Is it sensible for a city such as Edinburgh, so dependent on public services and bank subsidies, to be growing its very own housing bubble on the eve of the biggest cuts in public spending in British history? Cuts that will lead to many thousands of job losses.
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You might have thought Edinburghers would be counting their pennies instead of taking on ever greater debts by bidding up house prices. Glasgow’s property market shows more rational behaviour for a country struggling to emerge from deep recession. According to the Registers of Scotland, prices in the west have declined in real terms over the past quarter, leaving average home values in Glasgow not much more than half of Edinburgh’s -- £127,566 as against £213,915.
This summer boomlet is an echo of the early years of the decade when house prices were pumped up by low interest rates, irresponsible lending and inflated bank profits. Now it may not have escaped your notice that banks such as Lloyds Banking Group are now coining it in like it was 2007 again. Even delinquent Northern Rock is in profit again after three years in intensive care. State-owned RBS is expected to announce on Friday it is back in the black too. Since we, the taxpayers, own RBS, the Rock and a big chunk of Lloyds, which includes HBOS, this has provoked headlines about the public “cashing in” on the bank’s success. Happy days are here again.
Except that they aren’t. These profits are wholly artificial, resulting from exceptionally low interest rates, the government bailout and reduced competition. The Treasury -- that’s us -- took over hundreds of billions in unsellable bonds generated by institutions such as Edinburgh’s Royal Bank of Scotland and HBOS -- two of the biggest and baddest banks in the world. The total public sector rescue required £1 trillion of public funds, according to the governor of the Bank of England, Mervyn King. Of course, all that money isn’t lost and most of it will return to the public accounts, but the point is that the public sector saved the banks from insolvency by underwriting their dodgy loan books.
Taxpayers have seen very little in return for this astonishing generosity, except the return of obscene bonuses for banking executives and sky high prices in cities such as Edinburgh where bankers live.
The other key component of banking profits is zero interest rates. Banks such as HSBC, Lloyds and RBS would not be delivering profits at all had the Bank of England not slashed the cost of borrowing to the lowest level in 300 years. This has been a no-lose bet for the bankers. They borrow at 0.5% and then lend it out again at many times that to homebuyers and small businesses -- or, rather, they don’t because the banks don’t really like lending to small business. They’d much rather use the cheap money to buy government securities or other bonds which give them a guaranteed profit without any risk. It is, quite literally, money for nothing.
By the way, anyone interested in how all this works would do well to consult my top holiday reading tip: Freefall by the Nobel prize-winning economist Joseph Stiglitz, who is coming -- appropriately enough -- to the Edinburgh Book Festival later this month. Freefall is a brilliant piece of work written in a clear and engaging style free from economic jargon or the mystifications of the financial services industry.
Stiglitz, the former chief economist with the World Bank, reveals how the public in America and Britain have been taken for the greatest ride in history by monopoly financial institutions that have been given access to almost unlimited sources of public finance. They brought the world to the brink of financial disaster, and they were rewarded with a blank cheque.
The handful of banks that have emerged from the 2008 crash are now bigger and badder than ever, precisely because they know beyond doubt that when the next crunch comes, they can rely on governments to ride to their rescue. There has been no serious attempt to restructure the banks, to separate casino investment banking from retail lending or to break up the monopolies. The banks’ refusal to lend to small businesses -- which has left Prime Minister David Cameron abjectly pleading with them this week -- is a sign of just how much power the bankers have acquired. They don’t need to listen to appeals from mere politicians any more. The tables have turned. The bankers who were public enemy number one only two years ago are in the driving seat again.
This puts the recovery in the property market in a disturbing new light. Joseph Stiglitz analyses the way in which banks used inflated property prices as an engine of speculation. The infamous Collateralised Debt Obligations, and the securitisation of mortgage debt, were based on property prices always going up. They were -- are -- a kind of Ponzi scheme, which only work so long as banks and governments encourage people to take on ever higher debts.
I’d hoped the Conservative/Liberal Coalition Government might actually do something about the UK property market to challenge the bubble mentality. Certainly Vince Cable has all the intellectual equipment and a very sound track record in challenging the gnomes of the City, but the Business Secretary hasn’t been able to do anything very much to alter their behaviour.
Cable has argued that the banks, such as Lloyds, need to be broken up to restore a degree of competition in the high street and to stop them speculating with other people’s money. But the banks have hired an army of lobbyists to head off any reforms. Taking on the banks is a thankless task, especially when the headlines are about the banks returning to “normal” and property prices “recovering”. All that’s happened is that near zero interest rates have boosted house prices by creating the illusion of affordability. How many of those taking out mortgages in Edinburgh will be able to keep up the payments if interest rates return to normal, as they surely must?
As this column has argued before, every new mortgage should carry a government health warning: “Interest rates will go up.”