Wednesday, 5 October 2011

House Price Crash

As Homer Simpson might say “We obey the laws in this house, including the law of gravity.” Yet, oddly house prices seem to have been ignoring the law of gravity. The reason they have been doing so, is because they have been, like those other objectives that rise rather than fall – in a bubble. But, bubbles always burst. This particular bubble has been blown up over a period of at least 30 years, and arguably for more like 40 years. In fact, it could even be argued that that the bubble first began to be inflated with the loose money policies of Tory Chancellor, Reggie Maudling, back in 1960.
The size of the bubble, indicates the size of the pop when it bursts. All the indications are that is not too far away. One of the indications that smart money investors use in determining the health of companies that want to invest in is what the “insiders” are doing. In other words, are the Directors of the company, buying or selling shares in the Company they work for. As, Moneyweek point out we have something similar with the Housing Market. A record number of Estate Agents are putting themselves up for sale!!!

Moneyweek is not some fly by night outfit whose views can be ignored. The Editor is Merryn Somerset Webb, a former Stock Market trader, who writes for the Financial Times. It is connected to the Agora Publishing group, which publish a number of subscription only investment newsletters, including the Fleet Street Letter, which has been going since the 1930's, and whose Editors have included people like William Rees-Mogg.
Certainly, given the choice of taking on board what they think house prices are going to do, or listening to the increasingly demented ravings of the Daily Express, which never fails to claim that house prices are rising by double digits, I'd prefer the former. But, in any case, the basic facts tell us that house prices are due to fall massively.

Firstly, house prices measured against long-term averages are hugely over priced. The OECD says that, in the UK, house prices are 40% above their long-term average, measured against household income. But, as I have previously pointed out, that 40% over pricing means that the correction must be much greater than that.
If house prices spend several years above the average level, then, by definition, for the average to be re-established, they have to spend several years, by a corresponding amount, below the average. As the OECD graph shows, for example, in 1990, house prices were 20% above the average, but in that year they fell by 40%, so that, as the graph shows, they spent several years at up to 20% below the average. They only recovered their 1990 level in 1996.

But, there are reasons to believe that the situation may be even worse than that. This average is related to average household income, but we know that average household income is falling. It is expected to have fallen by 7% during the current year, and with inflation rising, wages frozen, and unemployment about to soar, that is likely to worsen. Average household disposable income, which is decisive, when people are thinking about being able to move home, is going to be falling even further, as the effects of benefit cuts, for example for Child Benefit, and Tax rises are taken into consideration.
In other words, even if house prices remained constant, this over priced condition would be bound to worsen. The extent of it can be seen by the late age – 37 - at which people now buy their first home, by the number of people who cannot even save the amount needed for a modest deposit of between 10-25%, and the number of people, around two-thirds, who now say they believe they will never be able to afford to buy a house.

Yet, in many ways the conditions currently existing, are some of the best that a housing market could expect to have!


For one thing, demand for housing has been pumped up. Cultural changes have led large numbers of people to believe that they should have their own home. This is manifest in various ways. For one thing, after WWII, there was a large rise in home ownership, and a decline in renting, which had been, essentially, the only form of house tenure for the working-class until that time.
The idea, that everyone should aspire to be a home owner, was one that took off in Britain, during the 1960's, and onwards, in particular, a situation that is not common across most of Europe, where long term renting is the norm. From the 1960's on, until around 25 years ago, rising real wages, along with rising house prices, appeared to make house buying a one-way bet. An average semi-detached house in 1960 costing £2,000 would today sell for around £150,000. But, even by 1970, the £2,000 mortgage taken out in 1960, would appear rather small, due to the rise in inflation and wages. With inflation rising by double digits per year, during much of the 1970's and early 1980's, the £2,000 Capital sum of the mortgage was rapidly shrunk to nothing, whilst the house it had bought had already risen in price, as a result of that inflation, and more, due to excessive money printing, by much more than that, giving the appearance of a huge increase in wealth – which was, of course, merely an illusion.

