Nat O'Connor: Peter Bacon has suggested that semi-state assets be sold, and the money used to pay off the negative equity part of mortgages, where younger households are struggling. (Interview in the Irish Independent, and further article on mortgage debt). On a purely economic level, this is an argument to increase demand and boost the economy. But on a social and political level, it represents an appalling machination that could damage the economy in order to bail out only a small part of the population.
Bacon is correct to identify a need to do something about huge mortgage debt, although the articles do not give a lot of detail about what economic reasons motivated his suggestion. However, one can speculate. On a purely economic basis, bailing out our 'prodigal' sons and daughters would increase their spending, and thus boost aggregate demand in the economy. Releasing younger people from some of their debt would help maximise the productive capacity of the younger generation, and this could benefit the whole economy. But it is not clear that such benefits outweigh the inequality of the suggestion.
Young households who rent, or who bought smaller homes, or who are still living with their parents would receive nothing. Worse, their share of our semi-states would be given over to those younger households who bought more than they could afford.
And selling semi-states at the bottom of the economic cycle is like selling the family silver when everyone else is doing the same, and the price for silver has hit rock bottom in the market. These strategic assets have a role to play in generating annual revenue to bailout the entire country, and should not be sacrificed for the benefit of a minority group.
There are good economic arguments for the state doing something to help those struggling with mortgages, but there are far better methods. For example, the state could subsidise interest rates, so that people continue to pay back their loans, but are not overwhealmed. Keeping the mortgage repayment money flowing to the banks would reduce the cost of bank recapitalisation while helping people pay their debts. Alternatively, the state could set maximum amounts that householders have to pay on their housing costs, like a third of net income, through a deferral scheme. They'd still pay their debts, but more slowly.
Showing posts with label negative equity. Show all posts
Showing posts with label negative equity. Show all posts
Monday, 18 October 2010
Wednesday, 7 July 2010
The 'Prodigal Son' Dilemma in Irish Mortgage Debt
Nat O'Connor: Mortgage payments are on a lot of people's minds these days, and there has been a fair deal of coverage in the media about negative equity. One stark snippet from the Irish Time's today is that "Irish households are among the most indebted in the world – more so than any of their euro zone counterparts. The vast bulk of their debt is accounted for by mortgages." This should worry us all greatly.
The interim report of the Mortgage Arrears and Personal Debt Expert Group suggests some good practice guidelines for lenders. The detail of these has been reported elsewhere (e.g. Irish Times gives an outline, a Q&A, and an analysis, as well as reporting the Financial Regulator's reaction).
I think there is a background assumption around the perception of state intervention in personal debt that needs to be teased out. An extreme contrast illustrates what I see as the 'prodigal son' dilemma. The story is something like what follows. John worked for ten years, saved €500,000, and bought himself a house. That house is now worth €300,000. John can kiss goodbye to €200,000. The value of his investment went down, not up. Meanwhile, Seán got a 110% mortgage to buy an identical house priced at €500,000, next door to John. He borrowed the extra €50,000 (10%) to do up the house, but managed to fit in a holiday and several cases of champagne while he was at it. Seán's house is also now worth €300,000. Both John and Seán are complaining of negative equity. Seán is looking at the spectre of rising interest rates in the medium term and his ability to pay is coming under strain. John would be sickened if Seán got bailed out in some way, as he paid the full price for his house and €200,000 of his money is gone and no one is suggesting he should get it back. State intervention to help Seán often invokes the term 'moral hazard' – that is, encouraging prodigal, reckless, extravagent behaviour.
Some version of this prodigal son idea seems to me to vex a lot of people. Yet, like the original parable, envy or spite might be masking a more reasonable reality.
John has no monthly payments to make, and so he is comfortably off. He lost €200,000 on his investment, but he must take some personal responsibility for choosing to buy when and where he did. Meanwhile, Seán borrowed €550,000, but with interest rates over a long period (say 30 years), Seán will pay back at least €800,000 in total (assuming interest at a relatively low level, like 3 per cent). And Seán could well pay back over €1,000,000 if interest rates go to 5 per cent, and they could go much higher. Meanwhile, house prices may not make any significant rise for the next 30 years. After all, other countries, like Germany, have a very stable market. So Seán could be paying €1,000,000 for a house that in 2040 will still be worth something like €300,000, maybe €400,000, in today's money. Of course, not all of that €1 million will be paid in 2010 prices, but it is still a lot more money than the house is now worth or will be worth. In sum, Seán has 30 years of steep payments to make, while John can live comfortably, save money and make other investments. In the long-term, it was Seán who made a worse investment than John.
It would be one thing if John were to shrug his shoulders, say 'you win some, you lose some' and look to tomorrow. John lost money on his investment, and equally the bank (as a business) will lose money on the loan to Seán if they have to write off part of it. But banks are no longer operating as purely private businesses. John knows that the banks are all being bailed out by the taxpayers. So John is, in a real sense, being asked to swallow his own losses and then help his ‘prodigal’ neighbour too.
