When Falling Prices Still Signify A Bubble

Nearly everyone now recognises that London property prices are in a massive bubble. Even the Governor of the Bank of England has hinted at as much, and the Bank has ended its Funding for Lending scheme aimed at providing cheap money to banks to lend to house-buyers. But, the Government has continued to press ahead with its “Help To Buy” scam, designed to buy votes ahead of the General Election, by blowing up the property bubble even further, by providing tax payer subsidies for those that cannot afford to buy overpriced houses. The government does not even openly admit the existence of a bubble in London, but argues that the scam is justified because, in the rest of the country, house prices are lower than they were in 2007, and have not been rising at the same rate as London. Indeed, they even admit that in places they have continued to fall. But, does the fact that prices are still falling mean that these prices are not in a bubble? The answer is no.

The argument that house prices are not in a bubble because they are not at the level of 2007 is silly, because, in 2007, everyone accepts there was a massive property bubble. That indeed is why it burst, and led to the Financial Crisis of 2008. But, the fact that prices may not be at quite the same astronomical level as in 2007, obviously does not mean that they are not in something like the same kind of massively inflated bubble. Just because one bubble is not quite as big as another does not change the fact that it is a bubble. Moreover, its not clear that the current bubble is not even bigger, even if prices are lower, because in the intervening period, incomes have fallen substantially.

But, what about the fact that prices have been and are falling in parts of the country? Doesn't that mean that it can't be a bubble, because usually bubbles continue to blow up until they burst, causing not gradually falling prices, but a huge collapse? The operative word here is usually. Usually, bubbles, including property bubbles behave in that way. Its likely this one will too at some point in the not too distant future. But, there are specific and fairly obvious reasons why this one has also seen falling prices rather than just a sudden bursting of the bubble so far. The Government's “Help To Buy” scam is just the latest example of the reasons why that has been the case. In other words, the bubble would already have burst catastrophically, like all other bubbles, were it not for the fact that the state has kept sticking its fingers in the dyke to prevent it bursting and sweeping the banks away in the deluge.

Its a bit like a bike tyre. You get a burst, but you quickly mend it with a patch, or else you had some gunk in the tube that sealed it; you pump up the tyre and continue, but the repair still lets air out slowly, so you have to keep blowing it up. But, around the original puncture, the tube gets continually weakened, so that if you examine it, the weak spot balloons out, and eventually it fails catastrophically. That's what has happened. In 2007/8 there was the puncture; it was quickly repaired as the banks were nationalised, and huge amounts of money pumped into the financial system, the money directed specifically to reducing mortgage rates; when the effect even of that began to wane, the Government stepped in to pump things up again with repeated measures to provide cheap money to the banks provided they use it to avoid foreclosing on failing mortgages, and to keep the property bubble inflated. The property market is like a bike tube with several weak spots. London is just the weakest spot, and the pressure has caused the biggest bubble to inflate, but the fact that air is leaking from slow punctures elsewhere, doesn't change the fact that the tube is over inflated, and that sooner or later it will burst.

But, as I've pointed out in the past, its not just the Government that is involved in keeping the bubble inflated – The Great Property Market Conspiracy. Besides its desire to get elected in 2015, the reason for the “Help To Buy” scam is no concern for house-buyers, but only a concern for the banks that will go bust, when the property market collapses, just as they did in Ireland and elsewhere. The banks themselves, therefore, have good reason to keep the bubble inflated for as long as possible, because it maintains the illusion of their balance sheets, and gives them time to recapitalise using cheap state financing. They have every reason to avoid foreclosing at the moment, and instead to engage in “extend and pretend, even though millions of house-buyers are failing to meet their monthly payments, despite record low mortgage rates, and even though many of them have large amounts of additional debt besides. If the banks began to foreclose, house prices would go into a firesale that no amount of government meddling could prevent. So, the state, the banks and the estate agents all have an incentive in trying to deny that a bubble exists, but equally each has an incentive in denying that prices are falling, because that would only encourage potential buyers to put off their purchase. Keeping the bubble inflated requires that a continued supply of “bigger fools” enters the market to buy property at unsustainably high levels.

