Big pictures are made up of lots of little observations. That’s pretty much what’s happening with the credit crunch at the moment. No one really seems to have a complete understanding of why the markets are so gripped with panic, but gripped with panic they are. We are not about to go to war, there isn’t an asteroid about to impact, we aren’t all dying of plague, and Spurs have started the season with their customary flourish and lie bottom of the table. In fact, in many ways, it’s quite a normal autumn. So why are banks in Europe and America going down like ninepins? And why has the housing market come to a complete standstill?
Here’s my fourpence worth. We have a big problem with land values. We’ve enjoyed (or some of us have) a 50 year bull market in building land which has caused a huge disparity between the value of ordinary land (i.e. designated as agricultural) and building land. Like, building land being around 250 times more expensive than fields. This is all because of planning restrictions, or what the Americans would call zoning. The value of building land has inflated slowly and steadily during this period, accelerating in the past fifteen years only.
The point about this bubble is that it’s been so slow to inflate that people haven’t recognised it as a bubble. On the contrary, it’s been seen as being “as safe as houses”. And people have got very wealthy by buying building land (and the houses that sit on it) and just sitting there and watching the bubble inflate. And banks have lent bucket loads of money, secured against these inflated house prices. The more the land goes up in value, the more mortgages get repaid, the more money the banks had to lend to the next generation wanting to ride this gravy train.
And the government in this country has stoked the fire by claiming that there is a housing shortage and that we have to build millions more houses in order to make them more affordable. There isn’t a housing shortage, any more than there is a road shortage, but if people say it loud enough and often enough, everyone gets drawn into the illusion.
Everything has conspired to make this particular bubble seem very real and very permanent.
And yet, and yet. Eventually something has to give. Eventually people started saying “enough is enough, I have better things to do with my life than pay 50% of everything I earn to service a mortgage for a crap house.” The worm started turning about four years ago. Just a few people, a trickle no more. It greatly affected the quieter districts of the country — it took me a year to sell a house in Norfolk back then. But then it spread. More and more people stopped believing in the inexorable rise of house prices and sometime last summer it tipped the balance and prices started falling across the board.
The image that keeps coming to mind is the tide. All these deals which made sense when the tide was coming in no longer make sense now the tide is going out. They are left exposed on the beach, the loans that supported them looking naked and ashamed. That is why it’s the banks that are copping it, because a huge chunk of banking over the past 50 years has been based on property values. At the moment, it’s the banks that took on the riskier loans which look exposed, but if the tide keeps going out and prices keep falling, then the so-called safe loans, made at 70% of value, start to become exposed too. As long as property prices keep falling, then more and more bank loans will loose their security. This is why the banking system is now in crisis. The more conservative banks are best placed to ride through the storm, but ultimately all banks could be at risk if the storm doesn’t pass.
So what we really need to bring back stability to the system is for house prices to stop falling. It doesn’t matter so much whether they fall by 15%, 30% or 43%, just so long as they stop falling.
We can already see a pattern emerging. The governments around the world are moving in to bail out the distressed loans. As a result, they may well end up owning lots of houses that these loans have defaulted on. Private houses will become council houses, and mortgage defaulters may find themselves council house tenants. Afterall, it makes no sense to throw all these people out of their homes: you’d end up with a million homeless families and a million empty homes, so they might just as well stay put.
There is a better solution to this crisis than buying up distressed debt. Instead of bailing out the banks that made these loans, the government could instead bail out the people who took on the loans and can no longer afford to service them. In effect, the government could and should become house buyers of last resort, so that if someone wants to sell a house and they can’t find any buyers, the government would have to take it off their hands at a reasonable price and then make it part of their council housing stock. The price paid for the house would have to reflect the rent achievable so that the government borrowing would be supportable. And the purchase could include a right-to-buy scheme so that in future the tenants could once again become property owners, should they wish.
In effect, government intervention could set a floor on how far house prices will fall. Once we have a floor, then stability can return to the markets, the banking system will pick up again, builders will be able to dust off their toolbags and financial meltdown will be avoided. We’ll still have a nasty recession because the housing bubble is over for a long time to come, and there are all manner of businesses (the banks being a prime example) that have built their business models on ever increasing land values.
But if we can at least stabilise house prices (and the government has the power to do this), then we can start to repair the damage that’s already been done. But it’s not going to happen until the government comes out of its state of denial about the nature of the housing crisis, and its fruitcake aim of building 3 million new homes by 2020. That is the sort of thinking that has caused this problem in the first place.