Yet clarity on this issue may again be blinded by envy and spite. John is not a heartless capitalist. He believes that the state has a role in providing people with their human rights, such as education, access to healthcare and housing. This is where John needs to put aside his emotions and think business again. He is willing to pay tax to house people who need to be housed. And if the state has to rehouse Seán in social housing or through rent supplement payments, this may represent worse value for taxpayers’ money than assisting him to pay his mortgage. Even if that means writing off €100,000 or €200,000 of his debt.
John might initially think that instead of writing off €200,000, why doesn’t the state buy a house with that amount of money and stick Seán in it. The problem is that if this happens, Seán may default on the whole €550,000 mortgage. And the banks won’t absorb that loss, the taxpayer will – including John.
The best scenario is thus for Seán to be kept going in his house, paying as much of his debt as he can afford, while still living a reasonable quality of life. ‘Affordable’ for housing costs is typically defined as a third of after-tax income.
And because the state is different from commercial entities, it doesn’t even need to write off any amount of Seán’s debt. Instead, the state can take a long-term equity stake; effectively freezing a large chunk of Seán’s mortgage but clawing it back whenever Seán sells the house. The state can even wait until Seán dies and, like the tax inspector, have first claim on Seán’s estate. The state won't make the kind of profits banks make from charging compound interest, but Seán's debt to the state could be linked to house price inflation to avoid it dwindling away.
All of this can be worked out in a businesslike way. What blocks this kind of transaction is the ‘prodigal son’ culture, which could otherwise be termed class prejudice. John doesn’t want to live beside Seán. If Seán is getting state assistance, John wants him to live in inferior quality housing, in a less desirable location. Or at least, John feels that he should get better quality housing in a better area because he paid for it all by himself.
Yet, housing studies consistently argues that social mix creates the most thriving residential areas, with busy shops, less crime, etc. There are also sound economic as well as social arguments for keeping people in their homes, while making their mortgages more affordable.
Ireland can solve its crisis of mortgage debt. But it can only do so through solidarity. The example of John versus Seán is extreme, but as people nurse their wounded pride (and their ‘loss’ in their ‘investment’ in housing), they need to be persuaded of the rationality of helping their prodigal fellow citizens, while also reassured that more responsible borrowers in negative equity will also benefit.
And don’t forget that one in four households pay rent in private or social housing, and they all pay tax too. These are the citizens who are not too interested in the jealousy between one middle class homeowner versus another, as they wrangle over bailing out themselves and the banks. The renter households in Ireland need to be convinced that any mortgage rescue for others, will also involve a whole new national housing policy that will benefit them. That means the state’s role in providing housing must be to ensure everyone receives equally good housing, in a good location with good amenities. We have the means through NAMA, massive quantities of vacant housing and plenty of skilled people who can build the amenities like schools, transport infrastructure, etc that are required to add ‘locational value’ to Ireland massive stock of badly located housing.
And it is the locational value – proximity to services like schools, shops, playgrounds, public transport, green space, etc. – that is the real fundamental in the housing market that will determine quality of life through quality of the built environment.
In this context, the Mortgage Arrears Group’s recommendations really pale into insignificance. They are taking some steps to stop the banks making the situation worse some people by getting them off lower interest tracker mortgages. But the group’s remit does not extend to dealing with the massive crisis in Ireland’s housing system.
In fairness, it is an interim report. The Irish Times reports that “It had been hoped by those struggling with excessive mortgages that the group would recommend some element of debt forgiveness, or introduce debt-for-equity swaps, which would help them to reduce the overall size of their loan. However, this report makes no such suggestions ... In a follow-up report, which is due to be completed by the end of September, the group indicated that it will address the issue of ‘borrowers with unsustainable mortgages’.” But this is not just a problem for those borrowers. The cost will be passed by the banks to all taxpayers. Hence, we need a radical rethink of how we as a society will respond to a crisis that affects all of housing policy.
The interim report of the Mortgage Arrears and Personal Debt Expert Group suggests some good practice guidelines for lenders. The detail of these has been reported elsewhere (e.g. Irish Times gives an outline, a Q&A, and an analysis, as well as reporting the Financial Regulator's reaction).
I think there is a background assumption around the perception of state intervention in personal debt that needs to be teased out. An extreme contrast illustrates what I see as the 'prodigal son' dilemma. The story is something like what follows. John worked for ten years, saved €500,000, and bought himself a house. That house is now worth €300,000. John can kiss goodbye to €200,000. The value of his investment went down, not up. Meanwhile, Seán got a 110% mortgage to buy an identical house priced at €500,000, next door to John. He borrowed the extra €50,000 (10%) to do up the house, but managed to fit in a holiday and several cases of champagne while he was at it. Seán's house is also now worth €300,000. Both John and Seán are complaining of negative equity. Seán is looking at the spectre of rising interest rates in the medium term and his ability to pay is coming under strain. John would be sickened if Seán got bailed out in some way, as he paid the full price for his house and €200,000 of his money is gone and no one is suggesting he should get it back. State intervention to help Seán often invokes the term 'moral hazard' – that is, encouraging prodigal, reckless, extravagent behaviour.
