Comments: House prices just keep on flying

HI David

Very good article, however IMHO the only point I would raise is that the market only picked up after the BOE cut rates.

This is, not the correct IMHO. The market saarted to pick up when people realised the BOE were done with with rate rises, the Approval figures reach a low in Nov 2004 (E&OE), and then picked up. This reduced the excess stock levels, and so at the same time the BOE cut rates the maket was already looking fairly strong.

Sometimes inaction moves the market, not use actions

Posted by Kingofnowhere at October 29, 2006 08:31 AM

David,

Why do you still persist in flogging this dead horse "house prices only go up" mantra? Your article has an air of desparation around it. When house prices fall, the hundreds of thousands in negative equity will blame YOU.

Posted by SD at October 29, 2006 10:19 AM

If there's dead horse that's being flogged, it is by the tired old 'house prices will crash' school. That's where you find you'll your air of desperation. By holding out the 'hope' of a sharp fall in house prices, they've done a lot of harm, not least by influencing people who wanted to get into the market but decided to wait it out, to their cost.

Posted by David Smith at October 29, 2006 10:36 AM


"To their cost" what cost is that? If house prices stay where they are, what exactly have I lost? The opportunity to get in to crippling debt?

I can rent for 1/3 my monthly income and have a life, or I can buy and it cost me over half my monthly take home and I can struggle to make ends meet.

I earn twice the average salary, I don't work for McDonalds.

Posted by FrozenOut at October 29, 2006 11:52 AM

The problem is that house prices have not stayed where they are. A property that costs £200k a year ago probably has gone up £16k this year.

Unless 2/3 of your annual rent is £16k, then you've lost out since you'll have to pay the higher prices UNLESS:

1. House prices drop when you decide to buy
2. You decide to rent forever and the cost of renting over the rest of your lifetime turns out to be less than buying.

Posted by Charles Darke at October 29, 2006 12:47 PM

But you are talking about PAPER gains!!!

Posted by FrozenOut at October 29, 2006 12:51 PM

Who said anything about 'crash'? All I said was 'fall'. Is it possible you are becoming paranoid?

Do you really believe house prices will never ever fall again? Ever?

Posted by SD at October 29, 2006 01:45 PM

No, we're talking about the cost of entry. The longer people have held off in the hope of a crash, the more that cost of entry has risen.

Posted by David Smith at October 29, 2006 01:46 PM

SD's comment came in when I was responding to an earlier one.

You draw the distinction between fall and crash but to produce hundreds of thousands in negative equity, you'd need the latter. No, I don't believe house prices can never fall, and you won't find that in anything I have ever written. What I've said is that you have to have the conditions for a fall and those, typically, are a loss of control of monetary policy - sharply higher interest rates - and a rise in unemployment/sharply falling employment. Under those circumstances, as in the early 1990s - when interest rates and unemployment doubled - house prices would fall.

Posted by David Smith at October 29, 2006 02:04 PM

See I disagree, we have high asset prices with low rates, meaning the smallest of movement in interest rates causes much more pain - we won't need 14% IR rates to cause a crash, I think we won't need much more then 6.5%

Remember those who took out MASSIVE loans at 3.5% are now exiting these deals to HUGE increases in payments - and I bet the majority of these people haven't had over inflationary payrises to keep up with it.

Just look at Londons Central bankrupcy courts, hundreds of people every week are going to the wall.

Posted by FrozenOut at October 29, 2006 02:16 PM

Fine it if keeps you happy but this is just wishful thinking. The rise in personal bankruptcies has very little to do with housing debt and quite a lot to do with changes in the bankruptcy laws.

Posted by David Smith at October 29, 2006 05:06 PM

"Fine it if keeps you happy....."

Sounds like you're getting more than a bit tetchy,Dave. Why's that I wonder?

"......but this is just wishful thinking."

I'm coming round to the view that all the wishful thinking is on the part of yourself and all those others who claim this house price pyramid selling scam is not going to end in tears for the mugs who fell for it.

Posted by Crowley at October 29, 2006 06:40 PM

No. not the slightest bit tetchy, why should I be? But you're going to have to do a bit better than 'this house price pyramid selling scam'. Just puerile nonsense. If you want to have a decent debate, let's have your arguments.

Posted by David Smith at October 29, 2006 07:13 PM

Calm down, calm down.

I know things aren't really going your way, David, but try to avoid the playground remarks old chap!

The fact is surely one of affordability. There are no signs whatsoever of financial strain on borrowers and they are happy to borrow ever increasing multiples in order to get a place on the house price ladder. They are terrified of missing the boat.
Ergo house prices will continue to rise.

Per ardua ad astra!

Posted by Casual Observer at October 29, 2006 08:35 PM

David,

Having read your article I think it provides a good explanation of why we are experiencing another house price surge.

At the same time I thought the article did not carry enough weight on the future downside risks.

You said 8% IR was the threshold where prices would be clearly overvalued. This figure is based upon house prices remaining subdued.

I agree with the Halifax that prices will rise strongly next year (say 15%). If they do then the 8% IR “bubble” level should probably be reduced to 6-6.5%.

If the surprise of 2007 is that inflation rises faster than we thought then 6-6.5% IR is not a ridiculous possibility.

One thing that strikes me about the graph is there appears to be 3 distinct time periods
1962-1972
1973-1994
1995-2006

The first and the last periods are above the long term average. The middle period is below.

The first and last periods were predominantly low inflation, low IR, low unemployment. The middle period had much greater volatility.

It seems to me that period 1 and 3 are very similar. It only took period 1 to reach 80 points before a crash. Period 3 has already dropped 20 points from its high. If period 3 goes the same way as period 1 then a crash may occur at 80 points too.

The double combination of fast rising house prices and significant IR hikes could enable this 80 point mark to be reached in 12 months. Your article gives the impression that any crash, if it happens, is much further away than that.

PS

I found this article about the 18-year land market cycle the other day:-
http://www.cooperativeindividualism.org/putland-gavin_review-of-boom-bust.html
Have you read this and what is your overall impression?

