Mortgages and Reposessions (2012), by D.J. Webb

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Mortgages and Repossessions
by D.J. Webb
Published on the LA Blog
12th march 2012

Traditionally in England it was considered disgraceful not to pay your debts. Yet with the current financial crisis apparently running and running the way in which financial products are rigged against the consumer—and the way in which property prices have been fuelled over decades by a number of government policies—has introduced the notion of the lenders’ responsibility into the debate surrounding the property market. I welcome this development.

While I realise many libertarians will not approve of state regulation at all, I would like to see some defence of people’s rights, as long as this is done by Act of Parliament and not secondary legislation or regulations handed down by the civil service. Once Acts are on the statute books, it should not be “regulatory bodies” that manage the implementation, but the person affected who sues for redress in the courts. Of course, all this presupposes we can return to the erstwhile tradition of non-politically inspired judgments in courts, although that is a separate issue.

The basis for calling into question some aspects of the financial services industry lies in the traditional prohibition against usury. Failure to pay one’s debts rightly evokes disapproval, but by the same token usury is immoral too, and it is lopsided not to balance out these moral issues. A balance has to be struck between the two. Fair financial products should not be seen as incompatible with libertarianism.

First, let us start with the fact that all loans require risk on both sides. It is moral hazard to allow the debtors to escape scot-free without paying their loans. But it is also moral hazard to prevent the banks from running any risks in their lending policies. It should not be forgotten that in any mortgage contract the balance of power lies with the bank, which is likely to have a broader understanding of macroeconomic factors and their likely impact on property prices.

Second, while a householder’s bankruptcy will not bring down the entire economy, a bank’s bankruptcy can lead to calls for state intervention in a way that will saddle the entire economy with bad debts for decades to come. For this reason, it is desirable that laws relating to mortgage loans are constructed in such a way as to enjoin caution on the lenders. Banks should not be able to assume that they will be bailed out by the taxpayer, and enough risk, for the banks, should be written into the laws to ensure that the banks are mindful of the need not to create systemic risk via their mortgage lending.

For these reasons, I would like to see American-style non-recourse mortgage loans introduced, and made mandatory, in the UK. What this means is that if house prices plummet, and the mortgage loan is secured on the property, householders can send the keys back to the lender (something known as “jingle mail”) and owe nothing further, regardless of whether the lender is able to sell the property for a price that covers the mortgage debt or not. Instead of this, what we see in the UK is the banks’ pursuing householders for the balance (including their inflated repossession fees) for up to 12 years after the house is repossessed.

The American way allows for quick deleveraging. The property market crashes quite swiftly—and bargains become available for those who are not indebted—allowing for a national economic recovery thereafter. The example of Japan’s lost couple of decades shows that quick deleveraging is preferable to decade after decade of indebtedness. The household concerned can start afresh, with no debt, allowing for consumption spending that supports the economy as a whole.

The example of Argentina’s sovereign debt default a number of years ago shows the advantages of debt repudiation, allowing economic growth to begin anew. What about the banks, you may ask? What about them? If they go bust, they go bust. They should not be rescued. The wider economy should not seek to sustain zombie banks. In a true collapse of the financial system, a depression might be occasioned, but by allowing the banks to go bankrupt, new institutions can be formed with no legacy of debt. The depression would then be worked through, hopefully as a V-shaped, rather than an L-shaped economic event.

This is not ideal of course, but then a well-managed economy would not face the same fate: by keeping asset prices under control, by not setting interest rates according to inflation measures that deliberately strip out house prices and by not importing millions of migrant workers that pressure the housing stock, economic depression consequent on banking collapses could be avoided. The avoidance of systemic risk is really something that the government and the financial services industry need to focus on; the ordinary housebuyer does not control the overall quantity of money in the economy and cannot be expected to factor detailed macroeconomic forecasts into his house purchase decisions.

The second policy I would like to see is an end to government housebuilding and government intervention in the housing market. People should find their own housing, and without the constant schemes to support the construction industry (one such was announced by David Cameron today), house prices might be lower. No attempt should be made by the government to prevent house price crashes.

As far as mortgages are concerned, there are a number of changes that would be desirable. Firstly, there should be no such thing as a buy-to-let mortgage. These are designed to allow a minority of people to profit passively and parasitically from the rise in house prices as facilities and infrastructure are put in place. Buying houses is really not an investment: it is not as if the landlords were investing in productive activity. There are also many anecdotal accounts of landlords pricing out first-time buyers from the property market by outbidding them on a property. The abolition of buy-to-let mortgages would probably bring house prices down over the long term.

There should also be no fractional home ownership. Scams whereby households are sold a 25% share in a house, while continuing to pay rent on the additional 75%, are designed to support house prices for the developers. These houses are difficult to sell on, and the situation where the householder bears 100% of the maintenance costs (while being in a 75% rented property) underlines the point that this arrangement is a con.

