Mortgage News

The past two decades have seen two spectacular boom and busts in the UK Housing Market. Whenever there is a bust, it is hard to imagine that we could return to yet another period of spectacular house price growth. But, with housing supply falling woefully short of government targets for population growth; there is every chance of another housing boom. - perhaps not for another 2-4 years; but, it could definitely happen again.
The costs of allowing housing boom and busts are too great, there needs to be effective policies to moderate unsustainable booms in lending, house price growth and the consequent adjustments this causes.

What Should Government Do?

1. Change Monetary Policy

At the moment, monetary policy is primarily targeted at the control of inflation and stable economic growth. If the MPC were given two targets inflation and avoiding asset bubbles, then maybe we could avoid booms in the Housing market. i.e. they would raise interest rates if house price growth was too high. However, there are problems with this.

• It is hard to target two things at once. During 2004-07 House price growth was frequently over 20% a year, but, CPI inflation was averaging 2.7%. To reduce house price growth would have caused a painful decline in output. It could even have caused a premature recession; the MPC would have been widely criticised for causing unemployment just to prevent house prices rise.
• Interest rate increases would have had to be very high.
  
• Difficulties of Knowing why House prices are rising. It is difficult to know when house price growth is a consequence of excess lending / speculation and when it is due to economic fundamentals of demand greater than supply

As Charles Bean (deputy governor of MPC of Bank of England), commented in a recent speech on 22 Nov 2008 :

“It is simply not credible to believe that the UK house-price boom that is now unwinding would never have happened if only the Bank’s Monetary Policy Committee had set official interest rates just a little bit higher. “

Banks were really keen to lend, and I doubt slightly higher interest rates would have discouraged many homeowners from taking out mortgages. - It is similar to the fact that cuts in interest rates have failed to stimulate the housing market.

2) Regulation of Banks.

One policy suggested by Anil Kashyap, Jeremy Stein and Raghuram Rajan [1], is to get banks to purchase private capital insurance from a suitable ‘deep pocket’, such as a sovereign wealth fund, that pays out if aggregate financial conditions deteriorate sufficiently. The idea is in boom conditions to make banks save more and reduce the growth in their credit lending. Then in a bust, the banks can rely on their own private insurance schemes to meet shortfalls - rather than rely on government bailouts. This scheme is not aimed at reducing overall bank lending. But, making bank lending less cyclical and volatile. It would mean less 125% mortgages in the boom years. But, it would also avoid some of the freezing of mortgage markets we see at the moment.

3) Spanish Example

In Spain, banks are required to build up a general reserve equal to the difference between an estimate of long-term losses and specific provisions on currently impaired assets. It is noteworthy that Spanish banks have largely avoided the credit crunch. Abbey owned by Spanish group Santander have been one of the few banks to lend more. (Though Spanish house prices still rose too much and are now falling)

Traditionally the idea of government regulation of banks is dismissed by free market economists. They argue that it will reduce investment and anyway banks can get round the regulation.

However, these are not good reasons.

4) Increase Supply of Housing

Whilst there is a shortage of housing, the scope for rapidly rising house prices always remains. However, in the US, the supply of housing increased in response to the boom, but, the massive homebuilding didn’t prevent the boom. (in fact many houses were still coming onto the market at the end of the boom - when it was too late.) this shows that addressing supply issues will not on its own solve the propensity to a credit boom and bust.

Also, of course, the UK is notoriously bad at meeting targets for building new houses. Everybody agrees new houses should be built - just as long as they are not anywhere near where they live.

Conclusion

We cannot rely on monetary policy to prevent house price volatility. The MPC should be free to target inflation and output directly, without trying to solve micro economic housing problems as well.

Nor can we leave this issue to the dynamics of the free market. The consequences of housing boom and busts are too painful for the economy. It will not be easy to regulate the banks; but since they have been humbled and forced to come begging to the government, we will never have a better chance to force them to take responsible steps to moderate boom and busts in credit / mortgages.

[1] See Anil Kashyap, Jeremy Stein and Raghuram Rajan, ‘Rethinking Capital Regulation ‘, presented at
Federal Reserve Bank of Kansas City Symposium on Maintaining Stability in a Changing Financial
System, 2008.

• Who is to Blame for Housing boom and bust?
• Is Media to Blame for Boom and Bust?

Original post by Tejvan R Pettinger

The collapse in mortgage lending is becoming a real concern. Next year, the association of British Bankers predict net mortgage lending could be negative. Despite lower interest rates, it is still as difficult as ever to get a mortgage. As a result, housing sales are at their lowest level on record.

