The Great Carry Trade

I was much taken by one of Larry Elliott’s pieces for the Guardian a couple of weeks back. Larry identified several eras: the Great Depression; the Great Compression, the period of strong growth and increasing equality after WWII; and the Great Moderation, the period of low inflation from the late 1990s to the early 2000s. We’re just ending the Great Recession (as this term was overused to describe 19th century episodes, I prefer “the Great Crunch”, which I think has a more modern flavour, but let’s go with Larry’s nomenclature today). I’d like to add to the mix the Great Inflation of the 1970s and 1980s. The question Larry asks is: What now? The Great Escape?

I’d like to argue that we’re likely to enter a period that we might call “the Great Imbalance”, reserving, on second thoughts, the title I’ve chosen – “the Great Carry Trade” – for the underlying cause. In fact, you could argue that the Great Moderation and the Great Recession are merely episodes in the history of the Great Imbalance.

Let’s first consider the causes of some of these various eras. Here’s my simplification of some complex phenomena:

• The Great Depression is so-called because growth stagnated in large part because of a breakdown in trade.

• After WWII trade resumed, but crucially without the Soviet Union and satellites, China and India. Larry’s Great Compression resulted from the growth in this era, together with, crucially, greater bargaining power on the part of workers, as collective bargaining reached its apogee. This combined with a squeeze on that critical resource, oil, to produce the Great Inflation.

• In 1989 the Berlin Wall came down. China and India have since become global players. This has locked in the reduction in workers’ power that occurred when unemployment resulted from the Great Inflation, permitting rapid non-inflationary growth – the Great Moderation.

Now, Larry writes that:

“One feature of the Great Moderation was the build-up in debt that allowed consumers in the US and Britain not just to live beyond their means, but to mop up the excess output from the low-cost factories in Asia. Debt is now being paid back, and it will continue to be paid back as the monetary and fiscal authorities withdraw the emergency stimulus packages of the past 12 months.”

But I’d argue that, far from “the build-up in debt” being a “feature” of the Great Moderation, it is a result of the fundamental cause of the Great Imbalance, that is of the Great Carry Trade.  And the Great Imbalance is not over, because international debt is not, in fact, being “paid back”.  And the Great Carry Trade itself has a cause: the false idol of export-led growth.

Larry also suggests that:

“The Great Moderation … could only be temporary, since its reliance on levels of debt that were only sustainable provided asset bubbles continued to inflate meant we were buying stability today at the expense of instability tomorrow. As such, Alan Greenspan created a housing bubble out of the wreckage of the dotcom bubble, thus disguising the structural problems in the US economy.”

I disagree: the cause of the Great Moderation phase of the Great Imbalance was not the debt, but globalisation. Larry is also writing in the UK, which somehow sidestepped a recession after the dotcom crash, so perhaps sees more stability than Stateside commentators. Regardless, I suggest that the conditions are already in place for the next bubble, because the underlying imbalance has not been addressed.

Larry titled his piece “Eastern promise holds little hope for west”. But why should this be? Growth based on trade is mutual – it’s not a zero-sum game. If I buy Chinese toys for pounds, the only way to zero out the transaction is for British products to be purchased with those pounds. The cash acts as a store of value. That’s the point of it.

But what’s happened is that the pounds and dollars used to purchase goods from China and other countries following a similar strategy has not been spent on imports from UK or US. The ramifications seem no less serious now than when I wrote nearly a year ago. Since then there’ve been a few developments:

• The worst recession for a generation.
• A fall in the value of the dollar (and pound) against the euro.
• A massive recovery in emerging markets in particular, fuelled by investment flows.

But no change in the value of the renminbi against the dollar.

So what’s going to happen?

Let’s consider trade first.  The eurozone was until recently in rough trade balance.  Now, though, the US trade imbalance with China (and others), which is an inevitable result of the currency pegs, will be shared by the eurozone.  Additionally, the eurozone will see a deteriorating trade position against the US (and UK).  In short, the next phase of the Great Imbalance will see the addition of Europe to the debtor countries.  This is inevitable with current policies.

But there’s another feature of what’s going on which leads me to highlight the Great Carry Trade.  Investors – ironically as a result of articles like Larry Elliott’s – see the big opportunities as in the developing countries.  What was a minor part of portfolios is becoming mainstream, egged on by the investment industry.

Why do I talk about a “carry trade”? Well, the effect of investment in higher-yielding currencies is – whether or not one organisation carries out all parts of the transaction – borrowing in the low-yielding currency (the dollar or pound, say) at low interest rates to lend (or invest) in a high-yielding currency (such as the rouble or renminbi).

A key point is that all the dollars or pounds invested come straight back. Think about it: to invest in China, you (or an intermediary) have to sell your dollars to a bank to buy the local currency. These dollars are then available to lend on the international money markets, depressing dollar interest rates. The carry trade is self-fuelling, reinforcing the trade imbalance.

With free-floating currencies, the capital flows will eventually force up the currency of the destination country, and investors will no longer see the opportunities they did. There’ll be some kind of correction, quite possibly an “emerging market crisis”.

But with pegged countries there are fewer ways out. Obviously there is a possibility of investor confidence becoming undermined and an asset (e.g. stock market) bubble bursting, but failing that, either inflation could occur or the currency peg could break. But both of these tend to help the foreign investor, by increasing the value of their assets. The pegging country is likely to find itself in a policy straight-jacket. Increasing interest rates to cool the economy simply encourages the carry-trade. Hinting at appreciation, or a limited appreciation, of the currency is likewise a red rag to a bull. They could try to directly control the capital flows, like Brazil did recently, or try to manage asset values directly. But such policies are difficult to implement. All very unsatisfactory.

I can only conclude that unless emerging market currency pegs are abandoned we will simply have a repeat of recent history, with a slightly different flavour.

Much depends on what happens in the deficit countries. Current policies suggest that governments will try to rein back on their borrowing. That leaves even more potential for bubbles in the property and the corporate capital (equity and bond) markets.

It now seems to me that in the UK, at least, property prices will resume their upward path. This will be driven not by low-income owner-occupiers, and maybe not even by the recent type of buy-to-let investor. Rather corporates will invest, which will increase construction rates (because such investors require large numbers of properties), which will help fuel the economy, sucking in more imports, of course. Foreign buyers will also continue to stoke the market, particularly in London. Interest rate increases to choke this off will have limited impact as they will tend to push up the pound, encouraging the very imports and capital flows that are fuelling the Great Imbalance.

In an even world, investment flows into UK equity and bond markets should, over time, exactly counterbalance flows out. But we live in an uneven world. Furthermore, when capital returns to the UK (or US) it has had the risk taken out of it. Companies, just as in the dotcom boom, will, even when raising equity is possible, still over-leverage.

