Citywire for Financial Professionals
Stay connected:

View the article online at http://citywire.co.uk/money/article/a534443

Savers subsidise homebuyers by £100 billion a year

The Bank of England's low base rate is subsidising homebuyers at the expense of savers, says Lorna Bourke.

 
Savers subsidise homebuyers by £100 billion a year

The Bank of England's low base rate is subsidising homebuyers at the expense of savers, says Lorna Bourke.

£100 billion subsidy

Inflation at a frightening 5.6% – or ‘only’ 5.2% if you believe the consumer price index – is devastating for us all, particularly as incomes are static or even falling. But it is far worse for savers, who suffer erosion of their spending power, than for borrowers, whose debts are inflated away while they pay record low rates. 

Figures from HSBC have revealed the massive extent to which savers are now subsidising borrowers. Savers are paying more than £100 billion a year as an interest-rate subsidy to borrowers, while suffering a massive erosion of their savings – and there is little or nothing they can do about it.

Savers massively worse off

HSBC looked at the relatively recent past – in 1984, 1988 and 1991 inflation was running at around 5% – and compared the figures with today. It found that the average saver now holds three times more than in 1991, yet earns only a third of the income. 

Meanwhile, mortgage borrowers have four times the debt on average, but pay only £3 billion more in interest today than in 1991 when bank base rate stood at 11.6% and the average mortgage rate was a massive 11.39%. In 1991 total mortgage debt was £320 billion, while total mortgage interest paid was £36.44 billion. Today total mortgage debt is £1,242 billion, but total mortgage interest is £39.6 billion.
 
In 1984, 1988 and 1991 savers could invest at double the rate of inflation – around 10%. Today savers receive a return averaging just a fifth the rate of inflation or 1.1%. The average mortgage rate today is around 3.2%, well below the rate of inflation, compared with 11.39% in 1991. Today’s homeowners typically borrow at just 60% of the rate of inflation, versus almost three times the rate of inflation in 1988.

Is this fair? Clearly not. Although homebuyers today have to borrow a larger multiple of their earnings to buy a home and house prices are currently stagnant, over the longer term property has been an inflation-beating investment  – and is likely to be so in the future. 

House prices and inflation

House prices doubled between 1997 and 2007, while inflation over the same period was 40%. Even taking into account house-price falls over the past four years, those who have owned property for 10 years or more are still well ahead of the game. In addition, people have to live somewhere, and in some cases mortgage repayments are now lower than rent. The high deposits demanded by the lenders are the real obstacle, not the monthly repayments.

So why would savers put their money into a bank that lends the money to a homebuyer who is acquiring an appreciating asset at a subsidised rate only to receive a rate of return that erodes their spending power? Because that’s what the government wants them to do as it hopes to inflate away its own debts.

Although borrowers have never had it so good, savers have never had it so bad. You would have to look back to the mid to late seventies, when inflation hit 27%, to see savers suffer as much as they do today. 

Inflating away debt

In the past the government was keen to bring inflation down, so in 1984, 1988 and 1991 the bank base rate was roughly double the inflation rate and mortgage rates topped 11%. Today, at 0.5%, the base rate is just a 10th of the inflation rate, giving us a clear indication that the government has no intention of containing inflation, as it needs to inflate away its debts. 

As Bruno Genovese, HSBC’s head of savings, observes, ‘the government and Bank of England have been clear their priority is low interest rates. Without them, the government will pay more to fund its deficit and more consumers may struggle to meet their debt repayments. The hope is that eventually, low rates will tease growth out the economy by stimulating businesses and consumers to invest and spend.’ 

It isn’t difficult to see why the government is reluctant to increase interest rates. In 1991 total mortgage balances outstanding were £320 billion, and we owed just £9.8 billion on our credit cards. Today homebuyers owe £1,242 billion on mortgages, four times as much. But credit card borrowers owe a massive £57 billion, nearly six times as much, with a substantial proportion likely to become bad debt.  Credit card companies are writing off debt at the rate of around £4 billion a year – which is why responsible credit card users are paying around 18% for credit.

