Household Debt Restructuring Post Number 4012

The household debt restructuring (I’m not going to use the ‘f’ word) debate rumbles on. From the blanket coverage in the Sunday papers, Colm McCarthy’s Sindo post and Stephen Donnelly’s pieces were, I think, the best. For context, earlier in the week Seamus Coffey looked at the numbers in arrears from the Central Bank. From Colm’s article:

It would be wrong to dismiss the ‘forgiveness’ campaign as just a silly season space-filler revved up by a woolly-minded media. There is a real problem for many people and some mortgage debt will have to be written down. You cannot get blood out of a stone.

The danger is that the campaign will encourage everyone in negative equity to disguise themselves as stones and to lobby politicians for relief from debts that they are able to service. The politicians need to understand that debt relief, beyond the minimum necessary to acknowledge that some people simply cannot pay, comes at the expense of a bankrupt Exchequer. Do they really want to go to the IMF/EU looking for a further loan to recapitalise the banks yet again?

The best way to proceed is for all banks to be treated equally, regardless of ownership, and encouraged to write down mortgage debt that cannot realistically be serviced. The process will not be left entirely to the bankers, in whom public confidence remains weak, and it makes sense to have active oversight from the Financial Regulator to ensure, for example, that there is no preferential treatment for favoured borrowers, such as bank staff.

Debt write-downs should be expedited where these are unavoidable and extra staff assigned to the task. A modernised personal bankruptcy code would help and legislation has been promised.

I agree with Colm’s assessment of the situation. With the date of the expert group’s report hurtling towards us, it might be useful to consider a few worked examples of debt restructuring as and when they become important to us. Here is a google spreadsheet considering those cases.

I chose just one restructuring instrument, a debt/equity swop, although there are many others. See appendix 2 of the MARP report for worked examples internationally. The headings of the spreadsheet should take you through the logic of the examples.

First off, these are archetypal cases made up to make some points about types of mortgages in difficulty, so they are subject to a series of assumptions I detail in the spreadsheet. They are not meant to be anything other than exemplars, though they are driven by real life cases I’m familiar with. Anybody wishing to improve the ‘reality’ of the examples, by including interest and arrears for example, or another debt restructuring mechanism, please have a go on google docs and I’ll link to your examples in the comments.

Second off, it’s pretty clear from the spreadsheet that very few cases actually qualify for some kind of restructuring. Of the 6 cases, only 2 mortgages are deemed ‘sustainable’ when the bank takes a 45% equity stake, and only 1 is sustainable when the bank takes a 35% stake. So, under the present set of arrangements, the rest of these mortgages would most likely end up becoming court cases, with the attendant stresses on household and society, and the possibility of the bank recouping only the secured asset. If, and it’s a big if, these examples are any guide to reality at all, an efficient personal insolvency mechanism is clearly the first step towards resolving the debt crisis, with a subset receiving some form of restructuring.

It’s clear there is a need for an efficient filter to decide, based on individual circumstances, which mortgages aren’t sustainable, which are, and which might be, given other considerations.

In practice, here’s how I see such a filter working.

1. The process is done through the banks but supervised by the regulator. Another quango or NAMA we really don’t need. Banks are best placed to work things out with their borrowers, but they should be supervised–especially the uncovered banks and subprimes but most importantly the ‘pillars’. A metric agreed by both sides on the debt profile of the individual lender and borrower should be constructed.
2. The implementation should be a menu of options available to the bank, one of which *must* be used depending on the outcome of a series of tests for income, etc., applied in stage 1. The penalty for misrepresenting yourself to the bank should be fraud charges. Cute hoors need not apply in other words. This will reduce the moral hazard element enormously.
3. This menu will include: straight out bankruptcy, debt/equity swops, repayment rescheduling, debt writedowns in cases where the banks have clearly acted inappropriately, giving the house back to bank in full and final settlement but renting the same house again, and more.

The principle, I feel, should be means tested income streams plus arrears rather than negative equity. Each menu item (a, b, c, etc.,) will come from an individual pot of money in the banks (e, f, g, etc.), all overseen by the regulator in a monthly report to them.
4. The objective is to be fair to both parties (lender and borrower) while allowing people to get on with their lives. The perspective, in some sense, is social welfare rather than letting banks or borrowers off the hook. Understanding you’ll never get this just right is key.
5. The guidelines should have the force of a directive on the banks from the regulator, eg it should remove a lot of the discretion from the banks and add clarity to the process while differentiating between ‘can’t pay’ and ‘won’t pay’ and ‘might pay’ and ‘will never pay’.

Update: Karl’s Business and Finance piece this month is excellent on this issue.