Time to tackle consumer debt crisis

The state and banks' response is like using a hairdryer to thaw an iceberg

With over one third of all homeowner mortgages in negative equity, the Central Bank’s report on mortgage arrears for the first six months of this year hints at the scale of the consumer debt crisis.

Since this time last year the number of households with distressed mortgages has increased by 10,000 to 36,400. The numbers jumped by over 4,000 from April to June this year. Should this trend continue, by the end of the year the number will be close to 50,000. To put this in perspective, it’s the entire homeowner population of counties Wexford or Wicklow.

Between 2005 and 2008 banks lent €130bn in mortgage debt at peak property values. With values fast approaching or at 2001 levels, most of these loans are now in negative equity. But negative equity doesn’t of itself trigger mass default. It takes rising unemployment and a sudden drop in take home pay. Facing long term sustained unemployment levels and permanent decline in household incomes the extent of householder distressed debt is slowly becoming apparent.

If 5% of home owner mortgages are irreparably distressed then how many more have been massaged through loan modifications? Some reckon that upwards of 40,000 have been modified already. Adding the two together means that 10% of home mortgages are already troubled. Most of these are in negative equity which only increases as the interest clock is still running. And with a second round of fiscal austerity measures to come, rising bank rates and a likely increase in ECB rates, many more households will be tipped into mortgage default next year.

For every distressed mortgage banks are facing losses of between 25% and 50% if they were to formally demand repayment in full, repossess or force the sale of homes. While homeowners might legally still owe the balance, banks know full well they will have little chance of ever recovering it and would be faced with a write-off.

Collectively owing €6.9bn, the average distressed mortgage is €189,000 including arrears of €16,000. As property values have declined by at least 40%, should these homeowners sell up and move on, they would still owe upwards of €70,000 before costs. To put this another way if US style “short selling” were allowed here -where you can sell your home for what you can get and the bank writes of the balance owing- Irish banks would face losses close to €3.3bn on the €6.9bn of distressed mortgages reported on last week.

Typically as households experience a sudden drop in income they burn up savings first and only then go into arrears. And as paying mortgages is prioritised, it’s highly likely that people in trouble with their mortgage are also in serious trouble with other personal loans. Amounting to over €30bn, the Central Bank does not publish arrears data on these other loans. As credit unions who account for about €6.5bn were reporting arrears of 13% earlier this year, it’s likely that banks are experiencing similar personal loan deterioration.

Central Bank data also excludes one important sub-sector - the ubiquitous “buy to let” mortgage used by our amateur landlord class. Between 2005 and 2008 over 88,000 of these loans totalling almost €25bn were issued. How many are in distress is unknown but with the total amount owing declining, it seems that investors are either paying off their loans from savings or being forced to sell at fire sale prices.

Small business debt is also unreported on. No one knows how badly these loans have deteriorated but it’s been said that over a third are experiencing difficulties. As most are business loans are personally guaranteed they immediately mutate to personal debt once they are called in by the banks.

Central Bank mortgage arrears data merely sketches the tip of the consumer debt iceberg. Anxious to talk up the low numbers of home repossessions, Minister Eamon Ryan and the IBF praised the virtue of mortgage lenders forbearance which sees them forced to hold off on repossessions and modify distressed homeowner mortgages to make them temporarily more affordable. These measures only serve to increase the amount owing and are cold comfort for the tens of thousands who have no hope of ever repaying what they owe.

Government’s response and banks forbearance measures are no more effective than trying to thaw the iceberg with a hairdryer. It’s important for those who would talk down the problem to come clean. Informing the debate on what must be done to sort out this mess will take a lot more than the pretence that all is well as only 4.62% are in trouble and repossessions are still quite low.

Finding a solution will not be easy. One thing is for certain without allowing for the possibility of writing down mortgages to affordable levels and tying these to the current value of homes, forbearance will only make things worse.

A version of this article appeared in the Irish Examiner Monday September 6th 2010, Business Section