Menu Menu


Category — Monetary Policy and Interest Rates

DANGER: Even estate agents think house prices rising too fast

Calls to cap house price rises are clear sign of housing bubble

RICS is shouting from the rooftops – are the authorities listening?

No more ‘Help to Buy’ we need ‘Help to Build’

Clear signs of housing bubble: The RICS has issued an unprecedented call for a cap on house price rises.  This suggestion, from the industry most closely associated with the housing market, clearly indicates that house prices are in bubble territory.  It has been clear for months that the mortgage market is taking off again with many more people chasing up property prices.

RICS is ‘shouting from the rooftops’ but Bank of England not listening: The Bank of England has promised it will not allow a house price bubble to develop – those words ring hollow when the bubble is already here and yet the Bank’s forward guidance insists interest rates must stay at emergency low levels.  Mervyn King, in his 2012 Today Programme lecture, lamented the fact that the central bank had not done more to warn of the unsustainable nature of excessive borrowing.  He said  “With the benefit of hindsight, we should have shouted from the rooftops” about the dangers in the system.  Now the RICS is shouting about the dangers of a housing bubble, but who is listening?

We have not learned lessons of the last crisis:  Lord King stressed that the Bank of England needed to learn from the financial crisis and said “our role will be to take away the punchbowl just as the next party is getting going”.  Well the party is clearly well underway but the Bank remains complacent and promises it will keep rates down even as Funding for Lending and Help to Buy are further increasing house prices.

Not sure a price rise cap will work:  If the Bank is not willing to raise base rates, what else could be done?  The idea of capping house price increases is not really practical, but there are other measures.

1.  Abandon the second phase of Help to Buy.  The 2014 plan to force taxpayers to underwrite high loan to value mortgages exposes taxpayers to the risk of substantial losses, whilst also further inflating the housing bubble.  This scheme needs to be focussed on building new homes, not increasing demand for existing properties.

2.  Encourage new construction – ‘Help to Build’.  Special incentives for house-building would be a better use of taxpayers’ money than underwriting mortgages.  This would increase supply and help reduce upward price pressures.

3.  A curb on lending criteria.  Currently, there is a resurgence of 95% loan-to-value mortgages, which are exposing borrowers to significant risks when the housing bubble bursts.  Stricter criteria for responsible lending (such as 85% maximum LTV) would help to curb some of the excess.

Having just endured such a major crisis that resulted from over-exuberant lending and borrowing and rising property prices, we must not make the same mistakes again.

What do you think?  Who’s right on the housing market, the Bank of England or the Chartered Surveyors and Estate Agents?

September 13, 2013   No Comments

Blinkered Bank of England ignoring dangers of low rates as economy picks up

4  September 2013

  • Bank of England should take off its blinkers and look at the economic evidence
  • Low rates are distorting economy – causing borrowers and savers to take too much risk
  • MPC should consider a small rise in rates now

As the Bank of England Monetary Policy Committee meets, I urge its members to look carefully at the evidence showing a stronger UK economy and start the process of increasing interest rates to more sustainable levels.  Ultra low interest rates are distorting the economy now, driving borrowers and savers to take on too much risk.  This is what caused the crisis in the first place, when financial markets misunderstood or mis-priced risk and encouraged irresponsible borrowing or lending.

Forecasts of economic weakness are out of line with the evidence: The Bank of England seems to believe – as do many of those calling for ongoing monetary easing – that the UK economy is still weak, that recovery has not yet arrived or that growth is not yet strong ‘enough’.

Where is the weakness?:  Looking at the economy without blinkers, it is hard to see why rates are at the emergency levels of 2009.  Consumer spending is strong, house prices are rising fast, manufacturing and the Purchasing Managers Index have increased sharply, construction is picking up, exports have improved and around a million new jobs have been created.

Enticing people into loans at artificial rates is repeating the mistakes that led to the crisis:  Bank of England policy seems to be focussing on helping the housing market to keep house prices and other asset prices rising.  But such policies were a major cause of the financial crisis.  Until 2008, house prices were boosted by irresponsible lending in the form of  ‘Self-cert’, interest-only and 125% mortgages, which helped borrowers pretend they could afford large loans. Everyone believed these loans were not too risky because house prices were rising sharply, the same seems to be happening again.  This time, borrowers are being lured in with record low mortgage rates instead, but the principle of rising house prices validating the borrowing once again underpins policy.

