Housing finance deregulation: Britain's experience

HOUSING FINANCE DEREGULATION: BRITAIN'S EXPERIENCE

Mark Stephens

1 Introduction

In the 1980s the British finance system for owner-occupied housing was extensively deregulated. Deregulation is taken to mean the removal of restrictions and privileges imposed or conferred on specific financial institutions. Restrictions may take a direct form, such as prohibition from undertaking mortgage lending; or an indirect form, such as unfavourable balance sheet treatment. Privileges are merely the converse of restrictions, although privileges can be used to control institutions. Deregulation does not mean that all regulations governing institutional behaviour are removed. (This would be an unreg- ulated system.) It does mean that regulations are largely confined to the main- tenance of minimum prudential standards.

This article aims to assess the sustainability of housing finance deregulation in the light of the British experience between 1973, when key regulatory mecha- nisms were introduced, and Britain's forced departure from the Exchange Rate Mechanism (E.R.M.) of the European Monetary System in September 1992. It also aims is to examine the policy issues which arise from the assessment of Britain's experience.

The article is divided into six further sections. The second section outlines the context of deregulation in Britain in terms of the tenure structure and tax system. The third and fourth sections chart the movement from a regulated housing finance system to a deregulated one and examine the housing market and macroeconomic impacts of deregulation. The fifth section describes the behaviour of the deregulated housing market in recession and analyses its macroeconomic impacts. The sixth section assesses the sustainability of deregulation and the nature of government intervention in the housing market. The policy issues which arise from Britain's experience are highlighted in the concluding section.

Neth. J. of Housing and the Built Environment, Vol. 8 (1993) No. 2.

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2 The context of deregulation: owner occupation in Britain

The deregulation of the housing finance system took place in the context of a large and growing owner-occupied sector (Table 1).

Table 1 Housing tenure in Great Britain, 1980-91

Year Owner- Public Private Housing occupied rented rented and association

(%) (%) other (%) (%)

1980 55.5 31.1 12.7 1981 56.6 30.3 10.8 2.2 1982 58.2 29.2 10.4 2.3 1983 59.5 28.3 9.9 2.3 1984 60.6 27.6 9.4 2.4 1985 61.6 26.9 9.0 2.5 1986 62.7 26.2 8.6 2.5 1987 63.8 25.4 8.2 2.6 1988 65.1 24.4 7.7 2.7 1989 66.6 23.3 7.4 2.8 1990 67.1 22.4 7.5 3.0 1991 67.3 22.1 7.5 3.1

Source: Department of the Environment

The reasons for the long-term growth of owner occupation in Britain can be summarized briefly. The privately rented sector was subject to varying degrees of rent control from 1915 and this once-dominant tenure declined as landlords sold property into owner occupation. Secondly, owner occupation enjoyed favourable tax treatment. Although the scope of tax subsidies has been cut back in recent years, the cost of the principal tax subsidy, mortgage interest tax relief, grew throughout the 1980s (Table 2).

Thirdly, the public rented sector shrank in the 1980s. House building for the public sector collapsed throughout the decade, falling from 41,500 starts in 1980 to just 8,400 in 1990. The modest upturn in the building programme of state-sub- sidized housing associations after 1987 should be seen in the context of the sales of public rented houses to their tenants which occurred at generous discounts from 1980. The 1.5 million public rented houses sold under the 'right to buy' scheme since 1980 represent 6.6 percent of the housing stock (more than twice the size of the housing association sector), and they account for almost 40 per cent of the increase in the stock of owner-occupied dwellings since 1980.

With government support, owner occupation has become the dominant tenure in Britain. Apart from the Labour Party's initial opposition to the right to buy scheme, both main parties have supported owner occupation as a desired tenure. In the April 1992 general election all three national political parties declared

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Table 2 The growing costs of mortgage interest tax relief (M.I.T.R.), 1980-91

Year Cost of M.I.T.R. M.I.T.R. ceiling 2 as % (s 1990-91 prices of average house prices

1980 3.56 103 1981 4.09 101 1982 3.88 98 1983 3.85 104 1984 4.18 97 1985 5.10 90 1986 6.39 79 1987 6.08 68 1988 6.08 55 1989 6.38 48 1990 7.561 45 1991 7.70' 45

t Provisional

a M.I.T.R. was available on the first s of loans until April 1983, when the limit was raised to s It has not been raised since then.

