larus
Well-known member
Article by Martin Wolfe from FT.
This rejects a lot of the "it will be alright" views from some on here that house prices won't fall much and the effects won't be serious.
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What might happen to the British housing market? After a week of dire news from specialised mortgage lenders and housebuilders, this is an obvious question. It also plays directly into the darkest obsessions of the British, for whom nothing is more important than that houses become ever more ludicrously expensive.
Certainly, houses became impressively costly between the middle of 1996 and the turn of this year. Over that period, real house prices rose by close to 190 per cent, according to the Financial Times index. A trend fitted to a series on real house prices that goes back to January 1971 was 30 per cent below the peak reached at the end of last year. In the third quarter of 2007, the ratio of average earnings to house prices peaked at just under six. This was almost double the ratio at the trough of 1995 and well above the previous peak of five reached in 1989.
After the biggest house-price boom in the UK’s history, can the country avoid the biggest ever bust? Fathom Consulting began a bulletin released this week by remarking sardonically that “as the UK housing market downturn gathers pace, it is common for analysts and commentators to argue that this downturn will not be as bad as the early 1990s ... They are probably right. It looks [as though] it will be worse, perhaps far worse.” Fathom goes on to argue that nominal house prices are now falling considerably faster than in the late 1980s: the Halifax price index is down by 9.6 per cent since August. This is almost as big a fall as the 13 per cent decline in the early 1990s, when inflation contributed more to the decline in real prices.
As the saying goes, if one laid all the world’s economists in a row, they would still not reach a conclusion. In this case, too, economists differ on how far house prices have overshot justifiable levels. While it is possible to produce demographic and economic arguments for today’s prices, it is hard to believe that they did not substantially overshoot sustainable levels. A 30 per cent decline in real prices would hardly be surprising. It could well be considerably more.
If economists differ on whether house prices are now reasonable, they differ still more on whether a house-price collapse must spell ruin for the economy. A decline in prices brought about by a big boost to supply ought to be beneficial. Even a correction in a bubble should not bring pain: for owner-occupiers, the lower value of their houses is offset by the lower implicit cost of renting them from themselves. Moreover, the losses of those cashing out of the market are offset by the gains of those buying into it. This is why it is mad to applaud ever-rising prices.
Yet things are not so simple. What matters is why house prices are falling. It is no good having cheaper houses if the reason they are cheaper is that fewer people can afford to buy them because credit is so expensive. Spreads over the Bank of England’s policy rate are now higher than the 1997-2003 average, just as they were well below that average until the current crisis began. Moreover, many borrowers are being rationed out of the market altogether.
The tightening of credit to the housing market has wider knock-on effects on the economy. It makes it more difficult for households to extract the equity in their houses. it also brings down housing-related economic activity – construction, improvement, purchase of durables and the activity of selling. In the last big downturn, residential investment declined by just over 2 per cent of gross domestic product, though over 10 years. It fell by only 0.4 per cent of GDP between the fourth quarter of 2006 and the first quarter of this year: it could decline a great deal further. Moreover, between August 2007 and February 2008 the number of housing transactions fell by 40 per cent.
The biggest issue, then, is not the fall in house prices itself but the transformation in credit conditions that lies behind it. Yet even here the evidence is mixed. Between August 2007 and May 2008, both the number of housing loans and their total value did shrink by close to 50 per cent, according to the council of mortgage lenders. Yet so-called “M4 lending” – the counterpart of the broad measure of money – rose by as much as 12.4 per cent in the year to May. This does not look like a general credit squeeze, as yet.
Even so, spreads in the interbank market on three-month and six-month loans remain at exceptional levels. This suggests enduring mistrust by banks of one another. Moreover, a number of institutions that specialise in mortgage lending have suffered huge reductions in share values: Bradford & Bingley’s have fallen by 90 per cent since early August.
What is the bottom line? It is, quite simply, that a big fall in house prices is likely, partly because prices became extraordinarily high and partly because credit to the market has dried up. Yet whether that will itself drive the economy into a deep recession is not clear. In any case, as long as inflationary pressures remain strong, the Bank of England can do nothing about it. Those of you who hope for a soft economic landing need also to wait for a halt in the rise in commodity prices and a quick recovery in the health of global credit markets. I would not suggest holding your breath while you do so.
