by David Thorpe
April 2011
By the time this article appears in print, the European Commission proposals for regulating the sale of mortgages will have been scrutinised and the UK mortgage industry will have formed its own view as to their usefulness. My guess is that they will find them overly complex and expensive to implement and any possible benefit to the consumer will be outweighed by the additional costs that will have to be passed on to them by mortgage lenders and advisors. Interestingly enough, exactly the same thing has already happened in the US with similar consequences but more of that later. However, to appreciate just what the European Commission is dealing with it is important to understand what is happening economically in the Eurozone. Inflation continues to be a worry (another increase in February, this time up to 2.6%) and interest rates are expected to rise as the ECB attempts to bring inflation below 2%. The good news is that unemployment dipped below the 10% mark for the first time since January 2010. However out of the 77,000 new jobs created the bulk, some 50,000 of them were in just one country, Germany. Spain on the other hand saw its unemployment rise to 20.5% and in Ireland and Greece it remains at over 14%. What is interesting and which will possibly be quite surprising to many of you is that German owner occupancy rates are around the lowest in Western Europe (around 44%) whereas Portugal has one of the highest rates (approximately 76%). These two figures alone provide a fascinating picture as to the nature of the problem the regulators are trying to grapple with. For instance, in over 200 years, there has never been a single default of a German covered bond. In Portugal, all five of Portugal’s opposition parties have just rejected the government’s austerity measures and an EU bail-out now seems inevitable. It seems to me that the European Commission has quite a job on its hands just sorting out the economy. Regulating and standardising how each country sells its mortgage products seems to be the least of their problems. I can’t even begin to imagine what the cost of policing this initiative across Europe will be and I can’t believe anybody really knows.
In the States they are facing similar economic issues but the problem with the housing market appears far more complex. The legislation they adopted, the Dodds-Frank Act (DFA) was hideously complicated and according to many commentators, quite unnecessary. But more importantly, it failed to tackle the role government housing policies had played in creating the housing bubble in the first place. Opinion is firmly divided on this point but it is hard to argue with one of the facts. That is when the bubble finally began to deflate in the US, millions of high risk and sub-prime loans began to default at unprecedented rates with fairly dire consequences for those financial institutions in the US and around the world that were holding these mortgages or the MBS they backed. Questions are quite rightly being asked as to how it was allowed to happen in the first place. To try and put the scale of the problem in to some sort of context, the number of UK mortgages in 2009 more than 3 months in arrears was less than 2.5%. In the US the same number was close to 9.5%. But the number of US subprime loans more than 3 months in arrears at that time was over 25%. Unsurprisingly, repossessions in the subprime market increase dramatically when you combine low credit scores with LTV’s greater than 80%.
One of the characteristics of housing bubbles is that they are virtually impossible to identify while you are inside but very easy to recognise in hindsight. The consequence of this is that regulation is deemed only appropriate when there is a market failure. In the US, mortgage lenders and financial advisors are also having to digest a new Federal Reserve Board regulation that deals with the payment of origination fees. The intent of the rule is very clear. It is to prevent mortgage originators from ‘gouging’ mortgage customers. Already it is causing widespread confusion across the industry. Fees charged to borrowers are not allowed to go up from the initial fee quote provided. We all know from experience that trying to calculate a fixed-fee at the outset for all types of transactions is impossible but the rules don’t provide for exceptions. Like the DFA that was meant to protect consumers, the end result is higher bank and credit card fees for consumers. In this case, a regulation intended to protect the consumer will result in higher costs for mortgages. I think we all know what the real problem with the US housing market was and more importantly what needs to be done to fix it. I hope the European Commission is taking note.