Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

“Hey, Enda, leave those banks alone!”

Last week’s post discussed Ireland’s competitiveness. At the heart of the post was the trade-off in our on-going devaluation between making conditions worse for those with fixed debts (in particular peak-time mortgages) and making things better for the younger generation. They are debt-free and mobile. Their choice to stay or go depends on whether Ireland is an attractive place – i.e. with jobs and with a low cost of living including in accommodation – compared to other options. In response to last week’s post, Constantin Gurdgiev was keen to make sure that the older generation, the ones with peak-time mortgages are not forgotten. The point of my post was to make sure that the younger generation – as harbingers of future economic success or not – are also not forgotten: current mortgage-holders are loud, concentrated and voting; future mortgage-holders are not.

A higher interest rate does not a greedy banker make

Once you’re aware of this trade-off, it appears everywhere in current economic discussion. This morning, word has come out that National Irish Bank is ignoring the Financial Regulator’s call for the ECB’s rate cut to be passed on variable rate customers and will instead proceed with its planned increase in variable rates of almost 1%. Given that An Taoiseach Enda Kenny said last week that he would bring in laws to force lenders to lower rates in response to ECB cuts, surely this must be a case of greedy bankers taunting the public, right?

There are a couple of facts worth pointing out at this point. Firstly, according to CSO data, the average variable rate in Ireland is currently 4.3% so by raising its rate to about 4.5%, what NIB is proposing is effectively bringing itself into line with other banks – as shown in the graph below. Secondly, and related to this, NIB has also not increased its variable rates since June 2008. Thirdly, National Irish Bank is not funded by the ECB – it’s a subsidiary of Danske Bank – so changes in the ECB rate are largely irrelevant to the bank.

Variable interest rates for 80% LTV, various institutions

Most importantly, however, An Taoiseach Enda Kenny and perhaps more worryingly the Financial Regulator Matthew Elderfield are falling in to the trap of thinking that interest rates cause mortgage arrears. To put NIB’s move into perspective, its variable rate customers will face an interest rate of about 4.5%, which is in line with the average variable rate charged by Irish banks over the period 1999-2011. If its customers are struggling, they are struggling to pay back at a rate similar to when interest rates in Ireland were at historic lows. If that’s the case, something is wrong and it’s not the interest rate.

What causes mortgage arrears?

Last month, the Central Bank organised a conference, The Irish Mortgage Market in Context, which I attended as a discussant. The second and third sessions featured presentations on understanding what drives mortgage arrears and repossessions. The key debate at the conference was among those who believe that negative equity drives arrears (BlackRock Solutions, responsible for the stress tests) and those who believe that unemployment drives arrears (the academic experts). This is the so-called ‘double trigger’: negative equity and unemployment are both needed for arrears – the argument is about the weight attached to each part.

Ireland’s policy in relation to the mortgage market here urgently needs to reflect this discussion: interest rates don’t cause mortgage arrears, some mix of unemployment and negative equity does. The government getting into the business of setting prices charged by banks shows a complete misunderstanding of the nature of the problem. Given that the negative equity part of the equation will not be going away any time soon, to halt the slide into mortgage arrears, the government needs to tackle unemployment.

Today’s borrowers versus tomorrow’s borrowers

Policy here also needs to reflect the trade-off between current borrowers and future borrowers. According to work by economists at the Central Bank, just 30% of outstanding mortgage balances is on a variable rate mortgage. Of the 145,000 mortgages in negative equity out of the 475,000 mortgages covered in that study, 40,000 were on variable rates.

It’s my own belief that the next generation of Ireland’s mortgage market won’t just happen, it will need to be created by policy and that a central feature of the new market should be a requirement to issue covered bonds: i.e. banks borrow long (30 years) to lend long (30 years). Where this is the requirement, there is no such thing as a variable rate mortgage, a product viewed in the same terms as subprime mortgages in the US. Instead, the monthly mortgage repayment is fixed, providing consumers in Ireland with insulation from interest rates set with the rest of the Eurozone in mind.

