Home truths for Charlie Weston

Charlie Weston is the Personal Finance Editor of the Irish Independent. The Irish Independent in turn is probably the greatest receptacle of garbage posturing as journalism in Ireland. It is match made in heaven.

Friday is the day refuse is collected up my street. Friday was the day Charlie wrote this "opinion" piece:

http://www.independent.ie/opinion/columnists/charlie-weston/charlie-weston-lenders-ignoring-home-truths-with-rate-hikes-2252146.html

This gives the gist of the column:

IT makes little sense, and it was probably never meant to. At a time when record numbers of homeowners are at the pin of their collars trying to repay their mortgages, lenders are piling on the pressure by hiking interest rates.

In the past year alone, mortgage interest costs have shot up by 16.5pc, according to the Central Statistics Office.

The CSO only looks at standard variable rates when it examines mortgage costs, so the statisticians are reflecting the pain being borne by those with these variable mortgages.

Lenders are free to push up variable rates whenever they want -- something households with these types of mortgages have learned to their costs in the past year.

It is hard to get your head around the 16.5pc figure, but what it means is that a family with a not-untypical mortgage of €250,000 has seen the annual cost of repaying it jump by €1,300 in the past 12 months.

In monthly repayment terms the original payment of €954 a year ago has now zoomed up to €1,110, based on two separate 0.5pc increases in the past year.

...

This is at a time when the European Central Bank has not moved its main rate off it record low of 1pc since May last year

Such drivel perpetuates ignorance of financial matters. That would seem to me to be at odds with the general job description of a "Personal Finance Editor", even at a newspaper that chooses to inhabit the lower reaches of the newsprint media.

The ECB rate Weston refers to is of course the "refi" rate. This is the rate at which banks can secure short term liquidity (but increasingly long term over the financial crisis and beyond) by handing over assets like government bonds as collateral. It is a bit like going to the pawn broker. Of course, at the moment the pawnbroker is acting like Saint Vincent de Paul, charging banks little in interest and allowing more freedom in terms of collateral and term. Nevertheless this is short term and requires assets to be handed over.

What this refi does not do is determine the total cost of money bank have available to lend at all times, because that is determined by the major sources of their capital which includes:

• What banks need to pay to attract deposits
• What banks need to pay as interest in short and long term bonds to investors
• What banks need to pay other banks for short term borrowings (interbank funds)

All these are determined by a number of factors that are determined by the market in general and the specific bank concerned. Needless to say that the agents listed above (depositors, other banks, investors) have been and continue to be far less interested in giving charity to Irish banks - which is what the 1% ECB refi rate effectively is.

So the point good old Charlie should be making plain is that mortgages have gone up because that is the true cost of the money borrowed by Irish households. It is now better reflecting what they should be paying given what a risky proposition they are. In fact, what a risky proposition they always were, but haven't had to pay over the bubble times.

Of course I get the feeling that the intention of the piece is to make people think that banks are profiteering. As an unwilling shareholder in Irish banks, like every other Irish taxpayer, I only wish that was the case.

And just to put things into proper perspective, despite these shocking increases that Charlie is up in arms about standard variable rates range from a low of less than 3% for the most attractive customers up to the more typical 4%. To claim this is usury borders on outright lie. Strange how Charlie never specifically mentions these rates. I wonder why.

What figures Charlie does throw around includes the €1,300 annual increase in mortgage repayments for a hypothetical €250,000 mortgage. This is apparently beyond the pale according to Charlie, although remember this is price charged for something borrowers voluntarily agreed with the bank.

Here is something that is also putting "hard pressed homeowners" under pressure. It is also something that is dumped on homeowners with no choice on their part. Tax. Yes, if we imagine that this hypothetical €250,000 mortgage is held by a homeowner with a €65,000 salary (€250,000 is too much to borrow on that level of income, but it is a realistic scenario in Ireland - hence the problems) we would note that the tax burden of such a person has increased by about €2,600 over the last couple of years. And you can bet that homeowner didn't voluntarily enter into an agreement to set up one of the most over inflated, wasteful, inefficient and in far too many areas completely pointless public sector.

No the politicians decide that and simply send the bill.

But the following is the kickker as far as Charlie is concerned. This is what he wrote around a year ago, when the problem wasn't rising variable rates, but falling rates, which those people who had fixed their mortgage could not participate in and would need to pay some recompense to the bank if they wanted to welch on their deal.

http://www.independent.ie/business/personal-finance/fixed-rate-mortgages-fee-could--be-waived-1721541.html

Some people on fixed rates are paying up to €600 more a month more than those on variable home loan deals.

