This article is from the source 'guardian' and was first published or seen on . It last changed over 40 days ago and won't be checked again for changes.

You can find the current article at its original source at http://www.theguardian.com/business/economics-blog/2015/oct/04/george-osbornes-housing-based-revival-stands-on-flawed-foundations

The article has changed 2 times. There is an RSS feed of changes available.

Version 0 Version 1
George Osborne's housing-based revival stands on flawed foundations George Osborne's housing-based revival stands on flawed foundations
(about 2 hours later)
Napoleon was wrong. This is a nation not of shopkeepers but of estate agents. The UK economy ebbs and flows according to the state of the property market, sometimes gently but more commonly with giant waves of speculation followed by an inspection of the wreckage as the tide goes out. Warning: although the sea currently looks calm, the wind is freshening. The economy is sailing into a storm.Napoleon was wrong. This is a nation not of shopkeepers but of estate agents. The UK economy ebbs and flows according to the state of the property market, sometimes gently but more commonly with giant waves of speculation followed by an inspection of the wreckage as the tide goes out. Warning: although the sea currently looks calm, the wind is freshening. The economy is sailing into a storm.
This course was charted by George Osborne three years ago in order to get the economy out of the doldrums. Back in 2012, the chancellor was a worried man. His budget had flopped, the recovery from the deep recession of 2008-09 had stalled, and his deficit reduction plan was way behind schedule. He was booed at the London Olympics and there was talk of him being reshuffled.This course was charted by George Osborne three years ago in order to get the economy out of the doldrums. Back in 2012, the chancellor was a worried man. His budget had flopped, the recovery from the deep recession of 2008-09 had stalled, and his deficit reduction plan was way behind schedule. He was booed at the London Olympics and there was talk of him being reshuffled.
Revisions to official data now show that the economy was not quite as becalmed as it appeared at the time, but faced with headwinds from the crisis in the eurozone, an enfeebled banking system and Osborne’s own austerity measures, it was making slow progress. Revisions to official data now show the economy was not quite as becalmed as it appeared at the time, but faced with headwinds from the crisis in the eurozone, an enfeebled banking system and Osborne’s own austerity measures, it was making slow progress.
As a result, there was a change of tack. Osborne had arrived in office promising to rebalance the economy by promoting a “march of the makers”. In the summer of 2012, he decided the best way to get the economy going again and to quell an incipient mutiny was to revive a sluggish housing market.As a result, there was a change of tack. Osborne had arrived in office promising to rebalance the economy by promoting a “march of the makers”. In the summer of 2012, he decided the best way to get the economy going again and to quell an incipient mutiny was to revive a sluggish housing market.
Between them, the Treasury and the Bank of England came up with Funding for Lending, a scheme that provided banks with incentives to increase their business and mortgage lending. This was perhaps the single most important initiative taken by the government in the last parliament. It did little to increase flows of funds to industry but it worked wonders for the domestic property market. Within months, sales of property were going up, fears of recession were banished, the Labour party was wrong-footed and Osborne never looked back. He will be rightly feted by the Tory faithful this week as the architect of election victory.Between them, the Treasury and the Bank of England came up with Funding for Lending, a scheme that provided banks with incentives to increase their business and mortgage lending. This was perhaps the single most important initiative taken by the government in the last parliament. It did little to increase flows of funds to industry but it worked wonders for the domestic property market. Within months, sales of property were going up, fears of recession were banished, the Labour party was wrong-footed and Osborne never looked back. He will be rightly feted by the Tory faithful this week as the architect of election victory.
This victory, though, has come at a cost: the risk that an overstimulated housing market will eventually crash and bring the rest of the economy down with it. The preconditions for another boom-bust are already in place.This victory, though, has come at a cost: the risk that an overstimulated housing market will eventually crash and bring the rest of the economy down with it. The preconditions for another boom-bust are already in place.
The first is that borrowing is cheap and readily available. Official interest rates have been at 0.5% for more than six years and now that the housing market is moving again mortgage providers are competing to offer the best deals to borrowers. The first is that borrowing is cheap and readily available. Official interest rates have been at 0.5% for more than six years and now the housing market is moving again mortgage providers are competing to offer the best deals to borrowers.
Related: Quarter of all stamp duty comes from 10 boroughsRelated: Quarter of all stamp duty comes from 10 boroughs
The second is that Osborne was not content to boost the market simply through Funding for Lending. Instead, he introduced other measures that had the effect of boosting housing demand: Help to Buy, changes in stamp duty that resulted in 98% of buyers paying less, and a more generous inheritance tax regime.The second is that Osborne was not content to boost the market simply through Funding for Lending. Instead, he introduced other measures that had the effect of boosting housing demand: Help to Buy, changes in stamp duty that resulted in 98% of buyers paying less, and a more generous inheritance tax regime.
The third is that the low level of inflation – for both the economy as a whole and house prices – can breed policy complacency. That was what happened in the early 2000s, when cheap imports from China and other developing countries bore down on the cost of living and diverted attention from the nascent housing bubble.The third is that the low level of inflation – for both the economy as a whole and house prices – can breed policy complacency. That was what happened in the early 2000s, when cheap imports from China and other developing countries bore down on the cost of living and diverted attention from the nascent housing bubble.
Four years before the sub-prime mortgage crisis broke in 2007, the then chief economist of the Bank for International Settlements, Bill White, warned that financial imbalances can build up even when inflation is low and stable. The warning was not taken nearly seriously enough.Four years before the sub-prime mortgage crisis broke in 2007, the then chief economist of the Bank for International Settlements, Bill White, warned that financial imbalances can build up even when inflation is low and stable. The warning was not taken nearly seriously enough.
