Why we should beware cheaper mortgages

By Felix Salmon
September 8, 2009
Dominic Lawson (I was named after his grandfather, Felix Salmon) has a column saying that cutting bankers' bonuses would do more harm than good. He might be right, but his argument is a little bit odd:

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My distant cousin Dominic Lawson (I was named after his grandfather, Felix Salmon) has a column saying that cutting bankers’ bonuses would do more harm than good. He might be right, but his argument is a little bit odd:

When people get a cheaper mortgage because some financial whiz-kid on the trading floor did some clever forward buying in the currency markets, they don’t feel any particular sense of gratitude to the bank. Even in the good times, politicians are not likely to be misjudging the public mood if they propose to do something a bit nasty to bankers…

If a Treasury minister tells a Today programme interviewer that “we are imposing greater capital requirements on super-senior tranches of securitised mortgage obligations”, it is unlikely to resonate with the bleary 7am listener wanting to hear the noise of a banker having his head rammed hard into a wall.

The problem here is that never in the history of finance has a bank reduced its mortgage rates because it made lots of money in the currency forwards market. Banks aren’t charitable institutions which cross-subsidize their consumer-facing products from profits elsewhere: to the contrary, they will constantly attempt to maximize their profits in every business.

On the other hand, it was commonplace for people to get cheaper mortgages because banks had stupidly low capital requirements on super-senior tranches of securitised mortgage obligations. Thanks to those stupidly low capital requirements, banks could sell off “all” the risk associated with the bonds they originated, and keep billions of dollars of leftovers for themselves, without having to hold much if any capital against them. Since banks love to think of themselves as being in the business of buying and selling risk assets, they were happy to originate low-interest mortgages just so long as they could flip them for an immediate profit.

In other words, it’s systemically-devastating things like badly-structured regulatory structures and capital requirements which are likely to bring down mortgage costs and otherwise directly benefit the public. Large bonuses for traders, by contrast, will not benefit the public at all — they just benefit the traders in question.

More generally, anything which contributes towards people getting a cheaper mortgage is equally likely to contribute towards a housing bubble. Sometimes it’s very hard to tell whether a certain financial product is good for consumers or not.

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Comments
4 comments so far

> Large bonuses for traders, by contrast, will not benefit the public at all — they just benefit the traders in question.

no, they also benefit the traders’ wives and mistresses.

Posted by q | Report as abusive

cheaper mortgages will not necessarily lead to a housing bubble. The last bubble didn’t happen because mortgages were cheap, it was more because anybody could get one, even if they had no chance of paying them back. If all of those 2% intro rate mortgages were only made to people who put 20% down and could afford the payments when interest rates went to 5%, the bubble never would have happened.

Posted by KenG | Report as abusive

@KenG
– Not entirely true.
If mortgages suddenly became far cheaper, then of course house prices will rise since the supply of housing hasn\’t changed but the means to pay for it (I can afford £X interest per month = Y mortgage) has gone UP!

The \”bubble\” here is that if the interest rate is unsustainably low then eventually the reverse will happen when the inevitable rise in rates occurs.

Of course, easy access to credit pushed prices even higher but BOTH factors contributed to the bubble.

Posted by Tiny Tim | Report as abusive

> never in the history of finance has a bank reduced its mortgage rates because it made lots of money in the currency forwards market.

If currency forwards and mortgages can share a bank’s fixed resources, then raising the profitability of currency forwards will both lower the costs of being in mortgages and will increase the competitiveness of that market.

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