Thanks,
LL

Posted by LL at October 29, 2006 08:49 PM

Ok David, so interest rates doubling at the last peak of the market in 1989-91 caused the market to crash, but now we are 3/4 of the way to the same scenario you are ruling the same result out?

'This time' we have masses of personal debt, the tax burden is shockingly high, the inflation figures are the biggest load of rubbish I've ever read and wage rises are being held at 2% for the vast majority and people going bankrupt (lets not forgot the impact of going bankrupt on an idividual) left right and centre and reposessions rising.

I'm not an economist of your calibre, but I'm smart enough to see that everything about the economy is span is someway to favour ever increasing house prices, but at the end of the day, it will happen again because ALL economies have recessions, all of them! Time is certainly running out for UK PLC and it's retarded government.

Posted by FrozenOut at October 29, 2006 09:07 PM

Nor sure where Casual Observer is coming from but I expect that it has been a long day 'old chap'. He appears to be broadly agreeing with me - so I don't know why he thinks the argument is going against me, which it isn't.

Anyway, to answer LL's more substantive point. I think what the affordability index shows is that there were three periods of significant overvaluation - the early 1970s, the late 1970s.early 1980s, and the late 1980s/early 1990s. On other measures, notably the house price-earnings ratio, the current period would qualify as another. This suggests that is not the case, once interest rates are factored in.

But you are quite right in saying there has to be a limit. The more that prices rise, the more the interest-rate trigger point comes down - to 7%, 6%, 5.5%? That's why, one would hope, we get down to more modest house-price rises in the not too distant future.

I'm familiar with the Fred Harrison stuff and not particularly impressed by it. One simple error, mentioned in the review. Because the Bank of England targeted RPIX, it did not ignore the housing market. RPIX, which the Bank used for years, included house prices - though the current CPI measure does not.

Posted by David Smith at October 29, 2006 09:24 PM

Simple question: How are we three-quarters of the way to a doubling of interest rates?

Posted by David Smith at October 29, 2006 09:27 PM

David,

Thanks for your reply.

You said, “That's why, one would hope, we get down to more modest house-price rises in the not too distant future.”

I think you have hit the nail on the head. The MPC are “hoping” that house prices don’t take off. There are too many upward forces on house prices now there is momentum building:

Real shortage of supply
Parents subsidising children
BTLers subsiding new purchases from MEWing existing properties
Groups of friends buying together
Interest only mortgages
Mortgages that are 7.5 times income
City bonuses
Foreign investors

Interest rates are still to low. Raising them 0.25% a quarter is too slow to dampen this momentum.

Inflation over the next 12 months is an unknown but the risks must be on the upside.

When will the china affect end?
Protectionism is on the increase
What if the pound falls?
Wages are on the rise
Food prices rising
Money supply increasing

As I said before we could be 12 months away from this affordability index looking very different.

Almost the entire UK population are convinced house prices will NOT fall.

People buying now may get a gain of 15% in 12 months. If that gain then triggers a fall and recession, that 15% gain may well turn into 30-40% loss

Thanks,
LL

Posted by LL at October 30, 2006 01:22 AM

The times when things have gone wrong in the past have been when the authorities have lost control of inflation. It is a judgment, but I don't think this is the case now, and I'd take issue with some of the factors you mention, notably wages and the ending of the China effect. What's also true, of course, is that the Bank has freedom to cut as well as raise rates. The problem in the early 1990s was that rates could not be cut rapidly enough because of the constraints of ERM membership.

Posted by David Smith at October 30, 2006 08:51 AM

Interest rates are the key to property prices. With growing inflation / debt levels the BOE will have to act. When the sentiment of decline hits the market, property will leave a bitter taste in the mouth like the e-commerce boom did.

Take a look at the American / Australian property markets...

Posted by Peter Small at October 30, 2006 09:46 AM

Well, the low of IR's were 3.5%, by February I would hazard a guess we'll be at 5.25%

As I was saying, we won't need much more then 6.5% rates to send this cycle downwards (fast) - all the people who borrowed masses of money at 3.5% will be coming out of fixed deals to ALMOST double the repayments, when they were already stretched at 3.5%

This is simply a reverse of 1989-1991 but this time instead of relative to the time low house prices with wacking great big interest rates, we have low rates and masses amounts of debt.

A home is worth only what someone is willing to pay, and as the rates rise and the sentiment towards future capital gain against a massive mortgage debt erodes, you'll see massive slides in property values, and once that starts it won't stop.

Just because you have a mortgage of £200k on a property doesn't mean if you get in to trouble anyone buying owes you ANYTHING at all, if it's only worth £165k that THAT is all it's worth, the fact you have a short fall is the vendors problem.

You have to wonder why we're messing around with 0.25% increases, when a sharp 0.5% upwards would send a clear message to speculators, but the point of the matter, in the UK we produce NOTHING that anyone wants, all we do is buy and sell houses off each other and at some point with immigration keeping wages low and high asset prices, we're going to have a civil war in this country, or an extremist party (BNP?) are going to get in.

David, tell me why I can't afford anything more then a one bedroom flat on my salary of nearly £50k a year?

Posted by FrozenOut at October 30, 2006 11:52 AM

We've been through the Australian market before on the site, and its soft landing. Before people respond on this, please look at the data, not the folklore. US house prices are down by 2% on a year ago and Alan Greenspan tells us the worst is over. New home sales picked up strongly last month as developers cut their prices. As I've said before the US market is, much more than the UK, a series of regional markets. Some are weak, some are still rising quite strongly.

As for UK interest rates, I wouldn't get too excited about the effect of people renegotiating deals that were taken out at the rates trough. Those effects, which are often much talked about in advance, never amount to very much. Is the Bank going to raise rates so sharply it crashes the housing market? I'd be very surprised.

