Since You Asked

Back to the glory days of Northern Rock

“People buying newly built houses will need a deposit of as little as 5 per cent under measures designed by the government to help unstick the housing market.”

Financial Times, Nov 22

What’s the story here?

We need to go back to the height of the credit boom, four or five years ago. Banks were handing out mortgages without requiring a deposit. In the case of the most brilliantly managed banks, for example Northern Rock and HBOS, mortgages were offered with loan-to-value ratios of 125 per cent, in effect allowing house buyers to go deep into negative equity the day they collected the keys.

Was that a problem?

Yes, it was. Somebody in negative equity may be unable to move house without defaulting on the mortgage loan, which makes them a risky proposition for the bank, as well as trapping them in other ways – making it hard to move to find new work, for example. There’s also a fair case to be made that loose lending standards in the UK helped drive house prices up to absurd levels. If people tend to get carried away when they see rising house prices, which seems plausible enough, then their spending will be limited only by the giddy enthusiasm of the banks.

Oh. Sounds bad.

It’s good for elderly people who happen to move to smaller houses at just the right moment, and it’s good for presenters and producers of vacuous home-improvement pornography. But it’s bad news for anybody who owns less house than they’d ideally like – which is most of us, given how pokey British houses are – and it’s also bad news for the stability of the financial system. The crisis was triggered by similar loans in the US, not in the UK, but that doesn’t make overstretched UK loans a good idea.

Right. So what’s the problem that the prime minister is trying to solve?

It’s very simple: this unsavoury state of affairs stopped a few years ago, and David Cameron would like to kick-start it again.

I’m sorry, I must have misheard you.

That’s what I thought when I heard the policy being announced, but I am afraid it’s true. Such mortgages only made sense – for both bank and homebuyer – if you had (false) confidence that house prices would continue to rise forever. The government has noticed that banks have lost this confidence and now insist on substantial deposits as a cushion in case house prices fall. So it plans to throw the taxpayer guarantee in there – on top of the deposit cushion, the taxpayer is a kind of airbag. If prices fall and the buyer defaults on the loan, the taxpayer will absorb some of the impact.

On what planet is this a good idea?

Let’s be fair: more house building would be an excellent plan. It’s a contribution to the long-term wealth of the country; unlike manufacturing it cannot be offshored and provides plenty of employment, even from the young and the unskilled. And there aren’t nearly enough houses, which is another reason why prices are so high – relative to earnings they are still roughly at the level at the peak of the catastrophic late-1980s housing bubble. Private companies are building about 100,000 homes a year – low levels not seen since the 1920s. A few hundred thousand more houses each year at a time when prices are high and unemployment is also high would kill several birds with one stone.

But?

But this is surely the stupidest imaginable way to stimulate house building. There are three fundamental problems: prices look high, so banks don’t wish to be exposed to their likely fall by lending either to developers or to house buyers; the banking system itself is fragile, exacerbating the sense of caution; and above all, planning permission is hard to come by, so if you have the money to build a house the local council probably won’t let you. The government’s response is to try to prop up prices with the following proposition: lend money to people who should not be buying such expensive houses, and if things turn sour you can repossess the home, sell it at a loss and the taxpayer will see you right.

What does the opposition think of this plan?

They think it should be much bigger. Not nearly enough taxpayers’ money has been thrown into it, apparently. Without a more determined effort we’ll never get back to the aggressive lending of the glory days of Northern Rock.

What happened to Northern Rock again?

Let’s just say it’s gone to a better place.

Also published at ft.com.