Signals in the housing market

In a story in the Guardian today, it emerges that mortgage lenders are making borrowing less attractive in a reverse of the ‘easy, cheap’ credit terms offered in recent years.

In the height of the credit boom, I must have received something like 5 or 6 letters per week asking me to take out another personal loan or credit card. My postman seems happier now because there has been a steady drying up of these letters over the last year or so. My shredder has also seen less action in recent months!

Could the credit crunch signal the end of the 100% mortgage? In a rising housing market, banks were willing to lend 100% (or even more) on the basis that by the time the deal went through and the new owners moved in, the property was probably worth more than the initial purchase price. Thus, even if the buyer defaulted on their mortgage payments immediately (unlikely given the financial evidence a borrower must amass to apply for a mortgage), the lender would be able to recoup the debt and any administration costs by reselling the property.

A standard economic interpretation of the cause and effect of tighter lending is that fears over a housing market crash may actually create a self-fulfilling prophesy: tighter and more expensive lending leads to fewer mortgage applications and constrained offer prices, thus dragging house prices downwards in the process.

But is it more the case that this tighter lending actually signals the future fall in prices that the market is already assuming - it is likely to happen and this is banks adjusting to it. The tighter lending thus becomes the effect resulting from the cause - fundamental demand and supply imbalances in an over-inflated market.

You could argue these are the same thing, but I don’t think they are.

In a less buoyant housing market it is understandable that banks and building societies expect buyers to produce a deposit - after all, this acts as a buffer for them by allowing house prices to fall without the bank suffering a loss in the case of default and seizure of the property by the lender.

Perhaps we could read the minimum deposit required (ignoring more generous offers where punitive interest rates and other conditions are used to deter serious borrowers and shift risk to them and away from the lender) as a market expectation on future movements in house prices?

A student in class today asked me about prediction markets: the phenomenon of collective trading on future events, from the level of the stock market to the winner of X Factor 2008. Does the wisdom of crowds always pay off? Prediction markets force agents to put a price on risk by asking them, effectively, to gamble on their hunches. Is this what lenders are doing already? And might they be wrong?

And perhaps (on a lighter note) economic forecasters should be forced to spread bet on their predictions? They might just be more accurate if this was the case….