British economic governance encounters turbulence
Students of British history will recall the story of Thomas aâ€™Becket, the 12th century prelate who was handpicked by Henry II to become Archbishop of Canterbury because of his loyalty to the Crown. Within months of his appointment, aâ€™Becket turned against the King in the numerous conflicts between church and state. As a result, aâ€™Becket was murdered at the altar of Canterbury Cathedral in 1170, after four of Henryâ€™s henchmen heard their royal master mutter in irritation: â€śWill no one rid me of this turbulent priest?â€ť Archbishops do not have much political clout these days, but comparable spiritual importance now attaches to central bankers. And a central banker who suddenly seems reminiscent of Thomas aâ€™Becket is Mark Carney, the recently appointed governor of the Bank of England.
When George Osborne, the British chancellor of the Exchequer (finance minister), delivered his Autumn Statement on Britainâ€™s economic and fiscal prospects this week, he intended it as a â€śsoft launchâ€ť for the Tory-Liberal governmentâ€™s campaign for re-election in May 2015. The big set-piece speech offered Osborne an ideal opportunity to boast about the British economyâ€™s sudden improvement this year and to announce some populist measures, such as a â€śvoluntaryâ€ť price-control regime for energy utilities, that were carefully designed to wrong-foot the Labour opposition. Osborneâ€™s speech marked the start of a long political campaign designed to create a Pavlovian association in votersâ€™ minds between government policies, rising house prices and the economic recovery. If this campaign is successful it will virtually guarantee election victory for the Tory-Liberal coalition — and it could even make an outright majority for the Tories conceivable in 2015.
Last week, however, the plan for a mutually-reinforcing cycle of rising house prices, strengthening consumer confidence, accelerating economic activity and improving Tory fortunes suddenly came under threatÂ from the most unexpected quarter. Mark Carney was hand-picked this year by Osborne and was imported all the way from Canada because he seemed to offer less resistance than any plausible British candidate to the Tory plan for a pre-election economic recovery powered by rising property prices and re-leveraging by homeowners.
If Mervyn King were still governor, it is inconceivable that Osborne could have launched the audacious guarantee scheme for highly leveraged mortgages that has been one of the main driving forces for this yearâ€™s dramatic housing recovery (the other being the flow of money into London property from southern Europe, Russia and China). Last Thursday, however, Carney suddenly changed his tune, unexpectedly announcing that â€śwe donâ€™t want a housing market driven by deterioration in bank balance sheets and underwriting standards.â€ť That, of course, was exactly the purpose of Osborneâ€™s Help to Buy scheme, announced in the March Budget and accelerated in October, with its guarantees for mortgages of up to $1 million with leverage ratios as high as twenty-to-one. In response to Carneyâ€™s broadside, Osborne made his dissatisfaction clear: â€śThe market for higher loan-to-value mortgages remains very restricted by historical standards…and this is a significant barrier to first-time buyers.â€ť
The most important question now for Britainâ€™s political and economic outlook is whether this weekâ€™s rhetorical divergence is a blip in the cooperation between Osborne and Carney or a harbinger of much bigger clashes over the governmentâ€™s effort to stoke a pre-election property and mortgage boom.
The signs are that Carneyâ€™s U-turn towards tougher policies on housing and credit was not just a matter of rhetoric. To show he meant what he said, Carney immediately announced some moderate but significant practical measures. He withdrew the BoEâ€™s special financing facility for mortgage loans, declaring it â€śno longer necessary or appropriate to have our foot on the [housing and credit] accelerator.â€ť He reminded over-enthusiastic borrowers and homeowners that the Bank had an â€śextensive toolkitâ€ť available to restrain house prices, including higher capital requirements, tougher limits on loan-to-income ratios and other supervisory interventions. And he refrained from pointing out, as had been his previous practice, that the over-heated London property market was not typical of the rest of Britain, where house prices were still historically quite cheap.
Instead the BoE rammed home a bearish message on housing in its semi-annual Financial Stability Report, which includes a special eight-page section devoted specifically to the systemic risks posed by rising house prices and household leverage for the UK economy, warning that â€śa sharp rise in interest rates, especially if not associated with a strengthening in incomes, could test financial system resilience.â€ť
What happened? As recently as last month, Carney said at the BoEâ€™s regular monetary press conference that house prices in most of Britain remained quite moderate and that there was no risk of a housing bubble, at least outside London. Why then did he suddenly change his mind?
The likeliest explanation is that Carneyâ€™s initial support for Osborneâ€™s stimulative policies has been overwhelmed by the institutional opposition at the BoE to any hint of a housing and mortgage boom. In other words, Carney has â€śgone nativeâ€ť just five months after joining the BoE.
Instead of sweeping a new broom through the BoE, as Osborne probably expected, and replacing the relatively hawkish officials who dominated the bank under Mervyn King, Carney seems to have compromised with the ancien regime. He started this process in the summer, when he retreated from earlier promises to provide an unambiguous commitment to near-zero interest rates until 2016. And now he may have been similarly co-opted by the BoEâ€™s institutional opposition to higher house prices and expanding credit growth.
If so, then Carneyâ€™s tough new attitude could seriously obstruct the British governmentâ€™s strategy for re-election. How would the government react if faced by such obstruction from a â€śturbulentâ€ť central banker? Murder is no longer the instrument of policy that it was in the days of Thomas aâ€™Becket, but governments still have ways of making life very uncomfortable for turbulent officials — and maybe Carney could be persuaded to return to Canada before the end of his five-year term.
PHOTO: Britain’s Chancellor of the Exchequer George Osborne (C) delivers a budget update at Parliament in London December 5, 2013, in this still frame taken from video. REUTERS/UK Parliament via REUTERS TV