Jeremy Warner: This housing correction has a way to go yet
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Independent Minds
Outlook: The apparent green shoots of an uptick in house prices reported by the Nationwide Building Society earlier this week were trampled underfoot yesterday by Halifax's rival index, which showed the exact opposite – namely that prices continued to fall last month. The juxtaposition of the two indices reverses that of a month ago, when it was the Halifax saying that prices were recovering and Nationwide that they were still on a downward trajectory.
The dichotomy is easily explained. The housing market is so illiquid right now that a relatively small number of transactions can easily distort the monthly figures one way or the other.
So which way is the underlying market heading: up or down? The betting has to be that it is still the latter. Using the Halifax index, UK house prices have fallen a little more than 20 per cent in nominal terms since their 2007 peak. This is not so far off the peak-to-trough fall of the early 1990s, so on past precedent the market should be bottoming out soon.
Unfortunately, US experience points to more substantial falls to come. The housing correction started much earlier in the US than here, but still, and despite zero interest rates, there is no sign of the crash coming to an end. The cost of a mortgage is much lower than it was back in the early 1990s, but the size of mortgage debt relative to equity is much higher.
What's more, in a deflationary environment the size of that debt will begin to inflate relative to earnings. One of the reasons interest rates are so low is that assets such as houses are depreciating in value. If house prices are rising, you are forced to pay a price for your gains. When they are falling, banks are grateful just for the repayment of principal. What you gain on the cost of your mortgage you more than lose on the size of your debt, which is inflating relative to your equity and income.
For years, the dynamic has worked like this. Say you spent £100,000 on a house using £50,000 of mortgage finance and £50,000 of equity. By the time you came to sell the house, the price might have doubled to £200,000. If you kept the same proportion of debt to equity, you would then have £300,000 to spend on your next house.
That process has now gone into reverse. If house prices fall by 25 per cent in value rather than double, your equity would be worth just £25,000 but you would still have the same quantity of debt. Assuming you kept the same debt-to-equity ratio for your next purchase, the maximum you would pay would therefore be £50,000.
OK, so in practice, the housing market is quite unlikely to conform to such an artificial model, but what is true is that once a deflationary debt spiral takes hold, it's very hard to get rid of. The process of asset depreciation becomes self-feeding and the debt burden assumes ever more monstrous proportions.
Policy is, of course, wholly fixated on trying to avoid just such an outcome, but it hasn't succeeded in reversing the trend yet, and if it works at all, it may take a while. In the meantime, unemployment is rising fast, prompting growing numbers of repossessions and forced sales. That's hardly a conducive backdrop to a revival in the housing market.
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Comments
Yet when given the option of frivolous spending on the latest Louis Vitton accessory, or paying off a large slice of your mortgage, when staring down the barrel of the worst recession in history, obviously they were always going to
take the option of paying off the mortgage.
We, the potential FTBers, all knew that the real reason Brown stole money from the savers, and the pensioners, and the renters, was, in the hope that these people paying one pence per month, to stay in their 500k 2 bed
terraces, would believe that he, Brown, had done them a favour.
So when he calls a general election, Brown believes this demographic will vote for him. [He's got this spectacularly wrong however, as 40% of homeowners own outright, and all hes doing is damaging pensions.....AGAIN]
After all, they were suckered into buying at peak. Surely they could be suckered by Browns mortgage holiday too?
So Brown is stealing money from the prudent savers, to give it to the people who borrowed too much to buy a house.
But what about the savers, priced out for a decade? A large number have also recently lost their jobs. And they have to find their own rent, which, unlike the people on mortgage holidays, will cost hundreds and hundreds of pounds per month. Yet Brown is still stealing money from these very
people with meagre savings, not yet on the ladder, and pensioners, to give to the people on his Evil mortgage holiday!
Thats New Labour for you. No accountability. Bailout after Bailout.
Brown does not care a jot about the people he steals the money from. He just shuffles the financial deck, making sure he does anything possible to remain in power. Not caring who he hurts.
But when the holiday ends, chances are these people, if they could not pay their mortgage 12 months ago, will
not be able to in 12 months time.
So Whats next?
How will Brown cure that one?
