House prices reach all-time high, but there is no bubble says the ostriches
Category: Thought for the day
According to the ONS, UK house prices are higher now than at the previous peak in 2008. And all around, I hear the same words: ‘There is no bubble,’ says the ITEM Club from Ernst and Young; ‘There is no bubble,’ says the economics editor at the ‘Sunday Times’. ‘Don’t worry, we won’t let it happen,’ says the incoming Bank of England deputy governor. Even Capital Economics, known for its bearish view on the UK housing market, has dismissed bubble fears. But there is one dissenter, and he happens to be a man I would back over all the others put together. Besides, his views coincide with mine.
I will let you into a secret: the UK recession was not as bad as I expected it to be. I was chatting to an acquaintance in 2008. He had no idea what I did for a living, and conversation fell on the economic downturn. I made some flippant remarket saying: “If the economy ever recovers,” and he turned to me and said: “Of course it will recover, it always does.” Well of course, I have never really doubted that the downturn would end eventually, but I also thought it was going to be something of a record. Yet, funnily enough my rationale appears to have been wrong.
I just assumed, in 2008, that UK house prices would carry on falling, like they did in the early 1990s, only worse, and that this time the repercussions would be very serious. I thought the UK would mirror Japan from 20 years earlier, and felt the only solution was in some kind of mass default, or something similar. Thanks to the differences in the way negative equity on mortgages are allocated, this is pretty much what happened in the US. (In the US, if your home has negative equity you can hand it over to the bank, and abdicate all responsibility for the mortgage.) That is why (political impasse on Capitol Hill aside) the US economy is in a stronger position than the UK economy right now. By seeing much sharper falls in house prices and higher repossessions, but by dealing with this by splitting vulnerable banks into good and bad banks, the US was able to get the bad news out of the way quite quickly. This was in marked contrast to the previous Japanese experience, where, thanks in part to the policy of protecting zombie companies, households and banks, the fall-out from the Japanese bubble went on and on and on. I thought the UK experience would be more like the Japanese one.
There are indeed similarities between the UK property market and the Japanese economy of the last 20 years. To re-quote one of my favourites quotes from last year, Dr Angus Armstrong at the National Institute of Economic and Social Research said: “According to the FSA between 5 and 8 per cent of mortgages could be subject to forbearance. This has a familiar ring of the zombie firms in Japan which were insolvent but the banks would not close to avoid crystallising a loss.”
But the UK crash didn’t happen; house prices fell and then actually began to rise during the recession. The zombie households, if indeed they existed, were never truly exposed.
There are three reasons for this. Reason number one is record low interest rates. Reason number two is shortage of supply. Reason number three is that UK banks, chastened by the banking crisis, and terrified of the anti-bank fervour among the public, pursued a much softer approach to property repossessions than they did in the early 1990s.
Ever since 2008, the UK housing market has had two characteristics: very low demand and very low supply. In such circumstances a slight change in one of these variables can have a massive effect on price.
This week the ITEM Club said: “One risk that we believe has been strongly overplayed is the danger that the UK government’s initiatives to support the housing market will result in a housing bubble. The current rises in prices and transactions are from a historically very low base, and remain way below pre-crisis levels.”
Writing in the ‘Sunday Times’ (13 October), David Smith focused on the need for house building to kick start the UK economy. He praised both aspects of the governments Help to Buy scheme. By providing interest free loans worth 20 per cent of a new home’s value, the Help to Buy scheme is promoting new builds, and that is helpful. But why have the second phase involving assisting buyers of existing homes? Mr Smith said: “New house building is great but it cannot do everything…a property housing recovery requires things to move in the market for existing homes.”
Mr Smith is not all wrong. There is evidence of a sharp-pick up in residential construction, and the government can take much of the credit. This will surely help boost the UK economy.
The stance taken by Capital Economics is quite different. Unlike David Smith, they were property bears for years prior to 2008. They say there is no bubble in the making simply because they believe house prices are too high as it is. Their belief is consistent with the view that house prices have not yet fallen as far as they need to fall. Besides, they suggest, ONS data is distorted by over-emphasis on more expensive properties.
Now I turn to the man whose views are closer to mine. Martin Wolf, economics editor at the ‘FT’, said: “Ministers…pretend the guarantees are a purely temporary arrangement. Nothing is less likely: it is the temporary that endures. The government has increased its commitment to frighteningly expensive housing. It is a trap from which the UK may not now escape.” See: Buyers beware of Britain’s absurd property trap
But then again, Mr Wolf made a telling point that not many people seem to have grasped. He called the system we have in the UK, which is loaded towards boosting house prices, “vile.” But he also said: “A deregulated and dynamic housing supply could spell financial and political Armageddon.”
He is right. In 2008 I under-estimated the government’s resolve to do anything to stop house prices from crashing. That is why I thought the recession would be really really bad. But I also thought that once house prices fell to their right level, and if the UK could then adjust to being an economy which was less reliant on rising house prices boosting spending, but one that sees a higher proportion of finance go into business – especially budding entrepreneurs – the recovery would be pretty spectacular too.
My view on UK house prices is simple enough. The average price today is 247,000 according to the ONS. According to The Asda Income tracker index, total households’ income after tax is £588 a week. I just don’t see how the average household can afford the average house, no matter how low interest rates are. Even if interest rates were zero, the average household would have to allocate one third of their income to to-repay their mortgage over 25 years. The only way such a purchase can possibly make sense is if it is assumed house prices will rise. Given this I just don’t understand how the ITEM Club can say: “The current rises in prices and transactions are from a historically very low base.”
Martin Wolf said that to ensure the UK housing market operated effectively, the UK government should implement a land tax “to compel building” and to take on what are commonly referred to as the NIMBYs (not in my back yard) by making large amounts of land available for building. The UK can have its much need residential construction boom, and cheaper house prices, if it can introduce polices to bring down the cost of land.
The real tragedy of what it is happening is that it is disguising underlying forces at play which need to be grappled with. In a globalised world, the reward to capital is rising and the reward to labour is falling. This needs to be exposed, and subjected to the full glare of public scrutiny. (See thought for the day 14 October. The biggest economic challenge today is being ignored ) Instead the government has found a kind of opium of the masses. According to Raghuram G Rajan, former chief economist at the IMF and now the governor of India’s central bank, this is what the governments did in the noughties – rising house prices disguised the fact that real incomes were not rising. (See his book ‘Fault Lines’.) Martin Wolf put it this way: “The political genius of the scheme [Help to buy] is that it appears to help these hapless victims, while in fact helping the usual suspects: banks, homeowners, Nimbys and, if it creates another housing boom, the government.”
But what happens if interest rates rise for reasons beyond the control of central banks. See: Why interest rates may rise faster than the markets are expecting Now that does scare me.
These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees