MNI POLICY: BOE Mortgage Support Would Ease Collateral Squeeze

Tumbling UK house prices are set to prompt a squeeze on borrowing by small firms which rely on property for collateral, potentially raising questions for the Bank of England about whether it should take macroprudential measures to support mortgage lending even as it continues to tighten monetary policy.

With the Office for Budget Responsibility forecasting a 9% fall in house prices over two years as the BOE hikes rates, firms' borrowing constraints will bite, driving down on jobs, investment and ultimately hitting demand. (See MNI POLICY: BOE Points To 4% Peak At Most, Then Rate Cuts) In the past, the BOE has used various measures to support housing at difficult times, including providing cheap funding for banks to provide mortgages via schemes such as Funding for Lending.

COLLATERAL KEY

Research by London Business School professor Paolo Surico together with UCL's Saleem Bahaj, Angus Foulis and Gabor Pinter has highlighted the importance of residential collateral for business, with many small-to-medium sized firms only obtaining bank lending by using directors’ houses as collateral. When house prices fall, the constraint on borrowing bites, feeding through to cuts in hiring and investment.

"In advanced economies, between about 30% and 40% of small-to-medium entrepreneurs rely on corporate loans which are secured by a residential property or a personal guarantee of their director," Surico said in an interview.

While firms may not raise borrowing fully in line with rising house prices, falling house prices may feed directly through to lower borrowing as credit constraints kick in.

"Theory suggests that when house prices fall, the drop in consumption and investment should be proportionally larger (in absolute size) than their increase when house prices go up ... because falling house prices make the collateral constraint more likely to bind, whereas rising house prices tend to relax financial constraints," he said.

SIGNIFICANT EMPLOYERS

Smaller businesses of the type which tend to use housing collateral, such as restaurants and entertainment providers, tend also to employ a relatively higher share of lower-paid workers, which Surico noted would intensify the macroeconomic impact of any disruption in collateralised lending.

“Once house prices fall and, through the residential collateral channel, disrupt the business of those services, low-income workers may lose their jobs. As these workers tend to have higher marginal propensity to consume out of their income changes, the business disruptions may further amplify the decline in consumption. And the decline in consumption in turn makes life for those SMEs makes life for those SMEs even harder,“ he said.

This would only intensify a squeeze in household spending caused by the drop in real incomes from elevated inflation and rising interest rates.

The BOE launched its government-backed Funding for Lending Scheme in 2012 to encourage banks to expand lending by providing funds below market rates. Another option could be to restart mortgage holidays, with suspended payments of interest and capital added to the end of the loan.