Only a few days ago, EBS/DKM Affordability Index claimed that "over the past eight months, the average first-time buyer working couple in Ireland spent a consistent 24% of their net income on mortgage repayments, compared with 26.4% in December 2006".

According to the report, this signals simultaneously a "soft landing" in the housing market and an improved affordability of houses for first-time buyers. To those wondering as to how on earth can the mortgages costs to first-time buyers remain steady as the rest of Ireland is feeling the pain of eight consecutive increases in interest rates, the folks at EBS/DKM are quick to offer the following explanation.

Changes to stamp duty, mortgage interest relief and falling house prices all have more than offset the rising costs of mortgages. While house prices declined by approximately 2.6% in Ireland and by some 3.3% in Dublin during 2007, it is hard to imagine that stamp duty reform . . . something that affects less than 5% of the first-time buyers, can have any dramatic impact on the markets. But there is more bad news for the optimists at EBS/DKM Index.

Due to ECB interest rates hikes, direct mortgage costs have gone up roughly by 2.02% over the period in question. Indirect mortgage costs . . . the risk and administrative premia charged by the banks . . . show no signs of declining.

Yet, mortgage stress-testing requirements have more than doubled for even the shortterm fixed mortgages, implying that for an average first-time buying couple, some 25%-50% greater down payment may be needed to secure the same level of borrowing.

That adds up to around 2.5%-5% on the overall cost of moving into a new house for a couple that would have put 10% down on the property before the subprime credit markets debacle.

Last, but not least, the combined effects of interest rates hikes and tighter stress-testing imply reduced availability of credit facilities for first-time buyers, once again necessitating further increases in down payments in order to secure a mortgage.

All of this suggests that the 'improved affordability' really reflects a selection bias whereas only premium-quality candidates, with higher income-to-loan-value ratios are getting mortgages today.

There is a further caveat to the claims advanced by the ESB/DKM Index. If falling prices are so deep as to have a significant impact on affordability, and if these prices are expected to fall further in the future, as ESB/DKM Index predicts, how on earth can we call the current situation a 'soft landing'?

Just in case one needs any further proof, some of the largest mortgage lenders in the country expect some 18%20% declines in new mortgage lending this year relative to 2006.

Apparently, first-time buyers are not buying the improved affordability scenario. Instead, as last week's figures from one mortgage lender show, some 76% of Irish people expect the interest rates to rise by 0.5%-1% in the next 12 months and only 7% believe that there will be no further rates hikes.

Estate agents Hooke & MacDonald cited these figures after making a claim that "the Irish residential property market has now reached a turning point and already there are encouraging signs of a pick-up in activity, with sales enquiries through Hooke & MacDonald increasing steadily".

This begs the question:

given that Hooke & MacDonald provide no hard figures to support their claim of steadily increasing enquiries, what evidence do they have to make such a sweeping argument about housing market recovery?

Property buyers and sellers have only an imperfect information concerning the future direction of the interest rates, housing prices, their disposable incomes and other fundamentals that drive their decisions to enter the market.

When people possess imperfect knowledge, faced with external shocks to their confidence, their decisionmaking processes freeze and their assessment of risks becomes unpredictable.

The end result: the markets begin to behave irrationally and no amount of verbal re-assurances, new credit injections and other policy tricks can shift them out of this short-term equilibrium.

When considered in the context of the housing markets, this picture of dysfunctional financial markets is further complicated by the size and time-horizon of the investment decisions that involve hundreds of thousands of euros and 20-30 years long commitments.

The main lesson of the imperfect knowledge theory insights into the financial markets behaviour is that the only means for shifting investors out of their frozen state is to alter their expectations by improving the quality of their information.

In the case of the Irish housing markets, this means giving the punters information about the actual state of affairs, not a PR-spin about reaching some 'soft landing' marks and 'market rebounds'.

Dr Constantin Gurdgiev is an economist and editor of Business & Finance (www. businessandfinance. ie). constantin@tribune. ie