Sources: Board of the Inland Revenue; Council of Mortgage Lenders

their support for owner occupation and only the smallest of them, the Liberal Democrats, questioned its privileged tax treatment.

3 The regulated housing finance system, 1973-79

Prior to 1980, the mortgage market was dominated by the building societies, which are mutual organizations specializing in finance for house purchase. Traditionally, they were funded almost exclusively by retail savings. In the period 1973-79, the building societies' annual share of the mortgage market once fell below 70 per cent (when local authority lending was increased), averaged 83 per cent and reached 96 per cent in 1977 and 1978. This dominance was due to three regulatory privileges which prevented the commercial banks from entering the mainstream mortgage market. The banks' annual share of net lending averaged five per cent in the 1973-79 period (Merrett, 1982, Table 6.1).

The most significant regulatory barrier faced by the banks was the supple- menta ry special deposits scheme, more commonly known as the 'corset', and -~tccompanying guidelines. The scheme was reintroduced at the end of 1973 (after a brief experiment in deregulation) and reduced the banks' ability to lend, but it did not apply to the building societies. Banks whose growth of interest-bearing liabilities exceeded a limit set by the Bank of England were required to lodge deposits with the Bank. These deposits, which did not receive interest, increased

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according to the extent to which the limit was breached. The corset was subsequently activated for almost two years in 1975-76 and for 11 months in 1977-78. The Bank of England also issued guidelines for most of the 1970s which discouraged banks from making personal loans.

Secondly, the building societies occupied a privileged position in the savings market. They were allowed to pay interest to savers after tax had been deducted at a composite (or average) rate which was marginally lower than the basic rate of tax. Justified on grounds of administrative convenience, this arrangement enabled basic-rate taxpayers to pay tax on interest payments at a lower rate than they would if they held their deposits with a bank. While larger deposits were not included in this arrangement, it was possible for savers to have more than one account (Merrett, 1982).

Thirdly, the societies paid corporation tax at a lower rate than commercial organizations, including the banks. This concession, which was enjoyed by all mutual organizations, was partially offset and justified by the ability of banks to write off shareholders' dividends against tax liability (H.M. Treasury, 1984).

These regulatory barriers to the banks' entry into the mortgage market enabled the building societies to operate an interest-rate cartel through the Building Societies Association. The building societies were exempted from the extension of restrictive practices legislation to cover the service sector in 1976, so indicating the government's support for the arrangement (H.M. Treasury, 1984). Additionally, the building societies' then regulator, the Registrar of Friendly Societies, discouraged interest-rate competition.

The interest-rate cartel was operated to provide greater stability of interest rates relative to those prevailing in the money markets. This resulted in the periodic pricing of mortgages and savings at sub-market rates of interest. The sub-market pricing of mortgages was prevalent particularly in 1973-74 and 1979-80 (Table 3). Because the societies were insulated from price competition (the societies practiced non-price competition among each other), sub-market pricing sometimes resulted in mortgage 'famines' when mortgages were rationed by restrictive lending criteria and queues. Mortgage rationing was sometimes delayed by societies running down their liquidity and mitigated by the increased availability of local authority mortgages (1973-75) or by loans to building societies from the government (1975).

The government attempted to regulate building society behaviour through the Joint Advisory Committee (J.A.C.) which was established in 1973. A major purpose of the J.A.C. was to prevent sudden credit expansions, such as the one which was associated with the 1971-73 property price boom. The committee was made up of representatives of government and the building societies. Its role in economic, rather than in purely housing, objectives was underlined by the involvement of Treasury and Bank of England officials. The J.A.C. issued guidelines for building society lending (which were often breached) and attempted to keep down mortgage interest rates in support of the government's prices and incomes policy (Body and Lambert, 1988).

