Safe as Houses

Written by Merlene Emerson and published in Liberal Democrat Voice on Mon 23rd Feb 2009

I agree with Vince Cable MP that cuts in interest rates have reached their limit and that we now need different policies to stimulate the economy.

Despite general support for Keynesian economics (cf the Paradox of Thrift), Vince spoke out in favour of the virtue of saving and pointed out that there are 7 times more savers than mortgage borrowers who are being penalised under the present climate.

The global recession was first brought about by the collapse of the sub-prime housing market in the US. Hence it is back to the US that I would like to return in order to find longer term solutions to the current financial crisis.

Many trace the erstwhile easy credit back to the Clinton years when the political decision was made to widen home ownership to the less well off. In the 1992 Housing Bill, Congress set a quota of 30% for low income housing to be made available to own rather than rent. This quota went up to 40% in 1996.

Commercial banks were encouraged to pile into the home loans market offering low interest rates to sub-prime borrowers of poor or no credit history. Subsequent relaxation in US banking regulation encouraged securitisation of these mortgages and onward sale to other banks, many European, as rating agencies optimistically (or should I say recklessly) rated them AAA with credit enhancements by the likes of insurers such as AIG.

By way of illustration: in 1994 only 4.5% of home loans in the US were sub-prime and 31% of these were securitised. However by 2006 as much as 20.1% of home loans were sub-prime and 81% of these were securitised.

We know what happened next: first investment bank Bear Stearns, then Lehman Brothers, bit the dust. Even insurers AIG, and Government sponsored mortgage lenders Fannie Mae and Freddie Mac had to be bailed out by the US Government. As it turned out the mortgage market was not built of bricks and mortar but was a house of cards.

Although our UK housing market is quite different from that in the US, thanks to securitisation, European banks also have exposure to the US sub-prime mortgages. Moreover, the housing boom in the UK led to many high street banks lending based on inflated house values including cash back offers to tempt first time buyers with up to 125% loan to property values. Across the Atlantic we have had our own casualties; first Northern Rock had to be nationalised and now it seems that RBOS and Lloyds TSB are going the same way.

Right, we can understand what went wrong but how do we fix it? In the short term, ironically, the received wisdom has been to pump yet more money into the system. On 17 February President Obama announced his US$787 billion stimulus package which included measures to prevent mortgage foreclosures and incentives to refinance home loans where there is negative equity.

In the UK, PM Brown has been encouraging greater consumption with the ephemeral 2.5% VAT reduction before Christmas as well as huge cash injections into the banking system and into failing banks. Interest rates are now at historic lows and as Vince Cable pointed out, this has served to penalise savers and pensioners.

I believe that the solutions being pursued in the US cannot be the same for us here in the UK. Traditionally we do not have a sub-prime mortgage market as affordable housing has been provided by local authorities and housing associations with properties built primarily for rent rather than for sale. Furthermore social security and housing benefits are available to many housing tenants in the UK but the equivalent in the US, the Section 8 housing voucher, is much more limited.

I would go even further and suggest that the fall in house prices in the UK should be welcomed rather than decried. After the last extended housing boom average salaries do not now support average home prices and the market should be allowed to find its own realistic values. A fall in prices would also benefit first time buyers trying to get on the housing ladder.

At the same time I have to agree with PM Brown that banks should not allow 100% financing but borrowers should become more thrifty and learn the habit of saving up for a minimum down payment. Only then will any subsequent adjustment in market prices ensure that they do not instantly go into negative equity.

The current crisis is therefore not only a golden opportunity to change the old City culture of high reward for short term returns but also a chance for us to reassess our own values and expectations. Given time, with the banks returning to their traditional mortgage lending business and the implementation of more realistic loan to income ratios, investments in properties will one day become as safe as houses again.