BUSINESS OPINION:At least 200,000 households could be in negative equity by the end of next year, writes JOHN McMANUS

JOSEPH STIGLITZ has a Nobel prize in economics and, as such, it behoves one to listen to him. His area of expertise, however, is not the Irish economy, it is the efficiency or lack of efficiency of markets.

A serious question arises then as to how we should take the critique of the Government’s policy response to the economic crisis that he liberally dispensed on his whistle-stop tour of Ireland last week.

Pretty seriously is the answer. Not so much for what he was saying about the merits or otherwise of the National Asset Management Agency (Nama), but more because of the way he honed in on the issue of negative equity and the potentially corrosive effect it could have over the next few decades.

There is something of the elephant in the kitchen about the looming spectre of negative equity. Such is the scale of the problems facing the economy nobody in authority really wants to face up to it at the moment. The Government’s priorities – beyond surviving last weekend – are fixing the banks, fixing the public finances and restoring competitiveness.

The trouble is that the negative equity problem is potentially so large that it could compromise all three of these objectives.

The current best guess as to the number of households that will be in negative equity by the end of next year – at which point the economy is expected to turn – is almost 200,000. The estimate comes from the ESRI (Economic and Social Research Institute) and is relatively conservative on the basis that it uses the Permanent TSB house price index, which is showing a 24 per cent decline in prices since their peak in 2007.

Applying a more aggressive set of assumptions to the ESRI model – namely a 50 per cent decline in prices by end 2010 – gives a figure of 350,000 in negative equity.

The ESRI is surprisingly sanguine about the impact of all this, arguing that most people will keep on paying their mortgages regardless of negative equity. The consequences for the economy are more tangential, affecting issues such as consumer confidence, labour mobility and housing market liquidity, they argue.

Their optimism seems misguided. The the prevalence of negative equity will create a real dilemma with regards to how to best operate Nama in the wider interest of economic recovery.

At first glance widespread negative equity creates an attractive alignment of interest between Nama – and the banks and developers who are its clients – and a great swathe of taxpayers.

It would appear that it is in everyone’s interest that property prices should rise steadily under Nama. The agency would make money and service its debts, the banks would return to profitability, the developers would be back in business and people’s houses would once again be worth more than they paid for them. Happy days!

The problem is that from the perspective of competitiveness, which is ultimately what will determine recovery and sustained prosperity, we don’t want house prices to rise at all.

If you ask any business person what was the number one reason given by staff for seeking pay rises over the last decade, it probably related in some way to the cost of housing.

Workers who wanted to buy houses or move house found that the properties they could afford on their salaries did not match expectations – notwithstanding the banks throwing money at them. So they looked for and mostly got pay rises.

It follows then that keeping the lid on house prices is key to keeping down wages and in the process making the economy competitive. And via Nama, the State is in a position to do just this. In fact its ability to control house prices via Nama stands in some contrast to its inability to wield the more traditional weapons such as interest rates.

Once Nama is established the Government’s control over the property market will be all but absolute. If you accept there is a real nexus between house prices and competitiveness then it seems reasonable for Nama to operate with a clear target for house price inflation in mind. A very low one.

But doing so pretty much condemns between 200,000 and 350,000 households to literally decades of negative equity. It’s not really a viable political option and, even allowing for the rather benign view taken by the ESRI, would have very negative consequences for the wider economy and society in general.

Stiglitz posited the need for governments – both here and elsewhere – to start thinking about solutions to the problem. He favours an approach based around writing off part of people’s mortgages. The International Monetary Fund in its review of the Irish economy, has flagged the need to extend the scope of Nama to include residential mortgages.

A number of domestic commentators have also proposed solutions, but as yet the issue does not seem to figure in the Government’s thinking, or for that matter the Opposition’s criticism of Nama. The various proposals around repossession and personal bankruptcy in the programme for government agreed this weekend don’t really tackle the issue.

Strange, when you think all these people in negative equity have votes.