House prices suffer smallest drop in 12 months

The average house price fell by just 0.4% in November, according to the Nationwide House Price Index.

The value of the average house fell by just £430 in November – significantly less than in previous months. Between April and May, for example, prices fell by around £5,000.

This means the annual rate of house price decline has dropped from 14.6% last month to 13.9%.

Mortgage provider Nationwide Building Society stated that although the fiscal measures announced in the Pre-Budget Statement could have some indirect effect on the housing market, the measures announced to improve activity in the mortgage / housing market are more likely to help.

The Nationwide Press Release went on to state that ‘The estimated one-third of borrowers on tracker mortgages will have benefited one-for-one from base rate cuts. About one fifth of borrowers are on their lender’s standard variable rate (SVR) [mortgage]. Although SVRs do not change automatically when the base rate moves, most lenders have so far passed on a large part of the Bank of England’s 2.75% worth of base rate cuts since December 2007’.

Finally, it stated that while people on a fixed-rate mortgage don’t benefit directly from the cuts, they will face ‘much less of a payment shock’ when they come to the end of their mortgage deals.

A third of second home owners own less than a quarter of their home

A third of second home owners have mortgages of 75 per cent loan to value or higher, with a fifth owing more than 90 per cent on their home, according to a survey of holiday home owners conducted by holidaylettings.co.uk. Furthermore, three quarters paid more than £100,000 for their second home and 37 per cent have euro mortgages.

These figures tie in with nearly half (43 per cent) of the same survey respondents stating they let their home to paying guests ‘out of necessity to cover mortgage repayments and running costs’. Furthermore, the number of holiday home landlords entering the lettings marketplace has grown 84 per cent in the last 12 months when compared to the previous six.

The hard cash reality of owning a second home, whether in the UK or overseas has hit home in 2008. For example, a €200,000 interest only mortgage on a 6% deal will cost the home owner around €1,000 per month. Paying this via a currency transfer from pounds to euros would in 2007 have been at a rate of around 1.45 euros to the pound, equating to £690. Based on the current pound to euro exchange rate of around 1.2 it would cost £830 – a monthly increase of almost £140 expenditure.

Ross Elder, managing director of holidaylettings.co.uk comments: “It has been a tough year for any second home owner with a mortgage, which in part explains the growth in the number of owners letting out their properties in the first 10 months of the year. However, I believe there is also a transition of appreciation for the added value a second home has, not just as pension or capital gains income, but ongoing rental income.”

Buy-to-let Mortgages Increased by 48% in 2006

Land Registry figures show house prices still tumbling

The latest figures from the Land Registry reveal house prices in England and Wales have fell 10.1% year-on-year in October.

Government Action in Mortgage Market

The collapse in mortgage lending is becoming a real concern. Next year, the Association of British Bankers predict net mortgage lending could be negative. Despite lower interest rates, it is still as difficult as ever to get a mortgage. As a result, housing sales are at their lowest level on record.

When the government suggested banks should return to 2007, lending levels there was many raised eyebrows. Surely there is no sense in returning to lending levels that caused the housing boom in the first place?

However, the mortgage market has become so constrained that it now appears there is a case for government intervention to overcome the almost paralysis which afflicts the market. We are not suggesting we want a return to interest only, 100% mortgages - far from it. But, the banks have gone from one extreme to another. From freely offering mortgages, they are now being very conservative.

You could argue there is good reason to be conservative. Banks will correctly point out we are facing:

* Rising repossessions,
* Economic recession and rising unemployment
* falling house prices creating negative equity.
* Banks need to improve their balance sheets after years of over lending.

With these factors in mind, it is hardly surprising that banks are being more cautious in their lending. But, if the mortgage industry faces continued constraints we could see a market devoid of buyers; this will cause more problems. It also must be remembered that with low interest rates and falling house prices, the cost of mortgage repayments has fallen significantly. Although repossessions are rising they are still less than 1% of total mortgage loans. It is not that the government should try to stop house prices falling or return to 2007 lending. But, the market is showing signs of market failure, with banks wanting to retreat into a shell. Therefore, there is a case for governments offering some temporary incentives for mortgage lending, and more than just a stamp duty cut.

