This blight on all of our futures must be tackled
Not only is negative equity hindering our recovery, it will leave the most vulnerable with an impossible burden, writes Brendan O'Connor
Writing the other day in the Irish Times, Jack Fagan told of an investor couple who had booked a €450,000 apartment in 2007. The value of the apartment, even if they could sell it now, is notionally €220,000.
The couple had mortgage approval back in the heady days of 2007. Now that the time has come to complete on the sale, the bank is no longer willing to give them the purchase price. The developer is threatening to take the couple to court to make them complete the sale. The compromise seems to be that they buy their way out of the contract for about €100,000. It's a middle-class property investor horror story. And for "property investor" read presumably a couple who thought they would buy an apartment as a pension fund, not evil developers or, worse, rich folk.
And they aren't the only couple who booked apartments in 2007 at the peak of the market and who are now being expected to buy these apartments at the prices agreed then. Treasury Holdings was the first to initiate legal proceedings against such people, and that could be just the beginning of people being forced to buy apartments that are up to a quarter of a million euro in negative equity as soon as people take possession.
David Duffy of the Economic and Social Research Institute published a policy paper on negative equity last week in the spring 2010 issue of the Economic and Social Review. It seems to be an updated version of his working paper from last October. There is a lot of food for thought in Duffy's paper. And don't be put off by the economics; Duffy makes very accessible and straightforward points.
First, Duffy deals with the important point of why negative equity matters. Official Ireland can tend to dismiss negative equity. While it is apparently systemically important to bail out the big guys, the attitude to negative equity can be that it is people's own fault and they can now live with it for a few years, and shure they'll get out of it eventually.
Duffy points out that negative equity is actually systemically important, and shows how it is actually hampering the recovery of the economy. First there is the very simple fact that being in negative equity makes consumers save more and spend less, and thus chokes the consumer demand we need for the economy to recover.
John Waters spoke vividly last week to me on The Saturday Night Show about locking the door of his house every morning in the good times and going to work secure in the knowledge that his house would be earning much more than he was while he was out at work. They call it the wealth effect. People felt wealthy, so they spent. They also had access to more money by releasing further equity in their houses. That may not have been right, but it drove consumer demand, and now negative equity is doing the opposite.
Duffy also points out that negative equity dampens mobility. He says that those in negative equity will tend not to sell their houses for what they are actually worth because it is an appalling vista. And, as seen elsewhere on this page, they may have difficulty accepting the reality of how much their houses are worth if it puts them a few hundred grand in the hole. So people will sit tight. This in turn can affect the labour market, with workers feeling "locked in" to certain areas.
Perhaps most significantly, and most insidiously, Duffy says, "The reduction in the value of mortgage-based assets can have an adverse effect on lending due to the impact on bank balance sheets. This can lead to a contraction in the availability of credit to both households and firms as banks make provisions for an anticipated increase in expected losses."
We know all about that in this country. And of course that unavailability of credit can choke the housing market, the value of property, and the consumer economy even further. Ask anyone on the ground the single reason why property deals are falling through and they will tell you that it is banks pulling out of mortgages, or refusing to give people enough to buy the house they want.
Negative equity can also make it more likely for people to default on their mortgages. Mortgage default is considered the next big ticking debt time-bomb in Ireland.
The other myth the powers that be peddle about negative equity is that it is not that common, that it affects only a small minority of people. Not true. At the most conservative estimate, by the end of this year, Duffy finds that one in three households with a mortgage -- 200,000 households -- will be in negative equity. At his most realistic, when he takes into account anecdotal evidence that property has essentially halved in value, Duffy makes it 350,000 households in negative equity by the end of this year -- more than half of everyone with a mortgage.
And who is most vulnerable to negative equity? Simple, according to Duffy. Those with high loan-to-values, and first-time buyers.
Of those estimated to be in negative equity by the end of last year, three-quarters were first-time buyers. So that's young people, people who couldn't even get a decent deposit together and who had to take 100 per cent mortgages.
There was a time when the whole taxation, property and housing policy of this country seemed to be decided with reference to first-time buyers. As the Government strove relentlessly to drive property values down, its mantra was that we had to do it for the sake of the first-time buyers, a mythical, saintly crew of innocents for whom we all had to make sacrifices. Now that the first-time buyers have actually bought, and are up the creek, they seem to have lost their
worthiness and now we don't care about them anymore.
When considering first time buyers, bear in mind these statistics: not only did they get high mortgages, they got long ones. In 2007, at the peak of property prices, about two-thirds of mortgages taken out by first-time buyers had terms of longer than 30 years. A life sentence indeed. In the same year, at the peak of property prices, about two-thirds of first-time buyers also got mortgages greater than 90 per cent.
In fact, a quarter of first-time buyers that year got 100 per cent mortgages. So that quarter of first- time buyers alone could now be in negative equity to the tune of half the value of their house. And they are likely to have mortgages of over 30 years' duration. In short, they are probably in the most terrifying hole, and one they will never get out of.
They can't sell, because they will then realise unsustainable losses of hundreds of thousands of euro. They can't have another kid, because they can't move. If they lose their job they can't move somewhere else to get one, and they can't even liquidate their house in order to stop a mortgage they can no longer pay. Neither can they split up. It is a nightmare scenario and it is real for tens of thousands, if not hundreds of thousands, of young people.
There is an interesting addendum to all this, regarding the public and private sector split. Duffy breaks down unemployment by sector. Duffy takes job losses in various sectors between the start of 2007, when house prices peaked, and the start of 2009. One third of construction jobs went in that period; 11.4 per cent of jobs in other production industries were lost, and a similar amount in hotels and restaurants. Duffy concludes that people in those sectors are "more vulnerable to the combination of negative equity and income shock caused by job loss".
There is some good news, however. In health, education, public administration and defence (the public sector), the number of jobs has actually grown by about 5 per cent in the same period. Coincidentally, or not, these are also the sectors where more people have mortgages. About 14 per cent of heads of households work in these areas, yet they have about 35 per cent of the mortgages in the country. As Duffy puts it, "Many of those who have mortgages are employed in sectors where employment prospects remain relatively robust."
In other words, one of the things that could save us from mass-scale mortgage defaults in this country could be the fact that people in the public sector found it much easier to get mortgages and they are now in secure employment in a growth industry. This is in no way my read of the report or a spin. These are the bare economic facts and figures as outlined in the report.
The corollary is that negative equity is a uniting issue in this country, one that rises above the phoney war between public and private sector workers. Negative equity is a blight that concerns us all and, job prospects aside, concerns a much higher proportion of people in the public sector.
Maybe the Government would consider a gesture to disgruntled public sector workers, and at the same time to the rest of us, by engaging in some meaningful way with this blight that is threatening to put off this country's recovery and prevent a whole generation of the most vulnerable from ever getting back on their feet again, recovery or no recovery.