Problems with underwriting mortgages, or Why David Cameron Is An Idiot

This came out back in December, I think. I wrote something in the heat of the moment but didn’t post it. Then I added a bit, but didn’t post that either.

But, I feel like posting something, so here it is. I should caveat that although I think my general point is valid, I didn’t explain my point in the most rock-solid argumentation at times. But what can you expect from a half-educated wastrel responding to something in the heat of the moment? As I say, I think the underlying point is secure.

First, a little background. The government has announced, as I understand it, a plan to underwrite residential mortgages – that is, to promise to pay them back if the individual defaults, provided that the mortages are all good mortgages and aren’t bad loans to begin with. The idea is that at the moment people aren’t able to borrow enough, so lots of poor people can’t afford houses – so house prices haven’t been rising as they’re ‘meant’ to – and that if the government covers debts, banks will lend more, kickstarting the housing market again, and, by extension, the rest of the economy, while at the same time allowing more people to afford houses. The stated intention was to return to having 95% mortgages as the norm. I think there are some problems with this idea – weirdly, for perhaps the first time, I think that the government is being to left-wing and should think again before interfering in the free market! These problems include:

  1. 1. It won’t do what it’s meant to do. Price is set by supply and demand. Enabling more people to buy houses at current prices by definition increases demand, which will increase prices until the demand falls back again – in other words, the same people who can’t buy houses now will end up still not being able to buy houses, but the housing companies will make bigger profits from those that can. The hope, I suppose, is that increasing demand will instead encourage an increase in supply that will keep prices at the current level. Given the narrow oligarchy of major house builders, combined with the political and logistic obstacles to new housebuilding in desirable locations, it seems incredibly naive to assume that this will take up all of the increase in demand. What’s more, the number of people ‘needing’ houses is not fixed. If more houses go on the market more people will be able to buy them, but that does not mean that the number of people who can’t buy them will decrease – rather than the poor getting these new houses, it’ll simply be the case that people who would have bought their own home at 25 will now get given them by their parents when they’re 21. Just look at where houses get built. All those houses built in the south-east are not going to go to working-class families in council houses in Gateshead – they’re just going to encourage the atomisation of already-rich families.

    2. It exposes the government – i.e. us – to massive losses if a recession occurs. The government says that this isn’t government spending (which would be oh so bad, apparently, for reasons not entirely clear), because it’s just insurance against losses that won’t happen. Haven’t we heard that before? A 95% mortgage only leaves room for a 5% decline in house prices. House prices are currently overvalued, and people in the industry say that they may need to drop another 15-20% to reach a fair market value. That’s before we consider the possibility of a further recession, which hardly seems impossible right now. It’s fine to underwrite individual mortgages to people who look like safe debtors (i.e. an implict acceptance that we’re NOT talking about the poor!), because the chances of any of them going bankrupt is small – but that ignores the systemic risk taken on, and the possibility of an across-the-board decline in values. The government policy is exposing us to massive losses – just as any bank guarrentee does. Ask Ireland how bank guarrentees work out.

    3. It encourages reckless lending and a bubble in house prices. If lenders know the government is backing the mortgages, it need not ensure that it loans only to those who can pay back. If the banks don’t do adequate checks and analysis, does anybody seriously believe that the government is going to be able to spot the bad risks that the banks miss? Oh yes, that sort of massive expansion of the civil service, duplicating the work of all the loan assessing staff at all the banks, that’s really on the cards right now, isn’t it? So, banks will make riskier and riskier loans, allowing more and more people to buy more and more expensive houses with less and less chance of ever paying back their debts. Forget what I said above about the ordinary effect this would have on house prices – this wouldn’t be an ordinary market! This is a government-sponsered housing market bubble. Does anybody believe encouraging bubbles is sound long-term policy? And how did this plan work out when America tried it, please remind me?

