The Tracker Dilemma

This post was written by Seamus Coffey

Alan Ahearne writes on this issue here.

40 Responses to “The Tracker Dilemma”

  1. John Corcoran Says:

    @Seamus
    If deflation kicked in and interest rates fell below minus 1% could tracker mortgage interest rates be negative?

  2. Joseph Ryan Says:

    Is it not time to convert the ‘mortgage interest relief’ into a ‘mortgage interest supplement’.
    Relief for mortgages above 4%, surcharge for mortgages below 4%.
    That would level the playing field a bit.

    The ‘cap in hand’ for foreign money can hardly be justified, if it is used to subsidise a goodly portion of people on trackers who can well afford to pay their mortgages without subsidy.
    Trackers are in effect being subsidised from several sources; subsidised by variable mortgage holders, subsidised by the State in interest relief, subsidised by the State indirectly through bailing out the banks.

    Now we want to entangle them in KfW money, that will undoubtedly carry a contingent liability to the State, another subsidy!

  3. Seamus Coffey Says:

    @ John,

    This has already been an issue in the UK. During 2007 some lenders offered mortgages with negative trackers, i.e. the BOE rate minus a margin. The subsequent drop in interest rates resulted in the nominal rate on the mortgages becoming negative though I know of no case where the lender paid interest to the borrower. See this discussion from the BBC.

    The conclusion of the Financial Services Authority was:

    If the specified interest rate drops beneath zero, we believe that the borrower’s obligation to pay drops to zero, but not below.

    Some contracts explicitly stated that interest was payable by the borrower only. In Ireland some trackers were offered at rates as low as ECB +0.5%.

  4. colm mccarthy Says:

    Alan’s article raises again a little mystery: why is anyone on a tracker, vintage 2005-2008 (the vast majority), in arrears unless they have lost their job? The arrears rates for trackers appear to be too high, relative to variable-rate borrowers, given the big reduction in tracker rates.

    Second (Sorrowful) Mystery: Did anyone in the banks realise the basis risk involved, and the impossibility of hedging it out?

  5. seafóid Says:

    How come tracker contracts are so watertight? Why not break them (like BoI did in the UK) ? Pensions have been mangled, salaries for younger people have been slashed and Cyprus depositors had to pony up but Trackers are more holy than St Bernadette. Why?

  6. Fiatluxjnr Says:

    @seafoid
    And the rich have borne the brunt of the cutbacks…
    http://www.rte.ie/news/2013/1119/487667-troika-bailout/
    Or so say the Troika

  7. Ernie Ball Says:

    If the troika “think” that the rich have borne the brunt of the cutbacks, there truly is no hope. Up is down, ignorance is strength and we have always been at war with East Asia…

  8. Tullmcadoo Says:

    Ernie,
    It works like this. You argue that you have carried a disproportionate share of the burden. We know that the PV of your terms & conditions puts you at the foothills of Mount Plutocrat. Ergo the wealthy have carried the burden of adjustment. QED.

  9. Kevin Donoghue Says:

    Alan Ahearne: “If cheap money doesn’t come from the ECB and ESM, then perhaps the Irish authorities could consider another potential source of funding for the trackers. Since state-owned German banks can borrow almost any amount at near zero interest rates, the tracker dilemma could be solved if these banks were willing to lend funds to Irish banks at close to cost price.”

    Ye gods, is that supposed to be a realistic suggestion?

  10. Ernie Ball Says:

    right, tull. PS=the wealthy. Hammer that home every week in the Independent and soon you’ll get even the troika to believe that Ireland’s wealthy (who are overwhelmingly in the private sector) have made tremendous sacrifices. Never mind that 87% of those working in the PS made less than 65,000 per annum: they’re all plutocrats, I tell you!

  11. Darragh Doran Says:

    @ Joseph Ryan

    “Relief for mortgages above 4%, surcharge for mortgages below 4%.
    That would level the playing field a bit.”

    Why?? I have an ECB tracker +0.5%. Isn’t that just my good fortune? Why penalise me? I have a contract with the bank stating ECB +0.5%.
    Surely the point is to help those in trouble rather than dump on everyone?

    @ Seafoid

    “How come tracker contracts are so watertight? Why not break them (like BoI did in the UK) ?”

    As per above, is the fact that pensions and wages have been pillaged a good reason to start doing the same to tracker mortgages? FYI, I have also been on the receiving end of the aforementioned pension raid and have suffered tax increases on stagnant wages.

