So we have arrived at the day when the State has to deal with the consequences of the housing binge on the balance sheet of the ordinary person. A few years ago, people who warned this day would come were dismissed as doom-mongers. Now we see what was clear all along: the real merchants of doom were those who harassed a generation of people into debt, condemning them to negative equity and unpayable mortgages. This problem has to be fixed because the economy, burdened with such huge levels of debt, cannot grow.
It’s a simple equation. If people are paying back debt, they are not spending on other things. The economy runs on the basis that, in the aggregate, my spending is your income and your spending is my income.
Therefore, if people are not spending because they are paying back debt, everyone’s income eventually falls.
This fall in income becomes self-reinforcing. In turn, it leads to a situation where because of – not despite – your best efforts to pay off debt, your income actually falls faster than the rate at which you can pay off your debts. This leads to the strange and sometimes counterintuitive upshot whereby the person who tries to pay down debt fastest actually quickly ends up the most indebted relative to his income.
This contradiction is one of the crucial things to appreciate about macroeconomics. Macroeconomics is counterintuitive rather than intuitive. At its core is the “paradox of aggregation” which means what is good for the individual is not always good for the collective.
So for example, if I cut back on spending to pay back my mortgage, it – in isolation – is good for my balance sheet. But if everyone cuts back at the same time and copies me, who ends up spending? And, if no one is spending, who has any income?
In the end, the economy contracts and the level of debt – as a percentage of income – actually begins to rise rather than fall.
Seems illogical, doesn’t it? Well it is counterintuitive but that’s how it works.
Look at the chart; you can see what is happening in Ireland. Arrears have continually risen over the past few years and at the same time, more and more people’s incomes have fallen – a direct result of more and more people trying to pay the debts off. Debt repayment was meant to be the solution, but it is becoming the nub of the problem.
This almost upside down way of looking at things explains why the government is in such a bind. Today the State has to deal with two specific types of debtors. The first is the ordinary mortgage holder and the second is the buy-to-let investor.
Let’s look at the ordinary mortgage holder first. The heroine of my recent book “The Good Room”, Olivia Vickers, is a typical mortgage holder. She is a teacher on a temporary contract. She is still working, but faces lower income due to higher income tax and property tax as well as the arrival of a second child. Olivia’s story is typical and is replicated all over the country.
Politically, the government has to do a deal with people like Olivia – a deal that does not threaten eviction. If it were to preside over mass evictions, it is political suicide.
One way to help the hundreds of thousands of ordinary neighbours, sisters and brother, sons and daughters who are in trouble is via a ‘debt for equity swap’ with the banks. This would involve the banks taking ownership of, say, half the house. The mortgage holder would pay half the mortgage. In, let’s say, fifteen years’ time, when the house is sold, the bank would recoup some of the equity and the seller wouldn’t see all of the capital upside. This is fair and just.
It would give the person breathing space. In such a deal, the banks would have to have the extra capital to cover the loss they would have to carry today and only recoup in the future. Given that the banks have already set aside €17billion capital for mortgage arrears, there is already money in the kitty to cover losses. The question is whether this figure is enough?
If it is not enough, what then? This is where the ECB comes in.
Clearly the ECB is the last line of defense here. It can’t afford another shock in the Irish banking system and it has shown itself, under Draghi, to be very adept at playing the debt juggling game. The ECB might be persuaded to hold bank equity and extend loans to the banks so that the capital base is sufficient to execute the debt for equity swap with the citizens. In this case, the ECB is simply using its role as lender of last resort to facilitate a debt for equity swap in Ireland. This piece of financial engineering would ensure a fair and sustained deal for our people who are in trouble and, in turn, by loosening their purse strings, would underpin demand in the economy. Such an outcome is precisely the outcome that we need for the strapped homeowner.
If we turn to the buy-to-let investor, there is no political reason why they should be bailed out or offered deals. However, there may be a sound financial reason not to take possession of houses now and sell them all.
This reason is called the “paradox of deleveraging”. This works in the same way as the paradox of aggregation. When the buy-to-let investor is well underwater and in arrears, the natural impulse for the bank is to tell the individual investor to sell, in order to fix his balance sheet. This makes sense and sounds prudent. But this is only the case if, when the individual investor sells, no one else is doing the same thing at the same time. What if the banks move on all the buy-to-let investors at the same time? There would be a deluge of selling, leading to falling prices. But remember, while the prices of the properties fall, the debts don’t. So we get into a situation where the debt relative to the value of the property rises rather than falls as a direct result of trying to pay the debt back!