Its no wonder then that many people saw no option but to get on this merry-go-round of apparently free money that came from just buying a house. Other cultural changes meant that young single people sought to obtain this benefit too. In the post-war era, and into the 1960's, it was common for young married couples to live with their parents until they saved enough for a deposit on a house. Moreover, single people lived at home in the main. A number of factors have led to many single people leaving home at an early age, and thereby creating an additional demand for housing. The factors set out above, are one reason for that, as was the increasing availability of credit, and mortgages during the 1980's, without the need to demonstrate the kind of income levels that were required until then.

Another factor over the last 20 years or so has been the increasing numbers of people going to University.
In Europe, most people going to University, go to their local University, and remain living at home. They tend only to move away when they do a higher level degree. In Britain, there has always been a culture of going to Universities in some other area. In the past, this could be accommodated on Campus, but the much larger numbers of students now mean that an entire industry has developed, of landlords buying up properties, near to Universities, in order to rent them out to students. This has created a sizeable additional demand for housing.

Another source of demand has come during the 1990's, and early 2000's from the number of migrants coming to Britain. Many of these have come as individuals, and so the actual demand for housing units is proportionally greater than for housing families.

During the 1990's, the availability of cheap credit, with no questions asked, led to another new demand for housing. As in the US, where “flipping” - buying a house, speculatively, in order to sell it quickly, for a profit, in a rapidly rising market – took off, even amongst some better off workers, a new breed of speculator arose, who bought houses, or flats, in order to rent them out, then using the rental income as the means to take out yet further mortgages, to buy additional properties i.e. buy-to-let.

But, of course, the biggest factor, which means that the housing market has the best conditions it could expect, is the very fact of the cratering of interest rates that was brought about as a consequence of the Credit Crunch, and the measures taken by the Government and Bank of England in response.
Its estimated that the average mortgage holder has been given around £7,000 p.a., in their pocket, as a result of the slashing of interest, during that time. Of course, the other side of it is that pensioners, and anyone else with savings, has seen their earnings from those savings disappear, as a result of the same low interest rates.


But, if the housing market has been supported by new types of demand, it has also been supported by the conditions of Supply too. With the Cuts to Public Spending that began in the 1970's, came reductions in Council House Building. Thatcher reduced housing supply in the 1980's by selling Council Houses, whilst refusing to allow Councils to use the Capital receipts from the sales to build new houses. That continued throughout the 1990's, and effectively no new Council houses have been built since.

Marx theorised the consequences of a Monopoly of land ownership in his Theory of Rent.
The absurdity of the property market in Britain is that all residential development is squeezed on to just 10% of the land mass, with the other 90% remaining in the hands of the great landed estates such as the Duchy of Cornwall. This monopoly, which is also reinforced by planning laws that protect it, in relation to the Green Belt etc. artificially raises the price of building land, and thereby of house prices, and of rents. It is also what leads to the development of the huge cancer-like growths of City conurbations, that leads to congestion, ill-health, and all the social problems that go with it. As Marx and Engels argued in the Communist Manifesto, a rational socialist society would abolish the distinction between town and country.

But, the other aspect of rapidly rising house prices, has, in the way Marx set out in his Theory of Rent, fed back into rapidly rising land prices, as land-owners find that they can use their monopoly, to force builders to share their excess profits with them, in the form of higher land-prices (Capitalised Rent). That means that house prices, forced up by rising monetary demand, do not feed through fully to increased Supply by house builders, because the excess profits they would have made, are siphoned off by landowners.
Moreover, the large builders, who acquire large amounts of land, and store it in their own land banks, then have the same incentive as any other landowner i.e. they have an incentive to sit on it, rather than building on it immediately, because they believe that the price of the land will rise, and so the houses they eventually build on it, will be more expensive, and bring them additional profits!

So, despite the massive rise in house prices, there has been no corresponding rise in Supply, which once again disproves the claims of orthodox economics about the way in which the market is supposed to automatically meet the needs of consumers in response to price signals.