Avoid Boom and Bust in Housing Market

The past two decades have seen two spectacular boom and busts in the UK Housing Market. Whenever there is a bust, it is hard to imagine that we could return to yet another period of spectacular house price growth. But, with housing supply falling woefully short of government targets for population growth; there is every chance of another housing boom. - perhaps not for another 2-4 years; but, it could definitely happen again.

The costs of allowing housing boom and busts are too great, there needs to be effective policies to moderate unsustainable booms in lending, house price growth and the consequent adjustments this causes.

What Should Government Do?

1. Change Monetary Policy

At the moment, monetary policy is primarily targeted at the control of inflation and stable economic growth. If the MPC were given two targets inflation and avoiding asset bubbles, then maybe we could avoid booms in the Housing market. i.e. they would raise interest rates if house price growth was too high. However, there are problems with this.

* It is hard to target two things at once. During 2004-07 House price growth was frequently over 20% a year, but, CPI inflation was averaging 2.7%. To reduce house price growth would have caused a painful decline in output. It could even have caused a premature recession; the MPC would have been widely criticised for causing unemployment just to prevent house prices rise.
* Interest rate increases would have had to be very high.
* Difficulties of Knowing why House prices are rising. It is difficult to know when house price growth is a consequence of excess lending / speculation and when it is due to economic fundamentals of demand greater than supply

As Charles Bean (deputy governor of MPC of Bank of England), commented in a recent speech on 22 Nov 2008 :

“It is simply not credible to believe that the UK house-price boom that is now unwinding would never have happened if only the Bank’s Monetary Policy Committee had set official interest rates just a little bit higher. “

Banks were really keen to lend, and I doubt slightly higher interest rates would have discouraged many homeowners from taking out mortgages. - It is similar to the fact that cuts in interest rates have failed to stimulate the housing market.

2) Regulation of Banks.

One policy suggested by Anil Kashyap, Jeremy Stein and Raghuram Rajan [1], is to get banks to purchase private capital insurance from a suitable ‘deep pocket’, such as a sovereign wealth fund, that pays out if aggregate financial conditions deteriorate sufficiently. The idea is in boom conditions to make banks save more and reduce the growth in their credit lending. Then in a bust, the banks can rely on their own private insurance schemes to meet shortfalls - rather than rely on government bailouts. This scheme is not aimed at reducing overall bank lending. But, making bank lending less cyclical and volatile. It would mean less 125% mortgages in the boom years. But, it would also avoid some of the freezing of mortgage markets we see at the moment.

3) Spanish Example

In Spain, banks are required to build up a general reserve equal to the difference between an estimate of long-term losses and specific provisions on currently impaired assets. It is noteworthy that Spanish banks have largely avoided the credit crunch. Abbey owned by Spanish group Santander have been one of the few banks to lend more. (Though Spanish house prices still rose too much and are now falling)

Traditionally the idea of government regulation of banks is dismissed by free market economists. They argue that it will reduce investment and anyway banks can get round the regulation.

However, these are not good reasons.

4) Increase Supply of Housing

Whilst there is a shortage of housing, the scope for rapidly rising house prices always remains. However, in the US, the supply of housing increased in response to the boom, but, the massive homebuilding didn’t prevent the boom. (in fact many houses were still coming onto the market at the end of the boom - when it was too late.) this shows that addressing supply issues will not on its own solve the propensity to a credit boom and bust.

Also, of course, the UK is notoriously bad at meeting targets for building new houses. Everybody agrees new houses should be built - just as long as they are not anywhere near where they live.

Conclusion

We cannot rely on monetary policy to prevent house price volatility. The MPC should be free to target inflation and output directly, without trying to solve micro economic housing problems as well.

Nor can we leave this issue to the dynamics of the free market. The consequences of housing boom and busts are too painful for the economy. It will not be easy to regulate the banks; but since they have been humbled and forced to come begging to the government, we will never have a better chance to force them to take responsible steps to moderate boom and busts in credit / mortgages.

[1] See Anil Kashyap, Jeremy Stein and Raghuram Rajan, ‘Rethinking Capital Regulation ‘, presented at
Federal Reserve Bank of Kansas City Symposium on Maintaining Stability in a Changing Financial
System, 2008.

This article was taken from the Mortgage Guide blog

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