Tuesday, 22 October 2013

Intergenerational risk and banking...

The Rt Hon John Redwood MP has been busy "considering the house price conundrum", explaining "why we have to live with high house prices", and even lecturing us "let's avoid a battle of the generations".  For today's thought experiment, we can conflate all three posts as follows:

For every new buyer suffering from the high price, there is a seller who may be trading down, taking a profit or benefitting from an inheritance, who should have more money to spend.  We need to see more housing transactions. They generate income for those involved, and usually lead on to work for builders, decorators, home improvers, furniture suppliers and the like.  [The baby bulgers] children ... will come to inherit the wealth their parents have built up.  They are already giving them money for deposits on homes.


Let us consider two couples.  Couple A are 65 years old, retired, live in a 3 bed house the estate agent values at £100,000 and have paid off their mortgage.  Couple B, their son and daughter-in-law, are 30, and working and living with couple A.  They've scraped together £10k in savings when the Chancellor Help to Buy comes along.  Couple B decide to take the plunge and buy their home from couple A, who will continue to live in it whilst using the £100k to help provide an income in their retirement.  Couple B will put £5k down and spend £5k on professional fees and decorating.

Balance sheets before

Couple A
Assets: £100,000 house
Liabilities: None

Couple B
Assets: £10,000
Liabilities: None

Balance sheets after

Couple A
Assets: £100,000 cash
Liabilities: None

Couple B
 Assets: £100,000 house
Liabilities: £95,000 mortgage

Income statements before and after

Let us assume the banks are paying 3% per annum interest and lending at 5%.  Couple A's income has increased by £3,000 a year.  Couple B's income has decreased by £4,450 a year.  The banks earnings have increased by £1,550 and that's assuming the £5k spent on fees and decorating just circulates as cash.

What's the overall effect?

Apart from the obvious, Couple A are long sterling and sterling interest rates and sterling, while couple B are short the same trade.  Talk about generational conflict!  Provided couple B can keep paying couple A, through a banking system creaming off 2% per annum, they can all keep living in their home!!!

What would be a more sensible thing to do?

Drawing up a legally binding mortgage contract, secured on a property, is actually quite simple.  In our simple example, all sorts of intergenerational conflict (and care home fees and taxes) could be avoided by Couple A selling to Couple B on a 25 year fixed rate.  Of course most transactions aren't kept in the family and UK consumers pay the banking system to intermediate that risk, and when it goes wrong UK taxpayers prop it up.

And the point is?

The September MPC Minutes stated:

Since the spring, and after several years of stasis, activity in the housing market had been picking up and, on the basis of recent indicators, gaining momentum. Although still well below pre-crisis norms, monthly mortgage approvals had increased by almost a third over the past year ...  Increased housing market activity had the potential to support dwellings investment and spending on associated services, thereby boosting growth overall. And some rise in prices might provide a modest fillip to consumer spending and investment if, for example, the increase in collateral values helped to relax households’ and small businesses’ credit constraints.

This all gives use some insight into how the establishment thinks.  The more debt we all take out against their our houses the better.  The more house prices go up, the more equity we will have to borrow against, the more we will spend to keep things ticking and the more of our incomes we can all pay in rent to the bankers.  The more intergenerational interest rate risk we can all take on while we're at it.

But I'd be very surprised if the likes of MP's and MPC folk and other members of the governing classes had missed the trick of buying and selling direct to each other.  I mean, Peter Mandleson didn't did he?


Kj said...

Excellent point. It´s interesting to note the growth, or at least potential growth of P2P-solutions in finance and insurance, if financial regulations would be slightly less biased towards the "you have to have a bank to fleece folks"-model, and there are untold ways you could extend this outside of the family situation.

Lola said...

FFS It's not 'dwelling investment'. It's 'dwelling consumption'. Hells Teeth, will they ever ever get this?

Steven_L said...

Kj, thanks, I'm sure there are, maybe there's an opportunity there!

Lola, was I being naive thinking the meant 'housebuilding' there?

Mark Wadsworth said...


Ultimately there are two main beneficiaries from house price rises, that is the bankers and the large landowners. These are the people who are behind all this crap.