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Both debtor and bank must face a new reality after bankruptcy

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Gorse Hill, the opulent Killiney, Co Dublin home of the O'Donnell family

Gorse Hill, the opulent Killiney, Co Dublin home of the O'Donnell family

Gorse Hill, the opulent Killiney, Co Dublin home of the O'Donnell family

Every morning just before 8am I walk our dog over Killiney Hill. On a crisp morning, which is most days actually, there are magnificent views from the Obelisk at the top of the hill out to the Irish Sea and back around in a sweeping arc from Bray Head to the Wicklow and the Dublin mountains. It is a wonderful way to wake up, even more refreshing these recent few days due to the icy east wind on the sleepy face.

Last week, for I think the first time this winter, it was clear enough to see the imposing Mount Snowden in Wales rising majestically on the horizon some 60 odd miles away.

In the winter, the hill is special because the sunrise is late and first light sparks up the countryside beautifully.

Doubtless, views like this must inspire the O'Donnell family each morning. Their mansion, Gorse Hill, is directly under the Obelisk as you look down from on high towards the Dart line. In fairness, the public views from higher up must be better, but to wake up and look out at Killiney Bay from your own gaff every morning is obviously something worth fighting for.

I am not going to go into the "ins and outs" of this particular case, but suffice to say that it is less easy to feel sorry for the O'Donnell family's plight than it is for much poorer people, with much less salubrious gaffs, in much less upmarket areas who are also facing repossession.

That said, no matter what your circumstances, there is little doubt that bankruptcy is a horrible process and up to now it is one where the banks almost always win, even though the banks are as up to their necks in the reckless lending as the bankrupt is in reckless borrowing. This asymmetry is unfair because there were two parties involved in the initial loan and they are both responsible.

Co-responsibility should always be the end solution, whereby the bank takes some pain, as does the debtor.

Possibly the debtor should take more, but to frame the financial redress so the bank gets absolutely everything back merely encourages reckless lending. If there is no sanction for reckless lending, why would a bank ever not lend as much as possible?

Giving the banks primacy in a slump means that more assets are likely to be sold under the market value, ensuring the gap between the distressed sale price and the original debts will tend to be higher.

Why is this?

It is because of something called the "paradox of aggregation" in economics. This means that what looks good for the individual is not always good for the collective.

To see how this works, consider the example of bankruptcy. If your own balance sheet is broken with too much debt and too many leveraged assets, as is the case with the O'Donnell property empire, the bank will advise you to sell your assets to pay off your debts.

This is great as long as the bank doesn't suggest that everyone else does this at the same time.

If everyone sells their leveraged property at the same time, what do you think happens to prices? They fall.

But the debt doesn't fall. So in this way, the person who tries to sell most ends up with the most debt. Because the banks want all their money back, we tend to get this evolution of the property cycle. Bank lending forces up prices at the same time until they crash and then bank deleveraging forces all house prices downwards at the same time.

This implies that the gap between bad debts and realised asset values is large and permanent.

We would be better off if the banks took their time forcing sales, but the banks would only have an incentive to do this if they knew they were going to take a hit regardless. But they don't and we get the paradox of aggregation playing out on the upside and on the downside.

In truth, in the real world, no matter what the banks might maintain, when we have massive bankruptcies, everyone does take a hit. Everyone has to.

The borrower has to sell his assets and if these are not sufficiently valuable to cover the debts, then the bank should settle. There is no point going after a person if they have nothing left.

In Ireland we have always believed that somehow failure should follow people around for decades like a bad smell. This is in marked contrast to the United States where people fail all the time, before they dust themselves down and try again, often succeeding in the future.

If you adopt the Victorian debtors' prison approach to bankruptcy and punish the debtor to such an extent that the debts follow him around into perpetuity, what incentive has he to rebuild his life and income, if all his income forever more is going to pay for past mistakes?

Obviously, what the debtor thinks is reasonable and what the banks think is reasonable are normally miles away from each other, which is the primary reason they go to court.

It is hard to understand how Brian O'Donnell and his wife feel that with debts of over €70m, they can hang on to their house, particularly as it is such an obvious trophy home.

They argue that the house is owned beneficially by their children and they are giving the parents "permission" to live there.

Everyone is entitled to do whatever they like within the law, but the motives of buying a trophy house and then wrapping it up in a convoluted legal structure are difficult to understand.

Once the empire of debt crumbles, both parties have to face the new reality.

One of the best quotes about debts and crashes was coined by John Stewart Mill, the great English thinker and economist, who said of crashes: "the crash doesn't destroy wealth, but merely evidences the extent to which wealth has already been destroyed by stupid decisions taken in the boom". This is always the case.

The moment Mr O'Donnell started borrowing lots of money, he was destroying his own wealth.

Once the borrowing stopped, the asset started falling in value and he was left with the debt. Because in a crisis all the borrowing is withdrawn at the same time, there was nothing to support the assets, so it collapsed in value.

This is the age-old commercial cycle of ups and downs, booms and busts.

In economics and finance, as in nature, there is an almost relentless, repetitive cycle. The only way we can look forward is by acknowledging that yesterday is over, night falls and a new day dawns.

Irish Independent