Damien Kiberd on Private Sector Debt Forgiveness

Damien Kiberd’s prescription to deal with private sector debt for recent house-buyers in negative equity is something that I agree with emphatically. Last November, I suggested this course of action in principal to Richard Bruton. He replied that my suggestion of 15% write-off of morgage debt for the past 5 years for first time buyers would cost about €7 billion and would ignore the moral hazard of borrowing by the borrowers – caveat emptor – and would be bad value for the state. I disagree. We subsidise housing in many ways – morgage interest tax relief – first time buyers grants – affordable housing schemes – social housing – morgage innteret releif when unemployed etc. Thus I commend Damien Kiberd for writing this essay published in the Sunday Times on 11 June 2010. I wrote about this subject on this site last on 1st February

Forgive Borrowers or Forget Recovery

Damien Kiberd

You may not fancy paying for a bailout of housholds that took on big mortgages that they cannot now afford. But consider the alternative.

The Japanese have discovered to their cost that a debt-deflation crisis can hit economic activity for two decades.

Economists at Citi group reckon the issue is more serious than the sovereign debt crisis. They say that failure to deal with the burden of personal debt risks “a prolonged and disorderly deleveraging via rising bankruptcies in households and corporations”

Even the IMF shares the concern. Not because of compassion for those in debt, but because solving their debt problems may be a necessary precondition for economic recovery.

There is a bitter paradox at the heart of our public policy in 2010.

Our small, cash strapped economy can secure €40bn to buy toxic loans from banks and another €37.5bn to increase the banks’ capital.

But its contribution to helping residential mortgage holders in default this year is just €64m.

When the IMF and Citi Group suggested that there were good economic reasons to forgive part of household debt ministers Dermot Ahern and Brian Lenihan tried to kill off the idea with unseemly haste. It was just not “do-able”, they said. Debt forgiveness was not for the little people.

Future economic historians will marvel that one third of the toxic loans we bought through NAMA were used to buy overseas property. And that 75% of these loans were not generating any interest at all.

They will be even more baffled to learn that more than half the toxic loans were bought from zombie banks that had ceased to lend. And that those same zombie banks got nearly €30bn of the available new bank capital

Why do we display such munificence to the financially undead while ignoring the needs of the consumers and small businesses of the future? Is it because our policy is driven by an immobilising fear of default?

The report from the Expert Group on Mortgage Arrears contains a lot of good ideas. But it fails to deal effectively with two massive issues: long term debt forgiveness on unrepayable loans and/or voluntary surrender of unsustainable property.

The report is to be implemented in full. It will bring gains for distressed borrowers, viz:

*banks will be prevented from charging defaulters penalty interest. It is now charged by the big clearers at 6% per annum;

*the 12 month grace period before legal action for recovery commences will have legal effect;

*banks won’t be able to coerce borrowers to swap tracker loans for standard variable rate loans;

*distressed borrowers can claim the state’s Mortgage Interest Supplement
(MIS) while simultaneously trying to sell their homes;

*MIS benefit can be payable while one member of a couple is still working.

But the thrust of the report is very much “delay and pray”. It majors on “forbearance” and “communication” but does not really deal with more apocalyptic options. And the language it uses suggests it does not favour either long term palliative measures for defaulters or actual debt forgiveness for those facing negative equity, falling net income and stubbornly high debt.

This, I believe is an error. And not for sentimental but for practical reasons. The household debt problem threatens to sweep us all away, especially if interest rates rise in 2011 and beyond. Irish borrowers are only hanging on by the skin of their teeth because the ECB is keeping its official interest rate at 1%. If that is driven upwards they will face grave consequences indeed.

Household debt was 70% of disposable income a decade ago. Today it is 140%.
These numbers are averages, and therefore misleading. A cadre of primarily young consumers, who should be driving consumer demand, are much more heavily burdened than the average. They are not functioning economic actors anymore.

Some 32,000 mortgage holders are more than 90 days behind with their repayment. Some 17,000 are tapping the state’s MIS.

But 250,000 are in negative equity according to ESRI estimates. The vast majority of these people continue to pay their mortgages despite falling net incomes and the visibly wasting value of their main asset. Many of them cannot and will not function as consumers for as long as they are in such a hopeless situation. A rise in base rates or a further surge in unemployment will simply make the problem bigger and much more visible.

To suggest that such people be offered debt forgiveness will raise howls of protest.

Why should we pay for people who stupidly took on big mortgages?

The answer is clear. These people are partly responsible for their own plight. But the banks and the state too are responsible. The banks offered loans with loan to value ratios of 100% or more, they offered terms of up to 35 years, up-front interest holidays, interest only mortgages and loans that were typically seven times the borrowers incomes.

The state failed to regulate rampant bank credit creation. It promoted the house price explosion through tax breaks for builders, investors and borrowers. It did nothing to staunch the asset price bubble.

So all three (the borrower, the state and the bank) should share for the cost of extricating tomorrow’s consumers from today’s mess. And the sooner the better.

Those in negative equity could be offered a range of options.

They could be allowed to sell their homes for less than the amount owed on their loans with the bank forced to split the difference with the borrower.
This is the route of “voluntary surrender”. In such circumstances the state could be asked to provide low interest, tax relieved loans to the borrower to allow him/her to pay for part of the shortfall between the sale price and the outstanding loan.

But it would be even better if there was a scheme of outright debt forgiveness for those who are hopelessly over-borrowed. Such a scheme could be confined to mortgages on principal primary residences and would not be available on buy-to-lets or holiday properties. There would have to be a capital ceiling on the mortgage being relieved. And only mortgages drawn down during the peak years of the asset price bubble -that is from 2005 to
2007 inclusive- should attract the concession.

The evidence to hand suggests the property market peaked between September
2006 and March 2007. The frenzy had abated by 2008.

Taking this finite class of mortgages only, banks should be obliged to write off an initial slice of each debt, say 10%. Thereafter, for a period of two years, the borrower should be given an interest free period in which the interest is picked up by the state-reflecting its share of culpability.

During the interest free period the borrower would be incentivised to reduce the principal balance outstanding on the mortgage through use of net income, savings products, asset sales, life policy proceeds and so forth.

The combination of these measures would permit the borrower to get the net debt owed on the house to a reasonable level within an acceptable time frame. This would give the borrower hope for the future and a vital capacity to deal with future interest rate shocks.

If banks and corporations are allowed, or even induced , to de-leverage then why not households?