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.
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.