Tuesday 20 August 2019

Edmund Honohan: 'Promissory note' deal for mortgages ticks all boxes

Allowing people to pay their mortgages by IOU for three years would release that cash into the economy.

Edmond Honohan

Are we overlooking a simple way of avoiding the Japan-style stagnation which is now threatened? We are exhausted with the long debate over distressed mortgages. In parallel, we are ever conscious of the crisis in the public finances, the rating agencies, the bond market and the terms of the Troika bailout. Private debt. Public debt. Where is the macro economic synthesis?

A Keynesian stimulus is the lifeline the economy needs, but where is the money to come from? The answer is disarmingly simple: our private mortgage borrowers, both coping and distressed, paying perhaps €5bn per annum in repayments to both banking and subprime, should be given the option of "paying" by promissory note. Release into general consumption the money that was earmarked for the mortgage and watch the domestic economy revive.

Cue alarm bells all round. If it's that simple, they'll say, someone will have thought of it before now, and ruled it out as naive. Not so. In this groupthink society, conventional thinking will always be assumed to be optimal.

This proposal is a lawyer's solution to society's demand for economic stimulus. It ticks all the boxes, both legal and economic.

Allowing borrowers to call the shots will upset the banks' carefully laid plans to deleverage back to profitability? Probably not to the extent you'd imagine, given the multiplier effect on consumption and the likely repayment of unsecured loans. And as for the balance sheet and the capital requirements, rescheduling repayment of performing loans does not make them bad debts and delaying writedowns or repossession for unsustainable loans postpones the need for accountancy writedown.

The public finances and rating agencies? Not a problem. Inject €10bn or €12bn over three years into Ireland's economy and watch those growth and revenue figures improve. Even the property tax take will be better.

Payment by promissory note. Could this be the silver bullet for personal debt? For a few years we'll be diverting some of the mortgage repayments from the banks. We won't need their permission: after all, it was taxpayers' money which kept them afloat. Now it is the economy which must be kept afloat.

The proposal is simplicity itself. Over the next three years, instead of making the monthly mortgage instalment in hard cash, the borrower will have the option of handing over his IOU promising to pay the sum at the end of the term of the mortgage. The borrower is then free to use the earmarked cash as he thinks fit.

And now, the boring bit: the law. Watch this space for the kneejerk "it can't be done" reaction; the product of ignorance of the law and the politicians' nervous deference to anyone who gives the appearance of being slightly better informed.

Both in contract law and constitutional law, modern understanding is far more dynamic and pro-active than is widely understood. EU principles have been a tonic for the old Common Law.

The starting point is the lenders' offer of a loan or facility accepted by the borrower. This is the basic contract document.

Any time there's a proposal to legislate in regard to contracts, the cautious approach is to assume that the legislation will be read as actually effecting a change in the terms of contract and that such

would be an interference with contract affecting the constitutional right to property. But often the legislation will not be a variation of contract terms but merely a codification of existing law. A restatement will not actually change the contract. Even if the legislation goes further and effects changes, the constitutional property right is nowhere near absolute. Public interest is a trump card.

Governments run shy of legislation which might open the doors to claims for damages even if such is only a remote possibility, and even if the quantum of a claimant's alleged losses would be insubstantial or, as in this instance, far, far less than the value of the State's counter claim in regard to the night of the guarantee.

It is for reasons of official caution that none of the official suggestions for dealing with the mortgage arrears crisis ever impose fixed settlement formulae on an unwilling lender. Instead, he is invited to find a basis for a new agreement with the borrower and no lender can allege he was forced to make the changes to which he freely agreed.

Would legislating for payment by promissory note involve any significant risk for the State? I say not: the option of deferring payment is either already a term of contract, express or implied or, if not, it's a graft-on provision which is constitutionally sound.

An implied term? The law has always been on the side of the borrower in peril of repossession. The so-called equity of redemption always prevented the lender from seizing the property when the borrower could pay off the loan in full, even if the payment is late.

The courts' readiness to infer fairness and balance into contracts and especially into long-term contracts is sometimes justified on the basis of purposive interpretation techniques imported from European civil codes jurisprudence and there is convergence of the contract interpretative principles operative in both European civil code and common law courts.

We can therefore confidently conclude that the contract agreed already accommodates rescheduling of payments by a borrower, all within the timeframe originally agreed, provided the lender is not out of pocket overall.

But if the view is that the new legislative device is not a restatement but changes existing contractual arrangements, the court will focus on the extent to which this infringes the lenders' constitutional rights.

Interference with and regulation of contracts is constitutionally permissible provided it is "proportionate and objective" (Costello J in Heaney v Ireland 1994). Given the economic stasis, it shouldn't be too difficult to make an unanswerable objective case in the preamble, such as was done in the Anglo Bank Special Liquidation Act earlier this year.

As for "proportionality", Hogan J has recently confirmed (Irish Life v Duff 2013; obiter) that the first test is "whether the legislation was based on rational considerations". Again, not a problem.

In Tuohy v Courtney 1994, the Supreme Court confirmed that the role of the court was "not to impose their view of the correct or desirable balance" but to check whether the balance "is so contrary to reason and fairness as to constitute attack" on a constitutional right.

The court would be more activist in regard to the second question, namely whether the legislation "impairs those rights as little as possible and their effects on those rights are proportionate to the objectives sought to be attained". It would also "consider whether the essence of the contractual right had been attacked and whether it involved one sector of society being expected unfairly to bear the burdens from which other sectors are exempt".

Actually, as far back as Caffola 1985, Costello J commented that "interference with constitutional rights is not uncommon". A case familiar to politicians was the Article 26 reference in regard to landowners having to set aside 20 per cent for affordable housing under the 1999 planning bill: this was okayed by the Supreme Court.

Back to the economics. Payment by promissory note is a form of forbearance. It does not amount to

debt forgiveness. There is no write-off of the sums involved. Instead, the borrower is converting his liability to pay today's monthly mortgage payment into a liability to pay it at a specified future date, with some additional interest. The issue of moral hazard does not arise. It is rescheduling: the bank treats the monthly payment as having been paid, albeit fully financed by a new facility repayable in full with a balloon payment due at the end of the specified term of the mortgage.

The option to pay by promissory note would not be availed of by every borrower, but probably by most. The scheme is not one for an economy in normal times. It is an Irish solution for an Irish problem: the austerity imposed by the recession in large part caused by the banks' unregulated largesse and the subsequent socialisation of bank debt. The scheme is a form of cashback dividend for those who overpaid to buy a home. But the window of opportunity cannot be left ajar indefinitely. A three-year scheme would be enough to pump €10bn or €12bn into the economy just where and when it can be used to best effect.

In regard to the aggregate promissory note rescheduling private debt, from a macro economic perspective it doesn't matter much which cohort of consumers gets the extra "quantitative easing" spending cash. I suspect, however, that some groups, perhaps overlooking the positive results for everyone in the economy, will object that the windfall will be enjoyed largely by the negative equity generation. There is an unpleasant edge to debates which appear to end in the haves blaming the new have nots for their past folly and condemning them to the "sustainable" breadline. There are no winners in that plan.

In fact, it is the nouveau pauvre and their children whose economic growth path will determine all our futures. Now is a time for our normal standards for social solidarity, not for begrudgery. As a nation, we can afford this. It'll probably be, at worst, cost neutral even for the banks, but if it's not, Brussels will be on hand to help them with extra capital in three years' time when the new EU lender of last resort will be up and running.

Edmund Honohan is Master of the High Court

Irish Independent

Today's news headlines, directly to your inbox every morning.

Don't Miss