New ways to ease the housing pain
(31 March 2009)
A Durham University housing expert is calling on the government and financial institutions to back a new, safer system of home-ownership for the UK.
With repossessions estimated to climb to levels not seen since 1991, Susan Smith, Professor of Geography and a Director of the Institute of Advanced Study at Durham University, believes the time is right for creating a public-private partnership to make effective use of ‘housing derivatives’ – instruments enabling a range of individuals institutions to share in the fortunes of the housing market, whilst home-owners can buy and sell their properties with much less risk. In a paper to be presented at the British Academy today (Tuesday 31March) Prof Smith, whose research is funded by the Economic and Social Research Council, will explain how this can be achieved. She will argue that innovative financial instruments could be used by governments, banks and other organisations to enter into a partnership with home buyers, enabling them to choose: how much of their wealth to invest into housing, how much of their home to own, and what proportion of their incomes to reserve for other things. Prof Smith says: “We are in the midst of a financial crisis rooted in the housing economy; we can either patch things up and aim for business as usual, or take this unique opportunity to create a more sustainable housing future.” Patching things up means helping those in financial stress to continue to pay their mortgages. This is generally achieved by supporting incomes and deferring regular payments in the hope of better times ahead; or by easing the transition to renting. Durham University research shows that this only tackles half the problem. British home-buyers hold most of their wealth in their home, and they depend on this as a financial buffer to tide them over income falls and to manage unanticipated life events. Falling prices show how risky it is to hold so many financial eggs in a single housing basket, vulnerable to the ups and downs of price. Prof Smith says: “The only way to protect home-owners from this kind of risk is to create a different kind of housing system in which housing services and investment returns are not so closely linked.” The instruments required to achieve this are housing derivatives; financial instruments whose values derive from the performance of an underlying asset or index. They are used for trading products as diverse as pork and silver, and – despite the moral panic inspired by the misuse of credit derivatives – they can help provide long-term stability in fluctuating markets. Using housing derivatives (based on house price indexes), home buyers could trade lower housing outlays against future gains, first time buyers could buy in stages, and owners could recoup part of their investment in times of need. Such instruments could be used to: * reduce the costs of entry to the housing market, enabling first-time buyers to take out smaller loans at a low rate of interest; * insure home equity against slumping prices; * allow people in arrears to swap future price appreciation for a lump sum to reduce their loan (and perhaps stave off repossession); Professor Smith says: “In this new system a family in financial trouble could remain in their home with less cost and less distress than at present.” * help home owners balance their investments * provide renters with an opportunity to buy into future house price appreciation if they want to. The whole housing system could be transformed, so that there is no sharp financial divide between owners and renters, and all properties involve at least some equity share. Prof Smith says: “Ninety per cent of us rented at the turn of the twentieth century; and even in 1960 only 4 in 10 households owned or were buying their home. Today we are both a nation of home owners and a market of mortgagors, with far too much debt and way too many assets anchored in a single property. “Tomorrow we could be a society of home stewards, sharing the risks and returns on housing – as well as the responsibility of maintaining the stock for futures generations – among ourselves and with other institutions.” According to Prof Smith, financial markets – whose failures have caused the current crisis – will have to help. The financial sector will have to show that they can use these instruments to design new mortgage and insurance products that effectively share the risks and spread the gains associated with participation in the housing market. And the challenge for government is to be sufficiently nimble and imaginative to regulate them effectively. Policy has to be driven by evidence; but it also needs new ideas.