LONDON: Yet another major mortgage provider, this time the German mortgage giant Hypo Real Estate Bank, is teetering with the likelihood of being nationalized in a $54 billion state-led bailout. The contagion started by the US subprime mortgage crisis which has led to the worst credit crunch in global finance for almost a century seems to be continuing.
Already the scalps of household names such as Freddie Mac and Fannie Mae; Washington Mutual; Northern Rock; HBOS; Fortis; Dexia have already being claimed in this mortgage meltdown. Other banking majors, who have written off billions of dollars against expected losses in exposure to the subprime market after they invested heavily in collateralized debt packages backed by the mortgages, have managed to recapitalize with help, largely from sovereign wealth funds (SWFs) from the Gulf Cooperation Council (GCC) countries, China and Singapore. Their mortgage lending has also dramatically dropped, partly because the inter-bank market is too expensive because the banks neither trust each other nor their systems. Pundits warn of more banking failures on the cards.
In the UK, US and the EU mortgage market dynamics are breaking every record but alas in a negative way. This will be exacerbated if the march of the industrialized economies into recession is not checked in time. Indeed time is of essence for the policymakers.
But whether the College of Regulators agreed by the EU leaders at their extraordinary summit in Paris on Friday or the National Economic Council established by UK Prime Minister Gordon Brown to deal with the crisis in a joined-up coherent way, only time will tell.
A major consideration for the governments and regulators, however, will be the issue of risk weighting in mortgage finance. Risk weighting is the money banks and financial institutions offering mortgages have to set aside with the central banks to cover their lending. In the UK and US, for instance, risk weighting is set at a statutory 50 percent instead of 100 percent cover.
The rationale here is that in these countries the traditional mortgage is such a safe and secure institution and represents the single largest investment of the overwhelming majority of households in their lifetime, that the risks are not that great. As such mortgages do not carry the same risk considerations as exotics or derivatives.
The UK at the beginning of this year even extended the same 50 percent risk weighting for Islamic mortgages in the UK, which until recently had to cover its mortgage lending by 100 percent on the grounds that the diminishing Musharaka (shared ownership with the bank) or Ijara (leasing) mortgages were new products and not well-established in the market.
Indeed, some of the major Islamic mortgage providers confirmed that to date they have not had a single repossession on their Islamic mortgages. “Statistically, we should have had a few repossessions. But this far we have not had one. The impact on the Islamic mortgage market has been markedly different than in the conventional mortgage sector, where repossessions have run into thousands for the last few quarters,” confided the head of one of the major Islamic mortgage providers in London, who wished to remain anonymous.
The $700 billion US bailout plan signed into law on Friday by President George W. Bush after both houses of Congress — the Senate and the House of Representatives — accepted the plan, and the provisions of the takeovers of the UK and EU mortgage providers, clearly promise to reform the capital adequacy requirements of the financial institutions to ensure that they are better covered in times of distress. This includes mortgage providers who are perhaps the most vulnerable of institutions in a credit crunch and recession.
However, it remains to be seen how this will be applied in practice in the case of mortgage providers because it will have a Catch-22 impact. If the risk weighting is increased to 100 percent, then the banks will have to set aside more money to cover their mortgage lending.
There are two implications here. For the banks, the cost of mortgage finance will double; and for the homebuyers their mortgage premiums will be slightly higher as the banks try to recoup this extra capital adequacy requirement.
This will have a further dampening effect on the market as the banks become very choosy as to whom they provide mortgage finance. This in turn may lead to a serious undermining of the house-owning inclusion policies on both sides of the Atlantic, which really started during the reigns of Margaret Thatcher in the UK and Ronald Reagan in the US. While the general aspiration of the policy is noble; its implementation became ideological and corrupt. People in many cases were urged to buy houses, usually low-cost council houses, more for the sake of proving the policy politically sound rather than on the basis of whether they could really afford to do so. Others got onto the bandwagon simply to make money out of the policy through speculation in real estate. Others still, used the policy, as in the case of Dame Shirley Porter, then the leader of the Conservative-ruled Westminster Council, to bribe and buy votes by providing housing to selected ideologically like-minded buyers.
Some of the Islamic mortgage providers in the UK, when they were under the 100 percent risk weighting regime, actually subsidized their mortgage products simply to be relatively competitive with their conventional counterparts and to promote a loss leader until such time the market expanded to more profitable proportions. The current UK Islamic mortgage market, according to the FSA, which regulates both conventional and Islamic mortgages, is about 500 million pounds, estimated to increase to 1 billion pounds over the next few years.
This is miniscule compared with the conventional mortgage market which runs into over a trillion dollars. Of course the regulators could increase the risk weighting to 100 percent for a short period, say six months to a year — to stabilize the market which in any case is experiencing a correction as a result of the excesses and miss-selling of many mortgage providers over the boom years of the last decade or so. After all this is what they have done to the practice of short selling which is now proscribed in the UK till the end of January 2009.
Risk weighting is a global mortgage finance consideration. The GCC and Middle East are no exceptions as governments grapple with how to encourage housing development and financing in their countries. Housing construction and finance are significant drivers of economic growth in both developed and developing countries because of multiplier and employment effects especially to downstream industries. Indeed in July Saudi Arabia’s Shoura Council, the consultative assembly adopted a draft mortgage law, which is now awaiting approval by the Council of Ministers before being sent for Royal assent, probably before the end of this year.
The UAE recently passed Law No. 13 of 2008 and the Mortgage Law of Dubai, both of which are aimed at regulating the burgeoning real estate market in the UAE; safeguarding the interests of developers, investors and homeowners; and curbing speculation that is rife in the real estate sector and the unrealistic arbitrary price increases of off-plan properties. It would be interesting and revealing to see how these laws deal with the issue of risk weighting and the capital adequacy of mortgage providers.
