Sinéad Pentony: The issue of mortgage indebtedness has re-emerged. The number of mortgage holders in arrears for more than 3 months has reached 50,000 and this figure will continue to rise. Although we often hear that the level of repossessions in Ireland is low compared to our nearest neighbour the UK, the latest Global Distressed Property Monitor survey from the Royal Institution of Chartered Surveyors published today puts the scale of the problems in the Irish property market in a global context.
The survey finds “that Ireland has the highest projected number of foreclosures and sales by owners who cannot meet rising repayment fees”. The RICS survey also highlights the problems in the Euro periphery (Ireland, Spain and Portugal) where “the property market in these countries is riddled with both a high number of foreclosures and brand new homes which can't attract buyers. To boot, investment funds have lost interest in these markets as their economies try to balance bank bailouts and rising government deficits.”
The issue of mortgage over-indebtedness has been exacerbated by austerity measures, with more and more people going into arrears as their income declines through pay cuts and through unemployment or underemployment. Unsustainable mortgages are not just a problem for individual mortgage holders; they are a problem for the wider economy - given the scale of the debt overhang. Over-indebtedness has a strangling effect on the economy as a growing proportion of spending goes towards trying to service debts from a declining income.
The economy is caught in just such a debt deflation stranglehold. Historical experience has shown that lingering private debt overhangs delay the exit from stagnation because private spending takes longer to recover. The next three years of cuts will amplify this phenomenon.
Although Ireland is not unique in experiencing the problem of unsustainable mortgages the vast scale of the problem requires some fresh thinking and consideration of measures that have been tried and tested in other countries. Debt forgiveness (write-down) and debt restructuring are just two such measures.
In recent months there have been reports of individuals negotiating a write-down of their mortgage debt following the sale of distressed properties. However, these measures need to be part of a robust policy framework that mortgage holders and lending institutions can work within. Radical problems sometimes require radical remedies, and while proper analysis of the likely knock-on effects is required, it makes no sense to take any option off the table at this point.
Showing posts with label personal debt. Show all posts
Showing posts with label personal debt. Show all posts
Thursday, 25 August 2011
Tuesday, 8 February 2011
Credit cards in December
An Saoi: The Central Bank provides an analysis of credit cards as part of its monthly statistical report. It is the very final Table in the monthly report. It is of interest because expenditure on credit cards follows the trend of movement in retail sales, excluding motor vehicles (a person is unlikely to buy a car on a credit card.).
The December figures don't disappoint, and reflect the trend CSO estimates for December (Table 2). Helpfully, the report provides a split between cards held personally and those held for business purposes. The new expenditure on business cards is holding steady, but expenditure on personal cards fell by 11.3% against December 2009 & 27.5% against December 2007, when the Irish recession was getting going. Seamus Coffey has a vey good review, complete with numerous graphs, of the December retail sales available here.
The report also shows an extraordinary decline in the number of personal credit cards issued in Ireland, a drop of 36,000 cards in just one month and a drop of 103,000 in the last twelve, leaving just 2,072,000 in use, still a huge number by continental European standards. This fall is significant in itself as it reflects the closing off of access to short-term borrowing for a very large number of people.
New personal expenditure on the cards has fallen back to the levels of December 2004 and indebtedness is also falling albeit at an excruciatingly slow pace. The balance outstanding (owed) is now “just” 3.37 times the monthly expenditure
It would be interesting to know how many of the cards were cancelled by the issuer or voluntarily handed back. Also how much outstanding debt was written off or converted or “consolidated” into loans on cancellation.
However if we look at the trend, then it is clear that activity in the economy will continue to fall for sometime yet. Credit cards are used by many Irish people for their regular out of pocket purchases. This is called "Froopp" in the language of Eurostat (Frequent Out Of Pocket Purchases), which represent a large proportion of personal expenditure. A drop in credit card activity represents a decline in overall consumer activity. A decline in credit card numbers represents a serious decline in the confidence levels of both the issuing banks and consumers for the future.
Credit card spending is not restricted by weather, indeed bad weather is a boon for internet shopping, for which a credit card is a pre-requisite. The bad weather should be reflected by greater use of credit cards, not less as people used the internet instead of venturing from their homes.
