The  32nd annual Tanner Lectures at Clare Hall were given by the eminent Cambridge housing economist Professor Susan Smith in the auditorium of Robinson College on the evening of 3 November 2010, followed the next day by a panel of four respondents. The two lectures were together entitled ‘Care-full Markets: Miracle or Mirage?’

Since their inception, the distinguishing characteristic of the Tanner Lectures has been their concern with human values. Regardless of their special subject, lecturers have always been asked to pay explicit attention to ethics and moral philosophy.  Professor Smith has followed in this tradition, in considering the potential and the limitations of markets, when judged against ethical and moral standards. In this case, her subjects were the risks, rewards, and compromises that arise from trading assets and debts, as they are expressed in the housing market. The larger question she raised, indicated in her title, is whether, and to what extent, economic markets are compatible with an ethic of care. Acknowledging the shortcomings of markets, she asked whether they can be corrected, and whether ethical ‘goods’ can be pursued, not by arguing against markets (and in favour of some alternative distribution system) but rather by arguing for markets, albeit with a view to operating them differently.

1.     Moral Maze: Dealings in Debt

The first lecture, ‘Moral Maze: Dealings in Debt’, began with the debt side of the housing equation. Something went profoundly amiss during the early years of this decade: low interest rates funded a spending spree as mortgage markets exploded and borrowers seemingly never had it so good. For Professor Smith, the root of the credit crisis lay in what she called ‘a tale of three markets’: housing markets, mortgage markets, and financial markets. However, housing markets have been poorly understood, mortgage markets have been transformed through a process of deregulation and product innovation, and financial markets failed spectacularly to manage the risks that the deregulation and innovation created. In theory all these markets may be thought of as broadly rational and potentially efficient in the long run; part of the problem is that in the short run none of them has fulfilled this expectation. Instead they are infused with a mix of virtues and vices, and riddled with moralities and immoralities that are relevant both to understanding and resolving the economic shocks of the past five years.

The focus of the lectures throughout was on the UK, the US, and Australia, three nations with high levels of owner occupation and significant levels of mortgage debt. The three nations together can be seen as bellwethers indicating the direction in which most of the West’s housing finance systems have been moving, until recently. In all three housing and mortgage markets are almost completely integrated, providing an anchor for mounting levels of debt. 

In the past the assumption underlying the integration of the housing and mortgage markets was the desirable expansion of owner occupation. This changed fundamentally in the 21st century. Today the central idea is what Professor Smith called in situ equity borrowing (in the US known as cash-out refinancing). This has become the principal conduit between housing wealth and consumption. Although the macro-economic significance of this is now fiercely debated, its role and relevance for borrowers is poorly understood. To the extent that it is understood at all, it is based on what happened in the US, where an astonishing lack of regulation or restraint exemplified just how immoral predatory mortgage markets can be.

Professor Smith argued that for home-buying households, equity borrowing has turned housing wealth into a de facto asset base for welfare. For those households with a reasonable asset base, this borrowing typically occurred in order to cover potentially bridgeable gaps in liquidity. In that sense, such mortgagors were careful consumers rather than the dupes or madcap spenders that are so much in the news. For all their sensible behaviour, however, these householders have become part of a large-scale movement within societies that substitute high rates of home ownership for a well-developed system of welfare transfers.

Putting aside the question of whether this is a welcome development, the demand for such borrowing far exceeds that which can be sourced through savings, and so the entire process depends in increasing the flow of mortgage money by means of instruments traded on financial markets (mortgage securitisation). This integration of mortgage and financial markets is not necessarily a bad thing, but in practice it has proved to be dangerous. Effectively, the vices of unconstrained financial markets trumped the virtues of unconstrained borrowers, and subverted the hopes of governments that had regarded housing ownership as a social and economic panacea. Even though mortgage securitisation occurred on a smaller scale in the UK and Australia than it did in the US, cheap and abundant credit became the thin edge of an unsustainable wedge of debt in all three countries.

This discussion of the dangers of debt permits us to make three important observations. First, mortgage markets, like any others, are soaked in sentiment, which indeed is integral to the way they work. Second, to the extent that questions of morality and immorality lie at the heart of mortgage-market dynamics, during the decade preceding the crisis that market became the scene of rampant immorality. There is nothing ‘natural’ about this; the converse might also be the case. Finally, while it is tempting to blame everything that is wrong about borrowing on the overly close encounter of housing, mortgage and financial markets, in practice, housing markets have no direct link with financial markets at all. The next lecture shows that if the question is ‘what next?’, this critically changes the picture.

2. Ethical Investment? Attending to Assets

This lecture started with a discussion of the popular notion that dealing in assets must be a good thing and is essentially more virtuous than dealing in debt, especially when those assets are ‘safe as houses’. Of course homes are not just investment vehicles, but they are nonetheless big business, constituting the world’s largest single class of assets. In the UK alone, by the end of 2009 the housing stock was worth £4tn and accounted for 60 percent of the nation’s personal wealth and over half the wealth of the typical home buyer. The recent lending carnival notwithstanding, less than half this wealth is mortgaged. The situation is more ominous in the US, where the housing stock is worth $18tn, where mortgage debt doubled in the years between 2000 and 2008 and where two-thirds of housing wealth is mortgaged. Most ownership societies lie somewhere along this spectrum.

