fortunes of residential property in a more liquid fashion – property is a notoriously lumpy and illiquid market with high entry and exit costs. The nature of the market as it currently
stands forces investors (homeowners) to put all their risk in one place. An equity derivative such as the one Smith describes could offer the opportunity to offset some of that risk by investing in an index or a basket of properties that is geographically dispersed and embraces a variety of property types. Taking the idea still further Smith
points out that it would be possible to embed these products in mortgages. The Zurich Cantonal Bank for example
sold mortgages where the repayments were partly linked to a house price index and indeed, Castle Trust has recently suggested it plans to offer both fixed- term ISAs linked to the Halifax house price index and a Partnership Mortgage. This loan would see homeowners
borrow a second charge mortgage of up to 20% loan to value with no monthly repayments and then repay the loan either plus 40% of any house price increase or the loan less 20% of any decrease in value (see page 42). There are derivatives traded over the
counter based on the Halifax index in the UK. Repeat sales indices in the United States (like the Land Registry in the UK) also underpin the Chicago Mercantile Exchange’s attempt to sell options and
futures on home prices. Neither market has thrived. “There’s a compelling economic logic
as well as a social logic to using housing derivatives to shape retail products and housing policies,” argues Smith. “But if it’s so blindingly obvious the big question is why it hasn’t happened yet. There have been several attempts to build this type of market that haven’t worked in the past.” “There have been arguments about
the nature of indices used but I would argue there is no structural reason which couldn’t be addressed that makes this sort of market impossible, with the possible exception of liquidity. “Liquidity breeds liquidity in a sense so
the question seems really how to get a market like this going. The short answer is that government would need to be
involved. It would have to be a social and policy-led drive.”
GoVernment Appetite Smith says she is unsure of the government’s appetite to put this type of market in place though. “Politically everything in the past
half century has been geared towards homeownership,” she says. “Both the Conservatives and the Labour party have been unambiguous about it.” Citing a previous discussion she had
with David Willetts (now Tory cabinet minister for universities) and Labour MP Frank Field during a radio interview, Smith says her impression at that time was that “people at that level couldn’t think in anything other than the binary of renting or owning”. “I think if you really made use of
innovative and well-regulated modern financial instruments you could create a completely different style of tenure that was neither owning as we currently understand it nor renting as we currently understand it,” she says. “Every property would be effectively
partly owned and partly rented because every time you buy a house you have the option to buy all of the housing services (shelter and water etc) but only some of the enormous investment vehicle that’s currently attached to it.” The status quo means homeowners
are hugely over exposed to that investment vehicle and are vulnerable to house price movements while renters have no exposure at all and if house prices rise their ability to afford to own in
Susan J. Smith is Mistress of Girton College, Cambridge where she is also honorary professor of geography. She was previously at Durham University and has held various research fellowships, St Peter’s College, Oxford, Brunel University and the University of Glasgow, and was appointed to the Ogilvie Chair of Geography at the University of Edinburgh in 1990.
She has recently edited (with Beverley Searle) the Blackwell Companion to the Economics of Housing (Wiley-Blackwell, 2010).
mortgage introducer AUGUST 2011 45
the future is diminished as a result. “The question you have to ask yourself
is do we want to keep the housing system as it is? “Do we want a society in which the
majority of people are encouraged to invest everything they have into properties they may not be able to afford, while a minority are forced to settle for something many see as second best?” Smith says. “This has created a massive divide
between those who have a financial stake in housing and those who don’t. Do we adopt a business as usual strategy to get banks lending again, which is what the current policy is, or do we take this moment to rethink what we’re doing? “We’ve created a very odd housing
system where in order to meet our housing aspirations we have to have a massive concentration of our personal wealth into a single asset. What professional investor would do that?” As with any theory, the proof will
always be in the pudding and sceptics believe that the average UK consumer is simply not interested in something this complex. The attraction of a property after all is manifold – you can see it, touch it and make it your own. In a sense the more important thing
to take away is not why it wouldn’t or couldn’t work but how it can help inform both politicians’ and the industry’s thinking. It is a bold idea and it would create both liquidity and stability, two things the market is badly in need of. To that extent it is worth thinking about. n
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