This rejects a lot of the "it will be alright" views from some on here that house prices won't fall much and the effects won't be serious.
-------------------------------------------------------
What might happen to the British housing market? After a week of dire news from specialised mortgage lenders and housebuilders, this is an obvious question. It also plays directly into the darkest obsessions of the British, for whom nothing is more important than that houses become ever more ludicrously expensive.
Certainly, houses became impressively costly between the middle of 1996 and the turn of this year. Over that period, real house prices rose by close to 190 per cent, according to the Financial Times index. A trend fitted to a series on real house prices that goes back to January 1971 was 30 per cent below the peak reached at the end of last year. In the third quarter of 2007, the ratio of average earnings to house prices peaked at just under six. This was almost double the ratio at the trough of 1995 and well above the previous peak of five reached in 1989.
After the biggest house-price boom in the UK’s history, can the country avoid the biggest ever bust? Fathom Consulting began a bulletin released this week by remarking sardonically that “as the UK housing market downturn gathers pace, it is common for analysts and commentators to argue that this downturn will not be as bad as the early 1990s ... They are probably right. It looks [as though] it will be worse, perhaps far worse.” Fathom goes on to argue that nominal house prices are now falling considerably faster than in the late 1980s: the Halifax price index is down by 9.6 per cent since August. This is almost as big a fall as the 13 per cent decline in the early 1990s, when inflation contributed more to the decline in real prices.
As the saying goes, if one laid all the world’s economists in a row, they would still not reach a conclusion. In this case, too, economists differ on how far house prices have overshot justifiable levels. While it is possible to produce demographic and economic arguments for today’s prices, it is hard to believe that they did not substantially overshoot sustainable levels. A 30 per cent decline in real prices would hardly be surprising. It could well be considerably more.
If economists differ on whether house prices are now reasonable, they differ still more on whether a house-price collapse must spell ruin for the economy. A decline in prices brought about by a big boost to supply ought to be beneficial. Even a correction in a bubble should not bring pain: for owner-occupiers, the lower value of their houses is offset by the lower implicit cost of renting them from themselves. Moreover, the losses of those cashing out of the market are offset by the gains of those buying into it. This is why it is mad to applaud ever-rising prices.
Yet things are not so simple. What matters is why house prices are falling. It is no good having cheaper houses if the reason they are cheaper is that fewer people can afford to buy them because credit is so expensive. Spreads over the Bank of England’s policy rate are now higher than the 1997-2003 average, just as they were well below that average until the current crisis began. Moreover, many borrowers are being rationed out of the market altogether.
The tightening of credit to the housing market has wider knock-on effects on the economy. It makes it more difficult for households to extract the equity in their houses. it also brings down housing-related economic activity – construction, improvement, purchase of durables and the activity of selling. In the last big downturn, residential investment declined by just over 2 per cent of gross domestic product, though over 10 years. It fell by only 0.4 per cent of GDP between the fourth quarter of 2006 and the first quarter of this year: it could decline a great deal further. Moreover, between August 2007 and February 2008 the number of housing transactions fell by 40 per cent.
The biggest issue, then, is not the fall in house prices itself but the transformation in credit conditions that lies behind it. Yet even here the evidence is mixed. Between August 2007 and May 2008, both the number of housing loans and their total value did shrink by close to 50 per cent, according to the council of mortgage lenders. Yet so-called “M4 lending” – the counterpart of the broad measure of money – rose by as much as 12.4 per cent in the year to May. This does not look like a general credit squeeze, as yet.
Even so, spreads in the interbank market on three-month and six-month loans remain at exceptional levels. This suggests enduring mistrust by banks of one another. Moreover, a number of institutions that specialise in mortgage lending have suffered huge reductions in share values: Bradford & Bingley’s have fallen by 90 per cent since early August.
What is the bottom line? It is, quite simply, that a big fall in house prices is likely, partly because prices became extraordinarily high and partly because credit to the market has dried up. Yet whether that will itself drive the economy into a deep recession is not clear. In any case, as long as inflationary pressures remain strong, the Bank of England can do nothing about it. Those of you who hope for a soft economic landing need also to wait for a halt in the rise in commodity prices and a quick recovery in the health of global credit markets. I would not suggest holding your breath while you do so.
