NYTimes Op-Ed on Mortgage Limits in the USA

There is an interesting New York Times Op-Ed article relevant to the proposed Irish Central Bank LTV and LTI caps on residential mortgages. US financial regulators attempted to impose very similar caps, but the caps have now been diluted/dropped in response to political pressure.

The article is behind the NYTimes paywall, but a number of articles can be read per month without paying a subscription. A key quote:

“low underwriting standards — especially low down payments — drive housing prices up, making them less affordable for low- and moderate-income buyers, while also inducing would-be homeowners to take more risk.”

Comments

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46 thoughts on “NYTimes Op-Ed on Mortgage Limits in the USA”

  1. I am biased. Being a non property owner. However I welcome the Central Banks move. It’ll be difficult to save 20% but it’ll be easier if the is the price of the home is less than it otherwise would be. Also buying a cheaper home means I have less debt, more net income, making me a happy content consumer willing to help power the Irish recovery.

    As it is, I’m a nervous renter caught between high and rising rents and high property prices (in Dublin at least). Which makes me save as much of my income as possible (not much), as I feel insecure in my accommodation and know I’m not saving via home equity.

    I wrote to the Central Bank congratulating them on the policy and wishing them luck in defending it from the usual interests. I would like to see more policies to drive speculation out of the property market. Perhaps a re-introduction of the 2nd home tax, better policing of the BTL sector (about a 1/3 of the landlords I know pay no tax on rental income, though perhaps I’ve just know of more shysters)? I’m not entirely sure how to do it but what I do know is that it’s depressing showing up for an apartment viewing in the 200k range and seeing plenty of 60+ auld lads.

    In fact I got ‘out bid’ by an auld lad who had a cash bid 13k LESS than my credit bid back in 2012. Which hurts like hell considering the appreciation in the market since then (which has priced me out). Incidentally my mortgage approval was with the same bank selling the property (they had repossessed it)! When you get out bid by a lower bid you can’t help but feel the game is rigged against you.

  2. Its no game. But it is ‘legal’ – after a fashion. Think of it as playing against the House, when you know in advance that the House uses stacked decks. Play: you lose. Stay out: you remain solvent.

    “The regulators had wanted a down payment of 20 percent, a good credit record and a maximum debt-to-income ratio of 36 percent.”

    Translate that as the Gaming Commission mandating genuine card decks, and the House is prohibited from either dealing or playing. In effect it is a guarantee to the punter that when the ‘game’ is over they will walk away with at least their initial Stake. Maybe not a win, but certainly not a loss.

    That 36% you saw above, was not a random actuarial choice. But was chosen from long and bitter experiences. Below 36 the odds increasingly favour you. Above 36 they increasingly favour the House. Most ordinary folk just do not accept this, so the lenders self-imposed the limit on themselves. The lenders knew that they had deep pockets and could withstand some losses through defaults, but each borrower was on their own. Any significant, negative shock to the borrower’s income would be devastating. The outcome was residential mortgage default rates below 1%. Affordable housing. Social stability. And with luck, a slow, steady increase in asset value (negative equity virtually unknown). The lender was lucky too. On a 30 year loan, they probably earned as much in interest repayments as the house originally cost.

    The House also had two other restrictions: the player had to put down 20% cash, and the mortgage repayments, property taxes and mandatory insurance should not exceed 28% – of your disposable income.

    Deregulation of the financial services in the 1980s and 1990s changed the situation. The outcome for private residential housing has been a disaster. Default rates at 20%! Lots of Negative Equity. So just let reprise it! Just ask yourself – “Who benefits?”

    If stiff lending requirements for private residential lending were re-imposed – and maintained, residential property prices would decline. Affordability would re-emerge. Sales would pick up. Defaults should decline, though this is not certain. However, the Negative Equity issue would have to be solved by mandatory writedowns and writeoffs.

  3. Re: Long Term-in-ism and Risk

    @ Gregory,

    You can’t really talk about this problem of credit risk in residential markets, . . . without talking about the idea of long term retirement planning, and pension types of assets in the 21st century.

    People who were thinking about the problems of pension planning back in the 1980s and 1990s, never believed they would see a perfect storm, that would necessitate a total re-think about pension products.

    But it did happen in the early 2000’s, when the stock market plummeted and at the same time, governments lowered interest rates, . . . suddenly, whole corporations in America were going bust, not because of operational risks, but because of pension liabilities.

    I’m a bit too young, to have taken much notice at the time, but this is what I am told at least.

    Fast forward a number of years to the credit boom in the mid and late 2000’s.

    Like, you will listen to Irish radio or television, which features a lot of interviews in the last few years, with self-employed persons who were receiving advice, to purchase more property on credit, . . . and to use that asset, like a sort of pension plan.

    What is that they say about the three legged stool about long term retirement planning? Save more, work longer or take more risk? Or something like that.

    Standing back from it, for a minute.

    Governments in many parts of the world, down through the decades ever since the second world war, have heaped incentive on top of incentive, scheme on top of scheme, and tax break on top of tax break, . . . in an effort to do right by their citizens, to encourage higher levels of ‘home ownership’.

    But it ends up going far beyond that, . . . about owning a home, and we end up eventually in the middle of the territory, like that being described now by young self-employed folk, and their property portfolios, which they can no longer afford etc.

    And it’s not just the stock market going down, and interest rates being on the floor, and everything else, . . .

    It is also the political pressure, to remove any taxation privileges for folk, who have the luxury of being able to afford to finance some sort of pension plan.

    Because it is deemed biased against those folk, who haven’t got the same luxury.

