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
Showing posts with label moral hazard. Show all posts
Showing posts with label moral hazard. Show all posts
Monday, March 29, 2010
Monday, November 23, 2009
AIB Mending the Cracks
“AIB is facing a period of majority state ownership. The trick is to change its dominant culture and craft a new bank that acts in the best interests of all its stakeholders” writes Bill Hobbs
How AIB’s newly appointed senior managers unwind its aggressive business model and build a safer bank is key to its future as an independent bank. It is facing a period of majority state ownership and could be forced to divest itself of its international business in return for billions in state aid.
By making credit available to people and business, who make effective use of it, banks are central to what makes modern consumer economies and wider society thrive. It’s why banks are special and why they are regulated as public interest bodies. Without careful and prudent bank managers keeping a weather eye out for risks, a boom to bust credit fuelled economic cycle happens, as it has here.
Good bank managers should act responsibly in the best interests of all stakeholders and not solely in the narrow shareholder interest. Banking goes badly wrong when its managers use their power and influence to manipulate banking assets for short term gain and reward. It goes spectacularly wrong if they trade off their banks’ “too big to fail” status and take excessive risks, gambling that Government will always step into bail them out.
Moral hazard is the term used to explain this phenomenon. Governments and regulators are supposed to police and protect society from moral hazard risk. Bank managers should be constrained by public policy and regulations that inhibit their ability to destroy money and consequently undermine economic and social well being.
Banks are not inanimate objects that exist in parallel with the real world. They are business organisations of groups of people who act and behave according to norms they establish to get work done. They are led by small groups of powerful influential executives whose personal interests are aligned with shareholder interests. Bad banking happens when senior executives act irrationally and myopically to maximise short term gain at the expense of long term viability.
There are or course many fine people working in Irish banking who truly believe in prudent management. But if the dominant senior managers behaviours and values encourage excessive risk taking and insist on blind loyalty then bad things happen. Bad banking happens when good people remain silent and are manipulated and at times intimidated into acting out the designs of senior executives and their overseer boards.
Much has been written of the need to change banking culture or “the way things are done around here”. But changing culture isn’t easy. It takes authentic leadership and effective management to turn large organisations of thousands of people around. Unwinding from excessive risk taking embedded in “the way things are done around here” cannot be accomplished overnight.
This is the task of AIB’s leadership, both of its board and senior management team. But the jury is out on whether this aggressive, profit maximising, banking leopard can truly change its spots. AIB has a rich history where its private interests have collided with the public interest, stemming from a time when its senior executives learned how to leverage off it’s “too big to fail” status. Twenty years ago AIB management’s foray into insurance almost ruined the Irish banking system. Government stepped in and bailed it out by taking over the Insurance Corporation of Ireland and in the process burned up the states foreign currency reserves to support the Irish banking system.
Today AIB’s insistence on its absolute right to trade without due regard for public interest is seen within its arrogant rejection of a dire need for state aid and in subsequent behaviour during the process of appointing an insider as its most senior employee. While Bank of Ireland experienced flak for its own internal appointment, it has not engaged in protracted altercation with Government. Perhaps we are seeing the contrast between Bank of Ireland’s long experience of carefully aligning its interests with the State and AIB’s mercantile banking culture with its ambition to become an international bank headquartered in Ireland.
All organisations have a positive core – something they do well that forms the basis for their success. When things go badly wrong as they have for AIB, learning how to move on is as important as acting it out. The danger is that that internal change becomes a negative force intimidating people to fit the designs of those who continue to be wedded to the way things were done in the past.
Should its managers use the same forceful aggressive style that gave rise to the way things were done, then AIB may not change its ways. The trick for AIB is to change its dominant culture and craft a new bank that acts in the best interests of all its stakeholders – and gets good credit flowing again. Unfortunately bank managers are not known for their leadership ability – they may be good managers but can be extremely poor leaders.
How AIB’s newly appointed senior managers unwind its aggressive business model and build a safer bank is key to its future as an independent bank. It is facing a period of majority state ownership and could be forced to divest itself of its international business in return for billions in state aid.
By making credit available to people and business, who make effective use of it, banks are central to what makes modern consumer economies and wider society thrive. It’s why banks are special and why they are regulated as public interest bodies. Without careful and prudent bank managers keeping a weather eye out for risks, a boom to bust credit fuelled economic cycle happens, as it has here.
Good bank managers should act responsibly in the best interests of all stakeholders and not solely in the narrow shareholder interest. Banking goes badly wrong when its managers use their power and influence to manipulate banking assets for short term gain and reward. It goes spectacularly wrong if they trade off their banks’ “too big to fail” status and take excessive risks, gambling that Government will always step into bail them out.
Moral hazard is the term used to explain this phenomenon. Governments and regulators are supposed to police and protect society from moral hazard risk. Bank managers should be constrained by public policy and regulations that inhibit their ability to destroy money and consequently undermine economic and social well being.
Banks are not inanimate objects that exist in parallel with the real world. They are business organisations of groups of people who act and behave according to norms they establish to get work done. They are led by small groups of powerful influential executives whose personal interests are aligned with shareholder interests. Bad banking happens when senior executives act irrationally and myopically to maximise short term gain at the expense of long term viability.
There are or course many fine people working in Irish banking who truly believe in prudent management. But if the dominant senior managers behaviours and values encourage excessive risk taking and insist on blind loyalty then bad things happen. Bad banking happens when good people remain silent and are manipulated and at times intimidated into acting out the designs of senior executives and their overseer boards.
Much has been written of the need to change banking culture or “the way things are done around here”. But changing culture isn’t easy. It takes authentic leadership and effective management to turn large organisations of thousands of people around. Unwinding from excessive risk taking embedded in “the way things are done around here” cannot be accomplished overnight.
This is the task of AIB’s leadership, both of its board and senior management team. But the jury is out on whether this aggressive, profit maximising, banking leopard can truly change its spots. AIB has a rich history where its private interests have collided with the public interest, stemming from a time when its senior executives learned how to leverage off it’s “too big to fail” status. Twenty years ago AIB management’s foray into insurance almost ruined the Irish banking system. Government stepped in and bailed it out by taking over the Insurance Corporation of Ireland and in the process burned up the states foreign currency reserves to support the Irish banking system.
Today AIB’s insistence on its absolute right to trade without due regard for public interest is seen within its arrogant rejection of a dire need for state aid and in subsequent behaviour during the process of appointing an insider as its most senior employee. While Bank of Ireland experienced flak for its own internal appointment, it has not engaged in protracted altercation with Government. Perhaps we are seeing the contrast between Bank of Ireland’s long experience of carefully aligning its interests with the State and AIB’s mercantile banking culture with its ambition to become an international bank headquartered in Ireland.
All organisations have a positive core – something they do well that forms the basis for their success. When things go badly wrong as they have for AIB, learning how to move on is as important as acting it out. The danger is that that internal change becomes a negative force intimidating people to fit the designs of those who continue to be wedded to the way things were done in the past.
Should its managers use the same forceful aggressive style that gave rise to the way things were done, then AIB may not change its ways. The trick for AIB is to change its dominant culture and craft a new bank that acts in the best interests of all its stakeholders – and gets good credit flowing again. Unfortunately bank managers are not known for their leadership ability – they may be good managers but can be extremely poor leaders.
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