December 8, 2014
Forty years ago this weekend, at the Geneva peace conference between the Arabs and the Israelis, the Israeli foreign minister and one-time Belfast resident, Abba Eban, declared of the Palestinian negotiators that “they never miss an opportunity to miss an opportunity”.
Eban – born Aubrey Eban – was a great believer in trading land for peace and when seen now with the benefit of hindsight, it’s clear that the Israeli leaders of the 1970s, like Eban, were just the type of people the Palestinians should have dealt with – but didn’t. By holding out for a better negotiating hand, the Palestinian leadership could accurately have been characterised as never missing an opportunity to miss an opportunity. Now Israel is a different country; its shift to the right is permanent and today, the Palestinians have fewer influential friends than ever.
When looking at how our government is handling Ireland’s mortgage timebomb – the one obvious internal landmine that could blow the country’s economic recovery apart – you might quote Eban’s quip about missing opportunities.
The mortgage problem hasn’t gone away. We are still the most indebted people in the world.
The time bomb has been temporarily defused by incredibly low interest rates helping to push up house prices and push down negative equity. A boom in our real trading partners, the US and Britain, has allowed many Irish companies to weather the domestic slump of the past five years. It is no surprise that when the English-speaking world moved out of recession in 2011, it dragged its reticent cousin, Ireland, up too.
We have benefited too by the fact that our so-called partners in the eurozone are in trouble, driving down rates to the lowest level since the 16th century.
Incomes are slowly improving and there is effervescence in the economy, partly due to the pent-up demand of money that hasn’t been spent for six or seven years.
However, it’s clear for anyone who takes a long-term, mortgage-length view of the world that interest rates will rise at some stage and, when this happens, it is quite likely that we will experience another mortgage default crisis. The reason is simple: many hundreds of thousands of people – mainly those on trackers – can just afford their mortgages because interest rates have never been lower.
Just to get an idea of how precarious the situation still is, look at the latest figures published by the Central Bank.
Despite the fact that interest rates in Ireland are at the lowest for 500 years, the number of accounts in arrears over 90 days in Q3 was more than 117,000. There has been a small improvement in this figure in recent months.
If the situation is still fragile, why is there not a greater incentive to consider what might happen if the rate environment were to change?
The relatively sanguine approach to the mortgage time bomb can be explained primarily by the fact that property prices are going up and going up quickly. This is repairing the balance sheet of the Irish banks at a much quicker rate than many imagined possible even a year ago. So there is no incentive for the banks to try to do anything about the overhang of mortgages that could turn sour in the years ahead.
The banks have been focusing on having enough capital. Bank capital is only all the assets of the bank added up and all the liabilities subtracted. So if assets are rising, then the bank’s capital looks better, so there is no need to worry. When property prices were falling, the banks’ capital was being wiped out and so, in order to prevent bankruptcy, there was huge incentive to get these bad loans off the banks’ balance sheets. No there is no such incentive.
The easiest way to deal with a bad loan now is simply to roll it over. As my old mate the former US bank regulator Bill Black explains, when speaking about the banks’ current attitude, “a rolling loan gathers no loss”.
After years of trauma, the Irish banks are happy as long as there are no losses today, so they might worry about tomorrow but don’t care about one year hence – and as for five years ahead, well that’s an eternity.
While the banks’ management might be able to behave like that, the managers of the country can’t. The state shouldn’t be so chilled about the possible impact of higher rates in Ireland. Because we have such huge mortgages, Irish incomes are very sensitive to changes in interest rates. When rates fall, our incomes recover, but when they rise the impact on Irish after-tax incomes is amplified by the size of our borrowings.
Dermot O’Leary, chief economist at Goodbody Stockbrokers, has examined the impact of a return to “normal” interest rates in Europe and has come up with this wonderful chart.
Looking back to 2004, you can see modest rises in interest rates; the huge increases in debts caused interest payments as a percentage of disposable income to rise rapidly from 6 per cent to 14 per cent. As interest rates collapsed after the crash, so too did interest repayments as a proportion of income.
Now look at what would happen if rates were to go from where they are now (0.7 per cent) to 2.5 per cent and then to 4 per cent (which is a historic norm). You can see that, very quickly, interest payments as a proportion of income would move up rapidly.
This would cause Irish disposable income to contract very quickly, and consumer effervescence to disappear overnight, leaving another mountain of debt.
So what could be done to avoid this? Is there an opportunity to take this debt (these tracker mortgages) off the banks’ balance sheets? And if so, would we be mad to miss an opportunity?
At the moment, the ECB under Mario Draghi is doing its best to get European banks to wrap up all these types of loans into what’s called “asset-backed security” instruments and loan them to the ECB in return for cash.
The ECB is bending over backwards to get these loans off the banks’ balance sheets in order to encourage the banks to use the cash to lend out to get the Eurozone economy going again. This is a huge opportunity for us.
If we can get the trackers off the banks’ balance sheets, we pass the risk on to the ECB. Who knows, given its proclivity for the unorthodox, the ECB may be persuaded to take equity in the banks in a debt for equity swap. Why not? The ECB has broken all the rules in Draghi’s quest to turn the euro into the lira, behind the backs of the Germans, to save the EU economy.
This is the opportunity, and it is staring us in the face. As long as the European economy is a basket case, which it is now, the ECB will try all sorts of stuff that it won’t when things recover.
However, Draghi won’t be around indefinitely. Last week there were signs of a mutiny at the ECB with the Germans saying enough of all this Italian flexibility. The opportunity is to negotiate with the practical Italian now rather than the hardline German who will replace him in in the years ahead.
Will we take this chance, or will we revert to form and never miss an opportunity to miss an opportunity? That’s the question.