The latest numbers from the Council of Mortgage Lenders come out on Thursday. The previous set reported that the number of mortgages was up 30% by volume and 47% in value on a year ago.
Those are sharp increases though volume is only half what it was during the peak months in 2006 and 2007. Remortgage levels are even lower, for the moment barely a fifth what they were before the crisis. You can read that in two ways: we are acting more cautiously; or there is a lot more housing boom to come.
These figures were on my mind while reading The House of Debt, a new book by economists Atif Mian and Amir Sufi analysing mortgages in the US. A major feature of their argument is that mortgages are bad for poorer households. Typically the equity in the house is their major or only asset, it’s a thin slice and gets wiped out as soon as property values fall. From that point on, they are ‘underwater’, owing more on the mortgage than the house is worth. This depresses their spending which is bad for the economy. They might even foreclose on the mortgage and analysis by the authors suggests that foreclosures reduce values further for everyone in the neighbourhood, potentially triggering a cycle of more foreclosures and more losses for home owners.
By contrast, the provider of the mortgage experiences no loss in the case of falling house prices, at least not right away. The value of the mortgage is unchanged even while the value of the house has fallen. Obviously that is the nature of a debt instrument, we shouldn’t be exclaiming ‘eureka’. But the point, suggest Mian and Sufi, is that house purchases could be financed differently, with mortgage providers sharing the risk of a loss as well as the profit from a gain.
To take an example, a house is purchased using what the authors call a shared responsibility mortgage of £180,000, and let’s say the value of the house is £200,000. If that value falls by 20% to £160,000, this makes no difference to a regular mortgage, but it would reduce a shared responsibility mortgage by the same 20% to £144,000. This means the home owner is not underwater, they retain what may be their only asset and their mortgage payments decrease too. Perhaps as a consequence they keep spending and aren’t forced into foreclosure.
When the value of the house is increasing, the value of the mortgage does not increase with it. It stays capped at the original £180,000. But the sharing of the upside comes when the house is sold. Let’s say it goes for £220,000. Then the modelling done by Mian and Sufi suggests that providing the mortgage provider with a 5% share of the gain – £1,000 – compensates them for the risk they are taking on the downside.
Too good to be true? It may be. When volumes of mortgages are at their highest – that peak in 2006 and 2007 – borrowers may not want to give up any slice of the future house price growth they are predicting to the mortgage provider. They may be more likely to do it when prospects are uncertain, which may be exactly when mortgage providers would much prefer to sell ‘classic’ mortgages.
We could regulate that shared responsibility mortgages are the only products allowed. But this may exacerbate cycles of boom and bust, with providers rushing forward with mortgages when prices are going up, hoping to capture some of the upside and feeding the boom, while closing up the shop when they foresee risk on house prices and sharpening the fall.
The authors don’t consider these dynamic effects in enough detail and for the moment neither do I. There is though a much wider argument here for their part. In effect the alternative type of mortgage Mian and Sufi propose would behave more like a share in the house, or an equity investment. We can see it as part of a wider argument that our economies are powered too much by debt and we should vary our “asset diet”. Not incidentally, the authors mention ‘Schiller bonds’, a proposal from the Nobel economist that governments could issue bonds that behave more like equity, paying a dividend based on GDP growth. Kenneth Rogoff, infamous for his conclusions about levels of government debt, suggests in other work that his real aim is to foster a wider range of more equity-like assets.
Again the challenge may be supply. McKinsey estimated a couple of years ago that the world was already facing an equity shortage of some $12 trillion in 2020 and that’s without trying to change the balance between debt and equity.
We certainly do live in a house of debt. Relocating isn’t going to be easy, even if the alternative is more attractive.