Some version of this prodigal son idea seems to me to vex a lot of people. Yet, like the original parable, envy or spite might be masking a more reasonable reality.
John has no monthly payments to make, and so he is comfortably off. He lost €200,000 on his investment, but he must take some personal responsibility for choosing to buy when and where he did. Meanwhile, Seán borrowed €550,000, but with interest rates over a long period (say 30 years), Seán will pay back at least €800,000 in total (assuming interest at a relatively low level, like 3 per cent). And Seán could well pay back over €1,000,000 if interest rates go to 5 per cent, and they could go much higher. Meanwhile, house prices may not make any significant rise for the next 30 years. After all, other countries, like Germany, have a very stable market. So Seán could be paying €1,000,000 for a house that in 2040 will still be worth something like €300,000, maybe €400,000, in today's money. Of course, not all of that €1 million will be paid in 2010 prices, but it is still a lot more money than the house is now worth or will be worth. In sum, Seán has 30 years of steep payments to make, while John can live comfortably, save money and make other investments. In the long-term, it was Seán who made a worse investment than John.
It would be one thing if John were to shrug his shoulders, say 'you win some, you lose some' and look to tomorrow. John lost money on his investment, and equally the bank (as a business) will lose money on the loan to Seán if they have to write off part of it. But banks are no longer operating as purely private businesses. John knows that the banks are all being bailed out by the taxpayers. So John is, in a real sense, being asked to swallow his own losses and then help his ‘prodigal’ neighbour too.
Yet clarity on this issue may again be blinded by envy and spite. John is not a heartless capitalist. He believes that the state has a role in providing people with their human rights, such as education, access to healthcare and housing. This is where John needs to put aside his emotions and think business again. He is willing to pay tax to house people who need to be housed. And if the state has to rehouse Seán in social housing or through rent supplement payments, this may represent worse value for taxpayers’ money than assisting him to pay his mortgage. Even if that means writing off €100,000 or €200,000 of his debt.
John might initially think that instead of writing off €200,000, why doesn’t the state buy a house with that amount of money and stick Seán in it. The problem is that if this happens, Seán may default on the whole €550,000 mortgage. And the banks won’t absorb that loss, the taxpayer will – including John.
The best scenario is thus for Seán to be kept going in his house, paying as much of his debt as he can afford, while still living a reasonable quality of life. ‘Affordable’ for housing costs is typically defined as a third of after-tax income.
And because the state is different from commercial entities, it doesn’t even need to write off any amount of Seán’s debt. Instead, the state can take a long-term equity stake; effectively freezing a large chunk of Seán’s mortgage but clawing it back whenever Seán sells the house. The state can even wait until Seán dies and, like the tax inspector, have first claim on Seán’s estate. The state won't make the kind of profits banks make from charging compound interest, but Seán's debt to the state could be linked to house price inflation to avoid it dwindling away.
All of this can be worked out in a businesslike way. What blocks this kind of transaction is the ‘prodigal son’ culture, which could otherwise be termed class prejudice. John doesn’t want to live beside Seán. If Seán is getting state assistance, John wants him to live in inferior quality housing, in a less desirable location. Or at least, John feels that he should get better quality housing in a better area because he paid for it all by himself.
Yet, housing studies consistently argues that social mix creates the most thriving residential areas, with busy shops, less crime, etc. There are also sound economic as well as social arguments for keeping people in their homes, while making their mortgages more affordable.
Ireland can solve its crisis of mortgage debt. But it can only do so through solidarity. The example of John versus Seán is extreme, but as people nurse their wounded pride (and their ‘loss’ in their ‘investment’ in housing), they need to be persuaded of the rationality of helping their prodigal fellow citizens, while also reassured that more responsible borrowers in negative equity will also benefit.
And don’t forget that one in four households pay rent in private or social housing, and they all pay tax too. These are the citizens who are not too interested in the jealousy between one middle class homeowner versus another, as they wrangle over bailing out themselves and the banks. The renter households in Ireland need to be convinced that any mortgage rescue for others, will also involve a whole new national housing policy that will benefit them. That means the state’s role in providing housing must be to ensure everyone receives equally good housing, in a good location with good amenities. We have the means through NAMA, massive quantities of vacant housing and plenty of skilled people who can build the amenities like schools, transport infrastructure, etc that are required to add ‘locational value’ to Ireland massive stock of badly located housing.
