Wednesday, 8 May 2013

Tired Drivers And The Property Market

For the last fifteen years, I have driven down to Spain, at least once a year, and one year down to Portugal. In the first few years, the drive was done without any overnight stops. I'd finish work on a Thursday evening. We'd already have the suitcases and other stuff packed ready, then having eaten set off for the Channel Tunnel. We'd begin driving down from Calais, usually just after midnight. By the middle of the night we'd be half way down through France. The trouble with starting off in the evening, however, is that you have already been up all day. By around three or four in the morning, your eyes start to close involuntarily, especially when everyone else in the car has gone to sleep. Eventually, you find yourself being woken up as the car starts to occasionally hit the rumble strips on the edges of the road. Its time to just pull over somewhere, and sleep.

You catch a few unsatisfactory hours of sleep, and then set off again. We took a travel kettle, and coffee, so that someone could be making coffee in the back of the car to avoid the need to stop. Every time you start to feel tired you overcome the feeling with more caffeine. Even so, the more time goes on, the slower progress becomes, because you find yourself needing to stop every hour or so, to just close your eyes. Eventually you get to the villa rental company, and get the keys. But, the first day at the villa is more or less wasted, because all you want to do is sleep, and you feel like shit, because all the caffeine is causing your head to buzz, like a hornet's nest. Your body needs to catch up on all the sleep you missed over the last 30 hours.

In the last few years, instead, we've planned the journey out, starting in the morning and organising stops at convenient places, at Formula 1 Motels. We've even a few times combined the trip down with a grand tour of Europe through Belgium, Netherlands, Germany, Switzerland and France.

What does that have to do with the property market? Nothing directly, only an analogy. The property market is precisely like a tired driver. It has been pushed beyond its limits, but instead of having a sleep, it has been kept going even further with continual infusions of artificial stimulants.

By any of the known metrics, UK house prices are overvalued by around 40%. That is the conclusion from the Nationwide's data on inflation adjusted prices; it is the conclusion from comparing the current price to household income with the average historical ratio; it is the conclusion that the IMF and OECD have reached etc. On every past occasion when house prices have been overvalued like this, they have corrected by a sharp crash in prices, that then takes several years to unwind. In 1990, when prices were 20% overvalued, they fell by 40%. In fact, logically, however much they are overvalued, they need to fall by twice as much to restore the average i.e. if the average is zero, and prices are +10%, they need to go to – 10%, or else the average could never be zero.

On that basis, house prices need to fall by 80%. That is a huge drop, bigger than any seen before in Britain. But, then house prices have never been 40% over valued before either. Like a tired driver, the longer you have put off the sleep you need, the longer you are going to need to sleep to recover. Of course, the 80% drop does not have to be all at once. It could come about as continued falls over a number of years. But, historically, as with every other asset price bubble, it usually involves a large crash at the start of that process. An 80% fall might seem extraordinarily large, but house prices have fallen by up to 75% in the US, by around 60% in Ireland, and around the same in Spain. In the late 90's property prices in Japan fell by 90%!

The fall in house prices could be a relative fall i.e. against incomes. But, there is not much hope of that. Incomes are falling not rising. Moreover, what is important is really disposable income, because people can only afford to bid up house prices when their disposable income is rising i.e. what is left of their income after they have covered the even more essential items such as food, clothing and fuel. Disposable incomes are falling even more than nominal wages. What the GDP and employment statistics demonstrate is that people are being kept off the unemployment statistics at the cost of falling productivity, and falling incomes. Wages for people in work are falling in real terms, whilst large numbers of other people are getting smaller incomes from classifying themselves as self-employed, but are really subsisting on obtaining scraps of often badly paid work where they can get it as gardeners, window cleaners etc.

The only thing keeping house prices from going into a crash is the continued infusions of stimulants being provided by the Government. But, just like a tired driver, such infusions can only delay the inevitable not prevent it. And if things go badly a tired driver doesn't stop in time, and themselves crashes. The danger with the housing market for the Government, is that despite all of the stimulus it is providing, it crashes anyway, and causes a multiple pile-up, as it crashes the banks with it, along with the rest of the economy. Of course, its out of a concern to prevent the banks crashing that the Government has kept this stimulus coming, and why the banks themselves have kept up the policy of “pretend and extend”. But, the inevitable cannot be avoided.

Some have argued that there is something different this time about the property market. Pundits said exactly the same thing in 2000 about Technology shares. They then collapse by 75%. The argument has been put that the fundamentals of the property market are now different, that supply is not meeting demand. This confuses demand with need. In fact, look down any road outside London and the South-East, and you will see that supply is way outstripping demand. That is why everywhere there is a forest of for sale signs, why houses are staying up for sale for a year and more, and why sellers are continually having to reduce their asking prices.