    The point I am making is, if the hypothetical self-employed entrepreneur, who acquired buy-to-let, real estate on credit, . . . took that approach to their pension planning, . . . it was sort of savvy advice from the point of view, that governments are less likely to mess around with the incentives necessary to prop up higher levels of home-ownership.

    And, looking at it from the perspective of pension advisers in the early to mid 2000’s, . . . they had never seen houses depreciate in value since the second world war, in the manner and scale that they did, post-crash in America.

    I just think, we need to frame this all, in the context of society and how it is all playing out, in the broader sense, beyond just looking at real estate and credit.

    The point that strikes home to me, from the best of the pension product theoreticians I have read, . . . is that good pension products, are ones that tend to be defined as having a floor, and a ceiling. And I’m not entirely sure that real estate, as a pension product, can fit into those constraints of a well designed plan, or ever will.

    The idea of the ceiling, being, in my view, is that you are selling off the highest part of the premium tomorrow, in exchange for the ability to consume a little more in the present. And investment in real estate, rarely includes for that ceiling feature, . . . and it doesn’t do a very good job at providing a floor either, . . . as witnessed by so many tales that arrive, to listen to now, on Irish media. BOH.

  4. Last time there was a rising market in the geared the asset class habitually engaged with by the Irish public, that public got exactly the kind of regulation and macro-prudential oversight it wanted.

    When that market declined significantly, and the geared plays became geared losses, that public complained loudly and indignantly about pliable regulation.

    The market has now been going up in the capital city, the very very dominant centre of population, for about 2 years. That would appear to be long enough to again provide public support for an Irish government to, very publicly, lighten-up the regulatory environment.

  5. In discussing the private residential (home purchase) property ‘market’ – and its no such economic entity, it is essential to consider each borrower as an individual. If you aggregate them into a ‘lumpen’ or herd you are engaging in intellectual laziness. Herds are easier to conceive of – easier to swing around. Makes for good press stuff. Trivializes the matter and disguises and smooths out the tricky, inconvenient human bits.

    I’m not going to rake over stuff I have already written about this residential property disaster, but one point needs a daily mention. The psychological anxiety, the physical stress, the real harm that attends a family group upon a defaulting home mortgage: its socially very destructive. And you know what – its almost 99% unavoidable. And I can quote that statistic knowing that for over 70 years, it was valid. But not anymore more. And the cause. The Financial Death Watch beetle has infected and infested the home mortgage Home.

    You want to restore things? Well, you gotta call in the financial equivalent of Rentokill and let them loose. “Yeh upta dat?” Appears not – not yet anyways. Just reprise a discredited, disgraced and disastrous policy. “Dat’ll show ’em, dat will!” Indeed it will.

    It was (and still is) the duty and responsibility of any government to protect its citizens, both individually and collectively, from predation – whatever its origin or nature. Except financial predation.

    Our government actively supports financial predation, in the dreadfully mistaken belief, that the wholesale slaughter of these predators would bring the world as we know it, to an end. Since, if I understand this correctly, those aforementioned predators actually, Atlas-like, support the sky above my head. Like f… they do!

  6. “low underwriting standards drive housing prices up ..”

    Low underwriting standards are lethal for credit bubbles of any stripe and could be the cause of the next crash in the US. There is an awful lot of money hunting for yield or as Grumpy once said picking pennies up in front of a steamroller.

  7. The key quote is putting the cart before the horse – people aren’t automatically entitled to get money from banks:

    “low underwriting standards — especially low down payments — drive housing prices up, making them less affordable for low- and moderate-income buyers, while also inducing would-be homeowners to take more risk.”

    The correct “horse-cart” way of putting it is – banks choose who they lend to:

    “low underwriting standards — especially low regulation — drive ROI on fraudulent loans up, making them more attractive to foist on low- and moderate-income buyers, while also inducing taxpayers to take more risk via TBTF government guaranteed banks.”

  8. Setting mortgage limits is very tricky given current conditions. Martin Wolf says the high income countries are in a managed depression. It would probably make more sense to reduce max loan amounts until it’s clear that economic normality is back. Current monetary policy has one very unfortunate side effect- ultra low interest rates that make expensive housing look affordable.

  9. To Seafoid — thanks for the link to the article on the New Beginnings proposed offshore (Malta-based) special purpose vehicle to purchase defaulted Irish mortgages. I have not yet been able to figure out the business plan; where exactly is the value added? Why the Malta-based incorporation? That sounds dubious. It certainly is not something one would want to the Irish government to be involved in … no reliable accounts, poor financial supervision of Maltese corporations.

  10. Property services can be consumed by owning a property or by renting a property. In all other eurozone countries lease lengths for residential properties are say three to ten years,with renewal rights and rents are reviewed each year with reference to increases in the CPI/inflation. At the end of the term, rent reverts to market rent.
    France and the Benelux countries have 3/6/9 leases where the tenant signs a nine year lease,rents are reviewed annually by the CPI for the nine years and the tenant can break the lease at the end of year3,6 and 9. At year nine the rent reverts to market rent. The tenant has renewal rights.

    If residential property prices in these countries become too high you have an option to rent,with renewal rights and some certainty about your future rent. Residential property lease law in all these countries is the same as commercial property lease law.

    In Ireland we have very different commercial and residential property lease law–commercial property leases are very long say 25/35 years and residential leases are very short say one year with no rent controls and no renewal rights.
    In Ireland the residential tenant and the commercial tenants are serfs to be exploited. The state actively colluded with these landlords and wrecked the country. All Haughey’s bagmen are state landlords.

  11. Re: More on Long Term-in-ism

    @ Gregory,

    There is something worth adding I think, to my points above, because it might relate back more to your original comment about the NYT op-ed.

