Personal Debt Write-off from an Economic Perspective Tom

Personal Debt Write-off from an Economic Perspective Tom Mc. Donnell TASC 19 April 2012

What is TASC? • An independent, progressive think-tank dedicated to promoting equality, democracy and sustainability in Ireland through evidencebased policy recommendations.

Part 1 Growth Prospects and the Impact of Debt Tom Mc. Donnell TASC 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 2. 9 - cumulative Future consolidation % of GDP ‘Projected’ General Gov. Deficit 8. 6 7. 5 5. 0 € billions Total Consolidation 3. 8 3. 5 3. 1 2. 0 5. 7 Expenditure 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 ? 14. 3 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 2 Housing Aftermath Tom Mc. Donnell TASC 19 April 2012

Wealth Destruction Daft 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 peak CSO – fall of 49% since peak National 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 • Black. Rock Stress Case Projected Loss - € 10. 53 billion • CBI Three-year Projected Loss – € 5. 92 billion

Ending the Decline Housing 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 future Price 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 3 Historical Experiences and Policy Options Tom Mc. Donnell TASC 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 Options Direct 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 MPCs MPC = 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 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 households But • No control over monetary policy or exchange rate policy • Limited fiscal space Nevertheless • 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 4 Reasons for Caution? Tom Mc. Donnell TASC 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 ways Rationale 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 5 A Wider Perspective Tom Mc. Donnell TASC 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 32

Other Issues Financial 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 Issues Financial exclusion – The Trap • Basic bank accounts • Hyperbolic Discounting • Below the radar personal finance – Payday loans – Cheque cashing operations – Buyback shops – Cash for gold etc