Economic Myths: Repayments of principal and interest

Banks are primarily balance sheet exercises. When they grant somebody a mortgage to buy land, they just 'split the zero' into an asset (the loan out) and a liability (the money which the vendor gets credited to his deposit account). This is about eighty per cent of all banks' assets and liabilities.

The banks then have to show that the value of their assets (mortgage principal) exceeds the value of their liabilities (all the deposits). As we will see, this is actually irrelevant.

(The banks then make real profits by charging mortgage borrowers more than they pay depositors. So really they are just being paid to act as debt collection/risk pooling agents for people who have sold land.)

Most mortgages are based on the borrower paying a fixed total amount in interest and repayments of principal for the next twenty-plus years. Once a loan has been granted, this is all that really matters to the borrower and this is all the bank really cares about as well.

So for example, you borrow £100,000 for 4% fixed over 25 years, your monthly repayments are £533. You get statements at the end of each year showing that the amount of principal is going down, which is nice, but pretty irrelevant. What really matters is how many more years to go.

But you can work backwards from the £533. It doesn't actually make any difference whether that is a £100,000 loan at 4%, a £75,000 loan at 6.9% or a £50,000 loan at 12.1%.

Which is why I can't take the whole concept of negative equity and the corresponding 'threat tio the health of the UK banking sector' seriously. Psychologically, it can't be a nice position to be in, and it only really matters if you want to move home (apparently a lot of banks allow you to 'port' negative equity anyway).

So if you have a £100,000 mortgage @ 4% on a home 'worth' only £75,000, all the bank would have to do is write the mortgage down to £75,000 and increase the interest rate to 6.9%. That's you out of nequity.

Although the bank's balance sheet would look a bit weird (liabilities now exceed assets), it doesn't actually make any difference to anything in the real world.

Economic myths: Negative equity [Square law of negative equity]

Yes, being in negative equity is horrible, whether that resulted from greed, recklessness, gullibility or sheer bad luck. So let's assume it would be a good idea to "help" people out of negative equity.

There are of course two ways of doing this in the short term*:
a) by pumping up house prices or
b) by writing off the element of any mortgage which is in excess of the potential selling price of the house (unsecured).

Let's look at the relative "costs" of doing this, and see what would happen if we went for option (c), allow house prices to fall and then write off all unsecured elements. We can illustrate this in diagrams.

As it happens, the distribution of mortgages by loan-to-value is almost a straight line (and even if it isn't, it makes the maths a lot simpler). In other words, one per cent of mortgages are almost paid off and represent only one per cent of the original principal/purchase price; one per cent of mortgages represent two per cent of the original principal/purchase price and so on. We also know that there are about 12 million outstanding mortgages with a total principal of £1,200 billion and about 12 million privately-owned homes which are owned outright.

To get the ball rolling, let's assume that a tenth of mortgages are in nequity (the official figure is half this, because of Funding for Lending and Help to Buy subsidies, but let's keep the maths simple). As things stand, there are 1.2 million mortgages with average unsecured principal of £10,000, that's total nequity of £12 billion (shaded red), which equals one per cent of total outstanding mortgages of £1,200 billion (0.1 x 0.1 = 0.01).


Under option a) we introduce a subsidy worth £20,000 per home/mortgage and eliminate nequity entirely (in the short term: this merely increases the risk that people will get into nequity in future). The total cost of the subsidy (shaded blue) required is twelve million homes x £20,000 = £240 billion - and we can double that for the twelve million homes which are mortgage-free = £480 billion. Which seems like a high price to pay for eliminating £12 billion of nequity. That means basically that future purchaser and taxpayers will end up net £468 billion worse off:


Under option b) the total cost of simply writing off all unsecured principal is a one-off cost of £12 billion.

What about option (c)? Let's withdraw some existing subsidies to land ownership and allow prices to fall by twenty per cent. The amount of nequity which now has to be written off is now 3 million mortgages x average £25,000 = £75 billion. This sounds like a lot, but in relative terms it isn't. £75 billion is only about one per cent of what UK bankers claim are their total/gross assets/liabilities (which are said to be five times UK GDP = £7,500 billion). This is 6.25% of total mortgage principal (0.25 x 0.25 = 0.0625).

