Tomorrow’sCapitalism

TheMadnessof
MortgageLenders
Housingfinanceandthefinancialcrisis

ByProfessorChrisHamnett,DepartmentofGeography,
King’sCollegeLondon

May2009

www.ippr.org/tomorrowscapitalism
2 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

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3 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

Introduction:theproblem
WeareallfamiliarwiththecollapseoftheUKhousingmarketsinceitspeakinautumn
2007.Housepriceshavefallen20percentfromtheirpeak,thenumberofsalesisdown50
percent–asisthevolumeofmortgagelending–andnewhousingstartsaredownby
around70percenttoaprojected60,000in2009.Inaddition,mortgagearrearsandthe
levelofrepossessionshaverisensharply.Thehousingmarketisintrouble.
Thisisnotthefirsthousingmarketdownturnofthisnature.Sincetheearly1970sthere
havebeenseveral,mostnotablythemajorslumpofthefirsthalfofthe1990swhenprices
andturnoverfellsharplyfromtheirpeakof1988.Whatmakesthisslumpdifferentfrom
previousonesisthatithasbeenaccompaniedby,ifnotdirectlytriggeredby,thecollapseor
takeoverofdemutualisedmortgagelenderswhohadexpandedfartoorapidlyduringthe
precedingdecadebyofferingverygenerousloan-to-valueandloan-to-incomeratios,funded
byshort-termborrowingonthewholesalemoneymarkets.Whenthecreditcrisishitin
summer2007,itbecameclearthattheywereunabletorollovertheirloansandtheyhadto
turntotheGovernmentforhelp,whichledtomanybeingtakenoverorsold.Inaddition,it
hassincebecomeclearthatanumberofmutualbuildingsocietieshavegotintotroubleby
makingcommercialloansatornearthetopofthepropertymarketorbyenteringthe
marketforsub-primemortgages.
Theargumentthatthispapermakesisthatthehousingbubble,andthesubsequent
collapse,oweagreatdealtotherecklesslendingbehaviourofanumberofmortgage
lenders,particularlythedemutualisedlenderssuchasNorthernRock,theAllianceand
LeicesterandtheBradfordandBingley,whoweredrivenbyhighlyincentivisedsenior
executivesinadriveformarketshareandexpansion.Insodoing,theyabandonedmanyof
theprinciplesofsoundlendingthathadguidedthebuildingsocietiesfordecadesandfailed
tolearntheveryclearlessonsofthelate1980sandearly1990shousingmarketboomand
bust.Theearly1990sslumpgeneratedsignificantlossesformortgagelendersandled
500,000ownerstoberepossessed.
Clearly,borrowersmustalsobearsomeresponsibilityfortakingonbigmortgageswhen
marketsareboomingandpricesarehigh,butmortgagelendershaveadutytoensurethat
theloanstheymakearenotexcessiveandthattherisksoffailuretorepayareminimised.
TotalgrossmortgagelendingintheUKrosefrom£115billionin1999to£364billionin
2007:amorethanthreefoldincreaseineightyears.Thishelpedfueltheboominprices.
Thekeyquestionwhichmustbeaskedis:Aremortgagelenderscapableoflearningfrom
historyoraretheydoomedtorepeatit?Atpresent,theevidenceclearlysuggeststhelatter
whichpointstotheneedforstronggovernmentorregulatoryinterventiontosteerthem
awayfromthispath.
Theproblemsinthehomeownershipmarkethavebeenreinforcedbytheverylowlevelsof
socialhousingconstructionandtheshrinkageofthesector.Sincetheintroductionofthe
RighttoBuyin1980,andthesteadyshrinkageoffundingfornewcouncilhousing,Britain
hasbecomeapredominantlyowner-occupiedsocietywithagrowingbuy-to-letsector.While
homeownershipremainsthepreferredtenureforthegreatmajorityofhouseholds,itraises
thequestionofwhetheritissensibleorappropriateforhouseholdstobuywhenthereisa
distinctpossibilityofthemgettingintonegativeequityorlosingtheirhomesthrough
repossession.Asignificantnumberofsmallbuy-to-letinvestorshavealsolostsubstantial
sumsofmoneyhavingbeentemptedbytheprospectoflargereturnsthathavenot
materialised.Forthem,buy-to-lethasbecomebuy-to-lose.Attheendof2008,some1.2
millionbuy-to-letmortgageswereoutstanding,10percentofthetotalstock.
4 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

Thestructureofthepaperisasfollows.
•First,itsetsoutthenatureofBritain’sstronglycyclicalhousingmarketandthe
previoushistoryofboomsandbusts.
•Second,itrecapssomeofthekeyeventsinthehistoryofthesub-primemortgage
lendingproblemintheUnitedStatesandthesubsequentcreditcrisisandtheimpacts
ontheUKmortgagelenders.
•Third,itlooksattheliberalisationofmortgagelendingintheearly-mid1980swhich
setthesceneforthecurrentproblems.Itpaysparticularattentiontothelending
practicesofNorthernRockandtheBradfordandBingley.(SeealsotheAppendix,
wihcdescribestheriseandfallofNorthernRock).
•Lastly,itsetsoutwhatneedstobedoneintermsofgovernmentpolicytoensure
thattheproblemsdonotoccurathirdtime.

