By Theodore Panayotou
NON-performing loans (NPLs ) reached €26 billion and continue their upward trend while property prices continue their downward march. Valuable time has been lost unnecessarily. More than 12 months have passed since the haircut and very little has been accomplished to stem the slump in prices and the rise in NPLs. Regaining trust in our banking system cannot be accomplished with conflicting statements, leaks, and populism.
In fact, you don’t understand what is going on until you consider the place and the context. This is the land of populism, favours and freebees, where “getting away with murder” is an accomplishment to be proud of; where almost no one is ever punished.
Jobs and houses we don’t deserve
Cancer specialists will tell you that metastatic melanoma is not an easily treatable cancer and is often fatal. The corruptive ways in which good jobs, promotions and positions of power are being secured have metastasized from the job market to the property market. If you can get a cushy job, a high position and a fat salary without deserving it why not an almost free house, preferably a big one with a sea view without having to pay for it?
You simply make a large loan from a bank (regardless of your income) putting as collateral the house you buy or build with the loan. You service your 20-year loan for a year or two and then you stop, claiming financial hardship. The bank cannot take your house away and throw you and your two Mercedes Benz out in the street. It is your human right to keep your house even if you didn’t pay for it; it has already been paid by some bank depositor who was gullible enough to trust his money with a banker who was greedy enough (for a bonus) to lend it to a borrower who had no intention to pay it back.
An imaginative system of social justice
This is actually an imaginative system of social justice, income redistribution and financial intermediation. The compassionate and financially disciplined bureaucrats of the Eurogroup should adopt it and institutionalise it throughout the Eurozone along with their successful Cyprus experiment of a deposits haircut which, by the way, they did not invent. Here, bank depositors and shareholders have been receiving regular haircuts for years by delinquent borrowers living in mansions. This is social justice the Cyprus way, and our bankers, until recently, were content to play the game since they received their cut until private debt reached the astronomical level of 300 per cent of GDP. If you continued to live in a small house, it was because you were not very smart. Not servicing one loan or two does not prevent you from getting another loan or a credit card to finance your overconsumption to go with the large house you secure with your non-performing housing loan.
NPLs induced by rumor and populism
But still, there were many good people who choose to service their loans until the economic crisis hit. The rising unemployment, the haircut of salaries and deposits, and the closing of failing businesses have robbed many people of their ability to service their loans. There is no question that people who stop servicing their housing loans because of genuine hardship deserve some assistance. The problem is that an even greater number of people, who are able to service their loans, exploit the situation. They expect to be helped too by a rumored loan haircut, or impending legislation to protect the first residence. They hoped that populism, another favorite Cypriot sport, practiced daily by politicians, will ensure that any legislation to protect poor people from eviction will be broad enough to include them too.
Moral hazard, pyramids and conflicts of interests
Another innovative financial instrument with which we accumulate loans we do not intend to repay is the short-term loan for land developers. Even though both the bank and the borrower know very well that a five-year loan for land development cannot be repaid in five years they proceed with it anyway. The viability and profitability of the development based on a sound business plan receive hardly any scrutiny. Soon enough the loan is extended and expanded for another five years, no questions asked. If the developer does not have the cash flow to service his loans he is given further loans to service them creating a sort of a pyramid founded on unsound financial and business assumptions and spurious thinking.
The situation becomes even more muddled when the banker and the developer are the same person; In the past, the Chairman of the Board of a bank borrows from the bank he chairs for his land development gambles. The intermingled conflicts of interest are another favourite sport of bankers, businessmen and politicians (not all but many) in this Mediterranean paradise.
Procrastination and uncertainty
The first thing that should have been done when the new management took over the Bank of Cyprus last September, was taken measures to arrest the growth of NPLs and tumbling prices of properties used as collateral to stabilise the situation and to regain trust in the bank. Instead of immediate and drastic measures, the issue of NPLs was allowed to falter for months with rumours being spread for massive divestitures and haircut of loans resulting in falling property values and rising non-performing loans. The lingering uncertainty contributed to reduced deposits and increased outflows while the leaks and mixed messages about splitting the BOC into good and bad bank further affected the psychology of the world and the reliability of banks.
What should be done?
We must now proceed without further procrastination but avoid also kneejerk moves. We need strategic planning, imaginative solutions, clarity and immediate and concerted action by all involved. Since the Bank’s management expended its grace period on secondary matters and failed to responsibly manage the destiny of our only remaining systemic bank, the Central Bank and Ministry of Finance must take a more active role. Failure to save the Bank will have severe macroeconomic as well as social consequences.
Real VS strategic NPLs
First of all we need to distinguish between NPLs due to real economic hardship because of the crisis and NPLs for strategic reasons. To terminate strategic non-servicing of loans, which could very well be the great majority, incentives and penalties must be established. An incentive / penalty could be to offer an interest-rate reduction for timely payments.
Genuinely non-performing loans should be separated into housing loans and business / development loans. The mortgage loans should be further divided into those deserving of social assistance based on specific income and asset criteria for social policy. Venture / development should be divided into potentially viable and non-viable based on specific business and economic development policy criteria.
Specify the number of genuinely non-performing housing loans that need and deserve social assistance on such criteria as the primary residence up to a moderate size, unemployment or substantial reduction of earnings of low-pay debtors, the absence of other significant assets, and the servicing of the loan before the crisis. This limited number of debtors should receive assistance from the government (ie. the taxpayer), unless the economic situation of the debtor is expected to improve in the foreseeable future. Helping people in dire need is part of the social policy of the state.
All other mortgage loans not serviced should be restructured with or without the help of the mediator. If the borrower and the bank fail to reach agreement, the property and the loan should be transferred to a Housing Finance Corporation (endowed or guaranteed by the state but independent from it) which would service the loan while the borrower would continue to reside in the house paying rent. If the rent is not enough to cover the interest on the loan, the difference will be added to the principal of the loan to be repaid over time. The debtor would have the right to repurchase the residence after a period of time 10-15 years ) at a predetermined price.
Business and property development loans
Genuinely non-performing loans should be separated into potentially viable and non-viable. A nearly bankrupt economy cannot afford to continue to maintain and support insolvent debtors and non-viable developments. On the other hand an economy seeking to restart growth cannot ignore the existence of potentially viable land developments and enterprises which, if supported to attract investors, would be the quickest way to recovery.
Property values will rise again
Property prices are currently low and likely to fall even lower, but the long-term outlook is bullish. In three to four years property prices are likely to return to the levels before the crisis; this time, not in the form of a new bubble but due to our genuine comparative advantages, including climate and location and the limited supply of land in an attractive Mediterranean island. The exploitation of natural gas deposits and possible settlement of the Cyprus problem would result in further increase in property values. We need a well-planned strategy which will end uncertainty, highlight our real comparative advantages and encourage foreign direct investment in the real economy.