Silver lining for those caught in debt nightmare

Law Reform Commission offers hope to those mired in Dickensian debt noose, writes Bill Hobbs

Last week, the Law Reform Commission unveiled a small silver lining from within a very dark consumer protection cloud that should force the snail like pace of Irish legislative reform.

In its 416 page report, the commission recommends fundamental change in the relationship between those who owe money and those who are owed money. Designed to redress laws derived from Dickensian societal norms, its proposals include a draft bill that should be law by this time next year, given this state’s solemn undertaking to revise its antiquated insolvency laws under the IMF/EU agreement.

With over 100,000 households experiencing significant mortgage debt problems, official statistics merely hint at the scale of wider unaffordable indebtedness. There is no financial safety net – no way for someone to earn a fresh start, to get out from underneath the unbearable burden of unaffordable debt save lifelong insolvency, bankruptcy, permanent emigration or death.

This is all about to change. The commission’s fundamental aim is to ensure that people who cannot pay off unsecured loans in full are provided with a statutory financial safety net mechanism to earn a “fresh start” - to become once again “economically active members of society”. In considering international principles and precedents it has designed an equitable and just non-judicial system for 21st century Ireland.

This design would see the establishment of a debt enforcement and settlement office to oversee the workings of a centralised debt recovery system and a new debt settlement scheme.

The scheme would be administered through a national network of licensed and regulated personal insolvency practitioners whose role would be to act as independent objective mediators in advising, arranging and administering debt settlement plans between consumer and small business debtors and their creditors.

Under these plans, people will agree to make debt repayments based on what they can afford to repay over a period of upwards of five years. Estimates of affordability will allow for a basic standard of living above social welfare rates while protecting a person’s ability to earn an income. Allowing people space to rebuild their financial affairs, should incomes improve then only 50% of future increases will be allocated to repayments.

Providing 60% of a person’s creditors by value agree to a settlement plan, then it will become legally enforceable. The schemes rules will protect people against manipulative creditor practices and its moral hazard measures will prevent people unjustly benefitting. Providing people stick to the plan, they will earn a fresh start when it concludes, as any balance left owing will be written off.

Provision is also made for “no assets and no income” or NANI cases. An order can be made preventing legal action by creditors and wiping out debts owing after twelve months. Other changes include shortening bankruptcy from twelve to three years, increasing the minimum qualifying threshold from €1900 to €50,000 and limiting priority debts including excluding revenue debt. 

The commission predicts most people will opt for debt settlement agreements as bankruptcy would be reserved for the wealthy or “once wealthy” category. In a radical step, it also says that nobody should be jailed for non-payment of debts including those who can pay, but refuse to pay – they would be subject to community orders.

While the commission did not deal with secured debts, its recommendation on dealing with the largest element of secured household debt – home mortgages- is quite interesting. It says that once called in, as the portion the loan owing over and above the value of the property becomes unsecured, it should form part of a debt settlement agreement. 

This could open the door to a mortgage option where a lender agrees to mark down the value of a loan to the current home market value and allows balance to be dealt with through the debt settlement plan. Treating unsecured mortgage balances in this way could provide a mechanism through which unaffordable negative equity is settled within five years.

The commission is quite strong on creditors paying the costs of operating the system. It also says debt collectors and money advisors should be licensed and regulated. While the Central Bank has a role in both, the boundary is somewhat blurred between these actors and personal insolvency practitioners. Establishing the correct compliance framework will be critical to make sure that regulatory white spaces don’t emerge where state agencies drop the ball, believing others are running with it.

There are far too many people suffering needlessly from failure of legislators to act in the past. Any new government must implement the commission’s reforms and resolve key policy areas such as priority debts and enforcing costs on creditors. 

Most importantly any statutory regime must have the powers to enforce compliance by personal insolvency practitioners, including setting their reasonable remuneration. Prevarication and dilution of the proposed reforms to favour sectional interests cannot be allowed to happen.

