The housing conundrum

House prices in the UK are too high. How much too high they are depends on where you are: house prices have been rising in London because rich Asian businessmen and French aristocrats are buying up prime real estate as a safe haven investment for their filthy lucre, apparently. But outside London and the South East, house prices have actually fallen over the last few years, a bit. But not much. Certainly not enough to make them affordable for young people on median incomes.

The trouble is, there are a lot of people out there who already own houses. Many of them are relying on the value of their property to top-up their pensions. And all of them have votes. The total voting power of homeowners in the UK far exceeds that of the young people who are being priced out of the housing market. It would be electoral suicide at the moment for any political party to sign up to policies that would cause a significant fall in house prices. 

However, there is future electoral benefit in making it possible for young people to buy houses. At some point many of these elderly property-owners are going to want to sell their houses, and if young people can't afford them then they are in for a big shock. It is not in older homeowners' interests to sit on an appreciating asset whose value is not realisable in practice. Writing down the value to something more affordable is a far more sensible strategy for older homeowners who have paid off their mortgages. Young people and old people therefore have more in common than they think they do. The people who really stand to lose from a major fall in house prices are those with mortgages, particularly those who over-borrowed prior to the financial crisis and are only just managing to service their debts. A fall in house prices could force many of these into negative equity. Painful though that would be, it would enable the housing market to readjust to a more sustainable level, and provided interest rates remained low, borrowers would be able to continue to service their loans. Yes, a lot of young families would be trapped in houses too small for them because the amount of their mortgage exceeded the value of the house - as I was in the early 1990s, the last time there was a significant house price correction in the UK. But repayment mortgages are forgiving things: eventually the outstanding amount would drop below the house value and they would be able to move.

So engineering a fall in house prices looks like a good economic strategy for the medium-term, although possibly not a wise one for politicians hoping to get re-elected in 2015. But the Government is not even discussing it. On the contrary, it is doing everything in its power to prop up house prices. It is not liberalising planning laws to enable expansion of private sector building programmes, as some have suggested. Nor is it sponsoring public sector building programmes. And on the monetary side, it now has two schemes designed to make it easier for first-time buyers - the Funding for Lending Scheme, which provides cheap funding to banks on condition that they lend more to house-buyers and small businesses, and the Help to Buy scheme, which guarantees part of the purchase price of a house, thus making it possible for people to buy a house without much in the way of a deposit. Both of these schemes have been criticised for potentially increasing house prices. 

This apparent short-termism is not entirely due to electoral considerations, though those are clearly a factor. A fall in house prices is not the easy solution it appears to be. In fact at the moment it would have disastrous effects on the economy. The reason is, of course, banks. And building societies. And indeed any financial institution that lends against property.

House price falls are disastrous for mortgage lenders. Mortgages are secured loans: the house that is bought is the collateral for the loan, and the loan is granted on the basis of the value of that collateral. As with all forms of secured lending, the value of the collateral usually exceeds the amount of the loan: the difference is made up with the house-buyer's own funds. Since the financial crisis mortgage lenders have reduced their loan-to-value (LTV) ratios considerably, which has made it very hard for house-buyers with limited resources to find the money needed for deposits (this is the stated justification for the Government's Help to Buy scheme). Good quality loans typically have a LTV ratio of less than 80%: the risk associated with the loan increases as the LTV approaches 100%. Above 100%, part of the loan is effectively unsecured. Without going into details about how bank capital ratios work, the higher the LTV, the greater the amount of bank capital required to support it, more-or-less. When house prices fall, LTV values rise - exceeding 100% for borrowers in negative equity. Falling house prices therefore eat up banks' capital, not because they took on risky loans but because their supposedly safe low-LTV mortgages become much riskier. Banks and building societies are already damaged from the financial crisis of 2007-8. A large fall in house prices could bankrupt many of them. Particularly at risk would be building societies and small retail banks, who tend to have lower capital levels than large universal banks because most of their lending is in supposedly "safe" mortgages. There is nothing "safe" about mortgage lending in an overblown and fragile housing market.

Improving the supply of houses without causing a major fall in house prices seems to be almost impossible. An extensive private sector house building programme would help the recession-hit construction sector, but it would force down house prices. That would apply whether those houses were for sale or for rent. Landlords borrow to finance the purchase of homes for renting out, and they carry the value of their rental properties on their balance sheets: and as rents tend to be set in relation to house prices, falling house prices would be likely to force rental values down. A major fall in house prices would therefore potentially bankrupt many landlords. And construction companies who borrow on the basis of expected returns could also be bankrupted if those returns fail to materialise because of falling prices. This is what happened in Ireland.

A social house-building programme similar to that after World War II might improve the supply of homes for rent without causing house prices to fall. Or it might not, if the effect was that people who might otherwise have tried to buy substituted into new social housing. And what if those houses were then sold to their tenants under the Right to Buy scheme? This would also cause house prices to fall, though perhaps more slowly than large-scale private sector house-building. Of all the options for improving the supply of housing without wrecking the financial sector, this looks the best. But it would require government not only to spend money, thereby increasing the fiscal deficit, but to abandon its ideological commitment to private-sector solutions and admit that we need an increased role for publicly-owned housing at the moment. I suspect hell would freeze over first.

