In the current media there is analysis of two potentially offsetting features of the UK property market. Firstly there is speculation of a further house price bubble sparked by the government’s ‘Help to Buy’ lending scheme and secondly the constant criticism of banks for failing to lend. Sir Mervyn King is unimpressed and has criticised the state position on home buying support as a ‘government-guaranteed mortgage market’.
The lending process of banks is tied to many factors beyond their control. They are constrained by capital requirements and the prospect of an increase in the interest rate increasing their bad debt recordings through repayment default. However, it is by no means clear state sponsorship is the solution to this.
From the point of view of the lender, a mortgage is used to buy property which is used to provide the loan security. The risk to the lender should be minimal. The borrower goes to the bank to get a mortgage and buys property which is security for the loan. In the event of any default on the loan, the lender takes possession of the property which can be resold to cover the amount outstanding. However, we must also consider the risk that the house price falls and the property can not adequately secure the loan – and any outstanding interest – should the borrower default.
On this basis, it would appear banks’ reluctance to lend implies they are expecting a fall in property prices. However, the government wants an increase in mortgage lending to ‘kick start’ the housing market. Rather than regulate the banks to change their business model the state thus proposes to interfere in the market by becoming the risk taker. For example, let us say I am requesting a mortgage of £220k for a property the bank feels is £20k overvalued. The bank should be happy to lend the £200k at low risk and government sponsorship may fund the rest – the risky (one might even say, ‘sub-prime’) part of the loan.
However, perhaps the banks are lending less, not because of risk, but because of insufficient demand for their products. Supply must, after all, equal demand. If potential home owners find mortgages are unaffordable they will not borrow. Under normal operations, a firm unable to sell its products because it has priced too high, reduces the price or reduces sales. For example, the candidates on the TV show The Apprentice have realised this in their beer selling challenge. However, it would seem banks need not lower the price of borrowing and make mortgages more affordable if the government is ready, in effect, to subsidise financial products and profits. Bank of England economists have indicated that private sector UK banks already receive implicit subsidies of hundreds of billions of pounds.
Put simply, either: 1) the property market is overpriced, in which case a risk adverse business model quite rightly indicates lending should be reduced: In this case, the government scheme will support my paying too much for property and potentially fuelling a property bubble. Alternatively, 2) the government scheme may be seen simply as one of many which supports bank profitability, effectively, a subsidy.
To boost sales, firms in other industries would simply have to lower their prices, why not mortgage providers?