Where the next gasket blows is anybody’s guess. Remember, excessive capital flows will once again be a global phenomenon. Governments will try to shore things up, but will simply have not enough thumbs to stick in all the dykes that could burst.

Mad Mortgage Rules – and Miles Brignall

Jay Rayner’s review of the Eastside Inn in today’s Observer magazine includes an unforgettable comment about its owner, “chef Bjorn van der Horst, who has the name of a porn star and the palate of an angel.” My partner wondered how Rayner comes up with something like that. I suspect it’s not that difficult – though it is a very good line – if all you have to do for a living is stuff your face and write about it.

Because clearly the restaurant reviewer has not been keeping up with the London Evening Standard newspaper (“the ES”). Rayner expresses surprise that fewer London restaurants have not “gone to the wall”. He goes on: “according to Harden’s, a fine restaurant guide in so many ways, London closures have actually been slightly down over the past year, at just 64 – the lowest rate since 2000. Openings are up 9%.” But a few weeks ago the ES revealed that because so many of the sorts of people who patronise upmarket eateries have had a mortgage windfall, takings have survived the downturn.

The point is that many mortgages have reverted (from a fixed rate) to banks’ standard variable rates (SVRs) which in many cases are tied to the Bank of England’s base rate. Tracker mortgages are again tied to the base rate.

Presumably the Guardian’s Miles Brignall is either not a gastronome or is simply insufferably smug, so has not accompanied Jay Rayner on any of his restaurant trips. If he had, Jay would be well aware of how Brignall has an interest-only mortgage, for which the monthly payments have decreased from almost £900 to £150.

In what must rank as one of the most irresponsible pieces of financial journalism I’ve ever seen, the Guardian ran a short piece by Brignall in Saturday’s Money section, perhaps to provide “balance” to a report on the FSA’s proposals to discourage interest-only mortgages.

Journalists often introduce “balance” when in fact there is no widely-held alternative position. The classic example is climate change. Approximately 999 out of 1,000 scientists working in the field broadly accepts the consensus view of the warming effects of human greenhouse gas emissions. But the crackpot 1000th all too often gets a platform. Result: the public believes there is a fundamental debate when in fact there is no such thing.

The FSA pointed out that (1) if someone takes out an interest-only mortgage when they could not afford a repayment mortgage for the same amount then they are likely to have a problem paying the principal at the end of the term of the mortgage and (2) it would be a good idea for people taking on interest-only mortgages to demonstrate that they have an investment vehicle for paying off the principal, e.g. an endowment policy. Such endowments were of course very popular back in the 1980s.

What the FSA says is very sensible.

But Miles Brignall appears to have committed both the cardinal sins. He writes that:

“By going interest-only, nice houses with gardens (well, vegetable-growing area) suddenly became affordable – all for the same monthly repayment had we gone for a smaller home, with a tiny garden – but funded with a repayment mortgage.”

And Brignall’s scheme for paying back his mortgage? Arbitrage:

“The pay rate on our mortgage is 1.24% – courtesy of the Bank of England – and yet I’m getting 3.01% on my Manchester Building Society Isa. You don’t need to be Mervyn King to know that that’s a good state of affairs.”

This is absolutely nuts. It is a pure cock-up that mortgage rates are lower than the rates paid on consumer deposits. The banks simply did not expect the Bank of England’s base rate to go down to 0.5%. Stupid. What the banks should have done, and will do in future is tie all mortgages to LIBOR – the cost of money in the interbank market – so this situation will not recur.

In bailing out mortgagees and other borrowers in general, by reducing interest rates dramatically, the Bank (the Bank with a capital “B” refers to the Bank of England) has, likely unintentionally, given a massive windfall to hundreds of thousands of borrowers with these daft mortgages for which the payments can drop to virtually nothing. A lot of them are spending their fortunate gains in restaurants, so we haven’t had a shake-out to separate the decent restaurants from the salmonella-factories.

From the Bank’s pov (point of view) reducing the rate so low doesn’r make sense in the long-term. Since in future fewer commercial rates will refer to the base rate, the Bank has got its powder wet.

—

The other recommendation by the FSA is less sensible. They want to ban self-certification mortgages. These have pretty much disappeared already, but the FSA seems to be keen to lock the self-employed and those with irregular income out of the mortgage market altogether.

All this will do is move the problem. Those unable to pay a mortgage would be unable to pay private rent either, so landlords would find themselves in difficulty.

This observation set me thinking. Here’s my suggestion. Mortgages should simply be provided to those who, regardless of their employment situation, can demonstrate that they have been able to pay a comparable private rent. This wouldn’t apply to everyone – some may live with their parents or pay a very low rent in a shared house while saving a deposit, for example – but would help a lot of people get on the housing ladder. Some legislation would be required – but the private rented sector is under review anyway – to require landlords to provide receipts for all rent paid in full. This would be good news for landlords as the need to collect such receipts would give a further incentive for tenants to keep up with the rent. Certified receipts would likely prove more useful than references for tenants seeking to move to new rented accommodation, but they would also demonstrate that a potential mortgagee can afford a certain level of mortgage payments. This would translate to a given size of mortgage. Mortgage lenders would require proof of rent payment for a number of years (at least 2 or 3) – this might vary for different offerings (e.g. depending on the deposit the buyer is able to put down). Some slack would be required. There are a few extra costs (e.g. maintenance and insurance) which property owners have to pay but tenants don’t. The big problem, though, is that interest rates can increase (and mortgages may be at “teaser” rates, liable to revert in the future to a higher rate, such as the lender’s SVR), causing difficulties for mortgage holders, so the government (or perhaps an independent regulator) would have to advise the rate for which affordable payments should be calculated, which may be somewhat above the market rate at any particular time.

An example is in order. Let’s say someone has been paying £1200pcm in rent for a few years. A lender might then assume they could pay a mortgage of £1050 a month to allow for other homeowner expenses. They may also allow for future interest rate rises, so accept the application only for mortgages requiring monthly repayments of £900. Got it?

What we’re trying to do is establish what outgoings a mortgagee can afford, so it is much more logical to establish what outgoings they have been able to afford in the past than to simply examine their income.

—

Postscript: Miles Brignall’s mortgage

Miles lets on that he’s paying 1.24% interest at the moment and that this works out at £150 pcm, or 12*150 = £1800 pa. Therefore on a house he tells us is worth £390K (or is that what he paid for it?) the mortgage is (100/1.24)*£1800 = ~£145,000. From a lender’s pov, £245K equity (reasonably plausible if, say, they bought their previous flat in the mid 1990s – they might have taken out a mortgage back then of well under £100K, with even less than that outstanding 3 years ago) is reasonable security, so they’re not the ones likely to get their fingers burnt.

