Colm McCarthy: Forgiveness is a virtue not needed by many
Debt relief can further weaken banks, and not all of those in negative equity can't pay, writes Colm McCarthy
Published 19/02/2012 | 05:00
Ireland's debt crisis has resulted in widespread financial pressure on households and small businesses, overshadowed by the headline-grabbing bankruptcies of property moguls.
It is clear that the insolvency laws are out of date, but the proposals from Justice Minister Alan Shatter to update the personal insolvency regime need to be seen in context.
Household mortgage debt is owed in the main to the three principal banks: AIB, Bank of Ireland and Permanent TSB. All three would have closed their doors without Government support.
Those in financial distress naturally seek relief from their debts, but this can only come from the banks or their guarantor, the Government.
There is a large and inescapable constraint on any programme of debt relief: neither the Government nor the banks can finance themselves, and are in a weak position to extend financial assistance to anyone else. The Government is reliant on emergency funding from the EU and the IMF, while the banks cannot attract adequate deposits or investor loans and continue to borrow prodigious amounts, also on an emergency basis, from the European Central Bank.
Should the banks decide to offer generous debt relief, or be required to do so by legislation, the recent repairs to their balance sheets could be undone, creating further burdens on the Exchequer.
The banks have been re-capitalised, at enormous cost to the State balance sheet, but those who lend to Irish banks are still not convinced that the banks are sufficiently credit-worthy. The bank rescue remains a work in progress. The State is not credit-worthy, is unable to borrow freely and remains on the hook for the banks.
As the Government battles with the European Central Bank to ease the Exchequer costs of Ireland's bank rescue, the reconstruction of the shattered banking system faces a major risk.
Substantial loan losses have been provided for but nobody knows, or can know, whether the provisions will prove adequate. There could be a benign outcome but if the economy does poorly over the next few years and more people lose their jobs, there could just as easily be a further deterioration in the financial condition of the banks.
Ireland has faced up squarely to its bank bust but nobody can be certain that there is no downside from the calculations already made.
So, the Government must be careful not to create any impression that those who can somehow meet their debt obligations are about to be relieved of that responsibility.
The impression can easily be created that a squeeze on household income equals
financial distress. It most certainly does not. Household income has fallen substantially and there has been a consequent drop in consumer spending.
Job losses have been a principal driver, allied to pay reductions, tax increases and cuts in government spending programmes. All of this is unavoidable and there is more to come.
But the portion of the population suffering financial distress is much smaller than the portion which has had to take a cut in living standards.
Around one in seven mortgages is more than 90 days in arrears or has been restructured, but not all are beyond hope of recovery. Financial distress means an inability to finance outstanding debt, not just difficulty in doing so. It does not embrace discontent with the reduction in living standards which has occurred.
In particular, negative equity, a situation where today's market price for an asset, for most people a residential unit, is below the mortgage outstanding, does not necessarily imply financial distress. Anyone who purchased assets at bubble prices (bank shares, for example) is nursing losses and faces lower living standards.
Those who borrowed to buy, as most home purchasers do, may be facing negative net worth, a situation where your liabilities exceed your assets.
This is an enormous disappointment to people, but it does not imply that they are in financial distress.
Those who have retained their jobs, even on reduced post-tax incomes, are clearly in the best position. If they took out tracker mortgages (most mortgages taken out over the 2004-2008 bubble peak were trackers) they are likely paying an interest rate below what they bargained for.
Those still working but on variable rates are in many cases facing higher interest rates and the financial pressure is greater. But it is those who are out of work and have substantial mortgages that are likely to be in financial distress. If they have variable rate mortgages rather than trackers, their position is even worse.
Some of these borrowers have fallen seriously behind with mortgage repayments and there comes a point where some form of personal insolvency becomes inevitable.
Banks can come to voluntary arrangements but it has been clear since the onset of the crisis that the legal framework is out of date and inadequate. The heads of a bill were released at the end of January and detailed legislation will come before the Dail in April.
The main provisions are a reduction in the period of bankruptcy from 12 to three years, a non-judicial state-run insolvency service and three new voluntary debt-settlement arrangements.
For smaller unsecured debts (up to €20,000) a certificate can be issued relieving the debt where there is demonstrated inability to pay.
The second scheme would cover larger unsecured debts but subject to creditor agreement. Secured debts up to €3m would come under a third and more formal scheme, requiring creditor consent, and the bulk of mortgage debt would fall under this provision.
Personal bankruptcy, voluntary or involuntary, would remain as a fourth and final option but with changes to the rules.
Any scheme which improves the deal for debtors may weaken the position of lenders. If the scheme does no more than formalise the debt-forgiveness which will take place anyway where people simply cannot pay, the effect on the solvency of lenders should be small.
But if expected loan recoveries for the banks are materially diminished because of the change in legislation, the re-building of bank solvency is endangered.
It is tempting to feel little sympathy for the banks but any hit to their balance sheets translates directly onto the balance sheet of their guarantor, the Exchequer.
The details of the new insolvency scheme must await the publication of the legislation, but warning bells have already been sounded by the credit rating agency Moody's.
Earlier this month they argued that " ... many mortgage loans will be written down and many borrowers will become discouraged from maintaining their mortgage-loan repayments." Moody's concluded that "A quarter of all Irish mortgage debt is susceptible to a write-down".
Mortgages are the biggest single asset remaining on the balance sheets of the troubled banks, so this sounds pretty alarming. But Moody's qualified their conclusion:
"In the unlikely event that all negative equity loans were to be written down to the market value of the home, we estimate that 25 per cent of all mortgage debt would be written off," they said.
Finance Minister Noonan responded: "It is premature for any rating agency to make any call," and he is right of course. The new arrangements will damage the banks, and hence the Exchequer, only if those who can pay are relieved of the obligation to do so.
The warning from Moody's is however valuable. Ireland needs a more active market in mortgage credit. Lenders will need to be able to finance new mortgage lending, through assuring depositors that their funds are on-lent to sound borrowers and through packaging mortgage-backed securities which will find buyers.
Legislation which weakens the quality of future mortgage loans will hinder the re-emergence of a normal residential property market.
There is no capacity, in the banks or the Exchequer, for some elaborate debt-forgiveness programme. Since you cannot get blood from a stone, it is desirable to streamline the personal insolvency arrangements so as to recognise this reality.
But no incentives should be created which encourage those who can pay to disguise themselves as stones.