Tuesday, February 14, 2012

Ireland shows how hard it is for bankers to lend when losses are still on their books

A Bloomberg article highlights how difficult it is for bankers to lend when they are still hiding losses on and off their balance sheet.

This confirms yet another piece of the Wall Street rescues Main Street blueprint.

Regular readers know that banks are senior secured lenders.  Their business is based on the idea that they take a security interest in collateral that has sufficient value that should it need to be sold the proceeds would repay the loan.

How exactly is a banker suppose to make a fully secured residential real estate loan when house prices are dropping by 10% or more every year?

Irish banks may be suffering a “fear factor” in lending after the collapse of a real estate bubble that resembled “a Ponzi scheme,” according to Justice Minister Alan Shatter. 
Lenders handed out 623 million euros ($827 million) of home loans in the third quarter, according to the Irish Banking Federation. They lent 11 billion euros in the same period five years earlier, the height of the boom. 
“What our financial institutions were running in the 2003- 2007 period was the nearest thing to a residential property pyramid scheme,” Shatter said in a Feb. 10 interview at his Dublin office. “We have gone from a situation from where they were throwing money at any dog that moved,” to one where the banks are being “unduly difficult” and “constipated.’” 
Almost 13 percent of private residential mortgages were either more than 90 days in arrears or restructured at the end of September, according to the Irish central bank. Moody’s Investors Service said last week Shatter’s proposed personal insolvency laws may leave as much as 25 percent of the country’s mortgage debt open to write-off. 
“There was the implicit suggestion that there would be some sort of banking Armageddon with this legislation,” said Shatter, who took office after the change of government a year ago, of the rating company’s report. “There are a whole range of things Moody’s are missing.” 
Shatter said that many home owners in negative equity are paying their loans in full and only “an extraordinarily small number” of home repossessions have been ordered by the courts. 
Stress tests of the nation’s lenders last year also accounted for “potential residential mortgage losses,” he said.

The state has injected about 62 billion euros into the country’s lenders over the past three years amid soaring bad- loan losses, as the economy struggles to emerge from what the government calls the worst crisis since World War II. 
The banks may be adequately capitalized to absorb the losses, but then again they may not be.  Without ultra transparency so that each bank's current asset, liability and off-balance sheet exposure detail is disclosed, how can any market participant know?

For their part, Irish banks have an incentive to drag out recognizing their losses as long as possible.  There is some chance that house prices will stop declining and in fact increase.

Unfortunately, the banks delaying recognizing their losses reinforces the ongoing downward spiral in house prices.

Both sellers and buyers can see there is a large inventory of houses that is going to come onto the market and put downward pressure on prices.  As a result, sellers who have equity in their house and would like to complete a transaction before the banks' inventory hits the market are cutting their price aggressively to attract buyers who could otherwise wait for the banks inventory to cause a further decline in house prices.

The way to end this downward spiral is to require banks to provide ultra transparency.  Then, whether the banks recognize their losses or not, market participants would know what the "true" housing inventory is and prices would stabilize at a level that would absorb this inventory.

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