Last night I got to help launch the ‘Irish Property Buyer’s Handbook 2012‘, the second edition which was written by Carol Tallon [disclosure: the lowlight is my chapter on mortgages]. Minister of State for Housing and Planning Jan O’Sullivan was the guest of honour. It went well, and I think the book will be a success amongst prospective buyers because it really is a great piece of work on the practical aspects of buying property.

Phil Hogan is looking for some new thoughts on how to avoid a repeat of Priory Hall, the idea being ‘compulsory certificates‘ by architects. This seems like a great idea in soundbite format, beyond that it will be tricky to implement, oversee and enforce, it will also drive up development costs.

NAMA mortgages are in the headlines again, the scheme is accused of placing a floor on the market, personally I don’t think it has the scope to do that given that the general market is so much larger than the offering. What I don’t understand is the internal workings of a cashflow on 90% of a price but the loan being only on 70%, there is obviously some kind of stooze in operation (haven’t bothered to do the figures yet).

When I do they’ll be posted!

6 News covered the report by the Central Bank titled ‘Why do Irish house prices keep falling?’.

This month the property-watch focused on Central Bank reports that property prices had overshot from 12-26% depending on the model used. This counter to conventional wisdom, so we chatted about this and other topics with Claire Brock, Martin King and Angela Keegan.

Which means that if you sold your property (we’re assuming it is in negative equity) for a €50,000 loss and the bank write that off, that in effect you have a non deductible loss which you didn’t pay and therefore you pay the tax on it (their equivalent of capital gains).

Like the US, Irish investors can offset capital losses against capital gains, in the case of your own home this doesn’t apply. In the American example a write-down creates a tax liability, although not in every state (my home-state of California being an example). This was becoming such a problem that the IRS brought out two special tax codes called ‘The mortgage forgiveness debt relief act & debt cancellation act of 2007′.

Is there any similar provision in Ireland? No…

Is that a problem?… No.

Because the Capital Acquisition tax & tax consolidation act 2003 have no provision stating that a debt write-down constitutes a gift or gain on a commercial agreement carried out at arms length.

Thankfully there is no lacuna, the recent Bank of Ireland debt write down case would be an example to prove the point. If this had happened in the US and the above acts were not in place there would be a CGT implication of c.15% (long term band) or about €22,500!

it is worth remembering that there are aspects of ‘the American way’ that we don’t consider when seeking to embrace their model of ’short sales’.

A key issue pointed out consistently is the role of credit. Cheap credit is often cited as one of the drivers of the property bubble, an NBER paper suggests it is only a component of about 20% of prices. The absence of credit is equally being seen as a downward driver of prices.

One of my minor hobbies is the history of Irish banking from an operational perspective, and on rare occasions it offers a nugget of insight.

In the late 1970’s Irish banks were not involved in mortgages, and only a few years before that they were not involved in hire purchase, they didn’t offer term deposits and credit cards were not available. In Ireland of 2012 it may be hard to imagine this but it was the case across the land.

The home-loan lenders were building societies (which were the descendants of British ‘friendly societies’ – a movement that is reasonably traced back to the year 1775). The building societies regularly ran out of money, they were funding loans from deposits, this required a strong savings record for the individuals hoping to borrow, but it also created huge problems because the people who wanted to borrow would end up in a long queue, and when their turn came if there was a temporary shortfall then everything dragged out.

This was not an ideal situation so banks were seduced into the market with a give-away. Namely tax breaks. On all mortgage lending the interest earned would be tax free – this had the desired result (tax breaks may not be ‘right’ but they are effective) and as they entered further into the market the tax relief was withdrawn. That only happened after they were embedded in home lending so they never pulled out of the market.

It is important to note that banks regularly lost market share and large tracts of profitability to other aspects of the market that they were not operating in (a separate blog on hire purchase and term deposits might be called for!) - and to some extent that remains true today. This is why banks are constantly looking to enter new markets they can exploit, obviously the likes of Dodd/Frank and the repealed Glass/Steagal acts see this as an issue, and rightly so.

That doesn’t mean you can’t use them to a national advantage. If an absence of credit is the issue, we could easily implement a law that allows tax free profits on marginal lending (the portion over and above any stated targets – so BOI would only get it after €1.5bn, AIB after €800m). This could be extended to any lender not operating in this jurisdiction as well on all lending (as it would all be new lending to the Irish market).

There are obvious issues with this, one upside is that banks might recover quicker (although accrued losses mean there is no tax bill any time soon in many cases), they might look like better take over targets in the future for prospective buyers. It may help to increase competition and bring in new entrants and of course it could (on the downside) fuel the makings of a new bubble.

Personally, I think we are going to have another big crash in the mid 2020’s anyway, nobody has ever truly solved the boom/bust tendency of the property market, with the exception of countries like Somalia who are in a near permanent ‘bust’ (not a desired outcome).

