Why the Bank of England should cap house price rises

The Royal Institution of Chartered Surveyors wants the Bank of England to limit house-price rises to 5% a year. How would this work?

The Bank of England should use its powers to limit future house-price rises to no more than 5% a year, according to the trade body for surveyors. The Royal Institution of Chartered Surveyors (RICS) believes that a house-price cap would 'blow the froth off' future property values, thus preventing booms and busts.

This is all well and good, but who would benefit most from this proposed ceiling, is it fair and, most importantly, how would it work in practice?

RICS calls for a cap

RICS reckons that an upper limit of 5% a year would "prevent another housing bubble, reckless bank lending and a dangerous build-up in household debt".

To enforce such a cap, RICS proposes that the Bank of England’s Financial Policy Committee should adopt this 5% ceiling as a new 'anchor' for house prices, after settling on the right index. The cap would be enforced by imposing stricter limits on mortgage lending as the housing market starts to heat up. These curbs could include:

• higher loan-to-value ratios, which would force buyers to find bigger deposits;
• lower loan-to-income ratios - for example, buyers might be allowed to borrow no more than three times their salary;
• mortgage durations - by limiting the life of home loan from, say, 30-35 years to at most 25 years, this would push up monthly repayments, reducing affordability; and
• regional variations could be imposed to reflect 'asymmetric' market activity in major regions, with tighter limits in boom areas such as London.

The four measures above would tackle one side of the equation: demand from buyers. However, RICS also argues that, if house prices start rising steeply, then the Bank could also moderate credit supply by imposing ceilings on the amount lenders would be permitted to advance in residential mortgages.

RICS argues: "Sending a clear and simple statement to the public that the Bank of England will not tolerate house price rises above 5% would help restrict excessive price expectations across the country. This policy would discourage households from taking on excessive debt out of fear of missing out on a price boom, and discourage lenders from rushing to relax their lending standards as they compete for market share."

In other words, RICS wants the Bank of England to dampen house prices in order to prevent British 'propertymania' leading to reckless lending and borrowing and excessive concentration of wealth in bricks and mortar. Were such a cap to work, then it would lessen - or even prevent - market meltdowns. 

Lessons from Canada

Mark Carney, the recently appointed governor of the Bank of England, can look to his native Canada for lessons on how to cope with rapidly rising property prices.

While governor of the Bank of Canada, Carney oversaw a programme of lending curbs introduced from 2008 to 2012, designed to gently deflate Canada's property bubble. After Canadian interest rates were cut aggressively, causing the housing market to start warming up in the late 2000s, Carney and the Bank of Canada acted to prevent another house-price boom.

To cool down the housing market, the maximum life of new mortgages was reduced from 40 to 35 years in October 2008. At the same time, the minimum deposit for homebuyer loans was upped to 5% from 0%.

In April 2010, the minimum deposit was raised again, this time to 10% for remortgages and 20% for buy-to-let properties. Also, a tougher affordability test was introduced, requiring borrowers to be able to afford the monthly payments on a five-year fixed-rate mortgage, regardless of the home loan they actually chose.

In January 2011, round three of Carney's tightening led to a further reduction to 30 years for the maximum mortgage term. In mid-March, remortgages were limited to 85% of property values. In mid-April, the government also stopped insuring loans secured against property not used for home buying.

In a fourth round of restrictions in June 2012, the maximum term of mortgages was reduced by another five years to 25 years. Remortgages were capped at 80% of property values and caps were introduced on individuals' debt-to-income ratios. Also, the government stopped insuring mortgages worth more than C$1 million, curbing demand for 'jumbo' loans.

Would curbs work here?

These lending curbs did the trick in Canada, slowing the pace of credit growth and house-price rises. The yearly rise in property prices slid from nearly 15% in 2009/10 to below 4% today. However, they were introduced gradually over a four-year period into a market with a healthy banking system and low interest rates.

One problem with introducing such 'cooling curbs' on this side of the Atlantic is that the Government is doing everything it can to lift house prices right now. With support from cheap credit from the Funding for Lending Scheme, interest-free shared-equity loans from the NewBuy and Help to Buy programmes, and Quantitative Easing keeping bond prices down, house prices are already rising at yearly rates above 10% across London.

What's more, in the capital and parts of the South East, prices have already exceeded their mid-2007 peaks and are soaring steeply once again, particularly at the premium end of the market. In order for property-price curbs to work successfully in the UK, RICS argues that they must be "transparent" and "communicated to the public in an open and accessible way".

Who wins and loses?

As governments often discover to their cost, the problem with brazenly manipulating the market is that this creates artificial prices - and participants in false markets often lose out, especially those latecomers to the party.

Those in the mid-price bracket would stand to lose, as their, say, £200,000 house could not rise by more than £10,000 in a year with a 5% limit in place. On the other hand, those at the top end of the market could see the value of their, for example, £2 million house rise by £100,000 under the same growth ceiling. In absolute terms, property millionaires will gain much more from a 5% cap than typical homeowners will.

Likewise, first-time buyers and young home-movers could stand to benefit from price-growth caps, knowing that values will not increase by more than 5% a year while they save hard for a deposit or pay down debt. On the other hand, property investors and buy-to-let landlords will argue furiously against any price cap, as it removes the chance of, say, the 25% rise in house prices seen in 2003 (the biggest boom year of the previous bubble).

I'm all in favour of imposing curbs on future property values, as I think our national obsession with housing has been disastrous for our economy, especially over the last decade. With £4 trillion of our £7 trillion of personal wealth in bricks and mortar, we are already dangerously over-exposed to property prices.

Any and all steps introduced to reduce such excessive risk-taking and future financial imbalances get a big thumbs-up from me!

What do you think? Is it the Bank of England's responsibility to cap house price growth like this? Could such an idea work in the UK? Let us know your thoughts in the comment box below.

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