And it is the locational value – proximity to services like schools, shops, playgrounds, public transport, green space, etc. – that is the real fundamental in the housing market that will determine quality of life through quality of the built environment.
In this context, the Mortgage Arrears Group’s recommendations really pale into insignificance. They are taking some steps to stop the banks making the situation worse some people by getting them off lower interest tracker mortgages. But the group’s remit does not extend to dealing with the massive crisis in Ireland’s housing system.
In fairness, it is an interim report. The Irish Times reports that “It had been hoped by those struggling with excessive mortgages that the group would recommend some element of debt forgiveness, or introduce debt-for-equity swaps, which would help them to reduce the overall size of their loan. However, this report makes no such suggestions ... In a follow-up report, which is due to be completed by the end of September, the group indicated that it will address the issue of ‘borrowers with unsustainable mortgages’.” But this is not just a problem for those borrowers. The cost will be passed by the banks to all taxpayers. Hence, we need a radical rethink of how we as a society will respond to a crisis that affects all of housing policy.
Tuesday, 18 May 2010
Property Tax
Nat O'Connor: The Taoiseach has been talking about the introduction of property tax (Irish Independent, Irish Times).
A part of this is tax on people's residences, although it is important to remember that 'property' has a much wider meaning, in terms of financial assets, other material goods, etc. There is a real risk that discussion of any new tax will focus solely on people's homes and not on other assets.
In the UK, 5 per cent of people own 40 per cent of non-residential assets. The situation in Ireland seems likely to be similar. This is also property wealth and a legitimate question to ask from an equality perspective is what other assets will be taxed by any future property taxes? Given the scale of the gap in the national finances, there is no doubt that assets beyond housing will need to be taxed and could make a vital contribution.
Additionally, on the subject of residential property, there are four inter-related issues that ought to be tackled at the same time: the moral hazard of any mortgage rescue scheme, stamp duty, private renting and local authority funding. But first of all, how much money could property tax bring in?
How much?
One factor affecting property tax is how many housing units are there in Ireland? The 2006 Census reports 1.46 million occupied dwellings, of which c. 1.1 million are owner-occupied. I'm assuming social housing won't be included and landlords (and therefore tenants) are already meant to be paying the €200 per year charge on second or subsequent houses, so let's assume 1.1 million dwellings will be eligible for the tax.
If property tax was also €200 (on average), this would generate €220 million in a year (less operating costs and assuming full compliance). Not bad, but not on the scale of really dealing with the €8.3 billion non-cyclical gap between tax revenue and spending identified in an earlier blog. So, you'd really need to be talking €1,000 per year (on average) before making a real dent, which would bring in €1.1 billion. To put this in context, the projected tax take for 2010 is c. €32 billion.
The next question is how much can people afford to pay? Well, this varies a lot. However, many people on low incomes in rented accommodation won't be affected. A flat tax of whatever amount will be regressive; costing proportionately more to those on lower incomes. Hence, there needs to be a strong link between the tax and both the value of property and people's ability to pay. Wealthier people in bigger houses in nicer locations should pay multiples of what lower income people in small apartments in peripheral areas pay.
In terms of those who can afford to pay more, there is an opportuntiy to introduce something like the (now dropped) policy of the UK's Lib-Dems to introduce a 'mansion tax' of 0.5 per cent of the value of houses over ST£1 million (which was estimated to cost 250,000 householders over ST£4,000 per year)? Given that house prices grow steeply at the high end, it seems reasonable to expect that property tax will also be high for so-called 'trophy homes'.
Those reliant on the state pension who own their own homes will be the most vulnerable, as they may be 'asset rich but cash poor'. People in these situations could be allowed to defer the tax with no interest until their decease, whereon their estate could pay.
Yet, to return to the possible figure of €1.1 billion from property tax (at an average of €1,000), this would play a useful role in closing the €8.3 billion gap. However, the remaining €7.2 billion indicates the need to look beyond residential property. Hence, taxes on other non-housing assets may be a necessity.
The Moral Hazard of Any Mortgage Rescue Scheme
One of the real consequences of any residential property tax is that it may push householders struggling to pay their mortgages over the edge. Yet, any waiver for people with problems paying their mortgages must be seen as a type of mortgage rescue, which therefore invokes the question of moral hazard; that is, why should the State help people (who perhaps borrowed too much) to pay their debts so that they can own property, when other taxpayers did not put themselves in this situation. This question will need to be addressed. Either property tax will be allowed to be the final straw for thousands of mortgage-holders, or else (if there's a waiver) the moral hazard question arises. One solution would be to allow tax deferral, like for people with valuable housing but low incomes. This way everyone pays their fair share, but people with high mortgages are not pushed into default.
