Ireland's credit rating downgraded; worse to come

Ireland has just been downgraded. It lost its coveted AAA credit rating. Standard & Poor’s weren't comfortable with the country's rapidly deteriorating public finances.

As soon as I heard, I quickly logged onto the Irish Department of Finance website, eager to find some lurid fiscal numbers as a basis for a new post.

Alas, the website is a total mess. The only thing I could find out for sure was that in 2008, the deficit was over 6 percent of GDP. As for recent performance, the Irish are keeping it quiet. As far as I can tell, they don't publish monthly tax or expenditure data.

Undeterred, I logged onto the Irish Central Statistical Office website. There I found some data that pointed to the source of Ireland's difficulties; the housing market, or to be more precise, housing construction.

The Irish bubble was totally different from the one in the UK. Whereas UK planning laws restricted housing construction, Irish planning laws encouraged new building. Over the last 15 or so years, Ireland embarked on a frantic construction frenzy. Between 1991 and 2008, the Irish built over 873,000 new dwellings. In a country with just 4 million inhabitants, this number was extreme.

More recently, the housing construction frenzy accelerated. Between 2002 and 2006, 378,000 homes were built, while census data recorded just 182,000 new households. Rough For every new household created, the Irish economy built two new dwellings.

In 2008, the construction boom came to a ruinous conclusion. The number of completed dwellings fell 45 percent from the 2006 peak. The collapse in construction activity pushed the Irish economy into an appalling recession. Tax revenues have crumbled, and the Irish government is now running up colossal deficits.

There is worse to come. The European Commission forecast that Ireland’s budget deficit may widen to 11 percent of GDP. Credit default swaps, i.e. the cost of insuring Irish government bonds from default, are hovering around 250 basis points. Wallpapering the deficit with Irish government paper is now extremely expensive.

As a member of the Eurozone, the Irish government has few policy options. It cannot devalue the exchange rate, nor can it adjust monetary policy.

With the cost of borrowing rising, it may have to consider an agonizing deficit reduction programme. This will, of course, only serve to reinforce and prolong the present recession. However, housing bubbles are like that. During the good times, they bestow prosperity, and then they cruelly steal it all back.