Mortgage doom catastrophising is the latest British disease

 The situation does not look nearly as bleak as in the 1990s

Source - Daily Telegraph 20/06/23

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As on most things, we’ve been here before.

Today’s “mortgage crisis” is in substance not unlike that of the late 1980s and early 1990s, when interest rates were raised sharply first to choke off an inflationary boom and then to protect Britain’s position within the European Exchange Rate Mechanism.

Only despite the frenzy of catastrophising we see in the media today, it’s not as bad this time around.

Doom-laden prediction and reflection has become very much part of our national psyche; the “mortgage timebomb” is only the latest outbreak of it. But are things quite as bad as portrayed?

There is no disputing the pain of the early 1990s – a severe recession, steeply rising unemployment, and a crash in nominal house prices, with many households left deep in negative equity.

People could genuinely not afford to pay their mortgages. Foreclosures, repossessions and forced selling became commonplace.

We don’t yet have that this time around. So far, there is no negative equity problem to speak of, foreclosures are rare, and house prices are barely lower than they were a year ago.

What’s more, both in nominal and real terms, Bank Rate is not nearly as high as back then, when it reached a peak of more than 14pc.

The operative words here are of course “yet” and “so far”. The media is full of catastrophising about what may be to come, much as it was last autumn over the separate “energy crisis”, when there were some particularly alarmist predictions about the sort of increase in bills likely to be faced by consumers.

In the event, prices had already peaked, and would soon be on a declining path. 

I don’t want to belittle the nature of today’s mortgage rate crisis. Many households are looking at real hardship.

The Left-leaning Resolution Foundation think tank calculates that 800,000 households forced to remortgage next year face an average £2,900 per annum rise in their mortgage bills. 

Others have pencilled in even larger estimates. And for many households, the mortgage crunch has already arrived. 

According to the Bank of England, some 1.3 million households will reach the end of their fixed-rate term between the second quarter of 2023 and the end of the year.

Adding these two numbers together, you get to just over two million mortgages involving extra costs of around £6bn a year.

This is admittedly a big drain on people’s disposable income, but at little more than 0.2pc of GDP, it is not in itself enough to cause a serious recession.

The Resolution Foundation goes further and extrapolates that annual mortgage repayments are on track to be £15.8bn a year higher by 2026, which would represent a rather chunkier 0.6pc of GDP. But for that to happen, mortgage rates would need to remain elevated until then, which doesn’t seem likely.

Furthermore, this is not money that disappears into a blackhole. Higher lending rates involve a certain amount of redistribution away from household borrowers to net cash savers, the latter of which are still by far the larger group.

Most owner-occupiers already own their properties outright, so will be completely unaffected by changing interest rates.

The share of homeowners with a mortgage has fallen to just 30pc, against around 40pc in the early 1990s. The pain is therefore concentrated in a much smaller group of people proportionately.

New affordability rules introduced after the financial crisis, moreover, require lenders to ensure their mortgage borrowers are capable of weathering an increase in mortgage rates of at least 3 percentage points, which is roughly where we are as things stand, with the average five year fix having risen from 3.2pc a year ago to 5.2pc today, according to the Rightmove mortgage tracker index.

Many households face a challenging period of belt-tightening, in other words, but in terms of negative equity and repossessions, things do not so far look anywhere near as bleak as they did in the early 1990s.

Besides, banks and building societies are under intense political pressure to show forbearance, by allowing mortgages to be extended, arrears to accumulate and borrowers to swap onto interest-only deals.

Nor do banks want to see another explosion in bad debt experience after the near-death experience of the banking crisis 15 years ago. Kid gloves will therefore be widely applied to distressed borrowers.

Stress testing of the resilience of the banking system to economic shocks last year war gamed Bank Rate rising to around 6pc, which is at the high end of where markets now expect it to end up. So on interest rates at least, banks are already worrying close to the extreme scenario tested for.

Even so, there were lots of other gory elements to the stress test, including a deep domestic and global recession and a collapse in asset prices. Never say never, but we are for now quite a long way away from such an apocalyptic state of affairs.

I don’t particularly want to add to the frenzy of media criticism that currently surrounds the Bank of England and its counterparts in Europe and the United States.

To do so further increases the risks that the Bank of England will overreact and, in its determination to demonstrate that it is still on the case, end up over-tightening into an environment where inflation may soon be yesterday’s story.

As it happens, there is a reasonably good case for saying the tightening cycle has already gone far enough. This is because of the aforementioned mortgage rate “cliff edge”. Back in the early 1990s, the vast majority of households were on variable rate mortgages. Any increase in Bank Rate would therefore immediately feed through to demand via higher mortgage costs.

Since then, the mortgage market has changed markedly. The great bulk of mortgages are now two, three and five year fixed rate deals. 

The upshot is that up until now households have been largely protected from the rising interest rates that began more than a year and a half ago.

Only now are the effects being felt as such deals expire and have to be refinanced at much higher rates.

In the past, the damage to disposable income from rising interest rates would be immediate, but this time around it has been on a long fuse. The Bank of England is therefore largely in the dark over what rate of interest is needed to bring inflation to heel. Has it already done enough? It’s hard to know.

As I say, I don’t particularly want to add to the orgy of Bank bashing; I’ve already done more than my fair share of it. But what is clear is that central banks are deeply complicit in promoting the idea that the ultra-low interest rates of recent years were permanent, and therefore that today’s bloated house prices were an affordable phenomenon.

“Forward guidance” to the effect that the central bank would keep interest rates low for an extended length of time became part of the lexicon of the Bank of England.

That the US Federal Reserve and the European Central Bank were even worse behaved in this regard does not excuse the Bank of England from this collective delusion.

Given what the Bank kept saying, it is not surprising that people assumed that mortgage rates would remain at 2pc forever, and acted on that assumption. Forward guidance has turned out to be a terrible mistake which has badly misled a whole generation of house buyers.

Nor can the Government escape blame, having actively encouraged essentially unaffordable house purchases with stamp duty holidays and help-to-buy.

Things have now changed, and today we have the opposite problem, a different sort of forward guidance where central banks say they will need to keep raising rates into the indefinite future to tame inflation.

This is beginning to look equally misjudged, causing interest rate expectations, and mortgage rates, to rocket. Our monetary gurus have created an awful mess, for which many households pay a punishing price.

That it is unlikely to be as bad as the early 1990s is little consolation to those at the sharp end of these policy misjudgments.