The current situation is grossly unfair to savers and those dependent on interest to subsidise income, and with little hope of any change the outlook is gloomy. By squeezing pensioners and others dependent on savings for income, the government will force them to spend capital. When that is gone they will become yet another burden on the taxpayer, creating another vicious downward spiral. 

16 comments so far. Why not have your say?

Another Pensioner

Oct 19, 2011 at 12:53

If the low interest was being passed on to home buyers, then this would be true. However, it's the bankers that are reaping the rewards at the moment.

report this

David 111

Oct 19, 2011 at 13:01

It is clearly the Government's policy to inflate its way out of its problems. This not only results in a massive transfer from savers to home-buyers (funny how some people can still argue that the baby boomers are having a laugh at the expense of younger generations) but also from savers to the Government. The latest round of QE will only increase the inflation we are all experiencing.

My personal take on this is that it is folly to hold assets which will not keep place with inflation (most notably cash) and best to try to seek assets which are as inflation proof as possible - equities and possibly property.

report this

Cockney Dave

Oct 19, 2011 at 13:04

another pointless story from citywire, i do wonder why i bother with this website half the time. This is stating the bleediing obvious readlly and we do not need HSBC to remind us of this.

I have some savings, and out of curiosity i went through the loan section of natwest to see what sort of interest i would pay on 25k, it was 11.9%. Now considering i have a fair amount in natwest paying me 2.8% how can this be legal even. Its a joke really. I do not own a home, and it annoys me that thise in debt are constantly looked after while i and many others bare the brunt to this whole crappy situation.

P.S, Citywire editors, please buck up your ideas and have better stories as they are getting weaker and weaker and more pointless

report this

Dek

Oct 19, 2011 at 14:15

Hi Lorna.

I have been quick to criticise you on some pensions articles you have produced but, despite the facts being "... bleeding obvious ...." as Cockney Dave so colourfully puts it, I am grateful for an article which takes all the different aspects of interest rates to borrowers and savers and puts these in a historical context.

Mervyn King's recent pronouncements hint at the fact that the position being taken by the Bank of England and the Government over the economy and especially interest rates is not sustainable in the long term. The reality is that house prices have been artificially lifted due to relaxed borrowing criteria in the late 80's and early 90's onward. Prior to this you would have needed a minimum 5% deposit and would only be able to borrow 3x your JOINT income; 2.5x if a solo application. This resulted in massive house price inflation and unsupportable private borrowing on the back of the resulting positive equity through the late 90's up to and including the credit crunch (and arguably beyond). This was mirrored by irresponsible state borrowings over the same period supporting what were unrealistic and inefficient state service provision.

As an example, I still find it incredible that we have managed to massively over pay for the procurement of two new aircraft carriers one of which is immediately mothballed and the other that we can’t afford to put aircraft on. To say this was insanity would be to insult the insane.

To unwind this is going to be very painful (an understatement if there has ever been one) but unwound it must be. Neither individuals nor the state can live on credit for ever. The problem is that we have brought up a whole generation of citizens who have never experienced any other way of life. Now we are asking not those who have borrowed to support their unaffordable lifestyle to pay but those who have been prudent and tried to make sensible provision for their future to pay the piper. In practice paying twice for very little real return.

It turns out that all those friends and acquaintances of mine who have splurged on the latest cars, clothes, gadgets and houses, that they couldn’t really afford, seem to have got it right. Is this really the behaviour Government wants to continue to promote longer term?

Let’s hope that Mr King can refocus soon on what is supposed to be his primary task of maintaining control of inflation and thereby get back to a realistic balance between saving rates and inflation.

Sorry for the moan guys but for once I agree with most points in this article and I genuinely believe that savers are being largely ignored by both the financial press in general and by Government policies.

