Ken Gibb's 'Brick by Brick'

Housing, academia, the economy, culture and public policy

Category: housing finance

The Future of the US Mortgage Market

“The trigger for the most recent crisis remains the part of the global financial system that has been least reformed”. The Economist, August 20, 2016.

There is a thorough and thought-provoking diagnosis of contemporary US mortgage markets in the USA in the new edition of the Economist. You may ask why this is a significant issue worth attention. First, the proximity of US mortgage securitisation to the global financial crisis and the extent to which earlier structural and other challenges have been repaired is important for the world financial system not least because the rest of the world owns trillions of dollars of US mortgage debt. Second, the US market has had a lengthy and difficult period which has had all manner of knock-on effects for housing, communities and the economy. Third, there is the key question of the future – how stable, resilient and sustainable is the current system and also proposals for reform. Finally, how relevant is any of this to the UK’s mortgage market?

The article argues that despite the rebalancing of Wall Street banks since 2008, alongside the banks sits the mortgage sector, which creates almost as much credit as the banks but unlike them the housing credit sector is much less capitalised and only just in profit. US mortgage debt is of the order of $11 trillion. The Economist argues that the taxpayer subsidies the system to the tune of $150 billion a year (tax breaks but also the indirect effect on interest rates of the Fed purchasing mortgage bonds). This is in part because of the conservatorship of Fannie Mae and Freddie Mac, or de facto nationalisation of the great majority of the US mortgage sector (at least 2/3 of new mortgages originate from agencies of government). The economist concludes that it is not the market but ‘administrative fiat’ which determines mortgage volumes, the structure of loans and attitudes to risk.

The collapse after 2008 led to major changes in the regulation, ownership and practice operating in the mortgage lending sector. The Economist stresses the withdrawal of traditional lenders from mainstream new home loans to be replaced by specialist orginators. Second, the Government’s rescue of the system between 2008-2012 left them in control of large parts of that system and in particular of securitization of mortgages. Third, although the old derivatives market has been largely removed, it is still the case that the ownership of mortgage assets is still widely distributed across the banks and internationally.

This is where the Economist’s argument gets a bit schizophrenic – they argue that on the one hand there is too little regulation of the new originators of mortgage loans is too loose but at the same time the rest of the mortgage market is far too regulated – with 10,000 pages of law and rules that tighten up who gets loan, what kinds of property and loan types are eligible. Yet loan to value ratios are weakly controlled and 95% LTV loans are increasing (25% of new loans in 2012) and down payment regulations have been loosened.

The upshot for the authors is that the US mortgage system seems to be playing two roles – providing liquidity in the mortgage bond market but also using implicit and explicit subsidy to boost home ownership. What is to be done –the Economist is not keen on just leaving it alone (which itself is a common response after the shocks of 2008 and thereafter). Instead, they want a market solution but also note that with the status quo remaining because of the dominant role of the state, a future default crisis in the mortgage market will need to be bailed out by the taxpayer and this might be huge.

What is the market alternative? Force mortgage lenders to recapitalise like the banks on Wall Street and at the same time raise fees to create profit signals and incentives to take risks (and bear their costs). Administrative control and subsidy would be reduced and mortgage rates would probably go up a bit too. The Economist reckons this would require about $400 billion of new capital.

There are however difficult political economy barriers to such reform: the Government currently receives income from its conservatorships (but does not have their debts on its books) and of course the twin reduction of subsidy and higher interest rates (plus potentially sounder market criteria and regulation for lending) does not win support from the middle classes.

This all sounds like the policy reform problems we have discussed many times before – important coalitions and stakeholders who thwart reform even when it is in society’s long term interests. Figuring out ways to build consensus or use opportunities to act while sorting out the design and implementation of system wide reform, and indeed to compensate or mitigate the impacts on losers from reform – is a challenging mix. Default to inaction is made all the more likely by the need to get new enacting legislation through a partisan Congress.

While one may not necessarily agree with the precise policy thrust in the article, the problems are real enough. While not accepting the prognosis we still have to confront how to make policy well in a complex and uncertain setting. For those thinking about wishing to tilt the UK mortgage market to or from further regulation, it is worth considering the experience of the different and distinctive US setting.

Thinking about local housing market volatility

A recent paper in Bank Underground (the Bank of England’s new blog site) by Arzu Uluc uses an interesting local-level data set (325 local authorities in England covering 1997-2009) with which to examine local housing booms and busts. The underlying model draws on data including real house prices, real gross disposable household income per capita, dwelling stock per capita and various mortgage market variables like loan to income, loan to value and the share of interest-only mortgages.

The author concludes that the local research allows us to infer (and reasonably so) that volatile housing markets can ‘threaten financial and macroeconomic stability’. Credit conditions in terms of the key ratios and types of mortgage products play an important role through the ‘1997-2009 housing cycle’.

