LONDON (Reuters) - Damaging swings in house prices could be greatly reduced by creating a market for third-party equity investors and would reduce reliance on interest rates and other policy tools to try to control the market, a top Bank of England official said.
Property markets in Britain, the United States and other countries are recovering from a sharp fall during the financial crisis. In Britain, government stimulus schemes have helped spur demand but the market is still seen by policymakers as a potentially weak link in the financial system.
BoE policymaker David Miles said allowing external investors to take an equity share in home purchases, in exchange for a slice of any future rise in the property's value, would leave homebuyers less exposed to the risk of falling prices and less willing to borrow heavily to bet on the chance of rising prices.
"High leverage is at the heart of problems in the housing market, he said in a speech to be given at the Dallas Federal Reserve on Thursday.
The "blunt instrument" of monetary policy or more targeted macro-prudential tools to curb risky lending can control leverage.
"But more fundamentally, use of outside equity might be a way of bringing down reliance upon debt financing," Miles said, taking up an idea he floated in another speech two years ago.
Switching 20 percent of funding for house purchases away from mortgages to outside equity investors could reduce the probability of a house being worth less than the value of the loan from 10 percent to 4 percent, Miles estimated.
Extrapolating this to the U.S. housing market, the share of homeowners caught in a so-called negative equity trap could be reduced from 14.5 percent now to 10 percent, he said.
That could have meant fewer people walking away from their debt during the 2008 crisis, lower mortgage-servicing costs, fewer foreclosures and less severe losses for banks. "The Great Recession could have been less severe," Miles said.
While Australia has developed shared equity funding, Miles acknowledged there were significant barriers to creating such a market. But he cited demand for the original part of the British government's Help To Buy scheme, which offers similar equity loans in a bid to spur new home building.
Miles said the downside of raising interest rates to prevent a housing bubble would be the impact on a broad range of asset prices and savers. It would also have a disproportionate effect if applied when house prices were rising faster than consumer prices, given the low weighting of housing in inflation indexes.
"That problem with using monetary policy to stabilise the housing market would be acute if housing markets were overheating when the wider economy was not," Miles said.
Reporting by William James; Editing by William Schomberg and Hugh Lawson