Consensus on need for private debt write-off marks progress

The trade-off between preserving bank reserves and stimulating the economy remains

DEBATE ABOUT mortgage debt seems to have come full circle. As of last Friday the official position – as stated on this occasion by the governor of the Central Bank – remains pretty much as it was before the summer began: the banks will be left to deal with the issue on a case-by-case basis but the Government expects them to act responsibly and compassionately.

There are, however, a couple of positive aspects to be take from this late summer brouhaha.

The first, but not the most important, is that the financial crisis that re-erupted at the start of August and threatened to envelop the world once again abated sufficiently to allow room for a bona fide silly season story.

This respite may prove short lived, with last Friday’s disappointing US job figures expected to lead to a ratcheting up of tensions.

The other and more significant dimension to the circular debate about mortgage indebtedness is that while there may be no particular solution in sight, it does indicate that the issue of private debt is finally being faced up to by policymakers.

It has been obvious – to some observers at least – since 2008 that the massive levels of private sector debt, and mortgage debt in particular, of Irish people were a factor in the toxic economic scenario that was unfolding. Any attempt to restructure and revive the economy would eventually have to confront the issue.

But the generalised denial that pervaded official circles at the start of the crisis, combined with the speed and force with which it then unfolded, meant that issue was not directly addressed.

The disinclination to identify the household debt burden as a major constituent of the economic crisis was entirely compatible with the refusal to acknowledge until late last year that all the banks were shot through and needed far more taxpayer cash than the Government claimed.

Publicly acknowledging that many people cannot and will not be able to repay their mortgages did not sit with the notion that the bill for fixing the banks would be somewhere in the region of €30 billion to €40 billion. With hindsight, it’s obvious that there was an understandable cognitive bias towards trying to limit the estimated losses at the banks to what the State could actually afford to finance independently

It is simplistic to say that a blind eye was deliberately turned to the issue. It has to be recognised that the limited political, institutional and financial capacity the State had to deal with a crisis of the magnitude of the one that enveloped Ireland was consumed in dealing with the immediate problem. Ultimately this capacity was inadequate. The State was overwhelmed and had to seek a bailout.

Arguably, it was only once the white flag had been run up and the management of the economy – particularly the banking sector - was reappraised by EU, IMF and the ECB that the issue of private sector debt was fully factored into the analysis.

This took the form of forcing the banks to make much bigger provisions after their mortgage and other lending books had been trawled through by independent advisers. The result was the commitment of another €30 billion or so to allow the banks meet their losses, much of it related to private sector debt.

This is the basis of the claim by the Minister for Finance that the banks have been given money to allow them to write off personal debts. But that is not strictly true. It would be more accurate to say that the banks have been given the money to write off personal debts if they need to.

The trade-off between preserving the now strongly capitalised balance sheets of the State-owned and controlled banks or proactively applying some of this money to stimulate the economy remains.

There are plenty of good arguments for not doing anything at this stage that would weaken the banks, given the distance they still must travel to win back market credibility.

However, there are equally good arguments – both social and economic – for the need to tackle mortgage over-indebtedness and negative equity. They are without doubt factors in the bigger-than-expected fall in domestic demand that is now worrying some economists.

If all the carry on over the last few weeks amounts to anything it is the forging of a consensus that the banks do need to write off some of this debt and the very public communication of such to them and the Government.

It is progress after a fashion.