Wednesday, 21 October 2009

Will there be a NAMA for personal debt?

Stephen Kinsella: No. The National Asset Management Agency, NAMA, is designed to remove the ‘impaired loans’ generated by excessive lending to the construction industry. NAMA will exchange bonds, backed by the taxpayer, for these impaired loans. The ECB will exchange the bonds for cash, injecting liquidity into the banking system and, so the story goes, getting banks lending again.

I don’t believe that NAMA in its current form will get banks lending again. Even if NAMA’s critics are 100% wrong, and NAMA succeeds brilliantly, bankers know that another set of ‘impaired loans’ are on the way, and so banks won’t lend into the `real’ economy — to businesses and households — at reasonable rates of interest, because they expect that householders will begin to default en masse. NAMA will fail in its primary objective of ‘getting the banks lending again’.

When interest rates go up, as the European economy recovers, many households now barely making their monthly mortgage repayment will find themselves having to restructure their mortgages, or default entirely. What’s going to happen when thousands of homeowners throw their keys back over the bankers’ desks?

Banks, through the courts, have a set of processes for dealing with the painful processes of individual mortgage defaults. There is no process for dealing with hundreds, and perhaps thousands, of mortgage defaults in a short space of time. Banks will be left with large swathes of bad debt, and will come looking for taxpayer assistance again if they can’t raise funds on the interbank market to cover their losses. We will be back to square one, needing a NAMA 2.


Like banks, individual households are highly leveraged, meaning the ratio of their debt to their equity (for most people, their home) is large. The recent Law Commission report puts the ratio of household debt to disposable income at 176%. Just for this reason alone, the probability of large-scale household default is very high. There are other reasons to be concerned about household debt however.

First, the current level of mortgage repayment is low, because of historically low ECB interest rates. Mortgage repayments must, as I’ve mentioned, rise as the EU economy improves in the coming eighteen months and the ECB increases interest rates.

Second, the Central Bank forecasts unemployment to rise to 14%, and perhaps above 14%, in 2010. More and more households will therefore be unable to meet their mortgage payments.

Third, a recent study by David Duffy of the ESRI puts the number of homes in negative equity at 196,000 homes, implying the pool of potential defaulters is large.

To get a very rough sense of the scale of the problem, multiply the 196,000 homes in negative equity by the average mortgage price of a home today, around €235,260. We have €46,110,960,000 of potential bad debts for banks, just from this pool alone. 46 billion euros. If even 15 or 20% of those homes, and only those homes, default, we have another banking crisis, because banks won’t have the capital to absorb so much bad personal debt at once.

Will there be a NAMA 2 for personal and household debt? Can banks and the government devise a formula to forgive part of the principal for homeowners, and absorb the losses partially through a combination of blanket restructuring, debt-equity swops, swift personal bankruptcy processes, and refinancing? I don’t think the combination of financial and regulatory innovation under political pressure is beyond our leaders, but it does seem like a lot to ask for, considering the NAMA 1 money will be well and truly spent in 18 months’ time, and Ireland’s national debt may be as high as 120% of its national output.


An Saoi said...

I agree completely with you. In a report produced some years ago, Dermot O'Leary of Goodbodys estimated that the average new first time buyer mortgage had a length of some 37 years. Interest rates are currently artifically low and even a process of writing off or leaving in abeyance a proportion of mortgage debt will do little to help such people.

Mortgage debt also includes considerable amounts which were extracted for other purposes such as spending on cars or putting a deposit on a second or third unit for renting.

There is also the 20% odd of the Irish mortgage market made up of buy to lets. With the likely rapid drop in population, leaving the market completely swamped, this sector must be the most likely to default.

If interest rates hit 6% plus as the ECB weans the screaming Irish baby from the tit of cheap money, that meal of wholemeal reality will be the last for many.

Stephen Kinsella said...

@ An Saoi,

It's great to be agreed with! The question is, is there a regulatory structure out there to encourage a 'good' bank model using largely private funds in Ireland, or another credit-issuance vehicle?

Nat O`Connor said...

@ Stephen and An Saoi,

One of the anomalies thrown up by negative equity is that it mixes in different groups of people, who one might have differing levels of sympathy for.

On the one hand, households who bought in the last five or so years are likely to face the biggest debt burden. If they can make their payments, they'll still have an asset (unlike renters) but if they default, they are in a bad situation and perhaps should be assisted to restructure their debt or have punitive penalty rates removed.

Then there is the buy-to-let group. Again I have some sympathy for individuals who sunk their pension fund into property and are now looking at a much more modest retirement. But I have less sympathy for wealthy individuals who were advised to keep buying Section 23 (etc.) properties as a 'tax shield'.

This latter group may include a large number of properties in negative equity, but do we really care?