  12. Joseph Ryan Says:

    @Darragh Doran

    “Why?? I have an ECB tracker +0.5%. Isn’t that just my good fortune? Why penalise me? I have a contract with the bank stating ECB +0.5%.”

    Indeed it is your good fortune that normal rules have been suspended, and that the State is keeping alive banks with a subsidy on trackers alone of €700m, as estimated in Alan Aherne’s article.

    I know some very very wealthly people, with several properties, that are benefitting from the State’s largesse in keeping the banks open, and their trackers subsidised. Some even managed to get interest only on the trackers while paying down more expensive debt. Way to go!
    Shure, its a great little country.

  13. vinny Says:

    Not all pensions/salaries have been ‘pillaged’ - senior public administrators? politicians? judges? senior execs in private sector?
    Very selective ‘pillaging’!
    As regards the suggestion that tracker mortgage contracts should be set aside?
    No doubt it has been touted/discussed but the potential political fallout would seem to have won the day for now…..

  14. Yields or Bust Says:

    @CMcC

    “..The arrears rates for trackers appear to be too high, relative to variable-rate borrowers, given the big reduction in tracker rates…”

    The primary source of the mortgage pain is generally the principal element associated with the debt. The primary source of the current mortgage pain is the principal size based on daft house prices. The principal drives the interest cost and the crazy repayment burden.

    The real issue was the pricing error in the market for the years that you mention where the availbaility of trackers exploded. Its always the underlying asset over valuation that causes the mess. We are slowly, very slowly begining to realise that we need to fix the pricing error. All other arguments will eventually come back to the same place, houses were mis priced for the best part of a decade - any basic yield analysis clearly establishes this very simple but basic reality - the banks mispriced the asset class they were lending against. To fix the problem requires an unholy debt write down, until that happens we won’t recover.

    Most who comment tend to believe that house prices are ‘market’ driven - whatever that actually means. Whereas in reality they are credit availability driven and that’s a bank required fix not the end consumer.

  15. seafóid Says:

    @Darragh

    Why should trackers be subsidised ?
    It’s costing the banks 700mil or so per annum. Should the taxpayer be bearing that load ?

  16. skeptic01 Says:

    Many households with trackers were encouraged (conned?) by society-at-large into over paying for their home during the peak years prior to 2008. That is possibly one argument for the justice of continuing the subsidy, albeit not a terribly strong one. Either way this is one group of Irish paying money to another group of Irish.. no case here for deploying European finance unless it is one of pure charity.

  17. Darragh Doran Says:

    @Seafoid/Joseph

    Hey, maybe I’ll just be one more subset of people defending their own position no matter what the cost to others…!

  18. Vinny Says:

    @Seafoid
    So when is a contract NOT a contract?
    When it suits govt?banks?irresponsible lenders?irresponsible borrowers(including ‘developers)?anyone/any corporate body which decides it is against their own interests?citizens?what contracts should be unilaterally be refuted?…………

  19. Robert Browne Says:

    Was Alan Ahearne’s advice to the late Brian Lenihan to ignore the trackers and kick the can down the road? Govern Honohan ditto. He now thinks the Germans might pick up the battered can, look at it and think it is a good idea to invest in it? They are German for God’s sake! The ESM might guarantee the loans? ESM is just a proxy also for German money so I should not hold my breath for that solution. The only solution is for the ECB to monetise the debt but that solution is also violently opposed by the Germans.

    These trackers, if they had been marked to market values after the bailout, plus 10%, would now be saleable loans. Investors could rid themselves of the properties, free up the seized property market and banks would get what they were still owed having received the rest of their money on those loans under the bailout.

    Instead, what banks did, was decided not to look a gift horse in the mouth. They took almost “free money” and left their hundreds of thousands of mortgage holders and BTL investors sweating it out on negative equity loans. Those on trackers can afford to pay the interest but as soon as ECB base rates rise these loans will most likely be defaulted on and that is the obvious reason the Germans will not be funding these loans. The idea that the ESM would back the loans is equally erroneous as the ESM is also a proxy for German money. Had we taken the above solution tens of thousands of Irish people, the very ones who funded the bank rescue would have been unlikely to loose their homes, they would not now face bankruptcy and destitution. Can kicking can be fatal especially when it is done by elites for elites.

