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Housing Is In Need Of Some Shock Therapy

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"Lord make me chaste, but not yet". I've used this famous prayer by St Augustine many times before in commenting on the public policy response to the credit crunch, and make no excuse for citing it again.

As the aspiration of chastity is pushed ever further into the future, St Augustine's lament seems to become more relevant by the day.

Since the start of the crisis, economic strategy has contained a central contradiction, bordering on outright hypocrisy. Developments this week make clear it's not about to change. Policymakers want to see the economy made more competitive, they want to see rebalancing, for housing to become more affordable, and for the nation to save more and borrow less, but they appear more reluctant than ever to take the painful decisions that would achieve these aims.

Despite the pressure from rising inflation for higher interest rates, the Bank of England is expected to continue clinging to its ever more incredulous zero interest rate policy at the conclusion on Thursday to its monthly Monetary Policy Committee meeting. Some MPC members are in open revolt, but it would require a blinding flash on the road to Damascus to convince the majority.

Meanwhile, there's the spectacle of the Government attempting to strong-arm the banks into lending more to an already seriously over borrowed economy.

I wouldn't go so far as to argue that Project Merlin sets the SME sector up to be the new sub-prime. The amounts involved are too small to pose any serious systemic risk. Even so, there will be a bad debt price to pay for the Government's political point scoring. To the extent that it means anything at all, Merlin is just another borrowers' charter.

Much more concerning is the way ultra low interest rates have become a life sustaining prop for Britain's over indebted households. At the trough of the banking crisis, nobody either in or outside the Bank of England would have dreamt that nearly two years later bank rate would still be close to zero, still less would they have imagined that with the inflation rate bounding away towards 5pc, there might be a perceived need for yet more quantitative easing. What was intended as emergency therapy has become the new normality.

So seriously entrenched in the nation's psyche has ultra loose monetary policy become that it is now quite widely assumed the economy couldn't withstand almost any rise in interest rates without triggering mass household insolvency and another recession.

One of the most articulate proponents of this view is Fathom Consulting's Danny Gabay. He's used the expression "zombie households" to depict the disproportionately high numbers of home owners trapped by excessive debt.

For significant numbers of mortgage holders, a rise in rates of even as little as two to three hundred basis points would increase debt servicing costs by 100pc or more. Many more would find their finances stretched to breaking point.

As it is, substantial numbers of homeowners look set to be plunged into negative equity. We've already seen a roughly 18pc nationwide fall in house prices since the peak. Market derivatives indicate that in nominal terms, house prices will be the same in six years time as they are now, which implies a real terms peak to trough correction of well in excess of 30pc. That's much bigger than occurred in the early 1990s, when millions found themselves in negative equity. Rising unemployment would deliver the final coup de grace.

I'm not saying this analysis is wrong, but I do question whether the maintenance of ultra low interest rates is the best way of insulating the economy from the consequences.

Everyone agrees that the root of the crisis was borrowing too much and saving too little. To respond by forcing savers to offer a negative rate of interest to distressed borrowers just seems perverse. When you consider that most households in Britain are actually net savers, the policy looks more debatable still. The thrifty majority is being forced to pay for the sins of the profligate minority.

Mervyn King, Governor of the Bank of England, says he understands the frustrations of savers. Yet he asks them, in effect, to shoulder the brunt of the inflationary adjustment to wealth.

The politics are easy enough to understand, but the economics are indefensible. By supporting housing investment, the effect of negative real interest rates is to perpetuate a fundamental misallocation of capital at the heart of the UK economy – housing.

The intention is to spread the household adjustment over a period of years, so that its impact on jobs, consumption and confidence won't be so bad. But if the consequences of that policy are that savers get hammered, the Bank of England's credibility goes out the window, and there is a further loss of economic competitiveness, you have to wonder whether it is a price worth paying.

As things stand, there is no mechanism for proper price discovery in the UK housing market, with potential purchasers holding off in the expectation of lower prices and sellers still clinging to the expectation of pre-crisis prices. Transactions are at a standstill. The whole housing market needs to be rebased at affordable levels. Until that happens, you won't see any durable recovery in household finances.

There are better ways of supporting over borrowed householders, if that's what the Government wants to do, than through interest rates. Banks could much more usefully be lent on to provide mortgage payment holidays than to load up SMEs with loans. Stamp duty could be suspended, or Miras reintroduced. Whatever the solution, deliberate destruction of savings is no way to run an economy.

I gave up highlighting relevant parts of the article because it's all so spot on.

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Banks could much more usefully be lent on to provide mortgage payment holidays than to load up SMEs with loans. Stamp duty could be suspended, or Miras reintroduced. Whatever the solution, deliberate destruction of savings is no way to run an economy.


Where does the cash for this little lot come from then Jeremy?

He omitted to mention that if the insolvent banks were allowed to default, savers wouldn't just be losing some real interest for a few years, they'd be having great chunks of their principal lopped off.

This was probably the best solution in the first place i.e. Anyone with savings of more than £35k in the banks should have been left to sue for the balance. Not sure how that would have benefitted savers though............

There's only so much cake left to go around after all.

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  • 311 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?

      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%

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