Posted to Daniel Finklestein’s blog, in answer to The three greatest obstacles to Britain’s recovery?

1. The ballooning deficit – Large tax rises and increases in interest rates will slow down any recovery. Real public expenditure cuts will only happen if we are forced to by the IMF.
2. The massive increase in regulation in the past decade means that the economy has not the flexibility to create new jobs quickly.
3. Most of the growth of the past decade came from financial services and the public sector. Neither of the sectors will create many jobs in the next few years. Neither are there emerging growth areas, as in the 1980s and 1990s (security, call centres, telecoms etc.)

Please note that the three are not mutually exclusive. The financial sector is going to be hobbled by increased regulation and government ownership. Whilst I am pessimistic about the ability of government’s to control expenditure, the public sector payroll will not be increasing much in the next decade.

It is possible to replace the third point by

3. The housing market. When housing activity increases, so does a large part of the retail sector such as DIY products, furniture and carpets. There is likely to be a prolonged slump, as the volume of house sales is constrained by current credit squeeze and the oncoming interest rate hikes. House prices are likely to continue to fall, as more buy-to-let investors either desire to, or are forced to sell up. Whilst house prices are falling, people will delay buying.

Spotted this article on LabourList on the difficulties of getting a mortgage for first-time buyers. The authour, Kate Groucott, complains of needing a 10% deposit for older properties, but 25% for new build flat. Kate complains that

            “This extra barrier for people buying new build flats is surely hurting the companies developing these properties, and I’m sure will result in some flats going unsold when people are desperate to live in them.”

Further

          “Our main frustration is about the rigidity of the rules imposed by the banks and the lack of help available. As taxpayers who currently make very little claim on public services, we thought the least we could expect from our publicly backed banks would be fair policies and consistency. Of course they need to be careful with public money, but this should be based on an assessment of our creditworthiness and the value of the property we are looking to buy, rather than a blanket policy. Those of us who have saved and want to buy a property within our means are being punished compared to those who bought a few years ago with 100% (or more) mortgages.”

There are two things that Ms Groucott needs to understand about the current situation.

The Risks for Banks

Imagine someone who loses their job a year after taking their first mortgage, so has to sell up quickly.

Up to mid-2007 the Housing Market was rising at 10% a year, and houses sold quickly. Someone who took out a 105% mortgage would be able to sell the house, pay off the mortgage and not be left with a debt. If the bank had to re-possess, it would be in no real haste to sell at a discount, as by waiting it would get a bigger return than by selling quickly. The jobs market was buoyant, so their were few people getting into difficulty and probably in a minority of cases would the bank have to repossess.

Now house prices are falling by 15% per year. New flats are falling (in value) even faster. In parts of Manchester that have fallen by 50% or more. Unemployment is rising rapidly, so there is a real risk that a fair proportion of the first-time buyers will get into difficulties in their first year. There are not many houses being sold, and to sell quickly requires a large discount. With a 90% mortgage, it is very likely that the homeowner will be unable to sell for more than the outstanding mortgage and the costs of sale. The bank will therefore be more likely to have to repossess, then auction off at a deep discount. With falling house prices, the longer the bank waits, the bigger the loss to the bank.

I would suggest that banks offering 90% mortgages in April 2009 are being more imprudent than those offering 105% mortgages in April 2005 or even April 2007 (based on the knowledge then available). If banks were

The Cost to the Taxpayer

As John Redwood has blogged, the taxpayer has sunk billions of pounds into the banks, and taken on hundreds of billions of toxic assets. We (taxpayers) may own a lot of banks, but they are like my late Father’s first car. In the late 1950’s he bought a 1932 Rolls-Royce for half the price a new mini. It was much grander than present day Rollers (and longer), but kept breaking down. It was not an asset, but a liability. One thing he did not do was race it around. In the banks we have a something like this 1932 Rolls. They may sound grand, but they are broken and in need of lots of maintenance. Bad debts need to be decreased, not (potentially) increased. It is imprudent to expect anything else.

Twenty years ago I was reading works by Soviet dissidents such as Vladimir Bukovsky and Irina Ratushinskaya. There are parallels in what they wrote about under a rule-bound state and what we are seeing today. I do not suggest that in Britain today we have gone nearly as far as the USSR, but we are being lead by people who, given time, are getting us there. There are a number of common factors such as

1. The belief that the government is always right.
2. Contrary opinions are to be suppressed.
3. The citizen is there to do the bidding and serve the state.
4. Reality and truth is whatever the propagandists decide it should be.