May 27, 2002
Time Atlantic
LONDON-- The British economy has come to depend on people like 26-year-old Rebecca Holyhead. She and her boyfriend Dave are about to put down the deposit on their first house. It may not sound like much--a two-bedroom semi-detached that used to be public housing, on the outer fringe of London and far from the Tube--but it's costing them a heady 150,000 [pounds], more than three times their combined annual salaries. (She's a nuclear safety engineer; he works in local government. Their parents are pitching in on the deposit.) Though it's a bit of a financial squeeze, Holyhead isn't complaining. "We actually feel quite smug," she says. "We put in our offer in January, but the property has gone up in value since then. If we were looking to buy fresh now, we couldn't afford the place."
Is this what a bubble looks like? Despite the global economic slowdown, the U.K. property market has been setting land-speed records this year. In April, the largest-ever monthly increase pushed the price of the average British home to 100,000[pounds], according to the Nationwide Building Society. That's over 16% higher than a year ago. And to help pay for these high-priced properties, Britons have also been piling on staggering amounts of debt, at a recent net rate of 7 billion[pounds] a month. They owe back at least 117% of their annual incomes, more than they did during the height of the 1980s boom, which ended with the collapse of the last great U.K. real-estate rally. In the difficult months since Sept. 11, the British economy has been kept out of recession by the willingness of consumers to continue their credit-card-fueled spending--and they're willing, for the most part, because rising residential property values have made them feel richer. But for how much longer can stretched borrowers be expected to keep feeding the property-market beast?
Maybe for a while yet. It's tempting to wag a finger at spendthrifts living beyond their means, or at the new breed of middle-class speculators taking out buy-to-let mortgages to become landlords. Yet most British borrowers look quite clear-eyed and rational once you've seen their household balance sheets. With base interest rates at a 38-year low of 4%, many feel they literally can't afford not to borrow.
Just ask Holyhead. She has paid rent of 750[pounds] a month for a one-and-half bedroom flat not far from her new house. Her variable-rate mortgage, on the other hand, will cost just 500[pounds] a month as long as rates hold. Overall, Britons pay only 8% of their income on interest payments, compared to 15% in 1990 after rates had soared into the double-digits, triggering the big credit crunch. "There is no evidence of people having pain servicing their debts," says housing economist John Wriglesworth of Hometrack, "despite lenders being very generous with their lending policies."
The trouble is, new mortgages last for 25 years and these relatively balmy economic conditions won't. One risk is that the economy, which grew a surprisingly sluggish .1% last quarter, doesn't pick up as strongly as economists expect and unemployment starts to rise. (Right now, it remains near historic lows at 3.2%.) Worried workers would cut back spending, and property prices could also fall as homebuyers became more cautious. Even those with secure jobs would suddenly feel poorer. "The debt would still be there, but the wealth would be eroded," says Jonathan Loynes of Capital Economics in London. The other risk is too much consumer-driven growth, which might get Bank of England Governor Edward George worried enough about inflation to push rates, and thus mortgage payments, back up--again, tamping down both spending and property markets. One of these two things is certain to happen eventually; how damaging it is depends on how abruptly it comes.
If this makes you nervous, take heart from the fact that none of this comes as a surprise to Sir Eddie. The Bank planned it to happen this way. "Policy has been keyed to engineering strength in the housing market and the household sector," says Loynes. The idea was to keep the consumer side of the economy going to make up for the sharp slide in the industrial sector. So far, it has worked. Last week, the Bank began signaling that a rate hike is on the way, but the evidence of an economic rebound remains ambiguous enough that even the relatively bearish Loynes doesn't expect anything drastic. With rates so low, however, small changes could have a big impact on homeowners' monthly bills, while continued low inflation means the real amount of their debt won't shrink as quickly as it once did.
So, yes, Britain's credit-rich homeowners have been economically rational--it's easy to be rational when things are mostly going your way. What's less clear is that they'll be able to play it so cool should trends reverse. There are tens of thousands of high-street financial advisers to push people into second mortgages when rates are low. Who will profit from telling borrowers, if and when the economy slackens, that it's time to scale back? The opposite danger is that even a tiny rate hike by the Bank of England could be read by the market as a sign of more to come, sending property prices down much too fast. "The U.K. housing market is driven by a lot of animal desires," says Loynes. "Fear of missing out. Greed." Sounds a lot like the stock market, actually. Except that you have to live there.
