Dáil debates

Wednesday, 1 December 2010

Adjournment Debate

Banking Sector Regulation

7:00 pm

Photo of Tom McEllistrimTom McEllistrim (Kerry North, Fianna Fail)
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With thousands of citizens currently in arrears on their mortgages and thousands more on reduced payments, is it not time to investigate better mortgage systems and devise a system for this country that will ensure a more stable and secure long-term financial environment for our citizens?

We all know the difficulties in the banks and the great lengths to which the Government is going to fix the problems in our financial institutions and to ensure that their essential services to the economy and the country are fully restored. However, it is incumbent upon us to look at the difficulties faced by mortgage holders who have suffered great uncertainty throughout this crisis. While there is an urgent need to help people in the short term we should also look to better long-term solutions for mortgage holders, the banks and the economy. While the current situation has required serious and immediate action in an effort to get the banking system working properly again, we must also look to the long term and develop a mortgage system for the citizen, who is more than just a consumer or customer. For the sake of our citizens we should look at how they can be best protected while at the same time devising a model that works for the banking system. When we finally see "normality" return, we need to ask ourselves if the system that has let us all down should be restored or whether the mortgage system should be reconstructed on a sounder, fairer and more stable basis.

One system that has been mentioned internationally is the Danish model. This is a system which has advantages and disadvantages but which has been seen to militate against the occurrence of negative equity. It has stood the test of time. The Danish model has withstood many tests since it was brought into existence after the great fire of Copenhagen in 1795. The Danish economy has experienced contraction but the resilience of its mortgage market means that it remains the best performing in Europe during the current crisis. There is no record of a mortgage bank defaulting on its payments in Denmark and some commentators have suggested that Denmark offers a model mortgage market in that it shows that there is a safe way to securitise home loans.

This is, apparently, mainly attributable to its legislative framework which has put great emphasis on the protection of the mortgage bond investor by imposing strict limits on the risk taking of the mortgage banks leading in turn to conservative lending practices. The strength of the system is low origination cost, the absence of sharp practice and complete transparency. Denmark's €490 billion mortgage bond market, the third largest after the United States and Germany has proved resilient during the global financial crisis.

At the core of the Danish system are seven mortgage banks that specialise in making mortgage loans. They fund their loans by selling bonds in the capital markets. The bonds are in all major respects identical to the mortgage loans they fund. What the Danes call the principle of balance means that every mortgage is instantly converted into a security of the same amount and the two remain interchangeable at all times. For example, if I borrow €200,000 for 30 years at a fixed rate, the loan would be placed in a large pool of 30-year, fixed-rate loans that serve as collateral for an equal amount of mortgage bonds held by investors. The mortgage bank would sell on my behalf an additional €200,000 of these bonds in the capital market and credit the proceeds to me. As I repay the loan, the mortgage bank passes along the payments to the bondholders in proportion to the amount of the total pool they own.

Mortgage banks are not exposed to interest rate risk from funding long-term assets with short-term liabilities. The Danish system is built on the principle of "match-funding", meaning that mortgages are funded with bond issues that have the same characteristics as the mortgages. Borrowers in Denmark can refinance by buying back bonds in an amount equal to their mortgage balance, at par or market, whichever is lower. When market rates go down they buy at par to take advantage of the new lower rate. When market rates go up, they can stay put, or they can refinance by buying back bonds at the depressed market price. They realise a capital gain in exchange for accepting a new higher rate on their loan.

The disadvantage is that loans are not priced for risk, so borrowers with poor credit are not served. Borrowers must also have a 20% deposit to put down. While house prices declined in Denmark during the crisis, negative equity did not become a problem because the great majority of borrowers had substantial equity in their homes when the crisis struck. That was a major reason the rise in defaults in Denmark was small and manageable.

The Danish financial system has been impacted by the worldwide loss of confidence in financial institutions and the associated liquidity squeeze. In 2008 the Danish Government guaranteed the unsecured creditors of all banks, including the mortgage banks. However, the guarantee did not include mortgage bonds, because it was not considered necessary.

There may be other systems around the world worth examining, but we should look to develop a system that will be of long-term benefit to our people and which ultimately would help to prevent the kind of crisis we are now experiencing. The Government, the Dáil, the Central Bank, the Financial Regulator and other bodies may have valuable insights to provide on developing a citizen-friendly mortgage model.

