Monday, 1 September 2008

The three elements of all housing bail-outs

This is the week when the housing market will be saved. We are about to be flooded with plans, initiatives, and new strategies. Later this week, we should see Darling present a package of measures aimed at propping up the price of housing. However, there are plenty of other plans out there.

For example, the RICS has just produced a 15 point plan. The RICS have plenty of actions to to suggest to the government. For example, the RICS would like tax-free savings scheme for first-time buyers boosted by government contributions. It would also like the government to legislate for the ability of homebuyers to rent a property for 3 years before buying at a price agreed at the start of the tenancy. The RICS would also like to see a VAT-cut on repairs to help bring the UK’s 600,000 empty homes back into use. So it goes on; there are proposals on mortgage rescue schemes, government guarantees, and reforming stamp duty.

The title is very telling: "Government must act on property market now". The RICS didn't say "sellers must act", or "Estate agents must act". It didn't even point to themselves and say perhaps we, the RICS should act. No, the RICS said that the "housing market on its knees, the RICS is calling on the Government to act swiftly and decisively on a range of proposals to help the buying and selling process - now and in the future - for both consumers and business."

It is a blindingly obvious question, but why should the government intervene in market that is currently adjusting supply to demand? The RICS and others provide a disingenuous answer to this question. It is an appeal to the centrality of the housing market to the fortunes of the UK economy. Housing is the crucial determinant of economic welfare in this country. If housing is good, then we are all good.

This is not a very appealing answer. If the economy is so dependent on the value of a single asset class, then it will always be a vulnerable and unstable one. Rather than asking for the government to save the housing market, would it not be better to ask the government to reduce our vulnerability to it? Solving this problem doesn't require the government to provide government guarantees and tax breaks. So, the "save housing to save the economy" answer does not stand up to serious scrutiny. So, what is really behind the RICS proposals?

When I looked at the RICS plan, I wondered whether it was worth the effort to explain why each idea was dumb, or dangerous. Ultimately, it seemed a tedious exercise. In the end, all such "save the housing market" schemes seem to come down to a series of core building blocks. The actual details are of second order importance. So, it is perhaps better to state the key elements rather than argue with the details.

Element 1 - risk shifting

The first element of all such schemes, or should that be scams, is risk-shifting. With house prices falling, anyone buying house right now runs the risk of serious capital loss in the future. Likewise, anyone trying to sell, will run a similar risk of making a capital loss today. With both buying and selling being very risky activities, there needs to be a third player that can absorb the risk. There is only one such player - the government. Ideas such as local authority purchases of empty properties come under this category

Element 2 - the market needs money

The second principle is cash injection. House prices are a long way from fundamentals. Everyone knows that prices are misaligned, and again, trading houses right now has the potential to be a serious loss making enterprise. However, injecting money into the market mitigates this misalignment. Hence, we have schemes to provide tax free deposits, and eliminate stamp duty. Again, only the government can throw money at the problem. The government can do this because it can procure other peoples money via taxation.

Element 3 - subsidize interest rates

The third and final principle is interest rate subsidization. The trigger for the sudden collapse in house prices was the sudden reassessment of risk. This reassessment was embodied in interest rates and lending criteria. All housing market rescue plans seek to lower market interest rates through some form of subsidy scheme.

This subsidy never explicit. Rather, it is hidden in the daily monetary policy operations of the central bank. Today, central banks are taking on huge amounts of mortgage backed rubbish onto their balance sheets. In return, banks receive liquidity at very low interest rates. The central bank is part of the public sector. When the central banks makes financial losses, the government picks up the tab. So again, it is the government that is the provider of the subsidy.

Sometimes, this element takes on a very extreme form. The central bank injects cash directly into bank balance sheets in the form of an explicit bail-out, as in the case of Northern Rock. Again, this was nothing more than an attempt to provide an interest subsidy.

Only the government will do

There is one thing the three universal elements have in common. The government pays the bill. Therefore, it is not surprising that the RICS should title their plan as the "Government should act". It would have been more honest to say the "Government should pay".

So we come to an answer to our blindingly obvious question. Why should the government intervene in a market that is quickly adjusting supply with demand. Market insiders don't want the adjustment, and the government is the only player with sufficient financial weight to prevent it .

This is what the RICS really had in mind when it drafted the plan. It wants the taxpayer to pay the cost of keeping the housing merry-go-round spinning around. Judging by the organized campaign of press leaks, it seems that Darling is about to announce a plan that should please the RICS. It will a a plan built around the three universal elements, all of which point to the government as the payer of last resort.


Anonymous said...