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Table 3 Mortgage and savings pricing, 1973-80

Year Average mortgage rate - average base rate

(basis points l)

Average savings rate - average base rate

(basis points t)

1973 26 -3 1974 -128 -109 1975 61 62 1976 -5 -31 1977 211 164 1978 51 60 1979 -174 -161 1980 -140 -155

I A basis point is one-hundredth of a percentage point

Sources: Building Societies Association; Council of Mortgage Lenders

4 The deregulation of the housing finance system, 1979-90

The deregulation of the housing finance system took place substantially between 1979 and 1988. Changing institutional behaviour impacted on the housing market which was now intimately linked with the macroeconomy.

(a) The deregulatory process Four sets of measures directly impacted on the structure of the housing finance industry.

First, the government abandoned attempts to control directly financial institutions' lending as a means of fine-tuning the housing market. The J.A.C. was suspended shortly after the election of the Conservative government in 1979 when the participants were unable to agree to a new limit for building society lending, and it was abolished in 1982. More importantly, the government abandoned the corset, by which it had controlled bank lending, in 1980. Its effectiveness was, in any case, being eroded by the abolition of exchange controls in 1979. The abolition of the corset prompted the banks to enter the mainstream mortgage market.

Secondly, the tax advantages enjoyed by the building societies over the banks were removed. The differential between the rate at which building societies paid corporation tax was allowed to diminish as the standard rate of corporation tax was cut. By 1985 the differential had disappeared. Also in 1985, the banks were allowed to join the building societies in being able to pay interest net of tax on savings.

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Thirdly, the wholesale markets were opened up to the building societies. Competition in the savings market, which began to increase in the late 1970s, caused the building societies' cartel to collapse in 1984. As savings and mortgage pricing reflected market rates more closely, the wholesale markets became a viable source for funds for mortgage credit. While retail funds would remain competitive when demand for credit was low and when interest rates were rising (because retail rates lag behind those prevailing in the money markets), wholesale funds were competitive when contrary market conditions applied. The government opened up the wholesale markets to the building societies by allowing them to pay interest gross on three funding instruments (Certificates of Deposit, time deposits and Eurobonds) in the Finance Acts of 1983, 1984 and 1985. The payment of interest gross enabled the societies to conform to the operating practice of the interbank market. The 1986 Building Societies Act, which became effective in January 1987, placed a 20 per cent limit on the proportion of funds which societies were allowed to raise from all non-retail sources. From 1988, this was raised to 40 per cent, the maximum allowable without further primary legislation. Smaller building societies, whose size prevented them from raising wholesale funds, were enabled to raise such funds indirectly through bank loans which, from 1983, ceased to affect their net liquidity. Previously, bank loans were deducted from gross liquidity.

The viability of wholesale funds and a buoyant housing market attracted a new type of institution into the housing market. Centralized lenders began to emerge from 1985. Most of them were subsidiaries of North American merchant banks and they generally relied on panels of insurance companies to originate loans. Funding was obtained solely from wholesale sources through the securitization of mortgages. These new lenders were able to expand quickly, since securitization allowed them to keep loans off their balance sheets, and wholesale funds were competitive (Bol6at, 1988). Subsequent increases in interest rates made the centralized lenders uncompetitive, and created a prepayment problem if interest rates were raised to maintain margins or losses if they were not.

Finally, the government widened the range of services which building societies were permitted to offer in the 1986 Building Societies Act. The legislation aimed to allow the societies to survive as lenders specializing in mortgage finance and mainly relying on retail funds. From 1987, the societies were allowed to widen their asset base to include, inter alia, current accounts and credit cards, insurance and estate agency services. The smaller societies have been unable to diversify significantly because of the associated costs. Only one society, the Abbey National, took advantage of the 1986 Act's provision which allowed societies to abandon their mutual status by becoming public companies. This enabled it to raise equity finance with which to fund diversification. Nine of the ten largest building societies have formed links with insurance companies which provide a valuable source of fee income through the sale of endowment and other insurance policies.

Diversification and wholesale funding have widened the competitive advantage enjoyed by larger societies over smaller ones. Consequently, the pressure for

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merger has continued. The number of societies fell from 151 in 1986 to 117 in 1990, and there are expected to be only 40 by 2000 (Council of Mortgage Lenders).

