I am less easily shocked by the idiocy of the financial-services industry than I used to be, but the latest product from Abbey left me temporarily speechless.
The UK’s third-biggest mortgage lender has chosen now, of all times, to introduce a mortgage that allows you to borrow up to 125% of the value of your house. You get 100% of the value of the property plus a £25,000 loan, so if your prospective home was worth £100,000, you would be borrowing 125%, and if the house was worth £150,000, you would get £175,000 or 117%.
The product is unusual in many ways. First, the entire 125% is secured against the house (other firms that offer 125% mortgages tend to only have the first 95% or 100% secured) and, second, everyone in the market thinks it is completely bonkers.
House prices aren’t rising now so why encourage people to borrow 25% more? Who at Abbey thinks that starting on the path to home ownership in negative equity is okay when it is actually a horrid form of modern slavery?
If you owe more than the value of the house you live in, you can’t sell it and you can’t move: unless house prices rise very, very fast, you can’t pay off enough of your debts to buy your freedom back.
Now I know it must be tempting to try to pick up some of Northern Rock’s business – it made 19% of mortgage loans in the first half of this year and that’s now up for grabs – but why make a specific play for the worst bits of its business? The Northern Rock debacle should surely be seen as a wake-up call to the other big banks, not as an opportunity.
Lend 125% of the value of a house and you’ve made a sub-prime loan. It’s lunacy for the lender and lunacy for the borrower. Anyone in any doubt about how fast these things can go wrong need only look at America, where house prices are still falling and repossessions rising.
On the plus side, while all those who have overstretched themselves to buy houses in the past two years may be unusually optimistic, they aren’t stupid. They know their bills are going up and they are cutting back on nonessential consumption.
I spoke to a group of 30 something women last week and found to my surprise that several had fixed-rate mortgages about to come to an end. They had already upped their savings to make sure they could meet their higher bills. Others were paying down their personal debts as fast as they could. Not one held a store card of any kind and all wanted to know which of the big-name banks was safest for cash deposits (HSBC and Lloyds would be two, by the way).
This trend towards tightfistedness is showing up in the retail sales numbers. Woolworths has warned that consumer confidence has been hit and Christmas may not be as good this year as it was last. Argos and B&Q have been reporting similarly downbeat news. That may be good news for individual bank balances but it is not good news for the economy as a whole.
There is a general view that the day will soon be saved by the Bank of England, which will cut interest rates to avoid a slow-down. Then mortgage rates will fall, consumer confidence will return and the boom days will continue as usual. I don’t buy it.
For starters I am far from convinced that the monetary policy committee will cut interest rates. Grain prices have risen 10% so far this year and oil hit a new high of $82 a barrel on Wednesday. There is inflation in the system and as, rightly or wrongly, this is what Bank governor Mervyn King targets, it is hard to see how he can vote to follow the Fed and slash Bank rate.
Even if he does, it may do borrowers no good. The crunch in the inter-bank lending markets might still mean the price of credit continues to rise. Abbey aside, the demise of Northern Rock as a relevant player in the mortgage market could be taken by much of the rest of the industry as a chance to finally bump up rates and margins.
Note, too, that the other sub-prime lenders – which, like Northern Rock, borrowed in the short-term money markets then rolled it into mortgage lending – can’t do that any more. We’ve heard less about their worries because no retired teachers have deposits with them but they are in trouble. One, Victoria Mortgages, went bust a month or so ago while all its one-time competitors have been slashing how much they lend, and ratcheting up their rates, in an effort to survive.
That means that a lot of borrowers on the edge of the main-stream market are finding themselves paying variable interest rates on their loans of over 10%. That isn’t going to leave much left over for Christmas presents, is it? Poor old Woolworths.
Finally, there is the issue of trust. If people are scared about the future it doesn’t matter how much you cut interest rates, you can’t make them spend – just look at Japan.
Northern Rock may be just a sideshow in a much wider crisis but it made Britain’s consumers aware of the risks. It scared them.
I don’t see how that damage can be undone in a hurry. There has been much discussion over the past few weeks about how the credit crisis in the financial markets will be transferred to the wider economy. This is how.
Merryn Somerset Webb is a former stockbroker and now editor of Money Week. Her views are personal and investors should always seek professional advice
First published in The Sunday Times 23/9/07