You can get out of debt whilst borrowing more

Some bloggers complain that I want to encourage more debt, to reinflate the bubble. They add that I do not take seriously the need for lower house prices, and want to carry on with the old model of inflationary booms based on rising house prices.

These are serious points, but based on a misunderstanding of the remedy I am proposing. We need to rebalance the economy, not drive it downwards.

Take the issue of debt. The public sector, some individuals and some companies need to borrow less. The process of cutting personal and company indebtedness is well underway. That’s why, for example, RBS has shed £700 billion from its balance sheet already and is planning to shed another £300 billion because it had borrowed too much. Individuals and companies who have still got too much borrowing would be wise to carry on with the necessary adjustment, and are likely to do so.

The public sector has only just begun to cut the rate of increase in its debt, and needs to do much more. That is what most contributors to this site have been agreeing and debating for the last three years.

To create a more successful economy we need more raqpid growth in a range of areas like exports, manufacturing and some private services. This is where we need banks that have the capacity to lend more. To grow an economy or to rebalance an economy you need a ready supply of credit for good investments, to pay for the productive and potentially profitable activities we need to strengthen. All those people and companies who have not overdone the borrowing need access to credit.

The UK needs new power stations, better roads, more exporting manufacturers. It needs to make more of the things we currently import from China. That is where we need more lending. The collapse of business lending by £60 billion in the last 17 months has overdone the repayment of the corporate collective overdraft. The business sector is now on average well financed and generating cash. It could do with a bit more borrowing.

House prices have fallen by around one fifth from their peak levels, but are still high compared to people’s incomes. Some of the quantitative easing seems to have found its way into some recovery of house prices from the low. In recent weeks agents report a surge of property coming back onto the market after a period of little supply. This is probably related to the abolition of Home Information Packs, which deterred people from testing the market with their homes. It is also likely that the CGT changes encouraged some buy to let owners to sell before the new higher rate came in.

Part of the rebalancing would in an ideal world allocate less money to housing and bring house prices back into a better relationship with earnings. This may now happen, with more real estate professionals expecting a period of house prices moving sideways whilst earnings resume some upwards progress. Stricter controls over immigration will take some of the demand pressure out. Tougher bank rules over deposits and the income needed to service a mortgage will also take some of the heat out. Sensible people will work out their family finances with the expectation that interest rates will not stay this low for ever.

Those who want a more abrupt adjustment of house prices to “get it over with” are also wishing for more instability in the banking system which could damage other activities. If the authorities allow too sharp a decline they may lose control, as they discovered in the autumn of 2008.

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36 Comments

  1. Katie
    Posted July 23, 2010 at 8:07 am | Permalink

    Easily said mate. Not easily done. Theoretical claptrap. Might have worked circa mid 20th century. Time to get real with how it is early 21st C.

    • John Hatch
      Posted July 23, 2010 at 10:00 am | Permalink

      It's always useful to have a well-reasoned opinion from an expert who can compare the current situation with that in 1950.

  2. Simon2
    Posted July 23, 2010 at 8:25 am | Permalink

    And there lies the problem, those of us considered 'sensible' people who budget for rate increases and make sure we live within our means have turned out to be not very sensible at all. The sensible ones were those who loaded up on debt to buy houses and then watched as their repayments plummeted, subsidized by the removal of returns on the savings of those who didn't buy a house because they considered it too much of a risk. I feel like a complete mug.

    I think its obvious rates will be kept recklessly low for a long time. The messages given out by all these borrower favouring policies are clear, don't bother saving, borrow to the max to get on the property ladder whatever the cost. I don't buy because I think this madness can't continue forever , but it does thanks to a changing of all the economic rules to keep it that way. Unless I go against all my principles and common sense I will continue to live a life in limbo.

    • Alan Jutson
      Posted July 23, 2010 at 9:24 am | Permalink

      Simon

      Agree with your point about most Banks wanting personal Guarantees if you are a small business and wanting to borrow. This is the reason why many SMe's do not borrow, but grow much more slowly out of reinvested profit.

      Problem with this is that growth is much slower, and can lead to missed opportunities, also does not help with many more jobs being created.

      The other problem at the moment with business at a low level, there is no profit to reinvest.

      On the plus side, you are in control and not at the risk of the Bank wanting the overdraft REPAID ON DEMAND.

      Your sensible policy of not purchasing that which you cannot afford may stand you in good stead, if you can hold out for a couple of years.