Stamp Duty
One suggestion of the 2009 Commission on Taxation report was that "homeowners who have paid stamp duty would be exempt from the annual property tax for seven years from the time they bought their property." (Irish Times report). This is a small compensation to those who paid tens of thousands in stamp duty. Yet, is the current proposal to eliminate stamp duty, or will property tax add to it? If we eliminate stamp duty (projected to provide just under €1 billion in 2010) residential property tax won't add much to tax revenue in the short-term, but it should stabilise revenue from this source (e.g. stamp duty collapsed from a height of €3.7 billion in 2006, and is unlikely to return to anything like that level). Given the crisis in the national finances, it makes sense to keep stamp duty in place as well as property tax.
Private Renting
Property tax will raise the cost of home ownership. Combined with everything else that's gone wrong in the economy, this factor is likely to lead more people to rent long-term. Yet another reason for the State to strengthen the protection of tenants to make renting a family-friendly option and an older age-friendly option.
Local Authority Funding
One possible role for property tax is to fund local authorities, which are set to spend a large chunk of the Department of the Environment's €2.2 billion allocation in 2010 (Revised Estimates 2010). On the local government scale, €1.1 billion in property tax could form the backbone of a coherent funding system (along with commercial rates, motor tax, waste charges and water charges). This would open up the possibility of local authorities varying the amount of property tax they charge, which might be more appropriate than a one-size-fits-all national formula, given how housing prices vary greatly across the country.
The original decision to abolish domestic rates undermined local government funding (followed by the legal case that removed agricultural rates also). The introduction of property tax is an opportunity to fix this system, above and beyond merely adding another patch to the national finances.
A part of this is tax on people's residences, although it is important to remember that 'property' has a much wider meaning, in terms of financial assets, other material goods, etc. There is a real risk that discussion of any new tax will focus solely on people's homes and not on other assets.
In the UK, 5 per cent of people own 40 per cent of non-residential assets. The situation in Ireland seems likely to be similar. This is also property wealth and a legitimate question to ask from an equality perspective is what other assets will be taxed by any future property taxes? Given the scale of the gap in the national finances, there is no doubt that assets beyond housing will need to be taxed and could make a vital contribution.
Additionally, on the subject of residential property, there are four inter-related issues that ought to be tackled at the same time: the moral hazard of any mortgage rescue scheme, stamp duty, private renting and local authority funding. But first of all, how much money could property tax bring in?
How much?
One factor affecting property tax is how many housing units are there in Ireland? The 2006 Census reports 1.46 million occupied dwellings, of which c. 1.1 million are owner-occupied. I'm assuming social housing won't be included and landlords (and therefore tenants) are already meant to be paying the €200 per year charge on second or subsequent houses, so let's assume 1.1 million dwellings will be eligible for the tax.
If property tax was also €200 (on average), this would generate €220 million in a year (less operating costs and assuming full compliance). Not bad, but not on the scale of really dealing with the €8.3 billion non-cyclical gap between tax revenue and spending identified in an earlier blog. So, you'd really need to be talking €1,000 per year (on average) before making a real dent, which would bring in €1.1 billion. To put this in context, the projected tax take for 2010 is c. €32 billion.
The next question is how much can people afford to pay? Well, this varies a lot. However, many people on low incomes in rented accommodation won't be affected. A flat tax of whatever amount will be regressive; costing proportionately more to those on lower incomes. Hence, there needs to be a strong link between the tax and both the value of property and people's ability to pay. Wealthier people in bigger houses in nicer locations should pay multiples of what lower income people in small apartments in peripheral areas pay.
In terms of those who can afford to pay more, there is an opportuntiy to introduce something like the (now dropped) policy of the UK's Lib-Dems to introduce a 'mansion tax' of 0.5 per cent of the value of houses over ST£1 million (which was estimated to cost 250,000 householders over ST£4,000 per year)? Given that house prices grow steeply at the high end, it seems reasonable to expect that property tax will also be high for so-called 'trophy homes'.
Those reliant on the state pension who own their own homes will be the most vulnerable, as they may be 'asset rich but cash poor'. People in these situations could be allowed to defer the tax with no interest until their decease, whereon their estate could pay.
Yet, to return to the possible figure of €1.1 billion from property tax (at an average of €1,000), this would play a useful role in closing the €8.3 billion gap. However, the remaining €7.2 billion indicates the need to look beyond residential property. Hence, taxes on other non-housing assets may be a necessity.
The Moral Hazard of Any Mortgage Rescue Scheme
One of the real consequences of any residential property tax is that it may push householders struggling to pay their mortgages over the edge. Yet, any waiver for people with problems paying their mortgages must be seen as a type of mortgage rescue, which therefore invokes the question of moral hazard; that is, why should the State help people (who perhaps borrowed too much) to pay their debts so that they can own property, when other taxpayers did not put themselves in this situation. This question will need to be addressed. Either property tax will be allowed to be the final straw for thousands of mortgage-holders, or else (if there's a waiver) the moral hazard question arises. One solution would be to allow tax deferral, like for people with valuable housing but low incomes. This way everyone pays their fair share, but people with high mortgages are not pushed into default.