This is the paradox of deleveraging and it is the dilemma faced by the government this morning. The best way to deal with this is to stagger selling the buy-to-lets and underpin the residential mortgages. Let’s see what Merrion Street decides.
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Getting the taxpayer to pay for part of home buyer mortgages is not fair on the taxpayer.
If the Government/Department of Finance lets people off paying (part) of their mortgages the slack will have to be picked up by the taxpayer (ordinary Irish people). So, the house owner gets let off and the taxpayer pays. How is this much better for the taxpayer?
How can we be sure banks won’t look after their own families/cronies in the process of letting off homeowners? Banks in the past have written of politicians debts. Why shouldn’t we expect more of practices?
“what is good for the individual is not always good for the collective”
It’s called capitalism David. You’re slowly getting it.
David, you have been reading “Thinking Fast and Slow”
Well said, David. Debt for equity swap is the way to go. The taxpayer doesn’t have to lose out at all, but judging by some of the comments above, Irish people will grumble over bank bailouts, fat cat salaries and the usual suspects walking into the sunset with rolls royce pensions, but they will simply not tolerate Johnny next door getting off scot free from “his” debts.
This thinking is irrational in the extreme, but we’re the people who voted in FF three times so rational thinking isn’t what we do…..
If a bank takes 50% of the equity in someone’s home, in return for 50% off the mortgage, then when the homeowner pays the remaining 50%, he can choose to stay on with the bank having a 50% stake in the future value of the home, which can be liquidated if the owner sells or passed on with the home if the owner bequeaths it to his children. The banks themselves should offer the 50% equity in such homes as equity for their own debts to the bondholders (should’ve happened in the first instance), the Irish State and the ECB,… Read more »
People may get a sense of satisfaction at the suffocation of “imprudent” borrowers going under (most of them were very prudent, just victims of time and circumstance, while the most reckless are being protected under NAMA anyway), but if middle continues to sink under this mountain of debt, we’ll have learned absolutely nothing about our economic history over the last 200 years.
We need a 21st century version of the Land League, to combat the neo-gombeenism of the banks (domestic and foreign, including Ulster Bank), NAMA and the ECB.
On buy to let, it has been happening already. No one is being public about it. I would say that per apartment complex, we are looking at between 20% and 40% of the units are affected. The upside is that the management companies can now get the fees in place to do the much needed improvements which will benefit the tenants who own their apts. This too will improve the property value. Could be a lot of paradoxes at play which if played right could benefit those who really need it. We shall see.
You say…”The economy runs on the basis that, in the aggregate, my spending is your income and your spending is my income”. Only true for a closed system. Ireland and most western economies are very open systems. Lets rewrite the phrase to reflect reality The economy runs on the basis that, in the aggregate, my spending is another economy’s income depending on local competitiveness and and that economy’s spending “may” be my income if I am cheaper than their local competition. Short of using trade barriers, you cannot stop leakage. The most the government can do is tinker around the… Read more »
If the banks didn’t provide an annual remuneration package of € 70k per annum for their pampered staff, they would be in a considerably less mess than @ present. When your boss is bust , you don’t get paid. Smell the coffee IBOA.
My parents were able to take out a 10 year loan to pay their mortgage in 1967. The value of the house they bought was twice my father’s income, who was 28 years old when he bought. If I had been that “prudent” when I bought at aged 29, I would have been able to afford a parking space and would’ve had to build my dwelling on it. And I’d have only 2 years left on the ten year mortgage. Why, oh why, was I not as prudent as my parents? Or Michael Noonan? They’d never get up to their… Read more »
Let’s say this would be done… then explain how:
How do you deal with the swap account’s value loss when inflation rises (and it will!)