P.S. My glass is still half full though.

report this

Marketwatcher

Oct 19, 2011 at 14:26

In the past it was possible to inflate one's way out of debt as income increased - as one's income increased, so the relative value of the debt fell. However, with little or no growth in GDP, rising unemployment and meagre salary increases for those in work, where is the rising income coming from?

report this

Chuck

Oct 19, 2011 at 15:58

Don't moan. Learn for the next time: get in with the boom, load up on debt, load up on property, load up on luxuries. The savers feel like fools because they didn't join the debt party but next time they will. The UK will be in the same position again because NOBODY will believe anyone that says "be prudent".

The more people that join the party, the less choice the BoE will have but to support it. Otherwise the UK will have a slowdown and dreaded deflation.

report this

Kevin Bonkers

Oct 19, 2011 at 16:15

"So why would savers put their money into a bank that lends the money to a homebuyer who is acquiring an appreciating asset"

...and just what's appreciating about a house? Prices are falling and will continue to do so. Stupid comment.

report this

Anonymous 1 needed this 'off the record'

Oct 19, 2011 at 16:32

David 111,

The transfer from savers to borrowers (home buyers) is true. Savers with a reasonable amount of money are likely to be the older members of society who have built up savings over many years. Home buyers are more likely to be older or managed to get on the ladder before prices trebled. These people may not be old but they certainly aren't under 30. Money circulating in the older members of society, which I think is the point you were making.

Without a very significant, politically damaging correction (crash) happening due to government policy of propping up the borrowers at all costs, obviously unaffordable prices will continue. These are the prices the young buy at (although currently fist time buyers are 40 ish?) and hence the transfer of wealth between generations. The young are either shut out of the housing market altogether or take huge risks in an enormous mortgage hoping the government will support the market as they did for those before them. They then pin all their hopes on house prices continuing to increase as they can't afford to save/invest once their mortgage has been paid for.

The lack of house building is a factor but is almost always overplayed. I don't know the figures off the top of my head but lets assume no houses were built in the last 20 years. Immigration, growth of single person households, planning policy etc etc etc accounts for an increased demand of x% (10?, 25? 150?) over those 20 years. Does this warrant house prices to increase by 300% in 10 years, let alone the increases in the other 10?

The key to house prices increasing was the amount of credit available. An off the books special purpose vehicle would be created by a large financial organisation and mortgages would be made. Critically, the mortgages (the risk) would be packaged up and sold off in tranches (a Mortgage Backed Security Credit Default Swap, MBS CDS) to get the risk of their books to get around the capital reserve requirements, freeing up money for further lending. Margins start to get thin with good borrowers as more investment banks jump on the band wagon so "innovators" begin to lend to less reliable borrowers, everyone believes a new paradigm of prosperity is upon us, everyone can afford the house and life they deserve. For the banks. the more money they lend, the more money they make and it is pretty much risk free as the risk is sold on each time (there is a risk to the bank if they don't sell all the tranches as they are underwriting them and will end up owning them) Instead of using mortgages as security, batches of MBS CDS are used to make MBS CDS of MBS CDS (MBS CDS squared) by the innovators that spreads the risk far and wide. Margins become thin and so they moved to sub-prime borrowers. It doesn't matter if they default as they risk is sold onto investors in MBS CDS deals. Sub prime inevitably defaults, the losses spread through every part of the financial world as it is impossible to tell who has what risk, credit that was relied upon on a lot of business plans dries up and the rest is history.

Unless credit returns to levels seen before recession, house prices are heading down. Basel III will increase capital reserves to 9-11%? Before the recession, the reserves were 1-2%. Doesn't sound like much but they use fractional reserve accounting so the effects are amplified. If the government finds a way to open the flood gates to credit (unlikely), the next generation will be buying houses at artificially inflated prices, transferring wealth between the generations. As government policies would only be able to support the prices for so long before a crash, those that buy before prices revert back closer to long term trends after gross distortions in the market will crystallise the gains made by the previous generation.

report this

Dek

Oct 19, 2011 at 16:47

Evidence Kevin evidence!!!

Price house falls have been minimal. Certainly no fall as experienced in the mid 80's when we had the last "price bubble" that burst.

If you are seriously telling me that the property ladder's first run is within reach of the average 25 year old without significant help from "Mummy and Daddy" you aren't in the real world.

