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Mr. Gruff

A Train Of Thought

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I've been thinking about houses and house prices a bit recently, particularly as I keep getting told that there's never been a better time to buy, with low, fixed interest rates available and lower prices. I need to get things clear in my own head, so what better way to do it than to write a rambling narrative and post it in to the economics subforum?

The way I see things, there is a balance of savings and debt, and all things being equal, the market will find the right equilibrium between the two, if left long enough and without interference, assuming, for some crazy reason, that everyone is rational.

With the lending market in equilibrium, house prices would be stable relative to inflation.

There are several ways the market can be upset. Government is the big one. Sentiment is the other one, and is quite often caused by the first. Government can interfere with the market by creating incentives to borrow (or for banks to lend), or to buy houses, or incentives to save or to sell houses.

So, what constitutes examples of each? Well, falling interest rates would be an incentive to borrow, signalling that what you can have today will be cheaper tomorrow, and probably with some inflation destroying some of the value. That's a powerful incentive. Similarly, MIRAS was a powerful incentive as it reduced the cost of borrowing, and effectively doubled the benefit over saving. Increased competition in the mortgage market, that's a powerful incentive as it makes the margin on mortgages tighter. Stamp duty holidays, that's not an incentive at all. Does that reduce the cost of buying a house at all? No, it simply means that you'll pay less to the government when you do sell a house.

Now, things that will swing the balance towards saving. Rising interest rates, will provide an incentive to save more. Tax relief on savings, will help with boosting savings rates. Decreased competition in the mortgage market. Removal of incentives to buy.

OK, so now we see what will help the housing market and what won't, now let's have a look at what's happening.

Since 1997, we have had:

1. Gradually declining interest rates

2. Capital reserve requirements on banks lifted

3. Increased availability of funding through subprime lenders

4. Improved rights for buy to let investors

5. Change from TESSA to ISA

6. Strong pound, imports cheap, exports expensive

So, of these six changes, and I'm sure that there are others, 4 pushed the balance towards borrowing and, the fifth will slightly have improved the savings rate. The strong pound shifted the balance of imports and exports towards importing and consumption.

So where are we going now?

1. Interest rates at historic low, nowhere to go but up.

2. Capital reserve requirement likely to be increased

3. Subprime collapsed, mortgage lending relatively low.

4. ISA limit raised slightly

5. Increased tax on savings(pensions), especially on high incomes.

6. Weak pound, leading to expensive imports and cheap exports.

So now we are in the situation that we have suddenly found ourselves in a consumption based economy with a weak pound and expensive imports. Fortunately our exports are relatively cheap, of which we have more than a lot of people think. The low interest rates are a signal that borrowing costs are going to climb, hence the scramble for fixed rates and the rapidly rising swap rates. Capital reserve requirement increases (implementation?) will lead to a further reduction in available funding for the banks, leading to decreased competition and higher margins. The increased ISA limit will boost savings but only marginally.

It seems that we have used up all our available sources of boosting the lending market. There is nowhere to go except down.

House prices have further to come down, and will do until the equilibrium in the market is restored, or the incentives are changed again. Still, could be worse, I could live in Sweden.

EDIT: Comments welcome, this wasn't really meant to be a discussion, more a way of clearing my own thoughts.

Edited by Mr. Gruff

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