Today someone of the radio told us that the credit crunch was easing in the UK wholesale markets, and intensifying on the High Street.
Thatâ€™s what you should expect to happen. Banks and Building Societies are getting the message from the money markets that they cannot carry on lending so much. Thatâ€™s why they are withdrawing their attractive mortgage offers, putting up rates and demanding larger deposits. They need to rebuild their margins (make more profit and protect themselves from loss) at a time when they cannot borrow cheaply in large amounts on the money markets, and cannot sell the same volume of mortgages on to others in the way they could in 2006. They need to husband cash and make more profit to deal with the write offs on past business and to combat the changed conditions they are experiencing for raising money to lend on.
As they withdraw their High Street offers, or ration them by price and deposit requirements, so their demand for extra funds from the money market declines. As a result, money market rates have started to come down, to get closer to the Bank of Englandâ€™s rate that has been an academic irrelevance for much of the time since the crisis struck.
Some of the money market reaction is a question of timing. Banks and mortgage companies need to be more careful at a quarter or year end, and can relax a bit mid month. Some is more fundamental, reflecting the big decline in credit being offered to consumers, reducing the banksâ€™ total need for cash.
It is by this mechanism that the credit crisis will move from hitting the financial sector, to hitting the consumers. All those who took pleasure in some well paid City types getting into difficulties and maybe facing cancelled bonuses or something worse, will now see that this is a crisis that will hit others too who were nothing to do with the credit explosion. The first casualties of the UK credit crunch will be first time buyers who will not have access to the same proportion of the selling price of a property on the same favourable terms as their predecessors in 2006/7.
There is a two way pull in the UK housing market at the moment. The price falls of the last few months have been small on average. The epicentre of the decline so far seems to have been some new flats in some city centres where developers had done well with their selling prices not so long ago, and where there is now excess supply. Some say the continuing pressure from new households, and the shortage of new build will keep prices up. They point out that interest rates are still much lower than in the last housing price decline. Others point out that whilst interest rates are lower, house prices are so much higher so mortgage payments are also very high. A one percentage increase in the mortgage on the base of say a 5% rate is a 20% increase in interest cost for the individual or couple concerned. If that is charged on a high house price and mortgage that can be very painful to the mortgage holder.
Whilst it is true that there are more people who want to buy a home here, that only keeps the market up and prices rising if it can be translated into effective demand through such people obtaining mortgages. There are always more people who want a first home or a bigger and better home than there are homes available. Prices sort out the imbalance in the market, limiting most peopleâ€™s ambitions by the reality that the house they might like most is simply too dear. We are entering a period when more people are going to have more limitation placed on their ambition to own a home or a better home, because there is going to be a painful shortage of mortgage funds.
In these conditions prices on average are likely to come down. That is also part of the painful process of adjusting after a long period of inflationary credit has been let loose in the system. Falling house prices bring other economic problems in their wake. If fewer people move the demand for carpets, curtains and new furnishings will take a knock from that source. If people feel less rich because their main asset is no longer appreciating, then they will spend less on luxuries. As people pay more interest on the mortgage, so they have less income to spend on other items, as the mortgage interest is like a tax â€“ you have to pay it or else. Itâ€™s all part of the economic slowdown most economists are now forecasting.
PS: Since writing this post I have seen the Halifax house price index for March. That shows a 2.5% fall on average in March 2008, taking the annual average increase down to just 1.1% despite the strong start to the last twelve months. It also reveals that the West Midlands and Wales are leading the market down, with London overall still up. I can’t see house prices suddenly reversing this downturn in the national average that has shown up so strikingly in the last month in this index.