UK interest rates: the chickens are coming home

Recently, the Bank of England hiked its interest rates yet again to 5.75%,the fifth rise since August 2005, and "further action" on interest rates could be on its way. The interest rate may go to 6% or more by the end of this year. The credit-led boom is now in jeopardy as central banks raise interest rates everywhere.

Location, location, location! Grand design! Home in the sun. Yes, those house and home TV programmes are still going, but maybe not for much longer.

Last week, the Bank of England hiked its interest rates yet again to 5.75%. This was the fifth rise since August 2005. And the head of the bank, Mervyn King, said that "further action" on interest rates could be necessary. Most observers reckon the interest rate that most borrowing and mortgages are based on - the bank rate - will go to 6% or more by the end of this year.

Already, the recent hikes have meant that the cost of typical £125,000 mortgage is now costing £130 a month more than this time last year. As much as 44% of the income of the average household is now being swallowed up by mortgage costs. Many households have fixed-rate mortgages that are unaffected by the bank rate moves. But 2.8m families will see a sudden jump in costs when their fixed rate schemes come to an end over the next year.

The bean counters (accountants) Price Waterhouse Coopers calculate that the burden of debt for the average UK household has now reached 19% of disposable income, a record level, passing the peak reached in the high interest year of 1990. Indeed, average household income rose 5.2% from 2004 to 2006. But after paying for higher interest-rate costs, the rise in income was just 3%. After taking off the rise in prices over that period, it means that most British households have not improved their standard of living since 2004 because of the rise in housing costs.

We know that British families have accumulated £1trn in debt at the last count. Of course, they have the value of their homes to put against that. But as the cost of servicing their mortgages rockets, the burden of financing this huge debt will rise even further.

The Citizens Advice Bureau, a body that must deal with the problems when people get into too much debt, announced that 2007 could go down as the worst ever for Britain's debt crisis. Personal insolvencies will reach a record surpassing last year's record of 107,288 bankruptcies.

The Bank of England is hiking interest rates because it is worried that the property market is getting out of hand again. In the leafy streets of Chelsea and Kensington where the super-rich Russian and Arab émigrés buy their property with wads of cash, prices have rocketed 30-50% in a year. But in the rest of the normal world, prices are not really moving up that much. They are already at levels that make it impossible for most young people to get on the ‘housing ladder'. And now with the cost of mortgages rocketing, all hopes are gone.

 

The real problem is not just the very rich driving up house prices with their tax-avoiding bonuses and illegal funds (that Gordon Brown's treasury did nothing about). It is not just excessive demand for property but the lack of supply. Back in the 1950s and 1960s, people on a working wage could expect to get a decent home through the council. It may not be much but at least it was adequate and at an affordable rent.

But now in 2007, that is cloud cuckoo land. It is a sorry state to say that in the 21st century in Britain, young people are forced to stay with their parents or in-laws up to their mid-30s before they can get a flat at some extortionate price or rent.

The reason is yet another part of the destruction of the public sector and the welfare state that successive governments, both Tory and New Labour, achieved in the 1970s and 1980s.

House building peaked in 1968 under the Wilson government when 426,000 homes were built, of which local councils built 46%. Council house building declined under the Callaghan Labour government, but of course it was really killed off under Thatcher. Building stopped and the existing stock was sold off at knockdown prices.

Council building is now virtually zero. It was supposed to be replaced by ‘social housing' with building by housing associations. But housing associations build only 20,000 a year, the same rate back in the 1960s - and indeed half the rate of the 1990s.

New home building is now totally dependent on private sector building for profit. And this they have failed to do. Last year, they built about 180,000 new homes (mostly flats not houses), still 20% below what they managed 40 years ago! And of course, these are for phenomenal prices, out of the reach of 35% of people not on the housing ladder.

The destruction of the public sector housing programme by the Tories and New Labour together helped create the housing crisis for majority. The population is bigger now than 40 years ago and yet house building now is just 40% of that achieved in 1968. Moreover, back then nearly half was for low rent accommodation that the poorest could afford. Now over 90% of new homes are at astronomical market rates and low-rent new homes are almost non-existent.

New Labour under John Prescott talked Blairily (lyingly) of building more homes. But these were to be mainly in the south-east where everybody is already suffering from overcrowding, noise and traffic. The regeneration of more lowly populated areas was ruled out because there are no jobs there. Why were there no jobs? It's because British capitalism is now so lopsided towards finance over industry that incomes, jobs housing and the environment are bent towards the south-east.

Our new New Labour prime minister, Gordon Brown, has claimed that he is a builder. Yet it was as chancellor that he presided over the worst slowdown in home building the country has ever seen. The Treasury so ruthlessly throttled the flow of funds to councils and housing associations that we now need 23,000 new homes year just to keep up with the demand for low-rent accommodation and we aren't getting them. In 2001, Labour presided over the lowest building rate for new homes since 1945. The 2012 London Olympics is supposed to revive a corner of East London with 40,000 new homes. That target has now been cut to 9,000.

Higher interest rates means suffering for many families in debt payments. But there could even be worse, if it causes house prices to fall as in the US. Then there is a double whammy, higher mortgage costs and falling house prices.

In the US, house prices have been falling for the first time since the Great Depression. As a result, many borrowers who either engaged in speculating on buy-to-let house purchases or were just lower-paid first-time buyers have been increasingly unable to pay and are selling up at prices below what they paid for. As a result, they are defaulting on their mortgages.

US banks have been lending to these people without even checking on whether they can pay their loans back because they expected rising house prices to cover any problems. People borrowed by just ‘certifying' themselves on their level of income and this was not checked.

Loans or mortgages in this ‘sub-prime' market were huge during 2005 and 2006 in the US (25% of all mortgages). Now the default rate on these loans has reached 14% and set tot rise to 20% - one in five of these borrowers are going bust.

And even more serious crisis beginning to come out of the bushes. The US financial sector has been doing big business laying off these loans to others in batches of debt called collateralised debt obligations (CDOs). CDOs were good business because incorporate huge fees and they were supposedly backed up by the rising value of property. But now all is turning sour and banks, hedge funds and other mortgage lenders who bought CDOs are getting into trouble. The big investment bank Bear Sterns had to announce the closure of its CDO hedge fund with billions lost. The stock market took a shudder on the news.

There is a real risk of a credit and financial crunch. That is the danger that is flashing amber right now. The UK will not be immune from a similar credit crisis. Sub-prime home loans are 8% of the UK mortgage market, worth around £30bn. According to the Financial Services Authority, most of the eleven big banks lending money in this market paid no attention to whether the borrowers could pay them back. Over half the borrowers self-certified their incomes!

The credit-led boom in world stock markets and property prices is now in jeopardy as central banks raise interest rates everywhere. Only this month, the European Central Bank, the Bank of England raised their rate. Central banks in Switzerland, Canada, Australia, New Zealand, India and China have also.

The pain is being felt in homes across the UK, the US, and much of the world.