    I’d like to look at that buy-to-let, example and at that self-employed Irish entrepreneur (these folk who are often termed the ‘economic engine’ of our recovered economy in Ireland), and their advice on long term financial planning.

    It should be pointed out, firstly, that risk is the product of a process that happens when competent and skilled professionals set about removing uncertainty.

    And going back to the three legged stool, there are these options, such as working longer, saving more, taking more risk, . . . that relate to longer term financial planning.

    Taking more risk, is seen as an option, where individuals look at the floor/ceiling in their product, and determine that they would like a higher ceiling. An opportunity at increasing their standard of living, in the future.

    The trade-off to that, is that they end up making the floor lower at the same time.

    One looks at buying of real estate, as conceived in that pension plan advice, and lets look at how it stacked up as a ‘product’ to achieve some additional pension income, in a few decades time.

    The idea of the mortgaged, buy-to-let, as a form of pension product, fails in a number of different ways.

    Like, even where it does work out, . . . the mortgaged buy-to-let, as a form of pension product, still takes away a lot of ability to consume in the present tense. And where the residential property market turns against you, as it has done for many people, . . . what we find is that people get to a point, where they cannot forsake any more present day consumption, to keep fund this product, . . . that will supposedly serve them well in the future.

    A well designed pension product, is supposed to give you back the ability to consume, at levels that are acceptable to the individual, in the present tense, . . . . and not place them in a position, where their whole life, . . . every scrap of their disposal income is sucked away into their pension plan.

    The mortgaged, buy-to-let, as pension product, falls down in another way too, compared to a product that is well designed around the circumstances of the individual, . . . in that the mortgaged, buy-to-let, . . . offers no ceiling feature, at all.

    Lastly, the mortgaged buy-to-let, as pension product, falls down as a product, . . . in that, it doesn’t offer an option, to adjust the amount of risk, that one wishes to take on board. It’s ‘gear-shifting’ mechanism is broken in that respect. It doesn’t offer a range of options.

    It just gives you this very wide range, between a floor that can be extremely low, and a non-existent ‘ceiling’ almost, . . . and then, there the problem in the meantime, of having to forego an awful lot more present consumption, . . . than would be desirable or acceptable, . . . in any well designed pension product.

    I.e. Looking at the three-legged stool, . . . the mortgaged buy-to-let, as pension product, could be improved upon, in all three legs of the same stool. It is very sub-optimal, . . . and it would appear from anecdotal evidence, has heard in Irish radio over the last several years, . . . that the mortgaged buy-to-let, as pension product, as a concept had been sold to their self-employed entrepreneur, economic-generator folk, up and down the country of Ireland, for at least a decade. BOH.

  12. @Brian O’Hanlon

    A home represents a highly leveraged exposure to a single,stationery plot of real estate-About the riskiest asset one can imagine
    No pension adviser would recommend property as an asset class to invest a significent amount of your pension in, otherwise he is negligent.
    Beware of the Bull–and beware of property.

  13. Re: Argument Further Clarification

    @ John Corcoran,

    We have to get away from this thing of ‘the pension adviser’. There really is no such beast, that is worthy of that glorious title. And the title also implies, . . . that their are individuals who have the time and brain bandwidth, to be able to consume ‘advice’ about long term financial planning, like it was a service.

    Apparently, people hate personal finance.

    Apparently people who work on Wall Street even, and how manage money for a living in their day job, . . . don’t want to handle personal finance themselves, . . . and want to out-source that responsibility.

    As far as pension plan products go, . . . they are the kinds of products that need to be straightforward for people to understand. I can understand this. I really do wonder about this profession, known as pension advising. I really do.

    I think perhaps, why so many savvy self-employed entrepreneurs, ended up with mortgaged residential property as their pension plan, . . . is because it was so straightforward. All that was needed, was for someone to sign on a dotted line.

    And a well defined pension product, should work like this too. But with the improviso, that people buying into a pension product, will be able to understand the trade off’s that they are making in one plan, versus another.

    In a modern world, where defined benefits have ceased to be, . . . what we have left, is a very complex problem. People don’t have time to sit down and become experts in managing long term personal finance.

    Someone has to study the problem and define the problem in as many of its dimensions as possible. Someone should at least be able to explain, why a solution as put forward in Ireland, of the mortgaged real estate asset as pension asset, . . . doesn’t stack up, as a solution, in a range of dimensions.

    Namely, I would say, mortgaged real estate assets, don’t offer you trade-off’s. It is forcing the consumer of that product, into a single set of decisions, which are sub-optimal.

    I am not naive enough, to believe that:

    A) The mythical beast, the pension adviser, exists.

    or that,

    B) Well designed longer term pension product alternative, exist in the market at the moment.

    But I think we should still be intelligent in our criticism of some of the solutions that have been filling the vacuum, in the absence of the right kind of advice, or the right kinds of products.

    I would argue, lastly, that it isn’t so much pension advice that people need or want, . . . so much as it is a well designed ‘product’ which offers consumer the transparency in its use, . . . to understand intuitively, the effects of the different trade-off’s that such a product would enable the consumer to make.

    And for definite, . . . I would say, . . . the biggest problem of all with the leveraged, risky and expensive bet on residential property as a pension plan, . . . was that it made so many of the crucial dimensions of the three-legged stool, entirely opaque to the consumer.

    I’m not against buying property, or even using leverage to buy it, . . . but I think the mortgaged real estate asset as a pension plan, . . . can be shown to have been sub-optimal, compared to what we ought to expect in this type of product.

    And some very large institutions in Ireland, and a lot of very highly trained and talented, well-paid executives and employees of those institutions, . . . worked to provide this sub-optimal solution.

