Personal Debt Write-off from an Economic Perspective

Tom McDonnellTASC

19 April 2012

What is TASC?

• An independent, progressive think-tank dedicated to promoting equality, democracy and sustainability in Ireland through evidence-based policy recommendations.

Part 1Growth Prospects and the Impact of Debt

Tom McDonnellTASC

19 April 2012

Outlook for Growth• Debt dynamics are immensely challenging

– Growth is the only panacea short of debt restructuring

• Growth constraints• Debt overhang (C)

– public/commercial/household• Aftershock of banking crisis (I)

– lack of lending• Fiscal consolidation (G)

– negative multipliers• Weakening exports (NX)

– uncertainty and fiscal consolidation in Europe

• Celtic Tiger catch-up has played out– Benign conditions will not be replicated

Scale of the Debt Overhang (end 2011)

GDP = €156 billion• Government Debt – circa €166-168 billion (105%)– Increasing y-o-y (government balance in deficit)– Will peak

• Household Debt– circa €185-190 billion (119%)– Decreasing y-o-y (household deleveraging)

• Business Debt– circa €140-150 billion (90-95%) – Decreasing y-o-y (deleveraging/write-downs)

Discretionary Fiscal Tightening, DOF, Nov, 2011

Green = Undertaken, Blue = Planned, Red = Fiscal Compact

2012 2013 2014 2015 2016-2018 cumulative

Future consolidation

% of GDP

‘Projected’ General Gov. Deficit

8.6 7.5 5.0 2.9 -

€ billions

Total Consolidation

3.8 3.5 3.1 2.0 5.7 14.3

Expenditure 2.2 2.25 2.0 1.3 ?

Current 1.45 1.70 1.9 1.3 ?

Capital 0.75 0.55 0.1 0.0 ?

Tax 1.6 1.25 1.1 0.7 ?6

Impact of Debt Overhangs• Cecchetti et al (2011) – Empirical analysis of 18 OECD

countries

• Evidence suggests there is a drag on growth beyond certain thresholds

• Government debt - 85%• Household debt – 85%• Corporate debt – 90%

• Ireland exceeds all three thresholds

Part 2Housing Aftermath

Tom McDonnellTASC

19 April 2012

Wealth DestructionDaft Asking Prices (2007 average = 100)• March 2007 = 100.3• March 2008 = 96.2 (y-o-y decline = 4.1%)• March 2009 = 80.3 (y-o-y decline = 16.5%)• March 2010 = 67.1 (y-o-y decline = 16.4%)• March 2011 = 57.3 (y-o-y decline = 14.6%)• March 2012 = 47.6 (y-o-y decline = 17%)

Daft – fall of 53% since peakCSO – fall of 49% since peakNational House Price Register to be launched this Year

Falling Prices and Multiple Equilibria

• Falling house prices generate a self reinforcing cycle– Falling prices mean declining net worth– Unwise to dismiss negative equity as a problem

• A barrier to second hand transactions– Continuous downward cycle of household

deleveraging drags on growth• We should be cautious not to distort the market

again but market is likely to overshoot downwards in the absence of a positive exogenous shock

Residential Mortgage Arrears (end December 2011)

• Total residential mortgage loans outstanding– €113.48 billion

• Total mortgage arrears cases outstanding– In arrears 91 to 180 days = €3.27 billion– In arrears over 180 days = €10.67 billion– Value of arrears for the above = €1.12 billion

• Restructured mortgages (Balance)– €13.29 billion (of which not in arrears = €6.1 billion)– Approx. 75,000 restructurings so far

Projected losses

• BlackRock Stress Case Projected Loss - €10.53 billion

• CBI Three-year Projected Loss– €5.92 billion

Ending the DeclineHousing market is moribund• Fewer than 4,000 mortgages per quarter• Around 15,000 mortgages for a housing stock of almost 2 million

units• No reason to assume market will recover in the foreseeable futurePrice should reflect underlying value• Prices may have further to fall• Clarity around personal insolvency legislation would help put a

stable floor on the market– That in itself will help resuscitate the market – Recovery will only occur when the economy recovers

Part 3Historical Experiences and Policy

Options

Tom McDonnellTASC

19 April 2012

Historical Experiences

Pre Great Recession Crises• USA (1933)– Home Owner Loan Corporation (HOLC)

• Mexico (1998)– Punto Final program

• Colombia (1999)• Uruguay (2000)• Korea (2002)• Argentina (2002)• Taiwan (2005)

Contemporary Experiences

The Great Recession• Iceland (2008)• USA (2009)• Hungary (2011)• Ireland (?)

