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| The UK housing market: a bubble about to burst? |
Hoogy
by Jon
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#1001529
of 3278
 16 Dec 2002
02:05 PM |
Thanks for the post, quite an education! Explained a few things I've been reading on this forum recently.
I've been checking this forum reasonably regularly because a couple of months ago I was desperate to buy, I had just had graduate terms at the bank and they'd give me 4 times my salary at 100%. But after doing a bit of reading round and research I decided to stick and save up.
I had started to get fed up with the posts on this site as they appeared to be all intellectual posturing, no real substance, but I've learnt some ecomnomics by reading posts here and a few other places, and I'm starting to realise that the people who bang there fists on the table demanding yes or no answers are missing the point (I get the same situation, I'm an engineer (rail!) the questions are generally 'is it safe to run' the answer is it depends on your definition of safety).
Speaking about my personal situation, I'm going to go on renting in Derby (£250pcm) and saving the extra £250 I would have spent on a mortgage every month until I've got a bit of a buffer saved up to protect against all of these uncertainties.
On a more general note, the tabliods (mail I think) have started carrying reports of house price drops over the next few years, how many buyers will be put off?? Once the old herding instinct gets going, it's very difficult to stop!
JON |
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by Stuthepooh
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#1001528
of 3278
16 Dec 2002
01:03 PM |
Good post Hoogie
I am interested to know: which bank did you work for?
Pooh |
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For the 5% that are interested in the economics...
by Hoogstraten
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#1001526
of 3278
16 Dec 2002
01:21 AM |
Si,
You say that you do not have an academic knowledge of economics, but the questions you ask are the issues that an economist would consider. If the supernormal profits derived in recent years is a result of moving into a low inflation, low interest rate and low unemployment paradigm, the central issue regarding the sustainability of property prices rests on the sustainability of this paradigm. All the other issues raised by contributors can be seen in this way to be hysterical, unrelated to the fundamental issues at hand.
Economics is a subject that you can learn a lot about reasonably easily (you have probably learnt a lot reading this forum?). The fundamental theories of all the great economists are reasonably straightforward – it is only when you enter the econometric world of modelling that the technical complexities increase substantially!
Economics is not a science like physics, trying to give the answers as fundamental laws, because it is effectively trying to study human behaviour. However, it is useful with regards to analysing financial issues, because the arguments contributors make have generally been made in some form by an economist hundreds of years ago (though the contributors themselves do not normally realise this is the case). Furthermore, when you recognise which argument the contributor is making, you usually find that some other economist has later disputed these findings.
When you can understand both sides of the argument from an economist’s point of view, and read both economist’s theories and the empirical evidence they provide it makes it easier to make a judgement as to whom you think is correct. I only mention all of this because there are many doom mongers who argue that macroeconomics is useless. They usually promptly propose a theory that fits almost exactly into one of the economists’ writings (though the contributor usually butchers the English language in the process)!
You say:
1. “If current house prices are sustainable at current levels more-or-less
…then is it the low inflation or the low interest rates which are primarily responsible?”
The low nominal interest rates are responsible. However, you can’t have low nominal interest rates without low inflation, so in this way they are both primarily responsible (it is a tautology). Practical monetarism (associated with Milton Friedman) believes that interest rates should be used as the main instrument to control inflation – higher inflation or higher inflationary expectations would almost certainly see the BOE increase the base rate. I do not think we can have low interest rates without low inflation.
2. “…if interest rates are forced to rise at some point in the coming years to counter inflationary-pressures (or is this unlikely), then do I take it that this may precipitate relatively small adjustments in house-prices, rather than a crash?”
If nominal interest rates rise, I would expect property prices to fall, other things remaining equal. Whether this would be a small fall or a crash would obviously depend on the size of the interest rate rise! There is relatively high interest rate risk at the moment, for the obvious reason that base rates are at 4%. A 2-4% increase in base rates would probably therefore increase interest costs by 50-100%, so there is a lot of risk to interest rates and the real economy if inflation does return. Remember that the US Fed has reduced base rates from about 6.5% to 1.25%, most of the cuts being over 12 months, so shifts of this magnitude are possible.