(b) Housing market impacts The housing market consequences of the deregulated housing finance system were striking. In the newly competitive environment, demand for credit was met by introducing market pricing and adjusting the terms on which credit was provided. Significantly more liberal lending criteria were adopted, with loans based on higher multiples of income and higher proportions of property value (Table 4).

Looser lending criteria are reflected in the averages for first-time buyers borrowing from building societies. In 1980 the average percentage advance was almost 74 per cent. This rose to almost 85 per cent in 1988. Similarly, average advances among first-time buyers rose from 167 per cent of incomes to 219 per cent in 1990. The general level of funds lent spiralled. In 1981, the year in which the banks entered the mainstream mortgage market and more than tripled their net mortgage lending, overall net lending increased by 50 per cent. Net lending increased by another 170 per cent before peaking in 1988.

The huge increase in mortgage lending in the 1980s, which the newly deregulated finance system facilitated, is a necessary part of the explanation for the extent of the 1986-89 house price boom. The abolition of mortgage rationing might be expected to be inflationary if monetary policy is not adjusted to take account of the previously unmet demand. This should be a once-only adjustment, although there is likely to be overshooting before a new relationship between incomes and prices emerges.

Yet the creation of a housing finance system, capable of mobilizing funds efficiently, was not the only cause of house price inflation. Other conditions, cyclical and structural, applied to the housing market.

Four cyclical factors increased housing demand in the 1980s. Demographic trends indicated an increase in the population of house-buying age. There was strong earnings growth and falling unemployment from mid-1986. Mortgage rates fell from 14 per cent in 1985 to 11 per cent in 1986, and from 11.25 per cent in 1987 to 9.5 per cent in 1988 (Council of Mortgage Lenders).

Table 4 Lending criteria for residential mortgages

Year Pre-1982 1988

Income multiples 2.5 - 2.75

Second income multiples 1.0 - 1.5

Loan to value ratio 80-85%

3.0 - 3.5 (and sometimes 4.0)

1.5 - 2.0

90-100%

Source: Milligan (1991), Table 5.5

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The British housing market also contains two distorting structural features which make it prone to inflation when cyclical factors increase housing demand. The tax system has distorted tenure choice in favour of owner occupation, while other tenures have been disadvantaged (Section 2). The size of Britain's private rented sector (the smallest in the E.C.) is particularly striking. Thus cyclical increases in demand for housing necessarily raise demand for owner-occupied housing.

Secondly, there is evidence to suggest that the supply side of the housing production process is insufficiently elastic to avoid inflation when housing demand increases. Planning policies and other restrictions on the supply of land for housing have inflated house prices by 35-40 per cent in some areas (Eve, 1992). The performance of the construction industry itself is questionable. For example, skills shortages and materials bottlenecks may result from the industry's vulnerability to fluctuating demand. Between 1988 and 1992 the construction industry shed one-fifth of its workforce (Department of Employment).

These distorting features imply that the housing market wilt remain prone to inflation, especially while a deregulated housing finance system exists which is able to mobilize funds into owner-occupied housing so efficiently. The house price inflation of 1986-89 therefore is unlikely to have been simply a one-off adjustment caused by the end to mortgage rationing.

(e) Macroeconomic impacts Rising levels of real house prices and owner occupation increase the wealth of the personal sector in the economy. Financial market liberalization also made this wealth more liquid and so allowed the phenomenon of 'equity withdrawal' to become more pronounced than hitherto. Equity withdrawal has been defined as

funds acquired from the sale of owner-occupied houses but not then used for house purchase; and funds borrowed on the security of owner-occupied house property but used for purposes other than purchase, improvement, or repair of houses (Holmans, 1991).

The argument that instability in the housing sector had adverse macroeconomic consequences is supported (although of course not proved) by the time-series data in Table 5. The coincidence of rising real house prices and net equity withdrawal with deteriorating macroeconomic performance (inflation and balance of payments) is striking. The contention is not that equity withdrawal was the sole cause of economic overheating, but that the two were causally connected.

