The Financial Policy Committee and the Housing Market
The Financial Policy Committee and the Housing Market
The FPC views the housing market through the particular lens of financial stability, as its remit largely dictates. There is a risk that the consequent policy stance will increasingly rub up against other Government policies (such as increasing the rate of home-ownership, or some interpretations of the levelling-up agenda). Many believe though this is not uncontested, that the UK has a housing crisis. But there is less agreement about how this crisis might be resolved, not least due to a lack of clarity about what would constitute a well-functioning housing system.
The Financial Policy Committee (FPC) views the housing market through the particular lens of financial stability, as its remit largely dictates. There is a risk that the consequent policy stance will increasingly rub up against other Government policies (such as increasing the rate of home-ownership, or some interpretations of the levelling-up agenda).
Many believe, though this is not uncontested, that the UK has a housing crisis. But there is less agreement about how this crisis might be resolved, not least due to a lack of clarity about what would constitute a well-functioning housing system. We have no settled metrics for concluding that the crisis has been solved (or alleviated). But we do have a sense that there are certain groups and geographies which are particularly affected. The FPC sits within the intersection between housing policy and macroeconomic policy. Its decisions may also have distributional impacts.
The present policies of the FPC, and the FPC’s commentary on their effects, run two risks. One is of creating excessive expectations of their likely success, especially in times of housing market volatility when ‘fine-tuning’ the tools may well not be practically possible. (Brener, 2020). The other is of losing political credibility if the distributional effects of its stance are not fully acknowledged.
In April 2015, the FPC was granted powers of Direction with regard to owner-occupied lending in relation to loan-to-value (LTV) and debt-to-income (LTI) limits. In late 2016 the FPC was also granted powers over loan-to-value and interest coverage ratios in respect of buy-to-let (BTL) lending. The FPC is clear about the purpose of these policies – which is to reduce the risk of financial crises stemming from lenders with risky mortgage portfolios and/or households with high debt-to-income ratios. In addition, the FPC seeks to moderate the self-reinforcing loops which can arise between house price expectation and lender/borrower behaviour.
The FPC is not the only regulator operating in this space. In 2014, the Financial Conduct Authority (FCA) brought the Mortgage Market Review into effect, regulating the way in which lenders should assess the affordability to a household of each loan, including a stress test to ensure borrowers could cope with a rise in interest rates. And in 2016 the Prudential Regulatory Authority (PRA) issued new requirements for lenders in the buy-to-let market.
The aim of the policies issuing from this triumvirate of Three Letter Acronyms is obviously worthwhile – it is to reduce the risk of repetition of a financial crisis on the scale of 2008/09. (It is questionable how far this crisis sprang simply from poor mortgage lending practices, but they were certainly a contributing factor). In downturns caused by factors outside the financial system, it is to reduce the impact of the behaviour of highly-indebted households exacerbating the recession. Over the same period, successive governments have pursued their own policies with regard to market housing (social housing and affordable rent, while important in their own right, are less relevant to this discussion).
In June 2014, the FPC recommended that mortgage lenders should not extend more than 15% of their total new mortgages at loan-to-income ratios at or above 4.5%. It also recommended a mortgage affordability test. This stress test was to assess if a loan could still be afforded if, at any stage in the first 5 years, the mortgage rate was to rise 3 percentage points above the origination rate, or above a specified reversion rate. The FPC describes these as structural measures designed to work through housing market cycles.
The FPC has published several commentaries assessing the effects of its mortgage market measures, and another review on the calibration of the present measures is due to conclude in late 2021. These have focused on two questions: firstly, to what extent the FPC’s Recommendations have constrained mortgage affordability; and secondly, what is the likely balance of macroeconomic costs and benefits.
With regard to affordability, the most recent assessment of policy impact (Bank of England 2020) suggested that only 2% of renters are constrained from buying the median priced property in their region by the FPC’s affordability test, taken in isolation. A far larger proportion of renters (75%) is estimated to be constrained by a lack of deposits. (It is not clear whether this analysis includes young people living at home who may wish to buy but have not yet formed a separate household).
With regard to the macroeconomy, the assessment is argued to be strongly positive. By constraining the growth of highly-indebted households in a housing boom similar to that preceding the Global Financial Crisis (GFC) (Bank of England 2019) it is estimated that FPC policies would prevent a 1.5% fall in GDP in a downturn. On the cost side, the policies would only have taken 0.2% off GDP (via dampening housing market activity) during the preceding boom. However, this boom has not yet occurred, and this may have protected the FPC from public awareness of the full impact of its policies.
Alongside this raft of regulatory policies, governments have pursued a set of policies generally aimed at increasing the supply of new housing and at assisting households who are constrained by their inability to fund a deposit due to a reduction in high LTV mortgages. Of particular relevance here is Help to Buy (HtB), introduced in 2013 which (broadly) offers first-time buyers of new properties a government-backed loan of up to 20% of the property value provided the buyer has a 5% deposit.
