The phrase “vulture fund” is very evocative, conjuring as it does the image of that much-maligned carrion bird of the African continent, picking over the corpse of some unfortunate animal. Vultures do not (generally) earn their keep by hunting and capturing their own prey – their entire life cycle is enabled by the misfortune of others. Somebody has to die, so that the vultures might live.
When you apply that term to financial institutions, as critics of these funds do, you are deliberately conjuring up a particular image of greedy financiers who are profiting from the misery of somebody else. As Theo McDonald writes this morning, those “somebodies else” are usually distressed mortgage holders, who suddenly find their mortgages owned by such funds, and typically find themselves paying higher interest rates than they would with a traditional commercial bank.
That this annoys and upsets people is natural, especially when those who are shareholders in the “vulture funds” are clearly profiting from the mortgage distress of Irish homeowners. There is an instinct – again natural – that makes people want to say “this should be banned”.
The problem with people who make such a case, however, is that they are rarely able to identify an alternative solution to the problem, or even to specify openly what the problem is. So let’s start from there.
The problem which gives rise to “vulture funds” is that some people cannot, could not, or (in more cases than we admit) will not or would not pay their mortgages. This is why those mortgages became “distressed” in the first place: People borrowed money and were either incapable or unwilling to repay it. The banks that owned those mortgages therefore had underperforming or non-performing assets.
But there’s also another problem, which is that a homeowner who does not repay their loans becomes a poor credit prospect. People are less willing to lend to poor credit prospects at low interest rates. It is a risk, obviously, to advance money to somebody who has previously not repaid their loans. That risk must be priced in. Hence, the interest rates offered to such homeowners tend to be higher.
In a normal situation with no vulture funds, when a person is unable or unwilling to repay their mortgage, the practice is for the bank to repossess the home and sell it on the open market, thus recouping their costs. The downside to this is that the process of repossession and sale makes the homeowner or borrower homeless – a solution that we would all surely prefer to avoid if it were to happen on a large scale. Ireland in particular has a historic aversion to “evictions”, even when those evictions happen because a loan is not being repaid.
Further, somebody evicted from their home in such circumstances is unlikely to get another mortgage to buy another home for a long time. It’s a bad situation all around.
A “vulture fund” provides a solution to this problem for all parties. They will buy the loans (often at a steep discount) from the banks. So, for example, they might pay €100,000 to acquire a mortgage with €200,000 of outstanding debt. The bank gets more money than it otherwise would for an underperforming asset, and the vulture fund acquires a potential profit. Meanwhile, the borrower usually gets to stay in their home. Because the vulture fund has acquired their mortgage for less than it was worth, they may also get a write-off of a portion of their debt, or an extension of the life of their loan, to make the loan more repayable.
In return, however, they must pay a higher interest rate than they would were they still with a commercial bank. They must pay a higher interest rate because they are higher-risk borrowers, and the vulture fund has acquired (usually by borrowing) money that it essentially uses to keep them in their homes.
This last point is the central issue that opponents of vulture funds almost never address: That the people who are the “victims” of such funds are in fact high-risk borrowers who have in many cases defaulted on their loans. Their debts are not theoretical: They borrowed money, and if they cannot repay it, somebody must take that loss.
So who should that somebody be?
The market has provided a solution, which is vulture funds. The state, by contrast, has provided no solution, presumably because all of the state funded solutions would be unpopular and constitute moral hazard.
For example, the state could decide to subsidise mortgage lending to high-risk individuals. This is what the United States did for years through its two state-owned lenders, Fannie Mae and Freddie Mac. The result was an orgy of high-risk, low-reward lending that provoked the 2008 banking crash and all the misery that followed.
But even if this was limited in scope – let us imagine that the state simply stepped in to help people currently with mortgages owned by vulture funds – the moral hazard would be real. The state would essentially be taking money from people who did pay their mortgages and giving it to people who did not. We would be transferring a loss on those mortgages from the banks to Irish taxpayers, many of whom don’t even have a home of their own.
Another thing the state could do would be to regulate: For example it could try to cap the interest rates charged by vulture funds. But this would simply collapse the entire business model of those funds, since there would and could be no accompanying cap on the cost of their own borrowing. If a vulture fund is borrowing money at 5% interest rates to acquire distressed mortgages where their interest rates are capped at 4%, then the vulture fund has no reason to exist as it would simply lose money. The market is providing money to these funds solely because they can make a return on it. If you take that return away, the market has no reason to be involved. The financial markets are not a charity.
So if not the vulture funds, then who? It is a basic question, yet one that opponents of such funds rarely answer in any detail.
The bottom line is this: Somebody has to pay for the fact that these people did not, could not, or would not pay their mortgages. Unpleasant as vulture funds might be, the cost of that problem is currently borne by the funds, the banks, and the distressed mortgage holders.
Any solution to this “problem” necessarily involves transferring the costs of that problem to somebody else, and with the very real risk of sending a message in the process that paying one’s mortgage is optional and that the state will save you if you somehow stop doing so.
There is a reason, in short, that Theo’s article, fine though it is, is so long on problems and so short by comparison on proposed solutions. Indeed, he ends with a generic plea that the Government should “clip the wings” of these funds.
What else does he suggest? Well, essentially what I set out above: He wants to go after the profitability of the funds by making them pay more tax. Fine at an emotional level, but in practice this will either mean that the costs are passed onto the homeowner (as all businesses do) or that the funds will simply leave, leaving us with the original problem. He also suggests some legal amendments to make it easier for distressed mortgage holders to extend the term of their loans, or get more forbearance when failing to make repayments. The problem here, again, is moral hazard: Many of these people have already managed to stay in their homes despite their inability or unwillingness to pay. At what point do you not just say “fine, you bought a house you can’t pay for, hand it over?”
The final point in Theo’s article that I’d address is the one that has always bothered me the most: The legal chicanery route of suggesting that people can stay in their homes without repaying loans because Vulture funds don’t have the correct legal title to the properties, which remains with the banks. There are some eminent lawyers (he quotes them) who agree that this kind of approach might conceivably be legally feasible. The problem? It’s entirely immoral. If you borrow money, you should pay it back. And if you cannot pay it back (and I speak from experience here) you should be prepared to negotiate and also face the consequences of that.
Vulture funds provide people with one route out of the mess they find themselves in. We do not have to like them to acknowledge that they are much better than some of the alternatives.