1. Strong business cycle
Financial deregulation in the United Kingdom was followed by an expansion of international banking and financial services. This resulted in a rise in occupier demand for office space and increased floor space per worker. At the same time, public sector demand for office space in Central London increased. The temporary shortage of space resulted in rising rents and capital values. Therefore, financial deregulation increased the demand for office space in London, while at the same time facilitating the financing of additional construction leading to increased supply.
2. Property development cycle
The London office construction boom was highly speculative due to a lack of pre-committed tenancies. While occupier demand increased steadily and rents rose by 90% between 1970 and mid-1973 (compared with a 30% rise in consumer prices) the supply of new space took several years before reaching completion.
3. Price distortions due to regulation
From 1964 onwards the Labour administration enacted legislation limiting new office development (Control of Office & Development Act of 1965) and imposed taxation (Land Commission Act of 1967) on property development gains, thereby disincentivising new construction. The corporation tax (1965) favoured direct ownership of property assets. Together, these regulatory changes stimulated investor demand while constraining supply, hence exerting more upward pressure on values. These policies were later reversed by the Conservative administration of Edward Heath from 1970 to alleviate the supply shortage. However, by then, easy credit was providing further stimulus for consumer and asset price inflation.
4. Lending boom and gearing ratio increases
The expansionary economic policy of the Heath government from 1971 led to low interest rates and a rapidly increasing money supply. The result was a credit growth boom. Since property values were rapidly increasing, banks concentrated their lending to this sector. Gearing ratios, often based on inflated values, increased beyond traditionally safe levels (up to 100%). Developer-borrowers were servicing their debt with additional loans solely in anticipation of capital appreciation. The office market boom, and subsequent bust, might be seen as collateral damage from the policies adopted to stimulate the broader UK economy.
5. Financial liberalisation
Sections 123 and 127 of the Companies Act of 1967 had spawned a category of secondary (fringe) banks without explicit regulatory oversight. These financial institutions relied on the ever-growing money markets as a source of (largely short-term) funding. The Bank of England's laissez-faire stance towards the loosely regulated secondary banks failed to monitor and to limit their over-concentration of lending to the commercial building market. The 1971 Competition and Credit Control plan also advanced banking sector deregulation by removing lending ceilings and reducing the reserve ratio, thereby releasing credit for lending. Deregulation resulted in increased competition among banks for market share, which led to the erosion of underwriting standards and increased risk-taking through highly leveraged loans priced at margins that did not adequately reflect the riskiness of the exposures.
6. The economic shock
The unanticipated shock of the 1973 oil crisis further accelerated the UK inflation rate.Annual inflation rose from 7.1% (1971) to an all-time record of 24.2% (1975), prompting the Bank of England to precipitously raise its minimum lending rate (MLR) from 7.5% in June 1973 to 13% in November 1973. Those property developments that were financed by short-term bridge loans (that were susceptible to rate rises) faced liquidity problems and many were unable to meet their debt-service obligations. Simultaneously, property values stalled because of price controls that limited rent increases and a reinstated development tax that curbed profits.
7. Belated strategies to limit the economic and financial fallout
The sudden shocks arising from these simultaneous pressures led to defaults and began a potentially self-reinforcing cycle of capitulation in the property market that resulted in the Bank of England's "Lifeboat" operation. The Bank of England, with the cooperation of UK clearing banks, established a liquidity fund of £2-3 billion to support the banking system in December 1973. Institutional investors (financial, pension and insurance companies, who were often creditors to property companies) were encouraged to take over their collateral, rather than force a distressed asset sale that would further depress values across all other similar assets. Institutional investors thus became increasingly involved in direct ownership of commercial real estate. In a further attempt to limit the "fire sale" of distressed assets, a moratorium of creditors established "Cork's dam" to manage the assets of the failed Stern Group of companies. Also in December 1973 the Bank of England introduced the Supplementary Deposit Scheme (the "corset") that continued until February 1975 and intermittently thereafter.
