US mortgage rates hit 6 percent this week, their highest level in 14 years, adding to housing market fears. But Americans live in a socialist paradise. Homeowners are protected from rising interest rates through 30-year government-backed fixed deals. When rates fall, the mortgage can be refinanced, locking in cheaper payments. If the rates rise, no pain is passed on.
Most of the world lacks this isolation. Refinancing at a higher rate is an increasingly grim prospect for individuals and businesses alike.
Fitch has warned that borrowers in the UK, Spain and Australia are particularly vulnerable, with between 42 and 93 percent of mortgages tracking central bank rates or short-term contracts about to expire.
This sounds like bad news for the banks. But the consensus is the opposite: Margins will improve as lenders raise rates for borrowers and pass crumbs to depositors. And this happy situation is supposedly sustainable because the system has been made more secure since the financial crisis.
Alastair Ryan, an analyst at Bank of America, noted that at the last serious housing shortage in the UK, way back in 1989, some 58 percent of first-time buyers borrowed at a loan-to-value ratio of 95 percent or more. Last year, only 0.2 percent was allowed to borrow at that level.
Despite rising prices in the meantime, homes in Britain are selling at lower incomes than 33 years ago. At the time, homeowners used their home as an ATM, with a mortgage withdrawal equal to 6 percent of the household’s after-tax income. This phenomenon has disappeared; people pay off early instead.
This credit conservatism, largely enforced by regulators, may be bad for the prospects of young people hoping to buy a home, but it certainly supports bank balance sheets.
To provide even more comfort, regulators stress banks annually to measure their ability to withstand an economic shock, which they generally withstand.
But the real world never matches the predictions. The latest UK stress test in 2021 assumed an unemployment rate of 12 percent with low inflation. The reverse has happened.
Markets have consistently underestimated the level and persistence of inflation and the power of the central bank’s drug needed to cure it. Simultaneously with rising energy and grocery bills, mortgage payments will also rise for more and more homeowners and landlords. This may not cause a financial crisis, but it’s not hard to see it causing a housing crisis.
On the business front, many of the biggest borrowers have exploited the era of cheap money to extend the maturity date of their debt. High inflation shrinks the value of that debt over time.
But this ignores large segments of the corporate world that are too small or too weak to tap markets for this cheap, long-term financing.
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The Financial Times this week profiled some of the companies with bond yields more than 10 percentage points above government debt. They include household names such as Bed Bath & Beyond and WeWork. Some of this debt matures in the next 12 months. Much more will be added in 2024 and 2025.
It’s a worrying time for anyone without the luxury of a US mortgage.