First Time Buyers

First time buyers now account for only 15 percent of new mortgages. Nevertheless, the number has recovered slightly relative to a year ago.

How should we interpret the increasing proportion of first time buyers? Overall, mortgage activity is a fraction of what it was before the crisis. There are few signs of a sustained recovery in lending.

At the same time, lending rates are at an all time low, and prices appear to have stabilised. The combined effect of lower rates and remortgaging has reduced mortgage costs for existing home owners. This has kept a cap on arrears, which have stabilised at around 3 percent of all mortgages.

Economic policy has long favoured debtors at the expense of savers. It has favoured homeowners over renters, and speculators over producers.

Mortgage approvals stagger on

I am going to quickly run through all my favourite charts. Lets see what has been happening while I was away.

Mortgage approvals seem to be drifting along at around the 50,000 a month mark. That is well down on the pre-crisis numbers. Back then, a typical month would see almost three times that many mortgages approved.

Perhaps 50,000 might represent a reasonable non-bubble level for mortgage lending. Normality in the housing market - now that is a radical thought.

To fix or not to fix

Fixed rate versus floating rate mortgages - which would you choose?

Being a renter, this isn't a question that holds my attention.

However, I do detect a treacherous little uptick in recent mortgage rates.

Do we have a trend

The Bank of England has just begun collecting data on mortgage acceptances. At the moment, banks approve around 75 percent of applications. It is up slightly from December 2009, when around 72 percent of applications were approved.

Are we seeing the beginning of a trend in approvals?

A newsletter - the right strategy to fight mortgage fraud

This is so "UK 2009".

Faced with a explosion of mortgage fraud, the FSA sets up a National Fraud Strategic Authority. Do we see a sudden increase in police activity leading to the arrest and prosecution of offenders.

Oh no, we get nothing like that. We get a newsletter. Excuse my cynicism, but there is now irrefutable evidence of mortgage fraud in parliament. Of course, don't expect anything from the FSA, or the police. They are too busy producing their NFSA newsletter.

Here is an except. Read on if you dare, because if you do, you will despair for the future of our country.

In July we (FSA) revealed a series of initiatives that we are putting in place to tackle the growing problem of mortgage fraud. It’s a programme that requires close cooperation with regulators, law enforcement, firms and the newly established National Fraud Strategic Authority (NFSA).

The NFSA aims to coordinate the public and private sectors effort to make the UK a hostile environment for fraudsters. This is of particular importance at a time when firms believe that financial crime is on the increase, as shown in the results of this year’s financial crime perception survey, which also attempts to measure how successful we are in tackling financial crime.

The housing equity economic cycle

There is something sad about our dependence on home equity withdrawal. When it goes up, the economy booms; when it goes down, the economy dives into a recession. Our economic fortunes have become utterly dependent on whether house prices rise sufficently quickly for home owners to borrow and consume against their imagined increases in housing wealth.

However, under New Labour this dependence on home equity withdrawal reached grotesque proportions. The government and the Bank of England have risked everything on stabilising house prices and re-establishing household sector credit growth. They have forsaken fiscal stability, cut interest rates to almost zero and started to print money. Yet despite every crazy policy gesture, home equity withdrawal has not recovered.

Over a third of UK mortgages have an income multiple of 3 or more

Limiting mortgages to income multiples of three or less would have a dramatic effect on house prices. Currently, well over a third of new mortgages have income multiples of greater than three. At least 10 percent have multiples of four or more (mostly to single buyers).

The FSA's plans to limit income multiples would make it much harder for housing bubbles to form in the future. Since mortgage availability would be linked to incomes, house prices would also be anchored by borrower's capacity to repay.

Limiting income multiples could be the first good idea that the FSA has produced.

one in twenty "together" mortgages in arrears

(click on the table for a larger image)

I cut this table out of the Northern Rock annual report. It tells us three things;

Arrears on NRK loans are significantly higher than industry averages;

Arrears rates are getting worse;

Almost 1 in 20 "together" mortgages are in arrears.

The NRK loan book is rotten, and it belongs to the UK taxpayer.