The reality is that "Buy to let" is still propping up the market and house prices will not fall while there is a shortage of property and lenders are reluctant to grant an advance unless the applicant has 10 or 15% deposit.

The demand for housing (and therefore the basic stability of and lack of a appreciable readjustment to market prices) is not coming from the traditional first time buyer as the base line of the market. 3X pay would in the 70s and early 80s have secured the necessary mortgage for most young couples and the deposit though hard to save was achievable. In a market where the lender would much rather provide funding to a "Buy to Let" client, with collateral backing them, the turnover and volume of mortgages granted is misleading.

Basically it is a skewed housing market compared to that of the last 40 years or so where the demand has a significant element of “Buy to let”, taking advantage of very low interest rates to generate long term capital growth and high rental returns to cover off the mortgage repayments.

However, just because it is a different market doesn't mean to say that it will change. The country may have to accept that the great dream of a predominantly home owning democracy has gone. They seem to manage without in most of Europe and as a result have more stable hose prices overall (excluding those areas where Brits are buying second homes).

This article quite rightly points out that this is mainly driven by cheap loans to those who can mange to persuade their banks or building societies to part with the cash.

If you want to see what a fall in property market prices really looks like have a look at Spain.

report this

Charles Zub

Oct 19, 2011 at 16:59

We were always going to see a readjustment of savings when the "baby boomers" came up to the age of retiring. Throughout their entire working lives they have never really been as rich as they would like to think they were. This was due to over-inflated earnings, and distorted exchange rates with our main trading partners. Exchange rates have been manipulated by exporting countries, and speculators. The traded price of a currency is not a realistic value of the exchange rate. The most realistic figure would be to look at the cost of living for middle class people in the other countries -- that would give you a real exchange rate, not what we have today. The British, the Europeans and the Americans have had a life style that is grossly above the incomes that they have generated. The microwaves, blenders, etc. that we have been purchasing have been at a distortedly (sorry for making up the word, but I think you know what it means) low price. We are not as rich as the goods that we have bought . We are not as rich as the money we have saved, because it was done over-inflated earnings that cannot be justified under any extent. If the exchange rates correct themselves with our major sources of household goods, then we could easily see ourselves paying four times what we do now. Are we really as rich as we thought we were? No,and it has to be adjusted. It is sad that people were mislead into thinking that they had more wealth than they really have, but there is little that can be done about that.

Quantitative easing will not cause the inflation that will be coming. I do not know where anyone got the idea that "quantitative easing" would cause inflation. Quantitative easing is a transfer payment (from the poorer to the banks), and it will only impact on inflation if these transfer payments are spent. So far the banks have pocketed the money, and not even lent it to consumers. The inflation will come because of the adjustment in the price of the goods that we buy. They have been grossly overpriced. We cannot buy ourselves out of this recession because we have already hocked the family jewels and silverware (gold as well -- the UK sold its gold reserves when the price was very low). We have to get our debt down and live within our means in the future. There is no new economics where we can just spend and spend -- it is over (I hold a degree in economics as well as other areas for your information).. We have Richard Nixon to thank for all the problems that we now have. He took the world off the gold standard. The gold standard had many flaws, but it had the feature of being self regulating and forced countries to live within their means. He also normalised relations with China, which is now coming to haunt everyone. China can be good for the world if exchange rates are at a realistic level.

We can look at the Great Depression, and the post 1974 era for guidance. The former probably does not offer much guidance. Virtually all of the programmes that were tried did not work, especially in the USA. It was only World War II that got the USA out of the Great Depression. The post 1974 era is probably the best for any guidance, and although we were "not as rich as we thought we were" at the time, it was not as bad as it is now. Also, at the time we did not have a Bank of England and Federal Reserve that had become totally separated from reality, and not responsible to anyone. They have mortgaged our future, as well as that of our children and our grandchildren and possibly their children. They are responsible to no-one. They should be elected on a short term basis like the USA House of Representatives, so that they are responsible to the electorate. They cannot mortgage future generations off of their own whim, or to protect their friends. Let people vote them out every two years, and make them state what they stand for.

