Opinion

James Saft

Britain eats (leverages) its young

November 22, 2011

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 jamessaft@jamessaft.com.

Comments
9 comments so far | RSS Comments RSS

You seem to summarise the problem very nicely, and I quite agree that it’s a totally bonkers housing scheme – just like ‘Homebuy’.

Personally I’ve been waiting for house prices to sink back to realistic levels (like the 20% drop you talk about) for years in order to up-size to a half-decent property. I’m starting to worry that our family will have burst out of the walls of our current house before house-prices get back to where they should be. Even our estate agent stated that the best thing to unblock the housing market would be for all sellers to drop their prices by 20%.

Posted by ActionDan | Report as abusive
 

@ActionDan:
Then you and your family can wait a long time. With an UK inflation rate of 5 %, do you think homeowners will give you a 20 % discount ? What for ? So that they can “safely” rent with exposure to inflation ? Their real mortgage debt liability is getting lower by 5 % per year and the bigger the house the better! You know that. Everybody knows that. As long as people can afford the interest payments (which are historically low so that is not so difficult) they stay. You get a chance on a 20 % drop only when people are forced out. That last situation means a severe slash in the UK economy – and then most likely the banks won’t have the stomach to give you a loan. My advice to you ? Buy or emigrate.

PS Sorry to be the bad messenger. If you want to wait, wait. It’s your dream. Just remember this post five years from now when everybody is laughing they have low mortgages compared to market value. Because your government certainly won’t stop inflation. On the contrary. They have an interest in keeping it high.

Posted by FBreughel1 | Report as abusive
 

Spot on.

I saw some statistics some time ago indicating that housing in Britain varies from boom (6x – 7x) to bust (3x – 2.5x) within a band of ratios relative to average income. At the moment, we’re still at the top of this curve. The housing market would already have started crashing, but for the tactics employed by Labour and Conservative-Liberal governments over the last three years so as to delay the bursting of the bubble so that it will happen during the watch of the next government.

It’s a political hot-potato, because the British national obsession with home ownership (and the dogmatic insistence of almost everyone here that it’s better to pay down a mortgage than to pay rent), along with British mortgage law, have created a nation of over-leveraged & immobile workers who largely become prisoners to negative equity during each down-turn. Since most Britons became “home-owners”, and have started holding the government responsible for the economic climate that determines the value of their homes; it has made political sense for Britain to eat its young…

Nobody can buy houses here any more without massive parental help.

If only for some politicians with principle…

Posted by matthewslyman | Report as abusive
 

You know I wouldn’t mind capitalism if the capitalists played by the rules and let the market pop…this capitalism on the way UP SOCIALISM WHEN IT SUITS IS KILLING ME.

Posted by Gillyp | Report as abusive
 

I don’t know much about the British real estate market.

However, I do know 5% is much closer to 0% down than 20%. The closer you get to that number, the more you court disaster. A mere 10% decline in real estate prices would happily put all the young victims underwater. And a good deal of those in any economic downturn would be unemployed and unable to afford the mortgage payments. The following wave of foreclosures would then put a great deal of pressure on home prices. Alas, the current home-owners and builders might not be saved to the extent they would like.

The kids are not so dumb, and you would not be able to implement this sure-fired scheme twice. In fact I am not sure that this great plan would work so well the first time round in such uncertain economic times that are being experienced globally. Perhaps Mr. Cameron and his cronies don’t realize that though Britain’s young people might not read newspapers, they do get a lot of information over the internet about what’s going on in the world.

In any case, I am very certain that Britain’s young people will learn much quicker about the pitfalls of poor financial decisions than its politicians will.

Posted by rwmccoy | Report as abusive
 

Indeed we do need house prices to fall, but they are unlikely to with people like my next door neighbours. At the height of the boom they bought a house they couldn’t really afford, with the aim of selling it to a bigger fool quickly. They were, of course, rescued by absurdly low interest rates after 2008, but their house has been on the market for three years now because they refuse to realise the loss on their speculative investment.

The only thing which will chisel them out of there is a significant rise in interest rates, which the MPC will not deliver for long as it believes in “low inflation tomorrow.”

So they are stuck with an overpriced house that they ought to sell but don’t want to. And I’m stuck, even though I’d sell at a realistic price, because nobody wants neighbours like them…..

Posted by IanKemmish | Report as abusive
 

The government needs to significantly increase the supply of housing to make it more affordable to the wider population. One quick and proven way is to build quality and affordable public housing estates which people want to live in – see Singapore for an example. Helping the young to increase their leverage to buy something they can’t afford is only going to end in tears.

Posted by Patong27 | Report as abusive
 

I particulary like this line:
“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”
Read it a couple of times and understand. There will be high inflation in the UK for years.

Posted by FBreughel1 | Report as abusive
 

If we are about to have a bout of deflation would nurses be advised to save? Given that NS&I have shut up shop because they know they will inflate?

If there is a debt jubilee should they not buy a massive house?

Posted by pfi | Report as abusive
 

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