Negative equity’s only a problem if you have to sell

Anthony Hilton
23 Oct 2008

A victim of the housing crash was complaining about the stress caused by negative equity. But it turned out he had taken a 120% mortgage with Northern Rock, so had willingly embraced negative equity from the moment he bought the house. What had changed was psychological. He didn't mind negative equity when he thought house prices would rise, but it was unfair when prices were falling.

That's one reason why scare–mongering headlines about millions at risk from negative equity are too simplistic. Householders have little to fear from negative equity, provided they do not intend to sell.

It is not a disaster if a house is worth less than the loan on it. It is a disaster if that loss has to be crystallised by a sale. So the risk is not negative equity — the risk is divorce, joblessness or ill health, the most common reasons why people have to sell unexpectedly.

Given that people have to live somewhere, the answer to negative equity is to keep paying the mortgage in the hope that in time normal inflation will lift the house value and erode the debt. And behave. It's a bad time to get divorced or sacked.

A deal whose time has come

They say in business that the longer something takes to do, the more likely it is to be of value. If there is any truth in this, the merger announced yesterday between two sets of financial plumbers, America's DTCC and London-based LCH.Clearnet, should be a blockbuster.

In fairness, though, it was fiendishly complicated. The shareholding of LCH.Clearnet, which was formed from a merger of the London and French clearing houses and subsequent recapitalisation, had a CDO-like complexity that was bound to take some time to unravel and had almost as many conflicts of interest.

It does not help, either, that so many investment banking shareholders have had difficulty staying on their feet. The decision in the beginning to include Euroclear in the talks also complicated things and spun them out for several extra months before Euroclear excused itself. But it seems to have worked as a strategy.

There was a risk that Euroclear, if sufficiently miffed, could have launched a spoiling bid itself for LCH. Now, however, the Brussels organisation will be content to take a stake in the enlarged group.

Users may groan at the thought of yet more changes in technology as LCH brings in DTCC's new systems, but it's another case of no pain, no gain. The advantage for the customer is a more robust system, cost savings, greater scope for risk control and margin offsetting and, most of all, the abandonment of LCH's for-profit business model in favour of what it did originally and what DTCC still does — namely, operate at cost so that the users get all the benefits.

This is clearly what the world needs. It creates — assuming management can handle the integration — an organisation with the experience and scale to extend what is taken for granted in equity and on-exchange derivatives clearing to the opaque new world of over-the-counter products.

LCH on its own did not have the resources to provide this with the necessary speed, while DTCC lacked the geographic reach. The merger — or, let's be honest, the takeover — addresses both these issues.

It is also a deal whose time has come. The recent turbulence has reminded market practitioners of the importance of transparency, certainty of delivery, solvent counterparties, unambiguous valuations and all the other good things clearing houses and central counterparties seek to provide. No one can doubt the opportunity for the combined group. Now it just has to deliver.