26/10/2013: Local Authorities Loans Arrears

While we know about the crisis in mortgages extended by the banks, we have very little information on the housing loans extended by the local authorities. These are not reported, nor published. The figures are hidden out of view of the public. Last week, Irish Independent made public the latest aggregate data on these. read the article here: http://www.independent.ie/irish-news/twothirds-of-local-authority-homes-loans-are-in-arrears-29696111.html

Aggregate numbers are horrific: of total 20,277 local authority loans, 6,275 are in arrears of at least 90 days. No data was provided on arrears under 90 days. In ordinary owner-occupier mortgages, 'only' 12.7% of accounts were in arrears 90 days or longer in Q2 2013.

Keep in mind, local authorities loans were supplied on the basis of exceptional discounting of prices on underlying properties, implying that local authorities can simply convert loans into rent schemes back and cover the interest costs of property carry... hopefully... unless...

It is extraordinary that there is no reporting of and accounting for the potential losses carried by the local government in Ireland.

11/7/2013: Sunday Times 7/7/2013: Defining Mortgages Sustainability

This is an unedited version of my Sunday Times article from July 7, 2013.

In coming weeks, the Irish authorities are planning to complete the general policy reforms comprising the Personal Insolvency Act 2012, the Mortgage Arrears Resolution Targets (MART), Guidelines on a Reasonable Standard of Living and Expenses, the Review of Code of Conduct on Mortgage Arrears, and the Land and Conveyancing Law Reform Bill.

All of the above documents define the core objective of the reforms as delivering long-term sustainable solutions to mortgages crisis. None, save for the Central Bank’s MART, bother to explicitly define what constitutes such sustainability. Sadly, the Central Bank existent definition is both vague and, arguably, counterproductive in terms of its potential impact on the economy and society at large. As such, it is in need of urgent clarification and amendments.

MART states that " the Central Bank will assess the success of the institution’s progress by sampling cases and gauging the plausibility of their sustainability, including through the use of quantitative tools".

The Central Bank is currently in the process of defining what these sustainability assessment tools will be and what methodology will underpin these.  The public is unlikely to see these in full detail. This week, Seanad reading of the Central Bank Supervision and Enforcement Bill 2011 showed clearly that the Irish authorities are also unwilling to grant the Central Bank sufficient powers to robustly curb potentially anticompetitive and consumer-damaging actions of the banks.

All of this does not bode well for the prospect of effectively resolving the longer-term social and economic crises related to the household debt overhang.


MART sets out three fundamental principles that must be respected with regard to sustainability. These include consideration of both current and prospective debt servicing capacity of the borrower; the "need to use an appropriate interest rate when discounting future income flows, which should take account of the lender’s cost of funds”, and the requirement for the lenders to apply "a realistic valuation of the borrower's assets" and costs of foreclosure on the loan.

As such, the existent concept of sustainability substantively contradicts the economic and social considerations of long-term household debt sustainability.

The Guidelines on a Reasonable Standard of Living and Expenses form the cornerstone of the test for what can be recovered by the banks from defaulting households. Yet, the Guidelines do not allow for households accumulation of pension savings and savings that can be used to cushion against any potential future adverse shocks to household employment, earnings, health or other unforeseen risks, such as an old-age parent dependency. As the result of this, a sustainable mortgage arrangement can easily become unsustainable overnight at any point in time following the original restructuring.

Worse than that, the risks to future sustainability are actually higher the greater is the extent of the original distress. This so, because current mortgages problems are linked to future risks of unemployment, poorer health and lower pensions provisions. The draconian insolvency and debt restructuring regimes promoted by the Government further compound these risks.

Economists know that a household experiencing unemployment are more vulnerable to higher risk of unemployment in the future. The duration of the original unemployment spell is also a contributing factor.

Households that experience mortgages distress are also more vulnerable to adverse long-term health effects. The long-term health risks arise from the current stress, as well as from the lower lifetime disposable income available to the distressed mortgagees. These two risk factors, in turn, are reinforced by the fact that in Ireland, preventative health is an out-of-pocket expense. This means that economically distressed households tend to cut back on preventative health expenditures early on in the crisis.  Having entered into the Guidelines-determined payments arrangements with the banks, these households will have no future funding for either preventative health or insurance cover that facilitate prevention, early detection and treatment of chronic and disability-related illnesses.