Last but not least:
http://trueeconomics.blogspot.de/2013/03/1332013-imho-press-release-on-cbofi.html
There were plans put to this government for a a new mortgage and Business Bank while ring fencing the existing Banks. They chose not to go with a Banking Strategy but with a word PILLAR as if you can name something and it is so. The Irish Banks operate in a bust economy the only way they will become viable is to do anything required to fix that economy including debt write down Otherwise they will continue like pariahs increasing rates and charges to survive. Foreign banks will not come in here until many years after the economy stabilises. Trying… Read more »
Solution A
1.Bank takes ownership of the percentage of the property equal to the percentage of the mortgage that the client cannot service.
2. The client pays a rent to the bank for that fraction of the house that the bank owns.
3.Client has option to buy back bank share.
This is a simple win/win or lose/lose solution for all parties which doesn’t result in emotive evictions and does not attract can pay/wont pay brigade.
The banks aren’t getting the cash at the moment anyhow so would be no worse off.
Solution A (expanded) 1.Bank takes ownership of the percentage of the property equal to the percentage of the mortgage that the client cannot service. 2.Client pays mortgage they can afford on the part of the property they own. 3. The client also pays a rent to the bank for that fraction of the house that the bank owns. 4.Client has option to buy back bank share or simply handing in keys with no recourse. This is a simple win/win or lose/lose solution for all parties which doesn’t result in emotive evictions and does not attract can pay/wont pay brigade. The… Read more »
“The economy runs on the basis that, in the aggregate, my spending is your income and your spending is my income.” When all that debt was taken on and spent on property, that income went to farmers and builders and contractors and decorators and cars and holidays so on and so on…so where did it all vanish to? Someone saving too much? No. It simply left the country buying services and goods from other countries. BMWs from Germany etc. Toys and TVs and Gadgets from Asia…very little from Ireland. By rights, debts should have fed to another part of the… Read more »
[…] Arrears and the Paradox of Aggregation | David McWilliams It would give the person breathing space. In such a deal, the banks would have to have the extra capital to cover the loss they would have to carry today and only recoup in the future. Given that the banks have already set aside €17billion capital for mortgage arrears, there is already money in the kitty to cover losses. Sign in or Register Now to reply […]
David, debt is a mugs game and this is the first thing people should teach their children. That along with a warning that adults should be seen and not heard If you switch off from the MSM and get on with your life you will have missed nothing of note. Why? Because all the talking heads know nowt worth knowing about life I don’t buy that people were railroaded into it. They made adult decisions that eventually herded them up dark lane and into a screaming nightmare. They drank from the poisoned chalice and the wine has turned to vinegar… Read more »
David
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Devil is in the detail.
O great the mortgages people can’t afford to pay are going to be given a write down to help the domestic market only this is the stuff of fairy tails.
There’s plenty of people here with no mortgage and they find things hard,I just don’t think this will be the saviour of the domestic market.
This government is again barking mad.
Unemployment
Tax
Petrol
Diesel
home heating
Food
electric
Vat
COST OF LIViNG ALL IS RISING AND UNTIL SOMETHING IS DONE TO SORT OUT GREED and corruption we are sunk .wheres the change mr Kenny and mr Gilmore .
Moral and ethical decay and corruption are endemic. Sound money systems lead to affluence. Affluence leads to depravity. Depravity leads to corruption. Most of those corrupted are within a corrupt system and do not know that they themselves are corrupted. We have everyone arguing about who should get this or that. Who should be relieved of personal responsibility and who should not. We hear the argument of “It wasn’t my fault, everyone else was doing it. The state (read my neighbour) should bail me out. Somebody else should pay , it’s only fair. It is not fair I should pay… Read more »
hi all,
fairly selfish question, but am asking advise,,,
we are a small family and thinking of buying a small house (largely with savings) in cork city. we have one permanent half time job and one half time self employed. should we or should we not.
any advise appriecated.
thanks in advance.
Is it my imagination or does “DECOs” recent posts sound like someone
else? Hi Deco is that really you or have you sold your moniker or had it hijacked?
Methinks it’s a different “Deco” to the capitals “DECO” username. The real “Deco” known around these parts is far more eloquent. Just my humble opinion.
Has anybody looked at this AIB legal document ?
Confidential document lifts lid on AIB veil of secrecy on mortgage deals
9 Mar (Sinn Féin News Report) Sinn Féin Finance Spokesperson Pearse Doherty TD has today released a confidential non-disclosure document used by AIB to gag borrowers in the buy-to-let market on mortgage deals with the bank.
