Distressed Mortgages

Brian Lucey writes an op-ed on this topic in today’s Irish Times: you can read it here.

49 replies on “Distressed Mortgages”

Some interesting arguments in this useful discussion of mortgage relief measures in an Irish context.

Disappointingly, from my perspective, the article misses what I consider to be the most important argument against such measures – they render more difficult the downward adjustment process in the housing market.

Brian talks about two interrelated problems for residential mortgage holders: Negative equity and payment distress.

In fact, I see both of these problems as symptoms of the same root cause: The housing market is (still) grotesquely overvalued.

From a welfare point of view, the pain which a downward adjustment in house prices occasions for sellers is exactly counterbalanced by the gain to buyers.

But the economy as a whole would gain enormously from a more rapid adjustment. Land prices are the only real element of our cost base which we can control. At present, we are pursuing a range of ‘policies’ (some four-letter acronyms come to mind here….) which are designed to shore up property prices in the short term. This is hurting competitiveness and costing us jobs, literally by the month.

As for the ‘human’ dimension (struggling families can’t afford mortgage, help them to stay in their homes etc.) I refer to my welfare argument above.

For every struggling family we choose to subsidise in order to keep in their home, there is another struggling family – one that did not choose to buy during the bubble – who is being priced out of that very home.

It is a form of moral bias to regard a current occupant as having a more just claim to that cozy three-bed, which I personally reject.

Re Brian Lucey in IT today ……….

“It is generally recognised (without much being done about it) that our personal bankruptcy laws are archaic and unsuited to a modern economy. Without widescale reform, this option would result in a generation of persons unable to access credit and with a major stain on their personal record.”

Reasonably swift action here on ‘personal bankruptcy laws’ would greatly assist in building the institutional foundations needed to get us out of this quagmire. Suggest appoint Judge Peter Kelly, and give him requisite resources, and six months to do the necessary. And the Oireachtas pass it before they head of to the sun by the 1st of July. Surely this is possible?

Sound small business people are also going to the wall due to lack of banking facilities – makes no economic or social sense to crucify these wealth creators for 12 years. Entrepreneurs in such situations will emigrate – and broader Irish society lose out. The threat of long term depression and stagnation in non MNC sector remains very real.

@Graham
theres only so much one can say in 1000 words. To be fair, I do allude to this in the concern re the validity of assuming markets will rise. The point of the piece is to air some concerns about framing the debate. Your point is very well taken however.
Im also not sure that “From a welfare point of view, the pain which a downward adjustment in house prices occasions for sellers is exactly counterbalanced by the gain to buyers”. I think theres a fair amount of research that suggests that buyers and sellers have different utility functions and it to me is not at all clear that theres a zero sum game in action. Its an interesting potentially empirically testable question.

Some views from across the pond:

How to shore up America’s crumbling housing market
August 27, 2008 2:22pm by FT
By Martin Feldstein
http://blogs.ft.com/economistsforum/2008/08/how-to-shore-up-america%e2%80%99s-crumbling-housing-market/
http://www.ft.com/cms/s/0/29e69ebc-736f-11dd-8a66-0000779fd18c.html

America needs a way to stem foreclosures
February 25, 2008 5:43am by FT
By Lawrence Summers
http://blogs.ft.com/economistsforum/2008/02/prevent-us-foreclosures/

Foreclosures: How to save America’s family equity
March 3, 2008 1:13pm by FT
By Michael S Barr and Laura D Tyson
http://blogs.ft.com/economistsforum/2008/03/foreclosures-how-to-save-america%e2%80%99s-family-equity/

The article hits a number of points: lack of data, moral hazard, the costs of a bail-out for homeowners, the effect on the banks (Brian Lucey’s dislike for the Government on moral grounds 🙂 ).

Hopefully people will now go further and start looking at:
1. The merits and drawbacks of specific proposals.
2. The practicalities of implementation.
3. The economic benefit to the general economy of implementing measures and the costs of failing to implement measures.

I have posted a number of links to ft.com in a previous post (awaiting moderation due to multiple links). It looks like we are two years behind them. Perhaps we should engage in a bit of leapfrogging by stealing some of their (and others’) ideas.

As someone who is in negative equity but mercifully still able to service my mortgage, I am not clear why negative equity is a massive issue for the Irish banks.

