What California can learn from Britain’s housing bubbles
California and Great Britain have much in common with regards to its real estate. California has witnessed three catastrophic bubbles over the last forty years as has Great Britain. Each bubble had different causes, but the timing was similar. California has strict land-use controls which creates artificial shortages of housing, and so does Great Britain. California’s economy has become dependent upon rampant HELOC abuse to fuel unsustainable booms and heart-wrenching busts. Great Britain endures the same real estate borrowing cycles of boom and bust. In this latest bust, lenders have not foreclosed on California’s mid- to high-end real estate keeping prices relatively unaffordable in prime areas. This has caused sales volumes to plummet due to the absense of a move-up market. Great Britain’s bankers dance to the same amend-extend-pretend policy, and their housing market is frozen.
The one key difference between California and Great Britain is that some in Great Britain see the folly in what they do and are proposing methods to end it. Here in California, we sit and wait for the next house price party.
Three boom-busts in 40 years are testimony to the failure of trying to control the housing market through interest rates alone
Easter is traditionally when the housing market comes out of hibernation – and if ever there were a time when it might be imagined activity would be buoyant, it would be this year. The Bank of England has pegged the official short-term interest rate at 0.5% for more than three years and is now part-way through a third round of asset purchases, which will in total boost the money supply by £325bn.
England has lowered its interest rates and printed money just as we have. It is having the same negligible effect on their housing market as it is having on ours.
For the past four decades, cheap credit has been the catalyst for property booms. That was the case in the early 1970s, when Threadneedle Street abandoned direct controls on lending and then watched helplessly as prices rose by 50% in 1973.
The late 1970s bubble in the United States was caused by lenders abandoning debt-to-income standards because they anticipated their borrowers would continue to receive 10%+ raises in wages every year due to high inflation.
A second bubble followed 15 years later as a result of a toxic mix of financial deregulation, cuts in interest rates and the pre-announced abolition of double mortgage relief.
The late 1980s bubble was caused by an expanding economy, a relaxation of lending standards, higher allowable DTI’s, interest-only loans, and the left-over irrational exuberance from the 1970s bubble. It was a baby version of the bubble of the 00s when the same issues where taken to a much greater extreme.
In the years leading up to the financial crisis of 2007, borrowers could secure loans at high multiples of their income with few questions asked.
Great Britain’s lenders completely abandoned lending standards just as we did. Unregulated securitization allowed money to flow into housing just like here in the United States. Ben Bernanke cites bubbles in other countries as evidence the federal reserve did not cause the US housing bubble. In reality, central bankers all over the world were equally as misguided as the federal reserve in the United States, and they all deserve blame for their failure to regulate toxic derivatives.
There will, however, be no housing boom this year. Transactions are running at half the level seen in the pre-crash period, and the pick-up in activity at the end of 2011 and in the early months of 2012 was linked to the end of special stamp duty arrangements for first-time buyers.
Great Britain is experiencing the same lack of real estate sales volume we are witnessing here in California, and it is for the same reasons: prices are too high. The first-time bomebuyer market is active in both places, and Great Britain tried a tax credit just as we did. The move-up market is dead in both places due to a lack of equity or savings.
The property market has been unusually quiet for the last couple of years, with a shortage of buyers, sellers sitting tight, and prices barely moving up or down.
This trend looks likely to continue. There is no real evidence that the Bank’s quantitative easing programme is leading to mortgages becoming more freely available, and potential first-time buyers are struggling to raise the deposits demanded by lenders before they will grant a loan. Prices need to come down to make residential property more affordable but that only tends to happen during periods of sharply rising unemployment, negative equity and aggressive foreclosure. That was the case in Britain during the early 1990s, and has been the reason for the big falls in house prices seen in the United States since 2007, but does not apply to the current UK property market.
On the contrary, banks and building societies have adopted a lenient approach to those unfortunate borrowers in arrears with their mortgage payments and, as a result, repossessions are low. There are few forced sellers, so little pressure to cut prices to levels that would make them more affordable to first-time buyers.
The amend-extend-pretend policy is having the same effect in Great Britain as it is having in California. The market is an illusion, and sales volumes are very low because people simple can’t afford the prices being asked. Lenders believe buyers will somehow be able to raise their offers, but that isn’t going to happen. For starters, lenders themselves aren’t providing the loans — and they shouldn’t — because borrowers can’t handle the payments. The only way the market improves is if the low end bottoms then moves higher to create move-up equity necessary to buy properties at the next rung of the housing ladder. That will take many years after the bottom, and we aren’t at the bottom yet.
Anybody thinking of buying a home can take their time, because prices will, at best, move sideways this year and there is currently not the remotest chance of the Bank’s monetary policy committee raising interest rates.
The same is true here as well.
All of which means this is the perfect time to take stock and to suggest reforms, should they be deemed necessary.
This is were Great Britain and California differ. Nobody here is talking about reform. The problem hasn’t been properly identified here. Many still suffer the delusion that prices are depressed from their appropriately high peak values rather than just now reaching stability and normalcy after an enormous artificial housing bubble. Our policies are all geared toward inflating prices rather than achieving stability at lower levels. Since the problem has been incorrectly defined, all policy actions are wrongheaded and counterproductive.