There you will find a link to the AIB PRE-NEGOTIATION NON-DISCLOSURE UNDERTAKING, to be signed.
How many have ben bludgeoned into this trap? Why is AIB afraid it becomes public I wonder?
Another excellent article explaining the legalized gangsterism of *bent economics*.
For the metalists and bi-metalists (gold and silver clique), have a look at polymetalic nodules:
Note that the giant defense contractor Lockheed Martin is behind this British effort to exploit our polymetalic nodules – A new and controversial frontier in mining is opening up as a British firm joins a growing rush to exploit minerals in the depths of the oceans.
UK Seabed Resources is a subsidiary of the British arm of Lockheed Martin. It has plans for a major prospecting operation in the Pacific.
As I was talking to a friend of mine ,I asked him was he going to pay the property tax,his reply was well I don’t want to but I have no choice.
He went on to say by the time this government are finished with us we will be left in our nude.
This to me is quite true,what makes things more depressing is when you look at the government and then you look at the opposition and the penny drops,we really are up the creek.
What is Olivia vickers doing having a second child when supposedly she is strapped for money?
Nice sentiments there DMcW, but without breaking the banks, they are merely that. Glass-Steagall is not sentimental, and is step number 1 for any possible recovery. I would not speak to the Irish as British East Indie Company chief Adam Smith did : “To man is allotted a much humbler department …. Nature has directed us to the greater part of these by original and immediate instincts. Hunger, thirst,the passion which unites the two sexes, the love of pleasure,and the dread of pain, prompt us to apply those means for their own sakes, and without any consideration of their tendency… Read more »
I really think the Irish hate or detest themselves. You say…”The mortgage holder would pay half the mortgage. In, let’s say, fifteen years’ time, when the house is sold, the bank would recoup some of the equity and the seller wouldn’t see all of the capital upside. This is fair and just.The likely reality of the Mortgage cleanup”. Here is the likely reality… http://www.trueeconomics.blogspot.fr/2013/03/1332013-imho-press-release-on-cbofi.html “Mr Elderfield’s statement claiming that the regulator intends to remove the current cap on number of times a bank is allowed to contact or call or visit a borrower ahead of the review of the code… Read more »
[…] full article at source: http://www.davidmcwilliams.ie/2013/03/14/arrears-and-the-paradox-of-aggregation […]
@Eireannach I have no problem with foreclosures, or accountability for one’s actions, so long as the banks don’t expect to keep going after the owner for debt after they’ve seized his property. If your attitude is the same as that of the UK and US (and it isn’t btw, our bankruptcy laws are still Victorian in comparison and the complete opposite to American bankruptcy laws) then you’d have no problem with the tens of thousands of people of my generation handing in the keys and calling it quits; but that’s not what’s happening here. The zombies still want to come… Read more »
Wrong about the Catholic guilt thing, Thomas. Very wrong. My view is – everything is twisted and corrupted. Banks shouldn’t be bailed out, pressed homeowners shouldn’t be bailed out, it’s all twisted and distorted. The idea that homeowners are next in line at the trough, after bankers and the public sector, politicians and tribunal lawyers and doctors….the whole thing smacks of the utter collapse of any verstige of a social contract. Now answer me this – will the Irish government’s policy change from ‘sort it out yourself with your lender’ to ‘debt-for-equity’ or other across the board ‘solutions’? I’m hard… Read more »
I believe in non-recourse, that is, if the bank forecloses, the homeowner loses the house and the bank can’t chase the homeowner for the outstanding balance. Why don’t we have non-recourse laws in Ireland? Because we have too many indebted households who still believe, even now, that they should be ENTITLED to keep the houses they can’t afford! There should be debt-to-equity, or some other accountancy trickery, to allow they to plod on as before toward happy retirement in ‘their own home’. Lots of Irish people still refuse to admit they’ve screwed up, epically. So they are fighting on the… Read more »
Why Must we go around In so many circles when surly we should be going in a straight line .
Surly the back bone of the domistic economy is the small buiness .
People need money in there pocket to pay for goods and services,quite simply the money has been removed from people’s pockets and so untill this is addressed properly window dressing is not going to work.
