The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (20 page)

These snapshots of the human cost of the post-crisis bust have their roots in the preceding boom. In Britain and in Ireland it was the biggest credit binge in world history. The apartments sold like hot cakes. The appetite for housing just kept growing. On behalf of property magnates, specialist spin doctors drew on the top end of celebrity culture to fuel the dream, planting fictitious stories such as the rumour that Robert De Niro was buying a penthouse flat in an old warehouse in London. The lies worked.

Britain turned from democracy to domocracy. Every link in the chain – from house-building to mortgage provision to estate agents to the construction of house price indices – became corrupted, common sense sacrificed at the altar of rising house prices. In the decade from 1997 to 2007 house prices trebled. More than that, the home evolved into a multi-faceted financial instrument, on top of its traditional role as an indicator of social prestige.

Every stage of the house chain is still riven with conflicts of interest, poor data, and ultimately a tendency to fuel inflation. Housing is the only basic human need for which rapid price rises are met with celebration rather than protest. The house trap stretches from the estate agents mediating house-selling, to the provision of mortgages to buyers, the supply of mortgage finance to the banks and building societies, the construction of house-price indices, the skewing of finance away from owner-occupiers towards landlords, the supply and construction of new homes, the relationship between elected politicians, property, and the media too. Homes were always castles, not just in England, but also across Europe and the USA. But during the madness they evolved into cash machines, surrogate pensions, principal pensions, and even livelihoods. And in many places, this is still the case.

Let’s go back to the foundations of what might be called the bubble machine. Rising house prices, to some degree, reflected underlying supply and demand in a competitive market. Greater increases in demand than in supply, and the prices went up, as in Britain. Large increases in supply over demand, as in the USA, Spain and Ireland after the crisis, and prices go down. Simple enough.

Except, of course, this simple model is entirely misleading. The housing market is not really a market for houses. The housing market is driven principally by the availability of finance, mainly mortgage debt, but sometimes bonuses, inheritances, or hot money from abroad – London in particular has become the preferred residence of the world’s wealthiest people, from Russian oligarchs to Arab oil sheikhs.

Let’s start with Britain. There are 27 million dwellings in the UK. The short-term supply is basically fixed. The number of new homes built each year has not topped 150,000 since the crisis – that’s less than 0.5 per cent of the total stock. The amount of homes traded is around 900,000 per year, about 3 per cent of the total stock. House prices set by the transaction of that 3 per cent of homes determine property values, the solvency of banks, and the statistic that the UK property stock is worth £6 trillion.

The first thing to notice is that this is a highly illiquid market. Only a small proportion of the housing stock is actually being traded, or ever will be traded. In comparison, the stock markets of developed countries trade around 100 per cent per year of the total value of all of the stocks (for Britain the figure is 138 per cent, for the USA 188 per cent, for Japan 109 per cent). These are proper markets, with lots of buyers and sellers – and that, in theory, makes it easier to work out the market price of a share. The British housing market at 3 per cent turnover, on the other hand, is analogous to the stock market in Mongolia, and the American housing market is on a par with the stock market in Peru. In Britain, the market is particularly thin given that transactions have halved since the go-go years. On top of all this, transactions in the housing market are costly. Estate agents’ fees in the UK can typically reach 3 per cent, and as high as 6 per cent in the USA, with stamp duty on top of that. These are the crucial features of a housing market: thin trading and high transaction costs. It is a recipe for dysfunction, distortion and inefficiency.

Imagine the entire UK stock of property was called Ladder Street, with fifty houses on either side of the road. Despite demand for two extra houses every year over the next decade or so, it in fact takes two years to build just one extra house. The result? Some of the extra demand will be met by converting houses into flats. But most of the demand will not be met at all. A house will be sold on Ladder Street only every four months. One house will remain empty. The end result is a long queue of people who will buy anything, old or new, good or bad, for sale on Ladder Street.

Now consider the price. In a market such as this, the buyer with the largest wallet wins the house and sets the price. At one time that would have been the buyer with the highest single salary, and who had saved the largest deposit. House prices would therefore rise roughly in line or slightly ahead of the rise in incomes. But imagine if the entire queue of prospective house purchasers is flooded with mortgage credit. At this point, the house price is set by the greatest optimist. Ladder Street’s housing market has become a market, not for homes, but for mortgage credit. It is the availability and terms of credit that have come to determine property prices.