Uluc presents his empirical work by generating six stylized facts. These are:

  1. Real house prices rose on average by 150% between 1997 and 2007 and then fell 12% by the end of 2009.
  2. Changes to the proportion of high loan to income mortgages were positively correlated with local housing booms and busts.
  3. There is a negative relationship between the changes to the proportion of high loan to value mortgages and the size of local booms and busts.
  4. Changes in the share of interest only mortgages were pro-cyclical (similar to 1. above).
  5. Housing booms and busts were also associated with real drivers like real income and dwelling stock growth.
  6. The bigger the local boom, the larger the subsequent bust.

A few caveats are in order – it is not clear why local authority data is particularly appropriate rather than broader more functional geographies; nor does it appear from the blog that there is spatial dependency accounted for in the analysis. I also wondered if the London effect needed to be explicitly modelled (or indeed some sense of North and South)? On the other hand, the author is clearly concerned about attribution and possible reverse causality or confounding factors in the models deployed. These are all things that can no doubt be explored in a longer paper.

What about the bigger messages?  The model is best summarised by a quote from the post: ‘the econometric analysis…suggests that booms and busts ere associated with both real factors and credit loosening. Higher real income growth [was] associated with larger booms in [the] 1997-2004 period, and in 2007-09 areas with higher growth in the dwelling stock per capita tended to see larger price falls”.

Thus, and despite the fall in endowment mortgage volume shares after 1997, changes in the share of interest only mortgages were associated with local house price booms. Similarly, higher loan to income ratio shares of new mortgages were associated with local booms. The interesting negative relationship between high loan to value mortgages as a share of the total and local house price growth – may be explained by the growth of the share of home movers as opposed to first time buyers among total transactions and the increased financial support utilised by remaining successful first time buyers from family and other savings (which also drove down LTV ratios).

As Uluc stresses, there are reverse causality explanations and possibly confounding omitted variables that may instead better explain what is going on – but the associations found are striking. It is a reminder of how difficult it can be to disentangle the relationship between the real housing market and monetary transmission through credit variables – something well known in the wider housing and economy literature but just as striking here.

Stylised facts are useful, but as the author points out, they are the starting point that we then develop models and theories from and look at fresh data to test the ideas that originally flow from these facts. It would therefore be interesting to extend this data forward beyond 2009 and also to aggregate a sub-sample of the local authorities into clusters that approximate for sub-regional housing market areas. If we did so, would we also be able to detect the influence of the changing regulation and practice of mortgage lenders in more recent years?

Housing Policy and the Election ‘Unpacked’

I have put a link here to a podcast I did yesterday with Alex Marsh while at the Housing Studies Association conference in York. It is a tour through the pre-manifesto proposals and pledges by the main parties with regular digressions into Scotland. We also talked about housing supply, property taxation, social housing, private renting, welfare benefits and demand-side home ownership policies. Hope you find it interesting. You will also find the podcast at Alex’s Archives.

International Evidence on Housing Booms

This post authored by Alex Marsh and Ken Gibb

A recent NIESR paper by Armstrong and Davis (November 2014) compares the last two booms and busts in major OECD country housing markets. The authors present a thoughtful macroeconomic analysis of national housing markets and from there conduct panel data analysis of the determinants of house prices focusing on financial, debt and related variables.

The authors argue that comparison of the two most recent housing market cycles (1985-94 and 2002-11) can test the hypothesis that there was something unique about the most recent boom and its aftermath. They state that the housing market is widely considered to be the main cause of the global financial crisis (quoting such authorities as the IMF). However, the authors come away from overall reading of the data for the two cycles unconvinced. In their view the two cycles are sufficiently similar that it difficult to draw the conclusion that the most recent cycle is different in meaningful ways: it is certainly not unique. The implications is that if the received wisdom is incorrect and other factors were important in causing the crisis then macro-prudential policies in countries like the UK may be incorrectly targeted at the control of house prices and mortgage lending.


We are interested in this broad area for several reasons: why did economists miss the bubble nature of the housing market and its departure form fundamentals? Why did they miss the downturn in national housing markets? How plausible are the microfoundations of the models being used to analyze the housing market and explain what is actually going on? What do these analytical weaknesses tell us about the health or otherwise of economics and its capacity to evolve and learn for future challenges?

On reading the Armstrong and Davis paper we were struck by several points that we felt warranted comment. First, is there something of a straw man at the heart of this paper – do we really consider the house price boom to be the source of the GFC? Second, while the descriptive analysis is valuable and the technique is sound and well-derived from the literature, might it have been done differently? Third, does the principal policy inference, regarding the greater regulation of house prices and mortgage lending, stand up on the basis of this analysis?

