Easy money blues

By Harry Keaney

As Ireland basks in the boom times, should it be concerned about its mortgage lending practices? Central Bank governor Maurice O’Connell certainly is.

What particularly concerns O’Connell, Ireland’s equivalent of the Federal Reserve chairman in the U.S., is the easy availability of mortgages, which is fueling the exorbitant increase in Irish property prices.

O’Connell aired his concerns in a recent letter to the chairmen of banks and building societies in Ireland. In the letter, he wrote that recent analysis by the central bank had revealed "some disturbing practices."

According to O’Connell, the quality and quantity of information in relation to the income of applicants for mortgages were "inadequate in several instances."

"A number of files had no evidence as to the source of funding of the balance of the house purchase price," O’Connell wrote. "Increasingly, lenders have been including additional income, from sources such as room rental, parental guarantees, or potential future earnings, when assessing an application."

O’Connell stated that a "particularly disturbing feature" had been the use, in some instances, of excessively high thresholds of disposable income as criteria for loan approvals.

"The pressure to be flexible in the face of increasing competition and rapidly increasing house prices is understandable," O’Connell told the bankers and building society chairman. And, he added, at a time of very low interest rates there is obviously an added incentive to adopt generous guidelines on mortgage lending. And the expectation of a continuing low interest environment increases the demand for higher mortgages, he added.

But, he warned: "While the immediate case for a more relaxed approach to lending might be persuasive, it remains vitally important to take a medium-term perspective as well, and to reckon with the potential consequences of rising interest rates and economic downturn in due course.

"All credit institutions have a duty to consider the economic and financial outlook, both in their own interests and in the interests of borrowers. They have an obligation to be actively aware of the economic and social consequences of a lending policy that is excessively flexible."

The central bank governor also reiterated in his letter what many observers of Ireland’s property market have been saying for some time. "The level of house price inflation in the recent past," he said, "has been excessive by any standards and prices continue to rise."

O’Connell said there is evidence that, in part, this has been driven by the "ready availability of mortgage finance on generous terms."

He went on to ask bank and building society chiefs to ensure that mortgage lending policies were "well understood at branch level" and "reflect acceptable prudential standards."

O’Connell said that the central bank, in the exercise of its supervisory functions, intended to intensify its analysis of mortgage-lending practices as part of its inspection routines.

He also asked that the Central Bank be kept informed at all times on changes of significance in criteria used by lending institutions for accessing applications for mortgage finance.

What if?

As house prices rocket ever more higher in Ireland, with purchasers apparently having no problems in obtaining mortgages, there is concern that there may eventually be widespread inability to repay, leading to widespread repossessions and negative equity. Bank stress tests — which examine borrowers’ situations if their circumstances changed or if interest rates went up — appear not to have been rigorously undertaken. In fact, O’Connell, in his letter to the lending institutions, stated that in a number of cases there was a lack of evidence to confirm that stress testing had even been carried out.

Interestingly, concern about inadequate evaluation of mortgage applications is not just confined to authorities in Ireland. Here in the U.S., the department of Housing and Urban Development plans to crack down on lenders who have excessive delinquency rates on new home loans. The federal government is planning to hold these institutions directly responsible for home buyers they finance who fall into default or foreclosure within the first 24 months after loan closing.

In an initiative targeted at the 7,000 lenders who provide loans to home buyers who use Federal Housing Administration-insured financing, lenders deemed to have too many seriously delinquent new customers may lose their rights to receive federal mortgage insurance to back additional loans.

The reasoning behind the initiative is that the first 24 months of a mortgage, especially for first-time buyers, are often the most difficult for borrowers and, consequently, the most revealing about the quality of lenders’ credit evaluation procedures.

"We’re not just in the business of helping families buy homes. We’re in the business of helping families keep homes," said HUD Secretary Andrew Cuomo, the son of former New York Gov. Mario Cuomo.

Of course, in Ireland, first-time buyers are finding that prices are often out of their range to begin with. Indeed, for those immigrants thinking of returning to Ireland, the cost of housing is becoming an increasingly important concern, if not indeed a disincentive. And with Ireland possibly experiencing a skills shortage, the issue is therefore as much one of national economic importance as it is a personal concern for individuals and families.

The issue of housing costs in Ireland has also been highlighted by the Organization for Economic Co-Operation and Development, a Paris-based think tank.

In its biennial country report on Ireland, the OECD recommends that, in an effort to take some heat out of the red-hot housing market, a new property tax should be introduced and mortgage interest relief abolished.

However, Finance Minister Charlie McCreevy told RTE News that the government had no intention of introducing a residential property tax.

Peter Jarrett, the author of the OECD report, told the Irish Times that the key to the future of Ireland’s economy was wage growth.

"The key factor in the coming months is the negotiation of a new [wage] agreement. If wages keep accelerating, it would be a major concern."

Despite its warnings, the OECD nevertheless described Ireland’s economic performance as "stunning."