In Ireland’s case, the Oxford economist John Muellbauer and his colleagues have calculated that 81 per cent of the rise in house prices was through changes in credit availability. A controlled experiment in this theory occurred in Britain during 2008, when Northern Rock was running down its mortgage book in the first months of its nationalisation so that government money could be repaid. The Rock was charging high mortgage rates to encourage customers to redeem their loans by changing lender. House prices collapsed from an average £196,000 to £160,000 in just a year. The strategy was reversed at the end of the year, and prices stabilised. In Britain, according to Muellbauer’s analysis, real house prices may have not increased between 2001 and 2009 – if there had not been a fundamental change to credit conditions. In other words, the boom would have petered out in the early 2000s, instead of prices nearly doubling in the eight years before the crisis of 2008. The Oxford economists infer this result from the relationship between house prices, unemployment, interest rates and credit supply. But it isn’t difficult to see how this torrent of extra credit flooded Britain’s housing stock. Every sluicegate was unlocked, then left ajar, and eventually flung open to accommodate the tidal surge of credit.

Take, for example, the length of mortgage repayment, beyond a typical twenty-five years. Between 1993 and 2000 the average mortgage period remained exactly twenty-two years. Around 60 per cent of mortgages were for twenty-five years, and, typically, less than 2 per cent of mortgages were for periods longer than twenty-five years. The Survey of Mortgage Lenders then, miraculously, stops for three years. When it restarts in 2006, nearly a quarter of all mortgages are for longer than twenty-five years. Around a fifth are now for thirty years or more, meaning an average first-time buyer will still be repaying home loans into their sixties. The big picture is that the proportion of very long-term mortgages provided by UK banks increased by tenfold during the boom. Mysteriously, the data for this structural change in the mortgage market was not collected during the period of take-off between 2002 and 2005. Two factors were at work here. Firstly, banks began offering mortgages repayable over periods in excess of thirty years. Secondly, there emerged a craze for remortgaging, meaning that individual borrowers effectively lengthened the original term of their mortgage.

This wasn’t just in Britain. In Australia, Spain, Greece and Finland (though not in Germany) average mortgage terms also lengthened. In Spain, France and Finland, a fifty-year mortgage is possible. In Japan and Switzerland you can get cross-generational, century-long mortgages. The longer the term, the longer it takes the homeowner to accumulate equity. Initially, the mere rise in house prices makes up for that. But the lifetime cost increases.

If house prices were rocketing, how could conventional calculations of housing affordability keep up? Take the average income of a UK house buyer over time. In the 1990s it floated not far from £20,000. By 2006, it was more than double that, £41,040. In 1995, over half of mortgage loans were to households earning under £20,000. By 2006, it was just one in twelve loans. Even more starkly, a third of all mortgages went to the poorest half of households in 2000. Just six years later, it was only a sixth.

What was happening? Of course average incomes were going up, but how was the median house buyer getting richer much faster? Mortgages were increasingly going to couples, assessed on their joint incomes, and to older remortgagers. So mortgage terms were being lengthened, and they were increasingly based on joint incomes. Lenders began to stretch the so-called ‘income multiple’ – the number of times a buyer’s income they were prepared to lend. Three times became four times – or even as much as seven times, in the case of some new mortgage companies desperate for market share.

By 2003 the dark underbelly of the house-price boom was already claiming victims in the form of first-time buyers, priced off the so-called housing ladder. The amount of deposit required by a first-time buyer in the 1990s had long been around 10 per cent of purchase price – an attainable sum for a saver in a middle-income job. In the first stage of the Labour housing boom, as prices went up, the average deposit required from first-time buyers more than doubled, reaching 23 per cent in 2003. But then the figure fell sharply, down to 16 per cent by 2007. This helped fuel another spurt of first-time buying, just as the housing boom reached its lofty peak. More recently, average deposits for first-time buyers peaked at 27 per cent, then settled at 25 per cent. Such high figures had not been seen since the 1970s, and then only sporadically. In that decade, house prices for first-time buyers were 2.2 times their average income. In contrast, since 2004, that figure has been more like 4.5 times income – well beyond the means of most young people, unless they have help from relatives. We are seeing the bottom rungs of the housing ladder breaking.

