I just couldn't look any more

Before today I haven't looked at UK house price data for at least six months. Understandably, this is quite limiting if one is running a blog that started out as a housing bubble blog.

When house prices were rising, I was angry. I found it outrageous that years of easy credit, speculation and excessive regulation on land use conspired to ensure that many young people could not afford to buy a home. Now that house prices are falling, I am frightened. 

For 40 years, the economic fortunes of the UK were tied to property speculation. As a country, we ran this scam as hard as we could. We took it to the limit.

Now, house prices have nowhere else to go but down. As they fall, so do the fortunes of the country.

Oil - the growth killer

The monetary miracle is over

One should never underestimate the importance of luck. For almost a decade, the Bank of England proved to be very fortunate. It managed to simultaneously keep interest rates low, dramatically increase the money supply, and at the same time meet its inflation target.

How did it pull off this monetary miracle? The chart above provides a comprehensive explanation. It breaks the CPI inflation rate down into two components; the rate for services, which are mostly produced domestically; and rate for goods, which are almost entirely imported into the UK.

As the chart illustrates, prices for domestically produced services have grown fairly consistently at between three and four percent a year. This is far in excess of the Bank of England's inflation target. Prices of goods, on the other hand, were falling between 2000 and 2006, exerting powerful downward pressure on the aggregate inflation rate.

The reason for this negative inflation rate for goods is well understood. China industrialised, and exported huge quantities of clothes, footwear, and electronics. Prices for these items fell massively. In contrast, domestically produced prices increased rapidly in response the the extraordinary surge of Bank of England inspired monetary growth.

For many of us, this inflationary dichotomy between its goods and services will ring true. Anyone who regularly hired an accountant or chose to educate their children privately will be familiar with the four percent a year price hike.

So, it is fairly easy to see how the Bank of England got away with loose monetary policy and low inflation. Nevertheless, there is a more intriguing question embedded in this chart. To what extent did the surge in goods prices trigger a financial crisis?

To see how the turn-around in import prices might have precipitated the crisis, it is worth remembering how monetary policy worked in the past. In previous decades, rapid credit growth would have quickly fed through into prices. Eventually, interest rates would have increased, credit growth would have subsided, the economy would have slowed, and eventually inflation would have moderated.

This didn't happen in a decade before the crisis. Credit exploded while the overall inflation rate remains subdued on account of cheap imports. The Bank of England didn't feel obliged to raise rates, and the credit bubble just kept on growing.

Unfortunately, the old trade-off, like an unwelcome relative, returned in 2006. Inflationary pressures were building in the East,and import prices began to increase.

There were tentative signs of trouble in 2005. The Bank of England made a half-hearted attempt to raise interest rates to stem inflationary pressures. But the monetary policy committee took fright when it saw the property market weaken. Rather than tackle the growing inflationary menace, the committee buckled, reduced the bank rate and gave the housing bubble a new lease of life.

This weakness before the inflationary enemy resulted in renewed price pressures. In the early months of 2007, the Bank of England and its sister institutions in the US and Europe, were belatedly hiking interest rates.

This changing policy stance was sufficient to expose all the poor lending practices and financial sector abuses that had built up through the previous decade. Many banks, particularly small ones like Northern Rock, had cut interest margins to the bone and jacked up their leverage ratios. The slightest perturbation of interest rates and the financial system was in deep trouble.

The rest of the story you know.

So here we are - four years on from the crisis - and inflation has hit 4 percent, and it is likely to go higher. The Bank of England now believes itself to be trapped. It fears to raise interest rates on account of what it thinks a rate hike might do to the frail recovery. As for dealing with inflation, it has no strategy. There is no plan, just a vague hope that somehow things will turn out alright in the long run.

In fact, there never was a plan. The only thing that kept inflation down for ten years before 2006 was luck and a flotilla of Chinese cargo ships packed full of goods.

Land Registry confirms falling prices

(click on the graphic for a larger version)

According to the Land Registry , UK property prices dropped by 0.2 percent in December - the fourth successive monthly fall in prices.

Nevertheless, the Guardian helpfully located the few remaining bubble boom towns.

UK house prices slip again

Today, the Nationwide printed its first house price number for the year. It was a bad one. Year-on-year, property prices are down 1.1 percent. Compared to December, prices are down 0.5 percent. It was the sixth consecutive month of declining prices.