  20. BeeCeeTef Says:

    Testing to see if peculiar problems with posting across multiple devices are associated with my ID.

  21. Ignoramus Says:

    Stupid question: (So if you could please just point me in the right direction to get an answer I would be very appreciative.)

    If I went into a bank in 2009 and the LIBOR interest rate was 4% and the ECB was 3.5%. The bank gives me a tracker at ECB+1%. I get the money on that day. Surely the bank also gets the money on that day so if the rate goes up for the bank it also goes up for me. The bank should not be losing money.

  22. Brian Woods Snr. Says:

    That Ahern piece is awful stuff.

    “Compared with other mortgage products, trackers have been a boon for borrowers” – A boon? Really?

    “Homeowners with trackers have felt the full benefit of the extraordinary easing of monetary policy in the euro area over the past five years.”

    So have financial institutions, Alan. Stow the adjectives and hyperbole.

    “With ECB rates having plunged from about 4pc in 2007 to near zero today, some €500 a month in interest payments have been knocked off a €250,000 mortgage. That amounts to €6,000 extra cash each year.”

    Nope. Get your ducks in line on this one Alan. Its only ‘cash’ (notes and coin in your pocket) when it becomes so. Think about this a bit more carefully Alan.

    “They are what economists refer to as quasi-fiscal costs: outlays that are not included in official government figures but are largely the same as other types of government spending.”

    Listen Alan. How about economists get real on this one and have an earnest, meaningful dialogue with the Great Unwashed about the spoof dished out by economists (all sorts of goofy, semi-comprehensible percentage stuff) - and their apparent inability to explain the unpleasant realities - for the soap challenged aforementioned, of the state’s unending and increasing borrowing to fund its day-to-day expenditures. The unpleasant consequences of this borrowing are rarely explained, in an ‘everyday’, woman-in-the-street manner. For sure, our politicians will not provide this explanation.

    “The damage to banks’ profitability from trackers also affects the wider economy.”

    Really? Evidence please.

    “The banks have raised interest rates for homeowners with variable-rate mortgages to cross-subsidize homeowners with trackers, wiping out some of the benefit to the economy of rate cuts by the ECB.”

    Really, interest rate cuts have ‘benefited’ our economy? How? Please explain this. Delete ‘homeowners’ from the statement. Then see how it ‘reads’. Bit different?

    “The banks are passing on these higher costs to new borrowers in the form of higher interest rates and charges.”

    They sure are! Now remind me about those nice new Robots I see in banks. No wages, no breaks, no pensions … … “Where have all the humans gone?” Robots DO NOT spend into the economy! That’s cool!

    “As a result, we have less new investment and fewer jobs.”

    Oh, its cause and effect now? Evidence please. Perhaps any ‘investment’ is into financial products. And since the financials can now borrow ‘lo’ and lend ‘hi’ - that’s exactly what they will do. Yes?

    Capital formation for productive investment is for Dodo’s. As for new waged-labour opportunities. Sure, there are some about. But at what rates? At what conditions?

    As regards the Trackers. These are the ‘fault’ of the banks (as in very dodgy risk-analysis). And I have raised this issue before. How much of the ‘loaned’ money was actually real? And how much was fiated-up by computer keystrokes? 1:10? 1:100? Nice when you can emit free stuff - with little risk to yourself. Then invoke the property laws of the state to force folk to pay you back for something that you never really ‘owned’ - at least it had no prior existence until you created it. Very juicy indeed.

  23. Ronan Says:

    “Second (Sorrowful) Mystery: Did anyone in the banks realise the basis risk involved, and the impossibility of hedging it out?”

    Ah, come on. It’s not like they could have inserted a few words to the effect of:

    “..but in no case shall be less than 2.5%”

    They’re highly paid bankers and legal minds, not fortune tellers.

  24. Michael Hennigan - Finfacts Says:

    DKM, Colm McCarthy’s former firm, recently said: Housing affordability nationally is currently estimated at 17.3% of net income for a First-Time Buyer (FTB) working couple purchasing the average property, down from 26.4% at the peak. With modest increases in property prices and incomes expected over the coming months, affordability is expected to end the year at 17.7%. The index shows a single FTB on average income allocates 35% of net income to fund a mortgage.

    Outside Dublin, housing affordability for FTBs has been around 16% throughout 2013 to date and is expected to be at 16.3% by December.