Back to 1974. We were not as rich as we thought we were back then. I do not know if anyone remembers the word, but it was "stagflation" -- inflation with no growth. It is the price that was paid for effectively living beyond our means. We had inflation, very rampant inflation. At the time I had two mortgages (I bought the other half of the semi-detached house I lived in) and inflation went to 22%. All mortgages were on variable rates. Boy, was I ever in trouble. Peoples wealth was eroded by the inflation that occurred. We could not turn on growth, until a new mega industry was created, and that only had limited impact in the early days -- this was the computer industry, which has affected every aspect of our lives and the world economy. The computer industry had two advantages. First it was started by people that had no business school education, and they were starting what were effectively family businesses. Therefore they did not have the philosophy of having to make the next quarter's earnings, and they thought long term decisions had a focal length of 20 to 30 years (what would make their company a great company), not what is considered long term now, and the business schools were a major factor in this -- three years is considered long-term planning, and sometimes it is only eighteen months. We became divorced from that for a period of time as the people that created this industry were not "educated" (I also hold an MBA from one of the leading business schools). The second thing was that they created an industry that was to permeate every aspect of our lives and the world economy.. It created the engine for growth that was necessary to end the very bad period that we were through. Also, the Bank of England and the Federal Reserve did not magnify the problems that existed. Creation of the computer industry was far better than World War II as a means of getting out of the economic problems at the time.

What did 1974 teach us? It is unlikely that we can the rapid inflation that occurred then. At least it will mean that our grandchildren and their grandchildren will not be burdened by the actions of the Bank of England and the Federal Reserve. We are going to have to accept the fact that savings will erode. People who are riding high on variable rte mortgages will pay, as mortgage interest rates follow, or even lead inflation. They will have great difficulty keeping their homes. If they make it through, they will benefit from being able to pay off their mortgages with "funny money", not real money.

I think both equities and bonds are both misguided investments in a period of rapid inflation. The former because most companies, even the largest, are torn apart because of the inflation -- not a good investment until they have been restructured for the new world. Who is going to take Lord Hanson's place? The later because like all savings, including bonds, will deteriorate in value. They will be paid back with "funny money".

What did we learn from 1974, that might help us now? One thing that happened during the period of stagflation, at least in the UK, was that many large companies only paid invoices against a writ. The longer you can delay paying your bills, the cheaper the money is that you will be paying the bill with. Banks were mysteriously delaying transfers of peoples money, to earn the high interest rates at the time. I do not advocate this. It is not much different than theft. Property followed inflation up, but with a lag. So, a fixed rate mortgage during the period of rapid inflation will mean that your equity is maintained fairly well, and you get to pay off the mortgage with funny money. You will do pretty well. The other thing that becomes important in business is the speed of turnover. If you can buy the goods in the morning, sell them during the day and start the cycle again the next day, you can keep as close as possible to inflation. Regardless, it will be hard. The post '74 era was devastating. What is coming will probably be worse. Baby boomers who thought they were going to live a lavish life style in their retirement had better face up to the fact that they need to stay in work during ths period of time retiring much later, and without the lifestyle they expected. Is it their fault? No, but they benefited from it and are now going to pay the price, even if they did not do it intentionally, but only did what everyone else was doing.

I doubt that anyone will read a comment of this length. The world is now accustomed to the text equivalent of a "sound bite" It is what the world revolves around, but some topics need serious discussion. Let's hope.

report this

Dek

Oct 19, 2011 at 17:57

Hi Charles.

For your comfort, and at risk of a "Sound Bite" response/comment:

Read in full

Understood - mostly

Agreed with - partially

I started work in 1973 and so have lived through and have vivid memories of all you describe. Despite this those who have NOT succumbed to the consumerism of the last 30 years will as you suggest suffer the consequences of unsustainable growth and disproportionate spending capacity (I use this word on purpose as opposed to wealth in recognition of your point that the perceived level of wealth in the "West" was and is in reality an illusion or perhaps best described as a mirage).

