Economics 27/05/2010: Mortgages arrears

RTE reports on the CB data on mortgage arrears, stating that:
"New figures from the Central Bank show a 13% increase in the number of mortgages [90-days or more] in arrears [relative to December 2009]. However, the figures also show a fall in the number of legal actions taken by financial institutions to enforce outstanding mortgage debt."

At the end of Q1 2010, over 4% of all private residential mortgage accounts in Ireland were in arrears - the total of over 32,000 of 791,000 mortgages worth €118bn. Median duration of arrears was in excess of 180 days.

"The Central Bank notes a drop of 4.8% in the number of arrears cases in which legal proceedings have been issued. There are just over 3,000 such cases. During the first quarter of this year, 91 properties were repossessed by banks, 26 on foot of court orders and 65 by voluntary agreement of the borrowers or by abandonment. At the end of March mortgage lenders held 456 repossessed residential properties."

The issues not raised by either the CB or RTE are:

1. Have the banks willingness to pursue cases in court been impacted in any way by Nama operations? Nama is a political entity, with potential to influence banks internal decisions.
2. With median duration of mortgages arrears of 180 days, can we expect the number of cases heard in courts to dramatically accelerate in H1 2011?
3. Mortgages reported in arrears do not include mortgages where lender and borrower have renegotiated mortgage covenants, avoiding arrears by switching to interest-only mortgages and/or changing maturity profile of the mortgage, and/or extending a payment holiday.
   
4. What is the median/average size of the mortgage in arrears. It is likely that mortgages currently under stress are larger and cover properties with much more significant extent of the negative equity.
5. What is the sensitivity of arrears to interest rate changes. The statistical eagles in the CB - we do have some there, right? - can easily compute the sensitivity of mortgages default to changes in retail interest rates. All they need for this is longer-run data on mortgages defaults, retail rates, macroeconomic parameters, housing prices etc. Shouldn't take much of time or effort for the CB to get this useful estimate. We can then see just how damaging the ongoing increases in mortgage rates by the banks will be to this society and economy.
   

In effect, we are only seeing the tip of an iceberg here.

Now, one interesting revelation that comes on the foot of these figures is the spread of mortgage debt burden in the country. 791,000 mortgages are outstanding, involving on average more roughly 2 individuals, majority of whom are in employment. This implies that mortgages debt cover in the workforce accounts for roughly 1,580,000 individuals, or 73% of the entire labor force.

Another thing - with 73% of working (or able to work in theory) households already carrying a mortgage (or two), and defaults on mortgages rising 13% per quarter, I guess two natural questions to ask are:

• In the short run: What stabilization in the property markets can one discern here?
• In the long run: what hope can the Government have to collect any sort of serious wealth tax, when most of our wealth has been tied up in, by now, largely devalued property?
  

Economics 28/12/2009: Investment Funds in Ireland & other

Two recent datasets: CB's Investment Funds in Ireland and ECB's Financial Stability Review for December 2009.


Central Bank of Ireland has published new data series on Investment Funds in Ireland in December 2009. The data is reproduced in the table below with my analysis added:
This data, of course, covers IFSC-based funds which dominate (vastly) the entire sample. Overall funds issuance is up robust 16.6% (although activity on transactions side is falling - we cannot tell anything about seasonality here, as the CB just started collecting data). Real estate funds are out of fashion. Clearly so. Mixed funds and hedge funds are relatively flat and judging by the collapse in transactions are still in batten-the-hatches mode. Equity funds are in long-only mode, on a buying spree. Nice sign of renewed confidence in the global markets. Bonds funds are steady rising, albeit not at spectacular rates, which, of course, is a sign on IFSC missing on bonds over-buying activity going on worldwide.

Chart below shows how the market shares evolved over time.


ECB's latest (December 2009) financial stability report throws some interesting comparisons for Ireland. Focusing on the charts: first consider the extent of deleveraging going on in the financial systems:
So the US leads, as per IMF GFSR, with most writedowns in quantity and relative to the system. The UK comes second. Emergent markets are catching up. Japan has much smaller problem, unless yen carry trades unwind dramatically. These are on track to complete writedowns in 2010. But EU states are lagging. Ireland's figures are skewed by IFSC institutions taking serious writedowns. But overall, we still have some distance to travel on domestic banks front.

