TheMadnessof MortgageLenders Housingfinanceandthefinancialcrisis ByProfessorChrisHamnett,DepartmentofGeography, King’sCollegeLondon May2009 Tomorrow’sCapitalism www.ippr.org/tomorrowscapitalism 2 Tomorrow’sCapitalism|TheMadnessofMortgageLenders Aboutippr TheInstituteforPublicPolicyResearch(ippr)istheUK’sleadingprogressivethinktank, producingcutting-edgeresearchandinnovativepolicyideasforajust,democraticand sustainableworld.Since1988,wehavebeenattheforefrontofprogressivedebateand policymakingintheUK.Throughourindependentresearchandanalysiswedefinenew agendasforchangeandprovidepracticalsolutionstochallengesacrossthefullrangeof publicpolicyissues. WithofficesinbothLondonandNewcastle,weensureouroutlookisasbroad-based aspossible,whileourinternationalandmigrationteamsandclimatechange programmeextendourpartnershipsandinfluencebeyondtheUK,givingusatruly world-classreputationforhighqualityresearch. ippr,30-32SouthamptonStreet,LondonWC2E7RA.Tel:+44(0)2074706100 E:[email protected] ThispaperwasfirstpublishedinMay2009.©ippr2009 ‘Tomorrow’sCapitalism’ Tomorrow’sCapitalismisamajorprogrammeofworkpresentedbyipprinconjunction withFriendsProvidentFoundation.Itaimstoexplorethefutureofourfinancialand economicsystem.Formoredetailsandtoaccessotherpapersfromtheprogrammevisit www.ippr.org/tomorrowscapitalism Theviewsinthispaperarethoseoftheauthoronlyanddonotnecessarilyrepresent thoseofipprorFriendsProvident. 3 Tomorrow’sCapitalism|TheMadnessofMortgageLenders Introduction:theproblem WeareallfamiliarwiththecollapseoftheUKhousingmarketsinceitspeakinautumn 2007.Housepriceshavefallen20percentfromtheirpeak,thenumberofsalesisdown50 percent–asisthevolumeofmortgagelending–andnewhousingstartsaredownby around70percenttoaprojected60,000in2009.Inaddition,mortgagearrearsandthe levelofrepossessionshaverisensharply.Thehousingmarketisintrouble. Thisisnotthefirsthousingmarketdownturnofthisnature.Sincetheearly1970sthere havebeenseveral,mostnotablythemajorslumpofthefirsthalfofthe1990swhenprices andturnoverfellsharplyfromtheirpeakof1988.Whatmakesthisslumpdifferentfrom previousonesisthatithasbeenaccompaniedby,ifnotdirectlytriggeredby,thecollapseor takeoverofdemutualisedmortgagelenderswhohadexpandedfartoorapidlyduringthe precedingdecadebyofferingverygenerousloan-to-valueandloan-to-incomeratios,funded byshort-termborrowingonthewholesalemoneymarkets.Whenthecreditcrisishitin summer2007,itbecameclearthattheywereunabletorollovertheirloansandtheyhadto turntotheGovernmentforhelp,whichledtomanybeingtakenoverorsold.Inaddition,it hassincebecomeclearthatanumberofmutualbuildingsocietieshavegotintotroubleby makingcommercialloansatornearthetopofthepropertymarketorbyenteringthe marketforsub-primemortgages. Theargumentthatthispapermakesisthatthehousingbubble,andthesubsequent collapse,oweagreatdealtotherecklesslendingbehaviourofanumberofmortgage lenders,particularlythedemutualisedlenderssuchasNorthernRock,theAllianceand LeicesterandtheBradfordandBingley,whoweredrivenbyhighlyincentivisedsenior executivesinadriveformarketshareandexpansion.Insodoing,theyabandonedmanyof theprinciplesofsoundlendingthathadguidedthebuildingsocietiesfordecadesandfailed tolearntheveryclearlessonsofthelate1980sandearly1990shousingmarketboomand