So forcing a house price correction would have horrible effects on the economy at the moment. But for many people, housing is at the limits of affordability. The rise in the price of houses in the last two decades has far outstripped incomes, which have actually stagnated in the last ten years. Low interest rates have encouraged people to take on mortgages that stretch them financially. A rise in interest rates would force many people into defaulting on mortgages or other loans, which would also have a serious impact on the financial sector. A sudden rise in unemployment would have similar effects. And as real incomes decline due to below-inflation pay rises, benefit cuts, tax rises and underemployment, more and more people are becoming financially overstretched. They don't default on their mortgages, but they cut spending in other areas. This depresses demand for goods and services in the economy, forcing companies to cut costs - which usually involves reducing jobs and/or wages - and even go out of business. It is a moot question whether the real problem here is low pay or high inflation: perhaps it is a bit of both. But the solution is not easy. Raising interest rates to counter inflationary pressures would cause financial distress to many households and businesses. Raising wages without an equivalent rise in GDP would be likely to create higher unemployment. And raising real incomes through higher benefits and/or cutting taxes would increase the fiscal deficit.

So we cannot force down house prices, we cannot force up real incomes and we cannot vastly increase the fiscal deficit. The housing conundrum resembles one of those games of the "there's a hole in my bucket" variety - a mind puzzle, if you like. Many people solve it by leaving out some of the pieces - which of course is not a solution at all. Others want to do something dramatic such as a large rise in interest rates or a massive state-funded construction programme to "shock" the system into correcting - the idea being that the short-term pain would be worth it to achieve a sustainable correction. I understand their frustration, but I am not sympathetic to their solution. This Gordian knot cannot be simply cut with a sword. It must be painstakingly unpicked - and I fear that will take a very long time.

Related links:

Escaping liquidity traps: lessons from the UK's 1930s escape - Nicholas Crafts (VoxEU)
The fatally flawed FLS - Coppola Comment
Help to Buy mortgage guarantee outline - HMT
IEA's Shadow MPC votes 6-3 for half-point rate hike - Economics UK
A history of social housing - BBC


  1. You miss an important point, which is that construction is the main driver of the business cycle. The US economy is now turning the corner because they have allowed house prices to fall to levels where private construction has restarted. By preventing house prices from falling the last two governments have put the UK economy into permanent non-growth limbo.

    1. I mentioned in the post that revitalising the construction sector would be helpful. But in my view describing construction as the "main driver of the business cycle" is overstating it quite a bit.

      I'm amazed that you totally ignore the catastrophic effect on the economy of bank insolvencies due to deteriorating asset quality when house prices fall as they have in the US. The US suffered a deeper recession than the UK and still has higher unemployment. Have you ANY idea just how many US banks have failed in the last 5 years?

  2. We had major falls in house prices in both the 80's and the 90's, nothing bad happened, the sky didn't fall in, the banks all survived and the economy didn't implode.
    Who pays for help-to-buy and who does it end up really helping?

    In London for example the average salary is £29,000 a year but the average house price is £370,000! Someone earning the average salary will undoubtedly be chipping into the help-to-buy funding pot but will it enable them to get a 10x plus salary mortgage to buy the average house? Of course not! And what about all those who don't earn anywhere near £29,000 but who still pay tax, aren't they funding and underwriting a policy that is pricing them onto the streets with their own money?
    Where does this all end I wonder.
    The main point of help-to-buy is to help people up to the house price instead of the price coming down to a level they could otherwise afford without the subsidy. It is a prop for house prices pure and simple.
    The official solution to the Gordian knot isn't to even attempt to unpick it instead they have settled for a plan where just enough people a year - about 200,000 - are given subsidised mortgages so it appears as if we have a functioning housing market as long as you don't look too closely.
    Given that you already have to be earning a considerable salary to even think of buying a home these days then what are the long term consequences for everyone else?
    The housing market is turning into a closed loop, an elite club into which only the rich and heavily subsidised can gain entry but which is paid for by all the people waiting in the cue outside. Trouble is as the years pass that cue will be getting longer and longer...

    1. Nice rant, but you have chosen to discount the main issue I raised in the post - namely our damaged financial system. So you have placed yourself in the category of those who leave out some of the pieces of the puzzle in order to find an easy solution.

      Regarding the sky not falling in: personally I remember the 1970s as the decade from hell. And as I recall the first half of the 1980s was pretty grim too. And your assertion that banks didn't fail is simply wrong. Banks did fail in the 1970s property market crash. Sixty of them were bailed out by the Bank of England in 1973-4. And I assume you have forgotten about the failure of National Mortgage Bank?

      The problem now, though, is that banks and building societies are more highly leveraged (have less capital)and are already damaged, and houses are far more overvalued than they were in the 1970s and 80s. A major price correction at the moment would be economically disastrous.

      Personally I think house prices do have to fall. But it would be in my view far better to orchestrate a gradual decline rather than cause a sudden fall. I also think wages have to rise, but again I expect this to happen gradually as the economy recovers rather than suddenly, sparking inflation.