That higher inflation (and consequently higher interest rates) could precipitate a crash is therefore no doubt theoretically correct.
The issue is therefore how likely is inflation to return?
Inflation has been consistently below the BOE target (I think something like 36 out of the last 40 months inflation has been below the 2.5% target). This is because of technological advances and goods being produced cheaper by China/Eastern Europe. The only thing that is keeping inflation as high as it is, is the Governments expansionary fiscal policy (20 bill pounds deficit this year and 24 bill pounds next year). If the inflationary effects of this were stripped out, the UK would be close to deflation. Inflation looks very unlikely to return in the short-run – the Government cannot afford the expenditure they are making now, so cannot continue inflating the economy alone. The private sector is operating in a goods price deflationary world.
3. “How does this low-inflation paradigm-shift counter the alleged mass-psychology of an over-correction?”
The biggest mass-psychology economic event of the 20th Century was probably the Great Depression. A speculative bubble followed by a collapse in Aggregate Demand, as confidence first eroded, and then collapsed, caused the Depression. This induced a later collapse in Aggregate Supply.
Note at this point that DryMartini is arguing that there will be a collapse on the supply side first, via a credit crunch. His argument is that there will be default on mortgages, which leads to the retail banks raising the real interest rate to recover their losses, which will then induce further default on mortgages. The examples of this occurring are almost exclusively South American third world countries, and Drymartini has yet to provide any hard evidence for his view (he seemed to simply copy it from a Financial Tabloid article).
The chances of the demand side collapse are very slim. The chances of a supply-side collapse are so remote that we should probably simply ignore it. However, the policy response that the BOE would implement if either circumstance should occur, would be to cut base rates.
One contributor (I think it was the The Grand Inquisitor) believed that I thought the BOE was like a put option (I think he is probably the FT Monitor, because this is the sort of clever stupid way they would express simple ideas).
Buying a put option means you are synthetically short the underlying – this enables you to hedge your long cash equity position. In regards to property, property owners are long (i.e. they own) the property. The hedge with property is the fact that if the property market collapses, the BOE will cut rates. I think The Grand Inquisitor also raised the issue of moral hazard. Moral hazard means that people will be tempted to engage in more risky behaviour since they are “insured” by the Central Bank in this way.
Believers of Hayek would therefore not like BOE intervention, because the result of this moral hazard may be sub-optimal outcomes for the economy at large. However, Hayek’s views are not practised in the UK. Moral hazard it may be, but pragmatism rules, irrespective of your economics!
The fact is that the real effects to the economy of property collapse would concern the BOE. I would wager that they would cut base rates like there was no tomorrow if there was a shock in the property market anything like what the doom mongers are predicting, irrespective of whether pure economic theory would indicate this is the optimal decision-making for the economy as a whole. “We are all Keynesians now.”
Finally, with regards to Richard Head’s comments, I must admit I thought he was doubling as The Grand Inquisitor as well. However, since The Grand Inquisitor only ever mentions Hayek, and Richard Head’s comments are Keynesian influenced, maybe they are not the same people. Mr Head believes that with regards to property prices “there is feedback from the output of our predictor back into the inputs to the predictor”, which is a concept emphasised by Keynes (multiplier effects are a cornerstone of the Keynesian world). I think you need to work out whether you want to model the economy (Hicks has already done this quite well) or whether you want to model an asset price.
Economists a long time ago realised that ceteris paribus is an assumption that is not realistic in the real world - but this is a trivial observation, because without this assumption no modelling or even theories can be undertaken! The alternative is to include every variable in the world in the model, at which time it ceases to be a model.
With regards to valuation equations of property, it could help to look at finance. The leverage aspect of property is akin to futures or forwards, but the valuations of these products move in relation to the underlying. OTC Options have similar forms of risk to property (price, interest rate, counterparty, liquidity etc), but volatility in the cash equity sense of the word cannot be accurately measured with regards to property. There is no time to maturity with regards to property, because property is an obligation rather than a right (the financing has a time to maturity, but not the underlying itself). Options theory is useful in classifying the risks of property, but in my opinion not much use in actually valuing it. If someone can prove otherwise, I would be surprised.
