OECD - UK House Prices Need To Fall 40%

Last night's "Newsnight", covering the fact that the UK economy is flat-lining, according to the latest data from the ONS, was interesting. Despite the Government trying to spin the data to claim that things were on track it is clear that this data was very bad, though not as bad as I'd expected - but we've still to get the revisions and final reading. The Government's own Office For Budget Responsibility, as well as the Bank of England, had been expecting growth of 0.8%, as opposed to the dismal 0.5% it turned out to be.

Some City analysts had been forecasting growth of as much as 1.1%. But, then when you are getting massive salaries, and bonuses in the millions, you are bound to get a much rosier view of the state of the economy than if you are earning Minimum Wage in McDonalds, or one of the Government's new Slave Labour Camps known as an Enterprise Zone.

But, it was not just Labour's ex City Minister, Lord Myners, who thought the data was bad.

Fund Manager, Nicola Horlick, also thought the data was bad, and was due to the Government's economic policies. After all when you've been in office for a year, its much harder to blame the previous Government. Besides, in the second and third quarter of 2010, as a result of Labour's stimulus package, growth was 1.8%. The fact that the economy has flat-lined ever since, even before the Cuts take effect, is clearly down to the Liberal-Tory Government's incompetence, and the way they talked down the economy with scare stories that Britain was in the same dire straits as Greece. Even the former CEO of ASDA, one of those people who signed the letter supporting the Tories proposals for Cuts, thought the data was bad, and things were going to get worse. He seemed much less confident now that these polices were going to lead to a bonanza of private sector jobs and growth.

But, the elephant in the room, also made its appearance. That is the question, I have been raising for nearly a year - house prices.

Vince Cable was asked directly by Gavin Esler if there was not still a massive bubble in house prices. Cable evaded giving an answer. But, there is no doubt that there is such a bubble. The OECD, as Lord Myners pointed out, have themselves said that UK House prices need to fall by 40%, to come back to a long-term average against incomes. As Deutsche Bank state,

"For both the US and the euro area the indicator crossed the long-term average in 2003 and reached new peaks in 2005 (US) and 2006 (euro area), respectively, with levels 12% to 18% above the long-term average. However, the regional differences were significant, with price-income ratios topping the long-term average by more than 40% in UK, Spain, Ireland, Finland and the Netherlands."

The IMF have arrived at a similar figure. But, as I've pointed out previously, that is just one measure of how much they are over priced. With real incomes being squeezed considerably - the ex ASDA CEO said the data he was still getting showed that real incomes had already fallen by 6% in the last year - this measure considerably understates how much house prices will need to fall. As illustrated by the figures I have previously given, showing the movement of house prices adjusted for inflation, UK house prices are around 4 times where they should be, meaning a 75% fall would be required. And measured against the very, long-term average rise in house prices of 4% p.a., house prices are around 10 times where they should be, requiring a 90% fall in prices.

Those figures might seem extreme, but they are not. In the 1930's, house prices fell by 90%. In 1997, property prices in Japan fell by 90%, as the Government attempted to remove its previous monetary accommodation. In 2001, in a similar bubble of Technology Share prices, the NASDAQ fell by 75%. In 1990, after a similar, but smaller, shorter lived bubble, UK house prices fell by 40%, and finally over the last year, house prices in Ireland fell by 60%, similar falls have been seen in the US, as the bubble in its housing market has burst, and renewed falls are being seen again. The figures provided by Deutsche Bank and OECD in the link above, show that the situation in other EU countries such as Spain is even more extreme, and shows the danger that these countries are in, and particularly that the Banks that lent to blow up this property bubble - including many from the UK and other Northern European countries - face when that bubble relly does burst.

It is no wonder that the financiers, and the politicians want to keep this quiet, because it threatens to blow the financial system wide apart. As I've said before, this private debt, much of it tied to housing, is far bigger, and a far more serious problem than Government debt. Government's can always print money to pay off their debt. Individuals cannot, and beyond a certain point, there only option is to default, and leave the Banks holding a worthless asset.

That is one reason the Bank of England is resisting raising interest rates despite soaring inflation. The Economist, which on its Price to Rent basis of calculation says UK house prices are 30% overvalued, says that house prices are now dictating interest rate policy not vice versa.

"What would such a prospect imply for a still-fragile economic recovery? Purists say that a further drop in house prices would merely shuffle wealth around. Homeowners would suffer, but those saving to buy a home would benefit. Reality is messier. Many householders have onerous debts, and would cut spending abruptly should prices plunge. For this reason, the housing market is likely to determine interest-rate decisions, not the other way round. If rate-setters prove cautious, house prices will take longer to reach bottom, but they are likely to fall all the same."

