Uncharted Territory

October 27, 2010

The Benefits of Being Ugly

Filed under: Economics, Housing market, Markets, Minimum wage, Public spending, Regulation — Tim Joslin @ 8:19 pm

I’ve just watched today’s Prime Minister’s Questions (PMQs) on iPlayer (warning: programme will probably not remain permanently available), because it’s simply not clear what aspects of the Coalition government’s benefits cuts programme Labour opposes.  It was ugly: the problem is Ed Miliband didn’t stick to the point.  There is a chink in Cameron’s armour, but Miliband missed it.  If he’d thought through his position rather better you feel he could have skewered the bastard.

The point is, if you watch the Guardian’s PMQ clip, Miliband appears to be latching onto the vindictive proposal to reduce Housing Benefit (HB) by 10% after someone has been on Jobseeker’s Allowance (JSA) for a year.

I’d thought Chris Bryant had been off-message when he took on Clegg over the £400/week limit on HB, which could force people out of central London.  Clegg did that old trick of ignoring what was asked and taking offence at the manner, suggesting Bryant had dissed those “ethnically cleansed” around the world.  Bryant said “sociologically cleansed” so Clegg was just being a prick.  I don’t like to use bad language on this blog, but I’m making an exception for the Deputy PM.  Anyway, back to the story.  Unfortunately, in PMQs, Miliband let Cameron talk about the £400/pw limit rather than the 10% reduction.

Labour is defending the indefensible in opposing the £400 limit and should be supporting it.  The 10% cut is a different matter altogether.

It’s depressing to see Labour in complete disarray in the face of the Tory onslaught.  All we’re seeing is uncoordinated rearguard action.  Ed won’t last long if they carry on like this.

The point is there are different motivations for different aspects of the welfare reforms.  Some measures are to restore fairness and others to reduce the overall cost.  There is an element of financial sleight of hand.  But there is also an attempt to punish the unemployed, and that is simply out of order.  Ugly, Cameron, ugly.  With around 1.5m on JSA already and with 500,000 civil service job losses to come, as well as transfers from disability and incapacity benefit, there are bound to be some people who don’t find work within a year.  Sure, some of these will be people who tried less hard than those who found work, but the point is not everyone will find work, even if all applied the highest standard of diligence in looking for a job.

So what are the main changes and their rationale?  Which should Labour oppose?

1. Reassessing disability and incapacity benefit claims

Labour was doing this anyway.  The Tories are not outflanking Labour though are giving the impression of doing so.  To be honest, both parties are cynically preserving votes, since there’s actually no reason why you need more money if you’re disabled.  The benefit should be the same as JSA, unless extra funds are needed to overcome specific disabilities. I caught a Radio 5 phone-in this morning and none of the callers fell into such a category.  RSI (“carpal tunnel syndrome”), chronic migraines and depression are unpleasant conditions, but do not in themselves result in expense.  The point is that paying more money gives people an incentive to label themselves as ill, which is in neither the public nor, arguably, their own interest.

2. Limits on the maximum HB that can be claimed

This depends on the number of bedrooms you’re assessed as needing.  The maximum (for 4 bedrooms) is £400/pw (the other limits are “£340 for a three-bedroom property, £290 for two bedrooms and £250 for a one-bedroom property”).  This is more than many working people can afford, so there is overwhelming public support for the limit for the unemployed.  And the Tories are milking it.

But employed people can also claim HB.  The answer to the case of the caretaker cited by Polly Toynbee is to demand a higher minimum wage in London (see my previous post), not to oppose the HB limits.  As I said, Labour is in disarray.

There are serious questions to be asked, too. And Labour isn’t asking them.  People on high rents are going to run out of money very quickly.  Is the government saying, for example, that if someone is made unemployed and they happen to be renting somewhere for more than the limit they’re entitled to – not difficult in London – or have two bedrooms when they’re only entitled to one, that they have to move immediately, or at least before any savings or redundancy payment run out?  The additional disruption is hardly conducive to rapidly finding new employment, is it?

