Alan Ahearne: Banks need a solution to tracker dilemma as economy is suffering
Remember the Financial Regulator's ad in the bubble years in which a guy stands up in a bus and admits that he doesn't know what a tracker mortgage is. If he had bought a property around that time using a mortgage product other than a tracker, he would now sorely regret that lack of knowledge.
Compared with other mortgage products, trackers have been a boon for borrowers – and a bane for banks, taxpayers and the economy.
The average interest rate on a tracker is about 1.25pc. This assumes a margin of 1pc over the ECB's rate and compares with an average rate on a variable-rate mortgage of about 4.5pc.
Homeowners with trackers have felt the full benefit of the extraordinary easing of monetary policy in the euro area over the past five years. With ECB rates having plunged from about 4pc in 2007 to near zero today, some €500 a month in interest payments have been knocked off a €250,000 mortgage. That amounts to €6,000 extra cash each year.
Of course the tax rises and spending cuts in successive Budgets since 2008 have had the opposite effect. Measures such as the USC, property tax, increases in the VAT rate, public sector pay cuts, reductions in child benefit, and so on, have badly hit disposable incomes.
Trackers have been a disaster for banks. Along with many other aspects of bank lending during the bubble, bankers were happy to offer these mortgages in the belief that the property market was heading for a soft landing. What was not anticipated was that the cost of funds for banks in Ireland, which for a long time had stayed close to the ECB's policy rate, would rise dramatically, even while the ECB was cutting policy rates.
Analysis from Merrion Stockbrokers suggests that AIB, Permanent TSB and Bank of Ireland are losing about €700m a year on trackers. They are loss-making because the banks are paying more for funds than they earn in interest payments on these mortgages.
As former BoI chief executive Mike Soden perceptively observed: "For a bank, when is an asset in reality a liability? When it's a tracker."
Those who earn a living by blatantly pandering to populist outrage about banks might just shrug their shoulders. But this ignores the reality that nearly three-quarters of the Irish banking system is owned by the State.
The large losses associated with trackers are not just a drag on the banking system – they are also an issue for the public finances. They are what economists refer to as quasi-fiscal costs: outlays that are not included in official government figures but are largely the same as other types of government spending.
If government accounting were done properly, Brendan Howlin would announce in the Budget speech that the Government would be spending roughly €500m of public money next year to subsidise holders of trackers, the same amount as this year.
In addition, some holders of trackers benefit from mortgage interest relief, though the amount of relief has declined along with interest rates.
The damage to banks' profitability from trackers also affects the wider economy. The banks have raised interest rates for homeowners with variable-rate mortgages to cross-subsidise homeowners with trackers, wiping out some of the benefit to the economy of rate cuts by the ECB.
Moreover, investors' concerns about the large amount of trackers on banks' balance sheets are adding to the cost of funds for banks. The banks are passing on these higher costs to new borrowers in the form of higher interest rates and charges. As a result, we have less new investment and fewer jobs.
If banks could fund the trackers at a very low cost, even these low-yielding mortgages could turn a profit.
One solution might be for the banks to present the trackers to the ECB as collateral against which the banks could borrow tens of billions of euro at 0.25pc. The difficulty here is that the ECB applies very large haircuts to trackers as many of these loans are non-performing or involve substantial negative equity, which makes them less attractive to the ECB.
The European Stability Mechanism (ESM) could make an arrangement like this work by guaranteeing repayment of the trackers. Guarantees would render these loans eligible for ECB funding operations without the need for large haircuts or discounts.
Unfortunately, its current rules don't appear to allow the ESM to offer such guarantees – and changes to the rules would likely meet with political resistance in parts of Europe.
If cheap money doesn't come from the ECB and ESM, then perhaps the Irish authorities could consider another potential source of funding for the trackers. Since state-owned German banks can borrow almost any amount at near zero interest rates, the tracker dilemma could be solved if these banks were willing to lend funds to Irish banks at close to cost price.
It is interesting that German state-owned development bank KfW is already providing cheap loans to Spanish bank ICO to be disbursed to SMEs in Spain. We were told last week that Angela Merkel has asked KfW to work with Irish and German authorities to discuss ways to improve Ireland's funding mechanisms. Those discussions could usefully include the potential funding of Ireland's infamous trackers.
Alan Ahearne is head of economics at NUI Galway and a former adviser to the late Brian Lenihan at the Department of Finance