resolving the mortgage crisis - submission to the expert group on a mortgage arrears resolution...

8/4/2019 Resolving the Mortgage Crisis - Submission to the expert group on a mortgage arrears resolution process

1/7

Resolving the Mortgage Crisis

Submission to the expert group on a mortgage arrearsresolution process

By Stephen Donnelly TD

September 10, 2011

[email protected] 618 4293
mailto:[email protected]:[email protected]


2/7

Resolving the Mortgage Crisis

The situation as it stands

At the end of 2010, one in ten mortgages was in trouble. By March this year,one in nine mortgages were in trouble. Today, almost one in every eight

mortgages is in difficulty: some 95,000 mortgages, or 12% of the 777,000residential mortgages in the country.i

Some 40,000 of these are more than six months in arrears, with an averagearrears per household of 21,000. Some of these households may manage tostart paying their monthly instalments again; but they will never pay off thosearrears.

Less visible are the thousands of households that are succeeding in paying theirmortgages, but only by drawing on an unsustainable (and potentially damaging)portion of their household income. The conveyor belt of mortgage distress

suggests that more and more of these households, and of the estimated200,000 households in negative equityii, will fall into arrears.

Those in arrears already, and those who are afraid of falling into arrears, arelabouring under great financial and emotional stress. This has wide-rangingrepercussions for the domestic economy: it reduces productivity, depressesconsumer demand, and chokes small businesses.

The normal consequence of falling into debt you can never pay off isbankruptcy. In other jurisdictions, bankruptcy is used both by individuals and by

the society as a whole to help ensure a level of dynamism in the economy. Inthe US, for example, failure is seen by many as a necessary step on the way toentrepreneurial success. But Irish bankruptcy law is draconian, and thereforebankruptcy law as an instrument of economic policy is ineffectual: there werejust 30 bankruptcies in Ireland in 2010 and nine in 2011, to date. (Bycomparison, in the UK, there were 75,000 bankruptcies in 2010; in NorthernIreland, there were 1,250.)iii Bankruptcy is expensive, intimidating, andunforgiving.

Almost 40,000 of those households that have found themselves in difficulty withtheir mortgages have succeeded in restructuring those mortgages with the

banks. However, reports from constituents, and in the media, suggest that theprocess is unduly arduous, even intimidating, for borrowers, and that there is noequality of treatment of borrowers: those who are more familiar with the lawand with banking are more likely to achieve a satisfactory resolution than thosewho have had little dealings with these institutions other than taking out theirmortgage in the first place.

The good news is that the majority of people are succeeding in paying theirmortgages as originally structured: roughly 680,000 of them.

The challenge

The challenge is to find a solution to the problem of those whose mortgages areunsustainable, without creating perverse incentives for others to abandon theirmortgage commitments.


3/7

This solution must rely on the principles of individual responsibility, sharedresponsibility, and economic self-interest. Those who took out unsustainablemortgages are responsible for their debts. However, these borrowers receivedpoor advice and irresponsible loans from lenders, who had a statutoryobligation, under their 2006 Code of Conduct, to be more prudent. Borrowerstook out those loans in an environment in which prudential regulation waslargely absent, and received implicit (sometimes explicit) encouragement fromtheir political representatives. The lenders, and the State, therefore, must sharein the responsibility for those loans. Economic self-interest dictates that we seekto avoid having a substantial cohort in our society living in fear of losing theirhomes, and/or paying so much of their household incomes to service bubble-eramortgages that they cannot meaningfully contribute economically. We need tohelp people get back in the economy. At the same time, it is of the utmostimportance that borrowers who can pay continue to pay their loans.


4/7

Resolving the Mortgage CrisisThe solution

Drawing on work by the Law Reform Commission, by the Mortgage Arrears andPersonal Debt Group, and by economist Stephen Kinsella, I suggest that ascheme to resolve the mortgage crisis (a mortgage arrears resolution process)should contain the following, or similar, elements:

1. A reformed system for personal bankruptcy.This should follow the detailed template laid out by the Law Reform Commissionin December 2010.iv Those who go through the judicial bankruptcy process inthe High Court should have their bankruptcy discharged after three years. (Inthe UK, the term is just one year.) Most debtors, however, should not go to thecourts, but should be dealt with by a new Debt Enforcement Office, which willhave the power to conclude debt settlements, under which the debtor will belegally bound to repay an agreed amount of debt for up to five years. In

extreme cases, the office will have the power to make debt relief orders.Misrepresenting ones income to such an office would be fraud, with theconsequent penalties applying; and the credit rating of the individual would beaffected as a consequence of entering the bankruptcy process. These measureswould serve to significantly reduce the risk of moral hazard.