Unless we see some upturn in the domestic economy very soon, the Central Bank's recent gloomy forecasts will begin to look overly optimistic.
The December figures don't disappoint, and reflect the trend CSO estimates for December (Table 2). Helpfully, the report provides a split between cards held personally and those held for business purposes. The new expenditure on business cards is holding steady, but expenditure on personal cards fell by 11.3% against December 2009 & 27.5% against December 2007, when the Irish recession was getting going. Seamus Coffey has a vey good review, complete with numerous graphs, of the December retail sales available here.
The report also shows an extraordinary decline in the number of personal credit cards issued in Ireland, a drop of 36,000 cards in just one month and a drop of 103,000 in the last twelve, leaving just 2,072,000 in use, still a huge number by continental European standards. This fall is significant in itself as it reflects the closing off of access to short-term borrowing for a very large number of people.
New personal expenditure on the cards has fallen back to the levels of December 2004 and indebtedness is also falling albeit at an excruciatingly slow pace. The balance outstanding (owed) is now “just” 3.37 times the monthly expenditure
It would be interesting to know how many of the cards were cancelled by the issuer or voluntarily handed back. Also how much outstanding debt was written off or converted or “consolidated” into loans on cancellation.
However if we look at the trend, then it is clear that activity in the economy will continue to fall for sometime yet. Credit cards are used by many Irish people for their regular out of pocket purchases. This is called "Froopp" in the language of Eurostat (Frequent Out Of Pocket Purchases), which represent a large proportion of personal expenditure. A drop in credit card activity represents a decline in overall consumer activity. A decline in credit card numbers represents a serious decline in the confidence levels of both the issuing banks and consumers for the future.
Credit card spending is not restricted by weather, indeed bad weather is a boon for internet shopping, for which a credit card is a pre-requisite. The bad weather should be reflected by greater use of credit cards, not less as people used the internet instead of venturing from their homes.
Unless we see some upturn in the domestic economy very soon, the Central Bank's recent gloomy forecasts will begin to look overly optimistic.
Wednesday, 31 March 2010
How much are the bank bailouts going to cost us?
Nat O'Connor: There is a lack of clarity about just how much the bank bailout will cost ordinary people. But based on recent news, the estimated costs are huge.
The Irish Independent states that "Every man, woman and child in the State will have to pay an average of €2,000 every year just to service interest payments on borrowings to pay for the bank bailout, estimated to cost €40bn."
In fairness, it's not clear that we have enough information to know that yet. If the banks raise their own capital we won't need to borrow as much. Also, if we part-recapitalise the banks out of the National Pension Reserve Fund (which is what we did before) we will borrow less again. But let's tease out the scale of what borrowing €40 billion would mean.
Unfortunately, not every man, woman and child in Ireland has an income. So will paying the bill fall on the shoulders of Ireland's 1.6 million households, rather than its 4.5 million people? The costs then comes out at roughly €5,600 per year per household. But with state pensioners and other people living on social welfare on incomes of around €12,000, are we talking about halving their incomes and plunging hundreds of thousands of people into destitution?
Alternatively, we could look at the 1.9 million people in employment, who would have to take on an average of €4,600 each (with couples, where both partners are employed, taking on €9,200).
Average earnings for someone in employment in Ireland in 2009 were around €36,300 per year (CSO). So, for example, a single person on this income, already on c. €29,500 after tax, will see their final income fall to around €24,900. (Of course those on lower incomes might pay less, and those on higher incomes might pay more... this is just the average cost applied to the average income).
The cost to those in employment is likely to be lessened by further cuts in public expenditure (social welfare cuts, cuts to pensions, cuts to public capital expenditure, cuts to public services of all kinds, etc). Except that these cuts will also reduce quality of life, health, education, and increase households' costs to fill the gap created by the absence of public services.
And this is just to pay the interest on the loans to bail out the banks.
All the above assumes that NAMA will work and we will only have to pay the interest on the loans for a period of years. If NAMA makes a loss, or further bank bailouts are required, the burden of paying for all this will increase.
