Regular readers know that the Irish Central Bank under the leadership of Patrick Honohan has been a strong advocate of banks recognizing their losses as not doing so drags out the financial crisis.
Such rulings will become increasingly familiar in Ireland as one of the biggest property bubbles in European history unwinds, a crisis masked this year by falling bond yields as investors bet that the worst is over. Yet for Irish banks, whose losses forced the government to follow Greece in seeking a bailout, the true cost of the debacle is about to hit.
“It’s the year when the world has to change, in the way we deal with this problem,” said Garry Stran, head of the arrears unit in Allied Irish Banks Plc (ALBK), the nation’s largest mortgage lender. “This time next year, when we’re looking back, we should have an absolute clear line of sight that we have restructured a significant number of people.”As you re-read the highlighted text, keep in mind that Iceland required its banks to recognize their losses at the beginning of the financial crisis. This protected Iceland's real economy and its social programs.
The losses that Iceland's banks recognized equaled what they could expect to lose if they went through the long process of default and foreclosure. This level of loss recognition doesn't create equity for the debtor, but leaves the debtor in a position where they can actually service the debt.
Lenders that were bailed out by taxpayers and are owned by the state are looking at a previously unthinkable mix of repossessions and debt forgiveness as they confront the specter of loans that will never be repaid.Lenders in the EU, UK and US face the same problem. Unlike Iceland's banks which have faced up to the problem and Irish banks that are going to confront the problem, EU, UK and US banks continue to kick the problem into the future.
They face the following conundrum: Move too quickly and aggressively in dealing with bad loans and risk cratering the banking system again and imperiling any recovery in real-estate prices, at least in Dublin. Move too slowly, and a debt-laden economy will struggle to grow as borrowers rein in spending.Modern banking systems, like Ireland's, are designed to allow banks to continue to operate and support the real economy even if they have low or negative book capital levels.
Banks can do this because of the combination of deposit insurance and access to central bank funding.
When banks have low or negative book capital levels, deposit insurance explicitly makes the taxpayers the banks' silent equity partner.
Irish household debt had tripled to 214 billion euros ($279 billion) when the real estate market collapsed in 2008, from 75 billion euros in 2002, according to Dublin-based Goodbody Stockbrokers. As a share of household income, debt has risen to 210 percent from about 117 percent. That’s about twice the average in the euro area.
Four years since the collapse, about 30 percent of Irish home loans by value, including so-called buy-to-let mortgages for rental properties, are in arrears or have been modified.
Banks have largely held off on repossessions or debt forgiveness after taxpayers were forced into a 64 billion-euro rescue of the financial industry.
While they have set aside about 6.4 billion euros of provisions for expected bad loans, actual write-offs in the 30 months through June were 250 million euros, according to Goodbody Stockbrokers.
“Banks have been playing a waiting game, hoping things improve,” Lars Frisell, chief economist at Ireland’s central bank, told reporters in Dublin on Nov. 28. “That’s not happened. It’s time to stop procrastinating, to find out where the losses are and crystalize them. Take the losses.”...Previously, Mr. Frisell worked for the Swedish central bank, so he is very familiar with the Swedish Model for handling a bank solvency led financial crisis. He understands why the losses on the bad debt need to be recognized so that the burden of the excess debt is removed from the real economy.
Most borrowers will keep their properties, as banks roll out plans to avoid wide-scale repossessions and forgive vast quantities of debt.This is what was done in Iceland and should be done in the EU, UK and US.
“By any definition, the financial crisis in Ireland in general and the mortgage crisis as part of that is massive,” said Jeremy Masding, chief executive officer of Dublin-based Permanent TSB, the largest mortgage lender during the boom. He said the bank won’t talk about writing off debt before “we have exhausted all our efforts” on other solutions.
In some cases, borrowers will be encouraged to trade down to smaller homes, while the central bank is pushing the idea of split mortgages, where portions of loans will be put on hold until the person’s circumstances improve.
For other debtors and banks, though, the future may lie in negotiating forgiveness....