Brian makes a number of important points on this issue (moral hazard, fairness of helping those who took out excessive mortgage, limited capacity of these banks to take further losses leaving it back on the hard-pressed Irish taxpayer, bankruptcy reform). I was going to post a comment on it but the thread’s already really long and I wrote too many words, so I’ll put this on the front page instead.
I’d like to add to Brian’s points by discussing a stylized example in which a mortgage modification plan could work in the sense of easing the difficulties of current owners without costing the bank or taxpayer anything. Then I’ll note how the conditions of the stylized example won’t necessarily hold in many cases.
A couple bought a house three years ago for €380,000 with a mortgage of €350,000. They have now lost their main income and have fallen behind on the mortgage. The house is now worth only €250,000, so they cannot pay off the loan by selling the house and moving to a cheaper one. However, they could afford a lower mortgage of €250,000. In this case, here’s two approaches the bank could take:
(a) The bank could look to repossess the house, put it up for sale and end up recouping less than €250,000, incurring a loss of more than €100,000.
(b) The bank could adjust the principal on the mortgage down to €250,000. In return, they could look for a two-sevenths ownership stake (i.e. a stake of 100,000 / 350,000) with the couple having an option to purchase the two-sevenths back at a later date. Fully marked-to-market, a loss of €100,000 has still been incurred. But I suspect that the bank could probably keep the combination of the loan and the equity stake on its books at a value equal to full €350,000 value of the original loan. (Perhaps those who know financial accountancy could tell me if they could get away with this – this idea may be iffy but it’s no dodgier than this kind of thing.)
However, there will be lots of situations in which the conditions described here don’t apply:
1. The couple may not be able to afford a mortgage for even the new reduced value of the home, in which case the bank is better off repossessing and selling the house.
2. If a program is in place to help people like this, it may be hard to really distinguish between people who genuinely can’t pay back versus those who could do so without the government’s help (for instance, via help from family, assets hidden from the government, or additional lifestyle adjustments.)
3. This example applies to people who have stopped paying back already and are in a hopeless position. Any program that starts modifying mortgages for those who are perhaps only a couple of months behind or are still paying but having difficulty doing so (e.g. the US HAMP program’s idea of risk of “imminent default”) could end up being extremely expensive.
4. Once such a program exists, there may be an incentive for people to stop paying their mortgages in the hope of obtaining a mortgage modification.
So I would argue that a carefully-targeted mortgage modification program might be a good idea in theory but it may be a legally complex thing to carry out successfully in reality. Larger less well targeted programs are likely to have significant deadweight loss, potentially be seen as unfair and could inflict very large costs on the banks, and eventually the taxpayer.