Here is an IMF paper on the subject if anyone is interested. It's a general paper and not specific to Ireland
http://www.imf.org/external/pubs/ft/spn/2009/spn0915.pdf
http://www.imf.org/external/pubs/ft/spn/2009/spn0915.pdf
IMF paper: Principles of Household Debt Restrucuring
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Brendan Burgess
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[FONT="]Sunny. Thanks for bringing that to our attention. It is very interesting. We were not aware of this paper on the Expert Group on Mortgage Arrears. I have extracted key points as I see them as a form of summary of the paper.
Executive Summary
The historically high levels of household debt in many countries currently facing financial crisis have heightened demands for government intervention. If unaddressed, household debt distress could be a drain on the economy and lead to social unrest. Well-designed and wellexecuted
government intervention may be more efficient than leaving debt restructuring to the marketplace and standard court-based resolution tools alone. This note assesses the case for government intervention in household debt restructuring. It proposes, in addition to targeted legal reform, a template for a government-supported household debt restructuring program designed to reverse nonperforming loans, which could be adapted to individual country circumstances.
Selected extracts
While governments with fiscal space may decide to pursue restructuring[/FONT][FONT="]policies on the basis of social considerations, the design of such debt restructuring programs should be based on sound economic principles[/FONT]
[FONT="]Essentially, this can be seen as a multiple equilibria situation: in one equilibrium, debt overhang is resolved more rapidly, leading to a stabilization of house prices and resumption of growth; in the other, debt overhang lingers, resulting in further declines in house prices and contributing to a worsening of the recession.[/FONT]
[FONT="]When government bank recapitalization programs are also envisaged, authorities need to consider any overlap between the costs of debt restructuring and the costs of bank recapitalization when assessing the impact of government intervention on public debt.[/FONT]
[FONT="]Under the first approach, the government establishes the legal and institutional frameworkthat supports case-by-case restructuring.[/FONT]
[FONT="]the wealth destruction and extreme liquidity pressures thatcan arise in systemic crises can be exacerbated by wide-scale resort to credit enforcement measures.[/FONT]
[FONT="]It is therefore important that an effective court-supervised insolvency framework be in place for individual debtors, providing for multi-creditor[/FONT]
[FONT="]restructuring through the following key legal features:
(i) an automatic stay on creditor enforcement and debtor payments during the insolvency proceedings;
(ii) when the debt is secured, but the market value of the collateral (including the value of the household property securing a mortgage) is below the value of the loan, the court has the power to restructure the amount of the deficiency as unsecured debt;
(iii) the modification of loan terms should take into[/FONT][FONT="]account the payment capacity of the debtor; and
(iv) a “fresh start” through discharge of financially responsible debtors from the liability for unsustainable debts at the end of the liquidation or rehabilitation period.[/FONT]
[FONT="]Case-by-case debt renegotiations between a creditor and debtor can result in an adjustment in loans on a voluntary basis to reduce debt payments through (i) interest rate reductions, (ii) principal amount reductions, and/or (iii) maturity extensions[/FONT]
[FONT="]A second approach involves the establishment of a government-sponsored debt restructuring program that involves some form of financial support.[/FONT]
[FONT="]the government can provide direct support to the households through some[/FONT][FONT="]form of subsidy, such as debt forgiveness, interest or exchange rate subsidies, or tax incentives [/FONT]
[FONT="]comprehensive debt restructuring programs risk being too generous by offering restructuring to borrowers that without debt restructuring would have been able and willing to make payments on their debt.[/FONT]
[FONT="]Ideally, debt restructuring programs should be designed such that they lead to a “separating equilibrium” in which only borrowers that are unable to repay their debt take advantage of the program. The degree of government intervention depends on the scale of the problem, the ability of debtors and creditors to absorb losses, and the fiscal space of the government.[/FONT]
[FONT="]ored debt restructuring program should help restore the viability of[/FONT][FONT="]individual borrowers, while minimizing the direct fiscal cost, reducing the risk of bank failures, and establishing the basis for the recovery of the real sector. These multiple goals may not be fully compatible and policy choices may need to be made as to where the balance is struck. [/FONT]
[FONT="]Page 9[/FONT]
[FONT="]The design of a debt restructuring program should incorporate a number of basic features:[/FONT]
• [FONT="]Objective: [/FONT][FONT="]Turn troubled loans into performing loans, while mitigating the moral hazard created by offering debtors the opportunity to not repay on the loan’s original terms. The program could be directed to reduce debt service requirements of certain borrowers that have experienced increases in their scheduled loan repayments as a result of adverse interest rate or foreign exchange rate shocks, or to address the build-up of a substantialamount of nonperforming loans.[/FONT]
