Inter-Departmental Mortgage Arrears Working Group report, released yesterday is a truly abysmal document that neither delivers meaningful
solutions to the problems it sets out to tackle, nor provides any really new
solutions that were not already discussed in the Cooney report of 2010.
Let’s consider the ‘solutions’ advanced by the Report. Let
us also juxtapose these ‘new’ proposals against the existent means for
alleviating stress on households finances arising from the excess debt or lack
of debt affordability, which are enumerated in the Report.
An excellent additional analysis of the report is provided by Namawinelake blog (here) and I am broadly in agreement with its author conclusions.
Note that, unlike the Report authors, I view two problems as
separate, but related.
The problem of debt overhang is the problem of too much debt
carried by the household preventing this household from accumulating pensions
and precautionary savings, reducing its ability to provide insurance cover for
catastrophic losses of income due to illness or unemployment, restricting
reasonable investments in household members’ education and skills (children
education, but also adult education – both of which require outlays from the
household finances), extending care for incapacitated relatives, saving for
potential investment in family business etc.
The problem of debt servicing is the problem whereby debt to
income ratios rise to levels whereby debt financing becomes unbearable for the
household. This can arise due to any of the following factors or a combination
of several factors, such as: loss of income due to unemployment, loss of income
due to wage cutbacks or decline in bonuses and commissions, loss of income due
to higher taxation burden, loss of income due to illness, increase in expenses
due to birth of a new child or arousal of new dependency from, for example, ill
close relative, etc.
What solutions does the Report propose?
Solution 1: Forbearance.
This is not a new solution and the Report states that as a
part of the “wait and see approach” already adopted by the Government, they are
not always appropriate. In other words, one of the solutions presented by the
Report is already deemed by the very same Report not to be sufficient.
Forbearance is ‘extend and pretend’ type of a ‘solution’ that temporarily
reduces the mortgage burden in the hope of short-term return to affordability.
It does not deal with the problem of excessive debt carried by the household.
Instead it actually exacerbates the problem by accumulating retained interest
and extending over time the period of principal repayment, as in the case of
forbearance households are mostly excluded from counting their repayments
against the principal. It is a very short-term measure (extending the period of
forbearance will have a compounded effect of increasing the overall debt level
of the household).
As an extension of the Forbearance scheme, the Group notes
that Deferred Interest Scheme has already been introduced in the state. The
Group fails to provide any meaningful assessment of the scheme claiming that it
is too new to allow for such assessment. In reality, deferring interest
repayment implies accumulation of higher debt over time through compounding and
roll up of interest into the future and has exactly the same shortcomings as
the general forbearance scheme discussed above.
Another major issue with both schemes is that they do not
alter life-time affordability of the mortgage, which is reflected in their
temporary nature. Temporary nature of these schemes, in turn, implies that
households entering into these arrangements cannot be expected to meaningfully
engage in the economy as savers and consumers. They are suspended in a debt
hell limbo for the duration of the scheme and face uncertain future as to their
ability to return to normal functioning.
What we need is: conversion
of the existent mortgages pool into non-recourse mortgages only for the amount
of negative equity. To deliver this, mortgages outstanding should be seen as
split between those covering 90% of the current value of the asset (10% cushion
provided for future decreases in valuations) and the residual. The 90% current
value of the mortgages is recoursed against the value of the home. The excess
amount of mortgages outstanding is non-recourse.
Solution 2: Mortgage Interest Supplement.
A measure that provides cash flow support to households that
are on public assistance due to unemployment or disability. The Group
identifies this scheme as in the need of alteration and suggests that
mortgage-to-rent (MTR)schemes (see below) can be used to move long-term
recipients of MIS off the temporary measure. This implicitly suggests that the
Group sees MTRs as a long-term default option.
Amazingly, the Group provides un-backed and un-specified
estimates for writing down the entire pool of negative equity or writing down
the most severe negative equity cases (2006-2008 mortgage originations) at €14
billion and €10 billion. The Group states in a blanket fashion that “scheme
would not be an effective use of State resources and would not solve the
problem”.
Worse than that, the Group has managed to produce not a
single meaningful or even token debt relief measures. The Group “examined the
proposal to increase mortgage interest relief to 30% for First Time Buyers in
2004-08 but it was considered that this change should not be recommended. The
proposal would give increased relief in an indiscriminate manner as it would give
benefits to all who took out mortgages in the relevant years, regardless of
their economic circumstances. The proposal would cost the Exchequer
approximately €120m in a full year and it would not be appropriately targeted
at those who need the support.”
This is an extraordinarily bizarre statement. The Group on
objective – as stated – included to consider measures “to reduce the drag on
the economy from a significant cohort of over-indebted people whose spending is
constrained by mortgage debt obligations.” And yet, the Group passed on the
only solution they considered to deliver some relief here. Reducing effective
cost of mortgages interest financing would have improved significantly many,
more stretched, households cash flows, especially for those early into the
process of mortgages repayment. In other words, it would have had a compounded
effect of reducing interest payments when these payments are the largest
proportion of the mortgage itself, potentially improving repayment of capital.
