Why falling house prices matter

Mar 05, 2010

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Every time I write about house prices, people ask why it matters if prices fall. After all, they're far too high. So the lower they go and the faster they hit bottom the better – right? Yes and no.

There is no fighting with mean reversion and, bar a few speculators, we all want housing to be affordable. The problem is not with the end result of house price falls – it's in what happens along the way.

In no other country are house prices so closely linked to economic performance. An OECD study a few years ago showed that, between 1971 and 2002, every 1% change in the value of British housing stock led to a 0.7% change in consumer spending. A strong economy creates higher house prices via rising incomes and falling unemployment. But in Britain, higher house prices themselves make the economy look even stronger.

In 2003, we felt so confident in our housing wealth that we took equity out of our homes to the tune of around 9% of our total disposable income. Even in 2007 we were still taking out 6% or so. Then we spent it.

Mortgage equity withdrawal (MEW) was a key driver of economic growth during the Blair years. Rising house prices also fed the wealth effect. If you thought you'd just made £50,000 on your house, you'd happily run up more credit-card debt than you could repay from income alone.

But all this works the other way around too. MEW is now running at the equivalent of -2% of disposable income. People aren't borrowing money to spend. Instead, they're saving money and repaying what they can off their mortgages. And as the economy deteriorates and prospects for house prices worsen, the wealth effect is turning negative too.

Much of the stimulus that caused our feeble 0.3% rise in GDP in the last quarter of 2009 has been withdrawn. The stamp duty holiday is over, VAT is back up, hiring freezes are in place – and everyone knows there is more to come. Taxes will rise in April and again when our new government arrives. Public-sector cuts will have to be savage so unemployment will rise. All this will make us feel miserable and less keen to borrow and spend. It's as nasty a cycle on the way down as it was exciting on the way up.

When the financial crisis first began, pundits (myself included) avoided answering the question of what we would do if we were in charge by telling the old joke about how we "wouldn't start ­from here", and desperately hoping our time was up before the polite laughter ended. The joke is more apt than ever when it comes to housing. We all want to end up in the right place – somewhere where property is correctly priced relative to the past – but we really wish we weren't starting from here. Affordable houses are good. Falling house prices are bad.

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  • 1. Andrew Beckett

    (04 March 2010, 06:43PM)  Complain about this comment

    This article raises a good point. It seems the only way to achieve lower house prices, without suffering the damaging effects of falling house prices, is to inflate our way out of the problem.

    If over the next few years CPI rises whilst house prices remain stagnant then house prices will fall in real terms. Although the effect would be the same as if house prices fell in a low inflation environment, the overall the impact on our property obsessed economy would hopefully be less severe.

  • 2. Paul

    (05 March 2010, 01:23PM)  Complain about this comment

    Rising inflation will cause a run on the bond Market increasing bond rates causing deeper govt cuts and higher mortgage rates all of which will drive down house prices. There is no way out for prices except down.

  • 3. JAW

    (05 March 2010, 03:19PM)  Complain about this comment

    Elation and depression, boom and bust conditions, in the property market will continue until we eliminate the free for all speculation that is at the heart of the present system. The houses are there, generally have been paid for by the time the occupants depart their worldly sojourn, so why do we make each successive generation pay for them all over again? We need to devise a system that transfers housing from one generation to the next without charge, without life-crippling, economy-inhibiting, cost. Transference from one generation to the next should be completely free. Measures which could move in this direction: No one can own a property which they do not use. Building land price to be fixed at maximum twice the agricultural price. As in France, government to make available a building plot, at low cost, for everyone once in their life, all dependent upon UK population stabilization with a one in one out policy.

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