• [FONT="]Scope: [/FONT][FONT="]The program should, where feasible, be selective and target borrowers who cannot meet their debt service obligations but whose ability to service their debt is likely to be restored upon restructuring. The restructuring program could be designed to compensate the targeted group of borrowers either partially or in full—but in any case at a sufficient level to restore sustainable debt levels and servicing capacity of borrowers. [/FONT]
[FONT="]Defining criteria for such selectivity and reliably applying the criteria could be a major challenge, especially where data is unreliable and political or social considerations are pressing factors. In cases where public funding is used, it would need to be sufficient to cover each qualifying participant. Conversely, the scope of the program would be subject to the public funding envelope.[/FONT]
• [FONT="]Proportionality: [/FONT][FONT="]The degree of government intervention in the program should depend on the scale of the problem, the capacity of creditors and debtors to absorb losses, and on 8 These basic features are designed on the model of a single (main) creditor for each household debtor and thus does not address creditor coordination and inter-creditor equity issues that would arise in countries where multiple creditors of household debtors are prevalent.[/FONT][FONT="]the fiscal space of the government. Intervention should not impede on government debt sustainability and burden sharing between creditors and debtors should depend on their ability to absorb losses.[/FONT]
• [FONT="]Participation: [/FONT][FONT="]Participation should be on a voluntary basis. Banks should be induced, not forced, to restructure their debts with borrowers.9 Compulsory restructuring, outside of the court-supervised insolvency process will give rise to legal challenges and should be avoided.[/FONT]
• [FONT="]Simplicity: [/FONT][FONT="]Given the large number of loans involved in household debt restructuring, design should be based on simple rules and verifiable information to speed up restructuring and reduce the potential for abuse. These rules should be based on analysis of the structure of the banks’ household loan portfolios, and, where it is not available already, banks will need to share with the government the necessary information to conduct such analysis should public funds be used to support the program.[/FONT]
• [FONT="]Transparency and accountability: [/FONT][FONT="]The program should include mechanisms that allow the authorities to monitor the progress in restructuring to ensure the accountability of the program participants, and to make adjustments to the program if necessary. Mechanisms such as ongoing reporting and audit requirements are especially important if public funds are used, as they would help safeguard the integrity of the program and the most effective[/FONT][FONT="]use of taxpayers’ money.[/FONT]
[FONT="]IV. IMPLEMENTING A GOVERNMENT-SPONSORED DEBT RESTRUCTURING PROGRAM[/FONT]
[FONT="]To avoid multiple rounds of debt restructuring, governmentsponsored[/FONT][FONT="]debt restructuring programs should generally not be introduced before macroeconomic policies have stabilized the economy and a bank recapitalization program has been put in place[/FONT]
[FONT="] design should mitigate such moral hazard and lead to a “separating equilibrium” in which only borrowers that are unable to repay their debt take advantage of the program.[/FONT]
[FONT="]Government incentives may be on occasion warranted to overcome obstacles to[/FONT][FONT="]borrowers seeking restructuring, e.g., in cases of significant negative equity, where it may be individually efficient for borrowers to walk away from their mortgages, but costly to the economy as a whole.[/FONT]
[FONT="]Administrative measures as last resort. [/FONT] [FONT="]If the size of the debt problem is overwhelming and other tools, including government financial support, are ineffective, administrative measures may become a last resort. Such measures include the imposition of a standard way of modifying distressed loans (possibly differentiated according to local market conditions) and a payment[/FONT][FONT="]moratorium or foreclosure ban on distressed loans. A debt payment moratorium is particularly problematic because it interferes with contracts, negatively impacting the market’s perception of the quality of contract enforcement going forward, and would not address underlying debt overhang problems. Similarly, the imposition of an administrative ban on foreclosures does not solve the underlying debt overhang problems and could generate incentives to default by[/FONT][FONT="]reducing the associated penalty, thereby exacerbating spillover effects on bank balance sheets.[/FONT]
Executive Summary
The historically high levels of household debt in many countries currently facing financial crisis have heightened demands for government intervention. If unaddressed, household debt distress could be a drain on the economy and lead to social unrest. Well-designed and wellexecuted
government intervention may be more efficient than leaving debt restructuring to the marketplace and standard court-based resolution tools alone. This note assesses the case for government intervention in household debt restructuring. It proposes, in addition to targeted legal reform, a template for a government-supported household debt restructuring program designed to reverse nonperforming loans, which could be adapted to individual country circumstances.