When the government suggested banks should return to 2007, lending levels there was many raised eyebrows. Surely there is no sense in returning to lending levels that caused the housing boom in the first place?

However, the mortgage market has become so constrained that it now appears there is a case for government intervention to overcome the almost paralysis which afflicts the market. We are not suggesting we want a return to interest only, 100% mortgages - far from it. But, the banks have gone from one extreme to another. From freely offering mortgages, they are now being very conservative.

You could argue there is good reason to be conservative. Banks will correctly point out we are facing:

• Rising repossessions,
• Economic recession and rising unemployment
• falling house prices creating negative equity.
• Banks need to improve their balance sheets after years of over lending.

With these factors in mind, it is hardly surprising that banks are being more cautious in their lending. But, if the mortgage industry faces continued constraints we could see a market devoid of buyers; this will cause more problems. It also must be remembered that with low interest rates and falling house prices, the cost of mortgage repayments has fallen significantly. Although repossessions are rising they are still  less than 1% of total mortgage loans. It is not that the government should try to stop house prices falling or return to 2007 lending. But, the market is showing signs of market failure, with banks wanting to retreat into  a shell. Therefore, there is a case for governments offering some temporary incentives for mortgage lending, and more than just a stamp duty cut.

Original post by Tejvan R Pettinger

Despite the frantic efforts of the government’s economic stimulus package, recovery in the housing market will still be a long way off. The UK economy in 2009, is likely to be characterised by rising unemployment, national debt and falling economic growth.

The recent economic stimulus package offers tax cuts, most notably VAT cut to 15%. However, the impact on economic growth may be muted to the continued credit crunch and low consumer confidence. Recent reports from the BBA suggested that mortgage lending in 2009 could be negative - i.e. the banks could be drawing in more repayments than giving out in new mortgages [BBC link]

Economic stimulus packages tend to have a time lag. With lower saving rates and high levels of borrowing, the tax cuts may not be sufficient to encourage an increase in spending

Also the tax cuts might discourage the MPC from cutting interest rates as the prospect of deflation diminishes with expansionary fiscal policy

National Debt is forecast to rise sharply over the next few years, as the triple effect of:

• recession (reducing tax revenues)
• Bank nationalisation and bank bailouts
• Tax cuts to try and boost economic growth

Even economic recovery may be insufficient to prevent house prices falling. Unemployment often lags behind the economic cycle. If the economy recovers in the second half of 2009, unemployment could still keep rising until 2010.

Original post by Tejvan R Pettinger

In the last housing boom and bust house prices peaked ato £62,782 in the third quarter of 1989, they then dropped to £50,128 in Q3 of 1993.  That was a fall of £12,654 or 20.2%. Prices then took another 2 years before starting to increase.

However, in the early 1990s, the inflation rate was much higher. Therefore, there was a much bigger fall in the real house prices. In real terms, the prices fell by 37.4% from a peak in the second quarter of 1989 to the trough in the last quarter of 1995.

So far, in this housing bust house prices have fallen 14.6% and are forecast to have fallen 16% by the end of the year.

The other big difference between the last boom is that interest rates are significantly lower in this crash. Home repossession rates in 2008, have not yet reached the rate of the last crash.

However, the level of transactions in this crash is even lower than in the early 1990s. This is due to the credit crunch and the difficulty of getting mortgages.

The Royal Institution of chartered surveyors suggested that Rentable incomes have fallen for first time since 2003.

Buy to Let landlords have the highest repossession rate.

Original post by Tejvan R Pettinger

Until 1997, Monetary policy was controlled by the Government. However, this was blamed for many boom and busts, e.g. Lawson boom - when government allowed economy to grow too quick causing inflation. Therefore, the government made the MPC independent to set interest rates. The government gave the MPC an objective of:

• 1. Low inflation of CPI 2% +/-1
• 2. Consider wider macro economic objectives such as growth and unemployment.

Therefore, the MPC’s primary target is low inflation, but the second objective enables them to give less importance to inflation if there is an unexpected shock to the economy.
Many argue the MPC have done a good job. Between 1997 and 2007, they kept inflation low whilst maintaining strong but sustainable growth. Unemployment fell and the UK enjoyed the longest period of growth on record (16 years). It appeared the MPC had avoided the old boom and bust cycle.

However, the MPC have been criticised

1. For allowing a boom in house prices which was unsustainable. Now house prices are falling the economy has suffered lower growth
2. Ignoring the impending recession and giving too much importance to temporary cost push inflation. e.g. David Blanchflower criticised MPC for keeping interest rates too high for too long. The dramatic cuts in rates, show how the MPC perhaps admit they were too high for too long.

