April 2008

Why a look back through history assures me I do not expect the market to crash!

Do you remember 20 years ago, when we faced far more alarming times than this?

HAVING run into a degree of flak of late, I thought that this month I would look at an even more contentious question – the future of the market, price-wise!

This is well worked ground with numerous pundits predicting gloom and doom – which always makes for a dramatic headline – even if the facts have to be changed to suit their angle. But I am not among them.

Here is one area where the lessons of history have been learned. Clearly mistakes will still be made but less so than in the last real housing market recession which started in the late 1980s. In fact one can specify the exact date – it was August 1, 1988.

That was the day mortgage interest tax relief at source (known as MIRAS) was withdrawn from new loans. It had already been limited to the first £30,000.

Severe mistiming

When the then Chancellor Nigel Lawson announced his decision in the 1988 Budget he should have treated it like cigarette or fuel duty “taking effect from six o’clock tonight”.

Instead he gave almost four months’ notice, which was a fearful mistake. Every headline screamed that if first time buyers missed out on MIRAS they would never be able to buy their own home! This was ‘last chance’ writ large!

With suitable property in limited supply, prices rose sharply with desperate first time buyers begging, borrowing or stealing a deposit. Rising prices normally deter buyers — here the reverse happened. As prices increased, so did the mania.

The 1980s were so different from the 1970s when the mortgage market had been one of feast and famine. Sometimes, when the building societies were in funds, loans only took weeks. At others, with funds restricted, the would-be buyers waited patiently in a queue, for months on some occasions.

Hoary but true — Young couple: “How do we stand for a mortgage?”; Building Society Manager: “You don’t – you grovel!”

Save that was no joke. Indeed I well recall one building society manager, long since dead, who got his kicks from giving the young applicants a sex lecture asking about their contraception plans.

We had to pre-warn couples to sit through this as, if they kept their cool, the result was a 95 per cent mortgage.

All that was to change in the 1980s under Margaret Thatcher. Among her policy objectives were the ‘right to buy’ and greater home ownership to increase mobility of labour.

However, in 1980, the Wilson Report on Financial Services had warned that the Government would have to intervene to regulate the growth in size and influence of the remaining building societies.

By then there were only 200 or so with the big boys rapidly snuffling up the smaller fry.

Tipping the wink

To the new zealous Conservative Government, that meant only one thing: they needed competition. And so the Bank of England tipped banks the wink that they might care to balance their loan book with a share of the lucrative mortgage market.

Once the notorious ‘corset’ was relaxed, change was inevitable.

Soon after, specialist mortgage lenders joined this feeding frenzy. Without branches, or 200 years’ history, to hinder policy-making, and into ‘wholesale’ funding, they soon took a lion’s share of the business with 95 per cent and 100 per cent loans on offer in six or eight days.

That frightened the building societies rigid – not so much the 100 per cent loans — they knew that was risky business — but six to eight days!

History is bunk

The competition worked. The building societies were suddenly minority lenders. At peak, some 70 per cent of mortgages were bank-based loans.

Provoked into retaliation, the more go-ahead societies, with young head-hunted, highly paid, chief executives, ignored the lessons of history and joined the fray. They also started lending 100 per cent mortgages, and almost as quickly.

For seven or eight years, all went well with both banks and building societies lending like mad. The market was booming like never before but, surprisingly, inflation did not get out of hand.

The Tories had latched onto privatisation. Much of the extra lending was going into second mortgages but the Government’s share sales took the surplus cash straight back into the Treasury.

This wheeze started with British Telecom. That sale was followed by the water companies and the other utilities. It worked like a charm; while inflation was held in check, vast sums were lent and sucked up by these massive share sales.

Be prepared

In October 1987 it suddenly went pear-shaped. The Government had lots of money swilling around to fund the flotation of BP shares.

But ‘Black Monday’ put paid to that idea and house-price and general inflation took off as all that money had to go somewhere.

It led to a hectic market in 1988 with well over two million houses sold at an average of £75,000. However, to reduce inflation, interest rates had to go up, and with them mortgage repayments.

Inflation was slow to respond. In this new liberalised mortgage market-place people could still find the funds from off-shore to keep spending.

So the Government had to target the housing market itself and withdrawing MIRAS was intended to quieten the market. As remarked, initially it did the very reverse.

However, following the mad rush to beat the August deadline, the market did stop.

