January 27, 2002

US mortgages a fairer deal

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If corporate America is experiencing a rapid recovery (which Alan Greenspan tentatively signalled this week), the main story of the late 1990s is that US houses did not fall in value as they have done in every recession since records began. When we look at the forces massed against the US housing market, its resilience is all the more remarkable.

The 1999 collapse of dotcom and telecom stocks wiped billions off US consumers’ wealth. This was followed by a slump in investment, widespread bankruptcies and over a million Americans losing their jobs. Then we had September 11. Yet house prices remained buoyant even as the stock market plummeted.

In contrast, Irish house prices fell rapidly, even though most people deemed the market to be impervious to the economic cycle because of our demographics. To the best of my knowledge, the population continued to rise, thus making a mockery of the simplistic supply and demand arguments trotted out by estate agents and their lackeys. The key to the housing market bubble in Ireland is credit — its availability and its cost.

Given the recent fragility of Irish house prices, it is worth having a look at the way the US housing market works. If US-style practices were brought into the Irish market, could last year’s collapse at the top end of the Irish market, and the more moderate generalised fall across the board, have been cushioned or even reversed?

On a more philosophical level, if it could have been softened, given the huge transfer of wealth from workers to landowners, would it be the right thing to do? By maintaining the house price bubble at all costs, a generation of Irish workers is condemned to mortgage-based serfdom. This outcome is highly questionable.

There are three central features of the US market that distinguish it from the Irish one. First, there is 100 per cent relief on interest for housing. Provided you have sufficient income, all your mortgage interest can be written off against tax.

This obviously buoys the market in good times and smooths its falls in recessions. It also acts as a huge subsidy from the government to landowners, by ensuring that the state underwrites the housing market. This explains the initial level of house values but not short-term changes in price. For example, if it weren’t for this subsidy the overall level of house prices would fall throughout the country as the cost of mortgages rose rapidly. However, regional boom-bust cycles would still occur.

A second important difference is that mortgages are non-recourse.

In Ireland, if the price of your house falls, the banks come after you (usually for reduced monthly payments, but for payments nonetheless), whereas in America the buck stops at the house, not the borrower.

A mortgage here is more like a personal loan, with the house as some of the ‘security’. This bargain is almost entirely skewed in favour of the bank and against the borrower. Individuals take all the interest and market risk, while exposing themselves to the danger of being blacklisted if the market turns down.

In America, mortgage lending is against the asset, not the person, and the bargain is more like asset financing than personal banking. So if you buy a house and its price falls, at least the rest of your income is safe from the bank. The bank and the borrower share the downside risk.

In Ireland, if you buy at the wrong time, get caught in a falling market and lose your job, the bank can come after you for years. It can force you to sell other assets and impose very strict repayments, all of which ensure that the bad decision you made on the house can haunt you for the rest of your life.

In the US, the opposite is the case: the bank gets the house, you walk away having lost the deposit and the equity in the house. The buck stops there.

The third major difference in the US is that the borrower can refinance at no cost. So if interest rates fall from 10 per cent to 5 per cent, borrowers can refinance straight away, lowering their mortgage cost immediately.

In Ireland, if you want to take advantage of today’s lower interest rates on an existing mortgage it will cost you, sometimes heavily. For example, in the above case, the Irish bank calculates the 5 per cent difference in the interest rate and multiplies that out for the remainder of the loan. This hefty figure, or something close to it, is the cost to the borrower of refinancing.

Not surprisingly, refinancing hasn’t taken off here. In contrast, American consumers refinance all the time. This year, American long-term interest rates fell from 5.5 per cent to 4 per cent between August and the end of September. By November refinancing was being cited as the reason early Christmas shopping was booming. In the US, the bargain between the banks and the borrowers is much more equal, because it is not just the bank or first-time borrower who profits from falling interest rates.

These three factors — significant mortgage interest relief, non-recourse financing and zero cost refinancing — make the US property market very resilient, and some would suggest fairer. But would it be wise for society as a whole to prop up our property market by adopting US practices?

Obviously, the banks would oppose any change in the status quo. At the moment they are getting a great deal by passing all the risk on to the borrower. They are exclusively benefiting from any falls in rates, while at the same time seeing the quality of their assets rise if house prices rise.

Of course, the individual would gain enormously. However, underwriting the housing market to such an extent creates more philosophical difficulties for our society. We have already created a generation of worker commuters who live in dormitories rather than communities on the outskirts of Dublin. This is a direct result of the housing price bubble.

By joining EMU and guaranteeing that inflation remains low, we have ensured that life means life — a 30-year mortgage means 30 years. In the past, inflation acted as a type of early payroll from the mortgage sentence. My parents’ generation happily saw their mortgages eliminated by inflation. No such luck for me! Keeping the house price bubble intact would condemn an entire generation to working to pay the mortgage that only benefits landlords and the shareholders of banks.

On the other hand, politicians facing an election don’t have to bother themselves with such long-term philosophical questions. Changing to the US housing market structure and getting the banks to pick up the tab has to be an election winner, particularly when house prices are shaky. With a Finance Bill due on February 7, stranger things have happened. Watch this space. 


  1. [...] Här stÃ¥r det lite om det, dock verkar den här killen ha fÃ¥tt en del om bakfoten. Men det här verkar som sagt stämma: “In America, mortgage lending is against the asset, not the person, and the bargain is more like asset financing than personal banking. So if you buy a house and its price falls, at least the rest of your income is safe from the bank. “ [...]

  2. [...] day ten years ago, arguing that the mortgage system was skewed completely in favour of the banks and this week, five [...]

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