Household Debt- a moral and economic dilemma

The high level of household debt poses a social and economic threat to the country.  However, debt “forgiveness” as a general policy would be impossible to implement. No matter how well criteria might be framed to provide the basis on which to write off debt, they would be circumvented. Those currently able to pay their mortgages would soon stop if it became apparent that by so doing they could get some of the debt wiped out. We would then have a new banking crisis based on badly performing mortgage loans. The State could not afford to stem another bank crisis, which could be on a larger scale than the property developers, since mortgage debt totals more that Euro 130bn.

Nonetheless, there is a strong economic case to be made to alleviate the burden of household debt because it inhibits consumer spending, which is crucial to the resumption of growth in the economy.  There have already been moves in this direction with the establishment of a framework under which borrowers and lenders may reach deals on a case-by-case basis.

However, mortgage arrears are still mounting and a more far-reaching and comprehensive scheme is clearly necessary.  The main objectives of such a scheme should be:

·        First, to allow as many mortgage holders as possible to remain in their homes.  In addition to its social benefits, this would reduce the number of repossessions and the over-hang effect of these properties on the housing market.

·        Second, to provide mortgage-holders with a realistic and manageable repayment schedule.  It would also be desirable to provide a means of fixing these repayments for a relatively long period, in order to reduce uncertainty and encourage consumer spending.

·        Third, to be fair and equitable to all mortgage holders and taxpayers.  In particular, incentives to default by those who can afford to pay – such as would be present in a pure debt forgiveness scheme – must be minimised.

Lower mortgage repayments are key to realising these objectives. Borrowers will require a range of flexible options, which are easy to understand and administer. These should include sharing housing ownership with banks and access to longer term mortgages with low fixed interest rates.  It should be open to borrowers to avail of some or all of these options, in accordance with their individual requirements.

The most effective way to reduce mortgage repayments is to reduce the size of the mortgage.  Putting in place a structure under which mortgage holders in difficulties can require their bank to take an equity stake in their house would provide the most substantive reduction in debt.

It is important that the householder retains the right to decide if and when to sell. Thus the bank’s stake should be less than 50%.  The value of the equity shares of the householder and the bank should be based on the original purchase price of the house for two reasons: first, for efficiency, since it avoids the problem of agreeing the present value of the house in an uncertain market; and, second, for fairness.  Since both the householder and the bank accepted the original valuation when the loan was granted it is only fair that both should share the risk of any loss which may arise.

Take as an example a house which was bought for €500,000, of which €100,000 was provided in cash and €400,000 by way of a mortgage. But now the householder cannot afford the mortgage repayments. Under the proposed scheme the householder could require the bank to take, say, a 40% stake in the house to which a value of €200,000 would attach, based on the original purchase price of €500,000. The householder would then owe the bank €200,000. His mortgage would have been halved and repayments reduced accordingly. The bank, instead of having an asset in the form of a mortgage of €400,000 would have a mortgage of €200,000 and a share in the house booked initially as worth €200,000.

Clearly the house is no longer worth €500,000, so the bank should write down its €200,000 stake to a lower value. The capital to enable banks to do so has already been made available by the taxpayer.

The advantage of this proposal, compared to a pure debt forgiveness approach, is the householder has to sacrifice a share of ownership to obtain the desired reduction in the mortgage debt. This reduces the chances that those who currently can afford to pay their mortgage will rush to avail of the scheme.

For some mortgage holders, however, giving the bank a share of ownership of the house may still not be enough to alleviate their mortgage payment problem. Other restructuring measures may still be necessary.

Lengthening the mortgage term is a means of providing further easement of the repayment burden. Heretofore, social, family and inheritance considerations made it the norm to seek to have the mortgage paid off within the lifetime of the borrower. But does it make economic sense to impose such a norm?

In purely economic terms a house is an asset like any other. But it is an asset that will last a hundred years or more.  It will yield a return whether in cash, through rental, or in kind by provision of family accommodation for generations to come. A house thus provides a very large flow of income or accommodation benefits over generations. How can it be reasonable to expect that such a long-lived stream of returns should be purchased out of income earned in a period as short as twenty-five or thirty years?

Mortgage terms in most countries range between 20 and 40 years. The European Central Bank reports that the typical maturity in the Euro area is between 20 and 30 years. But longer maturity mortgages exist in several countries, with up to 50 years in Spain and France and up to 60 years in Finland. At the extremes, Japan and Switzerland have 100-year (inter-generational) mortgages.

Low fixed interest-rate mortgages provide the final part of the jigsaw.  Variable rate mortgages carry the risk of larger repayments in the future and lead to higher precautionary savings.  Ireland has one of the highest proportions of variable rate mortgages in Europe, at about 85%.  But fixed rates are linked to bond yields and, where available in Ireland would be expensive.  More fixed-rate lending would be encouraged if banks were provided with funds at the same rates and maturities as Ireland can now borrow from the European Financial Stabilisation Facility (EFSF) and required to offer the same terms to customers.  The EU/IMF deal envisaged that some €35bn would be required to re-capitalise the banks.  This figure is now about €10bn lower.  These funds should now be made available to banks to enable them to deliver fixed-interest mortgages at rates as low as 3.5% for periods up of up to thirty years.  This initiative could be made available to all banks, not just those availing of the Government guarantee.  A sum of €10bn would more than double the value of mortgages which are currently fixed for longer than 3 years.  If demand to switch to such mortgages exceed this, further funds might well be available from the enlarged EFSF/ESM.

There is no panacea for the problem of household debt afforded by a policy of straight debt “forgiveness.” Indeed the adoption of a policy of readily accessible debt write offs would probably bring another crisis for the banks.

What we propose could enable mortgage borrowers to stay in their own homes by reducing repayments to manageable levels which could be fixed for up to thirty years. It would be fair and equitable to other mortgage holders and taxpayers because the borrower would have to elect to make concessions on ownership, depending on the degree relief sought on repayments. At the same time the proposal would force the banks to take a share of responsibility for their lending decisions by writing down the value of the property they take onto their books as part of the proposed scheme. The taxpayers’ recapitalisation of the banks would thus be put to work to help alleviate distressed mortgage borrowers, raise consumption and boost economic growth.