Negative equity - UK style

Negative equity is a very different beast compared to the last bubble.

There is a simple reason - sales volumes in the UK market are much lower than in the US. Comparatively few people were buying and selling property during the bubble. Moreover, much of the activity was between speculators taking a punt on the BTL market. For the vast majority of UK homeowners, conventional mortgage debt remains lower than existing home valuations.

Our problem lies elsewhere. It is with home equity loans. During the bubble, homeowners gazed with a greedy eye into their local estate agents windows, made a personal valuation of their home, promptly went down to the bank, and filled in an application for a home equity loan. A computer scored the application. Since computers don't think, the inflated home valuation was taken as a fact, and a big fat loan was approved.

With home values down 20 percent, this has constrained banks in terms of issuing new personal loans collateralized on property. This is why the Bank of England and the government are so desperate to see a return to housing inflation. Without it, banks can not ratchet up personal lending volumes, especially remortgages and home equity loans. Without a renewed surge of secured consumer credit, aggregate demand remains depressed and the economy continues to wallow in recession.

This sad problem illustrates just how distorted the UK economy has become. Economic growth no longer depends upon innovation, entrepreneurial risk taking and investment. It depends on our collective and highly subjective valuations of the homes we live in. If we don't believe that house prices are inflating, banks cannot increase their lending volumes and the economy grinds to a halt.

What a sorry mess.