A Bold Solution for Irish Debt
The new chief economist of the Central Bank stated the obvious last week when he said that there would have to be debt forgiveness on many mortgages that simply can’t be paid. Someone who signed a contract in good faith during boom conditions, when income and the price of the house was rising, simply cannot honour that contract if his income has shrunk and the price of the asset has collapsed. Many tens of thousands of Irish people simply do not have the money to pay the mortgage now and certainly won’t have it when the next round of tax increases are signalled at the Budget.
From the point of view of the banks, the more they kick the can down the road and pretend that the mortgage problem will go away, the more they turn into zombie banks. Unless they can crystallise losses on loans they have out against houses which have fallen in value and clients whose incomes have collapsed, the banks themselves will not be able to raise the capital needed to function like normal banks. This is because unless investors know that the losses in the banks are finally over, they will not invest any new capital. If they did that, new capital would only go to repay old losses and validate old mistakes.
This means that unless they admit and write down their losses on their mortgage books, the banks will have to be self-financing. In order to do that, they will have to get their loan- to-deposit ratios down to 100pc. At the moment, the ratio is 140pc for the main banks. This means that for every €140 of loans out they have only deposits of €100. They have to get this down and can only do this by taking in more deposits or by giving out fewer loans.
This implies that banks will be taking money out of the economy, not putting it into the economy, for the next few years. It also means that the velocity of money, the amount of times notes and coins change hands in the economy, will fall and this means that monetary policy as we understand it is ineffective in boosting demand. Such a situation calls for unorthodox measures and those unorthodox measures involve the Central Bank instructing the banks to begin to write down mortgages as soon as possible.
This doesn’t just make sense economically but it makes sense morally. It is immoral to keep thousands of our fellow citizens in what is in effect a debtor prison. The debtor needs a break. If they get no breaks and are out of work or find their income falling, there is no way they can pay even a portion of the debt. Thus they remain in limbo and are precluded from playing any normal part in the economy. It’s not hard to see how this leads to a vicious downward spiral, where people are trapped in their homes, unable to get on with a normal life.