At the end of a critical year in its development does the covered bond market have a clear conscience? Is it a force for good? Can it help address homelessness, one of the great scourges of our society?
According to a poll of critics conducted by the British Film institute in 2000 the docu-drama Cathy Come Home was the second greatest British television programme ever broadcast. It deals with the descent into destitution and homelessness of the eponymous heroine, a young mother of three in the supposedly glamourous 1960’s. It was a searing social realist indictment of British housing policy at the time and caused, as great art should, meaningful change. With comic incongruence, it was narrowly pipped to first place in that poll by Fawlty Towers.
It would be wrong to call it my favourite film, it is far to harrowing to be that. But I have watched it many times and, if you want a break from Disney-schmaltz and feel good movies this Christmas, it is recommended. You won’t enjoy it; you will be glad that you watched it.
We in the covered bond market deal mainly in housing. Sometimes we forget that and think of the underlying collateral as just another line on a balance sheet. But if we deal in housing, we deal in homes. And if we deal in homes then the consequence of homelessness should never be far from our thoughts. The market is no place for sentimentality – I’ll come back to that theme later – but public policy for covered bonds, one of the themes of the year as we finalise the covered bond directive, needs to be aware that mortgages are not just another form of collateral, that the details that we finalise have the potential, for good or bad, to affect the lives of today’s Cathys.
A legitimate concern with covered bonds is that they facilitate excessive house price appreciation. When the average salary is insufficient to buy the average house, then there is something wrong with housing policy, financial policy and, ultimately, with society itself. In Europe we have exactly that situation. The problems with society are increasingly manifest, most recently on the streets of Paris.
Should the covered bond market’s conscience be clear of the charge of fuelling this inflation? I have spent a lot of this year arguing that the link between the assets used as collateral and the availability of funding for that asset class is tenuous. This is the biggest flaw in the ‘SME loans as collateral’ debate – improving bank funding by using SME loans does not necessarily improve the flow of funds to the SME sector. That doesn’t mean that it isn’t a valid thing to do, just don’t overstate the directness of the link between the collateral used and the funding.
And there are two more important things that can and should be used to address the problem of house prices. As an economist by inclination I of course believe that it all boils down to supply and demand. Any political measure to help people get mortgages – whether a subset of society such as key workers or the whole of society who are helped by tax deductibility of mortgage interest – without a corresponding increase in the housing stock is demand without supply, which can only have one outcome. Any politician who thinks otherwise is economically illiterate, disingenuous or, in most cases, both.
An alternative of course is to reduce the supply of credit via prudential measures, in particular bank capital. Here the covered bond market’s conscience can be clearer than the conscience of some markets (don’t worry about the implied slight securitisation fans. In the interests of balance I’ll be nice to you in my next point).
Some will argue that measures to deter higher loan to value mortgages – such as the 80% rule in the new covered bond directive – are indicative of the greater social responsibility of the covered bond market than it’s sister market, securitisations. Time and again I have heard covered bond advocates pointing to the benefits of low loan to value ratios – the lower, the better. Perhaps yes from the perspective of financial stability and a bond’s credit, but certainly not from the standpoint of those struggling to get onto the housing ladder. Securitisations have frequently funded higher LTV mortgages, with well documented implications for the stability of that market, but also for their social utility.
In an early scene in Cathy Come Home, Cathy and her husband Reg fail to get a mortgage despite both being in work because they don’t have a sufficient deposit. This is the start of their downward path, they know it, you can see it in their desperation. High loan-to-value borrowers are not just a risk factor in a spreadsheet.
One of the other themes of the year has been the rise of ‘responsible investing’. I put that phrase in inverted commas not to disparage the concept but its nomenclature. What does responsible investing actually mean? How does it differ from sustainable investing?
A fault line in the construct of much of this market is the abnegation of an asset manager’s fiduciary duty towards their investors. Asset managers are required to maximise return for any given level of risk unless they are explicitly given an alternative objective function. A lower yielding green bond with the same risk as a regular bond is a breach of this principle. To argue that the return on a green bond is higher, all other things equal, because of a demonstrable benefit to wider society is an imbecilic amalgam of private and public benefits.
For what it’s worth - and this is a digression but hey, it’s Christmas indulge me - I think that the key part of the above line of argument is ‘unless they are explicitly given an alternative objective function’. The suboptimal allocation of resources is never a responsible or sustainable outcome. (“There is only one social responsibility of business – to use its resources..to increase its profits” – Milton Friedman. As a believer in free markets I concur). But it is responsible and sustainable for an individual to give to charity. Possibly accepting a 10 basis point lower yield on my investments may be a more effective way to achieve a greater good than to give an equivalent amount in cash terms to a charity. That ‘possibly’ becomes ‘probably’ when you consider the flaws exposed in some parts of the charitable sector recently and if (big if) you assume that the sustainable investment sector can come up with objective, transparent metrics to demonstrate benefit per dollar.
In the UK, Cathy Come Home raised the political profile of the largely ignored problem of homelessness, helped bring the charity for the homeless Crisis into existence and, ultimately led to the Housing Act 1977. Art matters.
The topic of homelessness is a central part of the Christmas story – no room at the inn. Whether you are a believer in a Christian God or, as I, not, the image of the homeless mother is a powerful one that reverberates through much of western culture from Fanny Robin in Far From The Madding Crowd to Lady Madonna by the Beatles (“Who finds the money when you pay the rent? Do you think that money is heaven sent? Friday night arrives without a suitcase..”); from Fantine in Les Miserable to ‘The Female Vagrant’ by Wordsworth.
If art can help, can the bond markets?
How many of today’s Cathys are in the emerging markets? The biggest demographic trend in the world today – possibly in human history - is urbanisation in emerging markets. This year tens of millions of people will, like Cathy in the beginning of the film, move from a rural environment to the inner city, all too often into overcrowding, shanty towns or, at best, sub-standard housing.
My final theme of the covered bond year is growth in emerging markets, most recently just a few weeks ago in Brazil, a country with very obvious housing needs. These bonds will be a cost effective way to finance the problem; but they will also yield a lot more than traditional covered bonds. Pfandbrief are great, but they don’t yield enough to fund anyone’s retirement. Fundamentally we in western Europe need emerging market covered bonds as much as emerging markets need our funding.
I believe that the development of housing finance on economically rational, not charitable, grounds can reconcile my belief in the primacy of the free market and my social conscience. Perhaps that is delusional? Certainly, it is comforting. In that it is the exact opposite of Cathy Come Home.
But it is an ideal, a very important one, to reflect on as we further develop covered bonds next year.
Merry Christmas and best wishes for 2019.
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