And there is an even bigger saving to future purchasers and taxpayers: the total principal value of the subsidy withdrawn is 24 million x £30,000 = £720 billion. So there is still a net gain to them of £645 billion (and that's even assuming that they would bear the cost of the initial mortgage write off):

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All of this leads us to Wadsworth's Square Law of Negative Equity - when you multiply numbers less than one, you end up with a smaller number than you started with.

Even allowing house prices to fall by fifty per cent and writing off all the unsecured amounts would only "cost" 0.5 x 0.5 = 0.25 x £1,200 billion = £300 billion. The reduction in the cost of the subsidy would be £80,0000 x 24 million = £1,920 billion, which is an overall saving to future purchasers of £1,620 billion.

If you take it to extremes and withdraw the subsidy to land values entirely and allow house prices to fall to £zero, the "cost" is £1,200 billion and the saving is £200,000 x 24 million = £4,800 billion, an overall saving of £3,600 billion.
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* The mainstream view is that a) is far better, as pumping up house prices creates or at least preserves "wealth" and that b) would lead to the banking system somehow "imploding" or that it leads to moral hazard. Method a) does not create or preserve "wealth", it merely preserves "privilege" (i.e. the flow of wealth from the productive economy and non-landowners to large land owners and bankers) and on closer inspection, b) does no such thing.

The longer term (and ultimately only sensible) way is to get the economy going again by e.g. reducing the tax burden on people with large mortgages relative to income. These will be largely recent younger purchasers who own, relative to their earned income, lower value houses, so shifting taxes from earnings to the rental value of land will benefit them particularly. But let's gloss over this for now.

This whole negative equity thing

Let's agree for the sake of this discussion that negative equity is in and of itself A Bad Thing, and it certainly is for those who are in it (be that through greed, recklessness, gullibility or simple bad fortune).

One of the arguments advanced for the Help To Buy scheme is to prevent people falling (further) into nequity and by association, to help them out of nequity by driving up prices, thus increasing the likelihood that future purchasers will end up in nequity and so on in a happy Home-Owner-Ist death spiral.

So Our Beloved Government has generously promised to create another £130 billion in credit, underwritten by the kind hearted taxpayer, sometimes disparagingly referred to as "extend and pretend".

You can make up your own mind what the costs (the interest subsidy) and potential losses from all this will be, let's call it one-fifth of the principal sum of £130 billion = £26 billion. And this is not the cost of sorting out nequity here and now, this is the cost of shoving it onto purchasers and taxpayers in future.

But how much nequity is there really? According to the Financial Conduct Authority Risk Oulook 2013, about four per cent of mortgage borrowers are in nequity (as many as twenty per cent in Northern Ireland). Let's make a guess that average nequity is one-tenth of the original mortgage/cost of home.

There are about twelve million households with mortgages, total mortgages are about £1,200 billion = average  mortgage £100,000.

So that means that about half a million households are in nequity (about 100,000 of those in Northern Ireland) to the tune of average £10,000 each, so the total amount of principal which would have to be paid off or written off to get them all out of nequity overnight is £5 billion.

It strikes me that spending £5 billion on paying off/writing off* every penny of nequity and telling people to be more careful in future is a more sensible course of action that putting £130 billion at stake with potential costs and losses of £26 billion. You can muck about with the figures as much as you like, the "pay off/write off" option is almost certainly cheaper than the "extend and pretend" option and certainly a damn sight more effective (providing it doesn't lead to moral hazard).

But maybe that's just me.

* £5 billion is about half the typical annual cost of UK bankers' bonuses.

Wildly misleading statistic of the day: "41% of homes sold at a loss since 2007"

This got an "oh woe is us" write up in some of the papers, but let's refer back to the original press release from Castle Trust:

Over 130,000 families have sold their homes at a loss since 2007, according to exclusive analysis of housing transactions by housing investment and shared equity provider, Castle Trust.

