Finding a way out of the mortgage arrears crisis

During the boom years both the Irish government and the Central Bank were fast asleep at the switch when it came to regulating property lending. As such, they are now obligated to come up with a solution to the problem of residential mortgage arrears. By John Farrell Clark.

Irish banks have a moral responsibility to help solve the residential mortgage arrears problem - the same residential mortgage arrears problem that would never have happened had they not enthusiastically participated in causing it. And the Government, including the Central Bank, has an equal responsibility to work in tandem with Irish banks to alleviate the problem.

Besides the morality of the issue, it also happens to make good business sense.

During the boom times, both the Central Bank and the Irish government were asleep at the switch; and when the problem became a crisis neither wanted to take responsibility. But in reality the government was responsible for overseeing the regulatory obligations of the Central Bank and the latter was responsible for properly regulating the banks that had too much concentration in property loans.

Both failed in their jobs. As such they are now obligated to step up and help solve the problem. There are workable solutions which, unfortunately, and for the most part, have been ignored.

Signs of an overheated property market were there as far back as 2003. Economists were sounding an alert, but their concerns were ignored. At the executive and board level, some of these bankers were more interested in their stock options and bonuses. It used to be their customers, the lifeblood of any company, they cared the most about.

But the banks were too busy trying to outperform their competition in a race to increase the value of their shares; and the government was enjoying too much the surpluses it was generating by way of stamp duty on property transactions as if they would never end; and the ‘Golden Circle’ of a few politicians and property developers were thriving at an obscene rate that would eventually cause the collapse of the Irish economy.

And the boards of directors of the banks pushed management to fund more and more mortgages, at one point up to 110%, instead of requiring larger down-payments which would have cooled down the market. These loans were secured by properties at outrageous valuations for the sole purpose of growing their balance sheets and producing profits that supposedly ‘justified’ huge bonuses for executives while ignoring prudent lending criteria. Their zeal for growth and profits was simply unconscionable.

Borrowers, of course, share part of the blame and need to do their part. Nobody put a gun to their heads to take out mortgages that in worst case scenarios they could not afford to service.

But up to now the burden has been mostly put on the borrowers; and they, by themselves, are in no position to solve this problem on their own. The Government needs to force the banks to restructure mortgages where there are legitimate hardship cases; and if the banks refuse to do so, then the only rightful and moral thing to do is to nationalise them. Once the problem is under control, then the banks can be privatised just as Sweden did after its banking crisis.

Here is just one suggested solution that could stem the freefall of a growing problem that now has one out of seven residential mortgages being in the arrears that will eventually lead to an unprecedented numbers of foreclosures. At the same time, and under new accounting rules, it will not impair the balance sheets of the banks.

The rationale and precedent for this solution is simply following what the government has already done with some of its own debts that have been extended for a longer term at a lower rate of interest. It would be in the best interest of both the banks and their problem borrowers.

For the sake of discussion let’s say the average arrears of a residential mortgage is €200,000. By taking a percentage of that amount, say €50,000 - or 25% - off the current principal and placing it as a straight note at a nominal interest rate to be accrued at the end of a new term of up to 40 years, the results would be as follows: the borrower would have a restructured mortgage with payments they could make while retaining ownership; and the bank would not have to write off the entire loan which would have impaired its balance sheet thereby requiring more capital from taxpayers.

An alternative would be to swap the 25% amount for an ownership position in the property whereby the borrower would own 75% of the property with the right to buy out the bank’s position at some time in the future. The bank’s 25% ownership would be reflected on its balance sheet as an asset under the category of investments.

With legitimate hardship cases, and based on performance, a partial debt forgiveness program could also apply.

New loans having a term as long as 40 years may not be appealing to either the banks or the borrowers; but at least these so-called “legacy loans” would benefit the children and possibly the grandchildren of the borrowers because of the simple fact their homes would stay “in the family”.

For the banks and the current Government to continue to act as they are now, the situation will only get worse; and that would be the height of irresponsibility. It will very likely result in a wholesale ‘write-off’ of thousands of mortgages by way of unnecessary foreclosures. Inaction will further depress the property market. It will cause even deeper despair for thousands of borrowers. In addition, it will impair the balance sheets of the banks. New capital will be needed to offset these losses. Another bailout will likely be required, putting an even greater burden on taxpayers.

It was said at the outset of the economic collapse that “we are in unchartered waters”. That being the case, then it requires new charts to be drawn up. If this means that new accounting rules need to be adopted and legislation enacted, it is far better than watching the Titanic go down with the Irish trapped in steerage. {jathumbnailoff}

John Farrell Clark is a retired commercial banker who has worked in banking in the US and Europe.

Image top: infomatique.