Have we forgotten the lessons of sub-prime?

Until I began to read deeper into the turmoil that has characterised housing markets in liberal economies over the last decade and a half, the term ‘sub-prime’ was associated with a particular time and place.

It meant the United States during the 2000s; where an increasingly desperate social class encountered a financial sector which was no longer concerned with the quality of loans it was producing. A number of terms not previously in our vocabularies soon became familiar: credit default swaps, NINJA loans, Hyman Minksy. To cut a long story short, a path to affluence and economic security which seemed too good to be true, proved too hard to resist for millions of American home-buyers.

It turns out that sub-prime had a number of meanings. One – particular to the US – is that a borrower has a FICO credit rating below a certain level. However another conventional, and more practical, definition is provided by Leonard Seabrooke of Copenhagen Business School, as being “someone who is spending more than a third of their post-tax income on personal debt”.

The unwillingness of policy makers to address the issue of housing affordability in the UK means that this alternate definition of subprime may have ongoing relevance. Earlier this year the Telegraph reported that based on the ONS’ House Price Index, the ratio of average house price to gross average annual income was approaching 10:1 for the country as a whole, and as high as 14:1 in London. Only in Northern Ireland is the ratio below 6:1, following a post-global financial crisis price crash of much greater magnitude than the rest of the UK (IFS Green Budget 2014, 97).

Factor in tax, non-mortgage debts and the fact that interest rates are historically low, and it appears that the ‘sub-prime’ label could easily be applied to an increasing number of existing and future home owners. Projections by the Resolution Foundation found that a reasonable increase in the Bank of England’s base rate and continued slow wage growth could “leave as much as 8 per cent of the population with perilous levels of debt by the year 2018” (‘perilous’ meaning debt  repayments in excess of 50% of disposable income). Their estimate for the proportion of households paying in excess of 25% of disposable income towards debt repayments (a measure closer to Seabrooke’s definition of ‘sub-prime’) in 2007-2008 is 18%.

The National Housing Federation suggested that you would have to have an income in excess of £100,000 a year to afford a typical mortgage on a London property, and found that the proportion of first time buyers relying on financial assistance from family has more than doubled since the mid-2000s, to approximately two-thirds of the market. Unless we see a substantial change in the way the housing market is constituted, it seems likely that home ownership will be beyond the reach of an increasing proportion of families, or will come only at the cost of households taking on significant economic risks.  

All of this reflects a shift in how we as a society regard housing; what was once a social right has instead become an investment vehicle for those hoping to benefit from capital gains. The dramatic fall in the provision of social housing, from 27% of the housing stock in 1981 to 11% in 2003 (IFS Green Budget 2014, 92), can understood in the context of what Yale political scientist Jacob Hacker called ‘the great risk shift’ from a system of collective social insurance to a one where economic risk is borne by the individual. Paradoxically however, even for those lucky enough to become homeowners in the current market, their resilience against economic misfortune is diminished as mortgage payments crowd out household savings, and it becomes more difficult to build up a buffer of home equity. A higher burden of mortgage debt also means that unexpected expenses are more likely to be covered through additional personal credit. Taken as a whole the debt charity Step Change estimates problem debt costs the UK economy £8.3bn.

Given the events of recent years, the head of a major bank may not be the first person to whom one might look for sage advice; however the following comments by Phil Chronican of ANZ Australia reported in the Sydney Morning Herald may be worth pondering;

Real estate should not be regarded as speculative investment vehicle to get rich, but as ''a place to live in, sleep, eat and raise your family''.


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