Emile Woolf: Free-market mortgages: don't ignore the hazards

Lending criteria must be reined in, or consumers confronted with the consequences of their reckless borrowing, if inflation is to be rationally controlled, says Emile Woolf.

Since gaining its independence from the Treasury 10 years ago, the Bank of England's pledge to control inflation as its overriding priority has, until now, been visibly honoured and we have all benefited.

Unlike the Treasury, however, the Bank's sole weapon in fulfilling its mission is its autonomy over setting interest rates, and the present threat of rising inflation has predictably produced an interest rate increase and the possibility of more to come, intended to cool consumer demand and bring inflation under control.

With taxation in its myriad guises running at close to its highest level in 50 years as a proportion of GDP, it is not surprising that wages and prices have risen to maintain living standards and a modicum of profitability.

The last thing that business needs, particularly while the pound is strong, is the additional burden of higher interest charges.

The mistake that governments make is to categorise any rise in the prices index, irrespective of the cause, as 'inflation' - and then to apply the traditional, and painful, remedies.

The rational way to keep prices low, as was recognised in the Reagan/Thatcher 80s, is to boost the supply side of the economy with low taxes and low interest charges. Today it would take a bold, even visionary, chancellor to steer the economy away from the nasty spiral that now threatens. Given Governor King's credentials as an economist it must be frustrating for him that his remit at the Bank is so circumscribed!

Personal debt

With the level of personal borrowings, the attitude of mortgage lenders is distinctly unhelpful to the Bank of England's objectives. Tracking interest rate increases is all very well, but its effectiveness is blunted if lending criteria are not similarly reined in. Certain institutions are still prepared to offer loans of five times salary and even to set the amount of a mortgage above the value of the property it is secured on. Such is the effect of a free market in selling loans.

If borrowers are willing to mortgage themselves into oblivion and lenders are prepared to take the risk, why should anyone interfere? History has a lesson. This has all happened before. The property boom of the late 1980s was fuelled by lenders and homeowners who, by their actions, were patently free market supporters - until their debt level was no longer sustainable and underlying equity disappeared.

Instead of allowing the consequences of such cavalier practices to bite, in October 1991 the Council of Mortgage Lenders lobbied the Major government for a 'mortgage rescue plan' under which housing associations could buy houses under threat of repossession at a cost to taxpayers of some £100m.

The Labour opposition demanded a moratorium on repossessions and public funds for those whose reckless borrowing had landed them in the financial mire. People who lost their jobs could claim benefits to assist with mortgage repayments.

Should lending be regulated?

If free market laissez faire is the order of the day, people must surely be allowed to face the consequences of their folly. The (equally valid) alternative is to regulate the mortgage market by imposing strict lending criteria. What is intolerable is the middle course of providing public funds to support unthinking profligacy or to pass laws that make bankruptcy more palatable.

Last year there were 56,000 personal bankruptcies, double those in recession-hit 1992, and 88,000 individual voluntary arrangements compared with 36,000 in 1992 - hardly surprising when the Enterprise Act 2002 made it easier to write off debts and allow bankrupts to be discharged in under a year.

Although the Act's purpose was to encourage enterprise, a 2006 study by Kingston University's Centre for Insolvency Law and Policy found that only 16% of personal bankruptcies were attributable to business failure.

The vast majority arose from unbridled consumer spending binges. Surprised?

Manically competitive lending, low interest charges and plastic money conspire to blind the unwary to the immutable laws of cause and effect.

Watch and wait.

Emile Woolf is head of Kingston Smith LLP's forensic accounting services, specialising in professional negligence and valuation claims. He is also a director of the Hyperion Insurance Group. The views expressed in this article are those of the author.

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