Boomerang: Travels in the New Third World

by Michael Lewis

  HOW DID ANY of this happen? There are many theories: the elimination of trade barriers, the decision to grant free public higher education, a low corporate tax rate introduced in the 1980s, which turned Ireland into a tax haven for foreign corporations. Maybe the most intriguing was offered by a pair of demographers at Harvard, David E. Bloom and David Canning, in a 2003 paper called “Contraception and the Celtic Tiger.” Bloom and Canning argued that a major cause of the Irish boom was a dramatic increase in the ratio of working-age to non–working-age Irishmen, brought about by a crash in the Irish birthrate. This in turn had been mainly driven by Ireland’s decision, in 1979, to legalize birth control. That is, there was an inverse correlation between a nation’s fidelity to the Vatican’s edicts and its ability to climb out of poverty: out of the slow death of the Irish Catholic Church arose an economic miracle.

  The Harvard demographers admitted their theory explained only part of what had happened in Ireland. And at the bottom of the success of the Irish there remains, even now, some mystery. “It appeared like a miraculous beast materializing in a forest clearing,” writes the preeminent Irish historian R. F. Foster, “and economists are still not entirely sure why.” Not knowing why they were so suddenly so successful, the Irish can perhaps be forgiven for not knowing exactly how successful they were meant to be. They’d gone from being abnormally poor to being abnormally rich without pausing to experience normality. When, in the early 2000s, the financial markets began to offer virtually unlimited credit to all comers—when nations were let into the dark room with the pile of money, and asked what they would like to do with it—the Irish were already in a peculiarly vulnerable state of mind. They’d spent the better part of a decade under something very like a magic spell.

  A few months after the spell was broken, the short-term parking lot attendants at Dublin Airport noticed that their daily take had fallen. The lot appeared full; they couldn’t understand it; then they noticed the cars never changed. They phoned the Dublin police, who in turn traced the cars to Polish construction workers, who had bought them with money borrowed from the big Irish banks. The migrant workers had ditched the cars and gone home. A few months later the Bank of Ireland sent three collectors to Poland to see what they could get back, but they had no luck. The Poles were untraceable. But for their cars in the short-term parking lot, they might never have existed.

  MORGAN KELLY IS a professor of economics at University College Dublin, but he did not, until recently, view it as his business to think much about the economy under his nose. He had written a handful of highly regarded academic papers on topics regarded as abstruse even by academic economists (“The Economic Impact of the Little Ice Age”). “I only stumbled on this catastrophe by accident,” he says. “I had never been interested in the Irish economy. The Irish economy is tiny and boring.” Kelly saw house prices rising madly, and heard young men in Irish finance to whom he had recently taught economics try to explain why the boom didn’t trouble them. And the sight and sound of them troubled him. “Around the middle of 2006 all these former students of ours working for the banks started to appear on TV!” he says. “They were now all bank economists and they were nice guys and all that. And they were all saying the same thing: ‘We’re going to have a soft landing.’”

  The statement struck him as absurd on the face of it: real estate bubbles never end with soft landings. A bubble is inflated by nothing firmer than people’s expectations. The moment people cease to believe that house prices will rise forever, they will notice what a terrible long-term investment real estate has become, and flee the market, and the market will crash. It was in the nature of real estate booms to end with crashes—just as it was perhaps in Morgan Kelly’s nature to assume that if his former students were cast on Irish TV playing the financial experts, something was amiss. “I just started Googling things,” he said.

