Soothsayer predicts property bust

It's the relationship between the perceived worth of a most households largest asset - property, and the amount of household expenditure. Both are subject to inflation.

Inflation at 20% House Price inflation at 20%

Year 1 Year 2 ------ ------

House Price 150,000 180,000 Mortgage 100,000 100,000 House Equity 50,000 80,000

Household Expenditure 15,000 18,000

In nominal terms over the year as far as the average house owner is concerned, their living costs have increased by £3,000 (20% inflation,) and their house price has increased by £30,000 (20% HPI). In real terms neither their expenditure or house price has increased. I'd say that the average householder would be happy with the nominal returns rather than disappointed with the real return, and, as such, the nominal returns are far more likely to influence household consumption and it's effects upon the wider economy.

Daytona

All other things being equal, their equity has gone up 33% in real terms. Surely that's the meat of the story, not that it's gone up

60% in nominal terms. And don't let's forget that their savings, if any, will have gone down in real terms.

Yes, but unless they intend moving downmarket, or need to borrow more money through a remortgage, their increased equity hasn't actually benefitted them at all. If they intend to move upmarket then high house price inflation is very bad news.

I would guess there are more home owners whose next move is going to upmarket rather than downmarket, so more home owners should see house price inflation as a negative thing rather than a positive thing. Yet it seems people abandon all logic when it comes to house prices...

"Andy Pandy" wrote in message news:9X7gc.31300$ snipped-for-privacy@stones.force.net...

Sad, but true. I have had to point this out to a few clients (and family members). Some have spotted it themselves - e.g. when he told me that the house he is thinking about buying was 50k cheaper last year (and his has only gone up by 30k).

On the contrary. High inflation has eroded the real-terms value of their 100k debt, so the benefit is that they are paying less interest in real terms. But remember, this example does not relate to the market as it is at present, because it supposes general inflation to be high, but house price inflation to be the same, i.e. zero in real terms.

What you say is true when *real-terms* house price inflation is high, as it is (has been) just now.

Yes, so the benefit is purely because of general inflation, house price inflation is irrelavent.

No, I don't believe the average homeowner is influenced, or even understands real returns. They have a large nominal increase on an expensive asset and relative to this, a small nominal increase on the smaller amount of their expenditure. The nominal increase on their house is ten times that of the increase in their expenditure, so I reckon they're happy, even though there's been a zero real return.

Daytona

That's about the size of it. Take my neighbours, who had a more understanding bank manager than I did. In 1988, we both bought adjoining and similar 1-bedroom flats for 85,000. By the end of 1988 mine was valued at

100,000. By 1992 they had 1 kid and a second on the way so they absolutely *had* to move. the trouble was, the flat was by then worth only 59,000 (this was in west London), and their mortgage was 80,000.

They accepted an offer of 59,000 and then got a mortgage of 155,000 on a flat they were paying 130,000 for. They used 25,000 to pay off the loss they made on the 1-bedder and the remaining 130,000 to pay for the new one. They thus had a 119% mortgage. It's now worth about 400,000, I guess.

My mortgage was 72,000 and my flat was slightly bigger than theirs, and hence probably worth a bit more. Nonetheless, at the time they sold, mine was probably worth not more than 65,000. So I had negative equity of

7,000. Selling would have incurred estate agents' fees, legal fees, and removal costs of about 2,000. Not being a company director, like he was, I'd have needed a 10% deposit to move, so if *I'd* tried to buy a 130,000 flat, I'd have needed 22,000 in cash to do it. This was about 23,000 more than I actually had at the time.

Their old flat is now up for grabs at 220,000. Mine is being offered for rent at 240 a week which suggests a price of about 240,000. When the market crashes, I guess these places will be worth about 140,000, which suggests that whoever buys it now will have a problem which approaches being

10 times worse than I did 12 years ago.

In article , The Blue Max writes

That seems a bit extreme. But I hope you are right, as I'll be first in the queue to buy. Rents are unlikely to fall that much, so they would cover any mortgage. Values will then take 5 to 7 years to recover their old levels, if past patterns hold, and that would just about sew up my pension.

For some reason my subconsciuos always reads the subject as "Smoothsayer ..."

I'm guessing that a 40% crash is about right for 1-bedders in areas which border nice ones but are in fact quite shitty. Last time around 1-bedders in Little Venice went to 130,000, then 1-bedders in Maida Vale went to

100,000, so 85,000 for my 1 bed on the Kilburn edge of Maida Vale looked pretty good.

Of course what then happens is that as the market gets brittle people think,

85k for somewhere in Kilburn when 100k gets me into Maida Vale? No thanks....and so the crappy areas collapse first and fastest. There's no reason to buy there other than nearness to somewhere nicer, and when the somewhere nicer cools by 10% the grotty edges fall 40%.

A fall of 40% from 220,000 would mean a price of 132,000. I agree this looks like an opportunity if it happens, because there are enough people able to pay more for it that you can feel sure of being able to sell. At

220,000 though, well, how many 1st-time single buyers on 60,000 a year with a 10,000 deposit are there? I think we might be running out.

In message , John Smith writes

No. It meant they had some extra dosh to settle the shortfall on their previous house.

Which they didnt.

No, cos it didnt happen the way you think.