That this is a good thing has certainly been the political and social assumption over the last fifty years (in the UK) and hundred years (in the US and Australia) in Anglophone societies. In recent years economists have conducted numerous qualitative surveys, speaking to householders who have bought homes; their replies unequivocally support the widely held idea that home ownership as a wise use of money and a hallmark of good citizenship. Such views are not without reason. Housing is the only financial asset that most households own, the only investment for which they can obtain leverage, and the only investment whose gains are tax-free.

Objectively considered, however, home ownership is a strange way to hold one’s wealth. A home is an indivisible package of housing services yoked to an awkward investment vehicle whose financial value waxes and wanes. This exposes households to a series of investment risks that are rarely acknowledged, barely understood and largely uninsurable. Such risks (e.g., that home values may fall, that house prices will not keep pace with other investments) are not new, but the more that housing provides the de facto asset base for its inhabitants’ lives, the more their importance is underscored. In truth the phrase ‘safe as houses’, like the Australian and American ‘dreams’, has fragile foundations, even without the effects of a financial crisis. That being the case, Professor Smith argues that it is hard not to conclude that debt-funded, ownership-dominated housing systems are inherently flawed.

The rest of the lecture was given over to a discussion of four ways that governments might manage this dangerous situation, four ‘visions of the future’. Professor Smith’s main point was that while most political energy has been devoted to dealing with debts, she believes that the best hope is to attend to assets.

1. ‘Back to the future?’ Most of the critical literature argues that housing, mortgage and financial markets are too closely tangled up, and that the best thing to do is to draw back. This theme is illustrated in a cartoon advocating a ‘crazy new scheme’ to shoppers called ‘buy now, pay now’. This solution does not help those already in debt, and it does not take investment risks into account.
2. ‘Business as usual’. This is the response adopted by most governments to the credit risks that have been revealed by the crisis. Business as usual in lending and borrowing means helping those who can stay in their homes and service their loans. Most such schemes have to do with deferring interest and rolling up capital repayments in the hope of better times ahead. None reduces the amount of capital owed, and none address householders’ investment risks (or make use of the housing assets whose title they hold).
3. ‘Varieties of capitalism’. This vision is rather different in that it recognises that there is far more diversity in the housing economy than is commonly perceived, and argues that solutions to existing problems may be found among the ‘whirlwind of inventions and interventions’ already present in existing housing markets. Some examples that employ equity- rather than debt-based solutions are Islamic home finance and co-ownership and shared equity schemes that now exist. Professor Smith acknowledged, however, that attempts to promote these schemes have had limited success. They rarely appeal to institutional investors, and remain primarily an aid to affordability that reinforces rather than marks a break with the home-ownership ideal. As a result, these solutions reduce entry costs and enhance sustainability, but only marginally affect the mix of credit and investment risks that underpin the recent crisis.
4. ‘Getting even’. Professor Smith began by acknowledging the hint of menace in the title of this vision. In order to make the best use of housing-asset-based solutions to the mix of problems in the housing economy today, she proposed to deconstruct the current model of home ownership. The cost of housing services should be separated from that of the associated housing vehicle, and make the investment element optional and incremental. To do this we would need to use instruments traded on financial markets, in the form of housing (or home price) derivatives. This has barely been tried. Such a separation would act to reconfigure the integration of the housing, mortgage and financial markets by making a direct link between housing and financial markets. Understandably, the disastrous experience with credit derivatives makes this a difficult and touchy proposal. The balance of the lecture provided an overview of what might be achieved in housing and urban policy under a well-regulated regime using such instruments. Ultimately, this could be a means of transforming entire housing systems in the interests of home occupiers (creating housing that is more affordable, in a system that is essentially tenure-neutral).

What it would take to achieve this end? Professor Smith here made three points. (1) It is time to break out of a consensus on the nature of markets, which has located some important human qualities outside the economy. (2) She agreed that there are qualities that money cannot buy, and goods that markets should not deliver, but housing is not among them.Where property is concerned—as with many other goods and services—there is a reason to bid for markets rather than to argue against them. (3) sWith sufficient political imagination, employed with an ethic of care, it might be possible to use existing financial tools to convert markets of mortgagors into societies of home stewards, detaching housing assets from home life, and managing both of them more wisely.

Can the housing market be changed to protect us from ourselves?

Kate Barker was a member of the Bank of England’s Monetary Policy Committee (MPC) from 2001 until May 2010.  During this period, she also led two major policy reviews for Government, on housing supply and on land use planning.

She is presently a board member of the Homes and Communities Agency, Chair of Governors at Anglia Ruskin University and Chair of the Northern Ireland Economic Advisory Group. 

Prior to joining the Bank of England, Kate was Chief Economic Adviser at the CBI. She was a non-executive director of the Yorkshire Building Society from 1999 to 2001. 

She was awarded a CBE in 2006 for services to social housing.