Yesterday Ireland’s Central Statistics Office released its inflation data for September 2011 which showed annual Consumer Price Index (CPI) inflation rising by 2.6%, with a rise of 0.3% in the month of September 2011 alone. But the increase in one component of the CPI, mortgage interest costs, had risen a whopping 17.2% in the past year and 3.1% in the past month alone. This morning, the Financial Regulator Matthew Elderfield has come out with demands that banks and mortgage companies put a stop to further increases. This entry examines the scale of the increases in mortgage interest costs, set in the context of CPI generally and ECB interest rate movements, and concludes that Irish mortgage borrowers are being scalped, and have been for some time.
Firstly take a look at CPI since 2007.
You see that inflation overall has been muted since the onset of the financial crisis in 2008; in Ireland we’d probably mark September 2008 as the point at which our crisis sprang centre-stage, even though house prices peaked in 2007 and there had been banking crises elsewhere, notably in the UK and US. Muted inflation is hardly surprising given the weakness in the economy, particularly the domestic economy where demand is weak, as a result of anaemic economic growth, high unemployment, a debt overhang which includes substantial mortgage debt and housing negative equity, downward pressure on headline wages, higher taxes and levies and fear/uncertainty for the future. The table above shows that between November 2007 and September 2011, CPI inflation inIrelandhas stayed broadly flat with the CPI actually dropping slightly from 104.6 to 104.4, which is probably what you might have expected.
However, take a look at one of the most important components of CPI inflation, mortgage interest which comprises nearly 7% of the basket of goods/services upon which the CPI is based.
From July 2009 to March, 2011 it has increased from 73.0 to 100.7, a 38% increase.
Mortgage interest of course is less dependent on demand, and more dependent on monetary policy by governments and central banks, and in our case the European Central Bank which sets interest rates for the entire EuroZone. So let’s look at the main ECB refinancing rate.
In the period from July 2009 to March 2011, the ECB main rate stayed flat at 1%. In the same period, CPI for all items rose by 2.1%. Plainly mortgage interest costs which increased by 38% had rocketed at a time when you might have expected them to stay flat or increase only marginally.
So in Irelandyou have the bizarre situation of mortgage interest rates rising despite inflation overall being muted, and in the context of the ECB keeping rates flat. And on top of that you have more than one in ten mortgages being in trouble (according to figures produced by the Financial Regulator for Q2, 2011, 7.2% of all mortgages were more than 90 days in arrears, a further 5% had been restructured which in some cases involved moratoria on payments and some 2% were in receipt of social welfare mortgage interest payments).
So this morning’s demands from the Financial Regulator who took up his post in January 2010, seem to come quite late in the day when rates have already rocketed. But will the banks listen?
The Financial Regulator seems to have no powers whatsoever to directly force banks to abandon plans for further rate rises. Reporting suggests that he may have to rely on threats involving unrelated areas of regulation. Of course the State has a strong controlling interest in the banking sector with practically total control over the largest mortgage lender (by reference to legacy mortgages) PTSB as well as AIB, which has now absorbed EBS. Bank of Ireland is nominally in private control but the State has a 10%+ stake and still provides the bank with a guarantee. However beyond these banks, there are others who have mortgages including KBC,Ulsterand Bank of Scotland (Ireland)/Halifax. It is not clear what pressure the Financial Regulator can bring to bear on these banks, one of which BoS(I) has in fact exited the Irish market for new lending and is now running-off its loan book.
Maybe he can scowl at them.
He might also try to bring pressure to bear on the National Consumer Agency to provide a mortgage comparison tool as demanded by the European Commission approval of the Bank of Ireland restructuring plan. Remember the EC was concerned that if banks like Bank of Ireland were supported by the State then competition in the State might suffer, and the EC wanted borrowers to have the means to move between suppliers of credit so as to avoid a distortion in competition.
NAMA Wine Lake 
EBS was absorbed by AIB and not BOI
@PO, thank you, now corrected.
Isn’t there a price to be paid for such interference? Would potential entrants to the mortgage market not consider this an obvious threat to potential profitability?
‘In the period from July 2009 to March 2011, the ECB main rate stayed flat at 1%. In the same period, CPI for all items rose by 2.1%. Plainly mortgage interest costs which increased by 38% had rocketed at a time when you might have expected them to stay flat or increase only marginally’
But ceteris paribus clearly does not apply. Ireland is in a ferocious bind on this..
Banks are under pressure to clean up their balance sheets. They can’t touch trackers, which they gave out like smarties while the party was in full swing. With bondholders protected, someone has to pay, so the variables and business borrowers get targeted.