However, I appreciate that until such a change is made, almost all new borrowers are going to be on variable rate mortgages.  This is a stream of probably 40,000 new borrowers a year into the future. So we face a situation where out of myopia and incorrect diagnosis of the problem, the needs of the 40,000 are being placed above the needs of the 400,000, the generation born in the 1990s. No-one is arguing that the pain faced by those on the cusp of mortgage arrears isn’t real – but in this debate we need to also remember that the welfare of others, less obvious or less vocal, also matters.

As outlined by Bob Quinn over on Money Adviser, the Financial Regulator believes that banks setting their own interest rates is self-defeating, “adding to the mortgage arrears problem and ultimately costing more in terms of capital”. Surely that is for NIB/Danske Bank – and possibly the Danish taxpayer as shareholder of last resort – to worry about.

What is certainly self-defeating is preventing banks in Ireland – particularly the few we have that are not taxpayer-owned zombies – from covering their costs. This is a Pyrrhic victory for current homeowners: its biggest impact is not reducing the price of mortgages, it reduces the number of new mortgages given out. This contraction in the supply of credit pushes down house prices, leading to greater negative equity. And unlike interest rates, negative equity does actually have an impact on arrears.

If the Government wants to change Ireland’s mortgage market, it should set policy not prices.

  • Donal O'Brolchain ,

    “It’s my own belief that the next generation of Ireland’s mortgage market won’t just happen, it will need to be created by policy and that a central feature of the new market should be a requirement to issue covered bonds: i.e. banks borrow long (30 years) to lend long (30 years). Where this is the requirement, there is no such thing as a variable rate mortgage, a product viewed in the same terms as subprime mortgages in the US. Instead, the monthly mortgage repayment is fixed, providing consumers in Ireland with insulation from interest rates set with the rest of the Eurozone in mind.”

    What is stopping this “covered bond” basis of providing mortgages being implemented forthwith?
    I gather this is well-established elsewhere in Europe.
    For those of us who are ignorant of the extent of this practice, perhaps you could point out a source of authoritative data.

    Am I wrong to assume that such methods have not been brought in here due to some toxic mixture of vested interests eg.
    – financiers including brokers,
    – government (as a recipient of taxes arising from construction etc),
    – developers/builders,
    – professional services “servicing” the housing business

    and/or a lack of managerial imagination in the policy-making classes in developing designs for a market that would provide that old Irish demand (eg. fair rents, fixity of tenure and freedom of sale) for something as basic as dwellings?

    Come back, Michael Davitt, we have forgotten our history!

    • Ronan Lyons ,

      Very well put Donal. My own view is that it is the conservatism of the class that currently run Irish banks and Irish public administration which prevents this idea from gaining traction.

      A good start point (can Wikipedia ever be anything but?!) is this page:
      References and external links very handy, including to an IMF study.

      • Robert Browne ,

        Ronan, a few thoughts!

        What caused negative equity? Practically no regulation. 80 different tax breaks and banks lending out at break neck speeds breaking all the rules of prudential lending while at the same time breaching fiduciary responsibility to shareholders most of whom were wiped out. Gratuitous wealth destruction. Let’s not forget that many of these “investors” had been identified by the banks trawling their own data bases, probably illegally, to identify people that might be able to “invest” in “AAA” bank shares. It took 222 years for BoI loan book to reach 100bn in 2004 yet by 2008 it had ballooned to 200bn. How much of that loan book will turn into arrears? What was the role of auditors in covering up such cowboy antics? They should have been pointing out the models were unsustainable but they wanted to be booked for the next audit!

        We know there is a correlation between negative equity and mortgage arrears but there is also a correlation between income, negative equity and mortgage arrears and anything that reduces that income will have an effect. It appears that you are framing the argument rather simplistically in terms of black and white i.e. people loose jobs….they go into mortgage arrears. Indeed, they do especially if they have not got savings to cushion them until they find another job. People that experience interest rate hikes go into mortgage arrears as you will see in the UK when they eventually raise interest rates.