Do analysts really generally view the housing market boom as the cause of the GFC? It is surely more that the sub-prime securitization and its exposure in the market for US mortgages in 2003 or 2004 onwards left the housing market vulnerable. Accelerating default contagion both collapsed the US housing market nationally (and that was different from the previous cycle) and spread through those exotic mortgage securities to stifle the wholesale money market and create the credit crunch which negatively impacted in many national housing markets across the OECD. Housing, and more particularly lending for housing, triggered a national market downturn which undermined wider international banking and thereafter fed back into other national housing systems.

Unfortunately, the data and analysis offered by Armstrong and Davis does not allow for this type of argument to be tested. In some senses, it requires a reconceptualisation of the housing (finance) market to recognise interdependence and network effects. It certainly requires a stronger focus on institutional innovations that is possible with the data available. To be fair, having presented their analysis, Armstrong and Davis note a range of factors and hypotheses ripe for further investigation. These include some of these institutional changes. So from our perspective it feels a little like the paper stops before it has a chance to grapple with some of the most interesting questions.

The analysis, understandably, constrains itself to using standard periods in order to attempt to capture national housing market cycles. Yet, despite the widely recognised increase in the synchronisation of housing market cycles cross-nationally, there is no reason to think that the OECD countries examined had similar period market cycles. The UK for instance moved into housing market downturn much later than the US. Moreover, downturns had different implications because of different default laws and bankruptcy implications. Getting a stronger sense of the timing of the turning points of these national cycles would itself be a useful contributor to the causal story being constructed.

Finally, the paper draws the policy inference that greater caution may be justified regarding the strength of the macroprudential case for regulating house prices and mortgage lending. It is important here to be clear what macroprudential regulation is seeking to achieve. Setting aside the macroeconomic stability arguments for a moment, isn’t there a housing-specific case for moderating the volatility of house prices and reducing market cycles? Whether macroprudential policy instruments are the right levers to use or are effective in damping price cycles are separate – and bigger – questions.

It may be that financial instruments are less effective than more direct housing policies in stabilizing the housing market. Or it may be that such policies can be complementary and work in tandem. Yet, in reality we face a context in which there is a willingness to consider active macroprudential regulation but a reluctance to intervene directly to generate greater housing market stability – if not an inclination among politicians to introduce policies that are more likely to increase volatility. Macroprudential tools can have more or less targeted impacts on housing markets. We should be cautious about bypassing them as a policy option. There is, of course, much more to learn about the most effective design for macroprudential policy instruments. This is an area in which a number of countries are experimenting with different approaches and there is undoubtedly scope for cross-national policy learning.

Alex Marsh is at the University of Bristol and is the purveyor of Alex’s archives at

Housing Economics Questioned

I have been at a European Network for Housing Research housing economics workshop in Spain. Among a series of more or less complete papers on microeconomics, housing finance, policy papers and the like, Alex Marsh and I presented a highly preliminary paper about the extent to which (and when) housing economists anticipated, understood and communicated the impacts of the housing market/mortgage market triggers of the Global Financial Crisis.

I don’t want to talk about the paper now – it is very early and rough (that is what workshops are for after all) but the discussion did raise a few interesting points about the sociology of academic economics and the place of the sub discipline within a wider field, and the international dimension. Moreover, it raises questions about the readiness of the academic community to support and facilitate innovation and experimentation that may be more widely beneficial.

Non economists often criticise the imperialist tendencies of mainstream economics across the wider social sciences. However, this may also pertain within the discipline in terms of how specific sub-disciplines evolve. For instance, the housing economics publishing outlets are clearly dominated by North American journals such as Real Estate Economics, Journal of Urban Economics, Journal of Housing Economics and one or two others. While there are mainstream economists who also publish in more multidisciplinary places like Housing Studies, Urban Studies and Environment and Planning – it is clear that getting ahead means learning, applying and privileging a specific set of methods, assumptions, forms of knowledge at the expense of others. Of course, a more pluralistic philosophy to economics research and publishing is greatly hampered by criteria for promotion, REF panels and the like. But, I would argue, it’s long term consequence may be lessen research impact on public policy, business and society.

While there may be rigour and logic and evidence of many good pieces of useful work to support what mainstream housing economics has achieved over the decades, may it nonetheless, to use one of the phrases so beloved of US economists, be leaving something ‘on the table’ by applying this intellectual straitjacket?

To take one example, it is right that we should look closely at the links between housing markets, mortgage markets and the financial alchemy that led to the sub-prime chaos that did down the banking system – but housing economists should not simply rely on the slavish application of ideas from financial theories designed for specific financial products and imagine they apply sensibly to the very unusual commodity that is a house. While I’m sure there is much to learn (and indeed has been learnt usefully) by such approaches, even a cursory reading of the main journals suggests that there is too ready a willingness to suspend the key characteristics that set housing apart in order to shoehorn it into more orthodox financial analyses.