    The value of trackers was €45bn of the €76bn in residential property loans end 2012.

    I have seen a statistic that two-thirds of distressed borrowers are in employment — that may range from a single part timer in a household to a couple working while defaulting on their tracker.

    It’s time someone took charge of this problem and sorted it out in months not another five years.

  25. Kevin Donoghue Says:

    Joseph Ryan: “I know some very very wealthly people, with several properties, that are benefitting from the State’s largesse in keeping the banks open, and their trackers subsidised.”

    This is misreading the law I think (granted IANAL). If the banks were liquidated, as Anglo Irish Bank at least should have been, it would have been the depositors and bondholders who lost out. I’m pretty sure no borrower could have been hit for an extra cent in principal or interest.

    Are lots of commentators confused about this, or am I missing something?

  26. Ernie Ball Says:

    Vinny, don’t worry. The only time a contract is not really a contract in Ireland is when it’s between the government and a public-sector worker. All other contracts, including those between bankrupt banks and their creditors, are ironclad.

  27. BeeCeeTee Says:

    To moderators, from BeeCeeTee. I am getting a 406 errors when I post, and cannot tell whether something technically weird is happening or you have blocked me. Testing to see if a short message works.

  28. BeeCeeTee Says:

    How come tracker contracts are so watertight in Ireland relative to the UK. I don’t know what the general answer is, but for me personally the answer is that I pored over my own Irish tracker to make sure there were no sneaky get-out clauses. If it had not looked watertight, I would have gone somewhere else.

    The Mail quotes BoI on its UK trackers as follows:
    “‘This increase is permitted by a specific clause in these mortgage contracts, which allows an increase in the interest rate differential after the guarantee period (i.e. after 31 December 2006). This clause was clearly referenced in the pre-sale offer document provided to the customer and the customer’s intermediary prior to completion.”

  29. Robert Browne Says:

    @all

    I seemed to have left out “What should have happened, is that instead of writing blank cheques for the banks every billion euro’s banks got, there should
    have been a commensurate write down on corresponding bank loans a quid quo pro.”

  30. Joseph Ryan Says:

    @Kevin Donoghue

    “This is misreading the law I think (granted IANAL). If the banks were liquidated, as Anglo Irish Bank at least should have been, it would have been the depositors and bondholders who lost out. I’m pretty sure no borrower could have been hit for an extra cent in principal or interest.

    Are lots of commentators confused about this, or am I missing something?”

    As far as I am aware, a liquidator can, with permission of the court or creditors committee of inspection, disclaim any onerous contracts in a liquidation. This happens regularly, without permission of court, in the cases of leases of equipment etc, and indeed contracts of employment.
    In fact liquidators, imho, play fast and loose with this power, eschewing the need to get permission.
    Liquidators have, for instance, disclaimed any obligation to continue to run sewerage systems or maintain estates, where developers have gone bust. They have not bothered, in many cases, to ascertain what a court might think, despite issue of public health and safety being at stake.

    Whether this power of liquidators would extend to disclaiming the tracker clauses in loan, would ultimately be a matter for a court to decide.

    The power itself is conferred in S290 of the Companies Act 1963, and there is probably a lot of case law on the matter.
    [One wonders what the IBRC liquidator has done with the trackers, or did he kick the can 'down the road', or will he accept a discounted value for trackers on his books, without attempting to force the issue.]

    http://www.irishstatutebook.ie/1963/en/act/pub/0033/sec0290.html

    [PS definitely IANAL]

  31. BeeCeeTee Says:

    I think bank liquidators might be reluctant and unwise to disclaim the contracts under which a bank is entitled to be repaid. A contract under which the bank gets an NPV of 70% of the loan back is much more attractive than no obligation to repay at all.

  32. paul quigley Says:

    @ ignoramus
    As no one else has obliged, here’s my tuppence worth.

    You get the money on the day all right. Then you have to pay it back plus interest, over many years. The bank makes a margin on the difference between its own borrowing costs (interest rates) and the costs it charges to borrowers. They borrow short, rinse and repeat, and lend long.

    Most mortgages were variable rate. So if the cost of money for banks goes up (interest rate) they can put their mortgage rates up, and all the mortgage holders take a hit each month. Ditto on the way down.

