As the Bank of England Monetary Policy Committee meets, almost certainly to raise interest rates, there is growing alarm in government about an impending crash in house prices. Higher interest rates and falling house prices could trigger a bloody end to economic growth driven largely by unsustainable consumer debt tenuously secured against nothing more substantial than asset inflation.
For a Government which has built its credibility on economic competence, and the end of boom and bust, an imploding boom is not an appetising prospect. It is a real threat, none the less.
It is not the professional doom-mongers but the sober Bank of England which, in last week's published MPC minutes, said that house prices were "well above" a sustainable level. And it acknowledged, for the first time, that the market was being driven by speculative behaviour. Somewhat illogically, the Bank then predicts zero house price inflation - rather than a fall - by the end of 2004. Forecasters who do not have a public duty to be optimistic remind us that equity values fell 20 to 30 per cent from a comparable starting point in the early 1990s.
A recent paper by the Bank of England notes that the ratio of household debt to post-tax income has tripled since 1980 and now stands at 120 per cent. The paper also notes that the ratio will continue to rise even if house inflation now stabilises. The ratio of house prices to income is now close to the level which prevailed before the crashes in the mid-1970s and early 1990s.
On top of mortgage debt is unsecured debt. The Treasury has confirmed new statistics in answer to my inquiries showing that debt such as unsecured loans and credit cards has risen by 50 per cent since 1997 - more than twice the increase in income.
Against this backdrop, the behaviour of mortgage lenders beggars belief. Their latest figures for September show that half of all new mortgages granted to individuals are given at three times annual income or more. Many new loans are not for property at all, but for general consumer purchases. Lemming-like behaviour by banks is familiar to students of past debt crises, domestic and international. Not much appears to have been learnt.
Debt distress is apparent. Leeds University Business School has estimated a 70 per cent rise in credit arrears in two years, with 20 million cases passed to bailiffs. The poor, with no bargaining power with creditors, suffer most.
The Government appears to have no strategy at all for dealing with bubbles like this and their painful aftermath. It is relying solely on interest rates, hence the chief economic adviser Ed Balls' nod of approval to a Bank increase. But if interest rates are now starting to move back to even a "neutral" level of 5 to 5.5 per cent, it will not merely prick the bubble of house price inflation, but risk stifling the modest recovery in manufacturing. Manufacturers have suffered a prolonged period of stagnation caused by an overvalued pound.
The conventional view, which the Government appears to share, is that in liberalised credit markets, nothing much else can be done. Markets will correct themselves, painfully or otherwise. To interfere will distort markets and create moral hazard.
To be sure, there should be no return to credit rationing and controls. But the City, and the banks, are already crawling with expensively paid regulators. They monitor process and tick boxes but don't appear to notice what is happening around them. Or possibly they turn a blind eye to imprudent lending.
What more can be done? The Danes, for example, impose statutory loan-to-value ratios, currently 80 per cent, depending on market conditions. In addition, we should be looking at the capital adequacy of financial institutions and whether it is sufficient to cope with the bursting of a housing bubble. Bankers such as Matt Barrett have complained vociferously about reckless lending by their competitors; but no one will take responsibility for reining them in without a political lead.
The Government must deliver on reforming consumer credit regulation. It is bizarre that lenders are allowed to penalise customers for early repayment. The Government seeks through regulation to stop mis-selling of investment products, but the mis-selling of credit is largely unconstrained. There should be clear "health warnings". For those with a bad credit history, especially the poor, the behaviour of some lenders and "debt managers" is seriously unethical.
Credit management is only part of the answer. Tax policy has major implications for property markets. Over-reliance on stamp duty has been perverse and has hindered mobility. The Government's recent attempt to stimulate a debate on property tax got off to an ignominious start, since it was reasonably assumed that the Government was more concerned with raising revenue than reforms to help to stabilise markets.
Over-reliance on interest rates to secure economic stability has been likened to a golfer's reliance on a single club. With the ball now heading for a rather deep bunker, the Chancellor's reputation as the Tiger Woods of economic policy will not survive long if he relies on a driver to dig it out.
The writer is the Liberal Democrat Treasury spokesmanReuse content