Caps on home loans may avert disaster

THE time may be coming when we must think the unthinkable about mortgages. Lord Turner’s call for official caps on home loans (see our interview on Page 95), whether a limit on loan-to-value or on the multiple of income that can be borrowed, will strike many as a horrific return to the bad old days when mortgages were rationed.

But these are still extraordinary times and such a radical move may be the only way to avoid a bubble in the housing market and a dangerous build-up in mortgage debt.

Barring a major upset, the Bank of England will next week keep interest rates at their record lows. As I have argued before this is quite right, as the recovery is still not so strong that we can be confident it could weather a rise in the cost of borrowing. The Governor himself highlighted some of the risks in his interview with The Mail on Sunday last week. He went so far as to say a rate rise is not a foregone conclusion.

But we must not assume that low interest rates are harmless – they encourage borrowing and to some degree are fuelling our spiralling house price rises.

The changes to stamp duty are hitting the top end of the market (see opposite), where prices are falling. But there is little sign that this is trickling down to the prices of more modest homes (or raising more income for the Treasury). Indeed, the stagnation at the top end may even be trapping people on the lower rungs of the housing ladder, increasing the imbalance of demand over supply in that part of the market and so adding to the upward price pressure.

So what happens if the wider economy slows further and the Bank of England decides interest rates cannot rise? How do we avoid a house price bubble and overborrowing by homeowners?

We may need other options. Putting limits on lending may seem like a blow against the free market. But the fact that a branch of government, albeit an independent one (the Bank of England), sets interest rates is itself a centralised form of controlling the market.

If house prices and the loans required to fund them keep rising faster than the wider economy and if interest rates cannot be raised to stem that flow of mortgage credit, something else will have to be done to avoid a fresh disaster.

Yes, it may mean some people would be refused a mortgage, but it may also calm the excesses of the market, which in the long run would make home-owning a viable choice to more people.

Interest rates at 0.5 per cent was unthinkable ten years ago. The idea that they would stay at that level for seven years was inconceivable. Perhaps it is time to adjust our thinking to match the reality.