“The borrower made a mistake, the bank made a mistake. The borrower gives up the house, the bank takes the loss. Both parties move on.” This was the summation of Michael Moore of the International Monetary Fund speaking at the Central Bank’s conference on ‘How to fix distressed property markets’ in Dublin earlier this week.
The title of the conference proved to be ambitious and not particularly apt as speakers went on to describe many solutions tried across many US states, with varying degrees of success. In fact, it raises the question; can Ireland adopt the strategies and solutions of more progressive countries without embracing the systems of regulation and controls?
Last week, speaking on RTE’s The Week in Politics, the Governor of the Central Bank of Ireland Patrick Honohan expressed his frustration at the slow pace at which Irish banks are dealing with the mortgage arrears situation. While opening the distressed markets conference he made reference to the previous such conference, which took place over 16 months ago, and the lack of progress made throughout that period. He referred to the “extraordinary rate of arrears” affecting not only the investment mortgages but also owner-occupier loans.
Anthony Murphy of the Central Bank compared the responses of both the US and the Irish authorities. He described the insistence to keep homeowners on tracker mortgages as “crazy and inefficient” making the point that if homeowners cannot afford a 2 percent mortgage, there is a serious problem. Forbearance appears to be the main Irish response to date. This contrasts sharply with the US response, which is a bundle of tiered solutions, starting with immediate identification, early intervention and debt modification. The US debt modification process involves working with the borrower to modify the repayments to a level not exceeding 31 percent of gross income. The steps are generally i) capitalization ii) interest rate relief iii) possible term extension iv) forbearance. It is worth noting that, to the end of 2012, almost 11 percent of Irish owner occupier mortgages had been modified.
Principle reduction was discussed at length and conflicting opinions and data were presented across the panel. The Irish view seemed to suggest that it was used with some degree of success in the US, therefore it should be considered here. Our American guest speakers were at pains to point out that shared appreciation mortgage modification is likely to be less costly and more successful than principle reduction or mortgage write-down. They spoke of many initiatives including the HAMP programme (which emphasises affordability), HARP, Hope for Homeowners and a foreclosure moratorium, all of which served to delay the inevitable, cause uncertainty in the local markets and drive down house prices; so far – so familiar. But this is where the similarities end. The US put tight time controls in place. This is a direct impact of robust regulation, which means that any mortgage in arrears for 60 days will be flagged by the early warning system. At which stage, banks must promptly charge-off the identified losses in the mortgage i.e. the negative equity. After 90 days, interest is suspended unless the bank can show particularly strong security or that recovery is realistically expected within a further 90 days. After 180 days, there is a charge-off of the balance of losses. It is important to note that this charge-off applies to the banks books only, not to the borrower. Once foreclosed, the house is prepared for sale and the aim is to sell all bank stock within a period not to exceed five years. Prompt recognition and resolution has been the key to recovery in many states. By way of example, the average time for all of this to happen in Arizona is 270 days. This is very different to the Irish 365 day moratorium, years of protracted court proceedings and unsatisfactory personal insolvency periods.
One interesting comparison put forward was between instances of foreclosures or repossessions and those of short sales, which we do not have (officially) in Ireland. A ‘short sale’ essentially refers to the sale of the property that is in negative equity, whereby the lender accepts the achieved sale price in full and final settlement of the mortgage. The personal credit rating of the borrower is adversely affected for a period of seven years following foreclosure, however, the short sale will only affect the credit rating for a period of three years. This has resulted in a higher level of short sales, rather than foreclosures, which speeds up the process hugely and has helped the property market in US states like Arizona and California to recover at a quicker rate.
Kris Gerardi of the Federal Reserve Bank of Atlanta spoke about foreclosure externalities and painted the following picture: Foreclosure increases supply in the housing sales market as more houses become available, however, it also increases demand in the rental market as that borrower must now live somewhere and buying is unlikely to be an option straight away. As demand in the rental market increases, so too does the rental price. As we know, higher rents generally serve to drive demand for the purchasing market (why rent if it is cheaper or as affordable to buy?), which in turn drives up property prices. The circle is complete. This contradicts the perception of repossessions being bad for the housing market. I should probably point out that it was many hours before the human cost of repossessions was even mentioned throughout this conference.
Michael Moore of the International Monetary Fund posed the question about what Irish policymakers can learn from the US mortgage. One of the main lessons was surely that by moving quickly and by taking decisive action, recovery can and will happen. Also, policy is the place to start. The Irish policy has always been to encourage home ownership. Many would argue that the rise in home-ownership rates in Ireland over the boom years were unsustainable, irrespective of all of the other influencing factors.
Dr. Alan Ahearne of NUI Galway facilitated an extensive panel discussion as to whether our lack of action and poor policy-making was the main contributory factor to the current mess, or rather, is Ireland a victim of the macro-economic conditions – does the blame lie with poor fortunes or poor decisions? An unhealthy dose of both appeared to be the consensus. Negative equity remains a problem for both markets and the US, similar to Ireland, appears to be sidelining the issue where no arrears occur. This does then raise the question of strategic default. One attendee expressed dismay at the current policy impetus, which he described as “stay away from the borrower”, therefore teaching borrowers that they do not have to repay. Fundamentally, this is a fairness issue and one that the US has had to deal with also. Their policymakers were reluctant to write down principle in such cases, therefore, even they do not know what the real effects would be.
The closing point from the conference was that the impetus should have been to ensure a functioning property market, not simply keeping people in their homes.
All presentations and grounding reports are now available on the Central Bank website (www.centralbank.ie)