Miles was paying “almost” £900 pcm before rates started tumbling or 6 times as much as at present. He may have paid off some of the mortgage, but at £250 a month for at most 3 years, not very much (no more than £9,000). This means his rate was getting on for 6*1.24 or over 7% (check: 900*12/154,000 = ~7%. Quite expensive, it seems to me.

How the rate has dropped by ~5.75% is difficult to explain, as base rates haven’t fallen that much (they were 4.75% in late 2006, rising to 5.75% in late 2007). Maybe the “almost £900″ was a reasonable bit less and the £150 is rounded up (or perhaps includes a fixed amount – e.g. insurance of some kind) or maybe he’s paid off a bit more than I’ve reckoned.

Anyway, most worryingly, Miles says he is only putting £250 a month into a savings account, so he’s getting used to having £400 extra to spend each month (£400 comes from the £900 mortgage payments less £150 he’s paying now, less the £250). I hope Mrs B doesn’t get too used to all those meals out!

Be very clear: the reason Brignall was able to obtain a mortgage on a £390K property was not because of the affordability of the monthly payments – it was because he had so much equity the lender didn’t consider him much of a risk. It’s the same as the logic behind sub-prime lending when banks thought they couldn’t make a loss because the value of the property would rise. Miles can presumably afford even £900 a month, but, in fact, he’s described exactly the sort of lending which concerns the FSA because it is in the interest (no pun intended!) of the lenders and not necessarily of the borrowers.

Someone with an interest-only mortgage like Brignall’s who couldn’t afford £900 each month could easily find their debts gradually increasing over time, as they were forced to put other spending on credit cards or take out personal loans.

The Great Crunch: It’ll happen again because we’ve gone soft on bankruptcy (Part 1)

The debate as to what to do to try to prevent a repeat of what I like to term the Great Crunch absolutely amazes me. There is virtually no analysis of what actually happened; instead the debate is dominated, it seems, by pre-existing prejudices. The whole financial crisis was caused by a cascade of bankruptcies, starting with so-called sub-prime lenders in the US and ending with Lehman’s failure, after which the authorities finally took decisive action.

Let’s start first with the least of the culprits. I worked myself into a bit of a lather late yesterday after reading a column by Vince Cable in the Times – see my comment there at 10:23pm on 20/10/09.

Why oh why do we persist in trying to devise policies to save people from themselves? Drugs? Ban them! Totally ineffective, in fact counterproductive, in fact worse than counterproductive in that the policy creates worse problems than those it doesn’t solve.

What we should be doing, in general, is equipping people to save themselves from themselves.

Tightening regulation of lending, it seems to me, is part of a paternalistic infantilising trend in our doomed Western societies that has been repeatedly shown to fail. It’s the wrong design principle, as was pointed out – to make a leftfield connection – in a thoughtful letter from Merrelyn Emery in last week’s New Scientist. Merrelyn notes “[t]he unstable nature of DP1 [hierarchical] systems” in comparison to “DP2″ type systems “in which adaptation depends on regulatory systems built into the operational parts of the system itself”. Quite so.

Back to Vince in the Times. Vince, it seems, very much approves of the regulatory proposals announced yesterday by the FSA’s Hector Sants. If there is a shred of understanding in my grasp of recent history, the FSA, of course, has shown itself to be entirely incompetent in enforcing the regulations it already imposes, so one has to imagine that tighter checks on mortgage borrowers will also be ineffectual.

The whole proposition makes absolutely no sense. It rests on no sound analysis. Here’s a more subtle way in which it will fail. Mortgage defaults in the UK are an inevitable result of this or any other recession. They arise because mortgages are a 25 year commitment, a long-term loan, whereas income is paid on a short-term basis. Mortgagees are no different to banks which lend long-term and borrow short-term. Proving your income at the time you take out a mortgage has minimal bearing on your ability to pay the mortgage over the long-term. As the economy now comes out of recession the housing market will pick up. Happy days will be here again, and the buyers will be once more out in force. Inevitably a proportion of them will lose their jobs in the next recession.

In actual fact, banks diversify their risk when they offer mortgages to those with sources of income other than regular employment. We know that employees will be made redundant in the next recession. Many some of those with other forms of income may well continue to be able to pay their debts.

If we’re to put the onus on banks the problem never ends: next we’ll be asking banks to evaluate the security of mortgagees’ employment. Then we’ll be requiring them to ensure mortgagees have access to funds to pay the mortgage if they lose their job and so on…

Hey why not take the same approach in other areas of life? Why not, for example, mandate bar staff to ensure customers can actually afford to buy the booze they want? Oh, sorry, our paternalistic policy for drink is to put the price up. That’s odd, because in earlier eras the problem with heavy drinkers was not so much that they destroyed their health or caused a nuisance in the town centre. Rather it was that they destroyed the family finances.

No, no no! What’s needed is tough love. People need to take responsibility for their own finances. What sort of policies would this imply?

Well, first, it might be an idea to tell people that the economy experiences ups and downs. Companies fail. Even in the public sector people can be laid off. So those planning to take on a mortgage need to judge what would happen if their personal circumstances changed. Do they have sufficient savings to tide themselves over? Could a couple pay a mortgage on one salary?

Second, we need to look at the balance between greed and fear in the housing market. When the market is rising people pile in. And I don’t blame them. This time round we’ve sent the message that there’s not much to be afraid of. The dominant narrative consumed and constructed by those who drove house prices to unsustainable levels is characterised by indignation against the banks rather than by remorse, by scapegoating rather than by learning. And there’s more: many have been saved by low Standard Variable Rates (SVRs). There’ve been few stories of borrowers being pursued for their debts. Compared to the 1990s we now have Individual Voluntary Agreements (IVAs) and one year rather than 3 year bankruptcy arrangements. As I pointed out a couple of weeks ago, we’re even allowing people to take banks to court over perfectly clear mortgage terms.

In actual fact, as the ultimate inditement of complete regulatory incompetence, I can’t help observing that right now I’m sure I’m not alone in having just taken on board the lesson that I should have run with the herd and taken on a mortgage when I had the chance! Regardless of house prices.

My recommendations are completely opposed to current mainstream thinking. But perhaps that’s because I’m looking at what actually happened. The whole financial crisis was caused by a cascade of bankruptcies, starting with so-called sub-prime lenders in the US. Why Northern Rock was left floundering when it was, and ultimately nationalised is still completely beyond me, but A&L, B&B and HBoS failed to a greater or lesser extent because of fears about defaults in the UK housing market. NR would presumably have been in trouble later on had the odious Mervyn King not decided to “make an example” of its reliance on money-market funding. The cascade continued as even the soundest banks were stressed by a secondary source of losses: the recession arising from the original financial crisis.

So to snuff out the next one, why don’t we start at the beginning of the cascade by increasing the value of these dodgy mortgage debts?