A trend has now emerged; banks appear to be less willing to lend into the property market. As the credit has stopped flowing, prices have started to slip. In short, we seem to have entered a second credit crunch.

Did you know you live in a plutonomy?

Citibank analysts have invented a new word - plutonomy.

This is how they define it;

"There are certain economies, driven by massive income and wealth inequality – plutonomies – where the rich are so rich that their behavior – be it negative savings, or just very low consumption of oil as a percentage of their income overwhelms that of the “average” or median consumer."

In other words, a plutonomy is an economy where only the rich matter. The average consumer is simply "overwhelmed". Who are the plutomonies - the US, Australia, Canada and of course, the UK.

Citibank cite three reasons for the emergence of the plutonomies; asset price inflation, the rise of managerial capitalism, and technological change leading to the creation of a new class of high net worth individuals. Twenty years of tax breaks for the rich, coupled with sophisticated tax avoidance arrangements, it seems, played no role in this happy state of affairs.

As Citibank casually point out:

"As the rich having been getting richer over the last 20 years or so – both in terms of their share of income and wealth – so too businesses that have been servicing the rich or selling to them have enjoyed a favorable operating backdrop."

And the implication for investors?

"We should worry less about what the average consumer – say the 50th percentile – is going to do, when that consumer is (we think) less relevant to the aggregate data than how the wealthy feel and what they are doing. This is simply a case of mathematics, not morality.

There is no right or wrong. It is all numbers. There are no value judgements. There are rich people and irrelevant serfs. What does the future hold for the plutonomies? There is good news and bad news. Lets serve of the good bit first:

"the plutonomists are likely to get even richer over the coming years."

However, there are risks. First, there is the danger of financial collapse:

"As much of the wealth of the plutonomists is held in one shape or other in financial wealth (as opposed to land or property), the state of the financial system is important. Financial collapse, as in the Great Depression in the US, would be a serious challenge to the plutonomists."

And there was I thinking that a financial crisis was a bad thing. However, there is more bad news.

"Perhaps the most immediate challenge to Plutonomy comes from the political process. Ultimately, the rise in income and wealth inequality to some extent is an economic disenfranchisement of the masses to the benefit of the few. However in democracies this is rarely tolerated forever.

We see the biggest threat to plutonomy as coming from a rise in political demands to reduce income inequality, spread the wealth more evenly, and challenge forces such as globalization which have benefited profit and wealth growth.

Reactionary political forces are likely to rise as globalization persists and the losers in developed economies gain in numbers. To an extent we see this happening in Europe, for example, where the rise in the profit share (fall in the wage share) has come at the same time as the rise of right-wing, generally anti-immigration parties. "

Up is down; left is right. A reactionary is someone who wants a fairer society. To oppose a fall in the wage share is to be anti-immigrant and implicitly racist.

Reading this memo, I can't help sensing that the authors are just being provocative. Is the world really this way? Or are they just trying to amuse us?

The Bank of England discover that UK household finances are under strain

How are UK households coping with the fallout of the financial crisis? Staff at the Bank of England recently tackled this question with a survey of households. So, what did they find out?

Like all good social science researchers, they discovered the obvious:

• While the UK economy has recovered, households’ financial positions remain under strain.

• Elevated unemployment, weak earnings growth and restricted credit availability still pose a problem for some households. Low interest rates have helped borrowers.

However, there were some rather more interesting observations.

• The burden of unsecured debt was higher than in the past and concerns about debt levels had increased, leading some to save more in order to reduce indebtedness.

• Households’ awareness of the coalition's fiscal consolidation measures was quite high.

Finally, Bank of England researchers discovered were concerned about the impact on their finances, although the majority had yet to take any action in response.

That sounds familiar, doesn't it?

The extraordinary real estate agent bubble

This is one of those "sign of the times" charts.

The housing bubble also generated a bubble in real estate agents. The number of people working in real estate activities almost doubled between 1996 and 2009. As of September last year, there were around 370,000 people employed within the sector. That is about one estate agent for every 70 workers in the UK.

