Monday, 14 February 2011

We really do need a property crash

I was musing the other day about what FatBigot Towers would command on the "open" market if it's value had increased at the rate of general inflation. Of course there is no way of knowing because there is no such thing as a single rate of non-housing inflation - it all depends what products you include in the calculation. To arrive at some sort of figure I googlised "UK inflation since 1993" and found a fun site that allowed me to find the value in 2010 of any given sum at an earlier date (here). I know not how accurate it is, but it's fun anyway.

What I found is that the rates of inflation used at that site indicate FatBigot Towers to have increased in "value" by almost two and a half times general inflation. That really is an absurd state of affairs, not that I mind because free money is free money and I might get around to cashing it is in the not too distant. One factor that needs to be borne in mind is that I purchased my modest hovel at a time when prices had fallen substantially and the market was extremely flat, prices could well have been below a fair market price due to suppressed demand. The vendors, who were and are friends of mine, had found their ideal property and beaten the price down substantially, they also had not needed to use estate agents, so it might well be that I paid a bit under the odds. Even so, FatBigot Towers would seem to be "worth" well over twice what it would have cost today had house price inflation been roughly in line with general inflation.

I can understand why the current government feels it would be politically dangerous to allow the property market to correct itself. We had a decade of Blair and Brown telling people they were rich because their houses had gone up in value, boom-and-bust was a thing of the past, caution was thrown out of the window and a lot of debt additional to house-purchase loans was secured on homes. That sort of thing gives rise to expectations. The government had made them so much richer than they were before, they thought, and if they still hold that view there is every likelihood that they will consider the government to have made them poor if prices crash to a sensible level.

The position is a little different to that of twenty years ago. The price bubble is much larger than it was then and far more people have dipped into the bubble to pay for holidays, cars and electronic goodies. Although a lot of loans have been repaid since things went bang that process has itself made people feel poorer, so adding a drop in house prices to the pot would risk adding insult to injury. There is also the psychological effect of the sums of money involved. Twenty years ago a property previously priced at £200,000 might have fallen to £140,000, that's £60,000 and no one sniffs at that. By contrast, today the equivalent sums for the same property might be £400,000 and £280,000; £120,000 is so much more, not least because it is six figures rather than five. The general inflation calculator I linked to above says £60,000 in 1991 is equivalent to £96,000 in 2010; for the loss to be £120,000 not £96,000 gives the impression things are worse even though the same percentage of bubble has been removed in the two examples.

Looking back to the early 1990s I cannot recall any significant political backlash as a result of the property market collapsing. It had collapsed by the time of the general election in 1992 but the incumbent government won a majority (albeit much reduced). All the usual suspects were bleating on about people losing their homes but when details were given it became apparent to all that the genuine stories of bad luck were accompanied by many more of people borrowing more than they could afford to repay. In those days that seemed to be considered the fault of the borrowers rather than the lenders. Interest rates soared because base rate reflected the state of the government's finances and the ERM farce had rather pissed in the soup in that regard. Nonetheless, the government got back in and, not least because bad debt had been written off rather than carried over, it took only a few years for the nation's finances to be on a very sound footing.

The whole mood seems to be different now. No doubt it is due in part to so much of life now being tied into government activity. Never before have so many been dependent on government for so much of their income - due in large part to the evil tax credits scheme. And never has government presented itself as having magical powers to solve all ills as it has over the last ten years or so. A problem arises and government appoints someone to deal with it and/or throws money at a quango to solve it. The problem usually doesn't go away and the level of amelioration provided in return for the taxpayers' buck is pitiful, but the problem is now in the hands of government. No other solution is affordable because no one has the money government has, and failure to solve the problem can only be explained by not enough tax having been thrown at it. And we are led to believe that more and more of life's problems are under the control of government because they have outlawed this, regulated that and have an army of day-glo jacketed wardens imposing fixed penalty notices for everything else. No solution exists other than government. Two consequences follow. First people believe government can control things it actually has no ability at all to control and, secondly, any problems that remain are placed firmly at the door of government whether or not it is realistic to do so.

Allow a collapse in the bogus wealth contained within the house price bubble and government runs a huge risk to its chance of surviving the next election. Or so it thinks. Maybe it is correct in that thought although I have my doubts. I talk to lots of people about these things, not just fellow pompous barristers but ordinary people doing ordinary jobs to support themselves and their families. The only people I hear supporting government involvement in everything are the "liberal" Islington chatterati who seem to have the view that only they are capable to supporting themselves and everyone else, all the little people, need a massive network of support and counselling in order to boil an egg. The people doing ordinary jobs just want to be taxed less and left alone to look after themselves. It does not, however, follow that they would vote for a governing party that withdrew all the nannying unless it also reduced their tax bills.

