Rate cuts haven't stopped the US housing crash

published 7 December 2007

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Well, they did it.

The Bank of England cut the base rate by a quarter point. The pundits were unanimous in their congratulations. And to be fair, the Bank probably felt it didn't have much option.

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After all, the market interest rates that it's trying to control have been largely ignoring the base rate since the credit crunch kicked in, back in August.

More on that in a moment. Anyway, as I said yesterday (Why the Bank of England can't save the housing market), I don't think this is going to make much difference to house prices, regardless of how the property sales people try to spin it.

You just have to look at what's happening in the US to realise that it sometimes takes more than a few interest rate cuts to stop a housing crash

The Federal Reserve has garnered much praise from pundits on this side of the Atlantic in recent days. The US central bank has been far more proactive in trying to stave off recession than our own Bank of England, they say.

Not only has the Fed cut rates by 0.75% since August, but it's likely to do so again at next week's rate-setting meeting. But the trouble is, none of this has made any difference to the ongoing US housing collapse.

House prices fell 4.5% in November. And a record number of US mortgages were "somewhere in the foreclosure process" during the third quarter, reports MarketWatch.com. A quite staggering 1.69% of all residential borrowers face losing their home, according to the Mortgage Bankers Association. Meanwhile, loans in delinquency (more than 30 days behind with their payments) hit a 21-year high of 5.59%.

With a massive pile of inventory to shift, despite a slowdown in construction by US builders, the US housing meltdown looks likely to continue for a long time yet regardless of what the Fed does. Cutting interest rates when the market has already turned is like "pushing on a string," as MoneyWeek publisher Bill Bonner puts it.

Don't be fooled by lenders' rate cuts

Besides, on this side of the Atlantic, the rate cut might take quite some time to have an impact on borrowing costs. As Neil Collins reminds us in the Evening Standard, "Libor, the rate at which banks lend to each other and the benchmark for most other lending, has escaped from Bank Rate, and will not quickly be recaptured."

Hopeful pundits pointed to immediate cuts in the standard variable rate by Nationwide and Halifax. But this ignores the fact that Nationwide just a couple of days ago upped its two-year tracker rates by 0.15%. So in fact, the rates on those products are only going to fall by a net 0.1%.

More to the point, banks and building societies can do what they want to rates the key thing is the ease of actually getting a mortgage approval out of them. As Collins continues: "with the wholesale markets effectively closed to many lenders, they [banks] must rely on retail savers, and we just don't save enough to meet the demand for advances."

Indeed, the Council of Mortgage Lenders warned last month that unless the credit markets defrost, lenders could be left relying on deposits from customers to fund lending. Retail deposits are expected to come in at £45bn next year; but the CML had been expecting mortgage lending of £90bn. That's a massive amount of money potentially being taken out of the market. And that means both that lenders will be more picky about who they lend to, and they'll also charge more when they do dole out money.

And as fewer people borrow less money, house prices will inevitably fall.

Turning to the wider markets...

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Rate cut fells to prevent housebuilder slide

In London, housebuilders led the FTSE 100 into the red despite the interest rate cut. A After a morning rally, the blue-chip index closed down 8 points overall, at 6,485. Persimmon was the day's heaviest faller, with peer Barratt not far behind, after Bellway released a statement containing gloomy predictions for the year ahead. For a full market report, see: London market close

Elsewhere in Europe, the Paris CAC-40 added 14 points to end the day at 5,673. And in Frankfurt, the DAX-30 was down 4 points to close at 7,940.

Across the Atlantic, US stocks ended a second day of gains as news of the government's proposals to aid subprime borrowers bolstered financial stocks. The Dow Jones added 174 points to close at 13,619. The tech-rich Nasdaq was up 42 points, at 2,709. And the broader S&P 500 added 22 points to end the day at 1,507.

Gold back below $800

Crude oil futures had slipped to $89.86 this morning, and Brent spot was at $89.92 in London.

Spot gold briefly hit $803.50 in Asian trader, but had since fallen back to $798.90. And silver had fallen to $14.41 this morning.

Turning to the forex markets, the pound was at 2.0272 against the dollar and 1.3868 against the euro. And the dollar was at 0.6838 against the euro and 111.28 against theh Japanese yen.

And in London this morning, Emap fell by as much as 9.6% - its biggest one-day fall in a year - after agreeing to sell its consumer magazines and radio units to Germany's Heinrich Bauer Verlag KG for $1.14bn. The company - which publishes titles such as Heat and Grrazia - will return $1bn of the proceeds to shareholders. Emap is yet to sell its B2B unit.

Finally, our recommended articles for today...

London house prices aren't immune to a slowdown

- There is a view that prime London house prices are immune form the credit crunch, says Merryn Somerset Webb. But it's a very blinkered one. To find out why the idea that 'stupid foreigners' will prop up the market no matter what happens - plus why you may find it hard to flog that second home in France - read: London house prices aren't immune to a slowdown

Why is the US prolonging subprime misery?

- Hope Now has ostensibly been set up to support US subprime borrowers facing a huge jump in mortgage repayments. It looks more like a misguided policy destined to prolong the US-housing led slump forever. For more on why it looks like taxpayers are going to have a foot a hefty bill for some poor lending decisions, read: Why is the US prolonging subprime misery?

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.