The UK mortgage market and credit conditions: macro-, micro and policy perspectives

Belgibayeva, Adiya (2020) The UK mortgage market and credit conditions: macro-, micro and policy perspectives. PhD thesis, Birkbeck, University of London.

Abstract

The mortgage market plays a crucial role in the UK economy. It enables hundreds of thousands of consumers every year to buy their homes or to refinance existing mortgages. In this thesis, we try to understand the mortgage market and general credit conditions, from macro-, micro- and policy perspectives. First, we look at the mortgage market from a macro angle. We aim at identifying the relative role of demand and supply conditions in driving the erratic evolution of UK mortgage credit. We aim at distinguishing demand from supply using a disequilibrium econometric model to then compare and contrast credit cycles for the past 20 years. We found that the periods of recession coincide with credit rationing and the periods of economic growth coincide with excess supply. Second, we look at the mortgage market from a micro perspective. In particular, we analyse the role of mortgage intermediaries and whether their incentives are misaligned with consumers they serve in terms of finding the best deal. For example, mortgage intermediaries need to spend time and resources to identify the right product for the borrower in terms of price, suitability and likelihood of approval by the lender. Lenders pay commissions (procuration fees) to intermediaries potentially distorting incentives of the intermediaries. Moreover, borrowers have little information or do not have tools to compare intermediaries. So we analyse how the price of similar mortgage products for like-for-like consumers varies across intermediary firms and what the drivers of the dispersion are. We find that the difference in average price of mortgage products can be as high as £800 over the incentivised rate period for the median loan amount. We find little evidence that intermediaries selling highly priced mortgages also receive high procuration fees and that the average price of the mortgages an intermediary sells is negatively correlated with the number of lenders used. Third, we evaluate impacts of the Financial Policy Committee (FPC) policy that aims at reducing risks of financial instability in the economy by limiting excessive household leverage in mortgages and unsustainable credit growth. It recommends that "mortgage lenders do not extend more than 15% of their total number of new residential mortgages at Loan to Income ratios at or greater than 4.5". We are interested in understanding whether it has any impact on consumers in terms of the redistribution consequences and price. The paper finds that after implementation of the recommendation the average loan size for high LTI mortgages increased by 4-7%. This suggests that lenders originated high LTI loans for borrowers with higher incomes. As a result, we find robust evidence of changes in composition of high LTI borrowers: 1) an increase in the proportion of home movers; 2) a decrease in the proportion of first-time buyers; 3) an increase in the proportion of joint income applicants. After implementation, although the overall proportion of high LTI mortgages to the total number of sales in the market stays around 10%, lenders’ individual exposure to high LTI mortgages changed. Some lenders, whose share of high LTI mortgages had been closer to the 15% limit, reduced their proportion of high LTI. In contrast, some lenders that previously had a low share of high LTI mortgages increased their proportion of them. After controlling for borrower, product, and lender characteristics, we find that post-implementation the mortgage price for high LTI mortgages on average decreased. The fall in the mortgage price was stronger for lenders that used to be closer to the 15% constraint. Fourth, we take a step back and look at the monetary and fiscal policies in the context of New Keynesian models with real rigidities and an economy at the zero lower bound. In this chapter, we are particularly interested in identifying optimal fiscal and monetary policies under strategic interaction among price- and wage-setting agents under zero lower bound. We found that the optimal length of the forward commitment concerning interest rates at the zero bound and key outcomes such as the magnitude of expected inflation or the depth of the recession under optimal policy depend crucially on the assumed degree of real rigidity in the model. In addition to simple parametric assumptions, more fundamental structural assumptions about the nature of the labour market play an important role in this regard. Labour market segmentation and the presence of staggered wage adjustment were shown to have particularly significant consequences for the type of policy one might wish to implement in an economy hit by a large shock that depresses demand. In those circumstances, it is a good idea for governments to lean against the wind in two different ways. First, an increase in government spending when output is low (and vice versa) stabilises output (and prices) but this policy can be justified almost wholly with reference to static public finance considerations. Second, an increase in taxes when output is low (and vice versa) stabilises prices via their impact on marginal cost. The results interact in interesting ways with the initial conditions in the economy. With higher inherited debt, fiscal sustainability considerations matter more for monetary and tax policy and the explained differences across market structures grow larger.

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