Friday, 12 November 2010

Mortgage forgiveness - an alternative

The "mortgage forgiveness" proposal is a bad idea. Firstly it does threaten to introduce as well as exacerbate moral hazard problems (these have been quite transparently glossed over by some of the scheme's proponents), but worst of all is that it will not have any material macroeconomic benefit. To suggest it will is absurd, to borrow a phrase.

The reason is because this scheme will only transfer wealth between parts of Irish society, when the problem is our complete lack of wealth in total, or more accurately our now massive net indebtedness as a country.

The proponents say it will address the "mortgage default overhang", which is essentially to say that it will allow further required contraction in the balance sheets of the Irish banking system by writing down those banks' assets. However, it will do so in exactly the same way that the hair brained NAMA scheme has and will. It will create a capital hole in the Irish financial system which will be filled by government borrowing. It didn't work for NAMA I and that was when Ireland was far less grossly indebted than it is now. This mortgage forgiveness will be NAMA II, where taxpayers are forced to pile even more of their money into those same banks from a far far more indebted starting point. It is a really really bad idea, especially because we have only just tried this stupid idea, it didn't work.

So what should we do? This is what we should do:

  1. Modernise Ireland's bankruptcy laws. There are many models in the UK, US etc., but they have similar features in that the force a crystallisation of loss on the debtor and creditor, the debtor is required to make as realistic reparation and there is a clear finite term (say 5-10 years).
  2. Repeal the bank guarantees - yes I have said it countless times since I declared it hair brained upon its introduction. Of course that leads to bank collapse, so you take them into nationalised administration under some properly drafted legislation (what they should have done in the first place) and begin capital restructuring talks with creditors while allowing them to continue business.
  3. End the political coercion that is stopping forclosure on mortgage holders who are defaulting on their loans.
  4. Let markets get at it.
What would this do? Well it would do the following that the "Times 12" proposal will never do:

  • It will have a beneficial macroeconomic effect. As banks begin to write down bad mortgages as they deal with them on a case by case basis, capital losses will be taken by the banks risk capital investors - mostly foreign - and not Irish residents. There will be a positive net wealth outcome for the Irish economy.
  • It will be much more efficient. The lenders themselves are best positioned to determined what mortgages will or will not ever provide an economic return and they can foreclose and take the write down under the modernised bankruptcy laws. Simply having "negative equity" won't be enough - nor should it.
  • Banks balance sheets will contract in a relatively orderly and proper way, with liabilities falling as well. Smaller balance sheet less encumbered by non performing loans.
  • This will be far more equitable. This won't represent the arbitrary transfer of wealth being proposed by the Times 12. Those who lose will be those who lent the risk capital to the banks, not Irish taxpayers who managed their financial affairs sensibly.
  • Reduced likelihood that we promote moral hazard. Although modernised bankruptcy procedures would allow a clear exit path for borrowers beyond the point of no return, it would still be onerous and clearly punishing. Effectively, having to work for your creditors and your creditors alone for 5 years or more isn't an attractive option.
  • It won't treat the existance of "negative equity" as a problem. It isn't People in negative equity have exactly the same fixed cash flow burden they anticipated when they borrowed the money. They still have their property and as long as they continue to pay off their mortgage there is no problem to try and "solve".

1 comment:

Fungus FitzJuggler III said...

Good ideas and well put!

People have to realize that your solution is kindest and more importantly, quickest. The Japan situation shows what happens when banks are pampered. The economy stalls. For decades!

Let us get going next year by followiong your plan!