    Would you agree? BOH.

  14. To unfeasiblycharming — Thanks for the link and the great name for the scheme, The Maltese Flog-on, a wordplay worthy of Myles. The linked comments on that site were mostly negative and did not describe any reasonable well-founded business case for the scheme. So if someone can provide such as business case I would be interested in understanding it.

  15. This problem has a simple solution and it all revolves around incentives.

    Change the incentives and you’ll change the behaviour.

    Right now Irish banks can lend out money with essentially no risk. Banks can pursue borrowers essentially forever. There’s no way to realistically avoid a debt for a residential borrowing. That’s not true for other loans. Commercial loans get written down all the time.

    Change that, make personal bankruptcy easier, give judges more power to cram down loans and all of a sudden you’ll suddenly see banks doing responsible lending procedures *without* having to impose such standards on them.

    If you must insist on setting standards like 20% down-payments, just set rules for bankruptcy judges that allow for 70% cramdowns when a blank lends w/ less than a 20% down-payment and only 30% when the bank lends with more than a 20% down-payment. That will see behaviour change.

    All of these discussions get incredibly complicated because we keep refusing to expose banks to risk. We have to stop doing that. Lending *is* investment. Investments can lose money as well as gain money. We keep screwing with that equation for banks. We need to stop that. Or we need to see banks in a different way(nationalising them and taking them out of the capitalist paradigm). Everything else is just fiddling with failure.\

  16. To Kevin Lyda — Your scheme does not work for the Irish domestic banks since all three are too big to fail; any cram-down losses will be paid by the Irish public not by Irish domestic bank managers. The scheme OK if it could be applied to foreign-owned banks only, but that seems difficult to pull off legally. So that proposal does not fly. Better to just have the 20% limit full-stop — punishing Irish domestic banks after the fact for risky lending does not work since it is biting off one’s nose to spite one’s face. “Punishing” the banks ex-post is just punishing the public.

  17. @BOH
    At the risk of being patronising let me outline a few opinions on pensions.

    There are mainly five asset classes that pension funds invest in; equities, fixed interest bonds/securities,index linked gilts,property and cash deposits.
    As a rule of thumb the % of equities in your pension fund should represent 100 less your age. The balance should mainly be bonds/gilts,which leaves a token amount for property and cash deposits.

    The risk with property is,it is the most illiquid of all asset classes.

    Most savy investors never invest in property.

  18. @John Corcoran

    Applying fixed rules to the percentages for each class of investment in a portfolio is daft.

    Profit (or loss) can come from any class of investment.

    It has more to do with knowledge, skill (and sometimes luck). It has more to do with doing proper research and buying and selling at the right time.

    Lots of people have made a fortune from property (not me).

    Try saying ‘most savy investors never invest in property’ to someone who bought a house in Kensington in 1976. Alas, I’m not one of them.

    A very good investment in recent years in Ireland would have been to buy Irish government bonds in 2011. Most of the cognescenti and posters on here would have been saying it was money ‘down the drain’. I posted here repeatedly at the time that it was a great investment. Stupidly, I didn’t follow my own advice.

  19. The Harvard/Yale endowment fund (Piketty Capital)has earned a return of 10% each year for the last twenty years,net of inflation and costs.

    Is Real estate an effective hedge against inflation?
    Recent research has seriously questioned the notion that real estate is an effective hedge against inflation. Joe Valente says such arguments are missing the point

    The inflation hedging quality of real estate is one of its most attractive and enduring investment characteristics. Indeed, it is the reason often given to invest in real estate, particularly by those investors who need to match long-term assets to liabilities. A number of major institutional investors have increased their allocation to real estate recently as a result of their respective house views that assume a significantly higher rate of inflation in the future. It is not just institutions. The continuing attraction of the asset class to an increasing number of high net-worth Individuals with a strategy underpinned by wealth preservation also implies a belief that property can and does act as a suitable hedge against rising inflation.

    Many practitioners have long asserted that property can be used as a hedge. Most investors tend to be of the view that property is, or can be, an inflation hedge, particularly over the long term. In the same way, most will recognise that, in the short term, local market fluctuations will tend to prevail and confuse the debate somewhat. It is clear, however, that the debate over the merits of real estate as a hedging tool has long been raging but that the evidence is remains inconclusive.

    This debate will undoubtedly gather further momentum given the growing concerns over a higher inflationary environment in the years ahead across Europe. No doubt this will trigger a wave of new research papers on the subject which, if anything like recent ones, will shed next to no light on the issue, and succeed only in adding to the general level of confusion surrounding the subject, or at least glossing over some of the most important characteristics of the asset class and its ability to perform successfully as an inflation hedge.

    The definition of what exactly constitutes a hedge is the first, and possibly the most important, source of confusion. An inflation hedge is often taken to mean an investment whose value is directly related to the level of inflation. In other words that there is a direct relationship between property values and some measure of inflation. So if over, say, a five or 10-year period, property values keep pace with inflation, or even outperform a particular benchmark, this is not in itself viewed as sufficient evidence that real estate is capable of performing a hedging function. For this to be the case, so the argument goes, property values have to move with, and react, to a changing inflationary environment.

    Far from semantics, the use of such a definition will inevitably lead to the conclusion that commodities, or even equities, offers a much better hedging mechanism than that provided by real estate. After all, real estate is lumpy, there is a lack of frequent real-time pricing – quarterly data in a few markets, annual indexes in most – and that’s not to say anything of the constraints imposed upon it by the landlord/tenant relationship which will vary not just between markets but over the course of the real estate cycle as well.

