Debate Magazine

Killer Arguments Against LVT, Not (313)

Posted on the 12 January 2014 by Markwadsworth @Mark_Wadsworth
Some more closely related KLNs are "House prices will plummet and millions will be trapped in negative equity" and "House prices will plummet and banks will go bankrupt

Firstly, as the LVT envisaged here would greatly reduce the tax payable by prospective and recent first-time buyers, so there is no reason to assume that house prices would change much.
Secondly, even if house prices fell by half, recent purchasers would have so much more extra post-tax income that they would be able to pay to pay off their mortgages in ten years, and they would be out of nequity after five years anyway.
Thirdly and slightly more radically, assuming that house prices fell by half, what would happen if all higher loan-to-value owner-occupiers' purchase mortgages were written down to the new reduced selling price of the home on which they are secured so that people can still sell their homes and walk away/start again if they so wish?
Let's assume that the 'losses' are split three ways: between borrower, bank and government/taxpayer generally.
a) Total outstanding residential mortgages in the UK are about £1,200 billion, of which approximately one-quarter relates to mortgage equity withdrawal and buy-to-let mortgages, which leaves £900 billion under consideration.
b) If you just look at principal, the numbers don't look too bad. Because of the fairly straight-line distribution of loans to value, the total principal amount of mortgages on which there would be a degree of write off is about £675 billion and the total write-off of principal would be one-third of that = £225 billion (or about 2% or 3% of what UK banks claim, probably spuriously, are their total assets).
c) That £675 billion is only part of the story of course. It is just a number on a bit of paper. What is actually relevant is the total future cash flows going from borrowers to banks. Assuming an interest rate of 4% and twenty years left to run, the total repayments for £675 billion in mortgages are £50 billion per annum, with total payments over the next 20 years of £1,000 billion.
d) The £450 billion replacement mortgages could be at a higher interest rate. So if these were at 6% interest, total annual repayments would be £40 billion, meaning that banks would receive £800 billion over the next 20 years, a loss to banks of £200 billion and a gain to borrowers of £200 billion.
e) The government could chip in (say) half that and give banks non-interest bearing government bonds with a nominal value of £100 billion which are redeemed at £5 billion a year for 20 years.
f) So borrowers would see their mortgage repayments fall by £10 billion a year or one-fifth (hooray); banks only have an annual shortfall of £5 billion (which they can easily recover by reining in salaries and bonuses at the top end) and the exercise only costs the taxpayer £5 billion a year for the next 20 years. Recent purchasers will end up paying the lion's share of that £5 billion in future, so it all pans out nicely.

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