Competition in the UK Mortgage Market did not Yield the Expected Boost to Economy - Dissertation Example

?Competition in the UK mortgage market did not yield the expected boost to economy Introduction The inter-relationship between the housing market andthe mortgage sector has the focus of many researchers. Housing is the most complex economic good because of its durability, heterogeneity and sensitivity to the financial and regulatory environment in which it is provided (Rozsavolgyi & Kovacs, 2005). The interplay between these two factors can lead to shocks in housing prices, the financial position of the householders and the economic growth of the country. These sectors can further impact the credit rate channel, the interest rate channel, and also make an impact on residential construction. The UK too experienced housing bubble burst as a reported 37,749 homeowners in the UK lost their homes to the bank between March and June 2008 (Seeking Alpha, 2008). The crisis deepened as banks cut off mortgage lending. Banks and building societies are expected to pay about ?130bn of the emergency borrowing they availed from the Bank of England and the Treasury (Bown, 2011). Rationale for research Traditionally, in most economies, people preferred to remain tenants throughout their life. Changes in lifestyles, education and temptations by the cheap lending rates introduced the concept of becoming house owners. Businessmen in earlier days would tend to invest any extra funds into their business rather than invest in housing (Lawson, 2011). The idea was that this would grow and bring in more prosperity and ready cash to be used for personal purposes than invest in dwelling which one never disposes off. Liquidity preference theory states that the more liquid an asset, the more attractive it is an asset as it can be traded easily (Wyatt, 2011). Properties, even in a buoyant market take several weeks to be traded and in a recessionary economy, it may take years. It is less attractive an as investment and the transaction costs are also higher because of the stamp duty and legal fees. Motivation for the study The motivation for the study has arisen from this concept – why did people become interested to invest their savings in dwellings which may appreciate over time but can be of no use to the person who has made the investment? It would also be interesting to evaluate the role that the UK government has played in boosting housing and mortgage of housing in expectation that this would contribute to the growth of the UK economy. Research Aims and Objectives With the objective to determine that competition in the UK mortgage sector did not yield the expected returns and was in fact responsible for the housing bubble, the objectives of the study are: To evaluate the measures that the government took in boosting the housing sector To list the incentives that the government provided to enhance competition in the mortgage market To evaluate the impact of the cheap lending rates in the housing market on the UK economy Literature Review While traditionally building societies were responsible for financing house owners, the concept changed in the 1980s. The business model of the building societies was very simple but as demand intensified, there were queues for mortgages which prompted government intervention (CML, 2004). Competition in the mortgage sector intensified as centralized lenders such as housing corporations entered the market. The UK property bubble was inevitable as the valuations were stretched and lending criteria loosened (Lynn, 2007). Unsecured bad debts and mortgage arrears continued to rise as owners could not keep up payments. The government made attempts in different ways to boost investments in housing. Government intervention in housing finance has always existed in every economy through the creation of special circuits for funding flows (Diamond & Lea, 2000). The idea was that investments in dwellings would enhance the banking and the financial sector which would support the growth of the economy. However, political and market forces have been responsible for eroding the reasons for creating the circuits. People became keen to buy their own properties as the government provided incentives through its Right-to-buy policy and by offering mortgage interest tax relief which cost the UK economy ?1.6bn in 1999-2000 (Appendix A). To cope with the demand in housing loan the subprime lenders entered the market in the 1990s, and non-conforming borrowers came into existence thereby increasing the risks for the lenders and exploiting the consumers (CML, 2004). To stimulate the market the government also introduced the ‘stamp holiday’. Downward pressure on the mortgage rates and an inelastic supply of funds increased the demand for favorably priced mortgage credit (Diamond & Lea, 2000). Further incentives became available as distribution channels for loans and mortgages increased. Gradually banks too entered the mortgage market and although traditionally mortgage applications were evaluated in-branch with face-to-face communication and interviews, over time e-applications