2013-14 Barrington Lecture: Dis-Entangling the Mortgage Arrears Crisis: The Role of the Labour Market, Income Volatility and Negative Equity

By McCarthy, Yvonne | Journal of the Statistical and Social Inquiry Society of Ireland, Annual 2013 | Go to article overview

2013-14 Barrington Lecture: Dis-Entangling the Mortgage Arrears Crisis: The Role of the Labour Market, Income Volatility and Negative Equity


McCarthy, Yvonne, Journal of the Statistical and Social Inquiry Society of Ireland


1. INTRODUCTION

With about one in five residential mortgages in a delinquent state, the Irish mortgage crisis is arguably the most profound across the OECD. The high rate of mortgage arrears has prompted much debate and a number of policy interventions to deal with the crisis. Despite this, the high rate of mortgage arrears has persisted. Understanding the determinants of mortgage arrears is a complex and difficult task, particularly in the Irish case. To date much of the discussion has centred on the role of negative equity and unemployment. Given the extent of the deterioration in these factors over such a short period of time, and the accepted role that these factors have played in mortgage distress in other countries, this is not surprising. Average house prices in Ireland have fallen by over 50 per cent since they peaked in 2007, and current estimates suggest that up to 50 per cent of mortgage holders could be in a position of negative equity. Unemployment, on the other hand, increased sharply from only 4.6 per cent at the end of 2007 to a high of 15 per cent at the end of 2012. However, other factors are also likely to be important to the Irish mortgage arrears story.

Over the period 2004-2006, when house prices were at their peak, almost 340,000 mortgages were approved out of a total stock of about 800,000. At the time, the Irish economy was experiencing significant improvements in living standards and hence the general ability within the economy to sustain such mortgages was thought to be quite high. However, many of these mortgages were taken out by a relatively young population at a time when eased credit conditions provided access to relatively high loan-to-value mortgages and mortgage repayments that consumed significant portions of household income. (2) Against this backdrop, most mortgages were reliant on at least two incomes to sustain repayments, and more specifically, were reliant on incomes remaining at least as high as they were at the point of mortgage approval. The sharp deterioration in the Irish economy since the onset of the current crisis, however, has had a depressing effect on household incomes which goes beyond the impact of unemployment alone. (3) In this context, additional labour market issues such as deteriorating employment terms and income volatility are also likely to be important considerations.

In this paper, we follow the recent literature on mortgage distress and explore the role of housing equity and unemployment in driving Irish mortgage arrears. Crucially, however, we also examine the importance of changes in household income and the labour market for mortgage delinquencies. This is the first attempt to explore these factors in an Irish setting since previous work has been based on limited datasets that did not contain any borrower-specific information on current affordability variables. Some recent work has attempted to proxy for such factors using variables like regional unemployment and income trends. These variables cannot capture the full complexity of the interaction between labour market developments and financial distress, and, furthermore there is evidence that the use of such aggregate affordability proxies can substantially underestimate the role of even these limited factors in mortgage distress (see Gyourko and Tracy (2013) for more on this). The work in this paper, therefore, will shed new light on the mortgage arrears crisis in Ireland.

The ability to undertake such a detailed analysis of mortgage arrears arises out of two new and unique datasets. The first is a mortgage loan-level dataset collected by the Central Bank of Ireland as part of a prudential capital assessment review exercise of the Irish banking sector. Covering three Irish residential mortgage banks, which account for approximately 70 per cent of the loans issued in the Irish market, the dataset includes a snapshot of the entire residential mortgage book of these institutions at June 2012. …

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