Parents, Pensions and Mortgages …

Well, the latest news is that Nick Clegg – our deputy PM – has come up with a scheme for parents and grandparents to guarantee the deposits for their children to buy a home.

This could be a really bad idea for so many reasons.

I’m going to leave aside the obvious – that this excludes everyone without a nice big lump sum stacked up in their pension fund (a whole different – moral – issue) and just address this for the housing market impacts.

I’m also only going to touch on the suspicion that accountants and lawyers will already be working on complex, “tax-efficient” schemes to let the 1% save for their little darlings pied-a-terre using their (tax relieved) pension schemes. I’d guess these may supplement the 12,500 who the Beeb report says could “potentially benefit”.
(Oh, OK then, here’s an idea how that would work – pay £60k into AVC’s, claim back the 40% tax to gross up the fund to £100k and secure as a deposit).

The Problem …

For decades, UK families have pumped any increase in disposable income into buying a new home. This has inflated housing prices (sustaining the problem), and means that people are working harder just to stand still.

Recent globalisation changes, however, mean that middle class incomes have been squeezed, and that there’s little real prospect of income (or – as a result – house price) growth in the foreseeable future. And price inflation is still positive, so we expect a fall in disposable income.

And a number of sources seem to support the idea that the UK housing market is overvalued. The IMF estimates that this could be by up to 30% !

So why aren’t prices falling ? Well, interest rates are ridiculously low, partly as a result of quantitative easing. The liquidity intended to boost the economy is keeping this – admittedly important – sector of the economy afloat.

Foreclosure and repossession – as we learned shortly after 1990 – means properties sold at distress values, which drives the market down. So – while the interest cost isn’t causing pain, the banks will be content to not kick off another round of negative headlines by evicting large numbers of their customers.
Of course, that may change if they have to start declaring losses …

“Doing the Math”

House prices move to reflect the disposable income available to meet mortgage payments (I’m ignoring the effect of the private rented sector, here, for simplicity).

So if  I have £800/month available, and interest rates are 4%pa, then I can afford a mortgage of £800*12/.04 = £240k.

If interest rates go up to 6%pa, however, those repayments will go up to £1,200/month – and I’ll have to find another £400 at a time when salary levels are static.

And in this case, a household with the same disposable income of £800 will only be able to afford a mortgage of £160,000 (£800*12/.06).

So there would be a lot less people able to buy my house (it takes more than one buyer to create market competition), and prices will fall – as people either need to move, or as banks eventually start repossessing. The move to fixed rate mortgages – not such a component in the 90’s crash – may spread this over time, but supply-and-demand means that prices will fall (especially in a thin market).
Interest rate increases may still be a year or two away, but they will come. And they’ll come as a shock to those who’ve made long-term decisions.

For those who weren’t around at the time, take a look at the Nationwide graph of the House Price Crash. 1986-1990 saw the “real” price increase by 56% – from £88k to £129k. Then interest rates went up. A lot.
And repossessions started.
By 1992 prices had dropped all the way back to £81k.
Of course, they’ve been trending down again since 2007, but when the banks think we’ve hit the bottom of the market, then deposit percentages will come down.

Trying to get a mortgage …

… has become difficult for first-time buyers, as the banks are asking for 20% deposits – over £30k for an average property, more in London. The narrative tends to be that the banks are being overly cautious, but, in reality, they’re probably being not unreasonable in reflecting the increased medium-term risk in the overstated market.

Buy to Let …

… on the other hand, is doing very nicely. If you already have properties, then you can buy more (being selective, at the right price) by leveraging the (over-valued) equity in your existing portfolio.

Interest rates are low, and – as more and more people need to rent – residential rental rates are going up.

There’s still that capital risk down the line, however…

Pester Power ….

You’ll be using your pension, ffs, to guarantee a house price in an overvalued market. So if/when prices do get more realistic, then that Round-the World trip you’d got planned for your lump-sum payout ain’t going to happen. Even if prices don’t fall, the mortgage is still likely to be running …

Then there’s all the acrimony with your children, when they can’t afford the repayments any more, and can only sell at a price that covers the mortgage.

Even for those with reservations about this scheme, it can be difficult to say “No” to those you love. But this scheme could mean “Pester Power” endures until your beloved offspring are in well into their 30’s.

I’m a Homeowner …

… and I’m in favour of people buying their own homes. Although I like the idea I’ve an asset, my home is somewhere to live.
I dont have children, or a lump sum to claim, so I don’t really have a direct interest.

But – as with any market – you should buy when prices are low and sell when they’re high.
Remember house prices don’t always go up.
Remember that early in life, you’re likely to move more often – crystallising any losses.
Remember and that buying / selling property costs money (stamp duty, estate agents, solicitors just to start with).

History suggests that using schemes like this to distort the market in the medium term have historically been liable to end in tears.
Like the 120% mortgages once offered by Northern Rock – which could never be covered by the sale of the house in a “flat” market.

