Will the UK Property Market Collapse?
After the fastest interest rate rise in history, borrowers are beginning to default on their mortgages. What happens next?
In the UK, the real estate market is extremely important. Those who own assets typically have a large proportion of their wealth tied up in real estate of some kind or another, and there is a widely-held desire to “get on the housing ladder”.
For the last few decades this strategy has been a winning one, and property prices have continued to rise consistently with only very minor depreciations in select years. So brilliant has the appreciation of real estate been that many view it as an invulnerable asset class that can withstand anything thrown at it, and a dream for those who are willing to take on leverage to become landlords.
The word “mortgage” is derived from the French words “mort” and “gage”, meaning “dead pledge”. The concept of lending money to someone else isn’t new, with the word first arising in the 12th century. However, the mortgage market of today is a far more commercialised industry predicated on strong political favour and protection, and the understanding that residential real estate is an extremely desirable form of collateral.
Everyone from older generations seems to recount that their home was the best investment that they ever made, and has some story of how they bought their flat in London in 1980 for £20,000 and is now worth £1m. In 1950, the average cost of a home sat at just £1,891, whereas today that figure sits at around £300,000. Has UK real estate became more desirable over the course of the last 70 years? Undoubtedly — we have double glazing now. Has it become over 10,000% more desirable when compared to the rest of the world in the same time period? Hmmm…
To understand the manipulation of house prices one has to first understand the manipulation of the currency in which we denominate the values of homes. The main demand for homes doesn’t come from people who have saved up enough money to buy outright (as was largely the case with the first building societies set up in the UK in the 1850s), but from banks extending loans in the form of residential mortgages and buy-to-let mortgages. It makes sense that real estate (with a S2F ~ 100) should appreciate somewhat in value, particularly when denominating against currencies that are designed to debase. With this in mind, rising house prices when measured over a period of decades can show us far more about the collapse of a national currency than the fluctuations in the desirability of property.
Interest rates go parabolic
Since 2008, interest rates have been extremely low, and the Bank of England has managed to get away with it because inflation also remained relatively low.
However, this was a mixture that could never last indefinitely, and by keeping interest rates so artificially low for so long the Bank of England has opened Pandora’s box and released the inflation genie.
When the government embarked on their insane policy of lockdowns, as though the economy could be turned off and on like a Nintendo 64, interest rates in the UK were slashed to 0.1%. This meant that bonds were offering real yields that were negative (as they have been for some time), and the capital markets continued to flood with currency.
At the same time, fractional reserve requirements for banks in the US were reduced by the Federal Reserve from 10% to 0%, a measure that can be described as desperate at best and morally absurd at worst.
By taking such drastic and hysterical decisions in light of the coronavirus outbreak, the Bank of England not only betrayed their only mandate (keep inflation around 2% and interest rates steady as possible), but they also betrayed the reason that Gordon Brown made The Bank independent in the first place: to respect and prioritise their mandate regardless of politics.
This isn’t the first time that The Bank has failed to respect its mandate of staying apolitical, with many political commentators casting aspersions that Bailey is too focused on woke conformism that he’s been distracted from doing his job properly.
By December of 2021, interest rates had risen to 0.25%, and throughout 2022 they were consistently raised to where they now stand at 5%.
Mortgage defaults start to rise
The first cracks in the UK housing market have finally begun to show, with house prices falling somewhat already.
According to the Bank of England’s Credit Conditions survey, the country is currently experiencing the largest increase in mortgage defaults since 2009, and expect that demand for mortgages will be heavily diminished in the coming quarters.
Eviction notices have risen by 98% and the government’s response of changing Section 21 notices has made letting out properties an even less desirable proposition for landlords than ever.
Is inflation the solution?
The largest expense that the UK government has is the NHS. Britons ritually prostrate themselves before the national religion, funnelling endless resources into a bureaucratic shitstorm with the only consolation being that at least things aren’t as bad as in the US. According to the NHS, they have a budget of £153 billion for the 2022/2023 fiscal year. Any attempt to dramatically cut spending to the NHS (no matter how common sense the approach may seem) would not be politically viable, particularly after years of government-sponsored propaganda and fearmongering (brilliantly detailed by Laura Dodsworth).
The UK’s second largest expense is state pensions at around £124 billion. With an ageing population and the significant political sway that pensioners have, this number also can’t fall much without extreme voter unrest.
The third largest expense is now servicing the interest on national debt — not actually paying down the principle, just servicing the interest. In 2023, the government is expected to shell out £114 billion in this regard.
If interest rates go much higher, then it is quite feasible that the largest expense of the government will be servicing interest payments alone.
Political analyst Dan Tubb believes that the government doesn’t really have a politically-viable option other than inflation, and that the government will have to continue to debase sterling. A hard default and restructuring process would be a disaster for pensioners and would neuter the bond market. Inflation may not be a solution that everyone loves, given that it will dramatically favour those with assets, but the government has already taken on so much debt that The Bank can no longer afford to raise interest rates to the levels required to fully contain inflation.
Inflation also seems the most likely outcome given the incentives held by those in The Establishment. For example, although he tries to blame The Bank for all the aforementioned shortcomings with sterling, plenty of blame lies at the hands of PM Sunak, who presided over the most fiscally insane programme of quantitative easing the nation has ever seen during his time as Chancellor. Those who are the most direct benefactors of the Cantillon Effect are unlikely to sign off a policy that distresses themselves and their voter base.
Fiat currencies are inherently political beasts, whether their control is centralised in the hands of politicians or central bankers. The result of the experiment since 1971 thus far has established a two-tier culture of myopic rent seekers that are incentivised to take on risk and leverage else have their savings debased.
The silver lining
Despite all of the doom and gloom, there are also reasons to be pleased, depending on one’s perspective.
For those who have pushed themselves right to the limit in order to be able to afford their mortgage when rates were close to zero, the lack of a financial buffer can be devastating now that interest rates have risen so significantly.
For those who have a portfolio of highly-leveraged buy-to-let properties, it may also be curtains. At the very least it is going to be extremely difficult to maintain a positive cashflow.
Over the short term, prognostications about where interest rates will go and the market will respond is a fools’ errand. The smug arrogant Keynesians at the Bank of England don’t appear to give any indication that they know what they are doing. Andrew Bailey’s supercilious approach to the state of the markets doesn’t cultivate much excitement for those who have a large stake in the economy.
However, for those who pay attention and wake up to the farce of the manipulated real estate market, the zeitgeist offers a litany of opportunities. The most significant of these should be that once more British citizens have been proffered with the lived of experience so as not to blindly trust everything their central bankers and politicians say. Despite the clusterfuck of 2019-2023, it seems that there are still far too many capital allocators who lack the ability to operate as independent thinkers and instead trust Powell and Bailey as though they were holy prophets. Even at the upper echelons of capital allocation, we see this playing out: the Silicon Valley Bank (circa ~$200 billion AUM) collapse appears to largely have been due to purchasing long-dated treasuries with the goal of holding to maturity and making no contingency plans whatsoever for rising interest rates.