TheUK’scyclicalhomeownershipmarket
Thedownturninthehousingmarketwhichbeganinautumn2007wasnotasurprise.The
marketwasgrosslyovervaluedandpriceshadtofalltorestoresomesemblanceof
affordability.Fromthisperspective,housepricefallsarenotadisasterbutawelcome
necessity.Housepriceshadrisensofarabovetheirlong-termtrendlinesince2000thata
correctionwasnecessary,ashadpreviouslyoccurredinthemid1970s,theearly1980sand
mostdramaticallyfrom1989to1995(Hamnett1999).
Takingalong-termview,housepricesandthehousingmarkethavebeenhighlycyclical
sincethestartofthe1970swhenthefirstwaveofbabyboomershitthehousingmarket.
Wehavehadfourmajorbooms(1970–73,1978–79,1985–89,2000–07)andfour
corrections,orperiodsofsloworfallingpricesandlowsalevolumes,ofwhichthelasttwo
havebeenbyfarthemostsevere.Thefirstdownturninthemid1970s(1974–77)waspartly
concealedbytheveryhighlevelsofinflationwhichmeantthatwhilerealhousepricesfell
sharply,nominalhousepricesremainedstatic.
ThefirstboomendedwhenChancelloroftheExchequerAnthonyBarberraisedthebank
rateto11percentinlate1973tochokeofftheboominconsumerspendingandmoney
supply.Thishappenedagaininautumn1989whenChancellorNigelLawsonattemptedto
chokeofftheboom.Eachtime,thehomeownershipmarketslowedrapidly.
Thedownturnswereallrelativelyshort-liveduntilthehousingslumpof1989to1995,which
sawsalesvolumesfallfromapeakofjustover2millionayearin1988to1.6millionin1989
andalowof1millionin1993.Negativeequityreachedsome2millionhouseholds,and
around500,000householdssawtheirhomesrepossessedduringthe1990s.Thissawsome
commentatorssuggestingthatthehousingmarketinBritainwouldneverrecover.But,aswe
know,themarketbegantopickupfrom1994onwardsandfrom1995tomid-2007national
averagehousepricesrosebyabout230percentfrom£60,000to£200,000.By2007house
price-incomeratioshadevenexceededtheirlevelsinthelate1980sandaffordabilityhad
becomeamajorproblemonceagain(Wilcox2006).
Sincetheearly1970sthepatternisoneofrecurrentboomandbust,withacycleofabout
seventoeightyearsonaverage.Atthepeakofeachboomtheaveragehouseprice-income
ratiohasrisensharplytoapeakofover4.3inthelate1980sand5.8in2007.The
proportionoffirst-timebuyersgenerallyalsofallssharply–from55percentintheearly
1990stoalowof30percentin2003asaffordabilityproblemsbite.Thecyclicalmovement
ofrealhousepricescomparedtothelong-termtrendofabout3percentayearisshownin
Figure1below.
5 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

Figure1.Real
houseprices, Base : 2009 Q1 Trend Real House Price
1975–2008 £210,000
Trend from 1975 Q1 to present
Source:Nationwide £190,000 Trend = c2.9% per annum
BuildingSociety £170,000

£150,000

£130,000

£110,000

£90,000

£70,000

£50,000

£30,000
1975 Q1

1977 Q1

1979 Q1

1981 Q1

1983 Q1

1985 Q1

1987 Q1

1989 Q1

1991 Q1

1993 Q1

1995 Q1

1997 Q1

1999 Q1

2001 Q1

2003 Q1

2005 Q1

2007 Q1

2009 Q1
Theforgottenlessonsofthe1990sboomandbust
Thecurrenthousingmarketslumpandtheproblemsfacingmortgagelendersfromthe
riseinmortgagearrearsandrepossessionsarenotunique.Between1990and1993the
fivelargestmortgagelenders,theHalifax,Nationwide,Woolwich,andLeedsBuilding
SocietiesandtheAbbeyNational,experiencedadramaticworseningofprovisionsforbad
debtsandwrite-offs.In1990theircombinedprovisionsforbaddebtsonresidential
propertytotalled£164millionbutby1993thishadrisento£1,278million.Taking1992
and1993togethertheirjointprovisionstotalled£2.38billionandtheirwrite-offsjust
over£1billion.Theirprofitsfellbymuchless,largelybecausetheywereabletooffset
thelossesagainstmortgageindemnitypolicieswhichgaveprotectiontolendersforthe
first25percentoflossesarisingfromloandefaultsandrepossessions.Thecostofthe
lossestotheinsurancecompaniesrosefrom£48millionin1990to£1.37billionin1991
(Stephens1996).
Governmentintervenedtotemporarilyraisethethresholdforstampdutyfrom£30,000to
£250,000foreightmonthsin1992andin1993itdoubledthethreshold.Wesawsimilar
changestostampdutythresholdsin2008inanefforttoreducetransactioncostsand
stimulatethemarket.
So,whatmakesthecurrenthousingmarketslumpsodifferent?Theanswerissimple:the
shortageofhousingfinanceandthenearcollapseoftheprivatehousebuildingmarket
asaresultofthedryingupofpurchases.NationalHouseBuildingCouncilfigures
suggestthatthelevelofnewhousingstartsinthethreemonthstotheendofFebruary
2009wassome15,000,60percentbelowtheequivalentlevelayearpreviously,and
privatesectorstartswererunningatjust8,000,down72percentontheyearpreviously.
Whilethehousingmarketwasclearlyover-valued,thetriggerforthecollapsewasnota
riseininterestratesaspreviously,butthecreditcrunch,therunonNorthernRockin
September2007andtheproblemfacedbymortgagelenderswhoweredependenton
wholesalefundingtofinancetheiroperations.Mortgagefundingeffectivelydriedup.
6 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

