Revision Notes MR

Note: Throughout the first half of 2007, the growing crisis in the US sub-prime mortgage market received increasing attention in the UK, where a sub-prime mortgage market has also grown up since the mid-1990s.

Note: Fear arose from a concern that a similar meltdown in the sector due to defaults, institutional failure and the exposure to reckless, fraudulent and predatory lending might occur in the UK, so tipping the wider housing market into recession

Note: Impact of US sub-prime crisis on the liquidity of world money markets impacted on the UK mortgage market in a rather different way as higher costs of financing mortgages from the wholesale markets kicked in and the range of riskier mortgage products declined, reducing not only the supply and price of new mortgages, but threatening higher risk borrowers wishing to re-finance their mortgages. 

Note: Mortgage market deregulation in the 1980s reduced considerably the numbers of credit constrained households as lending criteria were loosened and discriminatory practices were reduced. Discriminatory practices included a reluctance to lend to single people, particularly women, the failure to take into account a couple’s second (usually female) income and the refusal to lend on certain property types on in particu- lar areas – so-called red-lining.

Note: New centralized lenders that entered the market in the mid- 1980s tended to have relatively low-quality mortgage books (Bole ́at 1994). The poorer quality of their mortgage books arose because they accepted higher risk customers in order to gain market share and their lending. These lenders, that were usually the subsidiaries of foreign banks, incurred heavy losses and exited the market during the housing market recession in the early 1990s  

Note: The emergence of a modern sub-prime market in mortgages in the 1990s can be attributed mostly to a growth in demand arising first from the numbers of households whose economic position deteriorated so that they could not access mainstream mort- gage finance

Note: The actual size of the sub-prime mortgage market is not known

Note: The first to respond to the potential market for sub-prime mortgages were new entrants to the mortgage market. The Kensington Group is credited with having pioneered the sub-prime market in the UK.Mainstream lenders were also attracted to the market, not least because margins in the prime sector were being squeezed and the sub-prime market appeared to offer greater profitability. Many mainstream lenders chose to conduct their sub-prime mort- gage businesses through subsidiaries. 

Note: Mainstream lenders generally utilize securitization as a way to diversify funding sources and it is therefore undertaken as a means of balance sheet management rather than a necessary source of funding. Sub-prime lenders for most of whom ‘funding comes mainly from securitisation, which is the only source of long term funding for them. They securitise every mortgage that is originated. They do not originate mortgages unless they can be securitised 

Securitization is often promoted as taking mortgage markets to a level of efficiency that is unobtainable in convention lending systems.Yet it increases the possibility of market failure through asymmetric information enormously. This occurs because the ‘lender’ passes de- fault risk on to the ‘market’ in the form of the institutional investors in mortgage backed securities 

Note: Asymmetry may work in both directions as the broker may convince the borrower, perhaps attracted by a ‘teaser’ rate.9 that they will be able to remortgage onto a lower rate. As the Bank of England has commented, ‘the model involves a long chain of participants from the original lender to the end-investors. Those at the end of this chain, who bear the final risk, have less information about the underlying quality of loans than those at the start. And those originating loans and constructing financial instruments may not face strong enough incentives to assess and monitor credit risk as carefully as end-investors would wish

Note: It was this lack of information concerning who held mortgage backed securities backed by US sub-prime loans and exactly how risky they were that led to the huge drops in liquidity in the financial markets in the summer of 2007.

Note: The most visible manifestation of the credit crunch has been the run on the Northern Rock (a medium sized mortgage lender that had expanded aggressively by securitizing mortgages10 ) and its subsequent rescue by the Bank of England acting as lender of last resort.One immediate effect of the crisis has been the withdrawal of mortgage products for new customers, or very significant rises in their interest rates, mainly affecting the supply of sub-prime mortgages. 

Note: The reduction in the supply of new credit may affect the housing market by re- ducing demand, and so – indirectly – affect existing borrowers, especially sub-prime borrowers, if it leads to falling house prices. These would affect sub-prime borrowers the most because they are more prone to payment difficulties and have higher LTVs so are more vulnerable to negative equity which is a key driver of possessions.

