I have an enormous amount of respect for Vince Cable, not least because he's the only current front-line politician who had a published chapter on my international political economy course reading list when at university. A very good piece it was too, covering the inconsistent pace of globalisation. However, his argument on the Today programme about how the mortgage market should proceed was irresponsibly conservative and, quite frankly, perverse. The audio file is here.
What Cable is essentially arguing is that the housing market has been growing largely because of the availability of cheap mortgage finance. He castigates lenders for allowing borrowers to secure mortgage finance for up to an amount that is five times their annual income. Such lending is irresponsible in his view, and mortgage values should be limited to three times of annual income. By pursuing this more conservative course, we will begin to open up the market for first time buyers. The economics underlying this argument are plain wrong.
If the house sale market existed in isolation then he may have an argument. It doesn't. It exists in parallel to the rental market. If people aren't buying houses they are renting them instead- they've got to live somewhere! What this means in practice is that as house prices decline, the risk-return ratio alters in the rental market. In other words, rents go up, capital costs (i.e. house prices) go down so that spurs investment in rental property. So our first time buyer still does not own a house, but they are paying more rent to support the profits of private landlords.
This point was illustrated in report published yesterday by the National Housing Federation which forecasts a 25% increase in house prices by 2013. House prices will decline in the short term but will then continue their upward trajectory because the main driver of the market is demand. We live alone for longer, live longer, and get divorced more. Whether people are renting or buying, more people need properties and supply is not keeping pace with that. What's more, unless the mortgage market is kick-started even fewer houses will be built making the situation worse.
So Vince Cable's position actually puts first time buyers in a much worse position. The market fundamentals won't change but the ability of people to get on the property ladder will be devastated unless good mortgage finance becomes more readily available.
Turning to Vince Cable's contention that the banks have been lending irresponsibly and that we should return to a three times income rather than five times income norm, this is unduly conservative. Let's do the sums using the BBC's mortgage calculator.
'Kate' has an income of £40,000 and is looking to buy in the South East where a one bedroom flat is likely to cost her £200,000. She has £20,000 savings. If she can get a mortgage for £180,000 over a 25 year time frame at 6%, it will set her back £900 for interest only, £1173 for repayment per month. Her monthly disposable income is £2300 or so. Either option is affordable. At 12% it would be unaffordable (leaving her with a monthly post-mortgage income of £400 or so.) 12% interest rates would only be seen in an economy facing collapse so exceedingly unlikely.
Now let's move Kate to Cableland. Her income is still £40,000 but she can only get a mortgage worth £120,000 now. With her £20,000 savings that means she can get a house worth £140,000. That means that house prices will have to fall by £60,000 before she can buy. That's a fall of 30%!!!!!!!!!!!!!!!!!
Of course, that won't happen because assuming that wholesale markets do recover, finance will be in plentiful supply to allow private landlords to purchase the flat that Kate dreams of before it gets anywhere near £140,000. Poor Kate unless she gets a £20,000 pay rise- a 50% increase- is stuck in the rental market indefinitely. How frustrated she will be that she can't get a mortgage even though it is completely affordable with her income and she is paying the same amount, if not more, in rent as she would be in a five times income mortgage.
Now to Vince Cable's final argument that there should be no kick-start for the mortgage markets lest we repeat the mistakes of creating a house price bubble again. His argument against the Bank of England underwriting mortgage debt because it means that the public sector will take the risk and the banks will get the rewards is curiously out of date. The Bank of England has a scheme already in operation called the Special Liquidity Scheme which protects existing high-quality assets in a manner that contains the risk in the private sector. The UK housing market is not like corporate bonds or equities. It can't suddenly junk- the basic underlying assets, i.e. houses, have a pretty sturdy value whatever the short term fluctuation may be.
Sir James Crosby's report into the mortgage market to be published today does not envisage permanent government support for the mortgage market as exists in the US through Freddie Mac and Fannie Mae. That is right but an extension of the special liquidity scheme to new as well as existing mortgage assets could be advisable. Any extension would be time bounded until wholesale markets recover.
I'm afraid Vince Cable's arguments would have a devastatingly detrimental impact: house prices would continue their decline, the economy would suffer, and first time buyers, other than the very few at the margins, would actually be harmed rather than helped. Looking seriously at providing more liquidity to the system, but in a way that prevents the public sector assuming the private sector's risk, is the way to go. And hopefully, those five times salary 90% mortgages, at good interest rates, will become readily available again and Kate gets the pride and investment potential of her first flat.