Households at higher risk of unemployment also face exponentially higher risk of completing their work-lives without adequately providing for pensions, even in the absence of mortgages debt problems. Those that are forced to go through a debt restructuring processes are more likely to enter their retirement in poorer financial health. Which, in turn, implies that their pensions expenditures funding shortfall will be higher in the future than the gap which will befall their age cohort counterparts.

The endgame for the households experiencing financial difficulties today and facing a ‘sustainable’ mortgages restructuring can be high risk of old age poverty and low quality of old-age health.


The second point about the MART definition of sustainability is that it ignores the margins between the cost of borrowing for the households and the cost of funding these loans for the banks. This difference is non-trivial. The Central Bank criteria for sustainability require that a restructured mortgage should be at least self-funding for the bank. Currently, average new adjustable rate mortgage is priced at around 3.45 percent or ca 0.7 percent above the lowest cost of funding currently available via a bond placement. As the Pillar banks are moving toward the Government-set 2014 deadline for switching to independent funding, both margins and the funding costs for the banks are likely to rise.

Over 2003-present, average new business retail interest rates on adjustable rate mortgages peaked at 5.62%. Yet, during the period when the new business rates were at their highest, banks margins were actually relatively low. If the margins increase, as envisioned by the Central Bank-own policies on reforming the Irish banking sector, convergence of wholesale funding costs to historical averages will imply that the retail rates faced by the households can jump above 7 percent. MART definition of sustainability will account for only about 60 percent of this increase, with 40 percent left outside the official long-term sustainability consideration.

The third core component of sustainability definition under MART also requires significant re-thinking. The banks have no incentives, under the reformed personal insolvency regime to consider longer-term implications of household asset valuations and costs of foreclosure.

Taking all mortgages that are either in arrears, restructured and in banks possession, 238,254 mortgages accounts amounting to the total of EUR46.21 billion were at risk of default or defaulting in Q1 2013. While the number of accounts in distress was down 0.17 percent quarter-on-quarter in Q1 2013, the volume of lending these accounts represent rose 2.27 percent. The rate of increase in Q1 2013 was three times faster than in Q4 2012.

Some percentage of the non-performing mortgages is undoubtedly represented by the accounts that are in strategic arrears - the case brought to the forefront of the news-flow this week by the Ulster Bank statement on the matter. However, what is not in doubt is that overall, the quality of the outstanding mortgages pool in Ireland is deteriorating. This is happening at the time when the property prices are continuing to fall, especially in the areas and regions where mortgages distress and quality of mortgages loans are most likely the lowest – outside the core urban locations. With this, the costs associated with future foreclosures are rising as well.

Some anecdotal evidence and reports by the insolvency support organisations indicate that the banks are currently attempting to accelerate foreclosures on properties with some positive equity, where households have fallen behind their mortgages repayments. If true, this will put added pressure on the market prices and increases, not reduces the costs of foreclosure for the mortgages that are truly unsustainable in the long run. Perversely, the current system for mortgages arrears resolution is incentivizing the bank to pursue short-term maximization of funds recovery at the expense of genuine long-term sustainability.


Given the extent of the Irish mortgages crisis, we have no easy and painless solutions to the problem of household debt overhang. The more efficient and sustainable long-term options require direct writedowns of household debts to reflect, at least in part, collapsed asset markets valuations of Irish property. Arguably, with the Irish Governments committing all resources aimed at restructuring the banking sector to writing down development and investment loans underlying the commercial real estate bust, we no longer have this option available to us.

In its absence, we need to prepare for a wave of bankruptcies that will have to take place to absorb the losses accumulated within the banking system. Doing so will require taking a longer-term view of the Mortgage Arrears Resolution Targets, and relaxing significantly the Guidelines on a Reasonable Standard of Living and Expenses to allow for accumulation of savings and provision of health cover as discussed above.

We also need to cut the insolvency period duration from the current 6+1-years formula that applies to mortgages down to 1+2-years formula similar to the one that is in place in the UK, but only for households in genuine financial distress. Strategic defaulters who subsequently enter bankruptcy proceedings should be subject to the tougher regime as currently outlined in the existent legislation.