Sub-primemortgagesandtheemergenceofthecreditcrisis
Thecurrentglobalfinancialcrisishasitsoriginsinthelong-termexpansionoflendingand
indebtednesswhichgoesbackroughlyadecade(BankofEngland2008).Thesub-prime
lendingmarket–givingmortgagestopeoplewithpoorcreditratingsand/orlowincomes–
begantotakeoffintheUSin1997–8whenitrosefromalmostzeroto10percentofthe
mortgagemarket.Itgrewrapidlyandby2006accountedforjustover20percentofthe
totalmarketandalmost$700billionayear.Manymortgagesweresoldbybrokers(whohad
nointerestinthemortgagee’sabilitytorepay)onlowinitialratesofinterestoradjustable
ratemortgages(ARMs).Wheninterestratesrose,bothdefaultandrepossessionrates
soared,reachingonemillionin2008.
Unlikethetraditionalmodelofmortgagelendingwherethelendersretainedtheloanson
theirbooks,thenewmodelof‘originateanddistribute’meantthatmanylendersparcelled
uptheirloansintheformofmortgagebondswhichwerethenresoldworldwide.This
amountedtoanastonishing$7trillionin2007,ofwhichapproximately$4trillionwas
governmentbacked–guaranteedbyFannieMaeorFreddieMac,bothofwhicharenowin
majordifficulties(BBCOnline2007a).
Inretrospect,thefirstsignofthecomingcrisiswasthenewsfromHSBCinDecember2006
thatitsUSoperation,HouseholdInternational,whichithadacquiredin2003togetintothe
profitablesub-primemortgagebusiness,wasindifficultiesbecauseofthelossesithad
incurredinitsbusinessofsecondmortgagestosub-primeborrowers.Asecondsignalin
March2007wastheannouncementfromNewCenturyFinancial,theUS’ssecondbiggest
sub-primelender,thatitwasfacingacriminalinvestigationofpracticesanditsauditor
KPMGsaidithaddoubtsaboutitsabilitytocontinueasagoingconcern.
ThethirdsignalwastheannouncementbyBankParibas,France’slargestbank,inAugust
2007thatitwassuspendingthreeofitsfundsasproblemsintheUSsub-primemortgage
sectorpreventeditvaluingthem.Itstated:‘Thecompleteevaporationofliquidityincertain
marketsegmentsoftheUSsecuritisationmarkethasmadeitimpossibletovaluecertain
assetsfairlyregardlessoftheirqualityorcreditrating’(BBCOnline2007b).InSeptember
2007HSBCannouncedthatitwasclosingitsUSbusiness‘DecisionOneMortgage’,which
packagedupmortgagessoldbybrokersandsoldthemtoinvestors.
BythistimewewereawareofproblemsintheUSsub-primemortgagebusinesswhichhad
grownrapidlyinprecedingyearsbybrokersofferingmortgagestoborrowerswithpoor,or
non-existent,creditratingswhichweresubsequentlypackagedup,slicedanddicedandsold
ontoinvestorsworldwideintheformofcredit.Whenitbecameclearthatmanyofthese
mortgageswereunlikelytoeverberepaidandweresufferinghighratesofdefaultand
foreclosure,themarketfortherepackagedCollateralisedMortgagebackedObligations
(CMOs)andCollateralisedDebtObligations(CDOs)begantoimplodeasbuyersofsuch
instrumentsrealisedthattheywereunlikelytogettheirmoneybackandwereunableto
resellthem.Theinstitutionsthathadpreviouslybeenwillingtorefinancesuchshort-term
debtthroughthe‘repo’marketrefusedtodosoandthecreditcrunchbegantobite,
reinforcedbythegrowingriskofcounterpartydefault.
Aswenowknow,mostoftheseCMOsandCDOswereinsuredagainsttheriskofdefaultby
lenderstakingoutCreditDefaultSwap(CDS)insurancethroughasmallnumberofmajor
insurers,suchastheAmericanInsuranceGroup,forasmallpremium.But,asthedefaults
increased,itbecameclearthattheamountsowingonCDSweresolargethattheinsurers
werepotentiallyunabletopayout.Atthisstage,internationalwholesalemoneymarkets
begantodryuprapidlyaslendersbecamefearfuloflendingtooneanotherasthescaleof
theirexposuretotoxicdebtwasunclear.
7 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

