UK unleashes the dogs of subprime: James Saft
March 20 (Reuters) – Cry ‘Bubble!’ and let slip the dogs of
Britain on Wednesday unveiled a new budget including 130
billion pounds of mortgage guarantees which will enable patsies,
er, hardworking home-buyers, to buy properties worth as much as
600,000 pounds ($900,000) with as little as 5 percent down.
And no, thank you for asking, Chancellor of the Exchequer
George Osborne did not just wake up after six years in a
medically induced coma.
A smaller 3.5 billion pound program features a direct loan
of 20 percent of the purchase prices for newly built houses, so
long as the borrower has (a massive) 5 percent to put down.
These are truly terrible policies; they risk re-inflating a
housing bubble, will allow banks to transfer risk to the public
finances and will lure people into buying more house than they
have any business owning.
It also marks another step in the probably irreversible
underwriting by the government of the housing finance market in
Britain, a move which has led to miserable results in the U.S.
“The government needs to be careful this doesn’t create
another housing bubble – pushing prices up at the expense of
buyers,” said Simon Rubinsohn, chief economist at The Royal
Institution of Chartered Surveyors.
When people within the industry which stands to benefit
publicly call you out on a policy, you might want to consider
that just maybe you’ve got this one wrong.
In brief, here is how it is going to work. Under the larger
plan, home-buyers put 5 to 15 percent down and the government
agrees to insure the lender for its losses up to 20 percent of
the purchase price. Lenders will pay the government a
‘commercial fee’ for the insurance, though you have to guess
that if such insurance were obtainable on commercial terms the
government would not have to be offering it. In the smaller
plan, which is only for newly built houses, the borrower puts
down at least 5 percent and the government lends you up to 20
percent which need only be repaid when you sell.
The plan forbids lenders from offering refinancings to
existing borrowers in its mortgage book, a rule aimed at
stopping banks from simply laying off exposure to their worst
loans to the government. Of course, nothing will stop them
refinancing the worst loans of other banks’ loan books – loans
which will be far better risks for lenders with the government
Britain’s banks have effectively just been offered a deal
where they can earn good fee income and, as an industry,
transfer risky loans to the public treasury.
FAILURE TO LET MARKETS WORK
The real failure, and tragedy, of this policy is that it
works against allowing property prices to re-set lower in
Britain. People in Britain have a hard time scratching together
a deposit because housing prices are out of line with their
incomes. Given the downward trend in real earnings, we can’t
count on earnings to allow for more affordable houses, leaving
as the only hope a pricing re-set, perhaps driven partly by an
increase in supply.
In its supporting document to the policy, the British
Treasury notes that the number of loans available which allow
buyers to only put down 5 percent have plunged since the crisis.
There is a very good reason for this – those loans have long
proved to be bad bets, both in Britain and elsewhere. People
without sufficient deposits usually stretch themselves into
financially vulnerable situations.
As well, average down payments are now about 80 percent of
the typical first-time buyer’s income, a doubling since 2007.
Again, this reflects better lending standards in combination
with house prices which simply haven’t fallen enough. The
average house in Britain costs about five time average earnings,
a good 25 percent above its long-run average.
The average buyer thus faces two real and important risks if
they access these funds. First, prices fall or their
circumstances change and they find themselves tethered to a
house which may suit their aspirations but not their reality.
Second, prices rise and they and their children continue to live
in an economy where shelter is simply too expensive.
For the economy and the Treasury, the risk of course is that
the bubble someday bursts, with all of the damage we saw last
time round and perhaps some extra, just because.
To be sure, Britain needs more housing, and efforts to
revitalize home-building are a good idea. This should be done by
making it cheaper to obtain land and easier to obtain planning
permission. The goal should be to build so many houses that
prices drop gently in real terms over a generation.