State-backed, long mortgages at fixed rates are not the answer
The latest idea to stimulate demand in the housing market would involve government support to encourage long-term fixed-rate low-deposit mortgages
Our government will go to truly remarkable lengths to avoid allowing significantly more housebuilding to increase homeownership. The latest idea to stimulate demand instead would see government support (read: subsidies) to encourage long-term fixed-rate low-deposit mortgages, as seen in the United States. This policy, from the Conservatives’ 2019 manifesto, lost appeal as interest and mortgage rates soared, but now, with rates falling again, it’s being discussed as a potential election vote-winner for young families.
The government’s logic is straightforward: 30-year fixed-rate mortgages safeguard holders against rising interest rates while allowing them to benefit from any house price inflation. Consequently, a government guarantee for these mortgages (implicit or explicit) could reduce the bite of regulatory “stress tests” — assessments of a borrower’s ability to withstand higher mortgage rates — thus expanding affordable mortgage access to more families with lower deposits.
I didn’t have to travel far to find an expert sceptical of this idea. Mark Calabria, my Cato Institute colleague, previously was director of the US Federal Housing Finance Agency, the regulator for Fannie Mae, Freddie Mac and other federal home loan banks. When asked about the wisdom of the British government wading into state-backed long-term mortgages, he grimaced, before highlighting three truths that the Tories must bear in mind.
First, interest rate risk will always exist. Government-backed 30-year fixed-rate mortgages simply aim to make mortgage holders bear less of it and lenders more. In the United States, mortgage holders can refinance to capitalise on lower rates, yet remain insulated as rates rise. The catch? Surging interest rates cause substantial financial losses for mortgage providers. Households, as taxpayers, then often become exposed to massive contingent liabilities through bailouts and crises (see, for example, the 1980s’ American “savings and loan crisis”).
Next, government-backed long-term fixed-rate mortgages make macroeconomic stabilisation policy more difficult. Typically, mortgage rates fall in a spending downturn and rise when the economy overheats. This acts as an automatic stabiliser for the broader economy. Falling rates boost mortgage holders’ disposable incomes when aggregate demand is too low and rising rates reduce their income when demand is too high. Long-term fixed-rate mortgages obviously weaken this mechanism, making the Bank of England’s job at stabilising spending more difficult.
Which brings us to the distributional implications. The Conservatives want to help people they think could afford mortgage payments but who would struggle with deposits. In general, though, homeownership and having a mortgage are positively correlated with income. So this would subsidise the relatively lifetime-affluent, paid for by taxes or risks also borne by poorer households. The costs of monetary tightening, in particular, inevitably would fall more heavily under this policy on interest-rate-sensitive sectors, such as construction.
At the moment, the American property market is suffering from people being unwilling to move, precisely because more than 70 per cent of mortgages have 30-year fixed rates and new mortgage rates are much higher than most mortgage holders enjoy at the moment. Sales of existing homes have fallen by more than 15 per cent this past year to their lowest level in a decade. That, of course, harms first-time buyers who could otherwise afford properties, the very people the Conservatives say they want to help.
Although a government-backed 30-year mortgage clearly would be attractive to many homebuyers, then, it risks exacerbating Britain’s broader housing market dysfunction. Even outside proponents, such as the Centre for Policy Studies think tank, concede that without increasing the housing supply through planning reform, easier mortgage finance would mainly inflate house prices rather than homeownership rates.
Indeed, mortgage providers are at liberty to offer long-term fixed rates already, and some do. But the reason they are uncommon is these inherent risks. Paying for those risks should be the responsibility of the mortgage holder, not British taxpayers as part of an electoral giveaway.
Ryan Bourne is R Evan Scharf chair for the public understanding of economics at the Cato Institute
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