This is the situation as I see it: The economies in both the US and UK have enjoyed the longest periods of stability and growth ever recorded and have enjoyed a real boom. The big problem with that boom is that since around 2003 this has largely been based on borrowing that should never have been allowed. The moves by the Federal Reserve in setting interest rates down to 1% by 2005 allowed too many customers into the market, and made the cost of borrowing too cheap.
This move by the Federal Reserve to set interest rates low to stimulate growth in the economy did just that, but unfortunately, combined with poor regulation in the banking sector, that allowed mortgage lenders connected to banks to gain AAA lending status (the same as the banks of England), which resulted in a situation where customers with poor credit ratings could afford mortgages that were not properly risk-assessed and instead were seen as triple ‘A’ secured debts.
This had now created the perfect conditions for a housing boom where excessive demand led to an increase in every property’s value. This led to two destructive scenarios; customers selling up and trading up to a bigger homes with cheap mortgages they could afford for the initial introductory period, or banks offering customers the chance to increase the lending on their homes because the mortgage they had was only worth a fraction of the houses new value. These Equity Release Loans (or second mortgages) could then be invested in anything from holidays to renovations on the home, further increasing the value of the property and allow the owner to release more money from lenders, or trade up to a bigger home.
This cycle of lending was always going to end badly as its continuation was based on a constant level of high demand, which, in turn, created the constantly increasing prices. The big problem with this scenario is that at some point the demand will begin to fall and then so will the house prices. Demand will fall because cheap lending creates inflation (known as demand pull inflation) which is countered by increased interest rates ,which then removes cheap lending. At this point the Adam Smith effect of the invisible hand of the market kicks in, and the whole scenario is thrown into reverse with house prices returning to a more appropriate value for a property. This change is currently taking place in the US housing market, with everyone waking up together (banks, lenders and customers alike).
The problem that is left in the wake of this cycle is devastating. Customers are faced with mortgages they can’t afford and go into foreclosure, prices are still too high for first-time buyers to join the market and the loans available are too expensive to afford, so demand is further depressed.
The big sell begins with people unable to afford their properties now looking to sell, which results in far too many properties put onto the market at once, which further depresses values. In many cases customers are now in the negative equity trap paying for high value mortgages that are now worth more than the value of the property. If your bank is kind enough to allow you to sell the property at less that you paid for it, you are left with no home and have to keep paying back a loan on the loss you just made when you sold your house. If the bank forecloses instead then you are again left with no home, but this time the debt is for the full value of the home. As a regular salary or wage would not even cover the interest payment, and the debt will therefore only increase, declaring bankruptcy is often the only solution.
The main problems now are that with foreclosed properties being put on the market for sale by the banks at quick sale knockdown prices, customers not yet behind with payments but that need to sell up and reclaim the value of their homes before they get behind, can’t sell their homes because there are too many houses for sale to compete with, which keep dropping in price.
As is now evident in the US, the economic binge created by cheap credit has reached as far as the lending can reach, and the reality of poor choices at the top is being felt by the people on the ground.
