September 5, 2008 / 12:09 PM / 10 years ago

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.


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.

So, who is this program good for?

The main beneficiaries are banks, industries associated with property and anyone trying to sell a British house that is likely to have tripled in value in the past decade. All of those people will be feeling real pain, which is terrible, but Britain can no more keep property prices where they are than it can repeal the law of gravity.

To the extent that the scheme is successful, banks would gain time to reduce their considerable exposure to potential losses on mortgage loans.

There is another argument; that the freezing of the housing market is hurting the general economy, as lawyers, real estate agents, builders and others are left with little to do. But to say that we need to keep properties turning over at bubble prices in order to give work to those involved makes about as much sense as paying surgeons to cut off healthy limbs on slow days at the hospital.

It is true that the housing crash is hurting the general economy, but that is what happens after a decade-long misallocation of resources.

The best thing to do is very little; allow prices to fall back to a more sustainable level, and allow the capital and people sucked into the bubble to find their way into more productive areas.

I should at this point declare an interest: as a renter living in London I am running what amounts to a naked short on British housing.

— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund —

Editing by Ruth Pitchford

0 : 0
  • narrow-browser-and-phone
  • medium-browser-and-portrait-tablet
  • landscape-tablet
  • medium-wide-browser
  • wide-browser-and-larger
  • medium-browser-and-landscape-tablet
  • medium-wide-browser-and-larger
  • above-phone
  • portrait-tablet-and-above
  • above-portrait-tablet
  • landscape-tablet-and-above
  • landscape-tablet-and-medium-wide-browser
  • portrait-tablet-and-below
  • landscape-tablet-and-below