  Googling things, Kelly learned that more than a fifth of the Irish workforce was now employed building houses. The Irish construction industry had swollen to become nearly a quarter of Irish GDP—compared to less than 10 percent or so in a normal economy—and Ireland was building half as many new houses a year as the United Kingdom, which had fifteen times as many people to house. He learned that since 1994 the average price for a Dublin home had risen more than 500 percent. In parts of Dublin rents had fallen to less than 1 percent of the purchase price; that is, you could rent a million-dollar home for less than $833 a month. The investment returns on Irish land were ridiculously low: it made no sense for capital to flow into Ireland to develop more of it. Irish home prices implied an economic growth rate that would leave Ireland, in twenty-five years, three times as rich as the United States. (“A price/earnings ratio above Google’s,” as Kelly put it.) Where would this growth come from? Since 2000, Irish exports had stalled and the economy had become consumed with building houses and offices and hotels. “Competitiveness didn’t matter,” says Kelly. “From now on we were going to get rich building houses for each other.”

  The endless flow of cheap foreign money had teased a new trait out of a nation. “We are sort of a hard, pessimistic people,” says Kelly. “We don’t look on the bright side.” Yet since the year 2000 a lot of people had behaved as if each day would be sunnier than the last. The Irish had discovered optimism.

  Their real estate boom had the flavor of a family lie: it was sustainable so long as it went unquestioned and it went unquestioned so long as it appeared sustainable. After all, once the value of Irish real estate came untethered from rents, there was no value for it that couldn’t be justified. The 35 million euros Irish entrepreneur Denis O’Brien paid for the impressive manor house on Dublin’s Shrewsbury Road sounded like a lot until the real estate developer Sean Dunne’s wife paid 58 million euros for the four-thousand-square-foot fixer-upper just down the street. But the minute you compared the rise in prices to real estate booms elsewhere and at other times, you reanchored the conversation; you biffed the narrative. The comparisons that sprung first to Morgan Kelly’s mind were with the housing bubbles in the Netherlands in the 1970s (after natural gas was discovered in Holland) and Finland in the 1980s (after oil was found off its coast), but it almost didn’t matter which examples he picked: the mere idea that Ireland was not sui generis was the panic-making thought. “There is an iron law of house prices,” he wrote. “The more house prices rise relative to income and rents, the more they will subsequently fall.”

  The problem for Kelly, once he had these thoughts, was what to do with them. “This isn’t my day job,” he says. “I was working on medieval population theory.” By the time I got to him Kelly had angered and alienated the entire Irish business and political establishment, but he was himself neither angry nor alienated, nor even especially public. He’s not the pundit type. He works in an office built when Irish higher education was conducted on linoleum floors, beneath fluorescent lights, surrounded by metal bookshelves, and generally felt more like a manufacturing enterprise than a prep school for real estate and finance—and likes it. He’s puckish, unrehearsed, and apparently—though in Ireland one wants to be careful about using this word—sane. Though not exactly self-denying, he’s clearly more comfortable talking and thinking about subjects other than himself. He spent years in graduate school, and collected a doctorate from Yale, and yet somehow retained an almost childlike curiosity. “I was in this position—sort of being a passenger on this ship,” he says. “And you see a big iceberg. And so you go and ask the captain: Is that an iceberg?”

  HIS WARNING TO his ship’s captain took the form of his first ever newspaper article. Its bottom line: “It is not implausible that [Irish real estate] prices could fall—relative to income—by 40 to 50 percent.” At the top of the market, he guessed, prices might fall by a staggering 66 percent. He sent his first piece to the small-circulation Irish Times. “It was a whim,” he says. “I’m not even sure that I believed what I was saying at the time. My position has always been, ‘You can’t predict the future.’”
As it happened, Kelly had predicted the future, with uncanny accuracy, but to believe what he was saying you had to accept that Ireland was not some weird exception in human financial history. “It had no impact,” Kelly says. “The response was general amusement. It was what will these crazy eggheads come up with next? sort of stuff.”

