A week that taught me home truths about the housing crisis

In today's housing market, you don't argue with a potential buyer. Selling our house required us to exchange and complete in seven days and of course we agreed. The house price surveys don't convey the scale of the crisis in the market or the price falls. So, a frenzied seven days later, we moved out and probably became the British housing market's transaction in July.

It's only partly a joke. Mortgage approvals are running a third of a year ago; prices are down over 15 per cent from their peak, with the rate of fall accelerating. The situation is extraordinarily dangerous. In America, house prices have fallen by more than 20 per cent and the US financial system is tottering. One big West Coast lender, IndyMac, has gone to the wall; last week, Washington Mutual, the country's biggest savings and loan association, analogous to a building society, was reported to be in trouble. There was subsequent carnage in bank shares on Wall Street, despite the US showing an activism we can only dream about.

But the UK housing market and the position of our financial system are much more vulnerable than America's. Over the past 10 years, US house prices have risen by 105 per cent, ours by 180 per cent. Although both countries are saturated by mortgage debt, Britain is more indebted. Economists judge whether houses are cheap or expensive in relation to salaries, disposable income or rents. If, on a composite measure, American houses were 25 per cent too high last year, ours were 50 per cent too high.

Yet compare the reactions. The US has slashed interest rates to 2 per cent while British rates are pegged at 5 per cent. It has a system of standardised or 'conforming' mortgages that properly certify an individual's income and employment history and which can thus be guaranteed or insured by giant, government-sponsored agencies such as Fannie Mae, Freddie Mac and the Federal Housing Administration in the event of default. Eighty per cent of new mortgages in the first six months of this year were guaranteed conforming mortgages. Britain has nothing.

The US also has a well-developed system of protection and insurance for depositors. We have a Mickey Mouse system that the banks resist strengthening. The US markets in which banks trade in residential mortgage-backed securities (RMBS), a crucial source of finance for mortgage lending, are greatly helped by the Depository Trust and Clearing Corporation. It ensures that if for any reason a bank does not settle its bills, the Clearing Corporation will. So while the specialist American markets have been beset by fear like ours, they have not completely shut like the British.

I have no doubt that historians will look back at the early 2000s as years of dazzling incompetence. The largely unregulated British financial system was allowed to fuel an unsustainable house price boom. The consequent levels of debt collateralised against crazily valued house prices was an act of folly, a dereliction of duty by the City of London that financed the lending, the Bank of England and Financial Services Authority that indulged it and a New Labour government too frightened to prevent it. It will take a long time to be forgiven or forgotten.

The buy-to-let market, for example, was completely dependent on the RMBS market to finance its lending. Now it is in crisis; buy-to-let lending, which in 2007 represented 30 per cent of all new lending, has dried up. Paragon, Britain's third-biggest buy-to-let lender, has been unable to lend for six months; it is in talks with, among others, American private equity group, the Blackstone Group, in turn part owned by the Chinese Communist party, about a takeover. Its HQ in Solihull could thus become a small colony of the People's Republic of China, an unexpected boast for the West Midlands.

This is part of the wider dismemberment of our financial system. Alliance & Leicester is about to be taken over by the Spanish bank Santander. The vultures circle stricken HBOS. Northern Rock is in public ownership. The financial system is being rocked to its foundations more than at any time since the 19th century and, if house prices carry on falling, it will be even more shaken and without the basic protections that exist in the US

What to do now? The only good news is that at least house prices have fallen quickly, between half and two-thirds of the necessary adjustment. A couple of insiders, justifying the government's laissez-faire inactivity, have told me there needs to be a substantial correction before creating any American-style interventions to stabilise the market. Prices needed to fall, but I would be more confident if I felt that more officials understood the risks and dangers. If 2008's house price fall extends into 2009 and 2010, Britain will be engulfed. A recession will be guaranteed.

We need interest rate reductions and fast. Britain needs effective deposit insurance, for which the Governor of the Bank of England is agitating but which the British Bankers' Association (Bonuses'R'Us) naturally resists. We also need some government-initiated form of reinsurance for new mortgage lending to persuade lenders they have protection against default.

We need the RMBS market re-opened by a combination of creating a clearing corporation and the Bank of England being more generous about offering potential lender-of-last-resort facilities to the market.

The City will say these measures imperil its main objective of being more deregulated than anywhere else. I argue it has a prior responsibility to British depositors, policyholders, mortgage borrowers - us - and the wider British economy. No City or Conservative party spokesman agrees.

The government is inching towards a cluster of measures, some along these lines, to be announced in the autumn. But strong technical measures, if it has the chutzpah to initiate them, are only part of what is needed. The rest, borrowing from Barack Obama's appeal, is an optimistic rhetoric that public action can make things better. Success requires both. The government's future depends on it rising to the challenge.