        I just heard you make the argument on RTE radio where you got a very, very soft interview, that if banks could not set their own interest rates, there would be less lending for mortgages and that interest rates increases did not lead to defaults as these were caused by job losses and negative equity. Some truth there but rather selective. As you are aware many people in Ireland have entered into mortgages on the basis of having a certain incomes only to have significant portions of that income confiscated in a multiplicity of ways by government. With another 600 Euro on average to go per household next year after the budget. What happens when these peoples mortgage becomes unsustainable? Why would the tipping point for this “insolvency” not be interest rate increases by banks like NIB? It could be college fees too!

        Would you not agree that an interest rate hike which pushes up mortgage payments by 100 Euro is the the same as a tax hike which extracts another 100 Euro? All these have the same net effect i.e. the bottom line is, they reduce salary by 100 Euro?

        Banks are being preserved at the expense of tax payers who both own them and are propping them up. NIB played the game the same as all the others banks in terms of unsustainable lending practices in Ireland. They might have a different model for wholesale funding but that does not absolve them of the mistakes they made over the last 10 years. In short, just because they are controlled by the Danish Central bank it does not mean they can shrug their shoulders and say ‘nothing to do with us” we are putting up interest rates, “move along there ladies and gents” nothing to see. I think there is lots to see. A new banking model is desirable but you cannot magically get there. If Daft want to get rid of some of the properties clogging up their books they need to support the abolition of NAMA not support the argument of banks increasing interest rates and not letting governments interference in their rate setting. Constantine is correct the zombie banks need to be let go, the market needs to be allowed to clean itself out by banks being allowed to fail and individuals being allowed to walk away from loans that were pushed on people under completely false assumptions, valuations and the desire for expansion at break neck speeds.

        Yes, I know that banks are not charities but far too many of them, including the pillar banks in Ireland, are essentially still zombified institutions that need to be put to sleep as their model for lending has essentially ruined potential profitability, hollowed it out, both in the hear and now and in the future. They have no life after the bailout No 1 has been spent because they have wrecked the economy.

        NAMA makes it impossible for the property market to recover as they will simply dump their stock of commercial , residential and sites onto the market at any sign of recovery. Also, their ‘negative equity” mortgage is GUBU and totally monopolistic, anti competitive, making it virtually impossible for ordinary citizens to sell property. Some, have brought this to the EU commission. Most have given up trying to sell homes and in any event they could not possibly hope to compete with an institution borrowing at 1.5% and guaranteeing purchasers against negative equity. So Ronan lets see a bit of more integrated thinking on interest rates on NAMA on banking and the future of banking as run by government.

        • Unemployed Person ,

          I don’t think you can rule out interest rates being one of the drivers for arrears Ronan. Once tptb have managed to get rid of the politicians they don’t want in place in Europe, e.g. Silvio B, I suspect the ECB will then have a change of heart about being a lolr, print stacks of money and inflation will go up and they will steadily put interest rates back up. When interest rate average has gone up by another 2-3% then you will see a heck of a lot more arrears. Remember this predicition. It’s politics not economics.

          • AIB and BOI give the 2 fingers to Enda - Page 11 ,

            […] those debating here should at least be honest about their mortgages but I really doubt they will. “Hey, Enda, leave those banks alone!” | Ronan Lyons Reply With Quote + Reply to […]

            • Eoin Leahy ,

              Hi Ronan

              Of course if the government at the time had obeyed your injunction to “leave those banks alone” we wouldn’t be in this particular mess – perhaps a mess nonetheless but certainly a different mess.

              I agree that having a healthy banking industry with a resumption of home lending is key to rebuilding the Irish economy such that we have an attractive place for the “younger generation”, but maybe there’s a win-win for both generations. Taking the position that a duopoly of weakened pillars will never be the basis for economic transformation a Machiavellian regulator / minister might act as follows:

              1. Limit the profitability of pillars by pressuring margins on existing loans.
              2. Leads to less lending availability
              3. Make speeches decrying the large number of young people underserved by the Irish Financial Services industry
              4. Make speeches decrying the number of SME’s with no available credit facilities to avail of the expanding economy
              5. Repeat 1 – 4 until some Investment Banker notices and pitches the opportunity here for a well capitalized Retail banking outfit to enter the market
              6. Get re-elected on the basis of having engineered the recovery while cushioned the over-indebted.

