The home equity housing bubble

(click on the chart for a sharper image)

The recent housing bubble was strange. The volume of sales didn't increase much, yet prices shot up. This lack of activity also features in gross mortgage lending data. Loans for house purchases remained comparatively flat throughout the bubble (see the chart above).

In contrast, home equity lending exploded. By 2007, it accounted for almost 40 percent of all mortgages. Of course, these loans fed straight into consumption. Homeowners, who are mostly middle aged, borrowed and spent, based on the illusion that they were rich because house prices were inflating. In the post-bubble world of 2009, this idea seems truly bizarre, but that is how things worked in early 2007.

Buy-to-let was the other major growth area for mortgage lending. By 2007, around a quarter of loans were financing small time property investment. Many of these investors were already home owners, who used the equity in their homes to provide collateral to dive into fully fledged speculation via the BTL market.

There is an interesting implication here. While the housing bubble generated a huge amount of personal debt, it is heavily concentrated among home owners. Renters never found it easy to get access to credit. Apart from college loans and some heavy credit card balances, young people are also comparatively free from debt.

So behind the government's banking sector intervention lurks a homeowner bailout. Brown wants banks to increase their lending, in the vague hope that house prices will stabilize and the home equity bubble can resume.

This bailout works against the interests of both renters, and the young. Higher house prices shuts out renters from home ownership, while huge bailouts puts the burden of paying for this mess on young taxpayers.

There will be some pay-back for this mess. One day, those young taxpayers will have to pay for the pensions of heavily indebted homeowners. I wonder how generous they will be?

(The chart comes from the FSA's Turner report)