3. An increase in rents for new social housing tenancies to 80% of the market rate.

Judging by Toynbee’s comments, Labour seems to have missed the point of this.  The idea is to raise money for new-build social housing.  The idea is that providers will be able to borrow against the increased revenue stream.  (Most of the rent at present goes on repairs).  HB will have to be higher to fund the higher rents, so all that’s really happening is the cost of new social housing is being amortised – rather like the much-derided Public Finance Initiative (PFI) Labour used to get hospitals built.

4. Paying HB only for rents up to the 30th percentile for the area rather than the median.

It’s crazy that it was the median in the first place.  Over time, this must simply push up rents in general, since with HB-funded demand, any properties offered up to the median price will be let quickly (so no incentive to mark them down), whereas those marketed at an above-median price might find a tenant before they have to be marked down.  The median will steadily increase even if supply and demand are balanced.  It’s possible even the 30th percentile might not be enough to prevent this effect (since properties private tenants would pay less than the 30th percentile rate for will let to HB tenants at the 30th percentile rate).

5. And then there’s the 10% HB punishment if you don’t find a job in a year.

This makes absolutely no sense to me.  HB is supposed to be a payment in kind.  It’s to pay the rent.  If it’s reduced, then something’s got to give.  And apparently there’s more: I start to appreciate Polly Toynbee’s indignation:

“But that’s not all. The sum paid towards the rent will fall every year, in perpetuity: it will no longer rise as average local rents rise but will be pegged to the consumer price index. If that had happened in the last decade most people would have been priced out: rents rose by 70%, but the CPI only rose 20%.

Now add in something more sinister. Council tax benefit, worth an average £16 a week, is to be cut by 10% and then handed over to each local authority to decide how much benefit to offer: if some councils want to push poor people out, they can pay virtually nothing to their residents.”

This makes no sense.  I can understand the idea that you’ve got no job, the state covers your main outgoings (rent, Council Tax) and gives you £65/wk to manage the rest on.  But £65 seems pretty much a bare minimum for food, heating, clothing and so on.  Playing games beyond this point is simply vindictive.  To see someone of Cameron’s privileged background doing so is, frankly, a rather disgusting sight.

So, Ed, you need to inject some clarity into Labour’s position.   You’re going to have to give up some ground.  Most of what the Coalition is doing makes sense.  But punishing the unemployed doesn’t.

And come up with some alternatives.  A higher minimum wage to increase the incentive to work.  And a higher minimum wage in expensive areas, such as central London than elsewhere.

Most of all, please, please read the blogs and stop defending Housing Benefit of more than £400/wk!


Housing Horror

Over the last few decades, here in the UK, we’ve become very good at pointing to apparent failure.  Often despite considerable objective evidence to the contrary.  Apparently we’re no longer any good at making things (compared to Germany and China, maybe, but not to most other countries), our armed forces are puny (compared to the US, maybe…), our energy supply is insecure, our public services are falling apart, the English Premier League is in a mess…  Such angst is spreading elsewhere in the West, but somehow you rarely hear fundamental criticism of our political and economic system.  You’d think the political process was merely flawed, a little unfair in places, perhaps, a little too tolerant of peccadilloes by the powerful, but basically sound, and very difficult to improve.  Despite considerable objective evidence to the contrary.

We’re just now quite rightly much vexed over the issue of housing (warning, link is to page of all 865 comments, and counting).

The issue, in a nutshell, is the extent to which the state should pay to provide some people with a standard of housing higher than they can afford on the open market.  The 1997-2010 Labour government (supported by at least the non-Tory controlled local councils, who have executive powers in area of housing), was quite enthusiastic about doing so, though in the main merely continued existing policies.  As time has gone on, though, the provision of housing to some by the state has been a factor in driving those not eligible for, or simply not claiming, state support, into less desirable – smaller, and often, crucially, less conveniently located – accommodation.  It should be noted that Labour’s attempts to increase the supply of housing over recent years has been effectively stymied by nimby campaigns, if not supported, then at least not effectively challenged by foot-dragging Liberal and Conservative local councils.  Despite guilt all round, the new Coalition government has decided to address the problem, in part, I suggest, as part of their strategy of blaming everything on Labour.   And in that regard, housing is pretty much an open goal.

