ESRI's renewed crticism of the Central Bank's mortgage restrictions

Brendan Burgess

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The ESRI had another shot at the Central Bank's mortgage restrictions today.

"Developments on the supply side of the Irish housing market have a number of
important policy implications. For example, the Central Bank of Ireland has signalled that there will be a review of the macro-prudential policy measures in November of this year. These measures, which were aimed at curbing house price inflation, were introduced in February 2015 after a consultative process. The review exercise will be an important opportunity to modify the implementation of this crucially important policy tool.

In Duffy and McQuinn (2015) we argued that macro-prudential policy should be implemented on the basis of counter-cyclical policy rules. These rules would be triggered on the basis of a certain set of indicators focussing on house prices, supply levels and developments in mortgage credit. In recommending this, we
feel we were advocating the adoption of international best practice where influential contributors such as Bank of England (2009), have all broadly recommended such a course of action. The mere signal of a rule change can itself have a significant impact on market activity, although naturally rules in the monetary policy space have been demonstrated to provide greater clarity and transparency to different market participants if consistently applied. Furthermore, analysis in the previous Commentary demonstrates why it is important that housing market activity should have a significant weight in any decision rules. If housing supply reaches the level of structural demand in 2018, macro-prudential policy could then play an important role in ensuring we do not experience the spiralling levels of supply evidenced in the Irish market in the early part of the 2000s. It is, after all, the combination of overvalued house prices and large volumes of housing supply which poses a systemic financial stability concern."



In May 2015, it published a paper on the issue:
https://www.esri.ie/publications/macroprudential-policy-in-a-recovering-market-too-much-too-soon/

In December 2015, it had a general paper on the housing supply issue:
A Review of Housing Supply Policies
 
It must be clear to most people that lending over 80% of the value of the property is risky to both the lender and to the borrower? The suggestion from the ESRI that we can throw more borrowed money at the problem seems poorly thought out. It will push up prices which is great for sellers but not great for buyers. They argue that if house prices take off, then we can tighten lending. But that would be even more difficult to do at that stage.

The best way to deal with a credit and price bubble is to prevent it from happening in the first place.

It is not the responsibility of the Central Bank to solve the housing supply problem in Ireland on their own. Granted, they should not take some unnecessary action to make it worse. But the bigger problem is the very high cost of building in Ireland and the government's huge tax take on new houses.

Brendan
 
While broadly agreeing with you Brendan I still think that the CB need to adjust their required deposit strategy to account for renters (particularly in the Dublin area). I would agree on the necessity of a deposit but feel that it should be limited to say 10% for FTB's up to a higher limit than currently where they can display a regular rental outlay. X Income restriction should be retained.
 
Hi brendan

Surely it's the other way around? The rent substitution argument might apply to the 3.5 times income restriction, but I don't see its relevance to the LTV restriction.

A lender should not lend more than 80% of the value of a property. It's too risky generally, and particularly in Ireland where we don't allow lenders to repossess where the borrower chooses not to pay.

If the lender says to the borrower: "OK, you have the 20% deposit, but by my calculations, you can't afford the repayments from your salary." Then, the borrower could reply saying "Look, we have proven our ability to repay this amount for the past two years as we have been paying this amount of rent".
 
The ESRI would be far better off highlighting the very high mortgage rates in this country.

If we had fair value long term fixed interest rates, the Loan to Income restrictions and affordability stress testing could be reduced.

Brendan
 
Why should the deposit requirement be 20%, when having it at 10% didn't lead to any problems?

Other factors such as childcare, tax, rents, etc make saving circa €80k virtually impossible for the majority of people.

These rules are leading to greater inequality as wealthy parents and their kids hoover up the available property.
 