I don't know your personal circumstances and where you live. But, assuming you've saved something out of your £50,000 salary, a £200,000 property ought to be within reach. That will buy more than a one-bedroomed flat in most parts of the country and, indeed, in most parts of London. But, if your read the piece, you will see it argued for a substantial increase in housebuilding, without which the supply-demand imbalance will persist.

Posted by David Smith at October 30, 2006 12:21 PM

Somewhat off the topic slightly, but I think it is interesting to hear that the Bank of Canada Governor David Dodge strongly criticized the Canada Mortgage and Housing Corp. for bringing out new mortgage products and lending policies that he felt would increase inflationary pressures and were likely to drive up house prices, making them less affordable. Here's the link: http://www.cbc.ca/money/story/2006/10/30/cmhc.html

Posted by Walt at October 30, 2006 08:51 PM

"There's a very easy sum to do on this: In the past 10 years money GDP has risen by less than 70%, M4 has risen by 120%. Great relationship. Indeed, I can recommend a very good book --- The Rise and Fall of Monetarism, which I wrote quite a long time ago."

David Smith, 27 October 2006

"What's M4 telling us? Probably not much."

David Smith, 30 October 2006


"Interest rates in the main economies have still not been raised enough. There is a buoyancy in asset prices one gets with high-risk monetary growth."

Tim Congden, Visiting Fellow of London School of Economics and advisor to the treasury

"There is something of a revival of monetarism,"

Stephen Jen, London-based head of global currency research at Morgan Stanley, 30 October 2006

In military jargon, that's called being outranked, David Smith. As I've said before, I like this site for the consistency of analysis, the problem is that it's consistently wrong.

Posted by G Campbell at October 30, 2006 09:00 PM

The Canada point is quite interesting. The Bank of England has steered clear of this kind of intervention, preferring to leave it to the market. Canada doesn't tend to get noticed that much but personal debt levels there have risen strongly and, I believe, are at record levels in relation to personal incomes.

As for Mr Campbell, it would be a surprise if Tim Congdon (yes Congdon not Congden, and he is not an adviser to the Treasury) was not warning about broad money growth - he's been doing it for 30 years. I welcome your contributions but, to coin a phrase, they're just consistently wrong. In military jargon, you keep getting yourself SNAFU'd. But we'll get you there, and I'm looking forward to the day we can agree on something.

Posted by David Smith at October 30, 2006 10:38 PM

David

if nothing else I think we'd agree that there are few economic topics (with the possible exception of whether measured inflation matches people's perception of inflation) that would generate this level of debate.

I thought your remark to the effect that someone on a £50K salary ought to be able to look at buying a £200K property quite telling. You might be able to get more than a one bed flat in London on that - but it wouldn't be very nice - and it would probably be in a part of London that we'd have to search for in the A to Z.

Telling because five years ago £50K was a very respectable salary and would have allowed someone to live the kind of life one might aspire to on a very solid professional salary.

Now, without wishing to be too mean, you're suggesting they can aspire to the kind of life most of us led when we were students.

What I think we have is a complete imbalance between the story told by the figures, particularly the story told by economists on the basis of the figures and the story told by real people who feel priced out and boxed in.

The mismatch is that great that either we'll have to see a sharp fall in house prices or a sharp fall in expectations (ie that white collar professionals accept that they're the new 'working class' - because all they can afford these days are the working people's houses of 100 or even 10 years ago) - or the two adjustment meet somewhere in the middle.

Bottom line - something somewhere has to give (and I'm not saying it's necessarily house prices, though I suspect they may be more vulnerable to shocks than they were)

an enjoyable read as ever David

cheers

Posted by Jonathan at October 31, 2006 02:57 AM

I'm not sure we'll ever agree on this one, David. Even your seniors and peers seem to disagree with you on this:

http://business.timesonline.co.uk/article/0,,16849-2429345,00.html#cid=OTC-RSS&attr=Business

Posted by G Campbell at October 31, 2006 09:12 AM

Peers, maybe. I was a bit surprised by that because M4 was not the news yesterday - the statistics were no different to the provisonal figures we had a couple of weeks ago. The news yesterday was the strength of mortgage approvals. It also repeated the error about the MPC not taking any notice of broad money until recently. As a check I went back to the MPC's first meeting in 1997 where the Bank saw the real rate of broad money growth as signalling strong future demand. So it has always been there.

The right thing to do is look at the full range of influences on inflation, which is what the MPC does. What is M4 telling us? That the housing market is strong - but we know that from lots of other data and directly from the mortgage lending figures. And that there has been a lot of financial-market related lending, but we also knew that from financial market activity. All this confirms that asset prices are likely to stay strong, and that will support demand.

If your argument is that we should look at M4 among a range of other data, we've reached agreement. But if you're suggesting that M4 should be the Bank's main guide, we're still some way apart.

Posted by David Smith at October 31, 2006 10:28 AM

The M4 lending breakdown is quite interesting. Chart 2 shows that the underlying growth of household lending has actually been decelerating:

http://www.bankofengland.co.uk/statistics/fm4/2006/sep/FM4.pdf

Posted by David Smith at October 31, 2006 10:52 AM

I think that its to late to try and get on the property ladder now to gain from the housing boom. I say this because i don't expect house prices to keep on risng for more than 8 years mainly because of the monetary policy. With many remortgaging and buying expensive houses a small rise in interest rate will have a big effect on the borrower and this will lead to big problems and maybe an economic slowdown. All i can say is its better to wait for a house prices to fall and move on the property ladder. Its just like an investor's principle to buy when low than when high. The people who are gaining are those who bought houses earlier and not now.

Posted by Joe at October 31, 2006 11:53 AM

My argument was that the MPC has not been paying enough attention to runaway M4 growth when looking at inflation statistics, which you disagree(d) with, especially in their last decision. To think that you can expand money supply to its highest level for 16 years (without corresponding growth) and not see the consequences in inflation is just folly.

Obvious to the rest of us, but not so obvious to the MPC members and yourself. As I said, the current "see no evil" stance will wear very thin when we see the knock on inflation effect.

