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Relaxing mortgage policies to boost UK housing market

Thursday, 03 December 2009 15:16

The housing market is one of the most significant determinants for spending globally. While fluctuations in the housing market are quite common, a change in interest rates for instance can lead to a change in demand and supply which causes a more volatile market and can lead to a swing in prices, as of late the economic instability has led to extreme fluctuations. The economic recession has caused a severe shift in demand and supply in the housing market while at the same time the disturbance in the US property market was one of the main instigators of the recession.

Global house prices were increasing strongly between 1998 and 2007 which caused a global real-estate bubble. The boom was caused mainly by low interest rates, a positive economic growth, generous mortgage lending and conditions, a high confidence and a relative shortage of supply. The UK reported the strongest continuous increase in house prices throughout the EU over the decade. In the UK the average price of a property in 1998 was £60,000, this increased to over £180,000 in 2007. During these booming years both the U.S. and UK have gone through a period where banks were fairly relaxed in giving out high ratio mortgage loans, in the UK the costs of mortgage loans could lead up to around 50% of people’s disposable income.

This has led to a fictitious relationship between supply and demand. Despite the booming house prices in the UK, prospective buyers on an average income were able to afford these properties. The lending policies were such that demand was not noticeably affected by the increase in prices, high demand is no longer the main determinant of high prices. In fact, interest rates and lenient lending criteria currently influence the market and house prices to a much greater extent than demand and supply.

The high ratio mortgage loans in the U.S. became increasingly difficult to pay for many homeowners and posed an extreme risk to the world market since mortgage loans were sold as bonds in the capital markets. As a result of the inability for many homeowners to pay their mortgage loans, the value of the bonds dropped considerably. At the same time, repossession of property led to a strong increase in supply and subsequently a fall in value. While by 2007 real-estate bubbles were underway in many parts of the world, it was arguably the burst of the housing market bubble in the U.S. that lay at the foundation of the economic downturn, more specifically the sharp rise on defaults on subprime mortgages. The effect of the collapse of the world markets and the simultaneous drying up of mortgage finance in the UK because of high ratio lending has been disastrous for the UK housing market; it caused an extremely rapid drop in confidence and at its worst house prices were falling at an annual rate of 15%.

The consequence of the downturn for the UK housing market has been varied. Initially the market was oversupplied and with mortgages becoming more expensive because finance was drying up, the demand for houses slumped. This led to a strong fall in prices. Moreover, mounting unemployment created added difficulties for prospective homebuyers. The fall in prices had a severe effect on equity rates; many homeowners were facing negative equity with the fall in value of their properties.

While the UK had more controls in place when the housing bubbles started to burst late 2007, problems still arose for companies like Northern Rock. Northern Rock battled with a high percentage of risky loans on top of the highest percentage of loans financed through reselling on capital markets. Other banks in the UK, most notably HBOS faced trouble financing their balance sheets, the subsequent bail-outs and nationalizations led to a rapid decrease in consumer confidence which meant that demand for houses decreased even further.

As mentioned earlier, interest rates can have a strong impact on the property market in the UK. Due to the downturn, the Bank of England cut its base rate to a historic low of 0.5% where by most accounts it will remain for the foreseeable future. Low interest rates usually result in an increase in demand. However despite the lower interest rates, other more urgent factors, most notably the drying up of mortgage finance, have contributed to the ongoing imbalance between demand and supply on the UK housing market. Should there be indications that interest rates will increase in the near future, prospective buyers will undoubtedly flock towards the market to ensure a low interest rate on their mortgage loans, especially now that inflation rates appear to have stabilized somewhat. As a consequence prices will go up and more properties will become available. This again proves the fictitious relationship that currently exists between demand and supply since it is not demand but the interest rate that determines the boost in house prices.

As we have seen, at the initial stages of the downturn demand remained low and prices fell considerably, however since early 2009 prices seem to be picking up gradually. Nationwide has recently stated that house prices have continued to rise for 7 consecutive months, after the initial boom in prices at the beginning of the year prices are now rising at a more moderate rate. According to Nationwide unemployment figures are the key factor behind the rise in house prices. Nationwide’s chief economist claimed that "part of the explanation for why unemployment has not risen to the levels implied by the recession's depth is that in many cases employers have opted to reduce working hours and pay rather than make employees redundant.” Moreover, according to financial information service Moneyfacts, the lending criteria are gradually relaxing after an adjustment period following the onset of the economic crisis.

The continuous rise in prices has surprised many economists and real estate brokers but forecasts are not conclusively optimistic, the volatile nature of the housing market aggravated by the current crisis gives rise to speculation ranging between a loss of 10% in 2010 and a rise of the same magnitude. Simultaneously the rise in prices has not been consistent nationwide and it remains to be seen whether a sustained relaxing of bank’s mortgage lending criteria is taking place. According to a spokesperson for Capital Economics Ltd, the gain in average prices was primarily caused by a shortage of properties for sale and won’t be sustained. She also claims that the market is still severely overvalued and prices need to drop another 20 to 25% to get back to their long term trend. However, if prices fall to the level she has indicated, current homeowners will see a further build-up of negative equity. The housing market especially in the UK is indeed overvalued and it is tempting to suggest that prices need to fall in order to compensate for the overvaluation and make the market more accessible for first time buyers. However, since 78% of homes are already owned the consequence of the suggested fall will damage the larger part of the economy.

Determining the trend in the UK housing market is difficult to predict amidst so many conflicting reports. What can be recognized is the vital role of two key factors; the increase of interest rates to boost pricing and subsequently the market, as well as the bank’s sustained relaxing policies for mortgage lending. For the housing market to recover, this needs to be recognized and supported by the Bank of England, the government and regulatory bodies in the UK. It remains to be seen if measures to improve the housing market will be implemented before the elections of 2010 or if this will be part of the campaign strategy of the political parties.

Global Arab Network

Report on the UK Housing Market created by: The Egyptian-British Chamber of Commerce

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