  What the crazy egghead came up with next was the obvious link between Irish real estate prices and Irish banks. After all, the vast majority of the construction was being funded by Irish banks. If the real estate market collapsed, those banks would be on the hook for the losses. “I eventually figured out what was going on,” says Kelly. “The average value and number of new mortgages peaked in summer 2006. But lending standards were clearly falling after this.” The banks continued to make worse loans, but the people borrowing the money to buy houses were growing wary. “What was happening,” says Kelly, “is that a lot of people were getting cold feet.” The consequences for Irish banks—and the economy—of the inevitable shift in market sentiment would be catastrophic. The banks’ losses would lead them to slash their lending to actually useful businesses. Irish citizens in hock to their banks would cease to spend. And, perhaps worst of all, new construction, on which the entire economy was now premised, would cease.

  Kelly wrote his second newspaper article, more or less predicting the collapse of the Irish banks. He pointed out that in the last decade the Irish banks and economy had fundamentally changed. In 1997 the Irish banks were funded entirely by Irish deposits. By 2005 they were getting most of their money from abroad. The small German savers who ultimately supplied the Irish banks with deposits to re-lend in Ireland could take their money back with the click of a computer mouse. Since 2000, lending to construction and real estate had risen from 8 percent of Irish bank lending (the European norm) to 28 percent. One hundred billion euros—or basically the sum total of all Irish bank deposits—had been handed over to Irish commercial property developers. By 2007, Irish banks were lending 40 percent more to property developers alone than they had to the entire Irish population seven years earlier. “You probably think that the fact that Irish banks have given speculators €100 billion to gamble with, safe in the knowledge that the taxpayers will cover most losses, is a cause for concern to the Irish Central Bank,” Kelly wrote, “but you would be quite wrong.”

  THIS TIME KELLY sent his piece to a newspaper with a far bigger circulation, the Irish Independent. The Independent’s editor wrote back to say he found the article offensive and wouldn’t publish it. Kelly next turned to the Sunday Business Post, but the editor just sat on the piece. The journalists were following the bankers’ lead and conflating a positive outlook on real estate prices with a love of country and a commitment to Team Ireland. (“They’d all use this same phrase, ‘You’re either for us or against us,’” says a prominent Irish bank analyst in Dublin.) Kelly finally went back to the Irish Times, which ran his piece in September 2007.

  A brief and, to Kelly’s way of thinking, pointless controversy ensued. The public relations guy at University College Dublin called the head of the Department of Economics and asked him to find someone to write a learned attack on Kelly’s piece. (The department head refused.) A senior executive at Anglo Irish Bank, Matt Moran, called to holler at him. “He went on about how ‘the real estate developers who are borrowing from us are so incredibly rich they are only borrowing from us as a favor.’ He wanted to argue but we ended up having lunch. This is Ireland, after all.” Kelly also received a flurry of worried-sounding messages from financial people in London, but of these he was dismissive. “I get the impression there’s this pool of analysts in the financial markets who spend all day sending scary e-mails to each other.” He never found out how much force his little newspaper piece exerted on the minds of people who mattered.

  It wasn’t until almost exactly one year later, on September 29, 2008, that Morgan Kelly became the startled object of popular interest. The stocks of the three main Irish banks, Anglo Irish, AIB, and Bank of Ireland, had fallen by between a fifth and a half in a single trading session, and a run on Irish bank deposits had started. The Irish government was about to guarantee all the obligations of the six biggest Irish banks. The most plausible explanation for all of this was Morgan Kelly’s narrative: that the Irish economy had become a giant Ponzi scheme, and the country was effectively bankrupt. But it was so starkly at odds with the story peddled by Irish government officials and senior Irish bankers—that the banks merely had a “liquidity” problem and that Anglo Irish was “fundamentally sound”—that the two could not be reconciled. The government had a report newly thrown together by Merrill Lynch, which declared that “all of the Irish banks are profitable and well-capitalized.” The difference between the official line and Kelly’s was too vast to be split. You believed either one or the other, and up until September 2008, who was going to believe this guy holed up in his office wasting his life writing about the effects of the Little Ice Age on the English population? “I went on TV,” says Kelly. “I’ll never do it again.”