      • Simon2
        Posted July 23, 2010 at 1:19 pm | Permalink

        I think it was the other Simon who mentioned Guarantees.

        Problem is I've been holding off for nearly 10 years now.

    • JimF
      Posted July 23, 2010 at 2:56 pm | Permalink

      Yes you are right Simon, and John Redwood hasn't answered the point that this Government seems not to be looking after the sensible ones any more than the last one did. I actually put it down to the Gov's being frit of high unemployment, more than a bunch of greys with a few thousand pounds losing value. Unlike the Thatcher years, where money generally made money, we now have a situation where money is there to be spent on consumables, debt interest or lost altogether.

      The logical conclusion is for enough money always to be available by printing to pay anyone doing anything or nothing at all, no matter how useless. Debt is raised against these funny money wages to buy property. Wages are either spent on debt interest to the banks, third-rate items turned out by worker drones, or confiscated to fund others more willing to consume in the money-go-round. Eventually of course the currency becomes worthless and one has to turn to the traditional stores of value.

    • Ronald
      Posted July 23, 2010 at 11:37 pm | Permalink

      I am in the same situation. A sensible saver all my life, no debt. Cash rich because of it. Out of the property owning madness and relying on interest to pay my rent. Yet paying for next door's GBP 7,000 motorcycle, mortgage, and holidays in Cuba on borrowings whilst my savings are decimated with inflation and interest rates from the 1600’s.

  3. Nick
    Posted July 23, 2010 at 8:28 am | Permalink

    I agree on the HP issue.

    It has always been the case that if you want to borrow serious cash for a business, you need property because the banks want personal guarantees. That needs equity in property for most people. Falling prices means that they are unlikely to lend.

    Partly its control over immigration. Can I suggest

    1) You have to earn over 42K a year to come here. 42K a year generate 12K of tax. You spend 12K each year per person. Currently the threshold is closer to 20K. Don't forget, if an immigrant brings a family, they need to earn more.

    2) According to the libdems, there are 450K illegal immigrants in London alone. The home office puts the number of illegal nigerian immigrants at 1-3 million. (Personally I suspect its closer to the lower figure). Legal Nigerian immigration is 135,000. Getting rid of illegal immigrants means

    a) More jobs for people on benefits
    b) More available housing.

    If you take the 445K figure, its the same as the demand for housing from people on waiting lists.

    The UK needs new power stations, better roads, more exporting manufacturers. It needs to make more of the things we currently import from China. That is where we need more lending.

    It doesn't follow. If you need them, then you need to save up to afford them. There is a myth that governments need to borrow. Lets say you have no deficit. How long does it take the government to save 2 billion? Not long. Cut the deficit, and you can have these things from normal taxation.

    It is also likely that the CGT changes encouraged some buy to let owners to sell before the new higher rate came in.

    Certainly. A neighbour's house went to auction to avoid the increase.

    Expect CGT revenues to fall for the first year after the increase. Then I think you can say yah boo sucks to Vince Cable.

    Nick

    [PS. Vince is a plonker. You need him in the government to be the fall guy]

    • Simon2
      Posted July 23, 2010 at 8:37 am | Permalink

      CGT might have fallen, but general taxation would have risen with the removal of these tax perks, a missed opportunity and disappointing U-Turn by the new government.

    • Simon
      Posted July 23, 2010 at 12:34 pm | Permalink

      Hi Nick ,

      How about a cap and trade policy for intra-company visas, eg have a limit of 50,000 intra-company visa's (50,000 in total , not per year) and auction them off to the highest bidder at not less than £100,000 each per year ?

      This would show whether there really is a skills shortage in the UK and incentivise companies to invest in their employees .

      At the moment all these fast track visa's are just a way of avoiding paying a living wage to UK workers such as software developers who in many cases earn a lower total package than police constables .

      We have votes too and deserve a degree of protection .

      Would give school and university leavers more hope of work too .

  4. Simon2
    Posted July 23, 2010 at 8:44 am | Permalink

    Hoping house prices remain high is hoping for a continuation of the madness, social division and unfairness we've had for 10 years. I dont see why a fall in the nominal value of housing has to bring down the banks. Surely we will just bend all the rules again. Affordable housing will ultimately be a good thing for the economy.