    Issues that make real estate different and which will inevitably mean that values won’t be able to ‘react’ sufficiently quickly to changes in inflation. But this ignores the fact that growth in property values may well exceed inflation over a set period. In essence, the conclusion that real estate is a poor hedge against inflation is often solely the result of applying a definition that is ill-suited to the sector or doing so with little understanding of how the property market actually works in the real world.

    The key point is that real estate provides a long-term hedge against inflation but, in order for it to do so, certain other criteria have to be met.

    First, while the real asset nature of property underpins its inflation hedging quality over the long term, buying tangible assets as a protection against inflation is sensible only if done at the right price. It’s an obvious point but one that is overlooked a little too often.

    Second, properties with inflation-linked leases are increasingly attractive to a broad range of investors as they are often seen as defensive in nature. However, while such leases can offer many attractive qualities to the investor, rent indexation does not equal inflation protection – it is not a guarantee even if some investors tend to regard them as such.

    The reality is somewhat different – rent indexation in the absence of pro-active management results only in over-rented assets. Such leases should not be viewed as a guarantee of an outcome but rather as a starting point in the quest for inflation protection.

    Third, income growth is the key to solving the inflationary puzzle. The ability to retain a tenant in the building, maintain and grow cash flow lies at the very centre of an inflation-hedging strategy. And that applies across all markets and points in the cycle.

    And finally, the importance of income growth brings us to the missing link in much of this debate, which is simply the ability and expertise of the asset management team. The situation is the same for all real estate markets: in the UK with its longer leases and upward-only rent reviews; in the euro-zone with its propensity for shorter leases and rent indexation; in the US with year-long leases and no indexation, or in markets such as Turkey where the length and value of a lease can be somewhat debatable. In all these instances it is the ability of pro-active asset management to deliver value that consistently shines through time and again.

    The bottom line is very straightforward: a bad asset manager will underperform inflation no matter what the inflationary environment might be, the point in the economic cycle, the holding period or the relationship between landlord and tenant.

    Author: Joe Valente

  20. @ Gregory Connor

    “does not work for the Irish domestic banks since all three are too big to fail”

    How many “TBTF” banks are there in the EZ ? In the high income countries?
    How strong is the TBTF magic ?

  21. NO bank is TBTF – like NONE. That’s one of those Big (Josef G) Lies. And being told often and regularly – will eventually be believed by most. But it is just that, one whopping, Big Lie.

    Just imagine: Top Gang-land Lords, are too-big-to-arrest!

    The sooner one of these so-called TBTF banks is snuffed-out, the better for the taxpayer. Of course our government would have to repudiate what their predecessor guaranteed. Likely? Nope!

    Boiling water bad. But super-heated steam is awesome! 😎

  22. Locking in bank “punishment” policies as a method to ensure Irish banking system security is self-defeating. The Irish public will suffer as much or more than the banks if/when the locked-in punishments are activated.

    A much better strategy for Ireland is to ban unsafe lending practices, rather than relying on domestic bank’s risk aversion toward punishing penalties. Punishing penalties on any one of the three banks will be felt as much or more by the Irish public, due to the small number of domestic banks.

    It is acceptable to lock in severe penalties against banks for unsafe outcomes, but it is more important to ensure that these punishments will never be activated, by banning unsafe lending. Relying on ex-post punishment only is a bad approach.

  23. The question is not whether any bank is ‘too big to fail’.

    Its a question of whether, in any given set of circumstances, it is better for the long-term health of the economy to let it fail or to rescue it.

    Its a question of pragmatism, not ideology.

    It won’t be known with certainty for some years whether or not the decision to rescue the Irish banks was a wise one or not.

    But, if growth continues at close to its 2014 rate for several more years, it will be a no-brainer. The decision will have been vindicated.

    Knowledge of that is why those economists who opposed the bank rescue are so angry at the possibility that high growth has indeed resumed and is quite likely to continue. All their screeching and ranting will have been in vain. Very good example here.

    http://trueeconomics.blogspot.co.uk/2014/11/2112014-irelands-recovery-economic.html?spref=tw

  24. @Gregory Connor

    ” much better strategy for Ireland is to ban unsafe lending practices, rather than relying on domestic bank’s risk aversion toward punishing penalties. Punishing penalties on any one of the three banks will be felt as much or more by the Irish public, due to the small number of domestic banks.

    It is acceptable to lock in severe penalties against banks for unsafe outcomes, but it is more important to ensure that these punishments will never be activated, by banning unsafe lending. Relying on ex-post punishment only is a bad approach.”

    That’s because the Irish banks are primarily utilities who provide a vital intermediation service to the public. Taking big heads I win tails you lose risks is fine for Americans but not suitable for bland Irish banks with such a tie to the public who are lashed to their balance sheets no matter what happens.

    Given this, young thrusting bucks in the mould of Richie Boucher c 2002 should never be allowed near them.

    And regulation will have to be tighter than being marked by JJ Delaney.

  25. So, who will define ‘unsafe’?

    A committee of civil servants and academic economists with guaranteed jobs and guaranteed pensions, who have never taken a risk in their lives?

    All that these people will do is prevent entrepreneurs taking risks.

    But, entrepreneurs taking risks is what drives an economy forward.

    Its all partly to do with psychology.

    Some people will walk a tightrope between the Twin Towers. While, even in Ireland, some people won’t leave the house without their bodies first being sprayed with lavish quantities of snake and bear repellent, and an emergency supply of ebola tablets in their pockets.

    Ireland achieved massive growth between 1958 and 2007 because it had lots of risk-taking entrepreneurs. During that time GDP rose by 800 per cent. If every investment decision had first to be approved by some committee mandated to stop ‘unsafe’ investment, it would have been 100 per cent.