Stamp Duty
One suggestion of the 2009 Commission on Taxation report was that "homeowners who have paid stamp duty would be exempt from the annual property tax for seven years from the time they bought their property." (Irish Times report). This is a small compensation to those who paid tens of thousands in stamp duty. Yet, is the current proposal to eliminate stamp duty, or will property tax add to it? If we eliminate stamp duty (projected to provide just under €1 billion in 2010) residential property tax won't add much to tax revenue in the short-term, but it should stabilise revenue from this source (e.g. stamp duty collapsed from a height of €3.7 billion in 2006, and is unlikely to return to anything like that level). Given the crisis in the national finances, it makes sense to keep stamp duty in place as well as property tax.
Private Renting
Property tax will raise the cost of home ownership. Combined with everything else that's gone wrong in the economy, this factor is likely to lead more people to rent long-term. Yet another reason for the State to strengthen the protection of tenants to make renting a family-friendly option and an older age-friendly option.
Local Authority Funding
One possible role for property tax is to fund local authorities, which are set to spend a large chunk of the Department of the Environment's €2.2 billion allocation in 2010 (Revised Estimates 2010). On the local government scale, €1.1 billion in property tax could form the backbone of a coherent funding system (along with commercial rates, motor tax, waste charges and water charges). This would open up the possibility of local authorities varying the amount of property tax they charge, which might be more appropriate than a one-size-fits-all national formula, given how housing prices vary greatly across the country.
The original decision to abolish domestic rates undermined local government funding (followed by the legal case that removed agricultural rates also). The introduction of property tax is an opportunity to fix this system, above and beyond merely adding another patch to the national finances.
Tuesday, 6 October 2009
There are worse things than 'negative equity'
Nat O'Connor: There continue to be stories about falling housing prices (for example). We need to get some sense of what are reasonable housing costs and use this as a basis to co-ordinate policy and aim for stable housing costs.
Earlier in this blog, An Saoi has suggested that the current incarnation of NAMA is dependent on reinflating the property bubble. It's not the only state policy that may inflate property prices: the state pays the rent of over half of the private rented sector, it uses major tax expenditures to incentivise development and home ownership, and the move to leasing as the main source of social housing will also have a major effect on the rental market. None of these policies may have the explicit goal of propping up property prices, but there is no denying that huge state involvement in the property sector will have a significant effect.
High property prices sustained through public expenditure would be wasteful and are unsustainable. So, we need some kind of objective yardstick that might give us a sense of what housing costs would be reasonable. It is difficult to objectively identify a 'market' price when the state has such an influence on prices.
In the US housing market, long-term house prices appear to settle between 12 and 20 times annual rental yield value. In other words, if I can rent a house for 10,000 a year, it is worth somewhere between 120,000 to 200,000.
Irish house asking prices vary between 20 and 34 times their annual rental yield, for 3-bed houses in County Dublin, Galway City, Waterford City and Cork City. (Comparison based on DAFT house prices versus rent snapshot, Quarter 2, 2009). This suggests that they have further to fall before we get to some kind of sustainable position.
The above Irish Times article concludes (despite the weakness of the available data) that "it is likely that most people who acquired their home in the past five years are now experiencing some degree of negative equity."
Yes. There can be little doubt that the overdue, massive correction in the housing market means that house prices may have to fall a great deal and they may never again rise to anything like the equivalent of their inflated value. Remember, we had a crazy unsustainable situation where we generated a massive surplus of housing stock and yet prices rose steeply. So, 'negative equity' is definitely going to happen for many people.
But is negative equity such a bad thing? Well, first of all we need to separate the whole concept of housing-as-equity from the more basic concept of housing costs; that is, how much it costs to live somewhere in terms of rent or mortgage and associated charges.
If a lot of people cannot keep their housing costs to a reasonable proportion of their income, then that is a big problem. How much is a reasonable level of housing costs? It is suggested that housing costs shouldn't be more than a third of net household income. A household might choose to pay more in order to own or to live in a bigger house/nicer area, but this should be a choice. The state's goal should be for households to have the option of reasonable housing costing no more than a third of their income.
When households have high housing costs, it dampens their ability to do other things (which lessens overall economic activity). High housing costs also lowers Ireland's competitiveness. And when households cannot afford housing, the state currently expends resources assisting them: e.g. rent supplement, social housing, etc. It would be perverse for the state to also be expending resources that (intentionally or not) artificially maintain high house prices and rents. Essentially, the state would be raising costs that push more people to seek state assistance to meet those costs! That's unsustainable, but perhaps not so far from the current situation.
The only way out is for the state to allow a lot of households to enter negative equity; in the sense of the state avoiding actions that will inflate house prices. If households can meet their housing costs, then they will remain housed. So, that's problem number one taken care of.