  5. Ian Jones
    Posted July 23, 2010 at 9:17 am | Permalink

    The Bank of England will not let asset (houses) values fall, they believe that this deflation causes real debt to rise and so prevent a recovery. Instead they prefer to pass the cost onto savers and those who didnt buy because they knew house prices were over valued. Basically the policy is to realign the real price to nominal prices by generating inflation.

    Nominal house prices will not fall but their value in real terms will be reduced through inflation. This is why more QE is a certainty and why the Govt has pulled the National Savings certificates for RPI+…..

  6. Bill
    Posted July 23, 2010 at 9:21 am | Permalink

    House prices have a funny way of defying gravity.

    Late 70’s after leaving university prices seemed to rocket. Yet I couldn’t get a mortgage, fewer lenders then, at that time building societies only were lending. They insisted on having had a savings account for 3 or more years and had strict criterion on multiples of income.

  7. waramess
    Posted July 23, 2010 at 9:33 am | Permalink

    Hard to know where to start, however the most stark observation is that politicians should be there to sort out problems of their own making and that means reducing the debt mountain and reducing the size of government. You may think this is already something that has beeen addressed but the public have yet to see any progress..

    The private sector can look after itself and has shown itself to be very adept in past recessions but it needs the stimulus of reduced corporation taxes and regulation, Individuals likewise can look after themselves but again the stimulus of reduced taxation is an imperitive. Just imagine the changed attitude you would encourage.

    Then we need lower house prices and an ability to let banks fail. Just look at the pickle politicians create when banks are perceived to be too important to save.

  8. Nick
    Posted July 23, 2010 at 9:36 am | Permalink

    Lack of investment is an issue.

    You have to ask, why aren't people in the UK investing.

    Partly its financial ignorance. People think that you can get a decent retirement for 100 quid a month. Perhaps you can if you are in the public sector where you're sitting on 1.2 trillion of pensions, plus a share of the state pension debts. The state pension debts are 1.6 trillion so the public sector really are fat cats. How can they get nearly the same as the rest of us get?

    However, it shows where the solution lies.

    1. Stop all unfunded pension liabilities from now on. No more ponzi schemes.
    2. You keep your accrued rights.

    Then going forward you have compulsorary savings. Into an account in your own name.

    At retirement you get to draw down those savings. If and only if you run out, and have no other savings, will the rest of us help. If you die and still have money in the pot it goes into the pension pots of your heirs.

    That creates a vast pool of money for investment and not spending now. It creates jobs and helps those not in work.

    It's better than a ponzi scheme because it has the benefit of compound interest.

    An average worker saving their NI over the last 40 years, post crash would be on a retirement income of 20K, not the 5K of state pension.

    The government has ripped people off for vast sums.

  9. Nick
    Posted July 23, 2010 at 9:42 am | Permalink

    Last bit.

    Growth forecast 2%

    Borrowing cost 5%.

    Would you like to invest in my scheme? I'll give you a two percent return on your investment. I'll even loan you the money to invest. It's the same as the governement borrowing rate of 5%.

    A deal too good to miss. Perhaps John should suggest the treasury should do the same.

    Ah, they already are doing it.

  10. Lola
    Posted July 23, 2010 at 10:22 am | Permalink

    "…To grow an economy or to rebalance an economy you need a ready supply of credit for good investments,…"

    How about:-

    "What is needed is a ready supply of savings that banks – and others – can lend out to entrepreneurs and other businesses. And banks must be able to take real risks with such intermediation between savers and borrowers. Not all of the loans will be good investments, but more than enough will be, to compensate for those that turn out not to be. Crucially we need an era of sound money and a massively reduced State that will not send false signals to entrepreneurs and others and not lead to the massive misallocation of capital that has occured since 1997"

  11. StrongholdBarricades
    Posted July 23, 2010 at 10:34 am | Permalink

    I agree with the sentiment of your note, but am wary that it appears to be lacking in detail policy to actually achieve these aims.

    A period of 0% house inflation allows for the deleveraging still to come

    I still do not know how the coalition is going to affect the policies of bank lending to refocus it on quicker fractional returns, rather than the mortgage market.

