Housing Market To Crash

Written by Vincent Cable MP and published in The Independent on Wed 5th Nov 2003

As the Bank of England Monetary Policy Committee meets, almost certainly to raise interest rates, there is growing alarm in Government about an impending crash in house prices. Higher interest rates and falling house prices could trigger a bloody end to economic growth driven largely by unsustainable consumer debt tenuously secured against nothing more substantial than asset inflation.

For a Government which has built its credibility on economic competence, and the end of boom and bust, an imploding boom is not an appetising prospect. It is a real threat, nonetheless.

It is not the professional doom mongers but the sober Bank of England which, in last week's published MPC minutes, said that house prices were "well above" a sustainable level. And it acknowledged, for the first time, that the market was being driven not just by fundamentals, like planning constraints on supply, but by speculative behaviour. Somewhat illogically, the Bank then predicts zero house price inflation - rather than a price fall - by the end of 2004. Forecasters who do not have a public duty to be optimistic remind us that equity values fell 20 to 30% from a comparable starting point in the early 1990's.

A recent paper by the Bank of England notes that the ratio of household debt to post tax income has tripled since 1980 and now stands at 120%. The paper also notes the ratio will continue to rise even if house inflation now stabilises. The ratio of house prices to income is now close to the level which prevailed before the crashes in the mid 1970's and early 1990's.

On top of mortgage debt is unsecured debt. The Treasury has confirmed new statistics in answer to my enquiries showing that debt such as unsecured loans and credit cards has risen by 50% since 1997 - more than twice the increase in income.

Against this backdrop, the behaviour of mortgage lenders beggars belief. Their latest figures for September show that half of all new mortgages are given at 3 times annual income or more. Over half of their new loans are not for property purchase at all but for general consumer purchases. Lemming like behaviour by banks is familiar to students of past debt crises, domestic and international. Not much appears to have been learnt.

Debt distress is already apparent. Leeds University Business School has estimated a 70% rise in credit arrears over the past two years with 20 million cases passed to bailiffs. Inevitably, the poor, with no bargaining power over their creditors, suffer most.

The Government appears to have no strategy at all for dealing with asset bubbles like this and their painful aftermath. It is relying solely on interest rates, hence Ed Balls' nod of approval to a Bank increase. But if interest rates are now starting to move back to even a "neutral" level of 5-5.5%, it will not merely prick the bubble of house price inflation but risks stifling the modest recovery in manufacturing. Manufacturers have already suffered a prolonged period of stagnation caused by an overvalued exchange rate.

The conventional view, which the Government appears to share, is that, in liberalised credit markets, nothing much else can be done. Markets will correct themselves, painfully or otherwise. To interfere will distort markets and create moral hazard.

To be sure, there can and should be no return to credit rationing and controls. But the City, and the banks, are already crawling with expensively paid FSA regulators. They monitor process and tick boxes but don't appear to notice what is happening around them. Or possibly they turn a blind eye to imprudent lending?

What further can be done? There are instruments available to liberal credit regimes which are serious about achieving greater market stability. The Danes impose statutory loan to value ratios - currently 80%, but flexible to reflect market conditions. In addition, we should be looking at the capital adequacy of the major financial institutions and considering whether it would be sufficient to cope with the bursting of a housing bubble. Bankers like Matt Barrett have complained vociferously about reckless lending by their competitors; but, at present, no one will take responsibility for reining them in without a political lead from Government.

The Government must also deliver on promises to update consumer credit regulation. It is bizarre that lenders are allowed to penalise customers for early repayment. The Government currently seeks through regulation to stop misselling of investment products but the misselling of credit is largely unconstrained. There should at least be clear 'health warnings'. For those with a poor credit history, especially the poor, the behaviour of some lenders and 'debt managers' is seriously unethical, yet current regulation is full of holes.

Monetary and credit management are only part of the answer. Tax policy has major implications for property markets. Over-reliance on stamp duty has been perverse and has hindered mobility. The Government's recent attempt to stimulate a debate on property tax got off to an ignominious start since it was widely and reasonably assumed that the Government is more concerned with raising more revenue than tax neutral reforms to help stabilise markets.

Over-reliance on interest rates to secure economic stability has been likened to a golfer's reliance on a single club. With the ball now heading for a rather deep bunker, the Chancellor's reputation as the Tiger Woods of economic policy will not survive long if he relies on a driver to dig it out.