Selected extracts
While governments with fiscal space may decide to pursue restructuring[/FONT][FONT="]policies on the basis of social considerations, the design of such debt restructuring programs should be based on sound economic principles[/FONT]
[FONT="]Essentially, this can be seen as a multiple equilibria situation: in one equilibrium, debt overhang is resolved more rapidly, leading to a stabilization of house prices and resumption of growth; in the other, debt overhang lingers, resulting in further declines in house prices and contributing to a worsening of the recession.[/FONT]
[FONT="]When government bank recapitalization programs are also envisaged, authorities need to consider any overlap between the costs of debt restructuring and the costs of bank recapitalization when assessing the impact of government intervention on public debt.[/FONT]
[FONT="]Under the first approach, the government establishes the legal and institutional frameworkthat supports case-by-case restructuring.[/FONT]
[FONT="]the wealth destruction and extreme liquidity pressures thatcan arise in systemic crises can be exacerbated by wide-scale resort to credit enforcement measures.[/FONT]
[FONT="]It is therefore important that an effective court-supervised insolvency framework be in place for individual debtors, providing for multi-creditor[/FONT]
[FONT="]restructuring through the following key legal features:
(i) an automatic stay on creditor enforcement and debtor payments during the insolvency proceedings;
(ii) when the debt is secured, but the market value of the collateral (including the value of the household property securing a mortgage) is below the value of the loan, the court has the power to restructure the amount of the deficiency as unsecured debt;
(iii) the modification of loan terms should take into[/FONT][FONT="]account the payment capacity of the debtor; and
(iv) a “fresh start” through discharge of financially responsible debtors from the liability for unsustainable debts at the end of the liquidation or rehabilitation period.[/FONT]
[FONT="]Case-by-case debt renegotiations between a creditor and debtor can result in an adjustment in loans on a voluntary basis to reduce debt payments through (i) interest rate reductions, (ii) principal amount reductions, and/or (iii) maturity extensions[/FONT]
[FONT="]A second approach involves the establishment of a government-sponsored debt restructuring program that involves some form of financial support.[/FONT]
[FONT="]the government can provide direct support to the households through some[/FONT][FONT="]form of subsidy, such as debt forgiveness, interest or exchange rate subsidies, or tax incentives [/FONT]
[FONT="]comprehensive debt restructuring programs risk being too generous by offering restructuring to borrowers that without debt restructuring would have been able and willing to make payments on their debt.[/FONT]
[FONT="]Ideally, debt restructuring programs should be designed such that they lead to a “separating equilibrium” in which only borrowers that are unable to repay their debt take advantage of the program. The degree of government intervention depends on the scale of the problem, the ability of debtors and creditors to absorb losses, and the fiscal space of the government.[/FONT]
[FONT="]ored debt restructuring program should help restore the viability of[/FONT][FONT="]individual borrowers, while minimizing the direct fiscal cost, reducing the risk of bank failures, and establishing the basis for the recovery of the real sector. These multiple goals may not be fully compatible and policy choices may need to be made as to where the balance is struck. [/FONT]
[FONT="]Page 9[/FONT]
[FONT="]The design of a debt restructuring program should incorporate a number of basic features:[/FONT]
• [FONT="]Objective: [/FONT][FONT="]Turn troubled loans into performing loans, while mitigating the moral hazard created by offering debtors the opportunity to not repay on the loan’s original terms. The program could be directed to reduce debt service requirements of certain borrowers that have experienced increases in their scheduled loan repayments as a result of adverse interest rate or foreign exchange rate shocks, or to address the build-up of a substantialamount of nonperforming loans.[/FONT]
• [FONT="]Scope: [/FONT][FONT="]The program should, where feasible, be selective and target borrowers who cannot meet their debt service obligations but whose ability to service their debt is likely to be restored upon restructuring. The restructuring program could be designed to compensate the targeted group of borrowers either partially or in full—but in any case at a sufficient level to restore sustainable debt levels and servicing capacity of borrowers. [/FONT]
[FONT="]Defining criteria for such selectivity and reliably applying the criteria could be a major challenge, especially where data is unreliable and political or social considerations are pressing factors. In cases where public funding is used, it would need to be sufficient to cover each qualifying participant. Conversely, the scope of the program would be subject to the public funding envelope.[/FONT]
