Sunday, October 16, 2011

16/10/2011: Negative Equity and Debt Restructuring

This is unedited version of my article in Irish Mail on Sunday (October 16):

This week, we finally learned the official figure for what it would cost to address one of the biggest problems facing this country.

According to the Keane Report - or the Inter-Departmental Mortgage Arrears Working Group Report - writing off negative equity for all Irish mortgages will cost “in the region of €14 billion”. Doing the same just for mortgages taken out between 2006 and 2008 would require some €10 billion.

These numbers are truly staggering, not because of they are so high, but the opposite: because they contrast the State’s unwillingness to help ordinary Irish families caught in the gravest economic crisis we have ever faced with the relatively low cost it would take to do so.

Let me explain.

Firstly, the figure of €14billion itself is a gross overestimate of the true cost of dealing with negative equity. This is because this figure appears to include not just owner-occupiers but also people with buy-to-let loans in his sums.

Secondly, the real amount required to get rid of negative equity where it matters most – for ordinary first-time buyers - is lower still. For example the scheme could be set up in a sliding scale based on value of house compared to average house prices. This would reduce the final cost of the scheme and help those who need it most - moderate income and younger-age households.

In other words, a realistic and effective debt cancellation scheme can be priced at closer to €6-8 billion instead of the €10-14 billion estimated in the report.
In its simplest form it would work like this: say you bought a house for €300,000, with a mortgage of €250,000, and it is now worth just €150,000. The government, or the bank using the recapitalisation funds they have received, would pay off the €100,000 difference.

By doing this your monthly payments would be less, and you could now sell up to pay off the debt or move house, and in the meantime the extra money you have to spend could go back into the economy.

The scheme could even be set up so that write downs would be smaller on houses with above average values so as to prioritise young and low-earning families. In the above example, if the house was purchased for, say €500,000 and is no worth half that amount, the bank would write-off, say, €200,000, leaving the household with residual negative equity of €50,000. This would still improve affordability, but will also cut the overall cost of the scheme.

So why did the report completely rule this out? It was very clear on this topic: “a blanket debt or negative equity forgiveness scheme would not be an effective use of State resources and would not solve the problem,’ it says.

But it goes further, claiming that “the primary driver of mortgage arrears is affordability, not negative equity. While a write-down of negative equity would help mortgage holders in arrears, in many cases it is unlikely to create an affordable mortgage”.

I believe this rejection betrays the overall lack of understanding by our senior civil service officials of the problems we face.

The Irish economy is suffering primarily from three things. The biggest is excessive household debt.

While this would be bad enough, it is exacerbated by two additional factors. The cost of the government’s policy of bailing out our banks, which is being paid for with higher taxes on ordinary working households. And the rising cost of mortgagesdue to aggressive drive by Irish banks to improve their profit margins at the expense of the most vulnerable mortgage holders - those with adjustable rate mortgages who cannot protest. Both contribute to mortgages defaults.

By saying that cancelling negative equity will not be a magic bullet solution to the problem of the defaulting mortgages, the report is simply referencing the smaller problem of mortgage affordability to evade addressing the effects of the much larger crisis facing us.

Negative equity is the single most egregious and damaging segment of the debt problem faced by Irish families.

It is the most egregious because it was caused not by reckless borrowing, but by reckless lending by the banks - actively supported at the time by the Irish Government.

The problem of negative equity is the result of state policy in the first place, and it is up to the state to rectify it.

And contrary to the assertion of the report and Government claims, we do have the funds to deal with negative equity. Freeing these funds to help ordinary families is just a matter of priorities for the Government and the state-controlled banks.

To-date, the Irish Government has injected €63 billion worth of taxpayers’ funds into Irish banks.

Various other commitments, and the banks’ own state-guaranteed borrowings from the Central Bank bring the total cost of keeping our banking sector working to a gross figure of about €125 billion.

Yet while they have saved the banks, all of these measures have acted to increase, rather than reduce, the level of debt being carried by the households of this country.
In addition to their own household borrowings like credit cards or credit union loans, mortgages-holders are now in effect liable both for banks’ debts and their losses on property development and investment.