Both from the reading on cross-national housing economics and from simply being located in Europe and listening to differential national research papers in recent days – one cannot not be struck by the importance of different national contexts, legal and other institutional practices that filter international financial processes and suggest quite different stories and conclusions about our housing systems. In Britain, we are forever telling our students that supply inelasticity is comparatively very low compared with the USA – but while we more or less factor in key institutions like the idiosyncratic planning system and our volume house builders, many housing models still look to me, uncomfortably similar to those of their American cousins. Is there therefore an unintended danger in over homogenising our research?

I imagine many will disagree with this perspective and say plenty of good new work is forthcoming. I would not disagree but I do not think that means we are doing as well as we could. Far from it. A thousand flowers do not bloom, and, perhaps, if we do not offer a sufficiently pluralist approach to housing research to encourage the possible new hybrids, they never will see the light of day?

Private Renting and Institutional Investment: Possibility, Grail or Fable?

Ever since the original deregulation of private renting in 1988, there have been repeated calls for policies intended to promote private renting investment by means of our financial institutions. The pension funds and insurance companies need to earn a target rate of return across a diversified portfolio.  If that portfolio includes a small share (typically) held in commercial property, might they not also invest in market renting? This, it was argued, would help to modernize the sector, encourage new build purpose build renting, normalize the rental market and even encourage new partnerships with a potential role for housing associations as management agents. This would be good for the fluidity and stability of the housing system as a whole and would further wider economic objectives.

We have seen over the years tax based vehicles, plans for guarantees, loan funds and trusts – but the sector remains largely unincorporated and is fragmented among many small-scale landlords (the exception being the student housing model). This is despite the growth of buy to let and the sector over the last 10 years (even with the interruption of the housing market and economy collapse), as owning became less accessible and more expensive to achieve.

What now for institutional investment and will the current wave of policies and subsidies for the rental market achieve the desired effect? I was a minor player in a new report published this week for Homes for Scotland, written with Christine Whitehead, Kath Scanlon and Peter Williams. The report is called Building the Rented Sector and is available at . The focus of the research was to clarify how to help house builders increase the supply of new homes for the rental market. The research sought to identify key barriers to investment and development and how we might overcome them through new financial models.  Aimed at the Scottish housing sector, the research also speaks to the wider UK rental market.

What were the main findings?

First, the principal challenge is to create investment opportunities that are profitable for developers but also earn a sufficiently high risk-adjusted rate of return for investors (from both income and expected capital gain) that exceeds their opportunity cost of investment. While most of the growth in private renting has come from the reuse of existing stock in the last few years, the underlying strong demand for rental housing could be met from new investment in purpose built rented housing provided the barriers to earning the required returns could be overcome. Our starting point was evidence from the sector that there is increasing interest in the potential for large-scale investment on higher density urban sites financed by institutions and managed professionally.

Second, interviewees told us that the main barriers to investment were: the difficulties developers have in competing for land for renting against owner-occupation; the lack of development finance; low yields; lack of investor experience and hardly any performance data to benchmark with; the need for scale; negative investor and local government attitudes to the sector; poor quality and expensive management; reputational risk and uncertainties around the taxation and regulatory regimes. The lack of investment, also came down to a number of specific factors, prominent amongst them were variations in professional language and understanding of basic issues such as planning and development risk and even the determinants and interpretation of yields.

Interviews in Scotland and England suggested that the barriers did not really differentiate between Scotland and elsewhere in the UK. There is evidence of yields approaching the investment level, of demand in Edinburgh and potentially also in Glasgow and Aberdeen. However, UK investors will demand evidence of success first but may yet stall investment in the absence of the perceived scale required which may not be forthcoming outside of London and major English cities.

Third, what’s to be done?

  • Land, probably in mixed tenure developments, is required for new build and land for rented housing needs to be identified in local plans and perhaps in some cases exempted from S75 conditions. English policies have covenanted land, often public land, so that it remains in long term private renting.
  • Development finance is often an important market failure and may require something like the Build to Rent fund partnership with the State to overcome it.
  • Intermediaries will be required to aggregate up providers so that they match the minimum scale requirements of investors.
  • Investors are looking for a guaranteed income stream, especially as the market is in its early stages – the UK Government’s guarantee scheme for the PRS only applies to debt reducing cost but not addressing the need for secure income.
  • Management costs in Scotland appear to be relatively high, professional management is scarce and housing associations would have to learn to work in a quite different setting.

Fourth, the report made a number of specific recommendations. While there is no magic bullet in the form of a single financial model that seems workable without subsidy, guarantee or state-led partnership participation, it may be possible that a few practical steps might encourage the basis for developers and institutions to work together effectively. These would include: promoting a champion of the sector who would work with key stakeholders, trade bodies and government; explaining what the sector requires; supporting pilots and seeking to strengthen the environment that would encourage investment while at the same time encouraging innovation and experiment (there are 20 recommendations in all in the full report).

