Stamp Duty versus Mortgage Interest Relief

Here is a table of the amount of revenue raised from Stamp Duty on residential property and the amount of tax relief granted to residential mortgage holders for the past decade.

The figures for Stamp Duty are taken from here and relate only to Stamp Duty paid on residential property transactions, while the figures for mortgage interest relief are taken from here including the estimate for 2012, with a full-year 2011 figure here.  The amount of income tax relief granted to mortgage holders is equivalent to nearly 75% of the revenue received from Stamp Duty on residential property.

The two columns do not reflect the same groups of people but there is likely to be very significant overlap.  The Stamp Duty column will include duty paid by investment buyers who are not entitled to mortgage interest relief (but do get a separate relief).  If investors paid a quarter of the Stamp Duty and were omitted the sums of two columns would be almost identical.  The Mortgage Interest Relief column will include people who bought before 2002, though these will be smaller mortgages and many will have been repaid by the end of the period, and also first-time buyers who bought in the period in question but were exempt from Stamp Duty.

Although the Exchequer did collect significant revenue from the purchase of residential property by households in the last decade, the Exchequer has also lost significant revenue by awarding income tax relief for mortgage interest to households.

Retail Sales rise again, but…

The release by the CSO of the October Retail Sales Index contained one predictable result: the sales of Electrical Goods rocketed (in advance of the shutdown of the analogue broadcast signal for television).

This increase will distort the changes in broader measures of retail sales.  A core measure of retails sales excluding the motor trades rose in October.  The motor trades category has a weight of 18.2% in the October index so this represents 81.2% of the index.

In October, the electrical goods category makes up 4.9% of this core measure of retail sales so comprise about one-twentieth of the total above.
One an annual basis core retail sales have been showing positive changes for three months but the jump in October to a 4% annual rise by value and 3.5% by volume was significantly boosted by electrical goods.

On a monthly basis core sales in October rose by around 1.3% in both value and volume terms. 

The 25% rise in electrical goods means that this category alone would have contributed almost all of the monthly rise in October. [On a very crude basis the rise in electrical goods multiplied by its weight in the core index gives 0.25 x 0.05 = 0. 0125, or 1.25%.  All the series in the dataset are individually seasonally adjusted so such a comparison is not sound].
But assuming that the jump in electrical sales hadn’t happened and further assuming that the index had remained at its September level, then both the volume and value indices would be showing an annual rise of around 2.3% in October.  This is only a modest rise in comparison to the drops that preceded it, and since the positive rise in July retail sales have been relatively static since (excluding the electrical goods bounce in October with a more minor impact on September).
The arithmetic average the value and volume indices for the first ten months of 2012 is almost identical to the same measure from 2011.  Stabilisation? Yes. Improvement? Not yet.

Collecting more Income Tax?

The pre-budget submission of the Irish Tax Institute contains the following:

The income tax yield in 2011 exceeded that for 2007, despite the dramatically reduced number of people in employment. The revenue from income tax (including USC) in 2012 is projected to be the highest ever (€15.3 billion) despite the ongoing high unemployment levels.

Here is a table of annual tax yields from the Databank of the Department of Finance.  Click to enlarge.

It can be seen that the Income Tax in 2011 of €13.8 billion is indeed more than the €13.6 billion collected in 2007.  However there is an element of comparing apples and oranges in the figures used the Irish Tax Institute, who you’d think would know their onions on this.

Here is a table that sets out the various deductions on income made since 2007.

In 2011, the Universal Social Charge (USC) replaced the Income and Health Levies and all income from the USC is counted as Income Tax.  The Health Levy, as an appropriation-in-aid, was paid directly to the Department of Health and is counted as a social contribution.

A like-for-like comparison between 2007 and 2011 would be to sum the following receipts, such that they are, in each year

Income Tax + DIRT + Income Levy + Health Levy + Universal Social Charge

For 2007 this would give a total of €14.9 billion and for 2011 a total of €14.1 billion.  Although there have been significant tax increases in recent years the €15.3 billion that is projected to be collected in 2012 is not significantly higher than the €14.9 billion collected in 2007 but there is a dramatically reduced number of people in employment.

Taxing Wealth, er… Income

This week Sinn Fein released their budget proposals in a document called ‘Making the Right Choices’.  It contains a package similar in scale to the €3.5 billion of ‘adjustments’ proposed for Budget 2013. 

There are €2,758 million of proposed tax increases and €705 million of net expenditure ‘savings’ (though €433 million of those come from increased revenue measures in health (recouping the full cost of private beds from private patients)).

One of the tax initiatives is a new wealth tax.

A 1% TAX ON NET WEALTH OVER €1MILLION, EXCLUDING WORKING FARMLAND, BUSINESS ASSETS, 20% OF THE FAMILY HOME AND PENSION
POTS: RAISES €800million

Sinn Féin’s proposal is to introduce a 1% tax on all assets over €1million net of all liabilities, including mortgage and other debts. The tax would not be levied on 20% of the family home, the capital sum in pension funds, business assets or agricultural land.

It would apply to the global assets of those domiciled or ordinarily resident in the state and domestic assets only for those who are resident in the state for tax purposes.

Two examples are provided to illustrate how the proposal might work.  (Click to enlarge).

Here is a summary of Example B:

Of course, the first item on this list is not a typical component of wealth.  Wealth is usually defined as a stock measure of the difference between assets and liabilities at a particular point of time.  Income is a flow over a particular period of time.