This staggering growth in the number of real esate agents was brought home to me about 18 months ago when I visited St Albans. It is a small but beautiful town just outside of London. However, the number of estate agents and mortgage brokers in the town centre was extraordinary. Perhaps, every fifth shop front was somehow related to real estate activities.

Over the last year, the numbers employed in the sector have declined by around six percent. However, housing transactions are down by around 50 percent. This would suggest that salaries and bonuses have also fallen by around a half.

This is not the time to be a real estate agent.

(The Data is from the ONS - the ONS employment series code is ALY2)

UK property prices in 2011 - up or down?

So what is it going to be? A return to the bubble years, or a renewed property price crash?

Recent price developments haven't provided much guidance. As the chart illustrates, UK nominal property prices have been treading water for the last nine or so months. They have shown little inclination to go either up or down. Insofar as a trend can be identified, the market appears to be weakening very slightly. Since August, prices are down 0.5 percent. However, that is hardly the sort of decline that will give the nation's rapacious real estate agents sleepless nights.

UK property prices ended last year on a downswing. In December, the Acadametrics national index fell 0.2 percent, compared to the previous month. For the year as a whole, house price inflation was just under 3 percent, and therefore slightly lower than the overall inflation rate. In real terms, house prices fell by the smallest of margins.

Most predictions point to a further round of price declines in 2011. As always, much will depend on the future path of interest rates. If the Bank of England starts to hike the bank rate, the conventional wisdom is that the housing market will weaken.

However, we live in bizarre times where the normal rules no longer apply. In the short run, a rate hike from low current levels won't make much difference to mortgage affordability. Any homeowner with half a brain cell will have already locked in their super low rates when they remortgaged.

Ironically, a rate hike will signal improved economic conditions and an exit from the financial crisis. This will strengthen consumer confidence, which might spillover into the housing market. A rate hike will also improve the functioning of credit markets, which could also increase mortgage approvals.

However, if the Bank delays a rate rise, bad things will happen. It will prolong the pervasive sense of turmoil and weaken consumer confidence. It will also give further credence to the growing expectation of more inflation. If the delay extends into the second half of the year, higher inflation expectations could push long run interest rates upwards, and open up the possibility of a slowdown in GDP.

So how does this inverted story - where a rate hike buttresses consumer expectations and the housing market - fit into the long run assessment that property prices are overvalued? The 2008 house price crash was unusual. Prices fell in nominal terms, which is a rare event in property markets. In previous corrections, the downward adjustment was slow, with rising inflation and incomes doing all the heavy lifting. Homeowners are invariably reluctant to accept nominal price reductions, but seem prepared to absorb an inflation induced adjustment. The future correction is likely to return to a more normal pattern of seller denial, and a slow deterioration of home values as consumer price inflation outstrips house price inflation.

An early rate rate might affect the adjustment path, but it will not affect where prices will be over the long run. Within five or so years, the UK property market will have given up all those gains recorded during the bubble. A delayed rate hike, ironically, might actually speed up the adjustment path, since it will both weaken consumer confidence, and strengthen the growing inflation momentum that is now building up within the UK economy.

For what it is worth, and it is not much, I think the Bank of England will delay the rate hike. Accordingly, house prices will weaken during the first six months of the year. Inflation will pick up, and by mid-year some alarming consumer price index numbers will begin to be printed. At first, there will be denial within the MPC, but eventually there will be a panic rate hike, probably towards the end of the summer.

Once the MPC have come to their senses and begin normalizing the economy, a sense of calm will prevail. Overall, it will be a good thing, but as always, UK home owners will over-react. Towards the end of the year, house prices will temporarily stabilize, and perhaps rise.

So where will house prices be this time next year? It is only a personal view, but I think they will down slightly on where they are today. although I would not rule out the possibility that they are flat, should the MPC raise rates earlier than anticipated.

(Finally, just be clear, this my humble opinion, and it is for entertainment purposes only. If you are in the business of buying property this year, make your own mind up. I make no recommendation to buy, hold or sell.)

Learning from our mistakes

It is a sad fact that in the last 40 years, Britain has suffered from four separate housing bubbles.

The first occurred in the early 1970s when Ted Heath was Prime Minister. He liberalized the banking sector, reduced interest rates, and tried to keep the economy afloat with a huge fiscal deficit. He also antagonised the unions and drove the UK to the edge of hyperinflation. House prices rose and fell in parallel with Ted Heath’s opinion poll ratings.

