Monday, November 3, 2008

Why Can't Government Stop House Prices Falling?

Readers Question: Why Can't Government Stop House Prices Falling?

House Prices have fallen 15% and are set to fall by perhaps another 15%. Can the government do anything to stop the fall in house prices? And does it matter anyway?

Firstly house prices are causing problems
  1. Negative wealth effect of falling house prices and lower confidence means people are spending less; this is contributing to the recession.
  2. Negative equity. The Bank of England recently estimated over 1million people would soon be facing negative equity (when home value is less than mortgage outstanding.
  3. Slump in construction sector

Why Government is Not Able to Prevent Housing Slump

1. Policies inadequate. This August the government announced a freeze on the payment of stamp duty for house under £175,000. The freeze lasts for 12 months and may encourage a few to buy a house. However, saving 1% of a £150,000 house is relatively insignificant when you consider average house prices have fallen by £30,000 in the past 12 months. A stamp duty freeze doesn't hurt, but, it is hardly going to transform the housing market.

2. Interest Cuts. The MPC is coming under intense pressure to cut interest rates. This will help the housing market because it will make mortgage payments cheaper and avoid home repossessions. It will also make buying relatively more attractive than renting. However, even lower rates may be insufficient to kickstart the housing market. The main problem is lack of available mortgages rather than cost of mortgages.
  • Also, the government doesn't have control over interest rates. The MPC set interest rates to target inflation and economic growth - house prices are not a target. This is why the MPC didn't cut rates to prevent house prices falling. It also explains why they didn't increase interest rates to prevent a housing boom.
3. Confidence / Expectations. One of the most powerful influences in the UK housing market at moment is the expectations of falling house prices. Because people expect house prices to fall, people want to avoid buying. There is little the government can do to alter this expectation.

4. Difficulty of kickstarting Mortgage lending. The government had to offer a very large financial bailout for financial sector. This prevented the immediate liquidity crisis. But, the government will have more difficulty in making banks return to 2007 lending levels

Why Government doesn't Want to Prevent House Prices falling.

  • There is also an strong argument to say that house prices are overvalued and that trying to prevent house prices falls merely delays the problem. The sooner they readjust the better.
  • The real problem is not falling house prices but negative growth and rising unemployment. For example, negative equity is only a problem if people can't afford the repayments.

Despite the difficulties of preventing falling house prices. The government are right to try to make conditions easier for housing market. There is a danger people could completely avoid the housing market and the fall in house prices could become exaggerated. A 1 % cut in interest rates would probably have most benefit.

A more important question is perhaps the extent to which the government should try to prevent a future boom in house prices (which could easily re happen)

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