The Housing Market of the UK - Case Study Example

Introduction The housing market is considered as one of the most critical and important sectors in any given economy because its ability to interact “with the rest of the economy”. (Murphy, 2008). The impact of this market on the economy can also be assessed from the fact that the current economic crisis is largely being considered as the result of the failure of this market in the wake of the subprime mortgage borrowers failing to pay off their payments on time. A historical look at the housing market of the UK would indicate that due to consistent increase in the value of the households as well as the financial liberalization allowed many individuals to borrow against the real estate property offered as collateral. The expectations of equity appreciation in the form of increase in value of the households, however, forced many to narrow down their disposable incomes as more and more income earned were spent on repaying the debts. A housing market is critical in the sense that most of the wealth in any given economy is in the form of this market, and if we consider the case of UK, almost 75% of the houses are under the ownership rights of the individuals and characterized as the private property. As such, this market, therefore, has strong correlation with the different macroeconomic variables such as availability of credit to the sector, consumer spending, etc. Such a huge quantum of UK’s wealth in the form of households indicates that this sector is probably the most critical and presents significant challenges to the policymakers to design strategies in such a way that this sector remains under control. This report will present a detailed analysis of how the housing market produces macroeconomic affects, how strong these affects are on the economy of UK, a review of whether the policy response to such changes were adequate during the last five years as well as presenting a discussion of how the right policies can be adopted to properly respond to such situations. A description of the way in which changes in the housing market have macroeconomic effects? Britain witnessed appreciation in the housing market during the 1980s and similarly witnessed a decline in the market in 1990s too. However, despite such volatility in the market, the demand for housing units in the country hardly declined to a level where it can be considered as worrisome. (Ermisch, 1996). The changes in the housing market, therefore, have created different affects on the macroeconomic variables too as there have been many changes which have been witnessed mainly due to shift into the characteristics of the housing market. Ermisch (1996) is of the view that the financial liberalization as well as rapid growth into the incomes of the individuals allowed a larger portion of first time owners to own homes. This has been because UK’s demographics indicated a slide into the birth rates as well as increase in the mortality rates which allowed youngsters earning reasonable income to have their own homes. However, evidence also indicates that such changes in the housing market are also causing other macroeconomic affects on the economy too. First of all, the increase in the housing prices during the 1980s and then again, in the recent past indicates that the such price increases have considerably increased the housing inflation in the country resulting into making the house purchase specially by first time owners more difficult.(Hamnett,1992). This. Therefore, not only increased the expenditure of State on arranging the housing for those who lacked adequate housing. However, on the other hand, it also resulted into the pricing bubble within the sector. It has also been argued that the changes in the housing prices also greatly impact the consumer spending as housing prices can change the patterns of consumer spending in an economy. (Benito et. al. 2006). However, this relationship is considered as weak because according to Benito et.al. the recent changes in the housing prices have a very limited affect on the consumer spending. Further research also indicates that the changes in the housing market may have the short term impacts on the consumer spending in the economy because purchasing more housing units also result into the spending on purchasing other household items such as furniture, electronic items etc. Further, in another study conducted by the Benito and Power (2004) indicates that the changes in the equity withdrawals i.e. liquidation of investment from the housing units has a weak relationship between the equity withdrawals the consumption within the economy. This indicates that at the macroeconomic level, if there is a mass scale sell of the household units in the economy, the resulting wealth is not going to be consumed in the same proportion. As a result of the appreciation in the value of housing units, the construction as well as other associated industries such as steel, cements industry start to boom too because of the increase in the demand for new household units. The increase in the demand as well as price appreciation allows many new players to enter the market in a bid to reap quick profits and as such due to changes in the housing market patterns, the related industries also tend to boom too resulting into the overall increase in the GDP of a country. Further, the changing patterns in the housing market also create significant budget constraints for the government too as most of the governments of developed countries including UK are welfare States. Therefore, they carry the responsibility of providing social housing to those who do not own their own homes. Providence of low cost social housing, therefore, not only creates significant burden on the government’s fiscal plans but also produce strong socio-political implications for neglecting such welfare actions. An account of how strong these effects are in the UK economic context. As discussed above that approximately 75% of the UK’s wealth is in the form of housing units. Therefore, the impacts of the busts and bubbles are more devastating than the expected. The current state of the Britain economy is largely associated with the failure of the housing market in the economy as the adaptation of financial liberalization resulted into over-lending into the housing market. This, however, also resulted into putting much grave impact on the disposable income of the individuals as coupled with the increase in the interest rates, consumers found it difficult to pay off their liabilities in time. The period between 2001 and 2006 indicates that the housing prices and the consumer spending