To finance these measures, we need to secure long-term cheap funding for the banks that will allow them rebuild their balancesheets not in a matter of 12 months, as currently planned, but over the next 10-15 years. The latter should be the job for the Eurosystem and the Central Bank.

Three charts:

Box-out:


This week, the Central Bank of Ireland published the data on the holdings of Irish Government long-term bonds for May 2013. Since May 2012, the amount of outstanding long-term dated Irish Government bonds rose by some EUR6.4 billion, once we control for the new bonds arising from the conversion of the IBRC Promissiory Notes in February 2013. EUR3.41 billion of this increase in supply of bonds was absorbed by the non-resident investors and institutions, while Irish Central Bank and monetary and financial institutions (aka Irish banks) have increased their holdings of long-dated Government bonds by EUR6.37 billion. All other investors, including financial intermediaries other than banks, non-financial corporations and households have reduced their holdings of   long-dated Government bonds by EUR3.37 billion. The data clearly shows that the degree of the inter-connectedness between the banks and the state, as measured by the Irish Government exposure to banks demand for its debt, did not decline since January 2012 through May 2013. Instead and in contrast to all official statements on the subject of the Sovereign-banks contagion risks, such risks today are only stronger than they were seventeen months ago.

4/7/2013: IMHO Letter to Governor Honohan

Updated:

Here's this week's letter to the Governor of the Central Bank of Ireland from the IMHO on the topic of Declaration of Last Resort for Family Home Repossessions (you can click on each image to enlarge):

2/5/2013: ECB's message: "don't let the bed bugs bite..."

In light of today's 'historic' decision by the ECB to lower its refinancing rate to 0.50% from 0.75%, let's just not get too excited, folks.

Consider the historical perspective:

1) ECB rates are low. By ECB-own standards. But they are not low by pretty much anyone else's standards, save for countries, like Canada and Australia, which didn't really have a Great Recession. At least not yet.

2) ECB rates are low today, but they will be higher one day:

And when they do get to those averages, oh… the bond markets valuations are going to fly out of the window (leaving big black holes in banks balance sheets and pension funds assets ledgers), while equities are going to also suffer risk-repricing away from current dizzying expectations. Meanwhile, mortgages and credit costs will rise and rise faster than the ECB rates for 2 reasons: (a) legacy margins rebuilding that is not even started yet, and (b) see 'black hole' on the bonds valuations side. So when we do start heading toward that green dashed line (and above, as ECB averages are above that green line), things are going to go South fast.

3) And the ramp up back to the mean will have to be sustained and drastic:

We are clearly in an unconventional period when it comes to mean reversion. In all previous episodes, mean reversion took at most 40 months of deviation from the mean to deliver on (red lines). This time around we are already into month 53 and counting. The longer the duration of deviation, the greater the imbalance built up as the blue line above clearly shows.

Based on average overshooting of the mean in each reversion episode, we are currently 1.79 percentage points away from the mean target and are likely to see additional 1.71 percentage points overshooting of the target on adjustment, which means that the direction we are heading toward, if previous history of ECB rates were to be our guide (very imperfect, I must add) is 0.5%+1.79%+1.71%=4.0%

Close your eyes and imagine your mortgage bill with:
1) ECB rate at 4.0% and
2) Bank margin on ECB rate of x2 at least of pre-crisis levels.

Now, good luck sleeping.

But, hey, for now, there's more room for ECB to 'ease'…

And yet… things are already bad enough… ECB is running policy at massively above the G3 average rates and there is no real relief to the euro area economy in sight.

So what is really going on? My quick comment for Express today:

"ECB's 25 bps cut in the refinancing rate is the central bank's de facto admission of the limitations to its ability to have a meaningful impact on the ground, in the real economy. Let's start from the diagnosis. With previous rate cuts failing to stimulate credit flows and private sector investment, it is now painfully obvious that the euro area economy is suffering from a structural crisis, not a cyclical or a liquidity crisis.  going into today's rates decision the ECB had really just three choices: 1) Do nothing and keep pressure on the Euro area governments to introduce and implement real structural reforms, 2) Do marginally little to sustain some outward expression of monetary activism, and 3) Do something big to attempt unfreezing both demand and supply of credit. The latter would have entailed a cut in the refinancing rate of 70 basis points and setting up an LTRO- like 3- to 5- years programme for lending against collaterilised business and household loans. It would have been risky, but it would have stood a chance of possibly shifting increasing significantly new credit creation. even more dramatic would have been a programme for indefinite financing of the weaker banks - a super-LTRO - set against explicit targets for their writing down of some SMEs and household loans.