What I would take from a similar historic issue is that you can get credit flowing with (perverse) incentives, it works, pragmatic but perhaps not popular. The Irish banks have a reduced ability to lend as property prices drop further so it is in their interest to be the ones doing this but they lack the capital (it’s like trying to spend the same euro in two shops at the same time) so an open invitation to whoever does have money to lend here with some windfall gain might just do the trick, it already has a track record.

This may be down to disincentives, issues with management or the Department of Finance, but suffice to say, it doesn’t make sense that non-state owned banks and foreign banks are innovating in potentially beneficial ways for their customers and the banks we paid to save are not.

Who will the receivers be? I suspect it will be some of the well known estate agents who I know are in talks with other banks on the same basis. The ‘receiver of rent’ clause in many mortgage contracts is often unenforced. The ability to obtain it is not generally contested but it still requires a court order and then the operational difficulty of getting to the property to explain this to the tenant and then taking over the collection of the rent.

Why has the level of arrears spiked in the investment pool of business? Theories abound, my own (which makes me vastly unpopular) is that it is down to making a business decision in favour of oneself. However, getting a rent receiver is not a ‘fix’ and I think Bank of Ireland will learn that the hard way.

First of all there is the legal cost, then the engagement cost of appointing the receiver who needs to get in touch with the tenant who may or may not feel sympathetically towards their landlord - in some cases the tenant doesn’t cooperate with the request.

If this happens they do have a legal right to remain via their tenancy because the rent receipt is on foot of the mortgage but the tenancy is on foot of a lease so you are into a quagmire of issues, the bank were not the ones to register with the PRTB which puts another functional layers of problems into the mix.

What banks should be doing is just taking the properties but at present the Start/Gunn ruling that Justice Dunne deliberated on last July has caused a problem with the repealed 1964 Registration of Title Act upon which the right to repossess often stands.

The whole point of the exercise is to remove the incentive to default and divert monies elsewhere, by appointing a receiver of rent you strip out the income and leave the borrower only with the implications of the default, but what does that say of the implications of merely not servicing the debt? Avoiding the cost is not dissimilar to making a gain.

This problem won’t be going away any time soon.

Regulation is a tricky area, it is a branch of law more than of finance and like law it is open to interpretation, precedent and individual cases.

So when I see Anne Fitzgerald of the NCA say that AIB is ‘breaking the rule that required it to act in the best interests of its customers’. I am concerned because it doesn’t present the context of the rule, rather it just makes a statement.

The actual rule being mentioned is Section 2.1 & 2.2 of the 2012 Consumer Protection Code. Chapter 2 in general covers consumer credit, payment services, and electronic money. The actual text of this section (2.1/2.2) is as follows:

“A regulated entity must ensure that in all its dealings with customers and within the context of its authorisation it that it (2.1)acts honestly, fairly and professionally in the best interests of its customers and the integrity of the market and (2.2) [that it] acts with due skill, care and diligence in the best interests of its customers”.

What it doesn’t say is that ‘it acts in a manner in which costs are not recouped’ or that customers are foremost in price setting. And this is where anger (which I understand and agree with) meets law then comes out the other side as a mutated interpretation.

The premise of acting in the best interest of customers doesn’t just mean those affected, it means all customers, so when banks are serving multiple constituencies you can’t err on the side of only those that might be affected. This has already been seen where banks increased variable rates in order to increase margin because they couldn’t get it from tracker holders.

It is not dissimilar now, 40% of AIB account holders won’t be affected (in this instance they are like the tracker holders), and the rest will pay for the banks cost of operating the payments system, and that cost does exist, blogged on it only yesterday.

The other forgotten caveat is that they act with the best interests for ‘integrity of the market‘, the banks point on this will be that the payments system has to be maintained and that is a greater good for all constituencies that this is a viable and functioning piece of infrastructure than free banking is for some.

The final issue is that ‘best interest’ doesn’t mean ‘cheapest pricing’ and it definitely doesn’t mean ‘free’, they are quite really different things.

I accept that sometimes banks are places that help you with problems you would not have had without them, but ‘free’ was never prescribed in Consumer Protection policy in word or spirit, this is a blatant error by the National Consumer Agency and is frankly disappointing to see because it doesn’t imply the high standards that office normally holds, if you want to beat a bank with Regulatory Code then at least get it right, use the right tool for the right job.

Holding an average balance of €2,500 in your current account means that anybody on the average industrial wage will probably never qualify (because they’ll only earn about €2,330 per month after tax) unless they start to use it as a ’savings account’ as well.

Some thinking thus far is that you always have the option of putting €2,500 in an actual deposit account at 4%, that will yield €100 per year which, after our fancy new [higher] DIRT rate kicks in, will net you €70 or about €5.83 a month which will buy you a Mars bar once a week every week.