Reflecting on the wider questions, it seems to me that the current controversy over short tenancy length and calls for more regulation miss the point – the rental market is highly varied and the need for raising the floor of standards and protecting tenants at the bottom should not undermine the quality end of the rental market that purpose built institution-funded rental property would seek to promote. There is a challenge for policy to find ways to improve the quality of the poorer end of the market without dissuading the increasing interest in investment in different higher quality market rental segments. We all know the sector is split up into distinct sub markets – can we not facilitate regulation that recognises these differences? Wouldn’t a strong housing association role as a managing agent help do this as well as diversify their income base and promote the reputation of the market segment?

There is institutional investment taking place in London despite the lack of information transparency. There is demand in Scottish cities. There appears to be growth in interest from a range of investment funds in general. Will it be tapped this time? Will the pump-priming of subsidy and finance form Government make enough of a difference to support a self-sustaining market sector of new well managed housing? Perhaps it will in London but like the report says, much else has to be done to help support the rental market quality enhancement – and of course much resistance in Scotland remains in certain quarters. We are at a critical juncture.

New International Evidence on Policies to Stabilize Housing Markets

Fresh from David Miles intervention on equity loans discussed in my previous post, Tony O’Sullivan forwarded me another paper that I want to share with you. This is a new econometric study (November 2013) for the Bank of International Settlements by Kenneth Kuttner and Ilhyock Shim (BIS Working Paper 433) entitled: ‘Can non-interest rate policies stabilise housing markets? Evidence from a panel of 57 economies’.

The authors start from the generally held position that interest rates are a blunt instrument that often need to go up so high that they tip the economy into recession before they can bring the housing market to heel. Hence the search for other non-interest-based policy tools that might moderate and ‘tame’ the housing market.

Like Miles’ paper, this is closely related to the literature on macro-prudential policy that seeks to ‘limit systemic risk in the financial system as a whole’ (p.2) and to a growing series of papers on policy tools other than short run interest rates with which to stabilize housing markets (they identify such papers since 2005 – see footnote below).

The authors assemble a powerful panel data set covering 57 countries employing quarterly data from 1980 to 2011, which allows them to consider a series of policy interventions in different housing markets.  The authors focus on nine policy areas, grouped around three headings:

1. General credit policies

  • Reserve requirements (the percentage of liabilities that have to be held as liquid reserves).
  • Liquidity requirements (the ratio of highly liquid assets to total liabilities).
  • Limits on general credit growth.

2. Housing-targeted specific credit policies

  • Maximum LTV (sets a ceiling on housing loans).
  • Maximum DSTI (debt service to income ratio).
  • Reserve and liquidity requirements specific to housing credit.
  • Limiting bank housing exposure as percentage of total assets/liabilities.
  • Increasing the bank’s risk weight for housing (making it more expensive to extend housing loans for a given amount of bank equity – p.11).

3. Housing-related tax policies

  • A range of taxes and subsidies that reduce house purchase costs – wealth and capital taxes, stamp duty, direct subsidy and tax deductions, etc. This is conceived of as ways of changing the user cost of capital.

Cutting to the chase, having undertaken a series of cross-checking tests of the robustness of their results through techniques including panel regressions and sophisticated forecasting models known as event studies (which were new to me), the authors report findings of policy impacts with respect to both housing credit and house prices.

They find that many of the policy instruments studied are not effective but that housing credit constraints in the form of tightening debt service to income ratios do make a difference in statistical significance terms. They find that a small tightening in the ratio can ‘decelerate credit’ by 4-7% over the following year. Loan to value ceilings also had a significant effect on credit but are sensitive to the statistical model specification used. The other striking effect the authors found looking at policy effects on house prices (the only statistically significant factor) was that housing-related tax increases lead to a measurable fall in house prices (i.e. a small increase in housing taxes leading to a 2-3% reduction in house price growth – though this was not symmetric and did not reverse it though a reduction in housing taxes).

The authors recognise that their models has been applied to more than 50 different economies at different stages of economic development, income levels and institutions.  The results need, despite their exhaustive testing, to be treated with caution.  Average effects may wash out in certain circumstances and in others imply strong effects. The point, however, is that there are important negative findings – increasing the supply of general credit has little measurable impact on housing credit and credit policies do not seem to affect house prices. At the same time, housing credit policies based around the key debt servicing ratio and housing tax-related policies do seem to have a market impact.

The authors conclude that this is a promising basis for further research to understand how policy effectiveness is influenced by more narrow legal, financial and housing market institutions and structures (p.26).

This is an interesting paper, which makes a sterling effort to wrestle with a range of policy interventions across a range of national housing systems. Of course, there are genuine difficulties in interpreting just what results from such a wide range of countries mean and what average effects imply for a specific system such as that of the UK. But, for all that, the clarity of the negative results and the positive indicative ones suggesting market-moderating roles for taxation and for a debt servicing ratio ceiling/credit constraint – are certainly intriguing.

