A critique of the new Central Bank and CCMA measures

This article appeared in the Sunday Business Post on the 17th of March 2013

A senior banker described the new rules introduced by the Government and Central bank as ‘a charter for the obvious’ because ‘banks need to become banks not terminal collections companies’, and while some are quick to lend support or decry it as a travesty, we should instead look at the factual impact the new targets and code of conduct on mortgage arrears will actually have.

Policy makers say it is a leap forward, debtor lobbyists say it is nothing short of throwing borrowers to the wolves, both are wrong, its just a new set of trade off’s.

Being able to repossess a property is normal in any housing market, ‘bans’, ‘delays’ or ‘moratoriums’ on repossessions have been used in several nations (Czech Republic, Russia, Hungary, Ireland and the USA) and are government lead. In our case it was Government lead until the Dunne ruling in 2011 hard wired it into law. This must be reversed, it is logical, and fair to all participants to have enforceable outcomes on both sides so that incentives are aligned.

A bank unable to repossess will reduce lending and increase the cost of credit, international lending to Irish banks used for mortgage lending will be more expensive, this is demonstrably true both here and in Hungary, and also occurs in the covered bond market (which is used to fund loans in many countries).

Borrowers on the other hand will know that there is almost no enforceable side effect to not paying, how much of that is happening is a guess, but the ability to exploit the system should be closed down. A key trend to watch for will be how many loans become performing once repossession becomes a working reality again.

The Central Bank introduced moratoriums in 2009 with the first Code of Conduct on Mortgage Arrears (CCMA), this was a regulatory creation for which no cost benefit analysis has ever been carried out and which has not been adequately critiqued in terms of outcomes, one of which was to cause a rapid acceleration of arrears which decoupled from its correlation with unemployment long ago.

Part of what makes the mortgage crisis so big is that policy choices were made to date ensured the problem built up both momentum and size. This lead Dallas Federal Reserve economist Anthony Murphy to say that ‘Irish policy makers made bad choices from start to finish‘ at a recent Central Bank conference, during which he also criticised our policy decision makers as well as the inability of banks to repossess properties.

The outcry that there will be a ‘wave of repossessions‘ is partly true, but that is because we forced the pressure to build and build, the initial action on the houses that were never going to be sustainable (many of which are rental properties) will be in a swift fashion compared to what we have become accustomed to.

Not all homes taken by banks will result in the removals of the inhabitants, many will end up staying put as renting tenants. Housing agencies or local authorities will become the new owners, this is one of the many Keane Report recommendations.

The debate where ‘repossession’ are equated with ‘homelessness’ is simply ill founded, and to believe that banks can just ride in ‘rough shod’ is a misinterpretation of the code which gives more clearly defined protection to borrowers, whereas in the past opacity of definitions lead to abuses on both sides.

As for answers, many will be ‘more of the same’ but on a longer term basis. Split mortgages probably won’t be popular, the non-warehoused portion has to be on a capital and interest basis, in this instance it can work out more expensive than interest only. Take a €300,000 mortgage over 30 years on a 2% tracker, on interest only it’s costing €500 a month. If you chop it in half on a repayment basis it will cost €554 a month meaning its more expensive.

The warehoused portion will also attract interest, meaning you are compounding the debt. Only AIB are offering a zero rate of interest on warehoused loans, which inadvertently means it’s a state sponsored subsidy or transfer of sorts to borrowers of that bank in particular.

For property investors where a property is sold at a loss the unsecured portion can be dealt with via a Debt Settlement Arrangement utilising Section 69 of the Insolvency Act which protects the family home. For those who lose a family home at a loss the unsecured debt can be dealt with in general by a Debt Settlement Arrangement, Personal Insolvency may well prove to be less popular than has been anticipated.

The new CCMA will protect borrowers who engage, and ‘engagement’ is more clearly defined than it was in the old code, and those risking classification as ‘non-engaging’ will get a three strike policy in terms of warning procedures so that they can stay on the right side of the code. In simple terms, these changes don’t stop bad things from happening, but they do give structure and form so that any family home loss can be orderly and as painless as possible while weeding out strategic defaulters.

As for the ‘targets’, they are based on ‘proposals’, which mean banks are driving the ability to succeed or not, and mass ‘interest only’ options cannot be ruled out, because the proposals are not strictly prescriptive and as already demonstrated, they may prove to be the cheapest choice.

Penalties will hurt the banks risk weighted assets, but the banks are over capitalised, they may be happy to miss targets and move at their own pace. Forcing extra provisions is an income statement deduction meaning the banks are less profitable this is an own goal in the making. Or it could damage them to the point that they look so bad they risk funding gaps and a return to a reliance upon state funding, the likelihood is former.

Subjective targets don’t relate to the financial statements of banks, but enforcing different provisions based on these targets implies that banks may not be already adhering to best accounting practice or these provisions would already exist in the financial statements.

These proposals are show-boating, where success doesn’t reward the risk that goes with it, the best thing would be for the Government to have a functional Personal Insolvency Service immediately and the rest would fall into place.

How much of the target achieved will be based around ‘write down’ solutions? Outside of AIB or totally hopeless cases it will be near nil. The primary point nobody is mentioning is that interest rates are at all time historic lows, where will all these fixes all go when that changes?

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