  12. grahams
    Posted July 23, 2010 at 11:14 am | Permalink

    You are right to say that the economy needs rebalancing but I fear that even you do not realise what a titanic task this would be. It would require huge changes in public policy, monetary policy and public spending priorities as well as tremendous business and entreprenerial effort. I see no evidence of this even being considered, let alone happening. Rather, we are re-opening the gas cylinders to inflate the next asset price bubble with the inevitable consequences in a few years time. More lending to finance takeovers, leveraged buyouts and hedge funds will not help the economy. More lending to finance power stations will increase imports since we have destroyed our power engineering industry. More lending to buy existing homes will lead nowhere when the problem is a chronic shortage of housing and abysmal levels of housebuilding (still mainly domestic production). And cutting defence procurement will just cripple one of our few remaining successful manufacturing industries. A comprehensive new strategy is needed but seems to be beyond us.

  13. Peter
    Posted July 23, 2010 at 11:20 am | Permalink

    You say that some of the QE money has gone into supporting house prices. Is it possible for you to be more quantitative and estimate just how much money in total from the public sector goes into supporting house prices and in particular how much has been spent per annum over the past few years while we were in a housing bubble. Moreover can you say the scale of this sum relative to the value of the housing sector as a whole?

    • Mark
      Posted July 23, 2010 at 4:29 pm | Permalink

      I'll have a go at this. A significant chunk of the housing benefit budget is actually supporting house prices by overpaying for rents: this is something that will be tackled by the caps on housing benefit that take effect next year. There is another benefit chunk being spent on paying the mortgages of some people who lost their jobs. The really big money is lending from the Bank of England under the Credit Guarantee Scheme and the Special Liquidity Scheme, which was reported as being £319bn in total by the Council of Mortgage Lenders. This money essentially replaced loans from banks like Lehman Bros that actually did go bust, or other (mostly) foreign banks that refused to roll over loans they had made when the bubble burst. Other injections include the money paid to nationalise Northern Rock, Bradford & Bingley, RBS, Lloyds etc. which is in the order of another £100bn.

      At the moment, the CGS/SLS lending isn't officially recognised as government borrowing: it's an off balance sheet device about as valid as a derivative that allowed the Greek government to pretend it had borrowed much less than it actually had. However, the rules will force a change of treatment if those facilities have to be renewed.

  14. Jeff
    Posted July 23, 2010 at 11:38 am | Permalink

    John,

    I have always enjoyed reading your blogs and have great respect for your views. I would like to know more of your thoughts on the issue of moral hazard though. It's only in recent years that I have came across the actual term 'moral hazard', but the concept itself has always been screamingly obvious, (ok. not to bank regulators and most politicians). Do you really think that providing substantial protection to banks and to house buyers, by supporting inflated asset prices, has benefits that outweigh the changes these policies produce in peoples behavior?

    As a previous poster has said, he feels a mug for doing the sensible thing. Many others feel the same way. People who made sensible decisions are being penalized by the policys necessary to provide such support to banks and homebuyers. Conversely people who made what would normally be foolish choices have had their foolish behavior rewarded. Surely this means that many sensible thoughtful people will now change their behavior for the worse. At the same time, those who joined the asset inflation party have had their belief that they will be protected from any downside confirmed. They are not likely to change their behavior.

    I feel that even if a recovery is successfully engineered by a policy of bailing out banks and mortgage holders by fleecing savers and net tax payers, we will be setting ourselves up for even greater problems in the future. You appear to disagree.

    Reply: I opposed the massive bail outs of the banks and suggested cheaper ways of getting them through the crisis by making them take more of the hit. I opposed the big build of credit which caused the house bubble. Now I think we need more cash and credit in the private sector – it's always a question of balance and judgement.

    • THE VOICE OF TRUTH
      Posted July 23, 2010 at 1:15 pm | Permalink

      John – you still have answered the question – which is that sensible behaviour has been punished and those who through caution, prudence have, if not necessarily been rewarded, have been bailed out ! The fact is there is no easy way out – we will face a period of lower growth as we deleverage and yes that will mean stagnant at best house prices for a number of years. We have too much of a structural deficit when government both at national and locals are massively wasting money on areas that we can do without as well as a welfare system that completely distorts the economy – face up to it , we have been living in cloud cuckoo land for the last 10 years or so – it is either reflation or slower growth, there is no magic cure and both routes are painful.

      Reply: The whole basis of redistributive socialism is that the prudent and hard working bail out the others. There is still a lot of that in our governing system, and I do not expect the new government to sweep it all aside.

    • StrongholdBarricades
      Posted July 23, 2010 at 2:52 pm | Permalink

      It is always a question of balance of judgement, but what policies do you think can be introduced to make the banks think along those lines in the first place.