Against that background I can see why the current government will not step aside and allow property prices to fall to affordable levels as their predecessors did two decades ago. Ironically, the one thing they want to achieve is more economic activity in the country and a thriving property market helps achieve that because moving home always involves the purchase of new stuff for the new abode. A thriving property market is one in which there are many transactions and has nothing to do with the nominal value of each transaction. At the moment the complaint of those involved in the business of property is that few transactions are taking place. Were prices more realistic it is reasonable to infer that there would be more. The other side of the coin is that some would be lumbered with negative equity and would be unable to move or would even face insolvency. It happened before and things soon recovered. You cannot set economic policy by trying to protect everyone from ever making a loss on a deal - well, actually, you can but you would create something nearly as bad as the mess Gordon Brown left the country.

In this respect, as in many others, I despair at the lack of guts displayed by the current government. They know houses are grossly overpriced and that the result is the current generation of young adults being priced out of the market completely unless their families already have money. They also know that all sorts of businesses benefit from property transactions - builders, painters and decorators, carpet suppliers, white goods suppliers, garden centres and a host more; their trade is suppressed if the property market is suppressed. Although it would be a short-term political gamble, a government of principle would say it is the right thing to do and would explain why. My money would be on that position being accepted by far more floating voters than the number who reject it. In any event, and I know I am dreaming here, I wish that just once we had a government that looked to the interests of the country rather than to its own electoral prospects when deciding policy.


Tom Paine said...

I can't find the relevant numbers just now but the Economist occasionally tracks house prices vs average incomes (a better comparison than general inflation as capitalism's efficiencies have tended to make items in the RPI basket much cheaper over time - there is no "China price" for UK real estate). On that basis too, houses are still over-priced.

Another test is to consider the rent you would get if you let FB Towers. It should produce a good return on the capital value (with a considerable premium over the return on less liquid investments). If you can't command a rent that produces such a return, then the capital value is probably wrong. Reduce your assessment of that value until the return is correct and then - crudely - you are close to what it is "really" worth.

The Brits (and a few other nations, including the Chinese) have a dangerously emotional attitude to real estate, as if it was a more "solid" investment than others in the metaphorical as well as the literal sense. Yet, over the long-term, stock markets have consistently out-performed bricks and mortar. And bricks and mortar have to work damned hard (if viewed as investments) to cover the costs of paying for a typical mortgage. Have you ever calculated how many times more than the price you paid you have given to the bank or building society? Don't if you are of a nervous disposition.

Real estate guys don't consider owner-occupied housing as an investment at all. It's a misuse of the word to call it such (rather like Labour's use of the word in fact). In truth, it's just shelter; there to keep the rain off while you sleep. Those people who tell themselves it's part of their pension plan are fooling themselves. Their mistake is revealed by a simple question; they would be happy if the price of food went down, so why are they happy if the cost of shelter goes up? Perhaps worst of all, when they die, the taxman is going to take a further big chunk of the value they bought out of already taxed income geared up with long-term debt. Few houses would stack up as investments if that final loss is accounted for.

Real estate's big problem as an investment is evident from its name in most languages (immobilier, immobilien, nieruchomosci). You can't pick it up and run away with it. It's immovable, visible, vulnerable to being taxed. So if you feel yours is overvalued, by all means sell it. Buy something that works simply as shelter and spend the rest of the proceeds on stuff the taxman can't find when you die - like happy memories for yourself and your family.

Mark Wadsworth said...

Amen to all that!

My view is that the reason the 1973 - 1993 recession finally ended in 1993 was precisely because John Major allowed house prices to fall, it was better for nearly everybody (and only worse for a small minority). But did the electorate thank him? Nope (I certainly didn't at the time either).

And Labour and the Lib-Cons have learned from this - you only get to stay in government if house prices are going up, so that is what they are desperately trying to achieve (as foolish and damaging as that goal might be).

james c said...


I bought in 1994 and the numbers are similar. They can be broken down as follows.

1 Suppose that the 'fair value' of your house grew at 5% p.a.since 1993.

This is probably in line with average professional earnings for London.

Then the 'fair value' for your house would have grown by a factor of 2.3

2 Suppose also that property was at a 25% discount to 'fair value' when you bought and is now at a 25% premium.

This will have increased your returns by a factor of 1.67 (125/75)

The overall effect is to give a total increase of 2.3 * 1.67= 3.8

This is in line what has actually happened.

Local SEO said...

The entire suspects were bleating on about individuals trailing their homes but when facts were given it became obvious to all that the real stories of bad luck were accompanied by lots of people borrowing more than they could have enough money to repay. In those days that seemed to be careful the fault of the borrowers rather than the lenders.