Wednesday, November 16, 2011

16/11/2011: Irish Mortgages Crisis

Unedited version of my latest Sunday Times article (November 13, 2011).


Per latest data available to us – at the end of June 2011, there were 777,321 outstanding mortgages in Ireland. Of these, 55,763 mortgages were in arrears more than 90 days, up 53% on same period a year ago. In addition, 39,395 mortgages were ‘restructured’ but are currently ‘performing’ – in other words, paying at least some interest. Adding together all mortgages in arrears, repossessions, plus those that were restructured but are not in arrears yet, 95,967 mortgages (12.3% of the total) amounting to €17.5 billion (or 15.2% of the total outstanding mortgages amount) are currently at risk of default, defaulting or have defaulted.

Given the trend in these developments to-date, we can expect that by the end of 2011 there will be some 114,000 mortgages in distress in Ireland. By the end of 2012 this number can rise to over 161,000 or some 21% of the total mortgages pool in the country.

This is a staggeringly high number. When considered in the light of demographic distribution and vintages, 21% of all mortgages that are likely to be in arrears around the end of 2012-the beginning of 2013 will account for up to 30% of the total value of mortgages outstanding.

Mortgages at risk of default

Source: Central Bank of Ireland and author own calculations

This is a simple corollary from the fact that mortgages crisis is now impacting most severely families in their 30s and 40s, with more recent and, thus, larger mortgages signed around the peak of the property bubble. These households are facing three pressures in today’s environment.

Firstly, they are experiencing above-average unemployment and income pressures. Per Quarterly National Household Survey, in Q2 2011, unemployment rate for persons aged 25-34 was 16.5% and unemployment rate for those in age group of 35-44 was 12.4, both well ahead of the 8.95% average unemployment rate for older households. By virtue of being more concentrated in the middle class earning categories, they are also facing higher tax burdens than their lower-earning younger and more asset-rich older counterparts.

Secondly, they are facing higher costs of living, further depressing their capacity to repay these mortgages. More likely to live on the outer margins of commuter belts, our middle-income earners are facing more expensive cost of commute, courtesy of higher energy prices, high taxes associated with car ownership and the lack of viable public transport alternatives. In September this year, prices of petrol were 15.4% above their levels a year ago. Inflation in diesel prices is running at 14.8%. Cost of road transport increased 5% in a year through September, and bus fares are up 10.8% These households are also facing higher costs associated with raising children. Since the time these families bought their houses (e.g. 2005-2007), primary and secondary education costs went up 21-22%, and third level education costs rose 32%. On average, larger families require greater health spending, the cost of which rose 3.4% year on year in September and now stands at 16% above 2005-2007 levels. The three categories of costs described above comprise ca 19% of the total household budget for an average Irish household and above that for a mid-aged household with children.

Thirdly, as their disposable incomes shrink and mortgage costs rise (mortgages-related interest costs are up 17.2 year on year and 11% on 2006), the very same households that are hardest hit by the crisis are also missing vital years for generating savings for their old age pensions provisions and most active years for entrepreneurship and investment.

In short, courtesy of the crisis and the Government policy responses to it to-date, Ireland already has a ‘lost generation’ – the most economically, socially and culturally productive one. And this generation is now at the forefront of the largest homemade crisis we are facing – the crisis of mortgages defaults and personal bankruptcies.

Against this backdrop, the forthcoming Personal Bankruptcies Bill should form a cornerstone of the Government’s policy.

This week, the media reported some of the specifics of the forthcoming legislation, which include two crucial details: the 3-years release period for personal bankruptcy and the non-recourse nature of the arrangement. Under the former, the current period of bankruptcy will be cut from 12 years to 3 years, while under the latter, the new bankruptcy law will limit the extent of the household liability to the current value of the property underlying the mortgage. It is uncertain, at this stage, what claims, if any, can be levied against personal and family savings and other assets.

