If the government wants more mortgages it has to love the banks.

Can the government rescue the mortgage market? This question is being asked today by the government’s own adviser, as if the mortgage market can be sorted out in some kind of a vacuum, detached from the rest of the banking sector.

I can understand that the government wants to stabilise house prices, and fancies that making more mortgage finance available might do that. It is proof that not even the government believes its theory that the rate of new housebuilding determines house prices, for if it did believe that it would be delighted that not many houses will be built this year, and would be urging the cancellation of even more new build projects to stop the price fall.

Meanwhile over at the Bank of England they are less concerned that house prices are going down than that the prices of energy, food and other essentials are going up. They could take action to make more mortgage money available, by cutting interest rates to stimulate mortgage demand, but they fear that might lead to more money being borrowed to push up the prices of other things. The FSA could help stimulate the supply of mortgages by relaxing their requirements for the amount of capital a bank needs to sustain any given level of lending, but that too is unfashionable just after a period when banks lent too much without the capital backing the Regulator now thinks they need.

There is no evidence of any “joined up” thinking between government, Bank. FSA and the banking sector about what to do. The Bank and Treasury have lurched away from their view of last summer that banks had to sort themselves out, and it served them right if they had to rein back. They have not arrived at a new consensus on how loose or tight they now want monetary policy to be. There are some home truths the government needs to grasp before it makes more foolish statements about the mortgage market:

1. The mortgage market cannot be detached from other types of lending to people and companies. Many mortgages are advanced by banks who also lend for other purposes. Their ability to lend overall is constrained by the amount of capital they have and by the Regulators’ rules on how much capital they need to have for any level of lending. If the government wishes to solve the mortgage famine it needs to solve the banking problem generally.
2. House prices are still high relative to incomes , following a period of massive credit expansion which the Treasury and Bank together encouraged by their low interest rate easy money policies of 2001-6. This was also fuelled by the Regulators effectively encouraging off balance sheet ways of financing mortgages. On the government’s analysis and view that houses are not “affordable” it might prove necessary for there to be a sharp fall in house prices before the market starts to function as the government wishes, as people are being squeezed generally so they cannot afford to trade up or to buy a first home at current prices.
3. Keeping interest rates up also prevents housing recovery. Banks look at how easy it is for someone to afford a mortgage on their income. A mortgage at 8% is twice as dear as one at 4%, and so is ruled out for many people on modest incomes.
4. The nationalised Northern Rock is damaging the mortgage market, as a major lender is unable to increase its mortgage book – indeed it is having to run it down to repay government borrowings, and cannot compete strongly owing to Competition rules over state aids. Selling that bank on would help the market.
5. The government needs to accept that it cannot keep house prices up, stimulate more mortgage lending, cut inflation and place a windfall tax on the banks all at the same time. These different aims pull in different directions. Its first moves have to be to encourage the recapitalisation of the banks so they have the balance sheet strength to lend more – the government itself needs to concentrate on finding a solution to Northern Rock, so that bank can lend more. Windfall taxes are incompatible with this aim. In the meantime it has to accept that houses prices on most forecasts will fall more this year and next. The sooner they do so, the sooner homes will appear more affordable. The authorities could cut interest rates to lessen the extent of the fall needed to price people back into mortgages and homes.

Current policy is incoherent. Interest rate policy is encouraging house price falls. Banking regulation is restraining new advances after a long period of allowing lending growth. Housebuilding and planning policy is trying to encourage further price falls. Attacking banks for being too careless in their lending as the Chancellor did last year encourages a more restrictive attitude towards lending.

What do the government want? Perhaps they should decide that first, then they have to bend every policy instrument to that aim. They never did answer my question about how far they think house prices need to fall to be “affordable”, yet they have gone on about how they are not affordable. Muddle over that is at the heart of their problem.


  1. crown
    July 29, 2008

    10 years ago a borrower needed at least a 5% deposit, proof of their income and proof of repayment method. The borrowing limit was 2.5 times joint income. A 2 year fixed rate was 6.5% with a booking fee of £299

    Today a borrower needs a 10% deposit, proof of their income and proof of repayment method. The borrowing allowed is 4.25 joint income. A 2 year fixed rate is 6.2% with a fee of £599.

    So over the 10 years a larger deposit is now needed, although you can still borrow more historically and at a lower rate than 10 years ago.

    So why the fuss?

