Did Government Intervention Help create a UK Housing Bubble?

In May 2005, the UK Government announced a cooperation scheme between mortgage lenders and government to "help first time buyers onto the property ladder. At the time, Gordon Brown, then Finance Minister (Chancellor of the Exchequer), said the plans were designed to "offer young people financial help in buying their first home, [and would] benefit thousands of first time buyers.

Under the five-year part-ownership plan, buyers were expected to raise at least half the cost of homes sold on the open market, with the remaining equity shared by the government and the mortgage lender.

At the time, the Chancellor said: "It means that people who couldn't afford the full price of a home can afford the partial price, and they can gradually ramp up their stake.

"It's putting home ownership within the reach of thousands of people who would not be able to do so.

The Chancellor may have been taking well-intended steps to attend to the problems of a disadvantaged sector of population. His expectation probably was, that house prices would increase, and hence create equity for buyers. But his intervention might have exacerbated the problem in the long run. How?

The mere fact that young professionals in the first few years of their careers cannot even afford a mortgage for a small home is unreal, and should have acted as an alarm bell that there were severe structural problems in the housing market. In a non-interventionist world, home builders and mortgage lenders would eventually see an economic incentive to offer affordable housing to this demographic group. Alternatively, the market would have been allowed to auto-correct back to a "normal" state where housing becomes affordable for young professionals.

If anything, the government should have taken a closer at the buy-to-let market to see whether or not it was introducing pricing distortions into the market, and taken prompt measures to regulate it and stem the the rampant escalation. But this development appears to have been tolerated or even encouraged, as long as it was proving to be supportive for the economy.

The government's May 2005 initiative was essentially a subvention to the housing sector, since it represented a cash injection from the government, which was intended to generate material new demand for the sector.

On the 31st of January 2007, Housing Minister Yvette Cooper unveiled the first homes of the scheme in the South East region. Only nine months on, the market would peak and start falling. In my opinion, the market was due for a correction in 2005 and was already showing signs of weakness. Without the cash injection from the government, it would have suffered a smaller correction, brought back some reason into the sector, and the fall-out from the US effects in 2007 would have had a much smaller effect on the UK.

References:
1. Mortgages.co.uk
http://www.mortgages.co.uk/news/2005/May/Mortgage-lenders-and-government-help-first-time-buyers.html

2. UK government Office for the South East
http://www.go-se.gov.uk/gose/news/newsarchive/affordableHomeFirst/

IMF sees no end in sight to credit crisis

On Monday, July 28th 2008, one year after the Subprime crash in the US, the International Monetary fund issued a Bleak assessment of the global credit crisis. In its Global Financial Stability Report Market Update, the Fund warned that:

• "Banks under renewed stress, making raising capital hard"
• "Increased likelihood of spillovers into real economy "
• "Resilience of emerging markets now being tested"

"Credit quality across many loan classes has begun to deteriorate with declining house prices and slowing economic growth. Although banks have succeeded in raising additional capital, balance sheets are under renewed stress and bank equity prices have fallen sharply".

Further comments from the Bank appear to indicate that measures taken by banks so far to raise equity might not only be insufficient, but actually lead to negative consequences in the longer term. According to IMF Sources, "The Update notes that banks have been fairly successful in raising equity so far, amounting to about three-fourths of the writedowns to date.... However, the renewed stress has made raising additional capital more difficult and increased the likelihood of a negative interaction between banking system adjustment and the real economy".

We have already bee experiencing a growing de-coupling of financial instruments from consumer behaviours, and the Fund predicts that governments and central banks are going to find it increasingly difficult to strike a balance between inflation, growth and financial stability.

The report predicts a further weakening of the US housing market, and also sees a weakness in a number of European countries.

Overall, it expects global economic growth to drop 20% from 5% in 2007 to 4.1% in 2008, with only 3% growth predicted in 2009. By Q1 2009, I expected that 2008 numbers will have been revised downwards to about 3.8%. This is based on historical prediction trends, where growth forecasts in a slowing economy always turn out to be lower than the estimates six months earlier.