The hidden moral hazard of Help to Buy
The Government’s sheepish defence of the Help to Buy scheme (on the basis that the take up has been low and the impact therefore insignificant) may have kept journalists at bay this morning, but economists will continue to warn of the blindingly obvious risks of heating up even one part of the housing market by allowing individuals to buy over-priced housing they can’t afford.
But despite acres of newsprint, one aspect of the mortgage guarantee scheme has so far eluded journalists’ attention. It is a consequence of the scheme rules which admittedly are tucked away in an obscure 67 page document in which there are 89 defined terms and which in turn depends on further documents. Moreover even though each borrower who benefits from the scheme should be aware of the exposure I describe below, the documents shown to them by participating banks are effectively silent.
Thus journalists report only that these loans are guaranteed for seven years without enquiring into the implications. What exactly happens after seven years to these 25 year mortgages?
With normal mortgages there is no particular incentive for the lender to accelerate default or exercise the power of sale (“foreclosure” never happens in practice) until things have gone past any prospect of remedy. Judgements about the level of arrears are balanced against the prospect of say an unemployed borrower getting work soon, and trends in property prices are also relevant. Often this results in pragmatic delays to the resolution process which usually operate to both parties’ benefit.
But with the “Help to Buy: mortgage guarantee scheme” that can’t happen. There is an approaching cliff edge for lenders with a loan in default, as unless the position is crystallised the lender can’t benefit from the guarantee (for which incidentally he has paid a “commercial fee” the level of which isn’t easy to establish from published documents).
You might think, on a cursory perusal of the scheme rules, that this had been dealt with in the documents: clause 11.1(a) appears to be the operative provision, and it allows claims to be made both for losses after the property has been sold and for “Expected Losses” where the property hasn’t, on the basis of valuations. But if you persist with the document, clause 13.6(d) also makes it clear that unless a sale follows within 12 months, any payment for expected losses will be clawed back.
So (as far as I can see) the scheme hasn’t solved this problem. Lenders who want to get the protection for which they have paid will have every incentive to behave irresponsibly to crystallise default in the period shortly before the guarantees expire.
Conversely, while the Government has so far got away with this, the political implications of unnecessary repossessions will be huge. People will draw parallels with the conduct of RBS’s small business unit. (It would be interesting to know if any of the lenders’ credit committees debated this, or whether the Treasury was asked to comment: an FOI request might prove fruitful.) What this means is that there will be a great incentive to prop up house prices to avoid this nightmare unfolding publicly.
So the problem economists fear of artificial support inflating a bubble will hover not just over the scheduled end of the availability of the scheme, but for a rolling eight-year period after that. Expect artificially low interest rates for the indefinite future. This one can join QE among the poisoned chalices for the next lot. Boom or bust, anyone?