Should the country prioritise private debt over what the State owes?
By Economics Correspondent Sean Whelan
The news that AIB is going to write down the “warehoused” portion of debt in split mortgages from now on is to be welcomed.
It is a belated recognition from a big bank that some mortgages can never be repaid in full, and the bank is better off doing a deal with some customers and returning them to the world of normal spending citizens.
Pragmatic debt relief can help the economy by leaving people with debts they can afford to service, and a bit left over to spend.
It will probably work out cheaper for AIB as well, as the alternative of repossession usually means a hit to the lender. And the Central Bank will be happy that one of the banks has cracked, and is doing what most of us understand to be a “durable” solution for some classes of mortgages.
I wonder what the other banks think of this unilateral move.
Still on debt news, the Minster for Finance said last month that the Government’s debt has peaked at 120% of GDP and was now on a downward path, which will be helped by the spending of some of the cash buffers the NTMA has built up during the programme years (around 10% of Irish Government debt is held as cash).
But where should a state concentrate its efforts; reducing Government debt or private sector debt – household and commercial?
The IMF is in no doubt – deal with private debt first, then worry about the state debt.
In a chapter on debt in a new book on getting more jobs and growth in the Euro Area*, IMF economists say high private sector debt may be more damaging to growth than high public sector debt.
This is particularly bad news for us (and the other Euro area peripheral states) because we have very high levels of household debt, very high levels of corporate debt, and very high levels of Government debt.
And when all three sectors are highly indebted they combine to hold back growth even more.
The IMF’s advice to governments in the Euro area is:
“An accelerated clean-up of private and financial sector balance sheets can help prevent a protracted period of stagnation. Delays and resistance to working out NPLs (non-performing loans) in the banking system, and lengthy procedures for personal and corporate bankruptcies, increase uncertainty about the extent of the problem and put further downward pressure on asset prices and firm performance. At the aggregate level these feedback loops can trigger debt deflation dynamics”.
It also suggests some policities to help reduce the damage from high private debt levels; for example mortgage payments could be “eased” for highly indebted, low income households whose properties have been foreclosed. Government-sponsored programmes could also help encourage banks to reschedule household debt.
In the corporate and commercial sector, it suggests more use of debt-equity swaps and out-of-court procedures to support the early rescue of viable firms. Meanwhile assset management companies, (private or with some state participation), could help accelerate the restructuring of corporate debt while taking weak assets off the bank’s balance sheets.
Of course the banks need to have enough capital and provisions to absorb the losses such policies will run up.
The bitter pill could, the IMF suggests, be sweetened by tax incentives (or the removal of tax disincentives) for debt write offs.
But a key element is beyond the abilities of our Government alone to provide, and that is a pan-European backstop for solvent banks to break the negative feedback loop between banks and sovereigns that is causing financial market fragmentation (and widely differing interest rates across Euro Area banks).
That backstop is currently missing in action somewhere in the Brussels region.
The IMF’s main conclusion – that high levels of private debt is worse than high levels of government debt – is the latest salvo in the running battle over whether high levels of government debt – i.e. more than 90% of GDP – causes economic growth to slow down.
You may recall a flap in the world of academic economists over a spreadsheet error by eminent US economists Ken Rogoff and Carmen Reinhart, who had produced a fairly influential paper using lots of empirical data in support of the view that high government debt leads to lower growth.
Trouble is, when other researchers tried to replicate the findings, they discovered errors in some of the data.
For some it watered down the conclusions, for others (like Social Justice Ireland) it proved that the whole basis of austerity policies was wrong.
Listing the number of authors (not just Rogoff and Reinhart) who think high public debt (i.e. above 90%) leads to higher interest rates and slower growth, it appears at first that the IMF inclines to the Rogoff and Reinhart view.
But there appears to be a shift in favour of a lightly researched idea – that it is high levels of private debt that is the real cause of slow growth.
The IMF cites only one paper from 2011 (Cecchetti, Mohanty and Zampolli), which finds corporate debt of more than 90% of GDP and household debt of more than 85% of GDP become a drag on growth.
The link between higher private and household debt and growth drag is higher than in the government sector.
High public sector debt is only a problem if the household and corporate sectors are highly indebted as well. On its own, a high government debt has a “statistically insignificant” impact on growth.
It says that where household deleveraging is furthest advanced – in the USA – there has been early use of measures to strengthen financial institutions balance sheets.
Bank and private debt restructuring mechanisms have been used more widely in the US, facilitating the workout of NPLs and dispelling doubts about asset quality. These processes were supported by appropriate legislation and institutions.
And the IMF finds that having a banking crisis did not appear to increase the amount of drag on growth.
The IMF points out that overall debt levels in the Euro Area are about the same as those in the UK and US.
Government debt is at a comparable (high) level in all three regions, but Euro area government debt has grown more slowly since 2003.
But it is the US and UK that are experiencing a strong rebound in growth: the Euro Area is barely on the right side of the recession line.
And unlike the Euro Area, the US and UK have seen a reduction in household debt levels since 2009. The UK has also seen a fall in corporate debt levels. So moving to fix the private sector first rather than obsessing about state debt levels may be paying off for the US and UK.
In the first decade of the 2000s, private and commercial debt increased most sharply in the countries that are now under most stress, and both are particularly high in Ireland, Portugal and Spain – where household, corporate and government sectors all have very high debt levels.
Indeed, in the case of Ireland and Spain, high government debt only emerged when the sovereigns took on private sector liabilities as a result of the crisis.
The moral of the story? Bank of Ireland and PTSB need to follow AIB’s lead on split mortgages. The national debt will (more or less) take care of itself.
*”Jobs and Growth: Supporting the European Economy”, by IMF staff
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