It’s house prices, not bankers at the root of the problem
Wales Business — By David Jones on July 14, 2010 7:00 am
The true scale of our housing crisis in Cardiff
IT WAS just a few years ago that people who seemed rational and intelligent in every other part of their lives believed in the urban myth of inexorable rising house prices.
Many thought that their house would replace their pension. Others who moved home decided to hold onto their first house and become part-time landlords. The rent would cover the mortgage and houses became the start of a portfolio.
Those who stayed put discovered that their houses were easily re-mortgaged at a new value and this released money to be used for holidays, new kitchens or converting the loft. Everyone’s home became a cash machine.
Much has been written of the casino bankers who paid themselves excessive bonuses after being bailed out by governments, especially UK and US governments. But alongside this immorality is another question, of how appropriate it can be to gain wealth simply for benefiting from a market price rise. For every mortgage holder who enjoys a further 1% monthly house price rise, there are several others whose prospects of owning a home are made 1% more difficult.
Hence the well-argued logic of applying capital gains tax to house price sales.
Working as an employee in the private sector or in a public service role is a virtuous activity. Entrepreneurs who make huge personal sacrifice and take risks for a chance of wealth and freedom also deserve praise. Even those who choose to invest money to grow a business which employs staff also provide a benefit to society. But there is a fundamental difference between all those things and buying a house, and then making money simply because the market determines that this asset has increased in price.
The easy target for abuse over the past couple of years has been investment banks who bundled together hundreds of mortgages and then sold them to another bank or pension fund. All that was fine, until the housing market stopped rising, and at that point the unlucky business holding the mortgage had to face up to an asset worth significantly less than they thought. It led to the collapse of Lehman Brothers.
But the guilty includes more than just investment banks. The queue starts with governments, regulators and central bankers. Then there are the financial advisers, shiny-suited Audi-drivers who made commission by selling mortgages (“financial products”). But, at the end of the queue, are us, the punter-mugs who swallowed the dream of house prices. We wallowed in the knowledge that our Cardiff Bay flat bought in 2007 for £157,000 would soon reach the dizzy heights of - well – £116k.
Rene Descartes once said: “Good sense is of all things in the world the most equally distributed, for everybody thinks he is so well supplied with it.” And so it was up to 2007. Few were prepared to argue the inappropriateness of high prices and the impact of losing this wealth following a house price crash.
Back in 2006 and 2007, selling those bundles of mortgages between banks was not seen as a risky activity, by anyone. Even the rating agencies, whose job is to assess risk and attribute a specific likelihood of default, rated much of these mortgages at AAA, the highest possible grading.
Northern Rock once had a mortgage called Together, providing an astonishing 125% of the value of a house. Effectively, that meant that the borrower was given all money to buy the house plus a cash loan equivalent to a further 25%. The underlying logic here suggests that Northern Rock had assumed that the house price market would rise by25%. Compare that to an 80% mortgage which is far more common today – that allows for a 20% drop in prices before the lender starts to lose money.
But, as we all know, the bubble burst. Starting with sub-prime lending in the US, some of which were known as Ninja (No Income, No Job, No Assets), mortgages were sold to people that had no chance of paying them back. But by the time that would happen, the financial consultants would have driven their Audi to the next US town and the bank that offered the mortgage would have sold it already.
However, for every single sub-prime borrower in the US, there were five more who did have an income, but could only afford to pay their monthly mortgage while the Federal Bank interest rates were held low, or until the cheap introductory rate of interest expired.
In the case of sub-prime there is a clear argument that mortgages were mis-sold. Bbut this only affected a small proportion of the mortgage market.
Then, one day, the music suddenly stopped. Massive mortgage companies in the US and UK went bust and all the banks that bought those mortgages as part of financial instruments known as collateralized debt obligations, or CDOs faced huge losses. Only then did it become clear that banks had used these reputedly reliable AAA-rated assets as the basis for further loans. Not everyone was surprised. Economic commentators including John Mauldin, Jeremy Grantham and the late, legendary Ian Rushbrook all wrote extensively about this issue. Warren Buffet once described this industry practise as dealing in “financial weapons of mass destruction”. It’s a tragedy that politicians and policy-makers didn’t take in these wise words.
