Three boom-busts in 40 years are testimony to the failure of trying to control the housing market through interest rates alone
Easter is traditionally when the housing market comes out of hibernation – and if ever there were a time when it might be imagined activity would be buoyant, it would be this year. The Bank of England has pegged the official short-term interest rate at 0.5% for more than three years and is now part-way through a third round of asset purchases, which will in total boost the money supply by £325bn.
For the past four decades, cheap credit has been the catalyst for property booms. That was the case in the early 1970s, when Threadneedle Street abandoned direct controls on lending and then watched helplessly as prices rose by 50% in 1973. A second bubble followed 15 years later as a result of a toxic mix of financial deregulation, cuts in interest rates and the pre-announced abolition of double mortgage relief. In the years leading up to the financial crisis of 2007, borrowers could secure loans at high multiples of their income with few questions asked.
There will, however, be no housing boom this year. Transactions are running at half the level seen in the pre-crash period, and the pick-up in activity at the end of 2011 and in the early months of 2012 was linked to the end of special stamp duty arrangements for first-time buyers. The property market has been unusually quiet for the last couple of years, with a shortage of buyers, sellers sitting tight, and prices barely moving up or down.
This trend looks likely to continue. There is no real evidence that the Bank's quantitative easing programme is leading to mortgages becoming more freely available, and potential first-time buyers are struggling to raise the deposits demanded by lenders before they will grant a loan. Prices need to come down to make residential property more affordable but that only tends to happen during periods of sharply rising unemployment, negative equity and aggressive foreclosure. That was the case in Britain during the early 1990s, and has been the reason for the big falls in house prices seen in the United States since 2007, but does not apply to the current UK property market.
On the contrary, banks and building societies have adopted a lenient approach to those unfortunate borrowers in arrears with their mortgage payments and, as a result, repossessions are low. There are few forced sellers, so little pressure to cut prices to levels that would make them more affordable to first-time buyers.
Anybody thinking of buying a home can take their time, because prices will, at best, move sideways this year and there is currently not the remotest chance of the Bank's monetary policy committee raising interest rates. All of which means this is the perfect time to take stock and to suggest reforms, should they be deemed necessary.
It would tax even the most eloquent of advocates to make the case that 40 years of house-price inflation has been beneficial to the UK. It has certainly been good for the current crop of owner-occupiers in their 40s, 50s and 60s but not for the next generation, who are frozen out of the market by high prices. Since the early 1970s, UK house prices have tripled in real (inflation-adjusted) terms, with the biggest gainers those living in the south-east.
Germany, courtesy of ultra-low interest rates, has seen house prices rise by 10% over the past two years, but this is the exception, not the rule. The cost of residential property has barely budged in real terms in the past 40 years and, as a result, the economy has been better balanced and has been less prone to the sort of debilitating boom-busts seen in the UK, which have caused extensive collateral damage to manufacturing. Britain's labour market mobility has also been impaired by house-price inflation, because it has either encouraged or forced people to stay put. Owner-occupiers in the south fear that if they move to another part of the country, they will never be able to return. Those tempted to come south to look for jobs cannot do so because homes are so expensive.
History suggests that the current torpor will not last forever. There was a long period of stability between the end of the second world war and the start of the 1970s, but this was marked by an expansion of the housing supply and by much tighter credit conditions.
Yet, keeping demand and supply in balance is not easy. Britons are culturally wedded to the idea of owning bricks and mortar and live on a small, crowded island where the planning laws are tight and the tax treatment of property generous. The population is rising and during the recession house building fell to its lowest level since the early 1920s. The City is confident there will not be an increase in the cost of borrowing from the Bank of England this year, and some analysts think there may not be one in 2013 either. Most of the conditions are already in place for the next boom, although the fact that property is still expensive and lenders are still hunkered down means it may not happen for some while.
Preventing a future housing bubble is, rightly, a priority for the Bank, and it has been mulling over how to prevent one. Three boom-busts in 40 years are testimony to the abject failure of trying to control the property market through interest rates alone, and – not before time – there is now an acceptance that tougher curbs on credit will be required.
The Bank's financial policy committee has been looking at two possible instruments – loan to value ratios and loan to income ratios – that it might deploy if it thought the housing market was getting too hot. The first would prevent lenders from offering loans above a certain percentage of the property's value; the second would limit the extension of credit to a certain multiple of a borrower's income.
Make no mistake, these would be powerful weapons and even the threat that they might be deployed would have an impact. It would probably only require Sir Mervyn King to make a speech in which he said that the Bank was mulling the possibility of imposing a loan to value ratio of, say, 80% on all new mortgages for the market to be killed stone dead. Activity would dry up and prices would fall.
The Bank has two big concerns about the use of these tools: that their use might damage the economy and that they may prevent people buying their own home. But the benefits of long-term stability outweigh the sugar rush from a housing boom, while the best way to encourage owner-occupation is to reduce prices. There is an opportunity to wean the UK off its addiction with house-price inflation and it should not be squandered.