So, when representatives of the banks etc. appear on TV, its notable that they avoid answering these questions. A representative of the Nationwide, when asked, on TV, the other day, about the historically high figure of house prices to average household income, instead replied that mortgage payments were at historically affordable levels. But, of course, with interest rates at 300 year lows, you would expect mortgage payments to be affordable. But, in fact, that is one reason that house prices have been inflated! Yet, even with mortgage payments at these most affordable levels, millions of mortgage payers have been unable to meet those payments! Given that interest rates are rising – the yield on the UK 10 year Gilt has doubled over the last few months – and this will pass through into mortgage payments, whatever the Bank of England does, then monthly mortgage payments are set to rise very sharply.

In fact, the story over low interest rates is itself something of a con. Interest rates are only low for mortgages, and then only if you have a sufficient deposit. If you have a 20% deposit, you can get a mortgage with an interest rate of around 3%, but if you only have a 5% deposit, in or out of the “Help to Buy” scam, the interest rate is more likely to be around 6%. Moreover, if paying your mortgage means you have to pay for other bills using credit card debt, then you will be paying 20-30% interest, and god forbid even that does not suffice, and you have to rely on borrowing from a Pay Day Loan shark, as millions of people now do, you will be paying up to 4000% interest. What real relevance does the Bank of England's 0.5% official interest rate have to the interest rates millions of borrowers have to pay in the real world. It is only of relevance in setting a cap on the level of interest paid by banks to savers.

But, in any case, over coming months, as global interest rates rise, mortgage payments are likely to rise by at least 50%, and probably more. In fact, one of the reasons, 6,000 people applied, in the last 3 months, for mortgages under the Help To Buy scam, but only 750 houses have been bought, is that under the new guidance for affordability, many of the applicants would face mortgage payments amounting to more than 50% of their income, if rates rise, and so do not qualify for a loan. If that test were applied to those who already have a mortgage many millions would also fail it.

The other aspect of this scam is to persuade people that they must buy ahead of prices rising, yet even the building society figures do not give any evidence of that. The latest figures from Nationwide suggest an 8% rise nationally, but that hides a 15% rise in London, and a 2% rise in the rest of the country. Even this figure is bogus. It is a figure for asking prices not selling prices. Asking prices always rise at the start of the year. It usually means that sellers have to then wait longer to sell, and have to reduce their price in order to do so, several months later. There does seem to have been change in the market recently with more houses being sold, but they are still being sold at lower prices.

The two houses in my village that have been up for sale for two years, have now been sold in the last month or so, but both at significantly less than the original asking price, and also less than their latest asking price. One a very big, four bedroom, detached house with about an acre of garden, and stunning views was originally put up for sale for £500,000. It was reduced several times down to £425,000 only a few months ago. Its actual selling price was £405,000, a more or less 20% reduction. The other house an even bigger semi with about the same amount of land, was put up for sale at the same time for £450,000. The attached semi sold in 2010 for £500,000 having been put up at £550,000. It has had several reduction down to £350,000 a couple of months ago. Its actual selling price is not available yet, but is again likely to be around £320,000.

And the same applies at other price ranges. Last month I went to the property auction where we had my cousin's house was up for sale as part of his estate. The estate agents eager for business had been keen to tell us that the house, a double fronted, two-bedroom detached house with garden, in a semi-rural location, would attract builders and speculators. There would be no problem the price being bid up from a reserve of £55,000 to at least £70,000 and above they originally claimed. I doubted it from the beginning, and was not surprised then when it failed even to get bidders at the reserve price of £50,000.

As one of the estate agents told me separately, one effect of “Help To Buy” is that where people do want to buy, the need only to put down a 5% deposit means that where people were prepared to pay up to £50,000 for a terraced house, now they aren't, because they can buy a £100,000 semi instead. That is always the case with government subsidies, it causes unforeseen distortions. The real indication of the situation is given, not by the fiddled figures on asking prices, but by looking at the number of transactions. Although they have risen from their very low levels, which is partly due to Help To Buy, they remain at very low levels, because prices are in a massive bubble, and people cannot afford to buy as first-time buyers, and they cannot afford to make up the now much bigger gap between the price of their existing house, and the house they would like to move up to. The low level of transactions is an indication of low levels of demand at current prices. The only answer to that is either for incomes to rise massively – more than double current levels – which is not going to happen, or else for house prices to fall massively, at least halve, and more likely a fall of around 75%.

Current government policies instead of helping are making the situation worse. Sooner, probably rather than later that will become apparent via a new property price collapse.