Temporary Debt Solutions Not Enough

The Government needs to realistically respond to the biggest economic and social issue facing the country – the consumer debt crisis.

Banks are dragging their heels on dealing with it, the central bank hasn’t the powers to get them to behave themselves, and the mortgage modification programme is no more than an “extend and pretend” mechanism to protect bank capital. The Central Bank’s threat to look for powers to cap interest rates on variable rate mortgages was reported on as a consumer protection initiative. It could equally be considered a bank capital protection measure.

Mortgage lenders loan pricing behaviour is just one of many anti-consumer issues that have been conveniently ignored within a process carefully calibrated and designed to protect bank balance sheets. Both the “Cooney” and “Keane” mortgage arrears groups, which the central bank participated in, did not raise mortgage pricing behaviour as a policy issue.

There are other “kick the can” examples. In response to a MABS’ proposal on the voluntary surrender of family homes, the central bank said that as it had given the banks an undertaking not to review the mortgage arrears consumer protection code for a year and a half, it would not consult on the MABS recommendation until 2012. It seems consumer protection clocks in Dame Street tick as slow as they always have done. 

The Government’s policy response in insisting that mortgages are repaid in full totally conflicts with its policy on insisting that homeowners are not turfed out of their homes. That conflict can only be resolved by either permitting wholesale repossessions or implementing a proper loan modification programme including debt forgiveness solutions.

But modifying mortgages is a solution to one half of the consumer debt problem – the other half includes personal loans, investment property loans, personally guaranteed small business and commercial property loans, revenue and utility debt. 

If the Central Banks’ stress test is applied to all categories of consumer lending then under benign economic conditions, lender’s loan losses could amount to €5.5bn in home owner mortgages and €7.7bn in other loans of about €175bn in total consumer debt. While excluding other personally guaranteed loans that morph into personal debts once called in, the numbers are useful as they illustrate the size of a problem that no one has overarching responsibility for. Dealing with it piecemeal by focussing solely on home owner mortgages won’t work.

The Keane mortgage group report was not disappointing if what you were expecting was a five humped camel – a camel of course being a horse designed by a committee. The earlier Cooney report on mortgage arrears, a cousin of the Keane five humped camel, completely ignored personal loans which are just as distressing for indebted householders and just as toxic on bank balance sheets.

The most glaring omission of the Government’s “Cooney/Keane” approach has been the concept of debt forgiveness. Cooney/Keane harps on about moral hazard. Yet the Law Reform Commissions proposals which are built on the debt forgiveness concept, clearly and unambiguously set out how moral hazard can be minimised.

Why is organised debt forgiveness being ruled out? The problem for bankers is once the concept of debt forgiveness is introduced then they will have to deal with the loan losses they are hiding within their forbearance programmes. It seems that insolvency legislation is another can being kicked down the road to protect bank balance sheets.

Last Thursday, at the Central Bank’s conference on mortgage arrears, Blackrock Solutions presented on international mortgage modification programmes. It believes that certain types of loan modifications seem to work better than others and that U.S. experience suggests that principal forgiveness is more effective that other types of loan modifications. It also maintains that house prices are significant driver of defaults in “non-recourse” and recourse markets and that negative equity matters in all the markets it’s studied. It also observed that European loan modifications seem to be driven by accounting or capital preservation.

Called debt forgiveness here, principal forgiveness is an inevitable consequence of loan unaffordability and negative equity. While Blackrock leans towards negative equity as the key driver of loan defaults, the central bank leans towards affordability. Given the scale of distressed, unaffordable mortgages, impact of negative equity and negative long term impact on affordability it’s as clear as a pikestaff that principal forgiveness will have to be factored into loan modification programmes here.

How this is done is also important as any mortgage modification programme cannot be considered in isolation to other distressed consumer debt. Principal forgiveness and not capital preservation simply has to become a policy response to dealing with the consumer debt crisis. What’s more responding to mortgages on their own without dealing with other loans at the same time won’t work. It will take a complete solution including non-judicial debt settlement agreements and empowered consumer protector to oversee the totality of consumer debt – not just bank debt. 

A version f this article appeared in the Irish Examiner, Business Section, Monday 17th October 2011