Whatever happened to the 2 year 95 percent LTV mortgage

The Bank of England used to keep a data series tracking the interest rate on two year 95 percent LTV mortgages. After May last year, the data is blank. Presumably, banks simply stopped offering them.

They were getting rather pricey before they died. The last data point was 6.9 percent.

Northern Rock pocket 10 percent bonuses

Question: What is the price of failure in the UK today?
Answer: It is a 10 percent bonus, while the taxpayer is covering the loses on your loan book.

Come on, admit it; when you saw this story about Northern Rock staff getting a 10 percent bonus, you smiled. It is so ridiculous that you can't get angry.

This is Britain; financial services rule. Everyone else travels second class. Even state owned banks need their bonuses.

Government expenditure - just how bad is it?

In yesterday's posts looking at UK government expenditure, one of my regular readers - young mark - had a request. He wanted me to post a chart looking at total government expenditure as a percent of GDP. He thought that simply looking at the nominal growth of expenditure was misleading.

I was happy to oblige. Here is the chart - total managed government expenditure expressed in terms of GDP. I chose to start the data from the 1999-2000 fiscal year. When New Labour were elected in mid 1997, they promised to keep to the previous government's expenditure plans for at least two years. Therefore, this chart begins when New Labour started to develop their own expenditure plans.

The chart tells a very stark story. Back in 2000, the public expenditure to GDP rate was 36 percent of GDP. This year, it will hit 42.6 percent. Next year and the year after, it will rise to 44 percent. So by the time, the Brownite dictatorship will fall, the share of the public sector in the economy will have grown by about 8 percentage points.

Here is the rest of young mark's comment:

"You may also like to consider that the Government was elected three times on a clear mandate of raising public expenditure in order to improve public services. In other words, the public got what was on the tin.

I notice a number of posters have claimed that the increased expenditure was entirely wasted. Where is the evidence for this? The Wanless report into increased NHS funding certainly did not draw this conclusion."

The boy has a fair point here. We asked for it, and we got it. We voted for big government and Brown delivered.

However, what about young mark's last challenge. Is there any evidence out there that public expenditure increased waste? So come boyzzz, give me your worst examples of Brown's blow blowout binge of useless spending.

I will start the ball rolling with my favourite - the millenium dome.

Buy to let - investors keep piling in

It is hard to believe, but the number of buy to let mortgages increased in the third quarter of 2008. The total number of BTL loans stands and 1,134,000. BTL investors now account for 11.1 percent of the mortgage market.

The warning signs for BTL investors are screaming red; house prices are falling, and so are rents, why would anyone jump into such an investment? Can someone help me here?

UK Mortgage approvals down over 60 percent

It is important to keep a sense of perspective about the credit crunch. It is not the case that credit has dried up completely. In August, banks handed out over 40,000 mortgages to people buying homes.

Banks have simply tightened up their lending criteria. If you want a mortgage today, you better convince the bank that you can pay them back. That means a big deposit, some credible proof of income and a house purchase that doesn't leave you crushed under a ton of debt. In fact, the credit crunch is really a return to prudent old fashioned banking.

The really worrying thing about the credit crunch is that sustainable economic growth in the UK seems to be inconsistent with responsible banking practices.

Bonus time is just four months away

Christmas is just four months away. Along with Santa, dried out turkey, and crap TV, it is bonus time in financial markets.

Here is an interesting question; do you think the banks are going to pay out any bonuses this year? It would be hard to justify any payouts, given the appalling performance of the share prices of financial institutions.

I reckon that despite everything that has happened in the last year, we are going to see the same obscene greed raging in the city of London that we see every year.

Dealing with the shock

There is no need to speculate about Lehman any more; it has gone. Here is my quick list of post-Lehman issues.

A rate cute?

Will the Fed cut rates again? There is some speculation that Bernanke might make another panic-stricken response to another financial crisis. However, would it matter much if the Fed did knock off another 25 to 50 basis points off rates?

The situation is too far gone. Previous rate cuts actually did more harm than good. It spooked markets; and created a general atmosphere of fear that hasn't dissipated. Previous rate cuts did nothing to revive the US economy and actually contributed to higher inflationary pressures.