In the late 1970s, Jim Callaghan tried the same trick. He had less success than Ted. House prices didn't skyrocket in quite the same dramatic way. Nevertheless, his departure from office coincided with a house price crash.

Mrs Thatcher was a little slow in playing the housing bubble game. It was well into her second term as prime minister before she engineered the conditions for a hyperventilating property market. Nevertheless, it was a spectacular one. And when it crashed the whole economy sank with it.

John Major never got the chance to inflate the housing market. He spent most of his wretched time in office cleaning up the mess that Mrs Thatcher made. By the time he was shown the door, house prices had stabilized. This was good news for the next occupants of 10 and 11 Downing Street. The UK economy was ripe for another bubble.

Tony Blair and Gordon Brown produced perhaps the greatest bubble of them. When it finally burst in 2007, it did more than just send the economy into the longest recession since the war. It nearly destroyed the UK financial system. The UK economy came within a centimeter of Armageddon.

Have we learnt anything from these experiences? I am afraid not. As soon as this bubble has finally unwound, and the banks have recovered, the British people will be ready for another round of property market monopoly.

Deep down inside, we love it too much. We would miss those greedy conversations about how much price appreciation is now embedded in our homes. The illusion of wealth, it might be an imperfect substitute for being truly rich, but it will do for most of us.

However, there are others who look upon our experiences with unbridled horror. Having seen the harm that speculative bubble can inflict on an economy, the Singapore government introduced a series of measures designed to cool down their housing market.

The government announced its intention with extraordinary clarity: “The government’s objective is to ensure a stable and sustainable property market where prices move in line with economic fundamentals.”. Could you imagine a British government ever committing itself to that kind of sanity?

• It raised down payment requirements for second mortgages. Individuals with more than one mortgage can only borrow up to 60 percent of a property’s value, down from 70 percent.
• It extended the period homeowners must hold properties to avoid a sales tax. Sellers will now have to pay a stamp duty for all homes and land sold within four years of purchase.
• Singapore’s homeowners who sell a property within a year of purchase will have to pay a tax of 16 percent.

Earlier, the government barred interest-only loans for some housing projects. It also barred developers from covering interest payments for apartments still being built.

House prices in Singapore are rising rapidly. The risks to the financial system and economy are serious. Nevertheless, in contrast to our sorry history, the Singaporean government understands the dangers of permitting unbridled property speculation. Although, we cannot learn from our own history, there is some comfort in the fact that others can see the dangers that we cannot.

Rhetoric and reality

Reading the Bank of England's internet site always makes me laugh. There is a wonderful disconnect between rhetoric and reality. The bank talks a good game when it comes to inflation. Here is what they say about their principal objective:


A principal objective of any central bank is to safeguard the value of the currency in terms of what it will purchase. Rising prices – inflation – reduces the value of money. Monetary policy is directed to achieving this objective and providing a framework for non-inflationary economic growth.

This week, they had a chance to put their rhetoric into action. The monetary policy committee could have raised interest rates. Instead, they chose to do nothing, despite the growing and incontrovertible evidence that UK inflation is accelerating.

The reason for the decision is well understood. The monetary policy committee would like to keep commercial bank funding costs low. They would like to increase the difference between the interest rate banks pay to depositors and the rates banks receive on their loans. This is known as the fat spread strategy. Its purpose is to recapitalise the banks surreptitiously by imposing the costs on savers.

The absurdity of the situation is amply demonstrated by a simple thought experiment. Suppose that the financial crisis had never happened and that the Bank of England was faced with the same inflation data. What would be the most appropriate interest rate response to an inflation rate that has been above target for 40 out of the last 48 months? It would be a rate hike, of course.

Debt problems worse now than in 2008

London property market is burning up

(click on the graphic for a larger version)

This graphic presents a different way at looking at London property prices.  Dark red represents rapidly growing prices, dark blue represents rapidly falling prices.  The shades in between represents different degrees of price change (remember red means up, blue means down).

A couple of things to note.  First, the dark strip that starts towards the end of 2009 represents the crash.  As we know the change was abrupt.  This can be seen by the sudden shift from dark red to blue. 