A version of this article appeared in the Irish Examiner, Business Section Monday 20th December 2010

Government finally puts thorny issue of credit union restructuring firmly on the table

The Minister for Finance may now nationalise credit unions and transfer their business to a bank. Credit Unions have been included in the Government’s draconian new powers to restructure the domestic banking system, the Credit Institutions (Stablisation) act, because of worsening trends in financial stability due to both their current and potential loan and investment losses.

The minister may nationalise a credit union by requiring it to issue special shares providing him with overarching powers to direct a credit union’s affairs over those of a credit union’s shareholding members. It is how he currently controls the direction of the two building societies. The same approach with a credit union could see both the injection of tax-payer funds and subsequent transfer of its entire business to another credit institution. The Minister may also appoint a special manager to take over the running of a credit union, who may remove its board and management.

The act includes one important legal provision bound to upset credit unions and their trade bodies. The Minister will be able to direct the transfer of a credit union’s business to another credit institution, which may not only be a credit union but also a building society or a bank. Legal provision has been made to convert a credit union’s share accounts to deposit accounts where its business is being transferred. In essence takeover protection afforded to credit unions can be set aside to best protect people’s savings.

This sudden and unexpected development no doubt reflects concern for the stability of the sector’s 410 independent autonomous credit unions. Ranging in size from €1m to €350m in assets, they collectively hold €11.9bn of household deposits - mainly held in dividend earning share accounts. Early indications are that close to one hundred credit unions will be unable to pay a dividend this year, with close to two hundred paying less than 0.50%. As the ability to pay a dividend is a key financial stability indicator, these figures suggest some quite serious issues emerging.

Importantly then the EU/IMF financial support programme on restoring financial sector viability deals with credit union regulation and stability. Specific action steps required of the state include having a loan assessment (a structural benchmark) completed and comprehensive restructuring strategy in place by April 2011 and legislation on a strengthened regulatory framework including effective governance and stablisation requirements submitted to the Dail by December 2011. The Central Bank’s recent technical note on its Prudential Capital Assessment Review includes plans for the significant strengthening of the regulation and stability of the sector by the end of 2011.

Last June the bank invited submissions on its consultation paper on stabilisation - a resolution regime for credit unions. Unusually the bank has not published these submissions on its website. It said that they would be factored into its strategic review currently entering its second phase. This is an unusual development as, abiding with the principles for better regulation, it has undertaken to publish such submissions.

Perhaps the reason is contained in a recent speech, when in referring to stablisation the credit union regulator said that adverse trends emanating from the sector were suggesting “that even greater reform may be required than those envisaged in our recent consultation paper. We intend to bring forward proposals in this area early in the New Year”. He also warned of contagion risks to the sector.

What happened to change the bank’s view? Four significant things have occurred since last June.

The first is the bank’s stress test requiring credit unions to assess loan losses under differing risk scenarios. I wrote in this paper on the 15th November of how my own stress test analysis established a potential state solvency support funding of between €200m and €650m.

The second has been independent reviews reported to the bank of credit union loan books which have found they are on average 40% underprovided for bad debts.

The third relates to the strategic review’s first phase, financial stability analysis completed by Grant Thornton, a leading credit union audit firm.

While the bank has not published results of its stress test or the first phase of the strategic review, it’s clear it’s considered its June stablisation proposals are insufficient.

Finally and perhaps most relevant of all, credit unions have extensive investments in bank bonds which are or may become exposed to haircuts.

It shouldn’t come as a surprise, given the sector’s importance in the overall banking system, that credit unions have been included for in the banking stability bill or in the IMF/EU agreement. In ensuring it has the necessary powers to stabilise and reconfigure the banking system and to deal with the inevitability of some credit unions failing the Government has finally put credit union restructuring firmly on the table.

A version of this article appeared in the Irish Examiner, Business Section Friday 17th December 2010.

