After a prolonged period in which the cost of money has gone down and down, the talk over City lunch tables has returned to whether the next move in short-term interest rates will be up. Household debt in the UK, meanwhile, is at record levels both in absolute terms and in relation to gross domestic product. Does this mean that the British economy is once again about to career off the road, taking the housing market with it?
Consider one or two key items. For a start, it could be argued that the UK ought to have record levels of household debt. Nearly 80% of the outstanding debt consists of mortgages, and home- ownership has been on a consistently rising trend.
From the start of the last century, the proportion formed by owner-occupied housing of the total stock has risen from 10% to nearly 70%. The past 20 years has seen the number of owner-occupied properties rise by more than 5m or so to 17m-plus, and the number of mortgages from 6.3m to 11.2m.
Note, too, that there has been an increase in the size of properties, especially for new dwellings. Christopher Watling, an economist at broker Cheuvreux, points out that the percentage of mortgages on properties with seven or more habitable rooms out of all dwellings has risen from 13.6% in 1990 to 18.1% in 2002. For new houses that ratio has risen from 23% to 40%. And net wealth in the UK is at an all-time high.
It follows that crude debt figures are a poor guide to the vulnerability of households to higher interest rates or rising unemployment. There has been a structural increase in debt, so the real issue is whether the burden of debt servicing has risen.
Consider the context of the huge rise in the number of two-income households. The enormous increase in female participation in the workforce means that a given level of household debt is now supported by greatly increased earning power.
Since 1994 mortgage interest payments have been falling as a percentage of total household interest payments. Yet households have maintained their debt service as a share of disposable income at a constant level. In effect, they have increased the consumer credit portion of indebtedness in the mix.
Making use of data from the Office of the Deputy Prime Minister, Watling shows that a full 25% of outstanding mortgage debt is with households that have over £3,500 of disposable monthly income. He calculates that almost 50% of mortgage debt is owed by as little as 15%-20% of the tax paying population. For most of that 15%-20% (those with more than £2,500 of monthly disposable income), he argues, the monthly mortgage payment is very manageable, assuming that people continue to be employed.
No nasty shock is necessary
I make these points not to suggest that there will be no fall in house prices or that interest rate hikes pose a minimal threat, but to emphasise that the extent of the threat hinges very much on how abrupt and steep any hike in interest rates might be. And that depends partly on uncontrollable external circumstances in the global economy.
While it is true that house prices are well out of line with their normal relationship with earnings, it is still conceivable that the normal relationship will re-establish itself over a long period rather than through a nasty shock.
One interesting feature of this debate is that countries with housing booms, notably the English-speaking ones such as the US, UK, Australia and Ireland, are also the ones whose economies have been outgrowing the rest of the developed world. This is because the liberalisation of credit has produced wealth effects in the economy via its impact on the housing market.
I conclude from this that there is one relatively simple policy option open to the slower growing economies of continental Europe as they struggle with ageing populations: liberalise the financial system. That would lead to greater homeownership, house purchase at a younger average age and increased consumer spending, thanks to wealth effects and the withdrawal of equity from housing. Given how easy this would be to implement and the lack of pain it would inflict on voters, it is amazing that it is taking so long to come about.