              Fanciful I know, but the idea that a 25bp increase in margins on 30% of the existing mortgage loan book is essential to the viability of the pillars is pretty fanciful too – yet that seems to be the position of their executives. Waiting for a banking system to be created by policy seems no less fanciful – and to contradict your sentiment in the title to this entry. I have greater faith in Mr. Market than in any number of green and white papers, so it seems very unlikely to me that the current banking opportunity in Ireland will remain unexploited for much longer.

              • FERGUS O'ROURKE ,

                @Ronan & @Donal O’Brolchain

                I have been advocating long-term fixed interest rate finance for decades. Although the climate is now much more favourable, there was never any enthusiastic response from potential borrowers – they did not like fixed rates over such a period.

                Another problem is that suppliers of such 30-year bonds have never been plentiful, and the almost entirely irrational hysteria generated against bondholders over the last few years is unlikely to be an encouraging backdrop to any effort to recruit more.

                As for the conservatism of Irish bankers, I am as sure as I can be that that was not a significant issue. They would have been glad of any “new” product to sell into what was – yes, it was ! – an extremely competitive market.

                Intermediaries are a different matter. I am not an expert on the incentives for them, but I could imagine 30-year fixed-rate lacking attractiveness for them.

                (By the way, don’t neglect the issue of how to deal with the large number of mortgagors who do not persist for 10 years, never mind longer periods, and how this would affect the costs of longer arrangements)

                • Robert Browne ,

                  @ Fergus O Rourke

                  “They would have been glad of any “new” product to sell into what was – yes, it was ! – an extremely competitive market.”

                  Surely what you describe as “an extremely competitive market” was really a race to the bottom by bankers, none of whom were capable of proper risk analysis despite earning absurd amounts of money.

                  We guaranteed the finances of the state on the line to bail out insolvent banks and that is the primary reason for loss of sovereignty. If you need another reason, we pay our 7.5bn Euro’s more every year to our public and semi state employees than they would get if they worked in the UK. The evidence is there to suggest they are not better at their jobs.

                  How come Reinhart and Rogoff were able to author a book that charted 700 years of booms and busts but these people all thought that there was a paradigm shift and that “This time really was different”? What radically changed the situation and encouraged crazy risk taking was when banks stopped originating mortgages and holding on to them until they were paid off and choose instead to package them into MBO’s and sell them on with the help of ratings agencies to investors and institutions who again did not do proper risk analysis.

                  • FERGUS O'ROURKE ,

                    @Robert Browne

                    If you are under the impression that I fundamentally disagree with you, I cannot imagine why !

                    On a point of detail, though, your reference to banks getting out of mortgage origination is of almost no relevance to the Irish banking disaster, for two reasons.

                    First of all, the Irish banks could probably have survived their madness in the domestic mortgage business. It was commercial property that brought them down – Anglo did not have a significant share of the residential market, for example.

                    Secondly, the phenomenon of “originate and distribute” was not significant in the Irish market: most residential loans remain on the balance sheets of the original lenders.

                    • Hugh Sheehy ,

                      For me the most interesting assumption in Ronan’s whole piece is that the “needs of the 40,000” should somehow be compromised because of the “needs of the 400,000”.

                      House purchase decisions by the 40,000 now cannot impact the decisions of the 400,000 in the past. There is no just reason for the state to impose a burden on these 40,000 – to stop them doing the best they can for their families – because of the disastrous decisions of the 400,000 in the past.

                      Now, to be clear, I’m not opposed to sensible regulation of the mortgage market, but these rules should be decided on standalone basis. The idea that future house buyers should face punishment or extra restrictions just because of the dreadful problems the 400,000 have gotten themselves in to is injust.

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