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| Latest IMF report notes link between high levels of household debt and the effect on economic recovery |
The IMF has
said that targeted household debt reduction policies - including mortgage
write-downs - can deliver significant economic benefits.
The International
Monetary Fund made the comments in its latest World Economic Outlook.
The IMF
said such policies can substantially mitigate the negative effect of household
deleveraging on economic activity.
The report
noted the well established link between high levels of household debt run up
during a housing boom, and the effect of a high debt overhang on economic
recovery.
It found
that countries, like Ireland, that saw house prices and household borrowing
skyrocket, saw a longer than average period of recession after the bursting of
the housing bubble.
A large
part of this protracted recession it said is due to households trying to reduce
their debt levels, which in turn leads to less spending in the economy, driving
the recession deeper and further.
"Because
debt is acting as a brake on economic growth, it is important to unstick the
brake" said the report's author Daniel Leigh.
The IMF has
studied the response of a number of countries to situations where large parts
of the population are burdened with high mortgage debt in a recession, and
finds that such programmes can help prevent self-reinforcing cycles of falling
house prices and lower aggregate demand.
"Such
policies are particularly relevant for economies with limited scope for
expansionary macroeconomic policies and in which the financial sector has
already received government report", notes the conclusions. Ireland meets
both these criteria.
The report
highlighted what it calls the "bold " household debt reduction
programmes implemented in the US in the 1930's and in Iceland in this crisis,
which it said can "significantly reduce the number of household defaults
and foreclosures and substantially reduce debt repayment burdens''.
It
contrasted these examples with others that have not been successful, such as
the current response to the crisis in the US and Hungary, and the policies
pursued in Colombia and the Scandinavian countries in the 90's.
As well as
the "bold" approach, it said that ensuring a strong banking sector is
crucial during the period of household deleveraging. It stated that the
policies in Colombia and Hungary were not a success as they placed too much
burden on an already fragile banking sector.
It also
said the policies must be designed to have incentives for both banks and
borrowers to participate, notably by offering a viable alternative to default
and foreclosure.
The IMF
noted that government support for household debt restructuring programmes
involves clear winners and losers. "The friction caused by such
redistribution may be one reason why such policies have rarely been used in the
past, except when the magnitude of the problem was substantial and the ensuing
social and political pressures considerable",' it stated.
It cited
another study which found that political systems tend to become more polarised
in the wake of financial crises, and raised the question of collective action
problems - that distressed mortgage borrowers may be less politically organised
than banks - and this can hamper efforts to implement household debt restructuring.
In the US
in the 1930's the Roosevelt administration introduced the Home Owners Loan
Corporation, which bought distressed mortgages from banks with government
bonds, with federal guarantees on principal and interest. It then restructured
these mortgages to make them more affordable to borrowers.
80% of the
restructured loans (some 800,000) were protected from repossession by the
measure, and the mortgages were subsequently sold on over time for a nominal
profit at the time the programme was brought to an end in 1951. The mortgage
purchases amounted to 8.4% of 1933's GDP in the US.
The IMF
said "a key feature of the HOLC was the effective transfer of funds to
credit constrained households with distressed balance sheets and a high
marginal propensity to consume, which mitigated the negative effects on
aggregate demand" caused by the recession and need for household
deleveraging.
The main
mechanism to make loans more affordable was to extend the term of the mortgage
- sometimes doubling the term - and converting it from a variable to a fixed
rate. In a number of cases the HOLC also wrote off part of the principal to
ensure that no loans exceeded 80% of the appraised value of the house.
In the case
of Iceland the situation was more difficult, due in part to the much bigger
proportion of the population that was affected, and to the wide presence of
foreign currency mortgages.
The
government and the newly constructed Icelandic banks developed a template to be
used in case by case restructuring discussions between borrowers and lenders.
The templates facilitated substantial debt write-downs designed to align
secured debt with the supporting collateral (i.e bring the loan into line with
the value of the house) and align debt service with the ability to repay.
The IMF
found that such case by case negotiations safeguard property rights and reduce
moral hazard, but they take time. As of January of this year, only 35% of the
case by case restructuring applications had been processed. To speed things up,
Iceland has introduced a debt forgiveness plan which writes down deeply
underwater mortgages to 110% of the households' pledgeable assets.
It noted
that only when a comprehensive framework was put in place and a clear
expiration date for relief measures announced that debt write-downs finally
took off. As of January 2012, 15 to 20% of all Icelandic mortgages have been or
are in the process of being written down.
However, it
said the jury is still out on Iceland's plans, and said the extent to which
Iceland can put its citizens back on their feet and minimise moral hazard
remains to be seen.
ICELAND
The President Of Iceland Tells Us How He Had The Balls To Stand Up To Britain
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Channel: Wanderer of the Skies - April 14, 2012
Channel: Wanderer of the Skies - April 14, 2012
“… Your
nation of Iceland is being used as a testing ground for the rolling out of
financial strategies for the betterment of your planet. It would be wise to
follow their progress in this respect, as it will be the fate of all nations in
a very brief period of time. We have always advised you that such an action would
never come from the larger powers and nations of the world, but they will
follow in lockstep once the actions begin their domino effect…..”
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