AIB bonuses Workers paying for unethical looting

Ethical egoism has very little to do with the good running of banks, writes Bill Hobbs

At its epoch, in what can only be described as immoral and unethical looting, boom time Ireland’s senior bank managers were paying themselves obscene salaries.

Looting occurs when managers manipulate organisational resources for short term gain at the expense of their company’s long term sustainability. In terms of ethical frameworks, looters adopt a minimalist ethical position called ethical egoism, where their self-interest regards the interests of employers and shareholders as paramount.

This is seen in arguments used by senior managers to justify their salaries. They carefully craft a business case to demonstrate how they deliver on shareholder value. Indeed our government ministers and senior public servants have also used ethical egoism to justify their own bloated salaries. Zealously protecting freedom to manage as they see fit, they argue that an enterprise culture, freed from all but the most minimal of constraints, best ensures equality. But it’s an equality balanced in favour of the personal enrichment of an elite.

Ethical egoism was starkly illustrated in AIB’s corporate behaviour, which in the past two years saw its senior managers pay themselves close to €100m in bonuses.

Long imbedded in its organisational culture is a managerial sub-culture, a tribe whose members are self-promoted upwards to where the real gravy was at.

All large organisations have such sub-cultures. And the most influential are found at senior and middle management level. Self-serving and self-perpetuating this group knows how to manipulate organisational resources to protect their status and power. They are well able to loot companies to pay themselves well and use shareholder value creation to argue for ever higher salaries and bonus systems.

Their performance management systems favour those who buy into their vision and ambition. Does this have anything to do with running good banks well? The answer is very little. HR performance reward concepts are frequently manipulated with HR management willing participants in ramping up salaries and bonuses.

Bank directors have been rightly criticised for failing to exercise control. But in truth, control was exercised by powerful executive management teams who were free to act within policy boundaries established by their boards. There are no prizes for guessing who writes up these policies. While boards establish senior employee’s remuneration packages, what happens beneath that level is what matters most.

Senior managers define performance, pay policy and strategies. What gets measured gets managed and what gets managed gets rewarded. The problem in banking is this drove out wanted behaviours such as prudent safe lending. Salaries and bonuses were linked to performance concepts such cross selling and lifetime customer profitability. This bonus culture had a damaging effect – it broke the traditional boundary between prudent banker and customer. Bankers behaved as agents for their customers to extract value from the bank itself.

Using external salary reviews, senior managers engineered pay reviews benchmarked to how others elsewhere were being paid. Aided by specialist external remuneration experts, they used external validation to argue for ever higher salaries and bonuses. The bonused performance system became rooted in the way things were done. Banks were blind sided to risks, as their managers were hooked on the possibility of doubling, trebling and quadrupling their salaries through performance bonuses. No one questioned the effect this would have on banks internal control mechanisms, as heavily bonused high fliers ignored time honoured and tested lending policies.

It isn’t surprising then that AIB did not defend itself in the High Court. The bonus payment action taken by its employee was put through on the nod. Was this a case of a contract that had to be honoured or was it more a case of senior management deciding to ensure bonuses were legally copper fastened from challenge? Is it a case of senior managers manipulating organisational resources to achieve their own means?

Finance Minister Lenihan’s rush into the Dail stable waving a “90% future bonus tax” shovel was either another episode of being caught asleep on the job or worse a cynical attempt to kick over the traces. Ever since 2008, senior bankers have run rings around this Government in so many different ways; including the elevation and promotion of looters as their internal senior management tribes looked out for themselves.

Many honourable, hard working AIB employees were horrified to read of how once again their senior management sub-culture had gilded its cage in defiance of proper ethical and moral conduct. AIB’s corporate response fell far short of the mark in trying to draw a line in the sand between the past and the future. It ranks as a prime example of an organisational injustice as a small in-group, many of whom were responsible for the ruination of their bank and the economy, are paid a bonus while other employees are worried sick about whether or not they will have a job this time next year.

