Efforts must now be made to solve the shattered home mortgage market

A negative equity loan reduction programme is vital, says Bill Hobbs

A homeowner negative equity loan reduction programme is an inevitable consequence of the property bubble. Instead of temporarily reducing repayments to affordable levels until income “improves” and property prices “recover” there is a need to face up to the brutal facts. Tens of thousands are exposed to a permanent reduction in income and long term negative equity. People can no longer afford or are willing to repay loans used to buy grossly overpriced houses which are now worth half what was paid for them.

Unable to sell, people with negative equity are trapped within a broken mortgage market, cannot refinance at better rates and are at the mercy of banks increasing their loan margins. Labour mobility has declined due to negative equity, which is also severely impacting economic activity as people stop spending, pay down debts and increase precautionary saving.

Negative equity doesn’t cause loan defaults but is a necessary condition for loan defaults. And there are two forms of homeowner default – where someone is unable to pay and where someone is unwilling to pay anymore. For many people it would be better for them to walk away from their house, rent and start saving for a new one – their equity if they ever had any, is gone and they are paying a higher rent through loan repayments than they would if they rented a house. Called “strategic” default it happens when people figure it’s cheaper to rent than pay a mortgage. It’s a recognised rational phenomenon in the US and one which is also becoming a feature here. While an Irish bank may theoretically sue for the balance owing after it’s sold a house, it’s practically impossible to recover the money.

Short selling, where borrowers agree to sell their home and the bank agrees to accept the proceeds and write off the negative equity, is also quite common in the US. Talk there is of a negative equity resolution programme to force banks to write down loans to current house values. Its proponents say that “cramming down” loans in this way should leave the homeowner with some equity ownership in their home.

Here in Ireland nothing concrete has been done to make family homes more affordable or to address negative equity. Nor has there been any investigation into what went so badly wrong with the consumer mortgage market. The entire focus has been on stabilising the banks – the NAMA project. Its debt forgiveness bill for underwater land and property development loans amounting to tens of billions will be unveiled this week. Not a single scrap of official paper exists to estimate the scale of household negative equity. Not one official line has been printed on how to fix the shattered home mortgage market.

Instead there’s been a crisis response allowing for loan modifications at the discretion of the lender. A homeowner may be protected against repossession for a limited period of time, but they have no right to renegotiate or modify their loan. Banks are playing ball as they know repossessions are not on – they cost too much and would backfire in depressing the housing market even further. They also know that formally calling in loans will trigger loan losses they cannot afford. Yet loan forbearance – putting things off – worsens negative equity as costs are eventually capitalised and loans become even more unaffordable.

The Americans stopped talking about the problem long ago. They have two schemes targeting 10m at risk homeowners. One called HARP which refinances and insures loans at lower rates is aimed at reducing loan repayments. The other called HAMP is aimed at modifying loans so repayments fall to below 31% of household gross income. But take-up has been dismal as modifications are at lenders discretion. British schemes are also foundering as banks have the discretion to say no to loan modification.

Discretionary programmes fail to address the fundamental issue – without writing down some of the debt owing, people are left worse off, owing more then they started with. Talk is now switching from debt forbearance to debt reduction modifications that write down the amount owing to less than the open market value of the home leaving the homeowner with some equity with which to move on. This thinking takes into account the need for people to retain some sense of ownership, invest in maintaining their home and be able to sell and move on.

How bad is the problem here? Sparse data indicates there are about 790,000 consumer loans secured by houses, with attached borrowings of €147bn. About 640,000 households owe €118bn on their homes. And of these, if the collapse in prices drops to 50% this year, one in three will be in negative equity including 125,000 first timers. Negative equity would be €7.4bn, on average €38,000 per household. But this is an average. The true extent of negative equity is much worse for those who borrowed at high LTV’s over 30 years. A third of all loans issued in 2007 where for 100% finance. Many more were topped up with unsecured loans from credit unions and others. Over 25,000 are in serious default, 30,000 have negotiated forbearance and 20,000 are on mortgage interest subsidies. These are the loans in trouble – there are no estimates for those at risk of default. With 440,000 people unemployed and many more suffering permanent reduction in income the impact of negative equity and its capacity to undermine economic recovery is barely in understood.

A standardised regulated rules based approach to modifications should be introduced requiring all lenders to include for permanent reductions in principal to align mortgage debt to property values. These should be negotiated as early as possible even before a delinquency occurs. In addition, if mortgage debt is to be included in a personal insolvency regime then its enforcement officers should be allowed to modify the mortgage (downwards) to achieve an affordable repayment tied to property value today and not some assessment of likely future value. Consideration could also be given to from of negative equity certificate that could be used as a future claw back of the loan amount reduced.


