For more than five years, British interest rates have been at their lowest for more than three centuries. Even during and after the Great Depression, interest rates never went below 2%. But in March 2009, they were cut to 0.5%, part of the pounds 1tn mix of special liquidity measures, asset guarantees, quantitative easing and bank recapitalisations that had to be deployed to save the British financial system .
Last Thursday, Mark Carney, governor of the Bank of England, signalled in his Mansion House speech that this extraordinary phase of our monetary history was coming to an end. Unemployment is 6.6%; the economy is growing at an annualised 4% and house prices have surged. The arguments on interest rates, said Carney, are finely balanced and they could rise sooner than the market expects - in other words, this year. The Bank of England is keen to signal that when the rises come they will be gradual, and that it expects them to settle at 2% or 3% rather than around the 5% norm typical for the decades up to 2008.
What we are witnessing is an inevitable economic snap-back after the longest period of depressed output since the mid 19th century. But the underlying economic position in terms of productivity, international competitiveness, business investment and innovation remains desperate, which is why the bank thinks interest rates will settle at half their historic rate.
Carney exudes calm authority in predicting these baby step interest rate increases, but the open question is whether he and Britain - or any other developed country and its central bank - understand the degree to which their financial system has gone rogue. And, following from this, how the system should be managed and what the implications will be for interest rates.
Interestingly, also last week, the IMF launched its "Global Housing Watch". If house prices are rising fast in Britain after the crisis, it observed that they are rising faster in many parts of Asia and the US. And if British house prices are dangerously overpriced in relation to incomes, the same can be said of New Zealand, Australia, Canada, France and Belgium. Everywhere, banks are ready to pour money into residential property. Banks create money, but from China to Britain the most profitable lending target is homebuyers: they offer good collateral, try to maintain their mortgage payments and prices go up every year. It is an apparently guaranteed alchemy and enthusiasm always runs away with banks and borrowers.
Most financial crises in most countries over the past 50 years, including the last one, declares the IMF, have been preceded by residential property booms. But governments, it warns, need to stop standing idly by: the "era of benign neglect of house price booms" is over. The system could not survive another global financial crisis triggered by a property boom going wrong. And as Britain is the country that most combines rapid house price inflation and the overpricing of its housing stock, we should worry most. We could not do a trillion-pound bailout again.
Both the governor and, if he is to be believed, the chancellor get this. The governor is worried that Britain starts this economic "upturn" with household debt at 140% of household disposable income - a third higher than the average in Europe, Japan and the US. Already one in 10 new mortgages is being lent at 4.5 times borrowers' incomes. When interest rates rise, there will be huge economic distress. The cost of an average variable mortgage rate will still jump from around 3.5% at present to 5% or 6% - and this could now happen by 2016 rather than 2018. The Resolution Foundation identified 2.3 million low income overborrowed homeowners for whom the rise in interest rates would have been unaffordable in 2018; it can now bring that forecast forward. House price increases could be reversed, and banks would suddenly look very exposed again. I have argued for 25 years that the conventional free-market wisdom on finance - embraced by the Bank of England, Treasury, IMF, chancellor Lawson and chancellor Brown - has been wholly wrong. Interest-rate increases alone are not enough to manage the systemic proclivities of modern finance. Governments have to direct the amount of capital banks hold, regulate how much is lent to which category of borrower, cap the multiples of a homebuyer's income that can be lent against and what proportion loans should represent of a home's value.
Only thus can policymakers prevent absurd house price booms. Last Thursday, it was fitting that the chancellor, who had wept at Lady Thatcher's funeral, signalled - in a Nixon in China moment - the end of 30 years of Thatcherite financial nonsense. He is to give the full panoply of these long overdue powers to the banks. Now it will have to use them. He was also right to attack critics of Help to Buy as ideological: the average purchase price of a Help to Buy home is pounds 152,000, and almost all are outside the property cauldron of London and the south-east, helping first-time buyers without rich parents to buy in their 20s rather than their 30s. To blame this, rather than the structure of British (and indeed global) finance as the origin of the boom is perverse. The scheme may need to be focused on homes with average prices or below, but it is only a minor chapter of the house price bubble story.
To tackle the bubble, there are two more Thatcherite follies that Osborne will have to abandon. Britain needs to build 250,000 homes a year to accommodate the new households that are being formed. Since 1918, the private sector has only for a few years in the 1960s ever built more than 150,000 homes in a year. It is fine to set aside brownfield sites and all the rest, but ultimately the state will have to build homes on a serious scale. No council house sale should now be allowed without a commitment to build a replacement.
Lastly, the taxation of British residential property needs to be reshaped. The maximum council tax on homes worth millions is a tiny pounds 3,500, in part because there has not been a property revaluation since 1991 and in part because the council tax is barely progressive, echoing the disastrous poll tax it replaced. Minimal and non-progressive property taxation is another component of the Thatcherite approach to housing that will have to go.
Nobody relishes tax and interest-rate increases or looks forward to new disciplines in lending; but we dislike unaffordable housing, crashes and trillion-pound bank bailouts even more. We can't have any more benign neglect of British house price booms. We simply can't afford it.
Illustration: Brian Cairns.