We have taxes for income through Income Tax, USC and PRSI.  The above case would be subject to Sinn Fein’s proposed 48% rate of Income Tax on incomes above €100,000.  It also appears to be the case that those who are subject to the wealth tax will be subject to an additional 1% income tax on some measure of ‘net’ income.  Thus, the proposal is part wealth tax, part income tax.

If income was excluded from the base for the wealth tax (as would be expected) then the tax liability in Example B would be €5,150.  Raising €800 million from a wealth tax such as that would require the equivalent of 160,000 Ciarans.  A newspaper report of the proposal says:

Mr Doherty claimed that financial management company Merril Lynch had estimated there were 18,100 people living in the State with assets of more than $1m (€778,000).

Taxing Income (again)

A couple of previous posts have looked at the implications of changes to income tax, here and here.  A recent parliamentary question provides some details of what would happen if:

1. the marginal rate of tax on Income Tax was increased to 71% for very high earners or
2. if the effective tax rate of Income Tax + USC + PRSI was increased by nearly a third for high earners. 

The answers to these questions were provided in a recent PQ set by Socialist Party TD Joe Higgins.  The emphasis was on tax cases with incomes over €100,000.   The marginal rate of tax for PAYE employees in this category is 52% (41% Income Tax + 7% USC + 4% PRSI).  For self-employed/non-PAYE earners the marginal rate is 55% as there is an additional 3% USC levy for non-PAYE earnings over €100,000.

The question set looked for the impact of marginal rates ranging from 48% up to 78% on different income ranges excluding PRSI.  With a 7% USC rate the proposed income tax rates start with the existing 41% rate up t0 71%.

Unsurprisingly the proposed 48% raise no additional revenue as that is identical to the existing rate.  There is a minor gain from the 50% rate and from 55% up the suggested impact of the new tax bands and rates can be seen.  The largest amount of additional tax revenue is in the widest band between €250,000 and €1 million with over €400 million raised from a new 75%. tax rate. 

The marginal tax rate of 78% on earnings over €1 million raises just €110 million.  This is because there are so few people earning this amount.  The 2011 tax distribution statistics from the Revenue Commissioners show that just 636 tax cases reported an income of greater than €1 million.  It is not clear how many individuals have incomes in excess in €1 million.

If there was 636 such people they would face an extra tax bill of around €175,000 from the 78% rate alone.  The increased rates on lower income bands would mean the overall tax increase for such earners from these measures would be larger.

In total nine proposed new tax bands with a top marginal rate of 78% would raise a little over €850 million.  This would help close a budget deficit of €13.5 billion but makes clear that increased taxes on high earners alone falls far short of the eliminating the deficit.

The second set of proposals had to do with increased effective or average tax rates for earners in similar income ranges used above.  For incomes over €90,000 the proposal would see the overall effective tax rate rise from 34.6% to 40.2%, with an effective tax rate of 50% or more for all incomes over €300,000.

In total these increases would raise €1,337 million which is equivalent to around 10% of this year’s deficit.  This is similar to an earlier proposal from NERI but gives specific effective rates for each income range.  It differs in that the proposed tax increase is about twice as large and focussed on a third as many people.  In both cases no specifics are given on how implementing these effective tax rates would actually be achieved.

Unmodified Mortgages

The latest mortgage arrears statistics from the Financial Regulator show that there were 83,000 mortgage accounts in arrears of 90 days or more in June 2012.  The numbers on modified mortgages show that 45,000 of these have been adjusted in some way.  We looked at those in an earlier post and saw that around 75% of modified loans are meeting the revised commitments under the restructuring.

What about the other 38,000 of mortgages with 90 day arrears, those that are in arrears but haven’t being restructured?  Is anything being done for them?

From the way the arrears statistics are presented it is impossible to tell how much distress these accounts are in.  As the explanatory notes say:

The arrears figures denote the value of arrears (payments not received by the contractual due date) expressed as equivalent days past due. Partial payments received from borrowers will be credited to the oldest arrears amount which will have the effect of reducing the balance of arrears.

Arrears of over 90 days past due do not necessarily signify that borrowers have not made mortgage repayments for the last three months. For example, a borrower can be making partial repayments on a monthly basis but may still be in arrears of a value equivalent to over 90 days past due. In the same way, arrears of over 180 days past due does not necessarily signify that borrowers have not made mortgage repayments for the last six months.

At the recent Finance Committee sessions with the AIB and BOI the emphasis of the mortgage arrears discussions was on modified mortgages as highlighted in the earlier post.  The 38,000 unmodified loans are likely to contain some borrowers who have entered arrears by missing some payments in the past, but have now resumed making full payments without clearing the accumulated arrears.  This might describe some of the cases but it could be very few.

Here are some indicators on the mortgages that are more than 180 days in arrears.

The number of accounts in this category has increased each quarter since the statistics began.  The inflow peaked in Q4 2011 at 6,749 and has fallen slightly in each of the last two quarters.

Unsurprisingly, as the number of accounts in this category has increased the total amount of arrears owing on them has increased and is now nearly €1.4 billion.  However, the pattern in the average arrears owing per account is less consistent.  By Q2 2011 the average arrears was nearly €21,500.  This group are significantly behind on their mortgage payments and these arrears cannot be allowed to accumulate indefinitely.

The question is whether these arrears are still accumulating. In 2010 and up to the middle of 2011 the average arrears amount was showing an annual increase of around 10%.  Since then this is moderated significantly and in the past two quarters there has been a annual reduction in the average arrears amount.

What does this tell us about mortgages in this category?  Very little.  The average arrears will be brought down by the new entrants to the category who will have arrears just over the lower limit of six months, while continued deterioration in the performance of those already in the category will push the average arrears up. 