    4. In the best-case scenario, the boost to demand will spur an increase in supply – more houses will get built. The government has said that this is the idea – house-building boosts the economy and provides employment. OK – so what are we going to do with the new houses? We build 120,000 new houses a year, apparently, and the government wants to double it to 200-250,000 a year. Taking the top end of that for neatness, that’s 1 million new homes every four years – which is what we ‘need’, apparently. That’s 5 million new homes every 20 years. Well take a look at population projections, people. The UK is projected to grow by 5 million people in the next 20 years. So, obviously, we’re going to need more homes. Except… do we really need an extra brand-new 4-bedroom house in Tunbridge Wells for every single newborn? Seriously? OK, let’s say the average new-build has only 3 bedrooms – that’s still room for 15 million more people, when population will increase by only 5 million. Where will these extra people come from? Well, two places. First, where they’ve been coming from for the last thirty years or more: from the collapse of traditional families. More and more people are living alone, for longer, and there are more and more single parents. By increasing the housing stock faster than the population, we’re basically saying that we want families to become even smaller than they are. I’m normally not exactly a flag-bearer for the importance of the traditional family, but is this an entirely good thing? What’s more: given that the government explicitly wishes to encourage traditional families to remain together, isn’t this an entirely schizophrenic, nay hypocritical, policy? On the one hand they talk about a token tax break for married couples – and with the other hand, they massively decrease the cost of splitting up (and of kicking children out sooner, and of exiling grandparents and less-fortunate siblings), to an extent that dwarfs their symbolic marriage-credit offering. For once, the social right and the economic right should be in agreement – and in disagreement with the policy of the right-wing government! And then, second, there’s the other source of new people. Those population projections make assumptions about the rate of immigration – but those assumptions can change when the facts change. One reason why immigration is not higher is that the country is overcrowded and expensive – so if you create 10 million surplus bedrooms, all you’re doing is waving a big ‘hey, come live here, we’ve got spare houses’ banner. Again, I’m not anti-immigration myself – but last I checked, most supporters of the Tory party were (or, at least, were immigration-skeptical). When did they start thinking that “we need to build more houses to encourage more immigrants to come live here” was their kind of plan?

    5. What does the government want, in the long-term? Lower house prices, or higher house prices? It can’t expect house prices to simply stay exactly the same, without a continued miracle. It certainly can’t expect that and at the same time talk about how the market is ‘stuck’ and needs ‘kick-starting’. So, higher or lower? If prices are lower, more people will be trapped in negative equity and lose money when they sell their houses and feel like they’re in danger of bankcruptcy and spend less and tank the economy. That’s why whenever house prices fall there’s a panic. But all this house-building the government says it wants – more houses ultimately means lower prices, all else being equal. That’s how they expect to get more people into housing. But that would lead to massive overextension among house-owners… and now, under the new policy, it would lead to the government footing the bill. So maybe the government wants prices to increase? That would be safer. And the government seems to suggest that when they talk about housing being a major source of GDP growth. If our houses are worth more, we’re all richer! And the banks (and the government) can breathe more easily about all those loans – indeed, if they expect continued house price growth, they can lend more and more and still make money! Hooray. But there’s a catch: we can’t reduce the housing stock. That would be politically disasterous. Indeed, we’re building more homes, both to tell people that it’ll be easier to buy a house, and to provide employment. So how can we make the prices rise? Why, clearly, by artificially boosting demand! By subsidising house-buyers! Viz, by this policy. Hooray indeed, everybody wins. House builders sell more homes for higher prices, more people own their homes, home owners see their worth increasing every year, and banks have a profitable and safe place to put their investments.
    But hang on. At some point, we have to think rationally about this. This gain in ‘wealth’ comes through higher levels of debt. A 95% mortgage means more debt than an 80% mortgage. Now, sometimes debt is good. We can take on debt, use it to boost our economy, and pay it back with interest. Indeed, through the miracle of inflation, old debt just fades away. But this isn’t a one-off debt. This is a system that requires continual debt. And if we want to continue to increase house prices while also increasing the number of houses, it doesn’t just require continual debt, it requires continually rising levels of debt to sustain the growing disconnect between what houses ought to be worth and what we want them to be worth. This is why house prices have risen three times faster than incomes, while the number of households has grown relatively slowly. [House builders and their media lackeys like to scaremonger about how the current growth in the housing stock may be the lowest for fifty years. Well obviously! We’ve got the lowest population growth in fifty years!].
    In other words, this goes far beyond this particular policy. What we have is a fundamentally disfunctional attitude toward housing. We are intentionally inflating the prices of houses to provide a quick and easy boost to GDP. Leaving aside the question of whether these values are even vaguely sustainable, and the possibility of a catastrophic market collapse that would devastate the entire economy, this boost to GDP comes at the expense of higher levels of debt, particularly for the poor. [We wring our hands and say ‘oh how terrible, the poor can’t afford their own homes, prices are rising too fast’. So we give them money (directly through government grants or indirectly by subsidising banks and builders). Oh wow, that makes prices rise faster! Seriously, nobody in government is so honestly stupid that they think they can solve house price inflation that way. This is, quite literally, saying that you want to tackle inflation by printing a whole load more banknotes and giving £1000 to each person, so that they can pay the higher prices more easily. It’s a stupidity so collossal that it is impossible to believe it is honest.] As we now know, under the current economic system, the vast majority of GDP growth goes to the superelite, leaving the poor and the middle classes with only marginal increases in income. OK, fine – so long as nobody gets harmed in the process. But this isn’t just an issue of rising inequality – what we are doing is directly taking money from the poor and giving it to the rich. The poor think they have money still, because their level of debt is rising to meet the rising costs of living (and this isn’t just because of the housing market, but it’s a big part of it) – but mortgaging the poor and the middle classes to enable the rich to get richer is crippling the growth prospects of the indebted classes and putting the indebted more and more in the power of their creditors. When your employer and your creditor and your prime minister are all the same person, that’s not great for your prospects for practical liberty.