ThecreditcrunchhitstheUK:thecrisisofthedemutualisedmortgage
lenders
InBritain,inSeptember2007,reportsthattheNorthernRockwasseekingemergency
fundingfromtheBankofEnglandsawarunonthebankwhichculminatedinChancellor
AlistairDarlingannouncingthattheGovernmentwouldguaranteealldepositswithNorthern
Rock.TheGovernmentattempted,withoutsuccess,toengineerarescueforNorthernRock
andinFebruary2008itannouncedthatitwasnationalisingthecompany.
WhatsubsequentlybecameclearwasthatNorthernRock,alongwithanumberofother
demutualisedlenders,hadexpandedrapidlyintomoremarginalformsofmortgagelending,
financingthewholeedificebyborrowingonthewholesalemoneymarketratherthan
financinglendingfromretaildeposits.Thesewholesaleborrowingswerefinancedbyshort-
termloanrollovers,andwhenthecreditcrunchbegantohitinautumn2007lenderssuchas
NorthernRockfoundthemselvesinanimpossiblefinancialsituation:theyhadlentlongand
borrowedshortandcouldnotrefinancetheshort-termborrowingsorcouldonlydosoat
extremelyhigh(anduneconomic)ratesofinterest.
TheNorthernRocknationalisationwasfollowed,inshortorder,bythetakeoverofthe
AllianceandLeicesterinJuly2008andbyBradfordandBingleyinSeptember2008,bothby
BancoSantander.Bothhadalsoexpandedtheirbusinessbylendingtothebuy-to-letand
self-certifiedmortgagemarketandraisingfinanceonthewholesalemoneymarketswhich
theycouldnotrefinanceasdefaultsrose.AtthesametimeitwasannouncedthatLloyds
wastotakeoverthestrickenHBOS,whichhadgotintotroublewithitslargetoxicassetand
commercialloanbook.
Whatisclear,inretrospect,isthatallthedemutualisedandprivatisedmortgagelendershad
expandedrapidlyintomoreriskyareasofthemortgagemarketsinordertoexpandandgain
marketshareandhadfinancedthisbywholesalemoneymarketborrowing.Inanumberof
cases,theyevenacquiredpackagesofmortgageloansfromUSfinancehouses.Thiswasthe
casewithBradfordandBingleywho,inadditiontofinancing20percentofallbuy-to-let
mortgagesinBritain,alsoenteredintoagreementswiththeUS-basedGMACandUK-based
KensingtonGrouptopurchaseportfoliosofmortgageloans.Itundertookin2006tobuyup
to£4billionayearofGMACloansbutin2008itcutthisbacktoaminimumagreed£1.4
billionayear.Thecompanystatedinitsinterimreportin2007that:
‘WehaveagreedwithKensingtontovarytheForwardSaleAgreement
originallysignedinApril2007.Undertheoriginalagreement,12portfolios
havebeenacquiredwithanaggregatevalueof£850mandtherewasa
commitmenttopurchaseafurther£1,150mofmortgagesbyMarch2009.
Undertherevisedagreement,Bradford&Bingleywillacquireamaximum
aggregatevalueof£1,282mbyApril2011.Thecontracthastherebybeen
extendedby25monthsandthevalueincreasedby£132m.’
Thereportalsonotedthatmortgagesthreemonthsormoreinarrearsintheorganic
mortgagebookroseto1.78percentwhilearrearsinitsacquiredmortgagebookincreased
to5.11percent:somethreetimeshigherthanitsorganicmortgages.Itsexpansioninto
marginalmortgagelendingwasextremelyill-judged.

Theriseofbuy-to-letmortgages
Thebuy-to-letmortgagemarkettookoffinthelate1990sasaresultoftwointerrelated
setsofchanges:thefirstwastheemergenceofassuredandshort-holdtenancies,which
encouragedlandlordstore-entertheresidentialmarketintheknowledgethattheycould
regainvacantpossessionoftheirpropertyattheendofthelease,andthesecondwasthe
8 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

