Tuesday, January 22, 2008

The Scottish government goes sub-prime.

Well, it was nice while it lasted. Until recently, the Scottish government seemed to be talking sense about housing. It had quietly abandoned that manifesto commitment to giving a £2,000 bung to first time buyers. The SNP minister, Stewart Maxwell, said the priority was to improve planning laws to promote house building and abolish or curb the right to buy council homes. Hear hear.

Unfortunately, he takes a step backwards today by announcing a £24 million shared-equity schemes to first time buyers in Scotland. This means the state giving tax-free loans to people who can’t afford the excessive prices being charged for those pokey flats that are being pushed up everywhere. This is economically illiterate.

All shared equity will do, in a condition of housing scarcity, is push prices up further, put public money in the pockets of estate agents, and land yet more young families with loans they cannot afford. Make no mistake: these are sub-prime loans underwritten by the government. They are an incentive for people to enter a market which is profoundly oversold and due for a crash. Those shared-equity home owners will see their 60% stake drop in value. And they will also have to shoulder the costs of maintaining a difficult-to-sell property in a time of declining or static house values.

The only good thing to say about the shared equity scheme is that the sums involved are so small it is unlikely to make a great impact. But why do it at all? Well, because a terror stalks the land: the terror of falling house prices. Governments north and south say they want affordable housing, but they are afraid of the political consequences of falling house prices. Just look at the panic headlines recently when the rate of house-price inflation faltered in England.

But falling prices are a good thing. Most politicians now realise that house-price bubble is a gross economic imbalance which has created hardship for thousands of young families and undermined the banking system. However, they are scared that a drop in prices will bring the kind of economic chaos that is happening in America. Well, get used to it, because it is coming here as well.

There is no way that house prices at 8 times average earnings can be sustained. These prices will have to come down, either through a crash, rampant inflation, or through a phased reduction in prices. House prices cannot rise forever, and the longer governments prolong the inflation the worse the consequences will be.

Government ministers have forgotten that to get out of a hole, the first thing you have to do is stop digging. Instead of desperate attempts to keep prices high, they need to introduce policies which will stabilise the economy by managing the orderly decline in house prices, which must come if we are to avoid another credit crisis. This can be only achieved by returning to the traditional lending standards of the mortgage industry.

First: restore the old building society benchmarks limiting loans to three or three and a half time income with deposits of 15%. These rules were there for a reason. Long experience had shown building societies that throwing money at people only fuels house price inflation and leads to default. Loans must be proportionate to peoples’ long term ability to pay. “Teaser rates” which keep repayments artificially low for the first two years of a loan, should also be banned.

Second: interest-only mortgages should be outlawed, as should “suicide” loans which are higher than the value of the property. Banks like Northern Rock - which the taxpayer has had to bale out to the tune of £50bn - were lending up to 125% of the value of the house. This is instant negative equity, and utterly irresponsible.

Three: end self-certificiation. It is unacceptable for brokers to connive with mortgage-seekers in misrepresenting the borrower’s earnings so that the banks can give them loans they cannot afford. Lenders should be responsible for defaults on mortgages which are loaned to people who lack the means to pay for them.

Four: end the securitization of mortgage debt. The reason sub-prime has been so toxic is because the banks sold their mortgages on to third parties, thus washing their hands of the loans. Or so they thought. Banks which make loans should keep them on their books, and should finance them out of deposits. This is the “old fashioned banking” that the Chancellor, Alistair Darling, advised banks to return to after Northern Rock.

Five: make housing an economic objective of the planning laws. At present you can build any number of out-of-town shopping centres, because they create jobs, but you can’t build houses. Houses are just as important as Tesco supermarkets. Local authorities should be given emergency planning powers to zone land for house building and ordered to provide infrastructure

Six: end right-to-buy and restore council housing. Under right to buy councils have sold off all their housing stock in the most irresponsible exercise in public asset-stripping in history. Councils should be able to issue bonds to finance homes for rent, which provide a social and environmental benchmark which the private sector will have to meet. Social housing was there for a reason: many people will never be able to afford houses, and many others in insecure jobs may not want to take on the liability of a mortgage. People should have a choice.

Seven: End tax breaks for buy-to-let landlords. Why should people who buy houses as investments be allowed to set their mortgages against tax, while people who buy to live can’t? This is what has fuelled the buy-to-let boom, and priced ordinary families out of available homes. Scrap it. Buy to let is anyway doomed as prices slide.

Introduce these measures, and within five years, house prices would be stable and affordable. People would no longer have to live in fear of their debts, and would be able to turn their attention to more productive activities than house price speculation. These are measures which any alert regulatory agency like the FSA should be enforcing as a matter of course. It is the only way of preventing the American crisis being imported here.

Of course, the mortgage industry would squeal. But the silver lining in the recent sub-prime crisis is that it has made the banks question their own practices. Lending had got completely out of control, and they realise this now. The government has the moral and economic leverage to get change. There will never be a better time to get the mortgage industry to put its house in order.


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fred barboo said...

Is this some sort of conspiratorial collusion? I assert problem, you present solution?

The depth of my paranoia is on over-drive.

Did Mr Talbot go to Madras (a school)?

Can someone lend me a down payment on a house?

Tartan Hero said...

I disagree about your analysis on shared equity. Most shared equity schemes in Scotland (Homestake) are with housing associations who have first say in buying back the house.

Homestake has been successfully used to help existing homeowners to release capital to get themselves out of debt but not lose their home.

For others, Homestake has enabled them to have a stake in their home and community which previously they did not have. There is a strengthening of ties with this stake and I wouldn't under-estimate its value to changing some neighbourhoods.