Sunday, November 23, 2003
Putting balance back in the housing market
Posted by David Smith at 06:17 AM
Category: David Smith's other articles

Britain’s housing market is volatile, inflexible and has been responsible for most of the “stop-go” problems of the British economy over the past half a century. Those aren’t my words, although I don’t necessarily disagree with them.

They are the description offered by Gordon Brown, who normally sets out to praise the economy not bury it. And they are a reflection of the fact that a government proud of its record in eliminating boom and bust is still worried about potential for housing to wreak havoc.

Next month we will see the preliminary verdicts of two studies the chancellor launched earlier this year in response to his housing market fears. The studies, by Professor David Miles of Imperial College, London, and Kate Barker, of the Bank of England’s monetary policy committee, are due on December 10, alongside the Treasury’s pre-budget report.

While they remain under wraps until then, the broad outlines of the two studies seem clear. Both will identify what economists would regard as important market failures.

Miles was asked to look at the case for a market in long-term fixed rate mortgages in Britain and whether, if such a market is desirable, it is feasible to develop one.

The main argument in favour, of course, is that fixed rate mortgages reduce the sensitivity of housing, and in particular house prices, to changes in short-term interest rates. Had most home-buyers been on fixed rate mortgages over the past two or three years, it is possible that the Bank’s interest rate cuts would have succeeded in keeping the economy growing but without the unintended consequence of generating a housing boom.

It is also possible that, in the absence of a speedy pass-through from the Bank’s decisions to mortgage rates, the economy would have lacked the consumer stimulus to keep growing. Let’s not complicate things at this stage, however.

The mortgage lenders have responded defensively to the charge that there is anything wrong, by saying that Britain has a highly competitive and “complete” market. You can get, in other words, any kind of mortgage you want.

In the case of long-term fixed rate mortgages, however, there just isn’t the demand for them at the kind of interest rates now available, the lenders say.

The latest figures show that 34% of new mortgages last month were fixed-rate, down from an annual peak of 50% five years ago. Overwhelmingly, though, fixed-rate mortgages in Britain mean those fixed for up to five years, not the 25 or 30-year mortgages common in, for example, America.

That could change if the government decided to offer last-resort guarantees, like those offered by agencies like Fannie Mae in America, originally set up by the federal government. European mortgage lenders put up just such a proposal last week. Left to its own devices, however, Britain’s mortgage market is seen by the industry as working pretty well for both lenders and borrowers.

The Miles report is likely to disagree. It will paint a picture of a mortgage market which has become badly skewed. Mortgage lenders have got dragged into a competitive battle for new borrowers. They offer cut-price deals - low-rate fixed deals or discounted mortgages - on which they make little money, in the hope of signing up borrowers for life.

The economic effect of these deals is that existing home-owners subsidise new customers, the exact reverse of any kind of reward for loyalty. Increasingly, though, existing customers have not been prepared to put up with this. They too want the deals offered to new customers, hence the boom in remortgaging, which has accounted for nearly half of all mortgage lending this year.

This is not a market that does the lenders much good. It is not good for the economy in the long run; if anything it means the mortgage market has become more short-termist. And in the long-run it is not for borrowers, the “rate tarts” who take advantage of one special deal after another. In the end, the obsession with achieving the lowest possible initial payment on a mortgage probably encourages people to borrow too much.

Having identified the problem, how can the Treasury, armed with the Miles report, encourage people to become long-termist? There’s no shortage of City firms ready to bundle up loans and make long-term mortgages more readily available through the lenders. What you cannot get away from is that in most circumstances a long-term fix will be more expensive than a short-term rate.

The Treasury is not ready to set up a UK equivalent of Fannie Mae. It could repeat what it has done with other financial products, by giving long-term fixed rate mortgages an official seal of approval in the perhaps slim hope this will encourage take-up. It could provide a tax incentive for people to take out long-term fixed loans, or penalise those who borrow at variable rates. Or it may have to accept that, imperfect though things are, there isn’t much that can be done.

That may also be the conclusion when it comes to the other Treasury review. Britain requires between 220,000 and 230,000 new houses each year to keep up with demand. Last year 169,000 were built; the year before under 162,000 - the lowest level, apart from the war-affected 1940-47 period, since 1924. The last time more than 220,000 new houses were built was 1988, and before that 1980.

What’s the problem? the Barker review has looked at whether it is the fault of greedy housebuilders, hoarding land and limiting supply to push prices up. It seems to have concluded that this is not the problem, although the industry is unlikely to escape scot-free.

It is likely to find fault with the builders for not being responsive enough to demand. Some say this is because the penalties for getting it wrong, particularly for the quoted building firms, are much higher than for underestimating demand. The industry itself would argue that the government has loaded so much extra cost onto builders, including the requirement in many cases to include social housing in new developments, that this has become a serious constraint.

Mainly, though, the problem is that the private sector has failed to fill the gap vacated by the public sector. In the late 1960s, more than 400,000 new homes were built a year, half of them by local authorities.

That’s not a plea for a return to large-scale council housing. It is a recognition of the fact that, when councils wanted to build new housing, planning was rarely a problem. When the private sector wants to build, it usually is.

The Barker review’s main conclusion is likely to be that Britain’s planning regime seriously limits new housebuilding. Whether the government is prepared to grasp that nettle and force through extra developments against local objections remains to be seen.

PS Since DeAnne Julius left Bank of England’s monetary policy committee (MPC) in May 2001, those favouring low interest rates have lacked a patron saint. Now they have one in Marian Bell, a kind of Our Lady of the Doves.

While the other eight MPC members voted to raise rates earlier this month, she preferred to leave them unchanged, arguing that the Bank’s inflation projections are too gloomy. In this she bravely stood out not only against her fellow committee members but also against overwhelming City expectations (and she uses to be a City economist) of a rise. At a stroke, she has become the only current MPC member never to have voted to hike rates.

Bell’s vote, and the fact that the committee did not give serious thought to raising rates by more than a quarter, has tempered fears of an aggressive upward move in rates. It will be a big surprise if there is another hike next month (the MPC has never spoiled Christmas by raising rates in December).
I would expect the next small increase, from 3.75% to 4%, to happen in February, the time of the Bank’s next inflation report. It remains to be seen whether St. Marian continues to hold out against it.

From The Sunday Times, November 23 2003

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