The main government response was to reduce interest rates to effectively zero. That was probably the only thing that it could do – although it was like a turbo-charged hair-of-the-dog, solving a problem of debt by generating more debt. Further responses include a local authority-administered Mortgage Rescue Scheme, to allow the taxpayer to subsidise the mortgage payments. As of June 2010, this scheme has paid an average of £42,000 to 336 households in Wales. As Jocelyn Davies AM, the Deputy Minister for Housing and Regeneration, said recently, the scheme cannot continue indefinitely. At some point those households that are still unable to pay might have to give up their homes and move to rented accommodation. For each one that does, that £42,000 in mortgage payments will have been happily accepted by Santander, Barclays or Principality.
Every single family that is evicted from their home suffers a massive personal tragedy, but the causes are not just unemployment or loss of earnings. They include grossly reduced interest rates over several years, Thatcher’s obsession with selling council houses, and repeated Government and media assertions of the virtue of home ownership. In much of Europe, it is not considered a failing to rent a house.
The challenge now is how to move to a more sustainable future for house prices. In Cardiff, the average house price (rather than a flat) is £197,000. Taking the average two people earning an average UK salary of £21,000, a four-times mortgage is required, along with a deposit of £40,000.
My view is that house prices are between 30% and 50% overvalued and a full decade of zero growth in house prices would allow inflation to drag prices back to reasonable and sustainable levels. Comments this week from PWC appear to support this.
In parts of Cardiff, this unwinding has already begun, but the biggest impact has yet to be felt. The huge developments of flats, especially in Cardiff Bay, have seen terrifying drops in value and transaction levels. In 2007, there were 172 flats sold every month. So far in 2010, there are just 16 a month. In that time, prices have dropped by over £40,000. All this has happened at a time of uniquely low UK interest rates.
The bubble of house prices shuts out the lowest paid and causes misery for those who suffer unemployment and loss of income when it bursts.
The unwillingness of financial authorities, governments and the public to face up to the myth of house price rises has caused a near-depression in the world economy and is the single biggest cause of the financial hangover which will last for the next five years.
Tags: banking, Cardiff Bay, house prices, recession
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16 Comments
Interesting article David, and much to ponder, particularly in terms of how we move to a sustainable future for house prices, and engender a culture change so the default mindset is not ‘i own a house, therefore i am’. No easy answers
On the issue you raise about development in Cardiff, this is also complex. The Council’s recent Local Development Plan (thown out by inspectors) aimed to fulfil Cardiff’s undoubtedly growing housing need by building more flats. I, amongst others, argued strongly against this on the basis that it did not seek to provide the family housing that is required.
However, spare a thought for the council also, who have laudable aims to limit development on green belt land, by developing only brownfiled sites (an aim that few would disagree with in principle- myself included). If we are to prevent the sort of ‘garden grabbing’ development seen in urban wards like my own (Canton) where every spare bit of land/ garden is developed, we need to somehow square the circle.
Cardiff’s rejected LDP said that the only alternative to ‘brownfield sites only’ would involve the release of Greenfield land and the loss of countryside. I do not believe that this is the case. There are alternatives, including the development of terraced housing. High density doesn’t have to mean flats alone. Victorian terraces were built to a density of 70-100 houses per hectare, also incorporating open space. Such terraces are highly desirable in many of our wards.
Great article.
The amount of different circumstances I have gone through already (i am 27), getting my first and second mortgage during this period, is dizzying. We got a mortgage out at the height of the boom, moved on to far bigger house during the crash and now watch my brother and friends saving frantically or giving up on home ownership.
Some of my older friends bought their house in the valleys for 60k in 2000, and have pretty much paid off their mortgages. At one point his house had tripled in value!
As my father in law always maintains, your house is a place to live. Despite him investing alot and saving alot, he always made clear that his home was not part of the bargain so to speak, even though it still worth far more than he paid for it, and the mortgage is paid off.
I still hear my friends, I can still remember myself naively saying it a few years ago, that by selling on they will get this big wedge to spend as their house will rise in value forever. The shows on tv about buying property and making money off them do not help either.
Really enjoyed this article.
Thanks Cerys.