‘Free banking’ was never actually ‘free’, there were always charges for overdrafts, and referral fees, and bounced cheques. What was ‘free’ was the access and use of the payments system or the ‘money transmission system’ as we call it in bankolloxolgy.

the rage of the National Consumer Agency is an obvious vested interest position, something I don’t mind pointing out because I’m already going to hell anyway. Anne Fitzgerald has called for people to ‘leave’ AIB due to this, which is fine, but they never sought to understand the reasoning, which to me is a shame because the real question is ‘why’. People may leave anyway, but why are AIB doing this?

Before going further, I should point out that people probably won’t leave, Bank of Ireland did market research about 7 years ago that showed you are more likely to leave your spouse than your bank, so for all of you saying ‘I’m leaving AIB!‘, take a good long look at your partner, and then just leave them instead… You know you want to (o.k. I’m trolling on that one).

AIB say that 2 in 5 people will still get free banking as they are students, over 60’s or graduates. Personally I don’t think that being over 60 should get you free banking, in fact, if you are going to charge then everybody who uses the bank should pay to make it unbiased.

Better yet would be to have a ‘free account’ that gives minimal services - because access to banking is still an issue, one that the EU has attempted to address with calls for a ‘basic’ bank account for every person should they want it. As many as 100,000 adults are thought to have no bank account.

So that issue isn’t just confined to our former Taoiseach as we all suspected…

Banks are paying too much for deposits, part of this is compression caused by falling rates. Something I was banging on about even 4 years ago. Another issue is that of the actual ‘business’ of deposits, people think of banks as ‘loans on one side, deposits on the other’.

But in traditional banking there was a deposit business with a commercial spread (typically achieved by offering rates lower than interbank) which was achieved because banks held more deposits than loans, the reversal of this created a desperation for funding which feeds into modern banking problems, I’ll blog on that and cure your insomnia some other day.

So on to the main bit… €4.50 per quarter and 20-30c per transaction and a guide cost of €90  year. That would imply (taking figure of 25c per transaction) about 328 transactions a year. So why charge? In short, it is because the payments system is about 40% of banking operation cost. And banks, rather than cutting cost have found ways to increase it.

Sadly it is true, they aren’t just incompetent at lending.

Phone and internet banking were meant to replace branches. They didn’t. They became alternative channels and branches are still open, as are call centres, as are internet teams and extra IT security etc so rather than reduce overall cost they have embedded ongoing costs in the payments system, now they can’t get rid of any of the channels because each has it’s dedicated user base and many work across several channels.

Only NIB has made any headway in this respect, and they were able to do that because they lack scale, not an ideal strength in many respects.

Here’s a question, how much does it cost to lodge €1,000?

I hope you didn’t bother answering my teaming millions, you already know I’ll dick it up by giving a confusing response.

1. Are we talking about a €1,000 cheque that needs to be entered, sent for scanning then run through the payments system?
2. Are we talking about cash which has to be counted, entered the put aside with various security measures (creating cost) and transported elsewhere?
3. Are we talking about a mixture of foreign exchange, coins and bank drafts?
4. What about a foreign draft that has to go through reserve accounts at the central bank of two countries, get scanned, payments system etc… you get the idea.

You quickly see that €1,000 isn’t €1,000 from a branch perspective, rather it is (or has the potential to be) a series of costs that have to be absorbed or charged for. There are a few parties that can stump up

1. The account holder via fees
2. The bank by accepting reduced income, hitting shareholders or cutting costs
3. The depositors via lower deposit rates
4. Or borrowers via higher credit costs.

The last one is unacceptable, the third is unfeasible, the second untenable and the first unpopular, its all ‘un’s’ all the time.

The cost of providing an account? It is estimated at the cost of the payments system, which if €90 is the equivalent guide would mean that €2,500 earns a bank about the same amount in their deposit business, it implies an interest rate earned on free money (current accounts are also called ‘zero rated funds’ and have a very important role in banking) of about 3.6%.

When a bank gets zero rated funds they can place them with a different bank, or in other reserve accounts and make money on it, that is part of the ‘no lending required business of deposits’.

Historically not every bank was doing lots of loans, some were primarily deposit takers. In fact, Irish banks didn’t even do mortgages until the late 70’s, they got into car loans and credit cards in the 80’s (prior to that HP co’s and Barclays were the ones doing it).

The Central Bank or Regulator will do nothing, they don’t control pricing, and the Government likely saw the costs before this decision was made and have tacitly endorsed it as well. No free lunches, no free banking, shazaammm!!!! It has followed Tracker mortgages and the Dodo into a secret house in Area 51 where Elvis and JFK are playing their fourth game of chess today.

This week we spoke to Sybil and Martin about the sentiment of people in the market based on a Daft Survey. We also covered the CSO property statistics, and the brand new ‘Rent or Buy’ calculator that we created with help from MyHome.ie (it’s on their website).