How the 2007 financial crash has changed all that. Now they are watching it like a hawk, nervously registering another housing boom escalating across the globe, with the IMF now introducing its ‘global house watch’.
The IMF has worked out that of the most recent 50 banking crises, two-thirds were preceded by a boom in house prices, so the housing market has been a contributing factor; the recent crash at the end of the 2000s being the most dramatic example.
The latest figures showed that house prices rose annually by 9.9 per cent in the UK and twice that in London, which reinforces the high probability of a bubble in London. These are worrying increases by any standard.
So everybody is worried by this current boom, but raising the base interest rate is not the best way to tackle it. Mark Carney has hinted that it will happen soon, though he could taper the quantitative easing, which would have the same effect, but both could potentially kill off the UK’s nascent recovery.
We should be sensitive to the downside of raising interest rates. It will make mortgages more expensive and discourage people from buying houses, so slowing down the growth in house prices. But it might also damage consumer confidence, as those on tracker mortgages see their payments rise and defaults may increase among those who have ‘overstretched’ in the current boom.
It will also impact on the increasing number of decisions by companies to invest, like the manufacturing sector the government is so desperate to spark into life. It is going to halt the most important element of any recovery; raising interest rates might slow down markets you do not want to slow down. The exchange rate has already gone up against the dollar and the euro, and a further interest rate rise will hit our exports — it will damage the rest of the economy.
It is important to realise that the housing boom is, in fact, affecting more countries this time than it did ahead of the 2007 crash — it is a global phenomenon. The US has significant price inflation as well, while in New Zealand the problem is even worse. Also, the house price to income ratio, an important measure of affordability, rose strongly in 2013 in lots of countries, plus the house price to rent ratio is becoming very misaligned across the world.
These statistics are of increasing concern to the IMF and the Bank of England, which is starkly different to 10 years ago when prominent monetary policy committee members said it was not their responsibility to look at house prices, vowing that their only job was to control inflation. The housing market was neglected, but the crash has shown they can no longer afford to do that, as the IMF says the era of “benign neglect” of the house price boom is over.
Rapid growth in house prices in the UK and the US is, in part, a delayed consequence of quantitative easing, which started five years ago. But by driving down long-term interest rates, its effect on the housing market was not felt until 2013/14. It became very easy for financial institutions to lend mortgages at a very low rate once again, and despite QE tapering, which drives up long-term rates, this still remains true. This is exactly what happened in the US in the early 2000s, when banks were not always that careful about checking who could not afford to pay their mortgages. Lenders are more cautious now, but quantitative easing has encouraged this. There has been significant investment in house-building across the world in 2013, except in Germany, where people still prefer to rent. Investment in the UK rose by 5.7 per cent, in Japan it has grown by 9.1 per cent and in the US by 14.2 per cent, according to the OECD.
Other factors explaining the upturn in UK house price inflation are also in play. The estimates for people using the UK government’s ‘Help to Buy’ scheme are quite small, but its impact was much greater. It has helped to create a climate of confidence in the housing market in which buyers — especially first-time ones — began to feel they could buy houses again. That scheme has had a bigger effect than the numbers suggest, and there is a case for cutting it back.
Clearly, this housing boom needs to be tackled, but action must be more targeted. Interest rates are a blunt instrument; stricter regulation of lending in the housing market is a much more appropriate measure. As things stand, the FCA can set the rules for mortgage lending, and in April it tightened up procedures for ensuring any housing loan is affordable. This seems to have had a modest effect, especially in the re-mortgage market, but is unlikely to be enough.
Also, the Bank of England can enforce appropriate loan-to-value and debt-to-income caps. It used these powers in late June, when restrictions on higher-risk mortgages with a loan-to-income ratio greater than 4.5 were introduced alongside a stress test to ensure owners can pay their mortgage even if interest rates rose by three percentage points. Good measures, but likely to have a modest impact, affecting fewer than 20 per cent of mortgage applications — mostly in London — and hitting younger applicants hardest.
Regrettably, buy-to-let mortgages, which have helped to feed the surge in prices, are not included in these new restrictions. A reduction of the income-to-loan ratio to 3.5 would also have made more sense and reflect a more determined and less pusillanimous policy stance.
More stringent mandatory caps on loan-to-value and loan-to-income ratios have been used with some success in more than 20 advanced and emerging economies, according to the IMF. It is something George Osborne is said to be keen on, but surprisingly, legislation to strengthen the Bank’s powers was absent from the lightweight Queen’s Speech and is unlikely to be brought in until 2015.
Another measure could be to impose stricter capital requirements on loans to the housing sector, which would discourage over-exposure, which is what happened 10 years ago. This is done in Norway and they are now doing it in Ireland, which also suffered badly in the financial crash. So if the bank’s total loan to the housing market increases, they need more capital to allow for the greater risk.
The building societies that came out best from the financial crash, like the Coventry, are the ones that were much more careful about whom they lent to. They did not get carried away with low interest rates and have been much more prudent — their default percentage is extremely low. All the banks and building societies have to follow suit, and if they do not it is up to the government and the Bank of England to impose rules to stop these booms and busts.
Policy-makers need better signals to deal with the house price problem. It is unfortunate that house prices are not included in the inflation measure: the consumer price index. With central banks’ increasing concern over the housing market, this will surely change. There has been an attempt at this by the ONS introduction of the CPIH in the UK, but it is far from satisfactory and needs significant improvement.
Raising interest rates is not the best solution in the UK; there are better options and they need introducing now and with a more serious intent. If they are not, expect the housing market to cool but UK recovery to falter.
Dr Ben Knight is professor of practice at Warwick Business School
