The perils of Persimmon and how easy monetary policy helped create excess profits

One of the main themes of my work is that  the monetary easing by central banks has boosted asset prices, but the catch is that for example rises in house prices are inflation for the first-time buyer as well as those trading up. So the theme that it is all wealth effects is untrue. But we find that the effort to pump up house prices has also involved governments and in the UK much of this has been focused on the Help To Buy scheme. There are two main problems with this of which the opening one is simply that if you give people “help” in this form it is only brief because house prices rise to the new amount that can be afforded rather quickly. This creates windfall gains for existing home owners and the companies that build the houses. It is the latter we will focus on as there is a candidate in number one position for earning what in my days as a student were called “excess profits”. So one bit of economics 101 exists even if it is only good news for the shareholders and managers of in this instance Persimmon Homes.

Persimmon

From Reuters earlier.

Britain’s Persimmon Plc, which is under scrutiny from the government for its practices under the “Help to Buy” scheme, on Tuesday named interim Chief Executive Officer Dave Jenkinson to the role on a permanent basis.

The company, whose former CEO Jeff Fairburn stepped down last year amid backlash surrounding his bonus package, reported a 13 percent rise in full-year pretax profit to 1.09 billion pounds ($1.43 billion)

So profits are now over a billion pounds and we can remind ourselves that at Persimmon profits were at an excess level on an individual basis as we go back to the 22nd of October last year.

The boss of house building firm Persimmon has walked off in the middle of a BBC interview after being asked about his £75m bonus.

“I’d rather not talk about that,” Jeff Fairburn said, when asked if he had regrets about last year’s payout.

The £75m, which was reduced from £100m after a public outcry, is believed to be the largest by a listed UK firm.

In this instance we can spell excess profits with one word, greed. Returning to the company itself I explained back then how the excess profits were built up.

But the real problem is that Help To Buy provided what is called in economic theory excess profits for housebuilders. We have looked before at how it helped them to make high profits on the sale of each house and it also boosted volumes in a double whammy effect.

This morning we have been provided with some numbers to that effect. From the BBC.

Almost half the homes it built (7,970 out of 16,449) sold through the Help-to-Buy scheme Average selling price of all its homes: £215,563…….Mike Amey, managing director of global investment management firm Pimco, told the BBC that profit per household at Persimmon had trebled since Help To Buy was introduced.

I think he means per house built but we get the idea. So we see that Help To Buy has allowed Persimmon to build more houses at treble the previous profit. This has led to this.

The Persimmon money machine rolls on, profits past the £1bn mark and £2.2bn returned to shareholders in the past seven years, with the promise of more – much more – to come. ( BBC)

When Help To Buy started back in April 2013 the share price was around £9 as opposed to the current £24 and of course as noted above money has also been returned to shareholders. I guess that avoids the rise in the share price becoming even higher. As the current market capitalisation is £7.6 billion according to Investing.com the extra dividends have been both significant and material.

Shoddy Work

This is a section my late father would be more than happy for me to emphasise. His work as a plastering subcontractor saw him work on one estate which was built so badly it was easier in the end to knock it all down. Another was where the architect was proud of his inward sloping balconies and ignored warnings of the dangers, well until it rained anyway. So let me note that the excess profits have not been accompanied by high quality work.

Persimmon has been dogged by complaints about poor build quality among Help to Buy customers – with satisfaction rates remaining below its 4-star target of 80%. ( SkyNews )

Reuters have suggested the housing minister James Brokenshire is now on the case.

However the company – along with some others in the sector – has attracted criticism for practices such as selling houses with rising leasehold charges which make them hard or impossible to sell on, and for poor quality workmanship.

“Leasehold, build quality, their leadership seemingly not getting they’re accountable to their customers, are all points that have been raised by (the minister) privately,” the source said, echoing a report in The Times newspaper.