That, in the end, ECB has opted for the second option of providing token expressions of accommodative monetary policy using largely weak tools, speaks volumes about the ECB's inherent legal dilemma. The ECB is facing the problem of a structural crisis in the economy, while being armed with a mandate that forces it to explicitly ignore the real economy. Thus, as the result of the crisis, the ECB has consistently traded-down the reputational curve by continuously deploying 'extraordinary' measures of ever-increasing complexity, which are having little real impact in the private economy. ECB's most-lauded OMT, for example, has had zero positive effect outside the Government bonds markets. In short, much of what ECB is doing is providing backstop insurance for the crisis amplification, but little actual means for dealing with the crisis itself.

As the result, ECB's monetary policy decisions of late can be best viewed in the prism of the EUR foreign exchange rates and European stockmarkets valuations. Liquidity supply into the financial channels that are trapped outside the real economy so far have meant firming up of the euro and increased speculative inflows into European equities that stand contrasted with both the fortunes of the euro area economies and the realities of the European companies earnings. Today's decision simply reinforces this trend. yet, as the recent years have shown, the divergence between financial markets valuations and the real economic activity is the sign of systemic malfunctioning in the monetary, fiscal and economic environments. This is exactly the road down which we are traveling, guided by the ECB Governing Council."

And my tongue-in-cheek top of the line conclusion? "ECB's Council throws a wet napkin at Euro area's economic Chernobyl and rests for lunch… breathless from exhaustion..."

So for all of us in the eurozone, tune in at 00:59:
http://www.anyclip.com/movies/despicable-me/beddie-bye/#!quotes/

4/4/2013: IMF Analysis of Recent Personal Insolvency Reforms in Europe

In the previous post, I covered in 4 charts (via IMF research paper) the extent of the European debt crisis (link: http://trueeconomics.blogspot.com/2013/04/442013-real-debt-european-crisis-in-4.html?spref=tw ). Here, based on the same source, proposed solutions for dealing with the household debt crisis.


Per IMF:

"A number of European countries have introduced or refined personal insolvency regimes to achieve orderly resolution of the debt overhang over time." Note that here, "personal insolvency law may also cover natural persons who are engaged in business activities (traders or merchants)", which is of course something unaddressed explicitly in Irish reforms despite the fact that current system of insolvency effectively spells an end to the careers of many professionals and businessmen and businesswomen.

"For example, Estonia, Iceland, Italy, Latvia, Lithuania, and Poland adopted or amended the personal insolvency law. The Irish Parliament recently adopted an entirely new personal insolvency law to, inter alia; shorten the discharge period from 12 years to 3 years subject to certain conditions. [The bill also allows the court to require repayments for up to five years in the bankruptcy process.]

Here's a very interesting bit: "The German government is also considering a reform of the personal insolvency regime that includes a shortening of the
discharge period. [The proposal envisages to reduce the discharge period from six years to three years provided that at least 25 percent of all debt must be repaid by an individual debtor]." Now, again, interestingly, Irish reforms provide for no set bounds for repayment, thus implying that there is no set limit resolution to the post-bankruptcy liability.

"In designing such regimes, these countries have faced a number of challenges. First, unlike corporate insolvency, there is no established international best practice at all in this area, especially with regard to the treatment of residential mortgages in insolvency proceedings. Second, as individuals are involved, the design of the law is inevitably driven by social policy considerations; these include the goal to reinvigorate individual productive potential in the mainstream economy and to reduce the social costs of leaving debtors in a state of perpetual debt distress. [Note: this is obviously not a core objective for the Irish reform, as it provides virtually no protection to the borrower during the voluntary arrangements period prior to bankruptcy.] Third, the law needs to keep an appropriate balance between maintaining credit discipline and affording financially responsible debtors a fresh start. Finally, the design of the law needs to take into account institutional infrastructure that is critical to the predictable and transparent implementation of the law, including the availability and quality of judges and trustees, administrative capacity, accounting, and valuation systems. [Note: in the Irish reforms case, none of these objectives are met and in fact some are directly violated by the reforms.]"