    2. Sorry if I ranted but what you seem to have ignored are all the people who are funding/underwriting help-to-buy and as a result can't afford any kind of shelter themselves as it will keep prices out of their reach simply to get the banks off the hook.
      I don't mind if the banks have to be helped in this way but if the government want to do it they must also build genuine low income housing alongside help-to-buy otherwise all it does is underpin a huge house price bubble at the expense of all those unable to get access.
      One thing is certain help-to-buy isn't designed to orchestrate a gradual decline in house prices, and I see no other housing policies from any party.

      Maybe the plan is to get the taxpayer to eventually pick up the tab for the 20% equity loan that makes up part of the deal, developers are now advertising homes at a price that is minus the 20% as if it is the full cost.

    3. I am certainly not a supporter of help-to-buy. And I am not ignoring the needs of those who are struggling to afford housing. I'm simply pointing out that there is no easy solution.

  3. Frances, how about a Steve Keen debt jubilee?

    1. I've said before that I am quite "keen" on the idea of a partial debt jubilee. I could imagine Government agreeing to write down all mortgages to 80% of property value, for example. In effect that's what the Help to Buy scheme does for new borrowers. It could be used in conjunction with a large house building programme to force down house prices - although that would mean that Government writedown of mortgages would have to be repeated until house prices bottomed out, not a one-off event. An alternative approach might be to write down all mortgages to say 3x household income. Sounds complicated, but it's really only a tax credit scheme. These are the kinds of initiatives we need to be thinking about to rebalance the housing market without destroying something else.

    2. Perhaps we shoud remind ourselves what a mortgage largely is, interest paid to the banks on money they never had in the first place. Shouldn't we be addressing that issue first?

  4. Re "as rents tend to be set in relation to house prices, falling house prices would be likely to force rental values down".

    Ultimately, the lack of supply would put a floor under this. People still need homes and we haven't been building enough new ones for years. Even if purchase prices crash, rents will be sticky initially because many buy-to-let landlords will need to service their (now negative equity) mortgages. They will only be forced to drop prices if their renters (and wannabe owners) suddenly find the purchase market flooded with cheap supply, and that isn't going to happen. There will be some distressed sellers, but not enough to undermine the rental sector.

    NB: The problem in the US housing market, where prices have corrected, was about over-supply as much as sub-prime loans. Excess capacity has been a feature of American crashes ever since Florida in the 1920s.

    The only solution to our problem (which will get worse as the trend in density continues to drop) is to build a lot more houses. As you note, this is currently not in the interest of anyone other than wannabe home owners, and they are a powerless electoral bloc compared to the coalition of banks, buy-to-let landlords, nimbies and outright owners.

    One thing that could ease the pressure over the next decade would be for stronger growth (relative to the UK) in the Eurozone. Given the house price corrections that have already happened there (and historically cheaper rents), it would then be attractive for young Brits to move abroad (and for various continentals working in London to repatriate), thus easing demand.

    So, paradoxically, quitting the EU might be the solution to the UK housing problem. Oh lordy.

    1. David, re your last comment. exiling young people, though superficially attractive, seems a little extreme.

    2. David,

      As our pensions system is entirely dependent upon a plentiful supply of young people entering the workforce, discouraging young people from remaining here would only create different problems.

    3. If this comment is only about the state pension system it would be better to state that explicitly as there is a lot of confusion in the general public. Funded DB/DC schemes would not be problematic in their current form.

    4. Yes, sorry, should make that clear. Our unfunded state pension scheme relies on a continually growing workforce. As do the unfunded pension schemes for public sector employees.

  5. OK, how about stagnant house prices in nominal terms for a few years, combined with moderate wage/price inflation? Houses get slowly more affordable, banks still have security (or at least as much as they have now). Home owners don't yelp too much.

    How to achieve this? Outside my pay grade, but your suggestion of social housing as the least bad option looks right. I'm not too worried about people using right to buy in a few years time. It's still more homes in total. And the money might come in handy.

    1. Slow reduction would certainly be more manageable and less risky than a sudden crash.

  6. If you build housing for social benefit without right to buy, this will boost areas, local economies, employment, and national benefits ensue. This is ideologically impossible if you believe assets for profits is the only valid model. Both can exist. As Frances points out the least damaging is a social housing expansion. The damage is even LESS if RTB is removed.
    The equalisation of entry into home occupancy would be improved, as social homes would be available.
    The remaining issue would be the concept of housing as an appreciating asset for disposal later at a vast profit. This has been the main housing and economic problem. Housing bubbles burst, mortgage markets fail, all sorts of cascades hit. This is what needs looking at in a brand new manner.
    Hard to discount constructed reductions in house prices, but this , i agree would be slowed by a major investment in social housing.
    I hope this makes sense.

  7. In over seeing a house price correction, the government, rather than bail out banks should bail out people (i.e. under-water home owners). By liquidating insolvent banks the government could directly acquire more social housing (with sitting tenants newly feed from debt) without having to build.

    As well as being a necessity, housing is a cost to the economy. The lower the costs the more wage buying power can be channelled to productive investment. The same certainly goes for the financial sector, it is a cost to the economy. The UK could do with a reduction in size of the finance sector, painful in the short-term but beneficial in the long-term.

