Saturday, 25 October 2008

Average mortgage loans down 19 percent

For me, it is the contradictions that I find really irritating.

For example, we know that today's crisis is due to bankers handing out huge risky loans to overstretched borrowers. In extreme cases, loan to value ratios exceeded 100 percent.

We also know that this huge surge in credit bid up house prices, and encouraged speculation, with the buy to let scam being the pinnacle of this financial idiocy.

Last week, we heard from a chastened Financial Services Authority, who told banks that there was going to be no more Mr. Nice Guy. From now on, the FSA are going to get serious about bank regulation.

Then, we have the chart above. It suggests that the banks might have actually learnt something in the last six months. The average size of a mortgage loan is down 19 percent in the last six months. This decline is far quicker and deeper than the decline in house prices. This implies that loan to value ratios are becoming more prudent.

Yesterday, we learnt that the UK is in recession, a fact that was accompanied by the usual demands to cut interest rates. Moreover, the cause of the GDP decline was the housing crash. In particular, the sudden contraction home equity loans has cut back consumption, coupled with a growing awareness among homeowners that they weren't quite as rich as they thought.

Here we come to the contradiction. In order for a rate increase to work, the house prices would have to start to rise again. However, this implies rising debt levels, higher loan to value ratios and higher banking sector risk.

This doesn't sit easily with the FSA's promise to tighten up regulation. If banks are to improve the quality of their balance sheets, risky lending has to stop. Cutting rates while banks are cleaning up the mess strongly suggests that rates won't actually do much to boost output.

I don't wish to trivialize the pain of a recession, but the UK economy has entered a painful adjustment. To their credit, banks are beginning to understand this, and they have taken the first tentative steps towards recovery. Households are also starting to understand that personal debt levels need to fall, and consumption is falling back to more sustainable levels. This has inevitably led to a fall in output.

Even if rate cuts did work, with credit increasing, the housing bubble reigniting and output recovering, inflation would pick up. Somewhere down the road, the BoE would have to choose between a renewed round in rate hikes, which could re-ignite banking sector difficulties, or it would have tolerate permanently higher inflation rates.

What we need now is patience. We need to let the economy recover. It will take time for households to cut back their debt levels, and for banks to reduce their leverage ratios and clean up their balance sheets. What we don't need right now is some desperate short term measures that will interrupt this recuperation.

The only people who haven't "got the memo" are journalists and politicians.

12 comments:

Suzi Orman said...

I don't wish to trivialize the pain of a recession, but the UK economy has entered a painful adjustment. To their credit, banks are beginning to understand this, and they have taken the first tentative steps towards recovery. Households are also starting to understand that personal debt levels need to fall, and consumption is falling back to more sustainable levels. This has inevitably led to a fall in output.

RenterGirl said...

I agree that personal debt levels were too high, but isn't always down to greed and conspicuous consumption. Wages were low. Increases were below inflation. Some people felt obliged to buy petrol and food on credit. It was always going to end in tears, but that debt mountain didn't all go on shoes and trinkets.

Nick von Mises said...

If you spend more than you earn it means your sense of entitlement is too high. It's no excuse for going into debt to say you wanted a higher standard of living than you had earned.

People don't want to face the fact that Britain isn't as rich as they want it to be, and that they aren't either. But that's what happens under socialism - taxation and government interference progressively allocates capital away from its productive uses, so total wealth creation falls, so the country gets poorer.

They try to cover up the effects by ramping up the debt load. Then it crashes.

So colour me unimpressed by the "I didn't earn it but still wanted to spend it" line.

Anonymous said...

I obviously need to go through my understanding of matters again. I was under the impression that the whole system is dependant on a permanently increasing debt level, with inflation being hopefully at a low but positive value.
So how exactly can we pay down the debt this being the case ? I understand the problems come from excessive debt, but if the value can't shrink....
Do you mean that we don't take anymore debt on until wages catch up to debt levels, as in general inflation catches up to house price inflation?
Sorry to be dumb. Is it possible to pay down debt? I thought that the net creditor countries such as Japan were such because they were holding foreign currencies, but all money being debt so for example, yen debt is held by the government.

Mark Wadsworth said...

This implies that loan to value ratios are becoming more prudent.

... that depends on house prices; all things being equal, if loan sizes are down 19% and house prices are down 13%, that could mean: average LTV down from 90% to 84% (not a huge difference); if could mean that nobody is buying/selling big houses any more but people are still buying/selling cheaper properties with the same high LTV's.

@ Rentergirl, about 85% of the debt bubble was related to rising house prices (and we can include MEWing in that category). Sure, some poor sods have unsecured loans, but they only make up 15% of total household borrowing.

Anonymous said...

Totally disagree, you misunderstand, any LTV adjustment has a hugely disproportionate effect on prices.

90% LTV -> 84% LTV.(HUGE DIFFERENCE)
Typical deposit 20K.

So first scenario affordable house price would be 200K.

Second scenario affordable house price would be - 125K -.

Decreasing LTV even slightly kills the housing market stone dead. Thats not an adjustment.

Anonymous said...

On the series of LTV.
5% 10% 20%

For each of those adjustments the house prices would halve, i.e. 5->10 house prices halve. 10->20 house prices halve.

Going from 5% LTV to 20% LTV, which is what the banks have done, actually quarters the amount you can, and so basically quarters housing prices. 75% off !

CWS said...

only down 19 percent?

K said...

Thank you for your comments and post. I think that a mortgage will always have issues and questions, so it's good to stay abreast on the lates issues.

Anonymous said...

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