The mystery of Help to Buy Part 2 deepens. Is it a purely commercial activity by government, which the private insurance industry could and should have provided – but mysteriously hasn’t? In other words, is this a case of abject market failure where government needs to step in to protect citizens from the market?
Or is the government in fact offering a hidden subsidy, via under-priced provision of guarantees to banks? In which case, surely this is an illegal state aid under the EU Treaties?
We in PRIME have argued that Help to Buy Part 2 risked being an illegal state aid. On 13th September we tweeted:
“Is 2nd part Help to Buy with govt guarantee to lenders illegal state aid to banks under EU Treaty? Article 107 seems to catch it”.
Read on for details of the scheme, the state aid provisions, and the deep inner logic of the scheme. In our view, the government has offered, in the Help to Buy mortgage guarantee scheme, the strongest justification for government or state commercial activity that we have seen for a long time. The philosophical door to socialism has been re-opened!
On the government website, we read:
“The Help to Buy: mortgage guarantee scheme helps people buy a newly built home or an existing property with a deposit of only 5% of the purchase price.
The scheme is open for loans to existing homeowners, as well as first time buyers. The loans are available on new and existing houses with a value of up to £600,000.
The Help to Buy: mortgage guarantee scheme will increase the supply of high loan-to-value mortgages by offering a government guarantee to lenders who provide mortgages to people with a deposit of between 5% and 20%.
The scheme is not available for those wishing to purchase a second home or buy-to-let property and only repayment mortgages are offered under the scheme.
The guarantee protects the lender rather than the borrower against losses. Borrowers remain fully responsible for their mortgage payments and any shortfall in the normal way.
Lenders will pay the government a commercial fee for each mortgage that they guarantee, which covers the expected cost of the scheme for the taxpayer.”
It is true (though we had not seen this till now) that the government's "Help to Buy: mortgage guarantee scheme outline" argued in March 2013 that
"3.17 The Government believes that this scheme will fall outside the State aid framework".
We are not so sure that Chancellor George Osborne had actually grasped the implications of this in his budget speech on 20th March 2013:
“The second part of Help to Buy is even bolder – and has not been seen before in this country.
We’re going to help families who want a mortgage for any home they’re buying, old or new, but who cannot begin to afford the kind of deposits being demanded today. “We will offer a new Mortgage Guarantee. This will be available to lenders to help them provide more mortgages to people who can’t afford a big deposit… Using the government’s balance sheet to back these higher loan-to-value mortgages will dramatically increase their availability. We’ve worked with some of the biggest mortgage lenders to get this right. And we’re offering guarantees sufficient to support £130 billion of mortgages. It will be available from start of 2014 – and run for three years…
Help to Buy is a dramatic intervention to get our housing market moving: For newly built housing, Government will put up a fifth of the cost. And for anyone who can afford a mortgage but can’t afford a big deposit, our Mortgage Guarantee will help you buy your own home. That is a good use of this Government’s fiscal credibility.”
The references to “using” the government’s balance sheet, and “a good use” of fiscal credibility only make sense if the government is in fact holding significant risk under the scheme. Whereas if it were acting in the same way as insurance companies would act, i.e. totally commercially, this would surely have been mentioned.
According to The Daily Telegraph, Mr Osborne went further, saying:
"I just want to help families, hardworking families, buy a home, put down a deposit, afford the mortgage," he said. "And all those things have become unaffordable because of what’s gone wrong in our banks. I think there is a role for government and the rest of society to help people fulfil their dreams of homeownership." [our emphasis].
The truth seems to us to be that the scheme was announced without the State Aid implications having been fully thought through. This is what Article 107 of the consolidated Treaty on the Functioning of the European Union (TFEU) provides:
“1. Save as otherwise provided in the Treaties, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.
