The cost of mortgages
Tim Congdon
The building societies are not noted for deep thinking. But last week they were able to think long enough and hard enough to decide that delay was the better part of cowardice. By postponing the I per cent increase in the mortgage rate, to 12f per cent, until 1 January next year, they have ensured that their relations with the new Government will be cordial and friendly. Ministers did not disguise their delight. Mr Heseltine praised the societies for their 'ingenious' solution and Mr Lawson said that 'a valuable breathing space' had been gained.
The episode has been regarded as the Conservatives' first betrayal of market force ideology, Mrs Thatcher's warning to the societies in the House of Commons made it explicit that she did not want them to adjust their interest rates in line with the rates charged by other financial institutions, all of which have moved upwards following the announcement of the 14 per cent Minimum Lending Rate in the Budget. If the societies become uncompetitive against their will, that is their hard luck and the mortgagors' good fortune. The message seems to be that market forces will operate for shipbuilders on the Tyne but not middle class home owners.
In fact, the situation is more complicated. The building societies are not dynamic m aximisers of profit who relish the cut-andthrust of competition; and their managers are not generally endowed with entrepreneurial flair. On the contrary, building societies are intended quite specifically to serve their customers by not earning a profit; they pursue instead the social ideal of wider home ownership. To cast them as villains in a new drama of untrammelled market forces is simply a misunderstanding.
Ironically, it is the lack of a well-defined financial objective which has made them so powerful. As they are not accountable to equity shareholders and do not have to achieve a profit in the conventional sense, they have been able to grow more quickly than rival financial institutions. In 1962 the building societies accounted for a fifth of all deposits in this country; today the proportion is approaching a half. In the four years to January 1979, bank deposits rose by 50 per cent; building society deposits actually doubled. Moreover, as control over bank deposits is the essence of sound financial policy and building society deposits are in some respects equally liquid, the unchecked expansion of the latter is no longer an irritating sideshow, but is becoming a serious problem in macro-economic monetary management.
Is there a special reason for the building societies' growth? Much of their success is, in fact, attributable to tax privileges which were innocuous in a non-inflationary period, but have caused considerable distortions in recent years. The most important of these is tax relief on mortgage interest. In the early years of a mortgage, virtually all of the payments are interest and qualify for tax relief. When inflation and interest rates were low, the resulting tax advantage was modest. But, with inflation at over 10 per cent, interest rates have been much higher than in the Fifties and Sixties. In consequence, the cost to the Exchequer of mortgage interest relief rose to over 11,100m. in the 1978/79 financial year. The figure may be even higher — nearly £1,500m. — if allow_ ance is made for the higher rate bands into which tax payers would otherwise have moved.
At first sight, this is fair enough, as home owners, as well as the Exchequer, seem to suffer from the increased interest rate burden. But appearances are deceptive. Because of inflation the mortgagor's asset, his home, is rising in price to compensate for the high cost of servicing his debt; and whereas the capital gain on the house is tax-free, the cost is reduced by a sizeable tax concession. In effect, the home buyer is subsidised to make a small fortune.
Not surprisingly, almost everyone who might be able to buy a house nowadays wants to do so. A home is no longer regarded as somewhere to live, but as an investment or even a speculation. A foreigner listening to conversation at a typical English cocktail party might conclude that we are a nation not of shopkeepers, but small-time property tycoons. It is perhaps unnecessary to add that the country as a whole does not benefit from the frenetic merry-go-round of house buying and selling, although some may feel better-off or have made gains at the expense of others. Society gains only if the housing stock is increased in size or improved in quality.
It is because of the tax-motivated scramble for residential property that the queue for building society mortgages is now almost six months long. It hardly matters what the mortgage -rate is, as present arrangements ensure that there is an insatiable demand for housing finance. Since the building societies can (unless Mrs Thatcher intervenes) charge what they like on their lending, they can pay whatever they need to attract deposits. As a result, the interest rate differential on deposits they maintain over the banks has widened in recent years. Here is part of the explanation for the rapid growth in their share of deposit-taking business — and of their uncomfortable intrusion on monetary policy.
The solution to all these problems is to end tax relief on mortgage interest. For political reasons, this will be difficult to carry out, but a relatively painless approach is provided by the £25,000 limit on mortgage interest relief introduced by Mr Healey as part of his 'pip-squeaking' campaign in 1974. In a few years' time, £25,000 will be less than the average price of a house. It follows that the tax incentive to property ownership will be reduced automatically if the Government does nothing. For once, benign inactivity is the right answer. This is perhaps asking too much of politicians, who have a professional interest in doing 'something' to catch the headlines, but it would provide some reassurance that the present administration cares more about emancipating market forces than serving its traditional middle-class political constituency. However, the glee with which government ministers commented on the news of the postponement of mortgage rate does not give much encouragement about their real intentions.
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