The buoyancy given to the economy by the housing sector was demonstrated by the resilience of the economy to the stock market crash in 1987. The government's conduct of economic policy was also relevant to the deteriorating macroeconomic performance. Tax cuts in the 1988 budget added to the climate of confidence associated with rising house prices. Interest rate policy was also crucial. Interest rates were cut following the stock market crash to compensate for its feared deflationary impact. They were kept low because of the then ex-

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Table 5 Housing and macroeconomic variables, 1980-90

Year Change in Average Net equity Average house prices mortgage withdrawal inflation

(%)1 rate (s bn.) 3 rate (%)2 (%),

Balance payments

(s bn.) 5

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

16.7 14.92 -0.2 18.4 2.8 3.6 14.01 1.3 11.9 6...._66 0.3 13.30 4.6 8.5 4.6

10.___~6 11.03 5.0 4.7 3.8 7.2 11.84 6.7 4.7 2.0 9.1 13.21 7.5 6.3 3.0

11.0 11.83 13.0 3.3 0.1 15.4 11.54 13.1 4.1 -4.5 23.3 10.97 19.3 5.0 -16.2 20.8 13.65 12.0 7.9 -21.7 0.0 15.12 13.4 9.5 -17.0

Key

S o u r c e s :

l

2

3

4

5

Discontinuity in series

1980-83 Council of Mortgage Lenders, Housing Finance, Table 16, Not mix-adjusted; 1984-90 Halifax Building Society, mix-adjusted Council of Mortgage Lenders, Housing Finance, Table 26 Miles (1992), Table 5 Central Statistical Office, Economic Trends, Table 24: General Index of Retail Prices Central Statistical Office, Economic Trends, Table 27

change rate policy which was based on shadowing the D-mark and not allowing sterling to rise above DM3. Thus the macroeconomic damage of the house price boom was at least in part contingent on the general conduct of macroeconomic policy.

5 The deregulated housing market in recession, 1990-92

The government's policy response to the overheating economy was to increase interest rates very rapidly. Consequently, mortgage rates rose from 9.5 per cent in May 1988 to 15.4 per cent in February 1990. It is notable that the government was reliant on a single policy instrument. Government ideology ruled out income tax increases or restrictions on the tax relief on owner-occupied housing. Financial market deregulation had deprived the government of policy instruments with which to control bank lending directly. This left the government with the crude instrument of interest rates as the sole means of regulating the economy. With a lag, high interest rates were effective in deflating the economy.

The rapid rise in interest rates brought a sudden end to the house price boom in 1989. As was the case with the end to previous house price booms, the 1986-89 boom ended first in the South East, but for the first time nominal house

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price falls became widespread. This was of particular importance because of the intimate links between the housing market and the macroeconomy.

It was the recognition of the links between the housing market and the macroeconomy which provided a focus for government intervention in the housing market. Such pressures were increased by the behaviour of housing finance institutions in response to the recession, which had the effect of deflating the housing market still further.

(a) Mortgage arrears and possessions High interest rates and rising unemployment both contributed to a huge rise in mortgage arrears and possessions by lenders. There are three plausible reasons why the arrears and possessions problem has been much greater than before. First, borrowers dependent on higher loan-to-income ratios are more vulnerable to rising interest rates. Second, purchasers dependent on two incomes are more vulnerable to rising unemployment than those dependent on one, simply because the probability of an essential income being lost rises. Thirdly, borrowers with high loan-to-value ratios are particularly vulnerable to higher interest rates or income loss because the value of their properties is more likely to fall below the amount outstanding on the mortgage. In these circumstances, they are unable to trade down to an affordable property, even if they can find a buyer.

The upsurge in possessions clearly has a major depressing effect on the housing market and the construction industry. In 1988 fewer than 16,000 homes were possessed. In 1991 more than 75,500 homes were possessed. In 1992, possessions eased a little, with around 68,500 possessions in the year to March 1992 (Ford, 1992). However, there was a simultaneous build-up of long-term arrears in 1992 which might be expected to turn into voluntary sales when the housing market recovers, so dampening that recovery.