But to get out of these deals lenders impose a penalty, called a redemption fee. This is the cost difference between the rate the customer is on (which can be as high as 6pc) and the rate presently charged on its variable rate.

...

Granted, people locked into bad value fixed rates should have been aware of what they were getting into.

But as enormous flexibility has been shown towards our banks by the State, it is not unreasonable to expect banks to be flexible towards those stuck on fixed rates.

I would hate to enter into any type of wager with Charlie. Could you imagine the rules; "heads I win tails you lose".

A NAMA for the people

RTE 1 on the weekend had a panel with David McWilliams and some other members of the Irish social firmament bandying around yet more blah blah blah (excuse my sudden inability to articulate intelligently) about the Irish economy and our mess.

Yet again the cry for a "Peoples' NAMA", under the now common belief that NAMA was designed as a type of debt forgiveness program. Well, it may appear to be run that way, but the cold hard facts are that a "NAMA for the People" would do this:

• Transfer all the outstanding mortgages of those people deemed to be in "negative equity" to a special purpose vehicle - that just means a new company of some sort.
• Call in the mortgages of all those people.
• Begin to foreclose on those people who can't repay and plan for an orderly disposal of the houses.
• Pursue the outstanding amounts (the amount of the mortgage shortfall following the sale of the house) out of any other asset these people might have to the point of bankruptcy.
  

In theory, that is what a "NAMA for the People" would be. I was surprised that David MacWilliams failed to point that out to the journalist, lawyer, politician and broadcaster present and the many people listening.

I wish people with their hands on the microphones to the nation would stop perpetuating this fallacy that NAMA is a bailout. It is certainly the case that people who had command of tens or hundreds of millions of Euros - albeit borrowed - can legally squirrel a nice wedge away protected from future creditors. But it doesn't mean the process to recover as much money as possible from them and their companies is a "bailout" simply because it is frustrated by legal financial shenanigans and the underlying fact that there simply isn't enough money to repay all the debt.

So let's stop the cute hoor nonsense about "NAMA for the People" and start being honest. How about a "Money Grab for the Stupid People". Sound harsh? Well, not harsh enough for those who would insist I and other prudent savers in Ireland now pay to give them a fresh financial start. This isn't a diatribe against those people who are now in negative equity -mistakes are made. Many of those people will quietly and diligently save their way out of their predicament and as a nation we should hold them up as admirable. But I reserve disdain for those who would demand the government expropriate the savings or income of others so that they get a free ride.

The NAMA amateur players

I predict that NAMA is going to be the most entertaining theatre seen in the State since Oscar Wilde was in short pants. Already we have high farce, turning effortlessly to abstract fiction in the blink of an eye.

The first round of invitations to the NAMA drama, the opening night one might say, included the debts of one Ballymore Properties. This is a private company, originally the brainchild of Sean Mulryan - one of Ireland's "Masters of the [property developers] Universe". All I can gleen at the moment, given the paucity of information about how someone else is spending your and my hard earned income, is that Ballymore debt has been transferred to NAMA and the average NAMA discount was 47%.

Now, a logical conclusion to reach about a company that has had its debts sold on at a 47% discount is that the company in question is insolvent. It is a question of balance. Sheets that is. If NAMA, on the back of their own bottom up valuations and financial investigations think that 47% of the total obligations will not be recovered (remember this figure is supposed to include a premium for Long Term Economic Value), then the total value that will be recoverable from the assets of the company is extemely likely to be less than the orginal total value of the debt. If that is the case, there should be nothing of value left at any point for distribtution to equity shareholders of the company.

In other words, a shareholder of any company that has had its debts NAMA'd, should not be expecting any money back - because there won't be any after the debt and interest on the debt has been repayed (and then repayed only partially).

So what price would you put on a share of the equity of such a company? Go on, have try:

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Doo-doo, doo-doo, doodoodoodoo, boing

Did you guess zero? Well, you're wrong.

I have some sympathy. I can understand how you would make such an elementary mistake. The correct answer is anything from 30 cents per share to 79 cents per share.

That's right. Ballymore themselves, with the help of their mates at Davy Stockbrokers, reckon shareholders have a healthy 79 cents per share in the bank.

Some asset managers in the Irish market who were clever enough to drop a wad of client cash into this vehicle at inception are a bit more conservative though. Some of them think that shareholders can count on 30 cents per share and book that value in their clients' or pooled fund accounts.

So it's all fine, hunky dory, AOK. You see in NAMA world you can get something out of nothing.

