FINANCE Minister Michael Noonan and Central Bank governor Patrick Honohan addressed the Oireachtas finance committee during the week and both took the opportunity to inject some reality into what was becoming a surreal debate about mortgage 'debt forgiveness'.
here are two types of mortgage borrower in today's Ireland. A significant number of people cannot meet their obligations in full, principally because their incomes have dropped significantly since the mortgage was agreed. A much larger number can pay but would naturally prefer not to. Hopefully the provisions in bank balance sheets will be adequate to absorb the losses from the first group. If any encouragement is given to the second group, by politicians or anybody else, there will be a renewed banking crisis and a quick end to prospects of economic recovery.
Three Irish-owned financial institutions have survived the carnage, Irish Life & Permanent, AIB (which has absorbed the Educational Building Society) and Bank of Ireland. The first two are owned by the State. Bank of Ireland has survived in majority private ownership but only with massive State financial support and continuing State exposure to meet liabilities. Should any of these banks suffer bigger loan losses than have been provided for, the State is on the hook.
All three have assets consisting in substantial degree of residential mortgages. Thus the financial stability of these three banks, recently recapitalised largely by taxpayers, would be undermined if people who are able to pay are offered ways of not doing so.
The financial stability of the State would in turn be further damaged, since bigger-than-expected bank losses will feed straight through. For practical purposes, the mortgages on the books of these three banks might as well be owed to the State.
Some commentators have been arguing for 'debt forgiveness', as if the banks had capacity to exercise discretion about recovering their loan assets. They have no such discretion and are open for business only because the European Central Bank is willing to keep them liquid. They now meet capital-adequacy rules only because they have been bailed out by the State, which in turn lost its creditworthiness because of the horrendous costs of that bailout.
A particularly feeble line of argument that surfaces repeatedly is that negative equity, where the outstanding debt exceeds the value of the asset, should be a factor in justifying leniency towards borrowers. Lots of people who bought homes in the middle years of the last decade are in negative equity, but this does not affect their capacity to meet loan repayments.
Indeed, those fortunate enough to be on tracker mortgages are quite likely in negative equity but are facing repayments lower than they paid when the loan was taken out. For those who have held on to their jobs and who have trackers, affordability has actually improved over the last few years.
Banks do not, when they lend for asset purchase, offer to forget the debt if the asset drops in value. Every car loan is in negative equity the day the car leaves the forecourt. Of course, it is a shame that so many people paid over the odds for property and the drop in value is galling. But the same is true for those who bought bank shares or government bonds. Where mortgage debt has to be written down, this should only reflect inability to pay, which is not related to negative equity.
A related and equally strange idea is that mortgage debt should somehow be retrospectively deemed non-recourse, so that liability would extend only to the current value of the property. But banks would have charged higher interests rates for non-recourse loans, particularly when they were lending 100 per cent of the property value, because the security is much weaker. The simple reality is that they did not lend on a non-recourse basis.
In the United States, there have been legal efforts to cancel mortgage debt where lenders behaved fraudulently and some deserve to succeed since quite appalling tactics were employed to foist unaffordable mortgages on people with very low incomes.
But the Irish mortgage lending debacle was less of a subprime lending binge; it was more about lending excessive amounts to prime borrowers. Very few mortgages were extended to those in the lowest income groups, so a different argument has surfaced. This is that relief should be available if the loan was merely imprudent. It should be clear that offering forgiveness on imprudent loans from the 2004 to 2008 period would cover such a large portion of the loans made as to constitute a new threat to bank solvency.
Several banks which are not Irish-owned, including Ulster, KBC and National Irish, also have substantial mortgage books. These banks will be unable to avoid writing off unrecoverable mortgage debt but will resist doing anything more and cannot be forced to show leniency beyond what is indicated by their own commercial judgement. Bank of Ireland is largely in private ownership and will doubtless take the same approach. The Government will need to take care in any debt-resolution policies that emerge not to create unequal treatment, favouring borrowers from banks which happen to be state owned.
As part of the so-called deleveraging exercise, the banks are being encouraged to sell assets, including mortgage loans, for cash. Any debt-resolution scheme which requires a bank to dilute its loan recoveries will damage the value of loan books and diminish the prospects for deleveraging, which were never bright to begin with.
It would be wrong to dismiss the 'forgiveness' campaign as just a silly season space-filler revved up by a woolly-minded media. There is a real problem for many people and some mortgage debt will have to be written down. You cannot get blood out of a stone.
The danger is that the campaign will encourage everyone in negative equity to disguise themselves as stones and to lobby politicians for relief from debts that they are able to service. The politicians need to understand that debt relief, beyond the minimum necessary to acknowledge that some people simply cannot pay, comes at the expense of a bankrupt Exchequer. Do they really want to go to the IMF/EU looking for a further loan to recapitalise the banks yet again?
The best way to proceed is for all banks to be treated equally, regardless of ownership, and encouraged to write down mortgage debt that cannot realistically be serviced. The process will not be left entirely to the bankers, in whom public confidence remains weak, and it makes sense to have active oversight from the Financial Regulator to ensure, for example, that there is no preferential treatment for favoured borrowers, such as bank staff.
Debt write-downs should be expedited where these are unavoidable and extra staff assigned to the task. A modernised personal bankruptcy code would help and legislation has been promised.
Central Bank governor Honohan suggested that the following four principles should guide the process: "Resolution will be effective only if it is guided by clear principles, including (i) affordability for the borrower of any modified repayment plan (that is to say, recognising the true scale of the problem based on a sufficiently comprehensive assessment of household financial conditions; avoiding unrealistic plans likely to result in recidivism); (ii) avoidance of unnecessarily formal legal procedures; (iii) avoidance of perverse incentives for strategic default by those who can truly afford to pay; (iv) no avoidable losses to lenders, but banks to absorb unavoidable losses using their increased capital."
These are sensible ideas. Clearly, those who have contracted debts and have the capacity to meet them cannot be offered relief from these debts by banks largely reliant on the overstretched Exchequer to make up any new capital shortfall. The banks now have capital provisions adequate to meet the write-downs that are justified by borrower circumstances and the process needs to be speeded up.
Resolving the problems would be easier if activity in the housing market returned to normal levels. Distressed borrowers wishing to downsize would find it easier to do so. In some areas outside Dublin, there seems to be virtually no market at all.
While prices expected by sellers are beginning to look affordable for first-time buyers, the dearth of mortgage credit means that deals cannot be completed. There are credit-worthy borrowers to whom loans for 75 or 80 per cent of today's more realistic valuations should be more readily available and the banks are now better equipped to resume careful lending.
Colm McCarthy lectures in economics at UCD. He headed an expert group examining State assets and chaired the Special Group on Public Service Numbers and Expenditure Programmes, An Bord Snip Nua. He also authored the report into the semi-state sector from the Review Group on State Assets and Liability