Here’s my recommendation: treat debts from bankruptcy in a similar way to the UK’s student loans. That is, attempt to collect them directly through a levy on income (above a subsistence threshold) until they are repaid or for life and beyond. In effect, a bankrupt would pay higher levels of tax in the future. (I should add, that the level of interest would be low on bankruptcy debts, because the might of the state is to be employed to collect them). On death, any estate would first be used to pay off bankruptcy debts. The whole concept of bankruptcy needs to be rethought. We need to consider the general interest. At the moment, every time someone goes bankrupt, others must pay, increasing the risk that they too will get into financial difficulty. Why on Earth do we retain the archaic notion that bankruptcy can be “discharged”?

The effect on the bankruptcy cascade would be to increase the value of debts. Those sub-prime mortgage-backed securities (MBSs) would have been worth more than they were when the housing bubble burst.

That’s the stick. But we don’t want to be using it all the time. We also need policies so that the risk of bankruptcy is minimised:
- we need stable house prices;
- we need to hold house prices at the low end at an affordable level for those on the lowest incomes: in short, we need to raise the minimum wage and keep it in line with house prices.

Are we all Kevins now?

A while ago I started what was intended to be a series of posts detailing the causes of what I’m terming “The Great Crunch”.  I was planning to discuss the second cause today – but have decided forests merit my attention just now.  You’ve got to get your priorities right.

Nevertheless, as a bit of a trailer I feel I just have to draw attention to this Sky News story I just spotted on the handy syndicated financial news service provided by Yahoo!.  Yes, those nasty “Banks Face ‘Unfair’ Mortgage Legal Action” as Sky put it (and if their ambiguity was deliberate then I applaud it).

Well, we now all believe banks are intrinsically evil, of course, but let’s read a little further.  It turns out the noble David vs Goliath litigants took out somethings catchily called SAMS or “Shared Appreciation Mortgages” back in the ’90s.  And now the silly Sids are squealing because this time they’re not happy with how the deal worked out.  To be honest, I can’t even see why they’re upset, since they have apparently made money:

“The schemes, only available in 1997 and 1998 before being withdrawn from the market, allowed borrowers to take out loans secured against their homes, at a zero or reduced fixed rate of interest.

However, on repayment of the loans, they had to pay back an additional charge of up to 75% of the increase in the value of the property during the lifetime of the loan.

Their repayments ended up rocketing because of the sharp rise in house prices in the decade to 2007.”

The mortgagees, it seems, have been given free money (that’s what I term a zero interest loan), had the use of a property they presumably couldn’t otherwise afford for a decade or so, AND made a return of 25% of the increase in the value of the place.  Now they’re suing because, as Kevin would put it, “it’s so unfair” – presumably compared to the absurd windfall profits made by other homeowners or some other course of action they wished they’d taken back in the day.  “Aah, diddums”, I say.  From Sky’s story there seem to be no allegation of mis-selling.  The deal seems totally straightforward to me from a consumer point of view (and I’m not claiming special financial expertise here – I still don’t, for example, fully grasp why I would want to buy, for instance, “with profits” life and pension funds).

The point – which, as I say, I intend to develop further – is that – unless, of course, we want to experience never-ending financial crises – we have to somehow reach a state where individuals take responsibility for their own financial decisions.

It’s about weighing up individual interests against the general interest.  Once you strip away the bonuses, the Goodwinesque hubris, and the Byzantine financial complexity, banks are simply collective institutions for managing money.  Every dollar an individual takes from a bank undeservedly (or, indeed, deservedly) – whether as an unjustifiably (or, indeed, justifiably) massively inflated salary or bonus, through some court award against the bank, or, most significantly, through the writeoff of debt – must come from the other stakeholders in the bank.  Taking the banks as a whole, that includes all of us – especially as, at the end of the day, the taxpayer has to pick up the tab when the sucker goes down.

The Age of Stupid Planning Processes

Back in 1998, McKinsey published a famous report: Driving Productivity and Growth in the UK economy (pdf, free registration required), which noted the detrimental effect of inflexible and onerous (my words) land use regulations on UK productivity. They note, for example, that:

“land and property regulations … constrain the hotel and software industries… [T]heir effects can be seen in industries as diverse as airlines, banking and general merchandise retailing. By contrast, the combined effect of deregulation in capital markets and a liberal approach to the use of land in London’s Docklands during the 1980s fostered dramatic growth in investment banking and securities, a field in which the London market now leads the world.”

Whilst the McKinsey consultants were writing their report, a team of film-makers on a shoestring were working on McLibel, eventually released in 2005. A decade on, the same team have released The Age of Stupid, which I found most notable for demonstrating that onshore wind-power generation should be added to the list of industries throttled by the UK planning process.

***** PLOT SPOILER WARNING *****

The film is based around a future Pete Postlethwaite looking back on the current era from 50 years hence, when global warming has left London flooded and the world in anarchy. Postlethwaite views video footage which includes the stories of 3 particular characters. One was a New Orleans resident oil industry worker and hero of Hurricane Katrina. The point of continuing the reportage into the character’s retirement was lost on me. I was expecting him to denounce the oil business, but that never happened.

The other two stories were much more effective. At times the film achieved what I call “cringe humour”, as perfected by Alan Partidge, David Brent and Borat. The founder of an Indian budget airline created his own episode of The Office when he berated and threatened to fire his staff.

But the film is worth seeing most for the battle of David Cameron, sorry, Piers from Cornwall, a caricature of the upper-middle-class eco-nut – and I mean that in the nicest possible way – with a family to match. Piers’ partnership with a farmer was straight out of The Fast Show. The team wanted to build a wind-farm. But Piers was reduced nearly to tears (on the phone to his mum) by the nimby country-folk – some even more upper-class than Piers himself – who block his plans.

As The Age of Stupid demonstrates so eloquently, the UK planning process is completely dysfunctional. It effectively gives people – local residents with a vested interest and time on their hands – the power to make decisions on matters of which they know next to nothing. There is only one possible decision they can make, which is to reject plans, so the process is obviously skewed towards this outcome. The critical concept in this charade is power. As The Age of Stupid shows, the reasons for rejecting plans are often irrational, bordering on the ludicrous. Since the majority of us who would benefit from a development, such as of a wind-farm, have no say in the process, there is no other way those involved can demonstrate their power than by turning planning applications down. It is utter, utter madness.

I pointed out the same problem with housing a while ago. It is entirely illogical for local residents to be given the right of veto over housing developments that benefit (among others) prospective purchasers of the houses, who have no say whatsoever in the decision as to whether or not they are built. Where did this right come from? Some of the objections to the wind-farm in Stupid were on (largely unfounded) grounds of noise nuisance. But someone could quite legally create a similar noise, say by driving up and down a country road. Quite apart from the failure of the planning process to weigh general benefit to society against cost to individuals, it gives more weight to those nuisances (or imagined anticipated nuisances, or psychologically constructed imaginary possible nuisances) that arise from construction activity than arise in other ways.

