Is bubbling property really the greatest threat?
- 21 May 2014
- From the section Business
The governor of the Bank of England has put on record his concern that the greatest risk to the UK's recovery are the red-hot conditions in the London property market, the potential for contagion to the rest of the country, and the associated risk that banks may be lending recklessly.
Clever clogs Lloyds, that most politically astute of banks, has responded by announcing that if you want to borrow more than £500,000, you will only get the loan if its value is no greater than four times the income of your household.
"Wah?" you may say, if you are of a certain age. "When I was a lad, you were lucky to get a loan of three times income."
Which only goes to show that some pretty racy mortgages are being written by banks and building societies in the London and south east.
Perhaps the most amazing thing said by Lloyds yesterday is that this new constraint would have an impact on 8% of its London home loans business (and see my piece on last night's News at Ten for more on all of this).
So to repeat what I said yesterday, it would be a bit odd if the Bank of England's new Financial Policy Committee did nought next month to take some of the heat out of the residential property market.
Anyway, this is a long pre-amble to a tangential point, which is that not all Mark Carney's colleagues at the Bank regard the bubblelicious housing market as the most worrying possible sinkhole on our journey to the sunny uplands of renewed prosperity.
Which may surprise you a bit. But they take the view that after years of stagnation, property prices were bound to get a bit racy, once we all got a sniff of economic recovery. But that the Bank has important new tools to insulate banks and the wider economy from extreme housing-related shocks.
Hmmm. We'll see. The Financial Policy Committee's new tools are untested. Gawd knows whether they'll be used in a timely and appropriate way, or whether they'll have adverse unexpected consequences.
But I suppose the bigger point is that British homes aren't the only asset currently looking a bit toppy, in the jargon.
I am prohibited from recounting the contents of private conversations with Bank brains on all this. But I can give you this resonant quote from Charlie Bean, the retiring deputy governor of the Bank of England, who last night gave a valedictory speech at the London School of Economics.
This is what Mr Bean said: "Implied volatilities in many financial markets have been at historically low levels for some time. Together with low safe interest rates in the advance economies, that has underpinned a renewed search for yield and encouraged carry trades [where investors borrow cheaply to invest in assets offering a nominally higher return, but where that return is not necessarily higher when underlying risk is taken into account].
"Taken in isolation, this is eerily reminiscent of what happened in the run-up to the crisis".
Or to put it another way, those controlling the world's great pools of money believe the world is a much safer place than it really is, and are taking foolhardy risks with their investments.
In fact, the Bank's internal analysis shows that investors are behaving more irrationally and exuberantly even than perhaps implied by Mr Bean - the volatility of a raft of the world's most liquid and important assets, from shares, to currencies to government bonds, is lower even than at the peak of the boom before the devastating crash of 2007-8.
So as and when any of the following possible accidents materialise - exacerbation of turmoil in Ukraine, a hard financial landing in China, cack-handed end of the era of free money in the developed economies, inter alia - "we may yet encounter a few potholes".
Or so Mr Bean puts it, perhaps euphemistically.
One of the great possible sources of future instability is the great overhang of government and official debt acquired by the central banks of the big rich economies through the money-creation exercise known as quantitative easing.
Mr Bean signals that the Bank of England will not wish merely to sit on the £375bn of gilts or UK government bonds it has bought, and see that debt mountain gradually shrink as the Treasury repays on the assorted due dates.
If the Bank were to do that, the unwinding of quantitative easing, the withdrawal of the new cash from the economy, would take around 50 years - which would be too long, he seems to think.
So at some point, he says, the Bank of England will start to flog some of this stuff back to investors.
Well it ain't going to be very soon. Because there is a risk that investors and the market would react quite adversely - pushing down the price of debt, and increasing implied interest rates pretty sharply.
There could, therefore, be an over-reaction, in which the price of money would rise sharply, to the detriment of the wider economy.
Which is why Mr Bean says the Bank cannot start to sell its gilts till the official interest rate has been raised to a high enough level, such that the Bank could make an emergency cut in it, as a form of evasive action.
But in spelling that out, Mr Bean has telegraphed to hedge funds and other investors the rules of a potentially lucrative game - the losers of which could be all of us. In that the rational thing for any investor to do would be to dump gilts in size as the Bank's policy rate was raised, to pre-empt and perhaps even deter possible gilt sales by the Bank (such that the investors could buy the gilts back at a depressed price, in the expectation of a bounce).
Lucky Mr Bean is, of course, exiting the crucible of all this potential future mayhem before we find out whether the Bank of England will show wisdom and sensitivity in disposing of the debt and withdrawing £375bn of cash from the economy, or will emulate his famously accident-prone namesake.