Private Equity Crash Could Trigger Next Financial Crisis, Bank of England Warns 15 March (LPAC) The Bank of England has issued a warning that the huge amounts of bad loans on the books of banks that lent to equity firms for their wild leveraged buyouts of corporations prior to the crisis, will be the trigger for the next financial crisis. The warning came from a report published today in the Quarterly Bulletin of the Bank of England, which added that the BOE would use its new role as the watchdog of the City of London to monitor private equity deals… Read more »
“In, let’s say, fifteen years’ time, when the house is sold, the bank would recoup some of the equity and the seller wouldn’t see all of the capital upside. This is fair and just.” This is assuming and hoping that property prices will go back to the level it is before the boom in 15 years or thereabouts. I don’t know what percentage of the properties are sold in god-forsaken places in the country, little housing estates are scattered all over the place with hardly any amenities, schools or public transport. Looking at the current disasters: Priory Hall, estates on… Read more »
Tomorrow, Saturday 16th March 4pm
The people of Ireland will gather at the gates of Dail Eireann on Kildare Street in an act of solidarity to tell our government that we say NO to bank bail outs and heartless austerity measures and demand real representation. Put people first.
A warning of unprecedented emergency. The EU has started to levy depositors accounts directly to bail out Cyprus! In a radical departure from previous euro zone rescues for Greece, Ireland, Portugal and Spain, finance ministers struck a deal to lend the indebted island €10 billion. But in return, depositors would have to forfeit up to 10 per cent of their savings. As Deputy Doherty said, the Government needs to report on progress on their deal : “The decision last night to impose a levy of 6.75% on ordinary Cypriot deposit holders under €100,000 and a 9.9% levy on those over… Read more »
Once again EU/ECB Governments & their finance ministers reach in to the pockets of private citizens and steal their money for the Benefit of Bank & State bailouts. Cyprus was robbed today and nobody again,gives a shit…. What was done to Cypriots Today is theft..nothing more ..nothing less..Total Criminality.. If you are in Financial trouble, don’t worry about it…Banks can get bailed out,you are worth more than some fucked up Banking System & their puppet lackey finance Ministers.. And if you think EU ripping off Cypriot Bank Depositors is a one off..think again..this is a test.. They will steal everyone… Read more »
Once again EU/ECB Governments & their finance ministers reach in to the pockets of private citizens and steal their money for the Benefit of Bank & State bailouts. Cyprus was robbed today and nobody again,gives a shit…. What was done to Cypriots Today is theft..nothing more ..nothing less..Total Criminality.. If you are in Financial trouble, don’t worry about it…Banks can get bailed out,you are worth more than some fucked up Banking System & their puppet lackey finance Ministers.. And if you think EU ripping off Cypriot Bank Depositors is a one off..think again..this is a test.. They will steal everyone… Read more »
I will tell you just how terrified the I.M.F /E.C.B /E.U is
If they are unable to allow tiny banks in the overall context,in Cyprus go Bankrupt….Just how big is the coming financial Collapse going to be for bigger/Mega Banks…?
How insolvent are the Mega Banks ?…
Think you all better dust off those old biscuit tins…!
Except,of course,here in Ireland where everything is recovering & booming at a remarkable rate.
Greetings All
Happy St. Patrick’s
http://www.independent.ie/videos/garda-siochana-march-in-new-york-st-particks-day-parade-29134900.html
Who is paying for this?
Cyprus : German SPD and ECB directorate member Asmussen put it brutally : “Before the banks reopen, the mandatory levy will be drawn from the accounts. The rest of the account is free for disposal.”
He denied that this will be the policy for other countries. Nobody believes a word. So much for the SPD election platform.
German Finance Minister Schaeuble proposed a 40% (!) haircut on Cypriot bank accounts. This had also been the proposal of the International Monetary Fund- from CyBC and DPA.
So with an Irish EU Council presidency, the obvious questions.
reut.rs/ZzY13y via @reuters”
3 Cypriot parties say they will not support “bailout” plan/robbery
http://youtu.be/M6QmH-7fu68
A gentle reminder of EU democracy from 5 years ago..10 minutes long ..enjoy & reflect
How’s that for a paradox of arrears and aggregation. The EU simply steals the aggregation to pay off the arrears. Anyone who thought something is “solved”, “calmed”, “just make a deal”, is in for a wake-up call.