Mortgage finance and owner occupation in Britain and West Germany

Mortgage Finance and Owner Occupation in Britain and

West Germany

Progress in Planning. Vol. 26, pp. 185-260, 1986 Printed in Great Britain. All rights reserved.

Contents

0305-9006/86 $O.OO+.SO Copyright 0 1986 Pergamon Journals Ltd.

1. Comparative Studies of Mortgage Finance - Introduction Notes: Chapter I

2. Mortgage Finance Institutions in West Germany 2.1. The Financial Institutions 2.2. A Brief History 2.3. Forms of Housing Finance

2.3.1. Mortgage banks 2.3.2. Bausparkassen 2.3.3. Universal banks 2.3.4. Savings banks 2.3.5. Commercial banks 2.3.6. Credit co-operatives 2.3.7. Insurance companies

Notes: Chapter 2

3. Mortgage Finance Institutions in Britain 206

3.1. Introduction 206

3.2. The Decline of Private Mortgage Lenders 206

3.3. A Brief History of the Building Societies 207

3.3. I. Structure andfunctioning of building societies 208

3.4. Local Authorities 210

3.5. Insurance Companies 211

3.6. Clearing Banks 212

3.7. Savings Banks 213

Notes: Chapter 3 214

4. Mortgage Finance and Owner-Occupied Housing Provision 215

4.1. A Unijied vs a Fragmented Housing Market 215

4.2. Household Characteristics of Owner Occupiers 216

4.3. Housebuilding and Land Development 217

4.4. New Housing Output 219

4.5. House Price Injlation 220

4.6. Tax Reliefs and Subsidies 221

4.7. Recycling Housing Market Funds 222

4.8. Conclusion 223

Notes: Chapter 4 224

189 194

195 195 197 199 200 201 203 203 204 204 205 205

188 Progress in Planning

5. The Restructuring of Mortgage Finance in West Germany 5.1. Introduction 5.2. The Market for Housing Finance 5.3. The Rearrangement of Institutional Competition for Housing Finance 5.4. Institutional Restructuring in a New Phase 5.5. Problems of the Mortgage Banks 5.6. Problems of the Bausparkassen 5.7. The Competition for Funds for Mortgage Lending 5.8. Conclusion: the New Complex Web of Housing Finance

6. Restructuring Mortgage Finance in Britain 6.1. Overview of Recent Trends 6.2. Towards the Financial Supermarket - a Common Trend? 6.3. Greater Intensity of Competition 6.4. Pressures on the Building Societies 6.5. A New Regime of High Interest Rates 6.6. Effects of the Higher Interest Rate Regime 6.7. Expanding into New Areas of Business 6.8. Setting the Scene for Major Institutional Restructuring? 6.9. The Response of Government Notes: Chapter 6

7. The Impact of Mortgage Credit on Owner Occupation 7.1. Introduction 7.2. The Impact of Mortgage Institutions on Owner Occupation 7.3. The Turn of the Tide Notes: Chapter 7

225 225 225 221 230 231 232 234 235

237 237 239 241 242 244 245 245 246 247 248

249 249 250 252 255

8. Conclusions 256

Bibliography 258

CHAPTER 1

Comparative Studies of Mortgage Finance - Introduction

Changes in mortgage finance in many advanced capitalist countries are among the fastest moving and most dramatic of all current developments in housing provision. The outcome has been intensified competition. Despite the frequently held view that this competition is beneficial for housing consumers, this is far from certain. In this paper, we look at the changes that have been taking place in Britain and West Germany, and assess their links to the owner-occupied housing market and their effects on housing consumers.

Governments reacting to the changes have usually lagged behind market-led developments. The most extensive response has been in the U.S.A., where federal and state legislatures have swept away from mortgage finance much of the regulative framework which originated in the 1930s. Yet, significant changes over the past decade have occurred in Britain - where important legislative changes are now pending; and in West Germany - where the results of a substantial transformation of mortgage finance in the 1970s are now working themselves through the housing market. ’

Important differences exist between the two countries. West Germany’s mortgage institutions, for instance, provide mortgages for social rented housing as well as for

owner occupation. In Britain, on the other hand, owner occupation is the majority tenure with a unified mass market; while in West Germany, owner occupation is more limited, even after rapid growth in the 197Os, and there are only restricted second-hand housing markets and much ‘self-building’. In Britain, mortgage lending has long been dominated by the building societies; whereas in West Germany, a considerable range of specialist and non-specialist institutions is involved.

Comparative analysis can help elucidate the reasons for the differences in the two countries, and indicate what dynamics are generating the dissolution of the traditional isolation of mortgage finance from the rest of the financial system.* Comparative research helps first because it identifies more clearly how, in each country, the institutional arrangements for mortgage finance have been moulded by previous developments in housing provision, and legislative controls over those forms of provision. Second, and conversely, a comparative method can indicate how differences in housing provision influence the distinct ways in which mortgage finance is provided, and the operations of the financial institutions associated with mortgages. The differences between the two countries being considered here, therefore, enable current developments to be contrasted as well as compared. At a more general level, by

189


exploring the interconnections between mortgage finance and housing provision on a comparative basis, it is possible to identify ways in which broad changes in the capitalist economy and financial system are affecting nationally determined social relations of housing finance. We would argue that changes in mortgage finance cannot simply be ‘read off from some hypothesised transnational logic of capitalist development, but neither can they be seen as resulting solely from factors specific to each country.

But how should a comparative analysis be made? One model is provided in a recent study by Boleat (1985). The work consists of brief chapters describing housing finance arrangements in a wide range of developed and less-developed economies, with a short ‘theoretical’ introduction and a brief concluding ‘international overview’. Each chapter provides some details of the housing market of the country concerned, plus a description and an outline of some of the main developmental trends in housing finance. There is no systematic attempt to integrate the analysis of housing markets and finance, let alone to relate trends in both to broader changes. The theoretical introduction concentrates on setting out formally some presumed general requirements of any housing finance system. It refers to only one ‘contextual’ feature - inflation, and ends with a loose categorisation of types of housing finance systems and institutions.

Rather than descriptive accounts, comparative studies are needed which examine mortgage finance in the context of distinctive, nationally constituted structures of housing provision. Structures of housing provision identify agents involved in housing provision and the social relations that emerge between them (Ball 1983, 1986). The main purpose of the comparison made here, in other words, is to go beyond a static account of mortgage finance in an attempt to understand the dynamics of institutional change in mortgage markets and their close links to changes in owner occupied housing markets. Following this, we shall try to assess the impact of development in mortgage finance on the social relationships which characterise the two countries’ housing markets and hence on the position of consumers. It will, of course, be necessary to describe each country’s principal mortgage finance institutions and their development, especially the changes which have occurred in the past IO-15 years. But to understand why they have occurred, consideration must be given to other aspects of housing provision and to the savings and wider financial services markets in each country. It will also be necessary to refer to the impact of state policies.

Our aim is: (i) to outline the current institutional structures of mortgage provision in Britain and West Germany and to provide some insight into the reasons why they are changing, including their responses to the growing turbulence of their environment in the past few years; (ii) to suggest likely developments in mortgage finance over the next few years; and (iii) to assess the possible effects of current mortgage finance changes on owner-occupied housing provision and housing consumers. To achieve this, it will be necessary to consider briefly the following aspects of mortgage finance and housing provision in each country:

(1) The nature of the savings, mortgage and general financial markets. (2) The structure of owner-occupied housing provision and its relation to other

Mortgage Finance and Owner Occupation 191

forms of provision, e.g. social and private rented housing. (3) State policies with respect to housing provision, mortgage markets, financial

institutions and monetary control. (4) The dynamics of institutional change in mortgage markets. (5) The dynamics of change in owner occupied housing markets. (6) The impact of developments in mortgage finance on the social relationships

which characterise housing markets and hence on the position of housing consumers.

Chapters 2 and 3 provide initial accounts of the nature and historical development of mortgage finance institutions in West Germany and Britain, respectively. As an initial guide to the complexities of mortgage finance, Table 1 contains a summary of some of the main aspects, contrasting the British situation with the West German one. Chapters 2 and 3 only refer briefly to developments in the last lo-15 years, the period of major change referred to above, as this is dealt with later.

Chapter 4 compares the links between the housing and mortgage markets in both countries. The contrast between the unified British housing market and the fragmented West German ones is described. The difference relates to the position of owner occupation in the respective housing systems and the distinct types of agency associated with the tenure. Essentially, the comparison is between a situation (in Britain) where owner occupation is the usual housing solution for a wide range of the population, and one (in West Germany) where rental tenures still retain considerable importance, with owner occupation confined mainly to rural areas and to housing older, more affluent urban households. These characteristics are reflected in the specific arrangements for mortgage finance in each country. Chapter 4 also explores the differences between owner occupation in the two countries caused by the nature of housebuilding and land development. There follows a comparison of recent changes in housing output and house price inflation showing how they affect mortgage institutions. The chapter concludes by considering two further features which have considerable implications for these institutions: tax reliefs and other subsidies and the impact of recycled housing market funds.

Chapters 5 and 6 constitute the core sections of the report. In them we consider in detail the restructuring of mortgage finance over the past lo-15 years. The changes have not only resulted in a new pattern of institutional involvement in housing finance, but also in the emergence of restructured institutions and, in particular, the growing dominance of the universal banks, able to offer a wide range of financial services under one roof. Increasingly unstable housing markets since the mid-1970s have reinforced the trend by weakening the position of the main specialist housing finance agencies.

In Chapter 7 we conclude by discussing the implications of developments in the two countries for the social organisation of owner-occupied housing provision and for consumers. Housing finance institutions like to suggest that they simply respond to changes in the economic environment in which they operate. But, we conclude that they have a far less passive role, including an ability to influence government policies which regulate their activities. We also criticise the belief that increased competition is

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necessarily beneficial to consumers, highlighting the growth of mortgage defaults and forced sales which, in West Germany at least, are forcing financial institutions to change their lending strategies.

NOTES: CHAPTER 1

1. This report presents some of the first results of a project which is examining recent developments in mortgage finance in Britain, West Germany, Denmark, the Netherlands and the U.S.A. The assistance of the Anglo-German Foundation in supporting the part of this work reported on here is gratefully acknowledged. We should also like to thank the many people in Britain and West Germany who helped us with our enquiries.

The overall research programme is a joint effort of the three authors. In this particular part of the project, each author contributed different inputs, although the final report is a collective effort. Material on West Germany was collected via a series of interviews undertaken by Martens and Ball in summer 1984 plus extensive secondary source material researched by Martens. Harloe drafted Chapters 1 and 3: Martens drafted Chapters 2, 5 and much of 7 and Ball drafted Chapters 4, 6 and the rest of 7. Ball edited the final manuscript during the summer of 1985, in consultation with the other authors.

2. Harloe and Martens 1984 undertake a theoretical analysis of comparative housing research. As one part of housing provision, the points made there are obviously applicable to mortgage finance.

CHAPTER 2

Mortgage Finance Institutions in West Germany

2.1. THE FINANCIAL INSTITUTIONS

The West German banking system is rather different from the British one and may seem rather complex to Anglo-Saxon eyes. West German financial institutions can be distinguished in three different ways: (i) by type of ‘specialisation in financial mediation; (ii) by type of ownership structure; and (iii) by their geographical area of operation.

Concerning specialisations in financial mediation, there are three main types of lending institution, all of which are atypical for Britain. The financial system is dominated by universal banks. Their main characteristic is that they offer virtually all banking services under one roof, combining the business of deposit taking and lending with dealing in securities, including investments in other banks and non-banking firms (EAG, 1981). Universal banking is quite different from financial institutions in Britain, where traditionally “a clear separation has been enforced between various types of banking, especially between commercial and investment banking” (Francke and Hudson, 1984). Specialist financial intermediaries also exist, but only where institutional or legal barriers have prevented competition from the universal banks. The two major types of specialised lending institutions associated with housing provision are the mortgage banks and the Bausparkassen.

Mortgage banks are institutions which act as intermediaries between borrowers and investors in the spheres of real estate and local authority debt. The activities of mortgage banks are limited to long term lending. Funds are raised by issuing bonds, which are either secured by real estate or guaranteed by local authorities. Mortgage banks, in fact, dominate the bond market, as universal banks are only allowed to issue bonds up to three times their own funds: whereas mortgage banks can issue up to 25 times their own funds, and even up to 50 times, where municipal bonds are concerned.’ Bausparkassen are the second type of specialised lending institution. Often they are regarded in Britain as being like a building society, because, like building societies, they act as specialist housing finance intermediaries in the personal sector alone. Bausparkassen mainly raise funds from personal savers and invest in owner- occupied house mortgage loans. But, unlike building societies, Bausparkassen operate a closed system of low interest rate contract savings, subsidised by the state. Loans are only allocated to savers in the scheme, and the terms of the loan depend on the

195


amount saved and the length of time in the scheme. The exact conditions are fixed by contract at the beginning of the saving period. Allocation of loans and repayment periods depend on the funds available to the Bausparkassen. The closed nature of the Bausparkassen system means that households are involved in lengthy saving and waiting periods before they receive loans; the duration of which depends on the intake of new savings contracts.

Another way of distinguishing West German financial institutions is by type of ownership: public, private and co-operative finance institutions all have substantial market shares and are in fierce competition with each other. There are public and private mortgage banks, public and private Bausparkassen, and universal banks exist within all three sectors.

Private universal banks are usually denoted as commercial banks. The sector is dominated by the three largest ones; Deutsche Bank A.G., Dresdener Bank A.G. and Commerzbank A.G. In addition, there are so-called regional banks, which have traditionally confined their activities to one particular region or state, but have started recently to expand to the whole of the country. For instance, the Bayerische Hypotheken und Wechselbank and the Bayerische Vereinsbank had confined their business to Bavaria only. Commercial banks also include branches of foreign banks and private bankers, although, unlike in Britain, both are small parts of the sector.

Public universal banks are called savings banks (even though they have never solely specialised in savings). They are owned by local authorities (Stadtsparkassen) or regional councils (Kreissparkassen) and their activities are limited to the geographical areas covered by those authorities. Such regional confinements give importance to the eleven Landesbanken/Girozentralen (also publicly owned) at state level and the Deutsche Girozentrale at national level, which operate a giro system for cheque and money transfers of the savings banks. State banks and girobanks also undertake foreign exchange business and cost saving centralised services. The latter has been particularly important with the introduction of new technology. The central giro institutions have developed into large universal banks, and have become significant in international banking business (Francke and Hudson, 1984).

The last category of universal banks, the co-operative banks, have traditionally been the rural counterpart of the town-oriented savings banks, but with an ownership structure that derives from the self-help movement of agrarian and artisan producers. There are two types of co-operative banks, the ‘Volksbanken’, which originated from the self-help credit co-ops of artisans, and the ‘Raiffeisenbanken’ (named after their founder Friedrich Raiffeisen), which are credit co-ops set up in support of small farmers. The two types of co-op banks were in strong competition with each other until 1972, when they merged. Like savings banks, co-op banks are organised at three levels. Next to the local Volksbanken and Raiffeisenbanken, there are the ‘Genossenschaftliche Zentralkassen’ at regional levels and the ‘Deutsche Genossenschaftsbank’ at national level, offering similar services to the state banks and girobanks (EAG, 1981).

Lastly, West German financial institutions can be distinguished by differences in the geographical areas where they operate. As already indicated, savings banks can only do business within the locality of the government level that owns them. The same is


the case for the public Bausparkassen, which are owned by the state banks. Regional differentiations have also emerged from a division of labour in lending activities between financial institutions, as for instance, in the rural-urban division between the traditional co-op and savings bank sectors or from legal restrictions as were imposed on the so-called regional banks.

2.2. A BRIEF HISTORY

Much of the formal structure of the West German banking system developed during two historic periods: (i) the phase of rapid industrial growth associated with the dramatic expansion of cities during the second half of the 19th century, and (ii) the inter-war period, in processes linked to the social reforms implemented during the Weimar republic and the events which followed the financial crash of 1922-23.

From the mid-19th century onwards, German financial markets were dominated by universal banks. With respect to the commercial banks, both their foundation and expansion were directly linked to the industrialisation of the German economy. At the time, money markets were oriented on public investments and there was a reluctance to invest in private shares and bonds. A lack of borrowed funds inhibited the expansion of industrial capital, so industrialists themselves set up new banks. Industry and trade remained the main business of commercial banks until the late 1960s when they diversified into foreign debt and mortgage finance. Similarly, co-op banks were founded during the second half of the 19th century and expanded with the introduction of improved production techniques in agriculture. Only savings banks have an earlier date of origin. The first savings banks were founded in the second half of the 18th century. But their expansion was associated with rapid urbanisation in the 19th century. Saving banks are the only type of universal bank that has been traditionally involved in mortgage lending.

Private mortgage banks were founded from 1862 onwards2 and, like the savings banks, their growth at the time was related to the credit needed to finance rapid urbanisation (and, to a lesser extent, investment in agriculture). The outstanding debt of private mortgage banks has surpassed that of savings banks since the mid-1870s. The initial rapid expansion of mortgage banks arose from their ability to attract investors after speculative failures in railways and industries (1873), and from their ability to offer cheaper mortgage loans in place of more expensive debts (V.F.H., 1978). However, speculative failures also affected the mortgage market. The growth of mortgage banks was much slower after the real estate crisis of the 1870s. The subsequent fall in house prices and rents made investors question the way mortgage bonds had been secured. In addition, conditions offered to investors in mortgage bonds differed between mortgage banks as these were regulated by differing state laws. A unified scheme was eventually introduced with the National Mortgage Bank Act of 1900, together with regulations concerning land registration and mortgage default. Yet, while the Mortgage Bank Act may have dissolved ‘unequal’ competition between private mortgage banks (which were regulated by different states), it was in itself insufficient to secure a further expansion of mortgage banks. Constrained by high


1900 1910 1920 1930 1940 1950 1960 1970 1977

Year Source: VPH 1978

FIG. 1. Outstanding loan volume of private mortgage banks in West Germany, 1900-1977.

interest rates and inflation and later a mortgage moratorium, the business of mortgage banks stagnated from about 1910 onwards and this situation did not improve much until after the Second World War (see Fig. 1).

In the inter-war period, the significance of public sector banking increased. Public

banking expanded rapidly after the First World War with large state investments, in agriculture and (low income) housing, via public financial institutions. Saving banks, in particular, expanded and diversified into universal banking.

Reforms to the German banking system in the post-1918 years were implemented through an alliance between the land reform movement and the Social Democratic Party of the Weimar Republic. The German land reform movement, founded in the 188Os, had a very broad base amongst industrialists, tradesmen and the petit- bourgeois, based on the principle of reconciliation of classes against landowners and


speculative developers (Frank and Schubert, 1983). It argued that private mortgage banks must be abolished because of their support for land speculation, and that mortgage credit should be municipalised. Many of their demands were included in the housing reforms of the Weimar republic: via the founding of public mortgage banks (though without abolishing the private ones); by municipalising development and servicing of building land; and by making the co-operative housing movement instrumental in state housing policies (ibid.).