What will the Bank of England make of this research?  It should certainly note that many of the tried and tested measures may have less impact on the housing market than they may have anticipated but that there are some promising candidates, too. It is intuitive that more tailored housing-specific policies may be more effective but it is also salutary that many even of these instruments may not make much difference to the housing market. Like the authors of the study, the Bank should take this and related work and think through its relationship to UK markets and institutions. I think also that it is encouraging evidence, even if somewhat limited, for all of us who want to construct and implement tailored interventions that can promote more stability in the housing market.


Selected housing policy references in the Kuttner and Shim working paper:

Borio, C  and Shim, I (2007) ‘What can (macro-)Prudential Policy do to support monetary policy?’ BIS working paper 242.

Claessens, S, S Ghosh and R Mihet (2013): “Macro-prudential policies to mitigate financial system vulnerabilities”, Journal of International Money and Finance, forthcoming.

Crowe, C, G Dell’Ariccia, D Igan and P Rabanal (2011): “How to deal with real estate booms: lessons from country experiences”, IMF Working Paper 11/91

Hilbers, P, I Otker-Robe, C Pazarbasioglu and G Johnsen (2005): “Assessing and managing rapid credit growth and the role of supervisory and prudential policies”, IMF Working Paper 05/151.

Lim, C H, F Columba, A Costa, P Kongsamut, A Otani, M Saiyid, T Wezel and X Wu (2011): “Macroprudential policy: what instruments and how to use them? Lessons from country experiences”, IMF Working Paper 11/238

Shim, I, B Bogdanova, J Shek and A Subelyte (2013): “Database for policy actions on housing markets”, BIS Quarterly Review, September, pp 83–95.

Housing Market Instability, Equity Loans and the Wider Economy

I was going to write about something else today but then my wife forwarded me the speech made yesterday by David Miles, member of MPC of the Bank of England, at a conference in Dallas. His paper ‘Housing, leverage and stability in the wider economy’ has been press-released by the Bank of England [1]. His paper speaks to the capacity of central banks to help reduce leveraged debt in the housing market and thereby reduce housing market ‘turbulence’ in the wider economy. High leverage e.g. a 5% down-payment can leave owners highly exposed to small falls in house prices, let alone adverse movements in interest rates). This also speaks to earlier discussion regarding controlling house price volatility and the furore around the possible wider impacts of Help to Buy 2 and whether house prices ought to be an explicit target to be monitored and indeed intervened against by the Bank.

The argument in the paper is as follows (p.2): ‘I want to consider some of the policies – including monetary policy – that might be used to reduce the risks of turbulence in the housing market causing widespread damage. I will argue that one factor is particularly significant…leverage: that is the fact that houses are bought with such a high proportion of debt. In that context, I consider the advantages of (and obstacles to) greater use of outside equity in financing house purchase’.

His point is that the classical tool of market management, interest rates, is at best a blunt instrument. And of course the user cost of capital (broadly – interest rates minus expected house price gains) may be negative and unless one believes house price change makes up an unfeasibly large share of the CPI, a more housing/mortgage target set of policy instruments will be required. This will be particularly so according to Miles where the level of interest rates required to bring stability to the housing market are not those required in the interest of the wider economy – a classic case of too few policy tools.

So what is to be done? He repeats the recent Bank line that a ‘range of macro-prudential policy levers could be used to mitigate risks to financial stability emanating from housing markets, graduating from more intensive supervision…through variations in capital requirements on mortgage lending to limits on loan to income and loan to value ratios (p.8)’ (though the Governor viewed the latter as voluntary exhortation in recent pronouncements).

The paper by David Miles considers how to seek to reduce the proportion of home purchase that is debt and thereby reduce leverage and the instability, risk and exposure associated with it – by increasing the level of equity. How so?

A first way would be to use greater use of individual equity through lower LTV ceilings which if enforceable would of course increase the period required to save and the average age of first time buyers would remain high.

Alternatively, Miles suggests some form of outside equity or equity-like funding sharing the risk between the owner-occupier and the outside provider of funding. Such things, he points out have been looked at before in Australia, the UK and the USA (e.g. equity loan finance wherein the owner retains rights over all of the property unlike shared ownership).

The scope for developing this area further has been widely discussed by academics like Christine Whitehead, Judy Yates and other colleagues at Cambridge’s CCHPR.  In fact HTB1 looks very like such a risk-sharing device where the lender receives nothing for five years prior to a regular payment before recouping (hopefully) at sale. As Miles points out, in these cases the equity loan provider shares the risk of property price falls as well as the opportunity of sharing appreciation.

The UK is fortunate in not having tax relief on mortgage interest for home owning mortgage debt as this would, as David Miles correctly notes, act as a disincentive to reducing debt via equity loans (since deductibility depends directly on debt size). Moreover, Miles argues that even a small equity loan stake would have a major impact on leverage if home owners can provide an element of home equity themselves. His example in the conclusion of his paper is that a 10% down payment by the borrower subsequently augmented by a 20% equity loan changes the leverage ratio from 10 to 3.333 (plus the cumulative affordability saving by having lower repayments on a smaller mortgage).

