Monday, November 15, 2004

House price scaremongers' numbers simply don't add up

Bridget Rosewell

The Guardian


The Bank of England last week reiterated its warning about house price falls. Scary numbers, such as falls of 20 or even 30%, are being touted by some as necessary to "bring the market back into balance". Enough to frighten any recent or prospective house buyer.

It is indeed true house prices have reached their highest for 30 years in relation to income and look as if they have started to fall back. For most of the 90s, they stood between 2.5 and three times average incomes. The peak had been at three in 1989 - the time of the last house price boom. Now the average price stands at 4.5 times average income.

So perhaps it is no surprise that this is seen to be "wrong" and in need of correction. But it is also a simplistic way of looking at the question. We need to unpack this story to understand what is really going on.

Consider what we buy with a house. We can acquire housing services through renting or purchase. In the first, somebody else owns the property and we pay them a rent. In the second, somebody else, a bank or building society, also usually owns the property but we have an arrangement where not only do we pay them a return but also slowly pay off the value of the property and acquire an asset. For the purposes of consumption what matters is the interest. This allows us to consume the housing service, though not to own an asset.

In a small, crowded island many more people want housing in a particular type of location than can get it. Where there are restrictions there will be excess demand pushing up prices. If the cost of borrowing or renting falls, it is likely people will try to improve their consumption of housing. But if there is no more supply, prices will rise until the amount being spent has come back into balance.

And this is more or less what has happened. The amount being spent on mortgage interest in relation to income is no higher than in 1997. It reached a huge peak in 1989, when interest rates peaked at 15%. But at present it is still lower than in the late 70s. Moreover, arrears and repossessions are also at record lows.

This means there is no reason to expect prices to fall significantly unless there is a sharp contraction in the economy. This seems unlikely - unemployment is low and growth still higher than average. Although economic clouds can form at any time and at any size, the current batch is small.

Of course the Bank of England has been trying to avoid such boom and bust scenarios by tweaking interest rates. Its target is inflation rather than house prices - the last thing it wants is to trigger a 90s-style collapse in house prices by violent swings in rates.

When rates hit that peak house prices did fall, though unemployment rose too. This meant people could not manage newly very expensive mortgages, were forced to sell or default and prices fell further. The fall in real house prices in 1990 was 15%, though the swing from boom to slump was less dramatic than in 1973-4. The 1990 fall was the largest ever in nominal terms, with a fall from peak to trough of £9,000 in the price of an average house from May 1989 to February 1993, according to the Halifax data.

A fall of 20% would be outside all previous experience for a single year in real terms and one of 30% would be larger than that of the whole period of 1989-93. So these numbers are scaremongering. Of course there is a reasonable chance of a fall of some sort. There is a 10% chance prices could fall 10% in real terms. This is unlikely to put anybody into negative equity, since the average loan to value ratio is well below 60% and few are higher than 90%.

The studies that produce authoritative evidence for where house prices should be must be taken with a large pinch of salt. History gives us no reason to expect that a balance exists or that it will be reached. More helpful is to look at the actual situation: on that basis we should still be able to buy and sell houses.

· Bridget Rosewell is chairman of Volterra Consulting and non-executive director of Britannia Building Society, writing in a personal capacity

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