2. Debt for equity swaps.

The point of debt-for-equity swaps is to facilitate a family staying in their home,while compensating the lender for writing off a portion of the debt. However,where the negative equity on a property is such that, in order to restructure the

mortgage to a sustainable level, the lender would have to take a half or majoritystake in the property, debt-for-equity is not a viable solution: such wouldeffectively transform the lenders into property management companies. If,however, a household can meet a sustainable payment over a mortgage lifetime(say 30 years), with the total repayment equivalent to a majority stake in theoriginal mortgage (no less than 55%), then the household should qualify fordebt-for-equity. In this case, the lender would take a proportionate stake in theproperty equivalent to the balance of the original mortgage, and this balancewould be written down, thus ensuring actual burden sharing.

3. A clear framework for mortgage restructuring.

Guidelines for mortgage restructuring and for the above instruments should beput in place by the Financial Regulator and imposed upon lenders. Theseguidelines would include a metric for calculating the sustainability of amortgage. Critically, sustainability needs to be defined not as the maximumamount which could be extracted, but as the amount which would leave thehousehold with the ability to lead a decent life and contribute to Irelands socialand economic recovery. Once in the process, households would have theirmortgage sustainability assessed, and would be directed into the appropriateinstrument. Misrepresenting ones circumstances as part of this assessment

would be fraud. Households that believe they have been unfairly treated by thelender will have recourse to the Financial Services Ombudsman, which will beempowered to issue directions to the banks.


5/7

4. Tax credits for debt restructuring.

In the US, the Mortgage Debt Relief Act of 2007 pprovided for a portion of theamount of income saved as a result of any debt restructuring to be taxable, inorder to reduce the incentive of households to strategically default. Theopposite could be used to help lenders that have to write off debt as part of amortgage arrears resolution process. A targeted tax credit could apply to thoselenders engaging in restructuring. This may help to ensure that those banks notexplicitly covered by the banking guarantee are incentivised to engage with themortgage arrears resolution process.


6/7

Resolving the Mortgage Crisis5. Support for borrowers.

Either the Debt Restructuring Office (as above) or the Money Advice andBudgeting Service (MABS) should be given a remit to support householdersentering this mortgage arrears resolution process. This would be consistent withthe Programme for Government, which commits to converting the MoneyAdvice and Budgeting Service into a strengthened Personal Debt ManagementAgency with strong legal powers. The agency will support families who make anhonest effort to deal with their debts, including non-mortgage debt, providingprotection from their creditors where appropriate, so that they have time to sortout their affairs. In order to do so, the Personal Debt Management Agency willhave quasi-judicial status. A resource audit of MABS should be conducted todetermine its capacity to accommodate these new functions.

Ultimately, this entity could be empowered to fulfil a further commitment in theProgramme for Government: We will introduce new legally binding voluntary

commercial debt plan structures to allow small businesses to restructure debtswithout recourse to expensive court procedures.

6. Non-recourse or limited recourse mortgages.

One of the drivers of the reckless lending behaviour of the banks was theknowledge that, should a mortgage holder struggle to service their mortgage,the bank could not only seize the property as collateral, but could also pursue allother assets and income that the mortgage holder had. In the context ofIreland's current bankruptcy laws, this power extends to the full lifetime of themortgage holder, and even to their estate once they are deceased.

The introduction of non-recourse or limited-recourse mortgages would tie thelenders interests to the value of the property, thus strongly incentivisingprudent lending, particularly with regard to artificially high property prices. Thispractice is used successfully abroad. This measure would work particularly wellin tandem with the proposed changes to the bankruptcy laws.Conclusion

A suite of instruments will need to be developed to suit the vastly differing

circumstances of households in mortgage distress. Some options for these havebeen elaborated above. However, foremost amongst these instruments will be areformed personal bankruptcy procedure. The crisis is so severe that debt-for-equity, restructuring and other instruments cannot be a panacea. Reforming theIrish personal bankruptcy process is long overdue, and is now highly urgent.


7/7

i This figure includes the number of mortgages in arrears plus the number ofmortgages that have been restructured and are now said to be performing, but at aconsequent loss to the lender. This is based on analysis by FLAC of the figuresreleased by the Central Bank on August 29.ii http://www.irishtimes.com/newspaper/opinion/2010/1111/1224283092835.htmliiihttp://www.williamfry.ie/news-article/restrictive_bankruptcy_laws_focus_on_punishment_rather_than_rehabilitation.aspxivReport on Personal Debt Management and Debt Enforcement:http://www.lawreform.ie/news/report-on-personal-debt-management-and-debt-enforcement.324.html

resolving the mortgage crisis - submission to the expert group on a mortgage arrears resolution...

Documents