The scheme would have had no adverse impact on moral hazard and would have been
politically acceptable as a partial compensation for tax increases suffered by
the very same households. It is cheap (could be financed for 6 years out of
just one unsecured unguaranteed bond repayment by Anglo due this November at
€737 million) and effective in reducing the most egregious share of the debt
incurred – interest charges. It also could have served as a buffer for future
interest rate increases, thus effectively helping more, in the longer term,
those on the adjustable rate mortgages who are currently subsidising tracker
mortgage holders.
The fact that these considerations were omitted by the Group
shows that the Group was not fit for purpose – its members had no sufficient financial
insight into the debt issues and mortgages finance to make any reasonable
assessment of the situation.
What we need is: extended
Interest Tax Relief scheme covering all first-time mortgages for principal
residences issued in 2004-2008 with extension for 5 more years at 50% of the
total interest paid. The cost of this scheme should be in the neighbourhood of
€250 million per annum and it should be financed through writedowns of
unsecured bondholders in Irish banks.
Solution 3: Introduce New Bankruptcy Legislation.
This is hardly a new solution and as such the Group was
expected to provide more robust guidance as to the terms of reform of existent
bankruptcy laws. The Group correctly identifies one major part of the problem
with existent legislation as: “Given the full recourse nature of mortgages
there is no current insolvency option for many mortgage holders who are in
difficult or unsustainable mortgages – they could face permanent bankruptcy”.
In other words, the problem is in the full recourse nature of the mortgages and
the long-term or permanent nature of the bankruptcy.
The Group comprehensively fails to address both sides of the
problem in its recommendations.
With respect to the length of the bankruptcy status and
associated claim on the debtor income, the group states:
“The group understands that the automatic bankruptcy
discharge period under the judicial process could be set as low as 3 years”. In
other words, the Group fails to make any proposal as to the length of
bankruptcy period. It simply defaults to 3 years as the only option because it
is what it being discussed elsewhere.
What we need is a
two-tier approach to the bankruptcy reforms:
Tier 1: Emergency level legislation covering mortgages taken
prior to 2009 which will have automatic release after 12 months of compliance
with court-ordered repayment schedule and zero recourse thereafter. In the case
of non-compliance with repayments, the bankruptcy period can be extended to 3
years and then to 5 years. There should be no recourse on assets outside the
mortgage, but access to bankruptcy should be granted only to those unable to
pay their mortgages through current income as supplemented by a reasonable
drawdown of existent assets. For example, a household savings should not fall
below 20% of annual pre-tax income so as not to deplete insurance buffer
against household loss of income in the future due to illness or unemployment.
The households can be required to sell any other property assets they hold if
this releases funds to aid repayment of mortgage. The legislation should apply
only to primary residences and can be staggered to reduce its applicability to
‘trophy’ homes, so that only part of the family home mortgage under, say, the
threshold of €500,000 can be covered by such process.
Tier 2: Long term legislation covering all mortgages taken
since 2009 that will include, 3 year term for automatic release, recourse
against other assets and restriction on mortgages issued in the state to
non-recourse mortgages only, for all new mortgages going forward.
Instead of robust proposal for reforming the bankruptcy law,
the Group report produces extraordinarily woolly wish list of non-judicial
process proposals for dealing with defaults.
This includes a non-judicial settlement process that is not
backed by any compulsion on behalf of the lender to engage in such a process or
to deliver any specific targeted means for reducing overall debt burden of the
household. Instead of specifically calling for lenders being required to write
down some minimum share of debt, or some debt linked to, say, income and
affordability metrics, the proposal simply waffles on about “mortgage lenders
will need to make allowance within their mortgage solutions, on a case by case
basis, to make some funds available to facilitate unsecured debt settlement”.
And there’s more: “Uncertainty exists as to how the courts
will deal with an income earning bankrupt – it could require them to make
payments to the creditors beyond the discharge period.” Now, this begs a
question: why on earth did we need the Group report if all it can tell us is
that the courts will decide? And how can the report make a claim that this
entire strand of bankruptcy resolution has any whatsoever validity as a tool
for alleviating currently draconian bankruptcy conditions if it is left up to
the courts to decide?
Another ‘measure’ proposed by the Group is Debt Relief Order
(DRO), which will “allow persons with “no assets – no income”
to fully write-off unsecured debt within a short period of time”. How?
No information is given. How long is the ‘short period of time’? Unspecified.
But the Group refers to the UK DRO equivalent of €17,000. So, let’s summarize
this ‘measure’ – under DRO, once you are bled dry, the Government will
facilitate (legislatively, presumably) an up to €17,000 writedown of your debt
alongside the loss of your home, your assets and your income, while levelling
you with the very same bankruptcy burdens as above. The whole mechanism would
constitute a reasonable measure only in a lunatic asylum.
Solution 4: Mortgage to Rent
Scheme (MTR)
This implies converting existent mortgage to a lease with
the mortgage holder losing all future claim on equity in the property.
The problem is that, as the Group states: “The group
recommends the introduction of two mortgage to rent (MTR) schemes aimed at
those people who would qualify for social housing if they lost their home and
where their house is appropriate to social housing”
So explicitly, there is no cover for anyone who does not
qualify for social housing. In brief – you are either broke or you are not covered.
