The problem with mortgages

A recent article in the Times “New funding rules force builders to apply brakes” (I read the print edition from Saturday 14 February) highlights one of the problems of commercial debt

In my white paper I explain that having debt in an economy creates problems. It allows the economy to overheat when things are going well (debt financed growth) and then makes the recession worse when things are going badly (debt repayments mean that the total fall in GDP is bigger than any underlying reduction in real production).

So the mortgage market in the UK has pushed house prices up, because we think nothing of borrowing large amounts of money over long terms to buy houses. The debt means that more houses can be “afforded” and therefore increases the number of houses bought. This in turn means that more houses are built and the house builders are very happy. Economists are happy because house building contributes to GDP and everything looks great.

And then along comes financial regulation – last year (2014), the Financial Conduct Authority carried out a review of the mortgage market and came up with some new guidelines, which have meant that mortgage lenders are looking at mortgage applications more carefully and as a result reducing the amounts they are willing to lend. And this is what the Times article was complainingHouse under construction about – house builders are reducing the number of houses they build because these rule changes mean fewer houses are being bought.

This supports my view that the mortgage market – commercial lending – has affected the housing market and pushed prices up.

If my suggestion of outlawing commercial lending is followed through, then the housing market will not have the support of mortgage lending and house prices will fall (relative to earnings). This would be a good thing in that house prices would no longer be buoyed up when the economy is strong and sink when the economy falls, but will remain more stable.

Sadly there is another side to all this – which is the effect of withdrawing commercial lending on the economy as a whole. As the Times article indicates, house builders are building fewer houses because buyers are finding it more difficult to get mortgages. And the same is likely to be true of many other areas of the economy – by restricting lending, economic activity will be lower (as measured by the GDP measure economists use).

Are the benefits of a more stable economy and freedom from some of the other adverse effects of debt worth paying the price of lower levels of GDP? I would say yes.

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