If X bought a Section 23 apartment for €500,000, but could claim the purchase price against tax, (s)he only paid less than €300,000 for it in real terms. So, if it is worth more than €300,000 when (s)he sells, (s)he makes a profit (albeit much less than anticipated). But this kind of thing may be invisible in the global 'negative equity' statistics, because the property is in this example is theoretically in negative equity (if worth only 60 percent of the initial purchase price was €500,000).

Then again, not everyone who bought Section 23 apartments did so as a wealthy ‘tax avoider’. So, again, it could be very hard to tease out who in the mix of home owners in negative equity most deserve our sympathy.

Stephen Kinsella said...

Hi Nat,

That's a very important point: from a social justice point of view, it's hard to lump people who bought to let in with young couples facing the prospect of being thrown out of their primary home, but the stats do just that, which isn't acceptable. Unless there is a way to wash the buy to let people out (they are essentially investors, so perhaps we can control for the fact that they took a gamble by looking at whether the property in default is their primary residence or not, I'm not sure).

From a 'macro' point of view, however, the two defaults are going to be the same, especially in terms of the effect on banks' balance sheets, and the expectational effect on bankers' behaviours will of course be identical.

Nat O`Connor said...

Hi Stephen,

Is it certain that ”the expectational effect on bankers’ behaviours” will be identical?

The Section 23 purchaser can sell a property at 60 percent of its original value and still turn a profit. His/her 'negative equity' is only theoretical. Hence, bankers should expect these investors to be keen to find ways of getting out of these properties and into more lucrative activities. Even if they can’t sell, such investors should be quite happy to default on mortgages that equate to their properties’ current market value (depending on the rules re clawback of tax, etc).

However, households in their residences have different motivations; they still have to live somewhere! So, negative equity pins them down. And bankers should expect their behaviour to be quite different. They won’t sell, and they will probably be willing to pay a large proportion of their incomes to try to keep their homes; even though this might be irrational behaviour were they investors.

Can the banks not divide their outstanding mortgage debtors between investors and home-owners, and have different expectations for each group?

Moreover, the bank could respond to each group with different solutions. Propose ways of buying out the investors, who are likely to 'jump ship' anyhow and leave the bank with a bunch of apartments. But also propose mortgage restructuring, debt consolidation, and other services to assist homeowners who are motivated to continue to make their payments.

The banks could even suggest that home-owners down-size into some of the apartments that the banks suddenly find themselves owning!

Stephen Kinsella said...

Hi Nat,

I'd agree with you 100%, but perhaps I'd argue about the proportions. Say 20% of the homes in massive negative equity are S.23s with the perverse 'happy to sell at 60%' incentive, and the other 80% are poor starving young families with reduced (or no) incomes. The banks are right to treat each differently (from their points of view), but in tota the bad debt write off would be so massive as swamp the 20% actually getting off the hook, as it were.

This 20% are more likely to default in any case, as they are paying mortgages on several properties simultaneously, and in some cases, this may be causing liquidity problems for them. Also, their properties may be cross-collaterolised, making sales in any market unprofitable unless they sell above 100%. Finally the market is bad for the usual buy to let properties like apartments and starter homes that even 60% might be too much to ask for!

Joseph Morgan said...

Hi - this is not a criticism just an observation..... surely you don't need to be in negative equity to be in danger of being unable to pay your mortgage and potentially defaulting? You could still be in positive territory (if you're really lucky) but finding it more and more difficult to pay the monthly mortgage and that problem, as you say, will inevitably get worse when interest rates start to rise next year (as sure as eggs are eggs). The figure of potential defaulters then could be larger than the 196,000 you suggest here? I wrote an article a while back on that just covered the potential dark side vis-a-vis unemployed people with mortgages. I would be the first to admit some of the figures might be a bit 'back of the fag packet' but I think they have a degree of 'sensibility' about them and the figures look dire. Perhaps you could give me your thoughts on them
Additionally, I'm just starting to put together a radio programme on this (the unemployed people with mortgages problem) - I have one 'well known politician' and a 'well known economist' already signed up to do interviews on it so if there is anyone else out there who's well qualified to speak in this area then please drop me a line. I suspect I'm predicting that the brown stuff will really start to hit the fan next year in this area. Thanks, Joseph

Stephen Kinsella said...

Hi Joseph, of course you don't need to be in negative equity to default on your mortgage, but if you were looking at really high-risk properties, that's where you would go first, but there are other pools of risky properties out there, no doubt.
Cheers for the link, I'll check it out.

An Saoi said...

Stephen & Joseph

I have felt for a long time that the Credit Union movement could act as the basis for a "good" bank or rather a "boring old" bank, providing much of the normal day to day banking services required at community level.

