Good economics serves efficiency and fairness. Good politics serves the survival of the incumbent government. Sometimes all these considerations point in the same direction. Sometimes they don’t. Yesterday, in the UK, they did not.
The UK government yesterday announced that they were introducing retroactive mortgage payment insurance protection free of charge to qualifying residential mortgage borrowers; the cost of the insurance to be born, in as yet unknown proportions, between the tax payer and the mortgage lenders.
This policy is a typical example of ‘insider protection’ at the expense of outsiders and newcomers. Rent control is another example of the same phenomenon. ‘Employment protection’, aka as ‘protection of the jobs of those who have jobs at the expense of those without jobs and looking for jobs’ is another prominent example, especially popular in some continental European countries.
The details of the UK programme for a partial mortgage interest holiday, for up to 2 years, for households where there is a major loss of income (due, say, to a family member losing his or her job) are unclear. It may apply only to mortgages below £400,000.00. You may not be eligible if you have savings in excess of £16,000.00 – a nice example of how a policy proposal in one policy area – reducing repossessions of homes, and the fear of repossession of homes – creates perverse incentives in another – inducing households to save more during the high-earning years of the household life-cycle. The Chancellor of the Exchequer, Alistair Darling, may not be a manic micro-tinkerer like his predecessor, Gordon Brown, whose left hand had no idea of the (unintended) incentive effects of what his right hand was doing, but he can create Brownian distortions and disincentives with the best of them.
Why is this temporary mortgage interest holiday a bad idea?
First, why reward the improvident and those who assumed excessive risks by taking on mortgages they would not be able to afford should they or there partner become unemployed, and without buying mortgage payment protection insurance?
It is true that the mortgage payment protection insurance sector has recently been diagnosed as uncompetitive and providing poor value. But isn’t that where the government’s efforts should have been directed these past 11 years? If the government is worried about its middle-class supporters losing their homes when the unemployment rate rises rapidly, it ought to have mandated mortgage payment protection insurance with every mortgage taken out (perhaps it should even do so even now, for both new and old mortgages). Or if it does not like mandating, it could ‘nudge’ mortgage borrowers, by permitting only mortgages with mortgage payment protection insurance attached to be sold, but leaving the borrower the option of subsequently cancelling the insurance.
Retroactive free insurance creates terrible incentives. If people settle in a flood plain, they should not be surprised that the water occasionally rises to the rafters. They should not be expected to be bailed out when their properties are washed away. It is true that they often end up being bailed out by the tax payer, and then repay this generosity by returning to live in the same flood plain.
Bailing out existing mortgage borrowers threatened with the loss of their homes when, because of a crisis-related loss of income they cannot make the required mortgage payments, is good opportunistic politics. It is a hand-out to the middle class, which always feels hard done by anyway, and whose electoral support is essential if the government is to stay in office.
It does nothing for fairness or poverty relief. Those with mortgages of up to £400,000.00 are not among the poorest, most deprived or most vulnerable members of society. Without this hand-out, those who have taken out mortgages too large for them to service when there is a significant decline in household income, would have to sell their homes, move to more modest accommodations (purchased or rented), and get on with their lives. A shock and a source of unhappiness, no doubt, but not a reason for the government to intervene.
It is not the responsibility of government to make us (or some of us) happy, even if it knew how to do this, which of course it does not. It is the job of government to create the conditions under which we can get on with our lives as free citizens, with minimal dependence on hand-outs from others. There are also far too many far more urgent claims on government resources to waste any on middle-class mortgage borrowers.
Does the proposal do much to stimulate aggregate demand, or the supply of credit to liquidity- and credit constrained households and enterprises? Hardly. The amount of money involved is small (probably no more that £100 million per year, with a total contingent exposure of about £1 billion). It also does nothing to address the credit constraints faced by key spending units, non-financial enterprises and households wanting to take out new mortgages, including first-time borrowers.
External funding to non-financial enterprises through the capital markets has fallen sharply and in some cases (securitisation of new mortgage originations) virtually disappeared. Larger enterprises are increasingly dependent on banks for external funding, crowding out SMEs, for which banks are the only form of external finance in the process. Businesses need external finance to pay their workers and their suppliers (costs come before revenues). Without such working capital, otherwise viable enterprises die. And they are dying, unnecessarily, in their hundreds every week.
To restore external credit to SMEs and the the non-financial enterprise sector in general, several measures can be implemented. First, the government can guarantee bank loans to the non-financial enterprise sector. The fee charged will determine the magnitude of the subsidy to the borrower (and/or to the bank). Second, the Bank of England could purchase corporate debt instruments directly (the way the Fed does with commercial paper), or the Bank of England could lend directly to the non-financial business sector, competing with the commercial banks. Third, the government could instruct the banks it owns completely (Northern Rock and Bradford & Bingley), in which it is the majority shareholder (RBS) or in which it is the controlling minority shareholder (HBOS and Lloyds-TSB), to lend to the non-financial business sector or to SMEs. Fourth, the government could mandate all banks, regardless of whether it owns an equity stake in them, to increase their lending to SMEs or to the non-financial business sector in general. Fifth, the government could nationalise all high-street banks and instruct them to lend as in case three.
Proposals for the government to guarantee specific types of credit (e.g. suppliers’ credit) are a subset of the more general credit or loan guarantees described in the previous paragraph.
From the perspective of getting new mortgage lending back on stream, the government’s retroactive mortgage payment protection insurance proposal is actually counterproductive. To the extent that the cost of the proposal is not born by the tax payer but passed on to the mortgage lender, the proposal makes it less attractive to engage in new mortgage lending. A typical example of incumbent- or insider protection at the expense of outsiders and newcomers.
To get new mortgage lending going, extending the SLS to accept securities backed by new mortgages (i.e. mortgages backed by securities issued after 2007) would be helpful. The Bank of England still opposes this. The Treasury should simply take the SLS away from the Bank of England and manage it through the Debt Management Office.
The Crosby Report contained proposals for reviving securitised mortgage financing through government guarantees for £100bn of new high-grade issuance. The responses of Mervyn King (securitised mortgages were “a form of lending that for rather good reason has fallen out of favour”) and of Alistair Darling (deafening silence) were not encouraging. Surely, securitising ‘gold standard’ mortgages (strict limits on LTV ratios, strict limits on income multiples, no self-certification, no teaser rates and other unseemly features) will be part of our future, even if in the past much stuff that should never have been securitised was nevertheless securitised?
It has also been argued that the government’s retroactive mortgage payment protection insurance will lift the fear of repossession from millions of vulnerable British households and that this will cause them to spend more. Perhaps. I am sure they were all saving away earnestly to build up financial balances to tide them over a possible spell of unemployment without facing the loss of the family home. If they had actually done so, and succeeded in building up assets in excess of £16,000, they would of course not be eligible for the government’s program. Well, never mind.
The government’s proposal for subsidising those who took out excessive mortgages in the past, is a text-book example of bad economics. It is unfair, distorts incentives and does nothing to stimulate the economy. Zero out of three is bad indeed.