Saturday, 24 July 2010

Wages And House Prices

According to the last in the BBC's Money Watch programmes on the economic crisis, the long-term relation of house prices to average earnings is 3.5. The current relation is 5. That implies that house prices would need to fall by 30%. This is a bit less than my calculation that they need to fall by 50% to return to trend. In either case in a return to the mean, just as house prices rise above the mean in a bubble, so they decline to below the mean when the bubble is burst.

There is, of course, another alternative to house prices collapsing by 30, 50 or more percent. Wages could rise. However, whilst prices would only have to fall by 30% to restore the long-term average, wages would have to rise by much more to achieve that result. Assume that the index of average wages is equal to 100. Then at the long term average house prices would be 350. They are currently at 500. If they remain at 500, what does the index of wages have to rise to for the relation to be 3.5, answer 500/3.5 = 143. In other words wages would have to rise by 43% to achieve the same result. Given that wages are pretty stagnant, given that the Government is introducing a pay freeze for the 25% of the workforce that works in the Public Sector, and given that pressure will be put on all wages as a result of the 1.3 million extra unemployed the Treasury estimates will result from the Budget, a rise of 4.3% looks unlikely, let alone 10 times that amount. Moreover, what is important is not just gross earnings, but disposable earnings. Given that workers will face a rise in VAT, and rises in prices of other commodities, disposable income is likely to fall not rise.

As the economy goes into reverse if not into a double-dip, a serious house price crash now looks inevitable, and that in itself will have serious economic consequences. At the same time, there will be some who benefit. With the crazy casino Capitalist economy, especially as it applies to housing in Britain, luck or timing can seriously affect your wealth.

In 1947, when my parents bought their house, things were similar to today. There was a massive housing shortage, and large numbers of young men, like my Dad were being demobilised from the Army, getting married and having families. Building new houses takes time. My parents, were desperate for a house. With a small daughter, they had lived with relatives and in lodgings. It was very unsuitable as many people in similar circumstances today would attest. I'm not sure what my dad was earning in 1947, but it wouldn't have been much – I've got his Army papers somewhere, and I'll have to check what he was paid as a Corporal, which was probably more than he earned as an engineer. I know his wages didn't rise to £20 a week until the 1960's.

The old terraced house they bought cost them £1,000, and like today they had to take out a separate loan with the Co-op, to raise enough of a deposit to get a mortgage. 27 years later when the house was destroyed they got exactly the same nominal amount back! By contrast had they been able to wait for just two or three years, in 1947, they could have bought a brand new semi-detached house, part of a development in the village, for just £250! The difference between paying £1,000 for an old terraced house, as opposed to buying the new semi, for £250 was huge. Not only was the cost of repayment crippling, but the price of those same semis now stands at around £90,000 to £100,000.

If house prices do crash dramatically now in that way, then anyone buying after the crash stands to be in a similarly favourable position in years to come.

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