Hamish McRae: Thankfully, a housing boom is a long way off, but that will not dampen growth

Economic View
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The Independent Online

This will be the week when UK interest rates almost certainly stay the same and we get a warning that eurozone rates will soon go up.

A relief, you might think, for British home-buyers and a worry for Spanish and Irish ones. Of all the different chunks of the economy, the housing market is the most immediately and powerfully affected by changes in interest rates.

Housing markets are always interesting because they are an indicator of what is happening in an economy and also a shaper of that. In this cycle they have been particularly important because it was the mis-pricing of risk in the US housing market that triggered the global financial meltdown, the sub-prime crisis. Meanwhile, the housing booms in many countries, including the UK, enabled people to live beyond their means for a while, which meant misery for many when the housing market crashed.

The markets continue to be hugely important. In the past couple of months US home prices, which had recovered a little, have dipped again, falling below the bottom of the previous trough. One of the reasons why people have become so worried about the state of the US economy is that there still seems to be no floor yet to its property prices. There are similar concerns in the weaker European markets: in Greece, Spain and Ireland. Here in the UK, where the market had recovered a bit, prices seem to be moving sideways, firming a little in London and the Home Countries, but weakening elsewhere. This would reflect – but also be a cause of – the pause that seems to have happened in growth.

So what happens next? On the one hand, it seems unlikely that there will be any early resumption of a housing boom anywhere. The lenders have a sizeable backlog of bad debts, and while in the UK foreclosures have been limited, in parts of the US much of the supply of houses coming on to the market is from repossessions. But no one in their senses would want another housing boom, for prices in most markets (though maybe not parts of the US) are still high by historical standards.

The macroeconomic conclusion that you reach from all this is that the next growth phase of the world economy will have to take place against a backcloth of stable, maybe even falling prices, at least in real terms.

But housing markets, at least compared to stock markets, are all different. You can catch some feeling for those differences from the main chart, which shows what has happened in a selection of countries since 2000 and 2008. As you can see, in virtually every country house prices are higher now than they were in 2000, the only exception being Germany. Germany had neither a boom nor a bust. By contrast, even in the "worst" housing markets, the ones that have had the biggest crashes, such as Ireland and the US, prices are still up on 2000. And in France, Spain, Belgium and Britain, prices are still nearly double the level they were then. It may not be much fun if you own a house in southern Spain that you can't sell, but if you think in terms of the wealth held in those houses, it is enormous.

The plight of Spain's housing market is one of the subjects highlighted by Jefferies, the global securities and investment banking group, in a new paper. The problem, in a nutshell, is that the country had a huge housing boom but so far at least has not experienced much of a slump, as in the US or Ireland. According to Jefferies' calculations, a rise of 1 percentage point in eurozone interest rates would see debt interest payments for the whole economy rise by the equivalent of 0.3 per cent of GDP. This may not sound a lot. But for the quarter of Spanish households with mortgages the rise would be equivalent to 1 to 1.5 per cent of GDP. Not good.

If Spain is the most challenged housing market in the eurozone, and the US is second only to Ireland in experiencing the largest slump relative to the peak, what about the UK?

The first thing to say is we are not going to be getting big increases in rates at the moment, and the expectation of an increase this summer has now receded to the autumn and beyond. On the other hand, the people on mortgages linked to base rates will not enjoy their ultra-low rates for ever, so there is in a sense an artificial support for the market. Savers subsidising home-buyers bring long-term social and economic consequences.

There are as many house price forecasts as there are economists, and if you are interested, there is a fun website called housepricecrash.co.uk. But ignoring some of the more outlandish predictions, the general view seems to be of flat or slightly falling prices for the next couple of years. You can catch a glimpse of the longer-term trend from the graph on the right. Prices, with these falls, seem now to be back more or less to the long-term trend. In other words, prices are not cheap by any means, but they are no longer ridiculously expensive.

The trouble with that sort of statement is that housing markets are local. They are local within countries and between them. In the UK, the division is north-south, with London influenced by foreign buyers. In the US, distances are so vast and economic conditions so different as to make for totally separated markets. But – a point made in a new paper on the subject by Goldman Sachs – there was a period in the mid-2000s when housing markets did move pretty much in sync. Then global factor accounted for 90 per cent of the price variations. Now we are back to more local markets where about half the variation in prices can be attributed to local factors.

With that proviso, Goldman comments that valuations are much less challenging than before and that its expectation of healthy global growth this year and next should support markets where there is less of a credit-fuelled boom yet to unwind. I would put the point in slightly cooler terms: that housing will not be a drag on growth in most countries, including the UK but not I'm afraid Spain or Ireland, but housing will not positively help the recovery. We are a long way from the next property boom.

Where can we find the 'brave' investors who are in it for the long term?

The role of private equity in funding care homes in the UK has hit the news in the past few days. But the great strength of this source of capital is that private equity houses can make swift decisions, taking on risks that, with two main exceptions, other types of fund are not prepared to accept. But they are not in the main long-term investors, so of course you have to ask whether they are the optimal owners for care homes.

But the other two sources of "brave" capital are not ideal either: rich individuals and sovereign wealth funds. In a perfect world, care for the elderly would be provided by not-for-profit enterprises, and these seem to perform well. But given the scale of the funds needed, it is not realistic to expect them to be able to expand sufficiently quickly to meet demand.

But the wider issue this raises is the extent to which conventional sources of finance, at least in the UK, seem to have too short time horizons. Company executives often complain that shareholders in quoted companies are unreasonably short-term in their performance demands.

It is such an oft-cited concern that you have to ask whether things are really getting worse. Sadly, it seems the answer is yes. A paper last month from Andrew Haldane and Richard Davies, The Short Long, looked at the extent to which equity markets worldwide seemed to be operating on shorter and shorter time horizons.

So what is to be done? The authors concluded the authorities needed to look at transparency of information, sharehold- er action, tax incentives and so on. And that must be right. But I wonder too about the need for brave capital, investors prepared to move against the mood of the market. I am as worried by the herd instinct as I am by short-termism and the evidence of the past five years is that the herd instinct is as strong as ever.