The global Financial Crisis was both precipitated by and had major effects on the performance of housing markets around the world. Australia was one of the few Western country's where the housing market was barley affected

Housing Affordability in Australia: Low affordability compared to other developed nations like US. Price to income ratio of 6, almost twice the USA. Of the major markets, i.e. cities over 1 million, Australia had four of the top 10 least affordable.  While the increase in house prices was shared with many other countries, there has been no post-sub-prime correction in housing prices in Australia and the problems of housing affordability remain.  The most affordable housing is in outer urban areas that are poorly serviced by public transport and require high dependence on cars  

The housing structure of any country can be categorised into four sub-systems: production, concerned with the nature and techniques of land ownership, land assembly and housing production;  consumption, concerned with the forms and methods by which households consume housing;  exchange, concerned with the practices and institutions which facilitate the sale, renting and use of housing; and  management, that is, the practices by which the housing system is managed, including policy and planning at all levels of government.

The Australian Institutional Environment: Australians have a much softer or less raw form of market-liberalism than that of the USA, with a greater sense of fairness and equity which has spilled over to market transactions and the relationship between market and government The legal system is built around the strong protection of property rights, Like UK 

Social Values and Housing:A distinctive form of individualism - ‘wrap-around housing tenure’ because it is the form of tenure that enables households to add on, or wrap around it, the aspirational lifestyle that individualistic Australians value. Home ownership is more of a lifestyle choice.Much of the UK, Europe, and Asia and even many cities in the USA and Canada, households can own but, because the dwelling is an apartment, terrace or semi-detached, they cannot wrap around it a lifestyle to the same degree. Ownership in the latter context arguably becomes an issue of security and investment more than one of lifestyle. It can be argued that Australians have not aspired to ownership per se, but to ownership of a detached dwelling in suburbia with all its ability to wrap around it a specific and highly seductive lifestyle                             

The System of Housing Provision:Separation of the building industry from the land development industry.In Australia, the developers acquire land, obtain the necessary zoning, clear the land, subdivide and provide the appropriate infrastructure. The land is then sold to individual builders or, much more commonly, to households for subsequent construction.A consumer shops around the display village on a new estate (there may be up to 50 houses on display), chooses one and gets the builder to construct it on their own piece of land This contract method, rather than a speculative method of construction. The process of contract building effectively means there is little speculative construction, a major factor in insulating Australia from the 2008 international downturn in housing prices As affordability problems worsen, this system tends to produce a housing shortage. Only those with sufficient income can commission a new dwelling.   

The System of Housing Provision Con't: Sub-prime or low documentation loans did not emerge on any scale in Australia until the 2000s and since then have accounted for no more than 1 per cent of all residential loans. Low default rates compared to US More effective scrutiny of housing finance than appears to be the case elsewhere  Never had the same motivation to push low-income ownership and still has few products or programmes specifically for this purpose.

SubPrime Effect: Unlike USA where lower income family's entering the market drove up house prices – Affordability Issues drove up rents which resulted in house price inflation 85% Aus population adjacent to 8 major citys. Handfull of banks account for large share of loans. Less use of data-driven and credit scoring, more face to face approvals giving a greater ability to screen for risk. Low percentage of sub-prime loans 1%. Policy Issues – USA home ownership Four Australian Banks AAA during crisis, no bail outs, no high default rates, no credit rationing, and stable house prices Low interest rates still caused a Credit Boom – AUS has high levels of household debt.

Lehman's Commercial Real Estate Strategy: lending to office building developers and then slicing up and repackaging the debt for investors. Less risky pieces went to institutional investors; the lower-rated chunks to hedge funds and others hungry for juicier returns. Lehman pocketed a fee every step of the way, and it often retained a risky piece or two to give its own earnings a kick. Fed investigation into whether the firm improperly valued its commercial real estate holdings, among other things. Securitisation: No longer would lenders have to shoulder all the risk from real estate lending. Bride Equity: A short-term loan that is used until a person or company secures permanent financing or removes an existing obligation. This type of financing allows the user to meet current obligations by providing immediate cash flow. The loans are short-term (up to one year) with relatively high interest rates and are backed by some form of collateral such as real estate or inventory. Home prices reached unsustainable levels. Bernanke, Paulson, and Geithner refused to rescue Lehman. When Lehman filed for bankruptcy-court protection at the height of the financial crisis in September 2008, its real-estate holdings were valued at $23 billion

Note: Near the end, it carried $25 billion in toxic residential mortgages. It was wildly overleveraged.

