Housing Rescue Doomed To Fail

The government announces its grand plan to save the housing market. However, it will do nothing to prevent plunging prices.

Earlier today, the government announced its long-awaited rescue plan for our struggling housing market. However, homeowners shouldn't get their hopes up, because the bail-out kitty is practically empty!

How not to revive a housing market

In a nutshell, these are the government's proposals:

1.    Suspend Stamp Duty Land Tax (`stamp duty') on properties costing up to £175,000.

2.    An increase in shared-equity housing, where buyers buy a proportion of a property and the government takes on the remainder.

3.    Councils will be given extra cash to buy up homes in order to prevent repossessions, and help to increase their stock of social housing.

Let's look at each of these proposals in more detail:

1.    A stamp-duty holiday

At present, properties selling for up to £125,000 attract no stamp duty; between £125,000 and £250,000, stamp duty is 1%. The government is temporarily increasing the duty-free threshold by £50,000 for one year from 3 September. Thus, buyers of properties costing between £125,000 and £175,000 are now 1% better off. This is a relatively narrow slice of the market, perhaps one in ten sales, but this measure may cost up to £600 million.

At most, this stamp-duty holiday will save a potential homebuyer a one-off £1,750, which would be peanuts if house prices plunge another 10% to 30%. Furthermore, the Conservative government tried this tactic in 1991/92, when it failed to stop house prices from sliding. Indeed, I was house-hunting at this time, and waited until the stamp-duty holiday had ended before buying my first home for a fifth (20%) off the already reduced asking price.

In my view, all this measure will do is to pull down property prices above the new £175,000 threshold. In other words, someone aiming to buy a house for, say, £190,000 will demand a £15,000 discount in order to benefit from the raised duty-free threshold. As housing chains are tightly coupled, this discounting will ripple upwards, causing prices to fall further up the ladder. So, by making house prices fall further, this proposal will do the opposite of what was intended -- yet another example of the `Law of Unintended Consequences'.

2.    HomeBuy Direct: your negative-equity loan

Next, the government is working with major housebuilders to introduce HomeBuy Direct: `free' loans for first-time buyers. Funding will be provided by the government and property developers, and will allow buyers of new homes in England a five-year, interest-free loan of up to three-tenths (30%) of the purchase price.

Only those with a household income of less than £60,000 will be eligible, which is pretty generous, given that average household income is under £35,000. After five years, buyers will have to pay interest or a fee for this concessionary loan, although it is not clear how much this will amount to.

Thus, while British banks have withdrawn from lending 100% of a property's value, the government, working hand in hand with housebuilders, is bravely set to enter this market. In my view, HomeBuy Direct should be renamed Negative-Equity Direct, because it encourages buyers to borrow more than they can comfortably afford while house prices are falling. Still, it will probably create no more than 10,000 extra sales, which is a drop in the ocean, given the million properties currently up for sale.

In short, if I were thinking about buying a new home, I would ignore HomeBuy Direct and, instead, try to negotiate a steep discount (say, 25%) off the asking price. Desperate, cash-strapped property developers are already being forced to swallow reductions of this size or greater.

3.    Sell-to-rent `mortgage rescue' scheme

In addition, the government plans a `mortgage rescue' scheme costing £200 million. This will allow councils and social-housing organisations to pay off the mortgages of homeowners struggling to keep up their monthly repayments. The new co-owners will then charge their shared-equity tenants an affordable monthly rent. Also, the government has also promised to bring forward funding earmarked for building new social housing.

So, the government is all set to lose vast amounts of our money by buying surplus stock in the worst property slump in two decades. This is even dafter than the bone-headed decision to sell Britain's gold reserves before the price went on to triple. Doh!

Obviously doomed to fail

The UK's 26 million residential properties are worth roughly £5 trillion, or 3½ times the UK's gross domestic product -- a measure of national income and output -- of £1.4 trillion. The total cost of the above measures is estimated at £1 billion. In other words, the government's long-awaited shot in the arm comes to just 1/5,000th (0.02%) of the total value of UK property. This is a gnat on an elephant's back and will do little or nothing to stop the ongoing slump in property prices!

The best thing that the government can do for first-time buyers is to allow prices to fall to a sensible level. This will be far more effective than tinkering with stamp-duty rates and using taxpayers' money to bail out banks, housebuilders and some reckless borrowers. As the old saying goes: don't try to buck the market. If the government really wanted to create a stable housing market, then it should have intervened in 2003, when house prices rose by a quarter (25%) in a year.

Finally, here's some light relief from satirical website The Daily Mash: Can I have a car as well? Ask first-time buyers. What do you think? Should the government buy new cars for first-time buyers?

More: Bag a better mortgage via the Fool | Another Nail In The Housing Coffin | A Simple Answer To Britain's Debt Crisis