Debt forebearance won't work

With the two big banks reporting worsening home mortgage loan quality and bond rating agencies highlighting worsening trends, Government’s policy to tackle the consumer mortgage debt crisis sees it waiting at the cross roads for Godot to arrive.

But Godot won’t arrive and homeowner distress will considerably worsen once the full extent of banks increasing mortgage rates bite. Headline figures are stark with well over 70,000 homeowners in trouble. In serious default, over a third of these face losing their homes. At current property prices, they owe over €85,000 more than their home is worth. It’s an amount they have no chance of every repaying yet are expected to under current laws. Tens of thousands of others have had their loan repayments adjusted downwards in the vain hope that they may at some future time be able to recommence full repayments. Indicative of worsening homeowner financial distress, electricity providers were cutting off 2600 homes a month earlier this year.

While the depth of the banking crisis took everyone by surprise, what’s frighteningly disappointing is the slow pace of response to the consumer debt crisis. Government began the crisis with wholly inadequate debt resolution laws and systems. And the pace of its response since has been snail like in comparison to other countries where all of the proposals outlined by the Financial Regulator in its consultation paper last week have already been implemented and haven’t worked.

Government’s tardy response is clearly designed to buy time to stabilise the banking system. Measures taken allow lenders to forebear, to cut balance sheet slack. It’s a carefully orchestrated response, obliging lenders to play ball with the banking regulator. Sold as benefitting homeowners, in reality it’s required to maintain the illusion that home loan arrears are being managed and not massaged. But as Government kicks the consumer debt can down the road, the can just gets bigger as it runs out of road. And it seems it will run out of road next year as the second round of its fiscal austerity measures, bank imposed interest rate rises and possible ECB rate increases erode struggling householders take home pay even further.

The classic mortgage default option of wholesale market repossessions and forced selling is not possible given the sheer scale of arrears and a moribund housing market with its massive oversupply of new homes and depressed demand. While the decline in housing values may be slowing down settling at 2001 values, right now the only people buying are cherry picking first-timers with decent jobs, who are buying homes at bargain basement prices in larger urban locations.

Just how many people are caught in the homeowner debt un-affordability trap is still unknown. Without hard, accurate and timely data we are left with the regulator’s quarterly reports. Figures for the second half of this year have yet to be published. They will undoubtedly confirm the trends noted elsewhere and we can expect some more bad news.

The sum total of measures taken so far, oblige mortgage lenders to look to negotiate favourable terms with people who are in arrears or who face arrears problems. The focus is on tackling arrears and fore-stalling repossession action in the courts. Government’s more recent proposals will obligate lenders to establish special arrears management units and use a standardised approach. They may also be required to offer an internal independent review process. It also seems that struggling homeowners may be given second chance to negotiate a second round of forbearance. The net effect of all these measures leaves all the power with the lender. US experience has not been good with its schemes even where they used independent state funded third party debt negotiators. There, lenders cheery picked the better cases and refused the poorer cases. Even when re-set at lower repayment amounts nearly a third failed to keep to their new repayment levels. The main problem it seems is lowered repayments must be affordable and the loan owing must also be adjusted downwards. In short without debt forgiveness, it won’t work.

Managing arrears merely deals with the symptoms. Here nothing is being done to address the underlying problem which is wholesale loan un-affordability. Tens of thousands of homeowners can no longer afford to pay off loans they owe in full. But many can afford to pay off a more reasonable amount. A proper loan modification programme should calculate what can be paid back and adjust the loan owing down to this level providing the new amount equates to the market value of the home. This adjustment could also allow for some homeowner equity. Those who want to sell and begin anew should be allowed to short sell – sell their home for what it’s worth with whatever is left owing being written off.

This will mean biting the bullet on loan forgiveness and finding equitable ways to fund the costs. It also means making the banks incur the lion’s share of costs.