Falling Demand

But, these conditions of Demand and Supply are not set in stone. It is easy to see how even small changes, that are likely, will mean that the favourable conditions, that have existed for house prices, could easily, and quickly, reverse. For example, the longer people feel they are unable to buy a home, the more they get used to renting, the more the culture of home ownership will itself be undermined. There are many advantages to renting, especially for people who need to be mobile in search of employment, and who do not then need to sell their house.
Even more, in unstable economic times, renters do not have to worry about whether their mortgage payments might double over night, whether the market price of their house might drop by 20%, leaving them in negative equity, and in danger of being repossessed etc. Moreover, unlike the 1960's, 70's and 80's when inflation meant that rising wages quickly eroded the real amount of the Capital Sum, and shrank mortgage payments, wages today are stagnant, and real wages falling, and there is no chance that the Capital Sum will be inflated away. And, far from monthly mortgage payments being shrunk, there is only one way that interest rates can go from here, and that is up. Mortgage payers could find, in the next few months, that even modest rises in interest payments will double their monthly mortgage payments. All of those factors will increase the attractiveness of renting over buying bringing about what economists call a shift in the demand curve for buying, meaning that demand for buying will shrink at every price.

Its possible too that the increase in University Tuition Fees, and other costs of going to University, may result in a reduced number of people doing so.
Alternatively, they may feel that if they are going to pay such levels of fees they will seek out better quality Universities in Europe and elsewhere, in which case the housing demand will shift to this other country. Alternatively, the higher costs may result in more students going to a local University, and continuing to live at home, more in line with the European model. In any case, it is clear that students, coming out of University, with massive levels of existing debt, will be in no position to think about adding to it in the form of a mortgage, for many, many years. In all these cases the demand for housing is reduced.

In respect of migrants, that influx was due to the rapidly growing economy of the late 90's, and early 2000's, and the possibility for it, opened up by the accession of Eastern European countries to the EU. But, as recent data has shown, Britain has much worse Benefits than many other EU countries. With a British economy going into recession, and at the same time with the economy of Poland, and other Eastern European economies growing strongly, its likely that the migration will be reversed. Rather than providing additional demand, then, its likely that this reflux of migrants will cause a marked reduction in housing demand.

In respect of the buy-to-let merchants, this could quickly turn from being a source of demand for housing to being a source of cheap supply. The Landlords, of previous times, usually owned the properties they rented out. This meant that they were able to weather ups and downs in the economy, because they were not dependent upon the Rents, to cover mortgage payments on the properties they owned. But, the Buy-To-Let Landlords are different. Their existence is much more precarious. If either Rents fall, occupancy falls, or mortgage payments rise they can be wiped out. The Liberal-Tories are introducing changes to Housing Benefit, which will reduce payments, in expensive parts of the country, such as London, which is where much Buy-To-Let activity has taken place. This means that some tenants will be forced out of London, because they will not be able to make up the difference in the rent. That means occupancy rates could fall. It also means that downward pressure will be applied to Rents as a result. But, in addition, interest rates, whatever the Bank of England decides to do, will rise, because Banks and Finance Houses are finding it increasingly difficult to borrow. That is why
, George Osborne, in his speech announced that Government will replace the Capital Markets and finance Corporate Bonds directly, and guarantee the sub-prime business loan SIV. It is why, Cameron wanted to encourage people to pay off their debt, but found that ran up against the need for people to keep spending. That means the mortgage payments on these buy-to-let properties will rise sharply at the very moment when occupancy rates, and rents are falling. Either the Landlords will see the writing on the wall, and begin to sell up, before they go bust, or else they will go bust, and their properties will be repossessed, and sold off cheap by the Bank. In other words, a source of demand will become a source of additional cheap supply.

Rising Supply

But, other changes suggest that Supply may also increase. Firstly, there are already more than 700,000 empty homes in Britain. So long as you expect house prices to rise you have an incentive to hold on, and wait for a higher price. But, even if house prices stagnate, for a considerable period, let alone drop, the more the owners of these properties will begin to feel they are holding on to a wasting asset, the more the fear of making a loss will take hold, and the more they will be likely to want to realise the asset, by selling it quickly. In addition to this 700,000 properties, there exists planning permission for a further 300,000 houses, which builders have not acted upon. In other words, there is an overhang of more than 1 million houses already on the market.
With the number of additional houses needed per year estimated at around 250,000, that means that there is already 4 years supply of houses available, even if no further housing were to be built. By comparison, the Spanish housing market, which is seeing price falls of around 60% only has an overhang of 1.5 million homes.