The development of flats in Cardiff (and Cardiff Bay in particular) probably deserves a full article.
In researching this I tried to find more information on the ownership of all this negative equity – and much of it seems to be buy-to-let landlords. One person I spoke to suggested that 90% of the flats are owned this way (or should that be owed?)
Again it’s interesting and personally I see this as a moral question – A landlord who provides a flat or house is providing a service, but one who is merely speculating on the market rise is far from virtuous and close to being morally bankrupt, and based on the chart above, that’s their second category of bankruptcy,
Seeing a house as a home rather than a rung on the property ladder might result in locations being seen as communities.
Hi Dave, but who inflated the house prices ?
Bankers who lend money as much as you want regardless of the ability to pay it back or not, sometimes as much as 10 times your basic salary.
A story, somebody just left prison, no job, no income and managed to get £245k mortgage by simply filling a self employed form.
Bankers to blame full stop.
Nofal – I don’t think that the banks inflated house prices, I blame a lot of ordinary folk who should have known better, as well as TV shows, estate agents and lot more – they all refused to call the Emperors Clothes..
The bankers are responsible for holding and selling assets that they should have known were worth far less than they hoped.
But, many of these banks suffered massively, including shareholder of Northern Rock, who lost almost all their money. Depositors at Northern Rock were given 100% protection by the UK Government and their mortgage holders were rewarded with 0.5% interest rates.
David
David,
good article, you say:
“But, at the end of the queue, are us, the punter-mugs who swallowed the dream of house prices. We wallowed in the knowledge that our Cardiff Bay flat bought in 2007 for £157,000 would soon reach the dizzy heights of – well – £116k.”
I’ll assume the tongue’s in the cheek when you make this comment. We’re not talking here about ‘swallowing the dream of house prices’ but making a foolish investment decision.
Caveat Emptor (repeat after me) – or bust, was it ever different?
I bought a 3 bed house (in 2008), with a huge garden, in Cardiff city centre for less than the value this Cardiff Bay flat has fallen to. Supposedly it’s worth much more than this now but that’s up to a potential buyer, not me, or RICS or anybody else. You can still buy houses like this for no more than the insurance rebuild value – a fairly safe bet.
Either way, I took out a mortgage on property, with land, instead of some sq. ft in a tower block. If my house falls down, I have some land, if my house plummets in value, I have a house. If we have kids, I have a house big enough. If Cardiff Bay floods, I’m safe. This isn’t an attempt to be smug – if house prices were so high you had to buy a (cheaper) flat I’d understand – but given a straight choice?
The flats in the Bay were worth whatever the individual paid for them (wild variation even within same buildings) and they’re worth whatever a new buyer will pay for them. The flats unsold are worth nothing but dreams and debt until they’re sold.
Perhaps a deluded belief in ever-rising house prices led to both homebuyers and landlords into huge risk but the delusion sat alongside a commonplace failure to search for real value. Anybody who thought flat values would rise significantly in a city where land values are relatviely low (and economic prospects shaky) was taking a huge leap of faith, and I’m not big on faith. I know of one apartment block that is built on a patch of land acquired for less than half the list price of one of the 100+ apartments now built on it. I suspect there are others. Those adverts in the Bay saying ‘buy your own apartment for £99′ may yet have their day of chilling relevance, if they haven’t already.
Why anyone would think that they would make a great return from a flat in Cardiff Bay, baffles me. To begin with if memory serves me right, the land was sold to developers at very high prices. The other is the potential for flooding which could still happen (I don’t think having a house in Cardiff City Centre? would help that much either, I still remember flooding in Canton just check your basements). My sister sold her house recently for 100K in Caerau, she bought it for 50K, that I say is a good return. Also not close to any river no problem with flooding or subsidence. You say the banks are not at fault, yet I received an offer for a 2nd mortgage from Bank of America for 250K. I only paid 96K for the house. That I would say is prime example of a bank being irresponsible.
David –
You comment that the taxpayer subsidises people’s mortgages under the Mortgage Rescue Scheme. I happen to think that this was the lesser of two evils, in that it at least protected the housing market from suffering further ‘adjustment’ as a number of repossessed properties flooded the market.
