Friday 29 November 2013

The meaning of the housing bubble

"Sometimes thing don't always go/
From bad to worse..."

So wrote the poet Sheelagh Pugh, and I kind of agreed with her yesterday when I read about the Bank of England's decision to rein in Funding for Lending, and to provide a kind of ratchet effect that will reduce the dangerous acceleration of the housing market.

It isn't much and it isn't enough, but it is a start.

But first a bit of background.  One of the stories I told earlier this year in my book Broke: Who Killed the Middle Classes? was about the demise of the so-called Corset in 1980.

The Corset was the mechanism which restricted the flow of money into the mortgage market, so that house prices stayed stable, but housebuilders still made a profit.

Since it disappeared, the 30-year house price bubble - especially in the south east - first thrilled the middle classes and now looks set to destroy them (my children will be unable to rent or buy in London or the south east unless they work in financial services, a fate worse than death as far as I'm concerned).

The issue isn't really that the Corset should have stayed in place.  The end of exchange controls in 1979 guaranteed its demise.  The problem was that nothing was put in to replace it.  In fact, within months of the decision to end the Corset, the whole tenor of the debate had shifted.

We know now that the idea that somehow all prices reflected something real was a fundamental mistake which still infects many – especially in banks, where they still bolster their balance sheets with property values, only to have those values slip through their fingers.

We might know that now but, by the end of the Corset, it flew in the face of the new spirit of the times to point it out.

Hidden in the archives of the Bank of England, I discovered a revealing note. It was a memo from the governor (Gordon Richardson) in May 1980, weeks before the Corset was finally loosened, and described meeting a City grandee who asked him why nothing had been put in place to replace it.

The deputy governor had added his own note on the file describing the hapless grandee:

"Were he a Tory MP he would I fear rightly qualify for a certain adjective in rather wide current use."

The adjective he referred to was ‘wet’, Margaret Thatcher’s new designation for her opponents in the cabinet. ‘Rather sad, I think,’ wrote the governor.

Nothing has replaced the Corset, and Thatcherism – heralded by the new and vigorously enforced consensus implied by this note – would countenance no such defences against insanity.  House prices would find their proper level, whatever they happened to be, and the acceleration upwards had barely begun. The consequences have been profound.

Carney hasn't proposed a return to the Corset, but he has tiptoed in that direction.  Banks will have to assess whether people taking out mortgages will be able to afford an increase in base rates to 3%.  They will have to raise extra capital against the mortgages they lend.

There is no doubt that this will contract mortgage lending, though whether it will really increase small business lending remains to be seen - the evidence so far is that the big banks are no longer geared up or able to do this effectively.

I've just got two thoughts about this.

First, property prices in London and the south east are unsustainable.  They are geared for the pockets of the ultra-rich, for bankers bonuses and foreign investors.  They need to come down, slowly but surely, to make civilised life possible for the next generation.

Second, nobody seems to talk about this much, but the main source of money-creation in the economy these days is in the form of mortgage loans.  If they contract, and nothing replaces them, there will be less money in the economy - and we will all be wondering why the world is deflating around us again.

That is the consequences of our collective failure to rebalance the economy.

1 comment:

Wooh said...

You are writing the way good economists should write. You are pretty well spot on in everything you say. Having worked within the corset while at Barclays, I realized how important it was. I also helped Barclays make a small fortune when the market got events completely wrong after the corset ended. Had the bank followed conventional wisdom, it would have lost big time as did other banks that had taken interest rate positions. Keep up the great writing. You are a sun shining on the cloud of confusion gripping the UK.