Other changes may mean that the Supply of houses rises further, but even now the available Supply of houses is, in fact, much higher than the 1 million stated above. For one thing, if there is a change in culture, with fewer people going to University, fewer young individuals feeling they need to have their own house/flat etc., and more young individuals continuing to live with their parents, then this not only means a fall in demand, it means that if those individuals move back home, there will be, at the same time, an increase in Supply. However, there is an even greater potential for there being a large increase in Supply without a single house being built in Britain.

In Ireland, the construction and property boom, has left vast numbers of houses lying empty. House prices have fallen by 60%. One of the advantages of being in the EU is that British people can now take advantage of lower property prices, higher wages, and so on, that exist in other EU countries. Over the last 20 years, we have seen an increasing number of people retire to Spain and other countries. As the Government never tires of telling us, we have a rising number of retired people in Britain. It would be surprising, indeed, if an increasing number of retired British people did not take advantage of this facility. The TV is filled with all sorts of property programmes of the “Move To The Country” variety.
How long can it be, before such programmes begin to illustrate, to British people, the massive savings they could make, by selling up here, and buying a house in Ireland for a fraction of the price. It would also have the advantage of being no further away, for many people, than moving to Scotland or Wales. In addition, there would be no problems of learning a different language. All that plus continuing to benefit from the same Pension, and Benefits etc. as living in the UK.

When, people begin to twig the possibilities that such moves offer, then it could be expected that this existing massive supply of cheap property will quickly attract, large numbers of people towards it. The more these other EU housing markets are seen as being as much sources of housing supply as the UK housing stock, the more the calculations of Supply and Demand needs to be reviewed. The ability of workers to move to cheaper housing elsewhere is restricted by availability of employment, and consideration of relative wage levels. But, that does not apply to retired workers. They do not have to limit their decision on where to live by where they can obtain employment. It is no different than in the US, where many workers retire to the sunshine of Florida. And, because under EU Treaties, UK citizens are entitled to continue to receive the same Benefits and Pensions they are entitled to here, wherever they live in the EU, they are not limited by considerations of income either. On the contrary, there is an incentive to move to a country where the cost of living is lower, and those Pensions and Benefits will go further.

Its not just the EU that offers this kind of opportunity. If you move to the US, you can continue to receive your Pension, but the State Pension will not be uprated in line with inflation.
But, as I demonstrated recently, the 60% collapse in US house prices means you can now by a luxury 6 bedroomed house in Florida, for just £70,000!!!

Government Policy

The Government has been desperately trying to shore up house prices for some time – as did the previous Government, through its various ridiculous schemes (scams) such as shared equity and so on. They know that, in conditions where private debt, in the UK, stands at £2 Trillion – more than twice the Public Debt, which they insist has to be paid off – a severe drop in house prices would be very bad news for the Banks, whose Balance Sheets depend upon the nominal values of the properties against which they have made loans.
If a Greek default would collapse much of the international financial markets, a serious number of defaults on all this private debt would be likely to spell its death knell. But, all these desperate measures begin to look like sticking their finger in the dyke.

What is more, the other policies being pursued by the Government are having unintended consequences. The austerity programme, as set out above, in cratering the economy, is also creating the conditions for cratering the housing market. It was the onset of recession in 1990, which collapsed the housing market.
Rising unemployment means falling housing demand; rising inflation, through money printing, and low interest rates, means a falling pound and rising inflation; cuts in Housing Benefit means lower rents for Landlords, and, therefore, lower income against costs, encouraging them to Capitalise their rents by selling their property. But, the other policies announced recently by the Government, are likely to exacerbate that.

The Liberal-Tories are proposing encouraging more Council House sales via increasing discounts under Right To Buy. Unlike, the 1980's, because they are desperate to come up with a policy for growth, they are proposing that, for every house sold, Councils should build a new one, using the Capital receipts. This has a double effect. In building new houses, this means that housing supply rises. But, in offering much bigger discounts on sales, this means an immediate sharp, downward pressure on house prices in the immediate area. Previous discounts were up to around 60%. If it becomes possible to buy houses at those kinds of discounts, then that will force other sellers, in that area, to sharply reduce the prices of their houses, or they will not be able to sell.