Which automatically means the scheme does no work to alleviate constraints on
future savings and investment, pensions provision, education investment etc.
“The schemes should be subject to an initial review after 12
months and a value for money review after 24 months” In other words, the scheme
is non-permanent and cannot be considered a solution to the long term problem.
It is simply ‘extend and pretend’ type of a solution with the worst possible
outcome – all future uncertainty is loaded onto the mortgage holders.
A person entering the scheme, in effect, surrenders any
legal claim on the asset and any leverage for dealing with the default-related
loss once he/she signs the papers as the state can simply deny the benefit in
12 months or later.
Worse than that, “There may be a mortgage shortfall that
will still need to be dealt with” in other words, the negative equity component
of the mortgage remains unaddressed, i.e. it remains the liability of the
original borrower. This provision is simply mad, given the Group set out to
resolve the problem of defaulting mortgages.
Solution 5: Trade-down Mortgages (TDM)
Trade down mortgages is in itself not a solution to the debt
crisis, but an affront to those currently struggling under the weight of debt.
It ignores the fact that majority of those heavily indebted (relative to their
incomes) are younger families who bought their first homes – small, usually out
of town, lower-end-of-the-market dwellings trading down from which is an
equivalent to telling them to pitch a tent in a bog and call it a “more modest
home”.
Worse, the proposal admits that the scheme would increase,
not decrease, the overall debt burden carried by the mortgage holder as LTVs
are going to rise and not just by the amount of negative equity carried over,
but also by the closing costs which the Group has no grace to advocate
forgiveness for. Negative equity is then crystallized into real debt. In
medical terms, it is like advocating cutting both limbs for a patient with one
gangrened arm!
The Group’s brain-dead - and I cannot call it any other –
‘logic’ is such that they actually state: “While the increased LTV is relevant,
so long at the mortgage holder can afford the new mortgage and the ratio is not
so high as to be a disincentive to the mortgage holder, it is a secondary
factor”. In other words, higher debt is a secondary issue from the Group’s
point of view, despite the fact that it clearly contradicts their own objective
of reducing the negative debt effects on the economy.
What we need here is
an explicit cap on carry over of negative equity under TDM scheme. In other
words, cap the amount of negative equity to be carried to new ‘smaller’ dwelling
mortgage to not exceed 10-20% of the total new loan, with additional ceiling on
combined new mortgage not to exceed 110% of the current value of the new
property bought. This will provide both an incentive to engage in trade down
for the household and a finite cap on debt limits. It will also reduce future
default risk for lenders.
Solution 6: Split Mortgages (SM)
Split mortgages proposal allowing the household to split
existent mortgage into ‘affordable’ part to be subject to continued repayment
and the ‘unaffordable’ part to be either warehoused until repayment environment
(income) improves or until the mortgage holders is forced into other types of
arrangements.
This, of course, presents a number of problems. Firstly, it
is another extend-and-pretend measure not dealing with debt overhang, as the
overall level of debt carried by household remains identical to pre-restructuring.
Secondly, it introduces an incentive for the banks to hold mortgagees in
constant fear of foreclosure, especially if the property prices rise or if the
banks find capital to writedown the foreclosed mortgage. Thirdly, there is no
provision for the interest rate relief in the scheme, implying that interest
rate will roll up on both sides of the split mortgage. This means, the banks
can ‘warehouse the principal’ while forcing households to pay interest on full
amount of the mortgage. In other words, effective interest rate payable on
mortgages will rise and the present value of the lifetime debt will rise as
well.
The Group failed to see any of these possibilities in their
report.
What we need here is
a New Beginning type of a solution with added caveat that the warehoused part
of the loan does not involve roll up of interest for 3 years and that the part
of the loan due for continued repayment be structured in such a way as to
payments covering at least 50:50 the interest due on overall mortgage and
repayment of the principal. In other words, at least every €1 of each €2 of repayment
has to be used to reduce principal amount under mortgage. Furthermore, we need
protection of borrowers from increases in the interest rates, with warehoused
mortgage converted to fixed rate or tracker mortgage at inception.
Overall, therefore, the Keane report utterly and
comprehensively fails to deliver any new and/or meaningful measures for dealing
with the crisis. The Report is extremely weak on analytical details (using nothing more than publicly available data from the CB of Ireland, without even applying CBofI own model for dynamics of future mortgages distressed available from the PCAR/PLAR exercises). It is a lazy, write-off piece of work by people who appear to have no understanding of the realities of the problems they discuss.
The failure of this report is so comprehensive and represents
such a direct affront to the nation burdened with unprecedented debt overhang
that the entire report must be binned – publicly and irrevocably – by the
Government and a new, independent and broadly authorized commission should be
set up to produce real measures aimed at alleviating both problems:
Problem 1 – financial sustainability of currently distressed
borrowers, and
Problem 2 – overall debt overhang in the household economy.
Some of the possible measures aiming at dealing with the
above problems are already outlined in my comments above. More proposals will
follow on this blog in the future. Stay tuned.