    1. The idea of investment in New social housing can be seen as INFRASTRUCTURE to enable the economy, not as an asset ownership by the state vision by aquiring existing homes from owners. IF IT IS just bailing out existing owners and transfering ownership to the state.. Then there is no gain in infrastructurally important investment - it is a sink hole.
      The bailing out people idea for underwater owners has no net gain. The banks can fail as businessess. And underwater owners have borne and will see the consequences of risk. The least risk addition is clearly increase NON market stock - direct non profit investment. Which has clear cascading economic effect. Catalytic in fact. The balancing of the other areas is less core. After all the figures/ amounts / situations to be readjusted are speculative gains, why is everybody key to protect from speculative loss?

    2. I agree with your first point here - about the infrastructure-like nature of investment in housing.

      "Bailing out" underwater borrowers would prevent them from being trapped in houses far too small for them, as I was. After all, a house price fall is not their fault. But I was thinking that writing down mortgages to more affordable levels would relieve the pressure on overstretched borrowers - that's why I suggested limiting loans to 3x household income. That would give them more disposable income which they could spend now or save for their future, either of which would be beneficial to the economy (in different ways, obviously).

      The economic consequences of the sort of banking collapse we would be likely to see if house prices suddenly underwent say a 30% correction (which is the sort of figure I have seen estimated) would make bailout of even quite small players the best option - as indeed it was in 1973. In my view it is always preferable to bail out people rather than directly bailing out banks, which is why I would rather this was done by Government writing down mortgages than by Government giving banks money. But we have already suffered 5 years of economic fallout due to damaged banks. I really don't think allowing the entire sector to collapse through a sudden fall in house prices would be a clever strategy.

    3. Frances, we spoke on the complex matrix of the conundrum. I see your point. Distinct sectional thinking on each aspect is fine. The inter-relationship is the confusing aspect, the verification of which aspect is priority or first choice? The joining up of them all is the whole point of this blog. A great thinking point to move forward with . But before we fix an operational but broken bit thats limping, an intro of the forgotten infrastructure in a solid manner would seriously limit damage from correctional trials on the other aspects.
      The scaffolding needs placing before repairs are done, as a picture perhaps? The injection of social housing would in my view, lessen any error outcomes from incorrect solution of other issues.
      The 5 yr fallout to be repeated should be avoided so a major INPUT to the flow will lessen any impact of other failures.
      If that makes sense?

    4. My suggestion would be in addition to new social housing construction not as an alternative.
      I also think that alternative models of home ownership should be encouraged rather than the simple social/private divide. Land trusts are a particularly good example and can be easily started where a local authority owns potential development land. The speculative gains from land prices are removed from the equation and the outlay to the resident focused just on the 'bricks and mortar'.
      Also I would explore idea of using the rental value of the property as a limiter on the amount of lending, rather than multiples of wages.

    5. Alternative models of ownership - private/public partnerships as you suggest - certainly could help, and we are seeing growth of these.

      Relating lending to rental values is circular, since rental values depend on house prices. And the real issue is affordability, not price. So relating lending to incomes is more realistic in terms of people's ability to service their debts.

    6. I think you've got your circularity wrong. I would say rents are much more closely tied to wages than house prices as shown in the data:
      The rental market has a much higher turn-over (in the UK) than owner-occupiership and rents really do come out of wages whereas house prices are more closely tied to credit issuance. However it is right to say that ultimately house *values*, rather than prices, are supported by wages. Unless we return to a full-on 19th century model, whereby most of the property is owned by an elite few and most of the populous are private tenants.

  8. Frances, this is a good analysis but I think you're overstating the risk of an increase in market supply bringing about a precipitous fall in prices in the forseeable future. The housing vacancy rate is very low at 3% (as compared to Ireland's rate of 15% in 2006 before its crash) and rents are rising quickly. Before the recession the best estimates (from Geoff Meen and colleagues for the now defunct National Housing and Planning Advice Unit) suggested that we would have to build a lot more housing than we were at the time and sustain it for several years to start bringing down prices, such was the extent of pent-up demand. Given we've since had a few years of really awful house building numbers I'd say we're very far away from a supply-induced price crash.

    So while I agree completely that a big public house building programme would be a wise policy, a big increase in market housing supply would also be very welcome. Increasing supply in areas of highest demand would have the biggest positive economic impacts and would be much less risky than encouraging builders to develop marginal sites where the demand is more uncertain. So relaxing the rules (political as well as technical) that restrict housing supply in our most expensive areas (e.g. London, Oxford, Cambridge) would be a very wise move on the part of the government. Unfortunately, I think it's even less likely than a new social housing programme.

    1. Surely once people knew that large house-building programmes were on the horizon, the EXPECTATION of lower prices would be enough to force prices to fall? People would stop buying.....

      However, a more likely driver of a sudden fall in house prices would be a rise in interest rates. That's what precipitated the housing market crashes in both 1973 and 1990. We really need to think very carefully about the exit strategy from very low interest rates, given the fragility of many people's finances and the decline in real incomes.

    2. The chances of a supply increase kicking off an expectations-driven crash is an empirical question, but how close can we really be when vacancy rates are so low and household growth so high? If anything the evidence suggests that people under-estimate the prospect of price drops - see again the example of Ireland where prices were still rising when vacancy rates were at 15% and supply was through the roof. We would have to massively overbuild for about a decade to get to that point.

      Regarding interest rates, you're right that a sharp rise could put a lot of households in trouble. But that's a good reason not to raise interest rates! A combination of sustained low rates and sustained high house building seems to me the only way to stimulate growth, repair household finances and address housing need while reducing the prospects of another property bubble.

    3. I'm not necessarily disagreeing, Jim. I think house-building is appallingly low at the moment and we could certainly do more. The question is how much could be done before house prices started to fall. We don't currently have the bubble conditions that existed in Ireland - if anything the expectation is for house prices to fall, not rise - so I would not like to assume that a major house building programme here would not force down prices. While housing remains seriously over-priced relative to incomes and credit remains tight, the rational expectation would have to be that large-scale house building would cause prices to fall.

      I am appalled by the calls from monetary hawks for interest rate rises. They don't seem to care about the damage these would do. Rock-bottom interest rates will have to remain for a very long time in my view.

    4. Jim's right. For a property crash to happen, as in the US, Ireland and Spain, you simultaneously need buyers exiting the market en masse and significant over-supply.

      What distinguishes the UK market is the lack of the latter - i.e. we have not had a speculative building boom. What we have had is decades of capital being injected into existing stock, land being banked (as developers focus on margin over volume), and the imbalancing of the economy - which drives up prices in London and other hot-spots.

      The government estimated in 2007 that we'd need to build 240k houses a year for a decade just to meet growing demand (due to increased life expectancy and falling household density). The impact of the recession has recalibrated that to 300k. If the next government promised to build 1 million new houses during the life of the parliament, we'd still be behind the curve.

      The key trends that define the UK property market predate the credit crunch. Home ownership has been in decline since 2001. Parallel to this, the number that now own their home outright has increased. Homes owned with a mortgage or loan dropped from 8.4 million (39% of all households) in 2001 to 7.6 million (33%) in 2011 (census data). Homes owned outright increased over the same period from 6.4 million (29%) to 7.2 million (31%).

      Housing market experts now anticipate that non-mortgaged owners will exceed the mortgaged as soon as 2014. That date will probably also see the number of private renters exceed the number of social renters. The former have increased from 1.9 million homes (9%) in 2001 to 3.6 million homes (15%) in 2011. The next couple of years will therefore witness a watershed in terms of housing tenure composition.

      The future is less about mortgages and more about outright ownership for both occupation and renting out, with homes becoming cherished legacies and mobility from renting to buying grinding to a near halt. The musical chairs of the last 30 years has now stopped.

      In other words, we're seeing a gradual unwinding of historic property debt. Though the market would hardly blink if we built 1 million new homes a year, to add to the current stock of around 27m, it is more likely that supply will continue to be deliberately constrained to keep asset holders happy.

      The real issue isn't a crash in prices (though this is still possible under a number of conditions), but that on our current trajectory the situation for most non-property owners is going to get worse: no chance to buy and increasingly dependent on value-extracting private landlords.

  9. There was a study done by Policy Exchange in 2009 which put the “house price boosting effect” of planning restrictions at £45,000, as compared to the average house price at that date of about £160,000. See:

  10. The Revolution will not be started by property owning Liberals, obviously

  11. Rather than a dramatic shock to the system, we should simply put an end to the policies which exacerbate the issues.

    The risk is especially acute in London where everything seems to depend on foreign demand. If that dries up then the market will get a dramatic shock without any policy intervention.

    On my blog I'm following movements in the London market and there are some anecdotal indications that things are changing:

  12. Frances, I agree with your analysis, but disagree with your conclusions. A short sharp correction would indeed be devastating, but delaying the process adds new problems - lack of moral hazard for both the banks who over-lent and borrowers who over-borrowed (and this isn't a Calvanistic response - avoiding moral hazard has consequences); dragging in another soon-to-be-over-indebted-generation; high living costs preventing competitive trade with other nations - and so on.

    If I must have a leg amputated, I'd prefer clean and quick rather than this rusty blunt saw approach.

  13. 1) Separate gambling and retail banking (Glass-Steagal)
    2) Switch taxation from employment and productive activity to speculation and hoarding (Land Value Tax at the level of planning acquired)
    3) Capital Gains Tax (without inflation adjustment) on all house sales.
    4) Business Rates on anything not owned by a person for their own use (foreign shell companies, buy to let etc)
    5) Offset land Value Tax liability with previous employment tax payments.
    6) Right to build for an individual - limited to one house every 15 years.
    7) Ability of land banks (commonly and inaccurately referred to as 'builders') to sell only serviced plots as a maximum - not allowed to subcontract others to build houses.
    8) Minimum standards for rental accommodation.
    9) New build standards similar to the old ones used for social housing ie better than current private builds.
    10) Guarantee bank deposits at 95% maximum, so there is the incentive to choose/research the safer banks/building societies.
    11) Consider the Danish system of matching liabilities (debt such as mortgages) against assets (long paying - the other isde of the mortgage)
    12) Prosecute anyone who has broken the law. Bankers for fraud, trading while insolvent, self-cert mortgagors for either fraud or non payment of tax (where income and stated income do not match), mortgage advisors for accessories to fraud, managers suffering the larger punishments, politicians for expense fiddles where the expense was not 'wholly and exclusively incurred in carrying out the duties of the employment'.
    13) Proceeds of crime law to get back some money from those above. Bankrupt them, jail them - make sure this can never happen again.
    14) Education on how bad debt is.
    15) Unenforceability of new loans which are aggressively or recklessly advertised. All print must be the same size - so no smallprint and reviewed by a jury of people at advertisers expense. All advertising must be reasonable.
    16) Let the idiots who caused the mess suffer:- bankers, over-payers, politicians, debtors.
    17) Let those who didn't make the mess (too young, too sensible, too moral) have a better life:- less debt, less tax on employment, a healthier economy

  14. Useful perspective Frances. Thoughts:

    1) The allergy of the current government to useful fiscal solutions reminds me that Britain really needs a different government, ideally asap, but if not, then at least at the next election.

    2) If your fears about interest rates are correct, then this suggests we need radical restructuring of the banking sector first - as there will be a lot of pressure for interest rates to rise as soon as we have any kind of decent growth.

    3) As others have noted, there's reason to believe we could make a start on housebuilding and manage a slow adjustment. Writing down various overstretches would help too. In the end, if we don't begin to take on the problem we are storing up an even worse whirlwind - not only will vulnerable institutions stay vulnerably (the structure of the mortgage industry is not well suited to price declines ever) but we are storing up the potential for real social unrest.

  15. The people who have the problem could help solve it: move to a place where houses and cost of living are better value for money. Immediately helps on the demand side and the fear of becoming a retirement park may nudge politicians into fixing the supply side.

    1. The people who have the problem are young adults. Sadly the places that have the best value houses and lowest cost of living are also those with no jobs.

    2. The UK job market is not stellar either... There are lot of places which are both better value and have similar or better job prospects (US, Germany, Japan, etc).

      It can also work out at the other end, the differential is sometimes big enough that for a given standard of living moving can allow you to (semi-)retire a decade or two earlier (using the pile of cash left over if you swap a paid up UK house for a similar one somewhere sunny but distressed, combined with lower outgoings on living expenses).

    3. The prospect of young people moving elsewhere should be enough in itself to frighten older people into doing something about a) jobs b) housing. Their pensions, benefits and healthcare critically depend on young people staying, working and paying taxes. Sadly many older people don't seem to understand this. They seem to think their past payment of taxes entitles them to future benefits. That is not, and never has been, the case.

  16. One Word: savers
    Two Words: why does
    Three Words: no one care?

  17. Way back in the olden days of 2009 I suggested that a Property Tax could be on the cards at some time in the future if the failure to get the taxes in worsened. Fifty odd years ago I recall paying the Schedule A tax and wincing. The situation now is a dreadful mess and it is hard to see a way out. The trouble is that there have to be winners and losers. The politicians problem is that they do not want any losers and contrive to create a win-win situation by inflation and subsidy. This could turn into another big bust with a lot of very unhappy losers.

  18. Large House price rises are the result of real goods trade deficits.

    In a neo liberal economy this inflow of wealth is expressed via a rise in house prices & car purchase via the mechanism of consumer credit production and a subsequent rise in consumption in a sort of circular process which consumes more external wealth.

    Germany had / has no house price boom because it exports its wealth.
    Spain & Ireland broke or were forced to break that circle
    (Irelands domestic economy is more or less a distinct entity from multinational operations in its jurisdiction which distorted its trade balance)

    Well Spain & Ireland were in trade deficit until they were forced into surplus.
    The UK remains in deficit to Germany , China , Norway etc so its house prices remain high.

    I really don't see whats so complicated with this picture.

    The ability & willingness to consume physical goods is (perhaps short term) wealth.

  19. PS
    "as I was in the early 1990s, the last time there was a significant house price correction in the UK"

    There was a short correction in the UK trade balance during the first EMU crisis.
    German corporates could not sell its wealth to deficit countries in the manner they were accustomed.
    That was the crisis believe it or not.
    The system could not expand outwards for whatever reason.

    "But the Government is not even discussing it. On the contrary, it is doing everything in its power to prop up house prices"

    Houses as banking assets are a conduit asset for external consumption of goods.
    A sort of monetary battery system and are not valued on their basic utility value.
    Of course the politicos don't want it to go down.
    The house prices "up north" are not high because those people are generally not adding to the UKs trade deficit.
    Its the people down south which consume the BMWs and the large drive that goes with it.

    The workers up north could be bypassed by the people down south as there is no settlement between countries during these strange market state days.

    Are you suggesting there should be correction in the UK trade balance or should the UK spend external wealth on other items such as power plants ?

    1. The 1989 housing crash preceded the UK JOINING the ERM, let alone leaving it. At the time of the housing crash, the UK's trade balance was in the red by nearly £6bn. It gradually corrected itself between 1990-1994, during which time the UK both joined and left the ERM. The UK was in recession at that time and there were a large number of people in negative equity, of whom I was one. The correction of the trade balance at that time is almost certainly due to a fall in imports.