The financial product most like property is probably simple cash equities. For a few years during the dotcom boom, it was fashionable to use technical analysis and charts to draw squiggly lines on charts to value stock. However, fundamental analysis involving forecast PE ratios has now come back into fashion. This is essentially the same concept as evaluating property on the basis of the net present value of rental yields – it is no wonder that this is the way that everybody seems to use this method to gain a rough proxy of a property’s correct value.
Of course, property is an asset class all of its own – the relative lack of liquidity, the barriers to entry and the counterparty risk (when rented) are completely different from cash equities. Property is not purely an investment, but also a place to live! People’s behaviour when deciding to buy or sell property versus cash equities is in many cases completely different – for example, property will in my view always be stickier on the downward side in nominal terms than cash equities.
I leave it to the econometrically minded among you (Andy B maybe?) to do better… |
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"End of housing boom threatens UK economy" - headline on front page of "The Business" newspaper of 15 Dec.
by UnFAZed
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#1001525
of 3278
15 Dec 2002
01:03 PM |
Some time ago, John D French in "The New Pub" asked me if I read the above paper. I'd never seen it till I saw it on a newsstand today when I was buying the "Frankfurter Allgemeine SonntagsZeitung" here in Zug/Switzerland, and the headline as captioned above sounded very ominous to me, esp now that the lagging indicator - unemployment - is hitting the US, the UK(?) and Europe.
Here in Switzerland a 20% deposit is required by the lender from the purchaser of an apartment/house. In addition, the housing market is restricted to Swiss citizens and foreigners with "C" permits (who have had 5 years residence in CH), apart from some designated
regions like holiday resorts and others where demand is more elastic than in cities like Zürich and Geneva.
If the housing bubble in the UK does burst, then it is the direct result of a government which supports the free-market economy system, where the "first in, first out" are
always the winners.
Yet a home is an immovable asset, often the sole residence of a family, and for which there is no quoted market price. This is in direct contrast to stocks in any quoted company, for example, whose prices are quoted on the boards daily.
What will be the result of the UK housing bubble bursting? Same as last time, a decade ago. Negative equity for many unfortunate house buyers who came into the market late.
And what will the BoE now do about UK interest rates? |
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Hoogstraten (and anyone else): a kind question
by Si
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#1001524
of 3278
14 Dec 2002
11:47 PM |
I don't have an academic or professional background in economics, so I'm seeking clarification on this one point:
If current house prices are sustainable at current levels more-or-less, due to the low-inflation/low-interest-rate environment, then is it the low inflation or the low interest rates which are primarily responsible? And following from this, if interest rates are forced to rise at some point in the coming years to counter inflationary-pressures (or is this unlikely), then do I take it that this may precipitate relatively small adjustments in house-prices, rather than a crash? How does this low-inflation paradigm-shift counter the alleged mass-psychology of an over-correction?
Thankyou H and anyone else who cares to enlighten me. I remain to be convinced that some kind of correction isn't due, especially in some over-hyped areas of BTL/FTB properties (though not all) and 'up and coming' locations, but I'm all ears. |
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Triggers versus Timidity
by Hoogstraten
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#1001523
of 3278
14 Dec 2002
10:35 PM |
The timid doom mongers confuse what are the triggers for property collapse (higher inflation, higher interest rates and higher unemployment) with irrelevant superfluous information.
For example, mace says the triggers for a property collapse are as follows:
“1. Cost of borrowing (Mortgage rate - Inflation rate) is higher than the 60s and 70s”
The issue for the household is obviously the total interest costs/total household wages, not in this context the real interest rate.
Historically, inflation and interest rates have been at the levels they are now. Post-Keynesian economic ideas took over in the 1960s and 1970s. What Post-Keynesians believed is that there is a trade-off between inflation and unemployment – they effectively believed inflation was good because the real economy would expand if the Government inflated the economy.
In recent years, as a result of Milton Friedman and Monetarism, these ideas have been rejected, because Friedman believed that there was no free lunch from inflation. What has happened since is that policy makers no longer purposefully adopt the inflationary policies they once did. This has been combined with technological and trade advancements (manufacturing moving to Eastern Europe and China) that has created goods price deflation.
