Monday, June 21, 2010

Economics 21/06/2010: Innovation economy - Irish Banks' Style

Corrected version: hat tip to Mack

One must commend the Sindo team for putting forward series of articles this weekend on negative equity. One linked here refers my statement, contained in a series of posts on the subject I published here, here and here.

Now, in a farcical move, the Irish banks are apparently working on a scheme to allow negative equity homeowners to roll their mortgage in excess of the value of the house into a new mortgage (details are here, alongside some good analysis). Now, suppose you have a LTV 80% (at origination) mortgage for €400K on a property bought in 2006 and in 4 years since your family has grown in size. You weren't reckless then - borrowing only 80% of the value of the house, and you are not greedy now - requiring just an extra bedroom for those additions to the family. Below are summary estimates of the deal the banks are working out for you as we speak:
In other words, were you to fall for the trap being set up by the banks under the guise of 'We are doing our bit to help people in trouble', you will be either pushed into a 162% LTV ratio 30 year mortgage (good luck getting out of this level of debt with an asset in surplus value) or you'd have to pony up €197,400 for the privilege of seeing your mortgage shrink by €36,000 (the difference between what remains on your mortgage today and the mortgage you'll be taking out under the deal.

This deal is, in short, a pure hogwash for the majority of people in negative equity. The farce will be when, following the deal release into the market, our Government and its paid-for 'analysts' start cooing over the great rescue package for the hardest hit families... Watch their lips.

Of course another amazing thing here is that after all the talk about barring 100% mortgages, the new product will push more vulnerable households into mortgages multiples of the 100% leveraging. Happy times are just around the corner folks.

At 4% annual growth in house prices, the new mortgage will yield a break-even between the debt and the asset value by the end of 2023, not factoring in the costs of repayment. The old deal, were the household to continue with the existent mortgage, would have recovered by the end 2020. Hmmm... looks like our real estate brokers are just a month or so away from a rush of purchasers into the market with this kind of 'new products engineering' courtesy of the Irish banks.

But pardon me for asking. The same homeowners who are about to be offered this 'new deal' by the banks are also providing cost-free rescue to the banks themselves, their management and bond holders, while subsidizing shareholders and developers. 'Mortgage holders' from the development end of business have non-recourse loans worth tens and hundreds of millions. They are being offered a full write-off with virtually no consequences. Households in negative equity are being asked to pay for that, plus to engage in reckless financial engineering projects. Am I getting something wrong here, folks?


Mack said...

Am I getting something wrong here, folks?

Yep, I think so. An arithetic error in there I think. They're €124,500 in NE not €224,500. So the total loan for the second house should be around €440k. 140% or so LTV.

Also the costs might be overstated. Presume that's including stamp? They might avoid that by purchasing a new home somewhere.

And also possible that families and the like might move further out (i.e. sell a townhouse close to the centre of the town they live and head for the suburbs) - so the new home (for some) may not be more expensive than their existing one.

Anonymous said...

These are pure working examples of micro and macroeconomy of D. Begg. I wish, Ireland would realize, that is acting in real open economy not in scheme drawn on paper. Being fed up with semi concious statements provided by autorities, observing significant negative leverage occuring current economic climate I doubt with any artificial growth "promissed".

TrueEconomics said...

Mack, you are right. I assume decline of 42% of asking price and 5% closing cost - original stamps are counted separately. That's on the value of the house. So you are right vis-a-vis the mortgage, the negative equity is 124,500. But the losses on the house are correct. The end number changes - see updated table. And thanks for spotting the error.

Anonymous said...

From the spreadsheet - "Property value today"

How will this be worked out? Will they have to sell it first to find out?

Geckko said...

I find this post somewhat below your usual high level of insight and rigour.

"Of course another amazing thing here is that after all the talk about barring 100% mortgages, the new product will push more vulnerable households into mortgages multiples of the 100% leveraging. Happy times are just around the corner folks."

It may do that.

More likely, and given the reporting I have seen almost certainly, it won't "push" anyone into anything of the sort. The negative LTVs exist and a renogatiation of the debt won't change that.

You might have €100,000 in negative equity before, you will have €100,000 in negative equity afterwards.

What you don't seem to comment on is that at the same time you might have:

€600,000 gross debt before and have, say €400,000 gross debt after (in the case of someone wanting to reduce their debt and debt interst burden).

Or, you might have a disposable income fo €3,000 per month before and a €3,500 per month disposable income after (for someone who has an opportunity to relocate to a better job).

The response from the Financial Regulator on this news is sound - too much debt, negative LTVs are bad for all concerned and should not be countenanced if sound risk management is your objective.

But, the negative LTVs exist. Fact. With proper oversight and jusicious application this idea could be a good idea for some households.

The best thing about this is that it is not a "government initiative" and it (for obvious reasons) opens a potential avenue in selected instances for a bank-household win-win.