Turning the UK housing market

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.