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Repossession: why we need a new bank directive

Guest blogger and economist Stephen Kinsella is all too familiar with mortgage arrears through the charity work he does on repossession cases. Here he suggests a five-point plan for the government and banks

Debt relief for ordinary homeowners rather than developers is centre stage in Ireland at the moment after new central bank figures show one in nine mortgages are either in arrears or restructured.

We won’t know until the end of the month what solutions the government will propose. But with the report by the government’s expert group on mortgage arrears hurtling towards us, it might be useful to consider a few worked examples of debt restructuring as and when they become important to us.

A lot of people are talking about the ‘F-word’ – debt forgiveness – which is too simplistic an approach to a complex issue. However, I’ve come up with an alternative five-point mortgage debt resolution process, based on some cases I know of.

First off, these are archetypal cases created to make some points about types of mortgages in difficulty, so they are subject to a series of assumptions I detail in this Google docs spreadsheet. They are not meant to be anything other than exemplars, though they are driven by real-life cases I’m familiar with through my work with – a group of business people and barristers who are helping people facing repossession.

Anybody wishing to improve the “reality” of the examples, by including interest and arrears for example, or another debt restructuring mechanism, please have a go on Google Docs and I’ll link to your examples in the comments.

Second off, it’s pretty clear from the spreadsheet that very few cases actually qualify for some kind of restructuring.

I chose just one sample restructured mortgage – a debt/equity swap – although there are many other possibilities. The headings of the spreadsheet should take you through the logic of the examples.

What we can see is that of the six cases, only two mortgages are deemed “sustainable” when the bank takes a 45% equity stake, and only one is “sustainable” when the bank takes a 35% stake.

So, under the present set of arrangements, the rest of these mortgages would most likely end up becoming court cases, with the attendant stress on household and society, and the possibility of the bank recouping only the secured asset.

If, and it’s a big if, these examples are any guide to reality at all, an efficient personal insolvency mechanism is clearly the first step towards resolving the debt crisis, with a subset receiving some form of restructuring.

It’s clear there is a need for an efficient filter to decide, based on individual circumstances, which mortgages aren’t sustainable, which are, and which might be, given other considerations.

In practice, here’s how I see such a filter working.

1. The process is done through the banks but supervised by the regulator. Another quango or NAMA we really don’t need. Banks are best placed to work things out with their borrowers, but they should be supervised – especially the uncovered banks and sub-primes but most importantly the “pillars”. A metric agreed by both sides on the debt profile of the individual lender and borrower should be constructed.

2. The implementation should be a menu of options available to the bank, one of which must be used depending on the outcome of a series of tests for income, etc, applied in stage 1. The penalty for misrepresenting yourself to the bank should be fraud charges. Cute hoors need not apply, in other words. This will reduce the moral hazard element enormously.

3. This menu will include: straight-out bankruptcy, debt/equity swaps, repayment rescheduling, debt writedowns in cases where the banks have clearly acted inappropriately, giving the house back to the bank in full and final settlement but renting the same house again, and more. Each menu item (a, b, c, etc.,) will come from an individual pot of money in the banks (e, f, g, etc.), all overseen by the regulators by means of a monthly report to them.

4. The objective is to be fair to both parties (lender and borrower) while allowing people to get on with their lives. The perspective, in some sense, is social welfare rather than letting banks or borrowers off the hook.

Understanding that you’ll never get this just right is key.

5. The guidelines should have the force of a directive on the banks from the regulator – for example, it should remove a lot of the discretion from the banks and add clarity to the process while differentiating between ‘can’t pay’ and ‘won’t pay’, and ‘might pay’ and ‘will never pay’.

All comments welcome.

Stephen Kinsella is an economist at the University of Limerick © 2011 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds