Can the government save the housing market?
By John Stepek
December 05 2008
This housing market crash is getting worse, but is there anything that can be done to help it?
First, let's have a quick look at how bad things are right now: figures from Halifax show, in November alone, prices fell by 2.6%, taking the annual decline to around 16%. That's the biggest drop the index has ever recorded.
The average house is now worth £36,000 less than at the peak in August 2007 and there's no sign of things getting better - the number of mortgage approvals slipped back down to 32,000 in October, suggesting that demand is nowhere near picking up.
Falling house prices by themselves are not necessarily a huge problem. Negative equity (where you owe more on your mortgage than your house is actually worth) is unpleasant, but it's not a big deal unless you have to move. Far more important is your ability to keep paying your mortgage.
Paying for the crash
This is where the problems are really starting: during the boom years, it became almost impossible to get on the housing ladder without taking on more risk than would have been considered wise during more sensible times.
Interest-only mortgages with no plan for repaying the capital to back them up; couples borrowing to the hilt against their joint incomes; the idea that the economy might hit a brick wall didn't seem to occur to either borrowers or lenders.
But now it has. Unemployment is rising steadily, just as many borrowers' financial situations are more precarious than ever. And it's when the job losses start in earnest that people really start running into trouble repaying their mortgages. The Council for Mortgage Lenders reckons repossessions will hit 45,000 this year, and could reach their 1991 peak of 75,000 next year.
Plans to help those in need
Some of this might come as an unpleasant surprise to any voters who believed Gordon Brown's boast that he'd abolished boom and bust. So the government is desperately trying to find ways to stop the carnage. Hence the last-minute addition to the Queen's Speech - a two-year payment holiday for people having problems paying their mortgages.
Details are somewhat sketchy, and a little confused, but here's what we know about the scheme so far.
The scheme would cover mortgages of up to £400,000, and apply to those with savings of £16,000 or less. Households would also have to demonstrate that they were experiencing "genuine economy hardship", and have had trouble making payments for 13 weeks.
If they can, then they will be able to defer a proportion - up to 100% apparently - of their interest payments for up to two years, giving them some breathing space to get back on track. And people could also be switched to interest-only mortgages, so that in some cases, they could end up paying nothing at all.
Will it work?
That sounds like a pretty good deal. After all, more than 10 million homeowners out of 11.7 million have a mortgage of less than £400,000. So it sounds like it covers almost everyone. And the banks don't have to worry about it, because the government is going to underwrite the deal.
If a borrower ends up defaulting anyway, then the government will pay the banks any interest they missed out on by giving the payment holiday in the first place. The government reckons this guarantee could cost up to £1 billion, but in practice will end up being around £100 million.
But as they say, the devil's in the detail. Will borrowers have to pay interest on the deferred interest? How will "financial hardship" be defined? As Ed Stansfield at Capital Economics put it: "It is going to be difficult to distinguish who deserves the support and who doesn't."
Housing minister Margaret Beckett added to the confusion by saying only 9,000 homeowners would benefit, a drop in the ocean compared with the potential number of repossessions next year and suggests that far fewer people will be eligible than the initial numbers suggest.
Not just for homeowners
It's not the only move being used to prop up householders. The Income Support for Mortgage Interest scheme has also been improved. Homebuyers will also become eligible for help with mortgage interest payments three months after losing their jobs, rather than the current nine months. Interest on mortgages up to £200,000 will be covered, up from £100,000 before.
And of course, the Bank of England is pulling out the stops to help too. Britain's key interest rate is now at 2%, and is likely to go lower to levels never seen before in this country.
Not all homeowners will benefit - some banks are passing on more of the cut than others and it'll depend on what type of mortgage they have - but some will certainly see their payments fall.
So all of these moves may help to keep some people in their houses. That seems a good thing - no one wants to see people lose their homes. But you don't get something for nothing. All of these measures have a cost. And the more people who are bailed out, the more of a cost they'll extract.
The real cost of the plans
Repossessions are one of the ways that the housing market finds a bottom. Distressed asset sales drag prices down further, getting them closer to the point where they reach affordability.
While helping people get over a blip seems a good idea - and one which you can't rely on the banks to do themselves in this sort of environment - there is the danger that all you do in some cases is delay the inevitable. That means drawing the housing correction out. And the longer you draw it out, the more reluctant people become to buy, as they go from believing that "property prices can only go up" to believing - equally wrongly - that "property prices can only fall".
And also - I hate to bring this up as it seems deemed impolite - but there is also the small matter of personal responsibility here.
No one forced anyone to take loans from the banks. Some individuals chose to rent rather than buy, to save rather than spend, or to at least save up for a reasonable sized deposit and not overstretch themselves. All of these bail-outs aimed at saving the over-indebted extract a cost from the more prudent.
The big worry
Deflation may be the big worry of the moment and it certainly looks as though consumer price index inflation will turn negative at some point next year. But even so, the Bank of England's rate cuts are going to hammer savings rates at a time when CPI is still way above target.
And with sterling plunging, and the Bank now looking at the nuclear option of "quantitative easing" (that's printing money to you and me), there's no guarantee that deflation will be as significant a problem in the UK as anyone expects.
The trouble is that punishing savers is another great way to drag out the correction, because households need to rebuild their savings.
Before the current government came to power in 1997, households saved an average of around 10% of their income. That cushion has vanished. At the start of this year, the savings ratio actually went negative - meaning people were spending more than they earned and taking money from their savings to fund it.
We won't get out of this recession until consumers have saved a much larger financial cushion and so feel comfortable about spending again. But rate cuts, a shrinking pound and bail-outs funded by higher taxes make the job of building that cushion a lot harder. We're in real danger of dragging this process out - and in the long run, that'll be more painful for us all.
John Stepek is the editor of MoneyWeek