What we have seen in recent years is a sustained reduction in inflation and therefore in the natural rate of interest. This has lead to a one-off bonanza in property prices, which have been able to expand faster than real wages. To reverse this bonanza, either inflation (and therefore the natural interest rate) would need to rise, or unemployment would need to take off. Neither factor looks likely in the short to medium run.
“2.The general economy is doing badly”
The general economy still has GDP growth – not as high as everyone would want, but strongly positive all the same. The general economy would need to fall off a cliff to meet the doom mongers predictions of collapse. This seems unlikely.
“3. Consumer debt levels are at an historical high”
Consumer debts are affordable now because of the collapse in the natural rate of interest.
“4. House price/earnings ratio is at an historical high”
This is because the natural rate of interest has fallen, so a higher house price/earnings ratio is appropriate. Unless the natural rate of interest rises again, these higher ratios are appropriate because they are affordable given lower interest costs.
“5.The consumer boom was partly fuelled by equity being released from increasing house prices. Logically, if house owners have removed most of their gain, then they won't be able to afford as expensive houses, when they next buy, as they would have had they left the equity in.”
How will this cause property collapse? It might slow the rate of increase in property prices. What evidence do you have that house owners have “removed most of their gain”? With lower interest costs, equity release remains affordable, and will not cause a property collapse.
“6. First-time buyers can no longer afford to get on the first rung of the ladder.”
There is a risk and reward profile for all investments. So long as the return is acceptable, a benevolent landlord will buy the property instead, and the potential first time buyer can remain a multiple time tenant. My experience is that people will find a way to scramble onto the property ladder – it is usually defeatist losers who say it is impossible.
“7. Prices have already dropped in real terms in central London.”
Agreed – problems in financial services will have a negative impact in the short-term on expensive areas in London. These declines do not constitute a property collapse.
In summary, the doom mongers are struggling to find an argument based on real economic fundamentals (inflation, interest rates and unemployment). The arguments are therefore becoming more and more superfluous, to justify the doom mongers timidity in decision-making.
Perhaps Nietzsche was referring to the timid obscure property doom mongers when he said:
“Those who know that they are profound strive for clarity. Those who would like to seem profound to the crowd strive for obscurity. For the crowd believes that if it cannot see to the bottom of something it must be profound. It is so timid and dislikes going into the water.” |
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Housing
by Mr X
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#1001522
of 3278
14 Dec 2002
04:37 PM |
To Mace # 1521. What are you on about [back from the pub are you !!?]This is about affordability at a time when a person loses his / her job. Let me say it TO YOU once again - UNLESS YOU NEED TO SELL DOES IT MATTER WHAT THE DROP IS ? How a tenant can be better of by £525 per month by renting [and throwing money down the drain] when the paper value of a house you bought for £100,000 has gone down by £24,000 from a nominal £250,000 to £226,000 in 2 years is beyond me. Then perhaps thats why you still rent / live at home / whatever whilst I have made my dosh.
Get real will you. |
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Why would houseowners wish to rent?
by mace
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#1001521
of 3278
14 Dec 2002
09:42 AM |
Mr X,
You ask why a houseowner who has a morgage of only £525 per month would choose to rent the same property for £1000 per month. The answer's fairly obvious. If the house is worth £250,000 as you state, then it's quite possible that it will lose £1000 per month for the next 2 years, making the tenant £525 per month better off than the houseowner. |
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Evidence
by mace
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#1001520
of 3278
14 Dec 2002
09:35 AM |
For a crash:-
1. Cost of borrowing (Mortgage rate - Inflation rate) is higher than the 60s and 70s
2. The general economy is doing badly
3. Consumer debt levels are at an historical high
4. House price/earnings ratio is at an historical high
5. The consumer boom was partly fuelled by equity being released from increasing house prices. Logically, if house owners have removed most of their gain, then they won't be able to afford as expensive houses, when they next buy, as they would have had they left the equity in.
