It is a little odd. The UK enters its worst downturn ever recorded; average wages increase at a rate that is much slower than inflation meaning that for some time average households have been getting worse off, but what do house prices do? Sure they crashed in the US; they crashed across much of Europe – especially in the troubled parts of the region – they crashed in the UK once too, but that was back in the 1990s. But this time around, prices fell – a bit – but right now, and without doubt, they appear to be on an upwards trajectory. Some say there are similarities between the UK economy over the last few years and Japan 20 years ago. There is one glaring difference, however. In Japan house prices crashed and went on crashing. In the UK, the story has been quite different. So why is that? And can we expect a happy ending for the UK housing market?
Now Vince Cable has joined the ranks of those who fear that the government may be creating a housing bubble. He was interviewed on the ‘Andrew Marr Show’ yesterday, and said: “I am worried of the danger of getting into another housing bubble.” But frankly the warnings have been coming from every quarter and indeed from every quintile or even decagonal.
There is more than one side to this debate. What the UK needs is more construction, and more new houses. One figure being bandied about at the moment is that every pound spent on construction stimulates the economy by £3. A residential construction boom needs mortgages to be made available. The danger is that mortgage supply will rise, demand for housing will increase but supply won’t. If that were to happen we might get higher house prices, but it is questionable whether UK plc will be better off.
In fairness to the chancellor he is trying. When he recently unveiled his latest initiative for his Help to Buy Scheme, he invited house builders along to hear his announcement first hand. And there are signs of a pick-up in construction. After falling to its lowest level since 2001 in the first quarter of this year UK construction activity rose 0.9 per cent in Q2, according to the ONS.
A rough rule of thumb might go like this: a buoyant mortgage market leading to more construction is good, but one leading to higher prices but not more construction is bad.
Yet the UK media seem obsessed with the idea that rising house prices is a good thing. If we get the slightest hint that house prices are set to rise, certain newspapers splash it all over their front cover. In recent days we have seen the media say over and again: the weather is hot, Britain is winning in sport and house prices are going up!
But why is it really seen as a good thing when house prices rise? Why are the UK public so convinced house prices can only ever rise? One argument to justify the argument that house prices can only ever rise in the UK is that the UK is an island and land is in limited supply. If that is so, how is it that house prices have fallen in Japan, which you may have noticed is also an island based economy?
Ex MPC man – a man famous for his ultra-dove-like view on monetary policy, a man who continuously voted for more QE, and indeed called for QE being used far more imaginatively – Adam Posen penned a piece for the ‘FT’ this weekend and he made a good case. In an article headlined “The cult of home ownership is dangerous and damaging”, Mr Posen said: “There is no iron law that higher-income economies must have higher rates of home ownership: Mexico, Nepal and Russia all have home-ownership rates of more than 80 per cent, while the French, German and Japanese rates are 30-40 percentage points lower. The US and the UK rates sit between them at about 65 to 70 per cent.”
Mr Posen’s main point is that because in the UK our home is our main financial asset, he said: “We incentivise middle-class households to leverage the bulk of their savings into a highly volatile, difficult to price asset.”
There is one point about the housing market which gets overlooked. Sure housing has proven to be good investment over the last few decades, but the reason for this is not because house prices keep going up, it is because housing investment is just about the only form of investment available to the mass market that employs leverage. You borrow 75 per cent of the value of a property, and the property doubles in value, your equity increases fivefold. Leverage is also available to private equity companies, which is why they enjoyed a boom during the noughties, but leverage of investment trusts was one of the factors behind the stock market boom that led to the 1929 crash.
Leverage is appealing but it is also dangerous.
But here is a theory – just a theory – as to why the Brits so love the idea of house prices as an investment.
The Brits have bought into a story. It was a story that had its roots in the 1960s and 1970s. At the beginning of this period, house prices to income were quite cheap. Over the following two decades four things happened. Firstly, as mortgages became more widely available, house prices to income rose. Secondly, as productivity grew, real wages rose. Thirdly, inflation meant nominal incomes rose very sharply. Fourthly, for much of this period, real interest rates were negative, that is to say the percentage rate of interest was less than the percentage rate of inflation. These four factors, when combined with the magic of leverage, made buying a house an incredibly lucrative thing to do.
During this period the idea was born that when you enter the housing market the best thing to do was buy the most expensive property you could. This period also saw the birth of a new metaphor, ‘the housing ladder’.
The story that emerged during this period is so strong that people still think its lesson applies today.
But is that right? House prices are no longer cheap relative to incomes. Real incomes have not been rising for some time. Nominal wages have been rising only very slowly. Sure, real interest rates are negative again. But what will happen when the baby boomers retire, and many of them try to downsize, using the spare equity in their homes? What will happen if real interest rates rise, because of actions beyond the control of the Bank of England? See: The Great Reset
The narrative of the UK housing market suggests that house prices always go up. But many of the facts that created that narrative have changed.
When pieces of the narrative are changed at a later date, the overall initial impression is unaltered. The narrative changes us, and retrospective changes to the narrative don’t reverse the original effect it had on us. If we were to find out years after we first heard the story that that actually Cinderella, was a manipulative little so and so, we would probably still think she had an evil step mother and sisters.
Until that is the narrative is proven to be wrong beyond any doubt. But by then, it may be too late to do anything about it.
For other examples of the power of the narrative see:
© Investment & Business News 2013