bust.Theearly1990sslumpgeneratedsignificantlossesformortgagelendersandled 500,000ownerstoberepossessed. Clearly,borrowersmustalsobearsomeresponsibilityfortakingonbigmortgageswhen marketsareboomingandpricesarehigh,butmortgagelendershaveadutytoensurethat theloanstheymakearenotexcessiveandthattherisksoffailuretorepayareminimised. TotalgrossmortgagelendingintheUKrosefrom£115billionin1999to£364billionin 2007:amorethanthreefoldincreaseineightyears.Thishelpedfueltheboominprices. Thekeyquestionwhichmustbeaskedis:Aremortgagelenderscapableoflearningfrom historyoraretheydoomedtorepeatit?Atpresent,theevidenceclearlysuggeststhelatter whichpointstotheneedforstronggovernmentorregulatoryinterventiontosteerthem awayfromthispath. Theproblemsinthehomeownershipmarkethavebeenreinforcedbytheverylowlevelsof socialhousingconstructionandtheshrinkageofthesector.Sincetheintroductionofthe RighttoBuyin1980,andthesteadyshrinkageoffundingfornewcouncilhousing,Britain hasbecomeapredominantlyowner-occupiedsocietywithagrowingbuy-to-letsector.While homeownershipremainsthepreferredtenureforthegreatmajorityofhouseholds,itraises thequestionofwhetheritissensibleorappropriateforhouseholdstobuywhenthereisa distinctpossibilityofthemgettingintonegativeequityorlosingtheirhomesthrough repossession.Asignificantnumberofsmallbuy-to-letinvestorshavealsolostsubstantial sumsofmoneyhavingbeentemptedbytheprospectoflargereturnsthathavenot materialised.Forthem,buy-to-lethasbecomebuy-to-lose.Attheendof2008,some1.2 millionbuy-to-letmortgageswereoutstanding,10percentofthetotalstock. 4 Tomorrow’sCapitalism|TheMadnessofMortgageLenders Thestructureofthepaperisasfollows. •First,itsetsoutthenatureofBritain’sstronglycyclicalhousingmarketandthe previoushistoryofboomsandbusts. •Second,itrecapssomeofthekeyeventsinthehistoryofthesub-primemortgage lendingproblemintheUnitedStatesandthesubsequentcreditcrisisandtheimpacts ontheUKmortgagelenders. •Third,itlooksattheliberalisationofmortgagelendingintheearly-mid1980swhich setthesceneforthecurrentproblems.Itpaysparticularattentiontothelending practicesofNorthernRockandtheBradfordandBingley.(SeealsotheAppendix, wihcdescribestheriseandfallofNorthernRock). •Lastly,itsetsoutwhatneedstobedoneintermsofgovernmentpolicytoensure thattheproblemsdonotoccurathirdtime. TheUK’scyclicalhomeownershipmarket Thedownturninthehousingmarketwhichbeganinautumn2007wasnotasurprise.The marketwasgrosslyovervaluedandpriceshadtofalltorestoresomesemblanceof affordability.Fromthisperspective,housepricefallsarenotadisasterbutawelcome necessity.Housepriceshadrisensofarabovetheirlong-termtrendlinesince2000thata correctionwasnecessary,ashadpreviouslyoccurredinthemid1970s,theearly1980sand mostdramaticallyfrom1989to1995(Hamnett1999). Takingalong-termview,housepricesandthehousingmarkethavebeenhighlycyclical sincethestartofthe1970swhenthefirstwaveofbabyboomershitthehousingmarket. Wehavehadfourmajorbooms(1970–73,1978–79,1985–89,2000–07)andfour corrections,orperiodsofsloworfallingpricesandlowsalevolumes,ofwhichthelasttwo havebeenbyfarthemostsevere.Thefirstdownturninthemid1970s(1974–77)waspartly concealedbytheveryhighlevelsofinflationwhichmeantthatwhilerealhousepricesfell