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I think we're headed towards an Austrian analysis of the current problem. What happens when people used to seeing a high inflation and interest rate environment then encounter a low inflation and interest rate environment is what Mises calls "money illusion". Basically people see lower interest rates as costing them less and therefore become more willing to undertake more debt. What they don't viscerally understand is that in a low inflation environment, they'll effectively be paying close to the same real value for longer rather than seeing their debt eroded by high inflation. Only experience will teach this to those who can't reason their way to it, and if the credit bubble lasts that long, it'll provide a brake for it.

The Austrian view: it's unpopular. It's out of fashion. It's right.

FoFP

Have you looked at past credit bubbles? Tulip bulbs never recovered their peak value or anything like it. On the previous bubble, the Dow Jones Index recovered its 1929 peak value in real terms in 1992.

If patterns hold, what we'll see is what Prof Kindleberger called revulsion. People will be unlikely to borrow, and lenders, having been burned, will be much less keen to make loans. The pattern is likely to hold, though degenerate gradally, across two generations. The third will provide fodder for the next bubble.

Odds are that houses won't be the Magic Token next time though.

FoFP

I've been trying to think about this for a while now and I haven't come up with many options for the next token - the best I could think of was some energy-related instrument such as options on power station output (I think Enron may have put paid to that one), or CO2 credits.

Neil

Thinking of getting in early?

Looking at timings. Let's call one K-cycle 70 years. Guess that this bubble will burst next year, with the bottom say around 2008. That puts the reflation peak around 2043. The magic token will undoubtedly have been bought by some in the meantime but popular buying on credit should begin around then with the manic phase starting after an inflationary boom/bust say around 2060.

So what technologies are likely to appear in the next four decades which will slowly garner mass interest? Biotech? Nanotech? AI software?

An interesting scenario of course would be that as AI develops and makes several areas of commerce and industry more productive, the next bubble might well be the first in which the Magic Tokens are themselves active participants: AI's investing in AI.

What's clear is that people are generally more easily persuaded to part with their money, and crucially, borrow even more, when confronted with something new, and a more or less plausible story:

1. Tulips are imported from Turkey. Not only does all the nobility want them, but ordinary people will too! Get the bulbs of popular tulips, and learn how to bud them for giant profits! Get in now, before it's too late.
2. The South Seas will bring vast riches from unexplored lands. Buy now. These shares can only rise in value. Loans at reasonable rates available to good customers. Investors include Cabinet members and the head of the Bank. It's a new era for finance!
3. Canals. There's never been a better way to move goods. Become a canal owner today while stocks are still cheap.
4. Railroads. There's never been a better way to move goods. Soon the whole world will be travelling by rail. Buy the future today. Loans at very reasonable rates.
5. Stocks. Its a new era. Busts have been abolished by the application of scientific principles. These investments in the new technologies of radio, electricity and the automobile can't fail. Everyone will travel by car and have a radio. Pay only ten percent down and become rich now!
6. Japanese property: credit now available to everyone. Tokyo will soon be worth more than the whole US combined. Borrow now and make your fortune. Use your share gains as a deposit. Houses and shares can only go higher.
7. UK houses. You used to need money, but instant credit now available to all. It's a new economic paradigm. Six times earnings loaned even before you lie about them and don't worry about a deposit. We'll even throw in cash to help you move. In the future, everyone will live in a house! Buy now, before prices rise even further...

FoFP

How could I? We won't know until it's too late!

Seems to work as a description for 1-6 but

available

Is a house in the UK new technology? I would suggest it's the opposite - people turning away from 'investments', especially new technology, and turning towards property 'cos it's 'safe as houses'.

That's not to say that we won't get sucked into the next great technology boom. According to ITER, the first commercial fusion reactor could go online around 2050 - maybe that's newtech enough, and it fits with your timescale.

Neil

That's just Greenspan and his gang. There are some folks who believe that bubbles can be spotted during the bubble.

Of course spotting the asset which will feature in a bubble before the bubble starts is a lot harder.

[Major credit bubble historical list]

No. The new technologies are fiat money (not utterly new, but new on this global scale) and widespread credit available to pretty much everyone. The closest bubbles to this would be the Mississippi and South Seas Bubbles, but they didn't get close to current participation rates, nor in terms of debt relative to GDP.

I agree that there's been asset rotation from stocks to houses. However there were few people buying stocks on credit compared to the numbers buying houses that way. There was a stocks bubble too, but in the anglo-saxon countries, houses are the primary asset involved in the more major credit bubble. In the inflationary boom and bust in the 70's and

80's, stocks were involved, but houses were much more clearly the primary asset. You only need to look at the relative economic effects of the stocks crash in 1987 and the housing crash in 1989-93. Even by the mid 1980's, houses were marked here as the primary asset.

Oil's running out. In the future everyone will need energy. Where do I sign?

I still prefer the idea of a bubble with AI's investing in AI tech. Someday I need to write a story. Maybe I'll call it "The Way We'll Live Then".

FoFP

Neither did classic cars. But people need neither to live. They do need homes and they just aren't producing enough to match growing demand.

Lenders have short memories. They were starting to ramp mortgages in

1998 when repossessions were still a major problem.

When has property ever cycled over such long periods?

Glad you can forecast forward that far. Most have trouble predicting the next five years.