It would tax even the most eloquent of advocates to make the case that 40 years of house-price inflation has been beneficial to the UK. It has certainly been good for the current crop of owner-occupiers in their 40s, 50s and 60s but not for the next generation, who are frozen out of the market by high prices. Since the early 1970s, UK house prices have tripled in real (inflation-adjusted) terms, with the biggest gainers those living in the south-east.
The baby boomers are funding their retirements on the backs of their children. The children of the boomers are being forced to pay ridiculous prices for homes and fund the boomers’ social security. The children of the boomers won’t get either subsidy from the following generation.
The advocates of inflated house prices, many of which are in the federal reserve, believe mortgage equity withdrawal is positive for the economy. Rather than recognizing this as an unsustainable stimulus rife with moral hazard, policymakers encourage it as a benefit to our economy. Given the carnage of the fallout from the housing bubble, it is both shocking and dismaying that the federal reserve is still so clueless.
Germany, courtesy of ultra-low interest rates, has seen house prices rise by 10% over the past two years, but this is the exception, not the rule. The cost of residential property has barely budged in real terms in the past 40 years and, as a result, the economy has been better balanced and has been less prone to the sort of debilitating boom-busts seen in the UK, which have caused extensive collateral damage to manufacturing.
Britain’s labour market mobility has also been impaired by house-price inflation, because it has either encouraged or forced people to stay put. Owner-occupiers in the south fear that if they move to another part of the country, they will never be able to return. Those tempted to come south to look for jobs cannot do so because homes are so expensive.
The United States is facing the same problems of worker immobility, and for years many employers in California have struggled to get employees due to the ridiculous cost of ownership here.
History suggests that the current torpor will not last forever. There was a long period of stability between the end of the second world war and the start of the 1970s, but this was marked by an expansion of the housing supply and by much tighter credit conditions.
Yet, keeping demand and supply in balance is not easy. Britons are culturally wedded to the idea of owning bricks and mortar and live on a small, crowded island where the planning laws are tight and the tax treatment of property generous. The population is rising and during the recession house building fell to its lowest level since the early 1920s.
Sounds like California, doesn’t it?
The City is confident there will not be an increase in the cost of borrowing from the Bank of England this year, and some analysts think there may not be one in 2013 either. Most of the conditions are already in place for the next boom, although the fact that property is still expensive and lenders are still hunkered down means it may not happen for some while.
Preventing a future housing bubble is, rightly, a priority for the Bank, and it has been mulling over how to prevent one. Three boom-busts in 40 years are testimony to the abject failure of trying to control the property market through interest rates alone, and – not before time – there is now an acceptance that tougher curbs on credit will be required.
This is where the California and Great Britain differ. They recognize they have a problem, and they want to do something about it. We haven’t had the same epiphany.
The Bank’s financial policy committee has been looking at two possible instruments – loan to value ratios and loan to income ratios – that it might deploy if it thought the housing market was getting too hot. The first would prevent lenders from offering loans above a certain percentage of the property’s value; the second would limit the extension of credit to a certain multiple of a borrower’s income.
Neither policy would be completely effective. The best solution is to limit mortgage qualifications to 30-year fixed-rate mortgages with debt-to-income ratios less than 31%. If regulators don’t limit qualification to amortizing mortgages, the Option ARM may come back, and we all know what a disaster that was. Debt-to-income ratios over 31% are prone to very high default rates. Only in rising markets are the resulting loss severities manageable.
Make no mistake, these would be powerful weapons and even the threat that they might be deployed would have an impact. It would probably only require Sir Mervyn King to make a speech in which he said that the Bank was mulling the possibility of imposing a loan to value ratio of, say, 80% on all new mortgages for the market to be killed stone dead. Activity would dry up and prices would fall.
The Bank has two big concerns about the use of these tools: that their use might damage the economy and that they may prevent people buying their own home. But the benefits of long-term stability outweigh the sugar rush from a housing boom, while the best way to encourage owner-occupation is to reduce prices. There is an opportunity to wean the UK off its addiction with house-price inflation and it should not be squandered.
I am certainly in the minority in recognizing the damage from unsustainable borrowing. Federal reserve policymakers endorse and encourage our folly, and until that changes we have no hope of a stable housing market and a better tomorrow.
Thanks for the deed, now about that $1,397,553…
Some borrowers don’t stay and squat after they quit paying. Some deed the house back to the bank and hope the bank forgets about the debt. The owner of today’s featured property extracted over $500,000 before leaving the bank holding the bag.
- The property was purchased on 2/16/2000 for $612,000. The owner used a $489,437 first mortgage and a $122,563 down payment.
- On 11/16/2000, she withdrew $85,000 of her down payment with a stand-alone second.
- On 9/25/2002 she needed another $80,000 so she got a HELOC.
- On 1/30/2004 she refinanced with a $650,000 first mortgage.
- On 7/7/2006 she made a mistake which cost her the house. She refinanced with a $1,165,000 first mortgage.
- Total mortgage equity withdrawal was $675,563.
- She squatted for about two years.
She was fine up through the last refinance. I wonder what she needed the last $500,000 for?