As the debate continues, we see not one but two failings of our political system in stark relief.

The first failing is a confusion: are we making policy on the basis of reason or emotion?  Let’s take people who aren’t working for whatever reason (unemployed, incapacitated or retired).  Now, I’m not even going to argue this on the basis of rights.  It simply makes no sense, as hundreds of bloggers have pointed out (to massive approval, judging by “Recommendation” statistics), for workers to commute in every day from the outskirts of conurbations such as London, whilst people who don’t actually need to live there are paid to do so by the state.  Why, oh, why does Labour defend the indefensible? (Link to where Polly Toynbee explains the Coalition’s inhuman proposals – remember we’re essentially taking about a zero-sum game, here: what we give to one household, we deny to another).

But – there’s always a “but” – there are “priority cases” as a Councillor Timothy Coleridge (Tory, Kensington and Chelsea) explained on Radio 4 this morning trying to “soften” the policy.  There’ll be a “transition fund”, we were told.  He seemed to be particularly sympathetic to the elderly.  So it seems we’re going to make value judgements.

It might be worth digressing at this point to note that gerrymandering is a factor, because of first-past-the-post local elections.  Politicians want to keep their voters in their constituency and move the opposition’s out!  I suspect the Tories see the elderly vote as key to their next few terms in office, so I was immediately suspicious of Councillor Coleridge.  Any “prioritisation” must surely be done according to an objective, nationally applicable set of criteria.  Trouble is, value judgements are why we’re here in the first place.

If the policy is to minimise the fiscal cost of housing benefit, and optimise the use of housing, then that’s what we must do.

Here’s a case of the same sort of thinking, from a letter to the Guardian, by an Ann Tobin:

“The house was lovely, built to Labour’s postwar housing standards (later abandoned by the Tories). Us kids grew up and moved on and my parents stayed there until my mother died in 1998, 50 years after they had moved in. My father died three years before her. Yes, the house was too big for her, but she liked to invite her children, grandchildren and great-grandchildren to stay.” [my stress]

This partly explains how we’ve reached the present situation.  This identifiable individual (Ann Tobin’s mum) “liked” her big house, provided by the state.  Meanwhile, there is a waiting list of millions of families for such houses.  Maybe, because Ann Tobin’s mum was allowed to keep a house she liked, a family with a couple of school-age kids spent years moving about between emergency B&B accommodation to temporary lodgings.  Maybe that family would have “liked” a house of their own.  Because Ann Tobin’s mother has been allowed to stay in a family house, another family that can’t be precisely identified is living in poor or insecure accommodation.  This is crazy.  Housing supply is limited (though could be improved).  Why is it so difficult for people to understand that because of that limitation one decision impacts on others?  In areas with a limited supply of housing, its allocation is a zero-sum game.  You can’t give some people a place they’d “like” without denying others the same thing.

To my mind what we’re witnessing is the complete failure of post-war housing policy in the UK.  Council housing, for example, makes no sense.  It locks in housing allocation at one moment in time, making no allowance for the changing world we live in. Or the changing size of individual families for that matter.

This brings me on to the second failing of the political system.  Politicians see direct action by the state as the only way to achieve anything.  So we’re told we have to build more social housing.  Wrong.  We simply have to build more housing, period.  100,000 private homes will house 100,000 households just as well as 100,000 social homes will.  100,000 fewer households will be waiting for housing in either case.

