Philip Barton’s Property Blog

Well, here we are on the cusp of what would appear to be a fairly momentous announcement by the UK Government: the partial nationalisation of the UK banking sector. If the speculation is correct - and it appears that it likely is - Alistair Darling will announce that the government is to take a huge equity stake in UK banks. 50billion pounds is the figure being talked about, and this is probably not far from the mark if this is to be anything more than a gesture.

I’m not normally one for back-slapping on government decisions, but this time I think it’s the right thing to do, and underscores quite sharply the serious position we find ourselves in.

So why is this all happening?

So what’s driving this move by the government? Well, forget about share prices - the absolute price at any time means little. No, you should look to the bond markets for the real answers.

I won’t get too technical here (this is supposed to be a property blog, after all), but what is happening is investors are pursuing what is known as a ‘flight to quality’. In other words, everyone wants to buy government issued bonds rather than ones issued by the banks because they see the banks as a huge risk at the moment. Since this is one of the principal ways in which banks and companies raise money, this is a serious problem for the banks and their share prices will continue to be battered whilst this remains the case.

The government is trying to reduce the perceived gap in risk between IOU’s (i.e. bonds) issued by them and by the banks by simply owning part of the banks themselves and hoping the confidence in them increases as a result. Is it that simple? Will it actually work? Well, we should all hope that it does because we’re all in trouble if the banking system becomes unstable.

How does this affect property?

After the detour above, back to the property markets. In the UK particularly, the property market is tied strongly to the banks and the fate of one is the fate of the other. I would not be surprised to see a 0.5% base rate drop from the Bank of England. I would be amazed if we don’t see a 0.25% drop. Will that get passed on by the lenders? Good question…my guess is that even though they won’t want to they’ll be under pressure to give the market a boost by making some reductions, even if they are only small. But I wouldn’t be putting money on this call as there are too many factors to play out yet.

Well, it’s been a pretty busy week, hasn’t it? The press is chock full of words like ‘unprecendented’ and ‘landmark’ in relation to the current spate of bank takeovers and nationalisations. Hold on a minute - did you really say that dirty word ‘Nationalisation’? Just a month or two ago I commented that this was something that most western governments were strenuously trying to avoid as it could be seen to highlight their political failure. Yet here we today talking about it as if it were perfectly normal! It underlines the amazing changes that are currently underway in both structure, and more importantly in our perception of all our financial institutions.

After bailing out the first failure, virtually all western governments have come to the same conclusion - that they cannot afford to bail out any more, especially as there are likely more in the pipeline. What we’re likely to see is more banks fold or be bought out as the financial tectonic plates shift toward a ‘big is beautiful’ school of thought.

The role of governments themselves has changed markedly. No more are they making the pretence of being simple an impartial regulator, almost overnight they have become brokers of financial institutions - essentially middlemen in a huge car boot sale. They have all but abandoned any pretence at long-term consumer benefit, their only goal now is to protect the fabric of the system at any cost.

Tax-payer, beware

What does this mean in practice? Well, on both sides of the Atlantic governments are simply taking the bad stuff off the hands of the banks and onto the public balance sheet. The tax-payer gets all the risk whilst the banks get left with the stable ‘non-toxic’ stuff. In the case of the US, this is being done on a truly epic scale and we will feel its effects for a generation.

Big is best…?

The changes in the market are working on the premise that the bigger the bank, the better its chances of survival. But is that a rational one? We’ve seen the near collapse of some pretty massive entities over the last few weeks so I don’t see any evidence that this is true at all - in the current climate it appears that nobody is safe.

The more subtle strategy at work here appears to be the government working to rebuild a new stable core at the heart of the financial system. This is composed of a few ’super-banks’ that are well funded and stable. In some cases the government has helped ‘clean’ and stabilise them by taking away the nasty bits of their liabilities so they start with a clean slate. The hope is that these ‘white-knight’ banks will form a stable core and support the rest of their less stable kin.

