Nightmare on Acacia Avenue: As plummeting house prices turn dismay into panic, Gail Counsell asks how much further they can fall

IT'S KNOWN as the 'Doomsday scenario'. What if this were just the beginning? Could the house price slide turn into a free-fall of a kind never witnessed before - and what would it mean if it did?

All the big building societies have tried to imagine such a cataclysm, their economists feeding ever-worse figures into the computers to project what it would be like. But they are reluctant to talk about it.

'The last thing we want is people writing that sort of stuff,' said one. 'Even if it is hedged round with lots of statements that we think it simply can't happen, just mentioning it will undermine confidence still further.'

The market, they say, is adjusting to the unsustainably inflated conditions of the late 1980s. A further failure of confidence now might continue to depress the market even after that process was complete. What we have to fear most, this argument runs, is fear itself.

Fear there is aplenty. As house prices have tumbled across a swath of southern England, dismay has increasingly turned to panic. Home-owners and the powerful housing industry have begun to feel as though they are gazing into a bottomless abyss, and the Government is under pressure to do something to shore up the market.

But this is not free-fall. There are precedents for what we are seeing, and on the evidence of those precedents there is every reason to assume that the market has a bottom. We are simply not there yet.

House prices have exploded and collapsed twice before in recent history: at the beginning of the 1970s and again at the beginning of the 1980s. On those occasions it took between two and four years for the downturn to work its way through. The present downturn did not begin to bite nationally until 1990 - if precedent is any guide, we could have a couple of years to wait.

We also have a guide to where prices might stop. In the previous downturns, the cost of the average property fell from a peak of almost five times average earnings to nearer three. At the start of this year the average property was still costing more than 3.5 times average earnings.

So using the 1970s pattern as a guide, it will be 1994 before the housing market recovers and prices - which have fallen by around 6 per cent so far - will have to slide a further 5-10 per cent before it does: uncomfortable, but hardly disastrous.

In the Doomsday scenario prices continue to fall until they settle at a level well below what is necessary to make property 'affordable' again. This would break all the rules. Conventional wisdom dictates it is incomes which drive house prices. Since the Second World War the average home has been worth between three and five times as much as average earnings. In boom times it is at the top of that scale; when the inevitable downturn comes, it falls towards the bottom.

For prices to fall below three times earnings, there would have to have been either national economic collapse or a radical shift in the desirability of owning property. In the absence of an economic slump comparable with the 1930s - and we are a long way from that - it is difficult to imagine what could provoke such a shift. Property is not a fashion item. Everyone has to live somewhere and the need for a roof over your head (whether rented from someone else who owns it or owned outright), in a country where there are tight planning controls, tends to hold prices up.

But precedents can mislead, and the current downturn does have one characteristic which differentiates it sharply from the two previous cycles and which some argue could trigger Doomsday: nominal price falls.

For nearly half a century, adjustments in house prices have almost always taken place against a background of high inflation. When the house market fell in 1974-1977, for instance, at the bottom of the market the price of the average house still rose by a fifth from pounds 11,120 to pounds 13,922. In real terms the value of the property halved, but this was masked by runaway inflation.

This time inflation has been low and there has been nothing to conceal a slide in prices that is clearly visible in estate agents' windows. Since the beginning of 1990 the fall has been more than 6 per cent nationally; a drop of about 12 per cent in real terms.

These nominal falls have side- effects which are by no means nominal: up to 1.5 million owners may have homes worth less than their mortgages. The usual escape hatch of selling and trading down is not available, so arrears and repossessions have risen dramatically. More properties will probably have been repossessed between 1990-1992 than during the whole of the 1980s, and the 'forced sale' nature of the repossessed properties overhanging the market is another factor depressing prices.

Those not in financial difficulties have also been unwilling to move and lose capital they have tied up in their property. And buyers have proved equally afraid to act because of worries that any amount they pay now will look too high in a few months' time if prices continue to fall. As a result, the market has seized up, with transactions at half the level they were in 1988.

But could these factors by themselves presage a further collapse? Few think it likely. The more probable outcome is that they will simply delay the market's recovery.

'You can't write off further falls but they won't be dramatic,' said Robert Lind, an economist at brokers UBS Phillips & Drew.

It would take something extraordinary to push the market into meltdown, he said. 'Just psychology wouldn't do it. It would have to be something like a huge rise in interest rates and mass unemployment.'

A rise in interest rates is possible - building societies, strapped for profits, have been threatening to push them up, possibly by another half a percentage point. They seem for the moment to have pulled back from something they know would have very serious consequences for their business, but the possibility is there.

More unpredictable - and more dangerous - would be a rise in UK interest rates to support sterling, possibly following a vote by the French against Maastricht in September. That might mean one or two more percentage points on the mortgage rate. It could be highly damaging: property prices would probably have to fall further to compensate and what little confidence is left in the market would be smashed.

Such factors aside, however, it is unlikely dramatic falls are on the way, and some time in the next six months or so the market is likely to stabilise. But before then there may be a dip which will see prices drop by 10 per cent or more.

But what if the unthinkable happens and prices do plummet? Would a Doomsday scenario seriously damage the economy?

Oddly, when price falls of 30 or 40 per cent were run through the computer of one of the bigger societies, the conclusion it reached was that it did not make that much difference to the larger picture.

Businesses highly dependent on property would go to the wall - though the building societies and banks are unlikely to join them. Insurance companies would have to pay out ever-larger amounts under their indemnity policies. Estate agents would go broke. Solicitors would be discomfited.

The market would continue depressed with few people moving. Cautious lenders would insist on bigger deposits. As in France, first-time buyers might be faced with raising 10 or 20 per cent of the purchase price.

The 'poverty' effect, as the theoretical gains people had made disappeared, might make them less willing to spend money in the short term. But eventually the money saved on smaller mortgages would have to go somewhere, and the chances are it would be into higher consumer spending.

In the long run, as one building society expert admitted heretically, it might even produce a healthier economy.