CBI: dangers of bank manipulation of mortgage market

Scofflaw

On foot of a new research publication from the Central Bank:

The Central Bank has warned that lenders must never again be allowed to manipulate the housing market or we risk another property boom and bust.

New research has found that banks helped blow up the bubble by adjusting lending criteria to inflate the availability of home loans. They also made the crash worse by cutting off lending when the market began to fall.

This produced a disastrous effect, strangling the market of any life and accelerating the pace of the house-prices crash.

The new report from the Central Bank warned that any moves to make home loans more accessible must be handled carefully, because changes that appear to increase affordability push up risks in the housing market.

Its economic research found that the house-price bubble and subsequent mortgage crisis of the past decade was driven in part by banks' ability to manipulate so called "affordability" measures for borrowers.

It happened at a time when banks could for the first time borrow on the markets and so lend more than they held on deposit.

http://www.independent.ie/business/personal-finance/property-mortgages/banks-must-be-watched-to-halt-new-house-boom-regulator-29667478.html

Actual report: http://www.centralbank.ie/publications/Documents/08RT13.pdf

And from the report's conclusions:

Up to the recent financial crisis, many countries experienced a sustained period of house price growth. In general, this was facilitated by a combination of benign macroeconomic conditions and greater availability of mortgage credit. The Irish case is a profound example of this; a small open economy enjoying sustained economic growth with a financial system to the fore in exploiting new international funding conditions. It is the extent of these changes which makes analysis of the Irish property market over the period 2000 - 2011 such a compelling study.

Courtesy of granular, micro level stress-testing of the four main Irish financial institutions conducted by the Central Bank of Ireland, detailed mortgage loan level data is now available for a significant proportion of the Irish residential property market. Using this information we calculate the contribution to Irish house price movements over the period 2000 - 2011 of both fundamental economic factors and changes in credit policy.

It would appear that when Irish financial institutions were keen to increase the level of credit to the residential property market, they particularly availed of what we label the “income fraction” channel. Thus, for a given income level and mortgage interest rate, credit institutions were able to significantly increase the level of loans available by varying the income fraction. As well as being one of the main causes of price increases, variations in the fraction would appear to be one of the significant reasons for the sharp contraction experienced by Irish house prices since 2007. Thus, the fraction would appear to be highly pro-cyclical, fuelling house price increases in the upturn and exacerbating the decline in the downturn.

Essentially, the banks changed the proportion of your income they evaluated as being capable of being set aside for mortgage repayments, and this had and has a very large effect on the mortgage market and the price of houses.

This has been part of the explanation for the bubble all along, but only anecdotally, and it's nice to see some harder research being put behind it.

It appears, also, that the (apparently only recent) availability of the data used in the study offers new policy options for regulators:

The greater availability of detailed loan level data offers a number of policy opportunities, particularly from a macro prudential perspective. Given the role played by property markets in the lead up to the recent financial crisis, a renewed debate has centred on the appropriate choice of options available to policy makers and more specifically, on the relative contribution of financial innovation and fundamental economic factors to house price movements.22 A more efficient and precise calibration of influential macro prudential policy levers countering swings in the property market is now a much greater possibility with the availability of micro loan data.

I've argued before for 'prudential' controls as a microeconomic policy tool for cooling possible housing bubbles, so I'm glad to see the CBI thinking in this direction, and pleased to see that the research suggests this is something with a potentially large impact.

cordially,
Scofflaw

GCU Flexible Demeanour

Scofflaw wrote: »

I've argued before for 'prudential' controls as a microeconomic policy tool for cooling possible housing bubbles, so I'm glad to see the CBI thinking in this direction, and pleased to see that the research suggests this is something with a potentially large impact.

I'd be less confident that this actually represents a substantial change. Consider some quotes from various phases of the bubble period. They all suggest that, as far as the regulatory authorities were concerned, they were taking appropriate action.

http://oireachtasdebates.oireachtas.ie/Debates Authoring/DebatesWebPack.nsf/takes/dail2004062200161?opendocument

Written Answers - Banking Sector Regulation.