Will he get sick of his own complicated trickery, and just freeze everyones bank accounts, and then unaccountably, take whatever he wants, from whomever he wants?
Hes already stealing the money. But at least if he said he was stealing it, could you at least respect his honesty?
Thats the New Labour way.
All hes really doing is prolonging the pain.
Brown does not have any solutions.
So what if banks start lending again? What FTB in his right mind will buy a small 2bed bungalow presently priced at 240k, when it was sold for 75k in 2000? You could halve that overinflated price tag to 120k, and that would still be a 45k increase over 7 years. I.E. It would still be
MASSIVELY overpriced.
No FTB would touch it.
Prices have fallen 20percent nationwide, but every sensible, honest, non vested interest report tells us they have a HUGE way to drop yet.
The most recent ones In all the daily newspapers, state that houses are still 140percent overpriced when compared against historic levels.
Who could? And when the FSA rule that banks should return to 3x salary lending [10x was always insane, and allowed under Browns meddling. The BOE may have acted sooner, if Brown had not switched some of their core responsibilities to the FSA. And of course the CML, and NAEA, all widely quoted in the press, like the governmnet have huge vested intersts in screwing anyone who has not yet got a mortgage]
Keep digging yourself a hole Mr Brown.
I wont be buying until they reach 2000 prices. Down from 240k, all the way back to 75k. Most FTB i know feel the same way. Some say they wont be buying until they overshoot and reach 1996 prices!
We have had ten years of being priced out.
I know people who were suckered by Estate Agents. Told, noooooo, prices will never drop! And its criminal that within a few years, they will be paying mortgages that will have lost over half their value. But do not expect any accountability under Labour.
Brown has done everything he can, and he has done absolutely nothing.
{Except issue a stay of execution.}
The truth is that we would all be much better off managing deflation than attempting to force inflation.
The key bit you say is the fact that "asset depreciation becomes self-feeding" and this is absolutely the case. Right now we have downward momentum and like a super tanker the housing market will not turn quickly.
Personally I believe the Government should have simply tried to clean out more of the bad borrowing by not lowering interest rates quite as much as it has, this ultimately would have brought forward the recovery.
So what you're saying is that when house prices drop it won't be long til they're worth s0d all. Great. Fantastic news. But inferring that this somehow makes life miserable for everyone in a pathetic attempt to support the governemts reckless inflationary policies: "Policy is, of course, wholly fixated on trying to avoid just such an outcome" is just downright filthy.
Anyone who was prudent would be rewarded by deflation. Idiots who borrowed too much and got involved in the housing ponzi scheme get rewarded by the currently adopted inflationary policy.
And that is WRONG
So what you're saying is that when house prices drop it won't be long til they're worth s0d all. Great. Fantastic news. But inferring that this somehow makes life miserable for everyone in a pathetic attempt to support the governemts reckless inflationary policies: "Policy is, of course, wholly fixated on trying to avoid just such an outcome" is just downright filthy.
Anyone who was prudent would be rewarded by deflation. Idiots who borrowed too much and got involved in the housing ponzi scheme get rewarded by the currently adopted inflationary policy.
And that is WRONG. It is IRRESPONSIBLE and it is IMMORAL.
I just heard the BBC giving time to an Estate Agent complaining that surveyors are undervaluing property "taking the worst case scenario," the point allowed with little criticism, such as asking why estate agents always take the rosiest view.
A now-dead, but successful developer and lawyer named Murray Toomey once told me his key to valuing property, just after the US' early 1990s price adjustment, which the company he was chair of weathered well, when its peers were going bankrupt. His rule was that "rents don't lie" and that the value of a building, apartment or house was best determined by the rent that a tenant would pay for it. His explanation was simple, if a tenant must make enough money from the premises to justify the rent or the benefit of living there - the tenant would not normally pay more. His view was that to allow for costs, voids, etc. a landlord should get about a 8.5% yield (or divide the price by 12 to get a sensible rent) - if the property price indicated a yield less than that, it was time to sell and not buy, more than that buy and not sell. On that basis, certainly London rents, especially in central London reflect a property market that at twice the sensible level, that is to say rental yields are about 3-4%
Worse still, London rents are excessive by international standards, i.e., that 3-4% will likely decline over the next few years, as free spending expatriot corporate lets vanish with repatriated finance and legal employees, while the City fails to recruit its annual crops of young, highly paid professionals who lease the rest.