• [FONT="]Proportionality: [/FONT][FONT="]The degree of government intervention in the program should depend on the scale of the problem, the capacity of creditors and debtors to absorb losses, and on 8 These basic features are designed on the model of a single (main) creditor for each household debtor and thus does not address creditor coordination and inter-creditor equity issues that would arise in countries where multiple creditors of household debtors are prevalent.[/FONT][FONT="]the fiscal space of the government. Intervention should not impede on government debt sustainability and burden sharing between creditors and debtors should depend on their ability to absorb losses.[/FONT]
• [FONT="]Participation: [/FONT][FONT="]Participation should be on a voluntary basis. Banks should be induced, not forced, to restructure their debts with borrowers.9 Compulsory restructuring, outside of the court-supervised insolvency process will give rise to legal challenges and should be avoided.[/FONT]
• [FONT="]Simplicity: [/FONT][FONT="]Given the large number of loans involved in household debt restructuring, design should be based on simple rules and verifiable information to speed up restructuring and reduce the potential for abuse. These rules should be based on analysis of the structure of the banks’ household loan portfolios, and, where it is not available already, banks will need to share with the government the necessary information to conduct such analysis should public funds be used to support the program.[/FONT]
• [FONT="]Transparency and accountability: [/FONT][FONT="]The program should include mechanisms that allow the authorities to monitor the progress in restructuring to ensure the accountability of the program participants, and to make adjustments to the program if necessary. Mechanisms such as ongoing reporting and audit requirements are especially important if public funds are used, as they would help safeguard the integrity of the program and the most effective[/FONT][FONT="]use of taxpayers’ money.[/FONT]
[FONT="]IV. IMPLEMENTING A GOVERNMENT-SPONSORED DEBT RESTRUCTURING PROGRAM[/FONT]
[FONT="]To avoid multiple rounds of debt restructuring, governmentsponsored[/FONT][FONT="]debt restructuring programs should generally not be introduced before macroeconomic policies have stabilized the economy and a bank recapitalization program has been put in place[/FONT]
[FONT="] design should mitigate such moral hazard and lead to a “separating equilibrium” in which only borrowers that are unable to repay their debt take advantage of the program.[/FONT]
[FONT="]Government incentives may be on occasion warranted to overcome obstacles to[/FONT][FONT="]borrowers seeking restructuring, e.g., in cases of significant negative equity, where it may be individually efficient for borrowers to walk away from their mortgages, but costly to the economy as a whole.[/FONT]
[FONT="]Administrative measures as last resort. [/FONT] [FONT="]If the size of the debt problem is overwhelming and other tools, including government financial support, are ineffective, administrative measures may become a last resort. Such measures include the imposition of a standard way of modifying distressed loans (possibly differentiated according to local market conditions) and a payment[/FONT][FONT="]moratorium or foreclosure ban on distressed loans. A debt payment moratorium is particularly problematic because it interferes with contracts, negatively impacting the market’s perception of the quality of contract enforcement going forward, and would not address underlying debt overhang problems. Similarly, the imposition of an administrative ban on foreclosures does not solve the underlying debt overhang problems and could generate incentives to default by[/FONT][FONT="]reducing the associated penalty, thereby exacerbating spillover effects on bank balance sheets.[/FONT]
Brendan Burgess
Founder
- Messages
- 52,048
The Expert Group on Mortgage Arrears suggested the Deferred Interest Scheme which was based on the concept of what makes a mortgage sustainable.
It has long been a topic of mine, that if someone can pay the interest on their mortgage, then that mortgage is sustainable. This is not an easy concept for people to grasp and the IMF guys have overlooked this.
This is fundamental to the understanding of how to approach mortgage debt issues. It's hard to discuss the topic without fully appreciating this.
Switching a mortgage to interest-only, even indefinitely, is a better all round solution than reducing the interest-rate or writing off capital. Obviously the borrower would prefer to see the interest rate reduced. But why should the lender reduce the interest rate, just so that the borrower can begin to repay capital?
It has long been a topic of mine, that if someone can pay the interest on their mortgage, then that mortgage is sustainable. This is not an easy concept for people to grasp and the IMF guys have overlooked this.
This is fundamental to the understanding of how to approach mortgage debt issues. It's hard to discuss the topic without fully appreciating this.
