Personal Debt Write-off from an
Economic Perspective
Tom McDonnell
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 McDonnell
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
cumulative
Future
consolidation
% of GDP
‘Projected’
8.6
7.5
5.0
2.9
-
General Gov.
Deficit
€ billions
Total
Consolidation
3.8
3.5
3.1
2.0
5.7
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
?
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 McDonnell
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
• BlackRock 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 McDonnell
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 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
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 McDonnell
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
27
28
Part 5
A Wider Perspective
Tom McDonnell
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