The great engine of the British economy has slipped into reverse. Before the financial crisis, homeowners were pulling out about £12 billion a quarter in home equity loans. They used this cash to fuel a massive consumption boom that kept the economy growing at around 3 percent. Since the summer of 2008, homeowners have been paying down their loans by around £6 billion a quarter. So far, homeowners have paid off around £50 billion.
In terms of their economic impact, these numbers are very large. In the third quarter of 2010, these home equity repayments amounted to about 2.4 percent of post-tax personal income. Prior to the crisis, home equity withdrawals were equivalent to about 6-7 percent. In pure cash terms, this represents a net turn-around of £20 billion - almost 10 percent of post tax income.
This isn't how it is supposed to be. The Bank of England cut interest rates to discourage savings, and make it cheaper to homeowners to borrow money so that they could continue spending. So what went wrong? At least three things didn't go according to the script:
- First, home prices fell. This ate into home equity and limited the extent to which homeowners could use their homes as collateral.
- Second, banks were feeling vulnerable. They had too much exposure to potentially delinquent homeowners. They have cut credit lines and made it harder to obtain home equity loans.
- Finally, borrowers have become more worried about the future path of the economy. Even the most extravagent consumer-addled debt serf knows that it isn't a good idea to mortgage the house when the probability of losing your job has increased.
Taken together, these factors driven home equity withdrawal flows into reverse. One final dismal fact; home equity withdrawal has been negative for 10 straight quarters. This is the longest continuous period of negative numbers since records began in 1970.