Quick question: if I asked you to lend me £10 and then asked you to pay me for borrowing it from you, you’d think I was mad, right? Well this is currently the deal the world is getting when it lends money to Germany over any duration for the next 5 years.
That makes no sense right? I mean we all know how frugal the Germans are, but there’s still some risk being borne on the shoulders of the lender and they should be compensated for that risk. The only way that this makes sense is if something was making the debt more valuable than it seems to mere mortals like us.
Step forward every politician’s favourite safety blanket: Financial regulation.
After one of the many financial crises in the post-war period, a concerted effort was made to be seen to be working to make the financial system safer. The result was the formation of something called the Basel Committee, a group which devised and then revised a set of regulations dictating how banks and large financial institutions could operate.
One of the many rules they introduced was to do with how much capital a bank had to hold at any point in time.
See the problem was that in the past, banks’ balance sheets were pretty easy to understand. The underlying assets and liabilities were easy to measure – gold, jewellery, simple secured loans, etc. It was pretty straightforward to monitor how levered the bank was and, therefore, for a central bank or regulator to step in if it became too exposed.
However, in the modern world, products such as derivatives and synthetic credit obligations made it much harder to measure.
So what the Basel Committee proposed was the creation of a number of “buckets” into which all of these various products could be apportioned. Then, rather than having to understand and work out the precise amount of capital a bank should hold against each product, they would simply set a rule for each “bucket” (the “buckets” are official known as “tiers”, presumably because nobody wanted to be associated with a “bucket” based regulation).
Now the important thing here is to understand that for a bank to hold capital on its balance sheet is like England keeping Harry Kane on the bench – a total waste.
Banks want every single pound they’re able to create to generate a return. Risky assets – things like unsecured lending or complex credit products – require more capital to be held, whereas safer assets like mortgages require less. And the safest of all assets? Government debt.
Now, lets say we’re a bank and we buy £100m of some of that 5 year German paper. Under the current rules we can now take that £100m and create many billions more to put to work in riskier products that generate a much higher return.
So financial regulation has made the value of those German bonds much greater than their face value and hence their underlying price and return becomes irrelevant.
How does this relate to UK housing?
For all the talk of challenger banks, the UK is still very much a banking oligopoly, and one that has become increasingly concentrated in mortgages.
Now, let’s take the section above and replace government debt with mortgages. Yes, they’re not as safe, but under the Basel rules they’re pretty close.
For the UK’s banking oligopoly, the building of more private housing will have exactly the same effect as if, say, the German government auctioned off more debt: there would be a rush to securitise the fresh assets so as to feed the giant private money-creation machine.
The borrowers are almost irrelevant, in the same way that prices and interest rates on government debt is. Each mortgage secured on freshly built property will allow the banks to generate more money to invest in riskier products generating much higher returns.
The only thing that could prevent this is a drying up of potential borrowers, but property ownership is so deeply embedded into the mindsets of Brits that it is almost unimaginable for that to happen.
So, build more houses by all means, but don’t kid yourself that it will have any material effect on house prices.