In contrast, even at Keane’s upper estimates, the cost of paying off negative equity liabilities for household mortgages would require just one ninth of the funds we have made available to the banks.

Last July the Government injected some €19 billion worth of capital into Irish banks. This capital is provided to cover potential future losses on loans. This included €9.5 billion, which was the estimated worst-case scenario for losses on residential mortgages. It also included another €8.9 billion to cover remaining expected losses on commercial property.

If some of these funds were used instead to restructure negative equity mortgages on family homes it would do two things for the banks.

Firstly, because the banks would now have securities as valuable as the mortgages they have given, a mortgage default would not be such a threat in terms of losses. This then reduces the bank’s need for further capital.

Secondly, the writedown of the mortgages will prevent defaults in the first place, at least for some families.

This implies that prioritising how that money is used to help mortgages rather than losses on commercial property loans, will be a more effective way to improve their balance sheets.

And it’s not like the money is not there. Our banking system currently has surplus capital available. Since August this year, our ‘pillar’ banks, instead of helping the struggling households, have used taxpayers funds to quietly buy high-yield Irish Government bonds.

Some €3 billion worth of Government debt was bought by the banks using our money in order to beef up their own profits. Don’t tell us that the banks cannot afford negative equity restructuring when they clearly can afford buying junk bonds in the markets to book higher profits.

And the farcical nature of Irish government responses to the mortgages and personal debt crises continues.

The Keane report ruled out increasing tax relief on mortgage interest finance for first time buyers during the boom, 2004-2008. Why? Because the estimated cost each year would have been €120 million.

Yet, come November, the very same state will pay in full the unguaranteed and unsecured €737 million debt of the bankrupt zombie Anglo. Between Anglo and INBS, the state has also committed to repaying in full €2.4 billion more of similar bonds in 2012.

Instead of repaying un-guaranteed bondholders, the Government should use the funds available to the banks to cancel commercial property-related losses on banks books, freeing the capital injected for this purpose in July this year to restructure negative equity mortgages.

Earlier this year, I proposed that Irish Government impose an obligatory restructuring of all mortgages to achieve a maximum Loan-to-Value ratio of 110%.

This would reduce the problem of ‘moral hazard’ because households with greater borrowings will still be left with more debt than their more prudent counterparts. But it would also reduce the overall debt burden faced by our families, freeing them to return to active economic and social life, helping to restart the Irish economy. Based on the Keane Report’s own estimates of the cost of such a scheme we have more than enough money to make this choice.

All we need is the will - the will to free hundreds of thousands of Irish families from the negative equity jail that was built by reckless banks which lent the money with explicit approval of the previous Governments.


Sean Mc said...

"The Keane report ruled out increasing tax relief on mortgage interest finance for first time buyers during the boom, 2004-2008. Why? Because the estimated cost each year would have been €120 million."

The full answer is that the government is attempting to reduce the deficit in line with the troika requirements. Our government will not reduce welfare, reduce the government payroll or raise taxes, so they are scoobied.

We have the worst possible colaition. Labour blocking any cuts to welfare and Fine Gael blocking any tax increases. The deficit must return to 3% and becasue the government have boxed themselves into a corner they can't accept the simple answer to the mortgage issue you outline.

Niall Devitt said...

Hi Constantin,

The Keane Report is very disappointing, even the preamble is littered with bias, inaccuracies and just plain ignorance.
Page 2
"..consequently it
would be impossible to effectively target scarce State resources at those
most in need."
There is absolutely no attempt to distinguish FTBs from investors etc. I cannot see how it is "impossible" to be selective in approach. It is really disturbing, or just downright lazy, that the authors could not try to quantify any of this. Amazingly they were able to add up all the mortgages issued in the entire system from 2006-2008 and throw out a figure that has zero relevance. Nothing. Coincidentally the Fiscal Council released its "lets squeeze the belt more to knock off blood supply" advice for further austerity the exact same day. Message got... No money!! I really hope that taxpayer money has not been handed over for this disaster of a piece.

