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UK housing markets approach their Minsky Moment

Consumer demand
By Paul Hodges on 10-Nov-2012

UK housing Nov12.pngThe UK housing market has led a charmed life in recent years. Unlike the US, Spain, Ireland and many other Western countries, prices have not collapsed. Instead, near zero interest rates, and the high proportion of mortgages on variable rates, meant that UK homeowners have seen their monthly payments reduce dramatically.

There is just one potential cloud on the horizon, captured in the chart above from the Financial Times. This is that most borrowers in many parts of the country are not making any repayments of capital. For example:

• In London, 52.6% of loans are to borrowers in this position
• Similarly in the southwest and southeast, the figures are 51.2% and 52.4%
• Even in the north, the figure is 32.4%

Overall, the Financial Services Authority, the main regulator, calculates that over 40% of the UK’s home loans are interest only. Even more worrying, it believes 75% of purchases made at the top of the boom till 2007 were in this category.

Not to worry, say the optimists. People can always sell their house when the mortgage comes to an end, and pay the bill that way. Or they can take out another loan.

The boring blog worries that this may not be possible. After all, the reason that most mortgages became interest-only was that repayment became too expensive, as house prices boomed between 1991-2007. Instead, lenders and borrowers chose to assume that prices would always rise, and that sellers would always be able to find a willing buyer at their asking price.

What happens if these assumptions prove wrong? What happens, for example, now that most younger buyers are simply unable to afford the repayments on the large amounts required to buy a home? Or if increasing numbers of the UK’s ageing population decide to downsize their home as they find climbing the stairs more difficult?

The work of the great Hyman Minsky, whose work features in chapter 2 of ‘Boom, Gloom and the New Normal’, explains the risks. Just as in US subprime, the classic conditions for a ‘Minsky moment’ are now starting to appear in the UK housing market.

The use of leverage is reducing, and by 2014 borrowers will have to prove they can repay the loan from other resources. Already, several major lenders such as Nationwide have stopped offering interest only loans to new borrowers. Whilst new buyers already need much higher deposits than in the boom years.

House prices outside London have been slipping for some time. London prices may now follow the same path, as the financial services industry contracts and large bonuses become a thing of the past. Once the illusion of constantly rising prices is shattered, then the Minsky Moment will have arrived.

The next few years may therefore prove a lot more difficult than the recent past.