Chickens, eggs and houses

In the midst of all the talk about what policies are needed to revive housing market activity, there has been little consideration of what might be the main cause of the problem. Consumers are worried about job security and lenders have become far more cautious, but which of these factors is holding back the market?

Lenders have been under great pressure to tighten lending standards since the collapse of Northern Rock and this has manifested itself in lower maximum LTVs and more focus on the lowest risk borrowers.

We have seen the availability of finance to the buy-to-let and specialist markets largely evaporate and in some cases lenders have chosen to hibernate completely.

The mood of the mortgage market has shifted from an overt sales culture to one of risk minimisation and copycat conservative lending strategies.

Such an abrupt change in policy and sentiment has resulted in a sharp reduction in transactions and concern among quality borrowers that they might not be able to finance house moves.

In recent months the worsening economic outlook and rises in unemployment have also reduced consumer demand in all sectors, including the housing market.

The policy debate has focused on the need to increase the supply of finance as this has been seen as the major concern. However, the recent collapse in consumer demand should result in a more fundamental review of how we provide confidence to consumers and lenders alike.

The recent record 1.5% cut in the Bank of England base rate, although welcome, will have a limited impact on the housing market if it is not fully reflected in lower mortgage repayments and consumer borrowing rates.

Furthermore, consumers need some reassurance that the market has stabilised before they consider moving house.

House move volumes are at a level not seen since the mid-1970s and for this reason it should come as no surprise that prices are falling for home owners who have no alternative but to sell.

So, in this highly uncertain environment the time has come for a closer examination of what is going on in the housing and mortgage markets at a micro level.

The most worrying problem in the market at the moment is the absence of normal housing activity – that is, people moving house to accompany their jobs or trading up or down according to their housing needs.

The ability of quality customers to trade up or down has been dented by reduced mortgage supply and falls in overall consumer demand. Housing chains are becoming disjointed and the absence of credit for first-time buyers is affecting everybody.

Lenders need to have a close look at their existing loan books and assess the underlying risks of individual loans in light of the best available they have information.

Once this examination has been carried out there should be no reason why lenders could not rebuild their lending volumes to those sectors where the risks look most attractive.

Blanket LTV restrictions have the same impact on good and poor credit risk borrowers, whereas a more targeted approach could help to restore lending volumes.

The biggest risk we face is driving the market ever lower as expectations and consumer confidence are pushed downwards. Figure 2 shows how this negative feedback cycle perpetuates itself as lenders reduce credit supply in the face of falling house price expectations and weaker economic growth.

The time has come for a coordinated response from lenders, regulators, politicians and consumers to put the housing market back on a long-term sustainable path.

Unlike other asset prices such as equities and exchange rates, the housing market affects almost all consumers directly.

The market must be able to function efficiently and allow people to buy and sell houses to meet their needs. Without a combined policy effort we run the risk of freezing large sections of the market and reducing labour mobility even further, as happened in the early 1990s.