Britain's housing plan smells like Ponzi: James Saft

-- James Saft is a Reuters columnist. The opinions expressed are his own --

By James Saft

LONDON (Reuters) - Britain's plan to cut taxes and offer incentives to first-time buyers is sure to fail and smells a bit of Ponzi.

Britain this week announced a 1 billion pound package of measures including eliminating a 1 percent tax paid by buyers of houses costing less than 175,000 pounds and a program to give interest-free 30 percent down payment loans to first-time buyers with moderate incomes.

Ponzi schemes, called after a famous fraudster, attempt to use the money of new investors to pay unsustainably high returns to existing ones, but at their heart have no actual business or productive enterprise.

While by no means a fraud, the plan will in effect suck money from those not on the housing ladder or at its bottom to support those further up, as well, significantly, as the banks who've loaned them money. The plan also meets the Ponzi test in that it is an attempt to keep an overdeveloped and underproductive sector of the economy going.

It would be far better to acknowledge that British housing prices are much too high and likely to fall substantially from here, and to try to do what little can be done to soften the side effects.

Attempting to keep the unstable enterprise afloat by luring new buyers is a strategy headed for failure, and where it succeeds is bound to be a disaster for any unfortunate buyer who takes it up.

"Encouraging first-time buyers to enter an over-valued and sharply falling market seems like an odd thing for a government to be doing," said Ed Stansfield, a London-based economist at Capital Economics.

British house prices have fallen about 10 percent in the past year, having more or less tripled in the decade before. The average British house costs about 5.8 times average annual earnings, among the highest such ratios in the world.

The bubble in housing inflated thanks to easy money from a banking sector which has now thought better.

The truth, as reflected in the falling value of sterling and London's wobbly stock market, is that the bubble allowed Britain to become overly reliant on housing inflation and on the industries fed by it and the consumption it fanned. A period of painful adjustment is simply going to have to happen.

WHO BENEFITS?

Like a plane with smoke wafting from its engines while airline staff invite passengers to board, perhaps the best thing that can be said about the tax cut and the offer of "free" loans is that they are unlikely to attract many customers.

Avoiding a 1 percent tax when prices are, by most measures, falling between 1 and 2 percent a month is hardly an incentive to act now. Would-be buyers are far better off waiting until after the tax break expires in a year, by which time prices are very likely to have fallen by a further 15 percent.

The terms of the interest-free down payment loans have not been detailed, but that too seems unlikely to prove to be much of a bargain if prices fall from here. Even if an interest free loan on 30 percent of a purchase is worth, say, 10 percent of the purchase price over five years, the loan will still need to be repaid.