And in actual fact, over the last decade or so, demands for social housing have actually reduced the total provision of housing.  Why?  Because the main way social housing has been provided has been through Section 106 agreements with housing developers.  In this daft system, housing developers have been given planning permission in return for including schools, hospitals or social housing in their schemes.  And you thought schools, hospitals and social housing all came out of the health, education and housing budgets?  This tax on developers, or first-time buyers, however you want to look at it, has the effect of reducing housing provision.  At a given house-price level, building houses is less profitable than otherwise would be the case, so fewer invest in that activity than in other opportunities.  Fewer houses get built, house prices rise, and more prospective purchasers find themselves on social-housing waiting lists.  Section 106 agreements to provide more social housing because it’ll be needed are, in aggregate, self-fulfilling!

I can’t even bring myself to discuss how shared equity schemes and other devices to subsidise house purchases simply push up the general price in the market.

The solution seems to me blindingly obvious, so I’m going to cut to the chase (a phrase, incidentally, that grated when used by Bob Hoskins in Made in Dagenham, since it wasn’t in general usage in 1968 when the film was set – I remember first hearing it in 1994).

We’ve simply got to manage the relationship between wages, at the low end, and house prices so that working people can afford to house themselves and their families.  The implication is that there needs to be a higher minimum wage in areas where housing is expensive.  It is simple exploitation to be paying the national minimum wage in central London, because there are only a limited number of possible outcomes.  Either workers commute in which case they spend more time and money than if they were working near their home; or living-standards drop and people end up sleeping in shifts; or benefits are necessary to top-up earnings, subsidising employers and consumers in expensive areas.  Ideally, employers would have to pay more in expensive areas, but the labour market is, has been for some time, and will be for some time, a buyers’ market.  Indeed it is government policy to force people to take any job they can get.

What a mess! State provision of housing has led to a situation where the minimum wage is nowhere near a “living” wage.  Perhaps that’s a bit strong: rather, state provision of housing and other benefits has provided a safety-valve so that pay has been allowed to become gradually lower and lower relative to socially accepted minimum living standards.

Maybe some blame should be apportioned, in order to unravel some of the mystery how we arrived in this absurd situation.

First, there are those, almost all in the Labour Party, but not all of the Labour Party, who believe it is right that the state provides housing and benefits on the basis of need.  “Capitalism” is so “unfair” that the state must step in.  As I’ve mentioned this policy has failed.

Second, there are those in all three parties who take a position I would characterise as “hand-wringing liberals” who make no attempt to analyse the problem and produce a complete policy.  They just want to address the problems of those with whom they empathise.  The trouble is, as I’ve also already said, with limited supply, allocating a house to Mr Jones simply moves Mr Smith onto the waiting list.  As a rationalist this is the position I detest most of all.  Government has a duty to find as solution for everyone, not self-righteously apply sticking-plaster where they most easily can.

Third, there are those in all three parties – since many of the individuals concerned have a vested interest in the form of their own properties – who explicitly or tacitly believe the natural order of things is for people like themselves to own their own homes, ever-rising in value, and that there must necessarily be “the poor” who don’t deserve or are incapable of having the same thing.  Explicitly in the case of some Conservatives… heeeere’s Boris!:

“Better a stagnant housing market, [those arguing for an end to housing speculation] will say, than another great boom and another great bust. Which is all very well, in theory.

In practice, it looks as if flattening off the housing market is both risky in the short term, and unachievable in the long term. The sad truth is that it is still psychologically essential to the British middle classes to have a sense that our principal asset is gently appreciating in value, or at least that it will over the long term.”

Stark-staring bonkers, of course.

Houses simply can’t appreciate in value indefinitely compared to other goods and services.  The world doesn’t work like that.  Eventually house price rises will become self-defeating: even if they don’t stimulate more new-build supply (because of self-interested nimbyism); or inflation, causing interest-rate and hence mortgage increases; they’ll eventually act as such a drag on the economy that activity moves elsewhere – abroad, most likely – and housing demand and prices fall.