Switching a mortgage to interest-only, even indefinitely, is a better all round solution than reducing the interest-rate or writing off capital. Obviously the borrower would prefer to see the interest rate reduced. But why should the lender reduce the interest rate, just so that the borrower can begin to repay capital?
Brendan Burgess
Founder
- Messages
- 52,048
I wonder is this paper based on non-recourse mortgages? Recourse and non-recourse mortgages require very different strategies. The following wouldn't really apply to Ireland
We are in an odd position in Ireland because so many of the loans which should be in trouble, are not in trouble, as the interest rate is so low.
This is a very interesting idea which I have not seen raised before. On first glance, it seems reasonable. I have a house worth €200k and a mortgage of €300k and credit card debt of €30k. I can get the negative equity of €100k and the €30k debt settled but keep my house. The main problem with this is what happens if the house increases in value. The borrower gets all the benefit.
The other odd thing about Ireland is our very low level of repossessions. A good part of this paper assumes a high level or repossessions.
This bit was particularly interesting in the light of the moratorium on legal action:
We are in an odd position in Ireland because so many of the loans which should be in trouble, are not in trouble, as the interest rate is so low.
This is a very interesting idea which I have not seen raised before. On first glance, it seems reasonable. I have a house worth €200k and a mortgage of €300k and credit card debt of €30k. I can get the negative equity of €100k and the €30k debt settled but keep my house. The main problem with this is what happens if the house increases in value. The borrower gets all the benefit.
The other odd thing about Ireland is our very low level of repossessions. A good part of this paper assumes a high level or repossessions.
This bit was particularly interesting in the light of the moratorium on legal action:
I agree and, to me, this is the least contentious way of alleviating financial pressure on those struggling with repayments. No debt is forgiven and there is no ongoing 'loss' to the bank (with a knock-on to the taxpayer) if interest is being paid on the loan. However, surely this only applies if the interest rate is an economic one - ie not a low tracker as many recent loans are on? Should people have to switch from trackers to variable rates (or at least the banks 'cost of money' rate) to avail of interest-only on a long-term basis?
I think debt re-structuring is more realistic than debt forgiveness, however I think the banks are still making it awkward for customers to do this. Each customer now has to go, cap-in-hand to these institutions (which are part of the root cause of their problems in the first place) and beg for a few scraps with regard to changes to their mortgages. Why not introduce a code which grants the customer the right to, for instance:
1. Extend the term of their mortgage, say by up to 20% of term. This should apply to trackers, variable, fixed, no matter. It should be available as an automatic right to the customer, on a once-only basis. Obviously the bank would need to make it clear to the customer, that this would in fact mean they end up paying more. However a lot of customers would probably take that deal right now. The banks would also gain, as they get more money over the longer term for the same loan. Whether it should be available for investment properties would need further thought.
2. Switch to interest only payments for a period, say 3 or 6 months.
3. Skip 1 payment per year for a period of say, 3 years.
There would be more options but basically what I am proposing is that this menu of options be made available as a right, and to all customers, not just those in neg equity. (This eliminates the "why should I pay my mortgage when the Jones's don't" argument).
1. Extend the term of their mortgage, say by up to 20% of term. This should apply to trackers, variable, fixed, no matter. It should be available as an automatic right to the customer, on a once-only basis. Obviously the bank would need to make it clear to the customer, that this would in fact mean they end up paying more. However a lot of customers would probably take that deal right now. The banks would also gain, as they get more money over the longer term for the same loan. Whether it should be available for investment properties would need further thought.
2. Switch to interest only payments for a period, say 3 or 6 months.
3. Skip 1 payment per year for a period of say, 3 years.
There would be more options but basically what I am proposing is that this menu of options be made available as a right, and to all customers, not just those in neg equity. (This eliminates the "why should I pay my mortgage when the Jones's don't" argument).
If we're talking about the morality of not favouring people with debt forgiveness, then we have to stop talking about bank interest rates as if they are a performing business model that hasn't been bailed out by the taxpayer.
We also have to explain to the consumer where the banks mutual interest stop and their interest rates start.
Charging interest at rates at two per cent higher than the rate of inflation seems reasonable, but we've seen banks rates set at outrageous levels.
Lowering the rate to allow capital payback would deal with the prospect of eternal indenture that an interest-only scenario promotes.
Great for the bank, not so great for their customer.
I agree interest only (as opposed to default) is the best way forward in the short to medium term.
I think people who are willing to address their debts and who have paid a significant proportion of this already in an interest-only arrangement, should be offered a lower tax rate to allow them pay off the capital plus interest.