Cheap money didn't save Lehman and it won't save Washington Mutual.

Where is the consistency?

Why did the US authorities bail out Bear Stearns, but throw Lehman to the wolves? It is possible to cobble together an unconvincing story about Bear presenting more systemic risk that Lehman. Nevertheless, decision-making at the Fed does seem arbitrary.

Previously, the thinking was that the Fed would come to the rescue if a major bank were in trouble. Now, we know that is not true. However, no one knows the criteria for a bail-out. Risk premia will rise accordingly.

Who is next ?

There are some fairly obvious names out there. Next weekend could be just as hairy as the last one.

What about the UK banking system?

The UK housing bubble was far larger than anything experienced in the US. UK household are far more indebted; and there was much more buy-to-let speculation here than across the Atlantic.

Around 20 percent of the UK labour force work in finance or related activities. When the banking crash really takes off here, the economic fallout will be directly on GDP.

When the crash really takes off; things will be worse here than in the States.

The fire sale

The Lehman experience taught other banks one very harsh lesson. Rebuild capital now; because if you don't, bankruptcy is a really possibility. Since further capital injections from investors now seem highly unlikely, banks have only one other option; sell assets. The simple laws of supply and demand are about to take over. If everyone is selling, then prices must come down.

Mark-to-market accounting will make things worse. As bank-held assets fall in value; bank balance sheets will suffer. Since banks have only the slimmest of capital, the fire sale could put many banks into technical insolvency.

Is there a way out of this mess?

Yes, but it is painful. The US banking sector needs to be restructured. Bad assets need to be separated from good ones. The quicker this is done, the better. The simplest way of doing this would be to set a minimum capital adequacy standard. Any bank falling below this limit would be automatically nationalized; the share holders wiped out and all bank assets written down. Once the bank is cleaned up, it is privatized via an IPO type sale.

Home loan approvals down by half

According to the Council of Mortgage Lenders (CML), home loan approvals in July are down by about half compared to last year.

In response to thisrapid reduction in lending activity, the CML director general, Michael Coogan, made a rather curious statement:

"Tighter lending criteria have clearly made it more difficult for first-time buyers to enter the market. The stamp duty and shared equity measures announced by the government last week will be helpful to those first-time buyers looking to enter now, but many may be waiting for house prices to stabilise.

“Restoring the flow of funding to the mortgage market is crucial to helping the housing market recovery and we look forward to the findings of the Crosby Review at the end of the month."

So what exactly is he saying? His members in the CML have made it hard for first time buyers to get loans. However, the government is about to sort things out by reducing taxes and providing subsidies to anyone might be thinking of buying a home. Nevertheless, even these "generous measures" might not do the trick because house prices are falling.

His second comment is even more ominious. He says funding to the mortgage market needs to be "restored". In other words, he wants to see a return to the huge flows of bubble-financing that pushed house prices to their current unaffordable levels. He doesn't say who needs to "restore the funding" but gives a strong hint when he says that he is looking forward to the Crosby report, which will be published later this month.

Why is the CML so keen on the the Crosby report? I am going to take a wild guess. This report is going to say that mortgage market needs direct support from the public sector. A "housing market recovery" demands more cheap liquidity from the Bank of England; more tax breaks; and less stringent financial sector regulation. In other words, the CML wants the taxpayer to put a floor under their profitability.

Coogan and his mates in the CML have completely misunderstood what is going on right now. The housing market is recovering; prices are falling nicely; banks are deleveraging and therefore posing lower risks of a financial crisis; and personal sector debt levels will eventually start to come down. This are all good things that need to be encouraged and not hindered by the callous self serving demands for help from the CML.

The CML have not yet taken on board the fact that there is no possibility of reviving the bubble. It has gone; it is all over. The UK economy is in clean up mode, dealing with the consequences of the CML and their collective irresponsibility.

Free money

Why didn’t someone think of it before? It is so obvious. The logic is so simple. If the housing market is collapsing from a lack of credit, then why doesn’t the government step in and offer free loans to first time buyers. Problem solved. As soon as the money comes on line, house prices will stabilize. First time buyers will come flooding back into the housing market, waving their free loans at risk-averse banks.