Generally, financial resources for housebuilding were scarce in inter-war Germany. Taxation policies affected money markets particularly and the currency revaluation of 1923 lead to a massive destruction of savings. The large housing shortage further encouraged those in need of housing to set up collective savings schemes. Within these circumstances, the first Bausparkasse was set up in 1924 (today’s Bausparkasse Wiistenrot), and more were soon to follow. Initially, most private Bausparkassen were founded as co-operative and associations, but with centralisation from the 1930s onwards, most were converted to shareholding or limited companies. Public Bausparkassen were initiated by the Association of Saving and State Banks from 1928 onwards. But, unlike their private counterparts, public Bausparkassen were meant to provide mainly second mortgages, to avoid competition with the savings banks which offered first mortgages.

Failures of Bausparkassen fuelled the debate on restricting their lending to second mortgages only. Second mortgages became important in the 1930s as deflation had lead mortgage banks to restrict their lending limits to 40% of house prices. A national regulation was implemented in 1938, which legally restricted the first mortgage to 60% of real estate valuations and the loan from Bausparkassen could top this up to maximum 80%. A division of the mortgage market between specialised housing finance institutions, with mortgage banks providing the first mortgage and Bausparkassen the second, would remain characteristic for owner-occupied housing finance in the Federal Republic of Germany after 1948.

2.3. FORMS OF HOUSING FINANCE

This section gives a further description of how financial institutions are linked to the mortgage markets, how mortgage loans are refinanced, and in which housing sectors finance institutions have traditionally invested. Concerning the latter, it should be noted that, unlike in Britain, mortgage lending in West Germany is not exclusively linked to owner occupation but includes rented housing as well. The descriptions given here relate to the mortgage business of finance institutions up to the late sixties/early seventies. Much has changed since, but that will be dealt with in Chapter 5.

Mortgage lending activities of financial institutions can be distinguished in three different ways: (i) how mortgage loans are refinanced; (ii) which sectors of the housing market are concentrated on; and (iii) whether oriented towards lending on first or second mortgages. Another distinction concerns whether institutions are specialised in housing finance, but this mainly follows the types of housing finance circuit that can

200 Progress in Pkinning

be distinguished. All three aspects will be dealt with in the descriptions of the respective financial institutions.

The distinction between first and second mortgages (i.e. between loans given up to 60% of house prices and those above) is now a fixed limit laid down in West German banking laws (Glauner n.d.). It constitutes a legal distinction between different types of mortgage loan. The first mortgage, which is actually called ‘the mortgage’ (Hypothek) in West Germany, is secured by the real estate on which the money is lent. The second mortgage, in German referred to as ‘other loans’, is not legally secured by real estate and is thus less privileged at times of default. As the ‘60% limit’ is a formal one, financial institutions are not necessarily confined to issuing either first or second mortgages. Universal banks, or even mortgage banks, can give loans up to 80% or more of house prices, but in the land registry such loans are divided into mortgage and other loans (further referred to in this paper as first and second mortgages).

2.3.1. Mortgage Bank?

Housing loans issued by mortgage banks are refinanced by long term fixed interest mortgage bonds issued on the money market. The volume and terms of mortgage bonds have to correspond with loans for similar amounts and repayment terms. Thus mortgage banks offer fixed interest rate loans with a redemption period between 20 and 30 years. The amortisation rate of annuity loans is fixed at 1% (as is the case with all long term mortgage loans in West Germany) so that the precise repayment period depends on the interest rate at the time the mortgage is arranged.

Loans refinanced by mortgage bonds need to be secured and therefore can only relate to first mortgages (i.e. within the 60% limit). Mortgage banks thus specialise in first mortgages (for land, housing and commercial property), although they are allowed to use funds for second mortgages up to 10% of their oustanding loan volume. But such ‘unsecured’ loans cannot be refinanced with mortgage bonds, only with other types of debt papers or by using own funds.

The interest rate differential between mortgage bonds and mortgage loans is small, only about 0.5% (whereas the differential is about 3% for savings banks). The differential can be kept low as mortgage banks have few overhead costs. Administrative procedures are simple in comparison with financial institutions offering variable rate loans, because mortgage loans do not have to be renegotiated after they have been arranged. More important in keeping overhead costs low is that mortgage banks do not have a branch network, but only a limited number of regional offices. This can be explained by the fact that mortgage banks, up to the 197Os, were specialised in lending to housing development corporations (public and private) rather than to individual house buyers.4 Mortgage banks traditionally could negotiate large loans with relatively few borrowers compared to institutions that are oriented towards owner-occupied housing finance. Usually, mortgage banks’ loans to owner occupiers are sold via mortgage brokers or, more importantly, via estate agents. But this type of business only increased in significance in the 1970s.


Mortgage banks have been able to increase their business substantially in the post- war era. Up to the late 1960’s growth was linked to state-subsidised housebuilding, as this type of housing may only be financed by long term fixed interest rate loans: a requirement only mortgage banks and insurance companies can fulfill. Mortgage banks were instrumental in realising governmental housebuilding targets, especially in the 1950’s. For this purpose, a series of measures were introduced on a temporary basis. For example, mortgage banks were allowed to increase their turnover-own

capital ratio, and to increase non-secured lending up to 20% of the outstanding loan volume (VPH, 1978). The business of mortgage banks was also helped by tax exemptions given to investors in mortgage bonds used to finance social housebuilding. Such tax exemptions were introduced in the 1950’s (1952-54 and 1956-57) to raise relatively cheap funds for housing when market rates of interest were high. However, such measures were only introduced for short time periods and were linked to housing policy aims, rather than to giving mortgage banks a long term competitive advantage (VPH, 1978).

By 1970 mortgage banks were the largest housing finance institutions with a share of 36% of all outstanding mortgages. Two thirds of this share was taken by public mortgage banks (see Table 5). The expansion of the public mortgage banks relative to the private ones was established in the 1950’s when not only the social housing sector dominated housebuilding, but also most public investments were allocated via public institutions. Private mortgage banks became more important during the 1960’s, providing three-fifths of all new housing loans within the mortgage banking sector between 1959 and 1969 (VPH, 1970). The expansion of private mortgage banks followed the recovery of private housebuilding, including the growing dominance of private developers in providing state-subsidised housing.

2.3.2. Bausparkassen

The main business of Bausparkassen is to operate as intermediaries in a closed scheme of personal saving and lending for housing purposes (see also above). Usually about 33-40% of the loan amount needs to be saved, which takes about 7-10 years. Interest rates offered to contract savers are low, between 2.5 and 4% and are fixed at this level during the saving period. Bausparkassen loans have interest rates which are always set at 2% above their savings rates and are also fixed. This means that loan costs are guaranteed and independent of market rates. The low interest rates on Bausparkassen loans are offset by a high amortisation rate of 7%. As a result, loans are repaid relatively fast (within about 10 years), with annual repayment costs at least as high as any other type of loan. Another consequence of the high amortisation rate is that loans can only cover a relatively small part of the purchase costs of a house as otherwise repayment costs would become exorbitant. So the financial structure of Bausparkassen itself has helped to confine their investment area to second mortgages.


Representatives of Bausparkassen like to link the popularity of the scheme to an aversion of Germans to debt, so they prefer to repay loans quickly. A contributing factor may be that most housebuyers are relatively old (around 40 years) and like to repay housing debt before their retirement. However, a more important factor in the expansion of Bausparkassen has probably been the state subsidies given to the collective savings schemes they operate. The most significant subsidies are premiums of up to 14% of the amount saved (which used to be 25% until 1975) plus an additional 2% for each child in the household (introduced in 1952). Premiums are limited to a maximum amount and only given to contractual savings schemes which run for a minimum of 10 years and must be used for housing purposes only. Since 1975, there have been maximum income limits for savings premiums. In addition, personal investors with Bausparkassen (and insurance companies) are allowed to deduct savings from their taxable incomes, up to a certain maximum amount. This tax measure was part of an income tax reform introduced in 1958. Before the reform, personal investors with other financial instutions were allowed a similar tax relief. Finally, Bausparkassen are favoured by an Act which aimed to increase the savings capacity of wage workers. For particular types of savings (including those with Bausparkassen), up to 30-40% of the sum saved was added as a state subsidy. Like the premium scheme, the subsidy is limited to a maximum amount and the same income restrictions are linked to it (Lehmann, 1981).

Mainly personal savers hold savings contracts with Bausparkassen. The imposed income restrictions are simiiar to those for state-subsidised housing, and when introduced in 1975, about 60% of all households in West Germany were eligible for them. In the early post-war years, social housing institutions also had large savings contracts with Bausparkassen, parts of which were offered to households who bought homes from them. Such contracts disappeared when Bausparkassen savings schemes became popular amongst individual households.

The growth of Bausparkassen in the post-war years has been substantial, despite structural constraints, such as the long saving periods needed and the high amortisation rate of loans. By the 1970’s about one-fifth of all outstanding housing loans were issued by Bausparkassen, which made them the third largest type of housing finance institution. Their expansion was strongly linked to the growth of one and two family housebuilding, which up to the mid-seventies, was the dominant form of owner occupation in West Germany. The high amortisation rate made Bausparkassen loans too expensive to finance rented housebuilding.

The turnover of private Bausparkassen is almost double that of public ones. This may be explained by the fact that private Bausparkassen employ a dense network of sales agents throughout the country (often in cooperation with insurance companies); whereas the public ones mainly operate via the branch networks of savings banks, which are traditionally town oriented. And, as will be pointed out in Chapter 4, one and two family housebuilding has been mainly a rural and suburban phenomenon.

There are to date 13 public Bausparkassen, which are owned by the central giro institutions of the savings banks, and 18 private ones. Between the private Bausparkassen, 60% of the market is taken by the three largest, W~sternot, BHW and Schwabisch Hall and the remaining private Bausparkassen are all small ones.

All three types of universal banks provide variable interest rate mortgages which are predominantly refinanced via savings deposits but also via banks’ hquid assets or funds borrowed from the money markets. The interest rate differential between savings and mortgage loans is generally about 3%. Savings banks have the longest history of mortgage finance, whereas commercial banks and credit co-ops only entered the field in the late sixties.

The traditional role of savings banks is to provide credit for housing, small companies and municipaf projects and to encourage savings amongst lower income households. Sometimes savings banks are referred to as the bank of ‘the little man’. As a rule, savings deposits have to be used for long term lending. The business of savings banks is guaranteed by the public authorities that own them, which has given them tax privileges and thus a competitive advantage over other banks (EAG, 1981).

About three-quarters of savings banks’ funds derive from personal savings. Of all types of financial institutions, savings banks have been able to attract the largest share of personal savings, and so have benefitted in the most from the sharp rise in the savings ratio since the Second World War (EAG, 1981). Saving banks have also benefitted from premiums given to low and middle income savers on particular contractual savings schemes (introduced in 1959). Except for the Bausparkassen, competition from other financiaf institutions in the personal savings market was relatively weak, at feast until the late sixties. The business of savings banks is further helped by their local orientation, a tight branch network and a detailed knowledge of local markets,

About half of all investments by savings banks are in housing finance. Personal savings provide a relatively cheap source for mortgages. Prior to 1967, this was especially true because a compulsory interest rate cartel operated. Saving bank mortgages are generally cheaper than those provided by mortgage banks.

Unlike mortgage banks, most loans by savings banks are given to individual home owners. Corporate housing developers, at least for their main business in social rented housebuildin~, require fixed interest rate loans. Saving banks therefore have rapidly expanded their loan portfolios during the building boom in one and two family housing, for which they are the main providers of first mortgages_ Savings banks also issue second mortgages but these consist of a much smaller part of their housing business.

Savings institutions have expanded rapidly in post-war years and have been, since the mid-fifties, the largest banking sector in West Germany, with over 33% of banking business in the 1970s (EAG, 1981). Their growth is linked to the overall rise of the saving ratio and the post-war housebuilding boom. 611 savings banks exist, all of them linked to local or regional public authorities. Centralisation pressures in the banking sector have alsa affected savings banks, and during the 197Os, a number of them developed into very large banks (Francke and Hudson, 1984).


2.3.5. Commercial Banks

Mortgages provided by commercial banks also are variable interest rate loans, mainly refinanced via personal savings. Commercial banks began to enter the market for personal savings in the late fifties, although their savings business only became important from the late sixties onwards. The main source of commercial banks’ funds has remained the money market.

In expanding their share in personal savings, commercial banks had to compete with savings banks in particular, which forced them to expand their branch network. The savings business of commercial banks was helped by banking deregulation measures in the late sixties. Interest rates were finally decontrolled in 1967 and the introduction of VAT in 1968 abolished some of the tax privileges savings banks and credit co-ops had previously enjoyed (Schnitzer, 1972, Francke and Hudson, 1984).

Growth in the share of commercial banks in personal savings has been associated with an expansion by them of long term personal lending, on mortgages in particular. Earlier, commercial banks had specialised in dealings with trade and industry, and their overall share in banking business fell from 37.6% in 1950 to 22.1% in 1967 (EAG, 1981). The loss was due to a decline in the profitability of and demand for investment funding by big industrial capital. The declining share of banking business was most significant for the three big banks, and they were the most aggressive competitors for mortgage finance in the seventies. In addition to mortgage lending, commerical banks diversified into foreign investment, mainly through Luxembourg and London subsidiaries to avoid constraints imposed by West German monetary policy.

Personal clients of commercial banks have tended to be higher income groups. The type of personal customers served is reflected in the housing financed by commercial banks. They have, for instance, particularly been involved in developing and financing the so called ‘Bauherren’ model, a form of housing provision which maximises tax relief subsidies for personal investors with a high marginal tax rate (particularly self- employed professionals).

2.3.6. Credit Co-operatives

Co-operative banks are most similar to the savings banks, although their traditional specialisation has been in financing agricultural and artisan producers. Until 1974, co- ops were confined to lending to their members only which made them the nearest of German banks to pure deposit banking (EAG, 1981). Like savings banks, credit co- ops cannot issue bank bonds and are therefore restricted to attracting most of their funds from personal savers. But, unlike savings banks, the limitation has led to a financial structure dominated by short term lending. Since the late 1960s following banking deregulation, co-operative banks have become very aggressive competitors in the housing finance field. Saving banks have been affected most strongly by competition from the co-op banks, as both groups serve a similar clientele of middle and lower income owner occupiers.


The housing finance business of credit co-ops is facilitated by their extensive branch network. Following the merger of the two co-operative banking sectors in 1972 a number of smaller credit co-ops disappeared but their offices were retained as branches. As a result, co-operative banks have more branches than any other West German banking group. The traditional rural base of credit co-ops has also helped to expand their share in financing one and two family housing.

2.3.7. Insurance Companies

Next to the mortgage banks, insurance companies have been major lenders to state subsidised housebuilding, as they provide fixed interest rate mortgage loans. Housing finance was an important part of insurance companies’ investments in the fifties, but has declined since. Now, around 20% of new investment by insurance companies relates to housing loans, although in the 1970s this was lower at around 10%. About 10% of oustanding mortgages are held by insurance companies.

Indirect forms of involvement in housing finance have also been developed by insurance companies. First, as major buyers of mortgage bonds (like the universal banks) and second as the main shareholders of private Bausparkassen. In recent years, insurance companies became involved in issuing endowment mortgages, in a similar way to their British counterparts,

NOTES: CHAPTER 2

1. There are two exceptions to this: the Bayer&he Hypotheken und Wechselbank and the Bayer&he Vereinsbank have a long-standing privilege to combine commercial banking with mortgage bond business.

2. Institutions that issue mortgage bonds predate the foundation of mortgage banks. The origins of the mortgage bond scheme go back to mid-18th century Prussia when the war with Austria (1’756) destroyed the agricultural sector. In order to fund new investments, large landowners formed associations which issued value papers to their individual members. With these bonds long term loans could be raised on security of landed property. The scheme rapidly expanded to the rest of Europe except Britain, although even there it was legally made possible with the Mortgage Debentures Act of 1865. But the Act has never been taken into practice and was abolished in 1958 (see also Pleyer and Belhnger, 1981).

3. When using the word ‘mortgage banks’ we refer to both public and private ones. This is unlike the German concept where mortgage bank (Hypotheken bank} refers to the private ones and Realkreditanstalt to the public.

4. Unlike in Britain, both public and private housing developers can build and manage state subsidised housing.

3.1. INTRODUCTION

Until recently, the pattern of housing finance has been simpler in Britain than West Germany. For Britain emphasis needs to be put on the dominant mortgage finance institutions, the building societies. But reference must also be made to the other principal sources of finance: local authorities, insurance companies, clearing banks and - a relative newcomer - the Trustee Savings Bank.

In West Germany as the last chapter noted, it is normal for house purchasers to assemble a package of mortgage loans. In Britain, most borrowers obtain a single loan which can be up to the full amount of the required purchase money. The single loan arrangements were developed by the building societies in the interwar period, with the aid of private insurance schemes to meet the risk of borrower default. Nowadays, all mortgage finance institutions offer single, potentially high proportion loans. Most loans are at variable interest rates, at terms ranging up to 20-30 years (although the average redemption period is much shorter). The similarity of the debt instruments used by different financial institutions contrasts sharply with the West German situation where particular institutions are tied into certain types of mortgage loan (cf. the mortgage banks). In addition, house mortgage lending in Britain is associated almost entirely with owner occupation.’

3.2. THE DECLINE OF PRIVATE MORTGAGE LENDERS

While building societies have been for many years the dominant mortgage institutions, it was not until the 1960s that they began to provide the vast majority of all house mortgage loans. Nineteenth century mortgage finance was dominated by private mortgages, arranged locally between individual investors and borrowers, often using solicitors as intermediaries (Dyos, 1961; Offer, 1981). As Cleary (1965, pp. 28 l-2) and others have indicated private individuals continued to provide most mortgage finance well into the twentieth century. Mortgage loans were extended to

private landlords, as well as owner occupiers. Only fragmentary data is available, but in 1929 under 30% of all mortgage transactions (by value) involved building societies. By the 1950s the proportion had risen to SO%, with another 15-20% accounted for by local authorities and insurance companies. Allowing for a small number of bank mortgages,

206


this means that even in the 1950s ZO-25% of all mortgage finance was in the form of private loans.

Many private loans were made by landlords selling to sitting tenants. The properties concerned often were in poor condition and would not have been accepted as mortgagable by the societies or other institutions (or even the local authorities which tended to lend on more ‘marginal’ properties). By the 197Os, however, private loans had all but disappeared. According to a 1973 survey, only 2-3% of house purchasers used a private loan as the main source of finance (DOE, 1977). Low quality owner- occupied housing is still common in some areas such as the inner cities. Studies have shown that this housing has frequently been bought with loans from a variety of ‘fringe’ banks and other financial institutions, often on onerous terms (Karn, 1979; Harloe et al., 1974). Most of this lending does not appear in published mortgage statistics, although in volume terms it is small in scale.