It is also the case that the most extreme cases could have had their arrears capitalised into the principal.  In June 2011 there were 8,994 mortgage accounts that had arrears capitalisation applied to them.  By June 2012 that had increased to 10,228.

Also it is clear that something happened in Q4 2011 when the increase in arrears was €80 million.  In each of the three preceding quarters and in the two subsequent quarters the increase averaged €130 million.

The key point is that the arrears statistics don’t tell us what is happening to mortgage accounts now.  The overall trend clearly indicates that things are getting worse, and they will continue to do so, but it impossible to gauge from the arrears statistics how many borrowers are in distress now. 

We know that around 75% of the 85,000 modified mortgages are performing in line with the new arrangements provided for them.  We don’t know anything about the performance of the 38,000 mortgages with 90 day arrears that have not being modified.

What we need is a measure that tells us whether the monthly interest charge on the mortgage is being covered now, not a historical measure of performance relative to somewhat arbitrary contract obligations.  The “who is in arrears?” question in this post highlights the problems with using arrears as a measure of distress.

A Year of Bond Yields

This time last year doubts about Spain were a factor in driving up sovereign bond years for the ‘peripheral’ Eurozone countries.  The Irish nine-year government yield as calculated by Bloomberg rose from just over 8% up to near 10% in a couple of days.

Since then, for one reason or another, the path of the yield has been consistently down.   By dropping below 4.7% in the past few days the yield is at levels not seen since the summer of 2010 and well below the 7% levels that emerged in the weeks leading up to Ireland’s entry into an EU/IMF rescue programme in November 2010. 

Here is the range of Irish yields along the yield curve provided by Bloomberg:

• 1-year: 1.28%
• 3-year: 1.59%
• 5-year: 3.44%
• 7-year: 4.02%
• 9-year: 4.67%

A ‘Special Case’ in Statistics

Ireland is in the midst of a crisis that should not be under-estimated.  However, for some reason there are many people who go to great lengths to overstate it.  A piece in yesterday’s Sunday Indpendent  contains the following section in relation to Ireland’s status as a “special case”.

Well, Mr Rehn, we've seen a huge rise in deaths by suicides recently in Ireland, many shown to be connected to austerity. Between 2009 and 2011, 1,563 people in the Republic took their own lives, nearly three times as many as died in traffic accidents. Does this make us a special case?

Unemployment (at 14.8 per cent and rising) is considered "increasingly structural in nature" and more than 150,000 people have emigrated in the past three years. Emigration is the only career choice for the majority of our highly educated young people who have no future in their economically destroyed country. Does this make us a special case?

So many mortgages are in trouble that Fitch, the rating agency, believes at least 20 per cent will default sooner rather than later. Reports also suggest that 1.8 million Irish adults have less than €100 at the end of the month after all the bills are paid. Does this make us a special case?

Suicide, unemployment, emigration, household debt and poverty are all very serious problems which deserve serious attention.  They do not get it in the above paragraphs.  Some reasons for this are explored below the fold.

In The Irish Times last December Prof. Brendan Walsh wrote:

There is a widespread impression that our suicide rate soared during the recession. In fact, the suicide rate (including deaths due to “events of undetermined intent”) peaked in the late 1990s and fell over the first half of the noughties. While the rate rose significantly in 2009, it fell back in 2010 to the level recorded at the turn of the century.

The suicide rate among the highest-risk group – males aged 25-34 – is now one-third lower than it was in the late 1990s.

A couple of weeks later he gave a presentation on Well-being and Economic Conditions in Ireland at a conference on the Irish economy in Croke Park which illustrates the above findings (see slide 5 in particular).

Table IV on page 53 of the CSO’s Report on Vital Statistics for 2010 provides the number of suicides recorded each year since 1980.  The 2011 estimate can be seen in Table 2.15 on page 51 of the Vital Statistics Yearly Summary for 2011.  The population figures in the following table are taken from Table 6 in the most recent release of the CSO’s Population and Migration Statistics.

The total number of deaths recorded as suicide rose from 1,424 in 2006-2008 to 1,572 in the three years to 2011.  However, over a period when the number of suicides rose by around 10%, the overall population grew by 8%.  The suicide rate per 100,000 population did increase between the three-year periods but the rise from 10.9% to 11.5% could not be considered “huge”.

The claim that the unemployment rate is 14.8% “and still rising” can be assessed with Table 3 from the Live Register release.

An unemployment rate of 14.8% is unacceptably high, but in October of last year it was 14.5% and in October 2010 it was 14.2%.  The rate has risen from 14.2% to 14.8% but over a two-year period.  In fact, the current level of 14.8% was actually reached nine months ago in February and the rate has been almost static since then.

There are a number of important caveats with the unemployment rate.  One such is the number of people on ‘Activation Programmes’ who are not included in the Live Register totals.  A useful table of these is now provided as a annex to the Live Register Release (see page 13).

Over the past year there has been an increase of 5,245 people availing of these programmes.  If these schemes were not available and these people were counted as being unemployed it would have added around 0.25 of a percentage point to the unemployment rate.  The rate would be 15.1% rather than 14.8%.

A second caveat is the return to outward migration and this is covered with the claim that “more than 150,000 have emigrated in the past three years”.   This table is extracted from the Population and Migration Statistics.  (Annual figures are for the 12 months to April in each year.)

