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Paying the price on overpriced home - Irish property prices and the Irish banking system

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A cut-rate home in Co. Leitrim.
Last week Ireland passed its sixth financial inspection by the visiting team of experts from the IMF/EU.   We're now a year and a half into our bailout program, and we have to pass these quarterly inspections to keep getting the money.

We need the continuing access to bailout money to bridge the huge gap between our spending and our tax revenue. Without that money, services like welfare payments and health care as well as state workers pay would be cut by a third, leading to possible serious social unrest. So until we can balance the books again here in a few years (we hope!), we have no alternative. 

The quarterly inspections are very demeaning, of course, since they are visible proof that we have lost our economic sovereignty.   The expert team comes in to examine the nation's books and make sure we are sticking to the agreed tax and spending austerity regime that is aimed at leading us out of the mess.  

Every time we pass one of these exams, our senior politicians congratulate themselves and tell us what  a great job we are doing and how we are an example to the other countries in Europe who are in trouble.   

But the problem is that the tighter the austerity squeeze becomes, the more difficult it is for people to hang on to their jobs and pay their bills. 

The Irish economy is still on the floor, with barely any growth, and austerity is making it worse, not better.  More and more, it looks a second bailout program will be needed.

The payments on the enormous national debt we are carrying, thanks to our huge budget deficits and the cost of paying off the billions our banks blew away, gobble up a big chunk of our revenue.  Instead of spending the money on recovery, we have to watch as it is sucked out of the system.  That's the macro problem.

On the micro level, there is also a big problem with our level of personal debt.  During the boom people here borrowed and spent on a phenomenal scale. 

As long as the boom kept going, they were okay.  But when it collapsed, they were caught.  Many are now struggling to keep up repayments, which means that banks have a huge problem on that level which is now starting to fully emerge.

There was stupid spending on all kinds of things here during the boom.  But the biggest problem, of course, was the spending on property. 

Experts in this area who are dealing with cases  every day estimate that over 10,000 people here will have to hand back the keys of their homes in the next year or two.  These are people who just can't cope with their mortgages, either because they have lost their jobs or they have seen their incomes shrink and all their bills go up.

Most of these people are  at least a year behind on their payments and have little hope of catching up.   Some have stopped paying altogether.

In Ireland, their problems don't end when they hand back the keys.  This is because property loans here, unlike in the U.S., are not non-recourse loans. 
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What that means is that even if you give back the keys and the bank sells your home, you are still liable for any shortfall between what the property sells for and the amount of the original loan.

Property prices here are now down an average 50-60 percent on what the were selling for at the height of the boom from 2004 to 2008.  So people who bought then have a big problem when they hand back the keys and the bank sells.   They not only end up losing their homes, they also end up still owing the banks large amounts of money.  

This situation has caused a lot of concern here, and the government is struggling to deal with it.  New personal insolvency laws are due to be published here in a couple of months which may see the banks being forced to write down some of the debts of people who bought properties during the boom.  

So far, however, the banks are playing hardball.  If you borrowed €500,000 in 2006 to buy a property that's now worth only €250,000, they still want their €500,000 back.  Period. 

But one case here last week showed a shift by one major bank.  It got massive publicity because it seemed to offer hope to many homeowners who are in an impossible situation.  

This case involved a nurse who had borrowed €245,000 from Bank of Ireland subsidiary to buy a two bedroom apartment in a gated development in Coolock on the North Side of Dublin in 2005.  

Now those of you who know Dublin will stop right there, because Coolock is one of the poorer areas in the city (which is probably why the development was sold as a gated community). 

The idea of spending almost a quarter of a million euro on an apartment there -- not even a house! -- is lunacy.  But that is the kind of madness that went on all the time during the property boom here because people were desperate to get on the ladder.  

The other aspect of this is that the single woman involved, presuming she was earning an average young  nurse's salary of around €30,000,  was able to borrow more than EIGHT times her annual pay from the bank. 

The old rule in banks and building societies (savings and loans) here used to be an absolute maximum of three times salary.   But during the boom the rules went out the window. 

The woman got into financial difficulty for various reasons in 2009 and built up mortgage arrears, and the bank took legal action against her in 2010.   At that point she handed back the keys, and after some delay the property was sold.

But even after the money from the sale was taken off, she still owed €170,000 on the loan (which shows how overpriced the apartment was in the first place).  

A settlement was reached under which the bank wrote off €152,000 of the outstanding €170,000,  leaving the nurse owing €18,000 which she is now repaying over six years at €250 a month.  That's all she can afford after paying rent and other bills. 

The deal for the nurse was secured by a group of pro bono lawyers called New Beginning which say they have hundreds of similar cases on their books.   The banks say that there is no change in policy and that they are agreeing debt forgiveness deals in only a tiny number of cases, which are assessed on a case-by-case basis.

But there is no doubt that this is a significant move, and some experts are now predicting that thousands of homeowners who are in serious trouble will be demanding similar debt deals.

This is a situation that is fraught with moral hazard, as the economists call it.   Many people here who are making big sacrifices in their lifestyle so they can pay their bills and their mortgage every month are now asking  themselves, why there is no debt forgiveness for them? 

They didn't borrow huge amounts of money to buy property they could not really afford.  And they don't have a lot of sympathy for those who did.  

Even landlords are now getting in on the act.  One bank chief last week claimed that some people who bought second homes to rent out have started to hold back on mortgage payments even though they are still collecting the rent.  They are deliberately trying to make their financial situations look bad so they can get in on any debt deals that may come up. 

The other problem with debt forgiveness is that the money lost does not just vanish into thin air -- it simply translates into extra tax that everyone else has to pay, since the state now owns the banks thanks to the government rescue.

Of course you can also apply the moral hazard argument to the senior people in banks.  They are the idiots who lent vast amounts of money to people who  could not afford it -- like the quarter of a million to the nurse to buy an apartment in Coolock.   If there is no penalty for them, how will they learn not to do this in the future? 

And extending the net even wider, how come moral hazard does not stop us repaying all those big banks in Europe who lent billions to the Irish banks so they could get a slice of the high returns available during the boom?

Why should the big European banks who did not take a gamble on the Irish property boom act responsibly in the future if there is no penalty for the ones who did?

Moral hazard -- it's a tricky one.  Meanwhile, the unfortunate nurse who lost her apartment is struggling to survive like so many other people here at the moment.

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