"How much could prices fall? Calverley says that, if it is just a return to average levels, the fall could be 20-35 per cent. If it is a return to previous lows in relation to prevailing rents and wages, the fall could be 50 per cent....."
The chief economist at American Express Bank gave his views on the UK house price bubble at the the Royal Bank of Scotland's annual economics lecture ....................
Friday March 24, 03:20 AM
AFTER Bill Jamieson reported on Tuesday how the Edinburgh property market is still merrily booming, and Gordon Brown gave a boost to property investment on Wednesday, along came a man with a big bucket of cold water to throw on Bill, Gordon, and all you homeowners.
John Calverley, chief economist and strategist at American Express Bank, gave the RBS (LSE: RBS.L - news) annual economics lecture. He is an expert on "bubbles" - when the price of something inflates way above realistic levels and then bursts, leaving people who bought in at the wrong time a lot poorer.
His book - Bubbles and How to Survive Them (Nicholas Brealey Publishing, Boston) - is much discussed. And as his lecture topic - Bubbles and Busts: will the world housing boom end in tears? - zooms in on a matter of great personal interest to every householder, there was a big turnout.
What he had to say can be summed up in two questions and their answers. Is there a house price bubble? His answer - yes. Is it going to burst? His answer again - yes. At this point, people began to concentrate very hard, especially when he posed the obvious follow-up question: when is it going to burst? Rather disappointingly, he confessed that he did not know. Nonetheless, he is 90 per cent certain that the bust is coming.
So what's his argument? He points out that house prices have inflated across most of the developed world. Since 1997, British prices have gone up by 167 per cent, topped only by California with a 191 per cent increase. The only places where prices have fallen are Germany (down 1 per cent) Japan (-30 per cent) and Hong Kong (-45 per cent). He also notes that prices have risen much faster than incomes and rents, so much so that buying in Britain (including all taxes and maintenance costs) is now 36 per cent more expensive than renting.
Calverley concedes that there are reasons for prices going up. Social trends such as higher divorce rates means that more houses are needed for the same number of people. Mortgages are much more available and easier to get than in the past, and lower real and nominal interest rates mean they are a lot cheaper.
Yet he still thinks it is a bubble. The problem here is that, much though academics have tried, nobody has come up with a convincing way of defining, and hence predicting, a bubble. But he does think that you can draw up a list of bubble characteristics which you can then use to make a subjective judgment.
These are: high expectations of continued price growth; overvaluation compared with historical averages; being several years into an economic upswing; a new element in the market such as stable low interest rates; a change in attitudes such as regarding your home's value as your pension; new investors and entrepreneurs, continuing media and popular interest; a big rise in lending and new lenders; and a low rate of consumer price inflation. House prices check all those boxes, so there must be a bubble, Calverley concludes.
Moreover, he also contends that one country's housing market is increasingly affected by other countries' house prices. Residential property companies operate across national borders as do many individual buyers as they seek a second home that will not just be nice for holidays, but also be an investment. That implies that a house price bust in America will mean a bust here.
How much could prices fall? Calverley says that, if it is just a return to average levels, the fall could be 20-35 per cent. If it is a return to previous lows in relation to prevailing rents and wages, the fall could be 50 per cent.
Calverley did offer a little relief to his Scottish audience, noting that Scottish price swings have been much less wild than in the English market. But, he warned gloomily, Scots are liable to be hit at the same time as the rest of Britain.
That still leaves open the question of why and when a price bust may happen. The likeliest causes are an economic recession and a marked rise in interest rates. Neither of these things seem likely to happen. Barring the unexpected, such as a world flu pandemic, the world economic outlook is pretty good. So Calverley thinks we still have a year to go, maybe more.
Talking to people after this Corporal Fraser-esque lecture of gloom, there was a great deal of scepticism. Houses are necessities, unlike tulips or dot.com stocks, one listener told me, so there will always be a demand for them. And since the planning system makes increasing the supply of houses extremely slow, there won't be a sudden bust. That's true, but we have had slow punctures in 1972-77 and 1989-95 when British house prices fell relative to earnings, though the absolute fall in prices was less and shorter. Calverley also notes that a price recovery may take even longer, perhaps 15-20 years.
Before you rush to the estate agents, there are other equally eminent economists who disagree with Calverley. Roger Bootle, a much cited authority, spent most of 2005 forecasting a 20 per cent house price fall, then recanted, saying that cheap loans and the peculiarities of the British market meant that he had been wrong.
What really matters is people's ability to pay the cost of borrowing. Calverley's most worrying chart showed British house prices in relation to earnings since 1960. It shows bubbles in 1972, 1979, 1988 and now. Alarmingly, this bubble is the biggest of the lot, reaching 5.5 times average earnings whereas previous bubbles have only reached 4.5 times earnings. Yet on an ability to pay measure, it is much less troubling. Recent figures from the Alliance and Leicester (LSE: AL.L - news) bank says that the current average cost of debt servicing is 13.8 per cent of household income, half the level in 1990 when interest rates averaged 14.6 per cent and debt servicing cost 25.7 per cent of income. Interest rates have a way to go before this cost is really pushed up. A slowdown seems much more likely than a crash.