The proof that nothing fundamental has changed is demonstrated by what happened in 2008. Then as the credit crunch erupted, house prices fell sharply by 20%. So, clearly, there is no fundamental reason why prices cannot fall very sharply. In fact, there is every reason why they should. For one thing, the main limitation on demand is that the basic requirement for a rising market is missing i.e. first time buyers simply cannot afford houses at current levels or anything like it. Without new buyers coming in, there is no way that prices can rise sustainably.

In fact, what has been seen since 2008 is precisely that tired driver syndrome. In response to the Financial Meltdown, interest rates, which had been rising, to check inflation, were cut to near zero. The average mortgage payer received an annual bonus as a result of this rate cut equivalent to about £7,000! It stopped the fall, and enabled prices to recover. But, its really only the same as a driver whose hit the rumble strip, stopped for half an hour, and filled up on strong black coffee. Its not the same as getting the sleep you need.

But, that infusion in 2008, was only the latest in a series of such infusions. The process began at least as far back as the 1980's under Thatcher. It could be argued to have started under Tory Chancellor Reginald Maudling in 1960, who used loose money policy to juice the housing market, in an attempt to improve the Tories election chances. In 1970, Tory Chancellor Anthony Barber, did the same thing sparking the so called “Barber Boom”. But, it was Thatcher's deregulation of Financial Services that was the real cause of the 30 year bubble in asset prices we are today suffering from.

Before then, if you wanted a mortgage, you did not go to the bank, you went to a Building Society. They would usually need you to have been saving with them for several years, before they would consider you safe to be given a mortgage. Thatcher's deregulation of Financial Services, opened the monetary spigots as a means of stimulating the economy. It encouraged workers and the middle class to borrow like there was no tomorrow to offset the fact that their wages were falling, as her economic policy turned the country into an industrial wasteland. Banks seeing an opportunity to make lots of profits, began handing out mortgages to anyone who wanted them, and the so called “Lawson Boom”, caused house prices, and share prices to rocket. The real and unsound basis of that boom was illustrated in 1987, when similar policies in the US had created huge twin deficits, which spooked the markets, and caused the biggest stock market crash in history.

Ever since then, rather than accepting that these markets were overstretched and needed to fall, the State in the US and UK, where these policies were most pronounced, has instead responded by pouring more coffee down its throat. The bubble in share and bond prices, and in the property market that the economy is suffering from today, was made not in the last ten years, but back in the 1980's. It was then that these bubbles were actually blown up. All the money printing has done since then, is to stop them from properly bursting, and instead inflated them slightly more. In fact, its precisely because it is really a 30 year bubble that needs to burst in those markets, not just a ten year bubble, that means the burst needs to be so large.

But, just as a tired driver finds that eventually, even bigger and bigger doses of caffeine enable you to go for shorter and shorter distances, so the property market, and other markets are showing exactly the same symptoms. I described that in my blog QE III etc. Spells Desperation . Yes, the Dow Jones yesterday closed at another new high, but the amount it has risen in the last four years is quite small given the amount of money printing that has taken place in that time. In fact, in inflation adjusted terms, its probably not a new high at all. Certainly compared with the highs of 2000, they are not at new inflation adjusted highs. Yet, during that time, money has been printed on an astronomical scale.

We have huge amounts of money being printed in the US and Japan, and large amounts in the UK. We have interest rates kept at artificially low levels because of that money printing, and because the huge volumes of profits generated during the Spring Phase of the Long Wave Boom has meant that the Supply of Capital has exceeded the demand. That excess has meant that money capital thrown off from the circuit of capital could amass in money hoards that made possible the low interest rates, as it bid up Bond Prices. Yet, despite that vast and increased amount of money printing, share markets, bond markets and property markets are only just being propped up!

In the US, house prices have begun to rise again. But its becoming clear that the demand is coming not from actual home buyers, but once again from speculators. In the UK, the Government has resorted to more or less open bribery of potential home buyers in its latest schemes to keep the market from crashing. Yet, in the last year, its Funding For Lending Scheme that was intended to provide mortgages for 150,00 people, managed to entice just 150! The Daily Express is talking its usual nonsense, aimed at the Tory Pensioners that make up its readership when it suggests that the latest scams will cause prices to rise by 30% in the next two years. At best they may simply be additional, stronger stimulants to prevent the inevitable crash for a bit longer. It will mean that it will turn it into a multiple pile-up, as taxpayers themselves are drawn into the melee, having been committed by the Tories to pick up the tab for the defaults.


David Timoney said...

Buying a motor home might be a sensible move.

Boffy said...


I did buy a caravan as part of our planned relocation to Spain 4 years ago. It nearly killed us. I prefer now, to take a leisurely drive, and simply book into motels in advance.

However, there have been some nice pieces of land up for sale locally. Sticking a caravan on one of them would be a way of living in a nice spot without the cost, while I wait for house prices to crash. Odds are still on just buying a nice place in Spain for a quarter of the price here though. I have been thinking of Ireland as an alternative stop gap, but although its a really nice country, the main reason for moving would be the weather, and Ireland doesn't fit that bill.