HtB has attracted considerable criticism especially for providing support to developers rather than households. It certainly has had mixed regional impacts – evidence suggests that in areas such as London, where new supply is more constrained, much of the impact of HtB fed into house prices. In less supply-constrained areas, there was more impact on new construction (Carozzi et al (2020)).
Establishing exactly what the impact of the FPC’s measures have been, separately from the impact of these other regulatory and policy changes, and arguably a behavioural shift by lenders is not easy. But it should be noted that FPC analysis of the impact has been conducted from a macroeconomic standpoint. Broader public policy concerns about housing include a focus on supporting those who are just on the edge of being able to move into home-ownership. This is still the desired tenure for most people at some stage in their lives, and also has wider social benefits.
In the remit for the FPC, HMT comments that the ‘government is committed to supporting first-time buyers’. The most recent FPC response to the remit letter does not mention this policy goal. HMT could strengthen this comment, referring to potential first-time buyers across different UK regions and with different access to family support. The FPC would then need to add a distributional analysis, and consider whether its policy tools could be honed at least geographically.
Looking at the mortgage market in 2019, UK Finance observed that ‘several consumer groups remain less well-served in today’s mortgage market -those with small deposits, single-person households and households with complex incomes’ (UK Finance, 2019). In addition, macroprudential tools have had more impact, unsurprisingly, in high-price markets, although lending at loan-to-income over 4.5 has tended to be focused in these markets. As a result of the increase in house prices, there have also been impacts on those still able to borrow – lending terms have lengthened implying less capital repayment in the early years of a loan (in 2019 more than 40% of first-time buyers took out a term of 30 years or more)
The problem is that, for example, young single households from families with little available wealth to support their deposit are simply priced out of many parts of London and the South-East. FPC measures do not directly bear on the issue of high deposits as no loan to value (LTV) restriction has been introduced. However, the LTI restriction will have an indirect deposit requirement impact on some households.
Home-ownership is by no means a perfect financial option. Apart from the risk of failure to pay the monthly mortgage there are the costs of maintenance and higher costs of moving location. But it has the major advantage of being a hedge against housing costs in old age – with worries about inadequate pension provision this may be increasingly important.
Looking at the linkages between owner-occupation, house prices and macroeconomic stability, the key policy objectives are:
Ability to access owner-occupation for those able to afford it at the time, ensuring this takes full account of the costs of home-ownership
Restricting the number of high debt-to-income households, who are most likely to cut back their spending and amplify the shock of any downturn
Preventing too much relatively risky mortgage lending in order to ensure financial institutions can withstand downturns in the housing market.
As the first of these objectives has an apparent contradiction with the other two, the question for policy might be re-framed as – how much risk from increased home-ownership is the government prepared to socialise? This can be done by underwriting the mortgage market (as it has done through HtB, and as it could do through greater access for help with mortgage payments to the unemployed). As mentioned above, HtB is far from perfect, and it supports finance for those from wealthy and less wealthy backgrounds alike. It may address some of the income inequality which has arisen in recent years from the relative fall in younger people’s incomes, but not any concerns about housing wealth inheritance.
To sum up – few would argue against the conclusion that the FPC’s macroprudential policies are likely to be of benefit from a macroeconomic viewpoint. But the judgement that there has in practice been little effect on mortgage lending seems more questionable given that these policies came into effect alongside a range of other measures.
At present, Help to Buy is due to be phased out in 2023. The evidence cited above suggests that this is likely to result in a modest decline in house prices in supply-constrained areas, but clearly also reduced affordability for those who find it hard to raise a deposit. At this point the FPC’s structural policies may start to bite more effectively and the FPC be drawn more strongly into the public debate about home-ownership.
Obviously, the FPC is not responsible for all the problems of the housing market, which mostly lie outside its powers. But it should be more open in discussing the distributional consequences of its policies now, so that before Help to Buy is phased out there is a sensible debate about how to manage the risks inherent in and from the housing market.
Since 2013, the net effect of the mortgage market review, FPC policy and Help to Buy has been to reduce risk to lenders and borrowers and support new housing supply, with the government taking on some of the risks from a housing market downturn. As the financial crisis and the consequent large drop in new housing supply recedes into history, it is time to reconsider how policy towards the risks of owner-occupation is constructed to form a coherent whole. This would include better-targeted help into home-ownership, and better public support for those unlucky enough to experience unemployment once in home-ownership. At present, the overall policy stance risks cementing intragenerational inequalities due to the differential access to deposits. Within this, the FPC will still need to play the role of focusing more on the risks to lenders, but the FPC’s remit should be amended to ensure distributional analysis and considerations are not neglected.