Opinion: Safe as houses

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.

Merlene Emerson is the Liberal Democrat Parliamentary Spokesperson for Hammersmith.

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6 Comments

  • Steven Ronald 23rd Feb '09 - 10:46am

    I think the house price falls are a somewhat seperate subject – it’s just a market correction.

    As for savers being punished (and I am one)…you can’t really have it both ways – obviously it would be great to have high interest rates for savers and low interest rates for borrowers; temperory low interest rates for keynsian stimulus seems the obvious choice for the moment, but i’m no economist…

  • Steven Ronald 23rd Feb '09 - 10:54am

    Brown’s 100% financing plan is a perfect case of shutting the door after the horse has bolted. I for one think it’s also a bit puritanical as well.

  • Steven Ronald 23rd Feb '09 - 10:57am

    Another thing about these house price falls; we’ve got a long long way to go before the gains house owners have had over the last ten years are wiped out.

  • “we’ve got a long long way to go before the gains house owners have had over the last ten years are wiped out.”

    Yes but….

    In a flat market house price values are slightly illusory if you can’t actually find someone who will pay the “market value”

    IMO the issue isn’t 100% mortgages but whether people can afford to meet the payments. It’s not uncommon to get a 100% loan for a car purchase – which is an asset that will never appreciate in value.

  • Matthew Huntbach 23rd Feb '09 - 3:50pm

    If you can’t find anyone to pay the market value, then it isn’t the market value. The market value is defined as the price people are prepared to pay.

    Most houses will sell, so long as the price is low enough. The exception might be one with necessary repair liability so high that it would be necessary to offer it at a negative value – same as cars which get so old you have to pay people to tow them away.

    Real house prices now might be assessed by what people are paying at auctions. Auctions are for houses that HAVE to be sold – like when they’ve been repossessed. They will be a lot lower than the ticket value in an estate agent’s window. It’s a bit unfair as an assessment of the real selling price via an estate agent as auctions tend to have mainly buyers who know about these things, often estate agents who can buy up cheap and sell for more. There can sometimes be a charmed circle relationship, whereby they aren’t well advertised, thus allowing really low prices, thus leading to big profits for those in the know.

    Merlene writes “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”, but really, how can someone who is “Parliamentary Spokesperson for Hammersmith” get things so wrong? Unless by “traditionally” she means “30 years ago or more”. Merlene, do you know anyone who’s gone to LB Hammersmith & Fulham council and said “I can’t afford to buy a house, please give me a selection of those houses to rent you have so I can pick one” and got the reply “oh yes, here you are”? Only those with huge numbers of social problems and generally directly homeless get council house allocations in London these days, leading to a HUGE gap of people who can neither afford to buy nor stand a chance of social housing offers.

    OK, so private renting to some extent fills the gap – meaning we the taxpayers shell out to private landlords making BIG profits. We have to thank Mrs T and her right-to-buy for this system which has leached so much of our hard-earned money through taxes and put it in the pockets of people – private landlords – who do little to earn it. But the result of the gap has been loads of people taking on mortgages who couldn’t really be sure of paying them in a down-turn, and Northern Rock et al only too happy to offer them, thanks to the morons leading them who didn’t know what anyone with a brain who watches the UK economy would know – house prices reach a peak then crash at regular intervals.

    My feeling is that instead of bailing Norther Rock and the like out by just offering big sums of money, the government should just have taken over the mortgages, and got REALLY tough on repossession, with the proviso that no-one would be thrown out of their house, they’d just be turned into council tenants. So, no-one suffers the misery of losing a living space, but the state builds up a big collection of nice assets.

  • Andrew Duffield 23rd Feb '09 - 7:04pm

    “investments in properties will one day become as safe as houses again”

    Oh dear, oh dear. Real estate as investment. BOOM!… here we go again.

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