To revive the coronavirus-stricken British economy, U.K. Prime Minister Boris Johnson has proposed giving a boost to the country’s favorite asset: homes.
Johnson, addressing his Conservative Party’s annual conference on Tuesday, said it was time for the government to press ahead with a plan—first broached in the party’s 2019 manifesto—that would help first-time buyers to purchase a home with just a 5% down payment.
The government would help cover a portion of the lender’s losses if the borrower defaulted. It’s part of Johnson’s plan to create what he calls “Generation Buy” among young Britons.
“We believe this policy could create 2 million more owner-occupiers, the biggest expansion of home ownership since the 1980s,” Johnson said.
Home ownership for young families
It is true that levels of U.K. home ownership have been slipping. Those between the ages of 35 and 44 are now three times more likely to be in private rented accommodation than they were two decades ago, with only 50% of people in this age group having a mortgage today, compared to 68% in 1997, according to a report earlier this year from the U.K.’s Office of National Statistics. Those between 24 and 34 are twice as likely to be renters now as they were then.
But Johnson’s plan is sounding alarm bells among some banks and housing charities who worry that it represents a return to dangerous lending practices that U.K. regulators have been trying to stamp out since the 2008 financial crisis.
Eric Leenders, managing director of personal finance at banking trade body UK Finance, told the Financial Times that “firms have a duty to lend responsibly and consider the affordability of the mortgage in the long term, helping customers to avoid the risks associated with negative equity.”
Meanwhile, Polly Neate, chief executive officer of the U.K. housing charity Shelter, accused the Prime Minister of selling “pipe dreams,” given that the average house price is now more than eight times the average U.K. salary.
The Prime Minister’s plans to loosen affordability standards seemingly flies in the face of what British regulators have been trying to accomplish over the past decade.
In 2007, almost half of the mortgage products available in the U.K. allowed loan-to-value ratios up to 95%. Three years later, in the depths of the financial crisis, the number fell to just 1.2% of the market, as banks naturally pulled back on lending.
But in 2014 the Bank of England grew alarmed that high levels of mortgage debt, combined with rapidly rising house prices, were feeding a risky asset bubble in residential real estate—much like the 2008 collapse in the U.S. that helped trigger the global financial crisis. That year house prices galloped ahead at close to 9% annually, approaching their pre-crisis pace in September 2007.
In response, the bank imposed rules that only 15% of a lender’s mortgages could be issued with loan-to-income ratios higher than 4.5. The U.K. banking regulator also imposed tougher requirements on the amount of capital banks had to hold in reserve to cover potential losses on high loan-to-value mortgages.
Banks cut down on the amount of high loan-to-value mortgages they would underwrite. Some stopped offering mortgages with loan-to-value ratios above 85% altogether. The average loan-to-value ratio of a mortgage that was above the median level—which is 71% in 2019—is now 88.4%, down slightly from 90.6% back in 2006, according to the Bank of England.
A big piece of Britain’s wealth
It not hard to see why Johnson wants to get more buyers into the property market. It’s an easy way to stimulate some economic activity and goose household wealth during a time when most other areas of the economy have been flattened by the pandemic and looming uncertainty over Brexit.
Property wealth accounts for 35% of all household wealth in the U.K., second only to the value of pensions, and its contribution has increased 5% since 2014, according to ONS data.
And property values have never been higher. In September, the average house price in the U.K. hit an all-time high of £226,129 ($293,000), while in London the average house price is now a record £480,857 ($623,000) in September, 57% above 2007 levels. Meanwhile, new mortgage approvals are the most they’ve been in 13 years, according to the Bank of England.
Johnson’s latest promise of 95% mortgages is just one part of a strategy his government has pursued to pour rocket fuel on the already hot property market.
In July, Rishi Sunak, Johnson’s chancellor of the exchequer, announced a one-year holiday on stamp duty—a tax homebuyers pay on most residential property purchases—for houses worth up to £500,000 and a reduction in the rate, to 5% from 8%, for properties between £500,000 and £925,000. The cuts helped spur a massive jump in the number of people looking to buy as soon as lockdown restrictions were lifted in July, with the number of buyers in the market up 38% from the same period in 2019 and, by one estimate, one in every seven houses in the country finding a buyer within a week of being listed.
But it remains to be seen whether deliberately using the housing market to help make Britons feel wealthier and more financially secure in otherwise grim economic times is such a good idea.
At the end of the September, the Bank of England voiced concern about big U.K. banks not properly scoring the risk of residential mortgages and not reserving enough capital to cover potential losses. Some banks were assigning “inappropriately low” measures of risk to home loans, the BOE’s Prudential Regulation Authority said. The finding is adding to concerns about the stability of a financial sector that already is facing a potential tidal wave of $99 billion in bad debt due to the pandemic.
As a result, it is considering tightening reserve requirements. “It is imperative that risk weights are calculated and set prudently to ensure individual firms have sufficient capital for the risks they are exposed to,” the BOE said in the proposal published Wednesday. Bloomberg reported that some banks were applying an average risk rate of just 10% to mortgages in their own risk models, compared to 35% in the model the banking regulator uses.
After all, as some affordable housing advocates point out, getting a mortgage is one thing. Being able to pay for it is quite another.
“You have to question whether the Prime Minister is in touch with reality,” Shelter’s Neate said. “He is talking about giant mortgages at a time when more than 320,000 private renters have fallen behind on their rent as a result of COVID-19.”