At the center of the 2008 global crisis was the mortgage debacle. The U.S. government funded mortgage agencies that provided funding for residential mortgages, which in most cases, the mortgagee was not able to afford. The end results were foreclosures and a depressed housing market -- now headed into its fifth year.
As we all know, in the absence of a holistic economic plan The Bahamas continues to depend on the success -- or lack thereof -- of the U.S. economy. The Bahamas is now experiencing what the U.S. experienced back in 2008 in the mortgage market as a result of lenient lending practices. To fix the core of this problem we need policies that are realistic, achievable and measurable.
After reading the article "PLP to tackle mortgage 'crisis'" in Monday's Nassau Guardian, we felt compelled to provide some thoughtful analysis on the matter. We hold no political brief for any party, but as a financial research and investment company we have a professional and civic duty to opine on ideas which may impact our clients in particular or, as in this case, ideas which we think could adversely impact the Bahamian economy in the short and long term.
While the idea of providing relief for peoples having a difficult time meeting their mortgage obligations is arguably a good one, and one which we support, we have serious questions on some of the specifics outlined in the Progressive Liberal Party's (PLP) proposal as reported in The Guardian.
In order to place our argument in context, you may recall that our company argued against the loose monetary policy back in 2005-2006, when financial institutions and developers were very lax in their lending policies. We saw double digit credit growth and warned this would come back to haunt us in a very negative way. The loans default crisis (including mortgages) of which we spoke has arrived.
As regards the solution to the 'crisis' proposed by the PLP, there are several points that we support: the idea of extending "first time homeowners" stamp duty exemption to people who have lost their homes to foreclosure and are trying to purchase a new home; the argument for some form of review of finance charges and related fees; the regulation of "unregulated lenders"; and the proposal to, "bring under stricter control and supervision the system of salary deduction". We agree with the PLP that this is being abused by some lending institutions.
Concerns about the plan
Our greater concerns are related to the other recommendations in the proposal.
In a democracy it is not prudent for the government to mandate any financial institution to do anything. The shareholders, directors and management decide what course of action should be taken.
Governments and financial services regulators (central banks) sometimes resort to "moral suasion" in a credit crisis in order to try and persuade financial institutions to provide relief to mortgage payers. Alternatively, monetary policy initiatives by the Central Bank in the form of interest rate deductions are applied to solve the issue of mortgage delinquency.
That course of action, particularly with respect to our current predicament, is likely to be ineffective in and of itself. It is our view that a holistic plan is needed. A plan that will examine the likely outcomes and impact on all stakeholders in order to avoid unintended consequences.
By way of example, the recent reduction in prime rate caused serious issues for pensioners, insurance liabilities and National Insurance in terms of matching long term liability obligations.
While the government's debt obligations may have benefitted from the reductions, the real intended beneficiaries -- those who are already in significant arrears -- did not and will not benefit from the initiative. The unintended was the increase liability obligations by National Insurance, insurance companies and defined benefit pension plans.
What people need are jobs. Merely dropping interest rates or guaranteeing interest payments will not cause lenders to extend credit, especially since the creditworthiness of many borrowers was and still is slipping. In the case of new or revised loans at the lower rate, the average monthly benefit will not make much of a difference to the borrower.
The suggestion that a financial institution would simply write off 100 percent of the provisions is impractical at best.
Financial institutions are in business to return a profit to its shareholders. Further, the fact that these amounts are written off today does not preclude the financial institution from attempting to collect on the amounts written off sometime in the future when the circumstances of the borrower might have changed more favorably.
Provisioning for bad debts is an accounting requirement -- nothing more, nothing less. As regards the suggestion that the government would take a lien over the property, we do not see how this is possible given that the financial institution already has a lien over the property.
As for the government paying the interest of the delinquent mortgages, while this is a noble idea it is also not practicable and could encourage irresponsible future behavior.
Why would anyone who is current on their mortgage continue to pay if the government would step in and pay the interest for five years? This could have far-reaching consequences unless, of course, we have misunderstood this suggestion.
We are concerned about whether anyone attempted to do the math and cost-out the proposal to see if we, an already debt-laden country, could afford this ambitious proposal.
Has anyone given consideration to the moral hazard?
The cost
Let's see how much this will cost the people of The Bahamas.
Total Bahamas domestic credit was approximately $7.103 billion at the end of February. Loans or mortgages with maturity over 10 years stood at $4.639 billion. Mortgages outstanding was $3.090 billion with total private sector loans in arrears of $1.159 billion. Total mortgage arrears stood at $619.6 million.
Assuming the estimated proposed interest rate of 5.75 percent (again we do not know how the government proposed to do this in a capitalistic society, but accepting the proposal as is) this would translate into an additional annual commitment by the government of $35.63 million or $178.14 million over five years.
With what is essentially "free money" until 2017, those who are current on their mortgages would elect to stop paying since the government would be obliged to pay their interest until 2017. They would receive two benefits: a reduction from the average rates of 7.77 percent to 5.75 percent (an immediate savings of over two percent); and to have the government pay the interest until 2017.
It would be logical and indeed quite smart for everyone to stop paying their mortgages for the next five years and have the government pay on their behalf. This would translate into an annual cost of over $266.7 million per year in interest payments (more than the government's current debt service commitments) or $1.335 billion over five years.
All of this would further increase our debt to GDP ratio, which everyone is concerned about. What happens after 2017 if the economy does not turn around and continues to muddle through? We submit that given the current economic climate as well as the projected growth trajectory, it is highly unlikely that The Bahamas could afford this expenditure, unless we are able to grow the economy (provide more jobs) in the order of 10 percent per annum.
With reference to the suggestion that financial institutions extend maturity on the existing mortgages, as far as our research suggests, this is presently being done. With respect to using pension assets, again for the most part, this is being done already.
The reality however, is that less than 30 percent of companies in The Bahamas have a pension plan, so again, while a noble idea in the absence of pension legislation this will not result in any immediate assistance to the people it is intended for. Perhaps the idea of some form of mandatory pension may be considered to reduce the reliance on National Insurance in the future.
We again state, for the record, that this commentary is not politically motivated. We are simply interested in good economic policies which will further enhance the well-being of all citizens and permanent residents of The Bahamas. What we do not wish to see is capital being inadvertently driven away because of some ill-advised economic policy.
The Bahamas has any number of financial institutions which are ready, willing and able to provide advice on economic matters of national importance. This being one such matter, we felt compelled to present our views and to encourage political parties to consider stress testing some of their ideas that have been proposed so that we can navigate the future from an informed position.
CFAL is a sister company of The Nassau Guardian under the AF Holdings Ltd. umbrella. CFAL provides investment management, research, brokerage and pension services. For comments, please contact CFAL at: column@cfal.com.
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