January 28, 2009
What will happen to mortgages when unemployment rises to 15pc? How many first-time buyers, who bought at the top of the boom, will default? Will the banks throw them out on the streets and, if this happens, what benefit will the newly recapitalised banks get from an empty house with no tenant and a defaulted mortgage?
Widespread default on mortgages is likely to happen in the next year. This will accelerate the following year and will not stop until unemployment peaks.
As a result, house prices will fall dramatically in the next 24 months and this alone will influence many young people and couples to give the keys back. Negative equity causes people to give up hope and throw in the towel because, if there is no short- to-medium term reason for houses prices to rise, there is little point, bar your sense of obligation to the bank, in paying back the loan.
You might conclude that a charge against your name is a small price to pay. Furthermore, a charge against your name is of little immediate impact when you are on the dole. We can’t let this happen. We can’t allow people to lose hope.
The country finds itself in a conundrum. We are slashing public spending now on the advice of almost every economist in town. The logic is that this will get us back on some sort of track and that when we get out of this mess, we will be leaner, meaner and fitter. However, this view conveniently forgets that the banks are not lending, so there is nothing to raise local demand and the more you cut, the more you shrink the economy.
This will lead to a failed adjustment, and it will fail and fail again because there is no liquidity in the system and no prospect of liquidity coming back. There is now a real risk that the economy will contract by some 10pc this year and possibly more again next year.
If something like this comes to pass, Irish society will split in two. We will be left with what could be called an ‘insider’ and an ‘outsider’ society, as was the case in the 1980s. The insiders are, typically, a poor version of the European middle-classes whose jobs are reasonably secure and whose incomes have fallen by 5pc to 10pc from their peaks. Typically, these would be public-sector workers, semi-state employees, people who work deep inside the large financial institutions and small time businesses that sell into the protected sector of the economy.
Multinational workers whose jobs are not geared to the domestic economy exclusively might also escape the brunt of the depression.
These insiders are likely to be middle-aged who have bought their houses years ago and will not be hammered by the prospective fall in house prices.
Their wealth will be affected but as their mortgages were taken out in the 1970s, 1980s and early 1990s, their monthly repayments are manageable and negative equity doesn’t figure as a problem. Higher taxes will annoy them, but in general, their lives will not be enormously dislocated by the meltdown. They will fight therefore, to maintain the political status quo. The ‘outsiders’ on the other hand will get hammered and will find their tenuous grasp on a stake in society ripped away. Who are the ‘outsiders’?
They are people who have lost their jobs and will continue to do so, in sectors that are going to be trashed by the recession. They will be working in retail, construction, the more exposed sides of the banking and finance industry.
They are the many thousands who are in companies hammered by the overvalued exchange rate. They are likely to be younger, in many cases the sons and daughters of the ‘insiders’.
A significant proportion of them will be among the 200,000 first-time buyers who came into the housing market in the past five years. Negative equity will sap their energy, their resources and their will to stay here. As in the 1980s, many insiders will just assume that the outsiders have to emigrate, and that’s how we preserve social cohesion. But we can’t tolerate this.
Therefore everything must be done to prevent this happening.
How do we avoid this cleavage emerging in our society?
How do we give the outsiders a stake so that they don’t leave or they don’t sink under the weight of negative equity?
One thing we could do immediately is that the State, as part of the recapitalisation of the banks, acts to help those thousands of first-time buyers who are now drowning in debt.
The State could demand, as a condition of recapitalisation, that the banks re-negotiate thousands of mortgages. The principal could be halved now so that the debtor continues to service the debt, but on a much lower amount. This way they don’t default and the bank does not end up with a bad loan. But the debtor doesn’t get away with it. It is not a debt write-off, it is just deferred.
Initially, the State and the bank take the hit on the level of loan deferral. They pay 50/50. But this deferral, which is the difference between the old principal and the new principal, goes to the State so that when these houses finally rise in value again in, let’s say, a decade, the upside goes to the State and a proportion to the bank.
The bank’s proportion is much smaller than the State’s because the bank messed up in the first place. So although the State and the bank cough up 50/50 to pay now for the deferral, the State gets proportionally more of the upside so the taxpayer, not the future shareholder, is paid first and most.
The impact of such a move would be to release the noose of debt from around the necks of thousands of our younger generation. This will give them hope and maybe a reason to stick around. For the banks, it means the debt write-off will be smaller than they would otherwise be, and the loans will continue to be serviced.
This means the minister’s recapitalisation of the banks, with our money, might cost us less in the medium term because a smaller proportion of the mortgage loan book will go sour. Most significantly for liquidity, it will signal a floor to the house prices.
So how would it work? Consider a house bought in the boom for â‚¬200,000. The couple who bought it could just cover it with both working. One loses their job. The mortgage repayments now, more than likely, swamp them completely. They will not spend and the economy will contract more as a result.
What if we slashed their principal in half, so they now service a loan of â‚¬100,000? The State finances a proportion of this with a state-wide bond and the bank finances its bit out of its capital.
The State and, to a lesser extent, the bank, gets an option on all the price upside, up to and beyond, the old price over the next 10 years. As prices move back up, the State’s option becomes very valuable.
This means the State behaves responsibly and gives its citizens a break, while the citizens behave responsibly and ultimately pay the State back when they can. It is a win-win for everyone and is precisely the sort of lateral thinking we need to be coming up with.