I find myself wishing I had a pound for every time Chancellor Alistair Darling blames the UK’s growing economic problems on those annoying Americans and their subprime crisis (as he did in last week’s budget).
In fact, as is becoming increasingly obvious, the US and the UK are both suffering from a painful hangover after a huge borrowing boom. If we focus on the possible differences between the British version of the property bubble and its American cousin, we can see one immediate difference – the American bubble peaked in 2005, while the British one probably topped out sometime in early 2007. On this measure the UK is in a worse situation than the US, as it is earlier into the downturn (or further from the bottom).
But another revealing difference is emerging in the way the creditors deal with lenders who have got into difficulty in the two countries.
Negative equity is an unpleasant prospect for those who have bought near the peak of the boom, but with 125% mortgages common in the UK for the last two or three years there will be many people who are already in the position of owing more than their property is worth, now that prices are heading down. This is one of the most unpleasant side-effects of the casino that our politicians and regulators allowed the property market to become. Nevertheless, forewarned is forearmed, as they say, so let’s remind ourselves of the facts regarding repossession.
In the UK, if a mortgage borrower is unable to service the loan and has to return the keys to the lender, the lender will sell the property and the borrower will be personally liable for any shortfall between the sale receipts (after costs) and the loan amount. In England the bank can pursue the debt for up to twelve years from the date of any default in payment, and the interest on the debt for up to six years; in Scotland the bank can chase payment for up to twenty years.
Worse, any acknowledgement of the debt (even by phone) by the defaulted borrower during this period can reset the clock and extend the liability even further. Thus, in the Mail on Sunday a couple of weeks ago, there was a revealing story of a man who was pursued by HBOS bank last summer for over £26,000, the legacy (principal plus interest) of an £11,300 debt from a house repossession in 1991, sixteen years earlier!
In the USA, the situation is notionally similar. As in the UK, mortgage loans are recourse loans, meaning that the borrower is personally liable for any shortfall on repossession or foreclosure. Yet in reality, as the American-based blogger Felix Salmon has pointed out, there are several reasons why American courts have been increasingly reluctant to allow lenders to pursue defaulting borrowers – from problems with the mortgage documentation (most loans are sold on to investors and standards of record-keeping during the boom became increasingly slack), to a realisation that often there is little money left to pursue.
And so in the US the phenomenon of “jingle mail” has appeared – borrowers sending their house keys back in the post to the mortgage lender and walking away from their homes. The lenders are then forced to accept the loss on any foreclosed property, which in practice means passing it on to those investors who bought bonds backed by the mortgage loans. In one sense, this is rational behaviour by the individuals concerned.
It is not costless – the result for someone walking away from their home, apart from the trauma of being uprooted, will be a credit rating that is shot to pieces – but it’s easy to see why many people will accept this outcome rather than paying off a debt that is worth substantially more than the house.
This, we can see, is a significant difference from the UK, where the mortgage lender has up to now had no difficulty enforcing a court judgement against a defaulting borrower. Whether the debt is ever repaid is another matter – there is always the option of bankruptcy, or sitting out the 12 year limitations period (or emigrating!), but UK practice clearly favours the lender at the expense of the borrower, when compared to the US.
What are the implications of this for the property market, and the financial markets in general?
First, unless the laws change, we can expect the property market downturn to be steeper, but shorter, in the US than in the UK. A mass repudiation of debt by US mortgage holders will cause all kinds of problems, crippling the market for mortgage bonds and exacerbating the credit crunch elsewhere, as lenders tighten lending standards, but it is easy to see how in a rough and ready way this might get everyone through the property slump earlier. Add to this the US authorities’ emergency interventions – repeated interest rate cuts, liquidity injections, and central bank loans to those holding mortgage bonds for which the secondary market has disappeared – and you can see that the Americans are at least at work in the emergency room with their sleeves rolled up.
In the UK, by contrast, the combination of more draconian laws on mortgage debt liability and the fact that the central bank is much more circumscribed in cutting interest rates means that the property collapse threatens to be both longer and deeper than in the US. If one also considers that on many measures the UK property bubble was bigger than the one across the Atlantic, the outlook is bleak indeed.
The government has already hobbled itself with its Northern Rock intervention policy, committing the taxpayer to enormous liabilities on a mismanaged mid-level bank that could easily have been allowed to fail. Quite how the authorities intend to repeat this act across the financial sector if and when other banks get into trouble remains to be seen.
Paul Amery is an independent financial analyst based in London, formerly a fund manager and bond trader