 

MORTGAGE RATES HAVE FALLEN

Date

2-year fixed rate

Mortgage

75% LTV

%

5-year

fixed Rate Mortgage

%

Tracker Mortgage

%

Standard Variable Rate Mortgage

%

Mar 2008

5.80

5.70

6.04

7.24

Mar 2009

3.98

4.95

4.01

4.06

Mar 2010

3.92

5.50

3.76

4.04

Mar 2011

3.68

5.10

3.47

4.07

Mar 2012

3.44

4.19

3.57

4.10

Mar 2013

2.90

3.63

3.56

4.34

July 2013

2.60

3.38

3.39

4.33

Interest rate change

-3.2%

-2.32%

-2.65%

-2.91%

~Source:  Bank of England Table G1.3

 

Low rates are unhealthy for the economy as they mislead borrowers by subsidising loans: Funding for Lending has driven mortgage rates down for now, but these are 25-year loans which may only carry low rates for a short time.  So keeping rates at such low levels for too long is misleading borrowers, enticing them to take out more loans than they can really afford and is ultimately unhealthy for the economy. The Bank of England should be concerned now about what will happen when rates rise again and buyers need to find far more money to service their debt.

Forcing savers to take on too much risk:   A further economic distortion of maintaining rates so low for so long is that savers are being forced to take on too much risk.  Rather than providing cash savings for banks to recycle to riskier lending – as would be the normal function of the banking system – savers are being forced to turn to riskier activities themselves in order to stop the value of their savings eroding.  They are being enticed into peer to peer lending or high yield bonds and equities if they want to keep up with inflation. These are loans that the banks are unwilling to make because they cannot afford to absorb losses, yet the risks are now being passed on to savers who may be even less able to absorb the loss.  This exposes the economy to extra risks, because savers need their money for their future financial security, but the money may not be there if these risky investments let them down.

Rates should rise slowly to avoid sharper rises later:  House prices are already booming in many areas, and will be further boosted by the Help To Buy scheme that will expose taxpayers to large losses if mortgage holders default on their loans in the next few years.  So I strongly believe the MPC should start gently easing interest rates up now, giving people a better idea of what they can really afford, rather than the illusion of affordability created by current artificially low rates.  Relying on borrowing to generate growth is merely bringing forward growth from tomorrow to today.  When the debts have to be repaid, growth will be impacted.  Better to have a gentle rise in rates rather than a sharp increase later.

Low interest rates are distorting the economy and not feeding through outside housing:  The current low rate environment has not really fed through to most other types of borrowing.  Indeed, rates on loans other than mortgages are in many cases higher than they were before the crisis began.  Banks have also been imposing extra charges and tougher terms for loans, especially for small firms, so the low rates policy seems to be allowing lenders to make much larger profits, while distorting the housing market and denying savers a decent return.

 

OTHER BORROWING INTEREST RATES HAVE RISEN

Date

Credit Card          %

Overdraft

Rate

%

Mar 2008

14.75

17.57

Mar 2009

15.73

18.63

Mar 2010

16.53

18.96

Mar 2011

16.66

19.08

Mar 2012

17.31

19.52

Jun 2012

17.25

19.51

Dec 2012

17.33

19.65

Jan 2013

17.61

19.55

Mar 2013

17.69

19.55

Jun 2013

17.84

19.55

July 2013

17.89

19.55

Int. rate change

+3.14%

+2.0%

Source:  Bank of England Table G1.3

Forward Guidance has come too late – it lacks credibility as the economy picks up:  The Bank of England’s forward guidance is designed to encourage borrowers to believe rates will stay low, so they can keep on borrowing without worrying about higher repayments.  That might have been helpful a few years ago, but is too late to be credible now, as the economy is clearly picking up.  The Bank of England has suggested that rates will not rise before the unemployment rate falls below 7%, but the rationale for targeting the unemployment rate as a policy trigger is not clear, especially as unemployment tends to be a lagging economic indicator.  Indeed, as the Governor also says he will not allow a housing bubble to emerge and as housing market indicators keep strengthening, forward guidance is clearly inconsistent.  What will he do to curb house prices if unemployment remains above 7%?

