What kills you, cures you, according to the UK building society, the Nationwide. Since the rapidly-deflating UK housing bubble was brought about by excessive lending on insufficient incomes, the solution must be…more of the same.
Two days ago the UK lender announced the return of the 125% loan-to-value mortgage. While the offer is restricted to those who are already Nationwide mortgage clients, and who are in “negative equity” (i.e., their property is already worth less than the outstanding loan), it seems as though both banks and regulators are failing to put two and two together in identifying the root cause of the current recession.
The new 125% loan is made up from a 95% mortgage on the new property, and up to 30% in “negative equity” from the old property, carried over. In the US, a sale resulting in such a shortfall to an existing mortgage loan would be called a “short sale”, and in some cases the borrower can then walk away with his or her debt to the lender discharged, although a torpedoed credit rating would inevitably result.
In the UK the rules are stricter and favour the banks much more. Lenders can pursue a borrower for any shortfall resulting from the sale of a mortgaged property for up to twelve years, not including interest and charges. This, I suspect, is what is behind British lenders’ attempts to cobble together such new mortgage deals, and it seems likely that other banks will copy the Nationwide. Better to pretend that the loan is still serviceable and avoid the unpalatable reality of writing off bad debts or pursuing them from individuals who have little to offer in return.
Incidentally, the new Nationwide deal carries some eye-watering interest rates, given that UK base rates are at 0.5%, and three and five year gilt (government bond) yields are at 2.5% and 2.9%, respectively. The 95% loan on the new property carries a fixed rate of 6.73 per cent for three years, or 7.48 per cent for five years, while the negative equity from the old home (up to 30 per cent of the value of the new property) will be carried over at an even higher fixed rate of 7.23 per cent for three years, or 7.98 per cent for five years.
In the weird and wonderful world of banking, these new, higher interest rates will enable the lenders to pretend that they are earning increased profits – for a while – even if the underlying security, UK property, continues to decline in value.
The UK government’s approach to the post-credit crunch regulation of the banking sector smacks of similar inconsistencies. On the one hand the politicians and regulators want to force banks to hold more capital, a belated recognition that system-wide leverage got dangerously out of line in the last decade. On the other the politicians are keenly aware that to contract banks’ loan books (the other way of reducing leverage) will intensify the credit crunch, and so they urge banks to keep lending. It’s clear that the two objectives are mutually contradictory and cannot both happen.
What will happen? My guess is that the forces of deleveraging will overwhelm attempts, such as Nationwide’s, to prop up the system, and we’re heading for a prolonged period of stagnant or falling prices, and a steady increase in debt defaults. I’ll be making an attempt to investigate what this might mean for an ETF investor’s portfolio in my next feature for IndexUniverse.eu. Meanwhile, caveat emptor if someone tries to convince you that the solution to excessive indebtedness is to borrow more.