The government’s latest plan to prop up the UK property market has been criticised by almost everyone.
And rightly so. Encouraging lenders to give first-time buyers 95% home loans is downright immoral in the current climate. There’s a reason that lenders require big deposits and are reluctant to give people money just now – it’s because they think house prices are more likely to fall than to rise.
If the coalition really wants to help, they’d let prices fall. Of course, that’s not a vote-winner, so there’s no chance they’d endorse that policy.
But whether they like it or not, that’s what’s likely to happen…
The coalition’s first-time buyer scheme is a waste of time
Merryn Somerset Webb, our editor in chief, has already laid into the government’s ill-considered plans for propping up house prices on her blog: David Cameron is mad to spend £400m on the housing market. But you can never lambast a stupid scheme too much, so let’s have another crack at it here.
It’s hard to know where to start. The coalition makes a big noise about cutting red tape, then introduces a fiddly little scheme like this. It’s like Gordon Brown never stepped down.
In short, as Allister Heath in City AM points out, it’s all about giving banks a safety cushion. The price of a house bought under the scheme could fall by 14% and the bank will “still break even if they sell a repossessed property”. The lender has the security – it’s the naïve first-time buyer along with the taxpayer, who’s taking all the risk.
The team at Capital Economics also made some very good points about the overall impact of the scheme on the housing market. For one thing, it won’t boost the overall supply of home loans. Lenders remain “under pressure to boost their capital reserves”. And “wholesale funding has become more expensive and less freely available in recent weeks”.
In other words, there is a fixed pool of funds available. If more of this pool goes to first-time buyers, it won’t be available for anyone else. So you’re just shifting funds around. Worse still, the government is interfering in the credit allocation process, and reintroducing moral hazard into the market – which is partly what got us into this mess in the first place.
There’s an even more pertinent point. The government, and others with a vested interest in propping up house prices, blame high deposit requirements for “locking first-time buyers out of the market”.
But this is nonsense, notes Capital Economics. “Remember that the share of home loans advanced to first-time buyers fell to current levels in 2003”. In other words, first-time buyers have had a tough time for nearly a decade now.
This is nothing to do with high deposits or even a lack of finance. Back before the credit crunch, anyone with a pulse could get a loan. The only thing locking first-time buyers out of the housing market is the fact that house prices are still ridiculously high compared to incomes. And this scheme does nothing to help with that.
The only problem with the housing market – houses cost too much
This is the fundamental problem that no one wants to admit to. Houses cost too much, and the price needs to come down. And until that happens, the UK economy is going to be walking on eggshells.
It’s easy to see why the Bank of England slashed interest rates in March 2009. It’s also easy to understand why it’s reluctant to raise them again. Preventing house prices from collapsing probably did more to prop up bank balance sheets than any other action in the crisis.
But it means we’re now sitting on a time bomb. How many people could maintain their repayments if interest rates went up? And how long will that remain the case? Yes, the Bank of England rate will probably remain low for the foreseeable future. But if there’s a full-blown banking crisis in the eurozone, mortgage finance for home loans will get even tighter.
And there are several other reasons to expect prices to start falling harder. Unemployment is on the rise again. As more and more people lose their jobs, the chances are that you’ll see more and more ‘forced sellers’ on the market, which will drive down prices overall.
This is one area where the US has a definite advantage over the UK. The Federal Reserve has far less ability to influence mortgage rates directly than the Bank of England does. As a result, the cost of home loans could never reach the lows we saw in Britain.
Yes, it means that US property prices crashed. And it looks as though they’ll remain weak for some time. But it also means that the threat of a terrible slump in prices no longer hangs over the entire economy. Chances are, in a few years’ time, that’ll mean the US is in a much better position to recover while we’re stuck with either stagnation and paralysis, or another recession.
We’ll be looking more closely at the long-term outlook for the US economy and housing market in a future issue of MoneyWeek magazine. Meanwhile, getting back to the state of our own market – we recently got a panel of property experts in to discuss the outlook for house prices in the UK. You can read their views here: How much further will house prices fall? Suffice to say, we wouldn’t be encouraging first-time buyers to take up the government’s offer just yet.
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