If that wasn't bad enough, some people will be further affected by mortgage interest increases. The Belfast Telegraph suggests that AIB "will respond to its latest bailout by raising mortgage rates by a further 1.5% this year." That's on top of this week's 0.5 per cent increase. Assuming the other banks follow suit, that will increase pressure on tens of thousands of households.
Not every household is affected by this double squeeze, but it is hard to see how households will be able to afford to pay another couple of thousand extra per year on their mortgage repayments, alongside bearing the tax increases to pay the interest on the loans to bail out the banks.
It is possible that we could see a major wave of mortgage default and repossession, which would trigger a further crisis in the banks, and a need for further recapitalisation. Those who don't default are likely to be paying way more than they can comfortably afford to keep their homes; all to avoid the nightmare of selling their homes at a low price, while still owing the bank the balance of their original (massive) mortgage loans.
In a year or so, the State could own all or most of the banks, but the citizens who own the State will be paying increased charges to the banks as customers at the same time as paying taxes for the loans to own them. The burden of paying the interest on the loans will all but rule out any productive investment in better infrastructure, better education, etc. Most of our potential for investment will be tied up for years in paying for the mistakes made by past governments.
There is a need for much more accurate information to be made available on exactly how the Government plans on paying for the banks and at what point it would be cheaper to let some of them go bust. We need to know exactly how much households will have to pay and what will be the opportunity cost in cuts to public services and the loss of a generation's ability to invest in a better future. At present we can only speculate. But based on the figures currently in the news, it's a perverse and gloomy situation and we haven't gotten to the bottom of it yet.
The Irish Independent states that "Every man, woman and child in the State will have to pay an average of €2,000 every year just to service interest payments on borrowings to pay for the bank bailout, estimated to cost €40bn."
In fairness, it's not clear that we have enough information to know that yet. If the banks raise their own capital we won't need to borrow as much. Also, if we part-recapitalise the banks out of the National Pension Reserve Fund (which is what we did before) we will borrow less again. But let's tease out the scale of what borrowing €40 billion would mean.
Unfortunately, not every man, woman and child in Ireland has an income. So will paying the bill fall on the shoulders of Ireland's 1.6 million households, rather than its 4.5 million people? The costs then comes out at roughly €5,600 per year per household. But with state pensioners and other people living on social welfare on incomes of around €12,000, are we talking about halving their incomes and plunging hundreds of thousands of people into destitution?
Alternatively, we could look at the 1.9 million people in employment, who would have to take on an average of €4,600 each (with couples, where both partners are employed, taking on €9,200).
Average earnings for someone in employment in Ireland in 2009 were around €36,300 per year (CSO). So, for example, a single person on this income, already on c. €29,500 after tax, will see their final income fall to around €24,900. (Of course those on lower incomes might pay less, and those on higher incomes might pay more... this is just the average cost applied to the average income).
The cost to those in employment is likely to be lessened by further cuts in public expenditure (social welfare cuts, cuts to pensions, cuts to public capital expenditure, cuts to public services of all kinds, etc). Except that these cuts will also reduce quality of life, health, education, and increase households' costs to fill the gap created by the absence of public services.
And this is just to pay the interest on the loans to bail out the banks.
All the above assumes that NAMA will work and we will only have to pay the interest on the loans for a period of years. If NAMA makes a loss, or further bank bailouts are required, the burden of paying for all this will increase.
If that wasn't bad enough, some people will be further affected by mortgage interest increases. The Belfast Telegraph suggests that AIB "will respond to its latest bailout by raising mortgage rates by a further 1.5% this year." That's on top of this week's 0.5 per cent increase. Assuming the other banks follow suit, that will increase pressure on tens of thousands of households.
Not every household is affected by this double squeeze, but it is hard to see how households will be able to afford to pay another couple of thousand extra per year on their mortgage repayments, alongside bearing the tax increases to pay the interest on the loans to bail out the banks.
It is possible that we could see a major wave of mortgage default and repossession, which would trigger a further crisis in the banks, and a need for further recapitalisation. Those who don't default are likely to be paying way more than they can comfortably afford to keep their homes; all to avoid the nightmare of selling their homes at a low price, while still owing the bank the balance of their original (massive) mortgage loans.
