Why did the banks go mad on mortgages? The answer lies with write-offs. For many years, mortgages have been a remarkably riskless activity.
Although the amounts of mortgage write-offs have crept up in recent years, the overall level remains rather low. For example, in the first quarter of this year, banks wrote off just ₤35 million.
Credit card debts are a very different matter. Banks have been writing off around ₤600 million a quarter. This goes a long way to explain those huge interest rates on credit cards.
Write offs on other loans, which includes credits to companies and small businesses is also creeping up. In a typical quarter, commercial banks write off around ₤700 million.Why were mortgage write-offs so low? Higher property prices have concealed repayments difficulties and kept repossession rates down. If a borrower found it hard to repay their mortgage, higher property prices invariably ensured that the borrower had accumulaed some equity. Therefore, it was easy to sell and repay the bank rather than default. Even when banks were forced to repossess the house, the subsequent sale usually covered the initial mortgage. In summary, with rising property prices, banks simply couldn't lose money.
That has now changed. Prices are crashing and the option of a quick and quiet sale is no longer available to distressed borrowers. Just watch and wait; mortgage write-offs are about to explode.
20 comments:
Right chart, wrong conclusion. Write-offs are low because people can pay their mortgages. Underlying this point is low interest rates, which makes housing affordable. This is why the current fall in prices is a blip. Once the credit crunch slips away, and mortgages become available again, the market will recover, and prices will again begin to climb.
My house price predictions - a modest recovery in prices in the autumn and a boom year in 2009.
LEA, can you please link to some economic or demographic data which would explain why you believe the long-term real estate price to earnings ratio is destined to stay well beyond the average ratio effectively in perpetuity?
OMG and Estate Agents wonder why people snigger at them.
Alice, can you redo the first chart with cumulative write-offs as a % of all mortgages?
Thanks LEA, you brought a chuckle to my otherwise uneventful afternoon.
I'm sure you aren't as retarded as you make yourself out to be.
Default rates on mortgages have been tiny because prices were rising rapidly - far more rapidly than interest rates. Hence, merely owning a home has, for many years, guaranteed that you can repay the mortgage on demand. This is no-longer the case.
Your claim that interest rates are low, however, make me suspect that you are not, in fact, an estate agent. Compared to 5 years ago, interest rates are high - and could easily be forced higher still.
Mark,
I could try. Let me think about it. It might make more sense to plot current write offs and current mortgages.
Alice
Asteve, there is no need to get offensive. I recognise that interest rates have risen and that mortgage availability has tightened. This has, obviously, affected prices. However, my point was slightly different. Within a comparatively short period, rates will come down, and availability will improve. Once that happens, prices will recover and continue to grow. Much like they have for the last century, where prices have basically doubled every ten years.
What, exactly, suggests to you that interest rates will "come down" - within a "relatively short period" or otherwise?
Absolutely nothing suggests that to me. The only justification I can see for significantly falling central bank rates is the realisation of a massive global depression threatening a deflationary collapse... which, in turn, would be devastating for the housing market (as every market) whatever the central bank rate might be.
What you appear to fail to grasp is that the past decade or so has been extraordinary with respect to mortgages. UK debt has been financed short-term by foreign investors... who, by the miracle of derivatives (and the incredibly inept and/or corrupt FSA) were able to take highly leveraged positions with minuscule margins without making a loss. The long-run mean mortgage rate has been 8% - I expect it to settle at that level in the medium to long term. In the short term, I'd not be surprised to see mortgage rates exceed that level - just as they did in 1992.
The markets will return to "normal"... but this won't be the sort of normal that people have become accustomed to expect in recent years.
Correction: please substitute 199x where 0<x<6 for 1992.
Banks thought they could get away with this fiction of not writing off because the loans were securitised anyway.
The prevailing belief in the City had been that: not only were house prices rising, even if they did fall, the banks had offloaded the risk. So, there would be no huge writedowns for the banks.
This is false for three reasons:
1. Litigation: banks are being sued left and right.
RBC Case
Paramax case
Have a look at the Paramax case above. Cases like this one are going to happen a lot more in the future.
2. Drinking the Kool-Aid: Even after offloading the original mortgages, the bankers bought too many mortgage derivative stuff themselves: CDOs and RMBSs.
3. Puts: There are many covenants in RMBSs that state the loans can be put back to the bank in certain circumstances. Watch for this to happen a lot more as securtised mortgage pools fall apart. Litigation will be acute.
By the way, Clifford Chance is making a fortune from litigation.
Ed h, I found Paramax interesting... I think your link about RBC is broken... :(
The RBC link is broken, right. here it is:
http://www.creditwritedowns.com/2008/06/rbc-clients-file-lawsuit.html
Ta... interesting... but still small scale, I note.
I wonder if litigation will prove successful or if the losers are wildly screaming while waving their hands in the air? My gut instinct is the latter.
good question steve about who will win. on one level, the banks' losing makes it worse. but, on a more fundamental level, it doesn't matter because when you have litigation out the wazoo, people start getting conservative.
lawsuits make people think twice, all else being equal. And conservatism means less lending, less securitisation, less credit. that's a bitter pill to swallow for the UK and US economies, addicted to credit as they are.
LEA comes up with a classic bit of misinformation:
prices will recover and continue to grow. Much like they have for the last century, where prices have basically doubled every ten years.
The only sensible way of looking at house prices is the ratio of prices to earnings. The peaks were in 1948, 1973, 1989 and 2007 (when the ratio was 7 or more) and the troughs were in between when the ratio was 5 or less.
So in the long run, it is agreed that prices will increase in line with earnings growth (i.e. inflation plus a percent or two) but this is just a blip is nonsense. This is a crash, with real price falls of up to 50%, just like after 1948, 1973 and 1989.
Lets not discourage LEA from contributing...whilst I disagree with his view on house prices starting to "boom" again next year, he's surely welcome to express his opinion. Maybe the BoE will slash rates when deflation takes hold, and if mortgage rates also come down and wages don't crash, maybe property can do well (I don't believe in this argument one little bit, but hey it's always worth considering unlikely outcomes).
Kanami sang imo blog. Daw spaghetti.
Traderboy, that's a fair point - even if I might have seemed aggressive. The mere sight of Kirstie has that effect on me.
I am delighted to see contrary
views argued, but simply stating them is insufficient. Statement is not argument or debate - and I've become ever more aware of the effect of ill-informed (if not intentionally misleading) information from self-proclaimed industry experts.
If LEA wishes to claim that house prices will soon boom again, I respectfully suggest he attempts to explain how he expects the mortgages to be financed (securitisation is all but dead and unlikely to be revived) - and how he expects wages to be driven up to allow repayment of the larger debts he envisages for his future customers... in the context of global wage arbitrage. If there is no credible explanation I can only assume that the idea of another housing boom in the foreseeable future is, at best, deeply misguided - and, at worst, intentionally deceptive.
I'm all for debate, but, fallacious gibberish I feel obliged to challenge. ;)
LEA is trolling. I enjoy it.
Nick
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