Second, the market recovered in 20010.  However, the graphic tentatively points to a more recent slowdown - the right hand side edge is shifting from dark red to orange and yellow.

Finally, the data points around 2005 are very revealing.  At that time, the London property market was losing steam.  Unfortunately, the Bank of England started worry, and cut interest rates.  London prices surged afterwards.  Many of the worst excesses of the housing bubble occurred between 2005 and 2007.

Just think for a moment, what would have happened if the Bank of England had held their nerve and kept interest rates at more elevated levels.  Property prices would have cooled, the impact of the financial crisis would have been muted and the UK economy would have been in better shape to handle the crisis.

That rate cute also killed the Bank of England's inflation credibility.  For 40 of the last 48 months inflation has been above the 2 percent target. 

Ultimately, the rate cut in 2005 was the worst monetary decision in two decades.  We are paying for it now.

Come back MEW, the UK economy needs you.

The great engine of the British economy has slipped into reverse. Before the financial crisis, homeowners were pulling out about £12 billion a quarter in home equity loans.  They used this cash to fuel a massive consumption boom that kept the economy growing at around 3 percent.  Since the summer of 2008, homeowners have been paying down their loans by around £6 billion a quarter.  So far, homeowners have paid off around £50 billion. 

In terms of their economic impact, these numbers are very large.  In the third quarter of 2010, these home equity repayments amounted to about 2.4 percent of post-tax personal income.  Prior to the crisis, home equity withdrawals were  equivalent to about 6-7 percent.  In pure cash terms, this represents a net turn-around of £20 billion  - almost 10 percent of post tax income.

This isn't how it is supposed to be.  The Bank of England cut interest rates to discourage savings, and make it cheaper to homeowners to borrow money so that they could continue spending.  So what went wrong?  At least three things didn't go according to the script:

• First, home prices fell.  This ate into home equity and limited the extent to which homeowners could use their homes as collateral.

• Second, banks were feeling vulnerable.  They had too much exposure to potentially delinquent homeowners.  They have cut credit lines and made it harder to obtain home equity loans.

• Finally, borrowers have become more worried about the future path of the economy.  Even the most extravagent consumer-addled debt serf knows that it isn't a good idea to mortgage the house when the probability of losing your job has increased. 

Taken together, these factors driven home equity withdrawal flows into reverse.  One final dismal fact; home equity withdrawal has been negative for 10 straight quarters.  This is the longest continuous period of negative numbers since records began in 1970.

Whatever happened to self certified loans?

Before the financial crisis, the UK banking system offered around 750 self certified mortgage products. By the beginning of 2010, all those products had disappeared. The self certified mortgage is no more.

UK banks seem to learn something about lending. It was a simple lesson, but costly one. When writing out a loan, it's usually worthwhile to check out the documentation offered by the borrower.

UK House Prices - Four reasons to think the UK property market might be weakening

Hometrack has just released its December survey of estate agents and surveyers. The data points to a weakening UK property market.

Reason One: Average Time on the Market is increasing

Housing inventory is taking longer to sell. The average time taken to shift a home increased over the month to 10 weeks, the longest period since April 2009.

The time on the market is now over 3 months for three regions - East Midlands, North West and Wales.

Reason 2: Settlement Prices are falling relative to asking prices

Sellers are offering sizable discounts on property.  Settlement prices as a proportion of asking prices fell to 92.1 percent. This is a 16 month low.

The recent weakening was driven by declining demand.  Hometrack estimate that in December demand fell by 4.8 percent, the sixth monthly decline in a row. Supply also contracted slightly, falling 1.5 percent.

Looking beyond December, 2010 was marked by a sharp increase in inventory. Hometrack estimates that the supply of homes for sale grew by 24 percent. In the final 6 months of the year, demand fell by 18 percent.

Reason 3:  Prices are falling in around a third of the country

At the beginning of the year, hardly any post codes were registering price declines. Markets were either standing still or moving upwards. Things began to change rapidly over the late summer months.

Reason 4:  The number of post codes registering a price increase has fallen to zero.

According to Hometrack, there are no "hot" markets.

Hometrack also presented an unusually pessimistic projection for next year.  They expect house prices to fall by two percent.

UK Economy - Should I sell or hold out?

"Should I sell or hold out for more" - this is the terrible dilemma facing anyone trying to sell something.