In fact the unheard of started to happen – prices fell. Slowly at first during 1989 but the trend accelerated during 1990.

With repayment levels at an all-time high many home-owners fell into arrears. First time buyers, sharing a home with every penny committed to their mortgages, simply handed in their keys and walked away.

By 1991, prices were falling virtually everywhere in the country, with the number of house sales down dramatically.

Down by 50 per cent since the 1988 peak, the average prices were around £55,000 on a sales volume of barely a million.

So why had the dream gone so sour? The Government blamed Black Monday but in reality the real mistakes were made much earlier. Obsessed with increasing home ownership, it had failed to warn those who had little money in the first place.

Ten years previously, the building societies, with caution based on 200 years’ trading experience, were not overly keen on 95 per cent mortgages.

They might agree if the applicants were a young couple with commitment and clearly increasing earning potential, but for other people 90 per cent was the norm with a 100 per cent loan unheard of.

Hard grind

Houses have never been cheap: the 10 per cent deposit was then equivalent to around 12 months’ after-tax income. This meant that most home buyers had to save hard for at least two or three years. This delay also acted as a brake on house-price increases.

By then house purchase was no longer restricted to those with two years’ hard savings graft behind them. House prices broke free as demand was unlimited.

This was better than working. Starting with no money one could accrue several thousand pounds, tax free, within 18 months — and somewhere to live.

Incomes were rising, which gave people more spending money. If they took out a mortgage at three-times annual income (or more!) gearing meant they could spend even more.

Interest rates were low and if one building society would not lend them as much money as they wanted there were lots of other sources which would.

Many clever characters soon worked out that if you could get a mortgage with no deposit or savings record, you may as well get several.

Some of these clever characters were solicitors, while others worked closely with a solicitor who could deny liability if the whistle went and share in the spoils if it didn’t!

I co-authored a `Mortgage Fraud’ Report, commissioned in 1989, which found that over one mortgage in eight was to an extent fraudulent.

Some were merely a MIRAS swindle but the record was held by a building society, big enough to know better, which we found to have made over 50 mortgage advances all ‘secured’ on a single property!

Worse, the Government had seen the potential; it, too, got greedy. The inflated housing market created a feel-good factor which won two elections for Mrs Thatcher, but after a decade this house-price spiral became self-defeating.

Those clever characters with multiple-mortgages got caught first as interest rates doubled in 18 months.

So what to do? Some building societies had had the occasional arrears case and knew to tread carefully.

But these new lenders had bright lawyers and strict terms. One month’s arrears got a letter, two months a formal warning, the third and one was in court.

The Judges followed the terms of the mortgage deeds and granted possession. An average eviction was going through in a 10-minute hearing.

Consequently, 80,000 families hit the streets in 1991 — up a staggering 1,000 times on the number 10 years earlier. And these were merely the tip of a painful iceberg with one mortgage in six then two months or more in arrears – we saw reports suggesting 500,000 borrowers were in serious trouble.

Petard hoisting

Once those statistics worked their way through the Treasury model, even Prime Minister Major must have realised his administration was doomed. That was justice of sorts as it had been his decision, while at the Treasury, to pull house prices back to kill inflation.

Back in the real market-place, the few genuine buyers were spoilt for choice as these repossessed properties flooded on to the market.

The lenders had no answer but to reduce prices until the empty homes sold. In desperation some resorted to auctions held without reserves. Soon few would buy a genuinely private ‘for sale’ property when spoilt with such choice. Falling prices exacerbated the problem, fuelling a reverse spiral – equally self-defeating.

After this disaster, it took all of 10 years to see the market regain a degree of normality, but many hard lessons had been learned which is why the present scenario is somewhat different.

For the record, MIRAS was withdrawn completely on April 6, 2000.

At peak, there were reportedly over 2,000 sources of mortgage in the UK as banks from all over the world had joined the feeding frenzy. Many have since gone away completely with their remaining mortgage books securitised and sold on. Ironically, the Northern Rock was one of the best in the business at nurturing its arrears cases.

But here comes the good news: those lenders still around are now treating their arrears cases very differently. They realise that automatic mass evictions are not an answer.

Today, far more lenders make individual arrangements, accepting interest-only payments or whatever. I have even heard of repossession with the property let back to the original owners.

Prices may continue to ease back during the rest of this year but in a more orderly fashion — and those estate agents who survived the market I have just described will at least know how to deal with it!