The initial research, which tracks the proportion of properties selling at a profit or loss, includes an analysis of properties in England and Wales which were bought and sold between January 2007 and January 2013. Of these properties, 40.7% (131,442) were sold at a loss, with the average shortfall being £24,430 (on average 11.0% of the house price).

Over the same period, 55.6% (179,689) of homes sold for a profit generating an average return of £45,199 per transaction (on average 20.4% of the house price) and the remaining 3.7% (12,051) sold for the purchase price.

Let's gloss over the fact that lower house prices do not represent "a loss" for the honest hard working population of this country: the result of lower selling prices is that the purchaser saves more in mortgage repayments than the vendor loses in (negative) return on the cash he invests from the sale. So from our point of view, that's a significant gain and it's only a loss from the banks' point of view.

Let's focus on those two headline numbers: "130,000 families" and "41 per cent".

Readily available statistics, for example HMRC's Property transactions completed in the UK with value £40,000 or above show that there were 5,433,160 sales in the six calendar years 2007 to 2012, plus an unknown number of sales for £40,000 or less.

So either 41% is correct and about 2,200,000 were sold at a loss; or 130,000 is correct and 2.4% were sold at a loss. Or, more likely, both figures are completely wrong.

RETHINK: unless of course they mean homes which were bought after January 2007 and then re-sold before January 2013, in which case the 41% figure is probably about right, seeing as on the whole across England & Wales, house prices have been flat for the last seven or eight years; we'd expect half to have re-sold for a higher and half to have re-sold for a lower price.

Killer Arguments Against LVT, Not (227)

In the comments to KLN #226, Phil Jones said:

Now if [LVT had been] introduced from scratch, house prices and therefore mortgages and LVT would be low as no-one would really want to buy fearing increases.(1) It would be worse in a transition as high mortgages coupled with high LVT and low sale prices would bugger a lot of people.(2)

1) The first bit is quite correct, that's the good news. It's a question of what our starting point is; from the point of view of the future, NOW is the starting point, so we might as well get on with it.

2) I assume he's alluding to negative equity, which is very much a transitional issue.

i. As we are talking about tax and house prices, it seems reasonable to me to put some numbers on it: let's say that typical recent first time buyer household earns £40,000 gross, has bought a house for £160,000 with a 75% mortgage of £120,000. At 4% interest over 25 years, they are paying £7,700 a year in mortgage repayments.

ii. Let's assume that under full-on LVT, house prices would halve. So that typical household now has £40,000 negative equity. Using the tried and trusted spreadsheet, we establish that such a household would be paying £11,300 a year less in tax, so if they use this surplus to pay off the mortgage as quickly as they can, that gives them £19,000 a year to pay off their mortgage, so they will be out of negative equity within three years, and if they continue paying off the mortgage at £19,000 a year, it will be completely paid off after seven.

iv. For the remaining eighteen years of what would have been the mortgage period, they can spend that £19,000 if they wish, but comparing like-with-like, they could also put it to one side (they wouldn't have been able to spend it under the current tax system); even ignoring compound interest, that would give them a pot of over £300,000.

v. Households who buy their first house after LVT has replaced taxes on earned income will be laughing; if they knuckle under, they will be able to save up a deposit in a year or two and pay off an 80% mortgage in about four years.

"They own land! Give them money!"

Land owners love to shout "We own land! Give us money!" and now the government has gone into bat on their behalf. From The Daily Mail:

Banks are to be told to rescue middle-class ‘mortgage prisoners’ by loosening lending restrictions. Because they are locked in negative equity, hundreds of thousands of hard-working people are unable to move to a new home. Businesses are struggling to recruit managers from other regions and the housing market is stagnant.

But new mortgage application rules – to be announced next week by the Financial Services Authority – will give banks the green light to approve loans to trapped homeowners. This will apply to those whose loans amount to a very high proportion of their home’s value – and even those in negative equity...