became common place. This did attract many people to avail of e-mortgages but the concept was not successful because it was product-oriented and not customer-oriented service process (Coughlan, Macredie & Patel, 2011). Because of the ease of obtaining finance for housing, many subprime loans were taken out by fraudsters, which will never be repaid (BBC News, 2007). The UK government expected to create an expansion in the money supply leading to excess liquidity, thereby boosting the economy (Wyatt, 2011). However, for every action there is an equal and opposite reaction. The demand for property is driven by the availability of credit. As the lending standards were relaxed, the UK economy experienced the largest credit bubble in history. Thus, the literature review suggests that to expand liquidity, to expand the housing sector, the government provided incentives in various forms, which back-fired. The study would hence investigate the economic principles on which the government based its decisions. Methodology This would be a qualitative study where no fresh primary data would be collected. This is because the housing the mortgage sectors are very sensitive and none would be willing to talk about it. Moreover, sufficient facts and published data can be collected from reliable sources. The study would hence be based on secondary search and would include theories in the two sectors under study. Government published data would be sourced on housing loans, mortgages, number of fraud cases reported, the value of bad debts, the impact on economy, if any, in the initial stages and the expected way forward. Through academic journals previous literature would be synthesized and then compared with the government data. The data collected would be categorized, unitized and recognize the relationships between the variables (Saunders et al (2007, p. 479) and because the two sectors. Theories would then be tested to arrive at conclusion. Thus, the first step would be to review literature on the housing sector and the mortgage sector, and then the interplay between the two. This would be done by evaluating the concept in several countries. To recognize relationships, two or three mortgage companies as well as building societies would be selected. The industry shocks would then be evaluated. The research objectives would be tested and conclusion drawn. This process would require segregation of the data collected as vast amount of literature on the subject is available. However, for this study, this research method is considered the most appropriate. While all efforts would be made to collect data from government sources, the outcome is not in the hands of the researcher as government authorities may not be willing to part with sensitive data. Time line for the study The process of study would be followed based on the following time line: 1. Acceptance of proposal 15 days 2. Collection of data from government published sources 30 days 3. Literature Review of theories, and principles 15 days 4. Literature review of experience of other countries 15 days 5. Synthesis of data 10 days 6. Analysis and Conclusion 10 days References: Bown, J. (2011). What will house prices do in 2011? Accessed online 05 May 2011 from http://www.walletpop.co.uk/2011/01/10/what-will-house-prices-do-in-2011/ CML. (2004). The CML Mortgage Market Manifesto: taking the past into the future. The Council of Mortgage Lenders. Accessed online 05 May 2011 from http://www.cml.org.uk/cml/filegrab/pdf_pub_resreps_50full.pdf.pdf?ref=3869 Coughlan, J. Macredie, R.D. & Patel, N. (2011). Understanding the consumption process through in-branch and e-mortgage service channels A first-time buyer perspective. International Journal of Bank Marketing. vol. 29, no. 2, pp. 148-167 Diamond, D.B. & Lea, M.J. (2000). The decline of special circuits in developed country housing finance. Housing Policy Debate, vol. 3, no. 3. Accessed online 05 May 2011 from http://content.knowledgeplex.org/kp2/img/cache/kp/1341.pdf Lawson, D. (2011). Dominic Lawson: Why not have a return to renting? Accessed online 05 May 2011 from http://www.independent.co.uk/opinion/commentators/dominic-lawson/dominic-lawson-why-not-have-a-return-to-renting-2175224.html Lynn, M. (2007). U.K.'s Subprime Crisis May Be Worse Than U.S.'s. Accessed online 05 May 2011 from http://www.bloomberg.com/apps/news?pid=newsarchive&sid=axWmsMHJDjiQ Rozsavolgyi, R. & Kovacs, V. (2005). Housing Subsidies in Hungary: Curse or Blessing? ECFIN COUNTRY FOCUS, vol. 2, no. 18. Accessed online 05 May 2011 from http://ec.europa.eu/economy_finance/publications/publication1361_en.pdf Saunders, M.N.K. Lewis, P. and Thornhill, A. (2007). Research Methods for Business Students, Financial Times Prentice-Hall, Harlow. Seeking Alpha. (2008). U.K. Economy on a Tight Rope: How to Profit. Accessed online 05 May 2011 from http://seekingalpha.com/article/94118-u-k-economy-on-a-tight-rope-how-to-profit Wyatt, J. (2011). Property risk premia and deferment rates. Journal of Property Investment & Finance. vol. 29, no. 3, pp. 323-330 Appendix A Cost of mortgage interest Tax relief Source: CML (2004). Read More