sharply,nominalhousepricesremainedstatic. ThefirstboomendedwhenChancelloroftheExchequerAnthonyBarberraisedthebank rateto11percentinlate1973tochokeofftheboominconsumerspendingandmoney supply.Thishappenedagaininautumn1989whenChancellorNigelLawsonattemptedto chokeofftheboom.Eachtime,thehomeownershipmarketslowedrapidly. Thedownturnswereallrelativelyshort-liveduntilthehousingslumpof1989to1995,which sawsalesvolumesfallfromapeakofjustover2millionayearin1988to1.6millionin1989 andalowof1millionin1993.Negativeequityreachedsome2millionhouseholds,and around500,000householdssawtheirhomesrepossessedduringthe1990s.Thissawsome commentatorssuggestingthatthehousingmarketinBritainwouldneverrecover.But,aswe know,themarketbegantopickupfrom1994onwardsandfrom1995tomid-2007national averagehousepricesrosebyabout230percentfrom£60,000to£200,000.By2007house price-incomeratioshadevenexceededtheirlevelsinthelate1980sandaffordabilityhad becomeamajorproblemonceagain(Wilcox2006). Sincetheearly1970sthepatternisoneofrecurrentboomandbust,withacycleofabout seventoeightyearsonaverage.Atthepeakofeachboomtheaveragehouseprice-income ratiohasrisensharplytoapeakofover4.3inthelate1980sand5.8in2007.The proportionoffirst-timebuyersgenerallyalsofallssharply–from55percentintheearly 1990stoalowof30percentin2003asaffordabilityproblemsbite.Thecyclicalmovement ofrealhousepricescomparedtothelong-termtrendofabout3percentayearisshownin Figure1below. 5 Tomorrow’sCapitalism|TheMadnessofMortgageLenders Figure1.Real houseprices, Base : 2009 Q1 Trend Real House Price £210,000 1975–2008 Trend from 1975 Q1 to present Source:Nationwide £190,000 Trend = c2.9% per annum BuildingSociety £170,000 £150,000 £130,000 £110,000 £90,000 £70,000 £50,000 £30,000 1975 Q1 1977 Q1 1979 Q1 1981 Q1 1983 Q1 1985 Q1 1987 Q1 1989 Q1 1991 Q1 1993 Q1 1995 Q1 1997 Q1 1999 Q1 2001 Q1 2003 Q1 2005 Q1 2007 Q1 2009 Q1 Theforgottenlessonsofthe1990sboomandbust Thecurrenthousingmarketslumpandtheproblemsfacingmortgagelendersfromthe riseinmortgagearrearsandrepossessionsarenotunique.Between1990and1993the fivelargestmortgagelenders,theHalifax,Nationwide,Woolwich,andLeedsBuilding SocietiesandtheAbbeyNational,experiencedadramaticworseningofprovisionsforbad debtsandwrite-offs.In1990theircombinedprovisionsforbaddebtsonresidential propertytotalled£164millionbutby1993thishadrisento£1,278million.Taking1992 and1993togethertheirjointprovisionstotalled£2.38billionandtheirwrite-offsjust over£1billion.Theirprofitsfellbymuchless,largelybecausetheywereabletooffset thelossesagainstmortgageindemnitypolicieswhichgaveprotectiontolendersforthe first25percentoflossesarisingfromloandefaultsandrepossessions.Thecostofthe lossestotheinsurancecompaniesrosefrom£48millionin1990to£1.37billionin1991 (Stephens1996). Governmentintervenedtotemporarilyraisethethresholdforstampdutyfrom£30,000to £250,000foreightmonthsin1992andin1993itdoubledthethreshold.Wesawsimilar changestostampdutythresholdsin2008inanefforttoreducetransactioncostsand stimulatethemarket. So,whatmakesthecurrenthousingmarketslumpsodifferent?Theanswerissimple:the shortageofhousingfinanceandthenearcollapseoftheprivatehousebuildingmarket asaresultofthedryingupofpurchases.NationalHouseBuildingCouncilfigures suggestthatthelevelofnewhousingstartsinthethreemonthstotheendofFebruary