Mortgage Payments Crisis: The Root of the Problem

It was inevitable that rising interest rates would eventually push many mortgage payments beyond the affordability threshold. But the root of the problem is not rate of interest. It is the the size of the mortgage itself.   The underlying threat will remain if and when rates reduce. It is a threat not just to the stability of individual households. The entire economic model is on the brink of collapse, because the root of the problem is the massively over inflated value of property. Let me explain.

Think of a decent modern 4 bedroom property, not in London but in a sought after neighbourhood, with a current value of £1 million. Then go back to 1970. Since then the GB pound , like the US dollar, has lost 95% of its value. So in 1970 money, the same house would be worth £50,000. But in fact such a house in 1970 would have actually cost around £10,000. The average house price at the time was about £4500.

Now look at inflation over the period. A £10,000 house in 1970 would, if its value had kept pace with inflation, today be worth £200,000. But it is actually worth five times that. Why?

Because in 1970 and for some time after, the mortgage market was funded by UK savers who put their savings into building societies. The rate of interest charged to borrowers was big enough for savers to get a fair return and averaged about 5%. So borrowers were used to paying more interest, but on a smaller loan, because property was less expensive. Also more attention was paid to affordability and a lower multiple of earnings to loan ratio was used, usually x3. When the economy boomed people saved more and funds were plentiful, when times were hard, saving dropped and funds became scarce, so any overheating of the housing market was cooled off.

During the noughties the sub-prime time bomb ticked away in the US. The effects of big bang  in the UK allowed building societies to turn themselves into banks and to start borrowing money   overseas to lend to UK house buyers . Property prices began to accelerate way ahead of inflation. Even after the savage correction of the 2008 crash, house price inflation surged again, fuelled by low interest rates and reckless printing money by central banks generally and the Bank of England in particular. Such were the multiples of household income permitted, 10x or even 12x, there seemed no end in sight to the everlasting rise of house prices and the value of commercial property.  An important statistic will explain the magnitude of the crisis now building.

One of the measures used to test the shape and resilience of an economy is the proportion of fixed assets to GDP. This stands at mind blowing 440% for the UK, whereas France is at 242%, Italy 91% and Germany 98%.  Given that these assets are overheated in the UK to the tune of  inflation x5, that means nearly  £8 trillion of the £9.6 trillion total. In a hard landing that would be  seriously reduced or even wiped out.

Unfortunately this pumping of largely printed money into inflating property has broken an already misshapen financial model to the point where a very hard landing is fast becoming unavoidable. If you are of  the ‘yes but it will never happen’ tendency, think just two words.

Sub Prime.

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