In anxious times, there are few things more likely to induce an attack of nerves than being told that everything will be fine.
So as the pandemic roars back into high gear, with accompanying flashbacks to March 2020, take what comfort you can from the words of Bank of England governor Andrew Bailey: “I don’t think we are in a situation where there is sort of stress around the corner in terms of markets.”
Similarly, on the back of a double-digit house price boom that has pushed measures of affordability to lows not seen since before the financial crisis, the Bank’s financial stability watchdogs are confident enough to propose withdrawing one of the safeguards against excessive mortgage debt put in place in 2014.
It’s enough to bring on palpitations. These so-called macroprudential measures were introduced to keep a lid on housing market risk, by limiting to 15 per cent the chunk of a lender’s mortgage book that could be written at above 4.5 times a borrower’s income and by testing the affordability of payments at interest rates 3 percentage points above the prevailing market level.
The history of economies and the build-up in household debt is a long and unhappy one. The Bank cites research that mortgage lending is a significant factor in explaining the duration and severity of postwar recessions, with housing booms preceding two-thirds of the 46 systemic banking crises for which data is available. The UK, with its cultural and political obsession with house prices, may as well be the poster child here.
So why is the Bank proposing dropping its affordability test? Officials have a decent claim to be tidying up policy, rather than loosening it. True, the Financial Conduct Authority’s similar test is set at 100 basis points, so is considerably less stringent than the Bank’s equivalent. But the central bank says that it is the loan to income limit that has done the heavy lifting in its policy. The share of households with higher levels of mortgage debt has stayed at a relatively low level, even in the past couple of years.
Why not simplify policy when there is the chance, is the argument, rather than recalibrating a test that had got too high? The stickiness of standard variable rates, which have remained elevated even as mortgage competition has driven fixed-rate deals down, means the affordability test is about twice as tough as when it was conceived, notes the Bank of America.
The result is a faintly miraculous policy that had “minimal” impact on the way in (in the words of then-governor Mark Carney), produced the desired effect and can now apparently be withdrawn with barely a ripple. Banks were already testing borrowers at 2.5 to 3 percentage points in 2014. Mortgage debt to household income has since stayed pretty stable (though it has drifted higher recently) even as house prices relative to income have soared. Now, the Bank of England reckons just 1 per cent of renters are prevented from buying a home by its affordability test.
That isn’t the entire story. The inability to save a deposit has been the primary factor in shutting people out of the mortgage market. But the Bank estimates that 6 per cent of recent mortgagors could have borrowed more were it not for its affordability test. The Bank’s figures show a cluster of lending just below the 4.5 times income mark, despite the fact that in aggregate the system remains well below the 15 per cent limit.
Effectively, says Andrew Wishart at Capital Economics, the change opens the door for banks to give larger mortgages to those they deem creditworthy — and the Bank’s analysis assumes lenders will maintain a 5.5 times limit on loans to income as part of their own risk procedures. That could, while likely modest, give housing markets a push in places like London and the south-east where prices, valuation ratios and mortgages are all bigger.
The proposed removal of what was introduced as an almost symbolic guardrail against a runaway housing market is notable. Against the backdrop of the central bank’s slow moves to increase interest rates, elevated levels of savings and a race for space prompted by the pandemic? No reason to hyperventilate, but the timing feels at least a little odd.