Next chart shows just how advantageous our low profit margins on the lending side have been in terms of yielding lower burden of debt servicing. This can change very fast in the New Year as retail interest rates are bound to rise. No top-up mortgages here or car loans and personal loans secured against house assets, etc. And also note that these refer to the 2005 benchmark, plus, of course, these are percentages of gross income. Given our households are now faced with some of the highest income taxes in the Euro area, good luck sustaining this low burden into 2010.
And another issue - notice how significant is the rise in burden for lower income households. Guess which households are also facing higher rates of unemployment?
Table above shows the deterioration in house prices in Ireland relative to other countries. We are now 21.1% down on 2007 figures, or at 90.9% of 2005 level of nominal prices. The worst performance of all countries, including such bubble-lovelies as Spain.
And on the commercial real estate side, we are an outlier by all measures (remember, unlike Spain, our total banking sector includes non-domestic banks as well). That is another mountain yet to be scaled in this crisis.

Economics 22/12/2009: On-line advertising, Mortgages Arrears and Exports

Few interesting bits of news.

Chart below (courtesy of Economist, hat tip to Ronan Lyons) shows the sorry state of affairs in the 'knowledge' economy. Online advertising is an instrumental indicator for the extent of e-commerce in the country. Although rising this year (the only area of advertising holding up in this recession), our online advertising is lagging that of other countries.
In fact, we are languishing at the bottom of the league table - next to South Africa and way off from the peer group of advanced economies. One can only speculate as to the causes of this underperformance, but here are the potentials:

• conservative attitude by advertisers (anecdotal evidence suggests that Irish advertisers are yet to seriously commit to the web even in the context of market research);
• lack of infrastructure (my own experience shows that even having two connections to 'broadband' - with one through optical cable to boot - at home does not guarantee that you can sign onto the web);
• lack of competitiveness (years of roaring Celtic Tiger have resulted in lazy and uncompetitive attitude by retailers);
• inability to offer tax free shopping on the web (American retailers use the web to reduce the cost of goods to consumers by availing of the 'no sales tax' clause which allows them to ship goods tax free from one state to another);
• lack of anything to sell (with indigenous brands squarely concentrated in the area of butter, cheese, milk, crisps and the likes - what's there to advertise to the global web-based market place?)

Whether these are the real reasons or not, the signs are not good for Ireland's efforts to enter information age.


On finance side - the FR issued new data on mortgage arrears today (the details are here). You've heard the main headlines by now (note: the actual data was released once again in the same un-usable pdf format as the one employed by the DofF - another sign of information age illiteracy, one presumes).
Table above summarises FR's data. Given that we have no time series to compare against, the only thing one can say is that the data above, as bad as it might appear, is lagged by some 6-12 months in the case of court proceedings and by around 1-2 months in the case of arrears. This suggests that as time elapses, the above numbers will rise substantially.

Other reasons to expect significant increases in distressed mortgages:

• hike in the mortgage rates in January-February 2010 as the banks go on offensive to rebuild profit margins after Nama is fully operational (nothing to hold them back once taxpayer cash is flowing in); and
• over time, as redundancy payments and savings are exhausted, more households will fall into distress.

The only net positive in today's news is that after 29 months of financial crisis, FR finally decided to collect data on mortgages distress. Where were they over the last two years, one might inquire.


External trade data released today by CSO is showing that our (seasonally adjusted) exports were down 14% in October, relative to September 2009. back in September, exports rose by a robust 11% compared to August.

Imports fell by 7% in October 2009 relative to September and were down 1% in September
compared with August.

The value of exports in September 2009 was stable compared with September 2008 (down just €35 million from €64,469 million) and the value of imports was down 25%.


Computer equipment exports fell 25%, Electrical machinery by 28%, Industrial machinery by 33%. In contrast, medical and pharmaceutical products increased by 22%, Organic chemicals
by 11%, and Professional, scientific and controlling apparatus by 14%. The MNCs, in other words, were still firing on all cylinders in the pharma and pharma-related sectors, and medical devices.

Goods to Great Britain decreased by 15%, Germany by 21%, Northern Ireland by 22%, but goods to Belgium increased by 30% (a transit port for much of our trade with the rest of the world), the United States by 14% and Japan by 10%. So, apparently, there is little evidence of lasting adverse effects of the dollar devaluation on Irish exports then? Not so fast - remember that MNCs book transfer pricing through exporting to the US, and the strong Euro is just the added ingredient they need to cover the tracks.