The issue with leasehold charges is a national disgrace. The issues concerning leasehold and freehold ownership were supposed to have been settled years and indeed decades ago. Yet the scandal goes on and nothing has been done about it.

Comment

The environment remains extremely favourable for the likes of Persimmon and it continues to receive a bit more than a helping hand from the Help To Buy scheme. This is because whilst we have seen some house price falls these are mostly around central London where prices are too high for Help To Buy anyway. We are left to observe a scheme that has enriched one group of people the shareholders and massively enriched the managers and directors. It is not as if the quality of the work has been high and in fact the reverse seems to be the case.

There is a clear issue in the way that these things have been allowed to persist as we all make mistakes but even if we give the government a free pass on the first year or two we cannot give it a free pass on the way it has allowed this to persist. I do hope that government ministers will not in the future be joining housebuilders boards of directors.

If we move to monetary policy there may be further relief for house builders if the evidence of Sir David Ramsden to Parliament earlier is any guide.

I agree with the MPC’s collective view
that the monetary policy response to Brexit, whatever form it takes, will not be automatic and could
be in either direction.

Also Governor Mark Carney points out this.

Although the principles guiding the MPC’s choice of threshold still hold, the creation of the
Term Funding Scheme had reduced the effective lower bound on Bank Rate from ½% to 0%.

Also the Governor has got himself into something of a mess with this statement.

The MPC now views that the level from which Bank Rate can be cut materially is now
around 1½%.

So the cut from 0.5% to 0.25% was not “material”? Odd because I recall him claiming that it has saved around 250,000 jobs……

 

The problems of UK house building and prices are a result of government policy

This morning has brought news from the UK government on an area which is regularly reported as being in crisis ( housing supply) which brings us to a related area which has been in recession since the early part of last year ( construction). From the BBC.

Construction firms that have been slow to build new homes could be refused planning permission in future under a shake-up to be unveiled by Theresa May.

The PM will tell developers to “step up and do their bit”, warning that sitting on land as its value rises is not on at a time of chronic housing need.

There are various issues here as a fair bit of this is vague such a “slow to build” and doing your bit may be far from sufficient incentive to house builders who in some cases have been doing rather well.

Bonuses in the construction sector have been under the spotlight since Persimmon announced last year that 140 staff would share a bonus pool of £500m and that its chief executive was in line for a pay-out of £110m, a figure that has since been reduced by £25m following an outcry among investors

As an aside if £110 million is so wrong I find it fascinating that £85 million is apparently okay! Still at least something was done. As to the concept of housing need the Joseph Rowntree Foundation has crunched some numbers.

Independent analysis shows that an average of 78,000 additional affordable homes (a mix of low-cost rent and shared ownership) are required in England each year between 2011 and 2031. This level of supply is required to meet newly-arising need and demand.

 

Delivery has been falling short. On average 47,520 additional affordable homes have been provided in England each year since 2011, leading to a cumulative shortfall of 182,880 homes over the last six years. A step change is needed to boost supply of affordable homes by at least 30,000 more a year.

That seems a lot lower than what we are usually told which reminds us that such numbers are open to more than a little doubt and speculation. This poses a problem for a government increasingly heading down the central planning road.

Let me add another issue which is that a factor often ignored is that it matters where you build the houses as well as how many. This often seems to be ignored as for example once you think like that an arrow points at London and the South East. But you cannot just build anything as the current travails only a mile or two away from me at Nine Elms are proving.

The economic depression

There are quite a few problems for economics 101 in the current situation. Firstly you might think that higher house prices would quite quickly generate more supply but it would not appear so. Also the housing industry was supposed to respond to monetary policy and as we find ourselves after a cut and a rise back at the emergency Bank Rate of 0.5% there is much to mull and that is before we factor in the £435 billion of Bank of England QE.