Those who buy into the view that the increasing value of their home represents a permanent increase in wealth support the ongoing British class division implicitly.  What they refuse to countenance is entirely feasible: it is possible for everyone in work to own their own home, or rent at a market rate, if they prefer the flexibility they gain that way.

So the three stooges are “Old Labour” socialists, who don’t believe markets can ever be fair; bleeding heart, sawdust-headed “Liberals”; and divided nation, blue-blood-is-just-better “Conservatives”.

It doesn’t have to be this way.  Instead of accepting capitalism as it is (“Conservative”), or rejecting it (“Old Labour”), or ooh, poor little kitten! (“Liberal”), we can make capitalism fairer.  A much higher minimum wage, relative to local house prices, would solve many of the problems that are causing such angst.


October 18, 2010

Boris the Builder

Filed under: Economics, Housing market, Minimum wage — Tim Joslin @ 1:15 pm

When our civilisation finally collapses, and becomes of interest only to historians, explanations will be sought.  How did we throw it all away?  Many will argue that one of the main causes was a collective failure to regulate individual greed in one way in particular.  In the housing market.

This is what the Mayor of London has to say in this morning’s Telegraph:

“Recent pronouncements from the Coalition Government have suggested a new doctrine: that house prices should be flat, or flattish, while earnings rise to meet them.”

Makes sense.

“In other words, the British middle classes are being asked to wean themselves off house price inflation, and become more continental, with a higher proportion of rentals.”

An increase in renting compared to owner occupation is rather a non sequitur, but I’m still with you so far, Boris.

“And a lot of people will say amen to that. Why do we pump all this money into unresponsive bricks and mortar, when we could be investing our capital in stocks and shares and thereby in the flesh-and-blood businesses that add to the GNP of Britain? They will point out – entirely correctly, that this national addiction to house price inflation has bred a kind of financial illiteracy, an apathy about any other investment except the roof over our heads.

And they will point out that it was the house price bubble – the demented practice of giving vast mortgages to people with no incomes and no assets – that led to the crash. Better a stagnant housing market, they will say, than another great boom and another great bust.”

Still with you.  Though not sure about this use of the word “stagnant”.  The reason house sales are sluggish at the moment is that prices are too high.  Mortgages are more difficult to get and higher deposits are demanded, so obviously the same amount of activity will require a lower price level.

“Which is all very well, in theory.”

Uh, oh!  Where’s Boris going with this?

“In practice, it looks as if flattening off the housing market is both risky in the short term, and unachievable in the long term. The sad truth is that it is still psychologically essential to the British middle classes to have a sense that our principal asset is gently appreciating in value, or at least that it will over the long term.”


Even the most elementary reasoning shows house prices can’t rise faster than everything else indefinitely.  If they did, other things – food, energy, manufactures and so on – would eventually cost virtually nothing in comparison to house prices.

And more to the point, house prices can’t rise faster than labour indefinitely, otherwise everyone who doesn’t own a house would have to emigrate.


Ah, Boris has a solution: build more “affordable houses”: Here’s his argument:

“…the best way to help those millions in search of an affordable home is not to try vainly to ensure that the present stock of housing becomes more affordable – ie falls in value – but to increase the supply of affordable homes.”

All very Alice in Wonderland.  Readers unfamiliar with the UK housing market may need some translation assistance.  “Affordable homes”, as used at the end, is a euphemism, spin for “social housing”.  The first use of “affordable home” is in standard English.  From now on, I’ll write “affordable home”, “affordable housing” in quotes when it means social housing and affordable, home and housing without quotes when the words mean what they say.

Let’s dispose of the argument against all this based on principle.  Boris clearly believes in a two-tier society.  A class of which I guess he is a member, who own their own property – appreciating in value forever – and another class who are housed at the whim of the state.  Hint: make sure you’re a “key-worker” or have lots of kids.  Kind of a socialised Upstairs, Downstairs, with a bit of hand-wringing charity thrown in.  I simply don’t agree with this worldview.