I'll be harsh enough to say that if that happens, there will be a collective "we told you so" from the pundits, and while penning their letter to Mr Brown explaining themselves, the MPC members should maybe re-consider their retirement plans!

Perhaps its even time you put pen to paper again on this matter - the "Fall and Rise of Monetarism"??!

Posted by G Campbell at October 31, 2006 12:32 PM

And I thought you told us you weren't advocating the return of monetarism. You'd save me a lot of time if you took the trouble to study the Bank of England's minutes and the details of the M4 data. Otherwise, you'll just keep going round in circles and repeating the error you began with, which is very tiresome. I don't want to be rude, but I sense you don't know very much about these things, so a little research before sounding off again might be useful.

Posted by David Smith at October 31, 2006 01:10 PM

I was hoping you would be above such simple straw man arguments to discredit opposing views. I have read the minutes thoroughly and chosen my argument carefully - have you?

I'll leave it there, there's little point in continuing, but I sense the tide of opinion is against you on this particular one.

All the best

Gareth

Posted by G Campbell at October 31, 2006 01:25 PM

Gareth,
Not a straw man. But, as the October minutes put it:

"M4 growth had picked up to almost 14% in August, the highest rate since November 1990, with the increase in recent quarters coming from other financial corporations (OFCs). A significant proportion of the recent increase in the rate of growth of OFCs’ money could be accounted for by intra-group transfers – business between banks and their related non-bank entities such as securitisation vehicles. It was debatable when, or indeed whether, the latter type of balance sheet movement was likely to have much impact on future demand. However, even when those transfers were excluded, money growth had still been rapid, and was notably faster than nominal GDP growth. There remained a risk that the balances might be used to purchase assets in the future, driving up asset prices and then nominal demand for goods and services."

There are thus two questions to be answered:

1. Would the OFC element of broad money growth be affected by a change in monetary policy?

2. How much of the remaining growth in the money supply, not related to OFCs, would add to demand and therefore inflationary pressures?

The MPC is not unaware of rapid growth in broad money, and has never ignored money supply. It is just that the issue has a lot more subtleties than you have been suggesting.

David

Posted by David Smith at October 31, 2006 01:44 PM

David,

Having done some research into secular trends I am convinced we are on the verge of a secular housing bear.

Stock, commodity and housing markets are linked in the secular cycles they follow.
I think there is a 33-36 year cycle with all 3 of these markets. This puts the situation we are in today very similar to the early 1970’s. These cycles have had a pattern of approximately 17-18 years in a secular bull and similar time in a secular bear.

Stock markets
==========
The Dow Jones was in a secular bear market from 1966-1982. It then went into a secular bull from 1982-2000. The FTSE 100 has followed similar patterns.

The principals behind the secular trends are valuations. There were incredibly low PE ratios in 1982 and incredibly high valuations in 1966 and 2000.

In a secular bull there are many cyclical bull and bear stages. Each cyclical peak is higher then the previous peak. Each cyclical trough is higher than the previous trough.

See graph
http://www.zealllc.com/c2006/Zeal100606C.gif
Look at how the secular bear of the 1966-1973 matches the secular bear of 2000-2007
If the US slips into a recession and there is a shares sell-off then maybe the DJ will not go much above its 2000 high for another 10 years. The DJ was no higher in 1982 than it was in 1966.

Commodity markets
===============
Looking at the commodity markets, there can be similar comparisons with today as with early 1970’s. There was a commodities secular bear between 1980 and 1998 (18 years). Since 1998 the commodity market has been in a secular bull. With China and India consuming world resources at an alarming rate there is plenty of evidence that this secular commodities bull will run for another decade.

Eventually this secular commodity bull run will lead into increasing inflation.

Although the graph was produced 2 years ago there are strong similarities with the early to mid 1970’s
http://www.zealllc.com/c2004/Zeal090304A.gif

Housing market
============
Looking at the housing affordability graph
http://www.telegraph.co.uk/money/graphics/2006/10/02/cnhouse02big.gif

If we say housing was in a secular bear in 1974-1992 (18 years) and in a secular bull from 1992 we are surely on the verge of housing plummeting into being unaffordable.

The pattern of this graph in 1974-1992 is so typical of a secular bear. Each cyclical peak is lower then the previous peak. Each cyclical trough is lower than the previous trough.

Summary
=======
With all 3 markets in a 33-36 cycle, you cannot ignore the possibility that we could be entering a housing crash and recession in 2007/2008

I can see why looking at the current figures of inflation/IR/employment you may want to delay making a crash claim until the figures show it is inevitable. By the time economists start telling us a crash will happen it will be too late for those people who bought at the top of the market.

Thanks,
LL

Posted by LL at November 8, 2006 03:12 PM

Liam,
I don't want to dismiss it out of hand becasue you've clearly thought a lot about this, but I don't recognise these cycles at all. The great equity bull market is generally reckoned to have begun in the mid-1970s and lasted until the end of the century. As for UK housing, it is simply not the case that there was a secular bear market from 1974 to 1992. That period, as you know, included the great boom of the 1980s.

The reason I'm not talking about a crash is not because I'm trying to bury bad news - as i have said before there's been plenty of crash talk from many quarters (and many newspapers) over the past few years. It is simply that I don't think we have the economic conditions for a crash. Whether we do so at some stage in the future depends on events and the conduct of policy.

David

Posted by David Smith at November 8, 2006 04:22 PM

David,

Thanks for your reply.

Let me put some definitions on secular markets.

Commodity market:
==============
This is the easiest of the 3; a secular bear is when prices go from an all time high to an all time low. The commodities secular bear ran from 1980 to 1998 (18 years)

Stock market:
==========
This is not quite as clear cut as commodities. We can define a secular bear as when shares prices don’t make any gain over a very long period of time. As we can see from the graph http://www.zealllc.com/c2006/Zeal100606C.gif the DJ did not make any progress from 1966-1982. Although dividends would have been paid, inflation would have made the net result a loss for the investor.