Another dose of Chinese-inspired deflation is heading Britain’s way. Commodity prices are weak because China’s demand for fuel and raw materials has slackened. In addition, Beijing is likely to use a cheaper currency to flood the global economy with cut-price exports. It will be some time before inflation in the UK returns to its official 2% target.Another dose of Chinese-inspired deflation is heading Britain’s way. Commodity prices are weak because China’s demand for fuel and raw materials has slackened. In addition, Beijing is likely to use a cheaper currency to flood the global economy with cut-price exports. It will be some time before inflation in the UK returns to its official 2% target.
Meanwhile, the Office for Budget Responsibility is forecasting that household debt as a proportion of the economy’s annual output (gross domestic product) will have returned to its pre-crisis peak by the end of this parliament. Following the marked increase of indebtedness in the late 1990s and early 2000s, there has been only modest deleveraging by households subsequently.Meanwhile, the Office for Budget Responsibility is forecasting that household debt as a proportion of the economy’s annual output (gross domestic product) will have returned to its pre-crisis peak by the end of this parliament. Following the marked increase of indebtedness in the late 1990s and early 2000s, there has been only modest deleveraging by households subsequently.
The reason household debt is rising is simple. People are borrowing more to buy homes that are going up in price. One measure of affordability is the ratio of house prices to earnings, which has been monitored by the Halifax for more than 30 years. This ratio peaked at 5.86 in the summer of 2007, the eve of the financial crisis, and troughed at 4.40 at the time Funding for Lending was announced. Subsequently, it has risen in every quarter and is back to 5.26.The reason household debt is rising is simple. People are borrowing more to buy homes that are going up in price. One measure of affordability is the ratio of house prices to earnings, which has been monitored by the Halifax for more than 30 years. This ratio peaked at 5.86 in the summer of 2007, the eve of the financial crisis, and troughed at 4.40 at the time Funding for Lending was announced. Subsequently, it has risen in every quarter and is back to 5.26.
Borrowing has been concentrated in the buy-to-let sector. The first mortgages for buy-to-let landlords were made available in 1996: there are now more than 1,000 separate products on offer. As the Bank of England noted in the record of the meeting of its financial policy committee, the outstanding stock of buy-to-let lending has increased by 40% since 2008, compared with a 2% rise for owner-occupation lending. One in six mortgages are now for buy to let.Borrowing has been concentrated in the buy-to-let sector. The first mortgages for buy-to-let landlords were made available in 1996: there are now more than 1,000 separate products on offer. As the Bank of England noted in the record of the meeting of its financial policy committee, the outstanding stock of buy-to-let lending has increased by 40% since 2008, compared with a 2% rise for owner-occupation lending. One in six mortgages are now for buy to let.
These statistics help explain the anger of generation rent. They are going to be even angrier if this latest example of Britain’s grotesque misallocation of capital to non-productive uses ends in tears.These statistics help explain the anger of generation rent. They are going to be even angrier if this latest example of Britain’s grotesque misallocation of capital to non-productive uses ends in tears.
The Bank of England thinks there is a risk that it will. It notes that buy-to-let mortgages are typically extended on an interest-only basis. Landlords expect rents to cover their borrowing costs and for their properties to rise in value. If for any reason rents or house prices were to fall, buy-to-let landlords would sell up in droves, turning a downturn into a full-blown crash.The Bank of England thinks there is a risk that it will. It notes that buy-to-let mortgages are typically extended on an interest-only basis. Landlords expect rents to cover their borrowing costs and for their properties to rise in value. If for any reason rents or house prices were to fall, buy-to-let landlords would sell up in droves, turning a downturn into a full-blown crash.
Related: Housing bill needs radical, long-term measures to reform the marketRelated: Housing bill needs radical, long-term measures to reform the market
But although Threadneedle Street is worried about the buy-to-let market, it is not yet worried enough to do anything about it. Osborne gave the bank new and extensive powers to curb excesses in the housing market, including the ability to rein in buy-to-let lending. So far it has decided not to use them or to resort to a much blunter instrument: higher interest rates.But although Threadneedle Street is worried about the buy-to-let market, it is not yet worried enough to do anything about it. Osborne gave the bank new and extensive powers to curb excesses in the housing market, including the ability to rein in buy-to-let lending. So far it has decided not to use them or to resort to a much blunter instrument: higher interest rates.
Meanwhile, demand for housing is rising as a result both of a growing population and the UK’s ludicrously generous tax system. If the government was serious about preventing another bubble in the property market it would be announcing a long overdue reform of council tax bands and the levying of capital gains tax on main residences.Meanwhile, demand for housing is rising as a result both of a growing population and the UK’s ludicrously generous tax system. If the government was serious about preventing another bubble in the property market it would be announcing a long overdue reform of council tax bands and the levying of capital gains tax on main residences.
Fear of upsetting owner occupiers means both are political nonstarters. Despite his tightening of the tax regime for buy-to-let included in the summer 2015 budget, Osborne has announced state subsidies for owner occupation and made the tax system even more generous.Fear of upsetting owner occupiers means both are political nonstarters. Despite his tightening of the tax regime for buy-to-let included in the summer 2015 budget, Osborne has announced state subsidies for owner occupation and made the tax system even more generous.
The assumption seems to be that the bank will blow away the thunder clouds gathering on the horizon through timely increases in interest rates and the use of its new regulatory powers. That truly is the triumph of hope over experience.The assumption seems to be that the bank will blow away the thunder clouds gathering on the horizon through timely increases in interest rates and the use of its new regulatory powers. That truly is the triumph of hope over experience.