AT one point yesterday, I had to pinch myself to make sure I wasn’t having a nightmare. Is Gordon Brown still Prime Minister, I asked myself? The reason for my madness, dear readers, was the coalition’s dreadful neo-Brownite plan to part-guarantee 95 per cent mortgages. It was the kind of policy reminiscent of tax credits and of the meddlesome, flawed micro-management of yore. Why, oh why, does the coalition now also think that endless, ultra-targeted interventions in every nook and cranny of the economy is the way to go? As I argued yesterday, it is also reminiscent of the sub-prime fiasco in the US, where government-controlled agencies promoted unaffordable mortgages.
Having now read in full yesterday’s document, I suspect the indemnity scheme will fail even on its own terms. Lenders will offer 95 per cent loan-to-value mortgages to buyers of new builds, while being on the hook for 86 per cent of the property’s value. House builders will chip in 3.5 per cent of the price into the fund. The government will provide 5.5 per cent. Banks will be able to sustain a slump in prices of 14 per cent (excluding transaction costs) and still break even if they sell a repossessed property. In reality, house-builders’ contributions will be non-existent: prices to buyers will be 3.5 per cent higher than they would otherwise be, with the extra cash actually paid for by buyers. The real loan to value is therefore 91.5 per cent.
The government wants to indemnify 100,000 mortgages, 12 per cent of the total mortgages made over the past year. Such a target would be more than double the number of 95 per cent loans made last year, which means that their number could triple. In practice, however, in at least some cases the new offer will simply replace existing, non-guaranteed loans. It certainly will on new builds: banks will retain customers while extending themselves less.
The supposed clever trick is that because the indemnity is only for new builds, it will boost building (and GDP), not merely push up prices in the market for existing homes. But there are flaws in the scheme. First-time buyers will no longer have much of an incentive to buy an already existing home. This means that the guarantee could trigger a sudden, abrupt collapse in demand for existing houses, starting in the spring, precipitating large price falls (rather than a gradual, necessary readjustment of prices in an overvalued market) and pushing more people into negative equity. It could also trigger a mini-bubble in new builds if construction doesn’t jump.
As Capital Economics points out, the overall supply of mortgage finance may not increase despite the scheme. Lenders are under pressure to boost reserves; wholesale funding is expensive. A fixed pool of mortgage funds will merely be redistributed. Also, the take-up of the subsidised mortgages may be weak: people are too worried by the possibility of recession to borrow. Others are expecting further price drops and holding their fire. Take-up could be low for another reason: 30-something first time buyers are often looking for family homes, not small flats built on brownfield land, even if they overlook beautiful docks. If the planning system continues to promote the wrong sorts of new homes, even the promise of a 95 per cent mortgages won’t be enough to tempt buyers. Brownonomics didn’t work – if the coalition has already forgotten this, then what is its point?
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