    Of course, a risk-taking economy will hit the buffers more often than a non-risk-taking economy. But, during periods of global growth (the norm), it will achieve high rates of growth (5-6% plus) far more often than an ‘avoid-unsafe-at-all-costs’ economy. Germany may have survived the recession better than most. But, when was the last time its economy grew at 5-6 per cent plus, which Ireland has achieved 20 times in the past half-century and looks likely to achieve this year.

    An analogy can be drawn with football. One team plays every match with an 8-1-1 formation. Every match finishes 1-0 or 0-0. They never suffer a heavy defeat, but they finish sixth. Germany is that team. Another team plays every match with a 3-2-5 formation. They record numerous 4-1, 5-1, 6-2 victories, but once a season come a cropper and lose 5-0, but they win the league. Ireland is that team.

  26. Gregory, I think we have to ‘part company’ here.

    ” … ban unsafe lending practices, rather than relying on domestic bank’s risk aversion toward punishing penalties.”

    When the domestic banks implemented self-imposed, ‘safe-sex’ lending for home mortgages there were virtually NO defaults, and Neg Equity was rare (though not unknown). So what’s to re-learn here? These critters either have a sound (Capitalist) business – or they do not. If its the latter, then they get liquidated: QED. But they have copped onto a absolute winner: get your government to provide a TBTF guarantee. Utterly brilliant!

    These financial institutions need to be taught a very bad lesson: they must be liquidated. The Irish citizen will not be harmed – the government simply repudiates its guarantee – politicians do this all the time. Temporarily inconvenient – indeed. Life-threatening – rubbish!

    Is it totally beyond the realms of possibility for the state* to be able to re-incorporate replacement banks? The infrastructure + staff are already in place. It most surely is not! Anyhows, given our small population, one state (domestic) bank + one savings and loan + one commercial bank will suffice. Just tell the complainers to “stuff-it” – like Mr Enda does so well. Look, we just need banks to provide us with a money service and turn a normal profit – not lose money, then stiff the taxpayers.

    We did ‘suffer’ a 10 week bank strike a few years back. Life went on. Sky is still up there! This TBTF is pure propaganda – its simply a BIG LIE! Successful one, though.

    * On recent evidence, such a possibility may be zero – and rapidly going negative!

  27. @ JtO

    Taking risks on one’s own behalf is fine. Grabbing the gains while sloughing off the downside onto others is not entrepreneurial. It’s sharp practice dressed up as ‘enterprise’. Bankers and their political cronies have perfected the scam.

    Any institution which is government guaranteed has to be government regulated. Good economics is institutional economics.

    http://en.wikipedia.org/wiki/Why_Nations_Fail

  28. Re: Irish Banking and the Holy Grail

    Gregory wrote,

    It is acceptable to lock in severe penalties against banks for unsafe outcomes, but it is more important to ensure that these punishments will never be activated, by banning unsafe lending.

    Gregory, the esteemed academic economist, AND his colleagues working in the real world market situation, . . . . are both correct.

    What neither of the camps, seem to realize, . . . . is that Irish banks, are fully capable of squirrel-ing away vast amounts of risk capital in a whole variety of ‘dark’ places, . . . which will ensure that those risks (which Gregory points out, the rank-and-file citizens are exposed to), do not appear anywhere near the balance sheets of the largest Irish financial institutions.

    We still don’t understand, how the Irish banking system, managed to pull this off.

    There has been very little light, academically speaking, or otherwise, shone over this.

    We have never had a tell-all, see-all and show-all, banking inquiry, in Ireland.

    We do know for sure, that whatever mechanism operating, it did work extremely effectively over a very long period of time. It did manage to conceal a lot of truth from a great many shrewd investors, regulators, policy makers and international standards auditors (International Monetary Fund, etc).

    Some very highly credentialed contributors to the Irish Economy blog, working at the Irish Central Bank, in the lead up to the crisis, didn’t see anything so major, coming down the tracks.

    To suggest that we have a handle on this now, and that we have more wisdom, is fallacy.

    We have no idea, academically or otherwise, . . . even looking at the banking system in Ireland, in our rear-view mirror.

    Someone above, mentioned the period between the late 1950’s in Ireland and the late 2000’s, a period of approximately fifty years.

    The gross national product, in Ireland, grew by a very significant proportion in that same fifty years.

    I think, as a time frame to look at it, that fifty year time frame feels, about right to me. That is the period during which, many of the major players in policy making in Ireland, constructed whatever it is, we have now ended up with.

    (It was also a time, during which a lot of the smaller financial institutions, were merged together, into the smaller number of large ones, that Gregory has mentioned)

    Over that fifty year time frame, a lot of other countries around the world, had been actively studying the Irish model, and had in fact started implement, or tried to implement it in parts, the wealth-producing mechanism of this country.

    There are even still, a lot of eyes outside of Ireland, that will anticipate new information that a thorough and effective banking inquiry could reveal, about how the Irish system works.

    There is almost, a political back-lash, against a banking inquiry, . . . because we still feel, that doing so, . . . would be revealing too many of Ireland’s crown jewels, which it had enjoyed for half a century.

    A full and thorough banking inquiry in Ireland, would shed some light, not only into some very dark places that may exist, on the island of Ireland, but into those in a lot of other small developing nations too, . . . who have been trying to pursue ‘an Irish policy model’, for a very long time.

    In short, Irish politicians, in relation to Ireland’s economic affairs, can sometimes view themselves in a similar relationship, to that between the medieval knight and the chalice known as the Holy Grail.

