Disarming the 'mortgage timebomb'

Good morning from New Economy Brief.

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The mortgage crisis has dominated the UK news cycle for the last week, but the relationship between inflation, interest rates, and mortgages is not always well understood. 

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In this week’s newsletter we look at the impact of rising rates on mortgages, the political fallout, the solutions being proposed by the main parties and some progressive alternatives, before considering what this all means for the debate about how to tackle inflation.

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Mortgage misery. Last week’s decision by the Bank of England to hike interest rates by 50bps to 5%, the highest since the 2008 financial crash, has sparked a wave of panic in Westminster over what Money Saving Expert Martin Lewis has dubbed the ‘mortgage time-bomb’. It isn’t hard to see why. Mortgage holders who are on tracker products or whose fixed terms are coming to an end face significant increases of hundreds of pounds a month to their interest payments. These increases will intensify the cost of living crisis for millions, and put many families at risk of defaulting on their mortgage.

• A feature, not a bug. The intensification of the cost of living crisis is not a side-effect of the Bank’s actions, it is the intended consequence. Rate-setters continue to argue that high core inflation can only be tackled by removing excess demand from an economy which is ‘running too hot’. According to the theory, there are a number of ways that raising rates reduce inflation such as by encouraging saving, but a core plank of the theory is that rising mortgage costs force homeowners to cut back on other spending, thereby reducing inflationary pressures in the economy. 
• Delayed transmission. The Bank has taken action in response to stubbornly high inflation numbers which have seemed immune to previous interest rate hikes. Part of the reason for this is the structure of the mortgage market itself. Firstly, a large amount of (mainly older) homeowners own their homes outright and do not have mortgages, meaning that they are unaffected by changes to the base rate. (An important statistic comes via the FT’s Sarah O’Connor: in every region of England and Wales bar London, there are more homes owned outright than those owned with mortgages or rented). Of those that do have mortgages, only a small number are on ‘tracker’ products which are sensitive to changes in the base rate set by the Bank of England. The vast majority are on fixed rates deals which typically last between two and five years. Those homeowners unlucky enough to be on trackers or coming to the end of their fixed rates are seeing steep rises to their monthly repayments, but a significant amount of the mortgage pain is yet to be felt as fixed rates insulate many people from rate rises for a time.
• The risk of overshoot. The fact that much of the monetary tightening has yet to work its way through the system is one of the reasons that many have criticised the decision to continue hiking rates, arguing that it risks going too far and causing unnecessary damage and instability. Two members of the Monetary Policy Committee voted against raising interest rates for this reason, and the Bank’s decision has heightened fears of a recession (some commentators have been explicit in their belief that the Bank should be trying to cause a recession in order to tackle inflation). Others have argued that because inflation is being largely caused by supply issues (including the war in Ukraine, bad harvests relating to climate change, and Brexit trade barriers) and corporate profits, efforts to crush inflation by suppressing demand will be ineffective.

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Political fallout. The immediate political fallout has been three-fold. First, Labour have seized on the opportunity to brand the crisis as a ‘Tory mortgage penalty’, sensitive to the fact that middle-aged families with mortgages are exactly the demographic of people that the party hopes to win back from the Conservatives at the next general election. YouGov’s Patrick English has mapped the mortgage crisis and found a significant overlap with the most marginal constituencies in the country, while in the Times, Emma Duncan argues that this could spell the end for Conservative hopes in Barratt Britain (a demographic of northern homeowners largely thought to be responsible for Conservative victories in the ‘Red Wall’). Also sensitive to this fact are Conservative backbenchers in marginal seats who have been calling on the government to do something, anything, to alleviate the pain their constituents are feeling. And remember, the structure of the mortgage market means that the vast majority of homeowners have not yet felt the effects of monetary tightening on the mortgage payments yet, meaning that as millions of fixed rate deals expire between now and a likely general election next year, the political pain of this crisis is only going to intensify.

• Just blame the Bank. Thirdly, the Bank of England has come in for (occasionally contradictory) criticism from the Conservative backbenches, with the Bank being simultaneously accused of having lost control of inflation by being too slow to raise rates, and having caused the mortgage crisis by raising rates too quickly - with the central message being that angry voters should blame Andrew Bailey for their rising mortgage bills, rather than Rishi Sunak and Jeremy Hunt. Some have even gone as far as to question the independence of the Bank of England (although others would argue that the ability to blame the Bank for rising rates is one of the key political motivations for keeping the Bank independent of government).
• It’s hurting, but it’s not working. There are two unfortunate realities for MPs pushing this line however. The first is that the government has inextricably linked itself to the mortgage crisis by pledging to halve inflation this year (a pledge which now looks set to be missed). The second is that, as Jeremy Hunt has set out, the government has absolutely no intention of providing direct support to mortgage holders, arguing that doing so would defeat the object of interest rate rises and therefore prolong the inflation crisis. The logic of the government’s argument about inflation has always been that the cost of living crisis needs to be intensified for many families in order to re-anchor price expectations. It has so far largely avoided making this argument explicitly, and it appears that many of its own MPs are simply unwilling to tell their voters that the pain they are feeling is not just an unfortunate side effect of the fight against inflation - it is the explicit mechanism by which the Bank and the government intend to meet the pledge. In short, a pledge which was intended to ensure the government was rewarded for falling inflation while avoiding the blame for rising interest rates, now looks set to result in the government both suffering the embarrassment of missing its pledge while also becoming the focus for irate mortgage-holders.