A version of this article appeared in the Irish Examiner, Business Edition Monday 13th Dec 2010

All roads lead to a painful landscape

There is a fault line running through the eurozone’s spine, writes Bill Hobbs

Banjaxed, stripped of economic sovereignty, we must we wait helplessly for Godot to arrive at the crossroads of European Monetary Union. Those who maintain the Euro was designed to be irreversible, write of the horrendous consequences of its breakdown, arguing it’s an appalling vista no one should willingly opt for. Yet one of our roads leads to a hellish landscape should we have to go it alone.

There is a structural fault line running down the spine of the Eurozone every bit as dangerous as a string of interlinking volcanoes. Some like ours have gone critical. Unless it’s decided to force bond holders to share in Eurozone bank losses, more will go critical including the Spanish caldera. To stop this chain reaction, Germany and France may have to cede economic sovereignty to a US style fiscal and monetary system. Politically unwilling to do this for now, we must wait bleeding at the cross roads.

Environment Minister Gormley’s revelation that the banking guarantee had been decided on before and not on that most infamous of nights goes to the heart of what has since been passed off as economic planning. Apart from his revelation implicating his party in the most deceptive periods in Irish political history, it illustrates a fundamental failure to recognise that ours was no ordinary recession but a deflationary depression caused by a bursting asset bubble where the usual economic recovery rules do not apply.

Our Government opened a Pandora’s Box without understanding the consequences. We lost our sovereignty that night. It took two years to formally write it up in an ECB-sponsored, EU-influenced IMF bail-out agreement. An agreement that most observers say will inevitably lead to sovereign default as we simply cannot afford to repay the scale of private banking’s debts taken onto the public balance sheet from future tax revenues.

Bond investors who knowingly provided funds to our banking system to make the boom time, boomier must have quite vicious haircuts applied if this country is to stand any chance of economic recovery. Nationally and internationally, the economic commentariat are ad idem on one issue. Adding more unaffordable debt to unaffordable debt won’t work. Unless the true bottom is reached on valuing bank assets and property values, our banks will parasitically suck lifeblood from the economy.

But unilaterally reversing out of the bank guarantees and forcing bondholders to share in losses would mean telling Godot to get lost and walking away from the EU and ECB. Such a move would trigger a flight of capital as the current slow run on deposits would become a rout with ordinary depositors shifting their money of shore - this process is already well underway as smart money is moved to safer havens.

To stop a rout and preserve the banking and national payments system Government would have to pull out of the EMU and euro. This would mean declaring a bank holiday, shutting the banking system down for at least a week, while the printing presses rolled off millions in new bank notes.

At the same time banking systems would have to be configured to handle the new currency. By the end of this, all legacy banks would have to be encased in a debt sarcophagus in which bond holders are forced to bear losses. One or two new banks would have to open holding retail deposits and good loans. The new currency would be devalued at about 20% to 50% of the euro and could possibly peg to sterling. Rigorous exchange controls would have to be re-introduced. An emergency budget would have to brutally cut expenditure and raise taxes to close the €20bn revenue spending gap. All this would trigger rampant imported inflation and higher interest rate costs.

It would mean living within our means, or what would be left of them. Does anyone want to do travel this road? As we wait banjaxed at the cross roads for our erstwhile pals to arrive in the hope they bring good tidings of recovery in our time, we may have to at least plan for it.

Rebuilding confidence in Ireland abroad will not happen until confidence at home is rebuilt in four areas. We need new working banks and they will not be the ones we have at this time. We need to have a reformed political and public service with a ruthless determination to eradicate state sponsored cronyism. We need new political, public service and regulatory systems, fit for purpose to economically manage for an equitable and just society.

Finally a new economic model must be built, one based on long-term sustainable growth with no dependency on compulsive consumerism. All this might mean becoming more German than the German’s themselves – that’s if Godot ever bothers turning up at the cross roads.

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