3.3. A BRIEF HISTORY OF THE BUILDING SOCIETIES

Building societies have a unique legal status and are exempt from many of the controls which govern other financial institutions in Britain. They have also had certain tax benefits which will be outlined later. These advantages are a legacy of their non capitalist origins (Cleary, 1965; Pawley, 1978). The forerunners of modern building societies were terminating friendly societies which began in the eighteenth century. Friendly societies are, at least nominally, organisations owned and controlled by their members. Their original purpose was to collect members’ subscriptions and pay out benefits to them at times of need. The first building societies were special types of friendly society, in which the subscribers each agreed to pay a regular amount until enough had been saved to build a house for each of them, after which they ‘terminated’.

The number of terminating societies grew rapidly in the nineteenth century, even though they could only finance housing for a tiny minority of the better off, more stably employed working class (Gauldie, 1974). They were first regulated by Parliament in 1836, though more extensive legislation was introduced in 1874. The latter Act established the societies in a legal form which has varied very little since, although radical changes are now proposed (HM Treasury, 1984). The history of the societies is a rather peculiar one, consisting of long periods of featureless development, interspersed by the occasional period of turbulence, often sparked off by major scandals and resulting in legislation which amends the 1874 principles but does not basically alter them. This sequence of events characterised the successive Acts of 1894, 1939 and 1960 which were the major legislative developments. Currently the societies are governed by an Act passed in 1962 which consolidated earlier measures (Wurtzberg and Mills, 1976).

Perhaps the most significant change in the basic structure of the societies occurred in the mid nineteenth century. From 1845, societies began in forms which broke the link between investment and benefit. New ‘permanent’ societies accepted investments from the general public and allocated loans to applicants who might or might not be

208 Progress in Pla~~j~g

investors. These societies, however, still concentrated on collecting the savings2 of personal, mainly moderate income, individuals, i.e. collecting ‘retail’ rather than ‘wholesale’ funds. Recently, this has begun to change.

In the 1920s and 3Os, the speculative provision of owner occupied housing took off and with it the role of the building societies. It was then that the societies introduced high house price percentage, long term loans, and they increasingly became closely tied up with the speculative housebuilding industry (Pawley, 1978; Burnett, 1978; Jackson, 1973; Chapter 7 of this paper).

During and immediately after the Second World War, the societies accumulated large balances. But, in the 1950s and 6Os, the societies again boomed as real incomes and savings rose and new and second-hand owner-occupied housing grew rapidly. Post- war building society growth has been supported by successive governments, including Labour ones.

Ascendency over the mortgage market by the building societies since the inter-war period enabled them for many years, until 1983, to operate an interest rate fixing cartel under the auspices of the Building Societies Association (BSA). The cartel was formed at the end of the 1930s to stop interest-rate competition between societies over investments and mortgages at a time when the demand for mortgages was drying up (Jackson, 1973). Although some variations around the recommended rates did occur, the cartel led “to the determination of margins between the investment and mortgage rates that are sufficient to allow the least efficient societies to survive and, at the same time, to give generous margins to the more efficient societies” (NBPI, 1966).

Recommended rates were also argued to keep mortgage rates below market clearing

levels (DOE, 1977; Wilson Committee, 1980); although, given the pent-up demand for owner occupation and the lack of other mortgage alternatives, it is unclear whether the ‘market-clearing’ rates were feasible options especially at times of boom in the housing market. The major societies in the 1980s annoyed by the way in which smaller ones broke ranks over interest rates and keen to diversify out of mortgage lending, were increasingly prepared to accept the importance of market-clearing (i.e. higher) interest rates. In 1983, the cartel was formally dissolved. As only a handful of societies control most of the movement’s assets, however, a formal cartel has been replaced by oligopolistic competition in which the societies still openly meet to discuss

interest rate setting.

3.3-f. Stru&re and Functioning of Building Societies

A central feature of building societies is that since 1874 they have been legally required to use most of their funds to provide first mortgage loans for the acquisition and/or improvement by private individuals of ‘freehold or leasehold estate’, i.e. land and (mostly) residential property. Most loans are allocated to homebuyers and there is a maximum sum which can be advanced in any one case ($37,500 in 1982). However, up to 10% of lending in any one year can be in higher amounts and/or to corporate bodies. Much of this additional lending is to private housebuilders a practice which has led to critical comment (cf. Barnes, 1984).


Building societies are required to hold liquid assets amounting to at least 7.5% of their total assets and reserves: in practice, the ratio is usually between 15 and 20%. Liquid assets can only be invested in limited ways, primarily in bank accounts and public sector debt. The societies have been important dealers in government bonds in recent years. Profits from bond dealing contribute to their overall surpluses.

Building societies are also required to maintain reserves, ranging from 2.5% of the first $lOOm of total assets to 1.25% of assests over %lOOOm. The reserve and liquidity rules apply only to societies with trustee status. Only a few societies with a tiny proportion of total building society assets do not have trustee status.

Most investors in building societies are ‘shareholders’ but they are not entitled to any dividend from supluses as the societies are legally ‘mutual’, ‘non-profit’ bodies. Surpluses are instead added to reserves. Given the mandatory reserve ratios, societies have continually to add to their reserves if they wish to expand. A building society shareholder only has one share, whatever the size of their investment. Each shareholder has an equal vote at annual general meetings and on other occasions when the views of the shareholders are required: for example, when a merger with another society is being proposed. In theory, consequently, no-one can dominate the affairs of a society. In practice, societies are dominated by their directors and senior executives. Despite well publicised campaigns by the members of some societies in recent years, building societies remain undemocratic in practice. Their boards of directors are self- perpetuating bodies. Most directors are non-executive and part-time with strong representation from the worlds of property and finance (Barnes, 1984; CDP, 1976). There has been some governmental concern about this state of affairs, but recent proposals for new building society regulations are unlikely to improve the existing situation (HM Treasury, 1984; Ball et al., 1985).

Most mortgages are repaid on an annuity basis, with a constant annual repayment calculated on the basis of the length of the loan and the current mortgage interest rate. With general price inflation, repayments will decline in real terms over time. The other principal mortgage instrument is an endowment mortgage linked to a life insurance policy. Here the borrower only pays interest on the loan during its term plus insurance premiums which at maturity will pay off the loan. Endowment mortgages tend to be more costly because the societies charge higher interest rates on them (until 1986). Up to 1984, the extra cost was offset by additional tax relief on the life insurance premia. Following government abolition of tax reliefs on life policies in 1984, the societies still

issued many endowment mortgages. They are extensively promoted, are often linked to pension scheme for the self-employed and used to offer one of the few means of obtaining 100% mortgages. Building societies’ surpluses benefit from endowment mortgages through the income generated by the higher interest rate and the associated life insurance commission.

Traditionally, the societies have relied for their funds on the personal savings market. Their effectiveness in gathering personal savings has been aided by their favoured tax position. Under a special arrangement with the Inland Revenue they pay interest to investors net of tax, with the society directly paying the tax on the basis of composite estimates of the average of the tax rate paid by all investors in the societies. In effect low income investors pay more tax on their building society accounts than


their incomes would normally attract and higher income investors pay less. Until recently, other investment outlets paid interest gross of tax, although, in future, bank deposit accounts will have similar composite arrangements. Building societies have also enjoyed favourable tax treatment of their surpluses and the profits from their trading in government bonds.

One factor in the societies’ success in attracting personal savings has been the way in which they have marketed themselves via an extensive and rapidly expanding branch network. They have projected a friendly and accessible image; are open during most normal weekday shopping hours and on Saturday mornings; pay interest on all accounts and withdrawals normally can be obtained on demand. Current accounts at banks are more flexible and convenient to use but they are expensive for the consumer. Given the taxation advantages of the societies, their effective marketing and the disadvantages of the banks, such as the higher expenses they have to bear for maintaining a cheque clearing system, it is not surprising that building societies have been more effective than the banks in attracting personal savings.

3.4. LOCAL AUTHORITIES

Local authorities first obtained discretionary power to provide loans for the acquisition of smaller, lower price dwellings in 1899. In general terms, they have supplied mortgage finance in much the same way as building societies, using similar instruments and loan terms. They obtain their finance by means of loans raised on the capital market as a part of local authorities’ consolidated borrowing requirements. At times, the interest rates on council mortgages are lower than those provided by building societies, but the reverse has often been the case too.

Local authorities traditionally focus on enabling lower income households to buy. Councils have also been more willing than building societies to loan on older, unimproved housing, for example in inner city areas, (DOE, 1977). For many years, mortgage lending policy was almost entirely a matter for each individual authority to determine, within the broad control of the enabling legislation. Data on their lending is patchy but figures quoted by Cleary (1965) suggest that up to the 1960s it probabfy amounted even in its best years to less than 10% of all lending. Data contained in Merrett (1982) show that from 1945 to 1980 there were considerable fluctuations in the numbers of local authority loans made, especially after the mid- 1960s when local authority lending was alternatively encouraged as a way of expanding lower income owner occupation and then cut.

Local authority loans peaked in 1975, when over 100,000 were made, but they were cut back sharply and even more so after the Conservative government took office in 1979. By 1983, only about 3300 loans were made (plus some smaller loans for conversions and improvements) - a negligible proportion of the total mortgages issued in the U.K. The demise of local authority mortgages significantly reduced the availability of finance on reasonable terms for ‘marginal’ homeownership. Attempts to encourage the building societies to fill the gap left by the withdrawal of the local authorities have generally been unsuccessful (Merrett 1982; Boddy 1980).


3.5. INSURANCE COMPANIES

Ever since the nineteenth century there has been some insurance company lending for homeownership. In 1871, data on ten leading life insurance companies showed over 50% of the total assets of these companies invested in property mortgages (much on commercial property). By the end of the century, these companies had diversified their investment portfolios and, by 1925, only about 10% of assets were in mortgages; a proportion which remained virtually unchanged up to 1952 (Dodds, 1979). Data from 1961 to 1976 show that house purchase loans comprised a declining proportion of total insurance company assets, throughout the period, falling from about 10% in 1961 to about 6% in 1976 (Dodds, 1979).

Housing mortgages have been unattractive to the insurance companies because they cannot be resold to other investors, as there is no secondary mortgage market in the U.K. One commentator has suggested that “to compensate for their lack of marketability they should carry a yield above that of corporate bonds. This is not always possible because in the house purchase market . . . life insurance companies will have to compete with building societies. In fact, they do not compete actively, rather they use the house purchase market as a vehicle for obtaining new life business, so that overall the yield is often secondary and unattractive” (Dodds, 1979. p.61).

Insurance companies deal primarily in the upper end of the housing market. Between 1973 and 1983 only 15-20,000 home loans per year were made by insurance companies, equivalent to about 5% of all loans for house purchase. (Housing and Construction Statistics 1974-84; Boddy, 1980). A 1973 survey showed that the average purchase price of housing financed by an insurance company was considerably higher than that brought through building society loans; a feature which has continued (DOE, 1977; Housing and Construction Statistics 1974-1984).

Despite the low involvement in direct mortgage lending, insurance company linked endowment mortgages grew rapidly throughout the 1970s and early 1980s until their special tax status was withdrawn in 1983. Instead of issuing mortgages, the insurance companies chose to ally themselves with the building societies. The societies issue endowment mortgages in co-operation with insurance companies and are paid a commission from the insurance company on the additional life insurance business won. Building societies tend to be more generous with their morgage/house price ratios when the mortgage is linked to an endowment policy.

Growth of life and pension insurance business linked to house mortgage repayment has encouraged insurance companies to re-enter direct mortgage lending to ensure that they win the insurance business. Insurance companies can now use wholesale money market funds to finance mortgages, rather than their own funds which can be more profitably used elsewhere. The ability to tap wholesale funds has depended on the development of new money instruments associated with the financial services revolution. In a recent case, one insurance company, the Royal London Mutual, borrowed its mortgage funds from a syndicate of banks (Financial Times, 23.7.85). In effect, this is another means by which the banks are channelling funds into the house mortgage market.


3.6. CLEARING BANKS

Clearing banks derive their name from the joint U.K. cheque clearing system they operate. The major private banking groups in Britain are all clearing banks. The sector is dominated by a handful of large scale branch banking concerns plus a few others with a more limited regional presence. For a variety of reasons British clearing banks have historically concentrated on lending to industry, commerce and the public sector, mainly on a short term basis (Coakley and Harris, 1983). Traditionally, commercial banks followed conse~ative lending policies so that according to Sayers (1967) they were chronically ‘underlent’. Locked into an interest rate cartel which they were only forced to abandon in the early 1970s and restricted by various governmental controls, the banks were slow to diversify. But in the late 195Os, with the lifting of some of these controls, they did expand into the business of providing consumer loans and in the 1960s the first bank credit card was started. Even by the late 1960s however, they still regarded lending for house purchase as mainly something that should be left to the building societies and as something that was potentially too risky (Sayers, 1967).

There was some bank lending for house purchase throughout these years. The commonest form was the provision of short-term ‘bridging’ finance. Such short-term bank loans are used by many buyers. Longer term lending has traditionally been confined to a few limited categories (Merrett, 1982); first, at subsidised interest rates to the banks’ own staffs; second, to a handful of long term customers on up-market properties; third, as has been noted, on ‘marginal’ properties and to ‘marginal’ borrowers (although the major banks rarely were directly involved in this business). Banks also top-up building society mortgages by offering medium term loans to cover an additional percentage of the purchase price, although most mortgage borrowers have not resorted to such loans.

Few estimates exist of the historical significance of bank mortgage lending. In the mid-1950s, the sums advanced were negligible (Cleary, 1965) a situation which persisted until the early seventies (DOE, 1977). Thus bank lending was not a significant aspect of the mortgage market until the 1970s and, even then, it remained at a low level until the 1980s (DOE, 1977; Boddy, 1980; BSA Bulktin, 39).

Competition between the clearing banks and building societies has centred traditionalIy on the income, rather than the borrowing, side of mortgage finance; especially on the attempts by the banks to attract personal sector liquid assets through their deposit accounts. Banks have tended to offer comparatively poor returns on deposit accounts whereas their current accounts, although they pay no interest and incur transactions charges, offer transactions advantages which no building society has been able to match. Using current accounts for direct debiting and crediting (especially of salary payments), combined with the availability of cheque books, cheque guarantee cards, overdrafts, money transfer and other financial services enable individual consumers to slot into the general financial system in a way that a building society share account cannot offer. Presently, building societies are trying to widen the scope of their activities to encompass a number of the services available on current accounts. But today, and in the past, consumers generally regard building society share accounts and clearing bank current accounts as complements rather than substitutes.


As complements, money is invested in building societies for periods of months, while bank current accounts are used for daily transactions purposes. So banks and building societies have rarely in the past competed over short-term transaction funds (although the size of transactions balances might have been sensitive to the level of interest rates in investment alternatives like building society share accounts); nor have they competed much over funds already in investment accounts because of the stickiness of investable liquid assets once deposited in a savings medium. A survey undertaken in 1979 gives some quantitative indication of these roles in consumer finance.3 The sample survey found that 64% of building society investors had a current account at a bank - roughiy the same proportion as for the U.K. adult population as a whole. It also found that only 2% of investors withdraw money from building societies more than once a fortnight, while 92% withdraw only 3 monthly or less. It would seem that building society investors neither dip into their accounts frequently nor switch them around whenever another investment outlet offers a better return. For most investors, only new funds are highly sensitive to interest rate differentials; although for the minority of large and/or corporate investors - who are significant providers of total society funds - the whole of their portfolios are sensitive to differences in expected returns (DOE, 1977).

3.7.SAVINGS BANKS

Although savings banks developed in much the same circumstances as the building societies from the late eighteenth century onwards, they were not allowed to invest in housing, nor indeed in anything other than government debt (Horne, 1947; Gosden, 1973). By the post war period there had emerged, from the many small savings banks of the nineteenth century, a more limited number of ‘trustee’ savings banks (TSBs) - as they have been known since the legislation of 1817 which first regulated them - and a much larger Post Office Savings Bank.

In the 197Os, the trustee savings banks began to diversify their activities, following the recommendations of an official enquiry into national savings (Morgan, 1979). Some years earlier the TSB had become a federation of regional savings banks with a central clearing bank, Since the 197Os, the TSB has been progressively freed of its obligation to deposit most of its funds with the government or in government securities. It has expanded both its investments and its services to customers to become a competitor with the clearing banks. It is now expected that in 1986 it will be floated on the Stock Exchange. Meanwhile, it has been entering into competition with the banks in an aggressive manner and is becoming a major force in the banking industry (Hughes, 1984; Lascelles, 1984). Just as the banks have expanded their presence in the mortgage market in the past few years, so too has the TSB. From 1977, it has provided bridging loans and loans for improvement and, from 1980, house purchase loans. Up to 1980 it had only lent $13m for housing. This expanded to over di90m in 1980 and double that in 1981 (BSA Bulletin, 39). Since when the TSB has continued to expand its mortgage business.


NOTES: CHAPTER 3

1. In Britain social rented (council and housing association) housing is financed by local authority and central government borrowing. Virtually no new private rented housing has been built in the last 45 years, although some mortgages have been obtained for the purchase of second-hand property which is then rented out, often in contravention of mortgage terms which expressly prohibit such letting.

2. Strictly speaking we should be referring to the more accurate term ‘personal sector liquid assets’ rather than private individuals’ savings. For ease of exposition, however, we have chosen to use the common language expression.

3. British Market Research Bureau survey for the Building Societies Association, quoted in Gough (1982).

CHAPTER 4

~~r~g~ge Finance and 0 wner- Occupied lousing Provision

Differences in the nature of owner-occupied housing provision in Britain and West Germany help to explain the distinct institutional structures of mortgage finance in the two countries. The characteristics of mortgage finance have also helped to structure the countries’ housing markets. The influences of this symbiotic relationship will be explored in this chapter.

4.1. A UNIFIED VS A FRAGMENTED HOUSING MARKET

Perhaps the most striking difference between owner occupation in Britain and West Germany is in their respective housing markets. In Britain, there is a unified owner- occupied market; whereas in Germany a variety of markets exist - differentiated by house types and by region.

In Germany, once a household buys a house they tend not to move again. One consequence is that there are not, at any one time, large numbers of owner-occupied households trying to sell their houses and purchase others. Second-hand sales are limited to stock transfers from other tenures and to more or less forced sales of the homes of dissolved households (through death, marital breakdown, etc.), job movers and those in financial dif~culty. The lack of a steady flow of second-hand dwellings onto the market helps to explain why the housing market is fragmented. Housebuilding satisfies localised demand. Stock transfers appeal to particular sectors of demand, as transfers are generally associated with flatted accommodation rather than the traditional owner-occupied, single-family house. Obviously, national level influences, like the state of the economy and changes in housing policies, have a common impact across the different sectors - but there are no unifying influences at the level of the market itself. The fortunes of one can vary considerably from the others.

