The next crisis starts here

The Bank of England's astounding decision to cut its base lending rate by 1.5% is likely to have a whole raft of unintended consequences, few of them benign. Thanks to the British public's unhealthy obsession with property, the rate cut will distort the housing market and make the economy ever more dependent on credit.

The Government is playing the populist card as hard as it can, urging the banks to pass the full benefit of the rate cut on to their borrowers, or face the wrath of the public, or at least of Lord Mandelson. The scale of the furore that has been whipped up about this is amazing, considering that the vast majority of mortgage borrowers are either on fixed rates (and hence see no benefit from any rate cut) or on tracker deals, and hence see the benefit automatically. HSBC said yesterday that 97% of its borrowers were in one or other of these categories, though admittedly it is not a huge player in the mortgage market, and the numbers at other lenders may be somewhat different.

In any case, it's not as simple as the Government is making out, as of course the Government knows perfectly well. The whole reason certain banks had to be bailed out is that they were excessively dependent on wholesale funding, the cost of which is only indirectly influenced by the Bank of England rate. Wholesale funding costs, as measured by the LIBO rate, have been falling since the bailout scheme was announced. However, until the spread between LIBOR and bank rate returns to more normal levels, banks can't just cut mortgage rates willy nilly.

Banks also have to judge how far they can afford to cut the rates they pay depositors. Savers are already starting to squeal about seeing their returns cut in order to bail out what they see as irresponsible borrowers. If enough depositors start to redeploy their money out of the banks and into alternative investments, banks won't have enough money to extend new mortgages -- unless, of course, they resort to more wholesale funding, and we know where that leads.

Guess what the "alternative investments" are likely to be. There are already commentators saying that falling returns on savings accounts will drive more investors to consider putting money into the property market. Another group who may well be tempted to think the same way are pension savers, since annuity rates are sure to tumble further as official rates head toward record lows.

Where does this leave the housing market? If banks are forced to reduce the price of credit, they will be more selective about who they lend to. So the first time buyer will still find it hard to get credit, while the better-off will be piling back into the buy-to-let market. A year or so ago, the number of people owning their own homes in the UK fell for the first time in living memory. That's an unwelcome new trend that may be slow to reverse, regardless of how far the Bank of England slashes rates or the Government jawbones the banks.

At the root of all this is the UK's property obsession, and the Government's conviction, egged on by large sections of the media, that the way out of the crisis is to feed the already engorged beast. We're setting the stage for the next housing crisis before we've even seen the full extent of the current one.