Whether this will work remains to be seen. One should note that when the dust settles in the long term we will be left with a very anti-competitive market - the sort of market that the government was so keen to avoid in the past. Lloyds alone now has 30% of the mortgage market. Why bother with good rates when you have that kind of market share?

Will the $700bn US bail-out work?

Nobody knows. You were expecting something a little more enlightening weren’t you? The fact is that this has never been done before and we are in completely uncharted waters here. This is effectively a massive last-ditch gamble by the US government. My best guess is that it will work to stabilise the system medium-term, but at some considerable cost - any economists out there care to comment on what effect bringing such a vast amount of debt onto the US balance sheet will have?

So where next?

OK, trap yourselves in, we’re going back to my crystal ball for some rollercoaster ride predictions:

Saving rates: With the drop in consumer choice and banks wanting to rebuild balance sheets, savings rates are likely to get less competitive and stay that way for some time.

Mortgage rates: Difficult to call, but I’m going to go for ‘likely to stay the same’. I still think they will fall in the medium term, but short-term frankly you may as well roll the dice…

Mortgage choice: Will recover somewhat in the medium term, but not to the levels we saw before.

Your savings: The chances that any government will allow savers to lose money is very, very small - almost zero. Such a failure could cause runs on other banks and cause a wider collapse in confidence, the consequences of which would be disastrous.

The banking sector: Consolidation will likely continue for some time yet - even between banks who are notionally solvent. Size is being seen as key to survival.

It appears that the US government has bitten the (almost inevitable) bullet and launched what is likely to be the biggest bail-out we are likely to see in our lifetimes. Freddie Mac and Fannie Mae, the two institutions that underwrite US mortgage debt have been all but taken into public ownership.

Now, I’m normally negative on government intervention, but I think this has to be a good thing as a failure of either one would be disastrous for the US market, and by association the UK one, too. It brings some stability and certainty to the US market which can only speed up its recovery and begin to reverse the effects of the global credit crunch.

That said, a word of balancing caution - we’re not out of the woods yet and this action only stems the potential for further problems, and I think we’ve yet to see the last of the effects.

Are interest rate cuts looming round the corner? I think so, and so do most rate pundits. The Bank of England are desperate to cut them but are being held back by one thing only - inflation. If we make the leap of faith that fuel prices are unlikely to increase much more and food prices will slowly stabilise from their recent jumps then inflation must fall back pretty quickly (remember, inflation is a measure of the change that month).

I’m currency betting on a cut early next year (Jan 09), maybe a 1/4 point before that if the inflation figures soften a little and the bank feels that it is moving on a downwards curve.

UPDATE: 04 Sept 08, 21:47

Judging by tonight’s mood and Sterling’s free-fall, I think the odds on a rate cut Oct/Nov with more next year are growing by the day. I’m holding out for a few months yet before a remortgage!

I see the government announced some interesting changes designed to boost a static property market in the UK. Stamp duty has been axed for the next 12 months for purchases below £175K (up from the previous £125K limit) and we have the introduction of interest-free loans for up to 30% of the loan amount for first-time buyers. From the BBC website (http://news.bbc.co.uk/1/hi/uk_politics/7592852.stm):

• “Free” five year loans of up to 30% of a property’s value for first time buyers of new homes in England
• Extension of powers for councils and housing associations to be able to pay off debt for homeowners who can no longer afford mortgage payments and then charge rent.
• Shortening from 39 weeks to 13 weeks the period before Income Support for Mortgage Interest is paid
• Bringing forward spending from future years to encourage more social housing to be built

Whilst these can only be considered a good thing, If I were King, I would personally be looking to tackle the real source of the problem - the lack of availability of mortgages. Throwing the odd sweetener here and there doesn’t seem to me like it will have much of an effect overall. It also smacks of a bail-out for the large house-builders, which may or may not be a good thing depending on your viewpoint (these guys do employ a lot of people, directly or indirectly).