6. First-time buyers can no longer afford to get on the first rung of the ladder.
7. Prices have already dropped in real terms in central London.
For a slow reduction:-
1. Unemployment levels are very low
2. Other markets e.g. stocks and bonds provide less attractive returns to investors
3. Housebuilding is at an historical low
4. Singletons are on the increase, so there is a higher demand for property
5. London prices are lower due to unemployment in the city and IT. These sectors are less represented in other parts of the country. |
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Wishing Everyone a Merry Christmas!!!
by Hoogstraten
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#1001519
of 3278
14 Dec 2002
02:06 AM |
DryMartini,
Welcome back.
Your diatribe was addressed to Jack Straw and myself – I will answer from my perspective.
I rather thought you had given up, due to the pasting your arguments received the last time you ventured away from your small microeconomic specialism of money markets to macroeconomic theory.
Congratulations on the barrow boy bonus – I would think that you would promptly stick the cash you receive under your rented mattress in your rented property, since you believe that the banks are going to collapse, and property prices are going to fall by 70% in real terms?
One quick question which occurs to me DryMartini – if you are so wealthy and successful, why do you still need to work for a living? Is it because you missed the boat in the property market, hence you hope that it will collapse, because you are envious of the success that contributors such as Mr X have had in this market for a sustained period of time?
By the way, I worked in equity derivatives in investment banking, which is not really so much about macroeconomics as is it about finance – however, I would not expect you to know the difference when your role would apparently involve executing money market trades for customers. Of course, I am able to shift seamlessly between macroeconomics, microeconomics, finance and the practicalities of actually being a landlord.
“I am no man, I am dynamite.” Nietzsche
I would expect that my broad knowledge would be disconcerting for someone from the “cut and paste” school of thought, which eulogises some journalist with qualifications that are inferior to mine.
“That everyone may learn to read, in the long run corrupts not only writing but also thinking. Once the spirit was God, then he became man, and now he even becomes rabble.” (Nietzsche again)
Your comments that there is going to be a “consumer credit crunch and a banking crisis” is little more than the shrill hysteria I have come to expect from you. When you make wild projections about credit crunches and banking crises, it would help if you had some evidence. You apparently have none, which is presumably why you produce nothing. The retail banks remain robust and strong.
You say:
“What he fails to mention (and I think this is the only thing he left out in the whole article), is that after taking inflation into account, prices fell by 40% over that period. Now that inflation is very low and going lower, it is likely that a similar fall in the market will mean a fall in nominal prices of much more.”
This is also incorrect. From the last time you contributed, I remember that google is the source of all your economic knowledge (FT or Telegraph articles are usually also plagiarised). Try typing in “money illusion”, and you will find out about the ailment you are suffering. What economists have realised is the following:
“In particular, if the payoff information is presented to subjects in nominal terms, price stickiness and real effects are much more pronounced than when payoff information is presented in real terms.”
The lack of inflation will mean that nominal prices will not fall by anything like 40%, even in worst case scenario terms, because people will not realise these massive nominal (and in low inflation real) losses. I would explain the macroeconomics to you in more depth, but frankly until you acquire at least a basic knowledge of the subject, experience has taught me that this would be a complete waste of time.
Your predictions of 70% real falls in property prices are frankly at odds with common sense, economic theory and logic. Start again. |
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Housing
by Mr X
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#1001518
of 3278
13 Dec 2002
06:44 PM |
To Knowledge is Power #1516 Of course you cannot mitigate the effects of job losses etc. BUT, the same applies for those in the rental market. No different - except for the fact that there is more security with a mortgaged property than a rented one.
Most lenders can accept a period of lower monthly repayments [even if interest covered e.g in my last example £55,000 at 5 % per annum is £229 per month] How many landlords would accept a loss of £1,000 per month before throwing you out ? [I've done it myself as a Landlord - a few months non payment, and their deposit is forfeited and they are replaced. Why ? Non payment]Furthermore, these same friends have had the common sense to maintain their monthly payments at the same level today and for the past couple of years as interest rates have fallen. The result ? A "credit" on their account.
Providing you do not make a career from being unemployed for long stretches, then the well established buyer is far safer then the long term renter.
