Monday, October 13, 2008

Arm twisting

A question is being asked about the consumers who over-stretched to take on huge mortgages which goes like this: no one was twisting their arms to take on these loans, isn't there an element of personal responsibility? Sure there's some element of personal responsibility but let's not pretend that decisions to take on huge loans are made in isolation. If everyone else is taking out huge mortgages, house prices go up, and for an individual family the choice is to follow suit or live in a bad neighbourhood (say). Mortgage decisions are in this sense coupled: the prices of homes depend on how much others are willing to borrow, so the prudent have to pay a very high price, in terms of quality of life, possibly for a long period, before a house price bubble deflates and their prudence pays off. This simple fact limits the negative feedback we can expect to see cautious borrowers exert.

Worse, in the UK, the house buying mania is so deep seated that it's actually very difficult to raise a family in rented accomodation. The rental market for familiy houses is thin and the tenancy regulations not great for people in that position.

If even prudent individuals feel compelled, for quite rational reasons, to buy at inflated prices, you know you've got huge systemic problems!

I suggest:

(1) Act to make the rental market bigger and better. There needs to be a range of rental options at every level. The option to rent has a key role to play in controlling house prices inflation during bubble formation, by drawing the prudent out of the market.

(2) Impose limits on how much people can borrow. Mortgage borrowing is akin to an arms race: you need to control how much people can bid, or in small, locally rational steps, they'll bid prices up so high it hurts most of us.

(3) Simplify the mortgage business. How does the huge layer of brokers and other intemediaries add value? If there isn't a clear answer, get rid of them, and move to a simpler, stripped down mortgage service, using new regulation if needs be.


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