Tuesday, 22 June 2004

Minister for Finance (Mr. McCreevy): <…> The Financial Services Regulator performed a mortgage credit review in the first quarter of 2003. The overall general findings from that inspection were that no matters of financial soundness came to light, however credit institutions were required to put more robust procedures in place in the area of client income verification and the funding of mortgage loan balances to ensure that loans are properly secured and will be repaid in full. It is important to note that the majority of credit institutions now utilise net disposable income criteria in underwriting mortgage applications. Net disposable income criteria are considered to be a more accurate reflection of repayment capacity.

http://oireachtasdebates.oireachtas.ie/Debates Authoring/DebatesWebPack.nsf/takes/dail2005110900031?opendocument

Written Answers - Household Indebtedness.

Wednesday, 9 November 2005 Dáil Éireann Debate

Minister for Finance (Mr. Cowen): <…>While the report referred to highlights the increasing indebtedness of Irish households, it also highlights the fact that the sustainability of household debt is supported by strong demographics, low interest rates and a high savings ratio. This view is generally supported by the findings of the recently published Financial Stability Report from the Central Bank and Financial Services Authority. A key finding of the bank’s report is that a range of fundamental factors such as growing employment and incomes, falling inflation and low interest rates have supported the pattern of mortgage growth and associated debt levels. The Central Bank’s report does, however, highlight the continuation of strong mortgagecredit growth as an important risk factor. It, therefore, emphasises the importance of responsible behaviour by both borrowers and lenders, to factor into their financial decision-making the prospective impact of potential changes in the future economic environment.<..>

http://oireachtasdebates.oireachtas.ie/Debates Authoring/DebatesWebPack.nsf/committeetakes/EUJ2008072900005?opendocument

EU Mortgage Credit Markets: Discussion (Resumed).
Tuesday, 29 July 2008
Ms Mary O’Dea: <…>There was a good deal of discussion at the previous meeting regarding 100% mortgages. We have taken steps to ensure appropriate policies on management and lending are in place. In May 2006, when we became concerned at the growth in mortgage lending, we adopted measures to amend the risk rating of new Irish residential mortgages so that any mortgages which exceeded 80% of the value of the property would attract a higher capital charge. This means the institutions must set aside a higher amount of capital, thus dampening that type of lending. In addition, at the end of 2006, we took measures to increase capital requirements for certain categories of property related to lending with higher risk rates. These capital charges on speculative real estate and so on helped to dampen the market.

We are one of the few regulators internationally to have taken these types of capital measures using both the front-line consumer side and, in the background, the capital side. We have also revised our stress testing guidance so that, from 1 October 2007, institutions were asked to stress test all applications for residential mortgages at 2.75% above the European Central Bank minimum bid rate to ensure the customer could afford repayments after any interest rate increases. Affordability is the critical issue.<…>

Scofflaw

GCU Flexible Demeanour wrote: »

I'd be less confident that this actually represents a substantial change. Consider some quotes from various phases of the bubble period. They all suggest that, as far as the regulatory authorities were concerned, they were taking appropriate action.

I do take your point, certainly, but I think most of what is being dealt with there is LTV, rather than income fractions directly - I'm not sure that the relevant data was actually available at the time, and I don't see anything there that suggests that regulating income fractions was regarded as a possible regulatory point.

It's more that income fractions are being considered here explicitly as a possible policy tool by Central Bank authors - but, again, your point is relevant, because there's really no possibility of seeing problems when you really don't want to see them, and it's extremely easy to envisage a future regulator arguing that the use of greater income fractions in lending is a completely appropriate response to some notional fundamental change (aka "different this time"), and that whatever policy guidelines exist should be weakened or abolished.

cordially,
Scofflaw

hmmm

I wish they'd stop with telling us what the problem was and just get on with fixing it. They're the regulator, they're the ones that need to bring out the rules to prevent 100% mortgages on 5 times inflated incomes, otherwise we'll just repeat the same stupidity of the early 2000s in another few years.