    No one fully understands, whether this viewpoint may still be relevant in a modern age, or not. Mainly, because so much of it is still shrouded in much darkness and secrecy. BOH.

  29. @ PQ

    Sloppy regulation, credit relaxation and low interest rates pre Lehman drove house and other asset prices up but masked weaknesses in aggregate demand in the US and in the EZ.

    During the three years 2004-06, one former Fed official noted that a full 3.5 per cent of GDP came from households using their homes as ATMs, borrowing (and spending) against the equity they had in those homes. Once that game ended, “I knew growth would be lower”

    Americans are not getting pay rises above inflation.
    If this does not change the S&P will go right back down to 666. And house prices will crash again.

    BEB and Tull are very fond of the rich but they don’t spend money like the former middleclasses do.
    And it’s all about cashflow schlussendlich.

  30. Bloggers on this thread may find this Alphaville link of interest.

    http://ftalphaville.ft.com/2014/10/31/2025592/why-banking-got-out-of-control-in-the-digital-age/

    What if there is a collective tilting at the wrong windmill?

    A good point of departure would be to define what is meant by banking. At its simplest, it is surely that of maturity transformation i.e. matching varying borrowing and lending demands. By that definition, governments, banks, formally recognised as such and the shadow variety, are all in the same business. It is difficult to see how, in such circumstances, stability can be achieved, especially in this digital age. The best that can be would appear to be the existing state of unstable equilibrium.

  31. @JTO
    You want it both ways.
    You want banks to be allowed to be as pro risk as they like but reserve the right to “pragmaticly” get the government to save such banks if they cause a systemic risk when they go bust.

    That is not capitalism.

    There is an easier option.
    Low risk government controlled banks that will be saved at times of systemic risk and other small players who are allowed be risky within limits but are allowed fail.

    That’s fairly capitalistic but is not the wild west.

    The reason for the increasing size of financial crises is that financial institutions deliberately under price risk and governments do nothing to prevent them doing so. They do this because their sales people are paid on the loans they issue now and share prices are connected to quarterly based profitability figures and because they know they have a free insurance policy paid for by the state when it all goes wallop.

  32. @Eamonn Moran

    They shouldn’t be as pro-risk as they like.

    They should be pro-risk sufficiently to achieve a high economic growth rate.

    If there is a global downturn and some of their risk-lending goes bad, the decision on whether or not to rescue them should be based on pragmatism and not ideology. That is, will the economy perform better if they are rescued than if they are not? They shouldn’t be given carte blanche, but any decision on rescuing them should be evidence-based and not based on the fact that lots of media/academics/politicians hate them. Prior to 2007 Ireland had 21 years of spectacular growth, of which the banks were an integral part, therefore there were good grounds in 2008 for thinking that long-term growth would best be served by rescuing them.

    Recent spectacular growth seems to support this view.

    The EU today forecast high growth for Ireland for the next few years, the highest in the Eurozone.

    Would this be happening to the same extent if the banks had been allowed to crash?

  33. Re: Fundamentals of Finance

    JTO wrote,

    They shouldn’t be as pro-risk as they like.

    They should be pro-risk sufficiently to achieve a high economic growth rate.

    Unfortunately, according to the fundamental rules of finance, this sounds about right. It is impossible to make returns much higher than a base market rate, . . . without being in a position to take a certain level of risk.

    The argument is that Irish banks are not only in the position to do this on behalf of themselves and their customers, but for the benefit of the nation as a whole.

    Whether I can agree or not with this train of logic, which is extremely popular in Ireland, . . I can understand it holds a certain kind of logic.

    But this isn’t what happened up until 2007 in Ireland.

    The Irish banks squirreled away cash in the balance sheets of all kinds of borrowers, who didn’t understand money. For a finish up, the banks, could not even remember where they had buried more than half of it, . . . but they’re okay now, because they still have enough nuts left over for the winter.

    We cleaned up the balance sheet, of the Irish financial institutions, when their true exposure to risk had been exposed. We gave them all new money, to create zippy new advertising campaigns (or at least something to replace the lady with the braces looking for the ‘ching, ching’), . . . but we never bothered to figure out, where they buried all the nuts. BOH.

  34. @ JTO et al

    http://www.nytimes.com/2014/04/13/books/review/fragile-by-design-by-charles-w-calomiris-and-stephen-h-haber.html?_r=0

    The problem is not that the nexus banks (of the formal and shadow variety)/ politics exists but that there is little that can be done about it other than to make a continuous effort to not allow it to get out of hand.

    Conservative Ireland had an impeccable banking record until politicians – mainly from FF – turned financial services here into the Wild West (to quote a US newspaper).

  35. Re: The Truth about Risk Transfer

    Kevin Lynda wrote,

    Lending *is* investment.

    Investments can lose money as well as gain money.

    There is an argument here, worth expanding upon, because I don’t think anyone above has quite picked on the point, that Kevin expressed.

    There is something that I have long held as my suspicion about banking in Ireland, and it is the following. Although, I don’t think that it is safe to even speculate about these things, without have the means through an investigation and inquiry, . . . to work with some real data.

    I can recall that during the boom period in Ireland, that inside property development companies, when we looked at the balance sheet, it would appear that we carried an awful lot of debt that had been acquired to buy development land.

    But, when it came to getting finance to execute a real construction project, there wasn’t fifty pence available, more often than not.

    This is what I mean, by banks being able to squirrel away capital on the balance sheets of other companies. Assuming that land asset didn’t disappear into thin air, it could be financed on some kind of interest payment, and that capital was safe.

    What I mean, is that Irish banks were more biased in favour of lower risk lending, and less biased in favour of higher risk construction project lending.