Simple as that. |
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X-it Stage Left
by Rob G
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#1001517
of 3278
13 Dec 2002
04:59 PM |
Mr X,
Thanks for completely mis-understanding my point and answering a totally different question (incorrectly, I might add).
I asked for comments on what will act to stop prices from falling once this process has begun (as it is about to do).
In response to your own, rather obtuse posting:
It doesn't matter what the majority of people do in the case of a price fall. Only a handful of people need to buy or sell to establish a new pricing level, in exactly the same way as only a handful of sales are required to establish higher prices. Your house might have doubled in 'value' in the last 3 years while you were still living in it, after all.
To be honest, I really don't care how many people do or do not fall into equity problems as a result of a fall. I'm simply stating that a downward correction in prices is inevitable.
I'm asking anyone who thinks it will be only a minimal reduction (such as Jeff Morgan) to explain why this should be the case rather than a 30-40% fall as I have myself predicted. |
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Martini et al - Good Posts
by Knowledge is Power
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#1001516
of 3278
13 Dec 2002
04:20 PM |
MR X,
How secure are your friends jobs? last time I checked it's damn near global recession & the UK isn't coming out of it unscathed either. You're friends have still got to make the mortgage repayments, which can be hard when you're unemployed. Oh and if you think payment protection will cover it - no it won't. Check it out for yourself!
Mr X, you're friends et al may be in a fluffy wool covered nest, but you cannot mittigate external factors like loosing your job.
Martini et al are correct in what they say. 90% of the market never sells but it's the 10% that is all important. If you can't keep people buying what then? Well thus far reckless & irresponcible lenders are just extending the lending ratios. But even that will come to an end.
Mr X, don't loose sight that there are many who cannot afford housing (even at a push & living off baked beans). Affordable housing is vital, not just for the stability of the market, but for society in general. Brown & Blair have milked this cow for long enough, they now need to put safe guards in place double quick time. I think it's gone too far though & heads will ultimately roll.
Martini,
the US's interest rates are now down to 1.25% & the unemployment figures are still rising. Is this just a lag, or have the recent lowerings failed to kickstart the US economy. Would you care to make an update/assessment on the US risk to deflation. I've been following things closely & would value your opinion. |
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a few distressed sellers...
by Si
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#1001515
of 3278
13 Dec 2002
04:11 PM |
- people who've taken out too much 'equity release', more likely if they'd bought recently and weren't too bright, or a while ago and were even less bright, it's just a bigger mortgage/loan secured on your house, after all. Or of course people who just paid too much recently in the 1st place, or took out a 110% mortgage....?
- Ameuteur(ish) buy-to-letters who haven't done their sums or perhaps read this forum! I do realise that amongst our contributers there are many capable BTLs, it's not them I'm concerned about. And its so-called up-and-coming areas, not DHSS-rentals, that I see as a problem, following my discussions with Hoogy about his letting-fundamentals.
Amateur BTL aimed at professionals is interesting as it appears to be a more significant component of the current boom than previous booms, esp. in 1st time buyers' favoured areas/properties, which may offer another negative factor, in the event (which I see has been debated at some length!) that unemployment or interest rate rises do not have as much of an impact as they did in the early 90s, then rental falls may hit these housing areas and classifications in a similar way. |
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Moving
by Rik
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#1001514
of 3278
13 Dec 2002
03:53 PM |
Mr X, While I agree that the majority of people will not need to move if the market drops that is not to say that no-one will. The main reasons that people move are for work or increasing families. These will still happen.
It is true to say that most people will not be affected by a slump in the housing market as they probably don't need/want to move and the only loss they would make on their property is a paper one just as the gains they have seen so far have been paper ones too.
The point is their will be people who need to sell for one reason or another who cannot put it off and it is these people who will be hit if prices fall. Probably most of these people will still make a profit compared to what they paid but the point is they will be selling their property for less than it was worth X months ago and in that climate people buying may be nmore inclined to offer less than the asking price to protectt hemselves from further falls.
It is pointless saying that the majority of people will be unaffected. Of course they will! As the whole country is not going to decide to all move at the same time this is obvious. That doesn't mean that there won't be a fall and it doesn't mean that people won't be affected. |
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