The Home-Owner-Ist Death Spiral

From an article in yesterday's Evening Standard about flat-sharing in London:

Oliver Nice, 26, who works in film as a director of photography, has been looking for a five-person flatshare for almost two months. He said: "It has been ridiculously difficult. Properties would go off the market before you had a chance to look round. A couple of times we were shown round different properties. I'm going to be living with my girlfriend and three friends in a four-bed house in Stoke Newington. I own a one-bed flat in Ealing but I can't afford to live there because of the mortgage.

The article appears to be based on a press release by easyroommate, who have their own spin to put on it; they claim that "London has a flat sharing population of of nearly 653,000" which is nearly a tenth of the population of London (which might or might not be true).

From This Is Money (the Daily Mail's finance spin-off):

A quarter of all mortgaged homeowners find it almost impossible to move house or take out a new deal. Figures from trade body the Council of Mortgage Lenders (CML) show that more than one in twelve borrowers — some 827,000 — are in negative equity, i.e. meaning they owe more on their mortgage than their house is worth. Yet a further 1.7 million, roughly 17 pc of mortgage holders, have less than 10 pc equity in their properties, according to Money Mail research.

Many of these people took out mortgages with just a small deposit before the credit crunch, and are now trapped because their house price has fallen. Henry Pryor, an independent estate agent, says: ‘These people are prisoners in their own home and may be stuck on an expensive mortgage deal.’

Why do they insist on referring to such people as 'homeowners'? These people don't own homes at all, do they? They are more or less slaves indentured servants of the banks, who own them and their houses. So much for social mobility.

I thought that was the whole point? Why are they now squealing?

From The Daily Mail:

Three quarters of home buyers are concerned about mortgage rates, fearing it would take only a small hike to send them over the edge, a new report shows.

The research by consumer watchdog Which? shows one in seven cash-strapped buyers are already struggling to make their repayments. But despite their problems only a third of people affected are approaching their lenders for help.

Options available to those with difficulties include moving from a repayment to interest-only mortgage, taking a payment holiday or allowing them to switch to a different deal...

Now, perhaps I've missed something, but isn't the whole point of Home-Owner-Ism to encourage people to borrow as much as humanly possible and beyond to keep the bankers rich and the illusion of wealth (rising house prices) going?

And if some valuer is prepared to sign off on the fact that the potential selling price of your house has gone up, isn't the correct procedure to remortgage with a bigger loan to "unlock some of the cash tied up in bricks and mortar"?

So I really don't see what the fuss is about. The whole point of Home-Owner-Ism is for every generation to enslave the next generation with even bigger debts, or failing that, for people who ought to know better to enslave themselves, so that wealth cascades UP the generations, from young to old, from productive economy to monopolists etc.

If you ask me, the system has worked a treat. Keeping people close to the verge of bankruptcy used to be something to be celebrated - that way they have to keep their noses to the grindstone - so I appear to have missed that memo as well.

See also The 830,000 homeowners stuck in a negative equity trap

Lloyds ‘not particularly exposed’ to further house price falls

Shock horrors from CityWire:

State-backed lender Lloyds (LLOY.L) will be the ‘most exposed’ of UK banks if house prices in Britain fall a further 10%, as Morgan Stanley expects them to, the investment bank said in a report today...

Noting that 54% of Lloyds’ loan book is in UK mortgages (£341 billion at 10 December), Morgan Stanley's analysts forecasted that 27% (£90 billion) of these loans would be in negative equity by December next year.

Ho hum.

Just because a loan is in nequity does not mean much in itself, let's assume that a quarter of all Lloyds' mortgages are a hundred per cent loan-to-value as at today's date and house prices fall a further ten per cent. The bits of those loans which are then no longer secured on land and buildings is only ten per cent of face value of those loans, i.e. out of a loan book of £631 billion (£341 billion ÷ 54%), £9 billion (one-and-a-half per cent by value) can be shuffled from 'secured' to 'unsecured', and a commensurately higher rate of interest charged (let's say over 10% per annum).

