There once was a king in Sicily called Dionysus. He had a courtier called Damocles who, in his efforts to flatter his King, told his liege how fortunate he was. To teach the obsequious inferior a lesson, Dionysus offered to swap places. There was a catch, however; above Damocles, sitting on his newly acquired throne, there hovered a sharp sword dangling by a horse’s hair, and arranged that way by Dionysus. The fear that the sword might finally fall, severing poor old Damocles’ arteries, proved too much for the imposter on the throne, who eventually begged his lord to swap back. That’s the trouble with getting gold and riches; sometimes such ownership comes with a burden that is too high to bear. And that brings us to the subject of the UK housing market, the Bank of England, and a kind of monetary equivalent of a sword, dangling by the fiscal equivalent of a horse’s hair over the UK housing market’s equivalent of its genitalia.
You may have noticed that interest rates are quite low at the moment; lower in fact than a very low lower ground floor, which is good news for those with debts.
Suppose though that rates rise. For those who can easily pay their way that may not matter, but for those who can only just cover the interest on their mortgages out of current income, this may matter rather a lot.
"So what?" You might say."It is time people started to learn how to manage their own finances. If you can only just afford a mortgage when rates at are at a record low, then you shouldn't be getting yourself a mortgage at all." It is just that in the UK, groupthink says 'house prices always go up', the wisdom of our elders says 'always get the biggest possible mortgage you can possibly afford', and George Osborne, with a wink to the wise, and a scheme he calls Help to Buy, has said: "Look, that horse’s hair that holds up house prices will never break." The mix of panic over the prospect of missing out on rising house prices, fear over never being able to jump on the housing ladder, and greed over the prospect of making a fortune via the magic of leverage and the guarantee that house prices always returns a profit, makes a heavy cocktail and one that is hard to resist.
The snag is that it turns out that around 18 per cent of secured loans are to households with less than £200 a month to spare after housing costs and other items of essential expenditure.
"If interest rates rise 1 per cent," said the Bank of England in its latest Financial Stability Report, "households accounting for 9 per cent of mortgage debt would need to take some kind of action — such as cut essential spending, earn more income (for example, by working longer hours), or change mortgage — in order to afford their debt payments if interest rates."
"If interest rates rise by 2 per cent," suggested the bank, ditto, except that that it will be households accounting for 20 per cent of mortgage debt who will be so cursed.
Again, you might say: "So what? Get another job, worker longer hours, get on your bike." But when there is unemployment, it is not so easy. Besides if we suddenly see a rush of people, accounting for 20 per cent of mortgage debt, suddenly asking for overtime, there probably won't be enough to go around.
And that, as they say, is why a certain sword, not unlike the one Dionysus had arranged, dangles by a horse’s hair over the UK housing market.
But this story has another edge to it. "A study by the FSA," said the Bank of England, "found that 5 to 8 per cent of UK mortgages by value were subject to forbearance in 2012, which was broadly unchanged from 2011."
In the UK, chastened banks, many of whom are partially owned (via the government) by the taxpayer, don’t like the idea of repossessing properties. Then there is the issue of low interest rates. When they are that low, if a mortgagee gets behind with payments, why not give them more time, or so the bank might reason.
In the US it is not like that. In the US banks are more ruthless in their approach to repossessing property, but there is a good reason for that. In the UK, if a mortgage holder’s home is repossessed and it is worth less than the mortgage, it is up to the mortgagee to pay the difference. In the US, it is the bank’s responsibility.
So, US banks are more ruthless, but the consequences of negative equity are not quite as dire for US households.
So, will it happen? Will this latter day sword fall? Will the horse’s hair split? Mervyn King reckons UK interest rates won't rise for some time. But just remember that the US economy and that of the UK are at different stages in their respective economic cycles. If the Fed, let's call it Dionysus, increases rates, and the Bank of England (Damocles) doesn't, there is a risk that sterling may crash. To avoid this, Damocles may have no choice to but to up rates to, as it were, cut the very horse’s hair he depends upon.
© Investment & Business News 2013