But let’s move on to the sheer incoherence of Boris’s proposition, though perhaps I should note at this point that Boris is guilty only of voicing the consensus view shared by virtually all UK politicians, even if a few pay lip-service to the rational and correct argument that the relation between house prices and wages needs to be restored.  Some even realise that it’s best to do this with a bit of general inflation rather than by house-price falls.

First, just because homes are rented for less than the market rate doesn’t mean they’re worth less than others.  They could be rented out for more privately.*  More to the point, the money to have them built must come somewhere.  The land has to be bought.  OK, the state can give planning permission on land it owns, but this is just chucking money away, since they could simply have sold the land off to a private developer.

Second, providing social housing will reduce demand for private housing.  The increased provision of houses would lower prices anyway.  So Boris’s plan won’t even succeed in holding up house prices.  So as far as the Upstairs are concerned, building “affordable homes” is just as bad as building private housing! Of course, social housing is less efficient for several reasons, not least because people won’t move for work, because they’ll lose their home and may not get another or at least have a long wait.  The state should just get out of the way and make it cheaper to build private housing by stopping demanding all kinds of goodies (including “affordable homes”) in return for planning permission (usually under Section 106 agreements).

Third, where do ever-rising house-prices lead us?  Well, unless the salary structure of the economy changes, there will eventually be no buyers.  Possible the wealthy will buy to let as they did up to the crunch in 2007, but that makes no sense, since the tenants won’t be able to afford the rent plus a profit for the landlord and letting agent, since if they could they’d be able to get a mortgage!   So eventually we’ll simply run out of buyers.  Prices will simply have to drop to an affordable level, since otherwise properties will simply sit in estate agents windows.

No, Boris.  You’re not a dumb blond even if you do mumble and bumble in a ditzy manner.  Thatcher was right on housing.  The answer is to make just about everyone part of the property owning class (or at least renting by choice rather than necessity).  And for that to happen house prices must be kept down to a reasonable multiple of the lowest salaries.  Say three times.


* Notwithstanding the revelations in a DWP report, also featured in today’s Torygraph.  As there is insufficient “affordable housing” the state often simply has to pay private-sector rents.  Except that apparently the system is so inefficient that landlords can get more rent for social tenants that for private ones!  Though working people on low incomes end up in poorer accommodation than the state would provide:

” ‘[Low income working] Households with children aged under 16 do appear to be worse off in terms of the property size that they occupy and the rates they would be entitled to if they were eligible for housing benefit,’ the study said.”

You couldn’t make it up.

Politicians of all stripes have created this mess.  Sorting it out requires a step back.  The basic principles need to be laid down.  Starting with fairness.

October 29, 2009

The Great Carry Trade

Filed under: Concepts, Credit crisis, Economics, Housing market, Inflation, Regulation — Tim Joslin @ 4:08 pm

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.

October 26, 2009

Mad Mortgage Rules – and Miles Brignall

Filed under: Credit crisis, Economics, Housing market, Regulation — Tim Joslin @ 5:06 pm

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.

October 21, 2009

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

Filed under: Credit crisis, Economics, Housing market, Minimum wage, Northern Rock, Regulation — Tim Joslin @ 10:55 am

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.

October 6, 2009

Are we all Kevins now?

Filed under: Consumer gripes, Credit crisis, Economics, Housing market — Tim Joslin @ 2:54 pm

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.

March 17, 2009

The Age of Stupid Planning Processes

Filed under: Economics, Energy policy, Film, Global warming, Housing market, Politics — Tim Joslin @ 7:49 pm

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.


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.

February 24, 2009

Turning the UK housing market

Filed under: Economics, Housing market, Markets — Tim Joslin @ 5:03 pm

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.

February 13, 2009

Good Banks, Bad Banks and Nouriel Roubini

Filed under: Credit crisis, Economics, Housing market — Tim Joslin @ 12:22 pm

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.


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.

Older Posts »

Blog at WordPress.com.