If housing costs can be met (at a reasonable proportion of income), what is the remaining problem with negative equity? There seem to be three aspects to this: One is that the mobility of the household is constrained; Two is the loss of households' capital; and Three is that owner occupiers may end up paying unreasonably high housing costs.
1: A lot of people are perhaps realising that their 'starter home' may be for more than a few years. It's a pity we built so many small houses. The problem of mobility is really one of lack of uncertainty in the market, combined with a lack of credit, exacerbated by lower incomes. In other words, people are hanging on to see if they can sell for more and/or buy for less. However, if the house you sell and the house you buy are both down say €100,000, then you don't really lose out. But only if you can find a buyer for your house and only if the banks will remortgage you in your new house on the same terms as the old one.
2: The second aspect of negative equity is that people lose money that they could have spent elsewhere. Worse, they haven't lost it yet, but will continue to 'lose' it over the years where they pay more in mortgage payments than they would either in rent or if they bought when prices crashed. There is really not a lot the state can do about this. The news, like for bank shareholders, is that "the value of your investment went down, not up". Depending on how interest rates turn out, some people might actually be better off selling, write off their losses now and start again; although that may mean renting for life. Having said that, once the cost of the mortgage is even close to the cost of renting, the mortgage holder still gets to keep an asset at the end of the day, which the renter doesn't. The asset just ends up being more expensive than initially hoped for.
3: There is a risk that some owner occupiers will end up paying way above a third of their income on housing costs. Especially the newly unemployed, those who took out sub-prime mortgages or those who have lengthy fixed-rated high interest periods built into their loan. And if people get into arrears, penalty charges and a higher rate of interest can apply.
Which brings me back to the beginning. There would be a lot to be said for a state target of stable house prices in the long term. So, the state needs to examine carefully all the ways in which its actions affect the property market. Above all else, we must avoid another property price bubble, or we'll just repeat the madness all over again.
Now for the bad news, for a small number of mortgage holders in arrears, negative equity is part of a worse situation; that is, negative equity plus the inability to meet housing costs. Due to unemployment, a 100%+ mortgage or 'equity release' loans, or because their home was particularly high priced, these mortgage holders' property is not worth as much as what they paid for it AND they are unable to make their payments on it. The risk here is that these households will throw everything they've got into trying to pay arrears and punative interest rates, but in the end, despite years paying far too much for housing, they will eventually be repossessed. Not only that, but they are likely to still owe a large sum to a lender, which will not only prevent them buying again, but will take a chunk of their net income and limit their life options in many ways.
The state should have access to data about arrears and the level of household indebtedness, either through the Financial Regulator or through asking lenders directly for it.
It is the nightmare scenario of a combination of negative equity plus an inability to pay that will affect hundreds, maybe thousands of households; often those who signed up to sub-prime mortgages or who were pursuaded to 'release equity' from their homes. Yes, there was individual choice in this - but the lax regulation of credit certainly did not help. Those who get foreclosed in this above manner will end up seeking housing assistance from the state (either through rent supplement or social housing). There is an opportunity for the state to act now, to save these families much hardship and to help them restructure their debt while they still have more ability to manage it.
For example, the state (or NAMA) could act now to freeze their penalty payments, restructure their debt, and maybe fund the local authorities to buy half their property in a reverse version of the current shared ownership scheme. This will cost money, but it could be cheaper than waiting for them to become impoverished and then housing them; and it would certainly be more decent.
Earlier in this blog, An Saoi has suggested that the current incarnation of NAMA is dependent on reinflating the property bubble. It's not the only state policy that may inflate property prices: the state pays the rent of over half of the private rented sector, it uses major tax expenditures to incentivise development and home ownership, and the move to leasing as the main source of social housing will also have a major effect on the rental market. None of these policies may have the explicit goal of propping up property prices, but there is no denying that huge state involvement in the property sector will have a significant effect.
High property prices sustained through public expenditure would be wasteful and are unsustainable. So, we need some kind of objective yardstick that might give us a sense of what housing costs would be reasonable. It is difficult to objectively identify a 'market' price when the state has such an influence on prices.
In the US housing market, long-term house prices appear to settle between 12 and 20 times annual rental yield value. In other words, if I can rent a house for 10,000 a year, it is worth somewhere between 120,000 to 200,000.
Irish house asking prices vary between 20 and 34 times their annual rental yield, for 3-bed houses in County Dublin, Galway City, Waterford City and Cork City. (Comparison based on DAFT house prices versus rent snapshot, Quarter 2, 2009). This suggests that they have further to fall before we get to some kind of sustainable position.
The above Irish Times article concludes (despite the weakness of the available data) that "it is likely that most people who acquired their home in the past five years are now experiencing some degree of negative equity."
