Could this be the cure for Britain’s housing market?
How do we avoid a future meltdown in the housing market? Bengt Saelensminde explains the solution proposed by two Ivy League professors.
Has the housing market finally turned? That's the million dollar question
Is this just a seasonal pause for breath, or the start of a more severe correction?
As I pointed out in a recent Right Side, the guys with the most to lose here are the banks. After all, in the case of many house purchases, the banks put in considerably more money than the so-called owners'.
But let's not forget the homeowners. In the event of hard times, they're the ones that feel the pain first only after they're busted does the bank feel the pain!
Back in 2008/2009, the debt tempest was quelled by the central banking fraternity. Luckily for over-leveraged borrowers, central banks dropped the base rate from 5% to 0.5% saving the housing market (but also setting other areas of the market rampaging off to new highs!).
However, the interest rate spring can now be compressed no further. What happens next time?
These guys think they've solved it
Well, two Ivy League economics professors think they've got the answer.
In their newly published book,House of Debt, Atif Mian and Amir Sufi say that the last housing bust was dealt with in a highly inequitable way.
Instead of bailing out the banks (which is essentially what happened), and letting individuals take the pain, banks should have been forced to endure pain too.
What's more, they reckon their solution would have kept the major economies from suffering such severe recessions.
And, to top it off they believe that it would also rein in excessive risky lending practices by the oft reckless bankers.
So what's the big idea?
It's simple really.
If the housing market crashes, then rather than the central banks riding to the rescue (which, as we have seen they have limited power to do right now), then it should be the banks, as well as homeowners that take the hit.
They suggest that in the event of house price falls, mortgage debt should shrink alongside the falls in local house prices.
So, if house prices in your area fall 10%, well, then your outstanding mortgage does too. No need to ever worry about negative equity again!
In times of trouble, this would make mortgage repayments more affordable, thereby saving individuals from going into lockdown mode. It would also reduce the severity of recession. After all, there's plenty of evidence to suggest that consumer spending is heaviest among the most over-borrowed members of society.
And while forcing feckless individuals into bankruptcy (as happened in the sub-prime chaos) may seem fair and just, it's actually not a good solution for society as a whole.
As houses are foreclosed upon and sold, the market spirals downwards. There are costs associated with liquidations, and ultimately, much of the stock then stands idle. Wouldn't it be better to find a solution to avoid this harrowing process?
And anyway, the banks had to take the hit during the subprime blow-up. It's just that the Fed found ways of injecting them with cash to keep them alive. As things turned out, it was a case of sacrifice the homeowners and save the banks.
It sounds a little fanciful though, right? Why on earth would the banks willingly write down debt and take the hit?
The banks get a slice of your house
Well, here's the other side of the deal.
In return for writing these downwardly adjustable mortgages, the banks would get an equity stake in the house. The professors calculate that a 5% exposure to the upside value of the property would compensate for the bank's risk. When a house is sold, the bank takes its share.
The whole idea is to align the bank's interest with that of its customer the borrower. Taking a share of the downside risk of house prices would surely encourage prudency in lending decisions.
And homeowners relinquishing a 5% equity stake would help tame house price inflation too. The very reason house prices take off is because of massively leveraged bets taken by homeowners if at each rung of the property ladder, they had to pay 5% to the bank, then it would take considerable heat out of the market.
The 5% paid to the bank would be like an insurance payment. And it would be levied on those that put the industry at risk.
We're still a long way off
The UK government has, of course, gone the exact opposite way on this one.
In its various schemes to help homebuyers, it is, in fact, taking more and more of the risk onto the government balance sheet. That is all taxpayers regardless.
Its policies have helped to inflate the market further, while taking risk away from the banks, and actively encouraging risky lending.
The system is either set up for an interest rate-induced implosion; or the central bank just won't ever be able to elevate interest rates to its natural level.
Rather than encouraging the markets to find their own solutions to their own problems (which is how economies work best), Western governments are convinced that they, themselves need to prod and poke at the market from within that governments should be the market.
So, in the words of Lord Sugar, it is with regret that I have to say "Professors Mian and Sufi, your time has not come. You're fired!"