Taming the house price tiger

By Myles Neligan
BBC News Online business reporter

The housing boom is a headache for the Chancellor

Those who find the chancellor's speeches impenetrably dull will have plenty to distract them when he delivers his pre-budget report (PBR) to Parliament on 10 December.

Gordon Brown's statement will coincide with two high-profile reports which cut straight to the heart of Britain's most enduring national obsession: house prices.

The first, a review of the mortgage market, comes out on Tuesday 9 December, while the second, looking at housing supply, will be released just before he begins speaking.

The studies, commissioned by the chancellor, will explore why Britain's property market appears stuck in a cycle of boom and bust.

They come amid growing speculation that the next bust may be upon us in months, plunging the economy into recession.

In a fix

Gordon Brown himself is in no doubt that house price swings pose a major threat to the nation's economic well-being.

The idea that within six months, with a bit of legislation, we will have a different housing market is one that I find difficult to buy into Edward Stansfield, Capital Economics

Earlier this year, he blamed housing market volatility for "most of the stop-go problems that Britain has suffered in the last 50 years."

The root of the problem is that British consumers are more willing than their European counterparts to borrow in order to buy property - usually by taking out variable mortgages where repayments vary in line with interest rates.

This makes the UK highly sensitive to interest rate changes, limiting the Bank of England's ability to respond to wider economic developments.

This sensitivity is particularly acute when, as at present, a house price boom has encouraged homeowners to cash in on the rising value of their homes by remortgaging themselves to the hilt.

The reports will try to shed some light on why the property market is able to hold the rest of the economy to ransom in this way.

Pay later

The first report, by professor David Miles of Imperial College London, will look at why long-term fixed-rate mortgages - which insulate consumers from interest rate changes by fixing their repayments for up to 30 years - have not taken off in the UK.

Mortgages of this kind are common in the US and Europe, but account for less than 5% of British home loans.

Buy now, pay for 30 years

The report is likely to conclude that the main obstacle is price.

Lenders typically charge a premium for the greater certainty that fixed loans offer, but British homebuyers appear reluctant to pay it.

"The consumer mentality is very against paying upfront for certainty later," said Edward Stansfield, property market analyst at Capital Economics.

Professor Miles' report may look at ways of making fixed rate loans cheaper.

One recent suggestion is that the government could promise to bail out mortgage lenders if they get into difficulties.

This would allow them to raise money on the capital markets more cheaply, and pass on the savings to homebuyers.

Alternatively, the government could provide direct tax incentives to encourage homebuyers to take out fixed rate loans.

But either option would incur costs that would have to be met with taxpayers' money, and the government may prefer not to be seen to be subsidising homeowners.

Another difficulty is that countries such as the Netherlands and Spain, where fixed loans are the norm, have also experienced house price booms in recent years.

"Long-term fixed rate mortgages on their own don't guarantee stability," said Ray Boulger, senior technical director at mortgage lender Charcol.

Supply side

The second study - by Kate Barker of the Bank of England's rate-setting Monetary Policy Committee - will deal with the more fundamental problem of housing supply shortages.

New homes are in short supply

A large and growing shortfall in the number of new houses needed each year has been a key factor in the current property boom, particularly in the overcrowded south east.

Ms Barker's report will examine why house building, far from keeping pace with soaring demand, has lapsed to its lowest level since the 1920s.

Her main challenge will be to get at the truth behind a furious row between developers and the environmental lobby, who blame each other for the slow pace of new construction.

The Campaign to Protect Rural England (CPRE) has accused the industry of stockpiling undeveloped sites in an effort to force up prices, and justify its requests for more greenfield land to build on.

But house builders blame delays in obtaining planning approval, not least because of entrenched local opposition to new developments from green campaigners.

"Some developers may indeed be making money from the shortage," said Pierre Williams of the House Builders' Federation.

"But that is a situation that is not of their own making."

Next step

Possible recommendations include a tax to discourage developers from stockpiling land, coupled with efforts to speed up the planning system.

However, taxes of this kind are notoriously difficult to set because the value of plots of undeveloped land varies widely according to location.

And any move which would make it easier for builders to obtain planning permission against the wishes of local residents would be politically tricky.

The Miles and Barker reports have been portrayed as the starting point for a future government strategy to tame the property market once and for all.

The government has avoided committing itself to any such strategy, although it would certainly welcome a period of house price stability.

But some analysts believe that the studies are more likely to underline the complexity of the property market, and drive home the difficulty of reforming it.

"The idea that within six months, with a bit of legislation, we will have a different housing market is one that I find difficult to buy into," said Capital Economics' Edward Stansfield.