(b) Lending criteria and the mortgage indemnity market The growth of the mortgage indemnity insurance market in the 1980s enabled lenders to offer the very high loan-to-value ratios which became commonplace during the housing boom. Under these arrangements the large insurance companies fully protected lenders against losses on loans above 75 per cent of a property's value. Borrowers paid the fee to the insurance company and lenders gained commissions for each transaction. However, mortgage arrears, possessions and falling house prices caused the insurance companies active in the indemnity insurance market to make large losses on this business. The four largest insurance companies made losses of over s million on indemnity insurance in 1991 alone (newspaper reports).

In the summer of 1992, the four largest insurance companies acted to change the nature of indemnity insurance arrangements. Under these new arrangements, the indemnity policies are sold to the lender, rather than to the borrower, with the effect that lenders will have to pursue debtors vigorously before a payment is made. Additionally, lenders will be expected to carry 20 per cent of losses, whereas previously the insurance companies carried the entire loss. In some

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cases, insurance premia may also be increased. Although lenders now have to pay this, the cost is likely to be passed on to borrowers (Grinsted, 1992; newspaper reports).

With more expensive indemnity insurance and an increased incentive for lenders to be risk averse, the general effect of the changes to the mortgage indemnity market is likely to be a dampening effect on the first-time buyers' market, which is the key to housing market recovery.

(c) Macroeeonomic impacts The slump in the housing market has the effect of exacerbating the economic recession. This is more clearly the case in this recession than in previous ones because of the link between housing wealth and consumer expenditure provided by deregulation. As the value of housing assets falls, the potential for equity withdrawal is greatly diminished. Further, independently of equity withdrawal, lower levels of housing wealth are likely to affect the levels of expenditure by consumers indirectly (the 'feel good' factor).

The importance of the housing sector in this recession is demonstrated by its regional pattern (Table 6). Unlike its predecessors the post-1989 recession affected the southern much more than northern regions, Scotland and Northern Ireland. The South of England proved to be the most inflation-prone section of the housing market during the house price boom and it has been in the South that house prices have fallen the furthest and unemployment has risen the most. Regional unemployment rates, therefore, have shown a strong tendency to converge.

Indeed, there is a prima facie case for arguing that the rise in unemployment has been underestimated, particularly in the South. This is because of the loss of part-time jobs outside the national insurance system, which have a geographical concentration in the South. Part-time workers who do not qualify for national insurance benefits can claim means-tested benefits when unemployed, but if their spouse is still in work they are unlikely to qualify for them, and will not be recorded as being unemployed.

The uneven rise in unemployment partly reflects the much greater import- ante of the housing sector and the value of housing assets to the economy of the South of England than in the northern regions, Scotland and Northern Ireland. In 1989, owner occupation stood at 74 per cent in the South East outside London, compared with 49 per cent in Scotland. In 1987, the value of the housing stock in Scotland was equivalent to 159 per cent of its gross domestic product (G.D.P.). In London and the rest of the South East the value of the housing stock was equivalent to more than 300 per cent of the region's G.D.P. (Central Statistical Office, 1991, Tables 5.2 and 12.1). The macroeconomic effects of volatility in the housing market are therefore felt more strongly in the South East.

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T a b l e 6 Reg iona l t r ends in house pr ices and u n e m p l o y m e n t (in %), 1990-92

United Kingdom South East Greater London East Anglia excluding including

Gtr. Gtr. London London

Change Change Change Change in house Unem- in house Unem- in house Unem- in house Unem-

prices ployment prices ployment prices ployment prices ployment

1990 0.0 5.8 -8.1 4.0 -5.8 5.0 -11.6 3.7 1~1 -1.2 8.1 -6.1 6.9 -5.8 8.2 -5.0 5.8 1992(H1) -5.7 9.5 -8.8 9.1 -10.6 10.4 -7.9 7~

