A year ago, Professor David Miles of Imperial College was asked to examine why so few long-term, fixed rate mortgages are sold in Britain compared with the US and many other EU countries, and then to establish whether there had been any market failure that had held back their development. As such, the review has turned out largely to be a waste of space.
Most of the recommendations contained in Professor Miles' final report have little to do with either of these questions. Instead, he has chosen to concentrate more on whether the existing mortgage market can be improved, and in particular on how the playing field between new and old mortgage customers might be levelled.
The bulk of what's proposed is sensible and uncontentious enough, but the presumed aim of making the market more like America and Europe seems to have been almost wholly forgotten. As regular readers will know, I've been against any substantial interference with the UK mortgage market from the outset. There's nothing which says that a market based on long-term, fixed-rate deals serves the customer any better than the British system, with its huge variety of different products.
True enough, monetary policy would be easier to manage and short term interest rates might be a little lower than they are if everyone was on long-term fixes, but what the mortgage holder gains in predictability, he loses in flexibility and choice. As Alan Greenspan, chairman of the US Federal Reserve, pointed out in a speech recently, US householders would actually have been a lot better off during the last four years of falling interest rates had they been on variable rate deals.
The truth of the matter is that the Miles report was ordered as a sop to the Prime Minister and other euro-friendly members of the cabinet after it became obvious that Britain would fail the Chancellor's five economic tests for early membership of the single currency. One of the reasons why Britain couldn't join the euro, the Chancellor implied, was because of the housing market's attachment to variable rate mortgages, which made demand much more sensitive to the ups and downs of the interest rate cycle than it is on the Continent. Make us more like them and we would be in a better position to join.
As it happens, the last thing the Government would have wanted over the past few years is for the structure of the British economy to have been more like that of the Continent. One of the reasons Britain has been able to resist the recessionary pressures afflicting large parts of the eurozone is that monetary policy has been more effective in putting money into householder's pockets, thus supporting demand, than it has on the Continent. Mortgage holders on fixed-rate deals get no better off as interest rates fall, but those on variable rates, or in a position easily to remortgage on to better deals, plainly do.
So it was always going to be hard for Professor Miles to support the profound structural change in the British mortgage market the Chancellor's brief seemed to demand of him. In the event, even the harder line conclusions of his interim report, which threatened the industry with a Competition Act inquiry, have had to be watered down. Instead, Professor Miles finds the market to be "dynamic and innovative".
However, Professor Miles was never going to allow the industry to escape entirely scott free. He's had to justify his existence somehow. This is accomplished primarily through the recommendation that mortgage lenders make their full range of products available to all borrowers. Professor Miles' main gripe with the market seems to be not that it favours short-term deals over long-term ones, but that existing mortgage borrowers (the so-called back book) are routinely fleeced to subsidise customer acquisition.
If all deals were made universally available, Professor Miles, believes, the cross subsidisation would wither away. More longer-term, fixed-rate funding would be a likely consequence of making the market work better. I'm not so sure. What it would certainly do is lead to less competition for remortgaging, and it would favour the bigger players at the expense of the small, more innovative ones.
Most mortgage lenders have already moved a fair distance in addressing the cross subsidisation problem. They've been forced to, with a growing number of customers remortgaged from standard variable rate deals to the apparently cheaper initial deals offered by the competition.
For instance, the largest mortgage lender, Halifax, has over the past three years reduced the average difference between the rates charged on the front and back books from 2.2 per centage points to 1 percentage points. The Professor Miles reforms will presumably further erode this difference until eventually there is none at all. Those lenders that are more advanced in addressing the backbook problem will fair better in Professor Miles' brave new world than the laggards. Particularly exposed would be Abbey National, with nearly a quarter of its mortgage borrowers still in relatively highly priced standard variable rate deals.
In any case, it would be naive to think the effect of the reforms will be to level rates down to the lowest common denominator. Much more likely they'll be levelled up, or simply homogenised. Whatever happens it's hard to see why borrowers in a period of very low short- term interest rates would want to take on the extra cost of long-term fixes. Professor Miles expresses the hope that if the market is made to work more effectively, people will be better able to understand the risk and cost characteristics of mortgages, enabling longer term deals to be priced in a sustainable, transparent and fair way. This in turn might remove obstacles to the efficient funding of such mortgages.
Well, maybe, but somehow I doubt it. It's hard enough even for those of us who claim some understanding of the intricacies of the yield curve to decide which mortgage deal better suits us. Many will be thrown back on the recommendation of their financial adviser or bank, and we all know where that can lead. Long-term fixes as the next big mis-selling scandal already seems to have a certain inevitability about it.
Professor Miles' report is a commendably considered and well thought out affair, but he cannot help but think he drew the short straw from the two housing reviews the Chancellor ordered. Kate Barker's report on the all too apparent failings in the supply of new housing promises to be a more explosive affair, which is presumably why it's publication has been saved for Budget day.
I wrote the other day that I'd be amazed if the Chancellor did anything with stamp duty with the general election now little more than a year away. I may have spoken too soon. My Treasury mole tells me that stamp duty changes are highly likely. If correctly handled, they could raise more money for the Chancellor without it costing him any votes.
Any general increase in stamp duty on house purchases would be highly likely further to depress the supply of housing by making people less willing to move. Perversely, then, the effect of such action might be to add further to house price inflation as well as to depress the Chancellor's total tax take from the housing market.
But if the Chancellor were significantly to increase the rate of tax at the top end of the market, say for properties valued at £1m or more, it might help to put a ceiling on prices, and because such transactions are relatively un-price sensitive, still end up raising him more money. It might also allow the Chancellor to introduce a new 2 per cent tax band lower down the pricing ladder. Housing has long been a relatively undertaxed area of the economy, which in part explains why prices keep inflating by so much. Trouble is that governments tax it more heavily at their peril. If he values his job, the Chancellor must exercise extreme care with any changes he makes.Reuse content