Is throwing money at the mortgage market the solution?
You may have noticed over the last month many countries have past bills in their governments to inject substantial amounts of cash into their banking system. They have done this on the understanding that all the bad loans also known as toxic debt is weakening the institutions and rendering us unable to borrow money so leaving us all worse off as a result.
So the big question is will injecting this money actually get the banks lending again and if they do, will it have any effect on us, the general public. In answering this question and dealing with the issues here I can only comment on our particular situation here in the United Kingdom. Whilst it may be similar in other parts of the world I cannot comment due to the fact that I am unfamiliar as to how their market works, so what may have an effect here may not be the case anywhere else.
Now the general consensus would be that due to the credit crunch the various financial institutions involved in the lending of money are not at liberty to do so, through a lack of it. So it would then follow on that the way to solve the problem is to supply them with the necessary means, i.e. more money. But this approach does not begin to scratch the surface with regards to the underlying problem. The reality is that the banks have been badly hit by the credit crunch and so are quite unwilling to continue on with lending as if nothing had happened.
The main result and contributory factor to the current financial predicament is that of house prices, and house prices are not only falling but are set to continue to fall for the foreseeable future. Consequently lenders are finding that they have to tighten all their criteria not least in the area of loan to value LTV, that is the amount of money that is lent based on the value of the property. Most lenders during 2007 lent up to 95% LTV some lent 100% LTV and in some cases they went as high as 125%LTV.
While the market is buoyant most annalists will agree this type of lending is OK. Think about it if you lend on a 100,000 house 125% which results in a loan of 125,000 and the house price rises over the next three years at a rate of 10% per annum, which was not unheard of. Then your LTV in three years time would only be 93% this is alright from a lending point of view and what would be considered an acceptable risk.
However house prices are not rising by 10% per annum in fact they are falling by at least 10% and some people think that these falls will be worse. So with that in mind if you now lend to someone 85,000 on a 100,000 house in three years your loan could be as high as 118% LTV. This as I am sure you will agree unacceptable lending in this climate. This therefore clearly explains why lenders are unwilling to lend over 90% LTV and in some cases 85%.
So what does this mean to the bailout and the future of the market? Well in my opinion, and I may be right or wrong only time will tell, I think that the bailout will have little effect. Yes the lenders are under a commitment to lend at the levels of 2007 during 2009, but if you understand what has been said in my previous paragraphs they cant lend at the high loan to values. Most of the urgent cases for lending are the people coming out of rates that have been arrange in the last five years, these people are going to be pushing the LTVs due to the current house price falls.
Another thing to consider is the high amount of self certification mortgages that have been arranged over the last 5 years. These types of mortgages will definitely be a rarity because they are seen as to high a risk and the institutions don?t want to know. And even if they are available the LTV will be far lower so what are the consequences in that scenario?
Don?t get me wrong, I am all for the government trying to give the economy a much needed boost, but I just think that the institutions will be unwilling to take the risk on loans at the 2007 and before levels. They will most probably stockpile for the future. This will mean that house prices will continue to spiral downwards due to the LTV not being at a suitable level and the banks will be even more cautious about the type of loans on offer and also the vetting process. It really is a difficult situation and I think that the only way around it if for one of the institutions to bite the bullet and take a calculated risk with regards to their lending.
So the big question is will injecting this money actually get the banks lending again and if they do, will it have any effect on us, the general public. In answering this question and dealing with the issues here I can only comment on our particular situation here in the United Kingdom. Whilst it may be similar in other parts of the world I cannot comment due to the fact that I am unfamiliar as to how their market works, so what may have an effect here may not be the case anywhere else.
Now the general consensus would be that due to the credit crunch the various financial institutions involved in the lending of money are not at liberty to do so, through a lack of it. So it would then follow on that the way to solve the problem is to supply them with the necessary means, i.e. more money. But this approach does not begin to scratch the surface with regards to the underlying problem. The reality is that the banks have been badly hit by the credit crunch and so are quite unwilling to continue on with lending as if nothing had happened.
The main result and contributory factor to the current financial predicament is that of house prices, and house prices are not only falling but are set to continue to fall for the foreseeable future. Consequently lenders are finding that they have to tighten all their criteria not least in the area of loan to value LTV, that is the amount of money that is lent based on the value of the property. Most lenders during 2007 lent up to 95% LTV some lent 100% LTV and in some cases they went as high as 125%LTV.
While the market is buoyant most annalists will agree this type of lending is OK. Think about it if you lend on a 100,000 house 125% which results in a loan of 125,000 and the house price rises over the next three years at a rate of 10% per annum, which was not unheard of. Then your LTV in three years time would only be 93% this is alright from a lending point of view and what would be considered an acceptable risk.
However house prices are not rising by 10% per annum in fact they are falling by at least 10% and some people think that these falls will be worse. So with that in mind if you now lend to someone 85,000 on a 100,000 house in three years your loan could be as high as 118% LTV. This as I am sure you will agree unacceptable lending in this climate. This therefore clearly explains why lenders are unwilling to lend over 90% LTV and in some cases 85%.
So what does this mean to the bailout and the future of the market? Well in my opinion, and I may be right or wrong only time will tell, I think that the bailout will have little effect. Yes the lenders are under a commitment to lend at the levels of 2007 during 2009, but if you understand what has been said in my previous paragraphs they cant lend at the high loan to values. Most of the urgent cases for lending are the people coming out of rates that have been arrange in the last five years, these people are going to be pushing the LTVs due to the current house price falls.
Another thing to consider is the high amount of self certification mortgages that have been arranged over the last 5 years. These types of mortgages will definitely be a rarity because they are seen as to high a risk and the institutions don?t want to know. And even if they are available the LTV will be far lower so what are the consequences in that scenario?
Don?t get me wrong, I am all for the government trying to give the economy a much needed boost, but I just think that the institutions will be unwilling to take the risk on loans at the 2007 and before levels. They will most probably stockpile for the future. This will mean that house prices will continue to spiral downwards due to the LTV not being at a suitable level and the banks will be even more cautious about the type of loans on offer and also the vetting process. It really is a difficult situation and I think that the only way around it if for one of the institutions to bite the bullet and take a calculated risk with regards to their lending.
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