Over the past three years far more than 150,000 people have emigrated.  The actual figure is close to 240,000.  Accounting for the immigration of nearly 150,000 people, the level of net migration is an outflow of nearly 90,000 people, with Irish nationals comprising two-thirds of this total.

This of course further complicates the use of unemployment rates.  If the 34,400 net outward migration in the year to 2012 was added to the unemployment numbers it would have added about 1.5 percentage points to the unemployment rate over the year.

It is useful to look at the other side of the coin: the number employed.  Here are the overall numbers in employment since 2005.

Getting worse more slowly is still not the same as getting better though.  However, hidden with in this total is some detail.  Those employed can roughly be broken into three categories:

• Private-sector employees (1,112,000)
• Self-employed (290,000)
• Public-sector (including semi-states) employees (381,000)

Here are graphs that show what has happened to these since 2008.  There is a performance difference between the first two and the latter category.

  

Next is the claim that Fitch “believes at least 20 per cent will default sooner rather than later”.  We have previously looked at this in detail.  What Fitch actually predicted was a 20% “foreclosure frequency” for residential owner-occupied mortgages in Ireland.  In defining “foreclosure frequency” Fitch consider:

“the more than 90 days delinquent performance measure to be most useful for rating assumptions in terms of predicting the borrower’s likelihood of performing.”

Thus, Fitch predicted that 20% of Irish mortgages would fall more than 90 days in arrears.  The most recent release from the Financial Regulator show that 10.9% of all mortgage accounts are in arrears of 90 days or more.  In the ‘base’ scenario offered by Fitch they have a starting frequency of 10% for the following loans:

• loan is not in arrears;
• full-time employed borrower with full income verification and no adverse credit history;
• amortising loan paying monthly; and
• loan purpose consisting of purchase/refinancing of the primary residence.

With 10% of these loans falling into arrears (and higher frequencies used for loans with poorer characteristics) it is not difficult to see how their overall prediction of 20% 90-day arrears is reached.  This could happen and we await further releases from the Financial Regulator to see if the negative trend in the arrears figures is continued.

Finally we have the claim that “that 1.8 million Irish adults have less than €100 at the end of the month after all the bills are paid”.  This comes from the most recent release of Irish League of Credit Union’s What’s Left survey.  The survey was first published in April 2011. The following table is taken from the October 2012 survey.

Of course, the ILCU didn’t go around and survey the 3,500,000 people that the above columns total to.  They surveyed a sample of 1,000 people which “is nationally representative by Age, Region, Gender and Social Class” and extrapolated from the entire population of people aged 15 and over.  Here is a breakdown from the CSO of the population based on self-assessed principal economic status.

This is from Table 10a of the Q2 2012 QNHS, which surveys around 12,000 households and  is likely to be a better survey unit of measurement for disposable income.  Is it much of a surprise that hundreds of thousands of the people in the above table have less than €100 left after “essential bills” have been paid?  Students? Unemployed? Homemakers?

Only around half of the population here is at work and it not clear what “essential bills” actually means in relation to the measure of disposable income referenced in the survey.

The claims that:

• we've seen a huge rise in deaths by suicides recently in Ireland,
• unemployment (at 14.8 per cent and rising) is considered "increasingly structural in nature",
• more than 150,000 people have emigrated in the past three years,
• Fitch, the rating agency, believes at least 20 per cent will default sooner rather than later, and that
• 1.8 million Irish adults have less than €100 at the end of the month after all the bills are paid

may fit a popular narrative but they do not fit reality.   Some of them are partially reflective of our reality but some of them are plainly untrue. 

The reality is dreadful, truly dreadful but it makes little sense to over-exaggerate it.  If such a case was presented to Ollie Rehn, it would quickly be inferred that the only case in which Ireland was “special” was through an inability to use statistics.

Modifying Mortgages

The latest mortgage arrears statistics from the Financial Regulator show that 84,941 of mortgage accounts have had their terms modified in some way.  Of these, 40,221 of these are recorded as not being in arrears and 44,720 are listed as being in arrears.  The numbers here are taken from slide 9 from Fiona Muldoon’s recent presentation to the Irish Banking Federation.

It is commonly stated that this means that the almost 45,000 mortgages recorded as being in arrears after a restructuring "have fallen back into arrears" post the restructuring.  There  are many examples of reports like the following:

Furthermore, 84,941 mortgages have been classified as restructured at the end of June, which was a 6.6% increase on the 79,712 restructured at the end of March. Of the total restructured mortgages, 44,720 had fallen back into arrears of more and less than 90 days. The remaining 40,221 were sticking to the restructured terms.

This is not true.  In reality the splitting of modified mortgages in those in arrears and not in arrears tells us very little.  The 45,000 will include mortgages which have fallen back into arrears after a restructuring, but it also includes mortgages that had arrears on them before the restructuring which was not cleared.

If an account is in arrears and the amount of these arrears are not cleared when the account is restructured then the account continues to be counted as being in arrears.  This will be the case even if the borrower fully meets the adjusted payment obligation.  The borrower has not fallen back into arrears; they just have not made good on the arrears they accumulated before the restructure.  This is confirmed in the notes accompanying the release from the Financial Regulator:

Restructured accounts in arrears include accounts that were in arrears prior to restructuring where the arrears balance has not yet been eliminated, as well as accounts that are in arrears on the current restructuring arrangement.

Recent statements from the banks at the Oireachtas Finance Committee indicate that for AIB/EBS and BOI something around 75% of modified loans are performing in line with the revised terms. From AIB:

“Between 69% and 70% of our 33,700 customers who are in forbearance are affording the new restructured loans we have put them into.”

