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There has been a lot of talk since the Northern Rock collapse, particularly from Mervyn King, about the difficult balancing act between stopping the financial system collapsing, and creating "moral hazard". If banks are “too big to fail”, they will always be bailed out, out even if they behave recklessly.

What’s interesting is that moral hazard has generally only been talked about in the context of the banks. Record low base rates and money printing have bailed out homeowners and buy-to-letters and we think the danger of moral hazard applies equally to them.

In the 90’s recession the authorities left the housing market to find its equilibrium level. There were huge numbers of forced sales and repossessions, the banks took losses on the defaults and both banks and homeowners paid the price for reckless investment in the housing market.

This time around "things are different". This time the banks are so weak and properties so highly leveraged that the authorities can’t afford to let the housing market find its equilibrium. They have to bail out homeowners. The housing market, like the banks, is "too big to fail". Hence we introduce the moral hazard issue.

If the housing recovery were to stumble there would be significant consequences for the economy and country as a whole, not just for homeowners. As we know from our 2007/08 experiences the government/ taxpayer would carry the can for many of the defaulting homeowners. Not only does the taxpayer already own [84]*% of RBS and [43]*% of Lloyds TSB Banking Group but who knows how many more banks and building societies would need taxpayer support if UK mortgage defaults rose significantly - possibly more than the taxpayer could afford.

In 2010, most housing market commentators' house price forecasts are constrained by worries about one or all of rising interest rates, unemployment, tax rises, the “double dip” and excess supply.

The “too big to fail” theory allows us to make our much punchier 15% forecast because we think the authorities have no option but to ensure house prices keep rising. The implications for house prices are as follows –

• Firstly, it dramatically reduces the odds of significant house price falls from here;

• Secondly, because it’s so important for the authorities that the housing recovery doesn’t go into reverse, stimuli are likely to be overdone rather than underdone. That means rates will stay low longer than anticipated and more money will be printed to achieve this if necessary. We think this means the market will recover faster and more strongly than anticipated;

• Thirdly, there is the moral hazard issue. Homeowners and buy-to-let investors will get off scott-free despite many of them acting recklessly pre Credit Crunch. We think that means the lessons of the Credit Crunch will be quickly forgotten and once the bubble starts to re-inflate, it will do so very rapidly and with bigger risks being taken; and

• Fourthly, stimulating the housing market sufficiently is likely to have inflationary consequences for both house prices and the economy in general. That means it may be riskier not to own property than to own it!

The big question is whether the authorities would be capable of ensuring a housing market recovery if the economy started to slide again. Would the financial markets let them print enough money if it was needed!? They would have nothing to lose by trying. If the housing market falls signficantly from here we may well end up in a worse situation than we would have done by printing money. 

So, in summary, expects the authorities to do whatever it takes to maintain the housing market momentum and that the “too big to fail” and “moral hazard” issues will be two major factors ensuring the housing market roars in 2010.

* I’ve lost track of how much bank the taxpayer owns so please check these.

Disclosure: There are no stocks mentioned in the article published