Michael Noonan seems to be in Euro cuckoo land at the moment,all those flights around the continent are affecting the oxygen levels in his brain. What person in their right mind, who bought a house, paid a small fortune already in payments, now must hand over the keys and live as a social welfare tenant? People who buy houses generally try to avoid the social welfare net. We have been force fed an "open economy" model which advocates labour mobility, yet Michael Noonan will keep you near your school. Forget standards of living in this country, it's more like a standard of survival.

It isn't that difficult to quantify the negative equity in FTBs for people caught at the peak, 2006-2008. The government has the information, regardless of the bank, because mortgage interest relief would have been applied for. It can make an attempt to quantify what this is. More lateral thinking is needed. This is not "impossible".
Can a FOI request be made on all the TRS1 forms returned to the Revenue Commissioners between 2006-2008? Hey presto.... first step in the pretty easy task of prioritising those "most in need".

Hopefully the government will see beyond the limited scope of this paper and disregard all recommendations. Then it should pay some "genius" somewhere to get around the impossibility of targeting those in most need.


S O'Brien said...

Your suggestion in par. 6 to have "a sliding scale based on value of house compared to average house prices" could be facilitated by the state compelling estate agents to provide the sale prices of properties in the national interest. The privacy clause of private treaty sales could be retained by requiring the estate agent to privide a narrow 'price range' instead of the precise sale figure. It would be possible to produce useful statistics based on narrow ranges for the purpose of generating a reasonably accurate value of a house based on sale trends.
The government need reasonably accurate values of homes to calculate the degree of negative equity.

I do not know what the government could have done to come up the figure of 14 billion when they do not know the results of private treaty house sales (admitted in last Monday's Property Programme).


If the Keane report had suggested an emergency necessary measure of paying off half of the 100,000 (referred to in your par. 7) it would have acknowledged a fault on the part of the banking system, restored some confidence and would send a clear signal from the new FG-Lab government that it is not a case of "Bring in the new boss, same as the old boss".

AL said...

It takes 2 to tango, those who borrowed recklessly should not be forgiven any of their debt.

However, it should be made easier for Families to go bankrupt and let the bank deal with selling the house on the open market to recover any funds they recklessly lent.

Eamonn66 said...

in case you have been living down a hole for the past few years or are 12 years old, there is NO open market. The entire system is paralyzed and this notion that everyone should just go bankrupt is absolutely ridiculous.Property values across the board need to be reset to and maintained at levels of about 10 years ago with debts adjusted accordingly. The state and banks were primarily responsible for the situation we find ourselves in and it should be their responsibility to sort it out.

Dave said...

At the height of the boom Lehman Brothers alone were originating c. 8bn dollars per month in sub-prime mortgages. In other words, by their own rules 100bn dollars a year was being thrown at people who couldn't pay and then wrapped up as collateralized debt for our banks to gorge on. Is there no contractual obligation, if not moral, for these mortgage providers to compensate the mortgage holder for undermining the value of the home throughout their well documented professional misconduct? The fair and comprehensive proposal of Constantine above cannot be allowed to be simply dismissed. These political Muppets need to engage fully with the tax payers for once in their history.

Mezzos@ngue said...

"The problem of negative equity is the result of state policy in the first place, and it is up to the state to rectify it."
There is a solution, the one you propose in this article. I believe it's a great idea. Today many can afford to repay their mortgages, however the idea of repaying/putting money to the bin, for an house which is worthy less than its original mortgage and not worthy to be put on the market is changing the way people think and consume. People spend less even when they could spend. Other people simply cannot afford their mortgage, this is a social issue and again the government has done nothing yet. They should listen to you Constantin

Seamus said...

Great Constantin,
This makes sense.

But, why exactly are the Banks reluctant to deal like this?
I read your bit about their profits from bond buying (this happened in the U.S. too),but cannot fathom why defaults are more favourable?

Anonymous said...

Hi Constantin,

I would like ur view on my idea:
Why not sell the Nama properties to people in negative equity at todays market price, so that they can sublet them, and use the income to pay the NAMA mortgage as well as to help pay the original mortgage? Example: 100k apartment rents for 1000: 300 goes to NAMA loan and 700 goes to original mortgage. WIN WIN situation?