And BOI:

“We have more than 16,000 customers who are currently subject to mortgage forbearance or who have had their mortgages restructured. Our mortgage forbearance and mortgage restructures are based on customers who can meet, in our estimation and theirs, at least the full interest on their mortgages. Some 86% of those customers who are subject to forbearance or restructuring are fully meeting the revised arrangements.”

Between them they account for 50,000 of the modified loans and 37,500 are satisfying the terms of the modification.  All other banks have 35,000 modified loans and 95% of these would have to be underperforming the new conditions if the “fallen back into arrears” description of the Financial Regulator’s statistics is to be true.  It is not and it is likely that 60,000 or so of the 85,000 modified mortgages are performing in line with the revised terms.

That is not to suggest that these modifications will be successful.  Around half of the modifications involve a payment moratorium (4%), a payment less than the monthly interest charge (15%) or a move to an interest-only repayment (35%).  The majority of these borrowers may be performing in line with the adjusted terms but these changes can only be a short-term stop-gap solution. 

These modifications can offer relief to a borrower in temporary difficulty but unless the borrower can resume paying the full interest and at least some capital they will not be effective in the long run.

For borrowers with longer-term problems the forbearance modifications that have to be considered are (in increasing order of effectiveness):

1. term extensions (for those with remaining terms of less than 20 years),
2. interest forbearance (lower interest rates for non-tracker rate borrowers) and
3. principal forbearance (split mortgages with no interest on the shelved portion).

It is noteworthy that the latter two are not in the current list of modifications reported by the Financial Regulator.  The final one has been proposed on here since at least November 2010.  These will cost money but the cost of default would be even greater.  Unless borrowers are put on a manageable path in the medium term of making interest and some capital repayments the mortgage will not be sustainable.

The objective of the restructuring has to be to establish a capital and interest repayment that is below a certain income threshold.  This doesn’t have to happen immediately but there has to be a reasonable probability that this can be achieved. 

There is of course a fourth modification that could be used to reduce the monthly repayment: principal forgiveness.  There has been plenty of other discussion about that one.

If the mortgage cannot be modified to create the reasonable expectation of full interest payments and at least some regular capital repayments in the medium term then the mortgage is likely to be unsustainable.  Such mortgages should be ended via formal repossession or schemes such as Mortgage-to-Rent.  If the banks are left with a shortfall after setting the value of the surrendered house against the mortgage, this balance should be written off after a short period.

Interest Expenditure in Ireland

The non-financial institutional sector accounts include items for ‘interest paid’ and ‘interest received’.  However the number reported by the CSO is the total after adjustment for FISIM (financial intermediation services indirectly measured).  

The purpose of this is to try and account for financial services that are not paid for directly but are paid for indirectly via the gap between deposit and lending rates of financial institutions.  Thus a part of interest expenditure is to pay for the cost of the money provided and a part of it is to pay for the cost of financial services provided.  This latter part is included in consumption for households and as part of intermediate consumption for non-financial businesses.

The release last week by the CSO includes interest figures but these are after the adjustment for FISM has been carried out.  However, eurostat publish item D.41(g) which is “total interest before FISIM allocation” which allows us to produce the following table.

The total amount of interest paid was nearly €20 billion or 12.4% of GDP. 

If we were to assume an average interest rate of 4.0% that would imply a total debt of around €500 billion.  At 4.5% the debt would be around €440 billion.  These figures give the ballpark for what the aggregate debt burden of the government, household and non-financial corporate sectors is.

The FISIM adjustment for the household sector seems ‘large’.  For all years from 2002 to 2008 it was below €2 billion but from 2008 to 2009 it jumped from €1.6 billion to €4.3 billion.  It has remained high since then.  The FISIM for the non-financial corporate sector similarly rose in 2009 but it has fallen back since then.

A table of total interest paid since 2002 and some further details on FISMIM are below the fold.

The interest charge for the economy peaked in 2008.  Since them the amount of interest paid buy the NFC and household sectors has fallen significantly, while the interest bill for the government sector is going in the opposite direction.

Here are the FISIM amounts for each sector in the same period:

A query to the CSO on FISIM and the reason for “jump” in 2009 returned the following:

The FISIM adjustment is calculated on the basis on a  reference rate which is the average of the short term interbank rates up to 12 months maturities - this is considered to be the risk free interest rate .

FISIM is measured as the difference between this reference rate and the actual rate paid by these corporations applied to their loan liability positions.  The collapse in the reference rate from 2008 - 2009/10 meant that practically all the interest paid was recorded as FISIM.

FISIM is calculated in line with the agreed methodology outlined in ESA 95 - the EU standard.  However in the wake of the financial crisis it has become clear that this measure needs to be disaggregated into the service element and the risk premium  element.  To try to resolve this both OECD and Eurostat have Task Forces working on finding a solution to this matter.

Government Sector Non-Financial Accounts

The non-financial general government accounts in the Institutional Sector Accounts give a cash-based view of the general government sector which is more complete in scope than the Exchequer Accounts.  The general government accounts used for the Excessive Deficit Procedure are accruals-based.

Below the fold are the current accounts of the general government sector since 2007 (noting that the figure for ‘Value of Output’ is the sum of subsequent items in the accounts rather than a starting input, as most government output is non-market).

The current cash deficit of the general government sector has declined in each of the past two years (albeit slowly).   Here are the capital accounts for the same period.

The largest item in the capital account in recent years has been “other capital transfers” which reflects the direct capital injections into the banks (excluding those made via share acquisition).  These transfers were €4 billion to Anglo in 2009, the €31 billion of Promissory Notes to Anglo/INBS in 2010 and around €5 billion of the AIB/EBS recapitalisation in 2011.

