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Look back in wisdom

We should be guided by the experience of previous downturns rather than expect regulation to improve the lending market, says Gary Styles, strategy, risk and economics director at Hometrack

Economic trends continue to show a much sharper slowdown than expected and experts everywhere are revising down their forecasts for GDP growth while pushing up their estimates of the number of individuals who will lose their jobs.

Figure 1 illustrates the speed and extent of the revision in the consensus forecast for GDP growth since the start of 2008.

At the start of the year economists were expecting a soft landing and growth of around 2% in 2009 but by the time we reached summer this had been revised down to around 1%. In the past eight months this figure has been revised to a fall of nearly 3%.

This change in sentiment and confidence will have a bearing on how mortgage arrears and defaults unfold in the next couple of years.

The effect on output and unemployment is probably the key concern for borrowers and lenders alike. The experience of the early 1990s highlighted that it was not until unemployment started to rise sharply that repossessions and serious arrears started to hurt lenders and borrowers.

The big differences this time are the lower level of interest rates and the rapid speed of the present slowdown.

As we know, house price inflation and capital growth can disguise many underlying credit problems in the economy as borrowers are able to sell, re-mortgage or reschedule debt as servicing problems emerge.

The current market, with record low volumes and a shortage of available finance for the most vulnerable, makes the arrears and repossessions outlook more problematic.

Latest data for 2008 shows a marked increase in three-month arrears as well as in the more serious six-month arrears category. Figure 2 shows the historic path of these categories of arrears and highlights the peak in 1991/92, when three-month arrears reached 6.5% of outstanding mortgages.

Without intervention and allowing for the rapidly deteriorating unemployment and negative equity picture, we expect three-month arrears to rise to 4% in 2009. This translates into around 470,000 households in serious arrears by the end of the year.

Several banks have reported a sharp rise in the proportion of their borrowers they estimate to have zero or negative equity in their properties. Three big banks say that between 15% and 33% of their borrowers had zero or negative equity at the end of 2008. But performance across banks differs sharply, with several showing no significant numbers of customers in this category and recording low levels of arrears.

The divergence between lender and customer performance across the country makes forecasts of arrears at a national level difficult but essential. Lenders that concentrated on maintaining high credit quality in the boom will reap significant risk management benefits in the difficult times ahead.

The Council of Mortgage Lenders recently released repossessions figures for Q4 2008 which were better than expected as lenders held back under government pressure. But with the underlying mortgage arrears position de-teriorating, repossessions are likely to increase sharply in 2009 to 65,000, from 40,000 last year.

Those of us who lived through the 1991/92 downturn and remember the resulting changes in attitude and policy don’t need reminding of the need for prudent lending. It appears that memory is quickly clouded when boom conditions prevail but replacing this with rules imposed by regulators will not im-prove the picture.

“The story of the boom and crash… is worth telling for its own sake,” economist JK Galbraith wrote of the 1929 crash. “Great drama joined in those months with a luminous insanity. But there is the more sombre purpose. As protection against financial illusion or insanity, memory is far better than law.”


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