The “great equity bull” that started in the mid 1970’s could be classified as a cyclical bull in a secular bear trend. It is only after 1982 that the secular trend turned into a bull.

A complete 33-year valuation-wave cycle takes the Dow from undervalued levels to overvalued levels and back again. The undervalued component of this cycle happened back in 1982, when the Dow was trading under 7x earnings. The overvalued top was about 17 years later in late 1999 and early 2000 when the Dow was trading over 44x earnings. The next undervalued secular bottom will also almost certainly occur near or under 7x earnings again as they all do in history.

Property Market
============
This is the most difficult secular market to explain. I describe the secular bear in the housing market as between 1974 and 1992. This does not mean that house prices end up lower or even the same after 18 years.

The secular market is about affordability of houses rather than the house prices themselves. Just as the DJ secular trend is about PE ratios the property market is about the affordability index.
http://www.telegraph.co.uk/money/graphics/2006/10/02/cnhouse02big.gif

The graph shows clearly between 1974 and1992 that there were 3 troughs in the affordability index. Each trough was lower than the previous. This is a classic secular bear trend.

Fred Harrison is his book identified an 18 year land cycle. Although you found errors in his book (namely CPI/RPI definitions) there are many things is his book worth some value. I personally think that the cycle is more complex and 36 years long; made up from two 18 year distinct periods.

Summary
=======
If you compare the late 1960’s and early 1970’s you will see a very similar economic climate to today; low inflation, low IR and low employment.

I believe that the commodities secular bear (lead by China and India) will eventually lead to inflation and IR rates to increase significantly.

With house prices and stock markets at an all time high this surely spells a recession as we saw in the 1970’s. The trigger in the 1970’s was different; an oil shock. The trigger this time could be a number of things; currency crisis, US recession etc.

We entered a recession in 1990. If the 18 year rule holds the next recession should be 2008 (give or take a year)

I am not saying you are hiding the figures. Conventional economics will only predict a downturn once the data is there to supports it. Any analysis of the current situation must include “long term cycle” evidence to give a balanced view of all the risks. Your article does not give a balanced view of all the risks of the current situation

Thanks,
Liam

Posted by Liam Lyon at November 8, 2006 09:36 PM

Liam,
I think you meant to say commodity bull market at the end there but I understood your point. Two things: I've always been fascinated by long cycles. Most economists, and most economics writers, have a flirtation with Kondratiev and other long cycles. The problem is usually that they don't work terribly well. In particular, applying a long cycle to the UK economy and the housing market to predict a recession in 2008 is just not sensible. We had three recessions, and three housing market downturns, in the period 1974-1992 but, as I said earlier, I would struggle to see that period as a secular bear market for housing. If I wanted to apply that analysis based on affordability, surely you'd take it forward to 1995-6, when on most measures housing was more affordable than ever before. None of this means we won't have a recession, but I just don't think this kind of determinism works.

The second point is about the early 1970s. Industrial countries already had an inflation problem (5-6% inflation was typical) even before the Opec supply shock. There were many reasons why the low-inflation of the golden age of the 1950s and 1960s came to an end but the parallels with the current sitiation aren't good. The late David Walton did a good speech on this - http://www.bankofengland.co.uk/publications/speeches/2006/speech268.pdf

Posted by David Smith at November 9, 2006 09:33 AM

Dear David

Just a few comments from a very worried estate agent based in Maidenhead.

We're not getting any instructions, the phones have stopped ringing, we have lots of property refusing to budge despite discounts...my take (I'm 39) is that "hello, we've been here before in 1989-90". Lenders are being wreckless, we have in reality a RPI or CPI or whatever at 10%, money growth at 14% (surely this in itself is inflationary?), 16 months of rising unemployment, rising insolvencies, retailers going bust (OK M&S have done wonderfully well, considering) and a debt mountain that is sickeningly large....recession? I bet my life we are about to go into one!

The fact is that UK plc has been spending thanks to property inflation. Our homes have been used as credit cards - and it's payback time.

I'm retraining as an IVA practitioner and filling my boots in debt company shares, Gold, and staying in cash.

Best regards

Jonathan

Posted by jonathan tedd at November 9, 2006 04:53 PM

Jonathan, I'm surprised to hear that. Your friends at RICS agree with you that instructions are down but otherwise they could hardly be more upbeat:

House prices rose for the 11th consecutive month at the fastest pace in four years says RICS’ UK housing market survey published on 12 October 2006.

45.1 percent more Chartered Surveyors reported a rise than a fall in September, up from 34.9 percent in August, and more than double the long run average of 21 percent. RICS estate agents reported that price rises are being driven by a combination of would-be buyers returning to the market and the limited availability of property.

Price increases were again led by London and the South East, boosted by the a booming City economy, with rising investor confidence pushing the stock market to its highest level since May. Estate agents report that ‘gazumping’ is taking place amid prices in the capital rising at the fastest pace since January 2000. Elsewhere, a ripple effect is taking place across the country with house prices in the North West and East Anglia picking up sharply, while Wales, Yorkshire and Humberside also recorded price rises.

Buyer enquiries rose for the sixteenth consecutive month, the longest run on record. Above trend economic growth combined with a strengthening employment market continued to boost buyer confidence but the rise is the smallest since April 2006. New instructions to sell property fell for the fourth month in a row, at the fastest pace since June 2002, indicating that households feel under little pressure to put their property on the market.

Optimism in price rises is at its highest since October 2004. However, surveyors expect a modest slowdown in sales activity as interest rates are expected to rise again.

RICS spokesman, Jeremy Leaf, said:

“Greater economic activity has created a ripple effect in house prices across the country. With stocks of property low and buyer enquiries on the increase, sellers remain in poll position to benefit in the short term.

“Continuing house price rises will make it difficult for the Bank of England to leave the base interest rate level at 4.75 percent, unless the economy shows unexpected weakness. With affordability conditions for first-time buyers worsening, as price rises outstrip wages, higher interest rates will not help. However, a strong economy means that the housing market should see a soft landing in 2007.”

