Ten years at the helm: Sir Mervyn and the mortgage market
Published: 19 June 2013 | Author: Bernard Clarke
At the end of June, Sir Mervyn King steps down as governor of the Bank of England, bringing to an end a 10-year tenure that has been one of the most eventful in the Bank's 319-year history.
The outgoing governor’s period at the helm can be divided into two halves, the first characterised by a period of low and stable interest rate and steady economic growth, during which mortgage lending also grew. It was followed by a truly tumultuous period, in which the Bank, along with other key institutions in the UK and around the world, had to contend with financial disruption on a seismic and global scale. In dealing with the financial crisis, the Bank took unprecedented action on a scale that could not have been foreseen a decade ago.
The period of financial turmoil, and the ways in which the authorities have responded to it, have had huge consequence for all areas of economic activity, including mortgage and housing markets. This article looks at what has happened to those markets during Sir Mervyn’s period as governor, and assesses the legacy he leaves, the evolving role of the Bank and the challenges facing his successor, Mark Carney.
Interest rate policy
Before Sir Mervyn became governor in July 2003, he had been appointed the Bank’s chief economist in 1991, having earlier pursued an academic career. He became a non-executive director of the Bank from 1990-91 and deputy governor in 1998.
Sir Mervyn is the only original member to have served an uninterrupted term since the Bank’s monetary policy committee was given operational independence for setting interest rates in one of Gordon Brown’s first acts as chancellor in 1997. Bank rate stood at 3.75% when Sir Mervyn became governor and fluctuated in a range between 3.5% and 5.75% until 2008, when the committee began to cut rates aggressively in response to the financial crisis.
Overall, the governor’s voting record affirms a hawkish reputation on interest rates. On 11 separate occasions – mainly in the spring of 1998, during 2000 and in the summer of 2002 – he was in a minority seeking to increase rates but out-voted by the rest of their colleagues. Twice, in 2001 and 2005, he held out for unchanged rates while the majority voted for a rate cut. Since the onset of the financial crisis in 2008, however, Sir Mervyn has voted more consistently in line with the majority view of committee members.
Gross mortgage lending totalled £277 billion in 2003, but had been growing strongly for a number of years by that stage. In 1998, lending totalled £89 billion, and so had trebled in the five years before Sir Mervyn became governor. It went on to peak at £363 billion in 2007, but fell by more than half over the next two years. It then stabilised between 2009 and 2012 in a narrow annual range of between £135 billion and £144 billion. This year, however, we are predicting an 8% increase in lending, to £156 billion.
The decline in lending from 2008 onwards was driven on the supply side by a combination of a shortage of mortgage funding and the adoption of more risk-averse loan criteria by lenders, and on the demand side by the erosion of housing equity for some borrowers and a collapse in consumer confidence. As well as a fall in the value of lending, there was an even sharper contraction in the number of loans for house purchase, which more than halved from 1.25 million in 2003 to 544,000 last year.
Chart One: Mortgage lending during Mervyn King’s tenure
First-time buyers, remortgaging and buy-to-let
By 2003, affordability problems for first-time buyers were already becoming apparent, and their numbers were beginning to fall from the long-term historical average of around half a million a year. The number of first-time buyers totalled 370,000 in 2003, and continued to fluctuate between around 350,000 and 400,000 for the next few years before falling sharply to 192,000 in 2008. The number of first-time buyers then remained below 200,000 for four years before a modest recovery to 218,000 in 2012.
The contraction in remortgaging has been even more pronounced than the decline in lending for house purchase. The number of borrowers remortgaging had fallen to 316,000 last year, less than a quarter of the total of more than 1.5 million who remortgaged in 2003.
Challenging conditions for home-buyers have contributed to a decline in owner-occupation from 69% of the population in 2003 to 65% today – despite the continuing strong preference by consumers for home-ownership as the tenure of choice.
But the decline is home-ownership has been balanced by the growth of the private rented sector, which expanded from 11% of households in 2003 to 17% by 2011. This growth has been partly funded by the emergence of buy-to-let from the mid to late 1990s. By 2003, the growth of this sector was already well under way, with the number of outstanding loans already totalling more than 400,000 and worth £39 billion. By last year, the number of buy-to-let loans had expanded to 1,450,000, worth £164 billion.
