Eamon Ryan: intervention for homeowners

Last week, minister Eamon Ryan stated the government would implement plans by the summer to help struggling homeowners. Such a plan was part of the new Programme for Government put in place months ago by the Green Party and Fianna Fáil. A panel of experts is to be set up to advise the government on the best way to help these struggling homeowners. The proposal has been called in some circles "My Nama". It follows a Dáil motion put forward by Labour in October of last year, in which the party called for policies to enable people to remain in the family home, "where possible and subject to reasonable limits".

A policy to help struggling homeowners is in the state's interest in that it will bear some level of cost if a person loses their home through providing social housing or rent supplement payments. Also, with the government supporting the banking system, defaults of mortgages will have an impact through the government's investments in the domestic banks.

The first aim of any scheme is to try and prevent default and these are called forbearance policies; for example, policies such as the lender agreeing lower loan repayments and adding the shortfall onto the principal or the current mortgage supplement scheme whereby the Department of Social Welfare pays the interest on the mortgage for a period of time in the case of unemployment.

When forbearance schemes fail the next stage is repossession. There are a number of schemes that try to prevent moving individuals from their home. In Scotland they have the Mortgage to Rent Scheme whereby the Scottish government arranges for a social landlord to buy a home with a government subsidy and the owner stays in their home but becomes a tenant.

With a wide range of schemes to follow internationally, the government could easily put a number of policies in place to help struggling homeowners. While it is important to support such people, and to put plans in place such as the 'mortgage to rent scheme' for situations where people lose their home, the issue of negative equity needs to be considered by policy makers.

Some confusion exists over what negative equity is. This is the situation where the value of a house is less than the mortgage outstanding on the house. Basically, if the owner sells the house in the morning he will still owe the bank money as the proceeds of the sale are not enough to repay the bank in full. But studies show that negative equity is not the main cause of people walking away from their mortgage. A paper by David Duffy of the ESRI cites a number of reports that show negative equity in itself does not result in default. Mortgage defaults happen due to "life issues" such as unemployment, illness or marriage break-up. So why is negative equity a problem?

Negative equity has a range of harmful effects in an economy, that highlight the economic and social impacts of a residential property burst. Negative equity results in reducing the mobility of an economy's workforce. If taking a new job means a person moving house, a person in negative equity will not take the role. Families may find themselves in housing that isn't suitable, but due to negative equity they cannot move.

People become reluctant to sell in the hope prices will come back to what they paid, even when they are not in negative equity, reducing the level of transactions in the housing market. Banks demand higher deposits from buyers over concerns prices will fall further making it harder for people to buy a home, the other extreme from offering 100% mortgages in the boom.

Negative equity also has an impact on consumer confidence and spending within an economy. Individuals concerned they are in negative equity will increase their level of saving and try reducing their mortgage to below the current value of the house.

With the part of society that should have the highest level of negative equity being younger people who bought in the last number of years, this means a reduction in discretionary spending by a high-spending age bracket.

Even the concern over potentially moving into negative equity could result in higher savings levels by individuals. The end result is higher savings and less consumer spending, reducing economic activity in the economy. A recent ESRI report estimates the savings ratio in Ireland will hit 10.75% this year. When compared to a long-run average of 6.2%, in cash terms this is €4.2bn or €1,050 per person in the state.

Concerns over negative equity are part of the reason for this increase and even if part of this was released back into the economy, the impact on economic growth would be positive and very noticeable.

With regard to negative equity, as I highlighted this doesn't mean people default on their mortgages but it does have a very negative impact on the economy. What can be done for homeowners who have kept their jobs but have negative equity?

In the UK we have seen banks such as Nationwide Building Society offering borrowers 125% mortgages allowing customers in negative equity to move house. Criteria for this form of mortgage are stringent. With the problems facing the Irish banks currently, it seems unlikely schemes such as this will be offered here at the moment.

Therefore, policy must also be considered to offset the damaging impact of negative equity. This could include the provision of government support to families who need to move to more suitable housing through the guaranteeing of part of the new mortgage that relates to the negative equity the homeowner had in their last home.

Another potential idea is the creation of a state mortgage bank to increase liquidity in the mortgage market with a focus on individuals in negative equity, who have to move due to certain circumstances. The criteria to obtain such loans will need to be tight, but it would offset some of the issues of negative equity. It could also provide more competition for standard mortgages, especially since some of the foreign-owned banks are steering away from the Irish mortgage market.

In the future the creation of some form of compulsory mortgage insurance scheme such as exists in Canada and in Western Australia – that could offset some of the losses banks may take on defaulting mortgages and to provide support to borrowers impacted by unemployment or other issues – could be set up. The insurance scheme would be funded by borrowers and potentially by banks. This would take the majority of the cost of default away from the state and put it back on the fund.

So I would say to government to look at the schemes above to try and offset the impact of negative equity and create some form of mortgage insurance scheme to prevent the issues we are currently facing.