Investment expenditure by the government sector has declined markedly since 2008, and once depreciation of existing capital is accounted for, the net capital formation of the government sector in 2011 was just €1.8 billion.

Flows in the Household Sector

A couple of recent posts have looked at the financial stocks of assets and liabilities in the household sector.  The second part of the Institutional Sector Accounts is that which looks at non-financial flows; earnings, income, consumption and savings, investment and depreciation.

First, here are the figures for the household sector current account for the past four years.

For most of the aggregates there was very little change in 2011 on the 2010 figures.  The large drops seen in 2009 and 2010 eased somewhat in 2011, but there is little sight of a comeback in these numbers.

Production (value of output) in the household sector rose slightly in 2011 leading to a small rise in the operating surplus of the sector (+1.6%).  Wages paid to households (including employer’s PRSI) from the government, business and household sectors all declined in 2011, though at 1.3% the drop was the lower than previous years. These and other minor changes led to a decline of 1.3% in the Gross National Income of the household sector.

The aggregate that shows the largest change is "Taxes on Income and Wealth” which increased by 22.1% on the year.  However, much of this is a reclassification change rather than an increased tax burden on households.  In 2010, €2,018 million was collected via the Health Levy which was classified as a social contribution.  For 2011, the Health Levy was abolished (along with the Income Levy) and replaced by the Universal Social Charge and all the revenue collected under the USC is classed as a tax rather than a social contribution.

Reflecting this social contributions paid to the government sector from households fell 10.7%.  In 2010, social contributions paid to the government (all by the household sector) were €11.5 billion.  For 2011, this was €10.3 billion.  The remainder of the social contributions paid by the household sector were made to the financial sector (private pension contributions). 

These were largely unchanged on the year at €4.3 billion.  Social contributions to and from the household sector will be related to non-profit organisations which are included in the household sector.

In 2010, the total of income and wealth taxes and social contributions from the household sector paid to the government sector was €23.9 billion.  For 2011, this increased to €25.4 billion.  Social contributions paid from the government sector to the household sector were €23.8 billion, an increase of 2.5% on 2010.

The sum of these changes meant that the gross disposable income of the household sector declined from €86.2 billion in 2010 to €84.2 billion in 2011, a fall of 2.3%.  From this household consumption was €77.5 billion, a decline of 0.8% on 2011.

Here are the capital accounts of the household sector.

The household sector has moved from being a net borrower to a net lender.  This is largely as a result of the collapse in investment in non-financial assets by the household sector (buying new houses).

In 2008, gross capital formation by the household sector was €17 billion.  This itself was down from €26 billion in 2006 and the fall continued through to 2011 when investment by the household sector was just over €4.7 billion.  With depreciation of existing household capital slightly under €4.7 billion, the net capital formation of the household sector in 2011 was just €44 million.  Repair of existing capital and investment in new capital barely covered the depreciation of existing capital.

The household sector is not using its gross savings to invest in fixed capital.  Nor is the sector using it to build up deposits; it is going it to pay down debt.

Mortgage Arrears as a Measure of Distress

There are 22% of mortgage accounts exhibiting some form of difficulty according to the latest mortgage arrears statistics published by the Financial Regulator.

The mortgage crisis a huge problem (c. 130,000 households) and is not new, but 78% of mortgage borrowers are meeting their mortgage commitments according to the original terms.  These number almost 470,000 households.   The number of households in the table above is estimated using the fact that the average number of mortgage accounts per household with a mortgage is 1.27.

There are also 580,000 households who own their homes outright with no mortgage liability and 450,000 who rent from local authorities or private landlords.  Of the 1,700,000 million households in Ireland, around 1 in 13 are in mortgage difficulty.

From the bank’s perspective the key measure is not the number of households but the proportion of the loan book that is in distress.  It can be seen that over 27% of mortgages by balance have been modified or are in arrears.

Here is a set of five representative borrowers who each begin the year with a starting balance of €100,000 on their mortgage. 

They all have loans with an interest rate of 4% resulting in an opening monthly interest charge of €333.  The borrowers are making monthly repayments of nil to €823.  The closing balance is the principal after 12 months and the current monthly interest is the monthly interest charged on their mortgages after 12 months of these repayments.

Which of these borrowers is in the most mortgage distress?  Which of these borrowers are in mortgage arrears?  Are these the same question? Look at the five borrowers above and then check below the fold to see who is in arrears.

The only one in mortgage arrears is Borrower Five.  This is the borrower who is making the largest monthly repayment and has repaid the largest amount of the opening balance.  This borrower is in arrears because the original contracts specifies that the remaining €100,000 balance should be paid in ten years.

Borrower One who has seen the balance owing rise by €4,000 and now has an increased monthly interest charge is clearly the borrower exhibiting the greatest distress.  However they have been granted a payment moratorium by the lender, and thus are not in arrears even though no repayments are being made. 

The latest release from the Financial Regulator shows that a payment moratorium has been granted on 3,180 mortgage accounts.  The release doesn’t say how many of these are in the arrears figures but if there borrowers in this group not in arrears it is still the case that they are in severe difficulty.

Being in arrears does not tell us anything about what is happening to the mortgage account now.  A borrower could have missed three full payments in the early part of 2010 but has resumed making full payments for the past two and a half years.  This borrower is three months in arrears but is unlikely to be much concern to the lender.

