Sunday, March 07, 2004
Is the housing market close to cracking up?
Posted by David Smith at 09:01 AM
Category: David Smith's other articles

Exactly a year ago, with the air thick with warnings of an imminent house-price crash, I wrote a piece setting out five reasons why house prices were not going to fall.

This was, you may recall, a nervous time. Panic selling sent shares down to what was the low point of the bear market and some of the same malaise appeared to be affecting housing, particularly those areas most influenced by City bonuses.

My five reasons were:

* The housing market was already slowing of its own accord, with annual rises coming down steadily from the 30% rate touched during the previous year.

* The economic fundamentals of low interest rates (with 3.5% then yet to come) and strong employment were hugely supportive of housing.

* The rise in house prices was a rational adjustment by homebuyers to lower interest rates. Interest rates averaged 12% in the 1979-90 period but less than 6% since 1993. Households had realised that, despite higher house prices, their debt-servicing burden (mortgage payments as a proportion of income) had fallen.

* There was little evidence of housing-related distress, of buyers overstretching themselves, with mortgage arrears and repossessions at their lowest since the early 1980s.

* Housing supply was limited, with building at its lowest peacetime level since the 1920s, a fact that prompted Gordon Brown to commission a review by Kate Barker of the monetary policy committee.

Those five reasons, and perhaps one or two I did not mention, served me and the housing market well. There was no crash in 2003, nor did one ever appear likely.

One year on, however, the warnings are here again. I’m not just talking about the tabloid newspaper that appears to alternate its front pages between housing-crash and housing-boom stories. Durlacher, the investment bank, got some headlines last month with a report saying house prices will fall by 30% and could drop 45%. And Capital Economics maintained the market was “seriously overvalued” and riding for a fall. The International Monetary Fund told the Bank of England on Friday it must raise interest rates to reduce the risk of a housing crash.

So how do the five arguments against a crash stack up now? Those of a nervous disposition might like to sit down now, for all five are open to challenge, and I have a devil’s advocate sitting on my shoulder doing just that.

The market’s gradual slowdown, for example, has been called into question by figures showing that house-price inflation has spiked higher in the past couple of months. Nationwide’s spectacular 3.1% rise in prices last month may have been an aberration, but the Halifax’s report of a 1.6% increase was also uncomfortably strong. Both measures now have house-price inflation, apparently slowing in the autumn, back up in the 17%-18% range.

Second, while interest rates remain low, they are now on a rising path. The Bank of England’s monetary policy committee left interest rates unchanged at 4% last week. But another hike is likely in April or May, and a programme of quarterly, quarter-point rises, taking us to a peak of about 5%, seems in prospect.

Furthermore, as discussed here a couple of weeks ago, the job market is not as strong as it looks. There has been a rise in “involuntary” self- employment, and private-sector employment trends appear weak.

Some people, including one or two mortgage lenders, are also concerned about prospects for households’ after-tax incomes, especially if the chancellor were to raise taxes to close his budget “black hole”.

Third, when does a rational adjustment to lower interest rates become the “irrational exuberance” that Alan Greenspan once identified in the US stock market? There will come a point when we will have moved beyond the rational and into bubble territory. Are we already there?

Fourth, while there is still no evidence of housing distress (arrears and repossessions have fallen further in the past year), the question is whether this is a useful leading indicator of problems to come. Arrears and repossessions, after all, were low in 1988, the height of the last boom, but surged as the market collapsed.

Fifth, while housing supply is as limited now as it was then, and the Barker review on this will be published on budget day, March 17, there is evidence that housing demand has also faded. The proportion of first-time buyers, roughly a quarter, is at its lowest for years as potential homeowners are deterred by the high prices and the difficulty of putting together a big enough deposit. The lack of first-time buyers could reverberate through the market, cutting demand at all levels.

The devil’s advocate, one would have to conclude, makes some fair points. On most, however, I would stick to my guns of a year ago. The economic fundamentals, despite a few doubts, remain supportive. Interest rates are rising, but gradually, and are at levels that even three years ago would have been deemed extremely low. Economists expect real incomes to rise by a healthy 2.5% this year and next.

As for irrational exuberance, we have only just reached the point, says the Halifax, where the house-price/earnings ratio matches its peak in the boom of the late 1980s. Since lower interest rates should justify a higher price/earnings ratio, it is reasonable to argue, on this measure at least, that we have not yet entered serious bubble territory.

Arrears and repossessions may not be great leading indicators, but they are at least an antidote to suggestions that lots of people are already in deep trouble over debt.

So is it a case of carry on booming? Not quite. What does concern me is the recent behaviour of house prices. Nobody expects an instant response to changes in interest rates but it is surprising that house-price rises have accelerated since November, when rates began to rise.

It is hard to tell a soft-landing story if it is plainly not happening. We are not in trouble yet. But a few more months of house-price rises like last month’s, which would mean a return to sustained 20%-plus annual property inflation, would have me quite worried. Moderation is always a good thing. A bit of moderation in house prices is now needed.

PS “I don’t like it — it’s too quiet” is my favourite B-movie phrase, but I also feel that way about Brown’s impending budget, due in 10 days’ time. True, it is only weeks since his last effort, but we should be getting a bit more excited than this.

Even the Labour-leaning Institute for Public Policy Research believes it will be a sideshow. Andrew Smith, chief UK economist at KPMG, says the most excitement we can expect is a few slow-burn tax measures to help solve Brown’s borrowing problem after the election.

That’s not how it looks at the Treasury. The chancellor will signal the merger of most tax-collecting activities of the Inland Revenue and Customs and Excise, and he will publish the “envelope” for the summer comprehensive spending review — the overall expenditure rises for which Whitehall departments will have to battle in the coming months.

Brown, apparently now in demand at the IMF in Washington (if he takes the job I’ll eat my hat), is also feeling pretty smug. Last year’s growth came bang in the middle of the Treasury’s forecasts and this year is set fair for a 3% to 3.5% expansion. There will be no need for significant borrowing revisions. If the political task of a chancellor is to deliver an election-winning economy, he is keeping his side of his bargain with Tony Blair.

From The Sunday Times, March 7 2004



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