In Britain, the situation is very different. More than half the purchasers in any year are existing owner occupiers who move. New and existing dwellings compete for the attentions of would-be purchasers, and sates of existing dwellings - mainly of second- hand sales of owner-occupied houses - far outweigh those of new dwellings. New building now represents less than 15% of annual house sales. The juxtaposition of transactions of a large number of houses and households already in the tenure with

215


new entrants and new building creates a unified housing market. Sharp differences in house prices exist depending on the locality and house type in

question. But each sub-sector of the market is linked together through the widespread practices of trading-up and trading-down, dwelling improvement and conversion, and inter-regional moves. The result is that all parts of owner occupation in Britain are linked to common market forces. A spurt of house price inflation in one region, for example, is quickly transmitted throughout the country, while problems in one market sector tend to become generalised to others.

The distinct nature of the two owner-occupied housing markets stems from the position of owner occupation within the countries’ respective housing systems and the different types of agency active in owner-occupied housing provision.

4.2. HOUSEHOLD CHARACTERISTICS OF OWNER OCCUPIERS

Owner occupation occupies distinct positions in Britain and West Germany. In Britain, owner occupation is the major tenure - over 60% of households now live in it. For most people, from the time of independent household formation, owner occupation is virtually the only feasible option. Private rented housing is now around 10% and much of it remains only because of security of tenure legislation. Council housing has also been run down since its peak in the mid-1970s, through much reduced rates of housebuilding and sales to sitting tenant purchasers. The profile of housing opportunities in Britain, therefore, is very limited. Entering owner occupation becomes not just a preference of many, but an absolute necessity for most of those able to afford it. The age and income profiles of owner occupiers are very broad,

though on average they tend to be better-off than non-owners (Ball, 1983). The entry of newly formed households into owner occupation is facilitated by the common process of trading up; whereby new households buy cheap, small accommodation initially and gradually improve the quality of their housing by moving every few years when economic circumstances permit. Inflation aids this process, by eroding the real value of incurred mortgage debt and by giving households money gains on the differences between initial purchase and later selling prices. For many British households, a particular owner-occupied dwelling is a transient home. At each move, a mortgage is redeemed and a new one taken out. The average life of a building society mortgage in 1983 for example, was only four years, while 46% of the outstanding mortgage debt with building societies had only been issued in the previous two years, and an incredible 68% only in the previous four years (BSA Bulletin, 40).

West German owner occupiers come from more specific social strata, because of the position of owner occupation in the housing system. Strong private and social rented sectors exist, and have provided the bulk of new urban housing since 1945. Traditionally, owner occupation has been the tenure of West Germany’s large rural population, while its role in urban housing has been comparatively small. At the end of the 197Os, 37% of West Germany’s housing was owner occupied (Martens, 1985).

Owner-occupied households in West Germany tend to move into the tenure from rented accommodation at quite a late stage in their lives. The average age of new


entrants is around 35+. By this time substantial savings have frequently been accumulated and there are strong visions of individualised ‘dream houses’ in suburban or rural locations, often with house designs tailor-made. In contrast to much of West Germany’s urban housing stock, owner-occupied dwellings tend to be single-family suburban or rural units. Regional disparities weaken the generalisation. In some areas, like the Ruhr, much traditional working-class housing was built for owner occupation. Similarly, social housing subsidies (which are available in all housing tenures) have since the 1950s increased owner occupation amongst lower income groups. But, even so, the up-market image of owner occupation is strong.

In part, the role for owner occupation explains the very high prevailing house prices. According to a 1976 survey average house price-disposable income ratios in West Germany for one-family housing were 8.5 for urban areas and 6.0 for rural ones (Koster and Mezler, 1979). In contrast, in Britain at the same time the house price- average earnings ratio was 3.5. It is difficult to believe that quality differences alone account for the high level of prices in West Germany. It is a moot point how much the extra purchasing power, resulting from the long period of savings in West Germany, helps to push up house prices, as well as to make house purchase affordable.

Clearly, the characteristics of West Germany’s owner-occupied sector are linked to the mortgage finance system. Long-periods of saving as associated, for instance, with Bausparkassen, and the high down payments required in the traditional methods of mortgage finance are only possible when people are able to save substantial sums and can delay house purchase. The characteristics of owner occupation and mortgage finance are thereby intertwined. It is often said that Germans have an aversion to debt and a high propensity to save and that this has helped to structure West Germany’s financial institutions (EAG, 1981). Whether it was a fortunate combination of circumstances, with institutions merely matching preferences, that produced the mortgage banks and Bausparkassen as institutions able to feed into savings preferences via owner occupation is debatable. Post-war economic policy in West Germany has generally put strong emphasis on encouraging high savings ratios. In addition, the success of innovations in mortgage finance over the past decade, which shorten savings times and lower the required deposits, would suggest that the preference determination view of the reasons for long savings periods and late entry to owner occupation is questionable.

4.3. HOUSEBUILDING AND LAND DEVELOPMENT

Again, a contrasting picture emerges with respect to housebuilding. In Britain, new housebuilding is almost entirely undertaken by speculative housebuilders who buy up greenfield (or, sometimes, inner city brownfield) sites, devise an appropriate housing scheme, build the houses and sell them on a general market. Over the past 15 years, substantial restructuring of the speculative housebuilding industry has taken place. So now a handful of volume builders dominate owner-occupied housing production (Ball, 1983).

In Germany, there are two main types of owner-occupied housing production. Most

11”’ ‘i, I


owner-occupied housing is individually commissioned by the prospective owner occupier, who has purchased a plot of land. Often the process is referred to as self- building, though frequently this is a misnomer as building firms are employed to do all or part of the construction. On larger scale urban owner-occupied developments, speculative developers operate but they are very different from British ones; West Germany’s social housing institutions, for instance, have undertaken such owner- occupied developments.

Clear tenure distinctions in terms of subsidies and patterns of development do not exist in Germany, in contrast to Britain. Social housing is simply any housing that receives direct government subsidies, which includes lower priced owner-occupied housing (Wollmann, 1984). It is these types of owner-occupied developments that the social housing institutions undertake - though, of course, they mainly provide housing to rent. Another important distinction occurs in the initial site development phase, as, under West German law, planning authorities have a right to reparcel the ownership of building land according to the needs of the local plan. The original purpose of this 1919 legislation was to encourage housebuilding on orderly lines and to stop profiteering out of development. In the post-war era, greater emphasis has been placed on corporatist style deals between housing promotors, building companies and local governments (Lichlield and Darin-Drabkin, 1980; Konukiewitz and Wollmann, n.d.).

Distinctions between the principal types of housing development agencies are important because they affect the balance of power in a structure of housing provision. In West Germany, housing promoters and housebuilding firms are in a relatively weak position in owner-occupied housing provision. They are either fragmented and individualised - as with commissioned building - or owner occupation is not the central focus of their activities - as with the social housing institutions. Large independent speculative housebuilding enterprises do not exist in West Germany, whereas they have flourished in Britain. Potential financial gains from housing

development, therefore, are more likely to accrue as profit to housebuilders in Britain than in Germany. In West Germany, development gains can more easily be appropriated by others in the development chain, including mortgage finance

institutions (Frank, 1980). In part, the difference stems from the pattern of post-war housing development in

the two countries. It should be remembered that until the late 1970s most house

mortgages in West Germany were taken out for new rented housing by low-proft and private housing institutions, many of whom were large scale developers. Mortgages in Britain are associated solely with new and second-hand owner occupied housing. So British building societies have had to come to terms with large speculative builders, even if relations between them are generally harmonious. Harmony has been maintained because both building societies and speculative builders have done well out of owner occupation. Similarly, in West Germany, although builders are in a weaker position, they have still made substantial profits out of housebuilding. How much has depended on the volume of housing output, which means they suffered badly from the collapse of new social housebuilding from the later 1970s onwards.

4.4. NEW HOUSING OUTPUT


In both Britain and West Germany, there have been sharp falls in new housing output. From all-time peak years in the late 1960s/early 197Os, in both countries, total output had fallen by more than one half in the early 1980s. Cuts in social housing construction subsidies were a major contributory factor, affecting council housing in Britain and mainly rented housing in West Germany. Owner-occupied output is difficult to distinguish in the West German data, although one-family housing can be used as a rough and ready guide (see Martens, 1985). Owner occupation in both countries is subject to short-run cyclical fluctuations (see Fig.2), but there are sharp

I - - - One family housmg

01 1950 1955 1960 1965 1970 1975 1960 1965 Yei31

Source: Statlstlsches Bundesamt 1983

,_, --- - All

--- Prwate

I’ 0 I I I I I I I

1950 1955 ,960 1965 1970 1975 1980 1985

Year

source~c SO 1965.1984

FIG. 2. (a) Housing completions in West Germany 1950-1982. (b) Housing completions in the United Kingdom 1950-1982.

differences in the respective trends of output. In Britain, owner-occupied housebuilding has been on a secular decline since the mid-1960s; while in West Germany output remained steady until the early 198Os, when general economic crisis brought output down sharply. A temporary tax relief subsidy scheme helped to revive output in 198314, but the near future looks bleak for this sector of West Germany’s troubled construction industry.

Part of the explanation of the steadiness of commissioned housebuilding in West Germany was said (in interviews with us) to be the long savings period associated with owner occupation and the type of building process. The commitment to house purchase by West German households is often a long-term one, so substantial and

220 Progress in P~~~n;ng

long-term changes in economic circumstances have to exist to put purchasers off. In addition, with commissioned housebuilding, not all of the dwelling has to be undertaken at the same time or ambitious plans can be curtailed - thereby reducing the scale of the financial commitment required, when circumstances warrant it.

4.5. HOUSE PRICE INFLATION

Falling housing output could spell disaster for houseb~ilders and mortgage finance institutions alike, because both are operating in a shrinking market. Large increases in house prices offset the threat by raising the value of housing output, even though its volume has fallen. House price intlation has been strong in both countries.

TABLE 2. House price changes in West Germany and Britain

Estimnted annual house Annual rate of change price change (o/u) of retail prices (%‘o)

19X2-1975 5-8 1977 S-10 1978 10-15 1979 >30 i980 16 I981 -5 1982 -5 I983 -7

5.5-7.0 3.7 2.7 4.1 5.5 5.9 5.3 3.0

Approximate average house price changes of one-family housing in West Germany, 19X-1983 (source Martens, 1985). Note: no accurate national data either for new or for secondhand house prices are available for West Germany. The data given in this table are based on an unweighted crude averaging of local data provided by estate agents,

Actual pflce change

t

1 - J

-70 1 I’ 1 ,’

-15 F&;&e change

U.K. house price changes per cent per annum, 195742. Prices at mortgage approvai stage. See BS.4 BulkGz 19, p 21, for details of construction of house price index. (Source: BatI, 1983.)


Yet, as Table 2 shows, the pattern of house price inflation has differed. In Britain, there have been periods when house prices shot ahead of general inflation (viz. 1972/3, 1978/9, and 1983/6), and intervening periods when they rose slower, leading to falling real house prices. Nonetheless, there have never been sustained periods when actual house prices fell. So few householdshave had to experience a money loss on resale, which means that they can redeem any outstanding mortgage debt from the selling price - with funds left over for another purchase.

Data on West German house prices are poor. No systematic surveys are undertaken, and, as mentioned earlier, there are distinct markets which makes the notion of an average house price especially dubious (Martens, 1985). The data that exist are estate agents’ estimates of price changes, but they do enable broad trends to be discerned. It would seem that the pattern of house price inflation has been different from Britain. For most of the 1970s house prices more or less kept pace with general inflation; until 1977, when there was an unprecedented sharp rise in real house prices which lasted for 4 years. Since 1981, in contrast, house prices steadily fell, until at least 1984.

The implications for mortgage institutions of the distinct house price patterns in Britain and West Germany are considerable. Mortgage institutions in Britain have been able to rely on a very favourable market context - periods of rapid expansion of mortgage business during house price booms with consolidation during the intervening phases of stagnation. At the same time, the steady expansion of owner occupation and the increasing mobility of existing owner occupiers has led to a long- term growth in the levei of market transactions and concomitantly of mortgage lending. It is not surprising therefore, that in the 3 years up to 1985, for instance, building societies’ assets in real terms rose by a third. In West Germany, where second-hand sales are limited, mortgage institutions are tied to the fortunes of new housing markets. The 1970s were good years for housing finance institutions; the level of transactions was generally steady, and the decade culminated in rapid price inflation and a resultant growth in mortgage debt. But the 1980s have been far from good - falling house prices are not an attractive environment in which to do mortgage business.

4.6. TAX RELIEFS AND SUBSIDIES

Subsidies to owner occupation have considerable affects on mortgage institutions. An obvious case is the effect of savings subsidies on Bausparkassen. General subsidies to owner occupation, although not necessarily aimed directly at mortgage finance institutions, can still raise the volume of mortgage business and feasible levels of mortgage interest rates, because they make owner occupation financially more attractive to households. As examples of such beneficial subsidy schemes for each country, it is possible to highlight accelerated depreciation reliefs in West Germany, whereby households can write off against their tax liabilities the nominal depreciation value of their dwelling at a rate faster than that implied by the depreciation calculation itself, and mortgage interest tax relief in Britain.

The British subsidy system, which extends to all borrowers of mortgages, is

222 Progress in Pla~~j~g

especially advantageous to mortgage finance institution. Mortgage interest tax relief is equivalent to the owner occupier paying a lower rate of interest than that received by the mortgage institution. So owner occupiers are shielded from the full brunt of high interest rates. With only one type of institution, building societies, dominating mortgage lending in Britain, mortgage interest tax relief gives the societies considerable flexibility in their interest rate setting strategies. As financial intermediaries, the societies are aware that borrowers from them do not have to pay the full cost of any interest rate they may choose to set. Mortgagees will pay at most only 70% of them, with the rest paid by the Exchequer through increased tax reliefs. This means that comparatively high rates can be paid to depositors, enabling the societies to attract substantial inflows of funds and expand rapidly. The special tax privileges of mortgage debt, in other words, have contributed substantially to the rapid growth of the building societies relative to other financial insitutions.

Housing subsidies in West Germany are different from those in Britain, and are more complex in that the principles on which they are based are not related to owner- occupied housing in particular, but to new housebuilding in general whatever tenure it is destined for. There are subsidies on construction costs, usually in the form of interest free loans with maximum floor area and household income stipulations. These subsidies are available to lower income owner occupiers (and classify the dwellings as part of West Germany’s social housing stock). Multi-family housing has also generally received more favourable tax treatment since the war than single family housing (which is predominantly in owner occupation, whereas multi-family housing is usually blocks of rented flats). For taxation purposes, housing is treated as an investment good, on which an owner-occupied household can claim an annual depreciation allowance of up to 5% of the construction cost from their taxable income for the first 8 years. Since 1977, the allowance has been extended to second-hand dwellings as well, which has encouraged the conversion of rental housing to owner occupation. Each person can only claim this allowance once in their life. Conversely, there is an imputed rental income tax on owner occupiers; although in practice, given the low valuations and many offsetting exemptions on which the tax is based, few owner occupiers pay much. Lower income owners are also able to take advantage of West Germany’s housing allowance schemes.

Housing subsidies in West Germany are currently under debate and likely to change significantly, but still retain a strong bias towards new building. The current Christian/Free Democrat coalition government introduced a temporary programme of interest tax relief for all owner-occupied housing when it came to power, as part of an economic reflationary package.’

4.7. RECYCLING HOUSING MARKET FUNDS

All housing mortgage institutions receive substantial inflows of funds from owner occupiers, but particular housing market structures increase the inflow considerably. Repayments of mortgage interest and debt are obvious examples of receipts from owner occupiers. Yet the preponderance of second-hand sales in the British housing


market greatly augments the inflow. A large proportion of personal sector wealth in Britain is the net value (i.e. minus mortgage debt) of the owner-occupied housing stock. House price inflation and fixed historic cost mortgage debt have, since the 1960s led to owner occupiers making substantial money gains at the time of sale. Most of the money gains are absorbed in purchasing other houses, and so is not drawn out of the owner-occupied housing market. Even so, considerable sums are withdrawn. A common experience is moving owners using funds realised at the time of house sale (or remortgaging) to finance the purchase of other expensive consumer durables, like cars. In this way, they are able to use the tax advantages of mortgage interest on owner- occupied housing for other debt (Bank of England, 1984). Such withdrawals do not lead to additional savings, instead they reflect the advantageous, if often indirect, position building societies have in the general field of consumer debt (Financial Times, 22.6.85). In a number of situations, realised money gains from house sales lead to an increase in personal liquid assets: at death, where the gains are passed on as inheritances; when households trade-down at older ages and invest part of the realised proceeds in financial assets; and at times of household break-up caused by separation and divorce. A significant proportion of realised money gains are invested in building society accounts (BSA, 1979). As a result, building societies derive considerable funds from housing market transactions.

Clearly, when the level of transactions and the potential for money gains rise, as they do during housing market booms, building societies derive more from this source. On average, through reinvested money gains and through repayments of interest and principal, building societies derive around two thirds of their income from the owner occupied housing market (BSA, 1979). Because German mortgage institutions deal primarily with new dwellings and there is only a limited second-hand market, the recycling effect there is far less.

4.8. CONCLUSION

This chapter has tried to outline some of the differences between the housing markets of Britain and West Germany, and show some of the ways in which mortgage finance institutions are influenced by the character of the housing markets in which they operate. Owner occupation in Britain and West Germany is not the same thing in terms of costs and benefits to households, taxation reliefs, and the agencies operating to provide housing in the tenure. In particular, different histories and patterns of development have occurred. The starkest expression of such differences is seen in the falls in second-hand house prices in West Germany in the 1980s; an occurrence which up to now is undreamt of in Britain.

Some people have borrowed terminology from marketing to describe the difference between owner occupation in Britain and West Germany. Britain it is suggested has a ‘mature’ housing market, with second-hand and replacement sales outweighing new ones; whereas West Germany’s is still in the formative, ‘new product’ stage. One implication is that in a few years, if owner occupation keeps on expanding in West Germany, it will increasingly develop the characteristics seen in the mature British


market. Such characterisations seem to us to be misplaced. Owner-occupied housing provision in the two countries is undoubtedly changing, but not along the same path.

It is difficult to ascribe the differences associated with owner occupation in the two countries to a single cause, like ‘mature/immature’. Taxation and subsidy policy might seem a good candidate for the role, because up to recently subsidies in Germany were available only on new housing and can still be used only once by each taxpayer, whereas in Britain such constraints do not operate. It could thus be claimed that the fragmentation of owner occupied markets in West Germany and their unity in Britain are caused by the two countries’ respective subsidy policies. Such explanations, however, are of the ‘chicken-and-egg’ variety; subsidy policies, for instance, could reflect the nature of owner occupation as much as be the cause of that nature.

NOTES: CHAPTER 4

1. This account of West Germany’s housing subsidies is based on Galonska (198 l), Hallett (1977), Wollmann (1984), HPR (1977) and our interviews in West Germany.

