In 1985, falling prices for energy and agricultural produce led to a slump in Kansas and Missouri where these two sectors were key features of the economy. This led to a collapse in the local property market. However, at the time, by law all banks had to be local.
With their loan portfolios decimated by the crash, some banks were forced to close. The regional banking regulator, the Federal Reserve Board of Kansas City, had to clear up the resulting financial sector collapse.
Because this crisis only affected a couple of relatively small states, there were no wider repercussions from these financial difficulties. However, the Federal Reserve Bank – the US's Central Bank – drew a key lesson from the experience: it was risky to have banks that were totally dependent on a local, relatively small economy.
The law was changed to allow larger US-wide banks to open in the local economy. However a second key recommendation, repeatedly stressed by the Federal Reserve Bank, was that banks should spread their risks by selling some of their mortgages to financial institutions from other US states. This process is referred to as securitisation.
Securitisation remains a vital instrument for reducing risk for financial systems
This spreads the exposure to shocks in the local economy more widely. In addition, the proceeds of the sale of the loans allow the banks to continue offering mortgages to the local population.
Vital instrument
While abuse of securitisation, through the disguised sale of risky loans, contributed to the global financial crisis that erupted in 2008, nevertheless it is important to recognise that, properly used, securitisation remains a vital instrument for reducing risk for financial systems.
Today in Ireland, the main banks have most of their assets in Ireland and are very exposed to any risks to the local economy. Diversifying their portfolios through being able to sell on loans to financial institutions elsewhere is a vital tool in reducing this level of exposure, to provide long-term stability in our banking system. We already know the human, social and economic cost of a banking crash.
As a society we are very conscious of the need to protect vulnerable households. Following the banking collapse, changes were made in the law and regulations to protect vulnerable borrowers. These rights are fully protected when ownership of loans changes hands, so that from that perspective it is irrelevant which institution owns the loan.
Mortgage lending in Ireland has proven to be a high-risk business
But if we want to avoid the risk of another bank crash, then it is important that no further legislative obstacles are put in the way of future securitisation by Irish banks. One such obstacle could be Sinn Féin’s No Consent, No Sale Bill, whereby a loan could not be sold on by a bank without the approval of the borrower.
High-risk business
Mortgage lending in Ireland has proven to be a high-risk business. It has taken more than a decade to sort out the lethal combination of risky lending and over-indebtedness in the run up to the crash. The higher the perceived risk of lending, the higher the interest rates banks have to pay to attract capital, with Irish banks paying much higher interest rates than banks in much of the rest of the EU.
A recent Department of Finance paper has estimated that banks in Ireland, because of the higher risk, are paying about 0.5 per cent more to fund mortgages than is the average for EU banks. In turn, this extra cost is passed on to borrowers.
This means that mortgage interest payments in Ireland are about €400 million a year more than they would be if mortgages were less risky. Over the lifetime of these loans, the cumulative cost for homeowners here arising from the higher risk on mortgage lending here will run to billions of euro.
Lending institutions in Ireland are bound by statutory codes of conduct in relation to mortgages. Our courts are humane in dealing with borrowers who are making a genuine effort. But, however well-intentioned, any legislation that further restricts the ability of banks to recover the monies they have loaned would make the business of mortgage lending even more risky, and would add to the interest premium borrowers here already have to pay.
Expansion
Furthermore, the ESRI has estimated that our banks are likely be short of money by the early 2020s to fund the expansion in housing supply we so desperately need. Thus they will need to raise finance by selling on some existing mortgages to foreign financial institutions.
The push to further restrict the banks’ ability to manage their loans will raise interest rates for all borrowers. In turn, this will affect many of those who are hoping to borrow to buy a house in the future. So what looks like strengthening consumer protection could backfire on all mortgage borrowers.
