How a ‘hard Brexit’ could burst the London housing bubble

It looks like I was right when I said the UK was heading towards a hard Brexit. And after all, why not — it’s what’s people have voted for, even though few realise what this means.

The banks are already making plans to shift some jobs out of London into other EU capitals and the French government, usually considered anti-big business, is rolling out the red carpet.

There are some who say “good riddance” to a sector where all sorts of governance scandals have dominated the headlines since the crisis and into which UK taxpayers have had to pour billions to keep it afloat.

While it is true that bank bailouts have cost the taxpayer a lot, a diminished banking sector in the city of London would almost certainly trigger a crash in house prices, which in turn could start a recession.

Yes, I know that house prices are overvalued — a recent UBS report much quoted in the media said London is the second most overvalued property market in the world after Vancouver.

The Canadian city, like London, has been in the middle of a crisis caused mainly by Chinese buyers snapping up flats and keeping them empty as a way to hide their cash from the communist government. It had gotten so bad that Vancouver imposed a 15% tax on foreign property buyers.

In central London, there is the same problem — for decades, foreign buyers have poured cash in London real estate attracted by the authorities’ lack of curiosity about the source of their cash and by the stable laws and low taxation on property.

Still, there are signs that the Brexit vote is changing sentiment about London property. The biggest fear is the fact that the City of London will lose the right to host clearing of euro-denominated derivatives transactions, a business worth trillions of euros.

Another big fear is that London-based banks, investment management firms and insurance companies will lose the “passporting” privileges that allow them to do business anywhere in the EU without having to pass additional regulatory hurdles.

The City of London pays around £66 billion in taxes every year to the exchequer. If half of that is lost, or even a quarter, the government is in deep trouble. If the government loses that much money, it won’t be able to meet housing benefit payments for those renting in the private sector, meaning that either thousands of Londoners will have to move to cheaper cities or private landlords will have to accept lower rents.

This issue would be compounded by the losses of tens of thousands of jobs in banking. One way or another, these jobs support the housing market: people who are paid high salaries are able to support the high house prices.

For the moment, things are relatively calm among those in the property industry.

“There is certainly not the sense that the impact of the vote to leave the EU is likely to be as severe as in the early 1990s when the cost of debt spiralled, or the 2008 financial crisis when the Sword of Damocles hung over the banking industry,” wrote Katy Warrick from Savills Research in a report released in early September.

It’s true that the cost of debt, at least for now, is not a problem because of the Bank of England’s imposition of real negative interest rates. For the moment, it is much more efficient to take on debt than to save money.

However, this could turn around pretty quickly. The Bank of England, along with all the other major central banks, is trapped in the low-forever interest rates cycle. It doesn’t mean that the rates at which banks lend out mortgages will keep tracking the central bank’s rate.

Already, LIBOR has been creeping up: it’s 1.56% now from 0.86% a year ago. That’s despite the Bank of England’s 0.25% official rate. Banks cannot keep shrinking their margins to try to accommodate ever-higher debt brought on by rising house prices, and the government will find it increasingly hard to subsidise house prices via “Help to Buy” programmes.

With domestic buyers finding it difficult to take a first step or move up the proverbial “property ladder,” the foreign buyers will have to prop up prices by themselves. And while there are lots of articles out there speculating that the great exodus of wealth out of China is only beginning, it’s not clear why the Chinese, running away from their own weakening currency, would rush to buy assets in a country whose own currency is set to weaken further.