If someone can service their mortgage, why is its value that important?

I can see why stressed mortgages are such a huge problem so what am I missing.

By the way, Im crystal clear why negative equity is generally an unpleasant phenomenon, just not clear re its impact on Irish banks.

Is there any evidence that borrowers who are able to service their mortgage are choosing not to do so because of the fall in property values?

@Graham Stull, “From a welfare point of view, the pain which a downward adjustment in house prices occasions for sellers is exactly counterbalanced by the gain to buyers”

I’m not sure this is necessarily true in out current climate. Let’s say the market falls to a level that is not ‘grossly over-valued’. Another 50% drop, for example. Anyone who bought in the last decade with a LTV of 80% (at the time of taking the mortgage) would be left with lots of negative equity. If their circumstances change – through unemployment etc then they may become forced sellers. So the negative equity becomes crystallised as a loss on the bank’s books. Prof Lucey gives an (optimistic?) guesstimate of €7.5bn in his article.

But, because we (the country) are still on the hook for the banks losses, we will have to make up those losses.

So the options seem to be (i) House prices stay high, there is an economic recovery and the buyers pay through the nose and save the system. Or (ii) House prices continue to fall towards levels that are not ‘grossly-overpriced’ and everyone ends up paying.

Brian
You are one brave man! Well done for raising the issue. It needs to be done and a reminder, by someone else, in a few months would be a good idea. It is insoluble but fair play!

Graham Stull
Over valued. Yeessss. Indeed. Gaming theory does not apply of course. Every collaps overshoots. We are told this by the real estate folks so we know it is true…. Why is it so important that we attempt valuations, now that the bubble has burst? This is where folks get their fingers burned and distract from the main issue.

COC
Good points! But as time goes by, decades even, (and mortgages in Japan last for 100 years, how lucky are they?) more and more will want to sell up for the sake of a job elsewhere or migrate or whatever, people are so fickle! Know how long an average mortgage lasts? How is that going to be affected when deflation means that all mortgage holders bar those with just five years left, see the negative growing? As rents are getting cheaper? See a trend here? Getting hypnotized by banks that buying is good was a ruse but now it is bad news! Now renting is better. Oh and as you said, if they can service it. Jo0bs are disappearing! Capital will soon be far more valuable, get used to thinking that this is a deflation and a depression. Interesting times.

In a deflation, things are different.

What? Yes the main issue. Well why is it ok for individuals to go scot free via bankruptcy when we have to bail out banks and land owners? To find the genuine values and stop deflation by getting it over with, we need to pull the entire rug, in a very organized way…..

@GrahamStull “From a welfare point of view, the pain which a downward adjustment in house prices occasions for sellers is exactly counterbalanced by the gain to buyers” – Don’t make me come over there! This is almost certainly not true. However, you are right in questioning whether the extra “pain” that is caused by downward adjustment should be a focus of policy. This is really the debate rather than trying to reinvent the now accepted idea of loss aversion.

“I am not clear why negative equity is a massive issue for the Irish banks. ”
Its not, per se. It is a major issue when people need (vs want) to move or have to sell, or cant service due to rising interest rates. So theres more a contingent issue. That doesnt mean we ignore it.

Zhou, Your links are to articles from 2008 and looking through them I can see that each and every one of those proposals made assumptions that have been proven wildly incorrect in the intervening period. All of those proposals were faulty and would have done nothing to restore balance in the US residential market. This should be quite obvious to us now that we have the benefit of hindsight. If we want solutions, let us at least look for proposals that have not been proven to be wildly wrong since they were made.

Good article Brian. Seems to me it’s impossible to avoid the moral hazard it’s a direct consequence of FF’s faustian pact with the construction industry. If your estimates are correct, why would it be worse to subsidise normal people to the tune of 7.5bn instead of throwing 10bn into the rotting carcass of Anglo and accept that it’s a form of moral hazard but with lots of potential upside i.e. people start spending, work for estate agents / QS to value negative equity, certainty for banks on their loan book, possible floor to property market, better quality of life for 200,000 citizens.

You could isolate the relief so that it only applies to principal residence only and treat BTL as a high risk investment which went sour just like bank shares etc. You could cap the upside for homeowners in future (say over 10 years) like a reverse stamp duty if you eventually sell your house at a profit and you were subsidised for your negative equity. Can’t be that difficult to think of viable solutions – no shortage of ingenuity when it came to NAMA.