"A number of basic design features for an economically efficient personal insolvency law have emerged from the early cross-country experience:

• Allocate risks among parties in a fair and equitable manner; [Not delivered in the Irish case at all]
• Provide a fresh start through discharge of financially responsible individuals from the liabilities at the end of insolvency proceedings (typically after 3-5 years); [Provided in the Irish reforms]
• Establish appropriate filing criteria to make insolvency procedures accessible to individual debtors while minimizing abuse; [Irish reforms maximise potential for abuse in pre-insolvency processes of so-called voluntary arrangements by ensuring the banks have asymmetric veto power over arrangements, the banks have sole power of determination of terms and conditions for voluntary arrangements workout period, the banks control and own arbitration process, the banks are not compelled to transparently disclose their solutions and conditions for accessing these solutions, etc].
• Impose automatic and temporary stay on enforcement actions with adequate safeguards of creditor interests; [This is contradicted by the stated Government intention to speed up forced foreclosures as a part of restructuring of the banks mortgages books]
• Set repayment terms that accurately reflect the debtor’s capacity to repay to ensure an effective fresh start; and [Note: it is hard to imagine how this can be achieved in the environment of Irish reforms as outlined in the bullet point 3 above]
• Recognize foreign proceedings and enable cross-border cooperation to avoid bankruptcy tourism. [It is unclear how Irish reforms can reduce incentives to avail of the UK system given the conditions for insolvency in Ireland involve up to 6 years of voluntary work-out plus insolvency process, against 12 months in the UK].

What's happening beyond the above menu?

"The unprecedented challenge of excessive mortgage debt has prompted some European countries to introduce special legislation. [Norway, when facing its own banking crisis and recession in the early 1990s, adopted the Debt Reorganization Act in 1993 to provide debt relief to debtors who are unable to meet their obligations for a period of time. The law provides for voluntary debt settlement and compulsory debt settlement (e.g., reduction of principal of a residential mortgage to 110 percent of the market value of the residence). Now, wait, we were told that such measures (also deployed in Iceland) have never been tried and would lead to a wholesale collapse of the economy...] "

"Faced with wide-scale household mortgage distress in the aftermath of the recent crisis and the bursting of the real estate bubble, Greece, Spain and Portugal have introduced special legislation to address unsustainable residential mortgage debt burdens on households while limiting adverse effects on banks’ balance sheets and minimizing moral hazard."

All of these regimes differ in several respects:

1. "...While the Spanish regime allows financing institutions to opt into the scheme [Once a financial institution opts in, it must implement for at least two years a Code of Good Practices which provides for measures aimed at achieving a viable mortgage restructuring for debtors covered by the regime., banks’ participation is mandatory for Greece and Portugal]. 
2. ... Spain and Portugal allow mortgage debtors, subject to certain conditions and as a last resort, to transfer the mortgaged property title to the bank (or a government agency in Portugal) and obtain cancellation of the mortgage debt (up to the assessed value of the residence in Portugal). [Under the Spanish regime, the transfer of the property title and the cancellation of the debt can only happen after it has been proven that neither restructuring of the debt nor application of a partial release is viable.] Greece, on the other hand, allows the court to grant a full discharge of the mortgage debt if the debtor repays up to 85 percent of the commercial value of the principal residence determined by the court over up to 20 years. It is yet too early to assess the effectiveness of the Spain and Portugal regimes, but the Greek authorities are revisiting their framework due to its low rate of successful restructuring to date."

"A number of countries have adopted measures to facilitate out of court settlement for distressed mortgages. For example, Iceland, Ireland, and Latvia adopted voluntary guidelines or codes of conduct that provide guidance on mortgage restructurings for borrowers in financial distress. In 2012, Portugal introduced voluntary out of court guidelines for banks to restructure household debt including residential mortgages more generally with the assistance of debt mediation facilities. Estonia adopted a law effective in April 2011 aimed at supporting the out of court restructuring of debt obligation, including mortgages, of natural persons facing financial difficulties — although the procedure relies heavily on court input. To reduce the burden on the court system, the personal insolvency law recently adopted by the Irish Parliament introduces three non-judicial debt settlement procedures for household debt including a personal insolvency arrangement for settlement of secured debt up to €3 million and unsecured debt (no limit) over six to seven years. The effectiveness of these approaches in tackling mortgage distress remains to be seen."

