The Brits are reflating their housing bubble too

Banks around the globe face the same perils as those in the United States. Housing bubbles inflated in many countries during the 00s, and the banks that provided the cheap debt find themselves dangerously exposed to losses. The only way lenders can save themselves is to reflate the housing bubbles so they can liquidate their bad loans and recover their capital. The same dynamic that prompted US officials to coordinate with lenders to reflate a housing bubble is at work overseas. What can California can learn from Britain’s housing bubbles?

I’ve been reporting over the last few months that house prices in Coastal California have reflated back to historic levels of affordability. We aren’t in a bubble yet, but if momentum from all-cash buyers keeps pushing prices higher, we will be in a bubble soon. Reaction bubbles from stimulative government policies is always a danger, and markets like Coastal California, which are notoriously volatile, are the most susceptible to these problems. If we do inflate another bubble — and we probably will — then families lose wealth, overextended borrowers sell in distress, and the economy sputters. Do we really want to do that again?

Our method of reflating the housing bubble has relied on cheap money and inventory restriction. The debt is not coming from toxic loan products like it did during the bubble, but mortgage interest rates have fallen from 6.5% to about 4.25% today to make cheap money available to help reflate the bubble. The Brits have taken it a step further. They’ve adopted a “Help to Buy” scheme to encourage the populace to take on excessive debt to reflate their bubble. At least we adopted Dodd-Frank to combat the bubble. They’ve taken the opposite approach, and they’re doing everything possible to repeat the mistakes of the past to save their banks.

Hair-of-Dog Policy Risks U.K. Housing Boom Repeat, Turner Says

By Sharon Chen & Eshe Nelson – Oct 27, 2013 5:01 PM PT

Britain risks repeating the debt-fueled binge that led to the credit crisis as the government relies on a hair-of-the-dog remedy for the economy, said former Financial Services Authority Chairman Adair Turner.

We had a fantastic party, we got a whacking great hangover, and we’ve decided that the best cure is a really stiff drink,” Turner said in an interview in Singapore on Oct. 25. “Which is the same all over again — get the housing market going again.

That is a very good analogy. We know cheap debt policies inflate housing bubbles, and we know these policies always end badly. Why would any sane government official endorse them?

Because these politicians are bought and paid for by lobbyists for lenders.

I’m amazed we had the wisdom and the political courage to pass Dodd-Frank. Of course, the two authors of that legislation retired after it was passed — which was probably why they were chosen to author it. It’s far easier for politicians to do the right thing when they aren’t facing reelection.

House prices in England and Wales rose 3.1 percent from a year earlier, the biggest gain since 2007, Hometrack Ltd. said today. The report adds to evidence that Chancellor of the Exchequer George Osborne’s Help to Buy program is stoking the property market.

Turner added his voice to critics including the opposition Labour Party and the International Monetary Fund who say the initiative, which cuts deposit requirements for people wanting to get onto the property ladder, could fuel another property bubble. In London, prices are soaring amid demand from cash-rich international buyers.

“We now have an incredibly frothy central London and wider London market and an increasingly buoyant across-the-economy market,” he said. “It’s that increasingly buoyant across-the-economy market that we have to watch carefully and make sure that we don’t allow it to go from reasonable buoyancy to excess.”

The chart for the areas in Great Britain parallels the bubble reflation here in California. The better areas have reflated quickly while the beaten down markets of the Inland Empire have recovered more slowly. This also means the Coastal California markets are ripe for another housing bubble.

Market observers in Great Britain are very worried about moving from recovery to excess, and they should be. How do you stop the stimulus from inflating prices in better markets while sustaining a recovery in the weaker ones? You don’t. For example, if we are to reflate the bubble in Riverside County, we will need to inflate a new bubble in Orange County. Central bankers have no way to selectively apply stimulus to specific markets. It’s one of the main criticisms of interest rate policies, and it’s also why lowering rates has inflated bubbles in nearly every asset class.

Despite government pledges to rebalance the economy away from consumer spending and the housing market, “we now seem to be having a recovery which is heavily focused on that favorite old British activity, which is another house price boom,” he said. “That’s not a sustainable, balanced economy.”

Unfortunately, the financial media and politicians in the US don’t have this basic wisdom. Here, we are treated to articles telling us how rising house prices are great for the economy because it stimulates consumer spending. Giving free money to Ponzis certainly does stimulate the economy, but how long can that work?

I don’t have the data to support it, but many market watchers there believe they’ve already crossed the threshold from recovery to new housing bubble.

U.K. housing boom shifting to bubble mode?

October 29, 2013, 12:29 PM

It has started to look brighter for the U.K. economy. And actually a lot brighter if you look at the housing market. So bright that analysts worry that a housing bubble is under way which could erode the steady, yet fragile recovery.

Data out on Tuesday did little to calm those fears. The Bank of England for example said mortgage approvals climbed to five-and-a-half-year high at 66,700 in September from 63,400 in August, marking a 5.2% rise month-on-month and a 34% year-on-year.

Additionally, data from Land Registry showed September house price rose 1.5% since August and 3.4% on the year. And on Monday Hometrack said prices in the U.K. climbed 3.1% on a yearly basis in October, accelerating from the 2.4% gain the previous month.

The good news is that monetary policy is having a powerful effect, dragging the economy out of the quagmire of the past few years. Cheap credit is providing the fuel for this consumer led recovery,” said Rob Wood, chief U.K. economist at Berenberg, in a note.