    Because under Gordon Brown's watch the lenders changed their lending criteria to

    A borrower needing no deposit, no proof of their income, no proof of their repayment method, 6 times joint income on a 2 year fixed rate of 4% with a £149 booking fee.

  2. Iain
    July 29, 2008

    The mortgage rescue plan by Sir James Crosby sounds like a Fannie mae or Freddie mac solution where the state ends up as a guarantor to private bank lending, which has to be a bad idea.

    But as to the mortgage market the problems here are structural to our economy, where we have too few savings, too much consumption, and too much debt ( public and private ), essentially we have an economy that is built on tick, borrowing other peoples money to buy their goods which is under written by a bubble asset market these funds have helped inflate. It was always going to end in tears for eventually the countries lending us the money were going to see us as a bad credit risk with the result the funds would dry up, as they did.

    So either the state steps into the funding gap to keep the bubble asset economy afloat, which would eventually bankrupt the country, or we have to learn to do things differently, like learn the art of saving money, and start making some of the goods we so voraciously consume, for if we don't we are destined to relive the same bubble asset economy time and time again, but every time we do it we slip that little further down the wealth league, and find we have fewer national assets to flog off to pay the bills.

  3. Ken
    July 29, 2008

    I agree. I think the first thing that the government needs to do, is to ensure the stability of the financial system. There has been some clearing of the lines of responsibility between the tripartite regulatory system, but I predict further infighting when the next crisis occurs. By their very nature banking crises are problems of political economy, not purely economic in nature. The ability of the government, the FSA and the BoE to blame each other and squabble over who should take action (no one actually wants to be the one taking the action). The pathetic and late response to NR and the continued dithering over the deposit insurance are both examples of poor planning and poor execution on the part of the government. I worry that our next crisis will come from a crisis at one of the overseas banks offering UK deposits sometime early next year. Each moment of incompetence undermines the credibility of the banking system and the regulators. Until this area is competently handled liquidity will not return to global credit markets and especially to the interbank markets. At the moment, the emergency measures put in by the various central banks papers over the problem, but it doesnt resolve it*.

    1.) Windfall taxes – no way. Deposit insurance – yes a levy would be sensible. Hike guarantee to £100K and lend the deposit insurance corp money from the government in the short term.
    2.) Stabilise banking system, enforce the capital rules rigorously. Strengthen oversight, lines of responsibility and try to reach agreement before the next crisis between the different regulatory parties.
    3.) Forget about house prices, the market will clear at some point and a necessary, but not sufficient condition is that the banking system is sound and thus able to make loans.
    4.) The economic situation is insufficiently dire to require the BoE to subordinate the inflation fighting for economic growth. At best a moderate cut in the base rate, perhaps even a hike.

    * A further stage of the crisis will come if a bank is totally shut out of interbank markets and appears insolvent if they borrow such a large amount from a central bank that the haircut on their collateral is more than the bank's capital. Will the central bank keep lending to them? Should they?

  4. Tim
    July 29, 2008

    As the fundamental problem with the housing market is that it is currently in paralysis and banks need more capital to free up their lending.

    Why not look at allowing pension funds to hold residential property as an investment class, but with strict rules on the level of gearing required.

    This would provide a steady flow of new capital in the property market helping to avoid the correction in property prices going to low. It would encourage savings into pensions helping to adjust the structual imbalance in savings. As the lending to a pension fund would be at a lower level of gearing ( Loan to value) it would free up bank's capital. And pension funds would make better long term landlords as they are generally better capitalised than heavily geared buy to let investors.

    Institutional pension funds own large portfolio's of residential property on the continent.

    1. Ken
      July 29, 2008

      Pension funds already can invest in property, although they prefer to invest in large commercial deals. Pension funds do not want to deal with portfolios of small residential properties, but I do not know of any restrictions on their ability to do so.

      1. Acorn
        July 30, 2008

        Ken and fellow Redwoodians. Can I just inject a Radio 4 type "Thought for the Day". I am not sure that, as a pensioner, I want my pension funds in the residential mortgage business.

        Redwoodians who are BBC World Service fans, (the WS is the best thing the BBC does), may have been following this. I don't think the UK has the equivalent of the "non-recourse loan" concept on our mortgages; or, can consider a UK mortgage as a "Call Option". Never-the-less, the impact of just "Walking Away" in the US, could / will have an impact on a bank near you.

        Now that those of us, of a certain age, are trying to remember the lyrics to Just Walk Away Renee [Four Tops], click on.