I think this is appropriate for this thread also

The current deposit requirement for first time buyers could be resolved with a mortgage product that gives a fixed rate of interest for the full term of the loan thereby giving certainty of the cost of the loan and this will not need to be stress tested as the rate remains constant for the full term. However the issue, again, will be what rate the lenders here will charge when compared to similar products available in Europe. A rate of around 3% would help resolve a major part of this problem. Will lenders do it, I doubt it, but will continue to lay the issue with the Central Bank rather than bringing a progressive approach with workable solutions to the issue. Thinking outside their comfort zone (or how mortgages have been done to dates) and bringing appropriate products to suit the current climate will help while also delivering enough profit on the loan to the lender. THis will likely only occur when another lender brings the product to the market place. Then all will follow suit as a pack. Padraic
 
From a lending risk perspective we would always prioritise repayment capacity over collateral value. The income limit is a rough tool and I am never in favour of generalisations when assessing loan approvals.
If we exclude the calamitous lending which took place in the early noughties HL lending is generally at the lower risk level. I certainly take your point on the repossession issue and agree that while we have this ridiculous restriction on lenders it does create a problem in terms of future mortgage lending/pricing.
"Look, we have proven our ability to repay this amount for the past two years as we have been paying this amount of rent".
The difficulties here is that there is a likely limit to maintaining payments at a certain level. Stressed RCR analysis would factor in an element of stress to the repayment ability which meeting actual payments do not.
 
Why should the deposit requirement be 20%, when having it at 10% didn't lead to any problems?

Hi Gordon

It led to a lot of problems.

We have a huge mortgage arrears problem.

We have a huge negative equity problem.

We have very high mortgage rates.

The main determinant of the house price bubble was the lax lending. Had the Central Bank imposed an 80% LTV limit in 2004, it would have dramatically reduced the extent of the problems. A 90% limit, would have reduced the problems a bit, but not by as much.
 
From a lending risk perspective we would always prioritise repayment capacity over collateral value.

Surely you need both?

First, can a borrower meet their repayments? Make that assessment on 3.5 times Loan to Income or rent substitution or repayment capacity stressed for a 2% rise or whatever.

But secondly, what happens if they can't or won't meet the repayments? By insisting that they have 20% skin in the game, then you protect yourself from losing money and you encourage the borrower to keep up the repayments.
 
The root problem which the ESRI should focus on is not that people aren't allowed to get into too much debt, but the fact that apparently the costs for houses is way too high. Maybe they should target the criticism on the planning side of things, or god forbid on the simply put outrageous costs of building in this country. Why does a builder or developer have to make more than 7/8% profit? They usually don't take any risk whatsoever (given they never put their own money in), they don't have any incentive to bring down costs.

High house prices are the problem, not restrictions on how much debt people can get into.
 
What is the basis for the 3.5 times salary rule? Reduce this instead and allow 10-15% deposits.
 
Why the ESRI think that the Central Bank of Ireland should be bothering itself with how many houses Builders/Developers put on the market is beyond me. What next...the CBoI to police building standards!
Can you imagine if the rules were reviewed twice a year...deposit ratios up,down,up,down. Recipe for mass confusion.

The problem is not the current mortgage rules or anything to do with credit supply for Buyers. It's all down to housing supply and the lack of it. And thats where the incompetent Irish Govt/Civil Service come into play.
- Heavily tax land banks in the short term (regulate the price of development land in the longer term- Kenny report)
- Review all building standards - are they all needed, is there duplication/complication? Is this adding to the cost
- Change the rules on social housing - it shouldn't be for life, no matter whether your circumstances improve or not.
- Sort out rent arrears in the Social housing area...over 30% of local authority tenants are in arrears. And here we are shouting for tens of thousands of more social housing units to be built!
- Make repossessions much easier.
- Incentivise the building of 'retirement villages' in local areas. Allows for downsizing and we're not getting younger!
- Build higher, much higher, in cities. No reason why the docklands area of Dublin couldn't be 20 stories or so.

Anyways rant over. ESRI need to re think their areas of focus
 
The ESRI's idea that the Central Bank's macro prudential rules should somehow be connected to construction activity or some academic view of the prevailing supply/demand dynamics within the housing market is bonkers. How would that even work?

The aggregate level of mortgage debt being carried in Ireland is already extremely high by international standards. Ratcheting up debt levels to unsustainable levels may well increase the profitability of residential development but surely the dangers of going down that road should be obvious?
 
What is the basis for the 3.5 times salary rule? Reduce this instead and allow 10-15% deposits.

I remember when the Central Bank restrictions were published that I was not at all convinced by the level of research done to backup the 3.5 limit. I didn't get the feeling that they had really considered say 3 versus 3.5 versus 4; or for example, whether 3.5 might make sense at a certain level of income but not for all levels.