In a year or so, the State could own all or most of the banks, but the citizens who own the State will be paying increased charges to the banks as customers at the same time as paying taxes for the loans to own them. The burden of paying the interest on the loans will all but rule out any productive investment in better infrastructure, better education, etc. Most of our potential for investment will be tied up for years in paying for the mistakes made by past governments.
There is a need for much more accurate information to be made available on exactly how the Government plans on paying for the banks and at what point it would be cheaper to let some of them go bust. We need to know exactly how much households will have to pay and what will be the opportunity cost in cuts to public services and the loss of a generation's ability to invest in a better future. At present we can only speculate. But based on the figures currently in the news, it's a perverse and gloomy situation and we haven't gotten to the bottom of it yet.
Monday, 4 January 2010
Personal debt levels
An Saoi: The Central Bank published its preliminary statistics for November a day early, they are available here. The figures continue to make awful reading with no sign that Irish borrowers are getting their personal debts under any form of control. Though you would not get that view from the mainstream media, for example RTÉ’s coverage or Colm Keena’s article in Thursday’s Irish Times where he suggests “Irish people are significantly reducing their personal debt by paying down items such as credit card bills, mortgages and other loans, according to the latest figures from the Central Bank”. Though to give him his due, he does provide a more balanced view as one reads down. Indeed debt as a proportion of GDP/GNP has increased not decreased significantly in the last 12 months.
The Central Bank makes clear that most of the marginal decline in nominal indebtedness was down “…to valuation effects (exchange rate movements, write-downs of loans and increased provisions for bad debts).” and “When valuation effects are accounted for, the underlying stock of PSC was approximately 1.7 per cent lower in November 2009 compared with November 2008.”
Credit Cards are a very clear bell weather of consumer behaviour. They are a very immediate source of credit and have accurately reflected the state of the Irish economy on its downward trajectory. Spending is 5.7% below the level of November 2008, which was itself 16.8% below the November 2007 spending level. Indebtedness has fallen by less than 1% in the past year. The number of business cards remains exactly the same, but the number of personal cards has declined by 46,000 or 2% since the start of 2009. We are now into a second year of declining expenditure on credit cards and the cumulative decline in personal expenditure (on credit cards) of 22.6% in two years, yet personal debt has increased by nearly 8.5% in the same time.
The significance of the levels of personal debt must be seen in the context of declining prices and a shrinking economy. Prices declined by 5.7% to November and GDP is estimated by the Dept. of Finance to be declining by 7.5% and the ESRI suggesting (perhaps conservatively) that house prices in Dublin have declined by 19.1% in the year to October.
Dr. Morgan Kelly’s most recent broadside in Tuesday’s Irish Times and his more detailed paper linked to on this site and on www.irisheconomy.ie , gives us a picture of the type of zombie future we face because of the lack of a proper functioning banking system and unbearable levels of personal debt. Yet the Government continues to spin the myth that NAMA will free up lending. As Dr. Kelly points out our citizens are already the most indebted in the EU. The Central Bank used to publish a quarterly comparison but stopped doing so in June 2008. The last Table published is set out below.
This table of course would look much worse now, when the declines in prices and GNP/GDP are factored in.
Personal cash savings are likely to continue increasing slowly, and the lack of new personal credit will continue to inhibit new spending, let alone the obligations to pay off existing debt. On that basis, it is very hard to see tax yields dependent on personal spending, such as VAT & Excise increasing during 2010 or 2011. However I shall write further on this issue after the publication of the end of the year figures, which are rumoured to be far better than many were expecting. So good in fact they could not help leaking the news to the Sunday Business Post.
The Central Bank makes clear that most of the marginal decline in nominal indebtedness was down “…to valuation effects (exchange rate movements, write-downs of loans and increased provisions for bad debts).” and “When valuation effects are accounted for, the underlying stock of PSC was approximately 1.7 per cent lower in November 2009 compared with November 2008.”