And leaves us with a graceful transition to light opera. Cue Gilbert and Sullivan...

"A paradox, a paradox, a most amusing paradox,

haha haha haha haha a pa-ra-dox...."

Negative equity - what to do?

Negative equity is back in the headlines in Ireland again over the last couple of days. Here is a paper from the ESRI on this issue released this week.

Negative equity is when people pay too much to capitalise their future housing costs. This can be because:

• They over estimate the likely rate of increase in real rents, or
• Under-estimate the discount rate over the long term.

In Ireland, it is likely to be a function of both. People were expecting low interest rates over a long time that would, by the miracle of compound interest, make future rental payments very high in today's money. This is the fallacy of the "affordability" approach to property. Low short-term interest rates certainly make it easy to finance a variable mortgage, but to work out the price of a house you need to consider what interest rates will be in 5, 10, 15, 20, 25 and sometimes 30 to 40 years time.

When you get a decision like this wrong, by that I mean the decision to buy a very long series of cash flows (when you buy a house you a buying a lifetime of market rents), the ramifications are significant. Small changes in the actual increase in real rentals, or changes in expected interest rates will cause a large change in the capital value - i.e. the price of the house. A bond trader knows this. House buyers should also.

So Ireland now finds itself in a position where too large a proportion of the population got caught "on the wrong side of the trade". And they have a capital loss. What are the potential implications for the economy?

• The loss in wealth. Those people with no debt against their homes have suffered little. They were perfectly hedged - they had enough capital to finance their future rental costs and they still do. Those with mortgages have suffered because they were geared. They never had sufficient capital to pay for their future rental costs, they borrowed to do that and paid to much.
• The loss in mobility. This occurs geographically and demographically. Growing families need more room. Unemployed people need to go to where the work is. And people get together and separate.
• Lack of well functioning property market. People in negative equity can not sell their house for less than the mortgage. It is a legal impossibility unless the lender agrees to it. And no lender is willing to agree to it on this scale (size of potential shortfalls and number of borrowers affected). That means there is a significant proportion of the housing stock that has a an artificial price floor. The market wants to adjust to lower prices (there is excess supply), but sellers are not free to drop prices as far as they need to clear the market.

Those are the big ones. So what can be done? About the first, nothing in aggregate. You could transfer wealth from those not affected (the sensible/prudent) to those who have suffered loss. The loss hasn't vanished, it has just been redistributed. Would that be sensible? I would be most concerned about the clear message that sends to people making decisions in the future - don't worry about the risk. That is the "moral hazard" problem. So I think it a bad idea. People made a decision, a bad financial one and lost. It happens all the time. They can work hard and rebuild. It will be better for everyone in the long run if they do that.

What about the second. This is tricky. The benefits of mobility are not explicit. It is no doubt important that people are able to change their circumstances, but how important is not really quantifiable. Qualitatively, I would say it is pretty important.

The final point is perhaps the most transparently important one. Ireland is in for a long period of real house price deflation if nominal prices have a floor under them due to the extent and size of the negative equity problem. Like he removal of a band aid, getting you pain in one short burst is usually the best. So it is with prices. Just ask the Japanese.

Thinking about those points on balance, my default position is typically that public policy has a limited role. People need to save their way back to solvency.

However, I am ready to be convinced that there is a social and economic benefit to finding a way to facilitate a much faster resolution to the negative equity problem, due to the mobility and price adjustment issues, but would object to a policy based on wealth transfer.

On that basis I would strictly oppose some of the following, which are all a variation on a theme of wealth transfer:

• Debt forgiveness
• Government subsidies
• Any public funded sale and lease-back type agreements

So what would I propose? I would suggest a government financed unsecured loan, to the value of the negative equity. This would have the following characteristics:

• It would be a charge against the owner logged against their tax number by the Revenue.
• Recovery would come in the form of a levy on all income (say 5%, but could be more) through the tax system, until the debt is repaid.
• Interest would be charged at long term fixed rate at a modest premium to the current 30 year government bond yield.
• Repayment in full could be made at any time without penalty.
• An optional charge on the estate at death could also be include to strengthen the recovery.

That type of arrangement would keep the proper incentives in place:

• You would still want to get the best price possible for your house.
• You would not be getting a bail out, helping to mitigate against moral hazard problems.
• It would allow more efficient adjustment in the property market, by allowing losses to be crystallised by sellers at price buyers are willing to pay.
• Tax payers would not be bailing anyone out, although more public debt is required in the short to medium-term.
• With the correct interest rate, this could self financing - noting that some people will never repay all of their debt in their lifetime.