Here are 3 possible responses to this situation:
1. Confront the problem head-on: tell people they do not have the right they think they have. Take planning decisions at a higher level, weighing the general interest of the population against that of those near a development and achieving objectivity by excluding (either explicitly or by modifying the electoral process, i.e. introducing PR) directly elected representatives for the locale affected. Tightly constrain the grounds for objection, explicitly challenging, for example, the “right” to a particular view, the value of which before and after a development is purely subjective and subject to irrational fears. To put it simply, people get used to, and even appreciate, new features in their environment.

2. Spineless, self-serving politicians are unlikely to take sufficiently drastic action in removing the rights local residents have somehow acquired, so another tactic is to buy off the opposition. Simply pay people compensation, according to a formula, for the inconvenience of – say – being within a certain distance of a new wind-turbine.

3. Developers need to get wise. A lot of objections are entirely irrational. They arise, in part, because people want to feel they have power and are not helplessly subject to developers’ whims. It is essential to engage in the right way with the Residents’ Associations, local councillors and unaffiliated busy-bodies who are likely to block developments. They have to be involved in the process, so that they feel they have power over the shape of the development. I expect there are consultants specialising in this sort of exercise. We probably need more.

A full solution will involve aspects of all three of my proposed responses. Some changes to the UK’s planning regulations have taken place for large projects since McKinsey’s report. But much more needs to be done if we are not to become a nation of ever-poorer people, living in increasingly expensive houses, heated by energy that is both unnecessarily polluting and in shorter supply than necessary. Perhaps The Age of Stupid will provide a little more impetus for change. Go see this movie.

Turning the UK housing market

The housing market has been a British obsession for far longer than it has in the US.  A few years of “flipping” and they all suddenly go “underwater”.  Amateurs!  And the proper expression for “being underwater” is to be “in negative equity”.  “Underwater” is baby talk.

But the Brits know less about the behaviour of markets than the average American kindergarten kid.  Thus, as one contribution to a flurry of debate on the issue, an Independent editorial this morning suggested policies to slow the house-price fall are the right medicine.

The Government does indeed (as noted towards the end of yesterday’s post) seem to be following the Indy’s prescription by allowing Northern Rock to write new mortgages.

The divergence between the mainstream media and informed opinion on this issue is rather striking.  The Radio 4 breakfast-time programme, Today referenced the Indy’s daft editorial, but the vast majority of comments from the public say house-prices need to fall further.  They see the Government’s attempts to stimulate the market as what they are: panic ahead of the next General Election.

To be fair, the Indy’s own columnist, Jeremy Warner, on whose blog I was once again unable to post my thoughts, did question his own newspaper’s official stance:

“One way or another, the debt overhang of the boom has to be removed before a proper recovery can begin. The short, sharp shock approach may have something to commend it over the long, slow agony all this political meddling promises to deliver.”

Too right.

But what got my attention this morning was Today’s reference to Polly Toynbee’s column in the Guardian.  She suggests that:

“Now is the time to tell people that house prices will not be allowed to go mad again. Announce a tax to be imposed on future gains (not retrospectively). There are plenty of ways to do it. Some administrations impose an annual tax, including many US states. Some urge a land value tax system. It would be easy to impose capital gains tax on all future rises: that 18% on any inflation in value, only to be paid on selling it, could stop another bubble. The money raised could be earmarked for building social and private rented homes, or helping others to buy.”

Polly’s on the right track, but not quite there.

Here’s my recommendation.  I identify a number of steps in the line of reasoning:

1. The construction industry is a significant part of the economy. Restarting it would therefore be a large step towards ending the recession.

2. The Government could and should make life easier for the builders, as I’ve discussed in a previous post, but a full revival will only take place when house prices stop falling.

3. Falling markets in general recover only once “clearing prices” are reached, as the Yanks understand.  Things have to stop getting worse before they can improve.

4. Anyone struggling to repay a mortgage can do so for only a limited period of time.

5. Our problem is not that house prices are now falling, it’s that they rose too far in the first place (relative to earnings), at least at the low end of the market.

6. There are new “rules of the game” – purchasers are going to need a deposit of at least 10% and will find it difficult to obtain a mortgage for more than 3x salary.  This is as it should be, of course.

7. Points 5 and 6 imply prices have a long way to fall.  Points 1 thru 4 imply that the faster we get there the better.  So what could the Government do to encourage prices to fall faster?

8. The best changes are those that the market needs permanently.  I suggest two are appropriate:

9. First, abolish stamp duty, immediately (April 5th this year).  This is a tax on transactions and discourages people from moving, not just to take up opportunities for work, but also to somewhere more appropriate to their needs when their circumstances change – for example, to a smaller property when the kids leave the nest.

10. Second, announce that capital gains tax (CGT) will apply to all house sales completing after April 5th 2010.  This will encourage people – for example, those with bigger houses than they need, perhaps as an “investment” – to sell before the end of tax year 2009-10, getting the market moving immediately.  It would also give sellers an incentive to mark prices down, since they will lose some of the profit if they don’t sell in time.

11. My prediction is that, following steps 9 and 10, house prices would fall steeply, bottoming out around the time CGT is introduced.

Good Banks, Bad Banks and Nouriel Roubini

A number of pundits are being reported in the press, urging Governments, principally in the US and the UK, to nationalise their banks.  Some dress this up by suggesting the establishment of “good banks” or “bad banks”, but, I suggest, this comes to much the same thing.  Such advice is based on a number of premises, all of which are potentially unsound. These premises include the ideas that:

1. It is desirable for the overall level of lending and in particular mortgage lending to recover to its pre-crunch levels.

2. There are vast amounts of further losses still to surface.

3. Banks with large amounts of potentially bad debt on their books are a drag on an economy.

4. Recapitalisation of the banking system in Sweden and Japan not only allowed these economies to recover, but was beneficial in the long run.

Good banks, bad banks and nationalisation

Before addressing these fundamental premises, let’s just consider what the difference is between good banks, bad banks and temporary nationalisation.  Very little, is the answer, it seems to me, except that the last may be less disruptive to the organisations, but wipes out shareholders.

There appears to be a common misconception that governments can avoid liability for losses on bank assets by separating them off into a separate entity (or entities).  This is very unlikely to be the case.  I simply do not see how a Government could create a profitable business and an unprofitable one and then let the unprofitable one fail!  The lawsuits would be endless.