The provisions, as reported in the media, appear to be well-balanced for a normal bankruptcy reform, but remain excessively harsh for the legislation designed to tackle an acute crisis. Here’s what is needed.

A conditional bankruptcy release period for mortgages taken in the period of 2003-2008 should be set at 12 months subject to satisfactory completion of court-set conditions. Full release should apply after 3 years. There should be no restriction on companies directorships for those in the process, so as not to reduce entrepreneurship and small business ownership.

The lien against the personal income and assets should be designed as follows. No more than 25-35% of the after-tax disposable income can be diverted to the repayment of the mortgage, to allow for private sector rent payments. No more than 30% of the household assets below €25,000 can be used to repay the residual mortgage post-foreclosure. The amount can rise to 50% for assets valued between €25,001 to €50,000 and to the maximum of 70% for assets valued over €50,000. This will minimize losses to the banks, disincentivise strategic defaults and reduce moral hazard, while still allowing families to retain safety cushion of savings to offset the risks of sudden income losses or illness.

Banks objections to relaxing bankruptcy laws, raised this week, is that the new law will trigger a significant demand for capital as losses due to non-recourse clauses will be borne by the lenders. This is simply not true.

Firstly, with some claim on family assets in place, bankruptcy process will still be used only in the cases of extreme financial distress. A combination of a limited liability applying to some family assets and a 3-year repayment period will create both a disincentive to abuse the system and a cushion of burden sharing, reducing the end losses to the banks.  Savings on interest payments supports and legal costs will further reduce taxpayers potential exposure.

Secondly, the stress tests carried out earlier this year were supposed to provide ample supports for the banks against mortgages defaults. Blackrock estimates of the worst-case scenario losses on Irish mortgages over the life-time of the loans amount to €16.3 billion split between €10.2 billion owner-occupier and €6.1 billion for buy-to-let borrowers. Central Bank of Ireland assumed 3-year losses amount to the total of €9 billion. Reformed bankruptcy law is unlikely to raise the Blackrock estimates for life-time losses, but is likely to push forward the defaults that would have occurred outside the Central Bank-assumed time frame of 2011-2013. In other words, unless the stress tests performed were not rigorous enough, or the Central Bank assumptions on 2011-2013 defaults were not realistic, capital supplied to the banks post PCARs already incorporates expected losses.

Either way, there is neither an economic nor moral justification for using bankruptcy laws as a tool for locking borrowers in servitude to the lender. During the boom, the Irish state and banks have acted recklessly toward the very same borrowers. The duty of care to protect consumers and investors was abandoned by the previous Financial Regulator, the banks, public authorities in charge of regulating property markets and, ultimately, the Governments that presided over the system, which put full burden of risks associated with property purchases on the buyers. Remedying this requires giving distressed borrowers some powers to compel burden sharing vis-à-vis the banks.


Box-out:

This week, the entire world was consumed with the saga of Silvio Berlusconi’s resignation. Played out across the media – from print to facebook – the story of the ‘departing villain’ was almost comical, were it not tragic in the end. Tragic not so much in the inevitable rise in Italian bond yields, but in the sense of denial of reality that the media and political circus that surrounded Mr Berlusconi’s departure from power. Italy is a Leviathanian version of the zombie economies of Greece and Portugal. Between 1990 and 2010, Italian real GDP grew at an average rate of less than 1% per annum, less than half the rate of Spain, Greece and Portugal. Italian growth in exports of goods and services, over the same period was roughly one half of the rate of growth in Spain and 1.5 times lower than that for Greece and Portugal. Italy’s unemployment rate averaged just below that for other 3 countries. Italian fiscal deficits, at an average of 5.2% per annum, were greater than those of Portugal (3.3%) and Spain (3.1%), but lower than those in Greece (7.8%). Ditto for structural deficits. These are hardly attributable to Mr Berlusconi alone and are unlikely to be altered dramatically by his successors. While it is easy to point the finger at the internationally disliked leader, the truth remains the same – with or without Berlusconi, Italy is a nation with a dysfunctional economy.
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