Is throwing money at the mortgage market the solution?
You may have noticed over the last month many countries have past bills in their governments to inject substantial amounts of cash into their banking system. They have done this on the understanding that all the bad loans also known as toxic debt is weakening the institutions and rendering us unable to borrow money so leaving us all worse off as a result.
So the big question is will injecting this money actually get the banks lending again and if they do, will it have any effect on us, the general public. In answering this question and dealing with the issues here I can only comment on our particular situation here in the United Kingdom. Whilst it may be similar in other parts of the world I cannot comment due to the fact that I am unfamiliar as to how their market works, so what may have an effect here may not be the case anywhere else.
To most people the credit crunch is all about banks not having the money to lend. So it is fair to assume that if you give the banks the money that will solve the problem. Sorry this is not the case in fact this is actually far from the case. Banks not having the money to lend is only one aspect of the problem. Most banks are "once bitten twice shy" to coin a phrase. They have lent badly and are now paying the price, it is this issue that will be with us way beyond any bailout plan has been agreed and distributed.
One of the principal areas to focus on when assessing the reasons for our present financial crisis is the area of house prices. As everyone knows they have taken a big tumble and there would seem to be no respite in the immediate future. Lenders are now facing a situation in which they have to implement more rigorous procedures and one of the targets is that of loan to value, or LTV, which is the amount that they are willing to loan dependent on the value of the property. They were lending from 95%LTV up to a staggering 125%LTV.
While the market is buoyant most annalists will agree this type of lending is OK. Think about it if you lend on a 100,000 house 125% which results in a loan of 125,000 and the house price rises over the next three years at a rate of 10% per annum, which was not unheard of. Then your LTV in three years time would only be 93% this is alright from a lending point of view and what would be considered an acceptable risk.
However house prices are not rising by 10% per annum in fact they are falling by at least 10% and some people think that these falls will be worse. So with that in mind if you now lend to someone 85,000 on a 100,000 house in three years your loan could be as high as 118% LTV. This as I am sure you will agree unacceptable lending in this climate. This therefore clearly explains why lenders are unwilling to lend over 90% LTV and in some cases 85%.
So with regards to the money bailouts, what does this mean for our financial future? In my professional opinion I believe that there will be little overall effect, although with any luck time will prove me wrong. Although lenders are now obliged to lend in 2009 at the rates of 2007, as you will see from the first part of this article they won't be able to lend at the high LTV rates of 2007. The people who are now desperate to borrow are those coming out of rates already arranged in the past 5 years, and these borrowers are going to push the LTV to its limit because of the drop in house prices.
You also need to take into account that a lot of people in the last few years have acquired mortgages on a self certification basis. These sort of mortgages are now considered high risk for lenders and so are mostly unavailable, and even if they are available they will be at greatly reduced LTVs, so what options do these people have to chose from?
In conclusion, although the cash injections can only be welcomed as a step in the right direction, I fear that there will be little knock on effect whilst housing prices continue to plummet and lenders fail to meet the level of lending that was rife before 2008. It seems more likely that the money will be stored up for the future. This will unfortunately create a catch-22 situation where the prices continue to fall because of the low LTVs and the tight lending criteria, in turn making the lenders more nervous about lending. It seems to me that the only way out will be for someone to bite the bullet and take the risks again at lending, even taking into account the possible risks involved.
So the big question is will injecting this money actually get the banks lending again and if they do, will it have any effect on us, the general public. In answering this question and dealing with the issues here I can only comment on our particular situation here in the United Kingdom. Whilst it may be similar in other parts of the world I cannot comment due to the fact that I am unfamiliar as to how their market works, so what may have an effect here may not be the case anywhere else.
To most people the credit crunch is all about banks not having the money to lend. So it is fair to assume that if you give the banks the money that will solve the problem. Sorry this is not the case in fact this is actually far from the case. Banks not having the money to lend is only one aspect of the problem. Most banks are "once bitten twice shy" to coin a phrase. They have lent badly and are now paying the price, it is this issue that will be with us way beyond any bailout plan has been agreed and distributed.
One of the principal areas to focus on when assessing the reasons for our present financial crisis is the area of house prices. As everyone knows they have taken a big tumble and there would seem to be no respite in the immediate future. Lenders are now facing a situation in which they have to implement more rigorous procedures and one of the targets is that of loan to value, or LTV, which is the amount that they are willing to loan dependent on the value of the property. They were lending from 95%LTV up to a staggering 125%LTV.
While the market is buoyant most annalists will agree this type of lending is OK. Think about it if you lend on a 100,000 house 125% which results in a loan of 125,000 and the house price rises over the next three years at a rate of 10% per annum, which was not unheard of. Then your LTV in three years time would only be 93% this is alright from a lending point of view and what would be considered an acceptable risk.
However house prices are not rising by 10% per annum in fact they are falling by at least 10% and some people think that these falls will be worse. So with that in mind if you now lend to someone 85,000 on a 100,000 house in three years your loan could be as high as 118% LTV. This as I am sure you will agree unacceptable lending in this climate. This therefore clearly explains why lenders are unwilling to lend over 90% LTV and in some cases 85%.
So with regards to the money bailouts, what does this mean for our financial future? In my professional opinion I believe that there will be little overall effect, although with any luck time will prove me wrong. Although lenders are now obliged to lend in 2009 at the rates of 2007, as you will see from the first part of this article they won't be able to lend at the high LTV rates of 2007. The people who are now desperate to borrow are those coming out of rates already arranged in the past 5 years, and these borrowers are going to push the LTV to its limit because of the drop in house prices.
You also need to take into account that a lot of people in the last few years have acquired mortgages on a self certification basis. These sort of mortgages are now considered high risk for lenders and so are mostly unavailable, and even if they are available they will be at greatly reduced LTVs, so what options do these people have to chose from?
In conclusion, although the cash injections can only be welcomed as a step in the right direction, I fear that there will be little knock on effect whilst housing prices continue to plummet and lenders fail to meet the level of lending that was rife before 2008. It seems more likely that the money will be stored up for the future. This will unfortunately create a catch-22 situation where the prices continue to fall because of the low LTVs and the tight lending criteria, in turn making the lenders more nervous about lending. It seems to me that the only way out will be for someone to bite the bullet and take the risks again at lending, even taking into account the possible risks involved.
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