So here’s my suggestion: force the publication of the true junk debt levels held by the banks. There…wasn’t so bad now was it? Once everyone knows where they stand then the inter-bank lending risk plummets and everyone leaves with a smile on their face, the property market picks up confidence and the world is a happier, shinier place.

But then, I’m not King 

Sometimes I read the papers and wonder just where they get their ideas from. Maybe they have some bright stars working away in the background diligently researching the intricacies, effects and implications of the raft of policies that they need to produce. Or maybe they just think of things over the lunchtime Gin & Tonic.

This week we have the Lib Dem* Treasury spokesman Vince Cable leaping into the fray with a beany new idea that local councils can single-handedly support the currently slumping housing market by purchasing empty properties and developers’ unused land. I’m not sure what exactly they are supposed to do with these assets afterwards, and I’m not sure he does either, because a couple of seconds of thought came up with some rather obvious flaws.

Firstly, exactly who will fund this spending spree? Local tax-payers? Hardly. Council reserves? Well, they don’t have any these days. Government? I think not, they have bigger problems just balancing the books at the moment. Let’s not forget, they have to build on the land they aquire, so more cost there. Oh, and presumably they’d just grant themselves planning permission and side-step the normal messy round of objections and meetings? One certainly hopes not.

Now I have nothing against the Lib Dems, and in fact I can see this kind of policy being put forward by any of the main parties, and there is actually some possible good potential here to rebuild a better level of social housing stock at a reasonable price, but at the levels which it is likely to happen at it is not going to have the slightest effect on the property market.

Nice try Vince, keep ‘em coming.

* for non-UK readers, the Liberal Democrats (’Lib Dems’) are the second major party currently in opposition.

It looks like the Halifax are the latest to announce another series of rate cuts following a wider trend of slow lowering of rates across the board. The cuts are small and the banks seem to be edging forward on this front (albeit slowly).

Swap rates fell a while ago but up until now the banks didn’t seem to care (see my previous post for the reasoning). However, it appears that the herd is now moving so expect more small cuts to come with those who need less than 25% LTV benefiting most. It may well be worth holding out for a few weeks more before remortgaging.

We’ll be exhibiting the new software range at the show so if you fancy dropping by, I’ll be on the Property Intellect stand (908) at the show so feel free to drop by and say hello! I’ll be the one with the coffee cup.

Update 18 Sept 08: Stand number changed to 908 (not unusual for these kind of shows!)

One of the effects of the slowdown in sales has been the recent movement into the lettings arena by a number of estate agents. We are taking calls on a daily basis from would-be letting agents who are looking to lettings as the way to increase revenue and keep them afloat. They may be right - lettings is the one area of the market that is flourishing with a generally good supply of tenants as those would-be purchasers sit out the market problems in rented accommodation. This effect is reinforced by sellers - unable to sell to anyone despite monthly price drops - giving up and renting their properties. The overall effect is to increase supply and demand with the lettings market expanding as a result. An active and growing market can only be a good thing for (existing) landlords!

Unless you have been living in a cave for the last few months you will be all too aware of the so-called ‘credit crunch’. Despite what you might be led to believe by the press the mechanics behind this is not a new phenomenon - indeed it is all part and parcel of how a free credit market works. Lenders normally act fairly rationally by lending only to those they believe represent a reasonable risk, but what is different in this instance is the depth of the swing (more of a lurch really) in the perception of risk by the whole market of lenders. It is this sudden change that is at the heart of the problem.
Lending is essentially a game of ‘pass the parcel’ and lenders are paralysed by the fear that when the music stops (i.e. the real bad debt figures become clear) - that they may be the ones holding the problem parcel. It’s a simplistic view, but sums up what the real problem is - fear. The practical upshot is that whilst this level of paranoia persists then no amount of government or central bank intervention will make any significant difference. Essentially we are stuck with high rates until the lender’s collective hunger for profit overcomes their fear of making a mistake.