The Liberal-Tories are also proposing to allow builders to acquire Council owned land to build new houses, without paying for the land until the houses are sold. Again this has two consequences. Its likely that Councils would be under pressure to sell the land cheaper than private landowners would be prepared to accept. This means downward pressure on land prices, which form a considerable element in builders' costs. Secondly, it means that, in order to obtain this benefit, of lower priced land, for which they do not have to pay, until they sell the houses, they have to actually build the houses, rather than sit on it, as a land bank. So pressure will be put on house prices from both angles – reduced land costs, and rising housing supply.

Finally, the Liberal-Tories are proposing to change the planning laws in favour of a presumption in favour of development. This is a crack in the long-standing monopoly of land, which has kept land prices artificially high, and acted to restrict the expansion of housing supply. It has, not surprisingly, caused a backlash from the landed gentry, and their supporters. The campaign has been conducted through the pages of the Telegraph, and that means it may yet be reversed. But, the Tories are emphasising that the real intention is to allow these very local communities to have control over development themselves. In reality, as they say, a small village seeing the possibility of maintaining its viability, through the building of just a few extra houses, may see the advantages of that, provided they can be convinced that they are not going to open the door to vast new estates being built within their midst. Even one or two houses built in every village in the country would add a considerable number of extra houses.


And, there may be advantages in this for the Liberal-Tories, such that they outweigh the objections of their rural supporters. Its likely that they may calculate that their dyed in the wool support, in the countryside, will continue to vote for them anyway.
Meanwhile, to win an election, they need to win sufficient support in the urban areas. Its not just the OECD figures that show house prices as being 40% overvalued. The figures produced by the Nationwide, some time ago, show that on a different metric, prices adjusted for inflation, are around four times, the long run average price!!!. That has a significant distorting effect on the economy, because of what it implies for the Value of Labour Power.

As Stephanie Flanders reported some time ago, Fathom Consulting has produced a report, where they argued that collapsing the housing market would have significant economic benefits.

“How, you might ask, could a sharp fall in house prices possibly help the economy? It would help because it would get it over with. Like many economists, the authors of the report, Danny Gabay and Erik Britton, believe that the British economy will not truly put the crisis behind it until it has fixed the banking system and dramatically lowered the amount of private sector debt weighing on the economy.
Unlike some of their peers, they think that a correction in house prices is a crucial part of that process in Britain, and it has barely begun...

If you buy the Fathom view, policy-makers in the US and UK are making exactly the same mistake, only we're creating zombie households instead, who can only stay afloat because the cost of servicing their mortgage has fallen through the floor. As a result, banks don't have to face the fact that their mortgage-based assets are worth much less than they were at the peak of the boom - and the country can't move on.”

Asset Prices

It is usually, if not always, the case that when an asset price bubble bursts, it is followed by the bursting of other such bubbles. In part, that is because periods of loose money leads to the prices of all assets being bid up. But, by the nature of such bubbles, the asset class that seems to rise most, then sucks in further money. When it pops, the money flows into the next best asset, and so on. That was seen with the Stock Market Bubble, which then saw money flow into the property bubble. Its attempted to pop several times, but has been kept inflated by the massive additional funds pumped into it via massive money printing and near zero interest rates, and by the fact that, because people live in houses, their attitude to them is different to their share holdings.
But, when people hold on to unrealistic prices, for such assets, for too long, it only means that the crash is that much more dramatic when it occurs. It is a Black Swan event, as Nicholas Taleb describes them, the kind of occurrence that becomes all the more shocking for the simple reason that no one expects it, no one has seen anything like it before in their lifetime.

Stock Markets recovered some of the losses they inccurred in the Crash of 2000, though the NASDAQ, which fell 75%, from its high of over 5,000 in 2000, is still languishing at less than half that level. Yet, after 2000, companies returned to high levels of profitability, which is the basis upon which share values are calculated, so it is not entirely that those share prices have simply been reflated, as part of a new bubble. No such change in the fundamentals of housing has occurred.
In fact, if anything, the general rise in productivity, the improvements in technique, that lead, over time, to the fall in price of all commodities (in real terms) means that houses, like every other commodity, should become cheaper, not more expensive. The rise in prices can only be explained in terms of a bubble.

