On the face of it, the UK housing market should have been through a pretty tough period in the last few years.
Affordability has been squeezed by the higher cost of living and interest rates. There have been headline grabbing moments, such as the drawing up of the mortgage charter in 2023.
There was more bad news last week. In June, UK house prices dropped 0.8%, the most in any single month for more than two years, Nationwide’s house price survey revealed, after an increase in stamp duty in April.
Meanwhile, perhaps an apparent contradiction, the RMBS market has come through pretty much unscathed, as has most of the broader mortgage market. There are some lingering risks, but with rates falling it is likely that the worst of the challenges are in the past.
There is definite optimism in the securitization primary market - spreads are near post crisis tights for some RMBS assets with strong demand on show across the board.
Regulators might be tempted to pat themselves on the back that the mortgage and housing markets were able to absorb such a nasty rates shock. There’ has been no surge in foreclosures and only a small rise in arrears. Even that appears to have peaked, UK Finance data suggests.
Don’t get complacent
However, the real lessons are perhaps more nuanced. For one thing, the shock to the market could have been far worse. Inflation has been high, but unemployment has remained low hence wage growth has been strong.
That has allowed a real terms fall in house prices while nominal prices have been stagnant. As a result, borrowers’ equity has been protected and affordability challenges have been somewhat mitigated. That is about as good of an outcome as was possible in the face of such a shock.
It is certainly possible to contend that the current rules protect the housing market from medium sized shocks, but don’t rule out the possibility for a more significant shock particularly if unemployment rose sharply.
The 5.15% jump in rates in such a short space of time was certainly towards or beyond the upper end of much mortgage stress testing. In that regard the regulator should perhaps count itself lucky and take a lesson that rates can move much violently than many allowed for.
Stability of the graveyard
In addition, as with all rule making, there is a question of how far to go. Reviewing the last decade, innovation has been minimal. Most UK mortgage products are no more than a variation on the two and five year fix.
Some lenders are venturing into later life and second lien lending, while others are making progress with Sharia compliant products, but those remain small sectors – if overrepresented in the RMBS market.
It is a live issue, with the Financial Conduct Authority running a consultation on the future of the mortgage market, open until September 19. The regulator does seem keen to make changes.
“We want to evolve our mortgage rules to help more people access sustainable home ownership,” said a statement on the consultation from David Geale, the FCA's executive director for payments and digital finance. “Having achieved higher standards in the market, now is the time to consider allowing more flexibility in a trusted market.”
It should think carefully about how to do that and it isn’t necessarily about regulating defaults out of existence. Protecting vulnerable borrowers and systemic stability are crucial, but it is also important to allow space for innovation to access underserved borrowers.
In that respect, the progress in Sharia-compliant lending is positive.
The FCA consultation is keen to specifically address the regulation around later life lending. It is an area that needs tight regulation due to the vulnerability of the borrowers, but many see such lending as crucial to making up a retirement funding gap.
Longer term fixed rate products, which protect borrowers from rate shocks, are worth exploring too. Given the inbuilt protections, this is one area where the 4.5 times loan to income cap and other interest rate stress testing could be relaxed.
On the systemic risk side, it is beyond the scope of this consultation, but securitization could have a role to play in distributing risks to the most efficient holders and away from banks, as has been illustrated by some recent deals.
That is an effective way to achieve the FCA’s ambition of “rebalancing the collective risk appetite in mortgage lending” without exposing systemically important sectors.