Want to know the shape of things to come in Ireland? Spain?
Look no further than … Finland.
That particular Nordic nation experienced an almighty financial boom in the 1980s. In 1990 came the the bust — led by a slowdown in the global economy, the collapse of trade with the also-collapsed Soviet Union, and a rise in European interest rates.
Three consecutive years of negative Finnish GDP growth followed, with unemployment rising from 3 per cent to 16 per cent, and households embarking on years of painful deleveraging. It wasn’t until around 1994 — after devaluing and floating its currency — that Finland’s economy began recovering.
We bring the Finnish experience up because Moody’s have published a report titled “Finland’s 1990s Recession Paints a Bleak Picture for Irish and Spanish Consumer Asset-Backed Securities and Residential Mortgage-Backed Securities.”
The summary version is that the booms in Ireland and Spain share many similar characteristics with Finland, which means their busts might also end up the same way.
Only, potentially worse, according to Moody’s economist Nitesh Shah:
A debt-deflation spiral will lead to an increase in Irish and Spanish non-performing consumer obligations. When earnings and real interest rate developments fail to meet the expectations of over-indebted borrowers, they are often forced to sell assets to meet their loan obligations. Asset prices such as house prices are negatively impacted, and the process can spiral as weakness in asset prices contribute to more recessionary pressure and poorer income growth, which in turn feeds into further rounds of asset sales and hence price weakness. Often called a debt-deflation spiral, this process took place in Finland. Non-performing loans (NPLs) in the Finnish household sector increased from 4.3% of outstanding loans in 1991 to 7.0% in 19937. Household sector NPLs did not recover to pre-crisis levels until house prices returned back to their pre-crisis levels (Chart 1). Given the similarities of having high indebtedness and low income growth prospects, we expect a similar development to occur in Ireland and Spain. In Finland, cumulative losses in the household sector between 1991 and 1998 were over 5% of outstanding loans8. Given the prospect of a more prolonged economic recovery in Ireland and Spain, we believe losses will exceed 5% across consumer related assets.