By James Saft
March 20 (Reuters) - Cry ‘Bubble!’ and let slip the dogs of subprime.
Britain on Wednesday unveiled a new budget including 130 billion pounds of mortgage guarantees which will enable patsies, er, hardworking home-buyers, to buy properties worth as much as 600,000 pounds ($900,000) with as little as 5 percent down.
And no, thank you for asking, Chancellor of the Exchequer George Osborne did not just wake up after six years in a medically induced coma.
A smaller 3.5 billion pound program features a direct loan of 20 percent of the purchase prices for newly built houses, so long as the borrower has (a massive) 5 percent to put down.
These are truly terrible policies; they risk re-inflating a housing bubble, will allow banks to transfer risk to the public finances and will lure people into buying more house than they have any business owning.
It also marks another step in the probably irreversible underwriting by the government of the housing finance market in Britain, a move which has led to miserable results in the U.S.
“The government needs to be careful this doesn’t create another housing bubble - pushing prices up at the expense of buyers,” said Simon Rubinsohn, chief economist at The Royal Institution of Chartered Surveyors.
When people within the industry which stands to benefit publicly call you out on a policy, you might want to consider that just maybe you’ve got this one wrong.
In brief, here is how it is going to work. Under the larger plan, home-buyers put 5 to 15 percent down and the government agrees to insure the lender for its losses up to 20 percent of the purchase price. Lenders will pay the government a ‘commercial fee’ for the insurance, though you have to guess that if such insurance were obtainable on commercial terms the government would not have to be offering it. In the smaller plan, which is only for newly built houses, the borrower puts down at least 5 percent and the government lends you up to 20 percent which need only be repaid when you sell.
The plan forbids lenders from offering refinancings to existing borrowers in its mortgage book, a rule aimed at stopping banks from simply laying off exposure to their worst loans to the government. Of course, nothing will stop them refinancing the worst loans of other banks’ loan books - loans which will be far better risks for lenders with the government involved.
Britain’s banks have effectively just been offered a deal where they can earn good fee income and, as an industry, transfer risky loans to the public treasury.
The real failure, and tragedy, of this policy is that it works against allowing property prices to re-set lower in Britain. People in Britain have a hard time scratching together a deposit because housing prices are out of line with their incomes. Given the downward trend in real earnings, we can’t count on earnings to allow for more affordable houses, leaving as the only hope a pricing re-set, perhaps driven partly by an increase in supply.
In its supporting document to the policy, the British Treasury notes that the number of loans available which allow buyers to only put down 5 percent have plunged since the crisis. There is a very good reason for this - those loans have long proved to be bad bets, both in Britain and elsewhere. People without sufficient deposits usually stretch themselves into financially vulnerable situations.
As well, average down payments are now about 80 percent of the typical first-time buyer’s income, a doubling since 2007. Again, this reflects better lending standards in combination with house prices which simply haven’t fallen enough. The average house in Britain costs about five time average earnings, a good 25 percent above its long-run average.
The average buyer thus faces two real and important risks if they access these funds. First, prices fall or their circumstances change and they find themselves tethered to a house which may suit their aspirations but not their reality. Second, prices rise and they and their children continue to live in an economy where shelter is simply too expensive.
For the economy and the Treasury, the risk of course is that the bubble someday bursts, with all of the damage we saw last time round and perhaps some extra, just because.
To be sure, Britain needs more housing, and efforts to revitalize home-building are a good idea. This should be done by making it cheaper to obtain land and easier to obtain planning permission. The goal should be to build so many houses that prices drop gently in real terms over a generation.