However, in defence of the MPC

1. The MPC were not asked to target house prices with interest rates. Arguably this was a micro economic problem. If they had increased interest rates in 2004-05 to reduce house prices it would have caused lower growth even when inflation was on target. Rising house prices reflected shortage of supply and excess lending. The boom in house prices was undesirable, but, it needed to be tackled by measures other than interest rates.2. The recession was mainly caused by the global credit crunch outside their control. The UK government could have done more to regulate the financial system.
2. Many were surprised at how quickly the UK Economy slid into recession
3. Also the cost push inflation presented a difficult dilemma. The MPC feared that if they cut rates as inflation was increasing it could lead to permanently higher inflation expectations. The MPC were not confident oil prices would fall.

In hindsight, interest rates could have been cut earlier in 2008. The concerns over inflation have been outweighed by the much more serious decline in growth and rise in unemployment. This may have caused a sharper downturn. But, it was not the main cause of the recession - far from it. The main cause of this recession was the combination of a global credit crunch, falling house prices and decline in consumer confidence.

Overview of MPC at Bank of England

Original post by Tejvan R Pettinger

What Will Happen to Mortgage Rates?

After the Bank of England’s decision to cut interest rates by 1.5%, there was a predictable scrutiny of the high street banks to see whether they would pass the cut on to consumers.

Interestingly, one of the first banks to announce they would pass the cut on was Lloyds TSB and its mortgage subsidiary Cheltenham &amp Gloucester. The other part nationalised banks, Halifax, (HBOS) and Royal Bank of Scotland have all stated they intend to pass the cuts on. The only two to avoid trimming their rates so far are HSBC and Barclays (both of whom avoided requiring government funds)

However, even if banks do cut their standard variable rate by 1.5% there is no guarantee that all mortgages will be cheaper. In the boom years, anyone with any sense would remortgage to a better mortgage deal. To stay on your mortgage lenders standard variable rate was an expensive mistake to make. What will happen now is that banks will reduce the number of offers and special mortgage deals. The days of tracker mortgages 1% below the base rate are over. It will be harder for people negotiating a new mortgage contract to get a deal which offers any discount on the standard variable rate. For example, the Abbey, Halifax and Nationwide have all been increasing their tracker rates to new customers. The number of tracker mortages on offer has also nearly halved. Therefore, although the banks standard variable rates will be falling, many will not see the equivalent reduction in mortgage payments they might expect.

The Libor Rate

The libor rate is the rate at which banks borrow from each other. This is very important for determining the rate at which commercial banks want to lend. The good news is that this has come down. On Friday the Libor interbank rate fell 1.07% to 4.5% the biggest fall since 1992; suggesting an easing in lending conditions and making it more practical for banks to cut their own rates.

Availability of Lending

As many have pointed out the problem with the credit crunch is that banks don’t want to lend because they are desperately trying to improve their balance sheets. Therefore, although loans may appear cheaper, banks will not be in a rush to lend. With property prices falling, banks will be requiring large deposits to protect themselves against negative equity. Therefore, although mortgages may look cheaper, many first time buyers may still be unable to get a mortgage - even if they would like to get one. - Reducing the cost of borrowing is not really the problem; the problem is a shortage of funds, liquidity and confidence for lending.

The Devil’s in the Detail.

Even people on tracker mortgages may not necessarily find themselves with lower rates. This is because some tracker mortgages have what is known as a collar clause. What this means is that your rate follows the base rate upto a certain point. But, if base rates fall below 3%, the bank does not have to pass the lower rates on. (At the same time, these collar mortgages also often have an upper rate as well.)

Forecast for Interest rates into 2009.

The outlook for medium term interest rates is for them to fall and remain low. Although interest rates have been cut to 3%, many analysts suggest rates could fall to 2% or even 1%. This is because so far, the recession has been much steeper and deeper than expected. Unemployment is rising sharply. Output is falling across different sectors from manufacturing to retail. The housing market continues to drag the economy down.

Inflation is widely forecast to fall sharply from 5% to 2%, some in the MPC now fear that inflation could drop below the government’s target of 1% - raising the ugly prospect of deflation. The bank will certainly be keen to avoid this.

Original post by Tejvan R Pettinger

The most startling feature about trends in UK house prices is there volatility.

Recent Trends in UK House Prices leave you with a feeling of vertigo.

UK House Prices 2007-2008

After the last boom house prices fell for 4 years before entering another boom.

Why are UK House Prices so Volatile?

• Limited Supply. Difficult to increase supply during period of rising demand
• Confidence plays a big role. When prices rise, people jump on the bandwagon. When prices fall, nobody wants to buy.
• Interest rate changes have big impact in UK, where mortgage payments play a high role.
• Shifts in mortgage lending. During boom periods mortgage lending criteria relax. When house prices fall, lenders become worried over negative equity so make it more difficult to borrow aggravating the fall in prices.