CHAPTER 5

The Restructuring of Mortgage Finance in West Germany

5.1. INTRODUCTION

Major changes have occurred in West Germany’s mortgage markets since the late 1960s. The reconstruction of mortgage finance is related to a number of factors. The most important are: the changing nature of the housing market; growing competition between housing finance institutions in both mortgage lending and attracting funds; and the changing monetary environment, including inflation and rising and unstable levels of interest rates. In this chapter we shall first give an overview of the changing conditions for mortgage lending institutions, followed by a description of the transformation of the institutional structure of housing finance. The restructuring of the institutional arrangements developed in two phases. The first runs from the late 1960s up to 1973/4 and concerns the emergence of large financial supermarkets, which offer all services to house buyers under one roof. The following phase, from the mid- 1970s onwards, marks the increasing subordination of the business of specialised mortgage lending institutions to the investment interests of universal banks. Finally, we shall assess some of the consequences of the new institutional arrangements of West German banking.

5.2. THE MARKET FOR HOUSING FINANCE

By 1983, outstanding mortgage loans amounted to 701bn DM or 47.8% of all domestic lending to firms and individual persons in West Germany (DB, 1984). This share, which had increased from 41.0% in 1971, indicates the importance of housing finance in the country’s domestic banking business. The major area of growth in housing finance has been in second mortgages: in 1970 only 29% of all outstanding mortgage credit concerned second mortgages, whereas this had increased to 46% in 1983 (DB, 1984). It is, therefore, not surprising that the most significant changes in mortgage shares between housing finance institutions occurred in the area of second mortgages. As is shown in Table 3, savings banks and mortgage banks remained the main lenders of first mortgages. But, in the area of second mortgages, Bausparkassen lost a substantial market share to all three types of universal banks.

Investments in second mortgages had already expanded during the 1960s following

225

TABLE 3. Mortgage lending to domestic firms and private persons - oatstanding debt at the end of each year, percentage share

First mortgages Second mortgages 1970 1983 1970 1983

Commercial banks 4.0 6.8 7.7 15.2 Savings banks 43.9 41.3 12.9 20.3 Credit banks 3.2 5.8 10.7 16.5 Mortgage banks 48.8 43.2 2.6 3.6 Bausparkassen 62.7 42.5 Others 0.1 -& 3.4 1.7

Total in DM (billion) 135.72 379.70 55.32 321.65

Source: Adapted from tables provided by Dr. W~gl~~r, Deutsche Bank, Fra~kfurt/~.

policies introduced to replace subsidised state loans (which mainly covered the area of second mortgages) by state guaranteed loans from the money market. But the volume of second mortgages continued to increase significantly during the 1970s. This is partially explained by phenomena such as house price inflation in combination with an increasing mortgage-house price ratio (see Chapter 4).

Expanding investments in second mortgages during the 1970s related to lending to individual housebuyers, rather than to corporate developers. As Table 4 shows, lending to housebuiIding institutions (which represents mainly rented multifamily housebuilding) declined substantially relative to personal mortgage lending; especially since the mid-1970s. (Note, however, that the shift would be somewhat less marked had Bausparkassen been included.) The trend reflects the increasing significance of mortgage lending for owner occupation.

Another qualitative change in West Germany’s housing markets concerns the role of the existing housing stock. Until the mid-1970s virtually all housing finance was oriented to newly built housing. But inner city gentrification and an extension of depreciation subsidies to purchases of existing housing in 1977, helped to expand substantially mortgage lending on the existing housing stock particularly since the late 1970s.

TABLE 4. Second mortgages lent by finance institutions (except Bausparkassen); outst~ding debt at the end of each year

Firms Private individuals DM % RM %

(millions] (millions)

1970 10.7 52.4 9.7 47.6 197s 23.5 50.7 22.8 49.3 1980 44.7 35.4 81.6 64.6 1983 69.4 37.9 113.5 62.1

Source: Adapted from tables provided by Dr. Wagner, Deutsche Bank, Frankfurt/M.

Mortgage Finance and Owner Occupation

The expansion of investments in second mortgages, in combination with an

227

increased significance of mortgage lending to individual buyers of either new or existing housing, affected the financial institutions that traditionally dominated the mortgage market in several ways. Mortgage banks in particular had to adjust to changed circumstances, as they are, in the main, confined to lending on first mortgages. They also had to find ways of interesting individual housebuyers in their types of mortgage. Bausparkassen and savings banks, both traditional lenders to owner occupiers, had to deal with increased competition from the new entrants to housing finance: the commercial banks and credit co-ops. The new competition was not only fierce in mortgage lending, but also in attracting funds from personal savers.

Several circumstances favoured universal banks in expanding investments in housing since the late 1960s. Firstly, the mortgage market was expanding, which made it relatively easy for new institutions to enter. Secondly, personal wealth had increased substantially in West Germany by then, which encouraged universal banks, and particularly the three big commercial banks, to intensify their activities in the personal sector. Finally, rising and unstable levels of interest rates, which were characteristic of the 1970s have had a less problematic effect on the mortgage business of universal banks in comparison with mortgage banks and Bausparkassen.

5-3. THE ~~~~~~~~EME~T OF INSTITUTIONAL COMPETITION FOR HOUSING FINANCE

Recent changes in the mortgage Iending shares of West German financial institutions are given in Table 5. Mortgage banks have clearly been the main losers; from being the largest investors in mortgage loans, with a share of 36% of outstanding mortgage loans in 1970, their share fell to 25% in 1983. In nominal terms, however, mortgage banks continued to expand, Bausparkassen have more or less been able to retain their share in housing loans, whereas savings banks lost only slightly and became the largest type of mortgage lender due to the substantial decline of mortgage banks,

The market shares that mortgage banks lost were gains for the commercial banks and credit co-ops of about 5% each, Amongst the commercial banks, the gain was mainly taken by the big three, which had entered housing finance by acquiring majority shares in private mortgage banks. Commercial banks had been buying the shares of the private mortgage banks from the 1950s onwards, and by 1969 they held 25% or more of the shares of all but one. Seven commercial banks had majority shares in mortgage banks, but none of them were the three big banks. This changed quickly, as in 1970 the big banks started to exchange between themselves their shares in private mortgage banks in order to gain control over a number of them (VPH, 1978). In the contemporary West German press, this process was dubbed as the mortgage bank carousel. As a result, the Deutsche Bank acquired majority shares in the largest and fourth largest private mortgage banks, the Commer~bank in the third hugest, and the Dresdner 3ank in the three smaller ones (DLK, 1979).

The purchase of mortgage banks proved very profitable for commerciaf banks,

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Mortgage finance and Owner Occupation 229

particularly for the big three, even though the growth of mortgage banks in the 1970s was less spectacular than in the two previous decades. Ownership of private mortgage banks enabled commercial banks to develop the ‘finance out of one hand’ scheme. In this scheme, full mortgage packages were offered to customers, in which first mortgages were provided by mortgage banks, topped up by loans from the reievant commercial bank. Commercial banks, therefore, not only profited from the business of the mortgage banks they owned, but also developed a direct role in housing finance.

Co-operative banks increased their share in mortgage lending in a similar way to commercial banks. Their central bank, the Deutsche Genossenschaftsbank, became the full owner of the second largest private mortgage bank and also controlled a smaller one. A close business co-operation was also set up with one of the largest private Bausparkassen, Schwabisch Hall AC, in which the central co-operative bank is a major shareholder. So, since the early 197Os, full mortgage packages have been offered by all the branches of the co-op banking sector.

Offering full housing finance services under one roof was first practised by the public banking sector via the branch network of savings banks. Mortgage packages were put together from the resources of savings banks, public Bausparkassen and public mortgage banks. But a fundamental transformation of the traditional institutional arrangements of housing finance in West Germany was brought about when commercial banks and credit co-ops started to invest in mortgage loans. Until the late 196Os, mortgage lending was fairly well divided between financial institutions which were specialised in first or second mortgages, and rented or owner-occupied housing. But with the entrance of private universal banks to the mortgage market, housing financial institutions were rearranged around three large financial conglomerates, ie. in the public, the commercial and the co-operative banking sectors. And the business of mortgage banks increasingly became subordinated to the interests of the universal banks that owned them.

The new position of mortgage banks in the 1970s had different effects in the private and public sectors. Private mortgage banks increased their market share, as commercial banks and credit co-ops offered housing loans which complemented and enhanced those offered by mortgage banks. In addition, the branch network of the private universal banks allowed private mortgage banks to switch more lending to individual buyers in a period when corporate housing developers were contracting. Public mortgage banks, on the other hand, had to compete with savings banks because both had specialised in first mortgages, in a situation where savings banks had already a strong presence in the market for owner occupied housing finance. Over the last 15 years, therefore, the fall in market share of the mortgage banks has been due solely to the decline of the public ones.

None of the private Bausparkassen were purchased by commercial banks or credit co-ops. We have not found a sound explanation for this, but a number of factors may have played a role. The 16 private Bausparkassen that are shareholding companies (there are also two private limited companies), are mainly owned by insurance companies, of which ten have a majority share. Also a few banks have some small shares, but the typical relation established between private Bausparkassen and private universal banks is one of co-operation, rather than integration. It may be the case that


the current ownership structure of Bausparkassen was already established before private universal banks became interested in housing finance. Another factor may have been that these universal banks compete directly with Bausparkassen, as both aimed to attract personal savers to fund second mortgages. Mortgage banks, on the other hand, provide private universal banks with complementary, rather than competitive, business (apart from the added advantages of their profits and experience in housing finance). Private Bausparkassen continue to operate quite independently from the institutional structures of the large financial supermarkets that have developed since the beginning of the 1970s. The exceptions, of course, are the public Bausparkassen, which are integrated in the public banking sector and offer complementary housing loans to those of the savings banks.

In summary, during the early 197Os, commercial banks and credit co-ops adopted new strategies in housing finance via acquiring controlling interests in private mortgage banks. The takeovers mark the beginning of a new form of competition between the three types of banking concern. This first phase af institutional restructuring coincided with an unprecedented housebuilding boom (see Fig. 2). The housing boom was fuelled by generous lending conditions offered by banks to speculative housebuilders providing up-market flatted accommodation, which increasingly included owner occupied flats. Both house price inflation and interest rates reached a post-war peak in 1975’4, and this eventually led to a rapidly growing number of unsold dwellings. So the boom turned into a deep slump in 1974. The house building slump coincided with the worst economic depression West Germany had experienced since the Second World War.

5.4. INSTITUTIONAL RESTRUCTURING IN A NEW PHASE

The dominance of universal banks over the mortgage banks they controlled became more prominent during the second half of the 1970s. Before mortgage banks were used as a vehicle to enter the housing finance market; now private universal banks increasingly invaded the traditional lending areas of mortgage banks by curtailing mortgage bank loans to below the allowed 60% of house prices. In periods when universal banks were highly liquid, they aIso provided full mortgage loans themselves. Within the public banking sector, savings banks already dominated the finance of first mortgages, but increased their lending of second mortgages. As a result all universal banks started to offer full mortgage loans themselves, thus reducing their ‘commitment’ to providing loans that are complementary to specialist housing financial institutions. Universal banks not only considered mortgage lending as secure, but also as a very profitable investment in comparison with lending to industry and trade and lending abroad.

The second period of institutional restructuring paralleled the recovery from the mid-1970s housebuilding slump and the following boom in one and two family owner occupied housebuilding and in the so-called ‘Bauherren’ model {a form of private rented housing provision, in which investors are private individuals with a high marginal lax rate). During the same period, however, total housebuilding continued to


decline. The housebuilding boom of the late 1970s was qualitatively different from the previous one in that housing investments became dominated by private individuals rather than by corporate speculative developers.

Another major characteristic of the West German housing market in the late 1970s was an unprecedented house price inflation in comparison with other consumer prices (see Table 2). House price inflation further encouraged the generally held belief that housing finance was a secure investment. This, in turn, gave confidence to financial institutions to increase mortgage advances as a proportion of house prices. Advances of between 60 and 80% of house prices were common, but they even went up to 100%; although mortgages ratios above 80% need to be guaranteed or, more commonly, insured which makes them more expensive.

Competition in mortgage lending increased between the three types of financial concern during the second half of the 1970s. Savings banks, in particular, faced fierce competition from credit co-ops, as both served similar types of customers mainly linked to middle to lower income, one and two family housebuilding. Commercial banks, and particularly the three big banks, on the other hand, operated in more upmarket housing sectors and, as noted above, were the major promoters of the ‘Bauherren’ model. The scheme was offered as an investment to their personal clients, who would otherwise purchase company shares or bonds. Introduction of the ‘Bauherren’ scheme took maximum advantage of the available tax subsidies linked to housebuilding. As a consequence, prices of housing built within the scheme were pushed up to between 25 and 50% above the actual building costs, a rise equivalent to the size of the additional tax subsidies received by personal investors. The ‘Bauherren’ scheme also meant that investors do not need any own capital, which provided banks with the opportunity to lend large sums on units constructed in the ‘Bauherren’ form.

5.5. PROBLEMS OF THE MORTGAGE BANKS

Mortgage banks always face the problem that when interest rates increase, the market value of their bonds falls. In periods of rising interest rates, many bond holders try to sell their existing bond portfolios and reinvest in more recent higher yielding ones. At such times, mortgage banks are caught between investors who want high interest rate bonds and borrowers, who are unwilling to commit themselves to more expensive, fixed interest rate loans. Conversely, when interest rates fall, borrowers have an incentive to redeem their loans prior to the actual redemption date, while investors are less inclined to buy long term bonds for fear of a future rise in interest rates. In order to stay in business, mortgage banks are forced to issue shorter term bonds. The two cycles in interest rate levels in West Germany over the past fifteen years, with peaks in 1973/74 and 1980/81, have, therefore, had substantial effects on the term structure of mortgage bonds. At the beginning of the 1960s about 90% of all bonds issued by mortgage banks had repayment terms of 25 years or more (three quarters were over 35 years). The picture had completely changed by the 1980s with short term bonds now dominating (Table 6).

The interest rate cycle of the late 1970s affected the mortgage business structure of


TABLE 6. Repayment periods of debt papers issued by private mortgate banks (%)

Period (yrs) 1969 1979 1980 1981 1982 1983

1-4 1.4 17.1 31.7 47.3 39.4 43.0 4-8 5.1 47.3 47.9 38.9 42.9 43.0 8-10 0.3 6.4 4.0 2.7 4.8 5.0 10-15 2.4 28.6 16.4 11.1 12.9 9.0 15+ 90.8 0.6 - - - -

Source: VDH (1984).

mortgage banks more than the previous one, because of the changed nature of their clientele. The housebuilding slump of 1974/75 marked the beginning of mortgage banks’ growing involvement in financing individual house buyers. Before, corporate housing developers were their main clients and, despite rising interest rates, mortgage banks were able to expand their investments substantially. But when interest rates increased again in the late 1970s/early 198Os, individual house buyers were less interested in committing themselves to long term high interest rate loans. In other words, interest rate fluctuations have a less direct effect on the demand of corporate developers, than they have on individual house buyers (Heisig, 1980).

Volatile levels of interest rates during the 1970s forced mortgage banks to offer loans with rates that can be adjusted after a number of years. This, plus the reduction of the redemption date of mortgage bonds, has reduced the profit margins of mortgage

banks substantially. First, because overhead costs increase as loans need to be renegotiated more often than in the past. And, second, because when interest rates rise, mortgage banks have to repay holders of outstanding bonds who want to sell - losing funds that only can be replaced by more expensive ones (Franke, 1982). Volatile levels of interest rates, therefore, have given the variable interest rate loans of universal banks a competitive advantage.

5.6. PROBLEMS OF THE BAUSPARKASSEN

Bausparkassen were also weakened during the 1970s but in a different way from mortgage banks, because of their distinct sources of loanable funds. Bausparkassen had to deal with increased competition for personal savings, but from a disadvantaged position since their contract savings interest rates are fixed at a low level, while overall interest rates have risen. State subsidies to their collective savings schemes have not fully compensated for the rise in market interest rates. In fact, from 1974 onwards, income eligibility limits for savings premiums have not been adjusted for inflation, reducing the number of persons attracted to the scheme by the subsidy element. The subsidy premium has also been reduced a number of times since the mid-1970s: most

Mortgege Finance and Owner Uccupatim 233

recentfy in 1982, when it was cut back from 18 to 14% of the saved amount. When market rates of interest were at a peak in 1980-82, the inflow of new contract savings with Bausparkassen feif even in nominal terms and only started to rise again after 1983.

In the closed scheme that Bausparkassen operate, a reduced inflow of savings implies longer waiting periods before loans are allocated. Increased waiting periods reduce the attractiveness of the scheme, because savings cannot be touched for a long period and, yet, have only a low yield. House price inflation, in addition, reduces the share of the house price that households can expect to finance with Bausparkassen ioans. In response to the decline in new savings contracts and increased waiting periods, Bausparkassen expanded their non-collective business. Intermediate loans, offered to their customers to bridge the period until contract loans are allocated, grew considerably, for example. Such loans always have been a major investment for Bausparkassen, but have expanded considerably in recent years. Intermediate loans are financed from money market sources and from the profits from the collective savings scheme, The latter is done in order to reduce cost of such loans, but this is becoming increasingly ineffective, since Bausparkassen are legally restricted in the funds they can take out the collective scheme. The increasing cost of intermediate loans further reduces the competitive position of Bausparkassen, apart from the fact that such loans are also being offered by universal banks.

Bausparkassen contract savings schemes are increasingly being promoted as a method of financing endowment mortgages, in a similar way to schemes offered by insurance companies (both in Britain and West Germany). Savings contracts are also used to repay bank loans, particularly by those who are eligible for savings premiums. Both the endowment mortgage and the loan repayment schemes have been developed in cooperation with universal banks and indicate that the business of Bausparkassen is becoming increasingly linked to these banks.

More than anything, Bausparkassen depend on a growing inflow of funds and, hence, on a dense branch network to be able to attract new personal savers. The public Bausparkassen and the second largest private Bausparkasse, Schw%bisch Hall, can rely on the branches of, respectively, the savings banks and co-op banks. Other private Bausparkassen, however, have been forced to develop links with other financial institutions. Forms of cooperation have particularly been developed with insurance companies: in exchange for allowing private Bausparkassen to use the sales agents of insurance companies, agents and branches of Bausparkassen now sell insurance. At the same time, insurance companies have used private Bausparkassen (most of which they control anyway) to attract personal savings themselves and to gain a major share in the profitable business of intermediate finance. In recent years, insurance companies have stepped up competition with universal banks over personal saving and lending, With the Bausparkassen they control, insurance companies have developed housing finance services ‘under one roof. For example, insured savings plans (as offered by the Deutsche Bank) is a service insurance companies legally cannot offer, but Bausparkassen can. And sales agents of the two types of financial institution are expanding their traditiona activities by, for example, giving clients advice on investments and loans (Ziller, 1985). ,!, I ‘i..,. li


5.7. THE COMPETITION FOR FUNDS FOR MORTGAGE LENDING

Recent developments in the ability of financial institutions to raise loanable funds (known as the refinance potential) are given in Table 7. The table indicates that (i) the relative share of deposits with banks and (even more so) Bausparkassen has declined; (ii) the refinance potential of both banks and mortgage banks has a cyclical behaviour; and (iii) that insurance companies have been able to increase their share of deposit taking steadily and substantially.