What I mean is that the costs of running a house valued at €300,000 are not of a very different order to one valued at €400,000 or €500,000.
Does it really make sense that an income of €50,000 versus €75,000 or €100,000 should all be limited at 3.5? Surely what matters is how much disposable income you have after paying for a mortgage and other standard outgoings.
Compare the level of detail with say, repayment deals agreed with householders in arrears with banks where the costs of running a car, utility bills, medical insurance etc were all factored in.

Now maybe the Central Bank did crunch the numbers and it all just magically came out at a nice fairly round number of 3.5 regardless of income levels etc. But I am supremely dubious of that. My reading was that the research was done, and reports prepared, with the intention of justifying 3.5 rather than any systematic exercise in establishing what made sense in terms of best guidelines.
 
The ESRI's idea that the Central Bank's macro prudential rules should somehow be connected to construction activity or some academic view of the prevailing supply/demand dynamics within the housing market is bonkers. How would that even work?

The aggregate level of mortgage debt being carried in Ireland is already extremely high by international standards. Ratcheting up debt levels to unsustainable levels may well increase the profitability of residential development but surely the dangers of going down that road should be obvious?

I listened to an ESRI spokesperson on the matt cooper podcast yesterday.
His logic was absurd.

ESRI guy: "The LTV ratios should be adjusted to take account of property price growth rates"
- cause property always goes up in value? Didn't we get into trouble with this theory something around 2007?

ESRI guy: "The ratios should be adjusted to take account of underlying construction activity and supply & demand"
- So, because supply is short and demand is high, property prices are above what the CBI prudential rules allow people to borrow. Solution, loosen the rules so more people get more credit to fund the high prices, which in turn pushed prices higher as supply is constrained?

In my opinion this was awful logic. They'd be better off researching why it's so expensive to build in Ireland relative to the UK & Northern Ireland. I'd rather a cheaper house than a bigger mortgage.
 
I remember when the Central Bank restrictions were published that I was not at all convinced by the level of research done to backup the 3.5 limit. I didn't get the feeling that they had really considered say 3 versus 3.5 versus 4; or for example, whether 3.5 might make sense at a certain level of income but not for all levels.

In my submission, I think I suggested that they should be integrated. For example, with very low LTV, the LTI could be higher, and with a very low LTI, the LTV could be higher.

They did actual research and here is a chart from it showing default rates for first time buyers:
Macro-prudential Tools and Credit Risk
of Property Lending at Irish banks

upload_2016-3-17_16-14-32.png

It's a bit hard to make out, but there seems to be significant enough defaults for LTIs over 3.83 and LTVs over 90.

The lenders can make exceptions. And the lenders do measure the Net Disposable Income as well.
 
I listened to an ESRI spokesperson on the matt cooper podcast yesterday.

I read their QEC and it's poorly written. What I think they are saying is:

"When there has been a period of massive credit growth and increased house prices, tighten the rules to dampen the market and avoid a bubble. However, when there has been very little demand for credit, loosen the rules so as not to dampen the market".

I think that this is wrong. The CB introduced the rules at the right time to avoid a bubble developing.

I am not sure about the other point, which seems to be:

"By restricting credit, you have cut the prices of houses so that it's no longer profitable for the builders to build anymore. So increase the credit, that will push up prices and supply."

The balance has to be got right. And I don't think that their recommendation of irresponsible lending should be the solution to the supply crisis.

The government has to cut the cost of building new houses to make it profitable again, which I think, is the point you are making, Andy.
 
In my submission, I think I suggested that they should be integrated. For example, with very low LTV, the LTI could be higher, and with a very low LTI, the LTV could be higher... They did actual research and here is a chart from it showing default rates for first time buyers... It's a bit hard to make out, but there seems to be significant enough defaults for LTIs over 3.83 and LTVs over 90. The lenders can make exceptions. And the lenders do measure the Net Disposable Income as well.

Thanks for the info... Somewhat more reassuring when you can see data like that, if they had gone with 3.83 rather than 3.5 I would have been less suspicious ... I do think there is a degree of wiggle room there than another pass over the data could reveal e.g. an overlay of Net Disposable Income, an overlay of house price etc
 
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