      I agree about the bail out, but we are where we are. So how with all our "prescence" in the banking sector, are the thought processes of the board room going to be influenced to give up their current methods?

  15. JimF
    Posted July 23, 2010 at 3:05 pm | Permalink

    "Those who want a more abrupt adjustment of house prices to “get it over with” are also wishing for more instability in the banking system which could damage other activities."
    Yes, bring it on. Guarantee depositors' money and beyond that allow the banks to be the private sector instiutions they should be, rather than the politico-mollycoddled suckling pigs of the nation. You are getting back on to your "we must look after the banks and bankers" hobby-horse. Poor, helpless things.

    No, we must look after the depositors and beyond that good riddance.

  16. Lindsay McDougall
    Posted July 23, 2010 at 4:38 pm | Permalink

    I am going to be the blog bore and stress (yet again) that the average rate of GDP growth since 1979 has been 2.1% pa.

    Like everybody else, I shall be delighted if the growth rate over the next few years is closer to 3% pa. However, you would not expect an organisation calling itself the Office of Budget Responsibility to base its calculations on such an assumption.

    I think that the government,

    Replky: The OBR thinks the long term growth rate will be 2.1% (Labour used 2.75%)

  17. Mark
    Posted July 23, 2010 at 5:20 pm | Permalink

    I don't believe it is sufficient or desirable to hope to maintain stable nominal house prices: nor is that a likely outcome.

    A housing boom is more damaging the greater the number of people sucked into it. If only a few transact at inflated prices, then they are the only ones affected by it: those who remained in their properties aren't affected in the slightest by a temporary gyration. When the cancer is allowed to spread, more cells have to be treated to cure the disease. Left to spread too far, it can become terminal. Chemotherapy affects healthy cells, just as savers suffer from bailing out those who overpaid and overborrowed, and businesses suffer because banks know that house prices have to fall in real terms, so regard them as poor collateral. Incisive drugs that target the cancerous cells through repossession stop the spread of the cancer.

    The lending you seek to generate fresh economic production will only be forthcoming when the problems the banks have stored up for themselves have been tackled. Falling real house prices are a big key to that in the UK. The longer it takes, the later the recovery.

    House prices could fall in real terms if high inflation dominates, so that there is high wage inflation – not just higher retail prices (which merely depress real wages). A corollary is that there are high nominal interest rates. The high inflation route would almost certainly provoke large scale repossessions, because few could afford mortgage rates at 15% given the principal they have borrowed. There are many other good reasons why high inflation is an undesirable route, and why the Thatcher and Major governments did so much to eradicate it from our economic psyche.

    The other route allows house prices to fall in nominal terms. That has the big advantage of undermining the notion that house prices only ever increase and encourages proper evaluation of value. Banks already have a reserve in excess of their real need for capital, and at the interest rate margins they are coining, that reserve will only increase unless it is used.

    From the last BoE Financial Stability report I noted that UK bank lending to UK borrowers is 56% of bank assets and £1.8 trillion (of which around £1.5 trillion is property loans); Tier 1 capital is now around 12%, compared with 8-9% a year previously (of itself sufficient) – banks could probably afford to write down a further 3% of assets per year (on top of about 2% currently), or about 3% of 1.8/56% or roughly £100bn per year. They should be encouraged if not forced to do so by letting house prices slide through higher interest rates and tougher mortgage conditions on LTV and real income multiples. We know that 14% of borrowers would be in negative equity on a 10% price fall (but not necessarily in default).

    The issue might become a little more forced if there was a more widespread realisation of the 1 million new build properties in Spain, and 600,000 in Ireland, that remain unsold despite a halving of prices. Making use of that could also help with some of our own population pressures

  18. Iain Gill
    Posted July 23, 2010 at 6:42 pm | Permalink

    ill let you into a secret john

    average uk houses are only worth between 2.5 and 3.5 times the average uk salary

    any bank balance sheets built on any other assumption are nothing but fairy dust

    this reality will come to bite us one way or another

  19. BigJohn
    Posted July 24, 2010 at 1:33 am | Permalink

    If house prices drop quickly, I can't see how it will help anybody.

    It will only make the current situation worse.

    The creditors will be left with more losses, as the assets are worth less than the loan.

    And as people are thrown out of their homes, it will be the taxpayer that ends up paying again.

    The only sensible option is to try and deflate the bubble slowly, which seems to be what they are trying to do.