The chart above reeks of seller angst. In the immediate post-crisis period, sellers were desperate. Prices were collapsing, credit was tight, and the economy was tumbling into the longest recession this side of the second world war.  Settlement prices fell from 93 percent of the asking price to 88 percent.  On average, sellers were offering a 12 percent discount on estate agent window prices.

By the middle of 2009, sellers started to calm down and slowly the ratio of settlement to asking price began to increase. Unsurprisingly, this coincided with a recovery in prices.

But what is happening now? Since the summer, the ratio has started to slip south.  Is this something seasonal, or is the housing market starting to weaken again?

UK Economy - Housing heat map

(Click on the graphic for a larger version)

This is a house price heat map for the South West of England.

The blue areas indicate towns and cities where house prices have been falling. The darker the area, the deeper the price cuts. The red areas indicate rising prices; the deeper the red, the faster the house price growth.

So what is the housing heat map telling us about property developments in the South West?

• Prices were falling rapidly in throughout most of 2009.
• The market began to turn in the summer.
• By early 2010 virtually all the towns in the region were experiencing positive price increases. 
• Prices heated up during the summer of 2010.
• More recently, the market appears to be cooling again.

I am starting to feel sorry for bankers

An Irish Socialist in America; bad language and bucket of blame thrown on the heads of hapless bankers. There will be a temptation to cut this joker off  but it is well worth watching this thing till the end.

I know I've done my share of finger pointing, but I am beginning to wonder whether a little more personal responsibility might be in order.

How Gordon Brown saved the Euro

Poor old Gordon Brown; six months ago he was Prime Minister and sometime saviour of the world. Today, he is reduced to writing op ed articles in the FT.

Sadly, there is no link to Gordon's thoughts. The FT operates an impenetrable pay-wall. However, his article can be summarized in two short sentences. First, he was against Britain's participation in the Euro. Second, it is in no one's interest if the euro should collapse.

His second point is certainly debatable. For example, Ireland may well be better off if the Euro were to disintegrate.

On the first point, Gordon is almost certainly telling the truth and he has the track record to prove it. More than anyone else, he deserves the credit for keeping the UK out of the single currency. 

In 1997, He cleverly created those "five economic tests", which provided a technocratic barrier that the Euro-capitulators could never overcome.  That Brown-inspired nonsense was sufficient to keep the UK from the clutches of the ECB and monetary disaster.

Consider, for a moment, the counterfactual. Suppose that Gordon had been unable to persuade Blair, Mandelson and the other Europhiles from bringing the Euro to these fair shores. Suppose Britain had adopted the Euro in 1999 - what would have then happened?

The first 10 years of the Euro were marked by unreasonably low interest rates, which generated massive housing bubbles in the eurozone periphery such as Ireland, Spain, Greece and Portugal. The UK would have suffered a similar fate, which would have made the bubble we did have, look like a minor blip. With exchange rate risk eliminated,  a tidal wave of capital inflows would have drowned our banks.

With cash pouring into the UK, and no independent central bank to hold back the flood, our  reckless and largely unsupervised banks would have gone mad.  They would have given out credits to anyone warm enough to hold a biro in their hand and sign a loan application. House prices would have hit the stratosphere and when it would have all ended, the UK banking system would have crashed as if it were the day before Armageddon.

Bailing out Ireland and Greece is one thing, but covering up the losses of a Euro-driven British housing bubble would have been impossible for EU.  An exit from the Euro would have been the only sensible thing to do. As soon as any sensible government were elected, they would have pulled out immediately. This would have provided the necessary cover for Greece, Ireland, Spain, Portugal, and Italy to leave as well.

By keeping the UK out of the Euro, Gordon gave the single currency a chance of survival.  Keeping the pound was definitely good for Britain and its capacity to absorb the shock of the financial crisis.  But it was also good for the Eurozone. 

Today, there is no one in the UK who would seriously argue that Britain should join the Euro.  Even those Euro-fanatical Lib-Dems have quietly dropped their support for the single currency.  If there were a referendum today, only Peter Mandelson and his Brazilian man-wife would vote yes to Euro membership.

So well done Gordon.  Good call. It is pity that the rest of your time in office wasn't marked by such wisdom and foresight.