Killer Arguments Against LVT, Not (123)

The final counter-argument in the article at Appraiser10.com is this:

Loss of Asset Value

Land value is the discounted present value of expected future after-tax rents; so LVT, by increasing the taxation of those rents, would reduce the value of all real estate owners' holdings (1). A rapid reduction of real estate values could have profoundly negative effects on banks and other financial institutions whose asset portfolios are dominated by real estate mortgage debt, and could thus threaten the soundness of the whole financial system.(2)

Rapid introduction of LVT must therefore be considered a somewhat irresponsible approach, and most LVT advocates consequently favor a long phase-in process lasting at least a decade, and potentially much longer. (3)

If land's value were reduced to zero or near zero by recovering effectively all its rent, as many LVT advocates propose, total privately held asset value could decline by as much as 1/4 or even more, a massive reduction of private citizens' wealth. (4)

1) Fair summary.

2) No it wouldn't - that's just what They want us to think. On the basis of official statistics, my magic fag packet says that if house prices fell by a quarter and half of those in nequity lost their jobs, defaulted, went bankrupt and had their houses repossessed and sold at the new lower value, then rather surprisingly, the loss to UK banks would only be one or two per cent of their total net assets.

And as I explained in my previous post, actual businesses would be paying £300 billion less in tax each year, so there'd be plenty of money sloshing around for them to be able to meet their existing mortgage or rental commitments.

3) Five years seems about right to me. Although nobody likes transitions, people can adjust to things quite quickly, and there's no point dragging out the transition longer than necessary. Maybe a quarter of households would decide to trade down, all that means is that turnover in the housing market would go back up to 2006-07 levels for a few years and then we are sorted.

4) People keep talking about land as an 'asset' without realising that it is only an asset to one party (the owner) because it is a corresponding liability on somebody else (a tenant or future purchaser). It is not the land which generates the income to pay the rent or mortgage, it is the person living there and working nearby, or a business trading from those premises. And those people also have a massive future income tax liability, so by merging income tax and a large chunk of rents/mortgage payments into LVT, their overall lifetime net income (after tax + rent/mortgage bill) would go up considerably (especially if you include the boost to the economy from scrapping income tax).

In any event, it is land price bubbles which trigger 'financial crises' which is why we keep having recessions, so low buying/selling prices are inherently A Good Thing. Remember: high house prices make us poorer, not richer!

Negative Equity - more fun with numbers

To follow up yesterday's post, that 500,000 households are in negative equity (source: City AM), I shall quote from The Daily Telegraph*:

Shelter’s survey of 2,000 Britons found 3 per cent of households admit to being in arrears with their rent or mortgage, the equivalent of 835,000 – up from 405,000 a year ago. A third of these turn into repossession cases at court, according to Shelter. It equates to every two minutes someone facing the real threat of being evicted from their home.

Home owners are struggling to escape their misery by selling up as estate agents warn they are doing just one transaction a week amid a drop in demand from buyers who are unable to obtain affordable mortgages... It comes amid historically low interest rates, which financial experts expect to rise next year amid rising inflation.

For sure, being in negative equity (or 'underwater') is a different concept to being in arrears, and the bank only cares if you are underwater and in arrears. And for sure, Shelter have their own agenda - historically, they were on the side of the 'dispossessed' but now they are much more Home-Owner-Ist, and are bound to exaggerate things. But that's a heck of a lot of people in arrears, even despite the artificially low interest rates that a lot of them are paying (and despite all the subsidies like Support for Mortgage Interest)

* Via Growler at HPC.

Negative Equity - Fun With Numbers

From City AM:

CLOSE to half a million British households could be facing negative equity, according to survey released today by the Bank of England...

And more people could fall into negative equity if house prices drop further. Close to one in five mortgage holders have debts exceeding 75 per cent of the value of their properties, “not much changed” from last year, the report says.

Ho hum.

Let's ignore everybody with a loan-to-value ('LTV') of 75% or less and assume that one-fifth of borrowers have a mortgage of £180,000 on a house currently worth £200,000 (i.e. 90% LTV, the average of all those people with LTV between 75% and 105%).

If house prices were to fall by a quarter (similar to the fall post-1989), the average nequity of that one fifth of borrowers will be £30,000 (£180,000 mortgage minus house value £150,000).

