Negative equity victims carry on spending

The current runaway spending boom is being driven by households that suffered most from the "negative equity" nightmare of the last decade, shows surprising research published today.

The current runaway spending boom is being driven by households that suffered most from the "negative equity" nightmare of the last decade, shows surprising research published today.

The housing crash, which left millions owning homes worth less than the mortgage, encouraged homeowners to build up their savings. But this allowed them to embark on a much larger spending spree towards the end of the decade as house prices started to soar, three academic economists discovered.

The result will challenge the accepted wisdom that the shock of negative equity is ingrained in homebuyers' memories and is enough to prevent a repetition.

But one of the authors said consumers' eagerness to spend and borrow should remind the Bank of the England of the need to raise interest rates early to calm a housing boom to avoid massive hikes later on.

The research, delivered today to the Royal Economic Society conference, was based on 2,000 owner-occupier households. Almost 90 per cent saw the value of their home fall, of whom almost one in 14 plunged into negative equity.

Despite this, analysis of spending patterns after the housing boom began in 1996 showed those victims of the crash were not deterred from spending the wealth that was restored as prices rose.

Professor Andrew Henley, of the University of Wales in Aberystwyth, said households thatresponded to the crash by increasing the amount they saved, reacted more actively to the return of economic confidence. His research shows they spent four times as much of their housing wealth as did those who escaped negative equity.

Recent figures show retail sales are surging, house prices rising at their fastest pace for years and borrowers took on a record of mortgage and bank debt last year.

"It would suggest that policymakers should be very cautious," Professor Henley said. "In the 1980s rates did not go up fast enough or soon enough because people didn't see the link between housing and consumer spending.

"It is better to raise interest rates in a modest way and soon rather than end up hitting the housing market and peoples' mortgage payments hard."

His comments coincide with a separate warning that even a small rise in rates could trigger a "massive" rise in individual bankruptcies.

The Association of Business Recovery Professionals, said 20 per cent of domestic insolvencies in the UK are caused by credit card debts, and a further 18 per cent by the mismanagement of other personal finances.

"With the massive increases in consumer borrowing showing no signs of stopping, these statistics could be the precursor to a monumental upsurge in consumer-related insolvency," said Peter Sargent, a spokesperson. "A small interest-rate rise could tip many people over the edge, with many consumers, especially the young, having no idea what effect this could have on their level of disposable income."

However, a report from the Centre for Economics and Business Research showed there was little evidence that homeowners were over-borrowed. The total value of mortgage debt – £606bn – is overshadowed by the total value of property estimated at £2,110bn, while the ratio between average mortgage debt and house price had not changed over the last six years.