And I include the government’s “NewBuy” scheme in these distortions. This offers a 95% mortgage to people buying newbuild properties. But, of course, once you move in, it’s not a newbuild anymore.
So if you need to sell, then your buyer can only get an 80% mortgage. Alternatively, they can still get a 95% mortgage on a “real” newbuild. Probably even for an identical house on the same estate. The payments may be higher, but the deposit isn’t the constraint.
And that’s without recovering the premium charged for newbuilds – together with the carpets, kitchens etc. that often go with the deal.
So this may be good for the construction industry, but it’s not necessarily a good idea for their customers.

The UK housing market over the last 30 years is littered with examples of housing equity wealth being stripped – from endowment mis-selling to HIPS. Now, with all the equity stripped out of housing, a new scheme turns up to pump more money into this mostly non-productive sector – by stripping out pension provisions (which are, apparently, already inadequate).

This may be suitable for some, but if you go for this scheme, make sure your eyes are open.

I’m not a financial adviser, and you shouldn’t make personal financial decisions based on this article. Seek independent qualified advice before making important financial or life decisions.

Public Sector Pension increases

Lots of things to cover today …

The BBC is reporting that Public Sector employees will have to contribute up to an additional £3k  / year.

This has nothing to do with shortfalls in their pension fund. Because they don’t have one. Public sector pensions are funded from this year’s contributions. Or tax income. Or any cash they have lying around – they don’t differentiate.
The Unions are very clear. This isn’t going into a pension fund. This just goes into the Treasury.

So, as I say, this is nothing to do with the workforce, or the pension fund. It’s about deficit reduction.

The private sector had to give up this scam years ago. The Robert Maxwell scandal – where he was using a pension fund to prop up his company share price – highlighted the dangers to pensioners – both present and future – when a fund is not run in their interests.
And more recently, the failure of Marconi (formerly GEC) left many ex-employees with much less than they had been led to expect.

That led to an important principle that pensions should be independently administered – so they can’t be jeopardised by the incompetence or immorality of the employer.

Of course, every 6 months or so, we hear about the size of the private sector “Pensions Black Hole”. But why would a company let it’s pension scheme get into surplus ? That would then just provide another pot for the government to raid again in the good times – and then when times are hard, it’s the employer (or the pensioners) who has to top it up again.

Or not. Because ever since Gordon’s inspired move, companies have steadily shut down final salary (“defined benefit”) schemes – which we all used to have – and move to defined contribution schemes instead.

Which leads us to today’s announcement.

If I were the unions involved, I’d be campaigning on the basis that no government is fit to administer their pensions. That these funds should be ring-fenced and administered for the benefits of the pensioners – present and future. And that the government should make appropriate employer contributions.
Because the contributions to be made shouldn’t be dependent on whether or not we have a competent administration. Who apparently now looks on these pensions only as an annual cost to be managed down.

Of course, there’s no way this ring-fencing can ever happen in one go. The liability will be so utterly enormous that it could never be funded even over five very good years. It’s certainly not something that can be undertaken in times of austerity.
But it would be a start if there were cross-party agreement that this is a Good Idea. And if they could make a start by creating a fund with these extra payments, then it would be an important move in the right direction.

Now the unions agree that at the moment, these pensions represent good value for money.
But if things don’t go too well for the nation at any time in the rest of your life, then there’s nothing to actually back up all of those contributions.
Especially if the overall size of the public sector (and the contributions which flow from it) is reduced.
On an individual level, you want certainty that your pension is secure. You don’t want an employer that feels they can change their commitment when things aren’t going too well – because they may do the same again in the future when it’s inconvenient.
You especially don’t like possibility that the rule book could be rewritten after you’re too old to work and make up the shortfall.

Now a lot of the pension fund companies got their fingers burned after Thatcher’s promotion of “private pensions” – which  basically just created commission for financial advisers. Many pensioners had to be bought back in to the final salary schemes they’d been persuaded to leave. So those companies are going to be very wary of getting involved again.

But there’s a possibility that a large number of public sector workers could decide to “make their own provision” – or, at least, opt out of the government “scheme” and rely on a state pension.
An area where the government also sees the rules as flexible.

That exodus might accelerate if there was a tangible fund that had the support of the major unions, invested by professionals and valued by actuaries.
Such a fund would have enormous clout in the market.
Government wants to get an ever-increasing pension cost off its books.
So the unions should start negotiating now to make sure this happens through a planned, considered, cross-party process, rather than through successive knee-jerks of the ratchet.

Although, of course, that would mean that there would be less contributions to pay pensioners of the existing scheme…

[Edit 18:42]

The Punchline

After writing all of the above, I realised that there’s a much more succinct way to express the issue.

These public sector pensions have a 100% risk exposure to sovereign debt – that of the UK.

The Unions and the employers have a duty to start to mitigate this risk – or else if the IMF does ever move in,  those pensions could be rolled in as part of the negotiation.
Not just under this administration, but at any time until the rest of your life.

The only way to do this is to build a fund completely separate from the government’s clutches.

I’ve thought a bit more about this as well. The fund should be mutual, and should be (in general) managed for value. But it could reserve the right to publicly disinvest in any company which doesn’t treat it’s employees fairly and ethically.

Now that would make things interesting …