Multiply £30,000 by two million borrowers and we have a potential shortfall of £60 billion. Let's assume half of those in nequity now default; go bankrupt; AND have house repossessed and dumped at the new lower value.

The total loss to UK banks would be a laughable £30 billion (£60 billion x half), or less than half-a-per cent of what UK banks claim to have as total assets (about £7,000 billion).

In truth, UK banks wildly overstate their assets and liabilities to make themselves look 'too big to fail', so in truth that £30 billion loss would be slightly more than one per cent of total UK bank assets (which are primarily mortgages secured on land and buildings), but hey, it's not going to bring the country to its knees or anything.

Sorting out the UK banking system, part 3/3

1. OK. We assumed a catastrophic house price collapse of 50% and mass bankruptcies - or at least a debt jubilee - in Part 2 earlier today. The resulting consolidated balance sheet of the UK banking system is shown below, and as you can see, the consolidated total assets are still looking positive, albeit down from £873 billion to £36 billion.

2. The next Big Myth is that banks have to refinance £800 billion in bonds in the next few years (the actual figure of £800 billion is correct), and they are unlikely to get this so the government will have to throw another £800 billion of taxpayers' finest at them. Let's assume that the banks really can't afford to repay these loans (which does indeed seem impossible) but similarly that they can't borrow new money either.

So let's turn to our old friend: the debt-for-equity swap. As long as the underlying business has some value and will make more money by continuing under new ownership than it would from being broken up, a debt-for-equity swap is always the most viable option. As to all this Basel-style capital adequacy nonsense, see footnote D.

3. We've also got to show that neither shareholders nor bondholders are somehow being robbed, and that they are no worse off than before - as the balance sheet shows, there is no reason to assume that they would be. See footnotes below:

Footnotes:

A. The total value of all the bonds and shares was £723 billion before the hypothetical house price crash and balance sheet restructuring (see Part 2). For company law/insolvency law reasons, all the bonds would be converted into shares, and the former bondholders would acquire a majority of the issued shares. Twenty five 'new' shares would be issued to bondholders for every eleven 'old' shares (the shares would thereafter be identical, or 'rank pari passu' as they say in the trade).

B. Banks will be charging mortgage interest rates of 4.5% on average - a bit higher than now, but they don't need to worry about house prices crashing any more because they already have done. They'll still be paying a miserly 1.5% interest rate on deposits, and still have typical running costs of 1%, so their maintainable profits from the £1,800 billion average customer balances (deposits or loans) will be about £36 billion per annum. If you don't mind, I'll gloss over corporation tax liabilities and ignore any residual income from the £571 billion worth of 'securities for sale' and the income from their trading or investment banking divisions, which will net off to very little.

C. UK banks' price earnings ratios are currently between 9 and 30. Let's pencil in a price/earnings ratio of 20.1 (it might be higher; it might be lower), which we multiply by the £36 billion maintainable earnings to arrive at a total market capitalisation of £723 billion, which is exactly what is was before we started - this is hardly surprising as the markets have already factored in what will inevitably happen.

In other words, if you own £10,000's worth of UK bank bonds or 'old' shares today, once the dust has settled, you will end up owning about £10,000's worth of shares afterwards. What's not to like?

D. Of course, having shareholder's funds of £36 billion to support total assets of £2,442 billion is far too low. But we are looking at the bottom of the cycle. If we want UK banks to have a ratio of at least 6%, then they'll just have to stop paying dividends for three years, hey presto, job done. Under the circumstances, whether profits are paid out as dividends or retained in the business has relatively little impact, see also 'Berkshire Hathaway' or 'Microsoft'.

Or they can speed up this process by flogging off the 'securities for sale' for £571 billion (they may well get far more than that, of course), which reduces total assets to £1,871 billion - combined with three years' retained profits, they'd have a capital ratio of 10% which is more than adequate.

Sorting out the UK banking system, part 2/3

1. Having accepted that bonds are part-ownership and not a liability, and done all the netting off and contras from Part 1, we arrive at the more respectable balance sheet position shown below, with a healthy Basel ratio of 25% (i.e. £873 over £3,279). This deals with the first Big Myth, that UK banks are likely to go *pop* any second. I'll deal with the last Big Myth - that UK banks have to refinance or roll over £800 billion in bonds in the next few years - in part 3.