How did Brown and Darling justify this extraordinary generosity? In announcing their housing rescue package today, three themes kept cropping up; the first two were explicit while the third was implicit.

Give me the confidence

Confidence was the first theme of the day. With the onset of the credit crunch, Brown claimed that people had lost confidence in the housing market. Banks, buyers and sellers were all trapped in a crisis of self-doubt and uncertainty. Banks wouldn’t offer credit; buyers without credit could not make viable offers, while sellers had not reconciled themselves to lower valuations. The government’s housing package will put a floor on prices, this would buttress confidence, and gradually things would return to “normal”.

Help the home buyer

First time buyers were the second prominent phrase of the day. The government package intended to clear the path for those starting out on the long road to property ownership. Hazel Blears was on the TV this morning, talking like an estate agent. She told viewers that the new measures would allow young people to get a footing on the property ladder.

Housing inflation equals economic growth

The third big idea was rather more implicit. No one said it directly, but hinted that the economic growth depended on a thriving housing market. Kirstie Allsop came closest to pointing out the connection on Radio Four Today, when she offered support for the government’s plan. She pointed out that without housing transactions, people stop buying white goods; furniture gathers dust in the storerooms, while plumbers and builders remain unemployed. Therefore, the revival of the housing market is essential if the UK economy is to keep on growing. This theme can be expressed in starker terms; we all benefit from housing inflation, even those who are priced out of the market, because housing bubbles hold up economic growth.

Ineffective, costly and possibly both

None of these themes can withstand thirty seconds of serious scrutiny. Take, for example, the confidence and the government’s capacity to hold up prices with free credit.

In order to stabilize the housing market, the government would have to offer massive amounts of free money. A few simple numbers will prove the point. Between March and July this year, the total outstanding amount of mortgages outstanding owed to Banks fell from ₤559 billion to ₤546 billion – shortfall of ₤13 billion. Assuming a five percent interest rate, the government would need to supply ₤650 million in order to make up the shortfall in just four months. Simply put, the free loan scheme will either be ineffective or astronomically expensive. It might also be both. However, it will not put a floor on house prices because the government does not have the resources to supplant bank credit.

Will it help first time buyers? It might help a few, but the vast majority will be left worse off. Suppose the government offered ₤30,000 interest free loans to 20,000 home owners, the government would need to supply ₤600 million worth of credit. The number 20,000 represents one month’s shortfall of mortgage approvals this year relative to 2007.

To put it mildly, 20,000 doesn’t really begin to cover the number of bitter people who have been shut out of home ownership due to the bubble. Besides, first time buyers were receiving huge assistance from falling prices. It is hard to see how stabilizing prices at the current inflated levels helps anyone trying to buy their first house.

Turning to the third, implicit theme; does the UK economy need the housing market so badly that the government should try to subsidize grotesque house prices with free credit? Are we really that dependent on inflated property values? These are the wrong questions to ask. A better one would be how should the government act to unwind the UK’s extraordinary vulnerability to its property market? It is a difficult question, and it is hard to see an answer that does not include some kind of significant slowdown in economic activity. Since this question only offers difficult answers, the government prefers to hide behind a seemingly simpler task of holding up property prices.

Get prices right and everything will be alright (eventually)

The first crucial step towards solving any economic problem is to get prices right. Once effective demand equals supply, incentives are properly aligned, and markets will perform reasonably well. If any government interferes and sets up a policy based on sustaining misaligned prices, then it is only adding more difficulties upon the existing pile of problems. House prices are misaligned from long run fundamentals. In order to purchase a house today, home buyers need huge loans that place an unbearable burden on long term personal finances. Banks are no longer willing to supply credit because they have finally come to realize that default risk has risen to unacceptable levels.

Delaying the inevitiable

New Labour is unwilling to recognize this reality. Instead, it offers another misaligned price; zero interest loans in order to sustain overpriced property prices. Brown and Darling can harp on all day about confidence, help for first time buyers and the weakening economy. This package will only delay the inevitable.