But, the experience of the 1980's is that Governments and Central Banks do not control Monetary Policy, except in places with a central planning system, such as China. The biggest part of money creation takes place in the private sector through the creation of credit, and money creation by Banks and other financial institutions. But, similarly, that experience showed that when the Money Markets decide that interest rates are too low, then whatever oficial interest rates, central banks set, is irrelevant.

The "Bond Vigilantes", can simply stop buying Bonds, and push interest rates up, and it is these rates that the Banks and Building Societies have to pay to borrow money - especially now that near zero interest rates have caused a liquidity trap, with no incentive for private savers to deposit their money.

On CNBC, yesterday, legendary oil man, T. Boone Pickens, warned that if the trouble in the Gulf escalated, and drew in Saudi Arabia, oil prices could go to between $300-$400 a barrel.

Even without that, oil prices were going higher, he said, because of continued and increasing demand from the dynamic economies in the world such as China and India. Meanwhile, China and other dynamic economies are suffering rapidly rising inflation, largely driven by the massive amount of money put into the global system by the US and western economies, which is monetising the rise in primary product prices. Slowly, at the moment, China is revaluing the Yuan against the dollar, so as to reduce its dollar cost of imports of these products. The consequence is that the cheap Chinese imports, that the West has relied on over the last 20 years, to keep down its own inflation, and more particularly the Value of Labour Power, is going to go into reverse.

The hope, clung to by the Bank of England, that inflation is going to fall, is doomed, and sooner rather than later, the financial markets will decide enough is enough, and UK interest rates will be forced higher, whatever the Bank of England decides. Already, finance for house purchase is only being offered to people who the Banks feel are likely to be able to pay it back. They still have, however, huge amounts of outstanding loans, to people who increasingly, even with interest rates at 0.5%, are finding they cannot pay, and are going into arrears.

For now the banks have had an incentive in not pushing for repossession, which would cause a firesale of houses to start, sending prices spiralling down, and meaning that the Banks would be likely to only get a fraction of their money back. This is at a time, when the question of default on loans is being spoken of openly more generally.

The EU has said that after 2013, Bond holders should expect to have to take a haircut - lose money - on any money they lend to Governments such as Greece or Ireland, or Spain or Portugal, that cannot pay it back. Already, the option of a partial default is being raised in respect of Greece. Iceland already defaulted on its debts, and has benefitted by doing so.

Unless the EU can find a way - such as selling EU Bonds, as I've suggested in the past,of raising money to cover the debts of the periphery more cheaply than currently available through the EFSF and EFSM, then a default is inevitable, because it is clear that the austerity measures in Europe are being as destructive to the peripheral economies, as the Liberal-Tory measures are in Britain.

This heightened level of risk will mean that interest rates are raised in any case, but, as happened with the Credit Crunch in 2008, if lenders fear they will not get their money back, they will be reluctant to lend at almost any price, and will begin to try to retract the loans they have made to prevent the risk of them going bad.

The initial effect, of a significant house price crash, be it just the 40% the OECD say is necessary, or the 75%-90% crash, I think history suggests is more likely, would be pretty catastrophic. Not, it has to be said for individual homebuyers. If your house has a paper price tag on it tomorrow only a tenth of what it is today, it really does not make any difference to you in terms of its affordability, or in terms of what it offers you as a house. A house is a consumer durable the same as a car or a washing machine, and people should get away from the ridiculous idea that it is in some sense "an investment". If you were going to buy another similar house, or a more expensive house, then the price of that will have fallen just the same, so relatively you are no worse off, in fact, in absolute terms you would be better off if you were moving up to a more expensive house. The problem only arises for those people who can no longer afford their mortgage payments, which has nothing at all to do with the actual market price of the house, but is determined by income and interest rates. In those cases, of negative equity, people could not sell their house at a price that would cover the amount they had borrowed. But, in reality, that is a much bigger problem for the Bank that made the loan than the individual that defaults on it.

That is why the Government and the Bank of England are doing everything they can to prop up the banks and their shareholders by propping up the housing market. But, that dam is bound to burst.

The consequence will be that the banks will face a flood of defaults and bad loans on a far larger scale than in 2008. That will have an impact across Europe, particularly in the periphery such as Spain where house prices are in an even larger bubble.

Many more banks will have to be taken over by the State across Europe, and that will mean those States will need even bigger bail-outs than has been seen in Ireland and Greece, and shortly to be seen in Portugal and Spain.

But, for all those millions of people who for the last 30 years have been unable to buy a house as prices soared to astronomic levels it will be a very good thing. If house prices fell by 75-90%, then millions of people would be able to buy. It would force land prices down markedly, reducing the cost of building new homes too. That would give a huge incentive to house builders to start building many new houses, creating jobs for thousands of building workers. The question is how much of a hold does Financial Capital have over the Government to continue a policy of "Socialism For The Rich", as opposed to a real rebalancing of the economy away from this fictitious Capital, and towards real productive investment, and economic growth?