Universal home ownership: Risks can thwart aspiration

Sometimes we are so busy watching intra-day news that it takes time for us to see the underlying trends and reasons for the bigger picture.  I thought now would be a good time to consider what has been happening with our housing markets.

The main catalyst for this work has been How The West Was Lost which was written by the eminent Dr. Dambisa Moyo.

Forgive the juxtaposition between the US and UK but I have done this since it allows the clearest examples to be made in the shortest reading time.

Governments have responsibilities to their people and in trying to exercise this they have gone to extreme lengths. The world we live in has been molded by events and wars that have fought over land and trade. Recent governments and administrations have gone to war to defend energy stability but why then, working up Maslow’s Hierarchy from food, warmth and then shelter, do governments want house prices to go up? Are governmental policies geared at increasing the cost of housing, either deliberately or not?

UK and US Governments have actively encouraged home-ownership which has led to an over-allocation (more than there would otherwise have been) of our financial resources in housing stock.

An equity or bond is a cash-flow producing asset. The cash flow arrives via dividends or coupons. The value of these assets is sometimes measured as a present value of their future cash-flows. However a house is very different. Unless it is rented out, then it produces no cash-flow although it could be thought of as mitigating a rental cash-flow. Home ownership is more of a convenience asset, and a convenience we all hope to achieve and benefit from. During the recent past, under Thatcher in the UK and under Clinton in the US, encouragement of home ownership accelerated and governments created incentives to hard work and innovation. However in order to support such a large change in public policy, governments needed prices to rise to create a virtuous circle. This creates a treadmill like effect, where prices need to keep rising and ultimately a bubble is born. New house-buyers simply can’t get on the ladder – the treadmill is just going too fast.

The risk profile for property investors can vary dramatically. For a property funded by bank debt, such as that typically exercised by a buy-to-let landlord, house price volatility is a good thing. They benefit from the capital gains of the property as well as the higher yield demandable but their downside risk is limited to the capital invested in securing the deposit and other costs. This leveraged position granted to them by banks mean that they would always choose to play a game of increased stakes and volatility.

Just as price volatility affects the landlord, so it applies to one who lives in their mortgaged property. If prices rise people feel good and would then have the option to downsize with surplus cash or they may increase their leverage and upsize. This decision is very often determined by the age of the owner.  If prices fall then the worrying case of negative equity arises. This in itself is not the problem.  The risk to the mortgage payer and the banks is that the income used to repay the mortgage is impaired. In the UK and Canada, the mortgage holder is liable for the entire mortgaged amount whereas in the US, following foreclosure, then the defaulted mortgage borrower has no further liabilities. The actual meaning of negative equity really does mean negative equity in the UK and Canada but it is far less punishing to those in the USA.

For the mortgaged home dweller, the risk of losing the family home due to repossession or foreclosure cannot be more extreme, and this risk, no matter how small, would usually be considered intolerable. Unlike the landlord or an equity owner who can walk away from their failed investment, there simply is nowhere to go to for the repossessed. More than losing what was invested, there also remains the issue and cost of sourcing alternative accommodation.

The aversion to this extreme downside risk suggests that mortgage holders should be averse to volatility even though they would stand to benefit in the case of market gains. Of course, once the home is fully paid for, this risk profile becomes that analogous to an equity owner.

Facility and ability to allow home-ownership remains commendable in its ambition but erroneous in its extent and application. Quite simply it has turned the dial too far. There is a balance of wanting to hold equity to benefit from volatility versus reducing risk by minimizing debt and hence leverage. Governments need to be clear of its objectives of minimizing homelessness by repossession and foreclosure instead of maximizing home-size. This is achieved by minimizing debt (and hence leverage). The problem with the new proposed measures (recently announced in the UK Budget) is that they encourage investments where clearly the mortgage applicants are not yet ready to take on such responsibilities. The current high price of properties is the cause of this inability to accept these terms.

A very wide range of policy tools have been invoked to this end, but the underwriting of the lending institutions (Fannie and Freddie) will seem preposterous in the future.

We have come to believe the mantra that “house prices always increase over the long term”. [Has your stock-broker ever mentioned that equities do too?] This has been reinforced over the last fifty years but this does not credit the theory but allows it to deceive us, and the most vulnerable of us, in deepest circumstance.

It seems the new discriminating plan to support home owners by co-investing with them recognizes that debt solutions are folly, but just like we have bought into a few large banks that were going cheap and needed credit these last few years, there is an uncanny resemblance that we’re taking a punt on house prices again. We quite simply have to keep them rising to make sure that our tax-payer equity stake in these properties makes money.

I aspire to owning my own house and I do wish all my readers and everyone else for that matter the privilege and “convenience” of home-ownership. However we should be splashing out only when we can afford to do so. A home has to be forever.

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