A version of this article appeared in the Irish Examiner, Business Section, Monday 29th March 2010

Government inaction could lead to a debt revolt

A recent poster on the influential Irish Economy blog site wondered if they’re might be a debtor’s revolt. The notion of ordinary people revolting en-masse and refusing to repay their bank debts in full is not at all far fetched.

Household unaffordable indebtedness is known to cause immense social damage and incur immeasurable economic costs. Government’s budget this week will almost certainly worsen household financial fragility. Published last month, the 2009 Genworth Index, measuring financial vulnerability and security, reported Irish households as the most financially vulnerable of the countries studied. It seems four out of every ten households have difficulty in meeting their financial commitments and expect to have problems in the future. And only 2% feel financially secure.

During favourable economic circumstances and the low interest rate environment of the recent past, Irish household use of debt underwent a dramatic and fundamental transformation. Two powerful forces were at work. The first was “keeping up with the Jones’” as people emulated their neighbours lifestyles and role models promoted by mass media advertising. The second saw bankers relax prudent lending policies and broaden credit availability through financial innovation. Responding to these forces, households changed their behaviour, significantly increasing spending relative to income and consumer debt skyrocketed. People believed it was safe to borrow more and banks believed it was safe to lend more to them. Government, whose policies encouraged the debt fuelled consumption party, was blind to the twin dangers of exploding household debt and bank reckless lending to consumer and property sectors. Central bankers and regulators were lulled into a false sense of financial stability. By 2008 Government’s economic mismanagement created the conditions for a perfect storm for over-indebted households and triggered a dramatic collapse in consumption and tax revenues.

In the early 90’s a double income couple had to put 20% down and could borrow a maximum of 2.5 times one income and once the second income, to buy a home. By 2007 they could have borrowed 100% at multiples of four to fives times their income, and have two car loans, two credit cards and one or two unsecured loans. Experts argued the debt burden was affordable as incomes were rising and interest rates were quite low. They worried only about interest rates rising. Few considered a boom to bust cycle.

By 2006 household debt was running at dangerous levels – all it would take was an income shock and vulnerable households would be plunged into financial distress. This is precisely what has happened. Should interest rates rise, as they will, household financial fragility will worsen.

Experiencing increasing demand, largely from people on social welfare and low incomes, MABS offices took on 15,000 new troubled debt cases in 2009. MABS says its 30,000 active cases have average debts of about €16,500 which represents about €500m in collective debts. But with consumer loans of €140bn comprising some €110bn in mortgage debt and €30bn in other loans, the number of households experiencing financial stress requiring debt management and counselling services is likely to be considerably higher than the numbers currently going to MABS for help. Its figures are but the tip of a very large iceberg of household over-indebtedness.

Estimates put the number of overly indebted households at close to 300,000 with about 750,000 individuals experiencing problems with personal debt. By far the most vulnerable cohort is couples under age 40, with children, who have experienced a long term reduction in take home pay. Heavy users of debt many will or have become hopelessly insolvent.

So far Government has done little to understand or address the massive burden of unaffordable household debt built up during the boom years. Getting banks to forbear on home repossessions is like pouring sand on a land mine and claiming it’s been decommissioned. People’s capacity to participate in modern society depends on income security, access to affordable credit and ability to meet their financial commitments. Well documented, the social consequences of unaffordable indebtedness are dire, causing reduced workplace productivity, family breakdown, depressive illness and in some cases suicide. Stigmatised many people withdraw from being active members of society. Hopelessness and loss of self-esteem add to the misery of being unable to repay loans.

Exacerbating the problem, Ireland’s draconian debt collection law emphasises borrower’s obligations to pay debts in full and overly protects creditor’s rights. Lenders and their debt collectors are engaged in an unsecured loan collection arms race, with each one trying to get into court first to stake a claim on a debtors household income. What’s more when banks start lending again, they will tighten lending conditions, charge more for loans and refuse credit to over-indebted households. Consequently many people, once considered good borrowers, will be marginalised and financially excluded.

Other societies have long recognised the adverse social consequences and economic costs of household unaffordable indebtedness. The Danes led the way in 1984 when they introduced a landmark personal insolvency system designed to provide a full debt discharge over a reasonable period of time during which people pay what they can afford and the balance owing is written off.

NAMA whilst designed to rescue banking from failure, will write off billions in unaffordable loans over time. Most of its customers are hopelessly insolvent or unable to repay their borrowings in full. They will pay what they can and NAMA will write off billions in debt – some say it may cost well over €30bn.

But what of ordinary people who cannot afford to pay what they owe in full? People who borrowed believing it was safe to do so and who made rational decisions based on their expectation of continuing income security? Their expectations were fostered by a government that first promoted a consumption boom and then a soft landing. It could well be that ordinary people will organise into a collective group and demand a “NAMA for the little guy”. In the absence of affirmative action that promises a way out of unaffordable debt, Government runs the real risk of a citizen’s debt revolt.