Why housing bubbles are worse than all other bubbles

I chaired a panel a few weeks ago at the Just Banking Conference in Edinburgh. MPC member Adam Posen was one of the panellists. We both arrived a little early and so had time for a chat.

Niceties out of the way (the weather was awful, Posen had spent the day fending off criticism of his inflation forecasts, and we agreed that trains are superior to aeroplanes when it comes to travelling between London and Scotland) we moved right on to house prices.

Posen thinks that governments should make real efforts to head off house price bubbles. Why? Because of all bubbles they are the most destructive. They directly affect the majority of the population and therefore indirectly affect us all. They always hit the banking system, because they are always leveraged – and because they come with no upside at all.

Other bubbles – think railways or technology – tend to come with very beneficial side effects. Sure, the tech bust hurt people, but while it bankrupted some people and condemned others to a worse retirement than they had hoped for, the bubble that preceded it wrapped the world in cables we now use to full capacity.

The fact is that house price bubbles cause “real harm” in a way that most others just don’t.

There is a view that, while bubbles are harmful, there is no way to prevent them forming for the simple reason that there is no way to identify them. Posen isn’t having any of that.

Over the long run, he says, house prices are a function of the increase in population and the increase in disposable income. “If house prices rise more than the combined total of the increase in population and the increase in disposable income, they will fall.” He then noted that whatever the bulls might like to think, UK house prices have done exactly that – crashing everywhere except for in London. 
We didn’t get on to talking about what might make London crash. Clearly London is subject more to the vagaries of international political instability than the UK’s other cities and rising demand from the Chinese, Russians, Greeks and French plays a large part in the prime property market. But even so it is hard to see London prices rising forever – particularly now the pound is strengthening against the euro.

I’m also interested to see a note from Primelocation.com showing that it is now significantly cheaper to rent a prime property in London than it is to buy one. The average rent is £3,943, but the average monthly mortgage cost is £4,339 – and that’s assuming a loan-to-value of 80% and an unusually low interest rate over 25 years of 1.99%. Add in all the addition costs of owning a property and the difference is running at well over £1,000 a month.

It might be that the rich are rising in number fast enough and they are keen enough to own property in a brilliant and stable city that this is sustainable. But I am hearing increasing numbers of Londoners with properties to let out finding it tricky to do so.

One friend, with a nice flat in Notting Hill, tells me that her agent tells her that she has 21 similar flats on her books for rent. My friend is selling. Still, I have been endlessly wrong on prime London property, so please place no bets on my views on this.
Where we have not been wrong is on property around the rest of the country – where, as Posen points out, the crash is pretty clear.

For those still in doubt, I give you this auction website. Check out the auction results and you will see that 30-40% of houses don’t sell at any price. This is backed up by the latest RICS survey which shows that the balance of surveyors witnessing a rise in buyer enquiries has halved since March. Buyers are still very fragile indeed.

The only seemingly bright spot in the market is in the new-build sector, where housebuilders have reported strong site visits and more reservations. But the problem with this is that if you deconstruct it, it is more likely to be bad news than good. Why?

Because as Capital Economics points out, it simply confirms that “large numbers of buyers remain hugely dependent on artificial incentives to reduce the effective cost of house purchase”. You get those incentives with new builds. You don’t get them in the rest of the market.