Photo of Áine BradyÁine Brady (Kildare North, Fianna Fail)
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I thank Deputy McEllistrim for raising this matter. As he is aware, the Government has taken a series of initiatives to ensure the financial environment is returned to the stability and security required to support the credit needs of businesses and households. One significant recent initiative was the publication of the report of the Expert Group on Mortgage Arrears and Personal Debt, chaired by Hugh Cooney, on 17 November. The report made recommendations on measures to assist in dealing with the difficulties created by mortgage arrears following on from an interim report published in July. The Government is committed to solutions that are fair and appropriate to the current circumstances of home owners. Accordingly, the Government accepted the group's recommendations and indicated a commitment to implement them without delay.

Some of the findings of the group are directly relevant to the matter raised by Deputy McEllistrim. For example, the recommendations were a balance of proposals to improve the situation for those in mortgage and personal debt difficulties and to best serve the national interest. In its research, the group found that approximately 90% of mortgage accounts are being repaid in accordance with their contracts, repossessions remain low and lender forbearance has worked well to date and the mortgage interest supplement provides an essential support for almost 18,000 borrowers. As interest is paid in full, the debt of borrowers in the scheme does not increase.

Broadly in line with the matter raised by the Deputy, the group noted that an examination of international practices suggest that Irish debt legislation needs to be modernised. With this in mind, I would like to turn to the Danish mortgage system referred to by the Deputy. The House may wish to note that the Danish mortgage system was hailed by the International Monetary Fund, IMF, in late 2006 as "highly rated" and one of the "most sophisticated" in the world. It is worth considering briefly how the Danish system actually works.

Under this system, all mortgages granted by credit institutions to home buyers in Denmark must be supported by an equivalent bond with a maturity and cash flow that matches those of the underlying loans almost perfectly. Most long-term finance in Denmark is provided through specialist mortgage institutions. Typically, borrowers who are owner occupiers can borrow up to 80% of the buying price, with repayment periods typically from ten to 30 years. The lending activities are financed through the issuing of bonds, which are sold on the open market. Every mortgage is instantly converted into a bond of the same amount and the two remain interchangeable at all times. This means that the borrower can withdraw from the mortgage not only by paying it off, but also by buying an equivalent bond at market prices. Since the value of homes and the associated mortgage bonds tend to move in the same direction, home owners should not end up with negative equity in their homes. Likewise, if home prices decline, the amount that a home owner must spend to retire his or her mortgage decreases because he or she can buy the bonds at lower prices.

Would the Danish system suit the Irish market? It is important to remember that the Irish mortgage market and the Danish mortgage system result from different historic circumstances. The standard of housing in Denmark is high, with approximately 2.6 million dwellings for a population of 5.4 million in 2005. This amounts to approximately two persons per dwelling. Owner occupied housing accounts for approximately 52% of occupied homes. The rate was constant for many years with a slight decline since 2000, in contrast with most other European countries where the rate of home ownership has continued to rise. However, Denmark has a highly developed co-operative private ownership sector. If this is included in the equation, the rate of owner occupied homes rises to approximately 60%. Co-operative private ownership means that tenants can set up private co-operatives to buy their apartment buildings from landlords who are willing to sell. Moreover, Denmark has a long history of regulating and subsidising the housing market. Most cities have rent control apartments that were built before 1991 and there are rent regulations based on subsidised non-profit housing based on cost calculations, not on market conditions or quality levels.

Without going into too much detail, there are significant differences between the Irish housing market and the development of the arrangements for financing house purchase in Ireland compared to the situation in Denmark. These differences mean there is no simple template from other countries for mortgage financing that can be translated directly into our housing market. Nevertheless, it is important that we continue to look strategically towards practices in our partner European countries and learn from their experiences. We can then refine our solutions to best meet the needs of Irish home buyers.

In this regard, I can assure the House that the Government will continue to implement the policies needed to restore the stability of the Irish banking system, thus ensuring that credit flows more easily in the market and potential home owners can get access to such credit. As Deputies will be aware, the Government has taken a number of substantial measures, including the deposit guarantee schemes, the restructuring of the financial services sector and the establishment of a new structure of financial regulation with an integrated Central Bank replacing the Central Bank and Financial Services Authority of Ireland, CBFSAI.