GCU Flexible Demeanour

hmmm wrote: »

I wish they'd stop with telling us what the problem was and just get on with fixing it. They're the regulator, they're the ones that need to bring out the rules to prevent 100% mortgages on 5 times inflated incomes, otherwise we'll just repeat the same stupidity of the early 2000s in another few years.

I know this is re-opening that very topic that you feel is debated enough - and you could be right! But is the 100% mortgage issue really the point? Isn't the point more that if you give someone an 85% mortgage on the basis of a bubble price, and the property halves in value within a few years, then you've effectively given them an 170% mortgage.

I'd agree that the income multiple is pretty much a constant consideration - you can't give out a mortgage on the assumption that someone's income will increase five or tenfold over the next few decades. But I'd feel the 100% mortgage issue is a bit of red herring. Just conceptually, if the property is genuinely worth 100% of the mortgage advanced, then (leaving aside costs of repossession) the loan is fully covered, and the LTV will improve with each passing year.

I'm not sure where that leaves us - or what rule can cover a situation where 'professional' valuations systematically overvalue assets. But I would agree that practical rules with respect to income multiples could be framed.

I know this is old fashioned and not a runner today, Bank should not have residential mortgages as a large part of their business most if not all residential mortgages should come from mutual owned building societies and should have be based on all the old fashioned stuff such as saving for a deposit, strict income multiplies interested rates should be fixed for 5 to 10 years.

Finely using the family home as a guarantor for a business loan should be out lawed, all of the above would go along way to stopping any sort messing in the housing market. I know it would lead to tighter credit in the economy but you cant have it every way.

gaius c

Hmmm...
RTE News at 6: Department of Finance met to try and fix property market

Geuze

What should be law, not just guidelines:

Max LTV = 80-85%
Max duration = 20-25 years

And maybe put income multiples in law.

hmmm

GCU Flexible Demeanour wrote: »

But I'd feel the 100% mortgage issue is a bit of red herring. Just conceptually, if the property is genuinely worth 100% of the mortgage advanced, then (leaving aside costs of repossession) the loan is fully covered, and the LTV will improve with each passing year.

Banning 100% mortgages isn't about the property value. Borrowers should show an ability to save and service their mortgage, but offering 100% can often bypass this - if they're able to repay a mortgage, they should have been able to save a deposit.

Just look at some of the forums here with people trying to get mortgages. Some have never been able to save a penny, yet are trying to get a mortgage (often with a gift from their family as a deposit). If you don't have the discipline or ability to save now, how will they ever be able to repay a mortgage?

hmmm

Here's one radical thought. The CBI should ban variable mortgages. The ECB will begin to raise rates over coming years, perhaps by several percent. What's going to happen then to all these variable mortgages Irish people have taken out?

GCU Flexible Demeanour

hmmm wrote: »

Banning 100% mortgages isn't about the property value. Borrowers should show an ability to save and service their mortgage, but offering 100% can often bypass this - if they're able to repay a mortgage, they should have been able to save a deposit.

I do take your point, and agree that anyone getting a 100% mortgage would need to be in a relatively rare situation. As you say, you would have to wonder how someone could be stress-tested as able to keep up repayments, even in adverse circumstances, if they've no savings history.

However, I feel a point that needs to be aired is that the issue with lending in the bubble wasn't really about 100% mortgages - such mortgages were handed out, but they were always a minority element. The problem about the bubble lending was that it drove up house prices, so it looked as if someone was getting an 85% mortgage when, in fact, they were getting a 170% mortgage with a 30% administration fee.

(If the "30% administration fee" seems oblique, what I mean is the 15% of the purchase price that they would have paid from savings effectively vanishes into their negative equity hole.)

Scofflaw

It's possible for someone to have a "savings record" without a deposit, if they have, for example, previously had debt which they have discharged reliably.

cordially,
Scofflaw

FJR

Would Ireland Benefit from a creation of a "Public Bank" like North Dakota USA?
How would that work with the Euro?
Could we have say "Irish Punt" working between us here in Ireland and use Euro for International Payments(Exports/Imports)?

Who Controls money creation?

Bankers should get out of the business of government.

http://www.youtube.com/watch?v=hgmw1pChQ2E