    Inside a property development company in Ireland, if one wanted to fund any project on the construction side of things, one had to present collateral, usually in the form of a future guaranteed stream of incomes, from a commercial project, that was already completed and producing something.

    All of this, comes down to the risk management strategies that was employed inside of the lending institutions, themselves. In fact, the Irish banks tried a lot of means, to move shift efficiently away from themselves and towards their borrowers.

    This strategy did work well, up until the point that it didn’t work any longer, . . . and the mechanism used to achieve risk transfer between the parties, began to fail itself.

    Having been biased in favour of lower-risk lending, the Irish banks, lent a lot of money to a lot of individual parties, . . . to purchase the lower-risk part of the property development, . . . the basic land asset.

    In effect, this drove up the price that property developers had to carry on their books as debt, related to land purchasing. Which in turn made it more difficult for them to create successful schemes, that justified finance for construction, which it turn could have produced net incomes, which could allow those development companies to pay interest charges and fees.

    Remember, that in the late 2000’s in Ireland, property development companies were starting to carry several billions worth of debt on their books, in relation to non-income producing land assets. Which sounds like it is a lot, but at that time, sites in Dublin city had started to change hands for prices that were approaching the half a billion mark, at a time.

    What that had the effect of doing, was reinforcing the belief, amongst Irish banks, that their low-risk, strategy had paid off.

    They effectively starved property development companies on the construction loan side of things, and over-fed them on the land acquisition loan end.

    I can vividly recall in 2008, trying desperately to lease a shop unit, that we had constructed on a shoe-string, simply in order to pay to keep the concrete pumps turned on, in the multi-million euro construction project next store.

    By 2008, even before the crash had happened, developers were already living from hand-to-mouth, in order to cover the most basic operating costs. They were effectively out of business, even as the banks celebrated their best years yet, and distributed dividends amongst shareholders.

    And the reason, that I mention it at all, is there are strong echoes of this same pattern emerging in Irish construction and property in 2014.

    The fundamentals that created the first boom and crash, are still very much in tact. BOH.

  36. @ DOCM

    “Conservative Ireland had an impeccable banking record”

    Not true.
    AIB had to be bailed out in the early 80s over ICI losses
    I think the 1960s merger that led to the creation of AIB was also linked to tearing the arse out of banking/mispricing risk too.

  37. @ seafóid

    Point taken!

    What I recall most from the past years is the queues outside Northern Rock; the first bank run in the UK in over a century!

    In the general scale of things, one is forced to the conclusion that it would have been next to impossible for such a small financial community as the Irish not to have been swept along in the general melee.

    P.S. Ballyhea continues to say NO!

  38. Re: Banking Inquiry Objective

    @ All,

    What would be really useful, if they could include it as an objective in the Oireachtas banking inquiry, is if they could try and establish a timeline as it was perceived from multiple view points.

    I think this could be very useful.

    I am almost certain, . . . . that what the Irish banks were seeing from their end, . . . was nothing like what borrowers and their customers were seeing from their’s.

    The point is that sometimes, a quite determined effort on the part of larger institutions, . . . to avoid a particular type of risk, that they have identified, . . . can result in feedback that is telling those institutions exactly the wrong things.

    The Oireachtas banking inquiry could try at least to establish, if that was the case.

    I mean, a good example of it in recent times, is in Iraq/Syria, . . . where the a administration, had gone out of their way to avoid a certain kind of outcome, . . . and ended up causing in most spectacular fashion, precisely the kind of outcome that it had been trying to avoid.

    I am almost certain, that that is what happened within Ireland’s banking system. But it is a line of investigation, which the Oireachtas Inquiry, would need to pursue. It wouldn’t take too much effort, to establish some of the evidence for the same, even if not be proven definitively. To pursue an inquiry and not to gather a decent multiple-viewpoint timeline, would be a real shame.

    Does anyone know, what skill set level is present on the inquiry team? BOH.

  39. @BoH

    Generally rising property prices translate more to land price inflation than construction.

    The banking inquiry has been sufficiently delayed that many talented people are just not going to bother taking too much interest in it.

  40. “The banking inquiry has been sufficiently delayed that many talented people are just not going to bother taking too much interest in it.”

    That is a pity because if we don’t know what happened the last time we won’t have a clue what to do for the next one. Bureaucratic kicking to touch is all well and good but this banking stuff is existential.

  41. Re: Echoes of the 1920’s

    Seafoid wrote,

    if we don’t know what happened the last time we won’t have a clue what to do for the next one.

    It reminds me of that joke about the great crash, of 1929. It was a time of the democrat-ization of the stock market, . . . . or simply put, you too can loose money.

    Here in Ireland, people go on as if there was some shocking experience, that we have all just had to ensure, . . . a kind of a once is a lifetime nasty experience. We don’t need an inquiry. It’s a fait accompli, and we’re out of the woods now. I’ll tell you what, people have carried away one piece of information from crisis, . . . it is more profitable to make money out of disaster, than make it any other way.

    Far from the crisis being a once-off, I would expect it to be the first of many, a dress rehearsal, where the players involved, are simply sharpening up their technique, for the real banquet.

    There were many participants who could have inflicted more damage, had it not been for the fact, their technique was under-developed. Those folk won’t waste a second opportunity, and governments won’t escape as lightly, nor will society. We’re going to see bread lines, in the British Isles, before my life time is out.

    What you can try to do, if you are clever, is try to be prepared, . . . and it doesn’t appear that we are up to that task. Before you had 1929, you had a whole sequence of curtain opener’s that took place in the preceding decades. It took them several attempts, to finally break the system, but eventually the market found a way. BOH.

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