Charts below show the trends (these are not seasonally adjusted, but the trends are exactly identical to those in the seasonally adjusted series) - falling exports and collapsed imports.
Of course, the trade balance is rising which is due to the facts that

• as consumers we are worse off today than we were a year ago (consumer-related imports are down),
• as exporters our MNCs are really, really good, and
• transfer pricing is rampant (driven by the rising gap between imports of inputs and exports of outputs).
  

I leave it to the readers to make a call if these are the signs of an economy in a recovery.

Economics 13/10/2009: Nama politicised

Update: a must-read today is Morgan Kelly's article in the Irish Times (here). As I have shown in my Business & Finance column well ahead of Morgan, buying equity in the banks to repair their balancesheets makes financial and ethical and economic sense.


So the Greens are now going on a methodical politicising of Nama. This was predictable, but it is nonetheless ironic, for it is normally the domain of FF to turn every economic policy into a political / interest-groups circus.

As a part of their Programme for Government, the Greens have promised 'protection' of defaulting homeowners. Instead of calling for a reform of our archaic bunkruptcy laws the GP is now considering several possible options for doing so.

1. Force the banks to purchase homes from defaulting homeowners, writing down existent mortgage. Assuming 5% default by homeowners (conservative number in my view) on roughly €82bn worth of principal residence-tied mortgages will yield a direct hit on the banks balancesheets of €4.1bn in 2010. Given the lags, one can expect this to be followed by a roughly 3-3.5% default rate in 2011, inducing another hit of €2.9bn, for a grand total of €7bn in 2 years. But this is not all - buying these mortgages out will imply the banks will take on assets that are worth significantly less than the outlays implied. For example, assuming 75% LTV ratio and 50% decline is peak-to-trough valuations (note: the first to default mortgages are more likely tied to lower quality properties, so 50% assumption is a reasonable one, if the average peak-to-trough fall was to be around 35%) the banks will be taking on an asset value loss of 0.5/0.75=33% of the mortgages assumed, or an additional €2.31bn. So capital base impact of this scheme will be around: 10% of RWA of 7bn-2.3bn = 470mln + 10%*(1+expected default rate+expected devaluation rate) of 7bn liability or ca 840mln. New demand on capital for banks will be in the region of €1.3bn immediately. Two questions to our GP friends: (1) Where will this capital come from? and (2) Where will the funding for acquisitions come from? If Nama is to be expected to generate commercial lending, what funding is available for buying out mortgage holders?
   
2. The Greens are also considering US-styled scheme where lenders are subsidized to reduce payments by those in default. This would be a temporary (presumably) bridge. The problem here is that if you subsidise my neighbour, I will face a choice: (a) continue paying my mortgage at increased rates (someone will have to provide the 'subsidy') or (b) default and get subsidised too. Any guesses as to what a rational agent will do? Once again, who will pay for this scheme and how can it be made compatible with Nama objective of relaunching commercial lending. How will the banks exit this scheme in the long run?
   
3. Measures to reduce the interest on mortgages: now this is ironic, given that this coalition has already swallowed IL&P increase in mortgages charges with Brian Lenihan saying that the banks are private enterprises and must be allowed to increase their profit margins.
   
4. Banks taking equity in home loans - equity in what? In a negative equity asset?
   
5. Mortgage terms extended. Given that we have been saying that 30-year mortgages at 100% LTV were reckless lending, making the same mortgages (now at 140% LTV) a 40-year contract will certainly be a prudent idea.
   

In the end, Green Party's denial of reality is evident throughout these proposals. The Exchequer is broke and Nama now means that we have no longer any capacity to aid the economy - we have spent the entire family silver on rescuing a handful of banks shareholders and builders. Instead of correcting the Exchequer deficit, the Greens are now full set to expand it to plaster over their disastrous agreement to back Nama. All of the above proposals will contribute to the future deficits and to the ongoing squeze of consumers, mortgage holders and taxpayers.

Months ago, myself and Brian Lucey have told this Government (including our direct briefing of the Green Party leaders) that Nama will trigger a wave of households defaults and that this will induce a new run on banks capital. We were called scaremongers.

The IMF seconded our views. The Fund opinion was ignored.

Now the Greens are running for cover on this issue, having pushed through Nama in the first place. This ethically disastrous stance of the GP leadership is a glaring example of how not to do policy.

