The Bank and the bubble

The soaring property market is a cause for concern. But Mark Carney has the tools to prevent it over-inflating


The great lesson of the financial crisis is that free-market principles are insufficient when the property market is booming. For it was the excesses of the real estate market in the major economies, particularly the United States but also here and in the rest of Europe, that gave us “sub-prime”, toxic debt and all that followed,  eventually busting virtually every major bank in the Western world. “Never again,” everyone said. 

Not least the Bank of England, which must bear some part of the blame for what went wrong last time round. The Bank’s current caution is justified, and not simply because it is wary of being discovered “asleep at the wheel” twice inside a decade. The Bank is acting to raise loan-to-value ratios and imposing an interest rate “stress test”, under newly acquired powers. It is right to do so – but not because the Bank is the right body to manage the UK’s property market, something of a fool’s errand for a central bank. The point of policy is to prevent damage to the financial system and the wider economy when a bubble bursts. A vigorous housing market underpinned by rising incomes and without reckless lending by financial institutions is something the Bank can and should leave well alone, and let property prices go where they will. That is not the case today.

The market is not supported by strong growth in wages, which have only just edged ahead of inflation. And, while the Great Recession appears to be over, and notwithstanding the return of parts of Lloyds TSB to the private sector, our banks and building societies are still recovering the strength they lost in the crash. They are ill-prepared for any fresh financial onslaught from a property market in meltdown.

That is the direct risk to financial stability. An indirect one arises if households become badly overstretched as interest rates return to normality. That is why it is prudent to ask the banks to make sure borrowers can cope with interest rates at higher levels. While the recent signals on how soon the bank rate will go up have been confusing, the trend is not in doubt.

A return to normality will be something of a squeeze for the most heavily indebted households. Now consider the effect of some unpredictable external shock such as a hike in oil prices, for example. If that happens, unemployment rises and interest rates have to be set high to constrain inflation, tipping many households into negative equity, and leaving them unable to service their home loans, as happened in the early 1990s. That, in turn, would destabilise the banks. It is prudent to make sure that new borrowers can cope with the bad times as well as the good.

Before the invention of these “macro prudential” tools, to use the jargon, the Bank would have had to use interest rates to do everything. Fortunately the Bank can now take action on the housing market and the threat it poses to financial stability, at the same time as it keeps rates at a relatively low level to boost the recovery in the real economy. It has the tools; let us hope the Bank can finish the job.

React Now

Latest stories from i100
iJobs Job Widget
iJobs General

Sustainability Manager

Competitive: The Green Recruitment Company: Job Title: Scheme Manager (BREEAM)...

Graduate Sustainability Professional

Flexible, depending on experience: The Green Recruitment Company: Job Title: T...

Programme Director - Conduct Risk - London

£850 - £950 per day: Orgtel: Programme Director - Conduct Risk - Banking - £85...

Project Coordinator/Order Entry, SC Clear

£100 - £110 per day: Orgtel: Project Coordinator/Order Entry Hampshire

Day In a Page

Read Next
Former N-Dubz singer Tulisa Contostavlos gives a statement outside Southwark Crown Court after her trial  

It would be wrong to compare brave Tulisa’s ordeal with phone hacking. It’s much worse than that

Matthew Norman
The Big Society Network was assessed as  

What became of Cameron's Big Society Network?

Oliver Wright
Noel Fielding's 'Luxury Comedy': A land of the outright bizarre

Noel Fielding's 'Luxury Comedy'

A land of the outright bizarre
What are the worst 'Word Crimes'?

What are the worst 'Word Crimes'?

‘Weird Al’ Yankovic's latest video is an ode to good grammar. But what do The Independent’s experts think he’s missed out?
Can Secret Cinema sell 80,000 'Back to the Future' tickets?

The worst kept secret in cinema

A cult movie event aims to immerse audiences of 80,000 in ‘Back to the Future’. But has it lost its magic?
Facebook: The new hatched, matched and dispatched

The new hatched, matched and dispatched

Family events used to be marked in the personal columns. But now Facebook has usurped the ‘Births, Deaths and Marriages’ announcements
Why do we have blood types?

Are you my type?

All of us have one but probably never wondered why. Yet even now, a century after blood types were discovered, it’s a matter of debate what they’re for
Honesty box hotels: You decide how much you pay

Honesty box hotels

Five hotels in Paris now allow guests to pay only what they think their stay was worth. It seems fraught with financial risk, but the honesty policy has its benefit
Some are reformed drug addicts. Some are single mums. All are on benefits. But now these so-called 'scroungers’ are fighting back

The 'scroungers’ fight back

The welfare claimants battling to alter stereotypes
Amazing video shows Nasa 'flame extinguishment experiment' in action

Fireballs in space

Amazing video shows Nasa's 'flame extinguishment experiment' in action
A Bible for billionaires

A Bible for billionaires

Find out why America's richest men are reading John Brookes
Paranoid parenting is on the rise - and our children are suffering because of it

Paranoid parenting is on the rise

And our children are suffering because of it
For sale: Island where the Magna Carta was sealed

Magna Carta Island goes on sale

Yours for a cool £4m
Phone hacking scandal special report: The slide into crime at the 'News of the World'

The hacker's tale: the slide into crime at the 'News of the World'

Glenn Mulcaire was jailed for six months for intercepting phone messages. James Hanning tells his story in a new book. This is an extract
We flinch, but there are degrees of paedophilia

We flinch, but there are degrees of paedophilia

Child abusers are not all the same, yet the idea of treating them differently in relation to the severity of their crimes has somehow become controversial
The truth about conspiracy theories is that some require considering

The truth about conspiracy theories is that some require considering

For instance, did Isis kill the Israeli teenagers to trigger a war, asks Patrick Cockburn
Alistair Carmichael: 'The UK as a whole is greater than the sum of its parts'

Alistair Carmichael: 'The UK as a whole is greater than the sum of its parts'

Meet the man who doesn't want to go down in history as the country's last Scottish Secretary