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.