The big question is how to create a successful market in equity loans, in effect, providing a private sector version of HTB1? Other questions are – should it be national or regional, should it be targeted to first time buyers and should it have ‘affordable’ ceilings placed on purchase prices? How do we encourage banks and other equity investors to tie up scarce capital in this way?

David’s paper is in effect it seems to me to be saying that the BoE’s macro prudential and monetary policy measures can influence leverage but that a promotion of an equity loan market for home owners of 10-20% of value could, on an incentive-compatible basis, share risk and significantly reduce leverage and the wider problems that go with it. He recognises that establishing such a market will not be easy: ‘various shared equity products in the past (most of which were not equity loans) have a patchy success rate. But the recently launched equity loan product provided by the UK government for those buying newly built homes (under its Help to Buy scheme) has proved popular (pp.17-18)’.

All in all, an interesting discussion – a possibly larger role for Equity Loans for macro deleveraging reasons though big questions remain as to how to establish and then make such a market work. It is good to see that prominent thinkers on the MPC are encouraging debate even if they are on the one had writing in a personal capacity but, at the same time, being press-released by the Bank. As usual it is difficult to tell how much internal consensus there is about this direction of travel.


Taxing speculation in the housing market

In parallel to the much discussed idea of capping house price inflation (or at least the Bank of England setting it as a policy goal and then trying to lean on the banks), there has been much concern raised about foreign investment, viewed as largely speculative, in the London market (though not just there). Some commentators have suggested we might learn from speculation taxes employed in property markets elsewhere. Andrew Heywood and Paul Hackett have accordingly published a thought-provoking discussion paper for the Smith Institute, which express these issues further (the case for a property speculation tax) (1).

Their argument is as follows. Overseas buyers are investing something like £7 billon in London’s market, the same as 2/5 of all mortgage loans made in the capital, 38% of resales and 85% of new build in central London. A property speculation tax would, they argue, be a helpful additional policy lever to dampen speculation. They envisage a new tax drawing on the features of similar provisions in Germany – essentially a high tax is imposed on sellers who seek capital gain quickly after purchase with the tax rate tapering down over time i.e. it might be set at a maximum rate (they suggest 20-30% of capital gain) for sales within two years and then fall to zero over a period of say 10 years.

To be clear, this would exclude home-owners (i.e. owners of principal residences) and long term investors would also escape it but the tax could be aimed at second homes, empty property and the like. The primary target would be short-term investors, domestic and foreign, who have only short term capital growth speculative motivations.

The authors say this is not like the mansion tax – it is aimed at speculation rather than wealth redistribution and it might replace or add to existing capital gains tax provision on property (outwith primary residences of owner-occupiers). They believe that HMRC could readily collect it (immovable property is a good tax base of course from a collection point of view) and they make something of a case for regionally varying the tax.

It is an interesting paper. It sits somewhere between trying to float the idea, recognizing some of the possible shortcomings and providing a call for further debate in this general direction. A number of points strike me.

First, we already have a tax on second properties namely the council tax and my admittedly dim recollection was that it was set slightly punitively compared to occupied levels of tax (but I may be out of date). There would be a need, over and above mansion tax debates, about synchronizing the local tax with this proposed tax on speculation.

Second, the authors are balanced in their reporting of the experience of these sorts of taxes elsewhere an in particular the less effective role they played in Asian markets like Taiwan. However, the German example is much more conducive to their case. They recognise and we must also, however, that policy transfer from one type of housing system to another is a complex business that requires a lot of study to avoid it going wrong (see the excellent new book by King and Crewe – ‘The blunders of our governments’ published by Oneworld – to see some painful illustrations from recent public policy).

Third, I am actually less convinced about keeping the tax regionally varied. I would have thought that through the alchemy of financial leverage there is as much speculative gain to be made in low value property markets as there is in the high end of London ‘s stratospheric prices. This is still dysfunctional just not in quite so dramatic a fashion.

Fourth, I think there is clearly quite a bit of modeling work to be done on the revenue and displacement effects that different versions of such a tax might have on both capital gains tax revenues (if it partially or wholly replaced that function) but also in terms of its revenues in relation to costs of collecting and setting up. I would imagine it can piggy back on stamp duty – though that will be complicated in Scotland after it is replaced with a new transactions tax in 2015.

The harder question to answer is how it will affect behavior – the second round effects.  Heywood and Hackett note that most of this speculative activity is broadly associated with: American and North American investors seeking property in London for residential or investment purposes, non-OECD investors seeking save havens and otherwise secure property in a world city  (though often hardly if at all living there); and Asian investors who seek both capital and income returns. These groups will respond differently to such a property speculation tax. And just how would it affect the buy to let sector?