    • Mark
      Posted July 24, 2010 at 9:41 am | Permalink

      On the contrary, letting house rices drop helps by

      a) discouraging more people from overpaying for houses and overborrowing, storing up financial penury for their future and preventing them from affording a family or a retirement;
      b) reducing the subsidy already being paid to those who have overpaid and overborrowed, which is probably at least 3% of their outstanding mortgage per year on a cash basis, aside from the prop to capital valuation;
      c) force lenders to recognise their past mistakes, rather than pretending they can justify a big bonus ;
      d) refocus minds on the productive use of money;
      e) leave money in the economy that mortgages have sucked out of it (about half of mortgage debt was borrowed abroad when the crisis broke, so interest and repayments were going abroad, not staying in the UK economy: the BoE has temporarily lent to replace some of that borrowing lost in the bankruptcies of Lehman and Bear Stearns for instance).

      The aim should be to deflate the bubble as fast as possible, so that a real recovery can be built on secure foundations. That doesn't mean a 40% drop in prices overnight, but it does mean converting excess bank capital built up through artificially high interest rate margins into loan write-downs, not banker bonuses.

      • BigJohn
        Posted July 24, 2010 at 6:58 pm | Permalink

        > a) discouraging more people from overpaying for houses

        Why would anybody pay more than the market rate, also it is cheaper to rent than buy at the moment.

        > and overborrowing, storing up financial penury for their future

        People shouldn't be buying places they can't afford, this should be down to the lenders to check peoples ability to pay.
        I think the government have/are introducing new rules to stop this, the last thing we need here is a UK subprime problem.

        > and preventing them from affording a family or a retirement

        This has never stopped people in the past, just look at the amount of government money that disappears in benefits, even to people on a good incomes.

        > b) reducing the subsidy already being paid to those who have
        > overpaid and overborrowed

        What subsidy ?
        Most mortgages are 4-5% over Libor rates, if anybody is getting a subsidy it's the banks.

        > c) force lenders to recognise their past mistakes,
        > rather than pretending they can justify a big bonus ;

        I agree, and I think the government are looking at this.
        But as I said, creating another crisis similar to the American one that started all this, is going to make things worse for everybody.

        > d) refocus minds on the productive use of money;

        They are trying to achieve this by reducing the waste in government.
        As far as property in concerned, if somebody buys a house, somebody else is selling it, so receiving the money.

        > e) leave money in the economy that mortgages have sucked out of it
        > (about half of mortgage debt was borrowed abroad when the crisis broke,
        > so interest and repayments were going abroad,
        > not staying in the UK economy

        This all depended on who bought mortgage securities, are you suggesting this should of been limited to UK institutions only, would this not reduce market competition.

        > the BoE has temporarily lent to replace some of that borrowing lost in
        > the bankruptcies of Lehman and Bear Stearns for instance).

        This had nothing to do with UK mortgages, this is down to UK banks buying fraudulent American subprime mortgage securities.

        > The aim should be to deflate the bubble as fast as possible,

        I still disagree, I think it needs to deflate at a speed that isn't going to cause another crash.

        > so that a real recovery can be built on secure foundations.
        > That doesn't mean a 40% drop in prices overnight,

        I agree with this part.

        > but it does mean converting excess bank capital built up through
        > artificially high interest rate margins into loan write-downs,

        Or they could reduce the artificially high interest rates, and put the excess payments into paying down more of the capital.

        > not banker bonuses.

        I agree with this as well.

        • Mark
          Posted July 25, 2010 at 10:56 am | Permalink

          a) people tend to pay what the estate agent, surveyor and mortgage broker let them think it is "worth": in a bubble, people lose sight of rational value see Dutch Tulips, South Sea Bubble etc.
          Renting is not cheaper than buying, since the interest paid on a capital sum large enough to buy a house doesn't pay the rent, let alone cover the increase in house price (although that may be about to change). Renting does save on stamp duty at higher house prices, I will admit.

          b) According to the BoE in May Trends in Lending, advertised two year fixed mortgage rates for 75% LTV products are the lowest they have been since records started in 1995 (over 75% of new lending is in this category): a negative interest rate in real terms. There are ~25% benefiting from a base rate tracker, many of whom pay no interest at all. The banks are indeed getting a subsidy on funding at ~bank rate, and as part of the deal, they have not been charging a true long term market rate on mortgages.

          c) The crisis hasn't gone away you know. It was created by Brown's housing bubble that trebled house prices and mortgage borrowing in little over a decade: it is a convenient fiction that it "started in America" with American sub-prime. If we had not had our own bubble, we would have not had a crisis, just as Canada didn't have one. Unwinding the bubble is key to providing a secure foundation for the future. Of those countries who also had big property booms (e.g. US, Ireland, Spain, Baltic countries…) the UK is unique in trying to prop its one up: everywhere else has seen falling house prices on a big scale. Our bubble was dominated by "self cert" liar loans: a recent survey revealed that 46% of new mortgages are still being granted on a "self cert" basis, rather than against proven income.