Markets are telling us that rates will need to rise much sooner than 2016.  The longer rates stay so low, the more distorted the economy becomes.

September 4, 2013   3 Comments

Following the Bank of England’s statement

7 August 2013

  • Three more years of misery for savers and pensioners
  • Rates remaining at emergency levels whilst there is no emergency
  • Relying on borrowing and house price inflation to drive growth is how we got into the crisis

Anyone approaching retirement and potentially buying an annuity, anyone running a pension scheme and anyone saving for their future will have been disappointed by today’s masterly statement from Mark Carney, potentially promising three more years of emergency, ultra-low, interest rates.

The economy is recovering, there is no emergency any longer and inflation is a potential threat. Yet the Bank of England sees no danger in keeping rates so low.

The worry is that tying interest rates to unemployment levels rather than inflation or the real economy could just be repeating the mistakes that caused the crisis in the first place.

This policy relies on continued borrowing at unrealistic rates and ongoing rises in house prices to boost growth. That is similar to the pre-crisis environment.

With an ageing population we need to encourage saving so that people have money for their future, but this policy environment undermines incentives to save. It may suit borrowers short-term but is has dangerous longer term consequences.

I do hope as the economy continues to grow the Bank will start to operate with more foresight than today’s statement demonstrates.

August 7, 2013   No Comments

Low rates still damaging firms with pension liabilities

7 August 2013

Here is my latest piece, looking at the recent figures on UK pension deficits.  Firms are still struggling with the effects of QE and continued low interest rates, plus above target inflation.  I hope that Mr. Carney will not overlook these negative effects of low rates, although I fear it is not an issue he will take seriously.

Do give me your thoughts.  Comment below.

  • FTSE 100 pension deficits still rising despite strong markets and higher employer contributions
  •  Assets increased by £41bn but liabilities rose by £43bn
  •  Low interest rates are still damaging pension schemes

 

FTSE100 deficits still rising: The latest pension deficit calculations for the FTSE100 firms show a rise in deficits in the past year to £43billion.

Employers put billions in, markets strong but QE still drives deficits up:  Even though employers ploughed around £20bn into their pension schemes last year, and equities rose by 18%, the damaging impact of continued ultra low interest rates and above target inflation has caused scheme deficits to keep rising.

Firms struggling with pension costs and risk control:  FTSE100 firms with defined benefit pension schemes are struggling to contain the costs and risks of these promises, while the situation is far worse for smaller companies and charities which are unable to afford sufficient contributions to fill their deficits.

Assets increased but liabilities increased by more:  The Report by LCP calculates that although FTSE100 pension scheme assets rose by £41bn from £406bn to £447bn, liabilities increased by £43bn from £447bn to £490bn.  The rise in liabilities has offset the strong asset performance and is further evidence of damage done by QE to UK pensions.

FTSE350 firms’ pension funds hit by shortage of doubleA bonds:  FTSE350 firms are also finding it difficult to control the risks of their pension schemes, with Hymans Robertson pointing out that the shortage of AA corporate bonds, which are used as the discount rate for the accounting valuations of their pension liabilities, now means that they are struggling to find matching assets and that the prices of AA corporate bonds are rising.  This causes significant problems for many firms, because it is estimated that each 0.1% rise in the AA corporate bond yield can lead to a £12bn change in the overall FTSE350 pension deficits.

Ultra-low long bond yields have damaging side effects which are being ignored while small firms and charities go bust and workers’ pensions are reduced:  So far, all the talk is of the benefits of ultra-low bond yields and the merits of negative real interest rates on many maturities.  However, it is important to consider the problems of UK pension schemes and the rise in deficits which is damaging smaller companies and charities.  When these employers fail, all their members will see reduced pensions in the Pension Protection Fund.  This is a hidden cost of current policies.

August 7, 2013   2 Comments