Posted by David Smith at November 9, 2006 05:25 PM

Speculative markets! I can appreciate all the economic arguments for sustained high housing prices..but surely prices only went up because buyers believed they would continue to do so. If they believe they will drop then the reverse will happen. It only really needs a push from the media with a barrage of negative press and the 'Palace of Cards' ie high house prices, will collapse? Economic stats are great to support David's view but surely it is just about sentiment? If it can happen in the USA then why are we so immune? What is so different in the fundamentals here?
Expected a crash 18 months ago...sold up and am waiting!!

Posted by Gary the renter at November 9, 2006 05:38 PM

"mortgage rates will have to increase to above 8% in order for the housing market to become a bubble.”

This comment demonstrates a lack of understanding of the basics. Whether a bubble exists now or not has nothing to do with what the interest rate may do in the future - either we have a bubble or we do not - a future rise in interest rates will certainly not create a bubble.

A bubble exists when people buy only because they expect prices to rise further. That's where we are now - buyers overstretch themselves because they fear that if they do not, they will miss the boat.

Once people stop believing this, the bubble bursts - as it surely will.

A bubble defies the rules of economics, so renders all this hot air worthless. Once people stop stretching themselves to 'get on / up the ladder', the bottom will drop out of it. End of story.

Posted by Tony Marshall at November 9, 2006 08:43 PM

Don't know why there is sudden outbreak of interest in a piece posted nearly two weeks ago, but always glad of it. With reference to bubbles, I understand them very well, thanks. The point Lombard Street Research was making - indeed anybody who looks seriously at these things would make - is that interest rates are a key determinant of affordability. If the current level of interest rates is sustained, house prices are fairly valued - and looking back we'll say there never was a bubble. But if it turns out that this was a period of unusually low interest rates and the "normal" level is much higher, say 8%, then many people will have bought on false assumptions and house prices will fall.

The evidence for people generally over-stretching themselves is rather thin, if you look at the statistics for lending multiples.

Posted by David Smith at November 9, 2006 09:06 PM

Dear David

I thought your article was a pretty well balanced summary of where we are today with the housing market. I do have one or two questions I'd like to ask you though.

I live in Leeds and looking around me I see people desperately trying to clamber onto the housing ladder, stretching themselves to buy tiny properties in what can only be described as 'less desirable' areas around Leeds. To me, the reasons for this are as as much about panic and fear as they are about the points mentioned in your article. The general person in the street only sees house prices going up in the future and they will currently sacrafice a lot in order to get on the ladder or trade up.

My questions are around this 'softer' area around house buyer confidence. Firstly, what kind of economic shift do you think it would it take for house buyer confidence to diminish sufficiently in order to reduce house prices? If this happened, do you think that there is a danger that this could trigger an irrational response resulting in an exaggerated decline in house prices?

Finally, if you woke up tomorrow and you were 25 again, with £10k savings in your back pocket, would you currently take your first step onto the housing ladder....?


Regards
Richard

Posted by Richard Chandler at November 9, 2006 11:04 PM

Richard,
In answer to your question, we've got a bit of recent history on this. The market cooled significantly in the middle of 2004 on the back of a sequence of interest rate rises and what was taken as a house-price crash warning from Mervyn King, the Bank governor. That was partly a real effect - higher borrowing costs with no clear idea of where the rate hikes would end - and partly a confidence effect. What it didn't do was drive prices lower. I think a loss of confidence now would have a similar effect, in other words take us from a position of rising house prices to one of stability. To get falling prices you have to have real economic factors forcing people to sell - unemployment, significantly higher interest rates - that would be powerful enough to offset the factors such as rising population, limited housebuilding, etc, tending to push prices higher.

What would I do if I had £10,000 and was 25 again? Home ownership has proved itself over many decades, and this is what I would be aiming for. But whether it is best to get in at the stage you are at or hold on until later depends on what's available. If it looks like a bad deal, it probably is.

Posted by David Smith at November 10, 2006 09:10 AM

David,

The biggest bubble I can see is the one you seem to be living in.

All this prattling on - "interest rates are a key determinant of affordability. If the current level of interest rates is sustained, house prices are fairly valued" - is just so much nonsense.

You seem to think that HPs exist on their own, in the dark, away from multiples of income, inflation and huge, unprecedented personal debts, growing ceaselessly on a diet of hype and nonsense from industry players.

The RICS survey, as I understand it, is based on the opinions of surveyors, not any actual real prices. Its more of that soft information that you seem to like so much and is about as useful as taking the Rightmove "asking prices" as a guide to prices.
And when a (self professed) Estate Agent makes a point, you tell him he must be the exception.

When all this is over I hope you and the property profession are regulated and exposed to legal redress for all the problems your ramping will surely cause.

Posted by needle at November 10, 2006 10:23 AM

On balance I have to agree with David in the short term (next couple of years) I can only see house prices rising, but under 10% per year, except in London where demand will cause greater increases.

This is one of the most interesting graphs I've found in my research of affordability.

http://www.nationwide.co.uk/hpi/downloads/FTB_Affordability_Indices.xls

Looking at the UK wide column (O) It clearly shows just before the crash of 1990 Q2 that FTB were stretching themselves to 141% of the *average* income. We are currently at high levels compared to average income but not quite at crash levels 2006 Q3 116%, it is also interested to me to note the *bump* at the top 2004 Q4 113.8% then reduction, and now rise again this year which is surely one of the main drivers for the MPC increasing interests rates and are likely to do again early next year, over and above consideration for the (imho broken) inflation figures. (Thank gawd, not gord, for China!)

It is also interesting to see the low in 1996 Q1 of 46.2%! Its quite clear the market has bottomed out at this point and prices can only go one way!

