The Barker and Miles Reports

Written by Dr. Vincent Cable MP, Liberal Democrat Shadow Chancellor of the Exchequer and published in Liberal Democrats In Business on Thu 1st Jan 2004

The country's largest building society the Nationwide has recently released figures projecting house prices to increase by 9% next year, at least 3 times and possibly 5 times the projected level of inflation. This figure of course depends on whether one uses the Retail Price Index figures or the Harmonised Consumer Price Index in the government's new mix and match approach to government economic statistics. This growing inflation, the latest stage in a property 'bubble' which has taken house prices to a level in relation to income comparable to that before the market crashes in the mid 1990s and the early 1990s, is making owner occupancy something only the well off can contemplate in many areas.

The Barker report argues that a mismatch between demand and supply in the housing market has undermined growth, damaged the flexibility of the labour market and reduced standards of living. Its argument with the emphasis on increasing housing supply is broadly sensible provided there is a good balance of housing type including affordable housing. As Ms Barker notes however, increasing house building has to be done in a responsible manner and not at the cost of creating poor quality housing.

Barker's long term goals of reducing the bureaucracy in planning regulations will go some way to encouraging and increase in house building; but this cannot be done though at the expense of the environment. Developers are for example pressing remorselessly for permission to build executive homes in suburban areas at the expense of playing fields and public space, changing the character of neighbourhoods from low to high density in ways that are not thought through in term of traffic of public amenities. Such developments contribute little by way of affordable housing, unless councils are tough in demanding it, and undermine environmental standards.

Another approach to housing supply initiatives is that of empty homes, of which there are nearly three quarters of a million across the United Kingdom, 80% of which are privately owned. The Lib Dems would promote voluntary agreements with empty property owners to encourage and assist them renovate properties at affordable rent. Equally introduction of property management orders could be a backstop option to ensure owners of long term vacant properties would have to lease them at affordable rents.

There is however also a more serious problem with Barker in that it treats the current housing market boom purely as a 'real' phenomenon when there are good reasons to believe that these is a speculative 'financial bubble' element in which property is being treated as a highly desirable asset (relative to falling equities). This monetary phenomenon needs addressing through a combination of higher interest rates and more effective regulation of mortgage lending.

Equally importantly and as the Miles report identifies there is a justifiable call for reform in mortgage lending to cure undue short-termism and as a result the potential volatility in the housing market. The fact that nine out of ten loans are paid on variable interest rates or on fixed rate loans for less then five years of course makes borrowers extremely vulnerable to changes in short term interest rates. The Chancellor has argued that this is a serious obstacle to joining the EMU (where interest rates are set at levels which do not reflect the particular position of the UK economy let alone the housing market.)

Miles puts up a persuasive case that there is market failure in the lack of provision of long term mortgages and this market needs to be stimulated. This is though perhaps far easier said then done. To move to an American system which encourages long term fixed rate loans by allowing homeowners to remortgage at a better rate then their original long term fixed rate mortgage is problematic. The US government, in effect, underwrites the mortgage market, if it didn't the cost of remortgaging would be very high.

Even with a nation of homeowners who are on long term mortgages we still have to ask if this makes our economy a more stable and productive. If too many borrowers switch from short term variable rate loans to long term fixed rate loans this will merely make them hypersensitive to long term interest rates. This will create frenetic remortgaging activity when long term interest rates are low were we to adopt an American system of allowing remortgaging. Moreover, a country far less sensitive to short term interest rates may cause issues for economic stability. Monetary policy to either depress an inflating economy or revive a deflating economy would require greater changes in interest rates by the Bank on England. These increased fluctuations would adversely affect business, especially those already exposed to exchange rate fluctuations.

Like Miles argues we should be trying to create a better informed market as the key to stability in the mortgages is diversification with a more wide spread set of mortgages, concentrated across a variety of different types of mortgages. We can go some way from reducing the hypersensitivity of the market to short term interest rates such as happens now, without tipping the balance too far the other way.