As I've set out previously, the massive money printing that has taken place over the last 25 years, has resulted in a series of these asset price bubbles being inflated, whilst general commodity price inflation has been low, due to cheap supplies, from China and elsewhere. Now that is reversing. Not only is credit tightening – either through deliberate State policy, or because of a Credit Crunch arising out of the contradictions caused by previous credit excess – but, consumer price inflation is rising, because China is no longer the source of ever cheaper commodities.
It has suffered inflation too, the wages of its workers are increasing rapidly – in some cases with wage demands of 50% - and the Yuan is rising against the dollar, and other western currencies. That is a double whammy, of rising import costs, that is heading towards Britain, at a time when wages are being squeezed. The more money people have to allocate towards paying for their food, and energy, the less they have to bid up house prices. As with any Ponzi scheme, once no “bigger fool” can be found, to pay the higher prices, the whole pyramid collapses.

At the same time that share prices are collapsing, house prices are falling rapidly too. Much more than the official figures suggest. The official figures, much quoted in the media, only relate to asking prices, but what is important is the actual selling prices of houses. As the BBC reported recently, there is a massive gap between asking prices and selling prices.

“At £236,597, average asking prices are still far higher than selling prices.

The average UK selling price, as calculated by the Department for Communities and Local Government (DCLG) is £203,528.

This suggests that sellers or their estate agents are over-valuing homes by 16%.

The reality gap is even greater when asking prices are compared to house prices as calculated by the Halifax or the Nationwide.

The Nationwide says the average house now costs £168,205, while the Halifax says they cost £163,049.

That puts the reality gap at 41% based on the Nationwide's figures or 45% on those from the Halifax.”

That mirrors what has happened in other countries, where house prices have collapsed. In Spain, for example, it is still common for selling prices to be 30% below asking prices, even though, asking prices have fallen massively. A look at some of the UK Estate Agent websites, which provide details of selling prices compared to asking prices and so on demonstrates that. For example, Primelocation. Their figures, for actual houses, show that drops in asking prices of between 10%-30% are already common, and selling prices are already standing in about the same relation to asking prices. According to the BBC figures, there could already be as much as a 40% difference between asking prices, and selling prices, so it is no wonder that many people continue to ask unrealistic prices when they put their houses up for sale. That is why according to Rightmove, 70% of houses put off for sale remain unsold, and estate agents are seeing the houses on their books rise to new levels.

But, while these assets are falling, Gold is rising.
Gold is real money, it has an intrinsic value, determined by its price of production, the fact that it has to be found, mined, and processed, and no one will do that unless they can make a profit from doing so. For more than two decades, its price fell below this Value, because there was no demand for it to fulfil its historic role as Money, because that was being done by the dollar. The market price fell to about a quarter of its value, as all the excess Gold overhung the market. Now, the excessive printing of paper Money and Credit, has led to it being devalued. Rising inflation, and a currency war between countries, trying to depreciate their currencies even further, together with rising risk and uncertainty, is leading once again to a demand for Gold, which is why its price is soaring. But, where Governments have attempted to keep the price of houses artificially high, they have attempted to keep the price of Gold artificially low. That is why Gordon Brown, and the Central Banks of other countries, sold off large amounts of Gold, when its price was rising. They do so because, if Gold rises in price, it begins, even more, to take on, again, the role of real Money, and, thereby, undermines the current system, based on paper money, and the ability of Governments to manipulate it for their advantage.

The rise in the price of Gold has not yet led to it being seen as an important asset, however, in the way shares, or property have. On the contrary, the investment pundits continue to advise against it, in the main, whilst millions of ordinary people are encouraged to hand over their valuable gold in return for worthless bits of paper, by the rash of “Gold4Cash” merchants, that have sprung up on every High Street.
A good measure of when Gold is in a bubble, will be when those shops close because no one will sell their Gold to them, and when instead the people who are now selling their Gold, are clamouring to buy it. But, as that process unfolds, as with the collapse of every other asset bubble, it will be people clamouring to sell their houses – especially all those Buy To Let Landlords – who will be seeking to get money from those house sales in order to put it into Gold, to protect themselves.

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