Today we will highlight some changes that we may see come into the Irish mortgage market in the near future, as well as some suggestions from the think tank here in Irish Mortgage Brokers. The current economic climate is one where it is easy to look back and spot errors that were made, but rather than focus on the blame game we hope to consider ideas that will prevent a property asset bubble from occuring again as well as some ideas that could help promote sustainable lending, these ideas won’t beat the recession this time around but it may be good medicine for the future housing market.
1. Long term fixed rates: In the USA the prime mortgage sector is not going into the same kind of default as the rest of the sub-prime and Alt-A loans are, in the cases that they do it is down to redundancy and the other things that generally cause bad debt irrespective of the wider economy. One reason that this is happening is because loans there are taken out on a long term fixed rate basis, so rather than have a one year fixed rate they get a 25 year fixed rate.
In Ireland this was not popular because people have gone for short term fixed rates that are attractive for the initial period, the downside is that when we see rates at historic lows they will eventually start rising (for all the people who took fixed rates from 2002 onwards). And when this happens they come off fixed rates onto much higher variable rates or ‘existing business’ rates. This is precisely the problem with American lending, it was this shift to ARM (Adjustable Rate Mortgage – which is their equivalent to our Variable) that gave a cashflow shock to many people resulting in bad debt mortgages, this gave rise to weakness in the CDO market which hurt securitization, then monoline insurers, and ultimately the whole real estate and financial markets.
So one solution to stabilization in the market may be for banks to look at longer term fixed rates. This will not be easy because typically banks look at the long term yield curve and use short term money to do the actual finance then keep the difference, currently this curve is not favourable. However, in stress testing a loan (its a mathematical part of underwriting where a loan is looked at with the rate increases factored in) a long term fixed rate would be safe from market highs, meaning that if a person qualified for the mortgage in 2008 then no matter what rates did in 2015 they would still have the same monthly outgoing. The downside would be if you remortgage and have to pay a penalty for breaking the fixed rate but the upside of a good long term fixed rate likely outweighs the short term gain of cheap money when it cyclically occurs (because it always occurs to give short term stimulation to the market and get it moving).
2. Euribor Trackers: Nobody wants to talk about a tracker mortgage based off of the Euribor, however, that is actually how most commercial mortgages work. For some reason that didn’t translate across to the residential mortgage market. The credit crunch and liquidity crisis have seen interbank rates increase by almost 1% (which is a huge margin!) on the official side, on the auction side of the market (banks with money are auctioning the cash so the interbank rate is even becoming defunct) the margins can go upwards of 2%, and that’s mammoth margin for a bank to find any profit from. The effect is that this has to be passed on to the mortgage borrower, which is why we have seen all of the banks jacking up their margins on tracker mortgages, fixed rates and most punitively on variable rates.
Tracker mortgages based on the Euribor would be viewed as ‘harsh’ on the consumer, but not as harsh as the other option of not finding any institution willing to lend to you. One effect of the financial crisis will be that we need to re-think many aspects of banking and finance, on the corporate side but also on the consumer side. Euribor margins are likely to come down and the liquidity will rationalise eventually, it may be a painful process but if fiat money is to survive this will need to happen and when it does then perhaps we will see tracker mortgages based on the Euribor rather than on spectacular margins over the ECB because all that is doing is factoring in Euribor rather than just creating the margin off the cost which is the smarter long term way of doing things.
3. Stress testing on 10 year prices: If loans were stress tested over the 10 year bond prices rather than on ECB + 2.75% (as per the Central Banks rules) then it would be a more rational exercise, the result may be that you can borrow less but if that rule came in as standard then property prices would have to move to meet the new lending levels. One thing you can guarantee is that we will see the actual amounts people can borrow reduce in the medium term, this will mean that property will have to find a market acceptable level in order to sell and by that we are talking about a further fall in prices. There are no more 100% mortgages in Ireland, but if they ever do raise their head again then the only semi-responsible way to work it would be to have long fixed rates or at least rule that they should be on a 5-10 year fixed rate. Negative equity coupled with a jump in repayments is likely to motivate many people to hand back their keys.
The Central Bank also made an error when they made all lenders adhere to an ECB + 2.75% stress test. Why? Because before that loans were stressed on the Variable + 2% which meant that the Central Bank actually created rules meaning people could borrow more. This was done in August 2007, a month after the credit crunch had begun in earnest. The Central Bank also failed in not upping the reserve requirements of banks, I have said this often as of late, because many people felt that our Central Bank no longer had any fiscal power left, but this is not the case, it can’t control rates but it can control other flows in money which could have the same net effect.
4. Tightening Credit: It won’t be nice in the short term but in the long term a return to lending fundamentals will help to keep the market from going towards a bubble again. Think about this, the Central Bank allowed a change in lending criteria back in 2001 whereby old rules of three times income were dissolved. This meant people could borrow more, money got really cheap in 2003 and then prices really started to rocket. If money had not been made more available we would not have had a ‘generation who would never own a home’ as many thought, instead we would have seen property stock not sell and then the rational thing would happen, it would have dropped to a price that kept it affordable. In any case, the end result is that we will always see a certain portion of society that cannot afford housing, in the same way as there are people who can’t afford a car, or healthcare or many of the trappings of financial success. On that note we should push for affordable housing and government housing, the mark of civilized society can often be gauged in how it treats its prisoners and its poor people, according to Dostoevsky at least.
5. No bail outs no free lunches: I did a post on this yesterday, if we bail out a bank it will only send the message to all of them that it’s o.k. to act recklessly, if we let one of them collapse (as painful as it sounds) then the others will ensure that in the future they act with total prudence. There is the argument that allowing this to happen could cause systemic failure but so far in the USA this has not happened because the FDIC is well equipped, the problem this side of the Atlantic is that Ireland’s version of the FDIC, the Deposit Guarantee Scheme is not so well equipped and that perhaps is the only justification for a bank bail out. The problem with bail outs is where do you stop? What about people who are getting repossessed? Will we bail out them as well?
These are just some of the things that we may see coming to the mortgage market in Ireland in the future, if you have any opinions please be sure to leave a comment!