It would change the incentives for second home owners and owners of otherwise empty property – but while it may stop buying to keep empty it will not help or incentivise those already holding such property other than to hold on longer and perhaps seek income returns from a tenant- but it will depend on the motivations of such investors.

A speculation tax may have a modest but helpful impact reducing these pressures. Depending on how it is designed it may be a valuable fiscal tool to add to the largely monetary policy levers open to market stability and the other levers that might support sustained increases in housing supply. There are clearly many questions and trade-offs attached to design and consequences of the tax. However, I would not see it as a revenue-raising device but more as a tool to lessen speculative pressures. I am not so keen on the London only focus (though the authors do say that they think that the argument is finely balanced). It does need to cover its costs but it sounds like it would be relatively simple and cheap to administer. I also cannot imagine it would be that hard a sell politically in the current environment.

There are many practical hurdles and design questions to overcome but it is definitely worth further consideration as part of a broader package.

(1) Haywood, A and Hackett, P (2013) ‘The Case for a Property Speculation Tax’. A Smith Institute Discussion Paper.

The UN comes to town: to see ourselves as others see us

Earlier in the summer at a conference I met Raquel Rolnik, professor of architecture and urban planning at the University of Sao Paolo and UN special rapporteur on the right to adequate housing. I was interested to hear that she was planning a ‘mission’ to the UK. Shortly thereafter I agreed to convene and host a group of Scottish housing academics talking to Raquel and her UN colleague, Juana Sotamayor. We finally met last week and I have been reflecting on it and the wider responses that emerged.

The UN seeks an invitation from governments – so this ‘mission’ was an officially sanctioned one that involved meetings with organisations, academics, politicians, public servants, citizens and communities. This is an important point, as when they went round England, Scotland and Northern Ireland, they were accused of meddling in UK housing; yet, they were here by invitation. We will see what the report says when it comes out and what sort of response follows.

Although I think they would agree that one function of such a visit is to allow comparative policy analysts look at our housing system afresh and objectively but also to, as a result, ‘shake things up’ in the host country. Apart from questions of housing need, housing adequacy and the rights of minorities, The UK was of material interest to Raquel and the UN because of its status as a key source of the Global Financial Crisis, its financialised housing and mortgage markets and the apparent fact that the housing system had not collapsed in quite the spectacular way that was found elsewhere (indeed it had shown a degree of surprising resilience). Thus, they were interested in the causes of the 2007-08 crisis and the extent to which (and why) we have managed to apparently do a little better than anticipated in the most recent bust of the housing system.

A second reflection is that in the media spin world we live in, a structured and analytical focus on a range of topics (as Raquel intended to work through) can be somewhat lost in the froth of the major political debates of the moment. Perhaps it is therefore not surprising that the mission was to an extent overtaken by the housing sector’s antipathy to the bedroom tax (as opposed to the mid-range tabloid support of the policy).

I want to focus on a few of the general themes that emerged in the Glasgow meeting three days ago in an unattributable way. We did talk about welfare reform and the bedroom tax but more in the wider context of the fit into how the housing system integrates with welfare benefits i.e. we have spent so much money on housing benefit because (a) the private rented sector has grown in an uncontrolled unregulated fashion, (b) social security in the UK has been long premised on rather miserly general cash support because HB paid most eligible housing costs for the poorest and (c) in-work benefits like HB help to support low wages and maintain high levels of relative poverty internationally in the UK. This is a poor all-round background to the reforms underway.

Second, we discussed at length the new force of the private rented sector, its aforementioned lack of standards regulation, the consequences of higher rents and, in particular, the desirability of moving away from standard 6 month tenancy agreements.

Third, the Scottish homelessness policy and its implementation featured prominently, as you might expect. This is of course not independent of the changes to the rental market and the lack of sufficient new social and affordable housing given the financial constraints facing investment in the housing system in recent years.

Fourth, the rise of asset-based welfare through home ownership housing equity and its link to rising house prices and their societal and wider damaging effects was also thoroughly rehearsed. The case for a more balanced housing system, house price stability and more progressive subsidy and more investment also flowed – though I recognise that these questions raise important public policy opportunity costs – under austerity or certainly tightly constrained shrinking budgets, which other departments will pay for more housing funding, even if the case is objectively strong?

There was a final thing that struck me as our conversations widened into broad questions of funding and supply, levels and nature of material poverty and a long term view of housing in an urban setting like Glasgow . This was how much fun and how rare was the opportunity for housing academics across Scotland (and disciplines) to have this sort of roundtable free for all. I was a little anxious before the meeting about whether it would work or not – but it was a wholly worthwhile exercise that whetted the appetite for more of the same. I don’t think I was alone in reaching that conclusion.

I for one was therefore pleased to take part in this exercise and will be look out for Raquel’s report and in that way see ourselves a bit more as others see us.