Confronting the Bahamian debt crisis pt. 1
By Arinthia S. Komolafe
In the aftermath of the worst recession since the Great Depression, the government is challenged with reduced revenues, soaring energy and food prices, high unemployment, rising crime levels and social ills. In response to these challenges and in order to stay afloat, the government has resorted to borrowing. The reality is that imprudent borrowing practices prior to and during the economic downtown have exacerbated the economic soundness of our government.
The story of the sub-prime mortgage crisis and the lessons learned are well documented. However, four years after the ‘Great Recession’ commenced, the Bahamian economy continues to struggle. It was reported that the Bahamian banking system was resilient to the crisis and to some extent the economic downturn because of our credit policies as administered by the Central Bank of The Bahamas (CBB). However, was this assertion truth or fallacy? One wonders if based upon the facts and looking back in hindsight whether the current mortgage and ultimately debt crisis was an accident waiting to happen. Could it be that the economic downturn exposed flaws in our monetary policy and credit risk management framework?
A journey down memory lane and history, will show that the CBB in August 2004 in an attempt to ensure that credit expansion was consistent with economic growth, advised banks to monitor borrowers’ creditworthiness by limiting the debt service ratio (DSR) on loans to a range of 40 percent to 45 percent of ordinary income and require a minimum of 15 percent equity contribution on all personal loans with exceptions to those secured with mortgage indemnity insurance. A short one month later, the CBB temporarily relaxed those policies by eliminating the 15 percent equity requirement and raised the DSR threshold to 55 percent. It is noteworthy to state that the reason given for this change was to aid in relief due to the effects of Hurricane Frances. It is unclear, however, how many banks took advantage of this flexibility, the immediate impact on the economy and how long these policies actually remained in effect.
However, some four months later, the CBB reduced its discount rate (DR) from 5.75 percent to 5.25 percent and the prime rate (PR) was consequently reduced by 50 basis points to 5.5 percent. It is imperative that we examine the aforementioned policy decisions made by the CBB in the context of the Bahamian economy which is primarily consumer driven.
In the absence of an established credit bureau, it is difficult to assess the creditworthiness of Bahamian consumers and almost impossible to assess whether a consumer’s DSR truly falls within the 40 percent to 45 percent range. Taking a conservative hypothetical approach (and I must emphasize that this may be extremely conservative) and assuming that a majority of consumers had a ‘real’ maximum DSR of 55 percent as opposed to the required maximum 45 percent, it follows that an increase of the DSR to 55 percent would increase the ‘real’ DSR to 65 percent, leaving the consumer with an ultimate disposable income rate of only 35 percent.
In addition to the scenario painted above, a decrease in the DR and PR all things being equal, should further encourage borrowing and expand credit. This brings into question whether the objective of ensuring that credit expansion was consistent with economic growth was achieved. In 2004, with the CBB’s policy to restrict credit expansion, the amount of mortgages for new construction of single dwelling homes stood at a mere 894. To highlight the effect the aforementioned policy change had on the mortgage market, in 2005 and 2006 government revenue on stamp tax for mortgages almost doubled in 2005 compared to 2004 and increased significantly in 2006.
Further, residential mortgages for new construction of single dwelling homes stood at 1,428 and 1,137 in 2005 and 2006 respectively. The total processed value amounted to approximately $300 million for these years. It is uncertain how many persons painted a true picture of their DSR and the real question is whether the majority of persons who obtained mortgages during this period should have actually qualified for those mortgages. This is bearing in mind that as at December 31, 2011 mortgage delinquencies stood at approximately $650 million.
Mortgage sector and housing market in crisis
Today with unemployment at its highest in years and individuals on reduced pay, it seems fair to state that the mortgage sector and housing market are in a crisis. It is not surprising that many Bahamians have defaulted on their mortgage obligations with mortgage delinquencies standing at approximately $650 million in arrears for the entire Bahamas. In order to appreciate the extent of this debacle, a look in the newspapers will reveal a fraction of the number of foreclosed properties advertised for sale. It has been argued that the reduction of the DR and PR by 75 basis points in June 2011, although welcomed came too late and that the reduction was inadequate.
The government is being called upon to provide mortgage assistance for those who are losing their homes. Proponents of this relief effort cite the millions of dollars expended on capital infrastructure by the government in justifying this move as the right action required. They submit that if the government could spend such exorbitant amounts on infrastructure and the purchase of shares, it is only fair that the government would provide relief to struggling homeowners. Opponents of any form of mortgage relief efforts by the government argue that in a capitalistic society, the government should not interfere with private enterprise. After all, opponents submit the free market economy is designed to have minimal government intervention and market forces must be left to control the market.
In the final analysis, there is enough blame to go around; starting with the government, the lending institutions and the consumer. In the years leading up to the financial and economic downturn, the government benefitted from the credit expansion as a result of monetary policy in the form of increased stamp tax revenue, the lending institutions turned over record profits and consumers benefitted from unprecedented access to credit facilities.
It is only fitting, therefore, that the aforementioned benefactors should come together to bring resolution to this crisis. In order to avoid further deepening of this crisis, the government on its part, should explore establishing a fund to assist eligible homeowners in retaining their homes. Adjustments to the DR and PR by the CBB should be stalled until a credit bureau and robust consumer protection agency as a matter of urgency have been established. The lending institutions should take significant steps to refinance mortgages on more favorable terms for consumers and more importantly consumers should exercise increased prudence in the management of their finances.
•Arinthia S. Komolafe is an attorney-at-law. Comments can be directed at: email@example.com