Monday 29 May 2017

To make any debt forgiveness plan work, first seek clarity

No scheme will be perfect, but it must be fair and have the the interests of both borrower and lender at heart

RECENT days have seen a flurry of exchanges between ministers and the commentariat around the issue of debt forgiveness.

UCD's Professor Morgan Kelly kicked it off by suggesting that giving €5bn-€6bn of already-allocated funds to the State's pillar banks would solve many of the problems faced by ordinary people in dealing with mortgage debt.

Anecdotal evidence suggested banks have been engaging in 'one-off' debt forgiveness measures, opening up the potential for massive inequity in treatment of the more than 50,000 borrowers currently in arrears, due to the ad hoc nature of the process.

Ministers responding to Professor Kelly have expressed different ideas. Housing Minister Willy Penrose welcomed discussion; while Brian Hayes and Eamon Gilmore said no to blanket debt forgiveness schemes; and finally Joan Burton said the idea of debt forgiveness should be explored, citing international evidence of programmes that were working.

The Government still doesn't seem to know what it is doing, and has kicked for touch by setting up an expert working group to report in late September.

This is not encouraging: solutions for mortgage debt are mooted in the Programme for Government (remember that?), debt forgiveness has been discussed publicly for at least 18 months, and a series of reports on mortgage debt and bankruptcy legislation have already been written.

There is still no agreed definition of what we, as a society, mean by 'debt forgiveness'. The common perception is that many of those who speculated in the housing market and lost are now to be allowed walk away from that loss with the burden to be borne by the banks and their owners -- the taxpayer.

Letters to newspapers rightly complain about the unfairness of such a policy. "I didn't go mad during the boom, why should I bail you out?" is the common refrain. Policy makers worry about 'moral hazard', meaning if I know I'll get away with something like running up debt, I'm encouraged to do it again. Commentators worry about our ability to pay for this as a society. Surely debt forgiveness means higher taxes? Someone has to pay these debts. But we don't have any money. So debt forgiveness is a bad idea.

And yet, no one has proposed such a policy. The debate is moving on, thankfully, but it is still shrouded in emotion, uncertainty, and terminological inexactitude.

For example, lots of people worry about negative equity, but negative equity is not the key concern. Actual mortgage arrears are. Most people in negative equity make every effort to keep paying -- they want to keep their house.

So let's focus on those tens of thousands of homes not meeting their obligations as debtors.

There are several types of borrower we must consider.

First, those who will likely never be able to pay their mortgages.

Second, those borrowers who can't meet their current debt service obligations but whose ability to service their debts might be restored with some restructuring.

Third, those who can pay, even at some personal cost to themselves, much like myself. They should not be given any relief.

For the first type of debtor the options will be limited, and they will be painful. Either sell the house, give the proceeds to the bank in full and final settlement, and move on; or continue to live there as a renter, emigrate, or find social housing.

Reform of bankruptcy laws is the correct mechanism to help the first class of 'will never pay' mortgagees. Our bankruptcy laws are archaic. Any system which sees just nine people a year processed into bankruptcy is not working. Efficient bankruptcy legislation can help speed people through this very painful process. The staff of 2,100 in the UK's Insolvency Service processed 30,513 individual insolvencies in England and Wales in the second quarter of 2011. So it can be done, and done quickly.

With the number of homes in mortgage arrears rising steadily, the pressure to introduce this legislation will be extreme.

Just introducing new legislation for bankruptcy lumps the first two types together, harming a large section of Irish society needlessly. A debt forgiveness policy that can differentiate between the two types -- those who will never pay and those who might pay -- will save the taxpayer in the long run, help the struggling family, and bring clarity to banks' balance sheets.

Think about it in concrete terms for a second. John and Jane bought a house in 2005 for €400,000; it is now worth €200,000 if they are lucky. They can't service the mortgage. What can they do?

They can leave the house, try to sell it, and give the proceeds of the sale to the bank in partial or full settlement of the debt. The bank has to write off €200,000 as a bad debt, and John and Jane either emigrate or become wards of the State who require social housing.

John and Jane will likely never borrow again to buy a house. But they will require housing, and that will represent an ongoing cost to the State. John and Jane lose their home. The bank loses 200 grand (but gains certainty about that part of its balance sheet). The State bears the cost of housing them, and of injecting 200,000 into the bank from the €6bn earmarked for these mortgage losses. Everybody loses.

But imagine John and Jane "could", with some pain, service a €250,000 mortgage. Let's look at making debt forgiveness work. Various solutions could work in conjunction with an efficient bankruptcy system. We can test John and Jane to see if they will be able to pay, based on an affordable percentage of main income earner, then reduce the amount owing based on the real value of their incomes over the lifetime of their mortgage.

To pick a few options:

• Debt for equity swap. Suppose the €400,000 mortgage is in default. A reasonable mortgage restructuring might be to cut it to a serviceable €250,000 and create a €150,000 property appreciation option held by the bank.

The borrower agrees to pay off the property appreciation option out of future price increases on the existing home, if any.

• Partial debt write-down. Does exactly what it says on the tin, but worked out on a case-by-case basis using guidelines from the expert group meeting now.

• Converting a mortgage to rent. These schemes are running in the UK now. The bank takes on John and Jane's house, and rents it back to them, giving them an option to buy it back in a few years. Here again shared equity arrangements are possible.

• The owner vacates the house, sells it at market prices, hands the balance over to the bank which accepts the sum in full and final settlement of the debt. Everyone walks away poorer, but they walk away without €200,000 hanging over their heads. This is the US non-recourse option used recently by five homes in Ireland.

A key principle here is fairness. The modernisation of debt settlement in Ireland must take account of this and must seek a reasonable balance between the interests of borrower and lender.

Burying heads in the sand won't resolve the issue. No debt forgiveness scheme will be perfect, none will be to anyone's liking. But we must do this, or harm our society further.

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