growingwillingnessofmortgagelenderstolendforbuy-to-let.Thismarketexpandedvery
rapidly.CouncilforMortgageLendersfiguresshowanincreasefromjust29,000mortgages
outstandingattheendof2008(0.3percentofthetotal)to1,156,000mortgagesatthe
endof2008:totalling10.6percentoftotalgrossadvancesandworth£138billion.
Thebuy-to-letmarkethasbeenhitparticularlyhardbythehousingslump,primarilybecause
manynoviceinvestorswereseducedintobuyingnewlybuiltcitycentreflatsatinflatedprices
withpromisesofguaranteedlettingreturns.Inmanycases,thesereturnshavenot
materialised,vacancyratesarehighandthepriceofflatsinsomeNortherncitieshasfallen
by50percentormore.Evidencehascometolightofflatsbeingvaluedatinflatedprices
andoffraudulentpracticesinthebuy-to-letmarket.Notsurprisingly,thelevelsofmortgage
arrearsandrepossessionshavebothincreasedrapidlyacrosstheboardandcontributedto
theproblemsofBradfordandBingleyandsomeotherlenders.(SeeAppendixforan
overviewofwhathappenedtoNorthernRock.)
Theproblemswerenotsolelyconfinedtothedemutualisedlenders.September2008saw
thedistresstakeoversbytheNationwideoftheDerbyshireandCheshireBuildingSocieties
andthemuchlargertakeoveroftheDunfermlineBSinMarch2009,fundedbyapaymentof
£1.6billionfromtheTreasury.InthecaseoftheDerbyshire,thetroublewascausedbylosses
onitsportfolioofsub-primemortgagespurchasedfromGMACandKensingtonGroup.These
amountedto£1.4billion–morethanaquarterofitsmortgagebook–andtheproportion
morethanthreemonthsinarrearswasrunningat9percent.TheCheshireBSwasfacing
lossesonloansbyitscommerciallendingdivisionwhichofferedsecuredloanstocommercial
borrowersandRegisteredSocialLandlords(RSLs).InthecaseoftheDunfermline,itinvolved
whatcanonlybedescribedasrecklessandirresponsiblelendingatthetopofthemarket.Its
propertyinvestmentsinclude£650millionincommercialpropertyand£274millionin‘self-
certified’andbuy-to-letmortgagesinEnglandboughtfromtheUSbrokersGMAC,the
strugglingfinancearmofGeneralMotorsandaLehmanBrotherssubsidiarybeforethecredit
crunchandglobalmarketinthosedebtscollapsed.

Theliberalisationofmortgagelendinginthe1980s
Ifwecomparewhathashappenedtothetraditionalmodelofbuildingsocietylending,we
canseethemagnitudeofthechange.Thebuildingsocietieshadtheiroriginsinthelocally
basedmutualsocietiessetupinthenineteenthcentury.Althoughtherewasaslowprocess
ofamalgamationintosomelargenationalsocietiessuchasNationwide,theWoolwich,the
AbbeyNational,Halifax,andCheltenhamandGloucester,theyretainedtheirmutualstatusin
thattheywereownedbytheirshareholdersandprofitsweredistributedintheformof
annualdividends(Boddy1980).Inthepast,societieslenttoborrowersonthebasisof
conservativevaluations,loan-to-valueratiosandincomemultiplesthatrequiredclear
evidenceofincome,withtheirloansbeingfinancedfromretaildeposits.Itwasverycommon
inthe1970stoholdasavingaccountwithabuildingsocietyforatleasttwoyearsbefore
youcouldbeconsideredforamortgage.
Allthisbegantochangeinthe1980s.Thesocietieshadadominantpositioninthe
mortgagemarketbyvirtueofthecorsetonbankmortgagelendinganduntiltheelectionof
theConservativesin1979,therewasaformalMemorandumofAgreementbetween
governmentandthebuildingsocietieswherebytheygavepreferencetofirst-timebuyersand
limitedequityextraction.TheConservativegovernmentallowedthistolapseandliftedthe
corsetonbanklendingin1980.Buildingsocietiesheld80percentofmortgagebalances
outstandingin1980andprovided78percentofthevalueofloans.Thisrapidlydeclinedas
banklendingroseandmaderapidinroadsintothemortgagemarket.The1986Building
SocietiesActinturngavesocietiesthecapacitytocompeteagainstbanks.
9 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

TheBuildingSocietiesActs,1986and1997
TheBuildingSocietiesAct1986statedthat:‘Thepurposeorprincipalpurpose(ofabuilding
society)isthatofmakingloanswhicharesecuredonresidentialpropertyandarefunded
substantiallybyitsmembers.’Section6ofthe1986Actprovidedthatatleast75percentof
the‘businessassets’ofabuildingsociety(orgroup)shouldbeloansfullysecuredon
residentialproperty.Thiscouldbeeitherowner-occupiedorletandopenedthedoorto
lendingforbuy-to-letproperty.Therewasnostatutoryrestrictiononwhatcategoriesof
assetmightbeincludedintheremaining25percentof‘businessassets’,whichopenedthe
doortocommercialloanstohousebuildersanddevelopers.
The1997Actmadealargenumberofsubstantiveamendmentstothe1986Act.Itsmain
purposesaccordingtotheBuildingSocietiesAssociation,was:
‘Toremovethepreviousprescriptivepowersregimerelatingtobuilding
societiesandtoreplaceitwithapermissiveregimewithappropriatelyrevised
balancesheetlimits,thusincreasingthecommercialfreedomofsocietiesand
enhancingthescopeforincreasedcompetitionandwiderchoicefor
consumers.’(BuildingSocietiesAssociation2003)
Section7ofthe1986Actprovidedthatatleast50percentofthefundsofabuilding
society(orofthesociety’sgroup)mustberaisedintheformofsharesheldbyindividual
membersofthesociety.Thesinglefundinglimit,introducedbythe1997Act,replacedtwo
previouslimitsonfunding–the50percentlimitinrespectofnon-retailfundsanddeposits
andthe50percentlimitontheamountondepositsandloans(BuildingSocieties
Association2003).Thiseffectivelyopenedthedoortolarge-scalewholesalefunding.
The1986Actalsodealtwiththetransferofabuildingsociety’sbusinesstoacompany–
effectivelyaconversionfrommutualstatus.Thisrequiredaminimumof50percentof
borrowingsharemembersand75percentofallqualifyingshareholdingmemberstovotein
favour.Thiswasgenerallyeasilyachievedbytheofferofeithersharesoracashsumto
membersintheeventofconversion.Whatthisdidwastopavethewayforthe
demutualisationofmanyofthemajorbuildingsocietiessuchastheAbbeyNational,Alliance
andLeicester,BradfordandBingleyandtheirconversionintofinancialinstitutionsquotedon
thestockmarket(seeTable1).

