Technical difficulties and, frankly, my own stupidity, prevented me making three points I thought were important on Primetime last night.
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First was the nature of the problem: banks have liabilities in the form of loans that might go belly up, and homeowners have the other side of that balance sheet with their houses. Many, many people in Ireland won't be able to afford to service their home loans in 24 months' time, because interest rates (and therefore the cost of their repayments) will rise as the world exits the trough of the business cycle, thanks largely to massive government expenditure in the US, UK, EU, China, and South America. The inflationary effects of that expenditure must be dealt with by the relevant authorities (in our case, the ECB), and so interest rates will rise. We are therefore looking into the mouth of yet another banking crisis, only this one isn't systemic, unless the wave of defaults at any one time becomes a tsunami, and banks can, to a certain extent, control their loan books to stop this from happening. I've blogged about this before some months ago.
Back in October I wrote:
When interest rates go up, as the European economy recovers, many households now barely making their monthly mortgage repayment will find themselves having to restructure their mortgages, or default entirely. What’s going to happen when thousands of homeowners throw their keys back over the bankers’ desks?
Banks, through the courts, have a set of processes for dealing with the painful processes of individual mortgage defaults. There is no process for dealing with hundreds, and perhaps thousands, of mortgage defaults in a short space of time. Banks will be left with large swathes of bad debt, and will come looking for taxpayer assistance again if they can’t raise funds on the interbank market to cover their losses. We will be back to square one, needing a NAMA 2.
Will we see this NAMA 2.0? I highly doubt it, but this is Ireland. Anything is possible.
Second, an important question is how many home loans will likely go to the wall. I'm not chiefly interested in primary residences. The courts are, rightly, very reluctant to toss people out of their homes. What worries me is the number of buy-to-let or buy-to-flip properties out there with mortgages which aren't sustainable for someone in the short to medium term. If there's no NAMA for these types of properties, we have a problem, as the scale of defaults over a 3-5 year period could wipe out any and all equity capital the banks can build up to buttress themselves in that time frame. We have no data on the numbers of homes in these two categories experiencing difficulties. But Pat Farrell's members do. Publishing those numbers would go a long way to letting us know the scale of the difficulty homeowners find themselves in.
Finally, the range of options put forward by Minister Ryan to help home owners surprised me. First, the obvious extension of banks' moratoria on repossession. Fine, but it doesn't solve the problem, long term. Goodbodys estimated that the average new first time buyer mortgage had a length of some 37 years. Interest rates are currently artifically low and even a process of writing off or leaving in abeyance a proportion of mortgage debt will do little to help, simply because extending these mortgages means assuming people paying off mortgages in their 60s and 70s. Debt/Equity swaps might work too, as might working out percentage of salary based repayment schedules.Short selling might work in certain cases, but it would undermine the market in the medium term, and wouldn't help NAMA 1.0 do its job
The only thing I can see helping to alleviate the problem is a recasting of Ireland's personal debt laws, to make us more in tune with other countries like the US and UK. A mortgage is a contract. Sometimes things don't work out. Use the legal system to provide a simple, speedy, and fair process to declare bankruptcy and write down losses on both sides of the balance sheet, and move on. That's capitalism, and it is really unpleasant, but it works. The banks take short term pain, but are up front about it, so markets lending to them don't care so much, keeping the banks afloat. The existence of bankruptcy laws will change banks future lending behaviour, leading to a (slightly) more stable banking system as bankers become more cautious, and the homeowner walks away with what they can, safe in the knowledge that they won't pay a penalty for 12 years as a result of one poor decision.
I thought the banking federation representative's comment (didn't catch his name) that the subprime lenders account for 2% of the loan book but 40% of the repossessions was revealing. I thought that he was sincere when he said the Irish banks would avoid legal action on defaulters who engage in good faith with their lenders. I don’t think they will be so understanding with the buy-to-sell and buy-to-flip crowd. Agree, if we had bankruptcy laws here lenders would be a lot more careful about who they lend to.
Hi Frank, you correctly identify the problem: there are balance sheets to consider, and while the banks don't like the bad PR of pushing people out on the street (and the courts are loathe to let them in any case), they won't have any mercy for buy to let investor types. The sincerity comes from the fact that a wave of defaults would crush the banks immediately--so it is in everyone's interests to make the process of winding up mortgages that should never have been given out as painless as possible, and ensure that, in the future, we don't see a repeat of 2006/7/8's events. Thanks for the comment!