A borrower could have reduced their payment to 87.5% of the required payment two years ago.  Over the course of those two years they will now be the equivalent of  three full payments in arrears (24 x 0.125 = 3) but again this borrower is unlikely to be flagged as a major concern.

The arrears statistics excludes borrowers who are not in arrears because they have been granted a payment moratorium but are likely in severe difficulty. It includes borrowers who are classed as in arrears but who are now making their full repayments or close to it.

The arrears statistics are important and the quarterly changes are a very strong indication of the deteriorating nature of the mortgage situation.  However, the statistics are not necessarily the best indicator of the extent of borrower distress.

A truer level of distress, would not be payment arrears relative to somewhat arbitrary contract obligations, but a measure of accounts where the monthly interest charge is not being covered by the monthly repayment.  People should not be classed as in mortgage distress because of the length of their term.  Borrowers are in mortgage distress if they cannot service their mortgage.

Borrowers are definitely in severe mortgage distress if the balance owing on their mortgage is increasing and are almost certainly in mortgage distress if the balance is non-reducing.  Borrowers making only occasional inroads in reducing their outstanding balance may be in distress. 

The key issue is the persistence of these problems.  Temporary difficulties for six or nine months in a contract that was due to last 300 months (25 years) should not be a source of terminal concern.  In their 2011 Annual Accounts, BOI said that 98% of borrowers with rescheduled mortgages were making interest only payments or greater (see page 75).

There are borrowers in huge difficulty, who cannot, and are unlikely to be able to, meet the monthly interest charge on their mortgage for a period of years.  If the interest on a mortgage cannot be covered for an extended period, with no sign of a recovery, then that is an unsustainable mortgage which should be ended. 

Repossessions and Mortgage-to-Rent need to gain wider acceptance as solutions of the mortgage problems we face.  In increasing order of effectiveness, term extensions (for those with remaining terms of less than 20 years), lower interest rates (for non-tracker rate borrowers) and split mortgages (with no interest accruing on the shelved portion) can help borrowers who need some assistance but who can avoid repossession. 

Forbearance measures and repossessions are the solution to the mortgage crisis.  It is likely that these will be on a ratio of around four-to-one across maybe 100,000 households.  There is no need to complicate it further.

Reducing Mortgage Balances

The previous post looked at the household balance sheet and the declining levels of household debt in particular.  At the end of 2011, the household balance sheet has €179 billion of loans.  This can roughly be broken down as:

One aside of the above table relates the graph of debt-to-gross disposable income for the household sector at the end of the previous post.  As can be seen above about one-fifth of the debt in the household sector relates to buy-to-let mortgages.  These debts are not dependent on gross disposable income to be serviced; they are dependent on rental income.  These are not typical household debts; they are business or investment debts.

The buy-to-let sector will come into focus in the next few weeks with the first official release of arrears statistics from the central bank.  The sector is apparently in turmoil (see slide 7).  Apparently, because in Census 2006 there were 145,000 recorded as renting from private landlords while in Census 2011 the equivalent figure is that 305,000 households are now renting from private landlords.  There are more thoughts in the BTL sector in this comment.

The focus here is on the largest item of household debt; owner-occupied residential mortgages.  The Financial Regulator has been providing mortgage arrears statistics since the third quarter of 2009.  The following table combines this with data on mortgage lending from the Irish Banking Federation.

At the start of the mortgage arrears statistics in the Q3 2009, the aggregate balance on all owner-occupied mortgages was €118.7 billion.  In the 11 quarters since this balance has fallen by €6.7 billion to €112.0 billion.

This alone does not reflect capital repayments by borrowers as additional lending by new and existing borrowers will offset these repayments.  The IBF dataset breaks down owner-occupied mortgage lending into four categories.  Here they are with the amount of lending that has taken place since Q4 2009:

• First-time buyers: €4.3 billion
• Mortgage top-ups: €0.9 billion
• Mover-purchasers: €3.4 billion
• Remortgages: €0.9 billion

The first two are unambiguously new lending and are summed in the column labelled ‘New’ lending in the table.  Payments by existing borrowers must exceed these new drawdowns to reduce the overall balance outstanding.

The latter two are less clear cut. It is impossible to tell if mover-purchasers lead to an increase in mortgage debt.  This depends on whether they sell they existing home and on whether the new loan is greater than than the original loan.  Remortgages won’t reduce the amount of debt but it is impossible to tell if they increase it.   These are summed in the column labelled ‘Other’ lending and to be conservative it is assumed that they add nothing to new lending.

The Capital Repayments column is thus made up of the reduction in the overall outstanding balance and new lending to first-time buyers and top-ups.  With no allowance made for mover-purchasers or remortgages this is likely to be lower limit of actual repayments.

In this case there has been nearly €12 billion of capital reducing payments made in less than three years, an average rate of almost €1.1 billion per quarter.

At the start of the arrears statistics in Q3 2009, the total amount of arrears that had accumulated at that time was €354 million.  Since then it has risen to €1,439 million, an increase of €1,084 million.

The €1.1 billion rise in arrears in the 11 quarters since Q3 2009 is equivalent to the average amount of capital repayments that takes place in one quarter.  Also, the arrears figure includes arrears on capital and interest repayments on the mortgage.  Using the retail interest rates data from the Central Bank we can roughly gauge the interest component on mortgage repayments:

We can see that since September 2009 households have made repayments of around €21 billion on their home mortgages.  This is 20 times greater than the arrears that have accumulated over the same period.

This is not to dismiss the severe distress that thousands of households are suffering as a result of excessive mortgage debt.  There are huge difficulties and addressing these has to be a priority.  But there are many more households meeting their mortgage commitments.