did not vary in the same proportion as they were historically. (Benito, et.al. 2006). This has mainly because of the fact that the increase in the housing inflation shattered the confidence of the consumers in UK and as such in order to meet the future expectations, the consumers reduced their spending in relation to the inflation in the housing markets in order to meet the future expectations of price increase in the housing market. However, recent data indicate that the real housing prices as well as the consumer spending both are on the declining trend in the country indicating that the fall of the prices in the housing units is creating strong impacts on the Britain economy, mostly due to constrained credit extension to the consumers. The appreciation in the housing prices also encouraged the consumers and businesses to borrower more from the financial sector because it was speculated that the UK’s economy has successfully defeated the boom and bust cycle and as such the economy of the UK is showing a convergence with the rest of the economies of the developed world. It is also important to note that due to financial liberalization, banks in UK started to lend generously to the customers who were not considered as bankable risks as per the prevailing banking practices and procedures. However, banks in a bid to earn high returns started to lend in high risk areas which ultimately proved fatal for the whole financial system of the country. Most of that lending was made for taking mortgages and as such the changes were server with multiple impacts on the UK’s economy. Example of Northern Rock is one of the prime examples of how the changes into the mortgage market can lead to the collapse of a bank and potentially the whole financial system. An analysis of whether the macroeconomic policy response to changes in the housing market over the last five years has been correct or not. In recent past there have been increasing in the financial de-regulation with Bank of England been given autonomy to conduct monetary policy whereas the regulation of the financial sector was left to FSA. The policy response during the last five years has been quite liberal as both Bank of England as well as FSA failed to check in the increasing appetite of financial institutions specially to rationalize lending to the housing market. The unchecked appetite of the banks in lending to the housing market, therefore, created strong systematic risk within the economy faced specially by the financial institution due to their lending made to the housing market. (Mcllroy, 2008). Bank of England specially kept on following liberal monetary policy stance in order to encourage consumer spending and as a result decreased the interest rates to the level where it was easy for both the businesses as well as consumers to borrower at cheap cost to invest into the housing market. The availability of easy money not only forced banks to take risks beyond their capacity but also forced the housing market to heat up without basic changes in the fundamentals of the market. (Turner, 2009). It is also important to note that the policy response, especially during last five years was more of an oversight as most of the policy makers, citing the improved profitability of the banks, boasted that the housing market bubble would not bust as the banks are continuously supplying adequate financing to keep the demand stable at least in the short run. A discussion of the right polices to adopt over the next two years in the light of current changes in the market Since the housing market is closely linked with the financial markets. Therefore, it is strongly argued that the role of financial regulators shall be improved so that financing to the sector is controlled and kept within rational limits (Coheo, 2007). This would mean that not only the role of Bank of England shall be increased in managing the financial system but also fiscal measures by the government shall also be in-line with the monetary policy targets. Further, banks also devise mechanisms which ensure that the consistent flow of credit to the sector is ensured so that the demand patterns at least can be established. Those banks which are part nationalized therefore need to offer low cost mortgage loans to the consumers by rationalizing their own cost structures on the pattern of Stakeholder pension schemes where charging structure is capped. Further, government also needs to increase the fiscal expenditure on the social housing as not only there is an increasing influx of immigrants into the country but also there is a consistent rise in the first time owners in the country who may not be able to own their homes due to current economic conditions. Further, government, through its own guarantee scheme can allow relatively easy credit to the construction companies so that cheap housing can be provided to different classes of the society. Conclusion Housing market has strong correlation with the macroeconomic variables of any country as it not only impacts the consumer spending but also results into substantial outlay of funds to the sector. Due to its correlation with the financial markets, its impacts can also be felt on the financial system of a country also. During last five years, the policy response from UK’s government has not been as it should have been as there has been greater regulatory oversight which allowed financial institutions null to the housing market which resulted into the pricing bubbles within the housing market. However, a correct policy response, especially in coming two years could arrest the economic fallout of the housing market failure. References 1. Andrew Benito, Jamie Thompson, Matt Waldron and Rob Wood. (2006). House prices and consumer spending. Bank of England Quarterly Bulletin. 0 (0), p142-154. 2. Cocheo. Steve (2007). Can subprimes casualties be saved?. ABA BANKING JOURNAL. 0 (0), 28-35. 3. Ermisch, John. (1996). The Demand for Housing in Britain and Population Ageing: Microeconometric Evidence. Economica. 63 (251), pp. 383-404. 4. Hamnett, Chris. (1992). The Geography of Housing Wealth and Inheritance in Britain. The Geographical Journal. 158 (3), pp. 307-321. 5. McIlroy. David Halliday (2008). Regulating risk: A measured response to the banking crisis. Journal of Banking Regulation. 9 (4), 284–292. 6. Murphy, Anthony. (2008). Housing Markets and the Economy - The Assessment. Oxford Review of Economic Policy. 0 (0), 1-33. 7. Turner. Adair (2009). The financial crisis and the future of financial regulation. Available:http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2009/0121_at.shtmlLast accessed 06 March 2009. Read More