I’ve spent a large part of my working life implementing IT systems designed to reduce the risk of a systemic failure caused by problems at one financial institution.  I’m therefore somewhat disappointed that Lehman’s was allowed to fail in a disorderly fashion.  If the economic commentariat are agreed on one thing, it’s that Lehman’s bankruptcy should have been avoided at all costs, because of the knock-on effects.  Millions unemployed around the world simply to prove a point?  Not a good trade, was it?  Whether they create good banks, bad banks or maintain the existing industry structure, governments simply cannot allow another large financial institution to fail.  Governments are therefore responsible for the net losses of any institution.  Since more institutions are likely to have net losses if good assets are separated from bad, simply separating the two would be a very expensive exercise.

Nationalising banks may seem attractive.  But why bother?  Banks can and have been recapitalised short of nationalisation.  In the UK, there is some talk of the state lending directly to consumers.  I’ve long since given up expecting HMG to respect the money I pay them in tax, but letting the jokers who run local government make unaccountable lending decisions would be criminal.

There is nothing to stop new entrants offering loans in the UK.  The Government could even make it clear that they would be treated exactly like other banks in terms of receiving state support.  If the existing banks are so hamstrung by bad debts, why can’t Sainsbury’s Bank and Virgin Bank borrow on the money markets to lend for mortgages?  Except, as discussed yesterday, the self-defeating position the Government has taken that money markets are a bad thing.  Will local councils take deposits to back up the mortgage lending they propose to undertake?  Doesn’t sound like it.

There is a view that bank shareholders should be “punished”.  This deserves a whole post in itself, so I’ll try to be brief.  I wrote some time ago that moral hazard is “a special case of expectations”.  Wiping out shareholders for the sake of it would create an expectation of similar behaviour in future.  Shareholders would take even less of a long-term view.  They would tend to “take the money and run”.  They’d be happy to profit from the next lending boom, but would sell out at the first sign of trouble.  There was an interesting exchange in the Treasury Select Committee grilling of UK bankers this week.  Barclay’s Varley (sorry, I keep thinking his first name must be Reg, now I can’t remember what it actually is!) noted that shareholders tend to sell if they feel a company is being mismanaged.  It’s already the case that most don’t hang around to try to improve corporate governance.  The MP who asked the question was surprised.  Unfortunately, Varley didn’t press the point, since the MPs were there to impress their view on the bankers, not actually learn anything.  No, wiping out shareholders for the sake of it would be counterproductive.  They no longer, in general, have an active role in managing companies, if they ever did.  If we’re worried about moral hazard, we should also be worried about creating a perception of political risk in the UK (or wherever).  The mobility of equity capital suggests that political risk is the danger that applies to treatment of shareholders, not moral hazard.

Premise 1: Should we be resuming lending anyway?

James Crosby has exited stage left now, so perhaps we should have another look at the conclusions of his report on mortgage lending.  In blaming the details of bank management, the authorities are missing the wood for the trees.  House prices were too high.  The problem, in both the UK and the US, was that house prices rose too far, NOT that they’re now falling.  That is merely a symptom.  I feel like writing whole sentences in this paragraph in uppercase.  Bold.

Why on Earth would we want mortgage lending to return to its bubble-year level?  We need to let house prices fall.  We should aim for other forms of lending to increase to return the economy to growth.

If economies were growing as a result of house-price bubbles and, in some but not all cases, building booms, then this has now been shown to be unsustainable.  Such economies need to rebalance, which may mean a period of slower growth as other sectors of the economy catch up from a lower base.

A slight digression: note that the UK is in the fortunate position of being able to build houses.  As I’ve already spelt out, the Government should consider what needs to be done to stimulate lending for house-building.

Let’s just simplify the position and consider what must logically be the case, that is, that some banks have lent more to the housing market, and others to businesses.  The former will likely (at least once we start to pull out of recession) have more chronic bad debts.  These loans will prove to be less profitable than they thought.  If they are thus unable to attract fresh capital, funds will flow instead to those banks focused on lending to business.

The Government should therefore not be demanding the resumption of mortgage lending.  It should simply be allowing the banks to make their own lending decisions on the basis of what is likely to be profitable in future.

Premise 2: There are vast amounts of losses still to surface

Here’s what one of the jeremiahs, Martin Wolf, wrote in the FT a few days ago:

“But, [it is argued] the rest of the world will strike back: as the world economy implodes, huge losses abroad – on sovereign, housing and corporate debt – will surely fall on US institutions, with dire effects.  Personally, I have little doubt that [this] view is correct and, as the world economy deteriorates, will become ever more so.”

But the strategy is to try to stop the world economy deteriorating further!  If it “implodes”, then, by definition, we’re all toast!  That’s why Governments around the world are spending so much on fiscal stimuli.  Declaring most or all banks insolvent now would be to shut the stable door before putting the horse inside!  More specifically, are we really expecting sovereign debt defaults?  As Wolf himself argues, the countries likely to be vulnerable in a crisis have built up huge foreign currency positions.  The IMF has helped several countries, but there’s no reason to expect defaults in these or any others.  Especially as we are now so alert to the problem.

There may well be further losses if the global economy responds to the intensive care it is receiving, but at least some of the scaremongering is overdone.  And what really matters is whether bad debts have to be written off faster than individual institutions can profit from good lending or raise fresh capital, as Barclays has shown.

Premise 3: Banks with bad debts are a drag on the economy

I think I’ve moreorless covered this already.

What is this idea of “zombie” banks?  Carrying potentially bad debts is normal for banks.

Banks are only intermediaries.  If money wants to be lent, it will be, one way or another.  Other institutions – overseas banks, SWFs lending directly, or even private equity – will take up the slack. In fact, the “shadow banking system” was in large part responsible for mediating lending during the boom years.

I repeat, resuming indiscriminate lending is NOT a solution.  If overseas holders of sterling (or dollars) can’t see a decent return from assets denominated in those currencies, then they should sell the currency, which would be wholly a good thing, allowing global trade imbalances to correct themselves.

Premise 4: The Swedish and Japanese models

I’m deeply sceptical about these models for different reasons.

The Swedish banks were famously nationalised in the 1990s as a result of bad lending during a property boom.  No sooner had they recovered, I note, than they lent into another housing boom – in the Baltics!  Take the money and run!  Though they had learnt, perhaps, that there was a lack of profitable lending opportunities in Sweden itself.

Japanese growth is held to have been sluggish during their “Lost Decade”, and only briefly better since.  But their banks aren’t the cause of this.  Until Japanese property values declined from their ridiculous levels in the late 1980s there was a dearth of profitable lending opportunities in Japan.  In fact, since Japan has fuelled the “carry trade”, there is evidently still a lack of lending opportunities there, compared to overseas (their corporate sector is cash generative – probably!).  Given uneven economic development, especially in Asia, surely the Japanese would be expected to invest abroad?