There should be no early redemption charges on mortgages. These can leave people waiting for years to move after their circumstances change. They also mean that competition on mortgage rates is often dependent on locking people in for long periods of time, years on end. I would announce that all early redemption charges had been cancelled, giving people greater flexibility and leading to greater transaction volumes in the property market.

There should be no mortgage arrangement fees. Mortgage advisers are already receiving salaries for their work, so what is a mortgage arrangement fee for? A fee for nothing? There should also be no mortgage release fees at the end of the mortgage period: handling the documentation to release the mortgage is just part of the general work of the mortgage company. It should not be another excuse to charge a fatuous fee for nothing. Mortgage products need to charge one fee only—the monthly repayment—with all other fees and charges rendered illegal.

Finally, mortgage companies who repossess homes are pushing costs onto the taxpayer, knowing that many of the householders thrown out of their homes will seek housing benefit in rented properties. It makes no sense at all to allow mortgage companies to repossess homes and sell them at auctions at absurdly low prices. There should be a legal obligation to get the market price, as determined by a surveyor, for a repossessed home. This would also serve to increase the pressure on banks to be cautious in their lending. Repossession fees, arrears charges and the like should all be illegal: these are penalty charges that are used to boost the amount owed, with no connection to the real costs involved, and mortgage companies must simply examine their loans more carefully before extending them. They should be able to go to court and dock the wages of mortgage holders who are not paying their mortgages, but the panoply of charges simply disguises the fact that the risk is all borne by the householder today in the property market today. This must be evened up by creating risk for the banks too. It makes no sense to repossess homes in a market downturn, when the householder might be able to repair his mortgage in a year to two if the national economy picked up. In cases therefore where the householder had no income to be docked for mortgage payments, I would like to see a legal obligation on the bank to give the householder two years before repossessing the home. This would make it less likely the house would be sold off at a very low price, and the mortgage period could simply be extended by two years, with a considerable likelihood that the householder would eventually get on top of the payments. Everyone needs somewhere to live, and policies that turf people out of their homes at an early stage ignore the fact that further charges on the public purse are thereby occasioned.

As far as loan-to-value ratios are concerned, the banks should be able to lend what they like. If they want to extend 125% mortgages, they should be able to do so given that they would bear the risk if the housing market turned down under my proposals. I see no reason to demand 10% or 20% deposits, particularly given that taxation rates are so exorbitant most people cannot save them up.

However, house prices as multiples of an individual’s income are a valid cause for concern, because prices for run-of-the-mill houses five and six times average incomes are creating the likelihood of financial crises in the years ahead. Feminists have demanded that women enter the workplace, but the result was to push average house prices from three to six times the average wage, as more household income was available to finance the purchase, with the households seeing no benefit at all from the double income. I would like to see the maximum mortgage three times the salary of one individual, with no extra amount loaned in respect of a wife, girlfriend’s or any other additional person’s income. As the average wage is around £25,000 in the UK today—surprisingly low, when you think about it—it would mean that there was no market for starter homes priced above £80,000 (assuming some deposit is saved up). Property prices would no longer be dictated by banks’ creation of loans, but by the real ability of individuals to pay for them.

Inheritance taxes should be abolished, but the parasitic falling of higher property prices into the laps of householders benefiting from government policies to build amenities and infrastructure near their homes should be ended. I would official record the surveyor’s view as to the site value (the value of the unimproved land) separately at the time of the house purchase, and then impose a windfall levy of 100% of the increment in site value when the house is next sold. This is not as dramatic in its effects as calls for a land value tax (an annual tax that would make it difficult for pensioners to retain expensive homes), but it would capture the increase in the site value—an increase created by society as a whole in the form of investment in private and public facilities nearby—and prevent the “windfall” from being passed on as a legacy.

Let us imagine that a certain type of house has a building reinstatement value of £150,000. Insurers generally know how much it would cost to rebuild a house from scratch, and that is the building reinstatement value (and householders should be careful not to insure their buildings for more than the reinstatement value). Such a house located in a northern town might have a property price in the current housing market of £60,000. The property costs less to buy that it would to build new. This is partly because the property is old, but let us say that we would calculate the site value at a negative -£90,000. Somewhere else in the country, in the middle of London perhaps, exactly the same house, of the same age and condition exists, with a property value of £600,000. We would calculate therefore that the site value was £450,000. In both cases, any increment in the site value can be captured by a levy, thus tending over time to destroy property as an “investment” and restore property as a “place to live”. House price increases would be tamer as a result, and standards of living would go up. To do otherwise is to run the entire economy in the interest of the banks, and not of the people who the banks are supposed to be serving.

I am advancing a view of libertarianism where some fraudulent practices are outlawed, rather than the supposedly libertarian view that there should be no regulation at all, leaving individuals at the mercy of vested interests and big business. I do not believe that Parliament should sit all year round, but one or two Acts to clean up financial services in the way I have outlined would have a beneficial effect in the economy as a whole.