From a perosonal point of view I'm currently working in a highly paid job, and could quite afford to buy a 3 bed house in my chosen town of Leeds but have decided to rent in a nice area of the city. Rental costs £725 pcm. Property's in the same street for sale are going for ~£200,000 therefore a mortgage with 5% deposit would be £190,000 (Woolwich tracker) £1,048.01pcm personally its just easier, cheaper, and less worrysome to rent. But when the time is right I *will* be wanting to get onto the property market as will a lot of people my age, and in the end its this demand that will drive the market upwards.

Clarkey

Posted by Eliot Clarke at November 10, 2006 10:26 AM

In response to "Needle", I find that most of the prattling in this debate comes from people like him, hiding behind the cloak of anonymity and either unable or unwilling to understand the arguments. That the level of interest rates is central to the question of affordability is a simple fact. I pointed Jonathan Tedd to the RICS survey because his own firm's website says this is the best source of housing market information. But RICS fits in with all the other information we have at present, hard or soft.

And let us get away from this idea that I've been ramping up the housing market. I have not, indeed I warned before the recent rise that it could be a "suckers' rally". All I have said, consistently, is that we weren't going to have a crash, which is very different.

Posted by David Smith at November 10, 2006 10:39 AM

I should mention that what I like so much about the data above is that unlike most House price / earning ratio graphs this information is %age of FTB's earnings which go on mortgage repayments. This effecively removes variations in interest rates from the equation and clearly shows how much FTB's are streching themselves to get onto the property market.

I hope you don't think I was suggesting you are a serial 'talker upper' of the housing market David. I agree with your analysis we are not going get a classic crash senario unless the economic conditions change radically. Simple supply / demand shows this clearly.

Posted by Eliot Clarke at November 10, 2006 11:23 AM

No, not you Eliot, I was responding to an earlier comment. The table you drew our attention to is an interesting one. One small point - it is an index (1985 = 100), so it does not mean that first time buyers are paying 125% of their income on mortgages.

Posted by David Smith at November 10, 2006 11:33 AM

OK, fair point and that would technically be impossible anyway! Does this index take into account inflation I wonder. Things are never as clear cut as they first seem I guess, especialy when it comes to free market economics!

Posted by Eliot Clarke at November 10, 2006 11:52 AM

It's fine in that respect -- all it is is an index that measures the percentage of first-time buyers' income taken by mortgage payments. So if that was 30% in 1985 and rises to 45% in 1990, the index goes up from 100 to 150.

Posted by David Smith at November 10, 2006 12:07 PM

David, I don’t agree with your suggestion that bubbles are measured with the benefit of hindsight. If large numbers of people who have no real knowledge or understanding of the market, or of economics in general, are spurred on by expectation of future rises to bid more than they would otherwise bid, then you have a bubble. Plain and simple. And that's what we have in the property market.

Posted by Tony Marshall at November 10, 2006 01:58 PM

The long-run trend for real house prices is up, so people are right to think housing will rise in the long-term. But a bubble implies that people are buying for short-term speculative gains. There's no evidence that is the case. Indeed, the housing market is not particularly good for short-term capital gains because of high transaction costs.

Posted by David Smith at November 10, 2006 03:24 PM

"Indeed, the housing market is not particularly good for short-term capital gains because of high transaction costs."

So are you saying that property bubbles, by definition, don't happen?

The current surge in demand must leave a vacuum in its wake, as people find they have overstretched themselves and others become more cautious. That's when the bubble will burst - when the default position changes from 'pile in regardless' to 'don't touch it with a barge-pole'. In the meantime we shall get the 'wait and see' stage, but the slow-down from this (unless 'cured' by another rate cut, which seems unlikely) will lead to a cooling in demand and some fall in prices, then we move into phase 3 and it's down-hill all the way.

Posted by Tony Marshall at November 10, 2006 04:08 PM

No, as I said earlier, you can identify bubbles in retrospect if people have bought in the belief that interest rates will stay significantly lower than they turn out to be. If you think back to the late 1980s, there was a double-whammy -- a cut in interest rates to the then low level of 7.5% and the rush to buy ahead of the ending of double tax relief. People rushed in then without thinking of the consequences, and when interest rates and unemployment doubled they were caught out.

I don't believe that is the case now - current median income multiples for movers are just under 3 and median interest payments are 15% of income. For first-time buyers the figures are just under 3.3 and 17% respectively (CML data). As I say, I don't accept your view that this is a market driven by hope of speculative gains. There are underlying reasons for strong housing demand, not least rising population and household formation, set against limited new housing supply.

Posted by David Smith at November 10, 2006 05:12 PM

Tony puts the case very succinctly. I could not agree more. Of course we are witnessing a 'bubble', and it is no different to the dotcom crash and housing in the late 80's. I might add that if no crash is forecasted, then how does the 'correction' occur? House prices will plateau for 5-10 years? Is this not a risible proposition? Do any grahical representations of house prices ever show a long flat period? I think not. David and the other 'no crash' economists seem to be living in some kind of never ending golden era where economic balance is gauranteed. How can this positon be adopted given the downsides risks? Surely once the average Daily Mail reader is aware that the US housing market is on the skids, the question will be asked 'why not here'? Will David ask the doubting public to study the stats before reducing their house prices to get a quick sale at the approaching top of the market? Herd mentality will well and truly put paid to the 'sound fundamentals' we hear quoted by all the vested interests.

Posted by Gary the renter at November 10, 2006 05:20 PM

Whatever underlying reasons there may be for strong housing demand, there is a significant element on top of this from those who are acting purely out of fear that they will miss out by not acting now.

Furthermore, much of the demand based on economic activity ('real demand' if you like), is fuelled by an economy propped up by inflated house prices, through MEWing and a general feel-good factor that comes from seeing one's home treble in value.

Basic economic theory tells us that such things are cyclical and that this cannot go on forever and, once this element of demand is removed, it will be replaced with the opposite sentiment, which will cause everything to swing the other way.