      I think you have the direction of causation the wrong way round, because you seem to think that mortgage lending is dependent on banks having capital to lend. That is not the case. The primary driver of mortgage lending bubbles is an expectation of continually rising property prices by both borrowers and banks. If the expectation is that prices will always rise, then banks will offer high LTVs and income multiples - yes, we had subprime in the 1980s - and borrowers will leverage up their incomes. There is also more activity in the housing market as even quite ordinary people buy to speculate on rising prices rather than investing for the long term - and that increased activity itself inflates the bubble further. Even in the 1980s banks borrowed on the international wholesale markets to fund lending, so availability of funding wasn't really the issue. I would have to admit that, then as now, foreign capital inflows did push up the prices of PRIME real estate in London. But they had (and have) little or no effect on house prices in the rest of the country.

      I should add that Government behaviour can drive housing bubbles, too. In the 1980s there were tax breaks to encourage home ownership, notably MIRAS which benefited dual-income cohabiting couples (hence massive increase in cohabitation at that time too!). When the Chancellor announced the phasing out of double MIRAS, IIRC in 1988, there was a spike in house purchases by couples seeking to benefit from double MIRAS before it disappeared.

      As you rightly point out, wealth effects due to increasing property prices suck in imports, increasing the trade deficit. When those wealth effects disappear after the crash, the trade balance slowly corrects itself provided that exports hold up. But if they don't, the trade balance cannot correct even if housing has crashed. Currently, although housing hasn't crashed, the squeeze on real incomes is hitting imports, but the UK's trade imbalance remains severely in deficit because of the weakness of exports. Our export performance is frankly awful.

      I would be the first to agree that the UK's housing market is overdue for a substantial correction. Indeed I said so in the post. The problem, which you ignore completely, is the damage that a major house price correction at the moment would do to an already fragile banking sector and therefore to the rest of the economy. Maybe you don't care about the human cost of a major economic collapse. But I do - and that is why I say that there is no simple or quick solution to the UK's housing problem.

      This post is not about the UK trade balance and I do not propose to discuss it further here.

  20. @Frances
    I responded over in Steves site
    But just a quick look at the UKs Pink trade book from lets say 2001 will confirm my understanding of this.
    It shows the basic data from the post war period up to 2000 and has a wonderful map of the UKs current account with respect to mini me Europe and the world in the year 2000.
    For example you can clearly see Ireland getting stuffed foie gras like with credit from either London or Edinburgh free banking operations.

    Its a very sick world out there.

  21. I am currently looking to relocate to TN from NJ for work and I'm looking around for houses. I'm very environmentally conscious and I've heard that there are many available solar homes in Tennessee. I also wouldn't mind renovating a home myself in order to implement green technology.

  22. Portland, Oregon faced a very similar conundrum in the 1990's and did not want to become involved in public housing nor did they want to contribute to sprawl across good farmland and forest. They instead made a sweeping change to zoning, allowing every home owner to add a accessory house (garage apartment, studio, guest house) to their property with the caveat that it be less than 800 square feet.

    This allowed home owners through out the city to build small houses to rent out, allowing them to age in place, add income, provide a large increase in rental properties with out the attendant headaches of public housing and reduced sprawl.

    1. Ah. I take it you have never been to the UK? Housing density is far higher in the UK than it is in the US and there has already been extensive "infilling" of the sort you describe - people selling off their back gardens do developers. Sadly, therefore, the Portland solution would not work here.

  23. Tying this debate into your blog on QE. the chances of interest Rates rising I think are very very minimal, why because of the deflationary pressures in the economy. The Uk is very much a real estate centric economy, i.e most loans are priced off the value of real estate, commercial and residential. It really is the underpinning of the economy. that is why the government has done what it has had to do in order to stabilise it. Unfortunately all that real estate (loans) lies I think with a handful of banks, unlike in the US where it was spread more widely and had the Fannie's backstop. Here there is no such back stop.

    Your QE blog shows that the illusion of QE maybe fading as inflation drops. A point that was not brought up in that blog was that QE removes income from the economy, particularly from those not inclined to be too far up the risk curve. In that it is deflationary. i.e all those coupons are actually going to the treasury as opposed to into savers pockets. It is also obviously reducing risk free assets from the economy.

    From those I speak to who were vulnerable in 2008/9 with their over stretched mortgages they are still living close to the wire just to meet their monthly payments, particularly as cost push inflation has risen during those years.

    It is as you say a Gordian knot and one that I think will be either unpicked by unrest (although that is not really very British) or by the crescendo of elderly wishing to sell their homes to either downsize or to finance nursing home fees. That may not occur until the later half of the decade which gives the coalition a bit of time to try and get reelected in one form or another. But so far the continued short sightedness of politicians seems to be storing up more trouble along the way.

  24. But at the same time I get it, the whole world is in a low growth deleveraging cycle, only problem is it is not possible for everyone to delever at once. But you only have to look at EEM and you can see the slowdown coming through there. That I think was the great white hope that everyone had pinned their hat on for rescue. Not gonna happen I think unless they start having a go at each other. See the comments from the Bank of Japan chap to his Korean counterpart re yen inflation. In not so many words "deal with it, sunny."