Would also point out that with hundreds of thousands of seperated / divorced couples in Ireland (I’m one) a lof the negative equity will apply to second time buyers trying to get back on their feet.

John

@Garo

I don’t know what or which “proposals made assumptions that have been proven wildly incorrect but I think it is so obvious as to go without saying that “now that we have the benefit of hindsight [we should] at least look for proposals that have not been proven to be wildly wrong since they were made”.

The point of posting the linked articles was to show that similar (not identical) debates have been underway elsewher. Perhaps if you shared your critiques of the articles you would help move things on.

@ Liam, Brian

Okay, I accept that the utility functions between buyers and sellers may not be symmetric. The heuristic comparison is designed to evoke the simple point that seems often overlooked – from a welfare point of view, potential buyers should be considered too.

Once we open the wider welfare can of worms, we have to start asking whether foreclosure wouldn’t also have medium term gains even for those foreclosed upon (the Barbara Bush, Hurricane Katrina argument…)

Cracking the cue ball into the reds of the Irish real estate market is the best way to see bubble-riders out of negative equity and back into housing they can afford, after their credit mess has been cleaned up in a few years time.

In any event, would the welfare loss of unchaining stubborn bubble-riders from the plumbing be enough to justify the competitiveness effects of building mortgage relief dykes and levees?

Lorcan,

The net effect on banks balance sheets of pretending loans are worth what they are not is zero.

The subsidy to bubble-riding home-owners in the form of state-backed mortgage relief can just as easily be used to pay down the state’s obligations to the nationalised banks.

I see no argument there to pretend houses are worth what they are not.

Negative Equity reduces liquidity and mobility in the housing market.

The buyer cannot buy the house/apartment cheaply if the seller cannot sell.

Zhou: You could start by reading the two comments to the Barr & Tyson article. Both Martin Wolf (FT columnist) and Willem Buiter came out with very strong critiques of the proposal as did Edward Dodson who worked for Fannie Mae. I quote from Wolf:

Martin Wolf: I agree strongly with the concerns expressed by Willem Buiter and Mr Dodson. Is not the whole problem in the US that the government has intervened too heavily to subsidise owner-occupation, via both interest deductions from tax and government-supported, fixed-interest-rate lending? Anybody who purchases a house with debt s/he cannot service in normal times and conditions is a speculator. So the distinction the authors make between owner-occupiers and speculators is, in this case, particularly absurd.

What is really astonishing about all this is that Americans were the people who went across the world preaching the virtues of the free market – and not just preaching, imposing. And now comes a US crisis and the almost universal reaction seems to be “whatever happens, we must not let markets work their way through”. This is hypocrisy, quite apart from anything else.

Let markets clear; help make the process of clearing more efficient; preserve liquidity in financial markets; and keep aggregate demand up. This is surely what the authorities should now try to do.

Ditto, the comments to Larry Summers’ article.

“Let markets clear; help make the process of clearing more efficient; preserve liquidity in financial markets; and keep aggregate demand up. This is surely what the authorities should now try to do.”

Hear, hear! And, in terms of the Irish context: “here, here!”

The most viable solution is to make jingle mail an easier option for distressed borrowers. Individual solutions/loan modifications should be between bank and borrower.

The HAMP programme is not easy to apply to Ireland. Most Irish mortgages could be classified as Option ARMs. There is little or no scope to reduce the interest servicing costs. Where HAMP has seen some success is by reducing interest rates down to a minimum of 2%. This can be significant for Subprime and ALT-A, but of little use to the relatively cheap Option ARMs. The US is also at a significant advantage as lower interest rates can be facilitated through Freddie and Fannie special programmes. The Irish government cannot facilitate a cheap pool of funds.

It is important to remember that the vast majority of distressed mortgages in the US result in foreclosure.

