I’m rather enjoying this month’s search for a scapegoat for the banking crisis. Pretty much everyone operating in the financial markets is a bit to blame in one way or another. So it’s good to see them all getting knifed in turn – from bonus-crazed traders, short sellers, central banks and the regulators, right down to the general public and their once insatiable appetite for cheap debt.
Also fascinating is the argument about a possible solution and the knee jerk suggestion that it must be something to do with regulation. I’m not entirely convinced on this one. I can see why there is social and a political imperative for some kind of new regulation – the general public are pretty irritated by the banking crisis. But this is complicated stuff, bound as it is to come with endless arguments and decades-worth of unintended consequences.
Banking regulation is nothing to be rushed into. However that doesn’t mean Gordon Brown shouldn’t use this neat little opportunity to quickly slip through a pile of new rules. He should. It is just that he should forget the banks for a moment and focus on an easier target: the property investment market.
Imagine you had a portfolio stuffed full of shoddy and very illiquid shares you’d bought on the cheap and you didn’t much fancy hanging on to for the long term. Then imagine you came up with a fancy ruse to get rid of them. You placed ads in the press promising to make people millionaires if they attended a seminar you were holding at the Heathrow Hilton.
Then, at said seminar, you gave them a lecture about how it was possible to buy shares for less than their real market value. You added that if they followed your instructions they’d be millionaires in just two to three years and you persuaded them to give you £2,000 each to come to a weekend course where you would flesh out the details of your brilliant get-rich-quick scheme.
At that weekend, you give them some files full of educational-looking guff and then tell them they can buy your entire portfolio at a discount to the market price. It is actually a premium but, luckily, your shares trade so rarely that they don’t know that.
You then add a little extra icing to the deal by telling everyone that the more leveraged they are, the more money they’ll make. So you arrange for your mate – who runs an iffy loans company – to lend everyone a pile of cash at not particularly competitive interest rates and take a little cut for yourself.
The result? You’d be rid of the shares. You’d have a pocket full of cash from the fees and commissions you’d raked in. And you’d be on your way to Marbella to get yourself a yacht.
Unless, of course, the authorities got wind of your wheeze. Then you’d be in court. The Financial Services Authority simply won’t allow you to rip people off in this way. You aren’t allowed to give financial advice in the UK without taking a heap of exams. You aren’t allowed to ramp your own shares. You aren’t allowed to make stupid promises about markets without being very very clear about the risks. And if you are caught selling anyone an “unsuitable” investment, you’ll end up paying them compensation.
There is just one exception: if that unsuitable investment is a buy-to-let property. This area isn’t regulated at all. Replace the word “shares” with “flats” in the above ruse and you’ll be just fine. With property, you can tell people any old lie with impunity: that they can’t lose with property in Florida; that buying flats in developments in Estonia is risk free; that there is such a shortage of homes in Leeds that a 100% mortgage will always be covered by rent; that borrowing vast amounts of money is a good way to get rich in a hurry rather than poor in a hurry.
The stories now emerging as a result of this extraordinary regulatory freedom are heartbreaking. Think single mothers borrowing £700,000 to invest in five buy-to-let flats in Manchester, only to find they are unlettable and unsaleable and then losing their original family homes as a result.
Until the government gets around to noticing the human cost of all this, the rest of us should note that, according to Skandia, £30,000 invested in a UK equity income fund 25 years ago would now be worth three times what the same £30,000 invested in property would be worth.
The truth is that property has only gained its reputation as the best investment ever because it is bought with a great deal of debt. That’s fine in the good times. But I think we now all know what happens to highly-leveraged investments in the bad times… and why we should protect small investors from ending up with too much exposure to them.
• This article first appeared in the Financial Times