Hungary’s government just passed an ill-conceived plan to help households saddled with foreign currency debt on September 9. Disturbingly, more than two-thirds of lawmakers (277) voted in favour. This follows in the wake of an earlier plan announced in May (See: Hungary Mortgage Relief: Another Move to Delay the Pain).
While the earlier proposal from May had some flaws, the bill just passed is downright reckless. It will do nothing to help the economy. It won’t even provide relief to the indebted households that really need it. The government appears to have hatched this plan with little consultation or warning, marking the latest in a string of erratic policy moves. Below I detail the bill and some of its many problems.
What is the Latest Mortgage Relief Plan?
According to the bill, Hungarians will be able to repay their fx-denominated mortgages in one go, at well below market exchange rates. However, they must do so by the end of this year. Banks will become the fall guys, getting hit with the exchange rate difference.
Figure 1: Roughly 65% of the mortgage loans outstanding are foreign currency-denominated, mostly in Swiss francs
Source: MNB (National Bank of Hungary)
As seen in Figure 1, the majority of outstanding mortgage debt is denominated in Swiss francs. Under the plan, households who borrowed in Swiss francs will be able to repay their mortgages early, in one lump sum, at a preferential rate of 180 forints per CHF. Meanwhile, euro borrowers will get the same deal, but with the exchange rate fixed at 250 forints per €. As seen in Figure 2, these exchange rates are well below current market rates.
Figure 2: Exchange rates in the bill are far below market rates
Before I delve into the multitude of flaws in this mortgage relief bill, I want to make a few things clear. First, I am not an unyielding advocate of banks. If anything, I’m quite the opposite. Banks in Hungary lent heavily in foreign currencies to households earning in forint. This was clearly unwise (aka downright stupid), but everyone seemed to ignore the flashing warning lights and there’s plenty of blame to go around. Banks, as well as households, should have known better. Meanwhile, the regulators proved to be asleep at the wheel.
Hungary now finds itself in an FX debt mess. Debt levels in local currency terms have ballooned as a result of the forint’s depreciation against the franc, which is constraining consumer spending. As households struggle to repay their loans, the number of defaults is on the rise, constraining banks’ ability and willingness to extend credit, which in turn further weighs on the growth outlook. (See: Hungary’s Vicious Circle: Anemic Lending and Weak Growth)
However, this bill addresses none of these problems and manages to create new ones.
Problems with the Bill
- Unlikely to Help Borrowers Most in Need
The most glaring problem with this mortgage relief bill is that the borrowers most likely to take advantage of it are those who least need help to repay their loans. As I noted above, only those who can repay their mortgages in one lump sum by year-end 2011 qualify.
Those who are more than 30 days in arrears with debt repayments (eg. those who are struggling the most) would be disqualified, according to Portfolio.hu. Basically, anyone unable to beg, borrow or steal the money would be left in the lurch. Some may be able to borrow in forints to repay their fx-denominated debt, but again, those most likely to get such loans would be those less in need of debt relief. According to news reports, the Economy Ministry only expects 10% of borrowers to participate in the programme.
- Risk to Financial Stability
As economic research firm GKI notes, good debtors will likely take advantage of the plan to repay their loans at preferential exchange rates. This will reduce the outstanding stock of mortgage loans. Meanwhile, the rest will struggle. As economists at CIB note (via Bloomberg), the struggling households could actually emerge worse off due to the weakening of the forint, which will increase their debt burden in local currency terms. As a result, bad loans (as a percentage of the total) will likely rise. This will likely dampen lending and undermine the already stunted economic recovery.
More directly, the bill forces banks to swallow the losses from fixing the exchange rate at below market rates. This will trigger serious bank losses, the size of which hinges on the number of borrowers who participate in the plan. These losses will further constrain lending and could result in financial instability if banks fail (or come close to failing) as a result.
- Potentially Big Fiscal Costs
The bill runs the risk of deteriorating public finances in at least two ways. First, there is a good chance that the European Court of Justice will rule that the plan is illegal. According to portfolio.hu, the Justice Ministry believes Hungary may have to compensate banks for any incurred losses. This would add to Hungary’s already substantial public debt burden, which topped 80% of GDP at end-2010.
Second, Hungary’s sovereign credit rating is teetering on the edge of ‘junk’ status. All three major rating agencies rate Hungary at the lowest level still considered investment grade. S&P and Moody’s have Hungary on negative outlook, making a downgrade more likely than an upgrade in the near-term. Analysts at S&P have already expressed concern about the effects of this bill. If Hungary is downgraded to ‘junk’, it could be disastrous given the country’s hefty debt burden as it would likely trigger a big jump in borrowing costs, making it harder for the government to sustainably meet its debt service obligations.
- Underscores Erratic Government Policy
Investors are starting to realise just how unpredictable the current Fidesz administration can be. Since coming to office in April 2010, the government has engaged in a private pension fund grab (see here) in addition to implementing temporary ‘crisis’ taxes on the banking, energy, retail, and telecom sectors (see here). These policies were implemented with little to no consultation or warning.
This bill fits with the government’s typical modus operandi as it was unexpected and launched with little advance warning. All of this makes for a very erratic policy environment that is starting to spook investors. Notably, balance of payments data showed a net outflow of direct investment in Q1 2011, even before this plan’s announcement.
The Fidesz government may find this plan politically beneficially, at least initially, since it makes the government look like it’s standing up to the banks in the defense of debt-laden households. However, this mortgage relief proposal offers few, if any, positives for struggling households, the beleaguered economy, or the health of the banking sector.
The households that are struggling will continue to have difficulty repaying their foreign currency-denominated debt (and could experience even more difficulty if the forint continues to weaken). The losses banks suffer as a result of the exchange rate fix could endanger financial stability. Lending is already stagnant, and this bill will further dampen banks’ ability and willingness to lend, which will constrain already slowing economic growth. Meanwhile, investors – concerned by the government’s erratic policy moves – are likely to direct their funds elsewhere. Overall, this bill is a lose-lose proposition.