It was not British housebuyers who took on debts they could not repay in the recent boom: it was British banks.
Many people believe there was a housing bubble in the UK, that the bubble burst and the consequences took down British banks. Almost none of this is true. There was not a bubble in the British housing market, there has been no house price collapse and the problems of British banks have little to do with losses on residential mortgages in the UK.
Between 1989 and 1995 house prices in Britain fell by about one-third in real terms. In 1997, they began to rise rapidly and the pace accelerated. The first predictions of an impending crash appeared around 2001 and were repeated more and more frequently thereafter. But prices continued to rise until the credit crunch hit in mid-2007. There was a gentle fall and then prices stabilised so that the gains made in 2006-07 have been lost. The level of prices today is broadly that reached at the beginning of 2006.
But that represents a very big rise. The average increase in UK house prices from 1997 to the present is about 7½ per cent per annum, compared with an annual rise in the retail price index of 2½ per cent. The ratio of average house prices to earnings today is at a level only briefly seen in 1989 and at the height of the boom in 2006-07. Given the current shortage of mortgage finance and the rise in bank lending margins – rates on new mortgages have barely fallen despite swingeing cuts in official interest rates – it is surprising that house prices have remained so robust.
There are two ways of interpreting this data, and there may well be some truth in both of them. One is that UK house prices still have some way to fall. The other is that the rise after 1997 was justified by a shortage of desirable housing and falling interest rates. The increase in house prices was greatest in areas such as Greater London, the south-east and south-west, where land shortages are marked and good-quality property is scarce. Average mortgage repayments as a percentage of income are not historically high and never have been recently. A fall in real interest rates from about 4 per cent in 1998 to 1 per cent now roughly doubles the value of a long-dated indexed bond in real terms – and houses are, in financial terms, more similar to indexed bonds than to any other asset.
If there has been no UK housing market crash, why were large mortgage lenders – Northern Rock, Bradford & Bingley and HBOS – prominent among the British victims of the credit crunch? The answer is that losses on UK residential mortgage lending were not even a significant contributory cause of the failure of these businesses. Northern Rock expanded too rapidly – partly by making poor loans, to be sure. But the reason the company failed was not the rate of defaults on these poor loans. It failed because its excessive growth required constant refinancing and the company ran out of cash when wholesale credit markets dried up. Bradford & Bingley also had funding problems; but its need for major refinancing related not to its own bad mortgages but to the bad mortgages it had foolishly contracted to buy. And HBOS, for a long time the UK’s leading lender for house purchases, had a good-quality mortgage book. The bank ran into trouble because its traders and corporate bankers failed to display the same prudence.
Housing market bubbles contributed to Britain’s financial crisis, but the bubbles were in the US, not the UK. There was froth in sectors of the buy-to-let market, but throughout the boom most British buyers bought houses they planned to live in with mortgages they could afford to repay. Repossessions of residential properties are barely half the level of the early 1990s, when a perfect storm of falling prices, high interest rates, inflation and recession hit UK housing. Major mortgage lenders then sailed through these menacing seas with little impact on profits and cash flow, improving balance sheets and capital ratios. The novelty is not the scale of the crisis but the fragility of institutions. It was not British housebuyers who took on debts they could not repay in the recent boom: it was British banks.