Letting The Housing Market Crash

Over the last 30 years the number of households who own their homes has risen substantially, during this period house prices have risen, and in the last decade substantially. As a result of this economic boom, homeowners find themselves in a different position to those who are renters. Where the rental market has expanded and shrunk in only very small variants over the past fifty years, the home ownership market experiences frequent colossal shifts direction and has been constantly moving. The most recent of these colossal shifts has been the boom from the mid 1990s and the bust of 2007.With mortgages being a vital part of home ownership for most households, the financial framework around mortgage lending is the foundation to which homeownership can grow or shrink. In 1976 92% of new mortgages were from building societies who were tightly regulated and selective who they made eligible for their products. As a result it was not easy to get a mortgage for low income households, even if Margret Thatcher was selling houses for hugely discounted prices. More recently, lending trends have changed substantially. Squeaky clean building societies lost their near monopoly of the mortgage market when the government reduced its regulation over banks and other lenders in the financial sector in order to ensure that lending increased year on year.The world of finance quickly became murky and with phrases such as asset back securities, credit default swaps, derivatives and securitisation, its no wonder government turned a blind eye to it. With home ownership the only tenure actively promoted by government after 1979, governments and lenders realised that if they were to increase the number of people in owner occupation, they must enable lenders to give mortgages to more people. One way this could be achieved was the securitisation of assets. Securitisation is where pools of assets are created for the purpose of selling on for a fee. In the case of mortgage back securities (MBS) the pooled assets would be a group of mortgages, grouped up and sold off by a lender to an investor. The reason why securitisation has been popular is because the sum of money that banks have at any one time through deposits is not finite, selling off their mortgage books overcomes this problem and freed up more capital to lend to new first time buyers. Lenders no longer required customer’s deposits to lend out to home buyers, now they can simply arrange pools of mortgages and simply sell them off, in effect leaving depositor’s money safely locked away. In theory, as long as there were buyers of MBS, lenders could continue to lend more mortgages without ever running out of money.In the middle of all this buying and selling were rating agencies that advised the lenders on how to package the loans in order to achieve high ratings and prices for the securities, and therefore were obliged to rubber stamp the majority of securities with the lowest risk tripple A ratings.Mortgage securitisation was seen as a win win situation for all involved, from the bankers and mortgage brokers who sold the loans, the investment bankers who packed the loans into securities (in this case MBS), the rating agencies who advised how to package MBS, and the buyers of the MBS who got a sound investment. The incentive was for everyone to push as many loans through this system as possible. At no stage was the real value of the loans ever considered, it was accepted that as long as the housing market was buoyant and the unregulated rating agents continued to stamp the MBS with tripple A ratings, the securities would be of value.The second development became the increasing use of derivatives in the mortgage market. Derivatives are financial contracts or instruments that get (derive) their value from something else, this underlying ‘something else’ does not need to be owned by the trader. Commonly this is done on the value of something in the future, say, house prices. In this sense they are pure gamblers. In the past traders bought and sold future contracts by an agreement to buy coffee in three months time at a certain price now, protecting themselves from the worry that a crop failure might drive up the price of coffee in the intervening months. In the 1980s, these types of agreements became common place in the stock market, eventually some investment bankers began to turn this into ‘hedging’ and a profitable business in its own right, developing progressively complex ways of gambling. It is in a sense a gamble on future prices, and over the past decade the housing market has been one of the safest and popular markets for banks, pension companies and investors to gamble on. Huge sums of money were invested in the expectation of rising house prices.Both these practices have undoubtedly been significant in facilitating a housing boom and both have been undermined in the recent recession. These two practices are complex enough; however, when MBS were bought and sold as derivatives, the system became far more unstable and far more risky. Buyer would agree, in a contract to obtain the MBS at its given value at a future price at a future time (that price was derived by the assumption that the housing market would continue to rise) therefore there asset would cost more but would continue to grow.The problems arose when the values of MBS became less apparent due to the amount of defaulted mortgages that the MBS’s contained. Since no one really understood what assets were in the MBS, no one knew what the true value of the MBS actually was. This uncertainty led to a dry up of buyers and a frantic attempt to offload MBS. Banks and hedge funds had lots of derivatives that were both declining in value and that they couldn’t sell. When investors stopped buying the MBS’s, banks had to stop making new loans, which meant houses didn’t sell, which only put more downward pressure on housing prices, which then caused more loans to default. This is what became known as the house crash.The whole financial system is riddled with incentives for employees of institutions to take worryingly high levels of risk. Commercial and investment banks, insurance companies and pension funds among others were all given the freedom to take perverse risks in buoyant markets without any risk assessments or fall back plans. It is worthy to note that one of the biggest investors in MBS, and thus one of the biggest losers from the recession is pension companies. Standard Life is reported to have had half of its money in MBS. The relevance is that, while the social security of people’s homes has been undermined by the crash, their security in their pension may also be damaged.In addition to this, bonus cultures have exasperated risk taking. A bonus culture has always been prevalent in the financial market, as it is in many other sectors, however the development of the last decade has been the level to which these bonuses have been paid out. The Guardian reported in 2006 that city banker’s bonuses were worth around nineteen billion pounds. The bonus culture in banking of recent years is somewhat of an easy target and has already been widely covered in the popular media. Deregulation has allowed bankers and executives to give and receive huge financial bonuses in years where risks taken have produced high returns. The problem is that these bonuses are not subject to be paid back if the good years turn to bad years. The practices that bankers were engaged in encouraged them to behave in an unsustainable manner, often treating it like a game without consequence. The incentives for success were short term, regardless of longer term implication.This simple ‘through the key hole’ look at deregulation shows the emergence of a dangerous mixture of institutionalised, murky complex systems and huge incentivised risk taking, which brought about a chaotic meltdown that fell in on itself. All of these developments that created a housing boom, are equally responsible for its downturn. The deregulated market was allowed to produce an unsustainable bubble.

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