This sounds like the same nonsense justifying our endless quantitative easing, doesn’t it?

The bad news is that all the stimulus thrown at the housing market risks starting another dangerous boom-bust cycle. It is early days of course, as real house prices and transactions are still below their pre-crisis levels. But the key issue is not where prices are today, rather it is where they will be in a couple of years. Prices and activity are rising fast now,” he added.

That is the key issue. Today, we don’t have a housing bubble in Coastal California. But what about next year? Will 2014 see the inflation of a new local housing bubble? I certainly hope not, but it would give me something interesting to write about. Driven by data, I will be among those sounding an alarm if the market gets over exuberant.

The culprit behind the booming housing market is partly the government’s Help to Buy scheme that reduces mortgage deposits by guaranteeing part of the loan for lenders. The program was initially launched in April to encourage the sale of newly built homes to first-time buyers and was updated in the fall to include a mortgage guarantee to the lender and to include already existing houses. In essence, the scheme makes it easier for home buyers to afford more expensive housing, pushing up the property prices.

This is a terrible public policy. The only reason such a policy would ever be implemented is because the banking overlords made it happen. Such a policy ostensibly benefits buyers, but in reality, it only inflates house prices and benefits the banks. Everyone else gets saddled with oversized mortgages so they can pay off the bad loans from the previous housing bubble. Sound familiar?

“We expect house prices to rise 10% year-on-year next year and at the current run rate mortgage approvals could hit 75,000 by the end of the year. That would be 25% higher than the B)E’s latest forecast, from August. Housing is running way ahead of their expectations. The measures that selectively boost the housing market, like the Help to Buy scheme, should be scrapped,” Wood said.

But it’s not just domestic demand that beefs up the home prices. If you look at the variances within different parts of the U.K., London is by far the most popular region and the reason behind that can partly be found abroad. In October, asking prices in the capital soared by 10%, partly due to a frenzy of activity in prime locations, as wealthy overseas buyers look for safe-haven investments, Rightmove said last week. Indeed, 70% of all London newbuilds are sold to buyers outside the U.K.

We have some of this dumb foreign money flowing into assets they don’t understand here in the US too. It tends to concentrate in the most prime areas, but we also see it in smaller doses in places like Irvine. It reminds me of one of my favorite posts from Professor Piggington’s site, The Dumb Money:

One argument I hear a lot is that foreign demand for local real estate has grown substantially in recent years, and that such foreign demand will be supportive of prices in the future.

Unfortunately, this argument puts the cart squarely in front of the horse. Investors from other countries are well known to be the very last participants to arrive at the scene of a financial bubble. They are the last to hear about all the riches to be made, the last to buy in, and the last to realize that the party is over.

The chart to the right provides an example from the history of bubbles past. The blue line represents the price of the Nasdaq Composite Index during its late-1990s flight to the heavens, along with the very beginning of its eventual journey back to earth. The red line denotes the dollar amount of U.S. stock purchases made by foreign investors.

It can easily be seen that foreign buyers chased the U.S. tech stock bubble all the way to the tippy top, and that they lagged prices the entire way. The final onslaught of foreign cash did not even hit our shores until after the Nasdaq had begun to decline from its final peak.

Far from being a positive fundamental, a sudden excess of foreign participation in an asset market is indicative of ill-informed speculative money at work. When the foreigners really start piling on, it’s always a good sign that the end of the bubble is nigh.

The Brits are reflating their housing bubble using both Central Bank interest rate stimulus and direct assistance from government programs. We aren’t quite as foolish here in the US, but we are dealing with the same problems of a crippled banking system that needs house prices to be higher. Hopefully, we won’t implement the same disastrous policies here.

With rising house prices in Coastal California hearing bubble levels, it’s a good time to reform the HMID and lower conforming loan limits. That should take the momentum of of these markets which clearly don’t need additional stimulus.

[raw_html_snippet id=”newsletter”]

[idx-listing mlsnumber=”OC13221351″]

314 South LA ESPERANZA San Clemente, CA 92672

$750,000 …….. Asking Price
$1,637,153 ………. Purchase Price
8/12/2010 ………. Purchase Date

($887,153) ………. Gross Gain (Loss)
($60,000) ………… Commissions and Costs at 8%
($947,153) ………. Net Gain (Loss)
-54.2% ………. Gross Percent Change
-57.9% ………. Net Percent Change
-23.8% ………… Annual Appreciation

Cost of Home Ownership
$750,000 …….. Asking Price
$150,000 ………… 20% Down Conventional
4.15% …………. Mortgage Interest Rate
30 ……………… Number of Years
$600,000 …….. Mortgage
$144,111 ………. Income Requirement

$2,917 ………… Monthly Mortgage Payment
$650 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$156 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$3,723 ………. Monthly Cash Outlays

($672) ………. Tax Savings
($842) ………. Principal Amortization
$221 ………….. Opportunity Cost of Down Payment
$208 ………….. Maintenance and Replacement Reserves
$2,637 ………. Monthly Cost of Ownership

Cash Acquisition Demands
$9,000 ………… Furnishing and Move-In Costs at 1% + $1,500
$9,000 ………… Closing Costs at 1% + $1,500
$6,000 ………… Interest Points at 1%
$150,000 ………… Down Payment
$174,000 ………. Total Cash Costs
$40,400 ………. Emergency Cash Reserves
$214,400 ………. Total Savings Needed
[raw_html_snippet id=”property”]