Yet house building responded little to this as if we set 2015 as 100 we get some interesting numbers. The pre credit crunch peak was 2006 and 2007 which were both in the 95s. The scale of the initial hit is shown by the fact that 2009 was 55.4 showing a big hit and then crucially very little recovery as the number oscillated around 70 for the next three years. Along the way many smaller building firms went to the wall as our supply capacity fell and I wonder if that was a much larger factor than often realised. It is hard not to wonder if some support for smaller house builders might have protected us from the need for much larger support measures later. This meant that this sector clearly had an economic depression.

The official response

This provides quite a lot of food for thought for the central planners in Downing Street and Threadneedle Street because in response to the numbers above we saw a two-pronged strategy. In the summer of 2012 the Bank of England deployed the Funding for Lending Scheme which reduced mortgage rates quite quickly by around 1% ( and later by up to 2% according to its research) and made sure the banks had plenty of cash to lend. Then in March 2013 the Guardian reported on this.

In his budget speech, George Osbornelaunched Help to Buy…………This £3.5bn scheme will run for three years from 1 April and help up to 74,000 buyers, as well as providing a boost to the construction sector, said the Treasury.

This saw the UK establishment put the pedal to the metal in this area but the most recommended reply was already on this case.

Another tax-payer funded scheme to prop up house prices. Has it never crossed Osborne’s mind that if people are not able to afford a house on the basis of prudent lending criteria, house prices might be too high and should come down? ( ReaderCmt ).

There was a clear side effect to this as the tweet below highlights.

https://twitter.com/resi_analyst/status/970564907962896384

As you can see the clear effect here was on profits for house builders which surged and financed the payment of extraordinary bonuses for those at the top. This leaves us wondering if the house builders were happy counting their cash and in no great rush to expand supply as they were doing nicely anyway. How much of the effort simply went straight to the bonuses we looked at above?

House Prices

We know that these measures boosted house prices as according to the official series the price of the average house rose from £167,682 in February of 2013 to £226,756 last December. This provided its own problem however because real wages have in fact failed to recover to pre credit crunch peaks so houses became much more expensive relative to them. Yes the wheels of affordability were oiled by ever lower mortgage rates but at these prices demand for house purchase was always likely to dip which puts a brake on supply.

It is however nice to see the Joseph Rowntree Foundation implictly agreeing with my argument that house prices should be in the main measure of inflation.

Real income growth among the bottom fifth of the population in recent years is mostly wiped out once housing costs are considered, with consequences for the living standards of those on low incomes.

Comment

If we look at recent years we see that economic policy in the UK was based on the housing market. It was a type of credit easing and the consequences were higher house prices with large and what can only be called excess profits for the main house builders. No doubt some economic activity was generated but those looking to get a foothold in the market have been hit by high inflation when real wages have fallen. On that basis this is pretty much breathtaking.  The quotes below are from the BBC.

Young people without family wealth are “right to be angry” at not being able to buy a home, Theresa May has said.

Announcing reforms to planning rules, the PM said home ownership was largely unaffordable to those without the support of “the bank of mum and dad”.

This disparity was entrenching social inequality and “exacerbating divisions between generations”, she said.

It is of course true but it is a clear consequence of the policies pursued by what is now her government but before one in which she was Home Secretary. It came on top of house price friendly policies from preceding governments also.  Anyway the speech shows a complete lack of grasp of how the private-sector operates.

Mrs May criticised bonuses which are “based not on the number of homes they build but on their profits or share price”.

Another way of writing the quotes below would say you can only afford the new higher prices if someone who has already benefited helps you.

“The result is a vicious circle from which most people can only escape with help from the bank of mum and dad.

“If you’re not lucky enough to have such support, the door to home ownership is all too often locked and barred.”

That in essence the problem in the central planning approach as the initial problem is the apparent failure to grasp not only reality but their own role in the problem. I fear more central planning is unlikely to help as so far what has been called help has in fact mostly hindered.

Perhaps the biggest irony of all is that house building had responded in 2017 as according to the official numbers it was 20% higher than in 2015.