    6. The current policy intentionally distorts the market, because the insurance is only available when you buy a new-build house. So what, not content with building millions more homes, they want people to move out of the existing ones? Well, that’s ONE way to drive continual demand for new houses! Why not go the whole hog and make it illegal to buy a non-new-build house!? I mean, sure, the whole idea of ‘new is best, never re-use’ hardly goes hand-in-hand with the professed ‘green’ and ‘sustainable’ objectives of the government, but what the heck. Of course, this policy may in practice mean the worst of both worlds: prices of old houses declining, leading to house-owners becoming overstretched and trapped in negative equity, while the ability to buy decreases (since the cheaper mortgages are only available on the newer, more expensive homes). Joy!

 

 

Now, since I wrote that, I’ve thought a little, and I’d like to reiterate some points more clearly. What’s happening is this: we want our houses to have rising worth but declining cost. This would normally be impossible, but the government is stepping in to, very indirectly and without announcing that that’s what it’s doing, plug the gap in between. Prices can continue to rise, because subsidy leads to inflation, while at the same time affordability also increases, because the government pays some of the higher price.

The obvious objection is that this is unsustainable. Further price rises will require further subsidy: once the new price level is reached, the government will have to spend further to push it up higher again. At some point, the government runs out of money to sustain the inflated values, at which point we’re at risk of a crash.

A second objection is that this is incredibly left-wing: potentially massive government involvement in the market to redistribute money. I don’t have a problem with that, but I’m surprised the Tories don’t.

Finally, if that is your stated aim, is this the best way to do it? The scheme avoids the political and fiscal burden of direct government spending in two steps: firstly, the excess “spending” is in the form of debt, not cash, and secondly the debt is theoretically held by the individual, not the state. However, both steps are only theoretical: debt may eventually have to be paid back, and underwriting means that private debt can become public debt, and will do in the event of a general price collapse. So the government is exposing itself to risk, while not gaining any productive assets in the process; the buyers, meanwhile, take on increasingly large amounts of debt, but the underlying value of their assets does not increase – because the ‘price’ they have to go into debt to reach is based entirely on the availability of that debt – when liquidity crunches, and lenders need their money back, the value of the properties being used as collateral will plummet at the same time.  A mortgage is, for a bank, becoming a bet that banks will never need to call in their debts, or, more succinctly, a bet that the bank will never lose its bets – which is the opposite of a hedge: when they’re winning, they win more, but if they ever lose, they lose twice over.

This causes us to reconsider that prima facie “redistribution” thing. We’re not, at least in the short term, actually giving individuals more stuff – the same people will be buying houses, just at higher prices. Perhaps they may be buying them in different places – if so the redistribution consists entirely of allowing more people to bask in the glory of living near the ruling classes.

No, we’re not really channelling money to the poor – we’re channelling debt. We’re taking people who are already in debt and making them more in debt. Overall, their debt will increase more than their assets (because most people won’t move into considerably more economically-advantageous houses, they’ll just buy the same houses at higher prices, as a result of general house price inflation), so wealth is being extracted from the poor. Where is it going? To the rich, either through banking stocks or through builder stocks. And it’s not just money inequality – the direct relation of debtor and creditor is more coercive and unfree than the relation of poor and rich (all else being equal). The poor are, yet again, being pushed further under the control of the rich. The government shouldn’t be encouraging that.

To clarify: this isn’t being said out of some religious aversion to debt. Far from it. Debt is good. The ability to get into debt increases our wealth immeasurably. However, there are limits. Britain’s household debt is over 100% of GDP already, more than twice that of, say, France – and this contributes to a total debt-to-GDP ratio that is, after Japan, probably the second highest in the developed world. [Or third, after Switzerland?]

If the government really wants to provide more housing for poor families, it could cut through the bank profits and the builder profits and provide more social housing. [This is something it should have done on a massive scale in 2009, when prices were low and demand was high but credit scarcity led to stasis – only ideology prevented the government from increasing state assets at bargain prices, while giving homes to the homeless, AND boosting the house-building market at the same time]. This wouldn’t involve putting people into debt, and could be more targeted than a general blank cheque across the nation.

 

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