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Help for homeowners? Caught between the voters and the pledge on inflation, Chancellor Jeremy Hunt has attempted to walk a difficult line between being seen to respond to the crisis whilst not undermining the government’s central argument on inflation. The result is a ‘mortgage charter’ voluntarily agreed with some of the UK’s main mortgage lenders. The deal involves lenders offering various forms of temporary relief such as short-term switches to interest-only repayments, as well as a longer period between missed payments and forcible home repossession.

• Labour attack. This plan is not enough for Shadow Chancellor Rachel Reeves who has labelled it as a “bad cover version” of Labour’s own plan. The central difference is that Labour would force lenders into offering these forms of relief, as opposed to a voluntary charter.
• The conservative debate on intervention. The package also falls short of the expectations of MPs on Hunt’s own side of the House who are scrambling for solutions, from Cabinet minister Michael Gove suggesting 25 year fixed rate mortgages to Trussite backbenchers Jonathan Gullis and Jake Berry calling for the reintroduction of mortgage tax relief (a scheme introduced by Thatcher’s government in 1983 and later scrapped by Gordon Brown). The tax break is known as a mortgage interest relief at source (Miras), allowing borrowers to claim tax relief for interest payments on their mortgage. However, as the FT’s Stephen Bush points out, this would both cost a lot of money and defeat the purpose of rate rises, making this an unpopular suggestion among the majority Conservative MPs. As Bush highlights, this speaks to a significant ongoing problem for the Conservatives - how to stick to their pledges while assuring vulnerable marginal constituents that they may actually be able to alleviate the cost of living crisis.
• Equity stakes for mortgage relief. An alternative idea comes via a Joseph Rowntree Foundation paper earlier in the year by Toby Lloyd, Rose Grayston and Neal Hudson. They proposed that the government should “provide an exit route” for highly leveraged and low-income homeowners by establishing a new version of the Mortgage Rescue Scheme launched in the wake of the Global Financial Crisis, which would fund social landlords to buy the homes of mortgaged homeowners in distress: “Beneficiaries would see their mortgage debts cancelled by the purchasing social landlord with any negative equity gap funded by the Government, but, as social renters, they would not retain any equity". Having the government take public equity stakes socialises the risk of financial crisis and creates a new kind of tenure: co-ownership between the state and households, where the government receives a stake or income flow.
• ‍Rent controls. Of course, mortgage holders aren’t the only ones feeling the squeeze. A paper for the US Federal Reserve found that higher interest rates also increase housing rents, despite reducing house prices. Renters tend to pay around 30% of their income on rents, much higher than the predictions that mortgage holders will have to pay over 20% of their income as the current crisis unfolds, and many mortgage holders have benefited from the era of ultra low interest rates and rising house prices. In this context, Mayors such as Sadiq Khan and Marvin Rees are calling for powers to implement rent controls alongside any government support for mortgages. 

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Alternative strategies for controlling inflation. Ultimately, the mortgage-timebomb is caused by a combination of high levels of housing debt, and a policy choice of trying to control inflation primarily through interest rate rises. The result is a very big squeeze on one particular cohort of homeowners, which may prove to be politically unsustainable (and economically ineffective).  This also illustrates what UCL IIPP economist Josh Ryan-Collins calls ‘the paradox of contemporary monetary policy’: the tension between the Bank of England’s mandate to maintain both price stability and financial stability. As many commentators are starting to note, monetary tightening is far from the only tool for tackling inflation, and excessive reliance on it leads to political problems because the distribution of the pain is felt so unevenly. So what are the alternatives?

• Taxing those who can afford it. It may be political heresy in some quarters to suggest that taxes could rise, but this is one of the options available to the government to cool demand in a way that avoids penalising those worst affected by the cost of living crisis. Writing in the FT, former MPC member Adam Person suggests “taxes on high income workers, and capital gains, as well as on property”. A paper from IPPR demonstrated how the government can use fiscal policy to stabilise the UK macroeconomy, and, in order to tame inflation, “taxes will need to play a larger role, taking demand out of the economy”.
• Stopping ‘Greedflation’. Politico’s Esther Webber has suggested that “One alternative option would be to go after “greedflation”, where profits outpace costs among suppliers of goods and services, by asking the competition regulator to investigate the scope of the practice. Last year, IPPR’s Carsten Jung and Common Wealth’s Chris Hayes proposed that the Competition and Markets Authority (CMA), launch “pre-emptive investigations into the potential for excess profits in the most concentrated sectors in the UK economy.” (Pressure is also building to tackle corporate profit-driven inflation in the Eurozone…from the IMF, of all places.)  ‍
• Tackling profiteering in the banking sector. John McDonnell argues that UK banks have been profiteering from the rise in interest rates, citing analysis by Unite the Union that UK banks made an extra £7bn by refusing to pass on higher interest rates to savers. It is this kind of profiteering that has led some to call for excess profit taxes on the banking sector. McDonnell says that banks should "accept that mortgagees are struggling to pay and cut their interest rates, covering the cost from their profits. But if the banks are not willing to act, the government should intervene and levy an excess profits tax on the sector." He calls for a windfall tax of 15% on the UK's big 5 banks to fund a mortgage interest relief scheme of £5.5bn .