There may be problems with the role of overseas banks in an economy (that may be the understatement of the week) but nevertheless, the global economy is open.  If one country’s banks do become “zombies” and can’t lend until they’ve rebuilt their capital, foreign banks will step in.  Or at least they will if they perceive profitable lending opportunities relative to their home market or other overseas domains.

Conclusion

In terms of the structure of the banking system, governments in the UK, US and elsewhere are following the correct strategy of “muddling through”.

But they should be more focused on ensuring that there are no obstacles to lending to business.  This is best achieved by reducing the pressure on banks to make fresh mortgage lending.

The UK Government, mindful of the voters of Middle England, are in denial about the housing bubble. The Times reported yesterday that:

“First-time buyers typically had a deposit of 22 per cent in December, the highest proportion in 34 years of available data.  The average first-time buyer borrowed 3.1 times their income…”

Since only a small proportion of potential first-time buyers can find 22% deposits (+ other purchase costs) and earn 1/3 of the average cost of the first-time home (less 22%), house prices have a long way to fall yet.  And an average of 3.1x income is still too high – the maximum loans normally granted back in the 1980s were 3x income or 2.5x joint, if memory serves.  Interest rates won’t stay this low forever, and the longer they do, the more they will rebound in a couple of years.

The Government should, for once, tell the public something they don’t want to hear – that house prices need to come down, and stay down, relative to wages, at least at the bottom end of the market.

Where money comes from… the leveraging process – afterthoughts

My previous post and the one before that tried to explain where money comes from.  I described a process – leveraging – whereby banks and an economy as a whole creates more and more credit.

One point I omitted was to explain what happens when you are loaned money from a bank.  I noted in my first post on this topic, that banks must have sufficient funds at the central bank to cover any (electronic) payments made by their customers.  Sophisticated computer systems now control this process.

But what I didn’t mention was that money loaned to you by your bank doesn’t come out of thin air.  If they loan you money then this credit is balanced by a corresponding debit on one of the bank’s own accounts.  Thus the quantum rules governing the process are enforced.

And if you pay interest on a bank account, this money must come from somewhere. It must be credited to your account from another bank.

Perhaps it seems as if a bank is somehow creating money by charging you interest, but it’s not.  If you don’t pay it (say you only pay off the original debt), the bank will make no profit on the transaction (in fact it will make a loss, as the money paid to you is not free, but itself is subject to an interest rate).  Its capital to support further lending will not increase.

What might be confusing is that a bank will report (in terms of “balance-sheet money”, not “real money”) that its assets (loans it’s made) have a certain value based on the likelihood they will be repaid with interest, not repaid at all, partially repaid and so on.  This value can change abruptly depending on the economic climate and sentiment.  This is what happened to provoke the Great Crunch.  All of a sudden a lot of loans on banks’ books were perceived as worth a lot less than before.

This meant that banks suddenly had a lot less capital to support lending.  The problem was compounded by (at least) two catastrophic mistakes by regulators:

(1) The daft idea of mark-to-market, an accounting principle that banks must mark down the value of their assets to current market prices.  So, if a bank had some mortgages (an asset) that no-one wanted then it was forced to mark the value of these down dramatically – below the value they may have if held to term (i.e. until everyone has either paid off their loans or declared bankruptcy).

Mark-to-market is particularly insane, because it implies that the risk of one or more banks concealing the fact that they are insolvent is worse than that of banks failing (or having to be nationalised) when they are technically insolvent, but, if allowed some breathing space would be able to pull through.  There have been periods before when banks have been technically insolvent – e.g. due to the “Third World” Debt Crisis – but have muddled their way through.  As is now painfully obvious, a loss of confidence in the banking system as a whole is a lot worse than the occasional BCCI.

(2) Allowing banks to hold assets in off balance-sheet vehicles (e.g. SIVs, “conduits”).  At least some of these assets were “really” on balance-sheet, since the banks concerned could not walk away from their responsibility for them without destroying their own reputation.

The correct action at the outset of the Crunch was to order the banks to raise more capital, a prescription obvious at least a year ago.  In the case of Northern Rock King and Darling will no doubt rot in Hell for all eternity for not having the courage to shout from the rooftops at the outset that the Bank of England stood behind the Rock.  Instead of kow-towing to the queues of savers, they should (if necessary) have just shut the doors for a few days until they’d got this message across.

The whole Crunch could have been avoided if governments had:

(1) Made it clear that no bank would be allowed to fail – they are heavily regulated (e.g. by the FSA) and all solvent.  Central banks would lend to them without limit.

(2) Ordering the banks to recapitalise just in case.

(3) Ordering them to recapitalise again if confidence didn’t return.

(4) Repeat step 3 as long as necessary.

Now, of course, rapid deleveraging has led to a disastrous recession.

——–

Now, at last we’re in a position to understand the discussions of leverage.

Some – Niall Ferguson in a somewhat incoherent piece in the FT, for example, and Willem Buiter on his Maverecon blog, argue that lending (aka leverage) should be reduced.  I don’t doubt they are right.  The problem is this can’t happen overnight.  The plan is, or should be:

(1) To try to maintain lending levels to reduce disorderly deleveraging through bankruptcies and further bank failures.

(2) Address the causes of excessive indebtedness (though there’s no prescribed optimum level – the idea that it is excessive is subjective).  These causes include:

- trade imbalances and consequent surpluses and hot money (“The Chinese Mistake”);

- shocking levels of inequality (a contributor to “The American Mistake”);

- incorrect inflation targeting (“The Universal Mistake”) allowing asset bubbles to develop, particularly in the property market (“The British Mistake” and a cause of “The Spanish Mistake”).

Note that the undoubted failures of banking regulation, and even less the behaviour of “reckless bankers” are at best contributing factors, and arguably irrelevant – not just an insufficient cause, but also unnecessary.

I’m planning a series of posts addressing these causes of the Crunch in a little more detail.  Watch this space!

It’s the Construction Industry, Stupid!

To help revive the UK economy, the Government should change the rules to encourage more house-building for the private market.

Back in the early 1980s, I occasionally asked members of hard left groups, such as the Militant Tendency, how they proposed to lift Britain out of recession. I recollect that, after the mantra: “Nationalise-the-top-two-hundred-companies!”, their prescription was massive investment in the construction industry. They had a point.

Some of the objectives of the raft of economic measures the Government has announced are absolutely correct. Broadly, their aim is to short-circuit the process of reduction in bank-lending (“deleveraging”) which would otherwise occur. Renewed bank lending will hopefully slow the disastrous cascade of bankruptcies leading to further bankruptcies, for example, amongst failed companies’ suppliers and customers.

The Government hopes that renewed lending will also stimulate new investment and consumption, thereby promoting economic recovery. But where will economic activity increase in the UK? Financial services is on its knees, the car industry is practically mothballed and, from retail to aerospace, most other industries are seeing reductions in demand, albeit less dramatic.

