The Unique Property
Rising Interest Rates & Housing
The property market depends for its wealth effect on interest
rates. They are rising. But how far will they rise? And if they
rise much further, what will that do to other debt, such as
government debt, and company debt? Are we heading for a
financial meltdown if the first happens, and/or a business
meltdown if the latter?
On the other hand, are we heading towards a global systemic
financial collapse, and a reset? And what the heck would that
Some serious questions. Can we try and work thru some probable
That's entirely possible, but what I think is not possible is to
predict how the final cock-up is resolved. And working through
this is not going to take one short blog entry. But let's get
What is beyond doubt is the fact that banks have been expanding
credit like there's no tomorrow, and central banks have been
printing unbelievable amounts of money. That has led to a world
economy based upon debt, plus a dilution of the value of
currencies. These two activities have in turn led to several
situations which are all fine and dandy so long as the rules
dont change. But they do, and they have changed.
If inflation hovers around 1% and interest rates are even a
smidgeon below that rate, and the economy is chugging along
quite nicely, everyone is happy. What is there not to be happy
about? I can borrow money at 3.5%, invest it, and make anything
from 7% and up on relatively safe investments. I'm increasing my
wealth by 3.5% or more a year. With inflation only at 1% I'm a
happy bunny ending up by 2.5%.
Sadly, all those maths implode when inflation starts going
berserk. Let's do the sums again.
I can borrow money at 3.5%, invest it, and make anything from 7%
and up on relatively safe investments. I'm increasing my wealth
by 3.5% or more a year. But with inflation now at 10% I'm
getting poorer by a worryingly large margin. Result? I am a very
What we now have is businesses having to pay seriously increased
costs for the money they've borrowed. House owners are in the
same situation. And so are governments. And this is where it
For the home owner, the maths are disarmingly simple. That
£200,000 mortgage which used to cost, say 4%, was equivalent to
£4,000 a year, or £80 a week. If interest rates only double to
8% that is a serious increase in the daily outgoing. And that
rate would still be 2% below the inflation rate, which means it
isn't properly compensating for the real cost of lending out the
money in the first place. So why would the lender lend? I
For a business, the increase in the cost of money borrowed would
obviously impact on the prices a company would have to charge on
its goods in order to continue to make a profit. This will
naturally feed through to the consumer price index, and that
will show a further rise in inflation, which will mean the
lender will need more compensation for lending. Who wants to
lend £1,000 on january the first this year, if the return on
january 1st next year is only 4% when inflation is running at
The maths are relatively simple regarding house prices. To
compensate for the depreciation of the currency, the cost of the
money goes up, and so the home owner is under pressure, and may
be forced to sell if he can't keep up the increased payments.
That will put pressure on house prices in general. It will also
mean that prospective purchasers will have to consider whether
an increased interest rate is payable before they make an offer
on a house. If more money goes on interest, less goes on
repaying the mortgage, which means the average home purchaser
will have to lower his offer to buy in order to stay solvent.
The above scenario would put recent home purchasers under water.
We now have the beginnings of a tanking housing market. And that
is what is coming.
For businesses the same circumstances are about to hit hard,
probably leading to a surge in bankruptcies caused by companies'
inability to service the debt they have taken on. What was
payable last year is increasingly not payable this year. And
what about next year?
An increase in companies going bust is going to lead to more
people unemployed, and therefore more people unable to pay their
mortgages, leading to more forced sales, and more downwards
pressure on house prices.
What most people dont seem to realise is that all these
circumstances are not confined to mortgages and business debt.
What happens when banks have to deal with this situation? And,
more importantly, where does that leave governments with their
ridiculously bloated budgets?
I'll delve into those murky waters next week.