May 5, 2015
Could the governor of the Central Bank have resigned early because he expects some nasty surprises to come down the track, and because he doesn’t want to be around if a mortgage timebomb explodes?
As long as interest rates are low, the huge personal debts incurred by hundreds or thousands of Irish people are made manageable, because the real cost of these debts is diminished. This is obviously most evident in the area of tracker mortgages, where the banks are losing money because they are charging minimum interest on a huge part of their loan book. They are trying to recoup this money by very high variable rates of interest.
But will interest rates remain low forever? What would happen if rates were to rise? Does Patrick Honohan know something, or at least suspect something, that the rest of the population doesn’t? Could his move have been accelerated by the recent moves in the European bond markets?
In the past few weeks, long-term interest rates in Europe have risen, despite the ECB doing its best to drive them down. The reason is that the German economy is overheating. Property prices in Germany are flying, wage inflation is rising and unemployment is as low as it has been since the 1950s.
Much of the reason for this is that the ECB’s policy of the weaker euro of the past year has uniquely benefited Germany because it is by far the biggest exporter in the eurozone. Its more competitive factories have been operating at full tilt, driving up demand, wages and property prices. Soon Germany will need higher, not lower, interest rates.
If pressure for higher rates builds in Germany, what happens to peripheral bond markets with huge debts like Ireland, Spain, Italy and Portugal? What happens to countries with huge personal debts like Ireland?
These are legacy debts from the borrowing binge which have not disappeared.
The Irish balance sheet is still stuffed with debts that have been made tolerable only by emergency low interest rates. To get to the root of this, we have to go back a few years to the time when the men who are now apologising at the banking inquiry were blowing the balance sheets of their banks.
One of the most memorable ads from back then was the one where a bloke on the top floor of a bus stands up and admits to everyone, half-petrified, that he doesn’t know what a tracker mortgage is.
The ad captured the confused thoughts of the average punter on the bus going to work, in an era when everyone was using financial jargon, pretending they knew what it meant, but scared stiff to confess that they had no idea what they were talking about. No one wanted to admit that they weren’t up to date with the new lexicon, at a time when they were being bamboozled with incessant financial propaganda.
By locating the ad on the top of a bus, it reinforced the notion of ordinary people making extraordinarily important financial decisions without full knowledge. Most people now forget that the purpose of the ad was to reassure us that while we might have been perplexed, the Financial Regulator was in control.
The tracker mortgage pandemic spread like a virus though the homes of Ireland from 2001 to 2007. When the tracker virus crossed into the general population, it multiplied extraordinarily swiftly. Today the figures are startling – they reveal the extent of this financial pandemic and how it devoured the population.
Today, trackers account for 60 per cent of Permanent TSB’s €26 billion Irish residential mortgages. They account for 54 per cent of AIB’s €27 billion book and 23 per cent of the €16 billion book at its subsidiary EBS. Some 62 per cent of Bank of Ireland’s €28 billion book is made up of trackers.
All told, that works out at €51 billion, or about 52 per cent of residential mortgages at the four main banks. A higher proportion of buy-to-let mortgages, about 70 per cent, are on tracker rates.
Some 85 per cent of trackers were lent between 2004 and 2008, when they financed the vast majority of the new estates that were built in our suburbs. The trackers were injecting €51 billion of new credit into the market. This prompted builders to keep building; as the trackers grew and grew, so too did house building. They moved in tandem, the tracker and the hysterical end of the property splurge.
The banks knew they would lose money on trackers, but were confident that once they had you on a tracker, they could make money by lending to you for cars, kitchen extensions or holiday finance on top of your overdraft and credit card.
The number of people affected was staggering. The tracker went from zero per cent of all Irish mortgages in 2001 to 15 per cent in 2004 and over 50 per cent by 2008. This enormous debt is the great unexploded financial timebomb ticking away in Ireland, waiting to be detonated by rising ECB interest rates.
Had the Central Bank managed to get this debt off the banks’ balance sheets by orchestrating a large debt-for-equity swap with the ECB’s backing, this time-bomb would have been defused. As far as I know, this was never even broached under Patrick Honohan’s reign.
So if rates rise – which they will at some stage – who’d want to be the Central Bank governor when this one blows?
To avoid this, the new governor needs to put a significant New Deal for Irish mortgage holders right at the centre of economic policy. Otherwise, we are likely to have another tracker-inspired financial crisis when interest rates rise.