2. But let's now confront the second Big Myth - that we have to throw everything we can at propping up UK house prices, because if they fall by one single penny, the entire UK banking system will collapse. So let's do an extreme stress test and assume that UK house prices fall by half (which is unlikely to happen). I've pencilled in these write down percentages, and the resulting balance sheet will appear in Part 3 later today. Article continues below:
3. To see how undramatic the effect of a 50% house price crash would be, we have to remember that not all mortgages are 100% loan to value, i.e. if your loan-to-value ratio is 50% and prices fell by half, you would still not be in negative equity.

4. According to Table 2.17 of the Bank of England's latest Financial Stability Report, 59% of UK residential mortgages had a loan-to-value ratio of less than 50%, so subject to certain assumptions - that every borrower in negative equity declared him or herself bankrupt and handed back the keys (again, highly unlikely to happen), the total losses would be in the region of 15% to 20%. The same sort of figure applies to lending on commercial properties, and there is plenty of non-land related lending. In my 'write down' column, I have assumed a write down/loss of 20%, i.e. at the higher end.

5. Heck knows what's buried in 'Securities for sale'. It'll be a mixture of stuff that is worth what they say it is, second hand mortgages worth 80% of their face value (see 4.) and other US-origin sub-prime stuff that might be worthless. This averages out to 60% of current market value, so let's write this lot down by 40%.

5. For good measure, let's write down banks' own fixed assets - which include their commercial premises and 'good will' - by 10%.

6. You can't 'write down' customer deposits or trade debts as this would be open fraud and politically impossible.

7. And we have to keep track of the market value of all the bank shares and bank bonds in existence. Market value of the shares is explained in Part 1. I've assumed that bank bonds are trading, on average, at 80p in the £. Therefore the total 'enterprise value' of UK banks is £723 billion - the object of this exercise is to show that neither bond nor shareholders would particularly lose out if house prices crashed AND/OR if UK government bail outs were to be halted and reversed.

More negative equity fun

From today's FT:

One in 10 borrowers with an excellent credit record are trapped in negative equity, owing more on their mortgage than the value of their homes, says a report that forecasts a peak-to-trough fall in house prices of up to 35 per cent.Tuesday's report by Fitch Ratings, which is based on loan information from 2.7m borrowers, found the highest concentration of negative equity was in Northampton, where 17 per cent of borrowers were under water...

Lenders with the highest levels of borrowers in negative equity included Northern Rock, which was nationalised in 2008, Bradford & Bingley, also rescued by the government, Birmingham Midshires, which is part of HBOS, and Alliance & Leicester, owned by Santander, the Spanish banking group.

In its report, Fitch said negative equity could rise to 23 per cent of all borrowers and to a third of all loans by value if its forecast of a peak-to-trough decline in house prices of 30-35 per cent was correct.

The study derived house values from the Nationwide House Price Index, which is down roughly 20 per cent so far. The high numbers of borrowers in negative equity reflected the impact of falling house prices and "criteria creep" among lenders that had offered loans at ever higher percentages of house purchase prices during the boom...

Another day, another reckless throw of the dice (27)

From The Metro:

The Government is doubling the funding available to give people who face losing their home free legal advice in court. Housing Minister John Healey said the Government was increasing the extra money for the service from £750,000 to £1.5 million. The service offers free on-the-spot legal help to people in England who are in court facing having their home repossessed or being evicted from rented accommodation...

However, the CML has recently indicated that it is considering revising down its forecast for repossessions for this year from its near-record level of 75,000.

Assuming that £1.5 million is an annual budget, that works out as £20 of 'free legal advice' per case, which is enough to pay for about ten minutes of solicitor's time. And if the scheme actually 'worked', does this not set the 'moral hazard' alarm bell ringing?

