Total Cost 2,100 Value 3,800k Debt 1,700k

The net worth of the Black family at the end of 2007 was 2,100k
Mr. Black was earning 150k pa and received a bonus of 150k at the end of ’07. Mrs. Black is a teacher who was being paid 50k pa.
The loans were interest only and cost 50k pa

At the end of 2010, things have changed for the worse, and now the Blacks are in the red
Values have fallen as follows

Family home 1,000k (if they can find a buyer)
Investment property 350k (they are having problems finding tenants)
Bank shares 10k (no point in selling them at this stage)
Holiday Home 150k (lovely house on the Shannon that no one wants to buy)

Revised net worth Minus 190K

Mr. Black has taken a 20% decrease in salary to 120k and no bonus is being currently paid. Mrs. Black’s gross pay has remained the same but tax and deductions have reduced the take home pay.

In the case above, we might ask, where has the money gone?
There have been no transactions, so there is no money to follow.
But the problem for the Blacks, their Bank and the taxpayers who own the Bank, is that the Black family now owes more than they own and their chances of repaying these loans are very much reduced. They will have to be forgiven some of these loans if they are ever to repay the balance – but no one has worked out how much, or how it might be fair. The Black’s problem has become a problem for the tax payer including the Red family who have not moved house since they married forty years ago and never borrowed for anything but saved all their lives.

Here’s a Black example of money changing hands. Let’s imagine that the Blacks adult son bought an apartment in Dublin in July 2010 for 350k, which had been for sale in 2007 for 700k.
Let’s try and follow the money
Site cost to the builder in 2007 200k
Cost of building 2007/8 200k
Bank charges 50k
Overheads 40k
Fees 40k
Total cost 530k

Loss on the apartment 180k

Let’s see how the apartment was funded and follow the money

The Banks is owed 400k
Subcontractors 50k
Other creditors 30k
The Developer 50k

The following people will lose money (indeed already have)

The developer 50k
Subcontractors 20k (they will have to be paid something by the bank to finish the apartment
Other creditors 30k
The Bank 80k

That would explain why the developer has gone bust, why the subcontractor is hurting
And the bank is bleeding.

We might ask: what has happened with the money that was paid for the site – 200k?
It was paid to a farmer who sold 500 sites at the time and received 100m.
There are three possible general scenarios as to how he spent the money:

a) The farmer put the money on deposit and is playing golf in the Algarve

b) The farmer put one third on deposit, one third into property and one third into shares – he has probably lost only half his money and is now playing golf in Ireland

c) The farmer got great advice from experts who showed him how by borrowing 300m he could acquire a trophy property in Canary Wharf. Sadly now he has lost all his money and is probably worth minus 100m.

Anecdotally it seems as if option three was the only one generally employed. Assuming the farmer bought the property from an East end boy, someone in London is now playing golf in Florida.

Looking at Ireland Inc, a big part of our problem is that all of our overseas ventures and much of our domestic ones too were financed by overseas banks or by Irish banks who borrowed overseas and now our overseas friends want their money back.

As capitalism and leverage lifts us on the way up, it crucifies us on the way down. Ireland needs low interest rates so as to be able to repay the money but is punished with high rates which make the possibility of default a lot stronger.

Banking is the art of giving only money to people who don’t need it. Occasionally bankers forget this axiom and lapse by giving money to people who cannot afford to pay it back. A bank that has lost the confidence of its depositors is like a virgin who has lost her virginity, you cannot buy back either confidence or indeed virginity. Confidence in Banking as in life can only be given, it cannot be proscribed.

To conclude, much of what we have lost is implied value – that is not to say it is unreal, on the contrary the halving of the value of my house is very real for me and painful for my wife.

There is a further argument that would suggest that much if not all of our gains over the past ten to fifteen years have been made on the back of our simply borrowing from strangers who kindly lent to us having worked hard themselves to save the money in the first place. Now, the argument continues, we will have to work even harder for less so as to repay the debts. Not even a moneylender will look at us for the next few years. Our living standards will decline. The hard working, hard saving Chinese will see their standard of living rise. And there is nothing unfair about that.


  1. Hi Padraic,

    I just wanted to stop by and say HI!

    I hope you and your family had a wonderful Christmas!


  2. Hi Doris,,
    Thanks for your kind comment.
    Happy Christmas to you and yours and a very peaceful New Year!