Homeowners in Britain are especially at risk because of a shortage of long-term loans. The sooner the Bank of England acts to fix this the better
There is a cross-party consensus that Britain as a property-owning democracy should promote home ownership. To that end, 7.5 million people hold a record £1.7tn of mortgage debt. Yet that debt is more exposed to short-term movements in interest rates than in any other advanced country – placing millions of households in danger of extreme privation when, as now, interest rates suddenly rise. It is a lack of duty of care bordering on criminal neglect.
By next December, cumulatively 4.4 million households will have been forced to refix their mortgages at steeply higher rates since Russian tanks rolled into Ukraine last February and interest rates started climbing. Then, two-year fixed-rate mortgages were available at under 3%: today they cost close to 6%. The Resolution Foundation thinktank, assuming that the two-year fix will remain above 6% until next year, estimates that mortgage holders’ annual payments will jump by £15.8bn as their two-year fixes come to an end. Given that so few households have more than £2,000 of savings, the Institute for Fiscal Studies forecasts 2.9 million mortgage holders exhausting their savings completely.
Public trust in the Bank of England and its handling of inflation and interest rate policy has unsurprisingly plummeted to new lows. Last week, its hapless governor, Andrew Bailey, accepted in giving evidence to the House of Lords that mistakes had been made. But his focus was not on institutional reform or innovation that might change the dynamics of the mortgage market, but rather the Bank’s economic model, which had obviously given wrong forecasts. The Bank, he promised, would launch an internal review.
A review? Britain is experiencing the sharpest, fastest rise in interest rates since the 1980s, with more expected – and that after 13 years of rates at 0.5% or below.
True, other economies are facing interest rate increases. But what is unique about Britain is the degree to which borrowers are left to face so much interest rate risk alone. We need more than a review. We need a top-to-bottom investigation into the structure of British finance and how it could be made to work more fairly. And the institutions of economic policymaking need a makeover too.
Neither the complacent governor nor the chancellor of the exchequer – blithely saying that a recession is worth contemplating to get inflation down – seem aware of the structure of the British mortgage market. About 95% of British mortgages are either variable, linked to every quirk in interest rates, or a mere two-year fixed rate. So the rise in rates has proportionally more of a disastrous impact on household finances than anywhere else.
Lib Dem leader Ed Davey proposes a £3bn emergency mortgage protection fund – a baby step in the right direction, but which does not get to the root of the problem. We cannot allow borrowers to face a world in which lenders either withdraw mortgages at the drop of a hat or instantly reprice them, so that overnight they become unaffordable.
Instead, Britain needs to borrow from Franklin D Roosevelt’s New Deal – and on the same scale. American mortgage rates have climbed nearly as rapidly as ours – but over 80% of them are fixed for between 15 and 30 years, insulating the vast majority of borrowers from the impact of rising short-term interest rates. Why? The US mortgage market used to be like ours – but the New Deal reshaped it. Roosevelt invented a cluster of public agencies that either directly lent to home-buyers with fixed rates for up to 30 years, or, like the FNMA (“Fannie Mae”) or the FHLMC (“Freddie Mac”), backstopped the whole system so that private mortgage providers could refinance existing mortgages or offer new ones on better terms. Thus, the US government effectively offers a mortgage guarantee and a world of risk sharing and widely available fixed-rate 10-, 20- and 30-year mortgages.
Don’t think of a £3bn mortgage protection fund. Think of new British public agencies with the capacity to refinance and guarantee up to £500bn of mortgage debt so that the new norm would be 20- or 30-year fixed-rate mortgages.
Sure, the Bank of England’s economic models were caught out. Too much economic modelling assumes that economic agents are all-knowing, markets work perfectly, and institutions such as banks and mortgage providers have no agency but just passively reflect market forces. In this batty universe, not only do you make forecasting mistakes with profound consequences, the idea that a British Fannie Mae or Freddie Mac could make a difference is plainly off limits. If there is a demand for long-term fixed-rate mortgages, the market will provide them. No need for any New Deal-type agency to make the market work better. Andrew Bailey would win more public confidence if he ventured beyond hyper-conventional thinking he considers safe.
Today’s economic conjuncture demands imagination. For another facet of the crisis is that there is no systematic co-ordination of fiscal policy – taxing, public spending and public borrowing – which is the provenance of the Treasury, with monetary policy – interest rates and public debt management – which is the provenance of the Bank of England. On top, there is the Climate Change Committee, charged with advising on how to get to net zero. Already there are £650bn of potential infrastructure plans before 2030, which should ramp up to over £1tn if we are to achieve a green transition. But there is no mechanism for seeing how those demands mesh with existing fiscal plans, the management of £2tn of national debt, the unwinding of £895bn of quantitative easing debt, and the refinancing of hundreds of billions of short-term mortgage debt. It is a toytown institutional structure armed with Ladybird economic thinking.
We need more than an internal Bank review of its economic model. We need reform of the structure of the UK mortgage market and how fiscal, monetary, infrastructure and climate change policy might be better co-ordinated and managed. We can’t continue like this: too much individual pain, too much stagflation. Roosevelt was cautious about public spending and borrowing. As a result, to get the US economy moving, he had to be institutionally creative. Labour, also fiscally cautious, will have to be similarly inventive in power. We need nothing less than a UK-style New Deal.