Also, doesn’t the title of the property pass to whichever Housing Association ‘rescues’ the property – hence the taxpayer indirectly benefits from the increased capital and revenue that the HAs have as a result of the MRS. I believe that Housing Associations are the main provider of new rental property in the UK, aren’t they?
mike:
you’re probably right about the flooding, those darn EA maps haunt me!
I may be missing something here, but Nofal makes a salient point:
The more people could borrow, the further house prices were driven by increased demand. If banks had been a little more circumspect with their lending, then fewer people would have been able to purchase property. It’s fairly simple economics, really.
I read JK Galbraith’s 1970s reprint of ‘The Great Depression’ earlier this year. It included a foreword which drew parallels between the OPEC crisis of the 1970s and the aftermath of the 1929 crash. It’s amazing how history repeats itself, isn’t it?
….Perhaps the Liberal Democrats might wish to consult their history books on what happened to their predecessor party in the1930s (sorry – a bit off topic, but nontheless worthy of mention methinks).
Michael – I think that the key issue is whether house prices are sustainable.
In some States in the US over 50% of properties are either behind on their mortgage payments or facing losing their homes (“Delinquent or in Foreclosure”)
The latest numbers are
California : 35%
Florida : 47%
Arizona : 51%
Nevada : 70%
For me, the scariest part of the research is the number of transactions, not the prices, because if house prices are struggling when no one wants to sell, then once we all accept that the good days are gone, there will be a lot more properties going onto the market.
This was the message from Nationwide and Lloyds / Halifax over the past 6 months.
The truth is that the house have not fallen into negative equity – rather, they never had that value in the first place.
I really don’t know what the best solution is, there are only bad options left. But what is surely the worst plan must be to deny and support – the sooner we hike housing interest rates to a sustainable level, the closer we will be to facing up to the problem.
Keeping people housed is the end, home-ownership not necessarily the means.
David:
Excepting the position of individuals who took out mortgages of over 100% of the purchase price, I fundamentally disagree with your statement that houses never had that value in the first place.
As for those who did borrow over and above the purchase price of the property, this I think was both an institutional failing on the part of the banks, but is also the fault of the person who assumed that they were going to benefit from ever-increasing prices.
Good article.
The overlying picture is that we live in a society ‘of wanting now’, borrowing for a car, a conservatory, a greenhouse and so on and so on….it’s all about having it now, from fast food to 24 hr rolling media to repeats or re-runs of TV programmes… let’s have it now..
Patience is almost a slur word I find …a fuddy duddy concept, be patient on the road, patient at making food, patient for elderly people..its not a word that is valued.
Same with houses. There is many more units today of course and germany does not have the same problem as we do cus they tend to live in large houses with 3 or 4 generations, our culture emphasises a nuclear family under one roof. Put’s pressure on young people to get a property now.
With that emphasis and finance brokers desperately wanting to lend to anyone, even a guy who lives in a tent or a cardboard box outside the Senedd could probably get a mortgage and not pay back, with this and people wanting it ‘now’ in a recession, ..recipe for economic disaster
Perhaps it is house prices that are the problem. But house prices cannot be looked at in isolation from the problems with the banks and the Labour government.
During Labour’s time, banks allowed (and were allowed) to offer self certified loans with no checks done, these are now called liar loans). People would say they earned much more than the actually did so that they could borrow as much as they wanted. And the government allowed it to happen. Even after a BBC documentary exposed what was going on the government were happy for it to continue.
The result was house prices jumped from the average house costing around 3-4 times the average house hold income to the average house costing what the average irresponsible liar would claim the earned on a self cert mortgage. Vince Cable even called it ‘lie to bet’.
Consider that these things were happening at a time when mass immigration was happening both from Eastern Europe and the third world and the government (Labour) were building less council housing than was built under Thatcher and it’s easy to see why the younger generation are now screwed.
Immigration is one factor. We’ve had greedy landlords buying up properties to house immigrants and charging extortionate rents on these properties but also that house building has nowhere near kept up with the population boom which is occurring mainly in England. One impact of this of course is that Wales is becoming increasingly desirable for English people as their cities and urban areas become ever more crowded and less desirable to live in. Consequently this in turn raises our house prices in Wales and leads to the situation where areas of Wales are becoming dormitories for England.