September 6, 2012
The new chief economist of the Central Bank stated the obvious last week when he said that there would have to be debt forgiveness on many mortgages that simply can’t be paid. Someone who signed a contract in good faith during boom conditions, when income and the price of the house was rising, simply cannot honour that contract if his income has shrunk and the price of the asset has collapsed. Many tens of thousands of Irish people simply do not have the money to pay the mortgage now and certainly won’t have it when the next round of tax increases are signalled at the Budget.
From the point of view of the banks, the more they kick the can down the road and pretend that the mortgage problem will go away, the more they turn into zombie banks. Unless they can crystallise losses on loans they have out against houses which have fallen in value and clients whose incomes have collapsed, the banks themselves will not be able to raise the capital needed to function like normal banks. This is because unless investors know that the losses in the banks are finally over, they will not invest any new capital. If they did that, new capital would only go to repay old losses and validate old mistakes.
This means that unless they admit and write down their losses on their mortgage books, the banks will have to be self-financing. In order to do that, they will have to get their loan- to-deposit ratios down to 100pc. At the moment, the ratio is 140pc for the main banks. This means that for every â‚¬140 of loans out they have only deposits of â‚¬100. They have to get this down and can only do this by taking in more deposits or by giving out fewer loans.
This implies that banks will be taking money out of the economy, not putting it into the economy, for the next few years. It also means that the velocity of money, the amount of times notes and coins change hands in the economy, will fall and this means that monetary policy as we understand it is ineffective in boosting demand. Such a situation calls for unorthodox measures and those unorthodox measures involve the Central Bank instructing the banks to begin to write down mortgages as soon as possible.
This doesn’t just make sense economically but it makes sense morally. It is immoral to keep thousands of our fellow citizens in what is in effect a debtor prison. The debtor needs a break. If they get no breaks and are out of work or find their income falling, there is no way they can pay even a portion of the debt. Thus they remain in limbo and are precluded from playing any normal part in the economy. It’s not hard to see how this leads to a vicious downward spiral, where people are trapped in their homes, unable to get on with a normal life.
Yes they made a mistake, but who doesn’t?
The most perplexing thing about all this is that according to the banks’ own stress tests last year, the worst-case position is that mortgage defaults would cost the bank â‚¬16.3bn. This capital has been injected into the banks by the government’s re-capitalisation. For an excellent account on the details of this google Karl Whelan’s (University College Dublin) comments at Central Bank of Ireland conference ‘The Irish Mortgage Market in Context’, October 13, 2011.
So they have the cash buffer to absorb a significant amount of writedowns, so why don’t they do it and why haven’t they been doing it over the past few months? By writing down bad loans the banks would be signalling to the world that they are getting on with the real process of sorting out their balance sheets. At the same time, they would be forgiving people their debts, giving them a chance and some hope for the future.
This is where the issue gets political, both with a little and a big P. The fear on the part of the banks must be that the â‚¬16.3bn won’t be enough and that the overall cost of mortgage writedowns will be higher. If it is higher, the banks will want more money from the State — which it hasn’t got. A cynical interpretation of why the bank bosses don’t want this is that they are all — most of them financial mercenaries — brought in on short-term contracts to stabilise the banks and on course for bonuses if they just keep everything afloat.
If they began the process of debt forgiveness and this leads the bank to look for more money from the State, they, the bosses, would have failed. No one who is making a nice career for themselves, in the business of going from bank to bank after crises, wants to be the guy who failed. The key for them is to pass on the really nasty bit to the next guy. Therefore, they will adopt a “delay and pray” approach and hope that some miracle full tide will raise all the boats.
The other possible reason for the lack of action is that maybe the mandarins in the Department of Finance prefer not to face up to the scale of the mortgage default crisis as it would scare off our eurozone neighbours just as we negotiate a bank debt deal. There may be a notion within the halls of power that as the spotlight is off us now, we should do nothing which might draw attention to ourselves, particularly as we might have a deal in sight. This is a cute hoor tactic because we know that we will have to go back to the well if there isn’t enough in the â‚¬16.3bn to cover the mortgage default bill.
This seems to be a big risk to take because if mortgage defaults occur they will go viral and yet again we will be reacting to a crisis rather than controlling it. The man from the Central Bank is right, and he has the power to force the banks to begin doing deals right now in order to prevent a default crisis. The only way to do this is to press on with debt forgiveness in certain cases.
With mortgage writedown and debt forgiveness will come a certain amount of repossessions because there are cases where people have no ability to pay and the bank can’t just give them the house. This is where politics with a big P comes in, because there is no political party that will preside over repossessions given our history. The parties would be much happier for the banks to gradually become zombies than entertain the sudden political flashpoint of banks chucking people out on the street.
Taken together, this means that the prospect of organised debt forgiveness will be delayed and the risk of chaotic mass default be brought forward.