Credit Cards are a very clear bell weather of consumer behaviour. They are a very immediate source of credit and have accurately reflected the state of the Irish economy on its downward trajectory. Spending is 5.7% below the level of November 2008, which was itself 16.8% below the November 2007 spending level. Indebtedness has fallen by less than 1% in the past year. The number of business cards remains exactly the same, but the number of personal cards has declined by 46,000 or 2% since the start of 2009. We are now into a second year of declining expenditure on credit cards and the cumulative decline in personal expenditure (on credit cards) of 22.6% in two years, yet personal debt has increased by nearly 8.5% in the same time.
The significance of the levels of personal debt must be seen in the context of declining prices and a shrinking economy. Prices declined by 5.7% to November and GDP is estimated by the Dept. of Finance to be declining by 7.5% and the ESRI suggesting (perhaps conservatively) that house prices in Dublin have declined by 19.1% in the year to October.
Dr. Morgan Kelly’s most recent broadside in Tuesday’s Irish Times and his more detailed paper linked to on this site and on www.irisheconomy.ie , gives us a picture of the type of zombie future we face because of the lack of a proper functioning banking system and unbearable levels of personal debt. Yet the Government continues to spin the myth that NAMA will free up lending. As Dr. Kelly points out our citizens are already the most indebted in the EU. The Central Bank used to publish a quarterly comparison but stopped doing so in June 2008. The last Table published is set out below.
This table of course would look much worse now, when the declines in prices and GNP/GDP are factored in.
Personal cash savings are likely to continue increasing slowly, and the lack of new personal credit will continue to inhibit new spending, let alone the obligations to pay off existing debt. On that basis, it is very hard to see tax yields dependent on personal spending, such as VAT & Excise increasing during 2010 or 2011. However I shall write further on this issue after the publication of the end of the year figures, which are rumoured to be far better than many were expecting. So good in fact they could not help leaking the news to the Sunday Business Post.
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.
Saturday, 18 April 2009
Analysing credit
An Saoi: Let us assume that the Irish economy will decline by more than 10% in 2009 and that the consumer price index will also fall by around 7%. Without any increase in nominal debt, the value of the debt as a percentage of economic activity will increase by close on 20%.
The CSO has provided us with a reasonable picture of the position in 2008, which is set out in constant (2006) prices and at market prices. Click here to see my estimate of GDP & GNP figures using the above estimates of decline in the economy and the drop in prices.
The level of debt however has moved in a totally different direction, leaving all extremely more likely to default on their debt.
Private debt at 31st December 2008 stood at €424,865M or €344,277 M net of financial intermediation. Assuming that the level of debt remains the same, the debt to GDP ratio would move from 185% to 229% and perhaps more crucially from 220% to 263% when you use GNP. Click here to view a table showing private sector credit / GDP (GNP for Ireland) ratios, taken from Deleveraging the Irish Economy, Goodbody Stockbrokers, Oct. 2008.
Personal debt stood at €172,331M at 31st December 2008, or approx. 50% of total private (non financial intermediation) debt. While this may not increase in nominal terms, the decline in the size of the economy and in its value will dramatically increase it as a percentage of net disposable income.
While the decline in prices may seem extreme, there are substantial drops yet to be seen in the CPI. These include,
- Utility costs, e.g. ESB & gas.
- Imported goods from sterling area have more capacity to fall
- Rent reductions as more and more surplus accommodation chases fewer tenants
- Most recent interest rate cuts
- Falls in commercial rents being passed on.
- Greater competition in the retail sector
- Services sector falls in areas such as hotels, restaurants etc.
There is a great irony in this decline in prices. Ireland needs to get its costs down in comparison to its European competitors, yet the drop in prices is going to create massive other problems. The decline in the year to March has been 2.6%.
Effectively 50% of the commercial private sector debt will be transferred to State by way of NAMA. However the decline in personal income, whether it is caused by unemployment or declining incomes, is going to create a crisis separate from that caused by the developer loans. The balance outstanding on personal credit cards has increased from 2.96 times monthly expenditure in Feb 2008 to 3.8 times monthly expenditure in Feb 2009.
From this we should expect that the Government’s projections of increasing personal consumption from 2010 on will be seriously undermined by the extra debt burden and people’s attempt to deleverage. If this is the case, then their overall GDP/GNP growth projections contained in the recent budget will have to be revised downwards, with all the consequences that will mean for unemployment, investment and the fiscal deficit.
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