Adam Smith states, ‘There are two different ways in which a capital may be employed so as to yield a revenue or profit to its employer.’ The first is buying and selling goods, which he calls, ‘circulating capitals’. The second is the ‘improvement of land’ or ‘fixed capitals’.
It is this second way of making money that spawned a love affair with property, creating a series of booms and busts to rival any in the stock market. Until the middle of the twentieth century, home ownership was the domain of the wealthy.
DEFINING IDEA…
Few rich men own their own property. Their property owns them.
~ ROBERT GREN INGERSOLL, POLITICIAN
The English-speaking obsession with property came out of Detroit, USA. Hub of the motor industry, Detroit was hit hard by the Depression that began at the end of 1929. In riots outside the Ford motor plant, five people were gunned down and anti-corporate sentiment ran high. President Franklin D. Roosevelt pioneered the idea of a property-owning democracy in a bid to pacify his people. It worked, and in the UK, too, home ownership flourished. Today there are around seventeen million owner-occupiers in Britain.
The surge toward home ownership in the English-speaking world meant a growing demand for mortgages, but the banks only had so much in deposits. Not to worry: in 1983 chief mortgage trader Lewis Ranieri at Solomon Brothers in New York came up with the idea of Collateralised Mortgage Obligations (CDO). Mortgages were no longer held by the bank, but bundled together and sold to investment funds eager for a little extra interest. This allowed banks to lend indefinitely.
Singly, the idea wasn’t disastrous because mortgages were only given to those who could genuinely afford to repay them, but then George W. Bush signed the Dream Downpayment Act of 2003 saying, ‘We want everybody in America to own their own home.’ What followed was an avalanche of subprime loans. Ninja Lending had arrived (No Income, No Job or Assets!). CDOs were still used to re-fund banks only now they were toxic, backed by mortgages from people with no means or inclination of paying the mortgage once the low introductory interest rate ended.
The model worked beautifully when rates were low and property prices rose, but then the bottom fell out of the market: the underlying asset supposed to protect the bank was not worth what the borrower had paid for it. Throughout the US, ‘Jingle mail’ could be heard as occupiers moved out and mailed the keys back to the bank. Ironically, history repeated itself as the bad loans started to default in Detroit following a continuous downturn in the automotive industry. Sub-prime dominoes began to topple in the city where it all began, some eighty years before.
HERE’S AN IDEA FOR YOU…
When you’re buying a home, don’t assume that interest rates will remain as they are. In the not-too distant past the base rate has been as high as 15%. Individual banks were charging even higher! Could you afford the house you want to buy if interest rates reached double digits? Make sure you can comfortably afford a reasonable rise in interest rates. Peace of mind is always more important than that extra bedroom!