Future House Price Trends

- Will we have future Boom and Busts?

Probably, Many reasons for past boom and bust will remain in the future. Mortgage lending may be better regulated, but, the supply constraints, have if anything got worse.

Original post by Tejvan R Pettinger

The Bank of England surprised analysts with a massive 1.5% cut in base rates, 6th November (Bank rate cuts)

Interest rates are now at 3%, well below the CPI measure of inflation.

Interest rates have been cut on the back of a string of poor economic indicators, suggesting the economy is in its most serious slowdown since 1981.

It remains to be seen whether this bold move to cut rates will actually stimulate the economy. Interest rates may not solve the problem of recession because:

• Interest rates have a time lag
• Banks will not pass the full 150base points onto consumers
• Confidence is so low, people don’t want to borrow anyway.
• Banks don’t want to lend mortgages because of liquidity problems

Nevertheless it is good news for borrowers and the long pressed housing market.

Original post by Tejvan R Pettinger

Readers Question: I am British and live abroad but want to buy in the UK when the market hits its bottom prices. When do you feel that this will be?

It is hard to say, though I think another 12 months of falling house prices is likely.

If you look at historical UK House prices, in the last housing bust, house prices fell for 4 years. 1989 Q3 (£62,782) to 1993 Q3 (£50,128)

There were of course, some differences in the 1990s. In particular, interest rates were more important in the boom and bust; there wasn’t the same.

Next year, is likely to see a significant fall in interest rates which could make buying more attractive. But, the market needs to see mortgage lending become less stringent to really kickstart the economy.

The other factor is that the economy faces a serious recession and rising unemployment. This will lead to higher mortgage defaults and arrears.

My advice is to watch the market closely, basically, when national house prices start rising for 2 consecutive months will be an excellent time to buy into the market. I doubt there will be a double dip in house prices.

If house prices fall another 10-15%, there is great potential in buying for the long term. The current crisis has really caused a fall in the supply of new houses. When demand is able to return, prices could be pushed up again. (long term forecasts for house prices)

In recent data, house prices reached there lowest levels for 2 years, with prices falling especially in London and South East. The only good news is that property transactions increased 5%

Original post by Tejvan R Pettinger

The impact of the credit crunch has now caused the UK to enter into an official recession, with economic output falling 0.5% in the last 3 months. The Credit crunch is now not just hurting the housing market, but the wider economy.

Major effects of the credit crunch

• Difficult to borrow, especially difficult to get mortgage.
• Bank of England cutting interest rates is leaving us with negative real interest rates. Inflation currently 5.2%, interest rates 4.5% (and interest rates likely to fall to 3% soon
• Recession, causing unemployment to rise
• Lower real incomes. Workers accepting pay rises below or close to inflation to protect jobs.
• Falling Stock Markets

How To Survive Credit Crunch

• Don’t worry about buying a house. Prospects for buying a house will probably be much better in 12 months, when house prices have stopped falling. The next 12 months is an opportunity to save for a deposit if possible. In the current mortgage climate, it is even more important to save for a deposit, to enable a better mortgage rate.
• Keep a track on Savings. Although we have negative interest rates. Banks are keen to improve their balance sheets so are offering attractive rates for savers. Northern Rock, Abbey National and Halifax all are offering saving rates above the base rate. This is a way to protect the real value of your savings.
• Worried about safety of Banks. My advice is that if the bank / building society is British, your savings are as safe as you can get.
• Investment diversification. If you own shares you will have seen the value of your share portfolios fall. However, on long term price to earnings ratios, share are good value. They may continue to fall in the short term, but, in the long term, are liable to rise. Amidst the uncertainty, many are buying into gold stocks.
• Remortgage. Just because it is difficult to get a new mortgage doesn’t mean you shouldn’t continue to try and get the best mortgage deal. Even now, the benefits of remortgaging and avoiding your bank’s standard variable rate is as great as ever. (Checklist for remortgaging)
• Paying off Debt. Levels of personal debt in the UK are at an all time high. (See: Debt levels in UK) We are now waking up to the necessity of reducing debt and increasing our savings ratio. The current low rates of interest should be seen as an opportunity to pay off more than the minimum payments. Remember, even if interest rates fall to 3%, they could easily increase to 6% within a couple of years. Avoid the temptation to take on more debt because interest rates are so low. As usual, it makes sense to pay off the highest interest rate paying debt first. (10 Tips for paying off debt)

Original post by Tejvan R Pettinger