Subsidised Mortgages Are The Wrong Answer To The Housing Crisis
In Money Week, Matthew Lynn argues that subsidised mortgages are the wrong answer to the UK's housing crisis.
True, these are fairly desperate times for the Chancellor George Osborne. Growth is stagnant, and the economy may slip back into recession next year. The euro-zone could implode at any moment. The deficit targets look likely to be missed.
Still, even desperate men have little excuse for making a bad situation worse. In an attempt to get some favourable headlines, and to make the outlook seem a little less bleak, the government this week unveiled proposals to guarantee mortgages for first time buyers, and so help more people onto the housing ladder.
It is a terrible idea. In the US, it was the political push to turn people who couldn’t really afford to buy a property into home-owners that led up to the sub-prime crisis. Extraordinarily, the UK has decided, only three years after the crash, to repeat the policies that led up to the credit crunch.
It is certainly the case that twenty-something’s face bleak prospects right now. The jobs market is tougher than ever, and house prices still look high by any historical standards. Many of them face paying expensive rents for years, and won’t be able to start building up equity in their own home until they are in their late thirties or even forties. Whilst their parent’s generation might have expected to have largely paid off the mortgage by the time they hit fifty, this generation will still be burdened by huge monthly payments just to keep a roof over their head even as they approach retirement.
Interest rates are at a three-hundred year low and don’t look likely to go up any time soon, but that is not much use if you can’t get a loan. The lenders are demanding huge deposits – at least 20% of the purchase price of the property, and more like 40% if you want to get a decent rate of interest. With the average house price now £232,000, that means getting together a deposit of £46,000 – a struggle on most wages, particularly when there are student loans to pay back as well.
In response, the coalition has come up with a scheme to help. On Monday, it announced the government will guarantee part of the mortgage for first-time buyers, so that the banks can offer loans closer to 100%. If there is ultimately a loss on the loan, the government will be on the hook for it. It is, in effect, a subsidy. Any kind of guarantee reduces the cost of lending below what it would be in a free market. Government money is being used to reduce the price of something – and that is a subsidy.
And yet the history of subsidised mortgage lending is well known.
In the Great Depression of the 1930s, the Roosevelt administration created the Federal National Mortgage Association, known and Fannie Mae, to help local banks make more mortgages available, and so increase the supply of affordable housing. Over the decades that followed, the US government got more and more involved in ‘guaranteeing’ mortgage finance for the banks. Fannie Mae was joined by Freddie Mac in the 1970s, as the government tried to make mortgage loans available to everyone, regardless of whether they could afford them. As state-back entities, they encouraged lenders to view mortgages as if they were as safe as government bonds.
The result? Disaster. There were many causes of the sub-prime mortgage bubble in the US, including greedy bankers and gullible home owners, but the determination of the government to widen home ownership, and to subsidise mortgages to help achieve that, was clearly one of them.
Admittedly, the UK scheme does not go as far as that. There are restrictions. The loans are limited to first-time buyers, and the government’s potential loss will be restricted to the 20% stake they guarantee.
The trouble is, bad ideas always start small, and then they grow and grow. It will be hard to draw the line at first time buyers. What happens to people who buy a property on a state-backed mortgage, then need to move for a new job, or need a bigger house when they have children? They will need another subsidized loan. In a few years, we’ll be hearing complaint about how the scheme restricts labour mobility and stops people starting families. It will be extended to everyone.
After that, why stop at 20%? It will only make a small dent in the problem. In time, the government will end up under-writing the entire mortgage industry.
That, surely, is a mistake.
There is a reason why lenders are now reluctant to offer mortgages to many people in their twenties. The jobs market is too insecure, and their earnings prospects too poor, to make many of them a reasonable risk.
And there is a reason for demanding a 20% deposit. House prices still look high in the UK, even if rapid inflation is starting to bring them down in real terms. They could easily fall by 10% or perhaps 20% in the next few years, particularly if the Bank of England has to start raising interest rates to control inflation before we have emerged from this recession. Lenders need a substantial amount of equity in a property to make sure they are protected against that.
There are plenty of things the government could do to make property more affordable. Relaxing planning restrictions to allow more homes to built is a good idea – more supply will mean lower prices. It could open up more competition in the mortgage market. Or it could lower taxes so that people kept more of their wages. If homes were cheaper and people had more money then we wouldn’t have an affordability problem.
But, in the end, if people can’t really afford a home then it is better not to subsidize them. A distorted market is one that stops working properly – and that is always dangerous. The UK has just taken the first step towards its own sub-prime crisis – and that surely is the last thing we need.