Alice, lovely Alice with your fantastic blog, we are in a financial system based on debt.
We cannot save without screwing the whole economy up by shrinking the money supply. Houses are important solely because they are a reason to go into debt.
If people don't go into debt for houses then the amount of money floating about, which we all love and dearly wish to have, shrinks down, and then one and then another loses their job.
We are not on a gold standard anymore, the population -must- borrow, and they must increase their borrowing by 2% a year to enable previous borrowers to repay their loans.
Notice something fishy about the UK tax rebate... I am sure that New Labour accepted the change in accounting rules that they are in charge or requires a tax rebate to the population. Not a desperate attempt to ward off the forthcoming deflationary crisis, still not in the news... go watch the football kids.

Anonymous said...

As someone once said "You can't buck the market". All attempts to rig the property market will fail, either rapidly (best option) or merely putting off the day of reckoning for a while (not so good option). The length of stay of execution is dependent on the amount of money available to throw into the bottomless pit. As we all saw in 1992 the govt runs out eventually. And at the moment it hasn't got any room for manoeuvre anyway. There is no spare cash to waste on mad property schemes. There are large tax rises and spending cuts looming in the 2009 and 2010 budgets. Any schemes will most likely be tinkering at the edges, allowing politicians to be seen to be "doing something" with hopefully little overall cost or effect.

Mark Wadsworth said...

Ah yes, RICS' 15 point plan.

I sorted this all out over at HPC today/yesterday.

Anonymous said...

"It would have been more honest to say the "Government should pay"."

You can probably guess which word I'd substitute for Government in that sentence. Generally, I agree with your analysis. Although if you really want to bring out Occam's Razor, it's really a one-point plan:

"Somebody else should take my losses, it might as well be the taxpayer"


Anonymous said...

Nice piece

I would like to add that surely a policy of using public tax revenues to spend in the economy does sound an awful lot like 'Tax and Spend', our favorite friend from our Keysian ways back in the 1970's.

It didn't work then and won't work now, and just like in the 1970's, convincing ourselves that inflation will drift away because of 'Deflation' is again the same old wishful thinking. Especially when we have confirmation the spiral has now started.

After the last recession we put principals in place to show that we know better than to let the government run up debt trying to replace spending in the economy that should be done by the market place.

It's a real shame that when times are good we pat ourselves on the back for being so smart and knowing what mistakes to avoid, only to then go repeating these same mistakes as soon as times get tough. The independence of the BoE was meant to take policy away from the political interference, not during the good times but most importantly during the bad times, such as those we currently are experiencing. However the desperation of the markets and their insistence on perpetual economic growth means that Golden Economic rules are thrown out the window, the BoE starts chasing growth not controlling inflation and taxes get spent in an unsustainable way.

I had real hope that we had developed understanding and could hold to the correct path and avoid our previous pitfalls. However I now see that just like RICS, I’m full of wishful thinking.

Anonymous said...

When the shit hits the fan, British governments always show their true colours. This is a government that makes a value judgement (property owners are better people than non-property owners), knows that there is nothing solid to the UK economy except the fact that it is an island with houses plopped on it, and that it must constantly devise ways to get people to put their money into houses (which bankers can then take and malinvest, while nicking the transaction fees for their own wealth). It is all a con.

Anonymous said...

The continuing fall in house prices will be on such a large and unprecedented scale - because the bubble was, at a rise of over 200%, quite extraordinary - that the canny first time buyer will not be tempted in by the small sweeteners being offered for at least the next twelve months.

B. in C.

Electro-Kevin said...

You're analysis is brilliant, Alice.

Those in the housing industry conflate high population density with wealth creation.

Wrong wrong wrong !

Ask someone who lives in Calcutta.

Anonymous said...

It's true: high population and high immigration do not in and of themselves equal escalating house prices. First, to get the house price climb people expect from higher populations, you would need to make sure the jobs these people do pay at least the same as a good job does right now. Most migrants to the UK, however, do not earn great salaries. If you take California for example, it has a flood of people coming in, by it is unable to generate the high-value jobs out of this. For this to continue, London would have to start to look and feel like Sweden: the majority having a nice, secure middle class income. As anyone knows in London, vast swathes of the population duck and dive to survive. They do contract work, or work under the table. They are exploited and have very low wages, or very high obligations to send their money out of the UK in remittance payments.

Anonymous said...

"They are exploited and have very low wages"

I'm sure some are. Many of them have grudging unskilled labour that isn't worth the pittance they currently receive. Hardly exploited.

But yes, agree the main point that immigration doesn't increase house prices, effective demand does, and the two aren't directly connected.


Anonymous said...

Do you think the Government will take up this issue?

There are so many people facing debt and some companies are offering Equity Release schemes. What do you think of such schemes?