It would appear that the central planners of the Bank of England have very short or very selective memories. After adopting unprecedented easing measures during the covid crisis and after supporting the government in its efforts to flood the economy with fresh cash during that same period, the central bank has put itself in a particularly unenviable position.
With inflation soaring and living costs exploding for most consumers and taxpayers, hiking interest rates was the only way forward. However, that decision had a very important downside: it was politically untenable and the effects of it would inevitably soon become extremely unpopular, especially for borrowers. This could have a devastating effect on the housing market, which has been in bubble territory for some time already. And thus the solution was clear. Embracing a “don’t ask, don’t tell” approach to mortgages and turning a blind eye on who can actually afford them seemed to the central bank to be the most responsible way to deal with this challenge.
As the BBC reported, “mortgage borrowing rules have been eased after the Bank of England scrapped an affordability test. The “stress test” forced lenders to calculate whether potential borrowers would be able to cope if interest rates climbed by up to 3%.
Removing the test may help some potential borrowers get loans, such as the self-employed or freelance workers.”
This test, which is not longer in effect since August 1st, was first introduced in 2014, in an effort to ensure that the domino disaster of bad loans we saw in 2008 would not be repeated. Back then, banks in the US sold loans to people who could never afford to repay them, with the same “willful blindness” approach. The strategy back then was not to make money on the loans themselves, but to repackage and sell them on, which worked great until it basically caused the entire economy to implode. This time around, the risks are much greater.
For one thing, giving the legal leeway to banks to sell loans with more relaxed terms will inevitably lead to a pile up of bad debt. After 6 consecutive rate hikes, the business of lending is finally lucrative again, so it’s easy to see how banks will be more than happy to expand their costumer base, even if not all of them can really afford to pay off their debts completely.
What also strengthens the probability of this scenario is the fact that banks know they will be bailed out in the event that a 2008-style crisis repeats itself. After taxpayers footed the bill for their mistakes then and after the government clearly demonstrated just how far it is willing to go to provide artificial support to the economy during the covid crisis, with measures such as handing out checks to closed businesses and introducing a 3-month “mortgage payment holiday”, banks can today be confident that help will be once again forthcoming should they take more risks than they can actually handle.
Furthermore, scrapping the mortgage affordability test is also bound to further fuel the housing bubble. As more people are now able to take out loans, house prices are bound to keep rising. According to the Office for National Statistics (ONS), “the average home in England costs around 8.7 times the average annual disposable household income, the highest income to house price ratio since 1999.” At this point, taking into account the economic slowdown and the acute cost-of-living crisis ravaging most households, a housing market collapse appears to be inevitable. And while it might be hard to predict exactly when it will happen or what might trigger it, we can certainly already see how this recent decision by the Bank of England will ensure that its effect will be amplified.
Speaking of the cost-of-living crisis, it is very important to understand just how dire the situation is in the UK. Prices are currently rising faster than they have for 40 years and wages have failed to keep up. “More than a third of people across England, Wales and Scotland are cutting back on food and essentials in order to help with the cost of living”, according to a recent ONS survey. And as the summer comes to end, households are in for a very expensive winter, with forecasts predicting that average domestic energy bills could climb above £3,600 and with the Bank of England warning that inflation could rise above 13% later this year.
With this darkened outlook, it’s hard to see how borrowers that are already under financial pressure could prioritize paying off a mortgage they couldn’t afford in the first place over putting food on the table or heating their homes, especially as interest rates are set to keep climbing. All in all, this entirely avoidable and purely self-inflicted crisis is yet another reminder of the short-sightedness, the recklessness and the irresponsibility or politicians and central bankers.
Claudio Grass, Hünenberg See, Switzerland
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