While many of the smaller credit unions do not have the requisite skills in house, the purchase of or setting up of an institution owned by individual credit unions could provide those skills and services.It would also provide a better home for the considerable spare cash many CUs have at present than dodgy bonds sold by the spivs in Davys.

Had for example the ILCU been able to organise it's members to buy the TSB from the State, Irish banking would look very different today. The spare cash of the credit unions is a very important source of deposits for the associated banks. Without it they would be in serious trouble.

Joseph's point regarding mortgage arrears is correct. In many cases it is the loss of one of the two jobs in a house which is enough to throw the balance of bills out of kilter.I raised this point with one bank manager, who said that as long as there is something being paid and they are kept informed, banks are reluctant to actagainst anyone. However he said the number of people who will not engage in any contact is huge. He also felt that many had multiple debts. He has been saying for at least 7 or 8 years many people have lived at 110% plus of their earnings, juggling debt. It is like a drug addict, they are rarely addicted to one substance, rather they abuse many.

Anonymous said...

According to the law commission the household debt to disposable income stood at 48% in 1995 but in 2009 it had risen to 176%.

This is a sorely precarious position.

I saw that the savings rate was up to 10% now in the first quarter.

I've seen it commented that that with such a high savings rate the effects of any stimulus might be weakened. Furthermore it seems that for the forseeable future domestic demand is going to be very weakened as households seek to reduce that ratio. I dont know how long that might take and how low households might wish to see the ratio reduce to -all the way back to the 48% in 1995. Who knows but its likely to have a very serious effect on the economy.

Even beyond the immediate threat of mortgages foreclosures is there a danger that there just be no domestic demand for years to come

Stephen Kinsella said...

@ Anonymous,

You're dead right that there is a problem with depressed domestic demand after an asset price bubble bursts, and the unwinding of the economy back to something closer to 'normal' or 'natural' or even 'warranted' happens, but you've to remember that not everyone is in negative equity or up to their eyeballs in debt; just a lot of people, a whole lot. So domestic demand won't flag altogether, though signs of domestic demand growth above the rate of population increase will be hard to come by, unfortunately. The present set of policies (4bn out of expenditure this year is 'iron law' from the DoF, apparently) will of course be deflationary, and in the presence of large scale household indebtedness, we have a classic Fisherian situation described nicely in this paper:

Stephen Kinsella said...

@ An Saoi,

The credit union movement is a nice prototype of the good bank, but their relative size and easy politicization make them, in my opinion, unsuitable as good banks. I've got first hand experience of unsuitable lending practices by credit unions, but there is a third way: Irish retail banks are phenomenally profitable: despite the unmitigated balls-up in the property market, AIB managed to make 1.1bn on its retail banking operations in 2008/9!

So there is scope for a government-backed, but privately capitalized, Irish bank running on the 3-6-3 model: take deposits at 3%, lend at 6%, hit the golf course by 3pm :)

Call it the 'SIMPLE' bank. SIMPLE can get its branches from Anglo, AIB, and run services through An Post and online, as RABObank does. SIMPLE can do the usual deposit/overdraft/etc/ banking. It can offer standard fixed-rate 20year 90% mortgages for 3 or 4 times one's income, and it can hoover up depositors from other banks as a result of lower charges. SIMPLE would have to put up with only making 500million a year as a result of non-dodgy lending practices and a streamlined over the counter approach, with fewer staff and fewer products, but it could be done with some private finance and a bit of government muscle. It would actually be really easy to do.

But there would be a substitution effect, and an income effect.

When SIMPLE gets up and doing, and 'good' depositors leg it from AIB and BOI to SIMPLE, AIB and BOI would be left with, you guessed it, all the homes in negative equity--SIMPLE wouldn't take them--plus the dodgy depositors and highly leveraged property-related going concerns, making AIB and BOI unable to borrow on the interbank wholesale market against its now non-existent deposits, bleeding their balance sheets dry, and creating two more toxic banks.

So, I think, the non-creation of a third privately held and run bank is reverse-adverse selection on the government's part.

Oh, and, eh, NAMA's the only game in town ;)

An Saoi said...

@ Stephen

Apologies for the delay in responding - the day job interfering with more interesting work. I accept that there is a serious danger because many of the credit unions lack the skills necessary or are not necessarily interested in expanding their interesting services. However why not use the credit unions as the source capital for "simple bank" providing a more suitable home for their excess deposits and would maintain the appropriate level of independence for such a "simple" institution.

Stephen Kinsella said...

Hi An Saoi,

One simple reason is size, another is the range of services offered are lower. I think that credit unions, on the whole, do a pretty good job, but they don't really offer the full range of services a new bank would, which is why I'd rather see a brand-new Irish owned bank, not a subsidiary of a foreign bank, come into the market.