From a consumer perspective, this is just another kind of stealth tax, which will probably increase frequently and insidiously, irrespective of the broader interest environment. As you say, the Regulator has no power in the matter, and it might eventually come to unseat him, or at least discomfit him to the point where he prefers a quiter billet.
It would be interesting to establish what the legal position in respect of the varaible rate contracts is. I.e. have the banks/BS’s total flexibility under the contract to increase applicable rates at their own whim. Given that mortgagors have effectively no access to alternative sources of finance could the fairness of these contracts be questioned?
am not an apologist for the banks but looking at it from their perspective
a) funding for Irish banks remains expensive if available at all (note increase in their reliance on ECB from announcement this morning)
b) the length of time they have to give to defaulting mortgage holders, longer than in other regions
c) the market was over competitive and unfortunately the banks were writing unprofitable mortgages. Comparing to the UK, for mortgages over 75% LTV (which are the majority in Ireland) rates are 4-4.5% on average. This is a full 350-400bps over their appropriate base rate.
d) increasing their required capital base, either because enforced by the regulator or the onslaught of Basel III, with more capital required, the requisite margin will have to be increased.
Bottom line – credit has and will continue to remain relatively (to the last decade) expensive globally, even ignoring base rates.
I do have sympathy for the mortgage holders, and it is a major issue in the country. But not allowing the banks to replenish their balance sheets just exasperates the problem
@ PQ
As you clearly point out this is nothing but a stealth tax to bail out the banks. In addition, savers are being taxed as well by the very low return on their savings.
One has to admire the Greeks. They have cut straight to the chase and placed a non-stealth tax on all real estate and if you don’t pay, off go the lights. Cannot get much more blunt than that.
Also, if you prevent the bond holders from taking a hit, whilst the trackers can’t take a hit, limit the hit homeowners can take and now cap what the variable rate, will the banks just make up the difference elsewhere? Charges for day to day banking activity perhaps.
@JJ & PQ
Folks we don’t have functioning banks in that deposits continue to flow out the door, 8 in 10 SME loan applications sees the bin and mortgage lending is at 1971 levels. We have ECB conduits, that’s what we have and given this why are we insisting that these ‘banks’ comply with Basel iii rules at all. I’ve suggested here before we should declare Ireland a Basel III free zone for at least the next 5 years – would anyone really notice – I doubt it.
The additional cost in holding excess capital is absolutely killing the covered banks and for what reason exactly? I simply don’t know – there was a time the Honohan belived flooding the banks with excess capital would make the white knights come over the hills – I’m pretty sure he doesn’t believe that fairytale today.
So there is something the Regulator can do – he can reduce the capital requirements for the banks and start to raise them when the economy starts to recover.
Not sure reducing the capital requirement will help – (it is a vicious circle)
A reduced capital requirement, makes the bank more riskier, which prohibits interbank and short and medium term lending.
Thus reducing the banks ability to acquire assets – loans, SMEs, mortgages etc.
The reason to flood the banks with capital was to entice other banks and institutions to lend to Irish banks (with the assumption that the extra capital was sufficient to meet potential losses). It hasn’t happened, (small bit with BKIR covered bond program earlier this week), but reducing their capital requirement would only exasperate it.
Basell III isn’t until 2018/19 to be fair (i was slightly misleading earlier) but the banks can’t create liquidity. It has to be either borrowed from somewhere (either depositors or other institutions). So what will encourage an increase in this – a better capitalised banks with more clarity arround its asset quality
@JJ
“A reduced capital requirement, makes the bank more riskier, which prohibits interbank and short and medium term lending.”
Interbank lending is finished in the EZ and probably in a lot of the world for years to come. So too are bank bonds. The only lending that will take place if at all is secured lending. As for depositors, who are probably the largest group of lenders but the least powerful, their deposits are unsecured.
The ECB knows this . In fact most banks with excess cash now place it with the ECB. The ECB is happy to take the cash. It should of course charge for the privilege but it doesn’t.
All this talk about Basel 111 is just a smokescreen.
The EZ and world banking systems are completely broken. Basel 111 is a hugely expensive but useless system to attempt to keep bankers in the style they have been accustomed to.
Just look at the excess money lodged at the ECB, while a continent is again heading for recession.
@Jake Watts.
Thanks for posting this chart in a previous thread and drawing attention to it.
The Credit Institutions Bill gives the Minister the power to do whatever the likes with the banks, so I don’t think this is an especially debilitating condition for the Regulator.
Presuming of course that the Regulator has more influence over the Minister than the banks.