But there is huge unmet demand for housing. Waiting lists for social housing are at record levels. At the same time unemployment is heading towards 3 million. A naïve observer might suggest trying to tackle both problems at once. They’d be right.

So far the Government has attempted to address only the demand side of the housing market. Margaret Beckett is even, disgracefully, trying to scare first-time buyers into taking the plunge. But demand will only return when prices drop to a level justified by the new reality. Currently, sellers are marking house prices down by an average 2% a month. This rate may slow later in the year, but is so high it suggests prices are likely to fall for quite some time, until first-timers can buy for 3x salary, and enough of them have saved a hefty deposit.

Perhaps Beckett does not clearly understand that we have entered a period of consequences. The fact that house prices are falling rapidly now is a result of past mismanagement of the market. The Government is clear that we can’t return to the lax lending practices of the past. Quite right. It follows that the housing market will not return to its previous state.

Many commentators (and it seems Government ministers) appear to confuse the bubble phase of the housing market, when supply constraints inflated prices, with the current crash, when all that really now matters is affordability and hence demand. Observe how the oil price is behaving in a similar way to the UK housing market – the fact that we couldn’t get the stuff out of the ground quickly enough a year ago is suddenly entirely irrelevant.

The UK housing market differs from a number of others in that there was no oversupply during the bubble years. On the contrary, many first-time buyers were priced out of the market. It matters not a jot now whether there are 1000 properties on local estate agents’ books, or 10, if no‑one can afford to buy any of them. First-time buyers still can’t enter the market because, quite rightly, mortgages are harder to obtain and require a significant deposit. Unless the Government plans to encourage lenders to reinstate 100% mortgage deals, house prices will tend towards a new equilibrium level, at least in relation to average wages. The Housing Minister should be considering now how to change the rules of the game in order to incentivise developers to build houses for private sale in the lending conditions likely to prevail for the next 10 or 20 years.

Reading Margaret Beckett’s words: “If demand starts to turn up before supply turns up, you’re immediately back in inflationary pressures… when the upturn comes, there will probably be a mad rush”, it starts to dawn on me (to my horror) that the Government might be happy to see a lack of house-building for private sale. This is a mistake. Instead, the Government must do everything it can to promote house-building. In terms of the effect on the housing market, the pay for the jobs created would more than compensate for the increased supply of housing, since the full cost of construction has to be paid out when property is built (i.e. put into the economy now), but this money is borrowed (i.e. is only taken out of the economy in the future), first by the developer and later by the purchaser of the house.

So, encouraging a bit more house-building now would be a very good idea. The problem is that, not only is the housing market in freefall, the Brown Government has already splashed money about remarkably liberally. Rather than devise ways to help the banks raise fresh private capital by, for example, underwriting deeply discounted rights issues, the Chancellor has simply reached into the taxpayer’s pocket. The pound is now under pressure and concern about the fiscal deficit will make it more and more difficult for the Government to borrow. Consequently, the Government is not in a position to finance a massive social house-building programme, much as it would like to. But they could change the rules to reduce costs to developers, encouraging them to build more houses.

The reasons why there is so little house-building now are the same as during the bubble years. Then, the lack of supply inflated prices more than would have otherwise been the case, contributing to the mess the economy is now in. Now, more house-building would help the economy out of recession.

First, the local planning process is seriously dysfunctional. The Government should redouble its efforts to speed applications along. Unfortunately, there is stiff resistance to the necessary measures, and I also suspect the Government is in something of a bind, as one of their aims is to empower communities. The trouble is, when it comes to planning, “local democracy” is a contradiction in terms. Decisions are overly influenced by the concerns of anxious neighbours – often bordering on the ludicrous, for example, in terms of sensitivity to increased traffic – to the detriment of the general interest in adequate housing provision. At a minimum, the Government needs to constrain the planning process to restrict the grounds for objection. For example, objections on grounds of supposed traffic increases should only be admissible if a new through-road is being created.

Second, the level of house-building is much reduced by Section 106 agreements with Councils, whereby developers fund, not just supposedly necessary infrastructure improvements, but also the provision of new social and “affordable” housing. Section 106 taxes inevitably reduce the supply of housing because (as would be learnt in an Economics 101 class) restricting developers’ profits will, as sure as economic gloom follows euphoria, result in less investment in house-building. To try to increase social housing provision through such a measure as Section 106 is a colossal blunder, since, by reducing the overall supply of housing, more people end up on local authority lists because of the lack of supply to the private purchase and rental markets (and consequent high prices), than if Section 106 schemes to provide “affordable” homes didn’t exist! The Government should stimulate house-building by drastically restricting the ability of local authorities to, in effect, tax first-time buyers through Section 106 agreements, and permanently abandon the use of this method of funding “affordable” housing provision.

If the Government were to take these steps, house-builders would judge many more potential projects to be commercially viable than would otherwise be the case. For many developments, they would be able to reduce their costs sufficiently to be able to sell the property profitably when the housing market stabilises in a year or two. Developers would have an incentive to make use of the bank-lending the Government is encouraging and restart the house-building industry, providing a much-needed stimulus to the economy in general. The increased economic activity from a revival of the house-building industry would itself contribute to arresting the decline in house prices.

Renting References

Following on from my last post, there’s a great piece by Renter Girl in today’s Guradian Society section.  It’s not on her blog yet, but I guess may appear there soon.  Her point is that landlords as well as tenants should have to provide references.  As a comment on the Guardian piece puts it:

“…the laws governing private lettings need to be rebalanced.  Tenants rights have been minimal since assured shorthold tenancies became the norm (due to legal changes made in its death-throes by the Major “government”).

…the most important references would be from previous tenants, preferably at the same property or, for a new let, at another of a landlord’s properties.  New landlords should have to provide character references, but I expect even a no-mates weirdo king would be able to find a bloke in the pub to write something nice about them.

Any financial problems a landlord may have should not be allowed to affect tenancies, but – since it’s likely that a landlord’s credit score will only go negative when his BTL empire collapses – rather than provide tenants with credit references, I think it would be better to improve security of tenure, which should be maintained (as, to be fair, is the current insecurity of tenure) even if a property is sold.  Or repossessed.”

Another idea I haven’t mentioned yet was that the managing agent (see my response to Renter Girl’s point 2 in my previous post) should be responsible for maintaining files on properties to be shown to prospective tenants – a bit like Home Information Packs (HIPs) for house purchasers, I suppose.  As well as, for example, the newly introduced Energy Performance Certificates, such a file would include correspondence relating to the property, and in particular letters and emails from previous tenants and any replies.  Landlords would then have a greater incentive to deal with the cause of complaints.

Perhaps Brown’s government is too busy saving the world to do a bit of heavy-lifting – providing sensible legislation for the private rental market would improve the lives of millions of tenants.