TABLE 7. ‘Refinance potential’ of the West German economy

purchase investment of fixed investment

Total investment with interest with investments with Bauspar- rate insurance

DMbn banks kassen papers companies Other

(%) (%) (%) (%) (%)

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982

58.2 66.7 80.2 77.7 85.3

103.8 101.6 99.5

106.0 120.6 120.4 129.1 128.3

50.8 58.3 58.7 50.4 57.4 62.7 50.5 55.5 54.4 42.9 42.2 28.2 46.8

9.2 17.9 8.0 12.2 8.6 13.0

10.9 13.6 6.7 10.7 6.6 8.4 6.5 18.6 6.6 11.5 6.9 8.9 6.5 23.1 5.2 21.1 4.4 37.6 3.7 14.9

13.4 15.2 14.8 16.6 16.3 14.7 16.8 18.9 19.8 19.0 21.1 21.5 24.8

8.7 6.3 4.9 8.5 8.5 7.6 7.6 7.5

10.0 8.5

10.3 8.3 9.8

Source: Benolken (1983), Table 8.

As universal banks have expanded their investments in mortgage lending, retail savings have become more significant in refinancing such long-term loans. The term structure of savings offered to personal investors in West Germany differs substantially from that in Britain, because of the prominence of contractual savings in the West German banking system. While in Britain the vast majority of retail deposits can be withdrawn on demand (or at 7 days notice), in West Germany 80% of such deposits are in long-term (i.e. more than 4 years) savings accounts, certificates or bonds (EAG, 1981). The prominence of long-term funds in West Germany partially results from the encouragement of such schemes by state subsidised savings premiums. Looking at the existence of long-term savings from the perspective of the institution receiving them, the term structure of funds meant that the banks could expand in long- term investments, like housing finance, because banking policies try to match the maturity structure of borrowing and lending. Fluctuating levels of interest rates, however, have led to cyclical movements in the intake of retail deposits of the universal banks, as shown in Table 7.

As noted earlier, the demand for credit in West Germany is highly responsive to interest rate fluctuations: when interest rates rise, borrowers prefer short-term loans, in


the hope of reborrowing when interest rates fall. Interest rate ~uctuations affect the deposit structure of universal banks similarly. When interest rates rise (personal) investors go for higher yields, thereby taking away funds that are locked up in relatively cheap long-term saving schemes. On the other hand, when interest rates fall. investors hold on to the high rate savings. Volatile levels of interest rates have consequently affected the West German banking structure in three ways: (i) profit margins in the banking sector (including those of universal banks) have been squeezed; (ii) interest rates are being pushed up in the long run by financial institutions leap- frogging each other in the competition for these funds; (iii) during the high interest rate periods of 1973/74 and 1980/81, the ‘speculative” behaviour of borrowers and investors lead to an ‘inverse’ structure of interest rates, whereby rates on short-term funds were higher than those on long-term ones (Francke and Hudson, 1984). This phenomenon explains the opposite cyclical movements of the net inflow of bank deposits and fixed interest rate securities in Table 7.

Universal banks are traditionally major purchasers of mortgage bonds, particularly of those issued within their own banking group. But liquidity problems and rising bond yields in the early eighties encouraged banks to sell a large part of their stock in mortgage and communal bonds to insurance companies and personal investors. By the end of 198 1, nearly 40% of the total stock of fixed interest rate securities had been sold and universal banks were the major sellers (Glauner, n.d.). The recent liquidity problems of banks, therefore, have generated a kind of secondary mortgage market in West Germany.

5.8. CONCLUSION: THE NEW COMPLEX WEB OF HOUSING FINANCE

Over the past fifteen years, the housing business of West Germany’s financial institutions have become increasingly interlinked. Interlinkages developed via either formal control over financial institutions or business co-operation, and they have developed for reasons associated with both the asset and the liability sides of housing finance.

In attracting funds, greater competition for personal savers encouraged particularly universal banks and Bausparkassen to expand their branch networks, and to develop links with other financial institutions, including insurance companies. Through the ownership of mortgage banks, universal banks have been able to spread their money raising options; changing the emphasis on particular sources according to the state of the bank’s liquidity and the general levels of retail and wholesale interest rates in comparison with bond yields. Insurance companies expanded their role as buyers of mortgage bonds in the 1980s. This makes insurance companies the third major type of financial institution linked to the mortgage bond market, but one that is outside the sphere of dominance of the universal banks.

Interlinkages between financial institutions in the provision of mortgage loans have led to the ‘housing services under one roof schemes. Such mortgage packages - put together from the resources of several jointly owned financial institutions - are provided by each of the three types of universal bank. Forms of co-operation in


mortgage lending have also developed between independent financial institutions - especially in the fields of intermediate housing loans and endowment mortgages, with co-operative ventures between universal banks, Bausparkassen and insurance companies. Another form of co-operation between independent institutions has been the foundation of companies providing housing related services, like estate agency or housebuilding. Such companies are usually set up locally or regionally. Direct involvement in housebuilding and exchange has become significant since the housebuilding slump of 1973174 and the subsequent increase in one family, owner- occupied housebuilding. The public banking sector, co-op banks and Bausparkassen have been particularly active in diversifying into housebuilding and related housing services: moves made in order to expand their market share of mortgage lending.

Specialised mortgage lending institutions are becoming less specialised. The situation in which the financial circuit of mortgage banks remained separated from the universal banks that control them is gradually dissolving. Current government legislation is indirectly encouraging the dissolution by requiring that mortgage banks’ assets are consolidated with those of the mother bank. The move is designed to strengthen banking controls and is aimed particularly at the foreign branches of the universal banks, which previously have been outside of West German banking controls. The inclusion of the mortgage banks might simply reflect consistency in that they are as much subsidiaries of the commercial banks as are the Luxembourg banks; alternatively, their inclusion could reflect growing official concern over the future fortunes of the West German housing market (although the housing ministry itself did seem to be worried about the growing tide of mortgage defaults). Managers of the mortgage banks, not surprisingly, are strongly opposed to the consolidation measures.

Turning to the Bausparkassen, and particularly the three largest, the major development here has been the expansion of non-collective saving activities in recent years. In the case of the largest private Bausparkasse, Wtistenrot, for example, diversification has led to the setting up of subsidiary companies, which include a bank, an insurance company and several real estate firms.

In summary, by the 1980s all the major financial institutions in West Germany had become involved in mortgage finance, with the business involving increasingly complex interlinkages between them. Although few financial institutions fully depend on housing finance, the size of their involvement in owner occupation has meant that the housing market downturn in the 1980s seriously affected the banking sector in West Germany. This issue will be considered in the final chapter.

CHAPTER 6

Restructuring Mortgage Finance in Britain

6.1. OVERVIEW OF RECENT TRENDS

In this chapter we review some of the most important recent trends in the British mortgage market and then consider in more detail the significance of these changes.

Building societies over the past decade have begun to alter their focus of operations and to introduce new ways of raising income. At the same time, they have been subject to greater competition, both for personal sector savings and in the mortgage market.

TABLE 8. Mortgage lending by principal lenders 1960-84 (percentage share of net advances)

1960 1962 1964 1966 1968 1970 1972

Building societies 63.2 66.7 72.3 88.2 89.1 88.0 80.3 Banks 7.9 7.3 4.6 -3.3 2.6 3.2 12.5 Local authorities 11.1 11.4 16.0 7.1 0.9 5.8 7.2 Insurance companies 17.9 14.7 7.0 7.9 7.4 2.9 0.1

1974 1976 1978 1980 1982 1983 1984

Building societies 64.1 93.5 94.4 81.4 59.1 75.9 85.9 Banks 3.9 2.1 5.1 8.4 36.8 25.3 13.9 Local authorities 24.0 1.7 -0.8 6.4 4.0 -2.2 -1.1 Insurance companies 8.1 2.7 1.4 3.8 (0) 0.9 1.3

Sources: Boddy 1980, BSA Bulletin, Central Statistical Office 1985. Notes: ‘Banks’ includes a small amount of lending by other institutions and from 1978 by the

Trustee Savings Banks. ‘Insurance companies’ includes a small amount of lending by pension funds. The table excludes a small number of ‘other public sector’ lending, mainly by the Housing Corporation and New Towns.

Table 8 shows the market shares of mortgage advances by the various institutions from 1960 to 1984. The table shows that by 1970 building societies lent almost 90% of net funds. Since 1970 building society dominance has been challenged on two occasions. The first, in the early seventies, was caused by the temporary expansion of local authority lending, as noted in Chapter 3. The second challenge has been the enormous expansion of bank lending in the 1980s which is a feature of longer term significance.

237


TABLE 9. Personal sector liquid assets balances outstanding at year end: percentage share

1974 1976 1978 1980 1982 1984

National savings 15.7 14.4 14.6 11.3 15.4 15.7 Local authority debt 0.7 0.4 0.3 0.3 0.1 0.2 Monetary sector 40.0 35.4 31.7 34.8 36.7 33.2 Savings banks 5.4 5.5 5.8 7.1 - - Building societies 38.0 44.0 47.5 46.2 47.6 50.9 Other 0.2 0.2 0.2 0.3 0.1 0.1

Sources: Building Societies Association 1984a, Central Statistical Office 1985. Notes: There arc some minor changes in the composition of the sectors over time, the

main one was the inclusion of the trustee savings banks in the monetary sector after 198 1. The monetary sector includes the banks, the trustee savings banks and some other small institutions.

Building societies have been highly successful in the retail savings market. Table 9 indicates their success showing that the societies expanded their market share at the expense of National Savings and, more recently, the banks. Competition between the banks and the societies for retail funds has been growing for many years. Cleary (1965) reports that in 1948 about 6.7 times as much was held in bank accounts as in building society ones, but by 1963 the ratio was down to about 1.8. In the 1970s the societies finally overtook the banks.

Competition for funds has also been taking place among the societies themselves. Building society managers have energetically pursued growth and the resultant competition has taken a number of forms. First, there has been a remarkable evolution in the variety of savings accounts offered to investors. Until the 1970s most money was invested in ‘ordinary share’ accounts and most societies effectively had only one interest rate and standard withdrawal terms for all investors. Building societies then began to offer favourable interest rates for large, long-term investments by introducing new forms of high interest accounts, which had restrictions on the conditions under which funds could be withdrawn from them. Most societies now have a proliferation of ‘term’ and other accounts (i.e. accounts which earn a higher interest subject to a certain minimum sum being deposited and/or it being deposited for a fixed term).’ As competition has increased (recently the banks have begun to offer such accounts too), the ease with which investors can withdraw money has grown. Much of the hoped for benefit of such price discrimination has consequently been eroded. Term and other high interest accounts are now the main source of investors’ funds. In 1974 ordinary share accounts amounted to over 90% of all accounts; by 1984 they were down to 32%.

Competition has also led to a proliferation of building society branches. In 1962 there were about 1000 branches, by 1972 - 2,500, and by 1982 - almost 6,500 (BSA Bulietin 36). Building societies claim that branches pay for themselves because of the new investment income they bring in. A study by Gough (1982), however, showed that branching is an expensive way of obtaining growth. Again, the costs are passed on to the borrowers. Recently there has been a slackening in branch growth because saturation is being reached and because the societies are developing other sources of funds.


Pressure for growth has led to many building society mergers. The number of societies declined from about 800 in 1953 to only 227 in 1982. The societies argue that economies of scale are the main reason for mergers but the claim is weak. Once beyond a fairly small size, there are few economies of scale in the building society movement. Yet, the largest societies are monster organisations with assets of over g4,OOO million each - and virtually all societies want to keep on expanding. Given the non-profit nature of the societies, the desire for expansion can only be explained in terms of the objectives of senior management and the benefits they personally derive from expansion (Gough, 1982; Ball, 1983; Barnes, 1984).

Most building society assets are now in the hands of a few of the largest societies. In 1983,56% of the movement’s total assets were held by the largest 5 and 73% by the largest 10. At the other extreme were 170 societies with only 7% of all assets (BSA 1984a). Great pressure is being felt by the medium sized societies which are often too small to compete effectively with the giants. Several medium societies are seeking to merge with other similar ones or to take over smaller societies in order to join the big league (B&t Bulletin 36). There has been much criticism of mergers which have been pushed through with little or no opportunity for members of the societies to obtain a clear picture of the costs and benefits involved (Barnes, 1984).

In 1981, to the immense shock of the societies, the banks expanded their mortgage lending: taking over a 20% share of net advances and about 36% in 1982 (see Table 8). The effect was to accelerate the pressures that already existed for change in the building society movement. The societies’ short-run responses to the challenge of the banks (and to the contemporaneous decision of the government to increase the competitiveness of National Savings schemes) was to alter their mortgage terms and conditions. Longer-term, the entry of the banks into the mortgage market spurred the larger societies along the path towards becoming multi-purpose financial institutions.

Key events in these changes include a series of influential reports produced by the BSA proposing a restructuring of the societies’ constitutions and powers and an opening up of their ability to tap the wholesale money markets.2 There have also been a wide range of innovations in building society services: for example, cash dispensers, cheque books, and travel money facilities. In 1983, the government allowed the larger societies to issue Certificates of Deposit (short term, high value paper) on which the interest could be paid gross rather than net of tax, so opening up access to wholesale funds. These funds soon came to assume significant levels (even up to 50% of net inflows of funds in some months, although considerably less on average).

6.2. TOWARDS THE FINANCIAL SUPERMARKET - A COMMON TREND?

Contemporary trends in Britain superficially mirror those in West Germany a decade earlier. The traditional institutional specialisation of house mortgage finance is gradually disappearing to be replaced by financial supermarkets, where a whole range of general financial services are sold under one roof. Like West Germany, three different types of institution are making a bid for dominance in general retail banking. The three are distinguished by both their ownership and management philosophies:


the high street clearing banks, the building societies, and a belated but rapidly growing, savings bank movement. As the names of the three groups imply there has been, like in West Germany, a gradual breakdown of sectorally specialist financial institutions into broader competition between banking groups. The process is far from complete. Some commentators (e.g. Fforde, 1983) forecast the emergence of only a handful of giant financial conglomerates over the next decade. But, because of differences in origins, management philosophies and operating criteria, it is unlikely that the giant financial institutions of the future will be identical in all their characteristics.

A number of features leading to the movement towards financial supermarkets are common in the two countries.

In part, financial deregulation has spurred on the development of the financial supermarket. Deregulation has also taken place in ‘wholesale’ markets for financial assets - traditional divisions between stockbrokers, jobbers, merchant banks, and clearing banks are rapidly disappearing (Coakley and Harris, 1983; Rybczynski, 1984). Along with other financial institutions, especially from the U.S.A., British clearing banks are moving into wholesale areas previously denied them, as well as widening their retail activities. Soon, British clearing banks will be able to undertake all the functions of a West German universal bank, and more.

New technology, especially computerisation, is making some traditional banking divisions redundant. Once point-of-sale electronic debiting systems begin to replace cheques as the principal means of consumer payments, for instance, cheque clearing systems will no longer represent an insuperable barrier-to-entry to the retail banking sector. More mundane computerisation has made it possible for financial institutions to reduce considerably the administrative effort associated with their traditional activities. Building societies, for example, are now able to adjust mortgage interest rates quicker and cheaper, as mortgagees are now informed of their new repayments by computer print-out, instead of by labour-intensive clerical processes.

Declines in traditional areas of business have also played their part. Like their West German counterparts, British clearing banks have become more interested in retail banking with the fall in profitability of British industry since the mid-1960s. In the 198Os, foreign debt also proved a headache, with some of the British clearing banks heavily involved in third-world debt. All the major British clearing banks in the early 1980s tried to enter the U.S. banking scene with the onset of financial deregulation there. None have been successful, and the Midland Bank is still suffering badly from the disastrous takeover of the Californian Cracker Bank. The attractiveness of retail banking in Britain for the clearing banks and others, however, has been tempered by London’s booming role in world money markets - especially as the leading Eurodollar centre. London’s success, in fact, has drawn business away from other European financial centres, like Frankfurt. Recently, in 1985, one of West Germany’s big 3 universal banks announced the movement of all its foreign business to its London subsidiary, much to the consternation of the West German government.

For the British clearing banks, in summary, the last decade has been one of tumultuous change, the end results of which are far from certain. The two areas where they may come into conflict with the building societies, namely retail savings and

Mortgage Finance and Owner Occupation 24f

mortgage lending, are only two possible avenues of diversification among many. Retail savings and mortgage lending are not the central aspects of clearing banks’ development strategies, as inevitably they are for the building societies. The banks intervene there when they see profitable opportunities which do not absorb much managerial effort. This, along with the traditional focuses of large British banks, explains their often muted and ever changing response to competition with the building societies. It is possible to detect parallels here with the West German universal banks, who, despite the takeover of mortgage banks and the expansion of their retail activities, have not generally been the most aggressive operators in the retail market, except when alternative activities are at a low ebb. Instead, they have tended to follow rather than lead the innovations and practices of the savings and cooperative banking groups.

One area of declining lending activity which hardly affected British financial institutions was the rundown of council housebuilding. As we have seen, the fall in social housebuilding in West Germany badly hit the mortgage banks, especially the public ones. In Britain, council housing debt is consolidated into general local government debt, and then sold on the general money market. Consequently, no financial intermediary intervenes in the process of funding council housebuilding, so no financial institution lost business when council housing was rundown: while those holding council housing related debt could easily switch to other financial assets.

6.3. GREATER INTENSITY OF COMPETITION

Over the past 5 years there has been greatly increased competition in savings, mortgage and financial services markets in Britain. Some of the additional competition was highlighted earlier - in particular, a resurgence of a vigorous, government run national savings scheme, an aggressive expansion of mortgage lending by the savings and clearing banks, and the breakdown after over 40 years of the building societies’ interest rate faing cartel. On the minus side, insurance companies have virtually withdrawn from being independent providers of mortgages, as have local authorities (see Chapter 3) and the clearing banks have been ambivalent in their competitive stance.

Intensified competition in Britain’s retail savings and mortgage markets could be put down either to the revolutionary impact of information technology or to slumbering giants - such as the clearing banks and the state - wakening up to the activities of the building societies. Both elements are essential for a general explanation of the changes currently taking place. Government policy with respect to taxation and the revision of building society legislation is also important. We would argue, however, that their roles are structured by developments within the building society movement itself and the movement’s relationship to the owner-occupied housing market. New technology can be applied in a variety of ways, sleeping giants have to be woken and governments can be prodded in particular directions. On all counts, contradictory pressures on the building societies have been the stimulus.


