Nat O'Connor: Mortgage payments are on a lot of people's minds these days, and there has been a fair deal of coverage in the media about negative equity. One stark snippet from the Irish Time's today is that "Irish households are among the most indebted in the world – more so than any of their euro zone counterparts. The vast bulk of their debt is accounted for by mortgages." This should worry us all greatly.
The interim report of the Mortgage Arrears and Personal Debt Expert Group suggests some good practice guidelines for lenders. The detail of these has been reported elsewhere (e.g. Irish Times gives an outline, a Q&A, and an analysis, as well as reporting the Financial Regulator's reaction).
I think there is a background assumption around the perception of state intervention in personal debt that needs to be teased out. An extreme contrast illustrates what I see as the 'prodigal son' dilemma. The story is something like what follows. John worked for ten years, saved €500,000, and bought himself a house. That house is now worth €300,000. John can kiss goodbye to €200,000. The value of his investment went down, not up. Meanwhile, Seán got a 110% mortgage to buy an identical house priced at €500,000, next door to John. He borrowed the extra €50,000 (10%) to do up the house, but managed to fit in a holiday and several cases of champagne while he was at it. Seán's house is also now worth €300,000. Both John and Seán are complaining of negative equity. Seán is looking at the spectre of rising interest rates in the medium term and his ability to pay is coming under strain. John would be sickened if Seán got bailed out in some way, as he paid the full price for his house and €200,000 of his money is gone and no one is suggesting he should get it back. State intervention to help Seán often invokes the term 'moral hazard' – that is, encouraging prodigal, reckless, extravagent behaviour.
Some version of this prodigal son idea seems to me to vex a lot of people. Yet, like the original parable, envy or spite might be masking a more reasonable reality.
John has no monthly payments to make, and so he is comfortably off. He lost €200,000 on his investment, but he must take some personal responsibility for choosing to buy when and where he did. Meanwhile, Seán borrowed €550,000, but with interest rates over a long period (say 30 years), Seán will pay back at least €800,000 in total (assuming interest at a relatively low level, like 3 per cent). And Seán could well pay back over €1,000,000 if interest rates go to 5 per cent, and they could go much higher. Meanwhile, house prices may not make any significant rise for the next 30 years. After all, other countries, like Germany, have a very stable market. So Seán could be paying €1,000,000 for a house that in 2040 will still be worth something like €300,000, maybe €400,000, in today's money. Of course, not all of that €1 million will be paid in 2010 prices, but it is still a lot more money than the house is now worth or will be worth. In sum, Seán has 30 years of steep payments to make, while John can live comfortably, save money and make other investments. In the long-term, it was Seán who made a worse investment than John.
It would be one thing if John were to shrug his shoulders, say 'you win some, you lose some' and look to tomorrow. John lost money on his investment, and equally the bank (as a business) will lose money on the loan to Seán if they have to write off part of it. But banks are no longer operating as purely private businesses. John knows that the banks are all being bailed out by the taxpayers. So John is, in a real sense, being asked to swallow his own losses and then help his ‘prodigal’ neighbour too.
Yet clarity on this issue may again be blinded by envy and spite. John is not a heartless capitalist. He believes that the state has a role in providing people with their human rights, such as education, access to healthcare and housing. This is where John needs to put aside his emotions and think business again. He is willing to pay tax to house people who need to be housed. And if the state has to rehouse Seán in social housing or through rent supplement payments, this may represent worse value for taxpayers’ money than assisting him to pay his mortgage. Even if that means writing off €100,000 or €200,000 of his debt.
John might initially think that instead of writing off €200,000, why doesn’t the state buy a house with that amount of money and stick Seán in it. The problem is that if this happens, Seán may default on the whole €550,000 mortgage. And the banks won’t absorb that loss, the taxpayer will – including John.
The best scenario is thus for Seán to be kept going in his house, paying as much of his debt as he can afford, while still living a reasonable quality of life. ‘Affordable’ for housing costs is typically defined as a third of after-tax income.
And because the state is different from commercial entities, it doesn’t even need to write off any amount of Seán’s debt. Instead, the state can take a long-term equity stake; effectively freezing a large chunk of Seán’s mortgage but clawing it back whenever Seán sells the house. The state can even wait until Seán dies and, like the tax inspector, have first claim on Seán’s estate. The state won't make the kind of profits banks make from charging compound interest, but Seán's debt to the state could be linked to house price inflation to avoid it dwindling away.
All of this can be worked out in a businesslike way. What blocks this kind of transaction is the ‘prodigal son’ culture, which could otherwise be termed class prejudice. John doesn’t want to live beside Seán. If Seán is getting state assistance, John wants him to live in inferior quality housing, in a less desirable location. Or at least, John feels that he should get better quality housing in a better area because he paid for it all by himself.
Yet, housing studies consistently argues that social mix creates the most thriving residential areas, with busy shops, less crime, etc. There are also sound economic as well as social arguments for keeping people in their homes, while making their mortgages more affordable.
Ireland can solve its crisis of mortgage debt. But it can only do so through solidarity. The example of John versus Seán is extreme, but as people nurse their wounded pride (and their ‘loss’ in their ‘investment’ in housing), they need to be persuaded of the rationality of helping their prodigal fellow citizens, while also reassured that more responsible borrowers in negative equity will also benefit.
And don’t forget that one in four households pay rent in private or social housing, and they all pay tax too. These are the citizens who are not too interested in the jealousy between one middle class homeowner versus another, as they wrangle over bailing out themselves and the banks. The renter households in Ireland need to be convinced that any mortgage rescue for others, will also involve a whole new national housing policy that will benefit them. That means the state’s role in providing housing must be to ensure everyone receives equally good housing, in a good location with good amenities. We have the means through NAMA, massive quantities of vacant housing and plenty of skilled people who can build the amenities like schools, transport infrastructure, etc that are required to add ‘locational value’ to Ireland massive stock of badly located housing.
And it is the locational value – proximity to services like schools, shops, playgrounds, public transport, green space, etc. – that is the real fundamental in the housing market that will determine quality of life through quality of the built environment.
In this context, the Mortgage Arrears Group’s recommendations really pale into insignificance. They are taking some steps to stop the banks making the situation worse some people by getting them off lower interest tracker mortgages. But the group’s remit does not extend to dealing with the massive crisis in Ireland’s housing system.
In fairness, it is an interim report. The Irish Times reports that “It had been hoped by those struggling with excessive mortgages that the group would recommend some element of debt forgiveness, or introduce debt-for-equity swaps, which would help them to reduce the overall size of their loan. However, this report makes no such suggestions ... In a follow-up report, which is due to be completed by the end of September, the group indicated that it will address the issue of ‘borrowers with unsustainable mortgages’.” But this is not just a problem for those borrowers. The cost will be passed by the banks to all taxpayers. Hence, we need a radical rethink of how we as a society will respond to a crisis that affects all of housing policy.