Below are some excerpts from a recent Moodys article on HAMP:
“A linchpin in the Obama Administration’s plan to stabilize the housing market is the Home Affordable Modification Plan (HAMP) to keep millions of homeowners out of foreclosure. Recent reports from Treasury indicate that HAMP is starting off much more slowly than anticipated. Our analysis shows that only 400,000 to 1 million loans will be saved from foreclosure by HAMP, far short of the 3 to 4 million loans that the administration had hoped for when the program was announced. The small number of foreclosures prevented further underline our expectation that house prices will depreciate further before they stabilize toward the end of this year.
——
Briefly, the main criteria for eligibility in the program are: (1) loans must be originated prior to January 1, 2009; (2) mortgaged properties must be owner occupied; (3) outstanding loan balances must be below the expanded conforming limit; and, (4) borrowers’ front-end debt-to-income ratios must be greater than 31%.
In addition, HAMP requires that borrowers are either currently delinquent on their payments or otherwise deemed by servicers to be at risk of “imminent default.”
—–
Next, servicers participating in the HAMP program employ a net present value test to determine the fraction of the resulting HAMP eligible population of loans that would make economic sense to modify. That is, the NPV value after modification exceeds the NPV value without a modification. In order to meet this criterion, modification will have to result in a substantial reduction in the probability of default of the mortgage to justify the loss of income that comes from reducing interest rates.
—–
Data on redefaults for HAMP-modified loans is sparse given the limited history of the program, but previous servicer-initiated modification programs have yielded redefault rates around 50%, according to the OCC. Assuming that the documentation and trial payment requirements for HAMP are more restrictive than these other plans, the redefault rate may be closer to 30%. Under this assumption, 400,000 homes would avoid foreclosure under the plan.”

I believe the bond markets took a dim view of Greek plans to reform bankruptcy laws too.

I believe we need to get to a point where we no longer have a reliance on bond markets for day-to-day spending as soon as possible. If we get to that point, we will be in a better position to implement policy without being, eh, exogenised.

How this is to be achieved by keeping the banks afloat is a mystery to me (wrapped in an enigma). At some point when you are holed below the waterline, you may have to turn the pumps off and let the ship sink. In which case an orderly lifeboat plan and rescue ships are called for. I don’t believe the seriousness of the situation we are still in is yet realised.

@Ahura
I agree that most mortgages are ARMs, but disagree that they are Option ones. We, at least, don’t have pick-a-pay options… though I see some commentators want to introduce them as part of the solution!
http://en.wikipedia.org/wiki/Adjustable-rate_mortgage

In theory we should be looking to fix interest rates long-term for large swathes of people while rates are low. The problem is that the ARMs, particularly low margin trackers, are currently way lower than long-term rates and with the best will in the world many people can’t afford long-term rates.

I think some for of long-term fixing combined with principal reduction so the monthly payment only goes up a bit, but is then fixed for ten or twenty years might have legs (in that the short-term boost to interest revenue would make up for the loss in principal).

I can’t see that a change to non-recourse mortgages (allowing jingle mail) for existing mortgages would do anything other than bust all the banks (including the one that isn’t bust yet), much as I favour such a move for new mortgages (or a move to CoCos or partial recourse) for the future.

I left my views on the feedback section of the IT website (under this article) so not much point in ‘boiling my cabbage twice’. In summary – good article but I think you understate/underestimate the problem at 7.5bn Brian. I’ve been warning about this since last summer – blogged it last on

http://josephmorgan.blogsome.com/2009/09/05/aftershock/

I’ve also just finished editing a radio programme about this subject (Ronan Lyons – hat tip – is one of the contributors – along with Joan Burton TD, Noeleen Blackwell from FLAC and contributions from Focus Ireland and halfaloaf.ie) ….. I’ve just got to find someone to air in now!

And then…… as Brian rightly points out…… there’s the whole mess that is unsecured lending for all those credit cards/cars/holidays/etc.

Tips of icebergs and all that.

@LorcanRK – “So the negative equity becomes crystallised as a loss on the bank’s books. ”

Just a question. Is that true? Surely the bank sells the repossessed property and then the (previous) owner is still liable for the difference between the sale price and the outstanding mortgage……… which the bank will make look like another, smaller, loan on their books ……and the old mortgage has been ‘cleared’? Surely all it takes is just another sleight of hand accounting trick to not make it look like a loss?

