Thursday, July 26, 2007

Housing and the Debt Pool

Both Australian and the UK are facing a housing bubble with panicy headlines about housing affordability. Fingers are being brazenly pointed at governments and builders. While the actual cause is best described by Ross Gittins of the SMH in his recent article "Housing Crisis: We Did It Ourselves". Summary: greed of current house owners has pushed up the prices.

Various proposals have been made about "fixing" the problem. However, one fact is conveniently ignored. To "fix" the problem, house prices will have to fall. Not really a politicians greatest wish. Releasing more land, re-developing brown sites (particularly in London), reducing the bureaucracy for planning permission, cutting various taxes and changing tax treatment of investments will help the issue. The single biggest problem for politicians is managing the process that will see house prices stall or fall. House prices are invariable driven by demand, if supply meets demand prices won't rise as quickly.

Is that all that can be done? The fixes proposed will do a lot to alleviate the problem in the short to medium term. It will not fix the debt problem that is tied up into the "housing crisis." Instead, we need to look at how debt is managed for consumers. The debt repayments related to buying a house is what causes the stress. Dealing with this requires more than just lowering interest rates.

So how do we deal with the easy debt problem that leads to the payment stress? The total debt any individual needs to be capped based on their cashflow and the interest rates. This includes store cards, car loans, credit cards and all the other methods of debt.

It works by working out a total debt pool of an individual. The individual then gets to choose who and how much debt an individual provider extends to the consumer. The debt pool is calculated from cashflow and the inverse of the interest rate. This way the debt pool enlarges when the interest rate drops and falls when it increases. This will reduce the opportunity for individuals to fall into repayment stress. A buffer between theoretical debt pool and actual available is use to ensure that the individual never progresses beyond the debt pool.

A side effect of this will be that each individual interest rate change will have more effect as not only does it change the repayments an individual has to make it also changes the amount they can borrow.

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