        And then,

        1. Ken
          July 30, 2008

          Dear Acorn

          The bad news is that pension funds are heavily involved in the residential mortgage business. This will be through the ownership of shares in UK (and global) banks, whose travails of late are mainly from residential mortgages in the US. The UK banks will suffer as house prices fall. Pension funds will also have some peripheral investments in hedge funds that invested in mortgages and their derivative products.
          Many people have invested their pension money in Buy-to-let. Caveat emptor.

  5. mikestallard
    July 29, 2008

    This analysis of the problems besetting the government is, I am convinced, the right way forward. Well said!
    Did you see Polly Toynbee on Newsnight last night? Talk about despair! This government is not going to do anything at all. Gordon Brown cannot even delegate his powers to Harriet Harman when he goes away. As Boris Johnson (who was so right about Mr Blair) says in today's Telegraph: we can look forward to more and more quarrelling; more and more journalese about who is going to plunge the knife. This will last until the next election in a few years' time.

    I am in our family home for free, so I can speak freely. Are falling house prices a bad thing? If so, please explain why exactly. In a perfect world, wouldn't people put their money into doing something useful? For instance, they could invest in industrial/agricultural development of backward countries, industry or making money on the stock exchange instead of locking it up in a house spiral?
    And what about the poor? How can they afford these prices? So where do they live, please?

  6. William B.
    July 30, 2008

    In relation to mortgage lending we seem to be in the same position as in 1989-1990.

    Then far too much was lent on far too flimsy security to people without the means to repay. The influx of new home loan companies into the market caused cutthroat lending in which the lenders (not all of them banks in the conventional sense) were left exposed to a downturn in the economy through their own imprudence. The 100% mortgage with no need to prove income was not uncommon and the capital was to be repaid by an endowment policy. Along came the downturn, the borrower lost his job, it was too soon for the endowment to have any value, the lender repossessed and made a huge loss in a falling market.

    Even in a stable or mildly rising market, if you lend at 100% LTV the mere facts of repossession and forced sale are enough to almost guarantee a loss. A repossessed property sold at auction commands a wholesale price not a retail price and one sold through estate agents often realises a lower net price after taking into account (i) the time it takes to sell (during which time the capital of the loan is being financed by the lender), (ii) agents' commission and (iii) the weak bargaining position of the vendor. Of course lenders insure themselves (at the borrower's expense) for at least part of this loss but it is not often that such insurance is sufficient in a falling market.

    That type of lending helped inflate the house price bubble during the 1980s and exactly the same has happened over the last 10 years. The banks might claim they were responding to demand by offering products their customers wanted but it takes only a moment's thought to realise that lending to the impecunious on the security of a property with no equity gives the lender negative security. When there is a downturn and repossessed properties hit the market they accelerate market price falls because they add stock into the supply chain at a discounted price.

    There is, in my view, a pressing need for first charges over residential property to be limited to 75% of the property's value at the time the loan is made. Any further secured lending will then be seen for what it is – speculative lending subject to a risk of insufficient or no security.

    If the lenders are not prepared to protect themselves in this way there can be no reason to call on the taxpayer to dig them out of the negative-equity hole. More importantly, limiting the amount that can be borrowed against a first charge will reduce the risk of people borrowing beyond their means. It will depress the housing market, perhaps for many years, but only until the current bubble has been deflated.

    The problem of people on modest incomes not being able to get on the housing ladder is a serious problem. But it is not solved by lending them money they cannot afford to repay in order to buy a house or flat which is overpriced.

    Existing homeowners will face a substantial capital loss as house prices fall to a real market level but all we will lose is air from the bubble.

    In the long term it will benefit everyone to have a true market rather than one skewed by reckless lending. Those who will benefit most will be those hit hardest at present, the hard working people of modest means.

    My only political obsession is for economic policy which allows hard working people doing "ordinary" jobs to benefit fully from their labours. I want them to have every opportunity to own their own homes so that they and their children have security for the future and are not beholden to anyone (particularly the State). I have read many calls in comments on this and other blogs for the income tax threshold to be raised to £10,000 or more and I support those calls but they must be part of a package and strict controls over mortgage lending should be in the package. It will be of greatest benefit to those who most deserve to benefit from their honesty and industry.

    1. mikestallard
      July 30, 2008

      I must come back on this. With the benefit of hindsight, it seems quite outrageous that a tax loving Labour government could not have deflated the housing bubble. If they had done so – instead of actually inflating it – then maybe ordinary working people might have had a chance of buying a property at proper rates of interest.

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