    A substantial drop in oil prices would be helpful although would scare the BOE as it would slot it's inflation targets and those of many other countries. Besides Saudi sets the price there as the marginal producer and that would set up a whole load of fun in Russia and the Middle East.o where do we go for a ray of hope because it will come from somewhere otherwise the world needs to hit the reset button. (That is not facetious - what was Bretton Woods?) Butif there isSo maybe some hope it may come from technology. Whether 4G can make the whole country completely connected at blistering pace that would offset having to live in the outskirts of London to commute to central london. Perhaps and this is not necessarily great but I have spent the last hour on your blog, and I haven't consumed a thing other than a bit of education. Perhaps we'll just consume less whilst somehow being more productive. The internet allows us to set up a business and communicate to a much larger audience with small silo companies that can be based anywhere. Cost of telecommunications is cheap and video streaming is getting a lot cheaper. I don't know. How dies this help the housing market? People spend less on travel and more on paying off their debts. People become more entrepreneurial and productive as was the case in the early 90s when they had no choice but to. I am no tech guru but it'd appear that you can do a lot on line with not requiring a huge budget.
    I don't know the mechanics of a debt jubilee I only know that it has occurred reasonably frequently in history most likely from the same mistakes being made as have been made now.
    I guess if the average mortgage was £160,000 and the average salary was £25,000 and you wanted to have a loan to salary ratio of 3 then you would hand everyone in the country £85,000. Force those with a mortgage to put the money toward the mortgage and those without one to just pop it into their bank account you would re capitalise the losses the banks would make and force everyone into repayment mortgages. The only caveat and bit I probably can't work through is what happens to the loans made on the value of a property not related to housing. i.e I borrow some money on the value of my property to fund a business.

  25. I am not sure London house prices have remained high just because of investment from rich Asians and French! It is the capital and also has a very strong rental market and of course the recent Olympics had a small influence.


  26. This has been a long time coming and perhaps the silver lining of the financial crash is that it will force us to deal with the problem. IMHO it is the major problem that is facing the country by far. This has been exacerbated by a positive birth rate and immigration but we need both of these to survive, particularly as you point out to fund pensions.

    The origins at least go back to the right to buy scheme of the early Thatcher years but it was not buying that was the problem - it was that the local authorities were forbidden from building houses to replace to social stock sold. Housebuilding collapsed to of the order 10,000 units per year, to the massive advantage of course of those already on the housing ladder, particularly with larger houses. Add this to the banking big bang of the mid '80s and the perfect storm has been created. I make no comment on whether this was oversight or deliberate planning but the effect has been catastrophic on the economy as people have discovered that they can get rich by property investment rather than by entrepreneurial or other business activities (some bankers excepted of course).

    No politician has really grappled with this because the prospect of reducing house prices would make them unelectable. We have to avoid that also for the excellent reason of not undermining the banking system.

    So it is at least a 30 year old problem and will take a similar time to correct, if it is possible. Osborne's 2013 budget included effective mortgage guarantees up to 20% of £600k. This was cynically designed to give some feel-good in time for the 2015 election but guarantees are not in themselves a bad idea.

    I would suggest that guarantees could be written for up to 20% of mortgages up to £100k on new houses up to £150k. I don't have any feeling for the figures really - these are just ballpark figures. Maybe they would have to be higher in some cities, mainly London, and the property could be not only completely new build but also change of use brown field sites.

    Couple this with clear incentives to developers to build/develop such low cost housing and at least young people could start to buy their own homes again. And in so doing they would escape from the rental sector which in the UK is designed for short term contracts.

    The mortgage guarantee would be time limited on a sliding scale so that the cost to the owner would gradually rise. If an owner needed to move while part of the mortgage was still covered by a guarantee, the guaranteed proportion of equity would be returned to the state. The guarantee could be bought out at any time with some encouragement of course.

    Restricting mortgages to 3 times income would be rather draconian - even if interest rates rise eventually back to historic levels, a mortgage is still affordable at 4 times income, and low interest rates are here for a long time - or there will be real pain and deep recession. Let us deal with the supply side first.

    But it is only with clear long term bi-partisan planning that we will ever solve this problem. I don't suggest public sector house building.

    By injecting housing into the bottom of the market, the perturbation further up the scale will be minimised. Fiddling anywhere else will cause a house price crash. So it has to be done very carefully and with accurate monitoring.

    A side benefit would of course be that rental rates at the low end will stabilise and even decrease, which would help the enormous housing benefit bill.

    This would be helped even more if the minimum wage were increased substantially as HB is essentially a prop to low wages. There is no real evidence here or elsewhere that minimum wage has any effect on business - if anything it concentrates the mind into getting better productivity. But that's another argument...

    Or we could move to Austin, TX where I gather the ratio of median house prices to median income is about 2.9....:-)

  27. Lots of factors to consider but the Help to Buy scheme is artificially propping up the housing market. The UK Tax payer is in effect backing those that could not afford a house to get a house. In some places in northern England and Scotland property is being sold at a few pounds - these places need to be regenerated and developed.


  28. how about stagnant house prices in nominal terms for a few years, combined with moderate wage/price inflation? Houses get slowly more affordable, banks still have security (or at least as much as they have now). Home owners don't yelp too much.

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    How to achieve this? Outside my pay grade, but your suggestion of social housing as the least bad option looks right. I'm not too worried about people using right to buy in a few years time. It's still more homes in total. And the money might come in handy.

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  30. One way to solve the puzzle is currency depreciation. A sustained decline of GBP would reduce the real (but not nominal) price of houses without causing any collateral damage to banks or household balance sheets. Keep real interest rates negative for a few more years and it will eventually happen.


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