Director of Finance Online - Blogs - The Edge » Blog Archive » Interest rates were cut to save house prices – and banks

Director of Finance Online - Blogs - The Edge » Blog Archive » Interest rates were cut to save house prices – and banks

Why are UK interest rates so low? To curb inflation? To help industry? The real reason has been to save the housing market from collapse.

And why would the Bank of England, backed by politicians or all parties, want to save the housing market? Votes from homeowners? Not directly. It is because a slump in prices would leave a large part of the population with negative equity.

Apart from the collapse in consumer confidence that would infect the rest of the economy, that would more than wipe out the savings of millions and leave many with little reason for not walking away from their property and staggering into insolvency.

And that would be a problem for the country’s mortgage lenders. Whether or not they repossess these homes, the banks would have to take the loss on the loan onto their balance sheets – and that would cause a financial crisis far greater than that which engulfed, Northern Rock, HBoS, Bradford & Bingley or RBS.

A haircut on loans of just 10 per cent would wipe out a building society and cripple a bank such as HBoS that already had to make huge write-downs on its non-residential lending. The homeowners can declare themselves bankrupt and re-emerge within a couple of years: the mortgage lenders would have gone under for ever and taken even safe institutions with them.

So by cutting rates to save the housing market, the Bank was actually trying to save the financial system.

And it worked. However ............