6.4. PRESSURES ON THE BUILDING SOCIETIES

Problems faced by building societies over the past decade have principally been linked to their desire for expansion and their sole involvement in the owner-occupied market.

Throughout the post-war years, up to the mid-1970s building societies expanded rapidly in a sheltered environment. It is the breakdown of this environment, induced predominantly by the societies own success, which is helping to cause the restructuring of mortgage finance in the 1980s. Most of the sheltered environment has already been described, but it is worth drawing together the main items again. With the post-war growth of owner occupation, the demand for mortgages was high, and few other financial institutions were interested in providing them. Funds to finance mortgages were relatively easy for the societies to come by. The absolute pool of personal sector savings rose from the 1950s onwards with higher incomes, maturing insurance policies and growing equity withdrawal from owner occupation. Building societies also increased their share of the savings pool at the expense of the public sector national savings scheme, with the tacit acquiescence of successive governments. Competition between the societies was limited by their interest rate fixing cartel, but they did compete vigorously through other means: branch offices, for instance, expanded rapidly and extensive advertising helped to draw in investors. By such means the overall position of the movement against other savings institutions was greatly enhanced. Non-price competition was to the great advantage of the larger societies, because they had more resources and could spread the costs over a larger turnover. Over time, mergers converted the societies from predominantly regional institutions into national organisations.

The mid-1970s must have come as a considerable shock to the building societies. Owner occupation stopped growing for the first time since the 1920s if the war years are discounted. The ‘golden cow’ to borrow the West German phrase, looked like it might go dry. The rate of increase in owner occupation was tailing off, as inevitably it must once owner occupation becomes the tenure of a large proportion of the population. House price inflation and an increased rate of transactions might have compensated for the decline. But, outweighing these factors, in the 1970s the British owner-occupied housing market after years of steady growth entered its now familiar cycle of boom and slump. As Table 10 shows, the real value of outstanding mortgage debt in Britain actuallyfell between 1974 and 1980, despite intervening transactions and house price booms in the mid and late 197Os, respectively. The societies were able to stave off some of the effects of the decline by increasing their share of the mortgage market. Overall the societies recorded a small increase in their real mortgage business. Pronouncements of ‘record years’ had become dependent solely on inflation, and once interest rates were adjusted to the new inflationary environment (real rates were negative throughout the late seventies), the weakness of the owner-occupied market could spell disaster for the societies.

Inflows of investors’ funds were also becoming more volatile. Interest rates in general varied more sharply and the societies did not have the means to respond quickly. In part, the greater volatility of building society income was caused by


TABLE 10. Building societies: societies, branches and assets

243

NUMBER OF SOCIETIES 1900 1930 1940 1950 1960 1970 1980 1985 2.286 1.026 952 819 726 481 273 167 ~JMBER OF BRANCHES 1968 1970 1972 1974 1976 1,662 2,016 2,552 3,099 3,696 NUMBER OF BORRO WERS (million) I940 1950 1960 1970 1975 1,503 I.508 2.349 3,655 4,397 TOTAL ASSETS [fm.j 1940 1960 1970 1975 1980 756 3.166 10,819 24,204 53,793 MORTGAGES OUTSTANDZNG (sm.) 1960 1970 1973 1975 1977

Actual 2,647 8,752 14,532 18,802 26,427

Deflated to 1975 orices [deflator RPZJ 1,272 . 16,207 21Ji2” 18,802. 19,590 YO of building society assets held in 1981 by: Top 2 Top 5 Top 10 35 55 71

1978 1980 4.595 5,716

198 1 1983 5,484 5,928

1983 1984 85,868 102,689

1979 1981

36,801 48,854

22,900 22,400

1982 1984 6,480 6,816

1984 6,314

1983 1984

67,490 81,882

27,148 31,384

Source: BSA Bulletin, Wilson Committee (1980), BSA (1981).

fluctuations in the housing market, with the volume of equity withdrawal being influenced by housing market cycles (as explained in Chapter 4). In order to continue raising their share of personal sector savings, furthermore, societies were coming increasingly into competition with the clearing banks and had to be able to offer better terms than them. Overall, the societies’ interest rate balancing act between the rate they pay investors and the rate they charge on mortgages was becoming more difficult. If rates were set too low, a mortgage famine would result, and if too high, a glut of funds could result with nowhere to lend them. Variations in liquidity ratios could absorb some of the fluctuations, but the ‘feast and famine’ syndrome was not good for expansion.

In response to the changed circumstances, the societies adopted a variety of strategies in the late 197Os/early 1980s some of which were put into practice immediately and others which are only now being implemented. Before discussing them in detail, it is worth noting that since 1982 the societies have been operating in extremely favourable circumstances. First, against expectations, the owner occupied housing market boomed from 1983 to 1985 and real house prices rose significantly. Second, the Conservative government embarked in 1979 on a policy of council house sales at substantial discounts. Over half a million local authority dwellings have been sold and many tenant purchasers have taken out mortgages with building societies.3 Financially pressed councils have also transferred some of their outstanding mortgage loans to owner occupiers to the societies (Guardian, 28.8.82). As a result, the societies have faced strong demand for mortgages; a demand hardly abated by high real interest rates. In real terms, outstanding mortgages with the societies rose by 47% between 1980 and 1984. The societies could not have a better environment within which to


develop their new strategies. Less optimistically, the boom has managed to hide some of the inherent weaknesses and inconsistencies in their plans.

6.5. A NEW REGIME OF HIGH INTEREST RATES

To stabilise the inflow of investors’ receipts, building societies in the late 1970s started to offer interest rate premia on accounts where larger sums were tied up for defined time periods: term shares. Later innovations and competition between the societies for funds extended the premia to a large proportion of investors’ funds, as restrictions were gradually competed away. As noted earlier, by 1985, a wide variety of schemes existed with varying interest rate differentials - each society having slightly different terms from the others. Some of the higher interest rate commitments made by building societies are quite long-term. If interest rates fall, the proportionate effect of guaranteed premia rise sharply and building societies could find selling mortgages at commensurate interest rates difficult.

Competition between building societies has tended to bid up the terms and rates offered to investors. If any society fails to match the latest high rate scheme of another it will rapidly lose investment funds. For this reason, it is difficult for any one society to cut investors’ rates unless all others do so at the same time, even if a weakening demand for mortgage funds would suggest a reduction was opportune. Since the late 1970s an upward bias in investors’ rates has gradually become ingrained in the building society movement.

To fund the higher rates offered to investors, building societies have raised the relative level of mortgage interest rates. Gross building society mortgage rates have always been relatively high (Ball, 1983), but tax reliefs have still made them attractive to home owners. A noticeable upward drift in mortgage interest rates has nonetheless occurred since the introduction of higher rates to investors. The ideal approach to mortgage interest rates for a building society is to impose differential rates on particular types of mortgage (e.g. size of loan, type of dwelling, whether or not linked to an insurance scheme, first year penalty, etc). They enable market discrimination to be exercised, and avoid the need to adjust the politically sensitive ‘basic’ rate. The use of interest rate differentials increased considerably in the second half of the 1970s. Differentials, however, are possible only in the absence of strong competition in the mortgage market, otherwise competitors can syphon off the mortgages subject to higher rates by offering improved terms. During market downturns and periods of intensified competition, differentials disappear, as in 1980-81 and 1985, only to re- emerge during the next market upturn.

Apart from interest rate differentials, the only option building societies have is to raise the basic mortgage rate. Although the interest rate cartel is formally abolished, the average mortgage rates of societies tend to remain in line through competitive pressures. But it has been competition in the savings market that has made the running. All building societies’ mortgages interest rates are high because their investors’ rates are high. The societies are caught on a spiral which is difficult to break.


6.6. EFFECTS OF THE HIGHER INTEREST RATE REGIME

Higher relative interest rates on building society mortgages draw other financial institutions into the mortgage market. Their degree of involvement will depend on long-term management strategies, the contemporary profitability of other activities, and the costs of collecting loanable funds and servicing the operation. It is said, for instance, that clearing banks’ administrative overheads only make mortgage lending profitable when general interest rates are high.

Building societies moves to stabilise and increase the inflow of funds, therefore, enabled the entry of others - who could build up a portfolio of mortgage debt, a market presence and administrative network during phases of exceptionally high mortgage rates. A ratchet effect is also likely to operate, given the costs of entry. Once other financial institutions are in the market, they are unlikely to leave again because of the costs associated with entering and leaving the mortgage market - varying the volume of their lending instead.

Extra competitive pressures from other financial institutions have not had any major effect on the building societies so far. The slump in the housing market in 1980- 82 coincided with aggressive mortgage lending by the banks which forced the societies to change some of their lending practices. But the subsequent housing market boom from 1983 to 1985 made it possible for all institutions to lend large volumes, while the banks were at the same time reducing the growth in their net advances to more manageable levels. The building societies claimed to have beaten off the threat of the banks, as the latter’s market share of net advances fell from 1983 onwards. Yet the banks mortgage business in fact continued to expand rapidly; rising by 47% in terms of the real value of mortgages outstanding between 1982 and 1984. Clearing banks’ lending policies have also consolidated on the upper echelons of the housing market (BSA Bulletin, 41). When the housing market next takes a downturn, the extent of the new competition will become apparent. Locked into their high interest cost retail savings, building societies might then find the going rough.

Another effect of high interest rates is that the societies are themselves interested in tapping the wholesale money markets. The societies can now issue certificates of deposit and some have entered the syndicated loan market. One building society in 1985 announced that a syndicate loan had cost 1.5% less than retail funds (~in~n~i~~ Times, 12.6.85), illustrating the extent to which the traditional market for personal savings had risen above general money market rates. At present, the societies can borrow only 5% of their money from the wholesale markets, although the government has promised the societies that legislation will soon enable the proportion to rise to 20%.

6.7. EXPANDING INTO NEW AREAS OF BUSINESS

Owner occupation cannot continually offer the building societies the safe, expanding investment outlet it has in the past. The rate of increase of owner occupation inevitably slows down, unless there are dramatic demographic changes or a sudden


upsurge of stock transfers arising from, say, government council house sales programmes or the abolition of security of tenure in the private rented stock. As fewer transfers from other tenures take place, new entrants to owner occupation become increasingly linked to contemporary rates of new household formation. To use a phrase drawn from the consumer durables literature, owner occupation in Britain has switched from being a ‘new product’ to a ‘replacement’ market - and houses last a long time.

A number of diversification schemes have been mooted. Expansion into other Common Market countries is seen as a long-term aim. Depressed housing markets, intense competition, generally lower interest rates and different legislative frameworks make such a move unlikely; at least in the near future. More probable are moves in the opposite direction, with other European financial institutions moving into the British mortgage market, because of the relatively higher interest rates in Britain and the comparative ease of entry, especially when entry is undertaken in conjunction with an existing British fmancial agency. ABN, the leading Dutch bank, for instance, in 1985 announced mortgage schemes for British owner occupiers in conjunction with a British insurance broker (Financial Times, 18.5.85).

Domestic opportunities for the societies are considerable. Additional loan business can be generated through property development and general consumer lending. A number of societies have already been involved in schemes of housing to rent. Lending on terms unsecured by real property, and investments in the money markets, in particular, could become major parts of the societies’ future business. Current government reforms will enable up to 46% of societies’ loans and other investments to be outside of their traditional areas of business (Ball et al., 1984).

New areas of lending, of course, are not the only options for building societies. They are currently engaged in attempts to enter estate agency, conveyancing, and other services associated with house purchase. With an extensive chain of high street branches, the largest societies could easily diversify into a variety of consumer related activities from retail banking through to travel agencies and so on. A spin-off from diversifying into non-lending activities is that the profits achieved can be added to the societies’ reserves - increasing the volume of loans that can be made at prudent reserve ratios.

All such diversification attempts threaten the traditional business activities of powerful vested interests. Banks, solicitors, estate agents and surveyors are a few of those who will respond vigorously to any attempts by the societies to tread on their traditional areas of business. All of the proposed areas of diversi~cation are also inherently more risky than lending on house purchase has been in the past.

6.8. SETTING THE SCENE FOR MAJOR INSTITUTIONAL RESTRUCTURING?

Current changes in mortgage finance in Britain have been relatively short-lived. They only began in earnest in the 198Os, and the resulting institutional shakeout has yet to occur. Some substantial institutional changes could take place once the housing market turns down.


Life in the building society movement has become more risky, and it could get worse. Building societies, through a competitive bidding for savings funds, have locked themselves into a high-interest rate regime, which cannot be sustained once the current resurgence in mortgage demand tails off. Potential new areas of business, moreover, are more risky. So the movement might be subject to a substantial institutional change over the next five years. Mergers and rescues could lead to an even more concentrated movement in the future.

Most of the diversifications open to building societies and the ones that will be made possible by the forthcoming Iegislation - especially the move towards general financial services - are feasible only for the largest societies. Yet, all are caught up in the dilemmas of limited mortgage markets and a high cost of retail savings. The weakest societies, therefore, not surprisingfy are the medium-sized and smalfer ones4

A merger movement of general banks and mortgage finance institution in Britain could well be likely in the late 1980s/eariy 1990s as occurred in West Germany in the 1970s. In future the advantage of being a friendly society will be much less for any individual building society. It might be possible that some of the largest societies opt to become incorporated and float a share issue. More likely, perhaps, is that a building society which finds its business in trouble may turn to a corporate ‘white-knight’ rather than another society. Alternatively, a financial institution from outside the building society fold might encourage the management of a medium-sized or smaller society to propose a merger with them. A number of banks are known to be keen on expanding their retail banking business through acquisition of a building society.s In future, building society mergers wiff not be timited to the traditionaIly exclusive building society club. The door to the financial supermarket is beckoning, and there is no guarantee that the societies will end up on top.

6.9. THE RESPONSE OF GOVERNMENT

The British government has woken up only slowly to the revolution in financial markets and its impact on building societies, The Thatcher government has welcomed the increased competition within the movement and from the banks, arguing - in line with their general economic philosophy - that it will make for greater efficiency. Nevertheless, the benefits to owner occupiers are not clear cut, as Chapter 7 argues. In order to increase the ‘fairness’ of competition, a number of changes in the taxation position of the societies and the banks have been made to reduce the advantages of the societies (moves against which the major societies have made no more than token protests, rightly seeing that the parallel changes which have opened up the societies’ role are more beneficial than the taxation adjustments are harmful).

Further changes in the societies’ activities require a new building societies Act, likely to be introduced in 1985/6. Based on a 1984 consultative document (HM Treasury, 1984), it will allow the societies to expand into a whole range of housing and non- housing services (including for example, general consumer loans), to apply a far greater proportion of their funds for non mortgage purposes than in the past, and to further the transformation of building societies into general financial institutions.

248 Progmss in ~~~~~~~9

However, some conff ict is evident in government attitudes towards mortgage finance. While the government has opted for financial liberalisation, there is also a strong commitment to the expansion of owner occupation and to continued state subsidies, especially mortgage interest tax relief. Though the Treasury probably shares the widespread view in the City of London that the privileged treatment of housing finance should be ended, it is po~iti~a~iy unlikely that mortgage interest tax relief will be removed or altered in the near future.

New Iegisfation will still restrict building societies to a greater degree than some of them would like. The legislation is being formulated so that it can be easily revised, with only nominal parliamentary scrutiny if the societies and government feel additiona liberafisation should be required. Given the way in which deregulatory Iegislation and policy changes have tended to lag behind the dynamic of market developments (notable too in the United States especially in recent years, see for example, U.S. President’s Commission on Housing, 1982), it is likely that the government’s policy stance will evolve further in the next few years and in directions now being pursued by the larger societies.

NOTES: CHAPTER 6

1. To illustrate the variation in investment accounts now offered, according to Tke c;Uardian, 13.7.85, Eve main types of account were then available, ranging from the traditional share account [minimum deposit EL, withdrawal on demand, interest rate (tax paid) S.ZS%f to a high interest account ~minimum deposit ~l~,OO~. withdrawal before term subject to interest penalty, interest rate (tax paid) 10.25-10.75%].

2. The principal reports were BSA 1979, 1983, and 1984b. 3. In 1982, building society lending to sitting council tenant purchases was around E700m for the year

(BSA Bulletin, 39). In 1983, it shot up ta approximately E2,OOOm (Ball, 1985); although, in 1984, lending to ex-council tenants tailed off as council house sales began to dwindle.

4. Interestingly, even the smaller of the ‘big five’ societies feel under considerable pressure to amalgamate. Thus, in July 1985, the third and fifth largest societies announced that they planned to merge. It was reported “the reasons for the merger.. . are the need for ‘sheer physical size of financial resources’ for large technological investment and the ability to compete with other societies and financial institutions such as American Banks” (Dibben, 1985). Interestingly, it was admitted that the opportunity for greater economies of scale was nor the main reason for the merger. It was suggested that the three major building societies which would exist after the merger would have a combined share of 51% of the market and “they will be in a strong position to dictate buiiding society interest rates. If.. _ aIt this is essential to viability, what of those lesser societies which cannot join the giants? Tim Melville-Ross (a senior executive of one of the merging societies) forecasts that eventually there will be only 8 or 10 ‘mega-societies’ and a scatte~ng of small local ones. This will make for a few very powerfut individuals who coufd control not only what we pay for our houses but where and how we live” {Rodgers 1985).

5. Stockbrokers, Greenwell, have suggested as obvious bidders, the Standard Chartered Bank, the Bank of Scotland, and Citibank (of the U.S.A.). Quoted in Financial Times, 28.6.85.

CHAPTER 7

The Impact of Mortgage Credit on Owner Occupation

7.1. INTRODUCTION

This concluding chapter will assess the role of mortgage finance institutions on the structures of owner-occupied housing provision in Britain and West Germany.

Two topics will be considered. First, the influence of mortgage finance institutions on the social organisation of owner-occupied housing provision. Important here are the ways in which mortgage institutions have facilitated certain types of provision and closed off others. At issue is the power financial institutions have in the formation and development of a structure of provision, and their resultant ability to influence the distribution of economic gains from owner occupation. The second question is directly related to the first in that it concerns the effects of the organisation of mortgage finance on owner-occupier households, and on those who wish to enter the tenure or are excluded from it.

Mortgage finance in both countries has been changing rapidly. Conclusions made about its role as recently as 5 years ago would not hold today. This dynamic makes the task of evaluating the position of mortgage finance institutions in owner occupation even more difficult than it otherwise would have been. Our comments in this chapter, therefore, are inevitably tentative and speculative.

Two conclusions come out most strongly. Mortgage institutions tend to present an image of passivity in maintaining probity in the face of ever changing market circumstances. Such images are at best only half truths. Obviously mortgage institutions are constrained in the options they have, but they also have been influential in determining the environment in which they operate. This is true both in terms of the degree and forms of competition they face, and in terms of the nature of the owner-occupied housing system in which they operate.

