THE European Central Bank (ECB) will ultimately have to take over the mortgage book of the big banks. Or at least that is what will have to happen for this country and our economy to begin the process of a normal recovery.
It mightn’t be a bad idea to make ratification of the new fiscal compact deal contingent on the ECB taking the mortgage book from the banks. Never mind your promissory notes, the real volcano building under the finances of this fragile State of ours is the deeply underwater mortgage books of the big banks — Bank of Ireland, AIB and Irish Permanent.
A possible way out is to hand this problem to the ECB in the same way as the Greeks handed their government debt problem to the ECB last week and the ECB took the loss. Be in no doubt the Portuguese will be next in the queue, so while we are waiting for our turn we might as well figure out our demand and our price.
And given that there will be lots of behind-the-scenes negotiations in the next few months, this might be one of our demands in the horse-trading.
The latest figures from the banks and the property market reinforce the centrality of a mortgage solution and if the ECB doesn’t take over the mortgage book of the banks, we will have another major banking crisis through the avenue of mass mortgage default.
Many, many years ago this column warned of a generation in negative equity. Now it is a reality and one day these people will wake up and decide not to bother with the whole thing.
Yesterday we had figures confirming that house price falls are accelerating. We’ve now experienced 22 consecutive quarters of price falls. This is moving into world record territory for uninterrupted price slumps. A few weeks ago, this column wrote that if we followed the Japanese experience we’d see price falls ending next year, but there is no sign that we are following Japan. After all, Japan reacted to the economic slump of the 1990s by hugely expanding government spending; we are doing the opposite. The fiscal compact is a silly idea and will make the adjustment harder because without fully flexible wages, slashing government expenditure now just punctures demand and makes unemployment higher.
So without this direct support to demand, the economy will be more dependent on the banks to extend loans. But here’s the thing, the banking picture is getting worse not better in Ireland.
Last week we got a snapshot of what the country actually looks like in Bank of Ireland’s latest report. It shows us that 55pc of Bank of Ireland’s total mortgage book is now in negative equity. It also shows that 69pc of buy-to-let mortgages are in negative equity. â‚¬15.3bn out of total mortgage lending of â‚¬28.8bn is now underwater.
Obviously this is getting worse as shown by the figures from the CSO regarding house prices. This means that arrears, negative equity and ultimately defaults will get more and more common.
But has Bank of Ireland provided for this? Well this is where we find the real shock in the report. Bank of Ireland has only set aside â‚¬1bn to cover the potential losses on the â‚¬15bn that the negative equity figure suggests could happen.
But why have they only set aside such a small amount of capital for an event, which is practically guaranteed to happen?
The answer is that they have no money.
Here’s what is happening in the property market in Ireland. No Irish banks are moving against mortgage owners who are in arrears. Only the foreign owned banks are doing that at the moment. The spin is that this is because the banks are government-owned and can’t be seen to be moving against citizens. This may be true and hopefully it is in the very many atrociously difficult cases that are out there.
But what if the reason they aren’t foreclosing on mortgages is because they can’t afford to? To foreclose a mortgage, a bank needs to have a capital buffer to finance the difference between the loan and the new price they could sell the house for. But it can only generate this buffer sustainably from its margins, its on-going profits.
But here’s the rub. The banks in Ireland are caught between the rock of 400,000 tracker mortgages and the hard place of a deposit war.
In the next five years the Irish banks need to get their loans-to-deposit ratios down to 100pc. The average figure for the big ones is now around 140pc. This means that they will either have to make fewer loans or raise more deposits over the next few years.
BUT with the tracker rates being so low, we are in a situation where the banks are now trying to attract in deposits by offering interest rates that are higher than tracker rates. So they are paying more to get money in than they are being paid on the loans they have made. This means that their cost of capital is higher than their return on that capital. Even a Leaving Cert economics student can understand that that is how you go bust.
So the circularity of the argument is the banks aren’t foreclosing on mortgages because they can’t afford to, which means that the housing market won’t drop quickly but prices will continue to grind down relentlessly quarter by quarter.
This makes arrears and defaults all the more likely, against which the banks do not have sufficient capital to protect themselves.
They are snookered either way.
They can’t foreclose because they can’t afford to; but they also can’t afford not to foreclose.
The problem is simply too big for the domestic banks. The ECB will have to take the mortgage book in order to ensure that Ireland doesn’t suffer from a slow, mass default.
Ireland needs a Sugar Daddy to take one for the team. If the Germans and French want their fiscal compact, they’ve got to pay for it. Putting the mortgage issue firmly on the table mightn’t be a bad opener.