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The House Price Paradox Challenge – Whose Fault is it Anyway?

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By - Thursday 21 March 2013

The House Price Paradox Challenge – Whose Fault is it Anyway?

House prices are a closely followed subject in the UK, followed by everyone from the everyday person on the street right up to banks, lenders journalists and beyond. The commentary and opinion flies about from all angles yet none of it provides a solution to reinstating a relatively stable housing market.

Some say building more houses is the answer, others suggest lower lending restrictions will help. Raising or lowering taxes, incentivising builders, incentivising first time buyers, building on green belt land – the list of suggestions and ideas to stabilise the housing market appears almost infinite.

So where does the problem lie?

In this post, inspired in part by my fanatical attention to pointing out the flaws in many suggestions made by politicians, bankers and the public over the past few years (in particular where only one side of the problem is addressed) I am going to attempt to detect the root cause of the problem – and propose not one, but two possible solutions which you can all argue about.

Defining the problem(s)

In the first instance, we need to define what the general problem(s) are.

a)      Houses in the UK are now unaffordable – particularly for first time buyers

b)      Without first time buyers – the housing market stagnates

Then, we can take a look at the various ideas and policies implemented/suggested so far

Housing Solutions and Failings

Click to see the UK housing solutions and failings

Why the problem exists

As we all now know – none of the proposals above have had any significant impact as far as straightening out the housing market is concerned. The reasons for this are that none of them deal with the cause of the problem – they only attempt to deal with parts of the effect. In addition, several of the ideas are pretty much the same thing, just presented in a different way – in effect clarifying the definition of insanity by doing the same thing time and time again and expecting a different result.

Having defined the current problem and assessed the attempts and proposed solutions to it – the next step – which has yet to be noticed by the powers that be, or suggested by anyone with any power – is to establish exactly what the cause was of the problem we currently have.

Wind the clock back a little to the 60's and 70's when Building Societies existed in their true form (unlike the banking version that most are now). Despite flairs and bongs being all the rage – monetary sense did appear to exist at the time. According to a rather heavy research document I found here, banks were not the main providers of mortgage lending – building societies were.  Building societies were structured in such a way that they could not lend more than they had, and, as interest rates moved – the building societies' liquidity was adjusted.

All was well until 1973 when interest rates went through the roof (the Bank of England's Minimum Lending Rate reached 13.5% resulting in market interest rates hitting 15%+ with the end result being that building societies could no longer manage their mortgage books profitably). Various changes and guidelines were waved about – most of which unsettled the building societies – not least the idea of a mortgage stabilisation fund that would build up when interest rates were low, and used as an offset when rates were high.

At some point in the 70's there was a monumental shift around the provision of mortgages – with banks taking over the supply from building societies. Despite significant amounts of digging to find the exact why's and wherefores as to how it happened – I am unable to nail down exactly which piece(s) of legislation caused this shift – all I do know is it happened.

The fact that it did led on to the merging and/or conversion of the major building societies into banks we all know and love loathe today.

Subsequently (I believe) herein lies the cause of the enormous debacle we are faced with now. The pattern of events leading up to the problem pan out along the following lines.

  • Building societies had a business model that naturally captured most of the mortgage market business
  • The business model runs into problems when high inflation hits
  • Regulators experiment with a few ideas to temporarily ease the problem, whilst attempting to enforce back-up fund structures to protect future interest rate swings in tough economic times
  • Building societies quietly wind back their mortgage lending
  • Interest rates settle down – meanwhile, someone forgets to adjust the regulations back again
  • Bankers spot the decline in building society and the gap in the market realising there is money to be made
  • Old, disjointed regulation doesn't apply in the same way to banks as it did to building societies at the time
  • Eventually, banks buy out/merge with building societies to scoop up the old mortgage book data and clients – creating a very lucrative market place with less regulation
  • House prices are still on their way to the moon – meanwhile, bankers and building society managers are laughing all the way to the... well, err – bank
  • Bankers discover that trading mortgage securities might be a wheeze and begin laughing all the way to their own front doors again
  • Realising the successes achievable and the money to be earned by promoting mortgages on the promise that house prices were always going to rise – the concepts of "flipping" and "other peoples money investing" become rife
  • Global economic meltdown occurs as repeated quantitative easing causes the ratio of actual cash to fresh air reaches its flashpoint

All of the proposed "solutions" going on now in the UK are doing little more than exacerbate the problem – as Japan well knows after 30 years financial failings under its belt with little sign of ever recovering.

So, Whose Fault is it?

This is where we can play the "housing paradox blame-game"!

  • At a glance, it could be said the bankers are to blame
  • However, it could also be construed that fiddling with the regulation in the 70's and not reviewing it after interest rates had settled could be the cause – this would lay the blame squarely at the feet of the government.
  • Just for good measure (and to make the paradox complete) consider this point – who voted in the government?

The Solutions

Based on the above – it's pretty plain to see that nothing that is being done now will be the answer to the problem anytime soon (if ever).

The solutions are tough and somewhat dependant to if and what conclusion you reach with respect to whose fault it really is.

  • If you think it's the bankers and they should have been more responsible (they have proven beyond doubt they are capable of such practices) they need regulating. Solution therefore is for the government to implement decent regulation
  • If you think it's the governments fault for not regulating properly in the first place – well sadly, it appears we have discovered that democratic approach to running the economy doesn't work very well over time. The variety of different approaches to managing the economy are vast to say the least – If you think you have the answer, let us know in the comments below!

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