The Household Sector Financial Balance Sheet

Here is a summary of the 2011 financial balance sheet of the household sector from last week’s Institutional Sector Accounts.

The numbers are little changed from 2010 when a net financial wealth of €118 billion was reported.  The main reason for the slight increase in net financial wealth is the continued reduction in household loan liabilities.  The total wealth of the household sector would need non-financial assets (property, land and valuables) added to this €117 billion figure.  The value of houses owned by the household sector is probably around €300 billion.

One notable feature of the balance sheet of the household sector is the declining level of loan liabilities.  According to the CSO data, this peaked at €203 billion in 2008.  Since then it has fallen by €24 billion.

The fall in short-term loans may hit a lower bound but the drop and long-term loan liabilities has averaged around €6 billion per year and if current repayment and drawdown patterns remain this is likely to continue.

There is massive debt in the household sector in Ireland but it is clear that there are massive repayments being made.  The reduction to €179 billion is significant but the end-2006 figure was €169 billion so the progress in unwinding the huge borrowing of the boom is still small.  The 2002 figure was €110 billion.

Reductions in household gross disposable income means that the drops in the level of debt are not reflected in drops in the key debt-to-disposable income metric for the household sector.  This is reflected in this chart from the CSO.

Consolidated Loan Liabilities

The release on Thursday of the 2011 Institutional Sector Accounts by the CSO gives an insight into the financial stocks (assets and liabilities) and non-financial flows (income, consumption and savings) of the main sectors of the economy.  One addition to this year’s release is the inclusion of ‘consolidated’ tables for the financial tables.  As the release says:

This year both consolidated and non-consolidated tables are presented for the first time for the Financial Accounts.  The consolidated analysis allows a clearer view of transactions and balance sheet positions between institutional sectors. Transactions between entities in the same institutional sector are netted out in this consolidated presentation.

The end of year (consolidated) stock of financial assets and liabilities is shown excluding stocks which exist between units within the same sector. This view of the accounts can be very useful when analysing financial instruments such as loan liabilities as the consolidated view removes inter-sectoral balances.

Here are the consolidated debt liabilities of the household, government and non-financial corporate sectors at the end of 2011.

The differences between the non-consolidated and consolidated figures for the household sector are zero, while there are about €5 billion of extra liabilities on the government’s non-consolidated accounts (likely related the Housing Finance Association).  

The big difference is for the NFC sector where the consolidation reduces the liability figure by €45 billion.  These are liabilities owed by the resident NFC sector to other counter-parties in the resident NFC sector, i.e. domestic intra-company loans.

A recent table from the IMF which included the following 2012 totals for the gross, non-consolidated debts of the three sectors as a percent of GDP got a lot of attention, including in The Wall Street Journal.

• Household: 117%
• NFC: 258%
• Government: 118%

It can be seen that the figures for the household and government sectors reconcile roughly with those in the above table.  The 2012 deficit and return to bond markets of the government sector explain the increase that will be seen in 2012.  The figures that can’t be similarly reconciled are those for the NFC sector.

The 258% of GDP figure used by the IMF is a much greater than the 168% of GDP figure consolidated figure now provided by the CSO.  Some of the difference is due to the consolidation that removes domestic intra-sectoral balances.  It is also the case that the CSO have revised down the earlier figures. 

When they first reported the 2010 non-consolidated loans figure for the NFC sector it was €337 billion.  In this year’s release that figure has been revised to €298 billion.

It will also be the case that a significant proportion of the consolidated loan liabilities of NFCs are to the Rest of the World - predominantly the borrowings of foreign multinational
corporations resident in Ireland.  Thus the 168% of GDP figure in this week’s release is still an exaggeration of what might be considered “Irish” corporate debt, which is some level less that 168% of GDP.

According to data from the Central Bank lending from Irish-resident banks to Irish-resident NFCs peaked at €175 billion in the third quarter of 2008, of which €115 billion was to property-related sectors.  The lending to the property-related sectors is a mess and huge amounts of it won’t be repaid.  Transaction data shows that the €60 billion of non-property related lending to Irish NFCs has declined by the €6 billion in the interim.

The figure for “Irish” NFC debt will be high at the moment but it is still the case that much of the NFC loans are delinquent property-related loans that will not be repaid.  A large portion of these remain to be resolved but this process will reduce the NFC debt figure.

This process also means that the total of household, government and NFC debt results in some double-counting.  There are around €50 billion of property-related loans now controlled by NAMA in the NFC figure and the government loans figure includes the €25 billion of Promissory Notes to the IBRC to cover the losses on these loans. 

Either the developers will repay the loans they have taken out (they won’t) or the government will repay the Promissory Notes (they will).  They won’t be paid twice.  The government debt figure also includes monies for the recapitalisation of the pillar banks.

The most recent recapitalisation from March 2011 provided money to cover losses on household and business lending that the banks will incur before the end of 2013.  This has added to the government debt figure but when these inevitable losses are (eventually) resolved they will reduce the household and NFC debt figures.

Both the household and Irish NFC sectors have seen reductions in the amount of debt they are carrying for the past four years.  This process will continue through repayments and the eventual writing down of unpayable debts.  The ongoing deficits mean that the debt of the government sector continues to increase.

Ireland has a massive debt problem, and this top-level analysis does not reflect the huge difficulties faced by individual households and businesses, but the problem is not intractable.  The level of debt is probable somewhere around €500 billion.  This is three times GDP and four times GNP.