Not sure – I’m no accountant so don’t crucify me if I’ve got that wrong. I would have thought repossession and sale, with the mortgage holder having to pick up the tab for the difference, is a no lose situation for the banks?

http://www.nytimes.com/2010/02/03/business/03walk.html?ref=business

US situation. Many state there have non-recourse mortgages, ie the security is the house. . Period. . . No sue the borrower. Especially in view of reckless lending, where the borrower may try suing the lender!!! but that could never apply to Ireland where the banks only lend sensibly. The suit often succeeds if the mortgage agent is deemed to be ana gent of the lender, and acts fraudulently.

Irish banks usually insist on insurance whn lending over 80% ltv. They can recover against the insurance company which can then pursue Sean P Citizen for the costs etc.

@zhou_enlai “Perhaps if you shared your critiques of the articles you would help move things on.”

Ouch. Remind me not to cross you this afternoon 😉

I also meant to say….. I was also advocating last spring that instead of the government throwing tens of billions into the banks over the coming years (I’m starting to think that I’m a prophet) why don’t they just divvy it up between every head of household in the land and tell them to use it to pay off mortgages and other debt (or spend it into the economy if they don’t have any). I’m sure that would have worked but it’s just a bit too ‘outside the box’ I guess. Maybe not even in the same room as the box.

Joseph

That was the nature of the Australian stimulus package. They literally sent out money to people on the records at the rate of $900 a time, if in receipt of social welfare. And if students! There was an appreciable multiplier effect. Total cost of that ang building stuff at every school in the commonwealth: $40Bn.

But Ireland can’t afford it…..

It probably also should be pointed out that there are various levels of stress within the distressful mortgages.

How many mortgages holders will end up facing more limited choices with childcare, university for the kids, cars, home improvements, etc
where the stress of the mortgage impacts on all these choices, and ultimately the surrounding economy.

Wouldnt it be more factual to state that consumer spending is ‘diverted’ to mortagage payments, as opposed to characterising it as a national decrease, especially with deductions in wages.

Wont this depress the national economy for the next X amount of years?
X =31 of my years, anyway!

Al

@yoganmahew
“I can’t see that a change to non-recourse mortgages (allowing jingle mail) for existing mortgages would do anything other than bust all the banks”

I did qualify the jingle mail with “easier”. My view is that best efforts should be made for banks and borrowers to resolve their problems. I think it would be helpful to marginally strenghten the borrowers hand.

Realistically, a large majority of distressed debt should go to foreclosure. Only a small portion of debt will become affordable by restructuring.

Equally, I’m not convinced that the government should play any role.

@Liam Delaney (but also Graham and Brian)

It’s perfectly reasonable to suggest that the impact of a fall in house prices is an increase in utility to buyers of the same size as the decrease in utility to sellers. It’s true that the loss in utility to the seller is very easily identified – particularly in the case of negative equity – but that’s not the same as saying the loss for one is bigger than the gain to the other.

In any case it’s important to state that it’s not the moral responsibility of potential house buyers to indemnify excessively indebted house “owners” against the consequences of their bad decisions, nor is it reasonable for the state to mandate such an indemnification.

Just as it is not Microsoft’s or Exxon’s or CRH’s responsibility to indemnify Bernard McNamara against the consequences of his debts, it is not the responsibility of today’s unmortgaged house owner, nor today’s college leaver, or today’s renter to pay for today’s non-paying mortgage holder.

@AM

Surely the Govt has a role, be it active or inactive.
Because the Govt and the citizenry will face the consequences of a particular action or inaction.
At a minimum the mortgage interest relief for negative equity, which has already happened.

Looking at it from afar, it seems that they are on a go slow in recognising the full extent of our national situation, and until they end this ‘work to rule’ all actions will be half assed as they wont take off the blinkers.

Al

@Hugh “In any case it’s important to state that it’s not the moral responsibility of potential house buyers to indemnify excessively indebted house “owners” against the consequences of their bad decisions”.

True. Nor is it my responsibility to indemnify a totally corrupt and reckless Anglo. However I have been given no choice by the current Govt.

just wanted to say to Brian L – great article! within the confines on an op-ed you managed to get a great deal of difficult yet vitally important points across, a small miracle in itself!

Lucey writes “As of the end of 2009, there was something of the order of €75 billion outstanding in residential mortgages…”

The Central Bank monthly statistics show that outstanding residential mortgages in December 2009 were €147.6 billion. (€109.9 billion regular + securitised mortgages).