One of the shibboleths regularly trotted out is that Britain is a small, highly populated island, and thus excess demand should drive up property prices. Of course this is silly -- it the number of putative householders that one should count, but rather the number of incomes of each given size. If the simple number of persons looking for homes were the key demand factor in property prices, then Bangladesh would have the highest property prices in the world, and the Netherlands much higher prices than the UK.
Now for a frightening statistic -- only about 2% of UK households boast a household income in excess of £100,000 and the median household income, before this recession was about £33,000. Only Kensington & Chelsea has a median income over £100,000 and then just £102,000 or thereabouts (with an average property price well over a million pounds, this shows the extent of the non-dom presence there.)
What is a bigger problem is the impact excessive property prices in the UK and especially the South-East (not to mention the Republic of Ireland) has had on the economy. To put it simply, employers want and need to pay employees at least enough that they are not living in especially grim circumstances, if nothing else than because it hurts productivity. The result of this is that high property prices and indeed high rents have cascaded through the economy, raising labour costs and prices and making the UK uncompetitive, while having no positive impact on living standards. Lower prices may well be a good thing, after the dislocation of the crash, and its side effects has passed.
Vested interests would have us believe that the price levels over the last 5 years or so are the norm. Well, they are about as normal as nearly every bank in the country going bankrupt.
Yes, the government is going all out to support prices and this amounts to taking wealth from the prudent and gifting it to the indebted. Mr Brown, I can assure you this will not be forgotten come election day and despite your our behaviour you might be surprised just how many savers are out here.
I can do little about the government robbing me to pay for their policy mistakes (until May 2010) but I will certainly not be playing ball by buying into their housing pozi scheme.
So the majority of those on minimum wage have to rent privately or buy.
This means that a sustainable level of house prices has to be related to the minimum wage.
Mortgage companies used to calculate an affordable mortgage was 2.5 times annual income.
This is calculated as follows;
Minimum wage = 5.73 pounds/Hr (22 or over).
Weekly wage = 5.73 X 40 = 229.20
Yearly wage = 229.20 X 52 = 11,918.40 pounds
2.5 times yearly wage = 11,918.40 X 2.5 = 29,796 pounds
SO THE SUSTAINABLE AVERAGE HOUSE PRICE AT THE CURRENT LEVEL OF MINIMUM WAGE IS 29,796 POUNDS.
This is why a flexible labour market can only make the current economic outlook for the UK much worse, as the UK has a much more flexible labour market than the rest of the core EU countries.
For those that imply that deflation is somehow a lesser problem than inflation has not read enough economic history.
Inflation is driven by demand; a collapse in disposable income means a collapse in demand and a collapse in prices. This feeds through to a collapse in profits which companies try to overcome in the short term by forcing down wages and by redundancies (although this exasperates problems in the long term). This further reduces disposable income for consumers and with it demand and prices, this becomes a negative reinforcement cycle.
This is why inflation will not be a problem in the foreseeable future.
Although RELATIVE inflation will exist with imported inflation (due to collapsing pound making imports more expensive).
RELATIVE INFLATION IS WHERE WAGES/BENEFITS FALL FASTER THAN PRICES.
This DEFLATIONARRY cycle falls faster in a country with flexible labour laws, as wages and demand falls faster.
Mr. Jeremy Warner this is one of the reasons the down turn in the UK is going to be much worse than in any other developed country.
I point this out because Mr. Warner has previously commented that a flexible labour market would allow a country to weather a economic storm more effectively, their was a article contradicting this view even in the FT recently (I will post the link if I find it).
So the only ways house prices can become sustainable (no more boom and bust) are;
1/ Double the minimum wage
2/ Let house prices fall to 29,000
3/ Massive council building program so the majority of these on minimum wage pay a low social rent.
4/ Re-introduce rent controls.
It is the collapse in disposable income for the low paid, that has driven people into unsustainable debt, exasperated by the removal of rent controls, which has forced up housing costs.
Check it out: http://www.sfgate.com/cgi-bin/article.c