  KELLY’S COLLEAGUES IN the University College economics department watched his transformation from serious academic to amusing crackpot to disturbingly prescient guru with interest. One was Colm McCarthy, who, in the Irish recession of the late 1980s, played a high-profile role in slashing government spending, and so had experienced the intersection of finance and public opinion. In McCarthy’s view the dominant narrative inside the head of the average Irish citizen—and his receptiveness to the story Kelly was telling—changed at roughly ten o’clock in the evening on October 2, 2008. On that night Ireland’s bank regulator, a lifelong Central Bank bureaucrat in his sixties named Patrick Neary, came live on national television to be interviewed. The interviewer sounded as if he had just finished reading the collected works of Morgan Kelly. The Irish bank regulator, for his part, looked as if he had been dragged from a hole into which he badly wanted to return. He wore an insecure little mustache, stammered rote answers to questions he had not been asked, and ignored the ones he had been asked.

  A banking system is an act of faith: it survives only for as long as people believe it will. Two weeks earlier the collapse of Lehman Brothers had cast doubt on banks everywhere. Ireland’s banks had not been managed to withstand doubt; they had been managed to exploit blind faith. Now the Irish people finally caught a glimpse of the guy meant to be safeguarding them: the crazy uncle had been sprung from the family cellar. Here he was, on their televisions, insisting that the Irish banks’ problems had nothing whatsoever to do with the loans they’d made . . . when anyone with eyes could see, in the vacant skyscrapers and empty housing estates around them, evidence of bank loans that were not merely bad but insane. “What happened was that everyone in Ireland had the idea that somewhere in Ireland there was a little wise old man who was in charge of the money, and this was the first time they’d ever seen this little man,” says McCarthy. “And then they saw him and said, Who the fuck was that??? Is that the fucking guy who is in charge of the money??? That’s when everyone panicked.”

  ON THE MORNING of the day the Irish government planned to unveil a brutal new budget, I took my seat in the visitors’ gallery of the Irish parliament. Beside me sat an aide to Joan Burton, who, as the Labor Party’s financial spokesperson, was at the time a fair bet to become Ireland’s next minister of finance, the unnatural heir to an unholy mess. Down on the floor the seats are mostly empty, but a handful of politicians, Burton included, discuss what they have been discussing without intermission for the past two years: the nation’s financial crisis.

  The first thing you notice when you watch the Irish parliament at work is that the politicians say everything twice, once in English and once in Gaelic. As there is no one in Ireland who does not speak English, and a vast majority who do not speak Gaelic, this comes across as a forced gesture that wastes a great deal of time. I ask several Irish politicians if they speak Gaelic, and all offer the same uneasy look and hedgy reply: “Enough to get by.” The
politicians in Ireland speak Gaelic the way the Real Housewives of Orange County speak French. To ask “Why bother to speak it at all?” is of course to miss the point. Everywhere you turn you see both emulation of the English and a desire, sometimes desperate, for distinction. The Irish insistence on their Irishness—their conceit that they are more devoted to their homeland than the typical citizen of the world—has an element of bluster about it, from top to bottom. At the top are the many very rich Irish people who emit noisy patriotic sounds but arrange officially to live elsewhere so they don’t have to pay tax in Ireland; at the bottom, the waves of emigration that define Irish history. The Irish people and their country are like lovers whose passion is heightened by their suspicion that they will probably wind up leaving each other. Their loud patriotism is a cargo ship for their doubt.

  ON THIS DAY, in addition to awaiting word on the budget, the Dáil (pronounced “Doyle”), as the Irish call their House of Representatives, had before it what should have been a controversial piece of business: to vote on whether to call elections to fill its four empty seats. The ruling party, Fianna Fáil, held a slim majority of two seats and, because they are universally believed to have created a financial catastrophe, an approval rating of 15 percent. If the elections were held immediately, they’d have been tossed from power—in itself a radical idea, as they have more or less ruled Ireland since its founding as an independent state, in 1922. Yet they successfully resisted the call to fill the empty seats, right up until they were tossed from power in February 2011.