# Karl Whelan's paper on the mortgage crisis



## Brendan Burgess (27 Oct 2011)

This was presented to the Central Bank conference on the mortgage market

http://www.karlwhelan.com/IrishEconomy/CB-Comments.pdf


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## Brendan Burgess (27 Oct 2011)

> I understand there has been frustration with the limited nature of the recommendations of the Keane report, with its suggestion of a number of approaches that can be taken by banks, rather than directives from the government. However, I am broadly sympathetic to the report. I suspect that critics may overestimate the control the government has over the mortgage sector and also underestimate the logistical problems currently faced by banks that are overwhelmed by the scale of their bad mortgage debts.


I am delighted to see this. I seem to have been the only other person to broadly welcome the report, while noting its limitations. It's important to take the Keane Report and the two Cooney reports together. 



> one wonders whether those who are in favour of the proposal that people should be given years to pay two-thirds of the mortgage interest really understand the impact on the net present value of a mortgage asset of such a scheme (particularly if the loan is a tracker mortgage and is losing the bank money even if all the interest is being repaid.)


...



> However, I think it is also clear that the size of the Irish mortgage problem is such that even when mortgage debts are currently unsustainable, repossessions should not necessarily be the first choice. There is an enormous number of properties for sale on the Irish market today. A big wave of repossessions will only increases the gap between supply and demand and drive house prices down further. The banks that repossess these homes could be left with huge portfolios of empty, depreciating, homes.


The second quotation does not follow the first quotation closely in the report. But it illustrates the difficulty facing those of us who were tasked with coming up with solutions. 

There are three rough categories of current mortgage holders, with People moving between the three categories over time. 

  Those who are paying their mortgage on schedule
Those who are not on schedule, but given time, may get back on schedule
Those with clearly unsustainable mortgages
 It is my view that there are at least 10,000 unsustainable mortgages who should have their homes repossessed. This would count as "A big wave of repossessions "

The Deferred Interest Scheme gives the borrowers time to get back on track. Some of them may become unsustainable but most won't.

So when Karl Whelan wonders if those of us who support the DIS,  understand the cost of it to banks - we do indeed. But we understand that the cost of repossessing those houses now would probably be much higher.  There is no easy solution. 




> Given the widespread demands for the government to take strong action in relation to mortgages, the Keane report provides a useful reminder that despite the substantial role now played by the government in the Irish banking sector, the majority of distressed mortgages are not owed to banks directly controlled by the government. The report informed us that, despite having just over one-third of total outstanding Irish mortgages, non-covered banks accounted for half of the arrears to date. And about one-third of the mortgages owed to covered banks are accounted for by Bank of Ireland, in which the state has only a minority interest.
> 
> With over half of the mortgage arrears in Irish residential mortgages accounted for by banks outside state ownership, it is clear that the question of how to deal with mortgage arrears goes well beyond a policy of how to write down distressed mortgages in Irish-government-controlled banks. And with so many mortgages being held by banks whose private owners have provided risk capital to absorb losses, there should be no question of the Irish government providing handouts to these banks to subsidise mortgages losses.


This is a useful reminder of the distinction between state owned and private banks. The government cannot just tell the private banks to write down mortgages.





> In relation to concrete policy solutions, there can be little doubt that a significant increase in repossessions, which then allow people to walk away from their mortgage debt, must be an important part of the solution for those people whose mortgages are clearly unsustainable. Those in government who are making the absence of repossessions a policy goal in itself should perhaps reconsider their position.


I have been banging this particular drum for some time. The ministers should stop trying to minimise repossessions. 




> In the current circumstance, there may also a case for extending the “split mortgage” scheme to some who are in mortgage arrears but are in positive equity. As Rae Lydon’s presentation at this conference shows, a significant fraction of mortgage arrears in Ireland relate to cases in which the borrowers are currently in positive equity. If these borrowers are experiencing more than temporary problems, so that they will not be able to service their full mortgage in future, the traditional solution is for them to sell their house and pay off the mortgage in full. Given the current dysfunctional state of the Irish mortgage market, there is a question as to whether a split mortgage scheme may also work better for these borrowers and their banks.


This is a very odd suggestion in the light of his remarks on the cost of the Deferred Interest Scheme. 

Split mortgages make no sense. In one version, interest accrues on the warehoused part. So they end up paying capital off the "sustainable" mortgage while running up interest on the warehoused part. The Deferred Interest Scheme is much cleaner. The borrower pays as much interest as they can, and the bit they can't pay goes into a deferred interest account. This is a clear measure of the extent of their difficulty and how it is growing or reducing over time.  It also provides a mechanism for the government to support a distressed borrower if the government so chooses. The government can pay the deferred interest on the borrower's behalf.  I am not suggesting that the government should do this, I am simply pointing out that this would the best way to do it.

In another version of the split mortgage, no interest accrues on the warehoused part. This is even less sensible. The borrower gets an interest break, so that they can repay capital.

But a split mortgage for someone in postive equity makes even less sense. Simply roll up the interest which the borrower can't afford.


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