We're still living in a bubble

When our property experts met at last year's roundtable, they were mostly convinced that property prices would be down significantly by the time they met again. They were mostly wrong.

Instead, once the first round of forced sellers had been disposed of, ultra-low interest rates allowed everyone else to hang on: mortgage payments fell by two thirds in the year to March 2009. Supply collapsed as a result (people preferred to stay put than sell at non-peak prices), so much so that even with the mortgage market more or less frozen, prices started to rise. This week, depending on who you listen to, they are no more than 10% off their late 2007/early 2008 levels.

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But the real reason is pretty simple: our housing market is still a bubble.

But Britain isn't the only place still hanging on to its property bubble for dear life. In Spain, which doesn't even have the excuse of a supply shortage, prices are down just 15% from the peak and the price-to-income ratio is still 80% above its long-term average. That's despite prices doubling from 2000 to 2005, in spite of Spain's dismal fiscal position, and despite rampant unemployment. The reason? Same as here: government support for the sellers. In Spain, says Edward Chancellor of GMO in the Financial Times, supply has been constrained in much the same way as in the UK, due to low interest rates and "generous mortgage support for the unemployed".

The lack of proper housing crashes across the world might feel like good news. But it isn't. As Chancellor notes, unburst bubbles are "a potential source of vulnerability to the global financial system". If housing markets remain horribly inflated, how will it ever be possible for central banks to raise interest rates to anything approaching normal without causing a price crash and a second-round banking crisis? And if central banks can't raise rates, what happens to inflation?

Government policies might be able to stop house prices falling temporarily, "but they can't make the problems disappear". At some point governments will have to change policies they can't support one bubble at the expense of everything else for ever. When they do, things will get nasty again.