Note: Lehman was the symptom of how powerful this crisis was, not the cause or the precipitator

Note: Lehman had too much leverage, an over reliance on shaky real estate assets, playing down the risks on its balance sheet — were the same mistakes just about every firm made. Bear Stearns made those mistakes — and was rescued. Citigroup made those mistakes — and was rescued.To feed his desire for ever bigger bonuses, Mr Fuld encouraged the use of borrowed money to take big bets on rising property prices. (Bridge equity)

Note: The firm, realizing that it might need a Plan B, proposed that it be allowed to become a bank holding company. It also asked for access to the Fed’s discount window, which is reserved for troubled banks.

Note: Timothy Geithner, then New York Fed president, now Treasury secretary, didn’t like the idea of letting an investment bank become a bank holding company — so he said no. Immediately after the Lehman default, however, that is exactly what he allowed Morgan Stanley and Goldman Sachs to do, which helped stabilize both firms.

Note: UK measures to help struggling families through the credit crunch. Under the scheme, vulnerable families who are no longer able to keep up with their mortgage repayments will be offered the chance to sell their home and rent it back, or to enter into a shared equity or shared ownership scheme on the property.     The mortgage rescue scheme aims to help families avoid repossession, specifically targeting those who would be eligible for homelessness assistance. The Government is also introducing a shared equity scheme for first-time buyers and it is boosting the money available for affordable housing schemes.    

Note: Stamp Duty Holiday (2008) introduced to kickstart market, ended in 2009: “Homes worth £175,000 or less are to be exempt from stamp duty for 12 months as part of a package to revive the housing market. The change, which comes into effect on Wednesday, raises the threshold on which 1 per cent stamp duty is paid from its current level of £125,000. The move will save eligible home-buyers up to £1,750 when they purchase a property, and relates only to buildings entirely for residential use. 

Note: These measures are to help plunging prices and transaction prices in the UK housing market. as well as sinking number of new mortgages approved for house purchases.

Green Shoots = economic recovery during an economic downturn

Economic Recovery signs 2009: The Nationwide and Halifax both reported that British house prices had risen last month (1.2 per cent and 2.6 per cent respectively) rise in house sales  rise in mortgage approvals

Market analysis is important in order to determine the attractiveness of an investment and to identify the key risks involved. By identifying these issue an investor is able to develop strategic options to deal with them. Factors that affect supply and demand within an area. If Purchased - The Property must be a Good Investment  Lease Negotiation – Market information crucial to negotiating a good lease Expected Direction of Rental Rates. Effect on Property Values

The Decision to Buy or Lease is More than Financial • Cumstances: – Requirement For New Space: Can be satisfied by leasing or Building a new Multi Tenant Building –  Business is currently leasing satisfactory single/multi tenant space but has the opportunity to purchase the building   Considerations –  Extra Responsibility, Future Space Requirements  

The Advantages of Leasing   Leasing brings six major advantages, and all directly involve the company’s cash flow. Essentially, the advantage to leasing over buying is that there’s usually no large outlay of cash at the beginning of the lease as there is with an outright purchase.   100 percent financing: Many business leases come with 100 percent financing terms, which means no money changes hands at the inception of the lease. Obsolescence: Another advantage to leasing is working around obsolescence, which means the company anticipates frequently replacing the fixed asset. Flexibility: Asset flexibility is another leasing advantage. Based on the relationship between the lessor and the lessee, the lease may be for either just a few months or the entire expected life of the asset. Lower-cost financing: Based on many different variables, a company may be able to utilize tax benefits associated with leasing. Tax advantages: Separate from any tax benefit a company may gain, lease payments can reduce taxable income in a more appropriate manner than depreciation expense. Off-balance-sheet financing: Finally, operating leases provide off-the-books (or balance sheet) financing. In other words, the company’s obligation to pay the lease, which is a liability, doesn’t reflect on the balance sheet. This can affect a financial statement user’s evaluation of how solvent the company is because he will be unaware of the debt—hence the importance of footnotes to financial statements.  

Disadvantages of short-term leasing Cannot recover lease costs as equity in land Cannot benefit from appreciation in land value Limited control over land and improvements Less ability to plan or make improvements May be unable to get credit from lenders May lose investments in infrastructure and land if lease is terminated

Negative equity: Mortgage taking out is in excess of the value of the property

Subprime lending in the UK

Structure of Housing and the Sub prime Crisis AUS

Lehman Brothers

Green Shoots of Recovery

Buy Vs Leas