Table1.Buildingsocietiestakenoverbybanks(uptoSeptember2008)Source:Whitehead2008
Bradford&Bingley Floated4Dec2000
MortgagebooknationalisedandretailsavingstransferredtoAbbey(BancoSantander)Sept2008
BirminghamMidshires TakenoverbyHalifaxApr1999
NowadivisionofBankofScotland,whichagreedinSept2008tobetakenoverbyLloydsBank
NorthernRock Floated1Oct1997
Currentlyintemporarypublicownership(seeAppendix)
Bristol&West TakenoverbyBankofIreland28Jul1997
TransferreditsbranchnetworkandsavingsbusinesstoBritanniaBuildingSocietyon21Sept2005
Woolwich Floated7Jul1997
TakenoverbyBarclaysBankinOct2000andnowexistsonlyasatradingnameofBarclays
Halifax Floated2Jun1997
MergedwithBankofScotlandtoformHBOSin2001
InSept2008LloydsBankagreedtotakeoverHBOS
Alliance&Leicester Floated21Apr1997
AcquiredbyBancoSantanderCentralHispanoinOct2008
National&Provincial TakenoverbyAbbeyNational,5Aug1996(ceasedtradingunderthisname)
Cheltenham&Gloucester TakenoverbyLloydsBank,1Aug1995andnowexistsonlyasatradingnameoftheLloydsTSBGroup
AbbeyNational Floated12Jul1989
AcquiredbyBancoSantanderCentralHispanoinNov2004
10 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

Whathappenedsubsequentlywasfiercecompetitionformarketsharebetweenthebanks
andbuildingsocieties.Thistookavarietyofforms,includinghigherloan-to-valueratios,
higherincometomortgageratios,andthemovementintomoreriskytypesofmortgages,
includingbuy-to-letandself-certifiedmortgagesorso-called‘liarsloans’.Loan-to-value
ratiosroseto95percentormoreand,inthenotoriouscaseoftheNorthernRock’s
‘Together’mortgages,to125percentofthepurchaseprice.BankofEngland(2008)data
showthatovertheperiod1998to2007theproportionofloanswithaloan-to-income(LTI)
ratioofover2.5rosefrom40percentto70percent.Moretellingly,theproportionwithan
LTIofover3.5rosefrom5percentto35percentandtheproportionwithanLTIofover4.5
fromnearzeroto8percent.Thisclearlyindicatesthatlendersweretakingonagreater
degreeofmortgageriskthanpreviously.ThearrearsanddefaultratesontheNorthernRock
‘Together’mortgagesandtheBradfordandBingley’sacquiredmortgagebooksreinforcethis
point.

Thefutureofmortgagelending:whatpolicystepsarerequired?
Itisclearinretrospectthatthedemutualisationofmanyofthemajorbuildingsocieties,and
theirincreasingrelianceonwholesalefundingtofundagreatlyexpandedloanbookhas
provednothingshortofdisastrousgiventhecreditcrunchwhichhashighlightedthe
fundamentalweaknessoflendinglongandborrowingshortonthewholesalemarkets.In
addition,therapidriseinmortgagearrearsanddefaultshasagainhighlightedthedangersof
lendingatover-generousmultiplesofhousevaluesandincomes.Whiletheexpansion
permittedmorehouseholdstoenterhomeownership,itdidsoatgreatcostbothtothose
individualswhonowfindthemselvesdeeplyindebted,withnegativeequitycurrently
estimatedat900,000households(CouncilforMortgageLenders2009)andinsomecases
facingrepossessionandalsototheTreasuryandthenationasawholewhoarenowpicking
uptherescuebill.
Broadlyspeaking,therearetwomainoptionsforthefuture.Thefirstistosimplyallow
mortgagelenderstooperatetheirownpoliciesandlendastheyseefit.Thisisbusinessas
usual.Thesecondismandatorylendingguidelinesformortgagelenderstoensurethatthe
mistakesofthepastarenotmadeathirdtime.Thescaleoftheproblemissuchthatthis
mustbethepreferredoption.Byandlargethepoliciessetoutbelowshouldnotaffectthe
operationsofresponsiblemortgagelenders.