Data on the buy-to-let sector, lending to residential buyers and remortgaging confirm that by 2003 UK housing and mortgage markets had already been growing strongly for a number of years, and affordability problems were becoming apparent, particularly for first-time buyers. One of the unintended consequences of the Bank’s success in delivering an era of low and stable interest rates, which broadly benefited the UK economy, was that buoyancy in housing and mortgage markets persisted.
In 2003, the UK mortgage industry was still operating within a system of self-regulation under the Mortgage Code, introduced by the CML in 1997. Lenders were, however, preparing for the introduction of statutory regulation under the Financial Services Authority (FSA) from November 2004.
In the early years of Sir Mervyn’s tenure as governor, regulation of the UK’s financial sector was overseen by a combination of the Bank, Treasury and the FSA under a tripartite system, subsequently criticised for its failings in the build-up to the financial crisis, which was initially triggered by the collapse in investor confidence in re-packaged US sub-prime mortgages.
Some commentators have criticised the UK authorities, including the Bank, for its initial response to the crisis. The decision of the monetary policy committee to cut the Bank rate from 4.5% to 0.5% was drawn out over five months, for example. But the Bank did introduce a series of measures, including the special liquidity and credit guarantee schemes in 2008, and the asset protection scheme and quantitative easing in 2009, which successfully, if belatedly, underpinned the financial system.
It also helped shape the Banking Act 2009, which amended regulation of bank insolvency and administration. The Bank contributed to the G20 agreement on global standards for bank capital adequacy, stress testing and liquidity as part of the Basel 3 rules. And it helped establish – and now operates – the financial policy committee (FPC), with oversight of macro-prudential policy.
Mervyn King: his tenure divides into two halves. But all the
main measures of mortgage market activity are now lower
than in 2003.
The final years of Sir Mervyn’s tenure as governor have therefore seen a re-engineering of the UK’s regulatory structure, with a split between financial conduct and prudential regulation, and clearer responsibilities for the Bank and the new Financial Conduct Authority, which has emerged from the FSA. With operation of both the FPC and the new Prudential Regulation Authority, the Bank has been given extended powers, and will be a stronger institution. Outside the Treasury, it is now clearly the most powerful institution in controlling, regulating and shaping the UK’s financial system and the wider economy.
In the end, the Bank’s extended toolkit for supporting the UK’s financial system and economy, encompassing quantitative easing, the funding for lending scheme and other measures, has helped avert what might have been an even more damaging financial collapse. After being criticised for its initial response to the crisis, the UK’s approach is now widely acknowledged as finally having delivered the appropriate tools for dealing with the aftermath. The UK is now seen as something of a global leader in the response to the crisis, with the Bank in the vanguard. But it has left the financial system – and the UK economy – on a life support machine.
The future challenge for the Bank – and the incoming governor, Mark Carney – is to continue the process of institutional reform, with the longer term goal of re-establishing a financial system that is appropriately regulated but more market-based and much less dependent on official support.
In his evidence to the Treasury committee in February this year, Mark Carney made clear that he would serve a single five-year term as governor, during which governance of the Bank, re-structuring, succession-planning and other reforms would be a high priority.
In the UK mortgage market, there have been modest signs of recovery since 2012, but there are still major challenges in promoting greater competitiveness, access and wider choice for consumers, while managing borrowers through the transition, over time, to a period of tighter monetary policy and higher interest rates. Both Sir Mervyn King and Mark Carney acknowledge these concerns.
The government’s Help to Buy scheme, for example, is intended to widen access to creditworthy borrowers, whose purchase is delayed by the fact that lenders are primarily offering mortgages at a loan-to-value ratio of 80%. We are keen to help the government devise a scheme that works well for lenders and borrowers, but with a clear exit route – a view shared by Sir Mervyn, and explicitly stated by him last month. We support his longer term goal of the restoration of a healthy mortgage market, with competing lenders, and the need for planning the eventual transition away from Help to Buy while minimising disruption to the market.
We are similarly encouraged by what Mark Carney has said about his approach to managing the tightening of monetary policy, without putting too much pressure on financially stretched households. We support his approach to increasing Bank rate, over time, in steps that can be easily reversed, if necessary. More generally, we welcome the incoming governor’s acknowledgement of the need for transformation and governance reform over the next five years, and we look forward to greater transparency and the opportunity for collaboration with the Bank.