We have clearly sleepwalked into a post-modern tax/economic system, whereby savers are not only subsidising (reckless) borrowers (via artificially depressed interest rates), but then Timmy Taxpayer is being asked to foot the bill to help the self-same borrowers wriggle out of the responsibility of even paying the subsidised interest.

I accept that rising house prices are a symptom of a growing economy, but over the years, this logic has been turned on its head, and the generally accepted view is now that rising house prices are what drives the economy. Which is, presumably, why money is now being sucked out of the real economy in order to try and reflate the bubble...

Also chucklesome is this:

The Government has introduced a range of initiatives to help people avoid losing their homes, including the Homeowner Mortgage Support scheme, under which people can defer up to 70% of interest on their mortgage for up to two years.

It has also increased support for mortgage interest and introduced the Pre-Action Protocol under which courts can only grant repossession orders as a last resort. But recent figures showed that only two families have so far benefited from its mortgage rescue scheme.

NB, the original article appears to have disappeared.

OK. Who's lying to whom? And why?

The Bank of England said last week that "around 7%-11% of UK owner-occupiers with mortgages were in negative equity in the spring of 2009." There are 11.7 million outstanding mortgages in the UK, so that would give us between 800,000 and 1,300,000 in negative equity.

Lloyds/HBOS said back in February that about 16% of its borrowers were in negative equity. Lloyds/HBOS has 28% of the market, so whether you pro rate it up at 540,000 ÷ 8% or assume 11.7 million mortgages x 16%, it gives up a figure of about 1,900,000 in nequity.

Right. Lloyds/HBOS may have been hamming it up a bit in the hope of more bail-out money, and the Bank of England may have been playing it down a bit in order to boost confidence (which is part of their remit), but that's still one heck of a discrepancy.

Always look on the bright side of life ...

OK, we've finally wised up to the fact that a lot of MPs have second and third homes.

More widely publicised is the fact that the average house price has fallen by about £30,000 since late 2007. As heartbreaking as that may be for the one million borrowers in negative equity, does it not gladden your heart that for every £1 you have lost, the average MP has lost £3 or £4?

So, next time the government announces some grand plan to 'boost mortgage lending' or 'kickstart the housing market', just ask yourself: for whose benefit are they doing this, and with whose money?

Another day, another reckless throw of the dice (25)

From The Times:

HBOS, which is part of Lloyds Banking Group, will consider offering a new mortgage to customers in negative equity whose existing deal, such as a fixed rate, is about to expire.

Normally such borrowers would see the rate they pay revert to the lender's standard variable rate (SVR) and would be unable to remortgage if the new loan were greater than the current value of the property as a result of the decline in house prices.

But Halifax and Bank of Scotland, which are both part of HBOS*, are offering the rates on 95% loans to some remortgage customers needing to borrow more than the property value – up to 120% of the value in some cases.

* Allow me to insert the missing words: "Halifax and Bank of Scotland, which are both part of HBOS, which itself is part of Lloyds Banking Group which is 65% owned by the taxpayer..."

Hmm. I'm not convinced that this is the best use of taxpayers' money, but hey...

H/t QG at HPC.

Mark's Negative-equity-o-meter: Update

It turns out that my original back-of-fag-packet estimates were probably correct, i.e. there are 11.7 million outstanding mortgages and let's assume that loan-to-value ratios were evenly distributed at the top of the market, so for every one per cent fall in prices from peak, you'd expect +/- 117,000 more households to go into negative equity.

There were two stories this week, the first was that GfK NOP had interviewed 60,000 people and extrapolated this up to assume that there were already 3.8 with "loans worth more or close to the value of their homes.". The didn't define "close to", but let's assume that half of those are actually in negative equity as at today, or 1.9 million. The second is Lloyds Banking Group's claim that 540,000 of their borrowers are in negative equity. Lloyds TSB and HBOS together have 28% of the mortgage market, so that would pro rate up to 1.9 million as well.

According to the Nationwide, the average house price is down by 20% from the peak in late 2007, which would give us a figure of 95,000 mortgages in negative equity for every 1% fall in house prices. That's a bit less than 117,000, so let's split the difference and call it 100,000 additional cases for every 1% fall from peak.