South West West Midlands East Midlands Yorkshire & Humberside



1990 -8.6 4.4 -1.1 6.0 -3.6 5.1 6.6 6.8 1~1 -5.1 7.1 1.0 8.6 -Z8 7.2 12 8.7 1~2(H1) -8.5 8.7 -5.6 10.4 -6.2 8.6 -3.3 9.5

North West North Wales Scotland



1990 12.6 7.7 13.6 8.9 1.9 6.6 10.4 8.0 1991 3.9 9.4 2.8 10.4 -1.1 8.7 5.9 8.7 1992 (H1) -3.1 10.3 -0.4 10.9 -3.9 9.3 0.5 9.2

Northern Ireland

Change in house Unem-

prices ployment

1990 1.1 13.3 1991 11.2 13.7 1992 (H1) -1.1 14.3

Sources: Halifax Building Society, house prices are mix-adjusted; Department of Employment, Employment Gazette, Tables 2.1 and 2.3; Figures for 1990 and 1991 are annual averages, 1992 figures are for June

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6 Threats to deregulation or threats to/a/ssez-fa/re?

Britain's deregulated housing finance system has been associated with an overheating economy in the 1980s and with recession in the 1990s. It is not surprising that there was little pressure to reverse deregulation when both institutions and individuals appeared to be benefiting from it. Nor is it surprising that in recession there was significant pressure for government intervention in the housing market.

The nature of intervention has been of three kinds. First, the government has acted as a coordinator with lenders in order to persuade them to take collective action to revive the housing market (the 'December package'). Secondly, the government also used moderate fiscal measures intended to stimulate the market, but resisted pressure for even greater market intervention which would have marked an end to any pretence of a laissez-faire policy. Thirdly, the government was prepared to give a degree of protection to the housing finance circuit by itself withdrawing from the retail savings market. However, there was no pressure for financial market reregulation to be considered because this option is most obviously applicable to boom conditions. The pressures for government intervention in the housing market are detailed below.

(a) Political pressure and the 'December package' Pressures for government intervention were firstly political. As arrears and possessions soared in 1991, the government came under pressure from opposition parties and its own supporters to act on behalf of its own constituency in a pre-election period. Amid media exposure of the possessions issue, the government agreed a 'package' with the main lenders in December 1991, which was intended to defuse the issue. The government, which pays mortgage interest for unemployed mortgagees, agreed to make payments direct to lenders to ensure that these payments were used as they were intended. In return, lenders agreed to desist from possessing the homes of those affected. The lenders did indeed reduce possessions, but with the result that arrears mounted in 1992. T h e government also suspended stamp duty between December 1991 and August 1992. Stamp duty is the only tax on housing transactions in Britain. It is levied at one per cent on the total value of dwellings purchased for s or more. The logic of its suspension was to act as a 'pump-priming' stimulant to the market, encouraging buyers to bring forward their purchases. It was believed that a revival in the housing market would gain its own momentum and the tax could be reintroduced.

Most hope was pinned on the lenders' agreement to construct 'mortgage rescue schemes', usually with housing associations. These schemes were intended to provide help for households threatened by possession and to limit the depressing effect on house prices caused by the flood of possessed houses onto the market.

Under these schemes homes threatened with possession would be purchased by housing associations with loans provided by the lenders at sub-market rates.

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Dwellings would then be rented to their former owners. It was intended that rental payments should be lower than previous mortgage payments and that, as tenants, the occupiers might be entitled to means-tested housing benefit. Although the government hoped that 20,000 mortgagees might be helped in this way, these schemes proved to be legally and administratively complex, and sometimes technically misconceived as well. For example, debtors who bought their dwelling before the 1986-89 house price boom or had made significant inroads into the level of capital debt might find that the rent produced by a rescue scheme exceeded the original mortgage payments (Ford and Wilcox, 1992). In these cases, a shared ownership scheme might be appropriate, but these are even more complex than rent-only schemes. Consequently, only a handful of 'rescues' were completed in the first eight months after the 'Decem- ber package' was agreed. However, the December package did defuse the political pressure for further government action until after the government's re- election in April 1992.

(b) Institutional pressure for fiscal stimulus The failure of the December package to revive the housing market brought pressure from many lenders for government intervention to stimulate the housing market. Several institutions used the occasion of the announcement of their half- yearly results in August to call for government action. Usually these proposals concerned the more generous provision of mortgage interest tax relief (Table 7). The government, already facing a growing budget deficit resulting from the recession, resisted these calls and political pressure further to suspend stamp duty.

