The Escher Effect on the Mortgage Market

As a rule I personally tend to largely steer clear of politics for a several reasons. Firstly, because I am not a politician, it doesn't really matter what I think, if a change is made in parliament there is little I can do about it...

As a rule I personally tend to largely steer clear of politics for a several reasons. Firstly, because I am not a politician, it doesn't really matter what I think, if a change is made in parliament there is little I can do about it as an individual. Secondly, whilst I can hold my own extremely well when it comes to an argument, 99% of time I can't actually be really bothered because of the first point.

After yesterday's budget announcements though, I feel the need to have a bit of rant about the current government's blinkered and misguided view of the housing market and how it works.

George Osborne has announced that he is to pour 250 million pounds into shared equity schemes to assist first-time buyers. The Government's new Firstbuy Direct initiative helps first time home owners buy new properties by providing them with a 20% deposit, 10 per cent from the Government and 10 per cent from the house builder. The individuals will then be required to provide 5% equity themselves.

Whilst I will agree this sounds like a great idea on the face of it, it is not without its problems.

Before I elaborate on the problems, I will make it quite clear that I am not about bashing first-time buyers; the housing market needs them and will not thrive without them - the point of this post is to highlight (what would appear to be) the government's misunderstanding of long term lending and public appeasement.

I don't think many will disagree with the fact that it has, for as long as I care to remember, always been the goal of almost everyone to get on the housing ladder as early as possible in life. The concept is etched in the minds of everyone at an early age in the UK, and as this has become harder to achieve in recent years, the younger generation has started to think it's not fair that houses have become somewhat unaffordable in one's 20's or even 30's.

The housing market has of course evolved over the years, something most assets do over long periods - institutions will find new ways to invest in certain sectors which invariably has a knock-on effect in the main sector.

What has started to happen now though is excessive overlap. The vast majority of houses are bought using debt of some sort, usually a mortgage. Mortgages as we all know are provided primarily by banks. This in itself was fine before the invention/discovery of new mortgage products and the manipulation of terms to aid banking profits.

Basically, banks make a large amount of money arranging mortgages and lending you money. The more they lend, the more they make. Whilst this might not be too much of a surprise to anyone, (after all, business is business!) the fact is that there are no laws dictating how much money a bank can lend on an asset.

Anyone over the age of 35 will remember the days of banks falling over themselves in the boom times to give you a mortgage. So much so it led to the creation of "liar loans" and "NINJAS". The same people will also remember there have been times when it was tough to get a mortgage even with a partner's income on the paperwork.

As the last crash began to kick in, the banks reeled in their risk exposure - tightening the levels of risk they were prepared to take when lending money, in short reducing the amount they would lend you on the value of a property because the market wasn't moving in a positive direction. The result? Uproar from first time buyers being unable to get on the housing ladder.

The few banks that had lent a bit too much (you know, the ones now owned by the taxpayer) were bailed out, and are now at it again whilst they are still government owned.

Now George Osborne has decided that it's a good idea to throw a bunch of government money into the ring to help first time buyers. IF he was giving them the money that would be one thing, but no, it is an extension of the HomeBuy Direct scheme.

In essence, it is government funding to assist people buying a home, and the initial theory behind it is very sound but for all intents and purposes, it is still just another loan that has to be repaid. Oddly, there is no detail on the government site about what the process is if the purchaser defaults, or who has the primary lien on the property.

As I said, this post is not here to bash the FTBs, far from it. If you look at many countries in northern Europe, most people don't buy a house until their 40's and this is regarded as normal - they have enough money for a deposit at that age, despite renting for the entire time prior.

The point of this post is to illustrate what happens when you continue to throw money at something that is failing. I think everyone will agree that house prices at the moment are too high (I appreciate that anyone owning a house and trying to sell wants to get the best price they can - but this is not the point here) and that prices need to be more realistic to at least stimulate the market (although not too much turning it into the buying frenzy of pre 2008)
With government schemes making it easier for people to buy at the current price levels, and more banks beginning to offer more and higher LTV mortgages, all that is happening is the market is being artificially kept high and stagnant because of pseudo money, hence the "Escher Effect"

The Escher Effect on Mortgages

Something, somewhere, has to give - this, unfortunately is where it gets a bit tough.

  • If loose lending continues, prices will never come down, and sooner or later the pseudo money will run out (unless of course the UK invents something exportable at a vast profit next week that cannot be found or copied anywhere else in the World)
  • If more money is printed to make the pseudo money go further - it will buy some time, but just extend the problem for longer, and mean there is more to pay back at a later date, making the whole thing turn into a lifetime epic.

One possible solution which I believe becomes more attractive as growth continues to decline, and as inflation finally begins to increase is as follows.

  • Regulate the banks on lending at a government level. Look at Northern Rock - government owned, and yet it's allowed to wheel out 90% mortgages again! Restrict lending from any entity to 75% or even 70% LTV across the board - at least for 12 months.
  • Use subsidies to reduce rental costs meanwhile - and encourage saving. By doing this it means those entering the "I need to buy a house" phase of their life will actually stand a chance of having a deposit to do so.

Whilst my solutions might seem a little rash initially, the banks have proven they cannot be responsible when it comes to lending. If lending were to be properly regulated for at least a couple of years, it will at least prevent first time buyers digging themselves into a bottomless pit of negative equity and get the housing market back on its feet in a couple of years.


- Thursday 24 March 2011

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