Interest rates are going up – and mortgages will become harder to get
It's official: money is about to become more expensive. Mark Carney warned yesterday that rates could rise more quickly than the markets were predicting. The implication is that the base rate could increase later this year, rather than in the second quarter of next year; this is a major shift for the Bank of England and suggests that it is willing to be the first major international central bank to increase interest rates.
It is a dramatic change from Carney’s position of earlier this year, and stands in stark contrast to his original forward guidance, which suggested that rates wouldn’t go up until 2016. That said, he still believes that hikes will be gradual, and that rates will peak at well below five per cent. I suspect the second part of this prediction will turn out to be fanciful, but we’ll have to see.
One reason for Carney’s relative dovishness is that he continues to believe that macroprudential regulation will be able to perform much of the heavy lifting when it comes to choking off London’s housing bubble. His toolkit is about to be strengthened: George Osborne wants to give him the power to ban or limit individuals’ ability to take out mortgages deemed too big compared with their income or the value of their home.
It is astonishing how quickly policy-makers have been performing U-turns, and then U-U-turns on all of this. During the bubble, the establishment was absurdly relaxed about high loan to value mortgages, including some at well over 100 per cent; they were equally happy with people who borrowed many times their income. Then came the financial crisis, and the inevitable backlash. The regulations were changed and banks were forced to hold much more capital, drastically reducing their incentive to extend mortgages with low or no deposits. Their own beefed-up risk assessment systems also made them much more reluctant to lend out too much on the back of uncertain collateral, especially when house prices were still falling.
But the government gradually began to realise what it had done, and panicked. It started shouting at the banks, and when that didn’t work launched a number of initiatives to subsidise credit, including with help to buy. Its right hand sought to undo the impact of the regulatory changes that its left hand had pushed through; it was the very opposite of joined-up government.
All seemed well for a while – until the government started to panic again. House prices were rising too fast. The two main state-backed banks suddenly pushed through a maximum loan to earnings cap of four times on homes worth £500k or more. But the real U-U-U-turn came last night, with Osborne giving the Bank of England the power to cap loans, even though the Old Lady of Threadneedle Street had previously said that it didn’t actually want to be given such authority.
There are many problems with the Bank’s new macroprudential tools, not least the vast central command and control powers that come with them. Lending caps are partly predicated on the view that banks are too stupid to control themselves. That was true in 2006, when the state had (wrongly and short-sightedly) given all lenders an implicit guarantee that they (or at least their bondholders) would be bailed out.
It shouldn’t be true today – and it certainly wouldn’t be if the government were credibly committed to not bailing out bust banks. The plans for proper resolution mechanisms, living wills, bail-inable capital and all the other tools necessary to make sure that a non-bailed out bank would be wound down in a controlled manner are almost ready.
The priority surely ought to be to complete this vital reform, thus re-injecting the full discipline of the market into the banking system, rather than handing central planners the impossible task of trying to second-guess how much mortgage debt is right for the financial system and for individual consumers.
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