In principle I think we do agree on most of the points you raise but maybe disagree as to the size and timing of the impact of such a global readjustment.

In essence my glass is still half full even after reading your views.

report this

vivekanandan nagarajan

Oct 19, 2011 at 18:11

Not only UK but rulers in all countries have not tried to regulate the the prices in line with per capita income. In India you require 30 to 50 years of a family savings is required to buy an apartment of very average quality. Japan,US and the entire EUrope got into the mess due to this property prices. India and China are following the footprint of the west. Only diff is Asia is buying with unaccounted money so the banks are not damaged in the process. Asians are not financially not educated.

report this

S M

Oct 19, 2011 at 18:16

Unfortunately some borrowers have not got the message.

Still stretching themselves to the limit and not paying off loans.

Its created a culture that is far from healthy

There will be some screams when interest rates inevitably do go up. The localisation bill passed, the Planning laws revised and house prices plummet, particularly in the over inflated SE . .

Savers have been penalised for doing the right thing, about parr for the UK in the 21st century . .

report this

Charles Zub

Oct 19, 2011 at 18:48

Hi Dek,

I did not commit to a date for the inflation because I cannot see any way that you can tie that down. The problem is there, but government action can push it off. It won't get rid of it, but it makes anticipated timing for it difficult. Regarding size, my comment relates to what we buy -- hard goods, foodstufs, etc. Overall, I think three to four years of 20% to 25% inflation will go a long way to re-establishing a balance that we can live with. After all we are living with politicians, you cannot expect them to get rid of all debt.

You had more nerve than I did. I considered using mirage, but stepped back from it. You are absolutely right to use the term.

report this

Recently Redundant and Retired

Oct 20, 2011 at 14:11

Inflation I think is not such a bad thing, it does redistribute wealth and helps with growth. It also enables Companies and HMG to control or reduce pay and benefits by not increasing either by the true rate of inflation.

Inflation is good for those in work with debt, these are predominantly the wealth creators who make society work.

After 40 years of creating wealth and benefitting from inflation, I accept that part of my accrued "wealth" will be redistributed to the younger generation through inflation, just hope it doesn't get out of hand.

I agree long posts tend to get overlooked, life's too short, hope mine is the right length.

report this

Charles Zub

Oct 20, 2011 at 16:42

Dear Recently Redundant and Retired,

I think you are right. We need a redistribution to adjust for the fact that

people think they are richer than they really are. Wages, savings, etc.

have to be adjusted to as rich as people really are. Although many people

will complain that they are being unfairly hurt, I agree that this is the

fairest way. It is hard for people to accept that they have been overpaid

all of their life, and that the savings they have (including pensions, etc.)

are not really there. It could even help to adjust house prices, though they

do appear to follow inflation up normally. This time an adjustment here is

needed.

If inflation is not the adjustment process that is used, then I believe we

will have an awful lot of people losing their houses and going bankrupt. I

think that is a more damaging scenario. The question is, will three to four

years of 20% to 25% inflation be best, or is 5% to 6% a year the best. I

lean toward a short sharp shock, i.e. three to four years of 20+% inflation,

so that we can then establish a reasonable base and get the economy growing

again.

report this

leave a comment

Please sign in here or register here to comment. It is free to register and only takes a minute or two.

News sponsored by:

The Citywire Guide to Investment Trusts


In this guide to investment trusts, produced in association with Aberdeen Asset Management, we spoke to many of the leading experts in the field to find out more.

Watch Now

Today's articles

Tools from Citywire Money

From the Forums

+ Start a new discussion

Weekly email from The Lolly

Get simple, easy ways to make more from your money. Just enter your email address below

An error occured while subscribing your email. Please try again later.

Thank you for registering for your weekly newsletter from The Lolly.

Keep an eye out for us in your inbox, and please add noreply@emails.citywire.co.uk to your safe senders list so we don't get junked.

Read more...

The Accumulator: FTSE see-saws on trade war fears

by Michelle McGagh on Jun 22, 2018 at 14:57

Sorry, this link is not
quite ready yet