Margareta Pagano: Dr Doom predicts a housing disaster – and he's got history on his side
Midweek View: Prices are at least 20 per cent too high or earnings are 20 per cent too low. We know the answer to that
Margareta Pagano is a former business editor of the Independent on Sunday who now writes columns and business interviews for a range of publications, including the Independent, Independent on Sunday and London Evening Standard.
Wednesday 19 September 2012
Be careful what you wish for. All the chat about higher growth in the US and green shoots in the UK might bring with it just what we don't want; higher interest rates to contain inflation and with them, a crash in UK house prices.
If you talk to Andrew Gibson at Galvan Research and Trading, one of the UK's top contract for difference brokers, as I did yesterday after reading his latest special report – Why UK house prices are set to collapse – you'll discover we may be on the brink of another housing disaster.
Indeed, Mr Gibson predicts that house prices have to fall by at least 25 per cent – possibly more – for the market to finally correct after the financial crash. As my new Dr Doom reminds us, this was a crash that had the firepower of the Napoleonic wars, the Great Depression and two World Wars, all in one hit. Considering the sheer force of this blow, UK house prices have been astonishingly resilient – down by about 13 per cent from their peak in 2007 which, although not great, is not too bad if you compare it with the average 34 per cent fall in US house prices, in Spain where prices are 31 per cent lower and in Ireland, down a horrendous 53 per cent.
We're now in our second recession in four years, unemployment is at 17-year highs and people's incomes are being squeezed by inflation and low wage rises. Yet in the UK home possessions have been small – running at about 30,000 for the last two years, less than half the levels of the 1990s crash – although this number has been kept artificially low as some banks are helping homeowners stay afloat through forbearance.
And house prices are still surprisingly stable. As the latest figures from the Office for National Statistics showed again yesterday, house prices were 2 per cent higher than a year ago with an average price of around £234,000. But, to get a more accurate snapshot of the whole country, you have to strip out London, which is still sadly inflated by overseas buyers with their dodgy money, and the South-east, where the average UK house price rose by just a 0.6 per cent in the last year.
So how has the UK avoided a crash? Dr Doom says we haven't – just deferred it with central bank meddling that has kept interest rates dangerously low and cheap money. But it won't be long before we revert to the mean. As he says, look at the facts: from 2001 to 20011, the cost of the average house rose by 94 per cent compared to a 29 per cent increase in average salaries or, more simply, house prices rose three times faster than wages.
You don't have to be a genius to work out this is unsustainable over the long term. The best yardstick for determining the value of houses is to look at the ratio of prices to earnings; it's this that measures affordability and it's way out of kilter. Average UK house prices are still more than five times average earnings, which compares with a long-run average of four times, although it dipped to three times during the 1990s crash. This suggests, says Mr Gibson, that either prices are at least 20 per cent too high or earnings are 20 per cent too low. We know the answer to that.
Ultra-low interest rates are to blame for this market distortion, he says, coupled with a shortage of affordable homes made worse by tight planning rules. So the killer question is this: how long will today's low rates last? If you look back over the last 20 years, the base rate has been about 4 per cent above headline inflation and, with CPI running at about 2.6 per cent, this gives you a base rate of 6.9 per cent. Thus, to get the market working again, Mr Gibson reckons the current standard variable interest rate needs to be about double what it is today – doubling mortgage repayments for most families.
The Bank of England – and the politicians – will try to keep interest rates down for as long as possible to buy time for the banks and the economy to recover. But it's also likely that once the US election is out of the way the US Federal Reserve will raise rates again, and where its chairman, Ben Bernanke, goes, the Bank of England's Governor, Sir Mervyn King, follows.
It's tough knowing whether leaving house prices at such unaffordable levels does more harm than good in the long term, but it's clearly one of the reasons why the banks don't have any confidence to lend. Only a brave investor believes UK property prices can defy history and stay disconnected from salaries. It pains me to say so but Dr Doom has history on his side.
But there is a bigger message too: central bankers can't be allowed to play such dangerous games with peoples' lives by allowing rates to yo-yo as they have over the last four decades. It's irresponsible.
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