False Alarm on Mortgages

Whereas the production sectors of the economy are engaged in a relentless search for price reduction, important parts of the financial services sector are still locked into out-of-date mindsets which are largely concerned to keep prices up.

Thus the Council of Mortgage Lenders (CML) described the FSA’s latest plans for the mortgage market as “fatally flawed” and which would create so-called “mortgage prisoners”.

So what are the plans which have incurred the CML’s wrath?

Well, the FSA proposes that mortgages where people self-certify their earnings should be banned.  Lenders, i.e. banks and building societies, should carry out proper income verification and affordability checks.  Most people who don’t have a personal interest in the fee income generated by mortgage lending would assume that lenders do this automatically.

We know now that under pressure some mortgage brokers, some lenders, notably Northern Rock Building Society, had not been doing this, with the result, among others, that mortgages have been provided at multiples of six or even eight times the annual gross income of a couple, with repayments at half net income.  This was not quite as bad as the US Fanny Mae and Freddy Mac who lent to people with no income at all, but nonetheless it was an utterly reckless thing to do.

At the start of the enormous post-war house price inflation in the 1950s and 1960s, the multiple was limited to three times one partner’s (usually the husband’s) gross income, with monthly repayments limited to one-quarter of gross income, or one-third of net after tax income per month.

The nearly threefold house price increase in the 10 years of the Blair government (1997-2007), like the doubling of house prices in the early 1970s (the Heath-Barber boom) was due to the vast increase in the flow of cash imprudently borrowed by banks and building societies to lend to their mortgage customers, generating huge fees for themselves, estate agents, financial advisors and mortgage brokers.  Not only have these gushes of borrowed cash brought banks to their knees (London and Counties Bank in 1973, Northern Rock in 2008), they have done so without generating any long-term investment in productive assets.  The lack of this investment should be obvious to all, with British industry so shrunk as to be incapable of taking advantage of the 20% devaluation of the pound sterling against the US dollar, the euro and the yen since mid 2006.

The particular cry of the CML is about the estimated 650,000 homeowners unable to move because the mortgage debt on their properties exceeds their market valuations – so called “negative equity”.  But the inability to move is entirely of the British lenders’ own making, and can be easily corrected if they had the brains to see it, by simply transferring the loan security to a new property.

Mortgages are actually loans secured on pieces of real-estate.  The concern of the lender ought to be focussed on the ability of the borrower to service and repay the loan, not on the hypothetical value of the real-estate in a forced sale.  This is what the FSA wants the lenders to do, which the CML is complaining about.  If someone wants to move house to basically the same sort of house, what actually will change?

Apart from the case when someone wants a bigger loan, their ability to pay for their existing loan is unchanged by the fact of the move.  In principle all the lender has to do is to note that the property on which the loan is secured has changed, while the forced-sale value will be largely unchanged.  Other countries’ banks (e.g. Switzerland) do this by treating loans on property simply as overdrafts, avoiding the whole paraphernalia attached to mortgages in this country.

This brings into sharp focus whether we need the CML, mortgage advisors and brokers at all.  As with other sectors of the financial services “industry”, close inspection shows that they are principally fee-generators for the practitioners themselves, not benefactors of the domestic customer.  Future posts will focus on other sections of the financial services sector which have this as their main objective.

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