A new lobby will rise to topple the home-owners

ECONOMIC VIEW

If one had to choose a moment when the great housing slump of the early 1990s ended, now must be as good as any. We are getting reports from both Halifax and Nationwide of prices having risen by more than 5 per cent in the past year and forecasts that over the next year they will rise by double that. The number of people with negative equity is falling, turnover in housing (though still low by historical standards) is rising, and purchases of goods associated with home-buying, such as carpets, are soaring. All the previous incipient recoveries petered out; now it is clearly for real.

It is sufficiently real for the Prime Minister, John Major, to feel able to cite rising house prices as one of the reasons dissident Conservatives might return to the fold - that is one of the points in his new mass mailing to voters.

If one takes the end of 1988 as the starting point of the slump and reckon that the end of last year marks the end of it, we have just lived through a biblical seven lean years in house prices. To say that is not to imply that seven fat years will follow, for there are many reasons the swings in house prices are likely to be more muted in future. But for anyone who studies trade cycles, the fact that there has been a clear cycle of that sort of duration does carry some confidence that the next few years will see a positive trend.

Perhaps the best reason for confidence is the present affordability of house prices - their level relative to earnings. The chart on the left shows how this ratio, at just over 3 to 1, is actually a little below the levels of the early 1980s. In the 1960s the ratio did dip below 3 to 1 but not for long. If you regard that as a floor and take as a reasonable ceiling a ratio of perhaps 3.5 to 1, not the 5 to 1 peak of 1988, then there is still some way for house prices to rise before warning bells should ring.

So let's accept the present conventional wisdom that house prices will be reasonably strong over the next couple of years and maybe go a little further and say that prices will stay in that ratio range of 3-3.5 to 1 for the next seven years. If earnings continue to rise at their present 3.5 per cent a year, it would follow that house prices will rise, on average, by something like that.

But look at the consequences of that. Move up to the top of the range and growth will be a bit faster; come back to the bottom and they will be lower. Sure, house prices may run a little ahead of inflation, but this is not a re-run of the three big post-war housing booms by any means.

The reason is simple: in a low-inflation world it does not make financial sense to hold too high a proportion of one's wealth in housing.

The other two graphs help explain why this should be so. The middle one shows housing wealth in relation to family incomes through the 1980s. At the beginning of the 1980s the value of people's homes roughly matched the value of their financial assets. Then came the house price boom and the value of houses hit a peak at roughly double people's financial assets. Now they are back not just to the early 1980s relationship, but beyond it. Financial assets are larger than housing ones.

To many people this may come as a surprise: they may be home-owners but they did not realise they were capitalists too. But if you add up all bank and building society accounts, shares, and include rights to a pension fund, the sums become very large. Remember, too, to knock off the mortgage from the house price.

A world where people hold much of their wealth in financial assets rather than property is more normal by world standards and our own historical standards. Our preoccupation with home ownership was the creation of the tax incentives for borrowing of the 1950s, but it wasreinforced by the great inflation of the 1970s and early 1980s. In particular, it was reinforced by the period of negative interest rates during the 1970s, when banks and building societies paid borrowers (so to speak) to take the money off them.

You can see the oddity of that period in the right-hand graph, which shows real long-term interest rates since the First World War. The normal range for real interest rates is 3-5 per cent, but that return slithered away in the 1960s and for the best part of a decade until 1982 returns were negative or zero. Savers took their revenge in the 1980s by pushing real yields back to and beyond their long-term norm. Expect real yields to remain in the 3-5 per cent region for the foreseeable future.

One further point. Those rates are taken by looking at gilt yields; if the savings were invested in equities the real returns would have been considerably higher.

The implications are obvious. Just as it made economic sense between the middle-1960s and 1988 for people to hold most of their wealth in housing, since then it has made sense at least not to have a bigger house than needed and to build up financial assets. We are rational creatures (at least most of the time) so it is unsurprising that we should be doing just that.

We will go on doing so, too. Expect a further surge in our stock of financial assets over the next decade. There will be windfall gains for many holders of building society accounts with the flotation of several large building societies. These sales release the equity that people have held for years in the societies, probably without knowing it, and some of that equity will be saved rather than spent. Whichever party forms the next government, there will be further incentives for people to boost their private pension plans and other savings. There may even be some form of compulsory savings scheme. Inheritance will boost people's stock of savings. And high real interest rates will continue to hold up returns from those savings and put a penalty on unnecessary or excessive borrowing for home ownership.

This has profound economic, social and political implications. Looked at nationally, if individuals build up their stock of financial assets, companies have to create those assets for people to buy: they have to borrow or to issue shares. So building up financial assets has the direct effect of making money available for investment by industry and commerce.

If in economic terms this process is beneficial, in social terms it carries some dangers. The frugal who save will benefit at the expense of the people who don't. That might seem fine: virtue is rewarded. But of course it is not just virtue: it can also be luck. The reward is for wealth.

Finally, there are political implications. Successive British governments since the Second World War have been careful to woo the home-buying lobby. But there will be a new lobby, the owners not of property but of financial assets. They will want a decent return on their savings. They will lean strongly against inflation. They will cheer not so much if house prices go up, but if share prices do. Come the next election but one, expect the letters to voters from the party leaders to take a slightly different tone.