Tuesday, 8 April 2008

House Prices - The Inevitable Correction

"I will not allow house prices to get out of control and put at risk the sustainability of the recovery."
Gordon Brown, 1997 Budget Statement.

"House prices in Britain are likely to stagnate this year, the Halifax Building Society said yesterday. It expects high demand in the Midlands and North but a slowing down in the South."
Wednesday 22 MAR 1989 - The Times - Marking time, House prices in Britain

"Increasing pressure for rural housing to be used as second, retirement and commuter homes is destroying the fabric of traditional village life, a report out yesterday says."
Friday 24 MAR 1989 - The Times - Priced-out families 'need help', Housing

It's funny how history has a habit of repeating itself especially in the field of economics. Halifax has published it's latest figures for house prices and it was truly grim reading. I have been bearish on the housing market for some time now but even I was surprised at the figures as there is usually a lag on this type of data therefore the full extent of the credit tightening will still not be showing up. With ever increasing numbers of mortgage products being pulled, normality seems to be returning to the market with the repricing of risk. What was really shocking during the recent boom was the acceptance that house prices would just rise forever and the majority of the public refused to believe that house prices would correct. Even the so called 'experts' (the media property bandwagon) told us there could never be falls, just a nice leveling off.

Even better were the reasons given why prices were so high during the boom and the ideas that people began believing, which were underpinning prices.

  • "The next generation won't be able to buy."
This is so wrong and misleading. If the future generation couldn't buy in the future then how would the property market keep going? It contradicts the next fallacy.

  • "There's too much demand!"
Of course there was. It was the credit expansion part of the economic cycle. It just lasted a lot longer than usual due to very low interest rates. People were just competing with one another to take on ever escalating amounts of debt. There were huge numbers of leveraged speculators and the banks were throwing money at them, the television was peddling property programs night and day and of course there were the classic pyramid schemes going on. A bubble was obviously developing. Everyone always wants to buy something when its going up in value, but when it begins falling suddenly people are less eager to rush in and the demand vanishes.

  • "There's a lack of new builds, we live on a small island with limited space"
While I agree there has been underdevelopment in new housing all that was happening is old property was getting chopped up. I have lived in numerous rental properties that used to be conventional houses but have been split into flats. If you think about it logically if there weren't enough homes for people to live in, then surely there would be people homeless on the street. I never had a problem finding somewhere to live. Rents have also not increased in relation to house prices meaning it is much better to rent than buy. If I was to buy the place I am renting now, just paying the interest on the mortgage would be more expensive than the rent never mind capital payments. Try telling the above reason to the people in Japan.

  • "Interest Rates, Inflation and Unemployment are low"
This is always a favourite for people with vested interests. First of all these can change very quickly and the stats are not what they used to be. Inflation now uses CPI rather than RPI and has been changed quite a bit since 15 years ago. Interest rates are always the biggest misconception. The fact is they were 3.5% for five months and were raised to 5.75% fails to register with people. They were kept too low for too long, along with the FED keeping Americas rates at 1% thus in effect setting the worlds interest rates. It flooded the market with huge amounts of money that the world had never seen before. As long as interest rates change, boom and bust will always occur. Regarding unemployment, well we are just at the start of the downturn, so its going to get a lot worse. Unemployment round the world has generally been at low levels historically, but this is due to the era of cheap money. Also government statistics have been changed over the past decades, with ever increasing amounts of groups excluded that used to be accounted for (long term jobless claimants, full time students).

The simple factor driving house prices was greed. That's all. The banks were greedy to get market share so lowered mortgage rates and loosened their lending practices, the authorities and government were greedy to get the public approval of ever rising asset prices and the public buying the property were continually told of the great riches to be made from property. That's what drove the boom. Now we have the bust, where it will soon be a climate of fear.

The above points will now begin to turn and all work in completely the opposite way to exacerbate the downturn. 'Estimates' that authorities and experts publish as events unfold now begin to appear to try and gauge how much of an effect the credit crunch will have. It starts with, 'its just a blip, it will blow over', to 'well it may persist for a few months but the economy shouldn't be affected' then to 'it may last a year or two' and so on. The predictions are useless and in many cases lies. Most experts know that the situation is terrible, they just don't want to panic people. Take for example Alan Greenspan, when asked about the chances of a recession in the US he originally stated figures of a 30% chance then 50% and now has conceded that America is in a recession. Look at the links and you can see how quickly the predictions adjust. So don't listen to anyones predictions. Our economy is in bad shape and no one can predict how bad it will get. Just be aware that whatever is predicted, it will no doubt get a lot worse.

If this article seems gloomy, it is, as it reflects what is happening and that it will get worse. People and especially the people with interests in property often talk of 'gloom' news that we are 'talking ourselves into a recession' which is complete nonsense. The only thing that has brought about the current situation, are the excesses that occurred during the previous years. Of course nobody mentions this during the boom years, and the longer it goes on the more excesses and imbalances are created and worse the correction will be. In 2005 the market had a pause, but instead the Bank of England decided to lower interest rates, a quite clearly political and costly decision (General Election year). It set off a further 2 years of escalating excesses. This could prove to be a very costly error.

So we are now witnessing a case of house prices adjusting to more affordable levels. Usually these things adjust quite sharply and I see no reasons why there would be a 'leveling off' as has been suggested by numerous 'experts'. That's just estate agent and property spin, people who don't understand the economic data. If I went into Curry's or Dixon's and asked to buy a TV, I doubt the salesperson would understand how the TV works underneath. They see it for its worth and it's selling points, same as people who are involved in property. They are not aware of future developments and will only talk about the current time frame. In reality money is contracting, we have record low savings thus making it harder for banks and individuals to recapitalise and when this occurs there's not enough money in the system to pay the debt. People inevitably default especially with the levels of debt British people are in at the moment. The party had to end. We will just have to wait and see how bad the downturn will be.

"We learn from history that we do not learn from history."
Georg Wilhelm Friedrich Hegel
(1770-1831) German Philosopher

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