Lack of Debt Forgiveness Not Realistic

From today’s Irish Times,

Debt-forgiveness scheme not a realistic option, says Hayes

THE GOVERNMENT is set to resist growing calls for a debt forgiveness scheme for homeowners in mortgage distress.

Minister of State for Finance Brian Hayes said yesterday a proposal to write off up to €6 billion in personal mortgage debt was not a realistic option.

A spokesman for Minister for Finance Michael Noonan also indicated such a scheme was highly unlikely …. Mr Hayes, however, said there were “two huge problems” with the proposal.

“With any debt forgiveness, it will raise questions of fairness for people paying 100 per cent of their mortgages who are not getting any help from the State. It’s a huge issue for that group, who are already straddled with huge mortgages and who have not sought debt forgiveness.

“Secondly, the Government has put huge store behind the two pillar banks. To introduce debt forgiveness totalling €6 billion at a time when the Government is bringing those banks out of the A&E wards would be very difficult to justify,” he said.

These comments strike me as odd when one considers the underlying policy towards the Irish banks set out in the Financial Measures Programme (FMP) report, released last March and compiled with extensive (and expensive!) input from international consultants.

When Mr. Hayes talks about the “huge store behind the two pillar banks” I’m guessing he’s referring to the money being used to recapitalise them. Well, the recapitalisation requirements for these banks were dictated by the findings of the FMP report. 

The report estimates total lifetime losses on the €74.4 billion owner-occupied mortgage portfolio for AIB\BoI\EBS\ILP at €5.7 billion in their base case and €10.2 billion in the stress scenario. These loss estimates were then used to come up with the capital requirements for each bank, most of which has been met by putting public money into the banks.

For those who say that they don’t think that their money should be used to help write down other people’s mortgage debt, there’s bad news and good news. The bad news is that it’s already happened.  The taxpayer injections from the NPRF are covering mortgage debts that won’t be paid back. The good news is also that it’s already happened, i.e. implementing a debt relief programme won’t involve any additional costs to taxpayers over and above those already announced.

What this means is that the banks are sitting on mortgage losses that will be around €6 billion even if the economy recovers in line with the government’s projections.  This €6 billion represents debt that simply will not be paid back and taxpayer funds have already been injected to cover these losses.  At present, however, the banks are preferring to write these losses off as slowly as possible.  But whether the day of writing down is put off some more or whether the banks actively engage in a write-down programme, these losses are being incurred.

Brian Hayes may believe that the “extend and pretend” approach currently being adopted, while failing to resolve the debt nightmares of many citizens, is at least beneficial for the health of the Irish banks.  I don’t believe this to be correct.

A number of international financiers that I have spoken to recently have expressed serious disappointment at the slow speed with which Ireland is moving to write down mortgage debt. Their attitude is that they could deal with the Irish banks if they could see evidence that mortgage losses will indeed be limited to about €6 billion. However, at present, they do not see any “workout model” in place for dealing with Irish mortgage debt.  In the absence of seeing how such a model will operate, they will continue to be nervous about the size of the unexploded “mortgage bomb.”

What this means is that it will be beneficial for both the banks and their distressed customers to get on with implemented a well-designed debt relief programme. Indeed, prior to the comments from Brian Hayes and Mr. Noonan’s spokesman, I was under the impression that the government would implement such a policy. Certainly, the public statements of Jonathan McMahon, head of banking supervision at the Central Bank, indicate a preference for the banks to get on with writing down with bad loans.

What should a well-designed mortgage write-down programme look like? Brian Hayes raises the issue of fairness as if nobody has ever thought about this before. In truth, a lot of thought and effort has gone into dealing with personal debt problems around the world and there is a lot to learn from. We’ve also been discussing it on this site for a long time, e.g. this post I wrote eighteen months ago.

A well-designed programme needs to deal with mortgages on a case-by-case basis. In some cases, this can involve modifications of mortgages in bilateral deals between banks and their customers. In some cases, those who get modified mortgages will get to stay in their homes. In other cases, they will not.

In more serious cases, a process of negotiations between debtors and their creditors will be required, i.e. a personal bankruptcy procedure. The revised EU-IMF programme from April (page 15) contains a commitment to introduce a revised personal bankruptcy regime as well as a new non-judicial debt settlement and enforcement system. It claimed then that discussions were ongoing and would be completed shortly.

In light of the EU-IMF commitments on debt regimes, the stress test results and recapitalisation, and the stated approach of the Central Bank, I think the comments from Mr. Hayes about the inability to write down €6 billion in mortgage debt are unfortunate.

Let’s hope there is more progress being made on this issue than these narrow-minded comments suggest.

Mortgage Balances and Projected Losses

I’d written the comments below before seeing Stephen’s post on this, so I’m not trying to correct anything in it, just adding my own two cents.

I didn’t attend Morgan Kelly’s talk at ISNE yesterday so all I know about it is what I’ve read in today’s newspapers (e.g. this piece in the Irish Times) in which Morgan is quoted as saying “We are talking sums in the region of €5 billion to €6 billion which would be necessary to spend on mortgage forgiveness”. This evening, I heard a piece on RTE’s Drivetime in which Brendan Burgess of askaboutmoney.com was questioning various figures that were attributed to Morgan and arguing that Morgan was unnecessarily scaring people about the scale of mortgage defaults.

I’d like to make two (hopefully) clarifying points on this issue. First, the sizes of the owner-occupied and buy-to-let mortgage books for Irish properties of the four guaranteed Irish banks are not something that there needs to be any disagreement about, as the balances as of December 31 last year were published in the Financial Measures Programme (FMP) report of March 31 (page 19).

