The housing market is dire and will continue to be pretty dire for the next few years. So we had better figure out how to mitigate the effects of that on the economy and indeed on people's lives.
It would be nice to predict that house prices will stabilise soon, allowing the gradual rise in incomes to make them more affordable. In an ideal world we would adjust gradually, with prices more or less steady as incomes rose. There would be relatively little damage to the economy, and even people who bought at the peak of the market would eventually see their investments come good. But I don't think that is realistic, given the collapse in the supply of mortgages.
The number of new mortgages made each month is now lower than it was even at the bottom of the early 1990s housing slump. If the banks and the other lenders are not lending it is because they don't have the money to lend. If they cannot make the loans the inevitable result will be a decline in prices. We have only had eight months of falling prices so far. The US market topped out some 18 months ahead of ours and the boom in prices was broadly similar. Prices and sales there are still falling, so if that is any guide we have a long way to go.
Our own best template is the early 1990s slump. The scale of over-valuation relative to incomes was much the same. Prices fell peak to trough by between 15 and 20 per cent and it was about six years from the peak before the market got going again. It would not be exactly like that this time, for some things are better now and some things worse. Interest rates are lower and unemployment is unlikely to rise as sharply as we may escape recession. On the other hand, households' overall debt burden is higher and pressure on the global financial markets is such that it will be hard for the lenders to increase their flow of loans even to credit-worthy borrowers, maybe for some years to come.
You can if you want have a debate about how we got ourselves into this. Sure, we are not alone, for housing booms have been a global phenomenon. But maybe since we made this mistake once before in the previous 20 years, perhaps we should have done better – we could not have stopped the boom but we might have been able to curb some of its excesses. That is a debate worth having because we really have to learn from our mistakes.
But there is another way of looking at it, which is to say: we are where we are, so what do we do? The "we" in this instance is partly the Government and the Bank of England, partly the financial institutions – and partly ourselves.
The aim should be twofold. It must be to stop the present difficulties in the housing market becoming more serious than they otherwise would be. And it must be to try and stop a problem in this sector of the economy spilling out and damaging economic activity more generally. There is no magic wand but I think there are things that can be done, including things not done in the early 1990s, to help us scramble through in better shape than we otherwise might.
One thing was done yesterday: the new guarantee scheme for bank deposits of up to £50,000. We should not kid ourselves that this will have a huge effect but it should have been done earlier and will to some extent help restore individual depositors' trust in the banking system. Smaller institutions may find it easier to retain retail deposits, and that will, at the margin, enable them to improve their supply of new loans. The general pattern has been for smaller lenders to have to cut back harder than the big ones. On the other hand if banks have to put a significant sum up front to support the scheme, there would be a danger that money in that pot was money not available to lend in the mortgage pot, which would not very clever.
Much more important will be continuing efforts to rebuild the confidence of the banking system more generally. The most important single reasons why the flow of new loans is so low is that the banks can neither rely on the money markets for deposits, nor can they sell on packages of loans to other lenders. Here the monetary authorities can help quite a lot, by for example schemes such as the £50bn special scheme of the Bank of England that enables banks to swap mortgage debt (that cannot be traded) for government securities (that can). But this scheme just helped clear the backlog of existing debt and the issue is on what terms it might be extended to revive the flow of new mortgages.
This is a global problem and there is no simple way of fixing it. Until last summer a lot of British mortgage debt ended up abroad, for it was in one way or another taken up by foreign institutions. That is part of the difficulty now: we have to finance all our own mortgages and savings in Britain are too small to do so. The government cannot help even if it were appropriate for the taxpayer to fund residential mortgages. That is partly because it is strapped for cash itself and partly because the scale of the mortgage shortfall is too big even for the Government to make much impact. I don't think we should rule out further government action but I do think we should be realistic about its likely effectiveness.
Nor will cuts in interest rates, even if they were appropriate, help much because the problem is not the price of money but its availability. In the US, interest rates are 2 per cent and house prices are still falling. Thus the general point stands that until global money markets start functioning better it is going to be very hard to meet the underlying demand for mortgages and as a result there is a danger there will be a lot more distress in the housing market. So we have to try to find ways of limiting the damage this inflicts on the economy and on individuals.
One way will be to help people manage through their debts. Here the lessons of the early 1990s are helpful because some banks managed far better than others in keeping their borrowers going and eventually emerging on the other side. Forced foreclosures are a disaster in both financial and human terms. It is expensive in management time and banks have to account for loans that go into default. They also need to collect as much revenue as they can from lenders in difficulty so that they can lend on to others. Sometimes there is no other option but last time round some banks panicked, rushed into foreclosures and everyone suffered as a result.
There is a further lesson from the 1990s: how to prevent negative equity making it impossible for people to move home. There were a number of schemes then whereby people who had a loan larger than the value of their home but could still meet repayments, could borrow more than the price of their next home if they were moving. It looks like a bad principle but makes sense in particular circumstances.
And what about us? Everyone's circumstances are different, but I think it is a good starting point to appreciate that this housing market is unlikely to become much easier for several years. The better we plan our own affairs, the better chance the economy has of coming through a period of slower growth and some disruption without going into recession and without too many people losing their jobs.Reuse content