    The tracker doesn’t allow the bank to decide on its mortgage rate. If the ECB rate (related to their costs) goes down, they have to lower the mortgage rates, to track it. The monthly payment goes down. That means they are losing money on these mortgages, and they can’t get out of the deal. As you can see above this is a lot of billions, so they have to hit the variable rate folk extra hard to cover the loss. .

    Now if ECB rates rise seriously (what goes up…and vice versa) it is the tracker holders who will be getting stuffed.

  33. BeeCeeTee Says:

    @Ignoramus,
    When the Irish banks issued these tracker mortgages, their cost of funding the loans was at or below the ECB rate, and they expected things to stay that way. Now, their cost of funds is significantly above the ECB rate, but the interest rate they charge on trackers is still referenced to the ECB rate because that is how the contracts are written.

    There’s not much chance of those on trackers getting stuffed relative to those on standard variable rates over more than a short period. Historically, getting a tracker has been more about squeezing the lender on margin than taking a punt on interest rate trends. If the ECB rate goes up a lot, the SVR will go up too. Admittedly, there was a crisis during the 90s when interest rates on Irish trackers went up well over 10% (c. 14%?) while SVR rates stayed below 10% (if I remember correctly), but this state of affairs did not last for long.

  34. Hugh Sheehy Says:

    If the mortgages are contractually linked to a named ECB rate I suppose the ECB could create another rate with a new name, and use that new one for all the activities that historically used the old base rate, and crank up the rate on the existing named rate. A “base rate 1″ and “base rate 2″ approach. The trackers are all on the old named rate, which the bank can crank up as far as it likes.

  35. grumpy Says:

    Colm mcc

    “Second (Sorrowful) Mystery: Did anyone in the banks realise the basis risk involved, and the impossibility of hedging it out?”

    I am reminded of Equitable Life and the guaranteed annuitiy rates.

    For those not familiar, customers with guaranteed rates stood to gain ‘unfairly’ at the expense of those who did not. The value of their investments had been boosted partly by falling bond yields, but the guarantees meant they captured this gain without having to consequently (because lower bond yields made annuities more expensive)
    pay more for a given annuity. This left all the unguaranteed customers potentially ripped-off as ‘their’ part of the fund was raided to pay out on the guarantees.

    Management thought they could prevent this unfairness by allocating smaller discretionary bonuses to the guaranteeds’ pot. Their S67 argument which eventually did not succeed in the H/Lords was that they should not apply the guarantees to the unfair detriment of the other customers. There had been an assumption in the industry that the strength of the guarantees was such that they would break before the whole company did.

    I think it is an interesting parallel.

    Regarding kfw’s involvment in Spain it might be an idea to note the following:

    “We want to provide easier financing to companies that have a solid business model and good growth prospects,” Schaeuble said

    The tracker books generally are, by comparison, dross. Irish politicians might Might need to “tangle” a bit there.

    Regarding this bit:

    ” Those who earn a living by blatantly pandering to populist outrage about banks might just shrug their shoulders.”

    Is there a list?

  36. Ignoramus Says:

    @Paul and BeeCeeTee
    Thanks for that.

  37. seafóid Says:

    @ Grumpy

    It’s similar to Equitable Life but with the exception that the whole Irish banking industry thought this mispricing was a fantastic idea. Equitable was a controlled explosion. The banks blew up over the whole society.
    And what happens when a private sector utility company keels over? It will never happen until it actually happens. Someone has to meet the liabilities . At this point it morphs into politics.
    Add contract wording to the long Irish list of issues to be resolved before el Gordo arrives.

  38. Kevin Lyda Says:

    I’m confused.

    We can’t bail out homeowners who are underwater because they signed up for the loan and they should have known what they were getting into. And by we, I mean the gov’t or the banks - neither can or should bail out these people because moral hazard, etc.

    We can and are (apparently) bailing out banks that gave out tracker mortgages because the poor dears just didn’t know the economy was going to collapse - they’re just banks, what would they possibly know about money or the economy? But we’re not bailing them out *enough* so we should consider ways to penalise those evil homeowners who took out those mortgages or we should toss more free money at the banks. Or maybe both.

    Do I have that right? Is that what all the brilliant economists believe here?

  39. Ernie Ball Says:

    Where’s my NAMA?

  40. stephen gerard Says:

    we need to convince the tracker mortgage holders to do there patriotic duty and allow there contracts to be writtin..name and shame those with tracker mortgages….we must hunt them out f there beds in the streets ,,in the fields

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