Tax Cuts and Falling House Prices - really bad news?

Gordon Brown and his rivals have come out this week with tax cut proposals ahead of the pre-budget report which is expected next week. One thing they all agree on, consistent with the announcement of such cuts in the US and Germany, are that tax cuts are a useful tool during an economic crisis to increase consumer spending. The theory is simple, people pay less tax, they have more disposable income so they spend more (interest rates are low so incentive is to spend rather than save). Sounds like good news right?

The problem arises when the question is asked "how will the tax cuts be funded?"

The government is currently 43% of the UK's GDP or approx £640bn. A lot of this debt was accrued during the economic expansion and was used to fund public ventures (health care, education, etc). One obvious issue is that by lowering taxes now the government are prolonging the time it will take to pay it back - hence future generations will be burdened by our debt for which they will see little benefit (lower taxes now mean higher taxes in the future).

This is not my main concern. And this is ties in closely to falling in house prices. A cut in taxes could lead to a deterioration in the standard of living. All forms of public services run the risk of suffering cutbacks, the NHS, emergency services, public transport, schools, just to name a few. In my opinion, the public sector is full of unnecessary bureaucratic paper pushers burdened by inefficient management who have no incentive to streamline practices like competitive private firms (my economist side rears it's head!). And I doubt tax cuts will make the system efficient, but could rather reduce further the (somewhat questionable) levels of service. As a nation, we enjoy a high standard of living supported by our public services despite the issues I have highlighted above, if all of a sudden we were to find things not up to the standard we have grown to expect, I think many people would be angry.

In this weeks Money Week magazine, in a discussion about the outlook post the Troubled Asset Relief Program (TARP) in the US, have noted:

"According to John Hardy at Saxo Bank, the “best case” outlook from here is that the housing market bottoms out in 2009 as Tarp limits further price falls to around 10%. Foreclosures fall sharply as mortgages are rewritten, allowing most people to stay in their homes, and by the end of 2010 much of the unsold housing stock is absorbed. The more likely “middle case” would be that house prices fall a further 20%, while a sharp recession forces unemployment above 8% by 2010, and consumption contracts faster than ever before. Glimmers of a recovery might appear by 2011. But in the worst-case scenario, America lurches into depression, with GDP collapsing at its fastest rate since the 1930s. This lasts well into 2010, with unemployment nearing 10% and ‘underemployment’ approaching 25%. The housing slump grinds on into 2011, with some suburbs turning into looted “squatters’ towns”. Public unrest and criminality become endemic."

It may seem a little extreme, but the last scenario is a definite possibility. One only needs to look through history to see the social issues that have accompanied economic instability. Add this to the insistence of Mr.Darling that government economic policy should be implemented in accordance with Keynesian economic theory and we have a potential disaster! The theory that governments should save public money when times are good and spend on public ventures when times are bad is itself a good one. When the economy is growing, cut public spending and jobs so that when things get bad and private employment levels fall (as we are seeing now - unemployment is at an 11 year high) the government spends more money on public ventures (building schools, hospitals etc) which itself creates public jobs. Sounds good...apart from the fact that during the 'good times' the government increased public spending (government debt increased) and public employment is over-inflated. Why is it that Darling cannot see such an obvious fundamental flaw to his proposal??!

Going back to house prices - as a first time buyer looking to get on the property ladder, falling house prices is great news. The fact that the bubble did not burst sooner is testament to how sub prime debt was packaged in such a complicated manner by so called financial geniuses. According to the HBOS UK House Price Index prices have fallen back to what they were in mid-2005. I'd be looking for prices to fall to levels at the end of 2003 which is a further 18% drop before we even consider to be looking at the bottom of the market.

FTSE....

I hope people took some notice to my FTSE chat on Friday...if anyone was tracking the markets you would have seen the support and resistance points I mentioned come to fruition this week. The announcement of China's $586bn stimulus package on Monday gave the markets confidence, but that feel good factor soon wore off.

As you can see the FTSE touched the 4545 level which as a major resistance shows a sell signal. Further shorting opportunities at the 4440 and 4335 can also be seen as it hovers around those levels (add to the existing short position). In total from the top to the current level, one could have bagged 310pts. At £2 a pt and increasing the stake at each level one could have made £1550 (not considering he cost of the spread)!

Who said trading was difficult?!!

UPDATE - by the time I finished writing this the FTSE hit 4200 which is a recognised support. Closing here would have caught 345 pts.