Posted by Tony Marshall at November 10, 2006 05:48 PM

Ok, we're just going round in circles. You'll carry on believing what you believe - and I'll stick to my analysis. I'd encourage you to join in the discussion forum, click the link on the left of the main page. You'll see that the house price-earnings ratio has been thoroughly discussed, and why it may no longer be a reliable measure. I wouldn't get hung up on the idea of a herd mentaility. People buy because they want to, and they tend to only sell because they have to. We have never had a housing crash in the absence of a general economic recession, which produces forced sellers. I'm not saying, of course, we won't have a general economic recession again - we certainly will - but until we do we won't have a housing crash. As I say, join in the discussion in the forum.

Posted by David Smith at November 10, 2006 06:44 PM

You’ll want to skip this entry if you’re uninterested in politics. I hope it is relevant to the housing market: I believe it is.

I know nothing of economics outside of popular wisdom. But I know the world changes, and that there is grave social inequality in Britain of Victorian proportions. This began with Thatcher, and now politicians of all hues have abandoned all principle and behave with Feudal self-interest, buying votes by enacting outrageous and unpopular policies that openly discriminate in favour of their supporters, who because of our electoral system, make up the minority. New Labour have engineered a kind of Fabian bureaucratic Hell, in which their supporters are elected into well paid jobs that make up a quarter of the workforce and keep them in power. Now I don’t know which exact mathematical factors are propping up the housing market that helps these monsters to re-election, and I can’t explain why the boom has defied previous economic logic. It would be pointless for me to repeat all the much-heard crash arguments about nationalist China turning, peak oil, Mid-Eastern crisis, unrealistic inflation figures and herd mentality and the like, or the pro-ones, the only ones of which I grasp are globalisation immigration and increased demand - because I don’t really understand the figures behind any of them. What I do understand, is that I should believe what I see with my eyes in the world around me above anything I read or am told.

What I see around me is a ruling caste of people who are benefiting from the housing boom and higher employment because of their political colours. The relevant point is that a young ruling political caste has been created to inhabit over-priced homes and fulfil pointless bureaucratic jobs that allow them to afford those homes. As far as I can see it’s being created in two ways: firstly by overt discrimination against anyone who does not fit a New Labour voter profile in the jobs market. This is not just because of the percentage of that market which effectively constitutes the Government, but also because any private business of any scale is tethered to that Government by vague social laws that effectively constitute conveniently flexible political diktats, with disastrous penalties attached, as to who they may or may not employ. Now this will be a statement widely ridiculed in the virtual world of establishment media and politicised academia, but I look around me every day and I see the glaring, obvious fact that the victims and targets of this politicised society are overwhelmingly men and the perpetrators women. What is more, this system’s beneficiaries are not blacks, or Asians, or the disabled - and most certainly not the working class - to whom the Government would have us believe they are restoring a long unjustly withheld franchise - but selfish middle class woman, supported by a caucus of lazy so-called Liberal men who long ago forfeited their right to the name. Secondly, I think that divorce, and family law (for which read the atomisation of the family, as this legal sector, and increasingly the criminal sector, has been rankly politicised by violent feminist extremists over the last twenty years) has a dual effect on the same group so that when taken together, you are talking about a very real political persecution.

This leaves you with women in the housing market and in employment and men unfairly forced out of both. Which makes the UK economy and UK housing market built on injustice. If you want to wax poetic, I think the stilted economic figures reflect the stilted social groundwork for the boom. And I think political change could see an end to the resultant, apparently mathematically challenged boom. In the US, George Bush was not simply elected, as his opponents would have us believe, by religious hysterics and dim-witted traditionalists. No-one ever talks about his domestic policy, but one of the first things he did as Texan governer was reform so-called “family” law. This was by popular demand. Divorce and custody stopped being a gladiatorial combat in which embittered women were able to use their children as weapons in a rigged fight for unequal spoils, and as a result divorce rates went through the floor, a lot of Texan children are a lot happier, and couples who split up increasingly do so without any misery or bloodshed. (In the States, at least one “family lawyer” was shot dead by an “applicant“ father). Bush also axed a lot of unnecessary politicised bureaucracy, chiefly built around women’s groups who used taxpayers cash to lobby their fringe beliefs into mainstream law, and even tried to tackle the legal compensation culture. I don't believe America has turned against this sort of Conservatism in the mid-terms, it's turned against Bush and his glaring faults, which were previously ignored - because of the popularity of his mainstream domestic policies - by people who were suffering social injustice, amd were prepared to put up with some setbacks in medical research, and a little obvious stupidity, to be relieved of this suffering. If anything if you look at the results, you see a trend towards intelligent voting, for moderate politicians of both parties.

What has this to do with housing? Especially when the housing boom continued through the change in political colour in the US? Well I think it's relevant in the longer term. I think gradual social change can be predicted, and that in the UK as in the US, the majority of people increasingly view the political establishment as an out of touch, pseudo-socialist (‘Liberal’) elite, and object strongly, on basic moral grounds, to their destructive domestic social policies. I think these political factors over-ride economic ones in the long term, and that given time this change in popular opinion in the West will be properly reflected by a different Govt in the UK. Such a Govt must dismantle the unjust economic system that props up the current political one. Of course that’s not how it will happen - apart from anything, human nature being what it is, one elite tends to selfishly inherit the structure left behind by the last, and what Govt could be elected on a ticket of economic decline? No, I think the change will be helped along by any one of the many different factors cited by the pro-decline lobby, even if they do occur over time and in moderation. This is because I naturally disagree totally with David that it is ‘folklore’ to think a capitalist economy rises in smooth undulating waves forever! And I think the sounder anti-arguments weigh towards a long recession, rather than a sudden crash (unless extreme events brought about both - aren‘t we excluding the obvious possibility of a War?)

History teaches us that what appears unthinkable in one era can quickly become reality, and it would be interesting to see more of the economists contributing to this forum widen their arguments into other fields in which they may be less knowledgeable, but perhaps have a more original and useful insight. Apart from anything else - I can’t compete with them on the Maths!

Posted by phil at November 11, 2006 04:03 PM