‘If only we could afford a place of our own,’ says one dainty green extraterrestrial to another in the cartoon advertisement as they sit in a pink car parked in Lovers’ Lane. ‘You can,’ exclaims the advert, ‘with a Together Mortgage.’ The ‘Together Mortgage’ was launched by Northern Rock in 1999. In effect, it required of borrowers a negative deposit. Customers were able to borrow 125 per cent of the value of a home: 95 per cent as a secured mortgage, and 30 per cent as an unsecured loan. This was the type of loan taken out by Esther Spick. The ‘Together Mortgage’ was part of what Adam Applegarth, former chief executive of Northern Rock, called his ‘virtuous circle strategy’. This essentially turned what had been a solid northern English building society into a giant hedge fund, laser-guiding global flows of hot money into some of the most sensitive suburbs of Britain’s property market (see
here
). Although launched in 1999, it really took off as Northern Rock went into overdrive at the peak of the boom, doubling its lending every three years. Single borrowers were also offered multiples of as much as five times their annual salary, to help keep pace with those borrowing off dual incomes. Competitors such as Abbey National and HBoS (Halifax Bank of Scotland) scrambled to get in on the game, also offering ‘five times’ deals, and zero deposits.

Events have shown that the virtue of this particular circle has been more than somewhat compromised. And it was not just Northern Rock who strayed from the paths of rectitude and probity. At ‘Mortgages 4 You’ based in Newbury, John Apicella admits he was not entirely exacting in checking the incomes of his clients. Mortgage brokers such as Mr Apicella were the driving force behind the banks’ desire to supply credit, and the desperation of ordinary Britons to afford a property. In 2007, two-thirds of mortgages (three-quarters of first-time buyer loans) were sold through brokers in Britain’s high streets and on the internet. In the past, prospective home owners had been required to save for months or sometimes years before their local bank manager would even to agree to talk to them about a mortgage. In the boom, that first filter of the credit process was outsourced to a lightly regulated industry with opaque professional standards: the mortgage brokers. The result of this? Self-certification mortgages.

Mr Apicella put it rather clearly in documents published by the regulators, the Financial Services Authority. When he started working in the mortgage industry he was advised to ‘just put any income down’. ‘I was guilty of all that because that’s the way I was trained,’ he said. ‘That’s what the industry did.’ The whole of the industry took the same view on self-certification mortgages. He said it was not his responsibility to assess mortgage affordability. ‘It’s up to the client to see whether they can afford it,’ he told me. ‘I can’t sit in judgement and say you can or can’t afford it.’

When regulators eventually began to investigate certain mortgage brokers, they discovered they were using some innovative ways to up the income stated by mortgage applicants. In Colwyn Bay, at Property Park Mortgages, regulators found that an adviser called Darren Button had altered a payslip with Tipp-Ex. Mark Thorogood, also at Property Park, managed to record the income of a family member at £130,000, a convenient extra digit over the actual figure of £30,000.

A special prize must go to Mr Vigneswaran of Cherry Finance, Kingsbury, who was giving mortgage advice as an approved mortgage broker just as the credit crunch hit. The only thing was, he could not speak English. In fact, regulators discovered he knew little about Cherry Finance bar attending an opening ceremony. His son, already removed as an approved broker, had simply got the FSA to set his father up as a so-called ‘approved person’.

Spokespersons for the mortgage industry suggest that such practices (and there are hundreds of similar stories) are just the work of a few bad apples. The truth is that we simply do not know. Only a small minority of the deals done by brokers have been checked, even now. The investigations only began in earnest as the bubble was bursting. Up until 2007, there were almost no actual checks on the activities of over 7,000 mortgage brokers, responsible for the majority of new mortgages. This industry grew rapidly during the boom, lured by typical incentives of £500–£1,000 on each mortgage signed. Most brokers were small one-adviser shops advising fewer than a hundred mortgages a year. Of the few hundred that have been investigated, more than a hundred have conducted their mortgage broking in a way that warranted a prohibition, and thirty-five were fined. The time to be cracking down was surely as the bubble was inflating, not after it popped.