Second, rather than being a scary figure, Morgan’s estimate of between €5 billion and €6 billion for a substantial mortgage relief programme is, if anything, a bit low relative to what the Central Bank’s figures in the FMP report indicate is necessary.

On the size of mortgage books, here are the facts. As of December 31 last year, BoI, AIB, EBS and INBS had a combined €97.7 billion in Irish residential mortgages with €74.4 billion being owner-occupied and €23.3 being buy-to-let (Table 7, page 19 of FMP report).

On estimates of losses on the owner-occupied portion of Irish residential mortgages, the FMP estimates total lifetime losses on the €74.4 billion portfolio at €5.7 billion in their base case and €10.2 billion in the stress scenario. The amount of these losses to be realised over the next three years is estimated to be €3.5 billion in the base scenario and €5.7 billion in the stress scenario (see Table 9 on page 23).

This shows that Morgan’s estimate of between €5 billion and €6 billion corresponds to either the lifetime losses assumed by the Central Bank in the base case or the three-year losses associated with the stress case.

As I said above, I don’t know how Morgan came about his figures but the five to six billion figure for mortgage writedowns seems to me to be in line with the Central Bank’s official policy.

Furthermore, my reading of statements by Jonathan McMahon, head of banking supervision at the Central Bank (e.g. here and here) is that he is keen to see the banks get on with implementing debt writedowns that are in line with the Bank’s assumptions about mortgage losses. The banks have been recapitalised under the assumption that the losses in the FMP base case are going to occur, so it is surely time to start dealing with this problem.

Perhaps rather than have an unnecessary debate about figures that are actually published and can’t really be disputed, Morgan’s talk can serve as a useful starting point for a debate about exactly how mortgage debt write-downs should be implemented.

EU Interest Rate Calculations

Well thanks Silvio! If it weren’t for the comical actions of Signor Berlusconi, I doubt if we would have obtained yesterday’s long-hoped-for interest rate cut on our EU loans. Certainly, the cut isn’t in any way related to the negotiating skills of the government – who were last seen essentially waving a white flag on this issue.

On the substance of the deal, like Namawinelake, I’m frustrated at the lack of useful detail about the new interest rate and potential changes in loan maturities.

An annual saving of €800 million is being widely cited but I have my doubts if the correct amount has actually been calculated. My guess is that the final savings could be a bit larger, perhaps as much as €1.2 billion annually.

The first open question relates to which funds the cut is being applied to and the second relates to the size of the cut in the interest rate itself. The statement merely says

The EFSF lending rates and maturities we agreed upon for Greece will be applied also for Portugal and Ireland.

However, Ireland is only borrowing €17.7 billion from EFSF and no reasonable multiple of this number delivers annual savings of about €800 million. It seems most likely that the reasonable assumption is being made that the interest rate will also be cut on Ireland’s €22.5 billion of loans from the EFSM, though as this is an EU vehicle, last night’s meeting could not announce such a cut.

If we applied a cut of “about two percent” to the “about €40 billion” of EFSF and EFSM loans, then my fuzzy math calculations come up with “about €800 million”. So that’s the likely source of the figure.

However, it seems likely to me that the terms of Ireland’s €4.8 billion in promised bilateral loans from the UK, Denmark and Sweden will be renegotiated, so a more accurate fuzzy math would apply “about two percent” to exactly €45 billion to arrive at “about €900 million”.

Then there’s the question of the size of the interest rate cut. The Irish media have clung firmly to the notion that the average interest rate on our loans was about 5.8 percent, despite plenty of evidence that the cost of the EU component was going to be higher than had been projected last November.

As I reported here a few weeks ago, by my calculations (spreadsheet here), the average interest rate on Ireland’s EU loan was going to be 6.21 percent. The Eurozone statement promises an interest rate

equivalent to those of the Balance of Payments facility (currently approx. 3.5%), close to, without going below, the EFSF funding cost.

That could imply a cut of 2.7 percent, which if applied to the full €45 billion would give “about €1.2 billion”. That may be right or wrong since we don’t have much information yet. But I suspect that once things are worked out, the savings will be greater than the €800 million being quoted.

Update: Sean O’Rourke just put my calculations to Michael Noon on the RTE News at One. The Minister conceded that it was likely that the interest rate cuts would be extended to the bilateral loans and that this would get the savings up to €900 million.

When a higher figure of €1.2 billion was put to him, the Minister noted that this might have included the likely reduction in future IMF rates (something I’ve written about before but wasn’t including here.)  The difference here comes from my comparison of the “about 3.5 percent” with my calculated current average EU rate of 6.2%.

With the average margin over cost of funds currently running at about 300 basis points, it still seems to me that a reduction of this margin to get the interest rate “close to” the funding cost sounds like a reduction closer to three percent than two percent. But I could be wrong.

EU Council Statement: July 21

Here‘s the official statement of the heads of state of the Euro area governments from today’s meeting.

Fun with Instant Zero Deficits!

I know some of our blog commenters are big fans of the idea of ending the EU-IMF deal and immediately running a zero deficit. I spoke with Kathy Sheridan from the Irish Times a while back about how this would be chaotic.

It’s interesting then to see US politicians apparently eager to try out this experiment on their own economy, pretty much for the hell of it. Here‘s an interesting analysis of the decisions that could be facing the US Treasury on August 2. A corresponding analysis for Ireland would be really interesting.