Table 7 Selected proposals to revive the housing market, June - August 1992

Source of proposal Proposal

National and Provincial * Raise mortgage interest tax relief ceiling. Building Society

Woolwich Building Society * Double mortgage interest tax relief ceiling to s for first year of purchase.

* Double threshold on stamp duty to s

National Westminster Bank * Double mortgage interest tax relief ceiling to s * Phase out tax relief over 10 years.

Nationwide Building Society * Continue suspension of stamp duty. * Increase housing association funding to take houses off

the market. * Introduce mortgage benefit scheme.

Abbey National Bank * Tax deductions for losses made on home purchase.

Sources: Newspaper reports

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(c) Pressure for a 'protected' housing finance circuit In a third area, competition in the retail savings market, the government has been prepared to allow privileged access to funds for housing lenders by limiting its own intervention in this market.

The recession transformed the government's budget surplus into a large budget deficit. The need to fund this deficit brought the government into direct competition with the building societies in the market for retail funds. The government raises retail funds through the post office network and by post through non-tradeable securities, known as National Savings. Typically, National Savings certificates are made available at particular rates and are withdrawn when funding targets have been met. Eligibility for National Savings products have often been restricted to particular groups, such as retired people.

In his March 1992 Budget, the Chancellor announced a new National Savings product to help meet the growing budget deficit. Unlike previous products the First Option Bond was aimed at tax payers and it soon put pressure on building societies to raise interest rates when it was launched in July. One society raised its interest rates, and others threatened to follow. Two weeks after its launch interest rates on the First Option Bond were cut. Two weeks later interest rates on most other National Savings products were cut and other products were withdrawn. While the government's retreat from the retail savings market was temporary, it was clear that it was prepared to provide a degree of insulation for the housing finance institutions, specifically to prevent mortgage rates from rising and causing prolonged recession in the housing market. As the Chancellor said in his budget speech, retail savings are 'the very foundation of the property-own- ing democracy'.

(d) Devaluation of sterling Between October 1990 and September 1992, Britain was a member of the Exchange Rate Mechanism (E.R.M.) of the European Monetary System, operating within its ~wide' bands. Although later blamed for Britain's inability to reduce interest rates kept high by Germany's funding of unification, the initial attraction of E.R.M. membership was that it bestowed sufficient credibility on the government's anti-inflationary commitment to allow it to reduce interest rates without devaluing sterling. By 1992, however, British interest rates were being kept high by post-unification German rates. A strong D-mark combined with low U.S. interest rates and an exceptionally weak dollar to weaken sterling against the D-mark. This, in turn, led to the speculative attack on sterling which forced it out of the E.R.M.

Following sterling's exit from the E.R.M., the government took the opportuni- ty to cut interest rates and allowed the currency to adjust accordingly. Monetary policy adjustments have been adopted as the way out of the recessionary maze, just as they were adopted as the way into it.

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7 Conclusion

This article has traced the process of housing finance deregulation in Britain, examining its economic consequences and the government's response to them.

The examination of the macroeconomic effects of deregulation suggested that these were dependent on a number of factors, v/z.: the speed of deregulation and the institutional response to deregulation; the size of the owner-occupied sector and its relative financial attractions; the responsiveness of the supply side of the housing market to increased demand; and government macroeconomic policies.

The government's principal response to housing market volatility has been to adjust monetary policy, rather than to resort to re-regulation. The government may yet find the need to tackle structural deficiencies in the housing system which contribute to its volatility, such as the unbalanced tenure structure and the insufficiently responsive supply side. The need to tackle these structural defects will be reinforced should Britain return to the E.R.M., or eventually participate in a monetary union, because each would greatly reduce the government's control over monetary and exchange rate policy.

Acknowledgements I should like to thank Professor Andrew Bain, Professor Gavin McCrone and the Editorial Board of H&E for comments received on earlier drafts of this article. Responsibility for remaining errors of fact or judgement remains my own.

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Housing finance deregulation: Britain's experience

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