The second conclusion concerns the effect of increased competition between financial institutions in the provision of mortgage finance. More competition is usually argued, in both Britain and West Germany, to be beneficial to consumers. In practice, such statements seemed to be based on ideological faith in the curative powers of competitive markets rather than on the results of a substantive examination of the actual consequences of the ‘liberalisation’ of mortgage finance. The competitive model abstracts from many of the real world conditions in which circuits of mortgage finance exist and function; in particular, it ignores the fact that what is being analysed is a

.:. .‘i,’ I 249


handful of giant financial institutions jockeying for position in retail savings and housing credit markets. Owner occupation for them is not an end in itself but a means through which to expand. Negative consequences for households of the manoeuverings of these institutions are apparent in trends towards higher relative interest rates and over-extended borrowing.

7.2. THE IMPACT OF MORTGAGE INSTITUTIONS ON OWNER OCCUPATION

When the traditional mortgage finance institutions in Britain and West Germany are compared, it is apparent that some of the differences mirror distinctions in the two countries’ respective housing markets, as earlier chapters have noted. While precise effects are difficult to assign, it is probable that the emergence and growth of the current forms of owner-occupied housing provision in the two countries were facilitated by the types of mortgage finance available. Without those types of mortgage instruments and institutions, a very different form of owner occupation might have emerged. In some cases, it is even possible to suggest that the role of mortgage finance institutions was stronger than merely that of creating certain key ground conditions, as the example of Britain illustrates.

During the formation of the contemporary structure of owner-occupied housing provision in Britain, the available evidence points to an active role of building societies in creating the large-scale speculative housebuilders that now dominate owner occupied housebuilding. As non-profit making friendly societies, the building societies were not directly interested in such a speculative activity as private housebuilding. But they did require a mass market of standardised, cheap, easily resaleable houses in which to do mortgage business. Second-hand transactions within owner occupation were of limited importance until the late 1960s and so could not provide the housing market that the rapidly expanding building societies needed, but volume speculative builders could offer a mass market and the societies responded by supporting them. Sometimes, the competitive terms demanded by builders did evoke complaint. Yet, if societies wished to expand, they had little choice but to aid these housebuilders.’

In the inter-war years, building society support for large speculative housebuilders was particularly strong. One contemporary commentator - who was to become a chairman of the Building Societies Association - went so far as to suggest that the societies ‘were drawn off financing the building of houses to let by the . . . much more profitable business of financing house purchase at scarcity prices, mainly for the benefit of the builder-seller’ (quoted in Boddy, 1980, p. 15). The same person also suggested that ‘The profits of house builders and landowners are in many instances unconscionable and responsibility attaches to societies which make them possible. There is a growing danger to our movement, as well as possibility of injury to present home owners, in the reckless extensions of lending for which there is no demand . . . ’ (quoted in Cleary 1965 p.206). Such reckless lending, of course, is not necessarily a thing of the past - the last decade in Britain and West Germany highlights this fact, as we shall show later.

There is nothing conspiratorial in the mutuahy beneficial relation between building

Mortgage Finance and Owner Occupafic3n 251

societies and speculative housebuilders, Both needed the other, and still do. Economic forces dictate a common interest between them over the importance of expansion within the current structure of owner-occupied housing provision. Such communality has been reinforced by the close personal links between building society senior management and other agents in owner-occupied housing provision, especially via overlapping directorships (cf. CDP, 1976).

In their attempts to maintain financial security, building societies have also helped to create a relatively narrow range of dwelling types - among second-hand sales, as well as in new housing. Ziouses not conforming to certain market norms are likely to have a greater variance in their selling prices. For this reason, societies have frowned upon them. As a side effect, the homogenisation of owner occupation presumably encourages people to move up the fairly standardised quality ranges of housing rather than to improve their present dwelling or build their own. Similarly, building societies have been notorious for red-lining certain inner city districts and refusing to lend in them (Boddy, 1980), although they claim to have abolished the practice in recent years. Each of these aspects of building society lending practice has been criticised, and over the years building societies have eased their restrictions, aided by the spur of competition. Yet, ingrained notions of secure lending among building society personnei inevitably remain, and once set the parameters of market behaviour only adjust slowly. Whilst not the only cause, building societies therefore have contributed towards the mediocre design style of British owner-occupied housing, frequent household moves, and the owner-occupied stock’s geographical distribution.

Standardisation is also apparent in the types of household to whom building societies will lend. Secure incomes are emphasised; while both gender and racial discrimination have been pointed out in the past. The increased competition in the mortgage market over recent years may benefit households who, because of their characteristics or those of the dwelling they want to buy, find difficulties obtaining loans from the societies. Building societies’ diversification out of the housing market, however, might reduce the need to be more sympathetic to what they regard as ‘marginal cases’.

As West Germany does not have a single structure of owner-occupied housing provision, it is not possible to describe the role of mortgage finance there in a similar way to Britain. Even so, some clear determining links still operate - some of which we have discussed already, The fortunes of public sector mortgage banks, for instance, have been strongly tied to owner-occupied social housing (as well as to social housing as a whole). The ideology of long savings periods and of minimising debt also corresponds to the role of Bausparkassen and the rapid repayment profiles associated with loans from them.

In contrast to British mortgage finance institutions, the structure of West German mortgage finance encourages individual ‘self-building’. Traditionally, the Bausparkassen have been linked primarily to this form of owner occupation, while others have been willing to lend to the sector. West German mortgage institutions have not encouraged the development of independent large-scale speculative housebuilders and promoters, They have in fact, as Chapter 5 noted, set up their own housing development companies as part of their restru&tu~ng strategies - although


generally the development subsidiaries are relatively small-scale concerns. Rather than encourage volume housebuilders, it might be the case that, if anything,

West German financial institutions have hindered the development of this type of producer. A number of factors point to such a conclusion. As there is no mass housing market in the style of that in Britain, West German mortgage institutions are not forced to come to terms with the volume producers in such a market. It has, in fact, been argued by a number of West German commentators (e.g. Frank, 1981) that mortgage finance institutions have made the most economic gains out of owner occupation.2 Landowners have also prospered with the growth of the tenure. Reliable data on land prices do not exist in West Germany, but informed commentators regard them as high and unresponsive to economic fluctuations. During the long period of post-war prosperity, a plot of land became a safe investment, and little so far has shaken that belief. Squeezed between mortgage institutions and landowners, speculative housebuilders have had little chance to expand.3

With these general comments in mind, the next section will explore some of the consequences of the interlinkages between developments in owner occupation and the restructuring of mortgage finance during the years of mounting general economic crisis in the second half of the 1970s and the subsequent years of economic depression

in the 1980s.

7.3. THE TURN OF THE TIDE

The economic slump of the early 1980s affected owner-occupied housing markets and related financial institutions differently in West Germany and Britain. The prominence of second-hand housing in market transactions in Britain and the sale of council housing enabled building societies to expand housing loans substantially despite a secular decline in housebuilding. In West Germany, conversely, the downturn in owner-occupied housebuilding after 1980 had serious effects for both individual home owners and financial institutions. We shall first look at the situation in West Germany.

Total housing output has declined steadily in West Germany from the mid-1970s onwards. Since then only building for individual homeownership has expanded, and it is now a significant component of total new housing construction. Yet, despite the overall decline in housing output, the value of outstanding mortgage loans more than doubled between 1975 and 1983. The extraordinary growth in housing loans is explained by a combination of factors: (i) an unprecedented level of house price inflation (at least since the Second World War) (ii) an increase in mortgage/house price ratios, caused primarily by the expansion of second mortgage lending; and (iii) a growth in loans to buyers of existing dwellings, which only reached significant proportions during this period. Financial institutions, in part, engineered the expansion in mortgage lending themselves, most obviously via increased maximum possible lending/house price ratios and a relaxed view of the impact of mortgage repayments on disposable incomes.

There are no fixed lending criteria in West Germany to protect either borrowers or


lenders from overcommitting themselves. Financial institutions use rules of thumb. They mainly consider the amount households have left to spend after housing costs are deducted, often taking little notice of other major expenditures. Many home owners, for example, contribute self building, rather than a deposit to the house purchase. Self building may appear cheap, but is not without costs. In addition, financial institutions only tend to consider households’ incomes in relation to housing costs at the time of purchase, thereby not taking full account of the regressive character of the tax depreciation scheme, or of state subsidies in the case of subsidised owner occupied housing. In the late 1970s it was generally expected that personal incomes would continue to rise or, when borrowers defaulted on repayments, that forced house sales would recover the loans.

In the 198Os, it became apparent that an increasing number of owner occupiers had overcommitted themselves and were being forced to sell. Interest rates almost doubled between 1977 and 1981, which raised mortgage costs considerably. By then most housing loans had variable interest rates or short-term fixed rates, so that the cushioning effect of loans made at fixed, long-term interest rates no longer existed. In addition, West German subsidies to owner occupiers are based on notional depreciation costs, which obviously do not offset changes in interest rates in the way that occurs in the British tax relief scheme. In response to higher interest rates, the West German government in 1982 introduced temporarily a form of interest relief tax deduction for home owners. It did not help existing owner occupiers much as the scheme only brings relief for the first three years of purchase. So, during the early 198Os, the spending power of many homeowners was squeezed by rising mortgage payments and stagnating incomes. For some, particularly those at the lower end of the market, owner occupation became unaffordable. Rising unemployment and a growth in marriage break-down also contributed to an increase in forced sales.

There is little information available about the scale of defaults on mortgage payments in West Germany. The only study known to us concerns forced sales of state subsidised housing in North Rhine-Westphalia (Brambring et al., 1983). Some of its findings are summarised in Fig. 3. The table shows that the number of compulsory sale procedures increases during housing market slumps. But, in contrast with the earlier slump of the mid-1970s, the number of dwellings going through the whole process to the point of sale has increased substantially in recent years: from 355 in 1982 to 620 in 1983. Most of the dwellings were bought at the peak of the late-1970s’ house price boom. Compared to other households involved in compulso~ sale procedures, those that actually had to sell contributed relatively little of their own savings, or self building, to the house purchase. To make matters worse for some households, the selling price failed to cover fully the mortgage debt incurred at the time of purchase, due to the subsequent fall in house prices.

Financial institutions must share the blame for the collapse of the owner-occupied housing market. Their lending policies helped to sustain rapid house price inflation in the late 1970s during which time increased house price/income ratios continued to make home ownership feasible. The resultant increase in debt made many owner occupiers far more vulnerable to changes in interest rates (Martens, 1985).

Financial institutions initially tried to hide the phenomenon of widespread mortgage


Procedures

0 In progress

q Cancelled

Carrted out

250

Year

Sources Bramberg c s 1983. table 1

FIG. 3. Number of state subsidised dwellings in compulsory sale procedures in North Rhine Westphalia between 1975 and 1982.

defaults and the resultant losses they incurred. In interviews with us, representatives of financial institutions stressed that losses due to households defaulting on mortgage payments or to forced sales only concerned a very small percentage of their outstanding loans, but they also admitted that the problem was serious and was expected to get worse. For most financial institutions losses have run into tens of millions of Deutchmarks a year. Now more careful lending policies are being followed and mortgages above 7580% of house prices are difficult to obtain. It is expected, however, that sales by existing home owners (forced or not) will continue to increase. In part, this is because economic reconstruction processes have caused changes in geographical employment structures, leading to growth in inter-regional migration.

Mortgage defaults and forced sales have so far mainly affected the lower income end of the housing market, but in the future they are also likely to occur with housing built under the ‘Bauherren’ scheme, much of which has been financed with large, up to lOO%, loans. Under this scheme, the rental income is guaranteed for five years. But investors may face difficulties in finding tenants afterwards and some may be forced to sell. In such cases losses seem unavoidable, as the initial purchase costs are far above likely resale prices.

One major difference between the West German housebuilding slump of the mid- 1970s and the one of the 1980s is that in the former case speculative housebuilders (and in some cases mortgage banks) ended up with large stocks of unsold dwellings. In the 1980s it is mainly individuals who are paying the price of the slump.


In contrast to West Germany, British house prices have, since 1945, risen

255

continuously, at least in nominal terms. But the number of owner occupiers in arrears of mortgage payments has also reached a new peak in recent years. The growth of mortgage arrears largely results from lending policies of financial institutions and from government policies.

Council house sales, for instance, may have extended owner occupation to lower income households, yet the policy also allows for high loan/income ratios - with insufficient consideration of the actual costs of purchase in relation to available income (Doling et al., 1985). Building societies, in addition, have been more generous with mortgage/house price ratios in recent years (BSA Bulletin, passim). First time buyers, in particular, tend to have high loan ratios. Such lending practices mean that more young households with few own savings can be drawn into owner occupation, but individually they incur high loan commitments relative to income. The increasing monotenural nature of British housing provision frequently leaves new households with little alternative than to buy a home at high cost. First time buyers purchasing at the top of a house price boom tend particularly to have high housing costs and low incomes net of mortgage payments (Doling et al., 1985).

Recent increases in mortgage arrears and repossession orders indicate a growing vulnerability of home owners to changing circumstances in income, employment and the costs of debt repayment. Real interest rates are currently extremely high in Britain, “the highest for 150 years” according to the Financial Times (29.1.85). As in West Germany, growing unemployment and an increase in marriage breakdown also contribute to a rise in mortgage defaults. Changing geographical employment patterns may also force home owners to move. In such situations, owner occupiers find it difficult to time sales in order to maximise the money gains resulting from house price inflation, which would otherwise help to cover the costs of moving and buying another dwelling.

NOTES: CHAPTER 7

1. At the 1930 Association conference, one building society representative claimed that “the greatest menace which the movement has to face today . . . [is the] building syndicates, which . . . [hold] a pistol to our heads . . . ” quoted in Cleary (1965) p.205.

2. In France, it has also been suggested that financial institutions have dominated the pattern of change in owner occupation, especially the decline of the large promoter. See Topaiov (1981, 1985).

3. Hallett (1977) adds a note of caution to this argument. First, he points out that local authorities in West Germany have been substantial owners of the land used for post-war housebuilding. He suggests that cities with populations over half a million still own between 50 and 23% of the undeveloped land; much of the rest is owned by housing associations, churches and other charities which do not operate on standard land market criteria. He was not specifically concerned with development land used for owner-occupied housing, and this land may frequently involve different ownership relations. With self-building, for instance, the intending owner acquires the land plot, and the site may be derived from an inheritance, already owned agricultural land or informal networks rather than the anonymous ‘land market’.

Hallett (1977) also suggests that in West Germany, as in Britain, the prevalent perception of high land prices may be exaggerated. For social housing, he estimates that land costs have never represented more than 8% of total costs during the time of the Federal Republic. Prices could be higher for owner occupation, but there is no reason to expect the general level to be much greater, given the rural location of much of owner-occupied housing.

CHAPTER 8

Conclusions

Owner-occupied housing markets in both West Germany and Britain have become increasingly unstable, with housebuilding booms followed by slumps and similar, though not necessarily contemporanious, movements in house prices. In both countries, the financial institutions active in the mortgage market have contributed to creating and exacerbating the instability with, as we have seen, serious consequences for many owner occupiers.

It is generally believed that greater competition between financial institutions creates more choice for the housing consumer, because it generates easier access to mortgages and to personal investment facilities. But there is another side to the coin, as has become apparent in West Germany. There financial institutions were restructured around a few large financial conglomerates which now offer a wide range of financial services and incorporate different sources of funding for mortgages. These financial institutions compete fiercely for both mortgage loans and retail funds. But, for the consumer, a result of the increased competition has been relatively higher interest rates, raised in order to cover the costs of the attractive savings schemes offered to investors and the burden of an extensive branch network.

In addition, specialised mortgage institutions are becoming (in Britain), or have become (in West Germany), increasingly de-specialised; either because they have been incorporated into a universal banking system, as happened to West Germany’s mortgage banks, or via diversification, as the large Bausparkassen and building societies are undertaking. De-specialisation implies that mortgage finance institutions are less dependent on lending to housebuyers. When the housing market booms financial institutions compete vigorously in this profitable investment area. Such competition, however, generates substantial secondary effects on the housing market.

Increased competition and easier access to mortgage loans have not extended the opportunities of lower income households to become home owners, but instead have made it worse for them. This has occurred partially through secondary effects in the housing market, such as much higher house prices, and partially via the upward trend in indebtedness and the costs of mortgage loans; where, for instance, the cushioning and stabilising effect of long-term fixed interest rate loans has virtually disappeared in West Germany.

The overall consequences of the process of institutional restructuring of mortgage

256


finance in Britain is less clear than in West Germany, as the process started more recently. Some trends, however, are quite similar, The competition for personal savings and mortgage loans has increased in recent years, not only between financial institutions with different circuits of finance, but also between the traditional mortgage lenders, the building societies. Interest rates have increased substantially and an easier availability of mortgages has pushed up mortgage/house price ratios. As in West Germany, mortgage defaults have grown, which points to a decrease in the affordability of owner occupation in the current period. House prices in Britain have not fallen in nominal terms as in West Germany, but house price deflation cannot be excluded as a possible feature of the future (Bali, 1985).

From the perspective of the financial institutions involved, our comparative analysis has shown a major common trend in Britain and West Germany. There has been a greater involvement of a widening range of financial institutions in owner-occupied mortgage finance. In part, as we have seen, this growth has resulted from developments in financial markets in general and through quests for new markets to replace stagnating or saturated traditional spheres of operation. Consumer spending patterns have also helped, with a growing significance of homeownership in many household budgets.

Once committed to long-term mortgage lending, however, all financial institutions become directly affected by the volatility of the owner-occupied market. Downturns in that market may soon start to affect overall profitability in the retail finance sector. Although data is difficult to come by, such downturns are likely to have a considerable impact on the profitability of West German banks (Owen-Smith, 1983). In Britain, the owner-occupied market has not experienced a slump similar to that in West Germany. But some British financial institutions, at present, may not have the depth, diversification and financial muscle to survive a severe housing market downturn. The obviously weak candidates are the overly-ambitious building societies. Yet, paradoxically, at a time when the building societies are at potentially their weakest, legislative safeguards on prudent behaviour by them is being considerably watered down by the Thatcher government (HM Treasury, 1984).

We do not believe that the supply of mortgage credit has an overwhelming influence on the development of owner-occupied housing provision, as perhaps some extreme monetarist style explanations would suggest. Mortgage credit is essentially a facilitator of other processes associated with owner occupation, enabling households with constrained incomes to fund purchase of costly housing. Yet, as a facilitator, mortgage finance can still have substantial effects - house price booms, for instance, can get underway more easily with a ready supply of mortgage credit. What seems clear to us is that, while the situations in both countries are very different, the contemporary restructuring of mortgage credit in both Britain and West Germany is not benefitting the future development of owner occupation (and, hence, of housing provision in general). The negative consequences arise directly through the cost of mortgage finance and indirectly via notable adverse effects on housing markets and households and institutions operating there. Such adverse trends in systems of mortgage credit have been ignored in much housing debate. Whether they like it or not, politicians will most probably hear a lot more of them in the future.

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Mortgage finance and owner occupation in Britain and West Germany

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