Britain eats (leverages) its young
James Saft is a Reuters columnist. The opinions expressed are his own.
Four years, several failed banks and at least one global recession later, Britain has finally discovered what its young people need: 19-1 leverage.
Britain has announced a new housing initiative, the centerpiece of which is a plan to entice first-time buyers into buying newly-built properties with as little as 5 percent down.
Under the plan both builders and the government would contribute funds to partially indemnify lenders against what I am betting are the inevitable losses. Borrowers, who are almost by definition younger and less well off, will still bear all losses, but will be rewarded with the chance to take out the kind of loan which has proven time and again to be a bad idea.
This is utterly wrongheaded — the best possible thing that can happen for first-time buyers, and arguably for most Britons, is for housing prices to fall to a level commensurate with earnings.
Why are houses in Britain so difficult to afford? Partly because of problems with supply, issues that the housing plan takes some steps, almost certainly insufficient ones, to address. And also because Britons, first out of necessity and then in the fever of greed, borrowed so much money in order to wedge themselves into what little housing was available that they drove prices up to unaffordable levels.
Again, as in Europe and the U.S., we have governments which, when confronted with problems that are fundamentally about debt, decide that piling yet more debt on top is the answer. Like the European Financial Stability Facility, which has proved utterly ineffective in supporting Italian debt, this plan too will fail, but not before many people will be tempted into taking on houses and debts they ought not to risk.
Prime Minister David Cameron himself pointed out that in some places in Britain a police officer married to a nurse would not be able to buy a first home. Exactly, and the solution to that issue is not allowing young civil servants to take on more debt but rather concentrating on policies which will bring prices back into balance with household cash flows.
As it stands, most lenders in Britain require a down payment of about 20 percent, a far higher amount than required in the boom years, but historically not a particularly high figure. That’s right and prudent. People who have only been able to scratch together 5 percent of the purchase price too often prove to be not in a position to carry through on the commitment.
BRITAIN’S DEBT MOUNTAIN
To be sure, first-time buyers purchasing new houses helps to create jobs but this is a stimulative policy that depends on putting people in harm’s way for a supposedly greater good. Some borrowers will naively assume that it must be safe to borrow so disproportionately to their means simply because it is being done as part of a government program. They, however, are not the prime beneficiaries here. Instead, it is the building industry, and to a certain extent existing home owners and the banks which hold their mortgages.
It is not, after all, as if you can construct an argument that Britain has too little debt. Despite the imposition of fiscal cutbacks, overall indebtedness continues to rise and is the highest among developed nations. According to data from consultants McKinsey obtained by the BBC, aggregate indebtedness — household, company, government and bank debts taken together — is now 492 percent of British GDP, slightly higher than a year ago.
So why then when faced with debt problems do so many governments seek to solve them by adding even more leverage? For one thing in a balance sheet recession — the type we are now experiencing — all sectors of the economy try to pay down debts at the same time, creating further downward pressure in growth and asset prices. Britain’s government is attempting to pay down its own sovereign debt right now, though they are perhaps finding that the economy is deteriorating at a rate that makes this impossible.
Ultimately this phenomenon calls into question the solvency of borrowers, be they individuals owning housing, banks owning mortgages or governments backstopping banks. It is tempting then to support the asset prices by adding a bit more leverage.
What’s really needed is either a sustained bout of salutary inflation — a polite default on the debt — or some kind of organized jubilee to rebase both asset prices and the debt which supports them.
While the Bank of England is mulling yet another round of quantitative easing, the current high rate of UK inflation should fall rapidly, and shows little sign of spreading to housing.
Britain, and especially its young nurses and police, would do well to keep their heads down, save their pennies and wait for housing to fall another 20 percent in real terms, as ultimately it must.
At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at firstname.lastname@example.org.