It's A Mad, Mad, Mad, Mad World
Copyright 2004 Dow Jones Newswires
A DOW JONES NEWSWIRES COLUMN
May 7, 2004, Friday
Allen Mattich
Has the British public gone mad? Are U.K. housebuyers doing the collective St. Vitus's Dance of the financially insane? Despite warnings from the International Monetary Fund about overpriced U.K. property, stagnating incomes and fresh memories of a previous real estate crash, the U.K. market is hot. Are buyers crazy or is there some logic to their behavior?
Price increases in the U.K. housing market could well be a rational - or, to be more precise, a near-rational bubble. Of course, at first blush, that's not what the numbers suggest. The Halifax house price survey shows U.K. house prices rising at a 19% annual clip this year. That follows a 15% increase in 2003, 26% in 2002 and 12% in 2001. Average U.K. house prices have doubled to GBP154,000 since the start of 1999. That would make sense if wage inflation were rocketing as well. Or if housing had been particularly cheap back in 1999. Or if debt levels had been low. But the answer to all three is no, no and no. Average earnings grew at 3%-4% a year over the past half-decade. Add in tax increases, and disposable income barely scraped higher. And houses weren't particularly cheap in 1999. Back then, the ratio of house price to disposable income was around 3.5 times, broadly the historical average. Now it's at a record 5.3 times, according to the Halifax - and higher still in London, where prices are a third more than in the rest of the country, a gap that's only partly offset by higher incomes. Personal debt levels have gone from bad to catastrophic. Average credit-card debt is up nearly 60% to GBP1,140 per person. Overall personal debt as a percentage of disposable income has jumped to 130% from under 100% in 1999.
True, interest repayments as a percentage of household income is only 8%, down from a peak of 15% during the carnage of the previous house bubble, and interest rates would have to rise to 7% in order to hit that 1990 peak, according to HSBC economist John Butler. But they are already on the move - up to 4.25% Thursday from 3.50% in November. Bank of England policymakers have indicated a rate of 5.50% over the coming year. If they do rise that far, interest costs on the average-sized variable rate mortgage - around GBP80,000 - will have jumped between a fifth on normal repayment mortgages to a third on interest-only mortgages.
Concurrently, if rising interest rates cause house price inflation to slow down - as the Bank of England hopes - homeowners will get squeezed in another direction. Many have been cashing in on these price rises to finance the consumption of automobiles, fridges and expensive holidays. Mortgage equity withdrawal gave householders an 8.3% boost to their disposable incomes during the fourth quarter of 2003. If house prices stop rising, so does that nice bit of cash. And yet, despite all the evidence, maybe housebuyers aren't so dumb.
Anyone fearful of the house-price bubble might have exited the market two or three years ago, missing out on 70% worth of price gains. A rational bubble is one where investors expect further price rises in the future, never mind the present levels, believing they can get out in time, or ride the downdraft if they can't. It is known as the greater fool theory in the equity market, says James Montier, a strategist at Dresdner Kleinwort Wasserstein.
Homeowners who bought a year or more ahead of the last housing crash in 1990 would have ridden out the downturn flat at worst, says Gavin Cameron an Oxford University don and specialist in the U.K. housing market. That's because even though prices crashed 30% in London and 10% across the whole of the U.K. from peak to trough, they had gone up by more than 30% in the previous 12 months.
And there is another saving grace for U.K. homebuyers, if inflation spikes up again. Many will remember how well their parents fared during the 1970s when inflation rates of 25% knocked the value of their debts to a pittance, making borrowers much better off at the expense of savers.
You can email me at Gavin.Cameron@economics.ox.ac.uk
Last updated: 8 May 2004.