7/6/2012: Sunday Times May 27, 2012

This is an unedited version of my Sunday Times article from May 27, 2012.

Slowly, but with punctuality and certainty of a German train system, Irish mortgages crisis continues to roll on.

This week’s comments from the Central Bank of Ireland, the Financial Regulator and the Department of Finance have exposed the reality of the problem. Our banks’ extend-and-pretend ‘solutions’ to dealing with defaulting mortgagees, was only compounded, not ameliorated, by the State prevarication on core crisis resolution measures, such as personal bankruptcy reforms, developing robust measures to compel banks to deal with the owner-occupier loans arrears and putting forward an infrastructure of supports for Irish mortgagees.

Now, pretending that capital injections based on year-old PCAR tests were sufficient to manage ‘the isolated cases’ of defaults no longer works for the Government. As revealed in the Central Bank comments this week, mortgages arrears have now spread like a forest fire, overwhelming the banking system. Per Central Bank admission, almost one quarter of all mortgages in Ireland are now at risk of default or defaulting, with mortgages in arrears 90 days and over accounting for 10.2% of all mortgages outstanding or 13.7% in terms of the amounts of mortgages involved.

Based on the latest available data, 77,630 mortgages across the nation were in arrears over 90 days in Q1 2012. Using the trends in figures to-date, that would imply de-acceleration in the quarterly rate of arrears build-up from 11.5% in Q4 2010 to Q1 2011, to 9.5% in Q1 2012, although in absolute numbers, arrears increased by 6,719 in Q1 2012 on previous quarter, against a rise of 5,101 a year ago.

There are more ominous signs in mortgages data that are likely to be confirmed in the forthcoming Q1 2012 report.

The main one is the rate of deterioration in the quality of already restructured mortgages. In Q4 2010, 59.4% of all restructured mortgages were classified as performing. In Q4 2011, only a year after, that number was 48.5%. This doesn’t even begin to address the bleak reality of previously restructured mortgages that are currently ‘maturing’ out of the temporary interest-only and reduced payment periods.

Courtesy of the Central Bank of Ireland, we do not have any meaningful data for mortgages restructured in 2008-2009, nor do we have any data on what exact vintages and arrangements these restructurings cover. But we do have some information on the matter from the four state-backed banks annual reports. In the case of these, 10.8% of owner-occupied mortgages were in arrears at the end of 2011, while the arrears rate amongst the mortgages that have been previously restructured was running at close to 33%. More significantly, the rate of arrears build up amongst restructured mortgages was running at 77% over 2011, outstripping a 59% rise in overall number of mortgages in arrears.

Now, recall that the entire Government strategy for dealing with mortgages defaults rests on the extend-and-pretend principle of delaying the recognition of the losses. This is done through imposition of forbearance period, introduction on the voluntary basis of a repayments reliefs. Thus, the restructured mortgages are supposed to be cheaper to maintain than ordinary mortgages. Presumably, the restructured mortgages are also closely monitored by the banks, allowing for earlier flagging of growing problems with repayments and potential additional restructuring before the arrears build up.

Yet, as counterintuitive as it might be, the overall strategy is patently not working exactly for those who were supposed to have benefited from it. The menu of solutions developed by our reformed Financial Regulator and the Central Bank and the policy-active Government departments, alongside numerous working groups and task forces is both woefully short of tools and largely ineffective in scope.

The belated realisation of this has now led the Central Bank of Ireland and the Financial Regulator to make repeated calls for the banks to proactively engage in driving up foreclosures and repossessions, appointments of receivers and enforcers. The problem, from the consumer-conscious, yet banks-supporting Dame Street institution is that its estimates for mortgages-related losses produced back in March 2011 are now at a risk of being overrun by the reality. The problem from the economy’s point of view is that these calls come at the time when we have no new tools for dealing with negative equity involved in such foreclosures, thus risking accelerated foreclosure process to become nothing more than an extension of the crisis itself.