Where does the €75 billion figure come from?

@John H.
“Nor is it my responsibility to indemnify a totally corrupt and reckless Anglo..”
Can’t disagree there – but the implication seems to be that a second wrong will make the first wrong right. The fact is we (tax-payers don’t forget) can’t afford the bank bailout – do you really want to be “given no choice” in another bailout of reckless house buyers?

@John Heavey.
No argument from me about Anglo. In general it’s often true – as per Lazarus Long – that taxes are not levied for the benefit of the taxed but there are still cases where justice is far too egregiously ignored in setting taxation policy.

Anglo is one case. A mortgage bailout where value is transferred from the aspiring house buyer to the current house “owner” would be another.

Hugh S
Do you think we have as a society ANY duty of care to those who overborrowed? Sure, in all cases some responsibility lies with the borrower, and in some cases all such lies with them. The state (through lax regulation), the banking-developer-estate agent nexus , and the borrower all bear some responsibilit. What remains now is
a) decide how much each has to bear
b) decide how much each can pay.
Saying “not my problem” aint a solution. In this regard, we are our brother and sisters keepers, and while they need to learn a lesson (dont borrow more than your ability to repay) so too must we (dont let people do stupid things for decades and then act all surprised when the chickens come a-roosting).
B

@Brian
First, “society” is often a word that deserves scare quotes. When you say “society” do you mean me? Do you mean you? Do you mean my kids? Yours? My elderly mother? Yours? Do you mean people who are struggling and managing to pay their mortgages? Do you mean people who are living in private rented accomodation? Which people, exactly, is “society” in this particular context?

Second, even if you accept that “society” exists, you can argue that society has a duty of care to keep people from starving, from living on the street, from having no access to healthcare and education without agreeing that society has a duty of care to take some people’s money to keep other people living in houses that they are not paying for.

In essence society has the same duty of care to those who overborrowed as it owes to everyone, as mentioned above. Those who overborrowed are not entitled to special treatment.

The claim that “it’s not their fault” is true in some cases, and it’s sad. Some have been simply unfortunate, hadn’t overborrowed and still lost their jobs and incomes. That always happened and will continue to happen in the future and it is really unfortunate for those people.

The question you seem to be asking here is whether we should be unusually generous with those who did overborrow and who were – by any sensible measure – imprudent. My answer? No. If this seems to lack compassion for these people, it doesn’t. What is is, is compassionate to those who would be asked to pay the bill. These people have somehow become invisible in the debate. They should not be.

Amusing comments in last weeks Sunday Indo about the shortage of PhDs in banking policy circles and resulting mistakes.

Since I only have a Masters degree I must be wrong about the Central Bank monthly statistics showing that outstanding residential mortgages in December 2009 were €147.6 billion.

Lucey has a PhD so his figure of “€75 billion outstanding in residential mortgages” must be right, no?

@Bob the Banker.

“Lucey has a PhD so his figure of “€75 billion outstanding in residential mortgages” must be right, no?”

Looking at the breakdown of the Central Bank figures here (sept ’09) http://www.centralbank.ie/data/MonthStatFiles/Breakdown%20of%20Outstanding%20Residential%20Mortgages%20-%20Sep%202009.xls
The total of mortgages for principle dwellings is €78.6bn. Perhaps Brian, armed with his Phd, extrapolated the figure to end dec and arrived at €75bn?

After all, I’m pretty sure that any legislation would only be for mortgages on principle dwellings, so the €147bn would not be accurate to use in this case..

Joseph
That was actually tongue in cheek. Restriction on debate is a sign of ? Someoine tried to tar one of my contributions as a problem. Only one?

Housing
Just because the UN says we have a right to housing does not mean it can be inordinately at the expense of one sector of society. We have more houses than we need. So what is the problem? One created by lending!!!!

WE have what we wanted, enough housing for all!!! There is no problem just the challenge of who is to lose more money. This is a legal problem. It should be easily settled if we had a decent justice system. Do we? Are we giving bond holders good money for nothing?

@Bob the banker
LorcanRK’s figures are also available in that thread that you point to on thepropertypin. The clarification is welcome of just how much Irish mortgage debt the banks have on their books. Of course, bankers should be able to work these figures out for us amateurs… but then we have a problem with bankers and sums in this country…

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