2. The following shall be compatible with the internal market:
(a) aid having a social character, granted to individual consumers, provided that such aid is granted without discrimination related to the origin of the products concerned;
(b) aid to make good the damage caused by natural disasters or exceptional occurrences;
(c) aid granted to the economy of certain areas of the Federal Republic of Germany affected by the division of Germany, in so far as such aid is required in order to compensate for the economic disadvantages caused by that division…
3. The following may be considered to be compatible with the internal market:
(a) aid to promote the economic development of areas where the standard of living is abnormally low or where there is serious underemployment…;
(b) aid to promote the execution of an important project of common European interest or to remedy a serious disturbance in the economy of a Member State;
(c) aid to facilitate the development of certain economic activities or of certain economic areas, where such aid does not adversely affect trading conditions to an extent contrary to the common interest;
(d) aid to promote culture and heritage conservation where such aid does not affect trading conditions and competition in the Union to an extent that is contrary to the common interest;
(e) such other categories of aid as may be specified by decision of the Council on a proposal from the Commission.”
Guarantees to undertakings are generally seen as State Aid, unless provided on an entirely commercial basis.
But this brings us back to the question – if the terms are indeed entirely commercial, and the lending banks and other financial institutions are paying the full market rate for the insurance including the insurer’s full administrative costs, and receiving no other advantage, why is the private industry not providing the service? And why does this government, with its general pro-market anti-state philosophy, not simply bring the banking and insurance industries together and get them to work out the scheme without government direct involvement in its running?
Is it really true that the price being charged to the lender by the government is the real commercial cost? Or are the banks being helped in some way?
The Economic Voice on its website (8th October) highlights the key issue of capital relief – with a plea for a level playing field for the private insurance industry:
“It is also critical that Help to Buy does not crowd out the existing private mortgage insurance market, which offers a similar product to protect against high loan to value risk and incorporates all the experience associated with underwriting these risks for many decades. The fee is not the only important factor here – if a capital relief solution is only developed to suit the Help to Buy scheme, then this will affect the ability of the private sector to compete and may raise State aid issues.
Again, while there is no mention of capital relief in the rules, it is essential the Government and regulator do not create a capital relief solution which only works for the short-term Help to Buy scheme. Help to Buy is a temporary scheme to address a permanent problem. High loan to value lending consumes three times more capital than low loan to value lending, and Basel III rules will only increase pressure on bank capital. The capital relief solution needs to be sustainable, predictable and simultaneously available to the private sector to allow us to compete.”
The Bank of England has today issued its guidance on the capital treatment of Help to Buy guarantees, and stated that "the regulatory treatment described here would be applicable to mortgage insurance schemes with similar contractual features" in an attempt to deal with the argument that lenders are aided by the state by the proposed approach.
The wider logic of Help to Buy – running commercial businesses is a natural role for government
Help to Buy Part 2 has very wide implications – not least in political philosophy.
We have quoted Mr Osborne’s assertion that “there is a role for government and the rest of society to help people fulfil their dreams of homeownership."
This is an interesting claim – if it applies to the dream of homeownership, surely it can apply to people’s dreams in other spheres? Indeed, which other dreams, if widely shared, cannot be justified for help from government and “the rest of society”? The role of the state – far from contracting – can be opened up endlessly. We are not sure that his party understand the radical pro-state implications of his statement.
But still more importantly, the mortgage guarantee scheme is justification for any commercial activity by the government or state, in any field where government considers that the private sector has not got its act together to provide a much-needed service for at least a small minority of the population. It justifies the government acting as a legitimate complement and competitor to the private sector, at least for a term of years.
For what the government is really saying in the case of Help to Buy Part 2 is that the market failure is not mainly that of the banks and lenders, but of the insurance industry. And if it can take over the role of the insurance industry in this way, it can surely, logically take over – or take on – the role of the banks in providing what society needs, where the banking industry falls short. And if it can logically take over the role of banking, it can surely take over other commercial business roles where this is in the interests of society.
In other words, the inner logic of Help to Buy Part 2 is the nearest thing to socialism we have seen from any government for a long while. Thanks, George.