Limitthelevelofwholesalefunding
Thereshouldbealimitonthelevelofwholesalefunding,ofnomorethan,say,20percent
ofretaildepositsforspecialistmortgagelenders.Thisislikelytorestrictlending,atleastin
theshortterm,butthecollapseofthewholesalemarkethasalreadyhadthiseffect.This
restrictioncouldnotbeeasilyappliedtothelargebankssuchasLloyds/HBOSorHSBCwho
mayutiliseinternalwholesalefunding,anditwouldbedifficult,ifnotimpossible,for
overseas-basedbanklenderssuchasBancoSantanderwhichnowcontrolsAbbeyNational,
AllianceandLeicesterandpartofBradfordandBingley,butitwasthespecialistmortgage
lenderswhowerethemostdependentonwholesalemoneymarketstoexpandtheirlending
ratherthanthecommercialbanks.

Restricttheamountslenderscanlendfornon-residentialproperty
Thereshouldberestrictionsontheamountofmoneymortgagelenderscanlendfornon-
residentialproperty.Giventhatthisisnotpartoftheircorebusiness,andgiventheproposed
limitsonwholesalefunding,itissuggestedthat,withtheexceptionofloanstoregistered
sociallandlords,mortgagelendersshouldnotlendanymoneytonon-residentialproperty
developersorforcommercialpurposes.
11 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

Limittheload-to-valueratio
Thereshouldbeamaximumloan-to-valueratioof,atmost,95percent,andpossibly90per
cent.Andlendersshouldnotofferadditionalloanstobuyers.Thismayhavethesideeffect
oflimitingthenumberofyoungfirst-timebuyerswhocanenterthemarket,butitwillmean
thattheyhavesomeequity,andthattheyandthemortgagelendersareprotectedtosome
extentagainstfallingintonegativeequity.ItisnotablethatinSwitzerlandandGermany,
bothcountriesthathavenotexperiencedhousepricebooms,themaximummortgageis
generally80percentofpropertyvalue,whichrequirespotentialbuyerstosaveforadeposit.

Limithouseprice-incomeratios
Thereshouldbealimitonhouseprice-incomeratios,possiblytofourtimessingleincome
andthreetimesjointincome,totrytoensurethatnewbuyershavetheabilitytomeet
mortgagerepaymentsintheeventofinterestratesrisingonceagain.

Reducethenumberofself-certifiedmortgages
Thereshouldbeareductioninself-certifiedmortgages,wheretheborrowersimplystates
theirincomewithnoneedfordocumentarysupport.

Restrictbuy-to-letmortgages
Mortgagesforbuy-to-letshouldberestrictedtoamaximumof75percentofindependently
assessedvalueofaproperty(notthesaleprice).

Stopofferingbulkmortgagedeals
Mortgagelendersshouldnotbeabletoofferbulkmortgagedealstothedevelopersofnew
builddevelopments.

Prohibitnewmutualtoquotedconversions
Thereshouldbeaprohibitiononanynewconversionsfrommutualstatustoquoted
companies.Demutualisationhasbeenafinancialdisasterforshareholders,bondholdersand
thetaxpayeralike.Whilethismayseemtobeshuttingthestabledoorafterthehorsehas
bolted,thereisstillvalueinlimitinganyfurtherdemutualisations.

Stopperformance-relatedbonusesandstockoptions
Thedirectorsandtopexecutivesofmortgagelendersshouldnotreceiveperformance-
relatedbonusesorstockoptionsthatarelikelytoencourageover-lending.Anybonuses
shouldbedeferredforseveralyears,andberelatedtothelevelsofarrearsandrepossessions,
notthelevelofnewbusinessgenerated.

Prohibitthebuyingofmortgageportfoliosfromotherlenders
Mortgagelendingshouldbeself-originated.Thereshouldbeaprohibitionofbuying
mortgageportfoliosfromotherlenderstoincreasethesizeofthemortgagebook.Aswe
haveseen,thisisgenerallyaguaranteeofhighdefaultlevels.

Introducebi-annualreportstotheregulator
Allmortgagelendersshouldberequiredtosubmitbi-annualreportstotheregulatorybody
onthevolume,natureandcompositionoftheirmortgages,includingdataontheloan-to-
valueandloan-to-incomeratios.Theregulatorshouldhavepowerstolimitcertaintypesof
lendingiftheyseemundulyrisky.
Theseproposalsmay,intheshortterm,limitthelevelofmortgagelending,butitcanbe
arguedthatthelevelisalreadydepressedaslenderscutbacktheirpreviousgenerous
12 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

lendingpolicies.Atpresent,goodmortgagedealsrequireadepositof25percentofthe
purchaseprice.Buttheobjectiveofgovernmentpolicyshouldnotbetoseearapidreturnto
thepreviousover-inflatedlevelofeasymortgagelending,butamovetowardsapolicyof
sustainablelending.
Thisdoesnotnecessarilymeanareturntotherestrictivemortgagemarketthatprevailed
beforethe1980s.Thecompetitionbetweenbanksandbuildingsocietiesshouldensurethat
thereareavarietyofmortgagesonoffer.Whatitdoesmean,however,isthatthereshould
benoreturntothepoliciesofthelastfewyears,wherethenameofthegamewastogrow
theshareofthemarketandoverallmortgagevolumesbyexpandingintoevermoremarginal
andriskymarketareas.Theobjectivesformortgagelendersshouldberesponsiblelending
andriskminimisation.
13 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

