A collapse in the buy-to-let property market would cost millions - better safe than sorry

Just as with the much larger credit crunch in 2008, we could easily see a wave of domino losses across the financial sector

Buy-to-let isn't risk-free (Reuters)

Of the many structural weaknesses and imminent threats to economic stability, the buy-to-let property market must rank highly. It has expanded rapidly in recent years, with buoyancy born of economic recovery and a dearth of alternative investment opportunities.

For private small-time landlords this seems to represent opportunities for both a reliable income and, in due course, a capital gain. Although taxed more heavily than owner-occupied residential property, buy-to-let remains a safer option than, say, gilts, equities or other homes for spare cash.

It is not, however, risk-free, and the recognition of this fact has impelled the Bank of England to tighten borrowing in the sector further. The Bank’s cautious moves follow a succession of fiscal nudges form the Treasury, with higher stamp duty and a trimming of tax reliefs designed to cool the market gradually.

The authorities are right to act, both for the sake of the landlords themselves – who by and large ought to take the losses as well as the gains – and for the sake of the economy as a whole.

Like most markets with bubble characteristics, a crash in the buy-to-let market could be precipitate. With high ratio mortgages, small deposits and landlords with little if any reserves to deal with losses – mini overleveraged banks, if you will – the risks to the wider economy are obvious.

Just as with the much larger credit crunch in 2008, we could easily see a wave of domino losses across the financial sector. The taxpayer should not be left holding this particular baby when the buy-to-let music stops.

Large financial institutions, to be sure, may well be damaged, but the losses and the exposure of taxpayers should be limited because of the reserves of capital they are now being encouraged to build up.

Even so, a collapse in the buy-to-let sector would cost billions. Moreover, it would damage the banks at the worst possible moment, when the economy faces further headwinds and the Chancellor has hinted that the ability of the Government to stimulate the economy in such circumstances may be much more limited than in the past.

As has been noted, governments across the western world, and in some developing economies, are fast running out of ammo to deal with faltering growth. The scale of losses in the buy-to-let market, with knock-on consequences for the wider residential and commercial property sectors, as well as households, are too grim to contemplate.

Clearly such gruesome thoughts have crossed the minds of our central bankers and the Treasury too. The Bank’s Financial Policy Committee has asked for extra powers – it has shown sufficient mindfulness about the risk to the economy to make such a request easy for the Chancellor to agree to. Better safe than sorry - as we have already learned.