# Should principal forgiveness be introduced as it has been in the US



## kaplan (14 Oct 2011)

At yesterdays Central bank conference on the mortgage market, Blackrock Solutions presented on international loan modifications and concluded with the following:

*House prices are a significant driver of defaults in ‘non-recourse’ and recourse markets alike - negative equity matters in all markets which BlackRock has studied

The housing crisis in many countries is not over and requires policy response coordinated with implementation at a loan level basis

Little loan modification experience in Europe to draw from; much of it seems to be driven by accounting or capital preservation

Certain types of loan modifications seem to work better than others – the US experience suggests that principal forgiveness is more effective than other types of loan modifications*

It is notable that the mortgage group did not consider principle forgiveness. Many consider this as leaning towards bankers interests in protecting their capital.

Is it not inevitable that principal forgiveness loan modifications will be needed to cram down loans to affordable levels?


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## onq (14 Oct 2011)

I tend to agree with what you're suggesting Kaplan, but a few links wouldn't go amiss to see the run of play


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## kaplan (14 Oct 2011)

Link's gone from the Central bank site.


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## Brendan Burgess (14 Oct 2011)

I have asked the conference organiser to upload the papers.

Brendan


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## Jim2007 (14 Oct 2011)

kaplan said:


> It is notable that the mortgage group did not consider principle forgiveness. Many consider this as leaning towards bankers interests in protecting their capital.



And with good reason, mortgages are not financed out of the bank's capital, they are financed out of short term deposits from the customers!  That is the weakness of the business model used in the UK/Ireland/US, it makes the mortgage much more sensitive interest rate changes and at the same time ebbs and flows of deposits makes financing the borrowing difficult.

Compare that to middle Europe, where mortgages are funded from the long term deposits of pension funds and the like.  The mortgages are much less sensitive to interest rate changes and the mortgage company can better manage the funding of a mortgage because it knows the funds will be on deposit with them for 20 years or more.



kaplan said:


> Is it not inevitable that principal forgiveness loan modifications will be needed to cram down loans to affordable levels?



Not at all, once you stop using short term deposits to fund mortgages there is actually no reason why a mortgage has to be paid back!!!  Crazy... no I have such a mortgage, it is actually very common in middle Europe - when you take out the mortgage you agree with the bank how the mortgage will be split - a portion which you will pay back and is financed by the bank and a portion which you will not pay off and is financed by a pension fund or similar institution that needs a guaranteed income stream.

Jim2007


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## onq (14 Oct 2011)

Jim,

Are you seriously suggesting that mortgage lending is not governed by the same fractional reserve lending principles as other forms of lending?

Rules that allow money to be created from nothing by simple means of double entry book-keeping?


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## Jim2007 (14 Oct 2011)

onq said:


> Are you seriously suggesting that mortgage lending is not governed by the same fractional reserve lending principles as other forms of lending?
> 
> Rules that allow money to be created from nothing by simple means of double entry book-keeping?



Not at all, the key difference is the matching of long term deposits with long term borrowing.  In Switzerland and Liechtenstein for instance pension funds are involved in the full pension life-cycle, from initial accumulation of assets while a person is working to paying out the monthly pension.  Accordingly, the pension funds have a requirement for stable income generating assets such as mortgages that are never paid back!  This puts the banker in a position of being able to offer split mortgages on a property - one being for say 5 years with a moving average rate and the other being indefinite with a fixed rate for say the next 15 years and so on.  This brings a lot of certainty for everyone involved and of course interest rate changes have very little impact on the whole thing.

The requirement to have a steady reliable income stream means that the banks are very careful about their lending policy, the normal requirements are:

You have to have 20% or there abouts in hard cash - your savings and the such, excluding gifts and winnings
The repayments must amount to no more than about 25% of your monthly salary
There is a complex valuation method combining the current market value with the local authorities tax valuation of the property

Currently the deposit level has been raised to about 25% or higher in come case to prevent a property bubble the government felt was developing in some parts of the country.

Jim.


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