          I think you should understand the "customer funding gap" that emerged during the boom: Alice Cook has a nice explanation here:
          http://ukhousebubble.blogspot.com/2008/10/uk-cust

          If you actually examine the historic balance sheets of the UK banks that got most into trouble, you will find that indeed Lehman and Bear were providing large chunks of funding to the UK mortgage markets, along with other Wall St banks, many of whom were not in a position to roll over funding . Against this borrowing, RBS' investment of £34bn in US subprime is small beer.

          I find it of note that UK banks have to find nearly £800bn in re-financing over the next couple of years – slightly more than the customer funding gap as at mid 2008 of £737bn.

          I'm not sure that we really disagree on the idea of the pace at which the bubble should be deflated: a constraint that says "without giving rise to a banking collapse" is just what I had in mind, and have tried to calculate. If on the other hand you mean that house prices shouldn't be allowed to fall, then you believe in Brown's folly. The longer it continues, the worse the eventual outcome, just as with ignoring cancer.

          Artificially high interest rates? Mortgage interest is less than RPI for the average borrower, and lower than Bank Rate was during almost all of the 20th century – whereas mortgages are more typically about 2% over Bank Rate. Interest rates are artificially low, to the particular detriment of savers.

      • Sally C.
        Posted July 29, 2010 at 11:52 am | Permalink

        Absolutely right. Sorry this reply is so late but I have been away for a while. It is tempting to think that we can gradually allow house prices to correct, and perhaps that is what will actually happen, but the problem is that so many more people get sucked in to paying ridiculously inflated prices and take on too much debt to do so. Completely agree about the banks. It is nauseating to see bankers paying themselves so much money instead of writing down their loan books to the extent that they should.

  20. Paul B
    Posted July 24, 2010 at 7:22 am | Permalink

    “The UK needs new power stations, better roads, more exporting manufacturers. It needs to make more of the things we currently import from China. That is where we need more lending.”

    “Part of the rebalancing would in an ideal world allocate less money to housing and bring house prices back into a better relationship with earnings. This may now happen, with more real estate professionals expecting a period of house prices moving sideways whilst earnings resume some upwards progress.”

    John, we need cheaper housing, not static house prices. And we need this to come through lower prices in real and nominal terms.

    High, unaffordable housing (house prices and rents) means higher wages are needed. It also means a large proportion of earning go towards servicing debt. Higher wage demands mean we become less competitive in the globalised economy.

    Also, (and you haven’t said this here, but it’s still mentioned elsewhere as a solution), we don’t need housing to be made ‘affordable’ through lending (i.e. more of it at lower rates) or through absurd taxpayer funded schemes.

    We simply need much cheaper housing in this country.

  21. christina sarginson
    Posted July 26, 2010 at 12:51 pm | Permalink

    I do enjoy reading the arguments you put forward but sometimes am unsure if you realise that the world has changed so much since the 1950's some of the people I know are finding it difficult to pay mortgages and bills now due to the current climate I hope the MP's understand that

  22. George Currie
    Posted August 17, 2010 at 12:14 pm | Permalink

    An interesting article. Your final points on tougher bank rules are the key to future consumer lending. In the past few years banks were not that strict about the debtor's ability to repay mortgages due to the fact that if there was any problems the principal sum could always be recovers due to rinsing house prices. Obviously this is not the case now. This short term business model adopted by the financial institutions obviously came crashing down on them last year. However, banks never seem to learn from history lessons if there is easy money to be had, which is why they are regulated.

    I agree with you John, that these regulations should be tightened and I advocate that no loan should be approved unless there is evidence, in the form of a personal statement of affairs, to support that the loan could be paid back by the borrower. This measure would firstly lower the lending risk of banks, putting in place a sustainable growth model and secondly it would force those people who are not "sensible" to review their personal finances hopefully making a more considered loan request.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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