What if interest rates rise?

Just to stake some forward looking ground - here is a quick thought.

While we are preoccupied with the current crises, one has to wonder what the future might hold. Consider the following scenario.

Mid-2010 and German economy recovers slightly ahead of the rest of the Eurozone. Why? Because Germany is more exposed to global growth and thus will respond to renewed global demand for investment and consumer goods; and because German consumption has been suppressed since the mid 1990s, creating a significant domestic demand overhang. The ECB's response will be to immediately raise interest rates.

Of course, prior to German recovery, Manufacturing Purchasing Indices and other leading indicators will be flashing red for some time, prompting an earlier rise in interest rates in early 2010. So, say, Eurozone enters 2010 with 0.5-0.75% rate, goes to 1.0-1.25% by June 2010 and jumps to 2.0-2.25% by the end of 2010.

What happens then? Ireland, will by now have much higher taxes (three-tier rates structure of 25%, 48% and 52%), much lower standard deductions and standard rate ceiling, with higher PRSI and pensions tax relief at a standard rate. This will mean that before ECB rates hikes, our mortgages burden will be on par with those that prevailed at the onset of the crisis, but against a backdrop of lower disposable income. Now, as interest rates revert to rising, the burden of debt will start climbing up against decimated household incomes. Homeowners, with savings exhausted during the 2009-2010 downturn will be feeling more heat than they do today. Foreclosures will rise and personal insolvencies will go sky high. Consumption will remain suppressed, but this time, there will be no boost in savings. Ireland Inc might suffer a complete fall-out of the growth re-start.

An example
Here are some numbers. Assume we take a family with Q1 2008 after-tax income of €100 and a mortgage burden of €35 (35% of the after-tax income). By Q1 2009, due to falling interest rates, this family's mortgage costs will have fallen 26% (roughly 10% per each 1% fall in ECB rates). At the same time, the family income has declined to €91 due to increased taxation (Budget 2009) and recession. In Q1 2009, family mortgage burden was €26 or 28.5% of the disposable income.

Now, assume we are in Q4 2009 and recession continues and Mr Lenihan has stuck to his promises and raided the family income to 25-48-52% tax rates outlined above). The family after-tax disposable income now stands at €82, while the ECB has lowered the rate to 0.75% from current 1.50%. The family is now paying €24 in mortgage which constitutes a mortgage burden of 29.25% of the family income.

We go to Q1 2010 next. Recession and Mr Lenihan keep on robbing the family of income, so its after-tax take home pay is now €79.5. But due to advance leading indicators flashing recovery for Germany, the ECB tightens the rates a notch to 1.0%. Family mortgage burden jumps to 31% as the twin blades of higher taxes and interest rates inflict two simultaneous cuts to household's spending power.

On to Q4 2010. Things are going swimmingly in Berlin, so the ECB races with rates increases. We have three scenarios:

Scenario 1: relative stagnation in Ireland - so our income remains at €79, while German expansion drives rates to 1.75%. Irish family's mortgage burden jumps to 33.4% of the disposable income.

Scenario 2: recession in Ireland continues, with income falling to €76, while more mild German expansion drives the ECB to raise rates to 1.5%. Irish family's mortgage burden jumps to 34%.

Scenario 3: recovery shines upon Ireland and our income rises to €80, while rapid growth in Germany drives rates up to 2.25%. Our family's mortgage repayment burden is now at 36% of the disposable after-tax income.

Conclusion
May be Alan Ahearne, in his new capacity, can tell Minister Lenihan this much? Or anyone from a myriad of our vociferous social-democratic economists, begging the Government today to raise taxes. Little hope. His (and their) policy advice to date has been pretty much in line with the Government's efforts to demolish private sector workers in order to save public sector jobs. Then again, neither Ahearne, no Lenihan will be losing much sleep over ordinary families who will be unable to stay afloat in this WunderWorld of richly rewarded public sector and impoverished private sector workers that they are creating.

Recession? Raise taxes. Public finance busting at the seams? Raise taxes. Unemployment? Raise taxes. Public sector inefficiencies? Raise taxes. Exports plunging? Raise taxes. Banks falling off the cliff? Raise taxes. And always blame the outside world for any trouble we might land ourselves into. Classic economic problems with uniquely Irish responses.

"Pints!"