How policy encourages the banks to fleece us

Yesterday’s El País carried what to me was an extraordinary story about repossessions of Spanish homes. The recession has seen the number of repossessions in Spain rising to 100,000 per year, but far from suffering for making dumb loans, the country’s mortgage laws allow banks to profit from their clients’ failure to pay.

Repossession policy dictates that if a propert has to be handed over to a bank because its owner cannot keep up with mortgage payments, the bank must endeavour to sell it at auction, and use the proceeds to reduce the amount owed. In the current, stagnant environment, however, nobody is buying, even at repossession auctions, and much of what is on offer goes unsold. Such an eventuality does not perturb the banks, however – indeed, they are probably delighted not to sell – for in the event that a property fails to attract a buyer at auction, the bank gets to keep it for 50% of what it is adjudged to be worth.

Let us say, therefore, that someone has taken out a €100,000 mortgage on a house which at the time the bank judged to be worth €100,000 (many banks, of course, made 100% loans during the boom), and that after paying, say, €10,000 plus interest of that loan the debtor loses his job – not uncommon in a country with 23% unemployment – and can no longer make his monthly payments. The debtor now owes €90,000. The bank tries to sell the house at auction, with a reserve of €75,000 (the Bank of Spain says official house prices have fallen 17%, and the bank knocks off a bit extra to make it look like it is keen to sell). Nobody is interested. The house goes unsold. The bank acquires the house for €41,500 (50% of the official value of €83,000), and the debtor, who is now homeless and jobless, still owes it €48,500, plus interest.

It won’t have escaped your notice that this is a remarkably good deal for the bank. First, it received €10,000 plus plenty of interest – let’s estimate a further €10,000 – from the hapless debtor before he lost his job. Second, it is still owed nearly €50,000 plus interest. And third, it has acquired a house worth perhaps €60,000 (if we ignore the overoptimistic official figures) for just over $40,000. Even if the debtor now does the sensible thing and tells the bank where it can put the rest of the debt, therefore, the bank will have lost just 20% of the loan. Most debtors, however, will not be so bold, and will attempt to pay back the rest of the loan for fear of losing their hard-won creditworthiness. In the latter cases, the bank will have made a profit on the original €100,000 loan of €20,000 plus several additional tens of thousands in interest, so unless significantly more than half of debtors tell the bank where to go it cannot lose on these deals.

Of course, the above example is theoretical and the actual figures are likely to vary somewhat – the bank might sell the house for €70,000, adding another ten grand to its haul, and there are costs of selling to account for too. But unless I have miscalculated it does not seem too far-fetched. Under the current policy, banks benefit by making bad loans. Since most people will try to pay back the loan even though they no longer own their property, banks can easily withstand a few bad debtors, and it is not surprising in an industry where profit rules that their vetting policy is less than rigorous. A couple of commentators in the El País article recommend raising the 50% of the value at which the bank acquires the property to 70% – this would seem a bare minimum to avoid the moral hazard created by the current law. The protesters in the 15-M movement rightly blame the banks for causing the housing crisis, but where policy puts them in a no-lose situation it is inevitable that many will take advantage.