Saturday, March 06, 2010
DURING the week Allied Irish Banks announced losses of more than €2.65 billion for 2009. In explaining the situation, Colm Doherty, managing director of AIB Group, described the current state of retail banking in Ireland as "quite dysfunctional".
Since this country’s credit rating declined it has become more costly to borrow money. Now Irish banks have to pay more for the money they borrow than they were previously charging their customers. Hence AIB will have to charge more for the money it lends.
One does not have to be an economist to recognise that charges for money are going to go up in 2010. This will have to include mortgages.
Most people do not understand the amounts of money involved in the demise of the Celtic Tiger economy. The RTÉ News website reported during the week that AIB lost €2,656bn last year. This may have just been a typographical error in which a comma was used instead of full stop. It should have read €2.656bn. Maybe the writer was confused by the traditional difference between a billion on either side of the Atlantic.
Most people could not tell you how many noughts there are in a billion. In America a billion has always been 1,000 millions whereas in Britain it was a million millions. So for many years when one used the term "billion," it was necessary to state whether it was a British or an American billion. A British billion was an American trillion.
In recent years people have tended to use the American form in this part of the world, but you should not be overly surprised if those who talk in billions frequently don’t know what they are talking about. As George Bernard Shaw wrote, "England and America are two countries divided by a common language".
When I went to university in the United States in 1963, I soon learned that the word "pussy" did not always refer to a cat. I remember watching the movie Goldfinger in Texas. Honor Blackman introduced herself to James Bond with the famous line— "My name is Pussy Galore."
The audience cracked up. One girl couldn’t stop laughing. It was soon hard to know whether people were laughing at her, or laughing at the people who were laughing at her, or just laughing at something else that had been said on the screen.
As the movie continued, there would a brief silence and then somebody would explode laughing for no apparent reason and the whole place would start laughing again. I missed much of the movie because of what was happening in the cinema. When I came home on holidays the following summer I had the chance to see the movie again, but nobody in Tralee noticed anything funny about the woman’s name. "Pussy" still referred to the feline family exclusively.
Today it would be very different because we have adopted so many Americanisms. Nevertheless, whether one is talking about old British or American billions, the figures are beyond the comprehension of most people.
Much has been written about people facing repossession of their properties at current mortgage interest rates. If those rates go up further, the situation will become that much worse. It has already reached crisis proportions.
Before the bust, if Andy Anyone took out a €250,000 mortgage on a house at a fixed rate of 4.5% for 30 years, he would have to make 12 monthly payments of €2,269 each year, in addition to the closing costs, or handling fees for the transaction.
At the end of 30 years he would have paid a total of €456,840, plus the closing costs. Thus the bank would make a gross profit of over €206,840 on its original investment of €250,000.
Andy would probably lose money if he tried to sell his holding now in the depressed state of the property market, but over the next quarter of a century property prices are likely to fluctuate. Whether he loses money on the house will depend on whether the market is up or down when he sells.
Over 30 years the fluctuations in the market are likely average out. If Andy bought his house 30 years ago, it would still be worth a lot more today than what he paid for it.
If mortgage rates go up to 7% next year, will the bank be losing money on the €250,000 it loaned to Andy? No. The €250,000 is already gone and the bank does not have to borrow it at the current rates. Interest rates could double, but the original €250,000 does not change. This is a sunk cost— a done deal. The bank does not have to borrow that money again at the new higher rate. The bank should still earn a gross profit of €206,840 on the original loan.
The problem is that many people borrowed the money in variable rate mortgage. If the interest rate goes up, as it probably will, those people will be figuratively screwed.
Their housed may not now be worth what they paid for them and they may be stuck with negative equity for the present. To make it worse, their repayments are going to be higher than they expected. Some people might say, "that’s capitalism." The banks loaned money recklessly and they paid handsome bonuses to some staff members for this recklessness. Now they are going to have to try to recoup their money and, on their past record, they will likely screw anyone they can.
Remember that the government came to the rescue of AIB over the ICI debacle in 1984. That government didn’t attach strings to its rescue efforts.
AIB responded to that public generosity by screwing the Irish public, especially their own customers for anything they could get. AIB gave a whole new meaning to the term "bank robbery".
WHAT they did in many instances was criminal. They actually stole millions from customers and they shamelessly facilitated tax evasion with bogus offshore accounts.
If bankers did that in any other countries, they would have gone to jail. But no banker was even charged, much less jailed, in this country. Instead they were allowed to go on to create an even greater mess.
The Government is now mortgaging the future of the people in this country in rescuing the banks and, in the process, also attempting to rescue many of those who borrowed money to gamble recklessly on property speculation.
This time it should attach strings to ensure a sense of fairness by providing protection for those who borrowed to purchase a home.
The Government could, and should, insist that the interest rate at which those people borrowed money to purchase their homes should be frozen, as if the money were borrowed at a fixed rate.
Those people are already victims of the boom in that they were recklessly misled into overpaying for their property in the first place. The banks were largely responsible for inciting that extravagance and they must accept their share of the responsibility.
Banks should not be allowed to victimise them again by compelling them to pay even more in their repayments.
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