Hamish McRae: Rescue package won't save the housing market – but don't panic
An extra billion is irrelevant when the value of our housing stock is falling by roughly £1bn each day
Published 03/09/2008 | 08:05
Let's not kid ourselves: this is not going to revive the housing market and until the housing market does revive economic growth will be restrained. But let's not talk ourselves into believing that the UK is facing anything worse than a typical post-war dip, even if that dip does turn out to be a technical recession.
It is very easy to see why the housing rescue package will not have much impact on house prices, for the numbers are too small. Look from the perspective of the potential buyer. The saving on stamp duty is a maximum of £1,750 – i.e., 1 per cent of £175,000. But house prices are falling by an average of 1 per cent every month so the incentive to move quickly barely exists.
Now look at the overall sums. The total amount of money being injected into the housing market from this suspension of stamp duty, the mortgage rescue scheme, the HomeBuy Direct plan and so on, looks like being somewhere between £1bn and £2bn. But the value of the country's housing stock is falling by roughly £1bn a day – yes, a day. Or, look at it another way. The mortgage funding gap, the gap between the flow of money into new mortgages now and in the first part of last year, is about £50bn. Even allowing for the fact that the flow then was unsustainably high, an extra billion is irrelevant.
To be clear, none of this means that the rescue package is a waste of time and money. At the margin some families will be helped by it and that is good. Nor, conversely, does the stamp duty relief mean that some first-time buyers will be lured into buying on a falling market and therefore the policy is irresponsible. Buyers are adults who can make their own decisions, thank you.
But we have to understand that housing markets are bigger than governments. No government in the Western world can rescue its citizens from sharply falling house prices any more than it could have protected them from sharply rising ones. They can help a bit, as indeed can central banks. Some of us think that the Bank of England could have leaned harder against the housing boom by pushing interest rates up earlier and just about everyone appreciates that the United States Federal Reserve made the American boom worse by holding rates artificially low. However, anyone who thinks that cuts in interest rates here will help to halt the fall in prices should look at the US: rates are 2 per cent and the housing market still has not bottomed. Insofar as the problem with mortgages in the US, the UK and indeed the eurozone is not one of price but availability, the portents are not encouraging either. All the central banks have schemes to help support bank liquidity: we here have the Bank's special liquidity scheme, which allows banks to swap their mortgage debts, which cannot be traded, for government securities, which can.
The really important issue in housing finance is whether this scheme, which only applies to past loans, should be extended to cover new ones. The Bank is resisting any such extension, and the trouble with it might be that taxpayers would find themselves carrying the risk of mortgage defaults.
Whatever happens I think we have to accept that the flow of new mortgages will be restricted for some time and shortage of finance will remain a curb on house prices even after the housing market bottoms out. And when might that be? Well, if it broadly follows the pattern of the early 1990s, not for another year, maybe two, with prices flat for some time after that.
So the issue for the next couple of years will be how to prevent falling house prices from doing undue damage to the economy as a whole. The housing market has been a drag on the US economy but so far it has managed to avoid recession. For the UK the prospects are much more balanced than our Chancellor would have us believe, to judge by his weekend comments. Yesterday, the OECD came out with a clear forecast of recession, with GDP projected to decline in the third and fourth quarters of the year, the worst outlook for any of the G7 nations. So I suppose you could say that the OECD's view veers toward that of Mr Darling.
It may, however, be wrong. I have the highest regard for the economics team at the OECD, which is one of the best in the world, but on this occasion it may be underestimating the resilience of the British consumer and the impact of a weaker pound. Consumption is two-thirds of GDP, so what happens to that is by far the largest single determinant of what happens to the economy.
At the moment it seems to be stagnating rather than falling – you have to hedge any judgement because the retail sales figures jump all over the place. I know the official GDP figures for the second quarter have been revised downwards to show no growth, but they don't feel right either. The monthly estimates of GDP from the National Institute suggest that the economy was still growing through to the end of July. British consumers are pretty tough in the face of adversity.
The economy will also get more help from exporters. The simple effect of falling pound will be to help exporters and hurt importers. There are long lags in the system and it will be some months before the recent decline in the pound gives a solid boost to the economy but the rule of thumb was that a 4 per cent fall in sterling was equivalent to a 1 per cent fall in interest rates. It does not work directly, as changes in the exchange rate affect different parts of the economy, but we have had a 10 per cent fall in the exchange rate since the spring, so you could say that is equivalent to perhaps a 2 per cent cut in base rates. All this takes time but the Alistair Darling line that we are all doomed seems to me to be at least premature, probably plain wrong.
In short, we should not assume that recession is inevitable, despite what we are being told. There is a pantomime element to our politics at the moment. The Chancellor rushes on to the stage shouting that we are doomed. Then other ministers rush on and say we are not. "Oh yes, we are." "Oh, no we're not." Then the Housing minister shouts: "I have a plan that will rescue the housing market", and we all have to shout: "Oh, no it won't." And then the Prime Minister will come on and we will all shout: "Look behind you!"
Treat the political panto for what it is; focus on the real world of economics, where things are difficult – but nothing like the disaster of the 1970s, or indeed the recessions of the 1980s and 1990s either. The basic truth remains that while our housing market does seem to be following the pattern of the early 1990s, and public finances are deteriorating, the economy as a whole is better balanced. Inflation is above target but no higher than in other major economies. Our fiscal deficit is high by the standards of the G7, which is a sad legacy from Gordon Brown's term as Chancellor; but our overall public debt level is fairly low. And we have an independent Bank of England, able to set interest rates that are appropriate to the economic needs, unlike in the early 1990s when we were in the ERM. This is not an ideal position to be in and it should have been much better. But it is not dreadful.