Thursday, April 21, 2011

Mortgage Debt Forgiveness

The issue of mortgage debt forgiveness has come front and centre again.  The last time we looked at this was when 11 economists proposed a huge debt-forgiveness  scheme back in November.

The Irish Times article is here and the response on this site is here.  I remain opposed to the views in the article.  At one stage it says:

In the case of Ireland, such a formula would most likely lead to an implicit writedown of at least 30 per cent of the more recent mortgage amounts on average, yielding an expected total cost to the entire system of circa €37 billion to €49 billion.

I’m not sure the article is actually in favour of such a widespread scheme (but if not, why was the paragraph included I ask) but this is a huge immediate solution to what is a long run problem.  The article also overstates the size of the problem.

Their arrears of €10 billion would compare to total mortgage debt outstanding in the Republic of €115 billion.

This is wildly overstating the arrears problem.  The most recent recent figures from the Financial Regulator can be seen here.  There are 44,500 mortgages in arrears of three months or more.  The total outstanding balance of these mortgages is €8.6 billion and will likely approach €10 billion in the coming months.   This gives an average outstanding balance of around €190,000 per mortgage in arrears.

However, the balance outstanding and the arrears owing are two different things.  The total amount of arrears on these mortgages is actually around €700 million.  The average arrears per mortgage is around €16,000.  It is difficult to imagine the amount of arrears ever approaching €10 billion.  A solution based on clearing the balance of mortgages in arrears is just too broad when the problem is more focussed.  My initial thoughts can be read in the post linked above.

I still think that any solution should be based on interest relief rather than capital forgiveness.  I think the State should pay the interest on a certain portion of the loan for a certain period.  This is offering something to those in need but avoids shifting the burden of capital repayment around.  So, for some mortgages the State could service up to 50% of the loan for a certain period of time.  If these are tracker-rate mortgages the cost may be somewhat contained.  There will be some cost to the State.

[As an aside it would be great to know where the mortgages in arrears actually are.  What is the breakdown between the covered six, other domestic banks (UB, NIB etc.), banks that have left (BoS) and subprime lenders?]

Anyway once the State takes on the servicing of the mortgage to give these people some breathing space we need some process that sees the responsibility move back to the individual.  As in a debt-forgiveness scheme which would see people position themselves to benefit from it, I think the key is "incentives matter".  I would allow the scheme to extend, to say, 15 years but the individual decides when the mortgage moves back to them.

If they do so after three years they just take it back under the original conditions.  For every year after that the interest rate on the loan increases by some incremental amount (say 0.25%).  This extra interest does not go to the bank, but goes to to the State for providing the scheme.  The longer a person needs support from the scheme the more they will have to pay.  If they wait the full 15 years the extra interest will be 3% per annum.  These numbers are only for illustrative purposes.

A lot can happen over a period of five to eight years (even economic growth, inflation and the like can happen!).  I don't think we need a short-run solution (immediate debt-forgiveness) to what is a long-run problem (repaying a mortgage).

I may update this with further thoughts.


  1. Seamus

    Personally I think the better solution is for the State to buy the houses in trouble by taking 50% or 100% State ownership. It does not involve 2moral hazard" as any sale receipts on sale/death will revert to State.

    Shared ownership proved quite successful in the UK in the 1990's. The owner gets first chance to buy back the property.

    On a separate issue, I have some interesting comparative raw data on the the impact of USC /PAYE/PRSI on a live data set.
    It show that for a fall of 8% in payroll from Oct-Dec 2010 to Jan-Mar 2011, the total payroll taxes rose by 1.9%.
    If this data is average for the country, then the very poor Jan-March 2011 Govt "Income Tax" would indicate a very poor first quarter growth.

    The data has been impersonalised and is available.

  2. Seamus
    Don't forget that mortgages are in default and if the credit market were allowed work how many would be foreclosed?
    Losses on foreclosure would equal negative equity + fire sale discount + costs which may be close to 60% of original value in the case of 90%+ LTV 2005-2007 vintage loans.

    How many are say in the absolute foreclosure category? Look at 180 days+ stats and the numbers that have gone bad again after forbearance measures were applied.

    Seems there are three categories:
    Hardcore loans that should be called in
    Loans that could be adjusted downwards to current house values - with the balance treated to a debt settlement regime
    And those where repayment capacity may improve

    We have no handle on borrowers ability to repay profiles