Banks have to pursue all mortgage defaulters
Those seeking lenient treatment of mortgage holders who can pay, risk a fresh banking disaster, writes Colm McCarthy
Published 08/09/2013 | 05:00
The discussion about the mortgage arrears crisis is beginning to lose touch with reality. The solvency of the remaining Irish banks depends on their success in collecting on their loan assets. If they are not successful in pursuing all of those who can repay borrowings there will be another banking collapse and it will play out very differently from the last one.
The portfolio of loans accumulated by the banks during the bubble can be divided into developer and construction loans, residential mortgages and the rest, mostly business and consumer loans. The developer and construction loans have been bought at a large discount by Nama and are no longer the banks' problem. Crystallising the losses on these loans revealed the initial insolvency of the system, remedied through injections of taxpayer cash. But the residential mortgages and the business/consumer loans are still on the books of the banks, and it remains an open question as to whether they have enough capital to write off the unavoidable losses in these areas. They have been playing extend-and-pretend these last few years, have written off very little and the Central Bank has lost patience. Thankfully, there is a belated push to face the music over defaulting mortgage holders, the biggest threat to the viability of the surviving Irish banks.
If the banks are unable to collect enough from mortgage and other borrowers they could go bust again. The two banks wholly owned by the State, AIB and Irish Permanent, have very large mortgage books but so does Bank of Ireland (the Irish State owns 15 per cent) and Ulster Bank, majority owned by the UK taxpayers. Before considering the proceedings at the Oireachtas Finance Committee during the week, when the chief executives of all four of these banks were quizzed by Dail deputies and senators, it is important to be clear about the consequences of a second failure of the Irish banking system.
Since the State itself has gone bust, partly because of the cost of the first bank rescue, it is not possible for the Government to volunteer fresh capital injections should they be needed. The Government faces large borrowing requirements of its own in the years ahead and will have no more access to EU and IMF loans from the end of December. Even if the Government wanted to borrow extra billions to inject into the banks, it could well be unable to do so. There is an EU rescue fund but there has been no agreement that it would be available for another Irish bank recapitalisation. There are insufficient unsecured bank bondholders left to hair-cut, since they were unwisely paid off at the cost of the Exchequer. Finally, the banks themselves would be unable to raise fresh equity from the market, so any new hole in bank balance sheets could only be filled by writing down depositor balances, the route followed with chaotic consequences in Cyprus.
The Cypriot government has agreed to protect deposits up to the guarantee ceiling of €100,000, but unguaranteed deposits in excess of that level have been subjected to severe haircuts or forcibly exchanged for worthless bank shares. Some depositors have lost half of their funds and the Cypriot economy has seized up as a result of restrictions on bank withdrawals. Since there has been no agreement on a European approach to resolving failing banks, it is clear that the Cyprus template will be followed if some other eurozone country experiences a bank bust which exceeds the financial capacity of the government. The unguaranteed depositors will pay, since there is nobody else.
Those who seek lenient treatment of borrowers in Ireland who have the capacity to pay are courting a fresh banking disaster. If that pattern starts to emerge it would be exacerbated by widespread capital flight to avoid looming depositor losses. This would happen, as in Cyprus, in circumstances where an over-borrowed government could do very little about it.
A distinct lack of seriousness was vividly on display last week as the representatives of the people, in the personages of the Oireachtas Finance Committee, vied with one another in demonstrating greater compassion than the CEOs of the surviving banks. The deputies appeared to regard it as their central mission to display greater concern for struggling mortgage defaulters than the despised bankers, who have yet to face a serious inquiry into what actually caused the first Irish banking collapse, due to the indulgence of the same politicians. Elected representatives are content, it would appear, to strike poses, display concern and hopefully get re-elected, having won the compassion derby with the bankers. They would borrow yet more money, at the expense of the generality of taxpayers, to hand out to distressed mortgage borrowers if they could. Happily they cannot, since the national credit card has already been maxed out.
Last week's collective performance by the committee members was deeply depressing, if hardly a surprise. The intention of the bankers to collect as much as they can from their debtors was repeatedly portrayed as uncaring, unjustified or somehow contemptible. There was no acknowledgement of the precarious manner in which the banking system limps along, with unknown but undoubtedly large write-offs yet to be taken. Until these write-offs have been determined, there is a risk that their capital will be inadequate and their survival threatened. This fear has rendered the banking system unwilling to extend new credit to viable businesses. The Troika of the European Commission, the European Central Bank and the IMF have quite rightly insisted that this damaging stand-off cannot continue: economic recovery will be indefinitely delayed if a zombie banking system is permitted to limp along much longer.
Repossession is an unavoidable solution mechanism when borrowers default. The fact that banks have finally begun to issue legal proceedings, including moves which could lead to re-possession, seemed to come as a surprise to members of the Oireachtas committee, who pronounced themselves "shocked". Bank mortgage lending is secured on the collateral of residential property, which does not belong to the borrower until the full loan amount has been paid. So the lenders must proceed to repossession unless some other arrangement, financially viable for the lender as well as the borrower, can be agreed. Any bank executive who eschewed re-possession of the loan security would be risking the survival of the bank, already bailed out once at taxpayer expense, and would deserve dismissal. The members of the Oireachtas Finance Committee, on last week's performance, would lose even more money running banks than the Irish bankers have already done. Some members even objected to banks sending letters to borrowers pointing out something of which they are presumably already aware, namely that non-payment can result in re-possession.
It is past time to acknowledge some realities here. If the threat of repossession is removed and defaulting borrowers permitted to remain in their homes while paying no rent and making no loan repayments, they are getting their accommodation for free. There would be no incentive, in such a regime, for anyone to make mortgage repayments. There would also be no banking system. However much populist politicians may find the idea shocking, the threat of repossession is an essential tool in ensuring the survival of those Irish banks that remain open and an essential component of the system of mortgage finance for the future. The supply of mortgage credit for new borrowers remains inadequate and would contract further if the security of lenders to that market is further compromised. As well as precipitating a fresh banking crisis, this would remove whatever floor to house prices has finally been reached.
Even though the economy found some kind of bottom back in 2010, and despite encouraging growth in employment in recent quarters, mortgage arrears continue to mount. The arrears totals should have stabilised by now if there were no strategic defaulters, particularly given the low interest rate now payable on tracker mortgages. It was clear from the comments made by the bank executives that they intend to be selective in dealing with arrears cases. They know that some borrowers simply cannot pay and that write-downs are inevitable. But they also know that some defaulting borrowers are pushing their luck and will not resume mortgage repayments unless pressured to do so. While the bankers and their regulators bear primary responsibility for the first Irish bank bust, the politicians will be responsible if it happens again.
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