Policy OptionsDirect Payments to Individuals in Trouble

Option 1: Direct Payments to those in trouble (support through the social safety net)

• Individuals in trouble will have disproportionately high MPCsMPC = Marginal Propensity to Consume

• Virtually all of the disposable income of low income households cycles back into the local economy as consumption– Very high multipliers

• If not direct payments?• The Government’s fiscal adjustment should seek to ring fence low

income households as much as possible from discretionary adjustments– Taxes/cuts aimed at those on low incomes are more damaging to

aggregate demand and therefore have larger impacts to growth and employment

Policy Options Temporary Macroeconomic Stimulus

Option 2: Temporary Macroeconomic Policy Stimulus• Government spending targeted at financially constrained

householdsBut• No control over monetary policy or exchange rate policy• Limited fiscal spaceNevertheless• Policy choices do exist within the envelope of tax and

spend• Slightly over half of employment destruction has been in

the construction sector

Policy Options Assistance to the Financial Sector

Option 3: Assistance to the Financial Sector• Government capitalisation of banks• Government purchase of distressed assets (already

happened for commercial loans – NAMA)• Support by the monetary authority is critical

• Doesn’t necessarily incentivise the lenders to engage with borrowers

But• Can be a complementary policy

Policy Options Support for Household Restructuring

Option 4: Setting up Frameworks for Debt Restructuring• Legislation – improving the institutional or legal

frameworks– Frameworks for voluntary debt restructuring– Frameworks for ‘automatic’ debt restructuring

Other possibilities• Governments buying distressed mortgages from lenders

directly or through an intermediary institution• Quid pro quo

– Restructuring in exchange for moving trackers to the IBRC

Household Debt Restructuring:International Best Practice

• Pitfalls

• Incentives

• Key principles

Part 4Reasons for Caution?

Tom McDonnellTASC

19 April 2012

Burden on Taxpayers?

Restructuring involves clear winners• All taxation and public spending choices involve

transfers of resources from one section of society to another

• Bank bailout was itself a transfer of wealth• Social cohesion cuts both waysRationale for the taxpayer• High ‘propensity to consume’ of those in trouble• Benefits to the taxpayer in the form of increased

aggregate demand, higher growth and employment

Implications for Property Rights?Constitutional issues

International reputation• Crucial that there be clearly defined and transparent

rules for debt restructuring• What type of system?• Automatic triggering versus case by case discretion• What would the triggers be?

• Get it right the first time• Consistency and predictability

Impact on Lending?

A genuine dilemma• What can the Government do?– A grand deal involving the EFSF– IBRC as a bad bank

• Medium-term support from the Euro system is crucial

• What about impact on the future cost of mortgages?– It is entirely appropriate that the cost of future mortgage

borrowing accurately reflect the underlying risk– Dangers of cheap credit

Impact on Government Debt Dynamics?

• Second bailout is likely in any event– Medium term funding requirements– Irrational not to seek an extension of the current

programme

• Targeted debt restructuring would help growth dynamics

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Part 5A Wider Perspective

Tom McDonnellTASC

19 April 2012

A Multidimensional Crisis

There is no single silver bullet• Tinbergen– Achieving ‘n’ policy goals require a minimum of ‘n’

policy levers

• The interlocking crises of the Euro area

Causes of the Debt crisis• Design flaws

– Optimal Currency Area• Asymmetric shocks

– Single interest rate – Goldilocks syndrome• Massive credit inflows to the periphery• Current account imbalances• Asset price bubbles

– Multiple equilibria• No lender of last resort

– No mechanisms, protocols or conditions for writing down debt– No EU-wide special resolution regime for the banking sector– Failure to construct a banking union– No centralised financial regulation

Regulation and Governance in a Monetary Union

• Workable monetary union requires centralised oversight and enforcement of financial institutions– Narrow focus on ‘headline’ inflation rate is insufficient– Addition of additional indicators is helpful

• Mandate of the ECB is too narrow– Flexibilities required to counterbalance the one-size-fits-all interest

rate that creates localised private credit bubbles and amplifies the boom and bust cycle

• There are no protocols and conditions for debt write-down and debt restructuring

• There are no European wide special resolution mechanisms for insolvent banks

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Other IssuesFinancial exclusion

• Financial Exclusion– What about the people with no property?– Putting mortgage interest relief into context

• ‘Respectable debt’ versus ‘shadow debt’– Shadow financial sector– Reform is needed

Other IssuesFinancial exclusion – The Trap

• Basic bank accounts

• Hyperbolic Discounting

• Below the radar personal finance– Payday loans– Cheque cashing operations– Buyback shops– Cash for gold etc