Yes. There can be little doubt that the overdue, massive correction in the housing market means that house prices may have to fall a great deal and they may never again rise to anything like the equivalent of their inflated value. Remember, we had a crazy unsustainable situation where we generated a massive surplus of housing stock and yet prices rose steeply. So, 'negative equity' is definitely going to happen for many people.
But is negative equity such a bad thing? Well, first of all we need to separate the whole concept of housing-as-equity from the more basic concept of housing costs; that is, how much it costs to live somewhere in terms of rent or mortgage and associated charges.
If a lot of people cannot keep their housing costs to a reasonable proportion of their income, then that is a big problem. How much is a reasonable level of housing costs? It is suggested that housing costs shouldn't be more than a third of net household income. A household might choose to pay more in order to own or to live in a bigger house/nicer area, but this should be a choice. The state's goal should be for households to have the option of reasonable housing costing no more than a third of their income.
When households have high housing costs, it dampens their ability to do other things (which lessens overall economic activity). High housing costs also lowers Ireland's competitiveness. And when households cannot afford housing, the state currently expends resources assisting them: e.g. rent supplement, social housing, etc. It would be perverse for the state to also be expending resources that (intentionally or not) artificially maintain high house prices and rents. Essentially, the state would be raising costs that push more people to seek state assistance to meet those costs! That's unsustainable, but perhaps not so far from the current situation.
The only way out is for the state to allow a lot of households to enter negative equity; in the sense of the state avoiding actions that will inflate house prices. If households can meet their housing costs, then they will remain housed. So, that's problem number one taken care of.
If housing costs can be met (at a reasonable proportion of income), what is the remaining problem with negative equity? There seem to be three aspects to this: One is that the mobility of the household is constrained; Two is the loss of households' capital; and Three is that owner occupiers may end up paying unreasonably high housing costs.
1: A lot of people are perhaps realising that their 'starter home' may be for more than a few years. It's a pity we built so many small houses. The problem of mobility is really one of lack of uncertainty in the market, combined with a lack of credit, exacerbated by lower incomes. In other words, people are hanging on to see if they can sell for more and/or buy for less. However, if the house you sell and the house you buy are both down say €100,000, then you don't really lose out. But only if you can find a buyer for your house and only if the banks will remortgage you in your new house on the same terms as the old one.
2: The second aspect of negative equity is that people lose money that they could have spent elsewhere. Worse, they haven't lost it yet, but will continue to 'lose' it over the years where they pay more in mortgage payments than they would either in rent or if they bought when prices crashed. There is really not a lot the state can do about this. The news, like for bank shareholders, is that "the value of your investment went down, not up". Depending on how interest rates turn out, some people might actually be better off selling, write off their losses now and start again; although that may mean renting for life. Having said that, once the cost of the mortgage is even close to the cost of renting, the mortgage holder still gets to keep an asset at the end of the day, which the renter doesn't. The asset just ends up being more expensive than initially hoped for.
3: There is a risk that some owner occupiers will end up paying way above a third of their income on housing costs. Especially the newly unemployed, those who took out sub-prime mortgages or those who have lengthy fixed-rated high interest periods built into their loan. And if people get into arrears, penalty charges and a higher rate of interest can apply.
Which brings me back to the beginning. There would be a lot to be said for a state target of stable house prices in the long term. So, the state needs to examine carefully all the ways in which its actions affect the property market. Above all else, we must avoid another property price bubble, or we'll just repeat the madness all over again.
Now for the bad news, for a small number of mortgage holders in arrears, negative equity is part of a worse situation; that is, negative equity plus the inability to meet housing costs. Due to unemployment, a 100%+ mortgage or 'equity release' loans, or because their home was particularly high priced, these mortgage holders' property is not worth as much as what they paid for it AND they are unable to make their payments on it. The risk here is that these households will throw everything they've got into trying to pay arrears and punative interest rates, but in the end, despite years paying far too much for housing, they will eventually be repossessed. Not only that, but they are likely to still owe a large sum to a lender, which will not only prevent them buying again, but will take a chunk of their net income and limit their life options in many ways.
The state should have access to data about arrears and the level of household indebtedness, either through the Financial Regulator or through asking lenders directly for it.
It is the nightmare scenario of a combination of negative equity plus an inability to pay that will affect hundreds, maybe thousands of households; often those who signed up to sub-prime mortgages or who were pursuaded to 'release equity' from their homes. Yes, there was individual choice in this - but the lax regulation of credit certainly did not help. Those who get foreclosed in this above manner will end up seeking housing assistance from the state (either through rent supplement or social housing). There is an opportunity for the state to act now, to save these families much hardship and to help them restructure their debt while they still have more ability to manage it.
For example, the state (or NAMA) could act now to freeze their penalty payments, restructure their debt, and maybe fund the local authorities to buy half their property in a reverse version of the current shared ownership scheme. This will cost money, but it could be cheaper than waiting for them to become impoverished and then housing them; and it would certainly be more decent.
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