See you later, regulator

Another day, another consultation and still no prospect of regulating buy to let.

The Financial Services Authority (FSA) closed the consultation on its Mortgage Market Review (MMR) on Friday to a chorus of calls from lenders for more flexibility and pleas from organisations like Shelter for no more concessions to the banks. The charity also produced an animation to press its case against reckless mortgage lending.

However, none of them mentioned buy to let. Earlier drafts of the MMR had worried about the risk that lenders and borrowers might seek to avoid the new rules by looking for other forms of credit like second charge loans and buy to let mortgages.

The government has consistently rejected regulation of the sector both in the MMR and in a proposed European directive on mortgage lending. The FSA itself is due to be abolished and replaced as the financial regulator by the financial policy committee of the Bank of England later this year. This despite the fact that buy to let has been the key factor in the extraordinary growth of private renting over the last decade.

The previous draft of the MMR in December 2011 said that a decision on regulation of second charge mortgages had been delayed until 2014 and that ‘whether we regulated buy to let lending remains a decision for the government’. As I blogged at the time for Inside Housing, the FSA added a warning that:

‘We are currently seeing anecdotal evidence of buy-to-let mortgages being used by borrowers who would otherwise be denied an owner-occupied mortgage. We remain concerned that this problem may be exacerbated with the implementation of our responsible lending proposals.’

This risk has not gone away. If anything the FSA seems even more worried now. Three weeks ago it warned in its Retail Conduct Risk Outlook 2012:

‘We are seeing anecdotal evidence of unregulated buy-to-let mortgages being used fraudulently as a replacement for regulated residential mortgage contracts, as borrowers and intermediaries seek to circumvent more stringent income and affordability checks. These instances of misconduct could increase. This is especially likely as controls around self-certified mortgages have become tighter in recent years. The pressure to achieve greater margins on overall lending, given the current low returns available, and increasing competition in the buy-to-let market, might encourage firms to engage in this type of behaviour.

‘This inappropriate use of products may, in certain circumstances, result in the consumer’s loan being unregulated altogether. This means that consumers would be denied access to the protections that apply to regulated mortgages, such as our arrears handling rules, and access to the Financial Ombudsman Service. It also creates financial risks for the lenders involved.’

You don’t have to read too far between the lines to find out what the FSA thinks. So why has nothing happened? The failure to regulate buy to let is the result of a combination of circumstance, bureaucracy and ideology: circumstance in that buy to let is currently classed as a business rather than consumer loan; bureaucracy in that only so much can happen on financial regulation at any one time; and ideology in that there is a resistance within government to anything that smacks of red tape for private renting (even where, as with regulation of letting agents, reputable firms within the sector want it) and will act as a barrier to investment. That third factor applies especially at a time when the independent review of private rented sector investment by Sir Adrian Montague is underway.

However, the arguments for regulation are compelling (to me anyway) and go well beyond the FSA’s concern that buy to let will be used as a way to evade its new controls.

The absence of buy to let from the MMR is all the more remarkable when you consider that one of the main targets of the review is to clamp down on interest-only mortgages. Almost all buy-to-let mortgages are interest only, which gives landlord-investors a big financial advantage over other house purchasers that will grow bigger with time.

That relates to another concern consistently raised by groups like Priced Out and consistently denied by the lending industry: that buy to let prices out other buyers in general and first-time buyers in particular. First-time buyers face a frustrating time looking for a mortgage if they cannot get family help with a deposit and the search could become even more difficult under the MMR.

Priced Out argued strongly in its submission to the original MMR consultation against the government’s refusal to expand the remit to cover buy to let:

‘For first time buyers this is deeply worrying; potentially giving Buy-to-Let investors much weaker regulatory oversight and leading to further displacement of the chance of owner occupation by property investors. It also seems highly unjustified – Buy-to-Let investment has been much more volatile, has had a strong speculative component, has been more reliant upon securitised lending and specialised lenders and has suffered from substantially worse delinquency rates.’

However, the problem goes even deeper than that. A frustrated first-time buyer who cannot borrow against their future income to buy a home will may well end up renting from a buy-to-let landlord. In effect that landlord is taking over their ability to borrow against their future income and then charging them a premium (the difference between a mortgage payment and the rent) for the privilege.

Buy-to-let lending slumped during the credit crunch but has recovered strongly in the last two years. The value of loans for house purchase by landlords fell from £23 billion in 2007 to just £4.5 billion in 2009. However, the £6.6 billion total for 2011 was up almost 50 per cent up on that low point. Those totals do not include purchases with cash or with conventional mortgages so understate the size of the sector.

In the meantime, the bank that would once have lent to the first-time buyer gets a neat deal with a landlord that off-sets the risks associated with lending to individual borrowers. For good measure, the terms of the buy-to-let mortgage then insist that the landlord should only offer an assured shorthold tenancy of six or 12 months.

Although buy to let is classed as a business mortgage, it has a fundamental impact on hundreds of thousands of consumers too. As Shelter argued in evidence on the Financial Services Bill last year, a ‘lack of proper protection could place large numbers of tenants at considerable risk of losing their home’.

Finally, this whole system is being underwritten by the Bank of England through record low interest rates that have driven down the cost of a mortgage (if you can get one) and by the taxpayer through the housing benefit that pays the rents of just under 1.6 million private tenants.

Such a privileged position for buy-to-let investment might be defensible if it expanded the supply of new homes. However, the evidence suggests that even where it did go into new homes it merely resulted in a glut of city centre apartments.

Genuine investment that creates additional new homes – perhaps the build to let model proposed by the British Property Federation – deserves support. Buy to let is simply one more reason why the housing system is failing millions of would-be home owners and frustrated tenants.