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Home Publications Blogs Beat the Press UK Homeownership Program Big Winner, Just Like Subprime Lending

UK Homeownership Program Big Winner, Just Like Subprime Lending

Sunday, 19 January 2014 08:48

The Washington Post used a standard that would have shown subprime loans to be a great boon to tell readers that a housing program by the conservative government in the UK has been a "winner." The Post's declaration of the program as a winner is based on the fact that the program, which allows people to buy homes with a 5 percent down payment, has allowed many people to buy homes who could not otherwise afford them. This was true of zero down subprime mortgages issued during the housing bubble years also.

The Post is also confused in its assessment of bubble conditions in the UK. The article implies that existence of a bubble depends on the rate of price increase as opposed to the level of prices, based on this view it tells readers that there may be a bubble in London, but little risk in the rest of the country.

The chart accompanying the piece shows rapidly rising prices in the London market, with prices rising at a more modest pace in the rest of the country and still below their bubble peak in 2007. However the level of prices in the UK is shown as being more than five and a half times its 1983 level. This implies an inflation adjusted increase in house prices of almost 140 percent over the last three decades. Rents have shown no comparable increase, which indicates that house prices are not being driven by the fundamentals of the housing market.

At some point it is likely that house prices will fall to a level more consistent with the fundamentals of the UK housing market. At that time, the beneficiaries of the Conservatives' homeownership program will be winners in the same way that subprime purchasers in the United States were winners following the crash here.

It is also worth noting that the increase in consumer spending mentioned in this article is likely directly related to the renewed run-up in house prices. People are likely spending against the wealth in their home. This is the well-documented housing wealth effect which shows people increasing annual consumption by between 5-7 cents for each additional dollar of housing wealth. This wealth effect was the reason that the savings rate fell to nearly zero at the peak of the bubble and then rose sharply after house prices collapsed in 2007-2008.

Comments (7)Add Comment
It is all about the pricing
written by EMichael, January 19, 2014 9:19
High LTVs do not create a bubble by themselves, it depends on the pricing of the loan. Consider that FHA loans have been around a long, long time and never caused a bubble. That is due to the upfront PMI and monthly PMI costs.

Bubbles are caused by ignoring LTVs and DTIs and not adjusting the price when doing so, which greatly(and artificially) increases the number of buyers pursuing assets. That violation of basic lending is what the investment banks did in causing the housing bubble.

I can take the same kind of buyers and offer a conforming 20% down loan and a 3% down, sub prime loan and, through pricing, make the two loan programs perform exactly the same.

It is not a bubble if people make their payments.
and a 3% down loan and, through pricing, make both loan

written by John Shaplin, January 19, 2014 11:28
Is it all about the pricing?
written by Matt, January 19, 2014 11:29
Let's there are two otherwise identical people getting mortgages, one with a 20% downpayment, and another with a 5% downpayment. Six months after the signing of the mortgages, the economy takes a nose dive and house prices collapse by 10 or 15% (maybe the causality would work the other way, but whatever).

The one with the 5% down has lost all his investment and then some. The one with the 20% down has not. Therefore, the first person has a huge incentive to walk away, as his mortgage is probably underwater. This is not true for the other person.

So don't down payments have something to do with bubbles and bad after-effects, on their own?
Private Mortgage Insurance
written by Richard Genz, January 19, 2014 12:47
For decades, beginning in the 1950s, US private mortgage insurance companies made money guaranteeing loans to homebuyers with only 5 percent down. Fannie and Freddie purchased these insured loans for years, too. Downpayments were small but other criteria were tough. You can't automatically equate 5 percent downpayment loans with zero-down subprime mortgages.
Matt, why would you think
written by EMichael, January 19, 2014 1:13
the short term value of the home would impact a decision of a person to walk away? There are a huge amount of people in this country who are underwater that have not walked away. Main reasons? It is their home and they can afford the payments.

And I do not understand how the two buyers did not "lose" the same amount.
In reply to Emichael
written by John Wright, January 19, 2014 4:47
@EMichael wrote:

"And I do not understand how the two buyers did not "lose" the same amount."

In the USA with non-recourse loans, the buyer can walk away and return the house to the lender. The old tax treatment required the borrower to pay income tax on the debt "forgiven" as a result, but that was changed in the last crisis.

Assume one buyer paid 200K cash for a 200K house which then fell in half. Another paid 5%, or 10K down, and left 190K in the bank.

The 5% down person can walk away, handing the keys to the bank and have 190K net worth. The other person, has seen their net worth fall to 100K, and now has 100K equity left.

The 5% down payment purchaser is also in a stronger position to re-negotiate their loan, because the bank knows they can walk away as they have negative equity pushing them that direction.

Other countries have different rules.
written by dax, January 20, 2014 7:48
"It is also worth noting that the increase in consumer spending mentioned in this article is likely directly related to the renewed run-up in house prices."

Yes it is! But doesn't the count then as stimulus, since in the case of the UK it will be the government as the guarantor of the loans who will be holding the bag if and when prices go down and borrowers begin to default. This is one reason why I think it is too simplistic to say the UK is following austerity; it really is using stimulus, although a backdoor kind (rather than direct government spending).

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.