Problems in the UK Housing Market

The UK housing market has big problems that have been building for over a decade now. The cost of homes has been highlighted for some time now as being well beyond the reach of most UK first time buyers, with the charity Shelter reporting that the average price of a first home was around £52,000 in 1997, and is now around £160,000.

As a first time buyer myself I have been very aware of the extraordinary growth in prices. The over-supply of cheap credit by banks and lenders has seen the demand for homes grow to a very high level. This problem has created a situation where key housing market institutions (who shall remain nameless) proposed the very stupid idea that a shortage of supply will ensure that homes in the UK will not fall in price.

These two market events created a feedback situation where people desperate for a home believed these supposed market experts and tried to get on the property ladder before they could no longer get a mortgage offer, and in doing so helped the demand spike, resulting in yet further comments scaring people into believing prices couldn’t fall.

This awful situation was not challenged by a weak government in the UK which did nothing to discourage this problem. They instead allowed these comments to go unchecked and have presided over a situation that looks like unfolding as a complete disaster.

I say this because it is painfully obvious to anyone who isn’t a mortgage adviser, but knows about economics, that no single factor alone (namely a lack of supply) can ensure a single section of an economy will be shielded against the affects of a recession and continue to grow while the rest of the economy either stalls or shrinks. The problem of glorified salesmen/women, who earn commissions on sales of houses and have a vested interest in speaking out of their arses, helped this situation get to stupidly dangerous levels of home ownership.

I say the levels of home ownership are stupid because not only are most buyers since 2004 buying over-priced houses, they are not prepared for the high interest rates that will result from a recession in the UK economy. Most worringly though is the unchallenged nature of sales in two very bad groups of this home ownership market.

Back in the late 1980’s and early 1990’s the word ‘Second Mortgage’ was synonomous with those who had lost their homes, and was largley blamed for the worst of the housing crash. Since then lenders pretended that they had disappeared as a product – this is not the case however. They instead were rebranded as ERL’s (Equity Release Loans) because of the bad press assosiated with the term ’second mortgage’, and have been fuelling the building of extensions, conservatories and holidays ever since.

This time bomb will come calling in about 2010 when the UK government and regultors pretend they had no idea this was happening, as tens of thousands of ERL customers end up with negative equity and eventually reposessed homes. Spending on your home to incease its growth in price was seen as a sure thing and was supplied with lots of cash from lenders, but when the party is over and the property prices fall (as they are now), all these investments will only amount to debts with no asset growth to show for them.

Basically someone will get caught at the top of this game with mortages worth way more than the house, and not only will they not be able to afford the mortage, they won’t be able to sell when the market gets flooded with homes that no one can afford to purchase. Thats why they will all get repossessed.

The second and and probably most devastating part of recent lending practice is something no housing market has seen anywhere in the world before (and I believe i’m the first to really discuss this problem although please correct me if I’m wrong); the backing of unaffordable house purchases by parents’ who act as guarantors to their childrens home loans. This practice will result in not only the repossession of one family home, but will result in the forced sale or more likely second repossession of the lenders parents’ home as well.

This will see, for the first time, the crumbling of 2 generations of family home ownership in one market collapse, and when taken in conjunction with the miss-selling of ERL’s, will see a market collapse the likes of which has never been seen before. This will go down in history as the worst economic catastrophy in the UK since the development of the modern financial system.

I hope I’m wrong of course, but so far I’ve put my money where my mouth is and resisted the 6-monthly enquiry by my bank, as to whether I would like to take advantage of one of the special graduate mortgages to which I’m entitled. Given how the threats from the market suggested if I didn’t get a mortgage I would never own my own home, due to prices never falling back to my level, I’ve run contra to the choices recommended by the media, my brother and some friends, by staying out of the purchasing game. I worry that too many of the people around me have not seen the worrying signs in the market I believe are present, and that they are now exposed to the threat of repossession and financial ruin.

Is the Federal Reserve Chasing The Markets?

Are the recent actions of The Federal Reserve a demonstration of decisive, proactive action or a panicked, ill-considered attempt at rescuing undeserving speculators?

On March 11 2008 the US Federal Reserve pumped $200 million into the financial markets in a swap shop approach to bad debt, which will now see worthless mortgage debts (usually in the form of bonds) swapped for grade ‘A’ Federal Reserve bonds. Aside from the problems that the Federal Reserve has caused by removing all ‘Moral Hazard’ and consequence to lenders disgraceful actions, there is a very good reason why the money being pumped into the financial markets hasn’t been available until now and shouldn’t be made available at all.

By making vast amounts of credit available the Federal Reserve is adding new money into the system. Adding money into the pot is normally done in a controlled and careful way so as to not create inflation. Inflation is created this way because the volume of the assets compared to the amount of currency in the system has seen a dilution of each units worth. The GDP measure tells you how much your assets have increased each year and usually this will indicate how much more currency you can make available.

The problem with a $200 million dump of cash into the economy is that the total volume of the assets in the economy didn’t shoot up by $200 million on the 11th March. Instead the most recent data on the US economy shows that GDP is in fact likely to be below 1%, if any growth occurs at all, and this means that $200 million more cash is now represented by the same volume of assets as on the 10th March, resulting in a dilution of the cash-to-asset ratio. The more notes you print without a growth in assets to back them up, the less the currency is worth.

As the German’s found out after the First World War adding more currency doesn’t mean everyone is rich because they can get their hands on millions of Marks, or in this case millions of Dollars, it in fact means that the value of the notes is now worth less than before, and you will need to earn more and pay more just for the same amount of goods as you received previously. When you pay more for the same volume of goods as you did last time you made that same purchase, the increase is measured as a percentage and called ‘the rate of inflation’. As you can imagine the addition of $200 million out of nowhere will eventually have an impact on inflation.

The problem with this inflation is that it comes on the back of price led inflation already in the system from higher commodity prices such as gas, oil, electric and food. The next resulting move from the Federal Reserve would be to counter this inflation with an increase in interest rates. This would then be the worst possible situation, where the US economy has high inflation and high interest rates which would cause a major recession. The reason the interest rates were at 5.25% 12 months ago was to counter this evident inflationary pressure from commodities, but without this having disappeared the interest rates have been dropped to 2.25% and 200 million Dollars of inflation-creating money has been dumped into the economy.

This strategy smacks of desperation; all common sense has been thrown out of the window and the worst possible course of action is currently being taken. Rather than control inflation and keep this as low as possible, so the economy can recover quickly when the recession comes to an end, instead growth will be stifled as the Federal Reserve puts interest rates far higher than a recovering economy needs. The Federal Reserve are dealing with inflation caused when they decided to chase after the markets (lenders) mistakes in March 2008. The apt saying here is ’saving today at the expense of tomorrow’.

The worst part of this current move by the Federal Reserve to pump $200 million into the US economy is that it won’t save today but will definitely sacrifice tomorrow, because the inflation that is caused by this move will arrive before the benefits of a rate cut can feed through the system. The extra injection of cash these banks receive won’t save them so they can save everyone else when the recession comes, it will just save the banks, and it seems that the Federal Reserve and the investment banks have decided that a financial institutions survival is now more important than preventing a recession.

This short term approach by Ben Bernanke (Federal Reserve Chairman) and President Bush could be viewed more politically as avoiding a collapse into recession while a Republican is President, and once again just like after the last Bush Presidency in the 1980’s, leaves the Democratic President who follows with an economy in recession and a war to pay for. This may explain why the Federal Reserve are willing to run their current course of action, although I personally think that they are just to optimistic that they can do a quick fix, and recover the economy before inflation becomes a problem.