Wednesday, 16 June 2010

More Meddling

Rules do not solve things. They just make more problems. So I'm not overjoyed to hear about the new rules for stopping banks from ever doing silly stuff by, err, not letting them lend us more than 75% of the value of our homes. Apparently, we need to limit loans to 75% because:
The collapse of Northern Rock was widely attributed to its policy of lending customers up to 125 per cent of the value of their homes – despite the inability of many to repay the loans.
Hmmm. Let's look at that sentence. Two adverse factors are listed:
its policy of lending customers up to 125 per cent of the value of their homes
the inability of many to repay the loans.
I wonder which one might have been the problem? Let's try a thought experiment to see if we can find out. Let's just correct one at a time and see how much that helps. So, all of you, would Northern Rock still have gone under if it had:
Lent customers up to 125 per cent of the value of their homes, provided that they were clearly able to repay the loan
or if it had:
Lent customers up to 75 per cent of the value of their homes – despite their inability to repay the loans
I'm thinking that the main problem was perhaps that the customers couldn't pay off the loan? Maybe?

I speak as someone who has in the past borrowed 90% of the house value. Indeed, the lowest I have ever borrowed was for my current house, and was 75.24%. The 90% loans didn't get me into trouble, even during two periods of declining house values, because I made sure I could afford them first. I did this by at no point ever taking the maximum loan that the building society was willing to lend me. Each time I have moved, I have looked at that figure (and the associated repayments), turned a pale shade of white, and re-done my sums based on about a half of that amount. If that meant choosing somewhere cheaper, then so be it.

It's not the value of the loan compared to the house that is the problem. It's the value of the loan compared to the income. Duh.


  1. "It's the value of the loan compared to the income."

    It's not even that, it's the cost of the interest in relation to the income. I borrowed a huge multiple of my salary at a very high loan-to-value ratio. Before I did so, aware of the unusualness of my leverage, I experimented with possibilities such as "what happens if base rates go to 7%?" and "what happens if I have to take a job which pays a bit less?". I wouldn't have borrowed the money if I had not been able to meet the interest payments.

    The banks are only one of the parties to blame for the sub prime mess. Borrowers of stupid mortgages must accept their share of the blame as should banks who didn't bother to check whether people could afford to service the debt.

  2. It's not the value of the loan compared to the house that is the problem Err, it is when it comes to repossession.

    May I* point out that the UK domestic mortgage market is highly competitive. Mainstream margins are thin and repossessions are costly. So the more aggressive players (which are the ones that get into trouble as they grow their loanbooks too swiftly) offer people the most generously sized mortgages that other players would not in order to secure the business. Furthermore, if they have business on their books that other people would not touch with a barge pole, hence it cannot be transferred, these wide-boys will then hike up the rates and any fees. These charges can jeopardise people's ability to service their loans.

    Also, to further complicate matters, if you have a loanbook declining in size, increasing bad debts will play havoc with your ratios. The result of this is that the more speculative players in the market will look to write business at almost any cost in hard times and bet your bottom $ (or £), if bad debts are rising, the volume and quality of business is declining as people are losing their jobs.

    We all have vested interests (there may be macroeconomic reasons regarding the housing market for this), but few probably have the same job security as you, Patently.

    So you may be right, of course, in theory but you are not allowing for the mavericks in the market. Imposing a rule on loan to valuation is probably going too far. Perhaps a rule of thumb would be a better approach. Btw I am so pleased the Bank of England is getting her powers back. That Old Lady has always been a wise bird and has quietly bailed out some mortgage companies in her time without creating the calamitous conditions that surrounded Northern Rock.

    *I use to be a financial analyst so I could wax lyrical but I won't and I will keep it simple.

  3. I've only had two mortgages, and the first strictly limited to not more than two and a half times salary and not more than 75% of the house value. I could have had more when I took out the second, but I restricted myself to the previous criteria which I had found comfortable. In both cases, like you, I did the various calculations as to what might happen if interest rates changed.

    One problem is that large parts of the population don't understand percentages or compound interest. Too few appreciate if the interest rate they are paying rises from say 4% to 5%, the interest they are paying out has not gone up by 1% but by 25%!

  4. Up to 7%, Blue? My first mortgage offer was at about 7%. Then, while we were negotiating, it went up to 10%. Then 12%. Then, overnight, to 15%. Maybe that explains my subsequent caution, and my dislike of the ERM and the "closer European ties" that followed it. Black Wednesday? Great fun (not!)

    M - yes, I'll agree that the LTV ratio is highly relevant if you have to default. My planning has always been based on the assumption that a default was to be avoided at all costs, though.

    I'll agree that my job is relatively secure; after all, I'm unlikely to sack myself. However, the income from it is not - at the moment my taxable income is half what it was when I took out my current mortgage.

    EP - two and a half is a good rule of thumb, I think. I think you may have a point about the level of understanding of rates!

  5. Different era, P! Your 15% was of a much smaller capital sum. My flat was sold in 1990 for a tenth of what I paid for it in 2007.

    Measured - fixed rate deals avoid the shenanigans.

  6. Precisely, Blue.

    And the inflation in the price of your flat is purely due to the greater buying power afforded by the lower interest rates, chasing the same housing stock. Yet the price is still real money that you have to pay in the end. For that may we all give thanks to Gordon the bountiful, ender of boom and bust, ignorer of all matters economic.

  7. The only bit I object to is where they print government debt (a la the 'special liquidity scheme') and use it to buy your (now securitised) mortgages.

    When they did this they told us they were swapping 70-90% government debt for 100% AAA rated mortgage debt, and that the AAA rated mortgage debt was worth something, only that there was 'no market' for it. (Funny how there was still a market for other debt, like T Bills or Vodafone debt)

    Now the lending industry, through the CML, are saying that unless they 'extend' the SLS there will be a massive 'funding gap' (i.e. house prices might fall). So you have to conclude that the AAA rated mortgage debt was actually worthless.

    The other thing is, if they do extend it, we have to account for the few hundred billion in government debt we printed as government debt under Maaschrict rules.

    If we're going to 'print' anything and sell it, why not just print more residential planning permission and auction it? Why? Becauce it'll piss off the homeowning NIMBY's.