What keeps those responsible for ensuring financial stability awake at night? Plenty of things are on the authorities’ list of concerns, ranging from China and the eurozone through to cyber-terrorism and real-life terrorism. There is always something to worry about and the recent tragic events in Paris show that such worries are justified.
But one constant, it seems, is property. If regulators are looking for risks, it often comes down to property. Lord Adair Turner, the former chairman of the Financial Services Authority, highlights in his new book Between Debt and the Devil the rise in the banks’ property lending – across all Western economies – as one of the key vulnerabilities ahead of the financial crisis.
In 2007, 60% of all bank lending was property-related. This was not a sudden increase – the rise from 30% half a century or so earlier had been gradual – but it suggested a banking system highly sensitive to the ups and downs of property. It is why the Bank of England’s Financial Policy Committee and its Prudential Regulation Authority highlight property’s importance in their stress tests for banks.
In the 2015 stress tests, for the seven largest banks and building societies, the institutions had to demonstrate their resilience to a 20% fall in house prices and a 30% drop in commercial property values. The Bank simulated a scenario in which such falls emanated from a global economic shock.
Apart from those general worries, the authorities in Britain have a particular worry at present. It came up in the latest minutes from the FPC, released in October, and it was given added impetus in a speech by Sir Jon Cunliffe, the Bank’s deputy governor with responsibility for financial stability. The worry was in regard to the buy-to-let sector. Previously the Bank was concerned about the impact of higher interest rates on homeowners. Now the concern is that the key vulnerability is among private landlords.
Cunliffe, in a speech on 10 November, said that the rise in buy-to-let was the key development in the housing market over the past 15 years. In the past decade alone – a period that includes the mortgage “famine” around the financial crisis – the stock of buy-to-let lending grew from £65bn to £200bn. Buy-to-let lending accounted for nearly a sixth of the stock of outstanding mortgages and was growing by 9% a year. And, most striking of all, buy-to-let was responsible for 80% of net mortgage lending in the past year.
The rise of buy-to-let is a story of our times. It is a source of both pride – landlords believe they are serving the public good as well as making a living – and resentment, as would-be homeowners say they cannot complete with the buy-to-let crowd. In his summer Budget, George Osborne chipped away at the tax advantages enjoyed by buy-to-let, restricting mortgage interest relief to the basic rate. But how risky is it?
Cunliffe said: “It is not in my view at all impossible that sharp movements in prices and a loss of confidence in future capital appreciation, in combination with interest rate increases, could cause a substantial number of buy-to-let landlords to seek to exit the market. This could put downward pressure on house prices. Though buy-to-let investors are very different to owner-occupiers, there is in the end only one housing stock and housing market in the UK. So the risk is that they could amplify an adverse shock to the housing market.”
When a regulator says “it is not in my view at all impossible”, it is code for “I am quite worried about this”. I think the worries may be overdone. Most buy-to-let landlords operate on a small scale; nearly four-fifths have only one property. Many see that property as their pension, which suggests to me they will be in no rush to sell.
But the Bank’s worries will have a practical consequence. The Bank’s deputy governor went on to say that lending standards in buy-to-let will be monitored more closely. Getting buy-to-let finance could be more of a challenge in future.
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David Smith is economics editor at The Sunday Times