Back in March 2011, the Central Bank estimated base-line scenario 2011-2013 banks losses on residential mortgages books of the four core banking institutions to reach €5,838 million. The adverse scenario is for losses of €9,491 million. Taking into the account changes in house prices since the beginning of the crisis, the current running rate of arrears can put losses on mortgages, if the delinquent properties were to be foreclosed, closer to the levels that would wipe out the capital cushion provided for mortgages losses. And this just for the first two years of the three-year programme. Thereafter, either capital for mortgages losses will have to come from other assets cover (such as Commercial Real Estate or SME loans or corporate lending), or fresh capital will have to be injected.

The irony, of course, is that as I suggested in my analysis of the PCAR results a year ago, the Blackrock original adverse case scenario for life-time losses on residential mortgages – put at €16,898 million – was probably closer to what can reasonably be expected to materialize in the current crisis. Incidentally, the difference between Blackrock’s estimates and Central Bank provisions would mean an injection of €2-4 billion of new capital into the banks to deal with worsening mortgages losses over 2013-2014. This is exactly the volume of additional capital required as estimated by the Deutsche Bank analysts in a note published last week.

So the crisis has now crossed or is about to cross the lower bound of PCARs-allowed losses. And the Central Bank is spurring on the banks to more aggressively foreclose on defaulting mortgages. A major issue with such calls is that absent reforms of personal insolvency regime, accelerated foreclosures will mean lower banks losses at the expense of households. Central Bank’s vision for ‘more robustly addressing the crisis’ would put more people into a perpetual serfdom to the banks in order to undercut banks losses.

Instead of forcing banks to foreclose on defaulting and at-risk mortgages, the Central Bank should create a series of structural incentives that will compel banks to share burden of negative equity with households in financial distress.

CB should shed their pro-banks stand and force banks to take on deeper losses on defaulting mortgagees for owner-occupiers. They should re-evaluate banks capital allocations, and ring-fence specific funds, well in excess of those allocated under PCAR to mortgages writedowns only. In the case where mortgages are at risk of default bit not yet defaulting, banks must be forced to restructure these with a haircut on overall debt relative to equity.

One of the vehicles for restructuring can be the model deployed in the 1920s under the land purchase annuities. Funding a combination of interest relief and mortgage maturity extension can be secured via Central Bank underwriting for a ring-fenced distressed mortgages pool. In addition, it is crucial that banks are forced to consider both the current and the expected future taxes and charges increases in computing mortgages affordability.

Mortgage-to-rent scheme and split mortgages are valid tools in some cases, but these are not being deployed fast enough and the banks have no incentive to structure these in favour of the households. Short-term forbearance should be replaced by measures aimed at achieving long-term sustainability.

A functional and robust mechanism must be put in place to independently oversee the on-going restructuring of these debts. Having sided with the banks all the way through the crisis, existent State bodies cannot be trusted to deliver on this. Instead, a transparent and fully independent entity, involving the non-profit sector operating in the areas of assisting people in mortgages difficulties, plus the strengthened Financial Services Ombudsman and the National Consumer Agency, should be put in place to police the resolution process. Legacy institutions, such as Mabs, should be reformed, if not reconstituted top-to-bottom. Alongside the reform, their resources, professional and board-level, should be strengthened.

Simply talking tough at the banks, as our Financial Regulator and the Central Bank are doing, will not resolve the crisis we face.

CHARTS:

Source: Author calculations based on data from the Central Bank of Ireland

Box-out:

A recent World Bank research paper “Performance-Related Pay in the Public Sector: A Review of Theory and Evidence” surveyed the literature on the theoretical and empirical studies of performance-related pay schemes in the public sector spanning the fields of public administration, psychology, economics, education, and health. The authors found that, based on a comprehensive review of 110 studies of public sector and relevant private sector jobs, a majority of studies (some 60%) found a positive effect of performance-related pay, with higher quality empirical studies generally more positive in their findings (68%). However, these studies predominantly covered jobs where the outputs or outcomes are more readily observable, such as teaching, health care, and revenue collection. There is insufficient evidence, positive or negative, of the effect of performance-related pay in organizations characterized by task complexity and the difficulty of measuring outcomes. Several observational studies identify problems “with unintended consequences and gaming of the incentive scheme”. With a number of caveats in place, this evidence strongly suggests that Irish Government approach to ‘reforming’ the public sector within the confines of tenure-based, rather than performance-based salaries and bonuses, as enshrined in the Croke Park agreement, is a false start on achieving meaningful productivity improvements in the sectors where outputs can and should be measured and cross-linked to actual performance.