Mark Hoban is a former Financial Secretary to the Treasury and Employment Minister, and is MP for Fareham.
In a recent speech, Sir John Cunliffe, the Deputy Governor of the Bank of England, pointed out that “recessions associated with housing busts have tended to be over twice as severe as those without.” He went on to say that “for countries where there have been larger and faster increases in household debt levels, recessions have tended to be deeper still.” You only have to look at the length and depth of the Great Recession to recognise that description of what happened in the UK in 2008-9. The challenge for policymakers in its aftermath has been how to minimise the chances of the same crisis repeating itself.
You might have thought, given the frequency and magnitude of property price bubbles in the UK, that we would have had institutions in place to reduce their severity and frequency. Yet in the regulatory regime put in place by Ed Balls after 1997, there was no one responsible for scanning the horizon for threats to the financial stability of our economy. The FSA was responsible for looking at the safety and soundness of individual banks and building societies. The Bank of England had lost its regulatory function. The Treasury seemed keen to spend the proceeds of the house price boom, but had little interest in curbing it. So in the middle of the last decade, when a property market fuelled by cheap credit started to overheat, no one had responsibility for cooling it down. No one had responsibility for assessing threats to financial stability or tackling those threats.
It was clear when we were in Opposition that we had to close this gap in financial regulation. If we did not, then the mistakes of the past would be repeated. We needed a body that understood financial markets and had the credibility and authority to take actions which would have a real economic impact. We wanted a body that would take away the punch bowl when the party was getting out of control. As we developed our thinking in Opposition, it was clear that there was only one contender: the Bank of England. To use the jargon, the Bank would be a macro-prudential supervisor tasked with looking at the stability of the whole system. That’s why we set up, within the Bank of England, the Financial Policy Committee (the FPC), which has responsibility for scanning the horizon for threats to financial stability and tackling them as they emerge, rather than leaving it to others to clean up the mess when it is too late.
In Government, as we undertook the detailed design of the FPC, we used elements from the Monetary Policy Committee (MPC) to give our new body credibility and authority. So, like the MPC, the FPC is independent, and, again like the MPC, it operates within a framework laid down by Parliament in the Financial Services Act, and is accountable to Parliament. By being part of the Bank of England, the FPC has the freedom and authority to act independently of the Government. Parliament gave the MPC the responsibility for setting interest rates in order to achieve its inflation mandate, and Parliament has given the FPC the tools to tackle threats to financial stability.
This independence doesn’t mean that it is unaccountable. Appointments to the FPC and the work of the FPC are scrutinised by the Treasury Select Committee. Its thinking is exposed to the wider world in its six-monthly financial stability reports. Informal scrutiny is key, too. If it decides that there is a risk to financial stability emerging through house price increases then a decision to cool down the mortgage market will be scrutinised by economic commentators, banks, house builders and homeowners whether aspiring or existing.
By setting up the FPC, we have signalled that we are determined not to repeat the mistakes of the past; of allowing bubbles to build up and burst, putting the stability of the economy at risk. This is not to say that we have abolished boom and bust but, by establishing the FPC, and we should strengthen financial stability aiding the wider economy. We want the FPC to take difficult decisions and whilst this might be tough in the short term, it is in our long term interests.
Of course, it needs to exercise its powers carefully, since its decisions will have a broader impact on society. If it were to use its powers to take some of the heat out of the mortgage market, then it could price people out of that market by forcing up the cost of a mortgage, and also dampen the increase in the value of people’s homes. The FPC could require banks to hold more capital against mortgage debt, thus ensuring that banks are protected from losses if borrowers are unable to repay their mortgages. Banks facing higher capital requirements need to increase the cost of mortgages to offset the increase in the cost of their capital. There are other tools available to the FPC: for example, it could introduce loan to income caps which would act as a dampener on prices by reducing the amount someone could borrow.
Of course, the current debate on the housing market comes at a point when the FCA has introduced new rules for mortgages aimed at tackling bad practice that had led to people becoming over-indebted in previous cycles. It is important that people can afford mortgages not just now, when interest rates are at a historically low level, but also when rates rise. The FPC could toughen the stress tests built into the mortgage application process so that home owners must demonstrate that they can either afford their payments at higher interest rates or borrow less. Again, this will restrict people’s ability to bid up house prices by simply borrowing more.
Cooling the housing market will make it harder in the short term for families to buy a home of their own. So there will be a social cost of their policy choices, but we have also seen the cost to families, banks and the economy of the failure to tackle the house bubble during 2006/7. But the response to the impact on social policy should not be to limit its powers, but to get government to tackle the supply side of the housing equation. Overheating house prices are a function not just of strong demand but also inadequate supply.
As Mark Carney pointed out at the weekend, we need to increase housing supply. The FPC cannot build houses, and responsibility for housing supply rests with government and builders. That’s why interventions lsuch as Help to Buy that enable people to get on the property ladder and increase supply are so important. It is worth reminding ourselves that it was George Osborne who invited Mark Carney and the FPC to look at the parameters of Help to Buy ensure that it didn’t distort the housing market.
Despite the welcome improvement in house starts, home building has failed to keep pace with demand and that is one of the factors that is driving prices up and stopping young people getting on to the housing ladder. Our planning reforms will help to boost supply, as will measures such as the New Homes Bonus that rewards communities that welcome development. We also need to ensure that where large-scale development does take place we can have proper infrastructure largely funded by developers and landowners, but with public money to unlock sites. Boosting the supply of housing is vital if we are to meet the growing demand for new homes without stoking a house price bubble.
Property price bubbles have been a recurrent feature of our economy for some time and, when they burst, they hit families, businesses, the financial system and the economy. The FPC helps to square the circle of between the one hand taking action to tackle market failure in the housing market and on the other ensuring that we spread home ownership without putting at risk financial stability. A stable financial system is, of course, the foundation of a prosperous economy.