Jeremy Warner's Outlook: Dealing with Britain's beleaguered housing market may call for some radical solutions

Mr King has been forced into partial retreat from his position on moral hazard. Complete capitulation may yet be called for
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The Independent Online

Something must be done. So says Vince Cable, the Liberal Democrat spokesman on Treasury affairs, who rose to prominence by urging the Government to nationalise Northern Rock. With the wider housing market showing every sign of going into meltdown, he's again asking the Government to act. But how?

This is an altogether tougher question. Uncharacteristically, Mr Cable is short on answers. Yet with no sign of a market-led solution materialising, he is surely right in thinking that there needs to be an urgent public policy response.

The newsflow from the housing market was again dire yesterday. New mortgage approvals for house purchases (as opposed to remortgaging) were nearly two-thirds lower in May than a year earlier. John Charcol, the mortgage broker, is laying off 15 per cent of its staff, and Taylor Wimpey, one of Britain's biggest housebuilders, is being forced to go cap in hand to investors for £500m of rescue finance.

Among housebuilders, Taylor Wimpey is actually one of the luckier ones, with its share price still just about high enough to support a meaningful issue of new equity. Taylor Wimpey is adopting the same approach as Royal Bank of Scotland pursued among the banks in thinking there may be some first-mover advantage in leading out of the fund-raising traps.

Even so, shareholders are faced with 50 per cent dilution. Many analysts doubt the £660m landbank writedown flagged yesterday will be sufficient.

Pete Redfern, the chief executive, is unprepared to spell out the fall in house prices he's assuming in arriving at the size of the impairment charge because he fears it would become a self-fulfilling prophecy if he did. Buyers would immediately demand the assumed discount.

Yet if it is merely the 15 per cent implied by the last recorded landbank valuation of £3.9bn, then it may not be enough. Even the Government is assuming a 10 per cent fall for this year alone. We know this because Caroline Flint, the Housing minister, inadvertently allowed her briefing document to be snapped by photographers outside Number 10 Downing Street. The longer term peak-to- trough fall may be a lot worse.

In any case, with other housebuilders, such as Barratt Developments, the share price is already so low that only a debt-for-equity swap by lenders would have a meaningful impact on overstretched balance sheets. Mr Redfern says that the planned placing and open offer is part of the price he has to pay to persuade lenders to waive their covenant on interest cover. This is not breached at the moment but is highly likely to be over the next 12 months in the absence of a sharp recovery in house sales.

With other housebuilders, bankers are in no position to demand anything. They daren't pull the plug, since this would only crystallise losses they can ill afford to take on to their books. With most housebuilders, sitting it out may be the only available option. In the meantime, however, they are all staring into the abyss, with a fall-off in house sales worse than anyone can remember – worse, that is, than the housing crashes of the mid-1970s and early 1990s.

To those of a puritanical streak, this might seem like a necessary or even healthy purge of past excesses. Certainly, house prices had reached apparently absurd levels relative to earnings which could only reasonably be explained by the apparently limitless supply of cheap credit that was available until the crisis in financial markets broke nearly a year ago.

But you can always have too much of a good thing, and we now have the opposite – an extreme mortgage famine. This threatens not just a very nasty correction in house prices but also a wider contraction in the economy as a whole, resulting in distress sales, business insolvency and rising unemployment.

Most people would agree that lower house prices would be a good thing, making housing more affordable again. Yet a disorderly correction would be the worst of all possible worlds, resulting in possibly extreme collateral damage. Already, there are alarming signs of just such an outcome. New housebuilding development has now virtually ceased. In itself, this may not be hugely significant. Housebuilding accounts for only 1.2 per cent of GDP. Yet the trickle down effect of a combination of sharply falling house prices and levels of construction might nonetheless be profound.

David Miles, chief UK economist at Morgan Stanley, reckons that a 10 per cent fall in house prices would result in 100 basis points off growth, taking into account the impact on propensity to consume. But in a more extreme environment, with prices falling 15 per cent this year and transactions by 40 per cent, the effect on growth would be more than 300 basis points, plunging the UK economy into recession.

The fall in transactions already exceeds his bear-case scenario. Other forward indicators which in previous downturns have proved reliable guides to the future are also flashing full-on, red-alert, warnings. There was a truly shocking profits warning from the newspaper group Trinity Mirror yesterday. In the last nine weeks, there has been a precipitous 12 per cent fall in newspaper advertising revenues, with regional titles particularly badly hit. The three pillars of classified advertising – jobs, houses and cars – are all deep in the mire.

Fast growing online advertising is as yet too small to provide meaningful compensation.

It is just as well that Trinity Mirror resisted pressure to gear itself up with debt at the top of the market, or it would be in the same position as Johnston Press and Taylor Wimpey, with bank-ers forcing a rescue rights issue on reluctant investors.

As it is, the dividend seems to be gone, and the share buy-back programme has been cancelled. Companies that used debt to make top-of-the-market purchases are looking ever more vulnerable as the economy heads south. Two years ago, Pendragon, the car dealership, paid more than £500m for its rival Reg Vardy. After a sales warning yesterday, the whole company is now worth less than £100m.

The credit crunch has been on a long fuse, so much so that sometimes it seemed hard to believe that it was anything more than a temporary squall confined largely to bankers, yet, in combination with the ever climbing oil price, it now threatens profound damage in the wider economy.

What can policymakers do? For the time being, interest rate cuts are off the menu, with the Bank of England desperate to avoid higher oil and food prices becoming embedded in second- round inflationary effects. So too are the tax rebates being used to pump-prime the economy in the US. The public finances are already too stretched to allow for a big tax giveaway.

That leaves specific policy action aimed at reviving the mortgage market. Cutting or suspending stamp duty, as happened in the early 1990s, would certainly help. It may also be necessary to make the Special Liquidity Scheme (SLS), which allows banks to exchange their mortgages with the Bank of England for cash, open to new mortgages alongside pre-existing ones.

To date, Mervyn King, Governor of the Bank of England, has specifically rejected the case for underwriting new mortgage finance, as this would be tantamount to the Government itself entering the mortgage market and might encourage a return to the overheated conditions of a year ago. The intention of the SLS is to provide emergency liquidity to markets, not to replenish the punch bowl.

Commendable attitude, no doubt, yet extreme circumstances call for extreme solutions. The bail-out of the banking system agreed to through the SLS has already forced Mr King into partial retreat from his principled position on moral hazard. Complete capitulation may yet be called for. The alternative seems to be to just sit back, hope for the best and trust to the markets. Unfortunately, markets have not so far been good at finding solutions.

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