Safe as houses? Why savings should not always be in bricks and mortar.
December 15, 2010
Solve the underlying causes of the West’s failure to save adequately and the global imbalances that lie at the heart of the current financial crisis should then correct themselves. Yet as the events of these tumultuous past two years show us, this is far easier said than done. Populist measures to chasten the banking sector are simple enough to devise, but the underlying, deep-seated structural problems facing our economy require tough strategic analysis, potentially divisive policy changes and a harsh dose of reality.
Housing is the classic policy issue urgently requiring fresh collective thinking. Home ownership has blossomed in successive generations from a dream to goal to expectation for most Britons. Either in response to or as a direct driver of this trend, successive governments have willingly, indeed aggressively, encouraged the expansion of a ‘property-owning democracy’. But this has been a near universal aspiration by necessity underpinned by debt. Most recently, this collective borrowing has become colossal yet so socially mainstream almost to be considered unrisky. However with debt must come risk and the dangerous overleveraging of the individual, as we now know, has perilous consequences for the general economy. So we must ask ourselves: is the British love affair with ever increasing home ownership either desirable or sustainable for the future?
For much of the past decade the availability of mortgage finance went hand in hand with the increased availability of cheap and easy money (the causes of which I have discussed before). The stronger the competition in mortgage provision, the lower mortgage rates fell and the more open the market became to a wider range of borrowers. Alongside exceptionally low central interest rates, a housing bubble began to inflate without limit as property came to be seen as a safe (sometimes, ‘the only safe’) and lucrative investment. Swiftly rising prices sucked in more buyers anxiously convinced that they would never save as quickly as values would appreciate. Similarly, lenders calculated that appreciating assets outweighed the risk of defaulting borrowers. A diverse array of financial products followed, including the interest-only mortgage, designed to draw in a constant stream of new market participants. As homeowners borrowed against their flourishing equity stakes to fund holidays, cars, home improvements and general consumption, so the perceived gap between renters and homeowners widened to the extent that to rent seemed almost to become a new yardstick of poverty.
The UK economic downturn began when the household debt and housing bubbles simultaneously burst. UK house prices had risen by 88.5% in the decade to 2007 with average household debt leaping from 105% to 177% of disposable income over the same decade.
As we have sought to understand the roots of the ensuing financial crisis, focus has rested upon the role of bankers – their manipulation of and disregard for risk, their short-termism, their failure to respond to public anger and their apparent unwillingness to change. But there is another powerful group that has vigorously defended its vested interest in maintaining the status quo – highly leveraged homeowners. Just as bankers were broadly protected by the bailouts from the consequences of the risks they had taken, so too did policymakers move quickly to protect deeply indebted homeowners with even lower interest rates and mortgage protection plans once the financial crisis hit. The mortgage market may indeed appear to be ‘too big to fail’ but these measures are unlikely to be sustainable. At some point, I believe we shall have to create an entirely fresh approach to home ownership.
Worryingly in the meantime policymakers seem anxious simply to return as quickly as possible to the way things were. Excitable predictions suggest that once these past dismal years are behind us, we shall see house prices rising again. Indeed there have been short term rallies after the major falls of 2008 which many point to as evidence. But the unravelling of a market is not always linear. After any fall, it is hard to assess the bottom of the market which is why many were tempted into entering the fray soon after the crash by apparent bargains and low interest rates. A temporary squeeze in supply as large numbers of homeowners wait out the decline and a longer term one caused by Britain’s restrictive planning laws, give further fuel to those convinced of the inevitability of rising prices.
In reality, I suspect the British housing market will remain vulnerable for some years. The IMF suggests that UK house prices are still overvalued. Higher interest rates, perhaps driven by inflationary pressures as the economy recovers (I have spoken before about the temptation of inflation to any government looking for a speedy and politically palatable way of bringing down public debt) have the potential suddenly to make mortgages much less affordable for the majority of borrowers. For once we should not count on a plentiful and willing stream of new market entrants to shore up existing ones.
This exposure of the wider economy to mortgage holders’ risks is only one reason why we should look again at our addiction to home ownership. Ever increasing house prices have made an older generation complacent about the cost of retirement – with some justification. With the plundering of pensions, the lack of trust in the banking system and markets, and pitifully low interest rates, people understandably feel a sense of both physical and financial security in property. Equity release on a home increasing exponentially in value has become a popular means of funding long retirements. But this mechanism is unlikely to be able to sustain the length of retirement so many may need to anticipate. Indeed if it does, it will once again widen the grim generational divide that is fast emerging.
The boom years saw a massive transfer of wealth from young households to older ones. Older people with property assets were able to realise the gains of house price rises and reinvest in other products. Younger households, on the other hand, have simply taken on a very long term debt or now pay high rents to (generally older) landlords. The stacking of odds against the young is already beginning to convince some of our brightest and best to leave these shores. This trickle may turn into a flood…
For many of those twenty and thirty somethings tied into the conventional property market, meanwhile, home ownership has proven in many cases to be a millstone. While it has most commonly been praised for its ability to give people a stake in their community, buying a house often comes at the price of economic flexibility – one of the great sadnesses of negative equity is that it traps people at a time when they may most need to move to find employment.
Finally, houses have become increasingly expensive relative to disposable income. Mortgage debt has not only put householders at an enormous financial risk but it has diverted their disposable income from other sectors of the economy.
But reducing economic dependence on the housing market will be difficult for a nation that has come to consider home ownership an almost inalienable right. It may well come about without the need for government intervention. I wonder if we are now at a tipping point. Many would-be market participants are now concluding that the financial risk of a property many multiples of their salary, that rises in value only sluggishly, is no longer worth it. It will take many others a considerable amount of time to accrue the vast deposits now required to secure a mortgage. It may prove that the younger generation drives a psychological shift that levels the playing field between renting and homeowning which will help to smooth out the current disparities between the two.
But the government has tools at its disposal as well. Given the reliance of so many people on increasing house prices for future wealth and the sense that it is the only route for the aspirational, this is a tricky subject for any government to tackle with honesty. Housing Minister, Grant Shapps, has commendably suggested it would be desirable for house prices to remain stable for some time and believes we should return to looking at property primarily as a home rather than a sure-fire financial investment. He is also keen to increase supply not through national house building targets, but by devolving more planning decisions to local communities under the ‘New Homes Bonus’ so that they will feel more engaged in the decision making. At a time of austerity in local government finance and continued council tax capping, the New Homes Bonus is the only available source of income that most local authorities can create (it will give councils the first six years of new council tax receipts from new house building).
We must also strive to focus the mortgage market on the long term. Before the financial crisis of 2008, the UK market was commended for its diversity. In fact, while there was a variety of operators and the short term deals they offered, very few sold attractive medium to long term products. It was merely a mirage of choice for consumers who were often baffled by complexity into some pretty unattractive deals. The FSA is trying to smooth out some of these problems through its current Mortgage Market Review (MMR) but has already been subject to a barrage of criticism for trying to solve the causes of the last housing crisis, making borrowers jump through an interminable number of hoops and failing to take into account new storms that are likely to brew. The real prize must be to promote a more vibrant and sought after quality private rental market, so that house building can thrive again after a decade in the doldrums.
Either we face up now to the new challenges left by our old dependence on residential housing or, as the Governor of the Bank of England has warned, ‘we shall bequeath to future generations a serious risk of another crisis even worse than the one we have experienced’. But it will not be a comfortable ride. Some conventional assumptions of recent decades over the desirability of home ownership need urgent questioning.