References
BankofEngland(2008)FinancialStabilityReport,Issue24,October
BBCOnline(2007a)‘Thedownturninfactsandfigures’,21November,availableat
http://news.bbc.co.uk/1/hi/business/7073131.stm
BBCOnline(2007b)‘ECBmovestohelpbankingsector’,9August,availableat
http://news.bbc.co.uk/1/hi/business/6938425.stm
BoddyM(1980)TheBuildingSocietiesLondon:Macmillan
BuildingSocietiesAssociation(2003)TheBuildingSocietiesAct1986:ABSAsummary,4thEdition,
availableatwww.bsa.org.uk/consumer/factsheets/100003.htm
CouncilforMortgageLenders(2009)‘Homeownerhousingequitythroughthedownturn’,CML
HousingFinance,1:1-11
HamnettC(1999)WinnersandLosers:HomeOwnershipinModernBritain Abingdon:Routledge
NationalAuditOffice(2009)HMTreasury:TheNationalizationofNorthernRock,March,London:
NAO
StephensM(1996)‘InstitutionalresponsestotheUKhousingmarketrecession’,UrbanStudies,33.2:
337-52
WhiteheadC(2008)TheNatureandRoleofBuildingSocietiesintheUKStockholm:Statens
Bostadskreditnamd,availableatwww.bkn.se/upload/rapporter/Internationellt/
UK%20Building%20Societies081219.pdf
WilcoxS(2006)Thegeographyofaffordableandunaffordablehousing:Andtheabilityofyounger
workinghouseholdstobecomehomeownersYork:JosephRowntreeFoundation
14 Tomorrow’sCapitalism|TheMadnessofMortgageLenders

Appendix:TheriseandfallofNorthernRock
TheNorthernRockBuildingSocietywasfoundedin1965asaresultofthemergeroftwo
localbuildingsocietiesintheNorthEast.Intheyearsthatfolloweditexpandedtotakeover
30localbuildingsocieties.Itdemutualisedandfloatedonthestockmarketin1997andby
2000ithadenteredtheFTSE100asoneofthetopfivemortgagelenders.Therunon
NorthernRockanditssubsequentGovernmenttakeoverarewellknown.Whatisperhaps
lesswellknownisthatits‘Together’mortgages,whichboltedontoastandard95percent
securedmortgageanadditional30percentunsecuredpersonalloanofupto£30,000,
accountedforathirdofallitscompletionsin2006.Thisalsopermittedhigherthanaverage
income-to-loanmultiplesofupto5.9timesincomeforhighearnerswithagoodcreditscore
ofover£100,000ayearandupto4.4timesincomeforbuyerswithincomesoflessthan
£25,000.
In2006thebankmovedintosub-primelendingviaadealwithLehmanBrothers,though
theunderwritingriskforthemortgagesremainedwithLehman.In2009theNationalAudit
OfficeproduceditsreportontheTreasurytakeover.Amongotherthingsthisnotedthat:
‘Toraisethefundsitneeded,NorthernRockbecamereliantonwholesale
lenderssuchasotherbanksandonselling,ratherthanretaining,the
mortgagesithadalreadyissued.InAugust2007,creditconcernsstemming
frombaddebtsintheUSmortgagemarketcausedbankstocurbtheirlending
toeachother.Asaresult,NorthernRockbegantoexperienceproblemsin
raisingshorttermfundsandrollingoverexistingloansfromwholesalelenders.
Asthemarketworsened,thecompanybecameincreasinglyconcernedthatit
wouldnotbeabletorepayitswholesaleborrowingsastheybecamedue,and
askedtheBankofEngland(theBank)forfinancialsupportinitsroleoflender
oflastresort’.
Italsocommented,damningly,ofthedefaultratesonitslendingpoliciesthat:
‘NorthernRockcontinuedtowriteTogethermortgagesofupto125percent
ofaproperty’svaluethroughouttheperiodthatitwasreceivingemergency
support,albeitatareducedvolume.BetweenSeptember2007andFebruary
2008,over£1.8billionofTogetherloanswerewritten,around30percentof
totalmortgagelending,comparedwithjustunder£5billion(26percentof
totalmortgagelending)intheprecedingeightmonthsof2007.Around£1
billionofthesenewmortgagesreflectedcommitmentsmadebythecompany
topotentialborrowerspriortoSeptember2007.At31December2008,
Togethermortgagesrepresentedaround30percentofthemortgagebookbut
about50percentofoverallarrearsand75percentofrepossessions.’
(NationalAuditOffice2009,emphasisadded)
Thedriverofallthiswastheprospectofhighersalaries,bonusesandstockoptions,rising
sharepricesandgreaterfinancialrewardsfortheseniorexecutives.